“Fifty years from now, when you’re looking back at your life,
don’t you want to be able to say you had the guts
to get in the car?”

– Sam Witwicky: (Movie: Transformers)

Commentary

Is playing it safe is too risky? You bet it is. So I need big wins to balance the scales.

The dangers of taking too much risk are pretty clear: Leamon Brothers, Sears, Enron, the kitesurfer who tries his luck in a hurricane and slams into a building. But equally as dangerous is playing it safe – and its harder to see.

One of the more difficult challenges in developing a daily Options Spread routine is that I tend to spend too much time in the day-to-day trenches. Too often, I find myself missing the bigger picture. Being somewhat too myopic with my efforts to minimize my losses, I am not giving myself a fair chance to win. This is the reason I need robust Entry Rules and Exit Rules.

This week’s commentary is to look into using a 10-point Strike-Width for new spreads and then rely on the “Conditional, Trailing Stop Limit” (CTSL) Exit Strategy to limit my losses.

The 10-point Strike-Width will yield a much higher premium per position, but it also carries a huge risk if the market goes south. The 3-point Strike-Width has a better backstop against an unfriendly market, but I’m taking baby steps to earn enough for a monthly paycheck.

3-Point Strike-Width versus 10-Point Strike-Width

Up until now, I relied on the Long-Strike price to limit my max-loss – as a good newbie should. If the Strike-Width of a Spread is 3-points wide, then I must carry 3 * $100 = $300 cash in my trading account to cover the total kill of my open position. My max-loss for a 3-point wide Spread will the $300 plus the premium I collected.

To me, $300 is not a scary risk to carry. But the premiums for a $300 spread is meager.

If I entertain a 10-point wide Strike-Width, then the cash I have to carry to cover a total kill = 10 * $100 = $1,000. A $1,000 loss if the position goes south requires a bit more sphincter clenching. However, the premiums collected from a 10-point spread is considerably more.

What is the economic difference between a 3-point Strike-Width and a 10-point Strike-Width? And how does that difference change when using the same CTSL order as an exit strategy for both?

Consider this sample Spread:

Underlying: SPY
Date Open: 8/19/20
Expiration: 09/11/20
Current Value: $339.24
Short Strike: $325 (> 4% below the current value)
Long Strike: (see table below)

Premiums Available	3-Point Strike-Width	10-Point Strike-Width
Short Strike	$325	$325
Headroom	4.2%	4.2%
Probability of OTM (Short Strike)	77.2%	77.2%
Premiums Collected	$34.00	$94.00

Both the 3 Strike-Wide and 10 Strike-Wide has the same operational parameters. Both have the same amount of headroom to fluctuate before expiration, and both have an equal probability of success.

The big difference is that I can either collect $34 from the 3-Strike position or collect $94 from the 10-Strike position.

Stopping here, the 10 Strike-Width options is a PRO.

Dollars at Risk	3-Point Strike-Width	10-Point Strike-Width
Long Strike	$322	$315
Probability of ITM (Long Strike)	19.4%	13.6%
Max Loss	$266	$906
ROR	12.8%	10.4%

The difference between the Return on Risk (ROR) for the two strike options is less than what I would consider notable. But the notion that I could lose almost 3.5 times as much dollars with the 10-Point spread over a 3-point spread is striking.

The 10-Point spread has a little less chance of a total loss than the 3-Point spread. The 10-Point spread has a slighter 13.6% probability of hitting that Long-Strike for the total kill compared to the 3-Point spread’s 19.4%. But during a fast-fall market correction (like the COVID-Crash), a total-kill is likely to happen to both strategies.

Without an exit strategy (or the only exit strategy is to let the position expire), the dollar risk for the 10-Point spread can shut my account down very quickly.

Stopping here, the 10 Strike-Width options is a CON.

Leveling the Risk

A CTSL closing order is Long-Strike agnostic. It triggers off the Short-Strike and will behave the same regardless of Strike-Width. So employing the CTSL Exit-Strategy for any new position should allow me to mitigate the total loss of a 10-point spread while collecting the higher premium.

To compare the difference between Strike-Widths, I will attempt to simulate what would happen if the open-position suffers a rapid fall. The comparison was between a SPY position opened today (Short-Strike -4% below current value and an expiration date of 9/11) to that of a SPY position with a Short-Strike just inside ATM with an expiration date of 8/28. The narrative for this simulation is, “open a new spread following my Entry Rules, but the general market turned negative in just over a week, which time the position goes ITM.”

