Volatility contraction…
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
