This week’s journal entry will continue my review of making loss-Resistant Vertical Bull Put Credit Spreads. Specifically, I will look at my criteria for selecting the Market appropriate Short Strikes.

Loss Resistant Vertical Spread – Short Strikes

Loss-resistant Spreads are not designed to make big money fast.  Loss-resistant Vertical Spreads are Vertical Bull Put Credit Spreads that can generate a modest income during most market conditions. For example, if the underlying asset goes up, moves sideways, or falls slightly, I still want the best probability that my Spreads will yield a profit.

My Options Trading goal is not to win big.
 Instead, I want to win often.
Winning big comes when I can earn it.

Commentary Contents

• How To Make Loss-Resistant Vertical Spreads
• Short Strikes Below ATM
• My Rule of Thumb
  • Short Strikes Below ATM
  • Short Strikes Below One Standard Deviation
  • Strikes Below DEFCON’s POTM
  • Correction Proof Short Strikes
• Conclusion

How To Make Loss-Resistant Vertical Spreads

I found that loss-resistant Vertical Spreads require one or more of the following:

1. Constructing wide strike-widths
2. Short Strikes below ATM (this post)
3. Have Market awareness
4. Targeted expiration dates
5. Steady underlying assets
6. Be ready to manage losing Spreads

Short Strikes Below ATM

Stating the obvious, if I select a Short Strike at or below ATM (At-the-Money), and the underlying stays Bullish throughout my Spread’s existence, then I get to keep the premiums I collected – no loss to contend with. But Markets can unpredictably and abruptly turn downward, and losing an ATM Short Strike can be a significant loss.

One way to construct a loss-resistant Vertical Put Spread is to select a Short Strike below (less than) the current underlying value. My rules of thumb for picking a Short Strike is as follows:

 Clarence: “No, we don’t use money in Heaven.”
George Bailey: “Oh yeah, that’s right. I keep forgetting.
Comes in pretty handy down here, bub!

Movie: It’s a Wonderful Life

• Short Strikes must be below ATM
• Short Strikes should be one Standard Deviation below the current value
• Short Strikes should be above DEFCON’s POTM
• Correction Proof Short Strikes if DEFCON suggests

My Rule of Thumb (For Bull Spreads):

As a reference, consider the following QQQ Put Spread criteria:

• QQQ current price = $382.72
• Short Strike = (see examples below)
• Long Strike = 15 below Short Strike
• Expiration = 45 days

Short Strikes Below ATM

Technically, any Short Strike that I choose at ATM (At-The-Money) or lower can be considered loss resistant.

For example, using the reference QQQ Spread above:

• Sell Short Strike at ATM = 382.50; premium collected = $8.99
• Buy Long Strike (15 wide strike width) = 367.50; premium paid = $4.83
• Total premium collected = $8.99 – $4.83 = $4.16 X 100 shares = $416.00

At expiration, the price of QQQ can drop to $378.34 ($382.50 – $4.16) and not be considered a loss. This is a -1.1% drop from QQQ’s opening value (($382.72 – $378.34) / $382.72 = .011). Therefore, if my QQQ fell 1.1% from when I opened the Spread, all I have to do is pay back the premiums I collected and call this a draw.

Notes:

• Over the course of 45 days, -1.1% is NOT that much of a loss-cushion. That is well within the range of a daily thrashing for QQQ.
• As a personal rule, I will not pick an ATM Short Strike.

Short Strikes Below One Standard Deviation

To define a balance between the probability of winning the Spread versus the premiums I can collect, I can initially guess the Short-Strike to be One Standard Deviation (1SD) either above or below the current value (CV) of the underlying asset. Because this formula includes Implied Volatility (IV), it will adjust my short-strike guestimate according to the underlying’s volatility.

Or

1 SD above CV: $413.27 = $382.72 + ($382.72 * 22.7% * SQRT(45 / 365))
1 SD below CV: $352.17 = $382.72 – ($382.72 * 22.7% * SQRT(45 / 365))

For example, using the reference Spread above:

• Sell Short Strike below 1SD = 352; premium collected = $2.77
• Buy Long Strike (15 wide strike width) = 337; premium paid = $1.69
• Total premium collected = $2.77 – 1.69 = $1.08 X 100 shares = $108.00

At expiration, the price of QQQ can drop to $350.92 ($352 – 1.08) and not be considered a loss. This is a -8.3% drop from QQQ’s opening value (($382.72 – $350.92) / $382.72 = .083). Any downward movement by QQQ that is less than 8.3% will yield a profit.

Notes:

• Over the course of 45 days, an -8.3% loss-cushion covers a lot of Market ills.
• As a personal rule, this Short Strike pick strategy is my default.