Hypothetical Order Simulation

Underlying: SPY
Date Open: 8/20/20
Expiration: 09/11/20
Value at Open: $352.81
Current Value: $336.20
Short Strike: $337 (-4.5%)
Long Strike: (see table below)

Exit Rules set by CTSL:
Activate Trailing Stop (TS) at ITM of Short-Strike (TS = Mark + $.50)
Activate Limit Order (LO) when TS is reached (LO = Mark + $1.00)

With CTSL Order for Exit Strategy	3-Point Strike-Width	10-Point Strike-Width	Comments
Short-Strike	$337	$337
Premium’s Mark value at SPY=$336.20	$1.10	$2.43	SPY falls below Short-Strike (ITM) triggering TS.
TS activated with these thresholds	$1.60	$2.93	TS = Mark plus $0.50
LO activated at TS with these thresholds	$2.60	$3.93	LO = Mark plus $1.00
Position closed at	$1.61	$2.94	Assuming premium only lost .01 when LO was activated
Position’s Loss	-$127	-$200	Premium at close * 100 shares + premiums collected at open
% of Max-loss	48%	22%	Premium collected / Loss

Note: the premium’s Mark price for an Option entering ITM will vary due to Imply Volatility (IV) and Time Value (TV) at the time the Short-Strike goes ITM. 

This simulated trade was closed with two weeks remaining until expiration. So the premium price to buy back the spread included 2-weeks of TV. Therefore, the closer to its expiration when the CTSL exits a position, the cheaper it will be to close.

By employing a CTSL order as an Exit Strategy, I can almost level the dollar risk difference between a 3-point and a 10-point spread. With the 10-point spread, I can receive nearly 2.75 times more premium by selling a 10-point Strike-Width spread while risking 78% less.

Stopping here, the 10 Strike-Width options with CTSL is a PRO.

(Now I just need to prove it to myself!)

This Week’s Market Sentiment

(As of 08/17/2020)

This Market Sentiment is as of the start of my trading week. This analysis 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 slightly down to 22.5 from 23.9 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% or below will have an innate tendency to rise.

The 2-Month trend-channel was slightly adjusted this week to better reflect the “leveling” of the VIX. The yellow 1-Month trend-channel is showing a mostly sideways movement and a narrowing of extremes. So the assumption here is the Marketeers are still looking for something.

The Trump/Biden economic agenda is radically different, and whoever wins the November election will reshape the policies that all businesses will have to abide by. Fortunately, neither side will damage the system, but it certainly will tilt which sectors the investors will dump or buy. Therefore, until there is more clarity in who will reside in the White House on Jan 20, I would expect the VIX to stay above 15 until Nov 4th.

The current VIX is below the 9-Day SMA and the 9-Day SMA is below the 50-Day. So there is an inching downward of the Marketeer’s anxieties. But being above 15 (above 20), there is still a lot of disagreements as to what directions the markets will move. This disagreement will keep the premiums higher.

Because of the downward trajectory of the VIX, the current market direction is likely to continue.

Put/Call Ratio:

9-day SMA (all OCC options): stayed mostly flat at 0.57 from 0.59 last week.

Put Options are frequently used as protections against existing investments falling. When the ratio between Put Options bought versus Call Options bought is 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.

Last week, the Put/Call Ratio jumped above the four-month trend-channel. But at Friday’s (8/14) peak, it was still supporting a downward trajectory. I’ll suggest the reason for the end of week jump was because Congress could not agree on the current stimulus package, and then went home for vacation.

Even with the current P/C Ratio value well above the SMAs, there are still a lot more Marketeers buying Call Options than Puts. This Signals that the majority of us are betting on the market to continue to rise.

Consumer Sentiment Index (CSI):

The consumer Sentiment index hopes to take a broad snapshot of what we all feel to be the direction of the U.S. economy. It measures how consumers feel about their personal financial situation and compares that to what they believe is happening to others throughout the country. The survey contains 50 questions and is conducted to more than 500 people each month.

A low rating is a general dissatisfaction with our current management of U.S. economic policies. This dissatisfaction will imply that something has to change.

A high satisfaction rating suggests approval of the current policy management and implies market stability.

