When my Vertical Put Credit Option Spread is going bad, these are the Exit Rules I could follow to know when to close.

Your mind is a weapon,
Keep it loaded.

– John Wick (Attributed to)

Exit Strategy for Vertical Spreads

It is not hard to exit a sticky situation – if you are John Wick! But if the weekly Market Sentiment starts to get bloody, I need to have an aggressive plan to exit my open positions – more than just a few coins.

A lot can happen within the 8-week life of a Vertical Bull Put Credit Spread. It can be a beautiful sunny day when I open a promising new position. But along the way, a bad economic report, a national crisis (real or not), a Federal Policy change can cause a short-term knee-jerk market reaction or an aggressive market correction.

I started this topic in the post “EXIT RULES: VERTICAL CREDIT SPREADS – PT 1.” This earlier post reviews why I should early exit a working position. It details how to calculate an exit price and shows how to set up a Trade Trigger in Think or Swim. But it only shows a market-agnostic matrix of when to exit a position. This post means to complete this topic by providing a guideline for closing down a losing position.

Market Awareness

There is no formula to know when to exit a position that is moving in the wrong direction. Market Timing is nearly impossible, but Market Awareness is achievable. I need to understand that I have a wide range of actionable exit prices for wary positions.

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Do As I Say – Not As I Do

The matrix table below is meant to be taken more figuratively than literally. My decision to exit a position early or ride it out will depend on how I believe the underlying asset will perform over completing the contract. I may also be influenced by how many dollars I currently have at risk, how many open positions are misbehaving or if I need the at-risk dollars for a different spread.

Exit Matrix

Use as a guideline only

Weeks to Expiration Current P-OTM > Opening P-OTM1 Short Strike > 1-Standard Deviation of Current Asset Price2 Headroom < 2%3 Short Strike ITM4 Long Strike ITM5
1 Let ExpireLet Expire Exit Price = 90% Exit Price = 1% Let Expire
2 Let ExpireExit Price = 95% Exit Price = 80% Exit Price = 1% Let Expire
3 Exit Price = 90%Exit Price = 93%Exit Price = 75% Exit Price = 1% Let Expire
4 Exit Price = 85% Exit Price = 87% Exit Price = 50% Exit Price = 1% Let Expire
5 Exit Price = 80% Exit Price = 80% Exit Price = 50% Exit Price = 1% Let Expire
6 Exit Price = 80% Exit Price = 80% Exit Price = 50% Exit Price = 50% Let Expire
7 Exit Price = 80% Exit Price = 80% Exit Price = 50% Exit Price = 50% Let Expire
8 Exit Price = 80% Exit Price = 80% Exit Price = 50%Exit Price = 50%Let Expire

Notes

1 Current P-OTM Higher than Opening P-OTM:
Let a winning position play out. If the position is within two weeks of expiration and the current probability of OTM (P-OTM) is greater than P-OTM at open, there is no real reason to exit early. But if it is only a couple of weeks old, closing early will allow me to recycle the same risk dollars sooner.


2 Short Strike Higher than 1-Standard Deviation of Current Asset Price:
If the Short-Strike becomes higher than one standard deviation above the current underlying asset’s price, the current P-OTM has likely fallen lower than the P-OTM on open. This does not mean the position is not winning, but it does mean it is not moving in the right direction. It’s going to be a judgment matter based on the trajectory of the underlying’s price and the percentage of the P-OTM.

3 Headroom Less Than 2%:
I typically do not open a new position if the Short-Strike is less than 7% below the current asset’s price at open. But if I’m more than a couple of weeks out from expiration, and the Short Strike is higher than 1-SD, and the headroom is < 2%, I may want to avoid the angst and close the position at the first sign of profit.

4 Short Strike ITM:
This position is most likely a losing position, and I need to exit ASAP. Regardless of the asset’s trajectory, it may not recover enough to warrant the angst of another market downturn. If I am 6-8 weeks out, go for a minimal profit – but don’t hold my breath. Try for a 1% win if the trajectory is bullish and I have time. But if too far ITM, then consider an exit with a minimal loss.

5 Long Strike ITM:
This position is a total loss. There is nothing I can do but let it ride until expiration. If the position expires with the Long-Strike ITM, my broker will subtract all at-risk dollars allocated for this position from my trading account (max-loss). If I’m lucky and there is a last-minute rebound above the Long-Strike, then it’s a little less loss.

