Entry 24 June 23: Stricter Following Rules

By: nic

Improving options trading has everything to do with stricter following the rules you have set up for yourself.

I, therefore, did a clean-up of positions going over my loss targets (50% – 100%), closed unsuccessful butterflies, and did some rolling.

I also am reducing the number of symbols I trade into a list of not more than 15 highly liquid, narrow bid-ask spread backtested and diverse underlyings : C, DIA, DIS, EEM, GLD, GOOGL, IWM, KRE, QQQ, RIOT, SBUX, SPY, TLT, TSLA, UBER.

My intention is to keep it at 15 and then replace low performers with new underlyings. By reducing the number of underlyings to 15 I will be better able to focus on fundamental, technical and other factors impacting my trade choices.

For short premium traders, low volatility is risky. This has everything to do with the risk-reward being worse. You get less premium to compensate for outlier risk (skew).

Therefore, I am still not trading too much right now, and am spending most of my time learning Python. Actually, not trading too much is better since I will not lose too much money on commissions and fees.

I prefer delta-neutral trading and am using tastytrade’s beta-weighting deltas indicator to benchmark individual positions and sum them to understand the directional exposure of my whole portfolio.

I still have a negative portfolio delta beta. Given that many signs are turning to red and the threat of a recession is still not away, this may not be so bad.

How am I Doing Overall?

I am now over a year into options trading. Although I am still far away from the goals I have set for myself, I have shown a consistently positive balance since September of last year. I had two dips, but I reached another record, breaking the last $900 P/L YTD top in March, and I am again below at $867.33. This is mainly due to several plays going wrong in the past two weeks, which I therefore had to close.

So, I am not progressing the way I would like. I seem stuck in a ‘twilight zone’ around $11.000, which is somewhat below my in-lay. So my trading discipline/style today is leading to a slightly positive picture (given that it compensates for the commissions and fees I have to pay) but is far from the financial goals I set. I should by now have been comfortably going towards $13.000.

I still make many mistakes, and my trading discipline has improved, but it needs further work.

I am now at an $ 874 realized gain and an $877 P/L YTD, so I have a -$7 unrealized gain. Considering commissions and fees, I am only at $385 YTD. So Still far away from the goals in my financial plan.

What am I Reading?

And I started re-reading another ‘must-read-for-options-traders’ book that is really helping me in learning options trading.

The book is over 400 pages, and I am still cherry-picking my way through the book.

I am also reading a lot about Python.

Following the flow
Still a long way to go

Table of Contents

Last Week’s Options Trading

The VIX is still under 15 this week, so I need to continue adjusting my trading. It means fewer short premium strategies. I follow the tastytrade rules (not more than 25% of my money into short premium strategies – actually, I am 30% due to last-minute selling a RIOT put).

I only have eleven open positions end of the week, using around 29.3% of Buying Power. The issue is that it is very hard to find short premium plays. So I am more and more testing low-volatility strategies, as much as possible, delta-neutral, and only directional if all signs are on green. I still don’t feel comfortable about where the market is going.

Options Strategy Risk Management Rules​

  1. In high volatility (VIX >20), sell high vol (IVR>30) options to collect premium income while spreading the risk over various expiration dates (staggering dates to avoid expiration density); the higher the volatility, the more of your account you can allocate to short premium strategies.
  2. Sell options at high IVR (>30)  to extract high (overpriced) premiums (‘overpriced’, since predicted volatility is nearly always overestimated, and stocks are less volatile than predicted, so implied volatility implosion or IV reversion to the mean allows for profits to be taken early when stocks fail to be as volatile as predicted). ​
  3. In low volatility (VIX < 20), buy low vol (IVR <30) debit options (you pay the premium) and lower the total allocation; the less volatility, the less money you should allocate to options trading. New rule: only sparingly enter into debit spreads (especially bear puts!), and only do this when more than three signals (technical indicators) confirm this.
  4. Sell and buy options on liquid underlyings in the options market (to open and close positions easily and ensure trades can be filled with narrow bid-to-ask spreads for optimal option pricing ​).
  5. Sell and buy options across tickers with broad sector diversity across uncorrelated sectors to spread risk (too much concentration into any given sector runs the risk of stocks auto-correlating in the same direction and potentially jeopardizing all trades within the sector-specific bucket of trades).
  6. As much as possible (given a small account) stick to risk-defined trades (put spreads, call spreads, and iron condors) to mitigate risk and reduce the amount of capital required for any given trade.
  7. Probability of success (P50 in Tastyworks platform)> 70% to ensure a statistical edge
  8. Close the trade if 50% – 75% loss
  9. Close the trade and realize profits at 50% -75% premium early in the option lifecycle (21 DTE)
  10. Close-out trades (ideally 14-21 DTE) before expiration (before strike price gets challenged just before expiration (high volatility and higher loss probability!).
  11. Re-invest the capital made free towards additional trades.
  12. Maximize the number of trades to allow the expected probabilities to play out (trade small, trade often).
  13. Size position/portfolio allocation to manage risk exposure (worst-case scenarios always need to be considered therefore, I conservatively use small allocations to options trades, so only max 4% of my portfolio should only be used for any given trade). 
  14. Keep an adequate amount of cash on hand (~40% in my case) to protect your portfolio against any major market downturns (i.e., Covid-19 and Q1 2022, 2023 recession(?). Cash also allows me to buy stocks/long equity at heavily discounted valuations. ​

