Prologue

This week I am still reacting to the market meltdown that started July 31. Over the past 11 trading days, the Dow lost 1,600 points. As a result, my three Vertical Put Spreads that expires this coming Friday (8/16) are in danger. One of these trades, DIA is already deep ITM and if it expired today it would be assigned for the maximum loss.

My options trading strategy thus far has focused primarily on accumulating premium income from Vertical Bull Put Credit Spreads. Since I had (still have) a lot of peripheral lessons to learn, the simplicity of this options strategy was less of a distraction. And from this lessor distraction – I now know what it means to be hit by a truck!

This week, I’m going to look into two items.

1. Review the impacts of “Vertical Roll” order(s) versus closing trades early for this week’s three at-risk spread trades.
2. Consider alternatives to the Vertical Bull Put Credit Spread that will generate significant higher ROC than my current arbitrary 6%.

To Roll or Not to Roll ITM Vertical Spreads

When it is fairly evident that my trades are going to expire ITM, I need to make some decisions before the closing of the market on Friday.

Referencing my DIA Vertical Bull Put Credit Spread below:

DIA: $263p/$261p – 2 contract – Open 7/25 – Expires 8/16 – Net Premium = $33.05
When Opened: Probability of OTM = 82.0%, ROC = 9.2%, Max Risk = $360
Now: Probability OTM = 26.7% (8/15/19)

The DIA ETF is currently trading at $255.08 with 1 day until expiration. This trade is definitely in serious trouble of total loss. The DOW would have to jump 800 points to save this trade. I see these as my options?

1. Ignore the trade and let it expire Friday ITM.
2. Close the trade early and minimize my loss.
3. Roll the trade out a week or two and hope the market recovers.

Option 1: Ignore this trade and let it expired Friday ITM. I will lose $457.89-ish:
$1.00 per strike spread * 2 strikes spread * 100 shares * 2 cursed contracts = $400.
$400 – the $33.05 premium already collected = $366.95
$366.95 + $19.99 Assignment Fee for the $263 short-put = $386.94
$386.94 + $20.95 manual Exercise Fee for the $261 long-put = $407.89
$407.89 + @ $50 (or more) for Margin Interest = $457.89
This is the total kill – worse case.

Because my $263 short-leg will be automatically assigned shortly after the market closes on Friday, I will not have have an opportunity to implement the safety net by exercising my log-leg ($261) until after the market opens on Monday. Therefore, I will have to borrow $52,600 ($263 short-leg * 100 shares * 2 contracts = $52,600) from my broker’s margin account for the time between Friday until after the market opens on Monday morning. Monday, I can then manually request to exercise my protective long-leg for $52,200 ($261 * 100 shares * 2 contracts = $52,200) to pay back my margin loan, less $400. Borrowing $52,600 for 48+ hours racks up a hefty interest charge.

Option 2: Close this trade a day early. I will lose $353.90:
The current premium price for me to pay for closing this trade is $1.90
$1.90 per share * 100 shares * 2 contracts = $380.
$380 + $6.95 trade fee = 386.95
$386.95 – 33.05 net premium (original trade fee already collected) = $353.90

This is $103.90 better than option 1 primarily because I am not paying the fees for assignment/exercise nor the margin interest.

Option 3: Roll the trade out another two weeks and hope the market recovers. Cost = $85.90

A Vertical Roll trade is nothing more than closing my deep-ITM losing DIA spread at the current cost of $1.90 and then reopening the same deep-ITM spread but with an expiration date of 8/30 at the current price of $1.35. One benefit of a Roll strategy is I can combine these two separate transactions into one and save the $4.95 trading fee.

$1.90 per share * 100 shares * 2 contracts = $380. (Close 8/16 spread)
$380 – ($1.35 per share * 100 shares * 2 contracts = $270) = $110. (Open 8/30 spread)
$110 + 8.95 trade fee = $118.95
$118.95 – $33.05 net premium (less original trade fee) already collected = $85.90

If I am convinced that this market downturn is short-lived, then I can pay a fee to roll this trade two weeks (change the expiration date from 8/16 to 8/30) for a debit of $85.90.

If the market does bounce back and this new spread expired worthless, then I’m still losing on this trade. But instead of losing $457.89 (Options 1 above) or instead of losing $353.90 (Option 2 above) I would only have lost $85.90 (taking a much smaller bullet).

However, if DIA does not rebound above $263 by the new 8/30 expiration date, then I will be in the same boat as now – reweighing Options 1, Option 2 and maybe another Option 3 – on top of knowing that I already lost $85.90 just to get to this point.

P&L and Performance Status

Note, starting with this post and forward, I will no longer track P&L or transactions for Cover-Calls Options. The dollar success of my Cover-Calls obfuscated the performance of my spreads.

YTD (2019)

Realized Net Profit from Spreads: $-1,228.00
Spreads started: 49
Realized ROC (target = 72% for the year): -31.0%

Spread Trades Won:
Spread Trades Lost:
Win/Loss Ratio:

Last Month (July)

Realized Profit: $-675.45
Spreads Started: 8 (1 still open)
Realized ROC (target = 6.0%):-14.85%

Spread Trades Won: 3
Spread Trades Lost: 4
Win Ratio: 43%

MTD (August)

Realized Profit: $0.00 (no completed trades)
Spreads Started: 5 (5 still open)
Current at risk $$$ for Spreads (Max: $3,960): 1,475.95(37% of max risk)
Realized ROC (target = 6.0%): 0% (no completed trades)

Spread Trades Won: 0
Spread Trades Lost: 0
Win/Loss Ratio: 0

Schedule for this Week

Monday:

• Review and tweak Trend-Channels for all stocks in watch list.
• Confirm that the target expiration date for all options trades is set to Sept 6 (25 days).
• By 10 AM, stage possible trades for all watch list stocks (but don’t trade anything).
• Watch 1 Webcast or take one online mini-course to be completed by Friday.  

