Weekend Portfolio Analysis (July 15, 2017)

Market Analysis

The S&P 500 and Dow Jones Industrial Average reached new record highs on Friday, breaking out of a five-week period where weekly moves in the stock market had been muted, averaging only about 0.25%. Lifting the indexes was a continued rebound for tech stocks, as well as relatively dovish congressional testimony from Federal Reserve Chair Janet Yellen. During her semiannual testimony before Congress, she signaled that the central bank was in no rush to tighten monetary policy and offered reassurances on the current state of the economy. Friday also marked the start of the second quarter’s earnings season. Earnings of companies in the S&P 500 were up 15.3% in the first quarter of this year, helped by rising oil prices and the decline of the U.S. dollar. Analysts expect corporate earnings to continue to rise at a solid, albeit slower, pace through the remainder of this year.

The fed funds futures market still are pointing to the December FOMC meeting as the most likely time for the next rate-hike announcement with an implied probability of 50.6% down from 59.1% last week.

The S&P 500 (SPX) opened Monday at 2424.51 and closed Friday at 2,459.27 up 34.76 points, or 1.43%.

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Stocks exploded higher this week exceeding the expected move on both the S&P 500 and Nasdaq. In the case of the SPX, the expected move for last week was about +/- 23 points. However, the index actually moved up 34 points, 11 more than the options had implied. This is significant, particularly since it was to the upside. An upside breach of the expected move to this magnitude has not been seen since December 7. Markets are supposed to be contained within the limits of the expected move approximately 68% of the time (one standard deviation). In reality, the SPX has remained within the expected move more like 85% of the time this year.

Volatility is back at historic lows again, with a record low close for the CBOE Volatility Index (VIX) on Friday.

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Oil prices posted steady and solid gains this week, recovering from some of the most recent losses as U.S. government data confirmed a sharp decline in domestic crude supplies for a second week in a row. However, rising production in the U.S. and elsewhere continue to prevent the market from reaching a lasting balance between supply and demand.

On Wednesday, the U.S. Energy Information Administration reported that domestic crude supplies dropped 7.6 million barrels for the week ended July 7. That easily beat a forecast for a decline of 2.6 million barrels by analysts, but came in a bit less than the decline of 8.1 barrels reported by the American Petroleum Institute late Tuesday.

Baker Hughes reported its weekly count of oil rigs operating in the United States jumped by 2 rigs to a total of 765. The rig count has only dipped twice this year, but has shown signs of plateauing recently.

Crude oil futures for August delivery opened Monday at $44.35 per barrel and closed Friday at $46.68, up $2.33 or 5.25%.

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Grain prices reversed course this week and gave up much of the previous week’s gains. Last week grain prices experienced huge moves to the upside due to the drought in the Dakotas, which has impacted the wheat crop. Soybeans and corn got a “free ride” on the back of wheat, however conditions for these crops are actually quite ideal. Weather can significantly influence grain prices for the short term with markets pricing in a worst case scenario. This produces a surge in both prices and volatility, only to come tumbling back down when the damage turns out less than worst case as we saw this past week.

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Trade Activity

This week we closed out three trades, opened one new trade and also made an adjustment trade.

CL September 49/39 Strangle
On July 2, we closed out the put side of this strangle. This past Monday, we decided to close out the 49 call. As indicated in the trade alert, I did not like the price action that I was seeing and was concerned that crude oil prices might start to rally as short sellers started to cover their positions. On the put side, we made a profit of $102.78. On the call side, we only made $62.78. Overall, after commissions, our profit on the entire trade was $165.56 or 25% return on capital.

/ZW December 570 Straddle
Volatility in wheat during the first half of this week was very high with IV Percentile at 98%. After last week’s sizable loss due to the explosive rally in wheat prices, I wanted to take advantage of the high volatility and recover some of those losses as quickly as possible. When IV Percentile spikes to nearly 100%, my trade vehicle of choice is usually the straddle – selling an at-the-money call and put. On Wednesday, I was able to collect a huge premium for selling an at-the-money straddle in wheat utilizing the December options. The target profit level on this trade is approximately 25% of maximum profit.

