In my longing to see a sustained market rebound, I have to be careful not to confuse the beginning of a new bull market with a bull trap.

Beware the Bull Trap

My Options Income strategy centers around selling short-term (6-8 weeks) Option Spreads for a satisfying premium. The strategy’s success banks on the underlying asset’s trend (bear or bull) continuing for the duration of the position’s term and then expiring worthlessly.

Commentary Contents

• What is a Bull Trap?
• Past Bull Traps
• Signs of a Bull Trap

I believe we are solidly at the beginning of a prolonged bear market. Our national and global economic dynamics, from post-pandemic to a shooting war in Europe, have thrown our market futures into a bit of chaos. And in my longing to see a sustained market rebound, I have to be careful not to confuse the beginning of a new bull market with a bull trap.

What is a Bull Trap?

A Bull Trap is when the underlying asset of my Vertical Option Spreads has been in a downward trend for a while, then suddenly jumps into a rally. The rally is long enough and big enough to convince me that the underlying may have actually hit bottom. This illusion can lure me into either keeping a wrong strategy (as was the case earlier this year when I kept rolling losing Bull Spreads) or entice me into changing strategies too early. Then the rally runs out of gas, and the underlying reestablish its downward trend.

For Example, this SPX chart below (S&P 500 Index) for the first 6 months of this year shows 3 Bull Traps.

Each of these three Bull Traps shows a sustained market rally that lasted 2 or more weeks and each bounce saw a 6-10% return. And each time gave me the illusion that the market downturn was over.

Each of these Bull Traps lured me into rolling the deep ITM Spreads in my inventory. And each of the downtrends that followed these Bull Traps was long enough and steep enough that I lost almost all my rolled positions.

Past Bull Traps

During the 2008 Financial Crisis, Bull Traps faked out investors with three rallies between the Fall of 07 through 2008. These rallies were 8%, 12%, and 7%. After each rally, all dropped to new lows.

Over 16 months, the 2008 Financial Crisis lost 52% of the S&P 500 value. It had 3 1+ month-long rallies (bull traps) and many 1 or 2 week-long rallies.

There’s an ambush waiting for you.

– Diego (Movie: Ice Age: The Meltdown)

Signs of a Bull Trap

There is no crystal ball to help me recognize if we are in a Bull Trap. But there are some signs that may signal that a bull market may be close at hand (5 Things To Happen Before The Bull Market Can Return). And if we are in a nice multi-week market rally then I need to ask myself these questions:

Has the Global Economic Outlook Improved?

The Russian war with Ukraine and the China COVID lockdown is the one-two punch in a global economic meltdown. Both of these economies are significant in the worldwide supply chains. And with both of these economies out of action, I will expect inflation to continue to rise and stocks to fall.

Is the Misery Index Falling or Below 10%?

The Misery Index is an ideal measurement of the Fed’s progress to combat inflation. Combining inflation and unemployment will provide an index that will show if the economy is healing (regaining its balance between supply and demand), or still struggling. I’ll maintain that a Misery Index that is rising and above 10% is a signal for a bear market.

Have Oil Prices Dropped Below $100/bbl?

Oil prices above $100/barrel mean gas will stay above $4/gal. High energy prices will translate to a higher cost of production, thus higher prices for stuff.

Is Consumer Sentiment on the Rise?

Marketeers are consumers too. Currently, the Consumer Sentiment Index is at its lowest point on record. As long as the index is below 70%, it will be hard to convince me that the bulls grow nigh.

Negligible improvements in any one of these signs can trigger a rally in the broader markets – a Bull Trap. But for me to change my bear Options strategies, I need to see meaningful improvements in multiple signposts. The key to convincing me that we are nearing the end of the bear market is going to be found in my Market Sentiment section (below) in particular the “Ecopolitical Influencers” sub-section.

I just did something involuntary…. and messy.

– Sid (Movie: Ice Age: The Meltdown)

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 06/27/2022)

This section reviews five indicators: Ecopolitical events, VIX, Put/Call Ratio, Consumer Sentiment Index, the S&P 500, and how these could affect the market’s direction. Then, 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.