Slow success builds character.
Fast success builds ego.

– John Wick (attributed to)
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This Week’s Market Sentiment

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

(As of 05/10/2021)

In this section, I review five indicators: VIX, Put/Call Ratio, S&P 500, 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.

Geopolitical Tree-Shakers (GTS):

GTS 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.

  • Massive disappointing jobs numbers for April (published last week)
  • 8.1 million recorded job openings and no one going back to work
  • A $6T+ spending bills is being negotiated – expect lots of pork
  • Rising interest/inflation rates will be a continued background pressure for some time
  • Biden’s Tax Plan will specifically hit Tech stocks
  • Colonial Pipeline cyber will spark an energy shortage

The April U.S. Employment Report stunned the Marketeers. It showed employers added just 266,000 to their payrolls where the expectations by our faux-economists were expecting near 1,000,000. On top of that, there is a record-high number of job openings but few are interested in working. Congress may need to modify (get rid of) the Unemployment Benefits Bonus. The anticipated jobs recovery may not recover as fast as expected.

The Colonial cyber-attack has disrupted a significant percentage of energy transactions. This will cause a temporary bump in energy cost and a knee-jerk reaction in the markets. Fuel shortage fears are already having a market reaction.

Anticipation of the Consumer Price report this week is causing the Marketeers to rethink their portfolio. Monday’s market downturn was followed by a collapse on Tuesday. Over 1 1/2 days the markets fell by nearly 3%. This is definitely a market adjustment and may turn into a mini-correction.

I believe that we are seeing the beginning effects of the Biden financial policy (mainly bowing to the left). Treasury Secretary Yellen’s assurance that inflation will NOT be an economic issue is starting to unravel.

Due to:

  • Economic reports are not looking good
  • We are in a market adjustment, moving towards a mini correction
  • Expected reports of increased T-bills interests rates and Consumer Price increase to come
  • Domestic fears of gas lines are exacerbating things

This week’s DEFCON (Damocles Options Trading Readiness Signal) will be initially set at 3.

Setting DEFCON to 3

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, the markets with a VIX closer to 15% or below will have an innate tendency to rise.

CBOE Market Volatility Index - 05/09/2021
CBOE Market Volatility Index – 05/09/2021

The 1-month Regression Channel for the VIX has moved north. The impression we get is there is a shoe about to drop. We believe it will be from the general economic number reporting over the next several weeks: unemployment, new jobs, and the general fear of rising interests.

The VIX ended last week at 16.7%, lower than the week before at 18.6%. This drop happened just after the reporting that the unemployment rose to 6.4% and the expected new jobs created were much lower than expected. This suggests that the Marketeers were expecting much worse.

Market jitters are on the rise for the near term. The VIX (although not all that bad) is in sync with the GTS. If each DEFCON range had a scale in itself, I would think that we are approaching the next level up.

Down grading to DEFCON = 4

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 5/09/21
S&P 500 Put/Call Ratio – as of 5/09/21

The ratio slightly falling from .60 the week before to .54 by the end of last week supports the jump in the VIX.

The 9-Day SMA is now above the 50-Day SMA and above the .5 line. So the short-term trend is moving more to the jitters side. The 50-Day SMA is steadily rising and is about to breach the .5 line. All this suggests the Marketeers are more interested in buying Puts – believing lowering stock prices.

The steady rise in the 50-Day SMA signals rising jitters. So far, the GTS, VIX, and this P/C Ratio appear to be a response to worse-than-expected economic news and fear of more bad news coming. I’m going to lower the DEFCON to 3. Better news in the CSI and Market Movements below may change this level back to 4,

Upgrading to DEFCON = 3

Consumer Sentiment Index (CSI):

I’m searching for a new Consumer Sentiment Index (CSI) chart as provided by the University of Michigan.

A low CSI index 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.

I do not have an update since last week’s April final CSI numbers. At the end of April, the CSI improved to 88.3 from 84.9 last month. But the snail’s pace at which the CSI is recovering from the COVID-Lockdown is a bit disheartening – but recovering it is.

It remains below 90, so I can’t say “things are peachy.” But the continued improvement in Consumer Sentiment is a good sign that the economy is ramping up. With no updates for this week, I will keep the DEFCON as is.