Trade Details:
SELL 1 /ZW Dec 570 Call @ 41.50
SELL 1 /ZW Dec 570 Put @ 41.50
Credit: 83.00 ($4,150.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 487.00 / 653.00)
/ZW Current Price: $570.50
Margin Required: $639.00
Days to Expiration: 135
Probability of Profit: 51.26%
IV Percentile: 98.00%
Implied Volatility: 30.38%

/ZC September 410 Call
On June 16, we sold the /ZC September 390 straddle. With the huge drop in corn prices this week, we sold the /ZC September 410 call on Thursday as a hedge against further drops in corn prices. As long as corn prices stay below 410, this trade just adds to our bottom line. It also lowers our breakeven on the put side of the trade from 351.25 to 346. If prices were to drop further we could continue to hedge more by either buying a put or shorting the futures contract. At this point, I believe we will see prices start to stabilize. And, in fact, the marketplace is telling us this through the significant contraction in volatility that has occurred across the board in agricultural products on Thursday and Friday. Note that the margin requirement listed below of $417.00 is actually if the call was held exclusively. However, due to cross-margining and the risk that is reduced by holding this call along with the /ZC 390 straddle, the margin requirement was only about $100 to add this hedge to the straddle.

Trade Details:
SELL 1 /ZC Sep 410 Call @ 5.25
Credit: 5.25 ($262.50 per contract)
Max Risk: Unlimited (Breakeven Price: 415.25)
/ZC Current Price: $376.25
Margin Required: $417.00
Days to Expiration: 43
Probability of Profit: 84.48%
IV Percentile: 86%
Implied Volatility: 28.31%

/ZW December 770 Call
With the contraction in volatility along with the significant drop in wheat prices, I closed the the two /ZW Dec 770 calls that I had sold last week at 70% of maximum profit. After commissions, we generated a profit of $408.76 or 76.26% return on capital in just 8 days.

/GC September 1400/1150 Strangle
On Friday, as gold prices rallied, I closed out this strangle at 50% of maximum profit. I was in this trade a bit longer than I had hoped due to price movements and the low volatility when entering the trade. Our profit was $132.88 or 13.81% return on capital in 29 days.

Current Portfolio

/ZC September 390 Straddle
$1,937.50 Credit. 41 days to expiration. 61 deltas on the puts and 39 deltas on the calls. Currently at 17% of maximum profit. At this point, the trade looks good.

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/ZS September 1100/1120/900/880 Iron Condor
$200.00 Credit. 41 days to expiration. 7 deltas on the puts and 14 deltas on the calls. Currently at 43% of maximum profit. This trade looks real good. Because of the commission costs in this trade, we will likely wait until we are closer to 75% of maximum profit to close it.

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/ZS September 1100/860 Strangle
$450.00 Credit. 41 days to expiration. 3 deltas on the puts and 14 deltas on the calls. Currently at 20% of maximum profit. This trade looks much better this week due to the significant contraction in volatility for soybean options.

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/ZW September 620/640/460/440 Iron Condor
$400 Credit. 41 days to expiration. 12 deltas on the puts and 7 deltas on the calls. Currently at 37% of maximum profit. This trade appears to be in good shape at this point.

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Plan For Next Week

All of our current trades are profitable. With the trades that we close this past week along with current profits in our open positions, we are well on our way to recovery from the previous week’s loss.

We will be watching the grain products carefully, as we have a significant position in these commodities. I am also looking for an opportunity to re-enter the crude oil market again.

The portfolio is currently down 6.14% (vs. 12.19% last week) year-to-date versus up 9.23% for the S&P 500 (see Trading Results). The portfolio is currently 70% in cash.

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