Ecopolitical Influencers

Ecopolitical (Sociopolitical-Economics) Influencers (EPIs) 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. U.S. political polarization’s impact on Wall Street cannot be glossed over.

EPIs are 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 EPIs can significantly disrupt all the other indicators at the drop of a tweet.

Yikes – Yawns – Yays

• Misery Index over 12% – Yikes
• Feds backs 0.75% interest rate hike in July – Yikes
• China can’t get it up – Yikes
• Election year fearmongering escalates – Yikes
• North Korea prepares to conduct a nuclear test – Yikes
• Russia/Ukraine war continues – Yikes
• Russia defaults on debt – Yikes
• Ban on Russian gold – Yikes
• We are in stagflation – Yikes
• First-quarter GDP release Wednesday – Yikes
• Core PCE rose to 4.7% – Yikes

• Roe v. Wade decision – Yawn
• Gun Control bill signed by Biden – Yawn
• Biden Admin canceling $6B in student loans – Yawn

• WTI oil prices leveling? – Yay
• China moderating COVID restrictions – Yay
• Regulating the Regulators – Yay

Geopolitical

• Even though the Ukraine war is not dominating the headlines as it did a few months ago, it still rages and Russia’s sanctions and Ukraine’s oppression still inflicts pressure on a fragile supply chain and a vicious inflation. Adding to the already existing punitive sanctions on Russia will be a ban on the import of Russian gold by those countries that make up the G7. Russia also has entered its first major foreign debt default in over 100 years. Adding salt to Putin’s wounds, the last obstacle for Finland and Sweden to officially join NATO was removed this week when Turkey lifted its objection.

• President Biden’s canceling $6B in student loans is a bait and switch political story. Suing Universities over misleading student recruitment tactics, and reimbursing duped students have been a legal matter for dozens of years. This is not canceling debt but receiving retribution of a legal settlement.

• There’s another significant Supreme Court Ruling expected this week. West Virginia vs. the Environmental Protection Agency can be even more consequential than Roe. If the highest court rules in favor of West Virginia then that could upend how Federal and State governmental administrations implement regulations that impact everyone’s lives – by unelected bureaucrats. This may soften a lot of punitive rules that cost a lot of money.

• China has cut its mandatory inbound quarantine time from 21 days to 7 in its first move to ease its Zero-COVID policy. Shanghai is coming out of months of painful lockdowns. Easing their draconian containment policies is a first step in re-establishing their global economy.

• The hell and damnation reaction to the overturning of Roe is nothing more than a show to gin up hysteria for the mid-term elections. I expect the Progressive-controlled House will pass liberal versions after liberal versions of abortion bills, knowing that they will all fail in the Senate. The DNC desperately needs a supervillain to stir up the Woke generation prior to the elections. (The “make no mistake, abortion will be central to this mid-term election” threat is rich. When has abortion ever NOT been central in every election since 1973?)

Socioeconomics 

• Has stagflation arrived? The U.S. economy contracted by 1.5% in the first quarter and inflation has risen to 8.6%. We are experiencing stagflation now.

• Are we in a recession? A majority of economists are saying we are now at the front end of a recession.

• The Core Personal Consumption Expenditure prices (Core-PCE) rose by 4.7% over last year. This is 0.1% less than what was expected, but still mega high.

• Federal Reserve Bank of Cleveland President Mester reported that if the Yikes and Yays list remains unchanged, the Feds will likely vote to raise the National Discount rate up another 0.75% in July. The end of the year’s target rates keeps inching up the closer we get there. The current expectation is now 3.5% – originally it was 1.5%-1.75%.

• The initial report on the 1st Quarter GDP reported our economy shrank by 1.4%. The final update to this report will be released this Wednesday. The bet on Wall Street is that the final numbers will show a slightly deeper contraction. Next on deck will be the telling 2nd Quarter preliminary GDP release on July 28.

The systemic issues keeping pressure on the markets have not changed: War in Ukraine, high/rising inflation, China shuttered, oil price high, and sucky Consumer Sentiment. So, I’m keeping with the DEFCON 2 until one of these five starts to let up.

ETS votes a DEFCON 2

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 move but rather 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 correspond with the market’s innate tendency to rise.

The 4-week trajectory of the VIX Regression Channel continued its track towards more volatility.

