Put a ‘stop-loss’ order on your worries.
Decide just how much anxiety a thing may be worth
and refuse to give it any more.

– Dale Carnegie

Commentary

First question: Do Trailing Stop Limits really work?

To answer this question, I have to understand something about the dynamics of the markets’ movements.

In a normal market (if there is such a thing), thrashing is minimal, and the market’s movement is reasonably tame (in any direction). Like a ball lazily rolling down a bumpy hill, the spot where the ball touches the ground at one moment is not too far from the last touchdown. The price difference between one touchdown and the next is called “gaps.”

But not all market hills are alike. Some are gentle slopes with little bumps, some are steep hills with big bumps, and some are cliffs. In volatile markets, we see crashes, mini-corrections, or price glitch. I can identify what kind of market we are in by observing the VIX, thrashing amplitude, and Put/Call Ratios.

I have to also understand that the term “Stop-Loss” is a misnomer. Stop-Loss strategies do not necessarily prevent losses. It cannot guarantee an order execution at a guaranteed price. This failing is because the market can “gap down/up” far beyond the Limit price.

Reference Spread Position

Stop-Loss strategies are typically OTO orders (One-Triggers-the-Other). First, I need to decide what limit-price I would except as a loss, and then I need to choose at what point I want to submit the limit-order. The price difference between the Stop and the Limit is important.

As a reference for this Commentary, consider the following open position:

IWM: 142p/139p (1 contract) – Open 07/06/20 – Expires 07/31/20 – Max Gain = $100.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=54.2%, ROR=50.3%, PC/Ratio=1.4, Max Loss=$199.00, IV%=35%

In the screenshot above, I set a Trailing-Stop-Limit for the reference spread position above. These settings are interpreted as follows:

Order: TRAILSTOPLIMIT
Price: Limit order (LMT) is set at 30% and is “Linked” to the ASK/BID price
Stop: Trailing Stop price (TR) is set to 25% and is “Linked” to the ASK/BID price

ASK/BID: The trailing stop price will be calculated as either the Bid or the Ask price plus the offset specified as a percentage value. The system automatically chooses the Ask price for Buy orders and the Bid price for Sell orders.

Assuming that when this closing order is submitted, the Ask price for the 142 Put = $4.21 and for 139 Put = $3.20, then the spread’s Ask price = $4.21 – $3.20 = $1.01. 

When I click on the “Confirm and Send” button, the initial Limit order price is thought to be calculated at the current ASK price of $1.01 * 1.30 = $1.313. The initial Stop price should be set to the current Ask price of $1.01 * 1.25 = $1.2625.

Note to self: Using percentages as the criteria for setting a closing order (as suggested above) has presented a problem. A wining Spread position was stop-out early this week unexpectedly.

When the position was originally executed, I received a $1.00 premium. Upon entering the Trailing-Stop-Limit with the above percentage settings, the initial prices were Stop = $1.00 * 1.25 = $1.25 and Limit = $1.00 * 1.3 = $1.30. There was a 25 cent spread (breathing room) between the current premium price and the Stop price, and a 5 cent spread between the Stop and Limit.

When the underlying rose and the closing premium price dropped to $0.50, the Stop price was recalculated to: $.50 * 1.25 = $.625 and the Limit to: $.50 * 1.3 = $.65. This narrowed the breathing room to 12 cents and the spread between the Stop and Limit to 2 cents.

The observation here is that when using percentages to set the Stop/Limit prices, the more the closing premium price improves, the higher the likelihood of an early Stop, plus the higher likelihood of the premium price gapping beyond the Limit price – rejecting the order.

Next week, I will look more into using $ instead of % for setting these boundaries.

How a Stop-Loss Works

In a normal market environment, the stop loss should work as intended. I received a credit of $100 ($1.00 premium # 100 shares) by opening the above position. If I then enter into a Stop-Loss to buy back the spread at 30% above $1.00 (or at $1.30), then I am hoping to limit my possible loss on this transaction to $1.30 debit to close – $1.00 credit when opened = -$.30 (or -$.30 * 100 shares = -$30.00) loss. This order could execute without my involvement.