Maintain DEFCON = 3

Market Indexes:

DOW (DJX) = 34,778 – up 2.7% from 33,875 last week. (4 week deviation: 262 flat from 265 last week)
S&P 500 (SPX) = 4,233 – up 2.2% from 4,181 last week. (4 week deviation: 28.6 down from 47.81 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 Trend (Updated 05/02/2021)
Daily S&P 500 Index – Four Months Trend (Updated 05/02/2021)

Market Thrashing

4-Week Thrashing of DJX = +/- 262 points or 0.8% of the market’s volume is flat from 0.8% last week.
4-Week Thrashing of SPX = +/- 47.81points or 0.7% of the market’s volume is down from 1.1% last week.

The Indexes thrashing below 1.x% is indicating a steady-hand market. And since the S&P 500 and DOW’s trend trajectory is bullish, there is no reason to believe that will change. Even though the GTS, VIX, and P/C Ratio are showing rising market jitters, the Marketeers continue to see an improving economy. I will reset the DEFCON back to 4, but keep my eyes open.

Maintain DEFCON = 3

My sentiment for this coming week:

Of the five indicators:

  • the GTS lists several things that can shake the markets,
  • the VIX exhibits rising concern by the Marketeers,
  • the P/C Ratio shows that a growing number of Marketeers are betting on a market pull-back,
  • the CSI has no voice this week,
  • but the Market Movement is saying something different.

I feel the markets have a higher potential to move mostly sideways and down over the next week.

Trading Readiness Level for this week

DEFCON = 3

This week, I will focus on:

  • One spread late in the week (totaling < $2.5K risk) as the Markets see fit.
  • Spread term of 8-weeks or less.
  • Probability of OTM > 83%
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Profit and Loss Statement

(As of 05/14/2021)

Balance Sheet

Year
2021
Month
May
Week
#19
Beginning Account Balance$16,000.00$17,453.03$17,652.97
Deposits (Div. & Int.)$0.50$0.00$0.00
Withdraws (paycheck)-$1,200.00-$0.00-$0.00
Premiums on Open$3,278.01$350.00$138.00
Premiums on Close-$242.00-$9.00-$0.00
Fees Paid (total)-$46.56-$4.08-$1.02
Ending Account Balance$17,789.95$17,789.95$17,789.95
Total Gain/Loss$1,789.95$336.92$136.98
ROR1.9%0.8%
ROC11.2%

Progress Graph

Running P&L - As of 5/14/21
Running P&L – As of 5/14/21

(Note: the negative weekly results for weeks 4, 8, 12 and 17 are when I withdrew $300 from the Trading Account for my paycheck.)

My Performance vs. SPY

Hypothetically, instead of depositing $16,000 in my Options Trading Account, could I have done better if I bought $16,000 of the ETF/SPY instead?

Options TradingSPY
(Fictional)
Initial Investment
(As of Jan 4, 2021)
$16,000
(Cash)
$16,000
(43.39 shares @ $368.55)
Funds Added$3,140.51
(Premiums)
0.31 shares
(Dividends Reinvested)
Funds Removed-$288,56
(Early Close & Fees)
$0
(Fractional Shares Sold)
Ending Balance$18,989.95
(Cash)
$17,927.24
(43.70 shares * $410.28 CV)
ROI+18.7%+12.0%
As of 5/14/2021

Schedule for this Week

Goals for this week: (05/10/2021 – 05/14/2021) (Week #19)

  • 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: Jul 2 (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 05/14/2021)

Spread Count Summary:

Year
2021
Month
May
Week
#19
Vertical Bull Put Credit Spread3131
Vertical Bear Call Credit Spread000
Vertical Bull Put Debit Spread000
Vertical Bull Call Debit Spread000
Margin Interest100
Total3231

Current Dollars at Risk:

Year
2021
Month
May
Week
#19
Vertical Bull Put Credit Spread$13,839.$4,150.$1,862.
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$13,839.$4,150.$1,862.
Max Risk Allowed$16,000.00$8,000$2,500.
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New Positions Opened This Week

(05/10/2021 – 05/14/2021)

SPY: 365p/345p  – Open 05/13/21 – Expires 06/30/21 – Max Gain = $138.00 – Open Price = $408.94
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.2%, Head Room=-10.6%, Max Loss=$1,862.00, ROC 7.4%, 48d Dev = $8.18

Vertical Bull Put Credit Spread - SPY - Short: 365 Put - Long: 345 Put
Vertical Bull Put Credit Spread – SPY – Short: 365 Put – Long: 345 Put