Alternatives for Short Premium Strategies

I prefer short premium strategies so high volatility. But volatility is still relatively low. I need to be able to enter trades in all market conditions.

Historically, implied volatility has outperformed realized implied volatility in the markets. For this reason, we always sell implied volatility to give us a statistical edge in the markets. While I often search for a high IV rank at order entry, the market does not always accommodate me.

I, therefore, will start looking at adding these options strategies that benefit from increases in volatility, as well as more directional strategies to use during low-volatility markets to my playbook:

  1. Long bull call and (sparingly) bear put vertical spreads
  2. Ratio spreads
  3. Long put calendars and call calendars
  4. Long diagonal spreads
  5. Long volatility products

In bull(-ish) markets, implied volatility tends to be low in equities as the VIX drops. Just like I take advantage of reversion to the mean when IV is high, I stay engaged and do the same when it gets to an extreme on the low end. Therefore, in low IV, I will use strategies that benefit from this volatility extreme, expanding to a more normal value.

This doesn’t mean, however, that, in low IV markets, I stop looking for underlyings that have high IV. Premium selling is where the majority of the statistical edge lies.

Opened Positions

Opened on 2 June: Jul21 PLTR 11/13/18/20 Iron Condor for $67 credit, closed 11/13/20 on 23 Jun

25 June 2023: watch it: I messed this up (on mobile) and and now left with two naked positions!

Opened on 21 June: Jun 30/Jul 28 PLTR 14 Calendar Put for $45 debit closed Jul 28 on 23 Jun

Opened on 21 June: Jul 28 DIA 343/338 Bear Put for $190 debit

Opened on 20 June: TSLA Aug 18 Iron Condor for $165 credit

Opened on 20 June: Aug 18 DIA 342/337 Bear Put for $180 debit

Opened on 13 June: PTON 8 Jul 28 Short Put for $42 credit rolled to 7 Sep 15 for $14 debit

Closed: Opened on 13 June: ORCL Jun 16 Iron condor 102/106/126/130 for $135 credit closed 14 Jun at $90 profit

13 June 2023: earnings play

Running and Closed Positions

Closed: Opened on 9 June: RIOT Jul 21 8 Short Put for $42 credit rolled for $65 credit and closed 21 Jun at $29 profit

Date

10/6/23

Underlying

10.33

PoP/P50

77%

DTE

41

IVR

-0.6

Δ Delta

18.15

Θ Theta

1.13

Other

10 June 2023: Just opened and at $2 loss, needs to stay here or go up

Closed: opened on 8 June: GOOGL Jun 30 124/120 Bear Put for $190 debit, closed on 14 Jun for $35 loss

Date

10/6/23

Underlying

122.23

PoP/P50

49%

DTE

20

IVR

2.9

Δ Delta

-22.70

Θ Theta

-0.031

Other

10 June 2023: just opened an at $2 loss, needs to go down

Opened on 8 June: PYPL Jul 21/Aug 18 62.5/67.5 diagonal for $385 debit

Date

25/6/23

Underlying

66.94

PoP/P50

355

DTE

26

IVR

3.2

Δ Delta

-29.11

Θ Theta

-0.470

Other

Date

10/6/23

Underlying

63.49

PoP/P50

51%

DTE

41

IVR

8.6

Δ Delta

-21.23

Θ Theta

0.411

Other

Date

8/6/23

Underlying

64.48

PoP/P50

DTE

IVR

Δ Delta

Θ Theta

Other

10 June 2023: at 7.3% profit = $28; I need to understand better the nuts and bolts of a diaginal spread. This is what AI has to say about it (here I actually found out I placed the strike prices wrong – the short-term put should have been at a higher strike price compared to the longer-term long put):

The profit potential of a diagonal put spread will be affected by changes in the underlying asset’s price, but the extent of the impact will depend on the specifics of the trade, such as the strike prices of the put options and the time to expiration.