Likewise, if the underlining ETF/IWM rises in price, then the premium price to close the position falls, and the Stop-Activation prices will follow at the 25% distance. Thus, if the closing price drops to $0.50, the Stop-price would calculate $0.625 ($0.50 * 1.25). If the underlining ETF begins a pullback and the premium price to close the position begins to rise, when it hits $0.625, it will trigger a Limit buy/closing order at $0.65. This transaction will produce a profit of ($1.00 credit to open – $0.65 debit to close X 100 shares =) $35.00.

Both the Stop and Limit prices are continuously recalculated as the markets move. If the spreads Ask price hits the last calculated Stop price, then the last calculated Limit price is activated.

Caution! Stop-Loss strategies may not work.

In highly volatile markets, the likelihood of Stop-Loss orders to work is highly dubious. They can have vastly unexpected results or may not work at all. Here are the reasons why –

I am investigating two different types of Stop-Loss orders: Trailing-Stop-Market and Trailing-Stop-Limit. Both of these are OTO orders (One-Triggers-the-Other).

A Trailing-Stop-Market order is guaranteed to work in all types of Markets. But the guarantee is to the execution of the order, not the price.

For example, in a highly volatile market, or if bad corporate news is released, or a micro-crash occurs, or a false Tweet is published, this spread position could easily gap-up to (say) a $2.50 mark price. The stop price of $.62 will be triggered, and a Market Order to purchase/close the position will execute at the current (albeit momentary) market price of $2.50. This transaction will result in a $150 loss ($100 credit to open – $250 debit to buy/close the position).

A micro-crash can send the current price beyond max-loss, which would be devastating.

A Trailing-Stop-Market strategy is a definite no-no!

A Trailing-Stop-Limit is similar to the Trailing-Stop-Market, except when the stop price is triggered, a Limit Order is entered to purchase/close the position at a specific (or better) Limit price. This strategy will guarantee the order’s price, but it will not guarantee the order will be executed. Why?…

I entered a Trailing-Stop-Limit to have a Stop at ASK + 25% and a Limit at ASK + 30%. If the current premium’s Asking price for the above position is now $0.50, then the stop price will be set to $0.62. If lousy news occurs (such as what happened to win the March/Apri COVID-Crash) and the IWM tanks causing the premium to gap up to $2.50 or worse, then the Stop price will trigger a Limit order for $0.65. Since the current $2.50 price is now beyond the 30% Limit price of $.65, the ticket will be “Rejected.” I will continue to own the position.

Warnings:

1. I should not enter a Trailing-Stop-Limit order when the markets are closed. How the initial Stop and Limit prices are calculated could be crazy, and when the markets open, I could be Stopped-Out at a totally unexpected price.
2. The price space between the Stop-price and the Limit-price needs to be considered. In my example above. At the current price of $.50, the stop-price ($0.625) and the Limit-price ($0.65) are only 2.5 cents. In a slow-moving market, this two and a half cents may Stop me out. But in a fast-moving market, once the Stop-price gets hit, the gap may send the price beyond the limit price, and the position will NOT be closed.

Verdict

Today’s Market’s characteristics are considered highly volatile. We are still thrashing plus/minus 3-4% on a weekly bases, and the VIX is well above 30. Any kind of Stop Loss strategies will be questionable in this environment. So be aware of unpredictable results until we enter a less volatile time.

A Trailing-Stop-Market strategy has a far higher risk of significant loss than a Trailing-Stop-Limit plan. I will avoid Market Orders.

This Week’s Market Sentiment

(As of 07/06/2020)

This Market Sentiment is as of the start of my trading week. This is typically completed by midday Monday morning and I will use it to help guide my trading decisions for this week. By the time this journal is published, it will be a week old.

VIX – Broad Market Volatility:

VIX = 9-Day SMA drifted down to 31.4 from 33.2 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’s 9-Day SMA broke through the bottom of the sideway’s trend last week in a show of confidence towards a recovering economy. The 9-Day SMA is also about to drop below the 50-Day SMA, remaining a downward trend if the VIX.

