This week’s Journal Entry will examine how premiums diminish as I construct wider credit spreads. Using graphs for QQQ, DIA, IWM, and SPY, I can show how the spread’s premiums flatten out the deeper down the Put Chain I make my Long Strike. At what point do the Wide-Strike Spreads become unreasonable?

There are some things you can’t share without
ending up liking each other,
and knocking out a twelve-foot mountain troll
is one of them.

(Movie: Harry Potter and the Sorcerers Stone)

Commentary

Honing in on a profitable Vertical Bull Put Credit Spreads configuration is like battling a Mountain Troll. I can’t outright beat it – I have to wear it out. I can’t do it alone – I need companions to help with the attack. And I can’t attack it with just one strategy – I need to use many tactics.

To be successful at Options Spread trading, I need to constantly research different strategies, be engaged with the investing community, be aware of the economic environment around me, and be ready to err with low-risk positions.

What’s life without a few dragons.”
– Ron Weasley

How Wide of a Spread is Reasonable?

One attribute of credit spreads is that I am obligating $100 from my trading account for every strike-width I configured. If the strike-width of a new spread is 1, I need to have 1 * $100 = $100 set aside to cover the possibility that the spread will suffer max loss. Likewise, if I open a position with a strike-width of 10, I need to put 10 * $100 = $1,000 cash aside. Therefore, one universal characteristic of all spreads is one strike-width = $100 risk.

Unfortunately, that uniformity is not the same for premiums. Part of the voodoo-mathematics that calculate spread premiums includes both Time-Value (TV) and Implied Volatility (IV) for each leg. Thus, the further up the Put Chain the Long-Strike is, the smaller the aggregate premium is available to collect. This results in a diminishing premium value as the strike-width gets wider when compared to the dollar risk.

So this begs the question: Just how wide can I construct a credit spread before the parity between premium collected to dollar risks becomes unreasonable?

I solemnly swear I am up to no good.”
(Movie: Harry Potter)

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Diminishing Premiums Graphs

To provide a visual aid, I plotted charts for four of my go-to spread underlying assets to see just how quickly the aggregated premiums flattens out the wider the spreads I construct.

The bottom left corner of these plots is the pretend short strike price “At The Money” (ATM) and its corresponding premium price. The horizontal axis follows all the available long strikes up the Put Option Chain. The vertical axis shows the spread’s premiums available for each long strike.

My Entry Rules requires that I select a short-strike that is less than one standard deviation below the current ATM strike. (To see how I calculate Standard Deviation, see my post “Entry Rules for Vertical Put Credit Spreads.”) So, as that starting point, I have already bypassed most of the available premiums. If I revise my Entry Rules and pick a short-strike just above one standard deviation, then the premiums that I could collect will be much higher.

Things we lose have a way of coming back to us in the end,
if not always in the way we expect.”
– Luna Lovegood (Movie: Harry Potter and the Order of the Phoenix)

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How Low Can I Go?

To configure a spread that will yield a $1.00 premium, I will have to configure a spread of at least 10 strikes wide. Being 10 strike-wide, I will have to set aside $1,000 in my trading account.

If I wanted to add another $1.00 (total $2.00), I would need to extend my strike-width another 15 strikes and then allocate another $1,500 for set aside.

If I wanted to add an additional $0.75 premium ($2.75 total), I would need to pony up $4,000 more set aside dollars for that paltry amount.

It’s our choices that show what we truly are,
far more than our abilities.
– Albus Dumboldor (Movie:

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This Week’s Market Sentiment

(As of 03/15/2021)

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

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 – 03/13/2021

VIX 9-Day SMA dropped to 24% from last week’s 5%. The one-week deviation was +/- 1.6 percentage points, which is a bit more settled from last week’s 1.97 points (thrashed 7.7% of the current 220.7%). As a signal, this is showing less market uncertainty from the previous week.

The 1-month Regression Channel for the VIX reversed its trajectory to suggest more volatility may come from the unsureness of rising interest/inflation rates. With the added news of Treasury bonds now on the rise, last week’s market thrashing was a good illustration.

The VIX currently is 20.7% and has shot down below the 9-Day SMA, suggesting improvement. But the 9-Day is still above the 50-Day SMA. Apparently, after the 10-Year Treasury Note Auction early last week, there was a significant sigh of relief from the Marketers, and the current VIX value fell below the Trend-Channel’s support line.

The VIX continues to hover above 15, which in itself is waving the jitters flag. But the steep drop over last week to barely above 20% is a good sign that we are moving in the right direction. I will initially set this week’s DEFCON (Options Trading Readiness Signal) level to 3. Let’s see if the other indicators will change this level.

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.

