We’re on adjustment alert again Monday, after the market continued to test the limits of our May positions last week in terms of both price and volatility. Even as the Dow and S&P rebounded sharply on Friday and the VIX fell another 4%, hitherto stalwart IBM lost ground in an abrupt slide that began with an unremarkable inside-day reversal on Tuesday. Our adjusted IBM position was lifted out of the red when buyers took back control Friday afternoon, but our DIA trades remained under upside pressure into the close.
Considering all the factors working against a market-neutral calendar-spread strategy last week, our trades are holding up pretty well; nevertheless, coming into expiration week with the market literally pushing the envelope (SPX broke above the 20-day, 2-standard-deviation Bollinger band intraday every day last week, and closed above it Monday, Wednesday and Friday), we’re putting our portfolio front and center again in this week’s Update:
DIA May/June Double-Diagonal (Adjusted)
Friday’s surge drove DIA past our new adjustment point for this position, nearly to our upper breakeven. The adjustment trade we executed Thursday kept us from losing more ground in Friday’s rally than we would’ve in the unadjusted position—we’re now down about 5%, versus about 6.7% without the adjustment—but we’re going to want to flatten out a lot more if the Dow doesn’t give back more than half of Friday’s gain tomorrow morning.
As noted in Thursday morning’s pre-market e-mail update, our standard double-diagonal hedge (buying the diagonal opposite the threatened spread—in this case, buying the June 84/May 89 call spread) is priced over $3.50/share, which means that we’ll need more than $700 cash per 2-lot base position to make this adjustment (perhaps closer to $800 at this point). Account management is outside the scope of our newsletters, but we’d be remiss if we didn’t remind autotrading customers that brokers will not execute a newsletter trade if sufficient funds aren’t available in your account.
DIA May/June Double-Calendar
This position is showing an unrealized loss of about 5% as well, with DIA getting close to our adjustment threshold (but not yet there at Friday’s close). If we need to make the anticipated adjustment to our double-diagonal, that position’s net delta will turn positive, and the double-calendar’s negative delta will give us some downside protection. Nevertheless, if the rally in the Dow doesn’t let up, we might need to make an expiration-week adjustment to this position too in order to keep our upside risk under control.
IBM May/June Calendar Spread (Adjusted)
No sooner had we adjusted this position last week than traders decided to take profits en masse for no apparent reason other than that the stock was overbought. We expected a pullback for that very reason, but the depth of the correction is a bit puzzling in a week that was so bullish for the market overall (though, admittedly, not for the technology sector)—unless it’s a harbinger of a broader sell-off to come—and bore no news of any material change in IBM’s fundamentals. (Maybe Bloomberg will publish an article about the failure of fundamental analysis, based on the reporters’ misrepresentation of an oversimplified study of isolated fundamentals-based trading criteria over short periods…next in our series: “Fundamental Analysis Fails to Give You a Pony”.)
What’s important for Calendar Options members, though, is that our conservative approach—making the minimum adjustment necessary for risk-management purposes before committing to a more bullish stance—paid off. However, risk-management has its price: less negative delta means less gain on a pullback, and after the drop in the premium of our long puts when IBM went ex-dividend, our adjusted position is just at breakeven.
One more important note before a very brief market analysis: We’re well into our time window for entering June trades, and we expect to initiate at least one new position this week. Because we might, for the first time, have more than three positions open at once, we wanted to alert members—especially those autotrading the newsletter—that we could commit as much as $1200 per base position (or “unit”, in autotrading terms) in additional capital to another trade this week before reducing or closing another position.
The Beginning of the End?
Last week’s surge back into overbought territory after such a long, steep rally has the look of a buying climax, or at least the beginning of one. The S&P 500 Index closed Friday at 929.23, less than 15 points (1.6%) below its January 6th high and about 25 points (2.7%) from its 200-day moving average; the picture is almost identical for the Russell 2000. The NYSE Composite and the Philadelphia Bank Index are closing in on resistance at the 200-day and January high as well. While the Nasdaq Composite and Nasdaq 100 have surpassed their January highs, COMPQ struggled at its 200-day average last week and closed under it on Friday; NDX is above its 200-day and now testing it as support.
But there’s still room for a blow-off rally, especially in the Dow (where our portfolio has a negative bias). DJI closed Friday just below the downtrend resistance line drawn through the May 2008 and September 2008 highs—if it breaks above that line, the next major resistance area is the 9000–9100 range, where it topped out in January and would be meeting its 200-day average (see chart below). Short-term momentum (60-minute chart, not shown) turned upward in all the major indexes Friday afternoon and remained bullish into the bell. The only reliable prediction at this point is that the rally will keep going until it doesn’t anymore—which could be tomorrow or a couple weeks from now—which is why we’re focusing on following our adjustment rules and managing our risk from day to day as long as it looks like our portfolio of May positions has a reasonable chance of turning profitable by the end of the week.