Condor Options

Last week we noted tentative buy signals in the S&P 500 index but predicted that any rally attempt would not last long; even so, we were surprised at how short and feeble the rally turned out to be. Buy signals were confirmed on Tuesday, only to reverse on Thursday after the index barely touched resistance at the mid-February consolidation support level around 780. With Friday’s close, the S&P ended the day, the week, and the month below the November 2008 low as well as the low of 2002.

By any technical measure, the market outlook remains very bearish, even in the short-term. Friday’s close puts three major resistance levels between it and the 804–818 area labeled “The Zone” on the above chart (click to enlarge). Short-term momentum favors the bears going in to this week, but we’re getting into oversold territory on the daily chart, and the Nasdaq and Russell, though slipping, have yet to show signs of a major breakdown. A notable characteristic of the market this year (at least in SPX) has been a tendency to break above resistance or below support to create a bull/bear trap before reversing. Friday’s breakdown might turn out to be another bear trap, but we continue to emphasize the longer-term technical damage that has to be overcome before it’s safe to say the market has bottomed.

The other index we’re watching closely is the VIX. It’s somewhat disturbing that while SPX may be breaking down, volatility has continued to close below 50. That says option traders expect November support to hold—and they might be right. . .but what happens if evidence to the contrary becomes incontrovertible? If it turns out that Friday’s 47 VIX represents the complacency of denial, then we could be in for a rude awakening.

When it comes to our positions, however, one of our underlyings is looking like the MVP for the bulls:

IBM March/April Double-Diagonal

While traders were beating down the S&P (and NDX) last week, it seemed like they couldn’t get enough of IBM. After leading the market down for a week on heavy volume, the stock made a sharp turnaround on Wednesday after the company reiterated its 2009 earnings guidance. Suddenly the dog of large-cap tech became the stock everybody had to own. By the time it was clear just what a massive buying surge the company’s confidence would generate, we had already added to our upside risk by rolling our March/April 100/105 call spread down to 95/100.

From a probability perspective, this was a sound move at the time. Unfortunately, IBM’s bounce-back rally has defied statistical expectations. The stock has climbed $9.18 (11%) from its Wednesday morning low, and despite the broad-market sell-off Thursday and Friday, IBM logged two 1.6-standard-deviation days in a row. The silver lining now (for those of us short IBM calls) is that the stock is getting extremely overbought in the short-term and has yet to give a clear buy signal on the daily chart. In the last 10 minutes of trading Friday, a huge number of shares were dumped, and this morning IBM is off about $1 in pre-market trading. Although it’s pierced the 20-day moving average that we were counting on to cap any rally (at least temporarily), the stock is still below the $94-$97.50 zone that’s been a major area of support/resistance since the beginning of 2004, and our adjusted position would be able to tolerate an encroachment deep into that zone.

What matters most, though, is that our strategy provides ways to adjust when an underlying makes unexpectedly large moves. If there’s a sustained move above $96.50–$97.50, we’ll look at buying the April/March 95/100 diagonal. But for now, we’re still in a pretty good position: mid-price at Friday’s close was $0.35, for an unrealized gain of 7.2% on total capital risked. Our base-position delta, at –12.5, is well under control.

PG March/April Double-Diagonal

Our PG position took a slide this week with the stock, which lost $2.08 since the prior Friday close. Just before last week’s trading ended, the mid-price for our position was about –$0.45 (debit), which gives us an unrealized gain of 2.2%. Monday and Thursday saw unusually strong down moves, but the week’s loss was well under the one-week standard deviation predicted by the implied volatility when we entered the trade. The difference between Friday’s close and our lower adjustment point is close to the three-day standard deviation, which gives us some wiggle room—but if we get a closing price below about $46.80, we’ll follow our strategy rules and adjust the position so we can stay in the game and let time work in our favor.