The CSI for August was little changed from that of July’s 72.5. Although the framework of our lockdown-damaged economy has improved significantly since April, the unemployment numbers still have a psychological affect.

Even though we should be celebrating our country’s resilience to the pandemic, the majority of our faux-journalists are focusing on negatives and encouraging unrest. The media’s campaign to demoralize our society prior to the election seems to be working.

Market Indexes:

DOW = 27,931 – Up 1.8% from 27,433 last week.
S&P 500 = 3,373 – Up 0.7% from 3,351 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 continue to rise, even with the political deadlock on the Federal Stimulus Bill. Any positive news out of Washington this week should keep the tide rising.

The current value of the SPX is above the 9-Day SMA, and that is above the 50-Day SMA. Both SMA has been rising for nearly three months. This chart is showing a sustained growth in the S&P 500 since the COVID-Crash bottomed out in March.

Geopolitical Tree-Shakers (GTS):

• Election year politics continue to exacerbate economy fears
• Long term riots and violence in certain cities – simulated unrest
• Ongoing negotiations over a Stimulus Package
• Israel / UAE normalization agreement
• Exaggerated COVID infection/death numbers

Soundly amid the election season, I fully expect all kinds of outrageous news accusations and ridiculous political stunts from both parties. Unless a believable event occurs, I feel that the markets have already baked in political machinations into its value.

My sentiment for this coming week:

Of my five indicators above, the VIX, P/C Ratio, and S&P 500 reinforce each other in confirming a continued Bull trajectory for the general market. Therefore, on the Technical side of my sentiment continues to be Bullish.

Of the other two indicators, CSI and Tree-Shakers, are vehemently throwing up yellow flags. So on the Fundamental side, I want to keep cautious.

I believe we are too much influence by an agenda-driven media because there seems to be a significant contrariness between technical and fundamental of my five indicators. The Twitter Mob and other highly influenced influencers are pushing hard for a seismic jump towards a near Communistic/Green society. But I believe, for the most part, these are a very loud minute-minority – equivalent to the 60’s Flower Power kids. I think that most of the country’s electorate sees through this.

This week, I will focus on:

1. Limit the max risk per trade to < $1,000.00
2. Short Stike Price to be 3% – 4% below the current underlining’s price
3. Keep the week’s total dollar risk < $1,000.00
4. Keep the overall dollar risk to be below $3,000
5. Will focus on mid-term trades: 4-5 weeks
6. Credit spreads only (need positive cash flow for psychological reasons)
7. Will consider only Bull Spreads
8. Set Conditional-Trailing-Stop-Limits

Profit and Loss Statement

(As of 08/21/2020)

	Year	Month	Week #
	2020	Aug	34
Beginning Account Balance	$9,000.	$3,316.67	$3,727.47
Deposits (Div. & Int.)	$38.44	$0.00	$0.00
Withdraws (paycheck)	-$1,875.24	-$0.00	-$0.00
Premiums on Open	$4,924.00	$600.00	$185.00
Premiums on Close	-$8,024.00	-$0.00	-$0.00
Fees Paid (total)	-$151.84	-$5.25	-$1.05
Ending Account Balance	$3,911.42	$3,911.42	$3,911.42
Total Gain/Loss	-$5,088.58	$594.75	$183.95
ROR		17.9%	4.9%
ROC	-36.1%

Realized Profit by Strategy

		Year	Month	Week #
		2020	Aug	34
Vertical Bull Put Credit Spread		-$3,596.97	$65.89	$0.00
Vertical Bear Call Credit Spread		-$182.79	$0.	$0.
Vertical Bull Put Debit Spread		$0.	$0.	$0.
Vertical Bull Call Debit Spread		-$66.83	$0.	$0.
Icon Condors		$0.	$0.	$0.
Cover Calls		–	–	–
Total		-$3,846.59	$65.89	$0.00

Schedule for this Week

Goals for this week: (08/17/20 – 08/21/20) (Week 34)

• Max dollars at risk (for the week) < $1,000.00
• Max dollar risk per trade (new trades) = $1,000.00
• Update Trading Log as trades occurs