Strikes Below DEFCON’s POTM

Market Sentiment plays a significant role in picking the Short Strike. If Market jitters jump last week, or a growing dread is weighing on the Marketeers, I will set a not-so arbitrary floor on the POTM (Probability of Out-of-The-Money).

For example, if I intuitively feel the general Market angst is high, I may put a POTM limit of 85% or higher for any Short Strikes I select.

I will tend to follow this DEFCON rule:

• If DEFCON 5; Short Strike POTM = 80% or lower
• If DEFCON 4; Short Strike POTM = 80% – 85%
• If DEFCON 3; Short Strike POTM = 85% or higher

The POTM recommendation from my DEFCON level may or may not require me to lower my Short Strike even further below 1SD.

Notes:

• For a review of my DEFCON table, see the post “DEFCON: OPTIONS TRADING READINESS SIGNAL?”
• POTM is a calculated value based on the underlying’s Delta value. I can get this value from my Ameritrade ThinkorSwim Trading Platform. See my post “CUSTOM OPTIONS WATCHLIST USING THINKORSWIM IN EXCEL – PT 1” and search for “PROB_OTM”

Correction Proof Short Strikes

There is no such thing as a “Correction PROOF Spread.” But if bubbles are about to pop, Trump is about to Tweet on the Chinese Trade Treaty collapse, or economic signals are flashing other dire warnings, it may be time for a Market Correction.

Market Corrections happens – just like any other biological function. And if I suspect that we are on the precipice of a Correction, I can pick a Short Strike for my Vertical Spread that is 10% or more below the current underlying’s asset value (or, more wisely, not enter a Spread at all). This will yield a significantly less premium to collect, but, I will have a fantasized likelihood of collecting a few bucks during a Market downturn.

Conclusion

There is more to Vertical Spread loss protection than just picking a below ATM Short Strike. I need to also consider my Spread’s Strike-Width, expiration date, and asset and Market mechanics. And most important, I need to know – me.

Remember,
no man is a failure who has friends.

– Clarence (Movie: It’s a Wonderful Life)

Other Posts from Options Trades By Damocles

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 09/06/2021)

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.

Each of my five indicators will “vote” on a DEFCON (Damocles Options Trading Readiness Signal) level, exclusive to that indicator. Then, In the final sub-section “My sentiment for this coming week” below, I’ll compile the votes into a DEFCON level for the week.

Geopolitical Tree-Shakers (GTS):

Geopolitical events can be breaking news, political machinations, Federal Reserve musings, or even Twitter Trends. They are events that can abruptly change the dynamics of the current markets.

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.

• A desasterous Jobs Report last Friday
• S&P and NASDAQ continue to create new record highes (over heated Markets?)
• Talks of mask mandates
• Enhanced unempoyment benefits are ending
• High inflation remains the top issue
• $3.5T Spending bill is flagging
• Delta Varient fear-mongering lockdowns

The broader Markets continue to punch out new highs, regardless of COVID, sputtering recovery, and pending tax hikes. The rate of asset growth is higher than in history. Are we getting prime for a correction? One question I need to ask myself is, should I start “Correction-Proofing” my open Spreads?

The August Jobs Report was a huge disappointment. Only a third of the jobs expected actually materialized. But as a slight boon for this bust, the unemployment rate dropped from 5.4% to 5.2%.

With the continued COVID-mongering, the thread of mask mandates, vaccine mandates, and possible new lockdowns are weighing heavy on my decisions for new Vertical Spreads. If the government is going to implement behavior mandates that will prevent people from participating in commerce, then corporate stock growth will slow down.

The Federal Government’s Pay-to-Not-Work programs are set to expire at the end of September. I’m suspecting this will not have a big effect on the long-term Markets. (Note, nearly 12.2 million people receive some sort of unemployment assistance. That equates to about 3.7% of the US population.)

The Democrats/Progressives’ $3.5T tax and spend bill is hitting major Dem pushback in both houses. I suspect there will be reports of big compromises.

The GTS this week is showing signs of economic worry, but I do not think there is any evidence of a correction (but I may want to start thinking about how to “Correction-Proof” my open Spreads).

Therefore, based solely on what I listed here, I will vote for a strong DEFCON 4.

GTS votes a DEFCON 4

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 one-month forward-looking volatility, 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. Since the intrinsic nature of the Stock Market is to move up, a VIX close to 15% or below will have an innate tendency to rise.

The 1-month Regression Channel for the VIX trajectory continues a sideways trajectory.

The VIX ended last week at 16.41%, flat from 16.39% the week before, and the 9-Day SMA continues below the 50-Day SMA, while the 50-Day SMA levels off.

The VIX is still above 15%, so I cannot vote a DEFCON 5 for this section, but the direction is looking pretty good.

VIX votes a DEFCON 4

Put/Call Ratio:

Put Options are frequently used as protection 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 Friday, the Put/Call Ratio boomed above and below the 0.5 line last week. This happened just before the August Jobs Report was published. I will have to wait until Tuesday to see if the Marketeers will shrug this off.