S&P 500 Put/Call Ratio – as of 03/13/21

There was an Interset Rate scare that caused most of us to duck-and-cover. But that seems to have passed us by.

The 50-Day SMA, 9-Day SMA, and the current Put/Call Ratio is starting to merge and flatline below 0.5. I’m taking this to signal that there is not too much concern out in Options-Verse

I’m reading this indicator as contrary to the VIX. So I’m going to raise the DEFCON from 3 to 4.

Elevate DEFCON = 4

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Consumer Sentiment Index (CSI):

As of Mar ’21 CSI’s level rose to 83.0 from at 76.8 last week. (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: 03/13/21

The US Consumer Confidence index rose 8.1% from last month. This is a significant improvement since the COVID-Crash a year ago. Another improving indicator.

This index lever reinforces that current DEFCON level.

Maintain DEFCON = 4

Market Indexes:

DOW (DJX) = 32,779 – Up 4.1% from 31,496 last week. (4 week deviation: 5.0, up from 2.2 last week)
S&P 500 (SPX) = 3,943 – Up 2.6 % from 3,842 last week. (4 week deviation: 45.6 flat from 45.8 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 03/13/2021)

The S&P 500 rebounded last week and pumped the SMAs.

Market Thrashing

4-Week Thrashing of DJX = +/- 4.5 points or 1.4% of the market’s volume. Flat from < 0.1% last week.

4-Week Thrashing of SPX = +/- 49.5 points or 1.3% of the market’s volume. Mostly flat from 1.2% last week.

Last week’s 4-Week thrashing ratios appear to be in response to the rebound from the previous 10 days.

High thrashing is a signal for high volatility. Even though there is a consensus of returning to the bull markets, it also means that there may be some short-term profit-taking nearing.

So far, all indicators are signaling caution ahead.

Maintain 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.

  • More States are dropping draconian COVID restrictions
  • Reports of new COVID related lockdowns in other countries due to COVID variants
  • Increase vaccines becoming available as more people inoculated
  • Becoming hyper-aware of the inevitable rising of interest/inflation rates
  • The $1.9T COCID-CON stimulus bill was passed and signed by Biden
  • A Federal Infrastructure bill is nearing
  • Tech Stocks brushes with Correction Territory this past Friday
  • The 10-Year Treasury Notes are starting to rise
  • Federal Reserve is meeting this week – expect comment on rising Interest

Rebuilding the decimated small-business sector will raise the interest rates – as supply-and-demand dictates. And rising interest rates are always a competitor to stocks as many Marketeers will sell stocks and buy bonds. But this kind of shift in the equity markets has always been quickly absorbed, and market adjustments always rebound. But I need to expect Market-Shock (adjustments) as Interest/Inflation Rates start reaching new highs.

Maintain DEFCON = 3

My sentiment for this coming week:

There continues to be a lowering of the temperature in economic and geopolitical concerns at the moment (go figure, activist-journalists succeed to dump Trump). The CSI is on the rise, VIX is falling, and the Put/Call Ratios are confident. If it wasn’t for the Markets trying to find a new trend and the Inflation Rates getting a little scary, I would be inclined to raise the DEFCON to 4.

We are definitely moving is the right direction but I will maintain a solid DEFCON 3.

Trading Readiness Level

DEFCON = 3

This week, I will focus on:

QQQ was hit hard by the Tech-Correction a couple of weeks ago but is now on the rebound. So this may be a buy-low (or for Bull Put Credit Spreads, sell-high) time.

  • May consider one 20-Strike-Width as a research trade. If I do, it will be the only new position for the week
  • Two spreads (both totaling @ $2K risk) as the Markets see fit.
  • Spread term of 8-weeks or less.
  • Probability of OTM > 80%
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Cash Flow Statement

(As of 03/19/2021)

Year
2021
Month
Mar
Week
#11
Beginning Account Balance$16,000.00$16,486.26$16,820.18
Deposits (Div. & Int.)$0.23$0.00$0.00
Withdraws (paycheck)-$600.00-$0.00-$0.00
Premiums on Open$1,545.01$526.00$176
Premiums on Close-$91.00-$12.00-$0.00
Fees Paid (total)-$21.04-$5.11-$1.03
Ending Account Balance$16,995.15$16,995.15$16,995.15
Total Gain/Loss$995.15$508.89$174.97
ROR3.1%1.0%
ROC6.2%

Realized Profit by Strategy

Year
2021
Month
Mar
Week
#11
Vertical Bull Put Credit Spread$698.65$265.89$186.94
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$0.00$0.00
Total$698.12$265.89$186.94
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Schedule for this Week

Goals for this week: (03/15/2021 – 03/19/2021) (Week #11)

  • 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: May 7 (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 03/19/2021)

Spread Count Summary:

Year
2021
Month
Mar
Week
#11
Vertical Bull Put Credit Spread1641
Vertical Bear Call Credit Spread000
Vertical Bull Put Debit Spread000
Vertical Bull Call Debit Spread000
Margin Interest100
Total1741

Current Dollars at Risk:

Year
2021
Month
Mar
Week
#11
Vertical Bull Put Credit Spread$8,595.$4,974.$1,824.
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$8,595.$4,974.$1,824.
Max Risk Allowed$16,000.00$8,000$2,000.