• Last week the VIX dropped down to 27.23% from 31.13% the week before
• The VIX spent most of the previous two weeks above the 30.0% line
• The current VIX dropped sharply below the 9-Day but is still above the 120-Day SMA
• The 9-Day SMA is above the 120-Day SMA

The VIX’s high volatility is good for collecting premiums or pushing the Short-Strike further out. However, this confirms that a bear trajectory is likely for the next few weeks.

VIX above 30% is my demarcation for a DEFCON 2. But to get back to a DEFCON 3, the VIX needs to be below 30 and the 14-Day trajectory needs to move towards less volatility.

Being blind to all other indicators, I will vote for an optimistic DEFCON level 2

VIX votes an optimistic DEFCON 2

Put/Call Ratio

Put Options are frequently used as protection against existing investments falling. When the ratio between Put Options bought and Call Options bought rises, this indicates that the Marketeers are buying insurance for what they may see as declining markets (or a pending market collapse). Conversely, when the Put/Call Ratio falls, there is a general sense that the broader markets will increase, and more investors are buying more than selling.

• The S&P 500’s Put/Call Ratio dropped well below the 0.75 line and is sitting comfortably in the “Good Shape” region.
• The 9-Day SMA remains well above the 0.75 line, confirming the markets will remain bearish for a while

The significant drop in last week’s Put/Call Ratio gives credence that the rally last week may continue. Marketers are not buying protective Puts to their new assets acquisition, but more Calls for new buys.

Being solid in the Good Shape region, I will give this week’s indicator an unequivocal DEFCON 3.

Put/Call Ratio votes an unequivocal DEFCON 3

Investors’ Sentiment

Marketeers are people too. And when the economy is humming, investments are smoking. Conversely, when the economy is threatening their portfolios, they tend to run for cover.

Consumer Sentiment Index

A low Consumer Sentiment 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. Surveys of Consumers (umich.edu)

June’s final results weren’t too much different from the preliminaries reported two weeks ago. But it is still over 14% down from last month and over 41% down from last year. As a trajectory, these levels continue to showcase the doldrums of Biden/Progressive financial policies.

Misery Index

With the copious amount of economic pressures throughout the nation this year (inflation, employment, interest rates, etc.), knowing what the Misery Index is, and what direction the index is moving can cast a long shadow on Marketeer’s sentiment. Numbers are coming from the U.S. Bureau of Labor Statistics (bls.gov).

• Inflation Rate: rose 1.0% in May. Now up to 8.6% from a year ago.
• Unemployment Rate: May rate = 3.6%. Unchanged from 3.6% in April.

Misery Index = 12.2% (8.6% + 3.6%). Slightly up from 12.1% last month.
(Note: Ideally, the Misery Index should be well below 10% for a growing economy.)

The Misery Index continues to climb as half of all consumers believe our economy is moving in the wrong direction.

CSI votes a dismal DEFCON 2

Market Trajectories

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 Russell 2000 Index is commonly considered an indicator of the U.S. economic direction due to its focus on small-cap companies. The growth potential of small-cap stocks is attractive to Marketeers when economic expansion is expected. These same small-cap stocks are also the first to be jettisoned at the start of economic turmoil.

S&P 500 (SPX) = 3912 – up 6.4% from 3,675 last week. (4 weeks deviation: 184 up from 166 last week)
Russell 2000 (RUT) = 1766 – up 6.0% from 1666 last week. (4 weeks deviation: 91 up from 80 last week)

Market Performance

4 Weeks Thrashing of SPX = +/- 184 points or 4.7% of the market’s volume is up from 4.5% last week.
4 Weeks Thrashing of RUT = +/- 91 points or 5.1% of the market’s volume is up from 4.8% last week
(Market Thrashing below 1.0% might be a confirmation of the markets moving mostly sideways.)

• All trends continue decisively bearish
• Thrashing is high
• Both indexes popped 6%+ over the last week

The 6% pop for this past week was nothing more than putting back the 6% drop from the week before. All told, for the volatile past two weeks, the trajectory is still bearish.

The large down then up over the last two weeks may be nothing more than the Marketeer realigning their portfolio. Over the past 6-months, lots of quality stock got slaughtered and they are now on the undervalue list.