This chart suggests that the immediate Market trajectory is neutral to bullish.

Put/Call Ratio:

9-day SMA (all OCC options): stayed flat at 0.7 from 0.71 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.

This past week’s Put/Call Ratio 9-Day SMA recovered from the adverse reaction of the week before. The 9-Day SMA remains below the 50-Day SMA, and the current ratio value is just below the 9-Day SMA. This is insinuating shaky Market confidence in the current trajectory.

The ratio values are all at a level that I would expect a sideways trend to begin. When looking back three years, the Put/Call Ratio hovered near 0.8, and those years were healthy Bull years. Going forward, I should start looking at a 0.8 ratio as a red flag.

This chart is suggesting general support to whatever the other indicators show.

Consumer Sentiment Index (CSI):

We are now waiting for the July CSI chart from UM. But June’s jobs number released last week reported a much better than expected increase of 4.8 million addition to payrolls. The Unemployment rate fell a hefty 2.2% to 11.1%.

The workforce’s improvement, which will inject millions back into a restarting economy, should certainly confirm improved sentiment. We’ll find out this time next week.

Adding more fuel to the fire should keep the Marketeers happy for this week.

Market Indexes:

DOW = 25,827 – Up 3.2% from 25,016 last week.
S&P 500 = 3,130 – Up 4.0% from 3,009 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 S&P 500 had a significant bounce off of the bottom of the trend-channel last week. Adding to that, the current index value is above the 9-Day SMA, and the 9-Day SMA is also above the 50-Day SMA. All these levels continue to confirm a general and steady Bull Market.

Last week’s 4% S&P 500 bump continues to fall in line with the large oscillation of this index for the past several weeks. A plus/minus 4% movement each week is still high thrashing and can call any short term Vertical Bull Put Spread into jeopardy.

With the current index value floating near the center of the trend-channel, I think that whatever the movement is for this coming week will be moderate.

Geopolitical tree-shakers are:

• Election year politics continue to exacerbate economy fears
• Bad news in containing the Coronavirus is dampening the economic reopening, but good news on the vaccine front seems to balance
• Beijing clamping down on Hong Kong
• A string of Supreme Court decisions will come out this week

By far, the largest tree-shaker at this point is the heading up to the November Presidential election. Faux-journalists are exacerbating the current issues into crises to test President Trump’s leadership. I expect the fever-level rhetoric to stay negative over the next four months.

The increasing number of positive COVID numbers appears more related to the massive increase in COVID tests than an increase in the number of people contracting COVID who would otherwise not have. This sentiment seems to be supported by the number of hospitalization (nation-wide), and the number of people dying of COVID (nation-wide) is going down.

My sentiment for this coming week:

The Marketeers appears to continue to be trigger happy as illustrated by the high thrashing of the S&P plus the VIX continuing to be high. So any bad news may set the Market ablaze. But beyond this, all the indicators above are confirming a long-term Bull Market trajectory.

Crisis fatigue seems to be setting in with the general public. Those hot-buttons that issues of the past several weeks are starting to become old news. I see an increasing number of eye-rolling.

Because I currently do not have that much confidence is the mechanics of the Trailing Stop Limits settings, I am leary of upping my trade risks for this week. As a compromise, I will set my Strike-Width for any spreads to be no more than 3 Strikes wide, but still hold the number of trades down to two.

This week, I will focus on:

1. Limit the max risk per trade to < $250.00
2. Limit the number of new trades and keep the week’s total dollar risk < $500.00
3. Keep the overall dollar risk to be below $1,500 (with an effort at <$1,000)
4. Will focus on mid-term trades: 4-5 weeks.
5. Credit spreads only (need positive cash flow for psychological reasons)
6. Will consider Bull Spreads, Bear Spreads or even Iron Condors
7. Set trade triggers and exit positions as soon as possible

Profit and Loss Statement

(As of 07/10/2020)

Realized Profit by Strategy

Schedule for this Week

Goals for this week: (07/06/20 – 07/10/20) (Week 28)

