We are always coming into a New Normal.
New Normals are nothing more than
keeping life weird!

– Damocles

Commentary

How to trade Options Spreads in the New Normal?

The term “New Normal” is an overused cliche that basically means I learned something new. New Normal transitions are almost always benign, and rarely do we consider then. But sometimes it takes a real kick in the butt.

Militant journalists have used the term “New Normal” for many years as a fear-cudgel for those who fear changes. We see it regularly in articles from Climate Change crusaders along with pictures of devastation and dying animals. Now we see similar pavlovian references to a New Normal in post-pandemic economic predictions. But in reality, New Normals are not all bad!

We entered new normals when Eli Whitney invented the cotton gin, when Marconi broadcasted the first radio transmission, when the Wright Brothers flew at Kitty Hawk, and when we tested the first Atom Bomb.

We also enter new normals when less notable events happen, like when the grass starts growing in my newly seed back yard, when I got that promotion at work, when I graduated from High School, or when Taco Bell started offering 2-for-1 tacos.

For my two-year Options Trading experiment, the Coronavirus ushered in a new normal when the COVID-Crash crushed my entire Options Spreads portfolio. I now have to reevaluate my perceptions and comfort-levels for considering risk management for existing positions.

In a earlier post of “Managing the Rate of Max Loss,” I studied the “Law of Large Numbers.” This study illustrated the negative effects of relying solely on trade probabilities (and pretty much demonstrates why casinos always win). But I seem to not heed my own warnings. I continued to place a lot of weight on the Options’ probability of OTM. I knew of these risk levels but did not have to live through them until February 2020.

My “New Normal” will include these changes:

1. Exit as many positions as possible early if profitable. Don’t try to squeeze that last few pennies from a winning trade. Keep the total maximum dollars placed at risk as low as possible.
2. Start making near ATM Vertical Bull Put Credit spread trades. Keep the Prob-OTM and ROR better than 50%. Rely more on trend-trading, Put/Call ratios, volatility, and other technical indicators to reinforce the trade’s bullish sentiment.
3. Keep the dollar risk per trades at its minimum and diversify positions. Don’t think I need to make more trades if weekly premium income is not sufficient to support a paycheck.
4. If an Options Spread position enters its final week with its Prob-OTM under 50%, go ahead and cut it loose. If it is not in an obvious position to win, then minimize max-loss.

This Week’s Market Sentiment

(As of 05/25/2020)

VIX – Broad Market Volatility:

9-Day SMA, mostly flat at 31% from 32% last week.

The VIX is an emotion-gauge for the general investing population. It is thought to be driven by the Marketeers’ current level of greed or fear. As a one-month forward-looking volatility matrix, it is not designed to tell us which direction the market will be going, but more of how fast it can get there.

A VIX of 15% is assumed to be a market at rest. But since the intrinsic nature of the Stock Market is to move up, a VIX closer to 15% will have an innate tendency to rise.

The VIX continues to slowly level-out from the high volatility days of March and April. The daily VIX fell to 28% by the end-of-day Friday, 5/22/20. This value is lower than the 9-Day SMA, which is lower than the 50-Day SMA.

With the CBOE volatility leveling (but still high), I would expect the daily Markets Thrashing to recede a bit more and most individual stocks or ETFs to start making better trends.

The higher VIX will help generate higher premiums for spread positions, but at the same time, there will be a little sphincter-clinching as to what trades will succeed.

The trajectory of the current VIX trend channel continues to suggest a bullish direction.

Put/Call Ratio:

9-day SMA (all OCC options): dropped slightly to .75 from .79 last week.

Put Options are frequently used as protections against existing investments falling. When the ratio between Put Options bought vs. Call Options bought are above 1, then this is an indicator that the Marketeers are buying insurance to what they may see as declining Markets. Conversely, when the Put/Call Ratio falls below 1, then there is a general sense that the broader Markets will increase, and more investors are buying more than selling.

For this week, I redrew the trend-channel to fit the past two months’ activity better. The trend continues to show a less nervous Marketeers, but with a few periods of little-girl screams when startled. This Put/Call Ration trend shows that the Marketeers are moving towards re-accumulation.

