Weekend Portfolio Analysis (July 1, 2017)

Market Analysis

The stock market endured some turbulence this week after a series of hawkish comments from developed-market central bankers suggested that the era of ultra-loose monetary policy may be nearing its end. The S&P 500 was marginally lower, the Dow was unchanged, and the NASDAQ fell by 2.0% as continuing volatility in the technology sector weighed on investor sentiment. Investors also closely examined banks’ individual results of the Federal Reserve’s annual stress test, which showed that all 34 U.S. banks that were tested maintained capital ratios above the Federal Reserve’s minimum required level. This result helped the financial services sector move higher for the week.The energy sector also was strong this week as oil prices rebounded off their lows.

The S&P 500 (SPX) opened Monday at 2,443.32 and closed Friday at 2,423.41 down 19.91 points, or 0.82%.

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The SPX has remained trapped within a range of 2420 to 2440 for the month of June. Although it has tried to break out from that range (both to the upside and to the downside) several times, each attempt has failed. The VIX has remained at historic low levels except for Thursday when the SPX broke below the 2420 range. The VIX momentarily broke above the 15 level. However, as soon as the SPX returned to the 2420-2440 range, the VIX collapsed.

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Crude oil prices posted strong gains this week, largely from speculators closing out short bets. Hedge fund and other money managers have built up a record volume of bearish bets on crude over the past month, and it appears that a liquidation of these trades has driven crude prices higher. The U.S. Energy Information Administration (EIA) said crude stocks rose 118,000 barrels last week, however, weekly production declined 100,000 barrels per day (bpd) to 9.3 million bpd. That marks the biggest decline in weekly output since July 2016. Of course, you cannot discount the fact that the U.S. production decline last week was related to temporary factors like Tropical Storm Cindy in the Gulf of Mexico and maintenance work in Alaska that will likely be reversed in coming weeks. Libya’s output continues to rise and is now approaching 1 million barrels per day. That’s up from 935,000 bpd last week. Rising Libyan output is undermining the effectiveness of the OPEC production cuts. It remains unclear whether these prices will hold or if the increasing production from Libya could cause sentiment to shift bearish again.

The count of working oil rigs in the U.S. fell for the first time in 24 weeks, breaking a record streak of increases. According to oilfield services provider Baker Hughes, the oil-rig count fell this past week by two to 756.

Crude oil futures for August delivery opened Monday at $43.16 per barrel and closed Friday at $46.33, up $3.17 or 7.35%.

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The price of a wheat has soared this week to nearly one-year highs. A major drought in the Dakotas has caused spring wheat crop conditions to decline sharply in the past four weeks. That has lowered expectations for the spring wheat, a high protein grain used in artisan wheat foods like hearth breads, rolls and even pizza crust. A new crop progress report is scheduled for release on Monday by the U.S. Department of Agriculture and could potentially be another catalyst for higher prices. However, much of the rally is also being fueled by hedge funds and traders starting to cover a very large short position.

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The chart below shows the explosion in volatility as indicated by the CBOE/CME Wheat Volatility Index.

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Trade Activity

This week we opened only one new trade.

/ZW October 600/450 Strangle
On Thursday we opened a new strangle in wheat due to the large increase in both price and volatility. Unfortunately, we opened the position a bit too early as price continued to rally strongly on Friday and volatility expanded further. Although we are likely to see wheat prices increase a bit more, I believe the rally will be short-lived. We are currently showing a loss of $300 on the trade, however we still have plenty of room for prices to move up before our short call is in any danger. The loss is almost entirely due to the continued volatility expansion. Therefore, I do not believe that there is justification to make any kind of adjustments to the trade at this point.

