Weekend Portfolio Analysis (June 17, 2017)

Market Analysis

The stock market did absolutely nothing as the Federal Reserve was the focus of investors’ attention this week. Although the Dow Jones Industrial Average managed to set another record high on Wednesday, the Nasdaq and Russell 2000 displayed weakness. Despite falling inflation data in recent months, the U.S. Federal Reserve hiked rates on Wednesday as expected by 25 basis points. Also the Federal Open Market Committee (FOMC) announced that they would likely raise rates once more this year while also laying out its plans to reduce the size of its $4.5 trillion balance sheet. This is the Fed’s fourth short-term rate increase in the current expansion and its third increase in the last six months.

The S&P 500 (SPX) opened Monday at 2425.88 and closed Friday at 2433.15 up 7.27 points, or 0.30%.

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Every day this week, the market tried to sell off at the open. Yet no matter how hard it tried, it nearly recovered all of its early losses by the end of each day.

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Furthermore, the CBOE Volatility Index (VIX) continues to remain at extremely low levels. Until the VIX starts to hold above the 50-day moving average, this market has the potential to go higher. Of course, that does not mean there is no risk in this market. In fact, we saw similar low levels on the VIX in early 2006, just as the market was moving towards new highs. We all remember how that played out in 2007!

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While the FOMC was raising interest rates on Wednesday, traders were driving bond prices up. This, of course, is counter-intuitive as we expect rising rates to drive down bond prices. Note the rally on Wednesday in the 30-year bonds as depicted in the chart below.

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Also, we see that the yield on the 10-year Treasury note fell about 4 basis points from week-ago levels to 2.16% with the bulk of that drop occurring also on Wednesday. In fact, despite three rate hikes, yields on 10-year notes are now nearly a half-percent lower than when the FOMC resumed its tightening cycle in December 2016.

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The central bank believes that inflation will fall well short of its 2 percent target this year. In fact, they stated that inflation has declined recently, even as household spending has picked up in recent months. Their statement also noted that inflation in the next 12 months is expected to remain somewhat below 2 percent in the near term, but will stabilize. This is not good news for buyers of gold. The gold market needs either some sort of banking crisis or inflation to drive prices higher. The market lacks these catalysts and as a result, there is no reason for investor to think that it is a good investment right now. Gold prices continued to drop this week, opening Monday at 1269.7 per ounce and closing Friday at 1255.2, down 14.5 or 1.14%.

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Oil prices dropped to their lowest prices in seven months completely erasing all the gains made since OPEC originally cut production back in November 2016. Data from the U.S. Energy Information Administration (EIA) showed that domestic crude supplies fell by 1.7 million barrels for the week ended June 9, however this was much less than the expected 2-3 million barrel drawdown. The fear is that persistent oversupply will continue to weigh on crude oil markets. With U.S. shale producers continuing to demonstrate robust production growth, concerns remain that the window for net draws in the U.S. in is too narrow for total inventories to normalize.

The U.S. rig count rose by six to 747, according to oilfield-services company Baker Hughes. The crude oil rig count has risen for 22 straight weeks, extending a record-long streak of increases, and the count is at its highest since the week of April 10, 2015.

Crude oil futures for July delivery opened Monday at $45.80 per barrel and closed Friday at $44.68, down $1.12 or 2.45%.

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Trade Activity

This week was a fairly busy trading week. We had four closing trades and added four new positions.

/ZW July 445/455/400/390 Iron Condor
Last week we bought back the short 400 puts on this wheat trade. This past week, on Monday, we also closed out the call spread portion of the trade. Wheat prices moved sharply lower on Monday offering us an opportunity to exit this portion of the trade for a small loss. The long 390 put will most likely expire worthless next week. Assuming that the put does expire worthless (worst case scenario), this is how the trade played out. We sold the iron condor back on May 15th as a hedge for the original /ZW July 515/525/425/415 iron condor for 2.625. We then purchased back the short 400 puts last week for .25 and the 445/455 call spread for 2.50 on Monday. This resulted in a loss of .125 per contract. After commissions, the loss was $61.22. However, keep in mind that this was a hedge for the original wheat position that I had entered incorrectly. As luck would have it, the originally position ended up being profitable to the tune of $110.04 after commissions. So the bottom line is that the entire position net us a profit of $48.82 after commissions, a 7.76% return on capital in 5 weeks.

/CL October 60/35 Strangle
On Wednesday, following the EIA oil inventory report, I opened a new strangle in crude oil for the October expiration cycle. Implied volatility was in the 52nd percentile, the highest level we have seen since late last November. Although the outlook for crude oil is bearish, I think that there is strong support in the low $40 range. We allowed a little extra room on the upside just in case there is some geopolitical event that disrupts oil supplies in somewhere in the world. Since placing the trade, IV percentile has dropped back to about 12%, resulting in our position ending the week at 28% of maximum profit.