The current Put/Call indicator is well below 1.0 and trending down. This pattern suggests we are in a bullish direction.

Consumer Sentiment Index (CSI):

The CSI chart above has not been updated since the start of May. But when I combine the overly reported news of 39 million filings for unemployment (and how that has exceeded the 1930’s depression era), with the non-reported stats that a significant majority of these 39 million have either already returned to work or will be returning within the next couple of week, then I will speculate that the June’s revision will show a higher but yet a confused CSI.

This turnaround for the CSI indicator suggests bullish Markets.

Market Indexes:

DOW = 24,465 – Up 3,3% from 23,685 last week.
S&P 500 = 2,955 – Up 3.2% from 2,864 last week.

The S&P 500 is a stock market index that tracks the 500 largest companies in the U.S. This index represents about 80% of all the capitalization for the country. The S&P is widely considered the best indicator of how all the U.S. markets are performing.

The Markets gave back last week about what they took from us the week before. This dynamic corresponds with the flattening of VIX as it appears most Marketeers are entering a neurotic wait-and-see period. This behavior is an excellent example of Market Thrashing.

Six weeks inside the trend channel does not seal the deal for a New Normal (returning to the old Bull Market normal). But this past week behaved as well as the trend channel suggested.

The current SPX price is the center of the channel, but the 9-Day SMA is close to the bottom. In the Technical Analysis world, that would suggest that there will be more of an inclination to continue to bounce a little more towards the top side of the channel.

This technical indicator suggests that we are in a bullish trajectory.

Geopolitical tree-shakers are:

• The “Hong Kong” effect if Beijing passes its National Security Bill
• Stimulus bill being discussed in both Washington and the EU
• Historic high 39 million unemployed – but waiting (in vain) for reemployment numbers
• Election year politics continue to exacerbate COVID-19 and economy fears
• Hopeful news on Coronavirus vaccines and treatments by the end of 2020
• Oil continues to rise but remains below sustainable production price

My sentiment for this coming week:

Of the big-four indicators above, the VIX, P/C Ratio, and the S&P continue to move in Bull Market territory. But the high VIX suggests that the Marketeers are still mostly on edge, and any marginally disturbing news can shift directions fast.

The lack of a revised CSI should be interpreted as neutral. But I’m projecting this indicator to be bullish simply because of the reopening efforts.

For this week:

All four of the indicators above support the bullish perception, but it may be more of a slow-going slog. I am expecting more up days than down days, but it’s going to be hard to feel too confident in any new trades.

Coming off a Bull week last week, and the SPX is hovering towards the middle of the trend-channel. Recent history suggests that this week will be a bear, but maybe not too much of one.

I’m going to be bullish for trades this week, but will still limit my maximum dollar-risk per trade to less than $175.

This week, I will focus on:

1. Limit the max risk per trade to <$175
2. Limit the number of new trades and keep the week’s total dollar risk < $500
3. Close exiting position as soon as the minimum exit price threshold is hit
4. Bull Credit spreads only (need positive cash flow for psychological reasons)
5. Continue to focus on mid to long-term trades:  3-4 weeks
6. Set trade triggers and exit positions as soon as possible

Profit and Loss Statement

(As of 05/22/2020)

	Year	Month	Week #
	2020	May	22
Beginning Account Balance	$9,000.	$4,080.42	$4,786.45
Deposits (Div. & Int.)	$38.41	$0.00	$0.00
Withdraws (paycheck)	-$1,375.24	–$250.00	-$250.00
Premiums on Open	$2,04.00	$1,020.00	$239.00
Premiums on Close	-$4,895.00	-$109.00	-$55.00
Fees Paid (total)	-$92.89	-$24.14	-$3.17
Ending Account Balance	$4,717.28	$4,717.28	$4,717.28
Total Gain/Loss	-$4,282.72	$636.86	-$69.17
Return On Risk	N/A	21.7%	3.8%
Return On Capital	-32.7%	N/A	N/A