Trade Details:
SELL 1 /ZW Oct 600 Call @ 4.875
SELL 1 /ZW Oct 450 Put @ 3.25
Credit: 8.125 ($406.25 per contract)
Max Risk: Unlimited (Breakeven Prices: 441.875 / 658.125)
/ZW Current Price: $510.50
Margin Required: $326.00
Days to Expiration: 85
Probability of Profit: 72.46%

Current Portfolio

/CL September 49/39 Strangle
$660.00 Credit. 47 days to expiration. 5 deltas on the puts and 32 deltas on the calls. Currently has a loss of $360.00. The put side is at 50% of max profit and we will likely close this side of the trade on Sunday evening when the futures markets re-open. I believe that we are seeing just a bit of a dead-cat bounce in oil prices right now due to short covering, as the underlying fundamentals have not changed. Therefore, in preparation of another pullback in prices, closing the put now makes sense. We will only make an adjustment to the call side if prices continue to rise.

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/CL October 60/35 Strangle
$280.00 Credit. 76 days to expiration. 2 deltas on the puts and 4 deltas on the calls. Currently at 42% of maximum profit. We are in good shape on this trade and will possibly close it next week at our target of 50% of maximum profit.

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/GC September 1400/1150 Strangle
$280.00 Credit. 58 days to expiration. Currently at 42% of maximum profit. This trade also looks great and we will close it at our target of 50% of maximum profit. Due to a glitch in ThinkOrSwim this weekend with /GC options, I am unable to generate a risk profile or provide the current deltas on the options.

/ZC September 390 Straddle
$1,937.50 Credit. 55 days to expiration. 57 deltas on the puts and 43 deltas on the calls. Currently at 4% of maximum profit. Corn prices have moved back up since last week and are right in the range that we are looking for. Several readers emailed me over the past week or two as corn prices dropped and this trade indicated a small loss. They were concerned that I had not yet made any adjustments to the trade. Straddles can show a loss for much of the early duration of the trade. Also, unless the short call or put is significantly breached, it is best to not make an adjustment. Our target on this trade is still 20-25% of maximum profit.

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/ZS September 1100/860 Strangle
$450.00 Credit. 55 days to expiration. 11 deltas on the puts and 11 deltas on the calls. Currently we have a small loss of $62.50 on this trade, mostly due to expansion of volatility since placing the trade. We are in good shape on this position.

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/ZW September 580/420 Strangle
$512.50 Credit. 55 days to expiration. 2 deltas on the puts and 25 deltas on the calls. Currently has a loss of $525.00. We tried to exit this trade on Thursday at about 40% of maximum profit. Unfortunately we were not filled and a $200.00 profit quickly become a $525.00 loss! These things happen and it is just part of trading. As indicated above in the Market Review section, I believe that prices may stay at these levels or even move higher early next week with the report from the Department of Agriculture. However, it is likely that we may see some profit-taking towards the end of the week which could bring prices back down a bit. As you can see, this loss is largely driven by the increase in volatility. A contraction in volatility would bring us close to profitability again.

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Plan For Next Week

We need to watch crude oil and wheat prices carefully next week. Volume is likely to be very low on Monday due to the trading holiday on Tuesday. Therefore, I do not plan to consider making any adjustments to those trades until we return back to normal trading later in the week. However, the October crude oil strangle and gold strangle are very close to our target profit levels. We may try to close those out Sunday night or Monday morning.

The portfolio is currently up 22.19% year-to-date versus 7.63% for the S&P 500 (see Trading Results). The portfolio is currently 60% in cash. We closed out the month of June with very positive results (6.04% return on capital after commissions).

New Features for PRO members

This week we added two new features exclusively for PRO members. First, we have added a Trading Forums section to give PRO members the ability to interact with one another an various trading topics. Also, many readers have inquired about the Thinkscript code that is used to generate the IV indicator at the bottom of our ThinkOrSwim charts. We have now made this script available for PRO members here.

As always, comments are welcome below. If you have not signed up for your FREE membership yet, please be sure to do that so that you can access additional content on this site. Also, be sure to check out the PRO membership, our real-time trade alert service.

Have a safe Fourth of July holiday and Happy Trading!