Monday, May 17, 2010

I think there is more downside!

As I mentioned yesterday at our meeting in Long Beach, I think that there is still some downside in this market. So I am going to buy some 114/110 SPY bear put spreads.

As you can see from above I am selling 5 put spreads @ 1.42. I am setting my stop to the 116-116.50 (grey area on chart below) . As this would represent a gap fill from last Thursdays gap down and would also have SPY retake the 20 period moving average on the 20 day 1 hour chart below.

I am risking about $163 if I were stopped out at 116.50 and maybe a little less as a move up to this point may bring volatility down. The max gain at $110 is $1290.

I sold the $110 as this is the area of the 200 day moving average witch I think could be the next target for the SPY ETF to head.


  1. So the market has fallen pretty hard since I put this put spread on a few days ago. The market was trading at $114 ish and is now trading at 108.55. So my spread is completely in the money. The only thing is that I am only up about $350 of the total $1,290 of the available profit. This is due to the fact that there a lot of other variables that are being factored into the price of the options.

    What I would like to see next week after OPEX is some basing off lower levels. With this I think we can see volatility come in which is being bid higher and higher as the prices fall of SPY.

    I kind of feel that the "flash crash" that we saw 2 weeks ago was a glimpse as to what is to come whether it was due to computers, errors, or what not. I think that it only expedited the process.

  2. This is a frustrating position. You call things exactly right on direction, but timing isn't perfect. I forget which month this happened to me recently as well. I didn't feel like closing it out for something like 25% of the possible profit, even though like yours, the current price was below my naked put on the spread. I ended up losing 100% of that spread as the market recovered and this was during that melt up period.

    That got me thinking about the risk/reward trade off of a long put vs a spread. I want to have a decision ahead of time should this happen again. Do you take off your cost basis, take it all off and accept that you were right on direction but not timing, do you let it ride? I guess it will depend on your outlook given the move. It's easy in hindsight to say "I should have just bought puts instead of a spread."

    Another thing this got me thinking about was the initial return on risk calculations. When was the last time you held a spread to maturity and received the full gain possible at initiation? It seems we never hold to maturity or realize the maximum gain. So I'm wondering if maybe the initial return on risk shouldn't be a higher threshold to compensate for the fact that rarely is your timing and direction going to be perfect.

  3. I still feel comfortable holding this put spread. I don't think we are going to make any big moves to the upside anytime soon. But something that I can consider is selling the long puts and making a bet that we don't go down any lower...But then that goes against the whole idea of the put spread. I do have to admit that the market moved lower a little bit quicker than I had anticipated. And with hignsight I probably would had been better served buying the June Put spread instead of the July. But nonetheless I am comfortable with my position.

  4. Well this is why you do your trade write up at time of execution to remember what you were thinking at the time. It's fine to just say that things moved faster than you anticipated, but had you said you really want to buy puts but just feel more comfortable with the spread to lower your risk, then you would be guilty of being a turd.

    Like I mentioned earlier, I need to find a decision process for when this happens. Watching one go to zero instead of taking 25% of the possible profit was probably good for me to get me thinking about what to do next time. Had I just held and realized all the time premium I would continue the same behavior. I guess it's probably a good thing that I'm playing below my means right now as obviously I'm still learning from mistakes and formulating strategies and contingency decisions.

  5. You are right I played a spread spefically because I wanted to reduce my risk. If I bought the puts out right the postion would had cost close to $4k vs the $700 the spreads cost. I would not had been cormfortable with spending $4k on just the puts as if I was wrong and we got a huge ralley up like we did last week I would have shit my pants and closed out of the trade for a sizable loss.

    I did not put a time frame on this trade but when I put it on I did so with the belief that we were not going to have any huge movement to the upside between now and July expiration, at least not past my stop points. I am not saying that I intend to hold all the way to expiration but the longer I do hold and if the market stays down than the more profit I get to realize.Currently we are 57 days out from July expiration which a lot can happen between now and then.

  6. One of the things I noticed about keeping a trade spreadsheet is that my average holding period is very short, just a few days. And the ones I've held longer is simply because I don't want to give up the remaining time premium. It was keeping this file that showed me I was overpaying and/or leaving profit on the table by using contracts that had too much time in them. So unless it's a 6-month spread which is a real long-term view, then I'm sticking with front and next month contracts only. It just seems like we're still in a period where things are happening fast. A typical contract period of 4 weeks can be an eternity in this environment.

  7. And the market continues lower. I am now at about a 50% profit and still holding. The SPY is now trading $5 below my short strike of my put spread.

    I am really glad I put these spreads on as I initiated my ACAT to TOS and my hands are tied and can not make any new trades or adjustments to current ones until the transfer is complete.

    The lower we go the more comfortable I am to holding these spreads.

  8. I took a look at the difference between the profit on the same spread but in the front month (June expiry) vs the July spreads that I purchased. The front month spreads are worth almost 2 times as much in terms of profit. I will keep this in mind next time.

  9. Spreads are a bit difficult and frustrating for me so far. You have to be right on direction and timing. Obviously in exchange you get lowered risk. I hate having to make the decision to either leave profit on the table in the form of time decay, or take on additional risk by leaving it on and hoping it doesn't move against you. I think I suggested this before but here it is again, maybe we take half off in cases like that where the directional move happened faster than we thought.

  10. So today I decided to take the spread off. I intially paid $1.42 for the spread and sold it today for $2.85. That is good for a little over a 100% return on risk. I am leaving $1.15 on the table, but I would hate to see these profits evaporate. The lesson I learned is that I would had been better off buying the front month options with respect to profit realization. I have a tendency which I am trying to kill to go out in time because I feel it to be safer. In all reality my results show me that the shorter the time period the better I do.

  11. I used to do the same thing, the longer dated the option the more comfortable I felt. However, you are risking two things by doing this. First you are risking profits as if it hits your target fast you're leaving potential profits on the table. Second, if it moves against you you've just paid extra time premium for nothing. So it took me a while to see this, but using front month obviously gives you the opposite of the risks above. First, if you're right you can get out earlier with more of your profits. If you're wrong, well now you have a better entry point to do it again the next month, or you've saved yourself from paying extra time premium. I guess the only reason to go out further than front month is if your trade idea is for a longer time frame than one month.