Realized Profit by Strategy

		Year	Month	Week #
		2020	May	22
Vertical Bull Put Credit Spread		-$3,192.94	$242.24	$32.94.
Vertical Bear Call Credit Spread		-$182.79	$0.	$0.
Vertical Bull Put Debit Spread		$0.	$0.	$0.
Vertical Bull Call Debit Spread		-$66.83	$71.66	$0.
Icon Condors		$0.	$0.	$0.
Cover Calls		–	–	–
Total		-$3,442.56	$313.90	$32.94

Schedule for this Week

Goals for this week: (05/26/20 – 05/29/20) (Week 22)

• Max technical dollars at risk (for the week) = $500.
• Max dollar risk per trade (new trades) = $175.
• Update Trading Log as trades occurs

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?:
• Probability of OTM > 50%?:
• Dollar risk set at or below $175.00?:
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?:
• The Trend-Channel is Bullish?:
• Shortstrike price below the trend channel at expiration?:
• Shortstrike price below 1 standard deviation from current price?:
• Current ETF price within the bottom 1/2 of Bull Trend Channel?:
• 9-Day SMA above 50-Day SMA?:
• ROR > 50%?:
• Set a GTC trade trigger to close at 35% max gain?:

Monday:

• Determine/update this week’s market sentiment section
• Calculate/record Put/Call Ratios for all stocks on the watch list
• Review/tweak Trend-Channels for all stocks in the watch list
• Set target expiration dates for all options as follows:
  • Bull Credit Spreads: June 19 (<4-weeks)
• Look up Ex-Dividend dates for positions in/approaching ITM (MarketWatch/Calendar)
• Stage possible trades for all watch list stocks by 10:00 AM
• NO TRADING BEFORE 10 AM. (Let the Market find its direction after the weekend.)
• Watch one Webcast or take one online mini-course to be completed by Friday.

Tuesday – Thursday:

• Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movements.
• Submit a couple of Spreads, but keep a close watch. If one is accepted, cancel the others (we want only one new active trade per day).
• Be mindful of Entry Rules.

Friday:

• Review the total technical dollars at risk for this week. If significantly below $500, then submit additional spreads if prudent.
• Update and post weekly journal (this blog) with any lessons learned or strategy changes.

This Week’s Trade Activity

(As of 05/29/2020)

Spread Count Summary:

		Year	Month	Week #
		2020	May	22
Vertical Bull Put Credit Spread		34	12	3
Vertical Bear Call Credit Spread		12	0	0
Vertical Bull Put Debit Spread		0	0	0
Vertical Bull Call Debit Spread		7	0	0
Iron Condor		0	0	0
Total		53	12	3

Current Dollars at Risk:

		Year	Month	Week #
		2020	May	22
Vertical Bull Put Credit Spread		$947.	$947.	$461.
Vertical Bear Call Credit Spread		$0.	$0.	$0.
Vertical Bull Put Debit Spread		$0.	$0.	$0.
Vertical Bull Call Debit Spread		$0.	$0.	$0.
Iron Condor		$0	$0	$0
Total Dollar Risk		$947.	$947.	$461.
Max Risk Allowed		$1,500.00		$500.00

 

New Trades Opened This Week

(05/26/2020 – 05/29/2020)

MA: 297.5p/295p (1 contract) – Open 05/29/20 – Expires 06/19/20 – Max Gain = $85.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=56.4%, ROR=51.2%, PC/Ratio=0.7, Max Loss=$129.00, IV%=27%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (21 days)
• Probability of OTM > 50%?: Yes (56.4%)
• Dollar risk set at or below $175.00?: Yes ($164)
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?: Yes (0.7)
• The Trend-Channel is Bullish?: Yes (see chart)
• Shortstrike price below the trend channel at expiration?: Yes (see chart)
• Shortstrike price below 1 standard deviation from current price?:
• Current ETF price within the bottom 1/2 of Bull Trend Channel?: No
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• ROR > 50%?: Yes (51.2%)
• Set a GTC trade trigger to close at 35% max gain?: Yes ($0.55)

As a secondary data point to help select a Vertical Bull Put Credit Spread, I am looking at the one-week trend. If the main trend-channel is bullish, plus the stock movement over the last week continues to rise, then this adds another confirmation to this selection.

