I still have the goal of a monthly income, I still believe I can do so with Vertical Credit Spreads, and I still desire to be nerdy about it all. So here are my new Exit Rules for Yearly Vertical Bull Put Credit Spreads.
Clarence Leiter: Aren’t you the fellow who was shot?
(1954 TV series “Climax” – episode Casino Royale)
James Bond: No, I’m the fellow who was missed.
Exit Rules for Yearly Vertical Spreads
Surprisingly, Sean Connery was NOT the first actor to play James Bond. Barry Nelson was the first to play the iconic character in the 1954 Climax TV episode Casino Royale, preceding Sean Connery’s portrayal in Dr. No eight years later.
Now, after 60 years, the eighth Bond actor has found himself part of Eon Productions’ “Bond Exit Rules” – with Daniel Craig leaving the role after “No Time to Die”.
So, when considering that “All Good Things Must Come to an End,” this month’s journal entry will review new Exit Rules for Winning Yearly Vertical Bull Put Credit Spreads.
Commentary Contents
Monthly Income from Monthly Spreads
When I started trading Vertical Spreads about five years ago, my goal was to earn enough of a consistent monthly income to help augment my retirement savings. I speciously thought I should start trading Monthlys Spreads – and do so every week to ensure that I had diversified.
I would diligently run through several technical indicators, create charts, research financials, and do my best to predict short-term movement. I researched the geopolitical events that may come up soon and then tried to construct conservative Monthly Spreads. But after five years, I found this to be a lot of work for little value.
What I finally learned is that the success of a short-term Options investment depends more on geopolitical events and less on financial sanity. Short-term Options contracts are at the mercy of the Marketeer’s kneejerk reactions to Twitter trends, Congressional bickering, pending elections, media machinations, regional storms, beer sales, etc. Short-term Options are more about the impossible task of market timing than market trends.
For this reason, I have changed my Vertical Spread strategy to Yearlys instead of Monthlys.
Monthly Income from Yearly Spreads
I still have the goal of a monthly income, I still believe I can do so with Vertical Credit Spreads, and I still desire to be nerdy about it all.
With Yearlys, the ineffectual tasks of charting 30-day technical analysis are transformed into the more simplistic 1-year market trends of bull-bias assets, and short-term geopolitical kneejerk events are muted. And more appealing, the everyday brain load is lessened, and I can now focus on other projects.
In my post, Asking The Bing AI – 1 Month vs. 1 Year Vertical Bull Put Credit Spreads, I started to outline new Entry Rules for Yearly Vertical Bull Put Credit Spreads. I now only have a handful of entry rules, and most are based on obvious long-term sustainability. And more importantly, I am only planning to open one or two Spreads per month.
In this month’s post, I want to start a review of simplifying my Exit Rules for winning Spreads.
Explaining New Exit Rules
The number one goal stated in my post, “Budget, Goals, and New Rules for 2023 Vertical Spreads” is to outperform the ETF SPY for 2023. To track that goal, I’m going to rely heavily on the Annualized Return on Risk indicator (AROR).
Since the S&P 500, which the index ETF SPY tracks, has had an average annual return of 15% over the past 10 years, I’m going to focus both my Entry and Exit Rules on a +15% AROR. But since I want to do better, I will up that 15 to an arbitrary 20% annualized return. Anything above 20% I’m going to call “greedy.” (Note, greed is the SPECTRE to market trading.)
So as a matter of perspective, if any of my opened Vertical Bull Put Credit Spreads gains a current AROR above 20%, I can call that position a winner and can consider closing it.
AROR Realities
If my opened Yearly is tracking positive, the premium required to buy-to-close can drop pretty fast and my current AROR can sore. As an example, consider the Spread I opened just two days ago:
QQQ:270p/260p/X2 – Open 05/09/23 – Expires 03/28/24 – Max Gain = $322.00 – Open Price = 321.36
At Open: Prob. OTM= 73.9%, Headroom= -16.0%, Max Loss= $1,678, AROR= 21.5%
- The premium I collected for this position with an expiration date of 325 days from opening was $1.61 * 100 shares per contract * 2 contracts = $322.00.
- Two days later (expiration is now 323 days out), the premium I would have to pay to buy-to-close = $1.55 * 100 shares per contract * 2 contracts = $310.00.
- My profit, should I close, would be a $12.00 shrug.
But consider the difference in AROR:
- AROR when opened = ($322 (expected profit) / 325 days) * 365 / $1,678 = 21.5%
- AROR when closed = ($12.00 (actual profit) / 2 days) * 365 / $1,678 = 130.5%
If I hold onto the OTM Spread for the entire year and it expires worthless, the $322 profit will be an ROI of 21.5% of my $1,678 investment risk. But instead, if I chose to close that position in only two days, the $12 profit would represent a whopping 130% annualized return on my $1,678 risk. Even though I technically blew out the average annualized return on the S&P 500, it was only a measly 12 bucks and a lot of work.
