How our positions held up to the test…
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.