The Put/Call Ratio ended Friday at .6, a skittish jump above the 9-Day SMA. The 9-Day SMA remains above the 50-Day, and the 50-Day-SMA grew a smidgeon above the 0.5 line. Thus, all short-term trajectories are indicating a continuation towards concern and not so much toward fear.

The Marketeers continue to show a moderate degree of indecision, as indicated in the increased amplitude of the Put/Call Ratio.

I cannot ignore that the ratio is still well below the insidious 1.0 line (1 Put to 1 Call). Being below 1.0 suggests but above the .05 line indicates that we are generally in good shape even though we have some bad days.

Put/Call Ratio votes a DEFCON 4

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.

The boys at UM have not released the preliminary Sept data for the CSI. So everything I said last week still stands today.

The final two weeks of August showed no improvement from the collapse last month. So whether it is inflation fears, COVID fears, trillions of dollars Federal Budget fears, or the Fed’s preparation of raising interest rates to cool down an overheated economy – the future has started to look economically bleak to most folks.

Being blind to all other indicators and just looking at this week’s CSI, I still feel we should be extremely cautious.

CSI votes a DEFCON 3

Market Indexes:

DOW (DJX) = 35,369 – Down 0.2% from 35,456 last week. (4 weeks deviation: 179 down from 237 last week)
S&P 500 (SPX) = 4,535 – Up 0.6% from 4,509 last week. (4 weeks deviation: 40.72 up from 34.14 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.

Market Thrashing

4-Week Thrashing of DJX = +/- 179 points or 0.5% of the market’s volume is down from 0.7% last week.
4-Week Thrashing of SPX = +/- 40.72 points or 0.9% of the market’s volume is up from 0.8% last week.
(Market Thrashing above 1.0%. might indicate indecision for the Marketeers.)

Just looking at the Market’s performance, the four-month trend is strongly bullish, the four-week trajectory is strongly bullish, and overall Market thrashing is low. All of this signals a motivated Bull Market.

The S&P 500 made slight adjustments and quick rebounds after the second week in the last four months. This appears to be a reaction to the mid-month Consumer Sentiment report or the Job’s Report. So if history can be a predictor of the future, I might expect the same next week. But since the Marketeers seems to brush this indicator off quickly, I will not be bothered by it.

Being blind to all other indicators and just looking at current market trends, this week will vote for DEFCON 5!

Market Index votes a DEFCON 5

My sentiment for this coming week:

Of the five indicators:

• The GTS is advertizing possible kneejerkable content, but I should not be too concern – DEFCON 4
• The VIX improved but remains above 15% – DEFCON 4
• The P/C Ratio shows consern but not too much fear – DEFCON 4
• The CSI shows a consumer base not excited about our economic future – DEFCON 3
• The Market Movement continue to defiantly inch bullish – DEFCON 5

This week’s Market indicators show a DEFCON 4 level.

Trading Readiness Level for this week

DEFCON = 4

This week, I will focus on:

This week begins with some growing jitteriness in the Markets. But I’m still looking forward to a couple of weeks of good growth.

Because I see the next couple of weeks as a DEFCON 4, I will set my POTM sights to 80%.

• Open two 15-Strike-Wide Vertical Put Spreads for a total market risk this week of < $3K risk (as the Markets see fit)
• Spread term of 8-weeks or less
• Probability of OTM > 80%

Profit and Loss Statement

(As of 09/10/2021)

Balance Sheet

Progress Graph

(Note1: the negative weekly results for weeks 4, 8, 12, 17, 21, 25, 30, and 34 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?

Schedule for this Week

Goals for this week: (09/07/2021 – 09/10/2021) (Week #36)

Note: Monday is Labor Day and a financial holiday. This week will only be 4 trading days.

• 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: Oct 29 (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, if 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.

This Week’s Trade Activity

(As of 09/10/2021)

Spread Count Summary:

Current Dollars at Risk:

Vertical Spreads Opened This Week

(09/07/2021 – 09/10/2021)

SPY: 425p/410p  – Open 09/09/21 – Expires 10/22/21 – Max Gain = $119.00 – Open Price = $452.05
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=79.5%, Headroom=-6.0%, Max Loss=$1,381, AROR=72.5%

Entry Rules for Vertical Bull Put Credit Spreads:

• Current maximum dollars at risk < $16,000? Yes ($14,922)
• Max dollar at risk this week < $3,000? Yes ($2,761)
• Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (43 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 (1.1 up from 0.9)
• Current price above 9-Day SMA?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• Short-strike < 1 SD below the current price? Yes (1SD=$425.50)
• Short-strikes Prob-OTM > 80%? No (79.5%)
• 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)
• Strike Width minimum (>= 15)? Yes (15 strike width)

Prior to today’s Market opening, the US Jobless Claims report surprised most by falling more than estimated. This may be an indicator that the monthly dip may be muted this month.