• Max dollars at risk (for the week) < $500.00
• Max dollar risk per trade (new trades) = $250.00
• 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 $250.00?:
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?:
• The Trend-Channel is Bullish?:
• Short-Strike 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?:
• Current ETF 1-week or 2-week trajectory bullish?:
• 9-Day SMA above 50-Day SMA?:
• ROR > 50%?:
• Set a GTC Trailing Stop Limit to 25%:

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: July 31 (<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 07/10/2020)

Spread Count Summary:

Current Dollars at Risk:

New Trades Opened This Week

(07/06/2020 – 07/10/2020)

DIA: 258p/255p (1 contract) – Open 07/08/20 – Expires 07/31/20 – Max Gain = $101.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=53.0%, ROR=50.3%, PC/Ratio=1.6, Max Loss=$198.00, IV%=26%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (23 days)
• Probability of OTM > 50%?: Yes (53.0%)
• Dollar risk set at or below $250.00?: Yes ($198.00)
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?: Yes (falling)
• The Trend-Channel is Bullish?: Yes (see chart)
• Short-Strike 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?: Yes (see chart)
• Current ETF 1-week or 2-week trajectory bullish?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• ROR > 50%?: Yes (50.5%)
• Set a GTC Trailing Stop Limit to 25%: Yes (see screenshot below)

IWM: 142p/139p (1 contract) – Open 07/06/20 – Expires 07/31/20 – Max Gain = $100.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=54.2%, ROR=50.3%, PC/Ratio=1.4, Max Loss=$199.00, IV%=35%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (25 days)
• Probability of OTM > 50%?: Yes (54.2%)
• Dollar risk set at or below $250.00?: Yes ($199.00)
• Put/Call ratio below 1.0, or flat, or falling over that last 2-3 weeks?: Yes (falling)
• The Trend-Channel is Bullish?: Yes (see chart)
• Short-Strike 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?: Yes (see chart)
• Current ETF 1-week or 2-week trajectory bullish?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• ROR > 50%?: Yes (50.3%)
• Set a GTC Trailing Stop Limit to 25%: Yes (see screenshot below)

The Put/Call Ratio for IWM is current 1.4 – meaning that more Marketeers are buying protective Puts than Calls. But the ratio has been falling for the past 3 weeks, so I’m taking this as a positive.

Trades Currently Cooking

(As of 07/10/2020)

Trades Closed This Week

(As of 07/10/2020)

DIA: 258p/255p (1 contract) – Open 07/08/20 – Expires 07/31/20 – Max Gain = $101.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=53.0%, ROR=50.3%, PC/Ratio=1.6, Max Loss=$198.00, IV%=26%
At Close: Prob. OTM=44.7%, PC/Ratio=0.7 IV%=28%, ROR=-11.6%

Cost to open: $1.01 premium collected * 100 shares * 1 contracts = $101.00
Cost to close: -$1.24 premium paid * 100 shares * 1 contracts  = -$124.00
Net Loss = $101.00 to open – $124.00 to close = -$23.00 – fees
Actual ROR = -$23.00 / $198.00= -11.6%

This position was closed as expected. When opened, DIA was $260.47 and began a steady decline over the 1.5 days it was open. As part of my exit strategy, I want to exit the position early if they do not move in the right direction. I can now analyze the current market movement, and if I want to reopen a new position at an improved setting, then I will.

AAPL: 362.5p/360p (1 contract) – Open 07/02/20 – Expires 07/24/20 – Max Gain = $84.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=59.7%, ROR=50.3%, PC/Ratio=0.4, Max Loss=$165.00, IV%=19%
At Close: Prob. OTM=72.9%, PC/Ratio=0.3 IV%=21%, ROR=16.3%

Cost to open: $0.84 premium collected * 100 shares * 1 contracts = $84.00
Cost to close: -$0.57 premium paid * 100 shares * 1 contracts  = -$57.00
Net profit= $84.00 to open – $57.00 to close = $27.00 – fees
Actual ROR = $27.00 / $165.00= 16.3%

This position was closed at an unexpected price of $0.57. The surprise may be that I canceled the closing order and re-enter a new order with different Stop/Limit settings during the time the markets were closed. When the market finally opened, I watched the Mark price, and for a moment, it showed a -.63 (negative Mark price) before it settled to $0.53.

