Any break requires three things:
Knowing the layout, understanding the routine,
and help from outside or in.

– Ray Breslin (Movie: The Escape Plan)

 Exit Rules – Vertical Spreads

Exit Rules Credit Spreads

Having an Escape Plan (Exit Rules) for my open Vertical Bull Put Credit Spreads is just as critical as having Entry Rules. And like Ray Breslin’s strategy, my plan also requires three things: don’t be greedy, don’t be emotional, and don’t be in a hurry.

The primary goal for my escape plan is to exit every Options Spread position with a profit. And because each of my open positions requires between one and two thousand dollars of risk, the sooner I can close a position, the sooner I am not at risk of losing that money.

A Quick Review of Vertical Credit Spreads Entry Rules

There will be different Exit Strategies for different Spread Strategies. This post will only cover my Vertical Bull Put Credit Spreads.

Abbreviated Review Of My Entry Rules:

A substantial part of having an effective Exit Rule is to follow my Entry Rules. It is when I deviate too far from my stated guidelines for opening a new Options Spread is when I create positions that are poised to fail. So the first and most important rule for an Escape Plan is to design winnable positions in the first place.

  1. The Short-Strike will be greater than one standard deviation below the current underlying’s price.
  2. The Spread’s Strike-Width will be at least 10 or 15 points wide.
  3. The Expiration terms for my new positions will be six-weeks or less.

Since the standard deviation of an Options price is a function of the underlying’s Implied Volatility (IV), the headroom percentage between the current price and the short strike can change as volatility changes. Durning low volatility times, the percentage difference between the Short-Price and current prices can be just a few percentage points.

And, when the IV is low, the premiums that I can collect for selling an Option Spread are also low. So increasing the Strike-Width beyond 10 points can help compensate for the lower IV.

Breslin: Didn’t see that coming.

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Exit Rule 1: Escape Early when Profitable

Assuming I open a new position with the expiration date six-weeks out. If I can claim 80% of my Max-Gain within the first two weeks, I should close the position, solidify the 80% of max-gain and reduce the amount of total dollar risk. I’m now in a position to reopen a different spread using the same risk dollars.

Suggested Buy-Back Prices

Keeping close watch on the number days each of my open positions have until expiration, I may consider closing early if my current profit start to get close to max gain.

As a guide, I put this table in my watch list’s “Position Monitor” spreadsheet.

Days to ExpirationClose at % of max gain
> 20 days80%
20 – 13 days87%
12 – 5 days93%
< 5 daysLet it expire worthlessly

Note: This table has been updated in a newer post “Exit Rules: Vertical Credit Spread – PT 2“.

Rottmayer: You hit like a vegetarian.

Calculate Suggested Buy-Back Price

Once I open a new Vertical Bull Put Credit Spread, I should already know the expected Max-Gain for this investment. But to review, here’s the equation:

Max-Gain = Premium price * 100/shares * Number of Contracts (- fees)

For my latest SPY spread, max-gain = $.85 premium price * 100/shares * 1 contract = $85.00 (- fees)

As I write this, this position has an expiration date of 37 days away. Looking at the table above, the suggested buy-back price should be 80% of max-gain.

To calculate the buy-back price, I need first to calculate the Expected Profit if I closed at 80% of max-gain. The equation to calculate the Expected Profit is as follows:

Expected Profit = Max Gain * 80%

For my latest SPY spread, expected profit = $85.00 max gain * .8 = $68.00. Thus, if I could close at 80% of max gain within the first third of the position’s term, I can secure $68.00 plus free up $914.00 of risk money. I’ll call that a win!

I now need to calculate what the Buy-Back premium price should be to close this position and secure the $68.00 profit. The equation for the Buy-Back premium is as follows:

Buy-Back Premium = (Max Gain – Expected Profit) / 100 shares

For my latest SPY spread, the buy-back premium = ($85.00 max gain – $68.00 expected profit) / 100 shares = $0.17

Now that I know my suggested buy-back premium price, I need to set a trade trigger in Thinkorswim.

Rottmayer : You are not user-friendly.

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Set Trade-Triggers

Last year, I published a series of posts on using various “Stop-Loss” techniques to limit a position’s loss. But after using these Conditional Trailing Stop Limit orders, I documented many unexpected events that trigger the closing order at the wrong time. Instead of minimizing my losses, I blew up my account. From that point on, I was advising myself to NOT use stop-loss triggers – except for alerts.

But, I am now advising myself to start using Trade-Triggers as a mechanism to secure early, profitable exits.