This might be a sign that the Marketeers are seeing a rebound in the near future. But I would not count on that until I see a high volume of cash returning to the markets.

Being blind to all other indicators, I’ll go with an optimistic DEFCON 2.

Market Index votes an optimistic DEFCON 2

My sentiment for this coming week:

Of the five indicators:

• Ecopolitical Influencers have many systemic issues – optimistic DEFCON 2
• The VIX is above 30% – optimistic DEFCON 2
• The P/C Ratio in good shape – unequivocal DEFCON 3
• Investors’ Sentiment shows a consumer base not excited about our economic future – dismal DEFCON 2
• The market indexes remain bearish – optimistic DEFCON 2

All my technical indicators showed depressed Markets.

Trading Readiness Level for this week

DEFCON = 2

This Week’s Guidance

The current bull rally could continue for another short time, but I don’t see any of the signposts suggesting this might be sustained. I see this rally as the beginnings of a Bull Trap.

1. Open one or two Vertical Bear Call Credit Spreads

Entry Rules

Vertical Bear Call Credit Spread (DEFCON 1, 2):

• Entry Rule 3: Prob-OTM >= 85%
• Entry Rule 5: Call Short Strike >= 1 Standard Deviation
• Entry Rule 13: Strike-Width >= 20 (sum of all contracts)

Iron Condors (DEFCON 2, 3, 4):

• Entry Rule 3: Call Prob-OTM >= 85%
• Entry Rule 3: Put Prob-OTM >= 90%
• Entry Rule 5: Call Short Strike >= 1 Standard Deviation
• Entry Rule 5: Put Short Strike <= 1 Standard Deviation
• Entry Rule 13: Strike-Width >= 20 (sum of all legs and contracts)

Vertical Bull Put Credit Spreads (DEFCON 4, 5):

• Entry Rule 3: Prob-OTM >= 100% (No Bull Spreads)
• Entry Rule 4: Put Short Strike <= 1 Standard Deviation
• Entry Rule 13: Strike-Width >= 20 (per leg)

Exit Rules:

• Early close following this schedule:
  • 85% of max-gain if 4 or more weeks out
  • 90% of max-gain if 3 or more weeks out
  • 95% of max-gain if 2 or more weeks out
  • Let expire if less than 2 weeks out

• Roll or Close Spreads within 1 week of expiration if:
  • Short Strike is ITM, or
  • Short Strike < 1.0% below the current price and 1-week trajectory is bullish, or
  • Short Strike < 55% POTM and 1-week trajectory is bullish
  • In a bull market, do not roll Bear Spreads
  • In a bear market, do not roll Bull Spreads

• Allow NO leg to expired ITM and be assigned!

(Note: The markets have been collapsing for over four months, and I do not think we are toying with the bottom yet. Therefore, it will be unwise to roll any Bull Spreads.)

Profit and Loss Statements

(As of 07/01/2022)

Cash Balance Sheet

Cash Flow Chart

Note: Negative weeks 4, 8, 12, and 25 were solely from withdrawing my monthly paycheck. The other negative weeks are from losing positions plus monthly paychecks.

My Performance vs. SPY

Hypothetically, instead of depositing $28,000 in my Options Trading Account, could I have done better if I bought $28,000 of the ETF/SPY instead?

Schedule for this Week

Goals for this week: (06/27/2022 – 07/01/2022) (Week #26)

• Document lessons learned or new thoughts in Commentary Section
• Open one or two Vertical Options Spreads
• Update Trading Log as trades occurs

Monday:

• Determine/update this week’s market sentiment section
• Review/tweak Trend-Channels for all stocks on the watch list
• Set target expiration dates for all Options as follows:
  • Bull Credit Spreads: Aug 19, 2022 (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).
• 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 early trading.)

Tuesday – Thursday:

• Review how yesterday’s staged trades moved. Then, 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 open on any one day).
• Be mindful of this week’s 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 a weekly journal (this blog) with any lessons learned or strategy changes.
• Watch one Webcast or take one online mini-course to be completed by Friday.