New Trades Opened This Week

(03/15/2021 – 03/19/2021)

QQQ: 290p/270p  – Open 03/16/21 – Expires 04/30/21 – Max Gain = $177.00- Open Price = $323.99
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.3%, Head Room=-10.5%, Max Loss=$1,822, ROC 9.7%, 45d Dev = $9.91

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Entry Rules for Vertical Bull Put Credit Spreads:

  • Current maximum dollars at risk < $16,000? Yes ($8,595)
  • Max dollar at risk this week < $2,000? Yes ($1,824)
  • Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (45 days)
  • Long-term trend (four months) bullish? Yes (see chart)
  • Short-term trajectory of the underlying bullish? Yes (see chart)
  • Put/Call Ratio < 1, (or falling if it is > 1)? Yes (1.4 falling from 2.0)
  • Current price above 9-Day SMA?: Yes (see chart)
  • 9-Day SMA above 50-Day SMA?: No (see chart)
  • Short-strike < 1 SD below the current price? Yes (1SD=292.09)
  • Short-strikes Prob-OTM > 80%? Yes (81.3%)
  • Short-Strike price below the trend channel at expiration?: Yes (see chart)
  • Current price within the bottom 1/2 of Trend Channel?: Yes
  • Long-strike at maximum width (<= 15)? No (20 strike width)
  • Set a GTC Conditional Trailing Stop Limit (CTSL): (Not Set)

This is a test position:

  1. This is my first ultra-wide strike-width of 20. The is the widest I can go without going over my max-risk for the week rule. Thus this will make it my only position for the week.
  2. The 50-Day SMA is above the 9-Day SMA. This is due to the fact that the tech-sector just went through a correction (losing > 10% of its value) and has begun a rebound.

Trades Currently Cooking

(As of 03/19/2021)

IWM: 205p/195p  – Open 03/11/21 – Expires 04/23/21 – Max Gain = $103.00 – Open Price = $230.45
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.5%, Head Room=-11.4%, Max Loss=$896.00, ROC 11.4%, 43d Dev = 6.5
Now: Prob. OTM=88.0%, Head Room=-9.4%, IV%=6%

QQQ: 270p/255p  – Open 03/08/21 – Expires 04/23/21 – Max Gain = $145.00 – Open Price = $308.79
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.7%, Head Room=-12.5%, Max Loss=$1,354.00, ROC 10.6%, 46d Dev = 8.9
Now: Prob. OTM=73.8%, Head Room=-7.5%, IV%=11.2%

IWM: 195p/185p  – Open 03/02/21 – Expires 04/16/21 – Max Gain = $102.00 – Open Price = $223.41
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=81.2%, Head Room=-12.7%, Max Loss=$897.00, ROC 11.3%, 45d Dev = 6.6
Now: Prob. OTM=92.%, Head Room=-13.9%, IV%=6%

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
Now: Prob. OTM=90.2%, Head Room=- 13.9%, IV%=6%

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=92.1%, Head Room=-7.6%, IV%=21%

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=66.0%, Head Room=-2,7%, IV%=?

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=79.2%, Head Room=-4.2%, IV%=?

Trades Closed This Week

(As of 03/19/2021)

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
At Close: Prob. OTM=98.5%, Head Room=-6.8%, IV%=30.1%, ROR= 9.7%

Cost to open: $0.88 premium collected * 100 shares = $88.00
Cost to close: $0.00 premium paid * 100 shares = $0.00 (Expired)
Net Profit= $88.00 to open – $0.00 to close = $88.00 – fees
Actual ROR = $88.00 / $911.00= 9.7%

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
At Close: Prob. OTM=99.3%, Head Room=-8.4%, IV%=30.0%, ROR= 11.2%

Cost to open: $1.01 premium collected * 100 shares = $101.00
Cost to close: $0.00 premium paid * 100 shares = $0.00 (Expired)
Net Profit= $101.00 to open – $0.00 to close = $101.00 – fees
Actual ROR = $101.00 / $898.00= 11,2%

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Conclusion

The 20 strikes widespread that I open this week yielded $177 to my trading account. For this position to suffer max loss, the markets would have to be inflected by another COVID-Lockdown crash of 2020. And QQQ would have experience another +10% correction – just on the heels of the last one.

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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

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