QQQ: 350p/335p  – Open 09/08/21 – Expires 10/22/21 – Max Gain = $120.00 – Open Price = $379.40
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.7%, Headroom=-7.8%, Max Loss=$1,380, AROR=71.5%

Entry Rules for Vertical Bull Put Credit Spreads:

• Current maximum dollars at risk < $16,000? Yes ($13,541)
• Max dollar at risk this week < $3,000? Yes ($1,380)
• Max time to have any dollars at risk < 8 weeks (<56 days)? Yes (44 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)? Yes (1.5 down from 1.6)
• Current price above 9-Day SMA?: Yes (see chart)
• 9-Day SMA above 50-Day SMA?: Yes (see chart)
• Short-strike < 1 SD below the current price? Yes (1SD=$356.58)
• Short-strikes Prob-OTM > 80%? Yes (80.7%)
• 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)
• Strike Width minimum (>= 15)? Yes (15 strike width)

Vertical Spreads Currently Cooking

(As of 09/10/2021)

QQQ: 355p/340p  – Open 08/30/21 – Expires 10/15/21 – Max Gain = $123.00 – Open Price = $379.55
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=79.0%, Headroom=-6.5%, Max Loss=$1,377, AROR=70.3%

SPY: 415p/400p  – Open 08/24/21 – Expires 10/15/21 – Max Gain = $116.00 – Open Price = $447.85
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.7%, Headroom=-7.4%, Max Loss=$1,384, AROR=58.3%
Now: Prob. OTM=86.9%, Headroom=-8.5%

SPY: 430p/415p  – Open 09/02/21 – Expires 10/08/21 – Max Gain = $100.00 – Open Price = $453.48
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=80.7%, Headroom=-5.2%, Max Loss=$1,400, AROR=71.7%
Now: Prob. OTM=86.9%, Headroom=-8.5%

SPY: 395p/370p  – Open 08/19/21 – Expires 10/01/21 – Max Gain = $133.00 – Open Price = $2,367
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=85.4%, Headroom=-10.1%, Max Loss=$2,367, AROR=47.3%
Now: Prob. OTM=94.9%, Headroom=-12.9%

SPY: 405p/390p  – Open 08/10/21 – Expires 09/30/21 – Max Gain = $96.00 – Open Price = $443.20
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=84.3%, Headroom=-8.6%, Max Loss=$1,404, AROR=48.4%
Now: Prob. OTM=93.4%, Headroom=-10.7%

QQQ: 350p/335p  – Open 08/25/21 – Expires 09/24/21 – Max Gain = $90.00 – Open Price = $374.19
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.0%, Headroom=-6.4%, Max Loss=$1,410, AROR=76.8%
Now: Prob. OTM=90.0%, Headroom=-8.3%

SPY: 410p/400p  – Open 08/12/21 – Expires 09/24/21 – Max Gain = $70.00 – Open Price = $442.89
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=83.6%, Headroom=-7.4%, Max Loss=$930, AROR=63.0%
Now: Prob. OTM=93.9%, Headroom=-9.6%

SPY: 400p/380p  – Open 07/29/21 – Expires 09/17/21 – Max Gain = $1.11 – Open Price = $441.40
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=85.7%, Headroom=-9.4%, Max Loss=$1,889, AROR=42.5%
Now: Prob. OTM=97.4%, Headroom=-11.8%

Vertical Spreads Closed This Week

(As of 09/10/2021)

QQQ: 340p/325p  – Open 08/05/21 – Expires 09/10/21 – Max Gain = $82.00 – Open Price = $368.11
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM=85.1%, Headroom=-7.6%, Max Loss=$1,418, AROR=59.6%
At Close: Prob. OTM=99.9%, Head Room=-10.9%, AROR= 59.6%

Cost to open: $0.82 premium collected * 100 shares = $82.00
Cost to close: $0.00 premium paid * 100 shares = $0.00 (expire worthlessly)
Net Profit= $82.00 to open – $0.00 to close – $1.00 fees = $81.00
AROR= (81.00 / 35 days in play) *365 / $1,418= 59.6%

Conclusion

Can Options Trading be considered a Home Business? Can I make money at home by selling Vertical Bull Put Credit Options Spreads? These are questions that I am trying to answer for myself.

Three years ago, I set out on a task to see if I can make a retirement income from home by trading Stock Options. I began with NO knowledge of Options mechanics and only $8,000 to risk. And because I learn best when I write things down, I have documented every step of the way (every bonehead mistake, process epiphanies, interconnecting events, externalities, and so on).

Disclaimer

Even though I have tried to make it clear that this blog is my personal trading journal, 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.”