A diagonal put spread involves buying a long-term put option with a lower strike price and selling a short-term put option with a higher strike price. The idea behind this strategy is to profit from a moderate decrease in the underlying asset’s price, while also limiting your potential losses.

If the underlying asset’s price decreases considerably below the strike price of the long-term put option, the profit potential of the diagonal put spread will be limited. This is because the gain on the long-term put option will be partially offset by the loss on the short-term put option. At some point, the loss on the short-term put option may completely offset the gain on the long-term put option, resulting in a maximum profit for the diagonal put spread. Beyond this point, any further decrease in the underlying asset’s price will not result in additional profits for the position.

On the other hand, if the underlying asset’s price increases considerably above the strike price of the short-term put option, the profit potential of the diagonal put spread will also be limited. This is because the loss on the short-term put option will be partially offset by the gain on the long-term put option. At some point, the gain on the long-term put option may completely offset the loss on the short-term put option, resulting in a maximum profit for the diagonal put spread. Beyond this point, any further increase in the underlying asset’s price will not result in additional profits for the position.

In general, the profit potential of a diagonal put spread will be highest when the underlying asset’s price is near the strike price of the short-term put option at expiration. If the underlying asset’s price moves too far away from this strike price, the profit potential of the position will be limited.

Sage

So what is AI telling me about the (wrong) set-up I chose:

If you sell a short-term put option at a lower strike price than the long-term put option you buy, you would be creating a position that is the opposite of a conventional diagonal put spread. This configuration would create a bullish position that profits from an increase in the price of the underlying asset, while potentially limiting your losses if the price were to decline.

However, this configuration would also carry additional risks and potential losses that are not present in a conventional diagonal put spread. If the price of the underlying asset were to decline significantly, the long-term put option you purchased may not provide enough protection to offset the losses on the short-term put option you sold, resulting in a net loss for the position.

So I have to be careful here. If the price goes down I must close immediately!

Closed: Opened on 2 June: MRVL Jul 21 52.5/57.5 Bear Put for $255 debit rolled for $76 credit on 13 June and closed on 22 June for $19 loss

Closed: Opened on 8 June: AAPL Jul 21 180/175 Bear Put for $200 debit closed on 14 June for $44 loss

Date

10/6/23

Underlying

180.96

PoP/P50

41%

DTE

41

IVR

-2.6

Δ Delta

-16.83

Θ Theta

-0.218

Other

Date

8/6/23

Underlying

177.50

PoP/P50

DTE

IVR

Δ Delta

Θ Theta

Other

10 June 2023: -$48 in the red (-24%)

Rolled Opened on 26 May: AMD Jul 21 Iron Condor 100/105/140/145 for $180 debit; rolled put wing on 14 Jun to 110/115 for $65 credit and call wing on 20 Jun to 125/130 for $90 credit

Date

25/6/23

Underlying

110.01

PoP/P50

31%

DTE

26

IVR

21.6

Δ Delta

9.86

Θ Theta

0.750

Other

Date

10/6/23

Underlying

124.92

PoP/P50

62%

DTE

41

IVR

45.4

Δ Delta

-1.02

Θ Theta

2.133

Other

Date

3/6/23

Underlying

117.86

PoP/P50

64%

DTE

47

IVR

26.9

Δ Delta

3.01

Θ Theta

1.921

Other

10 June 23: still at $30 profit (16.7%)

3 June 23 : $30 profit

Closed: Opened on 18 May: ORCL Jun 16 Iron Condor 90/95/105/110 for $186 credit on May 18, rolled put wing to Jul 21 for $72 credit on 26 May, rolled call wing for $25 to July 21 on 1 June for $25 credit, rolled up put wing to 97.5/102.5 on 2 June for $15 credit rolled wings and with several rolls turned into butterfly 120/125/125/140 and closed on 23 Jun for $129 loss

