On the 4th November 2010, SK OptionTrader signalled to subscribers to put 20% of their options trading portfolio in two bearish trades on the SPY and DIA, (the S&P 500 and Dow ETfs), citing further sovereign debt problems in the EU and a fully priced in quantitative easing program by the Federal Reserve.
At the time the signal was sent out the S&P was trading at 1220 and, after rallying briefly to a high of 1227, the S&P fell to a low of 1173 in just a couple of weeks. In other words, our bearish trading signal came with 27 points, or 2.2% of the recent top.
Here are some excerpts from emails that were sent to SK OptionTrader subscribers, describing our reasoning for taking on the trade and how it was executed.
From “SK OptionTrader Update: Prepare To Take Bearish Credit Spreads On Equities” - 3rd November 2010
In our opinion, QE2 was not large enough to trigger a further rally in equity prices. The S&P 500 is overbought and up against resistance at around 1200. In addition to this, there appears to be more trouble brewing in Europe with the Irish-Bund spreads hitting a lifetime high of over 500 bps.
The Fed has made it clear they want to keep stock prices high, and so although we are not brave enough to stand in front of Bernanke & Co.’s efforts and take an outright short position on the stock market, we are now comfortable with taking a bearish credit spread position on SPY, the S&P 500 ETF.
For those subscribers who may not be familiar with this strategy, here is a brief explanation. However we encourage you to do your own research and ensure that you fully understand the mechanics of this type of trade before attempting to execute it.
A credit spread trade involves a purchase of one option and a sale of another option in the same class and expiration but different strike prices. Investors receive a net credit for entering the position, and want the spreads to narrow or expire for profit.
Our bearish credit spread on SPY will consist of selling an out of the money call option and buying an out of the money call option with a higher strike price. Since we expect both calls to expire worthless, we should pocket the net credit as profit when the contracts expire.
Credit spreads are negative vega (volatility premium) since, if the price of the underlying doesn’t change, the trader will tend to make money as volatility goes down. They are also negative theta (time premium) in that, if the price of the underlying doesn’t change, the trader will tend to make money just by the passage of time.
To put this trade as simply as we can: We are betting that SPY does not rise much between now and the December 17th close and if we are right we collect a modest premium.
We will probably look to place the trade towards the end of the trading session.
From “SK OptionTrader Trading Signal: SPY & DIA Bearish Credit Spreads” – 4th November 2010
We hereby signal to initiate the following credit spread positions, as previously discussed in our recent update.
Buy SPY Dec 18 ‘10 $130 Call @ $0.31, Sell SPY Dec 18 ‘10 $129 Call @ $0.43, Net Credit $0.12.
10 Units allocated (10% of model portfolio)
Buy DIA Dec 18 ‘10 $121 Call @ $0.20, Sell DIA Dec 18 ‘10 $120 Call $0.31, Net Credit $0.11.
10 Units allocated (10% of model portfolio)
From “SK OptionTrader Trading Signal: Close Out SPY & DIA Credit Spreads” – 18th November 2010
Since we can bank the majority of our profits on our SPY & DIA bearish credit spread trades, we are going to do so now, rather than wait another month until expiration.
We have closed them out at the following prices:
Having bought SPY Dec 18 ‘10 $130 Calls for $0.31, we have sold them for $0.05, a $0.26 loss.
Having bold SPY Dec 18 ‘10 $129 Call for $0.43, we have bought them back for $0.05, a $0.38 gain.
This gives us an overall profit of $0.12 or 12% on this trade in 15 days.
Having bought DIA Dec 18 ‘10 $121 Calls for $0.20, we have sold them for $0.01, a $0.19 loss.
Having sold DIA Dec 18 ‘10 $120 Calls for $0.31, we have bought them back for $0.04, a $0.27 gain.
This gives us an overall profit of $0.08 or 8% on this trade in 15 days.
We hope that these excerpts illustrates to those who are not subscribers how SK OptionTrader works.
As shown above we;
- Gave subscribers advanced notice of when we intended to place the trade
- Explained our reasoning behind making the trade, the factors that we thought would lead to the trade being a success
- Described out this type of trade worked, for those less familiar with options trading or perhaps rusty of the mechanics of a bearish credit spread trade
- Gave a clear instruction of when we were opening the position, and at what prices. The trading signal was sent out during market trading hours and prices were current at the time that the signal was sent.
- Also gave a suggested weighting to each trade, a 10% allocation of one’s option trading portfolio to each
- Gave a clear instruction of when we were closing the position, and at what prices. The trading signal was sent out during market trading hours and prices were current at the time that the signal was sent
The result of all this was that SK OptionTrader subscribers were given the opportunity to make a modest profit in a relatively short period of time.
The equity markets would have had to rally about 4.8% in 6 weeks before we would look like posting a loss on this trade.
If they rallied 4.7%, the trade is still profitable.
If they had gone sideways, the trade is still profitable.
If they had fallen, which they did, the trade is profitable.
Of course we could have made more money by being outright short on the market, and bought puts on SPY and DIA, but at the time we felt that since the Fed was committed to keeping stocks high, there was a risk that an outright short could result in losses by sideways movement in stock prices.
So we opted for a more conservative approach, and therefore took more modest profits. However, the important thing as we see it, is that we did turn a profit, and 12% to 8% in 15 days is not a bad return. This is on top of our recent, more profitable trades.
This brings the trading record of SK optionTrader to 53 closed trades, with 51 winners and two losing trades.
Our average return is 45.5% per trade, and $1000 invested in each trade would have led to $24,113.60 in profits.
Our model portfolio is up 117.45% since inception, an annualised return of 82.8% per year.
So if you would like to give us a try for just $99/6months or $179/year then simply click one of the subscriber buttons below.
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