Just reaching the 20% threshold is not enough. So I will concoct an Exit Rule that combines AROR (to ensure I am beating the S&P 500) and Max-Gain (to ensure it’s worth it).
Proposed Exit Rule 1
My proposed Exit Rule 1 will be a two-parter.
Exit Rule 1a: % of opening AROR > 200%
If the current AROR for the above opened Spread exceeds twice what the AROR was at open, I will consider closing early. For example:
At opening:
- Premium collected = $1.66
- AROR at open = 21.5%
Three weeks later:
- Current premium = $1.15
- Current AROR = 41.2%
- % Opening AROR = 41.2% (current AROR) / 21.5% (opening AROR) = 204%
Results: I’ll flag this position for a buy-to-close consideration because the current AROR is over twice that of when it was opened.
Exit Rule 1b: % of Max Gain > 50%
If the current premium for the above opened Spread exceeds 50% of the Max Gain, I will consider closing early. For Example:
At opening:
- Premium collected = $1.66
- Number of contracts = 2
- Max Gain = $1.66 * 100 shares * 2 contracts = $332.00
Three weeks later:
- Current premium = $1.15
- Current value of position = $1.15 * 100 shares * 2 contracts = $230
- Potential profit = $332.00 – $230.00 = $102.00
- % of Max Gain = $102.00 (profit) / $332 (Max Gain) = 30.7%
Results: Because the % of Max Gain is less than 50%, I will NOT consider closing early.
Exit Rule 1’s Thresholds
200% of AROR and 50% of Max Gains are arbitrary. I will set these as field values in my Custom Options Watchlist and tweak them as I feel comfortable.
I will also create visual flags to advise me when to close early.
My Custom Watchlist for Vertical Spreads
- E16: Percent of Max Gain to consider closing
- E16: 50.0% (arbitrary setting)
- F16: Percent of AROR to consider closing
- F16 = 200% (arbitrary setting)
- E26: Close early consideration flag
- E26 = =IF(AND(E27>E$16,F27>F$16),”SELL”,”Watching…”)
- Conditional Formatting Green: Cell Value equal to = “SELL”
- E26 = =IF(AND(E27>E$16,F27>F$16),”SELL”,”Watching…”)
- E27: Current percent of Max Gain
- E27 = =IF(AC21=””,0,AA21/ABS(AA23))
- Conditional Formatting Red: Cell Value less than = 0
- Conditional Formatting Green: Cell Value greater than = 0
- E27 = =IF(AC21=””,0,AA21/ABS(AA23))
- F27: Current percent of AROR
- F27 = =AB21/U21
- Conditional Formatting Red: Cell Value less than = 1
- Conditional Formatting Green: Cell Value greater than = 1
- F27 = =AB21/U21
Re Custom Vertical Spreads Watchlist:
Using Excel with ThinkorSwim
Custom Options Watchlist using Thinkorswim in Excel – PT 1
Custom Options Watchlist using Thinkorswim in Excel – PT 2
Proposed Exit Rule 2
If I close a Yearly Vertical Spread early, the AROR for the dollars at risk drops significantly if I do not enter into a replacement Spread immediately. For Example:
At opening:
- The above Spread risk = $1,678
- Days at risk = 358
- Premiums collected = $330.00
- AROR = ($330.00 / 358 * 365 / $1,678) = 20.1%
Assuming I close when AROR > 200% of opening and current profit is > 50% of Max Gain. And I did not reinvest the released dollars but instead held onto the cash for the balance of the time:
- Spread risk = $1,678 (no longer at risk)
- Profit = $330.00 – $115.00 (50% of Max Gain) = $115.00
- AROR = ($115.00 / 358 * 365 / $1,678) = 7%
If I close a Spread early, I will still technically surpass my 2023 Goal #1, “Outperform the ETF SPY,” for the time invested. But not reinvesting immediately will negatively affect my Goal #3 – “Supplement my investment income” (the whole reason for Vertical Credit Spreads).
Exit Rule 2: Don’t Close a Winning Spread if There Is No Replacement
If there is no valid replacement Vertical Spread, closing a winning position is counterproductive. It will be best to keep a winning Spread winning until I am comfortable with a replacement.
Once the current Spread is closed, the dollars set aside to cover the risk are freed. I will then open a new Spread using the newly released dollars.
- If the replacement Spread uses the same underlying, then roll (see: How To Roll A Vertical Spread In ThinkorSwim).