Date

10/6/23

Underlying

109.86

PoP/P50

35%

DTE

47

IVR

27.6

Δ Delta

-4.45

Θ Theta

1.228

Other

Date

3/6/23

Underlying

105.88

PoP/P50

35%

DTE

47

IVR

27.6

Δ Delta

-4.45

Θ Theta

1.228

Other

10 Jun 23: still going into the wrong direction (up): -$46 in the red (-13.5%)

3 June 23 : -$17 in the red

Closed Rolled: Opened on 17 May: KRE Jul 21 Iron Condor 30/33/43/46 for $100 credit and rolled the put wing up to 36/39 for $35 credit and closed for $48 loss

Date

10/6/23

Underlying

43.47

PoP/P50

38%

DTE

41

IVR

24.1

Δ Delta

-11.83

Θ Theta

0.9

Other

Date

3/6/23

Underlying

42.16

PoP/P50

59%

DTE

47

IVR

23.2

Δ Delta

-17.11

Θ Theta

0.876

Other

10 June 23: -$47 in the red now and went over 50% loss limit, now at -42.7%. Will small banks ETF continue to rally or go down again? On Friday it went down. But too much green in the signals still. So I may be forced to close it if the downtrends reverts again.

3 June 23 : $2 in the red

Closed: Opened on 17 May: MRK Jul 21 Iron Condor 100/105/120/125 for $167 credit and closed with $79 profit

Date

10/6/23

Underlying

110.71

PoP/P50

50%

DTE

41

IVR

4.2

Δ Delta

-24.04

Θ Theta

-0.08

Other

Date

3/6/23

Underlying

112.52

PoP/P50

67%

DTE

47

IVR

27.0

Δ Delta

-1.82

Θ Theta

1.810

Other

10 June 23: at -$2 in the red, but staying nicely in its iron condor box.

Closed: Opened on 21 Apr: PTON Jun 16 Short Put 7 for $32 credit, rolled to Jul 21 for $25 credit and closed for $40 profit

Date

10/6/23

Underlying

8.31

PoP/P50

75%

DTE

41

IVR

8.9

Δ Delta

20.99

Θ Theta

0.755

Other

Date

3/6/23

Underlying

68.37

PoP/P50

76%

DTE

47

IVR

-1.4

Δ Delta

22.33

Θ Theta

0.695

Other

Date

13/5/23

Underlying

6.94

PoP/P50

54%

DTE

34

IVR

10.2

Δ Delta

47.35

Θ Theta

0.885

Other

Date

22/4/23

Underlying

9.48

PoP/P50

81%

DTE

55

IVR

29.9

Δ Delta

15.34

Θ Theta

0.703

Other

10 Jun 23: -$1 in the red

13 May 23: -$35 in the red, which is over -100% so should have been closed ages ago.

22 Apr 23: opened based on technical indicators showing oversold and upward trend again. Now at $0

21 Apr 23: Another short put experiment with a low price (under 10) stock.

PTON

Peloton Interactive, Inc. provides interactive fitness products in North America and internationally. It offers connected fitness products with a touchscreen that streams live and on-demand classes under the Peloton Bike, Peloton Bike+, Peloton Tread, and Peloton Tread+ names. The company also provides connected fitness subscriptions for various household users, access to various live and on-demand classes, and Peloton Digital app for connected fitness subscribers to provide access to its classes. As of June 30, 2021, it had approximately 5.9 million members. The company markets and sells interactive fitness products directly through its retail showrooms and at onepeloton.com. Peloton Interactive, Inc. was founded in 2012 and is headquartered in New York, New York.

End-of-Week Active Positions Overview

Financials

Cash Balance JUNE 2023

P/L YTD now at 913.33. Low volatility still doesn’t make me much money!

I am automating the P&L overviews so as soon as I am ready I will here show the results. The overview here below stops at 3 June 2024.

Status 13 May 23 (not updated anymore – anyway not chnaged very much)

Due to the low volatility and not being able to find enough plays, my trading is suboptimal, I am not making full use of my cash, optimizing my positions enough, etc . and I am still making mistakes in choosing the right directions and the right options strategies. Still looking for the edge!

The points I have to look at are:

  • My positions are generally placed on the safe side with low deltas, risk, and profit. I am already increasing risk by widening spreads and picking higher deltas.
  • For a better-balanced portfolio allocation (based on VIX), I am adding non-short premium and passive income strategies to optimize my portfolio.
  • Except for a small short put undefined risk play in RIOT, I have been only doing a limited number of defined risk strategies which are lower risk but also less profitable: I may need to start looking at adding other defined risk strategies, and once in a while short straddles and strangles based on low prices underlyings. But my account is, at this stage, really too small for this.
  • I now select positions with higher premiums than the commissions and fees I have to pay and the target profit I have set as a rule (50%).
  • I am now also monitoring the beat-weighted delta of my positions and total portfolio; in periods like this, I need to manage it so that it remains close to 0. I am far away from achieving this.
  • BUT MOST IMPORTANTLY: I SHALL ABIDE BY MY ENTRY, ADJUSTMENT, AND EXIT RULES!