DIA: 254p/252p (1 contract) – Open 05/28/20 – Expires 06/19/20 – Max Gain = $69.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=51.3%, ROR=53.5%, PC/Ratio=1.1, Max Loss=$129.00, IV%=27%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (22 days)
• Probability of OTM > 50%?: Yes (51.3%)
• Dollar risk set at or below $175.00?: Yes ($129)
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?: No (1.1)
• The Trend-Channel is Bullish?: Yes (see chart)
• Shortstrike price below the trend channel at expiration?: Yes (see chart)
• Shortstrike price below 1 standard deviation from current price?:
• Current ETF price within the bottom 1/2 of Bull Trend Channel?: No
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• ROR > 50%?: Yes (50.3%)
• Set a GTC trade trigger to close at 35% max gain?: Yes ($0.46)

AAPL: 312.5p/310p (1 contract) – Open 05/26/20 – Expires 06/19/20 – Max Gain = $83.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=56.5%, ROR=50.3%, PC/Ratio=0.6, Max Loss=$165.00, IV%=15%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (24 days)
• Probability of OTM > 50%?: Yes (56.5%)
• Dollar risk set at or below $175.00?: Yes ($165)
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?: Yes (0.6)
• The Trend-Channel is Bullish?: Yes (see chart)
• Shortstrike price below the trend channel at expiration?: Yes (see chart)
• Shortstrike price below 1 standard deviation from current price?:
• Current ETF price within the bottom 1/2 of Bull Trend Channel?: No (but near)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• ROR > 50%?: Yes (50.3%)
• Set a GTC trade trigger to close at 35% max gain?: Yes ($0.55)

Trades Currently Cooking

(As of 05/22/2020)

AAPL: 315p/312.5p (1 contract) – Open 05/21/20 – Expires 06/12/20 – Max Gain = $83.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=56.5%, ROR=50.3%, PC/Ratio=0.6, Max Loss=$165.00, IV%=17%
Current: Prob. OTM=53.5%, PC/Ratio=0.8, IV%=16%

MSFT: 185p/182.5p (1 contract) – Open 05/19/20 – Expires 06/12/20 – Max Gain = $95.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=50.2%, ROR=61.0%, PC/Ratio=0.4, Max Loss=$154.00, IV%=17%
Current: Prob. OTM=35.2%, PC/Ratio=0.6, IV%=19%

MSFT has not advanced much over the last week. This is creating a bit of gastric reaction over these two spreads.

MSFT: 182.5p/180p (1 contract) – Open 05/12/20 – Expires 06/05/20 – Max Gain = $85.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=56.1%, ROR=51.2%, PC/Ratio=0.6, Max Loss=$164.00, IV%=17%
Current: Prob. OTM=43.7%, PC/Ratio=0.6, IV%=19%

Current Trades Closed

(As of 05/29/2020)

MA: 290p/287.5p (1 contract) – Open 05/22/20 – Expires 06/12/20 – Max Gain = $84.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=54.5%, ROR=55.0%, PC/Ratio=0.3, Max Loss=$160.00, IV%=21%
At Close: Prob. OTM=69.1%, PC/Ratio=0.3, IV%=17%, ROR=21.3%

Cost to open: $.89 premium collected * 100 shares * 1 contracts = $89.00
Cost to close: -$.55 premium paid * 100 shares * 1 contracts  = -$55.00
Net Profit = $89.00 to open – $55.00 to close = $34.00
Actual ROR = $34.00 / $160.00= 21.3%

This position was closed via a trade-trigger set at 35% of max gain on 5/26/20. I was able to close this position (removing the dollar risk) only after 1 trading day.

Conclusion

Tech stocks have pulled back some over the past few trading days. Both MSFT and AAPL have not advanced much from my original trade dates.

Disclaimer

Even though I have tried to make it clear that this blog is my journal documenting my trek into Options Trading, it has been suggested by others that I, nevertheless, include a general disclaimer. So here goes…

“This blog and the information contained herein is not intended to be a source of advice or analysis concerning the material presented. The information and/or documents contained in the blog do not constitute investment advice.”

 

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