- If the replacement Spread uses a different underlying, then buy-to-close then immediately submit a replacement Spread. (Or set an Open-at-Close simple ThinkorSwim Trade Trigger.)
Proposed Exit Rule 3
What happens if an open Spread goes negative?
This rule will have to be developed later. But if an open Spread is moving in the wrong direction, I will consider the following:
- If the Spread is months away from expiration, a market bounce of a bull-bias ETF is likely. I’ll wait to see what happens.
- If the Short Strike is currently ITM and months away from expiration, an assignment will be less likely than an ITM contract expiring this week. I’ll wait to see if there is a market bounce.
- If we are approaching the end of a one-year Spread, and the Short Strike is ITM, then it will be highly likely that the Long Strike will also be ITM. (See: Vertical Spread Assignments – The Good The Bad and the Ugly)
Exit Rule 3: Don’t Exit Losing Spreads
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Other Posts from Options Trades By Damocles
This Month’s Market Sentiment
This Market Sentiment Section is typically completed the first week of the month. By the time this journal is published, it will be mostly old news.
(As of June 2023)
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
- Debt Ceiling Looms – Yikes
- Feds Boost Interest Rate, yet again – Yawn
- Are the Feds done raising rates? – Yay
- Inflation is deflating – Yay
Geopolitical
- The Debt Ceiling bomb is lit, and the fuse is set to explode on June 1 with a first-ever (again) US Default on America’s credibility. Republicans’ stance is our current $31 Trillion debt is the antimatter to American prosperity. The Democrats’ stance is that every bit of that, plus more, is required to save the planet and right every equity wrong our Woke generation can think up. But we have been here several times before. This is nothing but a different verse to the same tune. So, although this spat could significantly impact when I open a new Yearly Vertical Bull Put Credit Spread, I don’t think it will affect the results at expiration. Will the disagreement extend to the knife edge of the doom date? Yes. But just like any James Bond thriller, expect the clock to time down to less than 3 sec.
- Did we dodge another banking crisis bullet? The sale of First Republic to JPMorgan may have placated the Marketeers for now. But the systemic problems of this administration’s failed Office of Comptroller of Currency (OCC) to oversee bank regulations, but instead to push Climate Change and Trans rights.
- Out with the old – in with the new. Could 2024 be the first time in American history that an Independent wins the White House? Trump is old and scary. Biden/Harris is old and scarier. Both are dominating their party’s polls, but none are firing up the electorate. An energetic third-party player may have a good chance of winning or, at the very least, being the kingmaker – much like Ross Perot and Ralph Nader.
- Expect the usual “end of civilization” rhetoric from the fearmongering media if the Republicans don’t drop their demand to cut spending as a condition for raising the Debt Ceiling, now at $31 trillion (a notion that Biden calls “wacko”). For my (now) yearly Vertical Bull Put Credit Spreads strategy, I doubt this round of hysterics will have much effect at expiration. But it will affect my timing to open this month’s position.
Socioeconomics
- On May 3rd, the Federal Reserve announced that inflation is slowing, but tweaks are still needed to put a cap on it. Therefore, the Feds raised the primary credit rate by another ¼ percentage points to 5.25%. This increase was initially believed to be the final increase for 2023 (according to Hedge fund Billionaire Paul Tudor Jones). But others are predicting one or two more small (0.25%) tweaks. Either way, the aggressive hikes are over.
- A survey of corporate CEOs believes that inflation has peaked as base component ingredients have slowed or ceased increasing. But there is no talk that prices will now start to fall. “This is the climate-change economy. Get used to it” – President Joe Biden.)
- Year to date, the NASDAQ is up nearly 17%, and the S&P 500 is closing in on a 9%, making 2023 an excellent four-month start. This marks when the Marketeers sitting on the sidelines start pulling that money from under the mattress and put it back to work.
This Week’s Guidance
Inflation seemed to have peaked, and the market’s trajectories are weak-knee, long-term bullish. But the short-term trajectories (20 and 7 days) tell a different story. The RSI for SPY is below 50 and falling, suggesting that the current downturn could continue. The short-term economic outlook seems sketchy.
- Be cautious with new Spread this week
- Follow the Entry Rules below
Profit and Loss Statements
(As of 05/26/23)
My Performance vs. SPY
Hypothetically, instead of depositing $20,000 in my Options Trading Account, could I have done better if I bought $20,000 of the ETF/SPY instead?
Quick reporting note.