Find out more about the platform I love to use for my options trading:

If you like it as much as I do and want to open an account, click here:

Disclosure: for each referral I will get credits for items or cash to support this website! Thanks!

Market Sentiment 24 June 2023

Stocks fell on Friday to wrap up their worst week since the collapse of the Silicon Valley Bank in March, indicating the market’s three-month rally may have come to an end

I mostly use eOption’s Closing Bell emails, StockTwits, BarChart, and Seeking Alpha I receive daily as a source.

  • Bank stocks were down for a 5th straight day amid talk of higher interest rates and increased capital requirements by regulators to strengthen the banking system.
  • Regional banks (KRE) were a drag on the Russell 2000 on Thursday, which carried over into Friday weakness while large cap banks (XLF, BKX) weighed in the S&P; GS said they are likely to take a large write-down for acquisition of fintech lender GreenSky, CNBC reported. The KBW regional bank index (KRE) caps worst week since May 5, down 7.4%.

1. Geopolitical Events and Economic Trends

During the week, I capture the most important news. Every weekend before the new trading week, I review the current markets, the general geopolitical events, and economic trends determining the sentiment in the world of options trading.

  • The war between Russia and Ukraine is still raging, and Russia (Prgozhin) is now fighting Russia (Putin). This could cause waves.

2. VIX Index

  • The CBOE Volatility index (VIX) is still down around 13.44 (!). Crisis? Near-time recession? Not according to the market.
  • The VIX Index measures the level of the expected volatility of the S&P 500 Index over the next 30 days that is implied in the bid/ask quotations of SPX options. Thus, the VIX Index is a forward-looking measure, in contrast to realized (or actual) volatility, which measures the variability of historical (or known) prices.
  • A VIX below 15% is very low volatility. A 15% or below VIX is assumed to be a market at rest. Since the intrinsic nature of the Stock Market is to move up, a VIX close to 15% or lower will tell us that the broader market is likely to head higher. 
  • Up to 19% VIX means the market is in ‘lull’ mode. 19% is seen as the ‘steady state’ VIX. This arena is inadequate for short premium plays, which require high volatility. This is where long calls, puts, and debit spreads may be set up. Only when VIX gets closer to 30%, selling options become viable.
  • At 20% or higher means medium volatility.
  • A VIX of 30% or higher means high volatility. When selling options, you want to sell out of stocks when the VIX is near 30. This is where credit spreads, short strangles, straddles, short iron condors, etc., can be played.
  • Above a VIX of 40%, this is still the case, but given the extreme volatility, you should be very careful.

If the market drops and the VIX goes up, the futures and options in the front month typically rise the most and more quickly than those in the back month.  And vice versa.

VIX for position sizing

So my maximum portfolio capital allocation for short premium strategies should remain at 25% of net liq. At the end of this week I have 30% allocated. This is mainly caused by the RIOT short put I so much like to play. Without this it is around 22%.

See also on this subject this Tastytrade video.

VIX

< 15

15-19

20-29

30-40

>40

Volatility

Lowest volatility, all comfortable

Market in ‘lull’ mode

Volatility high

Volatility very high

Volatility and fear levels highest

Maximum portfolio capital allocation

25%

30%

35%

40%

50%

Volatility and the VIX are significant in how I size positions and portfolio allocation. Since my focus is on short premium trading, I must balance exposure to substantial losses and reaching sufficient occurrences.

In 2022 the VVIX Index (VIX Volatility Index) has also traded within a fairly reasonable range (roughly between 83 and 150). The long-term average is 86, and the VVIX is mean-reverting.

The higher the VVIX is, the higher the premiums are on the VIX options, everything else being equal.  If the VVIX spikes higher, it indicates traders are buying VIX options either as a hedge against or as a speculation for, a market sell-off.  The VVIX is telling us in such a case that the market is girding itself for some downside. And vice versa.

The VVIX is nicknamed the “VIX of VIX” because it is calculated using the implied volatility of ATM and OTM options in the VIX itself, using the same calculation method as VIX. The index measures the “volatility of volatility, or the “vol of vol.”

