Last week the S&P 500 rallied off support at 820, briefly retested that level Thursday morning, then took off with the same kind of enthusiasm we saw heading into the new year. With SPX back above 858, the 850–858 resistance zone is again where we’d be looking for support if the rally stalls. A breakout above the late-January high, around 880, would be bullish, a bias also supported by the daily chart—although it would remain to be seen whether history repeats itself (in a bull trap like the prior two breakouts) or merely rhymes.
What we’d expect from a more poetic sequel would be a continuation deeper into overbought territory, possibly reaching the three-month downtrend resistance line just above 900, before a consolidation that might retest the 880 area later in the week. Overbought markets are unpredictable, though, and with ongoing developments in the economic stimulus and bank bailout plans in the news this week, we’ll be on the lookout for surprise moves and short-term price volatility.
SPY Feb/March Double-Diagonal
With the end-of-week rally, SPY is again in the range where we’re considering rolling up the put side of this trade. The position was up this week compared to last, with an unrealized gain of about 8.2% at Friday’s close, but our negative delta is starting to look a little high (about –25 on our 2-lot base position) in the face of such a strong buying surge. As subscribers to our Iron Condors newsletter read Saturday, we think the market is getting ripe for some short-term selling, and we’re going to be watching closely Monday for signs of a pullback. That might give us another opportunity to grab more premium now that SPY is again above the critical 85–86 support zone—but if the market continues to shoot higher we might have to take more defensive measures.
There are two defensive adjustments that we consider when an underlying gets close to a short strike. One is to roll the threatened short position vertically to cut delta and reduce our maximum risk. The other is to buy the complementary diagonal (in this case the March 91/Feb 97 call diagonal) to turn some or all of the threatened spread into a double-calendar. Note that the latter, in particular, would take a sizable infusion of new cash—potentially more than $3.50/share (i.e., more than $700 per 2-contract base position)—so we want to make sure we have sufficient funds available to make the adjustment, or we’d simply have to close the position (autotraders take note!).
Another possibility, though not the one we’d ideally want to come to, would be to close the position if the market is getting too wild. As noted above, we’ll be evaluating market conditions and our level of risk minute-by-minute as the week unfolds.
LMT Feb/March Calendar Spread
Time decay has started to do its work on our LMT position, which was showing an unrealized gain of about 9% going into the weekend. The stock has been whipping around on a day-to-day basis more than usual, but we’ll be in great shape as long as the intermediate-term trend continues sideways around our 80 strike for the coming week. The best-case scenario would be for LMT to swing through $80 Wednesday or Thursday, in which case we could be able to lock in our target 20% profit. A break below support at about $76.50 or above resistance at about $84 would trigger an adjustment (or closing the trade). Here, too, closing out to limit risk in the face of increasingly unpredictable price action is always a possibility.
One more note about what to expect this week: The next strategy piece we have in the works talks in detail about what we look for in a Calendar Options underlying and why. We’re planning to post it on the members’ blog this week, but if things start to get hairy (e.g., the market gives Treasury’s bank bailout plan a big thumbs down, the Senate stimulus-bill deal falls apart, or traders decide that the combination will magically solve all our economic problems and think “the bottom” might be in), we could get a little distracted from less time-sensitive priorities. We trust members will agree that demonstrating good risk-management practices trumps lessons about Calendar Options strategic fundamentals in the short-term. (And, as if everything else weren’t enough, we’re entering our time window for opening March positions!)