I have $20,000 allocated for Vertical Spreads in 2023, but not all this cash is invested. Therefore, for accounting and measurement purposes, I will only compare “invested” Spreads dollars to an equal hypothetical investment in SPY from now on.
| Options Trading Account | SPY (Fictional) | |
| Current Investment | $6,217.00 (Cash) | $6,217.00 (16.3884 shares @ $382.43) |
| Funds Added | $1,807.05 (Premiums, Int., Div.) | 0.132 shares (Dividends Reinvested) |
| Funds Removed | -$23.60 (Early Close & Fees) | -$0.00 (Fractional Shares Sold) |
| Market Changes | -$1,064.00 (Open Spreads’ Fair Market Value ) | $548.94 (Gain/Loss) |
| Ending Balance | $6,936.45 (Mark-To-Market) | $6,765.94 |
| ROI | 11.6% | 8.8% |
This Month’s Trade Activity
(As of 05/26/2023)
Spread Count Summary:
| Year 2023 | Month May | |
| Vertical Bull Put Credit Spreads | 13 | 2 |
| Vertical Bear Call Credit Spreads | 1 | 0 |
| Iron Condors | 0 | 0 |
| Total | 14 | 2 |
Current Dollars at Risk:
| Year 2023 | Month May | |
| Vertical Bull Put Credit Spread | $6,217. | $3,394. |
| Vertical Bear Call Credit Spread | $0. | $0. |
| Iron Condor | $0. | $0. |
| Total Dollar Risk | $6,217. | $3,394. |
| Max Risk Allowed | $20,000. |
Note: no new Spreads this week.
Options Buying Power:
Unallocated dollars available to open new Vertical Credit Spreads:
| Current Cash Balance | $21,785.53. |
| Set-Aside Dollars for Existing Spreads | $8,000 |
| Cash Available for New Spreads | $13,785.53 (Options Buying Power) |
Vertical Spreads Opened This Month
(05/01/2023 – 05/26/2023)
SPY:365p/355p/X2 – Open 05/19/23 – Expires 03/28/24 – Max Gain = $284.00 – Open Price = 419.11
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM= 74.7%, Headroom= -12.9%, Max Loss= $1,716, AROR= 19.1%
Currently: Prob. OTM= 74.3%, Headroom= -12.7%, Max Loss= $1,716, AROR= 19.1%
| Rule 1: Sell Only Major Market Index ETFs | Yes (SPY) |
| Rule 2: 50-Day SMA above 200-Day | Yes (see chart) |
| Rule 3: 20-Day Regression Line Bullish | Yes (see chart) |
| Rule 4: AROR > 15% | Yes (19.1%) |
| Rule 5: Prob-OTM > 70% | Yes (74.7%) |
QQQ:270p/260p/X2 – Open 05/09/23 – Expires 03/28/24 – Max Gain = $322.00 – Open Price = 321.36
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM= 73.9%, Headroom= -16.0%, Max Loss= $1,678, AROR= 21.5%
Currently: Prob. OTM= 79.2%, Headroom= -19.7%, Max Loss= $1,678, AROR= 167.5%
| Rule 1: Sell Only Major Market Index ETFs | Yes (QQQ) |
| Rule 2: 50-Day SMA above 200-Day | Yes (see chart) |
| Rule 3: 20-Day Regression Line Bullish | Yes (see chart) |
| Rule 4: AROR > 15% | Yes (21.5%) |
| Rule 5: Prob-OTM > 70% | Yes (73.9%) |
Vertical Spreads Currently Cooking
(As of 05/26/2023)
SPY:365p/345p/X2 – Open 04/04/23 – Expires 03/15/24 – Max Gain = $345.00 – Open Price = 411.13
(Vertical Bull Put Credit Spread)
At Open: Prob. OTM= 70.2%, Headroom= -11.2%, Max Loss= $1,655, AROR= 21.9%
Currently: Prob. OTM= 70.5%, Headroom= -11.0%, Max Loss= $1,668, AROR= 8.4%
QQQ:255p/245p/X2 – Open 03/23/23 – Expires 03/15/24 – Max Gain = $332.00 – Open Price = 311,39
(Vertical Bear Call Credit Spread)
At Open: Prob. OTM= 73.9%, Headroom= -18.3%, Max Loss= $1,668, AROR= 20.2%
Currently: Prob. OTM= 76.7%, Headroom= -18.8%, Max Loss= $1,668, AROR= 29.8%
Vertical Spreads Closed This Month
(As of 05/26/2023)
No spreads closed this month.
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.
My Options Trading activities include cover calls, cash-secure puts, Vertical Spreads, and other options strategies. Cover calls and cash puts assume that I already have a sizable portfolio and accumulated cash to generate a meaningful income. But short-term Vertical Spreads do not require a substantial cash investment to make some fun money. – This blog’s sole focus is short-term Vertical Spreads.
This blog is my Options Trading Journal. I will record my weekly Option Contracts 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 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.”