MarketNeutralOptions.com

Hi all,

Many subscribers have emailed me to ask about our current positions in view of the plunge on 27 Feb 07. I feel that it’ll be apt for me to unveil our defense strategies at this point to reassure our subscribers. Everyone’s panicky recently and understandably so. The massive sell-off on Tuesday had caused major hardship on many people. However, our market-neutral positions are resilient enough to withstand a massive blow to the market.

Let us start by talking about our DIA double diagonal initiated on 19 Dec 06 for $0.00. We rolled it into an iron condor for $1.20 credit on 31 Jan and we are currently long Mar 120 put, short Mar 122 put, short Mar 127 call and long Mar 129 call. We had this condor for a very good price of $1.20. This was how our risk/reward chart looked like then. And this is still how our risk/reward chart looks like now.

As you can see from the chart or by simple calculation, our breakeven points for this condor are 120.8 on the downside and 128.2 on the upside. When we rolled this DD into and IC on 31 Jan, DIA was trading at 125.41. It went up to as high as 127.77 on 15 Feb 07 and it closed yesterday at 122.66. Despite the massive up and down move that we experienced, our breakeven points were not breached.

We can close up this trade now for $0.60 which means we’ll lock in a profit of $0.60 per trade. However, we may want to adopt a more risky stance and wait out to see what the market does and eventually hope to close it at a lower price. We are able to do that because we have a very good risk/reward ratio for this condor. We are basically risking only $0.80 to make $1.20.

Even if our breakeven point of 120.8 (at current level, it represents a downward move of another 186 points on the Dow) is breached in the next few days, we’ll still have 15 days to wait for a bounce. History has shown us again and again that the Dow can suffer a single day drop of more than 186 points. Therefore, we are watching this position very closely. We’ll either take profit by closing this condor early or wait for the price to drop before closing to lock in more profit. Greed or fear… Bottom-line is: this position looks highly probably to be profitable.

Next, our RUT IC initiated on 1 Feb 07. We are long Mar 750, short Mar 760, short Mar 850 and long Mar 860. We initiated this IC for $2.30 credit for a margin of $770 per trade. We are risking $770 to make $230 per trade. This is not a favorable risk/reward ratio (it is less than 1:1). Thus, we have to be extremely nimble and alert when we are holding on to such high probability yet unfavorable positions.

As you can see from the chart, our breakeven points are 757.7 on the downside and 852.3 on the upside. As of now, we have a probability of 82.39% that RUT will expire between these points. Looks good, I’ll say. Considering that RUT suffered a massive sell-off on Tuesday.

However, as the market showed, massive moves can come too fast too furious. We have to prepare for any eventuality. We do have a battle plan and yes, we planned for war in times of peace. At the suggestion of another subscriber, we will include the details of our battle plans in our analysis in the future.

Alright, our plan. Even though RUT is currently about 33.3 points away from our short put of 760 (RUT closed at 793.3), we will want to watch the 790 level. 790, which is 30 points away is our first line of defense: a fence. If RUT manages to breach 790, we’ll be on high alert. We’ll start to activate our plans and heighten to DEFCON 2, war is imminent. We’ll start to plan for a roll down, specifically we’ll buy back our short put spread and sell another put spread at a lower strike, or we’ll simply close our short put spread, or we’ll close our short put spread and initiate a long put spread.

Which course of action we choose depends on the price level at that time as well as the market mood. So far, we’re safe. Our fence has not been breached.

Our next RUT IC initiated on 12 Feb is not so lucky. We were long Mar 760, short Mar 750, short Mar 850 and long Mar 860 for $2.00. Our fence of 800 was breached during the massive sell-down. We wanted to close up our short put spread on Tuesday but we hold our fire because we don’t want to be shot by the IV spike. This is why it is important to have a fence far away from our HQ, we’ll have time and distance to reevaluate the situation and make our move at an appropriate time. We closed our short 770/760 put spread for $1.65 yesterday. Even though the enemies managed to breach our defenses, we managed to “win” this battle with a small profit. We may launch a counter-attack by selling another put spread at lower strikes to increase our profit. For example, we may initiate a short put spread to sell a Mar 750 put and buy a Mar 740 put .