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?:
• Probability of OTM > 60%?:
• Short-Strike price (Head Room) >= 3.0% below the current price?:
• Dollar risk per trade <= $1,000.00?:
• Total dollar risk <= $3,000:
• Put/Call ratio below 1.5, or flat, or falling over that last 2-3 weeks?:
• The Trend-Channel is Bullish?:
• Short-Strike price below the trend channel at expiration?:
• The current price within the bottom 1/2 of Bull Trend Channel?:
• The current 1-week or 2-week trajectory bullish?:
• 9-Day SMA above 50-Day SMA?:
• The current price above 9-Day SMA?:
• Set a GTC Conditional Trailing Stop Limit (CTSL): (see screenshot below)

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: Sept 11 (<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 08/21/2020)

Spread Count Summary:

		Year	Month	Week #
		2020	Aug	34
Vertical Bull Put Credit Spread		62	5	1
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		81	5	1

Current Dollars at Risk:

		Year	Month	Week #
		2020	Aug	34
Vertical Bull Put Credit Spread		$3,100.00	$3,100.00	$815.00
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		$3,100.00	$3,100.00	$815.00
Max Risk Allowed		$3.000.00		$1,000.00

New Trades Opened This Week

(08/17/2020 – 08/21/2020)

UNH: 305p/295p  – Open 08/19/20 – Expires 09/11/20 – Max Gain = $184.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=67.5%, ROR=22.6%, Head Room=-3.3%, Max Loss=$814.00, IV%=12%

Entry Rules for Vertical Bull Put Credit Spreads:

• Expiration date set at <= 4 weeks?: Yes (23 Days)
• Probability of OTM > 60%?: Yes (67.5%)
• Short-Strike price (Head Room) >= 3.0% below the current price?: Yes (3.3%)
• Dollar risk per trade <= $1,000.00?: Yes ($814.00)
• Total dollar risk <= $3,000: No ($3,100)
• Put/Call ratio below 1.5, or flat, or falling over that last 2-3 weeks?: No (1.8 ↑)
• The Trend-Channel is Bullish?: Yes (See chart)
• Short-Strike price below the trend channel at expiration?: Yes (See chart)
• The current price within the bottom 1/2 of Bull Trend Channel?: Yes (See chart)
• The current 1-week or 2-week trajectory bullish?: Yes (See chart)
• 9-Day SMA above 50-Day SMA?: Yes (See chart)
• The current price above 9-Day SMA?: No (See Chart)
• Set a GTC Conditional Trailing Stop Limit (CTSL): (see screenshot below)

At the time I entered this order, the Prob-OTM for UNH was above 70% and the headroom was more than 4%. UNH (then underlying) then spent most of the day increasing well beyond the capture of this trade, but I left the order active for most of the day. Late in the day, a mini-market-wide correction occurred and UNH ended the day 1/2 percent down.

Trades Currently Cooking

(As of 08/21/2020)

SPY: 315p/306p  – Open 08/03/20 – Expires 08/28/20 – Max Gain = $121.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=73.1%, ROR=15.4%, Head Room=-4.2%, Max Loss=$778.00, IV%=19%
Now: Prob. OTM=93.3%, ROR=13.1%, Head Room=-6.6%, PC/Ratio=1.6, IV%=19%

QQQ: 258p/250pp  – Open 08/05/20 – Expires 08/28/20 – Max Gain = $124.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=72.9%, ROR=18.2%, Head Room=-4.7%, Max Loss=$675.00, IV%=23%
Now: Prob. OTM=89.3%, ROR=12.9%, Head Room=-6.6%, PC/Ratio=2.7, IV%=23%

MA: 315p/310p  – Open 08/11/20 – Expires 09/04/20 – Max Gain = $112.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=72.0%, ROR=28.7%, Head Room=-4.2%, Max Loss=$387.00, IV%=12%
Now: Prob. OTM=81.8%, ROR=15.0%, Head Room=-5.2%, PC/Ratio=0.5, IV%=10%

SPY: 324p/319p  – Open 08/13/20 – Expires 09/04/20 – Max Gain = $58.00
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=77.1%, ROR=12.9%, Head Room=-4.3%, Max Loss=$441.00, IV%=15%
Now: Prob. OTM=79.5%, ROR=2.5%, Head Room=-4.2%, PC/Ratio=1.6, IV%=19%

Trades Closed This Week

(As of 08/21/2020)

No positions were closed this week…

Conclusion

This week’s task was to better understand the results of a Conditional Trailing Stop Limit order as an Exit-Strategy. I’m not sure I achieved the level of confidence I was looking for.

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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