This Week’s Trade Activity

(As of 07/01/2022)

Spread Count Summary:

Current Dollars at Risk:

Options Buying Power:

Unallocated dollars available to open new Vertical Credit Spreads:

Vertical Spreads Opened This Week

(06/27/2022 – 07/01/2022)

DIA:335c/345c/X2 – Open 06/30/2022 – Expires 08/12/22 – Max Gain = $120.00 – Open Price = 307.90
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 91.3, Headroom= +8.8%, Max Loss= $1,880, AROR= 53.3%

Of my 13 Entry Rules, 1 has failed:

Rule 9: The 2 weeks trajectory was bullish because this was a Bull Trap.

QQQ:320c/330c/X2 – Open 06/29/2022 – Expires 08/19/22 – Max Gain = $158.00 – Open Price = 281.85
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 89.8, Headroom= +13.5%, Max Loss= $1,842, AROR= 60.6%

Of my 13 Entry Rules, 1 has failed:

Rule 9: The 2 weeks trajectory was bullish because this was a Bull Trap.

Note: this is the second QQQ Spread expiring on Aug 19. This was inadvertent because I had my Watch List out-of-order, and did not realize that I had already opened a QQQ Spread two weeks ago.

Vertical Spreads Currently Cooking

(As of 07/01/2022)

QQQ:325c/335c/X2 – Open 06/21/2022 – Expires 08/19/22 – Max Gain = $162.00 – Open Price = 282.21
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 90.3, Headroom= +15.2%, Max Loss= $1,838, AROR= 53.9%
Now: Prob. OTM= 92.8%, Headroom= +15.0%

SPY:415c/425c/X2 – Open 06/23/2022 – Expires 08/05/22 – Max Gain = $160.00 – Open Price = $376.95
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 89.8, Headroom= +10.0%, Max Loss= $1,840, AROR= 72.9%
Now: Prob. OTM= 92.8%, Headroom= +15.0%

IWM:190c/200c/X3 – Open 06/15/22 – Expires 07/29/22 – Max Gain = $148.00 – Open Price = 379.29
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 92.7, Headroom= +15.1%, Max Loss= $2,859, AROR= 41.0%
Now: Prob. OTM= 92.8%, Headroom= +15.0%

SPY:420c/430c/X1 – Open 06/15/22 – Expires 07/29/22 – Max Gain = $74.00 – Open Price = 379.29
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 91.2, Headroom= +10.7%, Max Loss= $926.00, AROR= 65.4%
Now: Prob. OTM= 95.9%, Headroom= +14.8%

SPY:445c/455c/355p/345p  – Open 06/08/22 – Expires 07/22/22 – Max Gain = $145.00 – Open Price = 415.60
(Iron Condor)
At Open: Prob. OTM= 87.8, Headroom= +7.2%c/-14.5%p, Max Loss= $857.00, AROR= 138.4%
Now: Prob. OTM= 99.3%c /61.6%p, Headroom= +21.6c% / -3.0%p

QQQ:345c/355c/255p/245p  – Open 06/07/22 – Expires 07/22/22 – Max Gain = $122.00 – Open Price = 310.16
(Iron Condor)
At Open: Prob. OTM= 90.5, Headroom= +11.3%c/-17.7%p, Max Loss= $880.00, AROR= 110.6%
Now: Prob. OTM= 99.1%c /71.6%p, Headroom= +25.6c% / -7.2%p

SPY:440c/450c/355p/345p  – Open 06/01/22 – Expires 07/08/22 – Max Gain = $134.00 – Open Price = 409.59
(Iron Condor)
At Open: Prob. OTM= 61.1%, Headroom= +7.3%c / -13.4%p, Max Loss= $868.00, AROR= 146.6%
Now: Prob. OTM= 99.6%c /65.6%p, Headroom= +20.3c% / -3.0%p

Vertical Spreads Closed This Week

(As of 07/01/2022)

No Spreads closed this week

Conclusion

Can selling options for income 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 could make a retirement income from home by trading Stock Options. I was an Options Trading Beginner, 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).

This blog is my Options Trading Journal for beginners (me). I will record my weekly Options contract buys and sells in hopes of gaining experience.

Experience is the ability to recognize that
I’m about to make the same mistake again.

– Damocles

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 are 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.”