Tuesday:

• Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movement (these are “long-shots”). 
• Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel the others (we just want one new active trade). 

Note: will not submit any new trades until the Market calms down…

Wednesday:

• If no “long-shot” spreads were accepted yesterday, then readjust premium to ATM prices and resubmit. We want only 1 vertical spread accepted so keep watch.
• Recheck/tweak trend-channels. 

Thursday:

• Reset target expiration date to Sept 13 (29 days out to the following Friday). 
• By 10 AM, stage possible trades for all watch list stocks. 
• Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel all others. (Do not submit a trade with for the same ETF as Tuesday.)

Note: Today, I will need to seriously consider closing some trades early or roll some to a later expiration. I will not submit any new trades until the Market can gain a direction.

Friday:

• Same as Wednesday.
• Update trading journal (this blog) and update it to the Internet by end of the day.
• Make sure you watched a webcast.

Trades Ended 8/2/19

QQQ: $184p/$182p – 2 contract – Open 7/11 – Expires 8/9 – Net Premium = $39.05
When Opened: Probability of OTM = 80.6%, ROC = 11.0%, Max Risk = $354
Now: Probability OTM = 70.7%

QQQ: $185p/$183p – 2 contract – Open 7/16 – Expires 8/9 – Net Premium = $31.05
When Opened: Probability of OTM = 83.0%, ROC = 8.6%, Max Risk = $362
Now: Probability OTM = 65.5%

The above QQQ spreads were closed 4 days early. At that time I was mostly convinced that the -7.6% drop in QQQ price (1,300 point drop in the Dow) that happened in the 3 trading days between July 31 and Aug 5 would not recover by Friday’s expiration. The realized loss for these two trades was -$323.8. Rolling these trades was not a consideration at the time.

Trades Still Cooking

QQQ: $184p/$181p – 1 contract – Open 7/23 – Expires 8/16 – Net Premium = $23.05
When Opened: Probability of OTM = 82.5%, ROC = 8.5%, Max Risk = $271
Now: Probability OTM = 61.0%

IWM: $151p/$148p – Open 8/1 – Expires 8/23 – Net Premium = $23.05
When Opened: Probability of OTM = 80.4%, ROC = 8.5%, Max Risk = $271
Now: Probability OTM = 16.8%

QQQ: $183c/185c – Open 8/6 – Expires 8/30 – Net Debit = -$115.95
Open: Prob. ITM = 40.1%, ROC = 72.5%, Max Risk = $115.95, Max Gain=$84.05
Now: Probability ITM = 43.9%

SPY: $277p/$272p – Open 8/9 – Expires 9/06 – Net Debit = 40.05
Open: Prob. OTM = 82.2%, ROC = 8.8%, Max Risk = $454
Now: Probability OTM = 80.4%

New Trades for This Week

This week’s Schedule and goals:

• Make 1 Vertical Bull Credit Spreads by Wednesday.
  • Must be >= 7.5% ROC
  • Short-legs must exceed 80% OTM probability
  • 9-day SMA must be higher than the 50-Day SMA (using 90-Day Time Frame)
  • Strike-width between 3 and 10
  • Max # of Contracts = 1
  • Max trade risk:
    • Per Trade = $495,
    • Per week = $990,
    • At any point = $3,960
• Make 1 Vertical Bull Debit Spread by Friday.
  (I do not have any rules defined yet.)
  • TBD

IWM: $147p/$145p – 2 contract – Open 8/15 – Expires 8/23 – Net Premium = $159.06
When Opened: Probability of OTM = 51.3%, ROC = 68.0%, Max Risk = $234.00
Now: Probability OTM = 51%
This IWM is a one week Vertical Roll from the spread that would have expired 8/16 as a loss.

DIA: $263p/$261p – 2 contract – Open 8/15 – Expires 8/30 – Net Premium = $263.05
When Opened: Probability of OTM = 22.6%, ROC = 202.3%, Max Risk = $130.00
Now: Probability OTM = 22.3%

This DIA is a two week Vertical Roll from the Spread that would have expired 8/16. This Spread is currently deep-ITM hence why the premium is so high.

The above graph shows the trend-channels for the April-May US/China trade snafu and the current US/China trade-related snafu. Both these downward tend-channels are very similar in intensity. I am hoping that it will also be similar in duration.

The red vertical line labeled “Original Expiry Date 8/16” is today and is showing that the current price for DIA is well below the $263 strike price. If I closed this trade today, then it would be a loss of $354.

The yellow vertical line is the new expiry date of Aug 30. There seems to be a reasonable possibility of DIA recovering above $263 about (just 1.5%) by this date. Making this Vertical Roll trade gave me a net loss of $86 – but only if DIA recovers.

Epilogue

This market’s maelstrom over the past 3 weeks has caused the majority of the current spread trades to go negative. As monetarily painful that this has been, this has allowed me to exercise some of the things I can do to mitigate negative effects. Additional, it has hammered in the reality of the Law of Large Numbers as it can come back to bite.

The 6% ROC expectation for Vertical Bull Put Credit spreads is not as effective as a sole strategy. There may be a place to use this as a supplement but I need to find and utilize new spread strategies that better balance the probability risks with the trades ROC.

Cheers…