Entry Rules for Vertical Bull Put Credit Spreads:

  • Current maximum dollars at risk < $16,000? Yes ($13,839)
  • Max dollar at risk this week < $2,500? Yes ($1,862)
  • Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (48 days)
  • Long-term trend (four months) bullish? Yes (see chart)
  • Short-term trajectory of the underlying bullish? No (see chart)
  • Put/Call Ratio < 1, (or falling if it is > 1)? No (1.4 up from 0.8)
  • Current price above 9-Day SMA?: No (see chart)
  • 9-Day SMA above 50-Day SMA?: Yes (see chart)
  • Short-strike < 1 SD below the current price? Yes (1SD=378.20)
  • Short-strikes Prob-OTM > 83%? Yes (83.2%)
  • Short-Strike price below the trend channel at expiration?: Yes (see chart)
  • Current price within the bottom 1/2 of Trend Channel?: Yes (see chart)
  • Long-strike at maximum width (>= 10)? Yes (20 strike width)
  • Set a GTC Conditional Trailing Stop Limit (CTSL): (Not Set)

The first three days of this week, the markets took a pummeling. But with the downturn chart started to look like the last market adjustment of about 6 weeks ago, I decided to go extra deep for the Short-Strike and then go extra wide for the premium. Between the current price of SPY and the short-strike, SPY will have to fall below correction (from this point, not from the last high) in order to go ITM.

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Trades Currently Cooking

(As of 05/14/2021)

10 Open Spreads

DIA: 325p/315p  – Open 05/07/21 – Expires 06/18/21 – Max Gain = $81.00- Open Price = $347.06
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.3%, Head Room=-6.4%, Max Loss=$919.00, ROC 8.7%, 42d Dev = $4.23

QQQ: 297p/282p  – Open 05/05/21 – Expires 06/18/21 – Max Gain = $131.00- Open Price = $329.06
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82.7%, Head Room=-9.8%, Max Loss=$1,369.00, ROC 9.5%, 44d Dev = $9.88

IWM: 205p/195p  – Open 04/29/21 – Expires 06/04/21 – Max Gain = $70.00- Open Price = $227.79
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=84.8%, Head Room=-9.9%, Max Loss=$930.00, ROC 7.4%, 36d Dev = $4.11

IWM: 205p/190p  – Open 04/28/21 – Expires 06/18/21 – Max Gain = $134.00- Open Price = $228.03
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.9%, Head Room=-10.2%, Max Loss=$1,366.00, ROC 9.7%, 51d Dev = $5.12

DIA: 320p/310p  – Open 04/21/21 – Expires 05/28/21 – Max Gain = $75.00- Open Price = $340.69
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=84.1%, Head Room=-6.1%, Max Loss=$925.00, ROC 8.0%, 36d Dev = $5.40

SPY: 390p/375p  – Open 04/21/21 – Expires 05/28/21 – Max Gain = $107.00- Open Price = $415.85
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82.3%, Head Room=-6.2%, Max Loss=$1,393.00, ROC 7.6%, 37d Dev = $9.65

IWM: 205p/195p  – Open 04/16/21 – Expires 05/28/21 – Max Gain = $100.00- Open Price = $244.17
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.3%, Head Room=-8.5%, Max Loss=$900.00, ROC 11.0%, 42d Dev = $5.42

QQQ: 310p/295p  – Open 04/14/21 – Expires 05/28/21 – Max Gain = $125.00- Open Price = $339.95
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=82.4%, Head Room=-8.8%, Max Loss=$1,374.00, ROC 9.0%, 44d Dev = $10.35

QQQ: 300p/280p  – Open 04/08/21 – Expires 05/21/21 – Max Gain = $119.00- Open Price = $333.83
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=85.4%, Head Room=-10.1%, Max Loss=$1,879.00, ROC 6.3%, 43d Dev = $7.80

IWM: 200p/190p  – Open 04/06/21 – Expires 05/21/21 – Max Gain = $80.00- Open Price = $225.02
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.8%, Head Room=-11.1%, Max Loss=$919.00, ROC 8.6%, 45d Dev = $5.80

Trades Closed This Week

(As of 05/14/2021)

No position closed this week.

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Conclusion

The past couple of weeks, I have been working through updating the theme for my trade journal (this blog). Many things are still not working. Please forgive the inconvenience.

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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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