Going forward – DO NOT enter stop order while the markets are closed.

MSFT: 197.5p/195p (1 contract) – Open 06/30/20 – Expires 07/24/20 – Max Gain = $90.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=56.0%, ROR=56.0%, PC/Ratio=0.4, Max Loss=$159.00, IV%=22%
At Close: Prob. OTM=75.6%, PC/Ratio=0.4 IV%=25%, ROR=29.6%

Cost to open: $0.90 premium collected * 100 shares * 1 contracts = $90.00
Cost to close: -$0.43 premium paid * 100 shares * 1 contracts  = -$43.00
Net profit= $90.00 to open – $43.00 to close = $47.00 – fees
Actual ROR = $47.00 / $159.00= 29.6%

This position was closed at an unexpected price of $0.43. The Wait Stop setting earlier is shown below. It shows a stop-price at $0.39 and a limit price of $0.39. Not sure why this exited at $0.43.

Conclusion

One gotcha that I seem to of discovered is when I enter a new Trailing-Stop-Limit order while the markets are closed.

The Market Makers set what seems to be an arbitrarily wide Bid/Ask spread when the markets close, the actual calculation of the Mark price when it reopens is initially crazy. And since the stop and limit prices for the Stop-Loss order are calculated at the Mark price when the order is submitted, these prices can be way off bases.

A rule may be to NOT submit Trailing-Stop-Limit order during the non-market time. Wait until the markets are open then submit.

The trailing stop is calculated using a certain price type, which you specify in the Order Rules dialog (STOP Linked To drop-down list). You can choose any of the following options:

– LAST. The trailing stop price will be calculated as the last price plus the offset specified as an absolute value. This option comes with a universal “don’t use it”, because the last price can be anything a crazy system can give you. The results mostly will be unexpected.

– LAST%.  The trailing stop price will be calculated as the last price plus the offset specified as a percentage value. Same red-flag as above.

– BID. The trailing stop price will be calculated as the bid price plus the offset specified as an absolute value.

– BID%.  The trailing stop price will be calculated as the bid price plus the offset specified as a percentage value.

– ASK. The trailing stop price will be calculated as the ask price plus the offset specified as an absolute value.

– ASK%.  The trailing stop price will be calculated as the ask price plus the offset specified as a percentage value.

– MARK. The trailing stop price will be calculated as the mark price plus the offset specified as an absolute value.

– MARK%.  The trailing stop price will be calculated as the mark price plus the offset specified as a percentage value.

– AVG PRC. The trailing stop price will be calculated as the average fill price plus the offset specified as an absolute value. The average fill price is calculated based on all trades that constitute the open position for the current instrument.

– LAST T.  The trailing stop price will be calculated as the last price plus the offset specified in ticks.

– BID T.  The trailing stop price will be calculated as the bid price plus the offset specified in ticks.

– ASK T.  The trailing stop price will be calculated as the ask price plus the offset specified in ticks.

– MARK T.  The trailing stop price will be calculated as the mark price plus the offset specified in ticks.

– AVG PRC%. The trailing stop price will be calculated as the average fill price plus the offset specified as a percentage value. The average fill price is calculated based on all trades that constitute the open position for the current instrument.

– AVG PRC T. The trailing stop price will be calculated as the average fill price plus the offset specified in ticks. The average fill price is calculated based on all trades that constitute the open position for the current instrument.

– ASK/BID. The trailing stop price will be calculated as either the bid or the ask price plus the offset specified as an absolute value. The system automatically chooses the ask price for Buy orders and the bid price for Sell orders.

– ASK/BID%.  The trailing stop price will be calculated as the bid price plus the offset specified as a percentage value. The system automatically chooses the ask price for Buy orders and the bid price for Sell orders.

– ASK/BID T.  The trailing stop price will be calculated as the bid price plus the offset specified in ticks. The system automatically chooses the ask price for Buy orders and the bid price for Sell orders.

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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