Or if the enemies prove to be extremely tough, we may even buy a long put spread to go with the flow and profit in the down move! For example, we may buy a Mar 780 put and sell a Mar 770 out to profit from the down move. If you can’t beat them, join them!

Alright, I hope this entry will serve to reassure you that our HQ is currently safe and sound. We’ll go light with our entries considering the market will continue to be a little erratic for the coming days.

Dear valued subscribers,

You should have heard, we’ve closed up all our February positions and all our trades are profitable. You can see the results here.

Instead of doing a normal market update this week, I’d like to share with you some of the questions that I’m asked again and again. So in case some of you out there are typing the same questions for me, you can have you answers now. lol.

Questions:

Why don’t you just do iron condors every month instead of double diagonals and/or iron condors?
Also why don’t you use SPX (which is European style) to do condors/diagonals
instead of SPY, IWM, etc that are American style which can get assigned any time!

Answers:

Double diagonals normally offer better risk/reward than iron condors. When we roll a double diagonal into an iron condor, the amount of credit we collected is often unachievable if we were to simply do an iron condor. Of course, the trade off is time, a DD is held up for a longer period. One more feature of a DD that I like is the chance to get out of a position clean even if the market moves big-time against our position. We usually paid a small amount to initiate a DD, and when the time comes to roll, we may find that the market has moved too close to our short strikes. When that happens, we can simply close up the trade for a tiny loss or even a profit. A DD has a buffer that allows us a margin of error. An IC is shorter term and offers no buffer.

One more reason why we do a mixture of both here is that IC is short Vega (Greek for IV) while DD is long Vega. The short and long vega from the positions will cancels out each other reducing our exposure to IV risk.

We do trade SPX and RUT almost every month. We use them mainly for condors. However, because SPX and RUT are only trade at the CBOE, they are very difficult to get filled at the right price. To be fair to our subscribers, we only send out an advisory alert after we can get it filled ourselves. By contrast, SPY, IWM and DIA are traded in most exchanges and thus are more liquid and offer better bid/ask price. Again, we want to strike a balance here and therefore, we trade a mixture of all.

I hope you’ve learn something from this entry.

Best regards,

Gary

Dear subscribers,

There is not much to update because not much had happened over the week. The S&P 500 and Dow is treading water, trading in a tight range for the past 5 trading sessions. Something’s got to happen soon. It’s either going to explode on the upside or down. It’s difficult to tell which direction is more likely now because it seems like both camps are equally determined.

Looking at the chart of SPX, we can see that the primary trend line is still a valid resistance. We mentioned that the SPX would face this trend line resistance dated back to August 2006. The SPX did not break through the resistance. However, the SPX did not crash upon hitting resistance. Instead, it is currently correcting by time and not by price and that is bullish. However, looking at the chart, a correction on the downside seems imminent.

We’ll be waiting for that correction to happen before closing up some of our SPY positions. We have two SPY Feb IC to close. Both are entered with very good risk/reward probabilities. We are short a 142/144/136/134 Feb IC for $1.50 and a 144/146/137/135 Feb IC for $0.95. We’ll buy back the call spread on a down day when the price is cheaper. It is unlikely that the 142/144/136/134 IC will be profitable but with the high credit that we received, the most we can loss is $0.50 per position. However, we are not letting up so soon. Many things can happen in 1 week and there may be a chance to turn in a small gain on this position if there is a sharp and fast down move on the SPX in this 1 week. For the 144/146/137/135 IC, we’ll wait till we either breakeven on this trade or make a small profit. We are not hard-pressed to close these 2 ICs because of the high credit that we received. We have a 1:1 risk/reward (a 50-50 probability) and a better than 1:1 risk/reward for the 142/144/136/134 IC (more than 50% probability). We should not concede defeat just as yet. The high credit we got help provides a buffer.