In Ameritrade’s Thinkorswim, open the “Monitor Tab” -> expand the spread that I wish to set the Trade-Trigger -> right-click on the spread (in this case the 1 APR 21 SPY vertical) -> click on “Create Closing Order” -> click “Buy +1 Vertical SPY…”.

Set Trade Triggers

In the trade block, enter .17 in the DEBIT box, and select “GTC”.

In the working window, confirm the order.

Set Trade Triggers

Monitor and Adjust

Now I need to keep track of the “Days to Expiration” for my open Options positions. If the number of days drops below 20, or below 12, or below 5, I will need to submit a “Cancel/Replace Order” to adjust the new buy-back price according to the table above.

Continue in Part 2

Exit Rules: Vertical Credit Spreads – Pt 2 was published May 14. This next post has some important insights.

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This Week’s Market Sentiment

(As of 02/22/2021)

In this section, I review five indicators: VIX, S&P 500 Put/Call Ratio, S&P Market movement, Consumer Sentiment Index, and Geopolitical events that could affect the market’s direction. I will use these indicators to help guide my trading decisions for this week.

This Market Sentiment Section is typically completed by midday Monday morning. By the time this journal is published, it will be a week old.

VIX: Broad Market Volatility

VIX 9-Day SMA dropped to 22% by the end of last week from 27% the week before. The one-week deviation dropped to 0.6 from last week’s 4.1.

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.

CBOE Market Volatility Index – 02/21/2021

The 4-month regression channel for the VIX continues its slow and steady decline from the uncertainty of 2020 and the COVID-CON hysteria. But it is also easy to see that from the angst of Election Day, it has been functional flat as the Marketeers continue to try to assess the new Biden Administration.

The VIX currently is 22%, which is still above 15%. But as an epic freeze continues to grip the nation, a little uncertainty is creeping in.

Since the VIX continues to hover above 15 and has maintained a level progression for the past month, I would initially set this week’s DEFCON (Options Trading Readiness Signal) level to 3.

DEFCON = 3

Put/Call Ratio:

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.

Daily Put/Call Ratio for all S&P 500 Constituents Options – 02/21/2021

The Put/Call Ratio continues to roll flat for several months. I could probably use the same graph for the last two months, as there has been very little to shake the Marketeers’ confidence.

I Still believe the bulk of the Marketeers who cashed out of the markets throughout 2020 have not yet put that back in. But from the Put/Call Ratio for the past several months, no one is too concern about protecting what is already invested.

Maintain DEFCON = 3

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Consumer Sentiment Index (CSI):

The Jan ’21 CSI’s level settled down to 79.0, flat from 80.7 from last month. (ycharts.com)

This Consumer Sentiment Index (CSI), as provided by the University of Michigan. This indicator tracks US consumer sentiment based on surveys on random samples of US households.

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.

Updated: Jan 21, 2020

The US Consumer Confidence index for this past week was unchanged from last. The general sentiment that the economy remains stagnant as the pandemic rages on. I also believe most of us are just waiting to see how the new congress will play together. The new Stimulus bill appears inevitable, but what it will contain is unknown.

There is not a suggestion that the CSI should change the DEFCON rating.

Maintain DEFCON = 3

Market Indexes:

DOW (DJX) = 31.494 – Up 0.3% from 31,372 last week. (4 week deviation: 6.1, up from 4.5 last week)
S&P 500 (SPX) = 3,907 – Down 0.2 % from 3,916 last week. (4 week deviation: 62.6, up from 63.5last 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.

Daily S&P 500 Index – Four-Months (Updated 02/21/2021)

The S&P 500 is closely tracking just above it’s 9-day SMA (with a few dips below now and then). This is keeping the index bullish. And the slowing rate of thrashing is helping to set a trajectory as well as lowering the general volatility.

The broader markets have be fairly flat for the past two weeks. The current SPX has dipped slightly below the 9-Day SMA, but remains well above the 50-Day.

Looking at the chart above, for the past four months, the S&P 500 has been tracking pretty much in the center of the Regression Channel. Being flat for the past two weeks is not a concern.

So far, there is nothing to suggest more caution is required for next week.

Upgrade to DEFCON = 4

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Geopolitical Tree-Shakers (GTS):

One way to look at the GTSs is like a lit fuse to a bomb. The fuse can be fast or slow, and the bomb can easily be a dud. But I need to watch this closely as an indicator. The GTS can significantly disrupt all the other indicators at the drop of a hat.

  • Texas devastated by an unprecedented winter storm.
  • New COVID cases dropping dramatically. We are now talking about head immunity by April.
  • Real-world results from Isreal prove the Phizer vaccine is near 90% effective.
  • Immigration policy changes may create an influx of illegal aliens and rising social costs.
  • 10-year Treasury bonds set to rise.
  • Jobs report set to come out mid-week.