Trade Details:
SELL 1 /CL Oct 60 Call @ 0.11
SELL 1 /CL Oct 35 Put @ 0.17
Credit: 0.28 ($280.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 34.72 / 60.28)
/CL Current Price: $46.16
Margin Required: $660.00
Days to Expiration: 93
Probability of Profit: 92.12%

/ZS September 1160/840 Strangle
On Wednesday, volatility started to contract in soybeans. We exited this trade by purchasing back the strangles for 5.375. We originally sold it for 9.00. This was just over 40% of maximum profit. We could have waited a bit longer, but I was not sure how long it would take to make the additional premium, and with two months remaining until expiration, I decided to take the profits. After commissions, we net a profit of $165.01, or 32.81% return on capital in 30 days.

/ZS August 1110/810 Strangle
On Thursday morning, we also exited our other soybean strangles that were for the August expiration cycle. We exited the trade at 50% of maximum profit. The strangles were originally sold for 3.50 and we bought them back for 1.75 which net us a profit of $71.26 after commissions, or a 16.69% return on capital in 20 days.

/GC September 1400/1150 Strangle
We have been looking for an opportunity to get back into another gold position for quite some time. With the weakness in gold on Thursday, I decided to enter a strangle, despite the low volatility. IV percentile was just over 5% at the time that we executed the trade. However, I believe that the fundamentals suggest there are pressures acting on gold prices from both sides that will keep it within a fairly narrow range for the foreseeable future. Because of the low volatility, we placed our strikes further out, just in case volatility does start to spike. The trade is already at 14% of maximum profit.

Trade Details:
SELL 1 /GC Sep 1400 Call @ 1.40
SELL 1 /GC Sep 1150 Put @ 1.40
Credit: 2.80 ($280.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 1147.20 / 1402.80)
/GC Current Price: $1258.50
Margin Required: $962.00
Days to Expiration: 74
Probability of Profit: 94.90%

/ZW September 580/420 Strangle
On Friday, wheat prices rallied to their highest levels since March 9th. This also drove up the implied volatility into the 95th percentile on the wheat options, its highest level since May 1st. We decided to sell another strangle position for the September expiration cycle and move the strikes in just a bit closer than on our other position.
Trade Details:
SELL 2 /ZW Sep 580 Call @ 3.125
SELL 2 /ZW Sep 420 Put @ 2.00
Credit: 5.125 ($256.25 per contract)
Max Risk: Unlimited (Breakeven Prices: 414.875 / 585.125)
/ZW Current Price: $482.25
Margin Required: $623.00
Days to Expiration: 70
Probability of Profit: 78.27%

/ZC September 390 Straddle
Our final opening trade for the week was a straddle in corn. We have not done a straddle in a long time, but with the very high implied volatility today (IV Percentile of 91%) and the fact that the notional value of this product is smaller than the other agricultural products we trade, I decided this was probably the best choice. We will be looking for a contraction in volatility and then exit the trade. On straddles, our target is 25% of maximum profit, although I often close them earlier if I can exit with a reasonable profit quickly.
Trade Details:
SELL 1 /ZC Sep 390 Call @ 20.125
SELL 1 /ZC Sep 390 Put @ 18.625
Credit: 38.75 ($1,937.50 per contract)
Max Risk: Unlimited (Breakeven Prices: 351.25 / 428.75)
/ZC Current Price: $391.50
Margin Required: $391.00
Days to Expiration: 70
Probability of Profit: 53.29%

/CL September 59/37 Strangle
Our final trade of the week was closing out this crude oil strangle for a nice profit. Although our profit was just a bit short of our target of 50% of a maximum profit, I felt that with today’s collapse in volatility on the /CL options, it was a good opportunity to lock in a nice profit and take some risk off the table going into the weekend. After commissions we net a profit of $115.56 or a 17.51% return on capital in just 16 days!

Current Portfolio

/CL September 39 Put
$220.00 Credit. 61 days to expiration. 10 deltas on the puts. Currently has a loss of $70.00. Earlier in the week the loss on this put was even more significant, however, crude prices have started to bottom and volatility has really contracted which has helped our position.

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/ZC September 500/330 Strangle
$325.00 Credit. 69 days to expiration.  4 deltas on the puts and 7 deltas on the calls. Currently at 27% of maximum profit. This trade looks good.

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/ZW September 600/400 Strangle
$350.00 Credit. 69 days to expiration. 4 deltas on the puts and 7 deltas on the calls. Currently at 21% of maximum profit. This trade looks real good right now and we have plenty of room on the on either side in case wheat prices continue to move around. Before the volatility started expanding, it looked like we might be able to exit this trade at 40% of maximum profit. I had an order in, but was never filled. Now that volatility has expanded, we will need to wait a bit longer before exiting.

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Plan For Next Week

We currently have trades in energy, metals and agricultural products, which offers some nice non-correlated diversification. We will continue to look for additional opportunities where we can deploy more capital.

The portfolio is currently up 20.54% year-to-date versus 8.07% for the S&P 500 (see Trading Results). The portfolio is currently 67% in cash. So far for the month of June, we have generated a 4.6% month-to-date return, which is very good!

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Happy Trading!