Situation is similar with the Dow. It is treading water like the SPX and something’s got to happen very soon. These major indices can’t go on treading water forever. Somebody told me this before: volatility contraction leads to volatility expansion.

More interesting is the Russell 2000 (RUT). After breaking the trend line in the beginning of this month, it is showing very bullish strength. We currently have a Feb and a Mar IC on RUT. We are seeing a decent profit from our Feb IC. Of course come next week we’ll try to close it to free up our margin. We’ll try to close it for less than $0.50. However, with the RUT only 13.61 points away from our short call of 830, it’ll be expensive to close this IC up prematurely. We’ll keep a close eye on this position. If RUT continues to rally, we may have to close it up before it gets any closer to our short call. We’re looking at 820. If RUT gets near to 820 in the next few trading sessions, we’ll close this entire position to lock in our profit. No point risking a profitable trade for a few dimes.

That’s all for this update. We’ll be in touch.

Gary

Dear valued subscribers,

Sorry for this much-delayed update. Things have been rather busy here. I can only hope for your understanding.

Ok, let’s get started by talking about the S&P500 (SPX). Since the last update (last week), SPX has climbed steadily to close at a new high of 1448 on Friday. Looking at the chart, SPX closed just a bit below the trend line established since August 2006. It has already tried in two previous attempts to break that line but failed. The only resistance the SPX has now is this trend line dated back to August 2006. If it were to break through the trend line, we may see yet another bull run for SPX. Support currently is provided by the secondary trend line and the 50-day MA.

We currently have no open positions on SPX but we do have two open positions on SPY. The SPY double diagonal (DD) we initiated on 28 Nov 06 for $0.25 debit and rolled on 19 Dec 06 for $1.75 credit is currently in-the-money and worth around $1.65. We have this iron condor (IC) for a net credit of $1.50. So even if we were to close up this entire position now, we would incur a small loss of $0.15. However, with the SPX hitting resistance yet again and about 2 weeks to expiration, we will wait for the SPY to correct before closing this position. As long as we can buy back this IC for less than $1.50, we can still manage a small profit.

Similarly, we will wait for the SPY to correct before closing the IC we initiated on 4 Jan 07. Our current positions on the SPY are generating an uncomfortable amount of negative deltas. That is because the SPY is trading very near our short calls. However, as I mentioned earlier, these trades have superb risk/reward ratio when we put them on. Therefore, we’ll wait till we have a favorable condition to exit these trades.

Similar to the SPX, the Dow is also facing the resistance of the trend line established since August 2006. We currently have two DIA positions but they are not expiring in Feb so we can leave them alone for now.

The Russell 2000 (RUT) is showing most relative strength amongst the main indices. Not only it managed to break the trading range that it was bouncing between, it also managed to break the trend line established since August 2006. This is very bullish. We currently have two open positions on RUT and one on IWM (the tracking ETF). The RUT IC initiated on 12 Jan is currently showing a gain of $1.35. RUT closed at 809.42 on Friday, which is still a cool 21 points away from our Feb short 830 call. However, we will be extra careful for this IC because its risk/reward is not 1:1. We’ll look out for a suitable time to close up this trade to lock in the profits. The latest RUT IC for March was initiated on last Thursday. I have feedback from subscribers that some of them still can’t manage to get it filled by Friday. As long as you can get the price of not less than $2.25 credit, you can still put up the trade.

The IWM IC initiated on 4 Jan is currently slightly ITM and showing a small gain of $0.05. Like the other ICs for SPY and RUT that expire in Feb, we will wait for a down day to close up these positions. With the last three bullish trading sessions, a correction should happen soon. So watch out for our close advisories.

We are currently stalking a Mar SPX IC. However, with IV so low again, we may have to forgo SPX IC for Mar. We’ll be in touch!

Take care and have a nice weekend!

Gary