The GTS that may have the biggest effect on my Options Trading is the revelations that the pandemic may be ending much sooner than expected. The vaccine improvements are showing greater effectiveness with just one dose, leaving the presumed second required shot for the other as the first. Therefore I would anticipate rallies in airlines, hotels, cruises, and other travel-related businesses that took it on the chin last year.

However, the certainty of the $1.9 billion stimulus is still in limbo and the vote count is too close. And even though Jerome Powers have reiterated a state course of for maintaining a historical low interest rate, inflation fears are starting to rattle some cages. Because the events (plus a high VIX) can affect short term traders, I’m going to be more cautious this week.

Reset to DEFCON = 3

My sentiment for this coming week:

There is a general contraction in economic and political concerns at the moment. Still, within the honeymoon period with the Biden Administration, Market Thrashing is definitely being rein in and softball treatment of the new administration is giving the Marketeers a little respite.

Economic numbers will be out this week and all eyes are on the 10-year Treasury Bonds.

Trading Readiness Level

DEFCON = 3

This week, I will focus on:

  • Two 10-Strike-Width spread.
  • Spread term of 8-weeks or less.
  • Probability of OTM > 80%

If the underlings continues to retreat during the week, I will delay opening new positions until late in the week.

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Cash Flow Statement

(As of 02/26/2021)

Year
2021
Month
Feb
Week
#8
Beginning Account Balance$16,000.00$16,222.98$16,710.19
Deposits (Div. & Int.)$0.12$0.00$0.00
Withdraws (paycheck)-$600.00-$300.00-$300.00
Premiums on Open$1,195.01$667.01$99.00
Premiums on Close-$91.00-$91.00-$21.00
Fees Paid (total)-$17.98-$12.84-$0.00
Ending Account Balance$16,486.15$16,486.15$16,486.15
Total Gain/Loss$486.15$263.17-$224.04
ROR1.6%1.3%
ROC3.0%

Realized Profit by Strategy

Year
2021
Month
Feb
Week
#8
Vertical Bull Put Credit Spread$432.75$432.75$83.94
Vertical Bear Call Credit Spread$0.00$0.00$0.00
Vertical Bull Put Debit Spread$0.00$0.00$0.00
Vertical Bull Call Debit Spread$0.00$0.00$0.00
Icon Condors$0.00$0.00$0.00
Margin Interest-$0.53-$0.53$0.00
Total$432.22$432.22$83.94
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Schedule for this Week

Goals for this week: (02/22/2021 – 02/26/2021) (Week #8)

  • Document lessons learned or new thoughts
  • Open one or two wide-strike spread
  • Update Trading Log as trades occurs

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: Apr 16 (6-8 weeks)
      Note: If there are no Options Chains published for the 8-week expiration, then use the next Options Chain down from 8-weeks (7-weeks, 6-weeks). Beyond 4-week expirations, only the monthly chains are available to trade.
  • 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.
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This Week’s Trade Activity

(As of 02/26/2021)

Spread Count Summary:

Year
2021
Month
Feb
Week
#8
Vertical Bull Put Credit Spread1271
Vertical Bear Call Credit Spread000
Vertical Bull Put Debit Spread000
Vertical Bull Call Debit Spread000
Margin Interest110
Total1381

Current Dollars at Risk:

Year
2021
Month
Feb
Week
#8
Vertical Bull Put Credit Spread$6,339.$5,440.$901.
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$6,339.$5,440.$901.
Max Risk Allowed$16,000.00$8,000$2,000.

New Trades Opened This Week

(02/22/2021 – 02/26/2021)

IWM: 195p/185p  – Open 02/24/21 – Expires 04/16/21 – Max Gain = $99.00 – Open Price = $224.68
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.6%, Head Room=-13.2%, Max Loss=$900.00, ROC 10.9%, 51d Dev = 8.7

Vertical Bull Put Credit Spread IWM

Entry Rules for Vertical Bull Put Credit Spreads:

  • Current maximum dollars at risk < $8,000? Yes ($7,232)
  • Max dollar at risk this week < $2,000? Yes ($901)
  • Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (51 days)
  • Is the long-term trend (four months) bullish? Yes (see chart)
  • Is the short-term trajectory of the underlying bullish? Yes (see chart)
  • Is the Put/Call Ratio < 1, (or falling if it is > 1)? Yes (1.5 falling)
  • The current price above 9-Day SMA?: Yes (see chart)
  • 9-Day SMA above 50-Day SMA?: Yes (see chart)
  • Is the Short-strike < 1 SD below the current price? Yes (1SD=197.74)
  • Is the short-strikes Prob-OTM > 80%? Yes (81.6%)
  • Short-Strike price below the trend channel at expiration?: Yes (see chart)
  • The current price within the bottom 1/2 of Trend Channel?: Yes
  • Is the long-strike at maximum width (>= 15)? Yes (10 strike width)
  • Set a GTC Conditional Trailing Stop Limit (CTSL): (Not Set)

The broader markets went heavily negative at the beginning of this week. Even though I was at DEFCON 4, I was figuring that I would not enter a new position this week because of the trajectory of the market. But the 7-day trajectory for IWM went bullish and the Headroom was more than 13%, I pulled the trigger.

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Trades Currently Cooking

(As of 02/19/2021)

SPY: 360p/350p  – Open 02/19/21 – Expires 04/01/21 – Max Gain = $85.00 – Open Price = $391.93
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.4%, Head Room=-8.1%, Max Loss=$914.00, ROC 9.2%, 41d Dev = 6.3
Now: Prob. OTM=74.6%, Head Room=-6.1%, IV%=14%

QQQ: 305p/295p  – Open 02/16/21 – Expires 04/01/21 – Max Gain = $100.00 – Open Price = $337.49
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=79.7%, Head Room=-9.7%, Max Loss=$900.00, ROC 11%, 43d Dev = 8.5
Now: Prob. OTM=62.6%, Head Room=-3.7%, IV%=15%

QQQ: 300p/290p  – Open 02/11/21 – Expires 03/26/21 – Max Gain = $95.00 – Open Price = $333.57
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.1%, Head Room=-10.1%, Max Loss=$904.00, ROC 10.4%, 43d Dev = 7.9
Now: Prob. OTM=68.9%, Head Room=-5.2%, IV%=15%

DIA: 290p/280p  – Open 02/09/21 – Expires 03/26/21 – Max Gain = $93.00 – Open Price = $313.15
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.7%, Head Room=-7.4%, Max Loss=$906.00, ROC 10.2%, 45d Dev = 3.7
Now: Prob. OTM=81.3%, Head Room=-7.1%, IV%=24%

QQQ: 295p/285p  – Open 02/05/21 – Expires 03/19/21 – Max Gain = $88.00 – Open Price = $329.98
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82,5%, Head Room=-10.6%, Max Loss=$911.00, ROC 9.5%, 42d Dev = 6.8
Now: Prob. OTM=76.5%, Head Room=-6.8%, IV%=15%

QQQ: 290p/280p  – Open 01/26/21 – Expires 03/19/21 – Max Gain = $101.00 – Open Price = $329.04
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.3%, Head Room=-11.9%, Max Loss=$898.00, ROC 11.1%, 52d Dev = 7.0
Now: Prob. OTM=80.8%, Head Room=-8.3%, IV%=15%

Trades Closed This Week

(As of 02/26/2021)

Positions that would have closed this week, were closed early when they had reached 90% of max gain.

IWM: 190p/180p  – Open 02/03/21 – Expires 03/19/21 – Max Gain = $107.00 – Open Price = $212.91
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=79.7%, Head Room=-10.8%, Max Loss=$892.00, ROC 11.9%, 44d Dev = 7.24
At Close: Prob. OTM=94.7%, Head Room=-16.1%, IV%=29%, ROR= 8.6%

Cost to open: $1.07 premium collected * 100 shares = $107.00
Cost to close: $0.21 premium paid * 100 shares = $21.00
Net Profit= $107.00 to open – $21.00 to close = $86.00 – fees
Actual ROR = $86.00 / $892.00= 9.6%

This position was closed 23 days early with a trade trigger of $.21 (80% of max gain).

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Conclusion

The 10-Year Treasury Note soared up to 1.6% on Thursday, the highest since Feb 2020 (pre-COVID-Crash). This jump got the inflation watchers spooked and the broader markets down nearly 2% in two days of trading. This market adjustment put a lot of pressure on my open positions but not enough to light a fire under them.

The position I open on Wednesday felt good at the time. I was going to wait until Friday for a second entry, but the market turmoil from the Bond Market made be reconsidered.

Next week’s post may expand more on why the Treasury Note caused this upset.

Exit Rules Credit Spreads

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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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Contact Me

To contact me or ask me a non-post related question, please use this form. If you want to comment on this post’s topic, please use the “Leave a Reply” box below so it can be attached to the post for future reference. – Thanks

#OptionsTrades by Damocles
Options Trades by Damocles