Today, the VVIX is down to 89.70 (so a little bit above average).

The VVIX/VIX Ratio

See more in this Tastyworks video.

SKEW

Also, watch this tastylive video on how to use SKEW as an extra indicator in low volatility environments. The SKEW index measures the tail risk by using out-of-the-money SPX options.

Low volatilty/high SKEW (>130) : danger, further reduce your trades!

3. Oil and Gas, Gold, Silver, and Copper (Metals & Mining)

The following sectors I look at – to understand the market sentiment – are, due to their massive impact on the global economy, commodities.

  •  WTI crude oil slips -$0.35 or 0.5% to settle at $69.16 per barrel well off the morning lows of $67.35 per barrel, but still down sharply for the week. Oil dropped for a second day as economic growth concerns outweighed lower U.S. crude stocks this week after central banks hiked interest rates and the Fed Chair Powell suggested two more hikes this year is likely. Natural gas prices gained +4.6% to settle at a 16-week high at $2.729/MMBtu, up 3.7% this week after rising 13 of the last 16 sessions (comes despite bearish nat gas inventory data Thursday).
  • Gold prices rose $5.90 to settle at $1,929.60 an ounce, bouncing off 3-month lows but closed the week down about 2% (and now down more than $150 since topping the key $2,000 level in early May). A stronger dollar, a steady hawkish stance on rate hikes from Federal Reserve officials, and central banks around the world raising interest rates weighed on prices. Silver prices fell over 7% this week to $22.32 an ounce and copper slipped over 2%.

4. USD and Other Currencies, Bitcoin and Crypto

The DXY, the symbol for the US dollar index, tracks the price of the US dollar against a basket of six foreign currencies that have a significant trading relationship with the US and are also hard floating currencies. The index will rise if the dollar strengthens against these currencies and will fall if the dollar weakens against these currencies. I also look at crypto trends, especially Bitcoin

  • The dollar index (DXY) rose to a one-week peak against its rivals as currency markets dominated by the Fed which remains hawkish on future rate hike outlook. Bitcoin popped to its highest levels in about a year, surging as much as 4% to $31,300 highs. Grain prices were broadly lower on the day, with corn, wheat and soybeans all falling. Treasury yields dip on day and week as the 10-yr fell 3.1 bps on week to 3.73%, snapping its 2-week winning streak (down 49 bps from 52-week highs in Sept and up 113 bps from 52-week lows in August 2022).
  • The U.S. dollar rose following comments from Federal Reserve officials that further interest rate hikes this year are likely.
  • Bitcoin up to 30708!

5. Yield Curves

Understanding yield curves also adds to better reading the market sentiment.

“A yield curve is a line that plots bonds’ yields (interest rates) having equal credit quality but differing maturity dates. The yield curve’s slope gives an idea of future interest rate changes and economic activity.

There are three main yield curve shapes: regular (upward-sloping curve), inverted (downward-sloping curve), and flat. Upward sloping (standard yield curves) is where longer-term bonds have higher yields than short-term ones. 

Standard curves point to economic expansion, and downward-sloping (inverted) curves point to economic recession.

Yield curve rates are published on the Treasury’s website each trading day.”

Source: Investopedia

i. The 10-Year Treasury Constant Maturity minus 3-Month Treasury Constant Maturity Yield Curve

The yield curve (T10Y3M) compares the 10-year with the 3-month U.S. Treasury bond yield. It gives insight into bank profitability, which is correlated with economic activity. Historically, the yield curve has been a reliable predictor of economic recessions.

An inverted yield curve has been a good indicator of an economic slowdown ahead. A 10-year-3-month treasury spread approaching 0 signifies a “flattening” yield curve. Furthermore, a negative 10-year-3-month spread has historically been viewed as a precursor or predictor of a recessionary period.

  • For some time now, the indicator has been predicting a recession.

ii. The 2-Year/10-Year Yield Curve

  • The separation between the two instruments still predicts recession.

“An inverted yield curve can be an important economic indicator and a likely precursor to a recession. 

When the curve inverts, the longer-dated bond (I am using the 10-year) will offer a lower annual yield than a short-dated bond (I am using the 2-year). This means that investors have bid up the prices on longer-dated bonds to the point where they yield less than short-dated bonds.

An inverted yield curve results from investor concerns about the economy and the stock market. History shows that investors tend to be right about economic weakness on the horizon when the yield curve is inverted. Since WWII, every recession has been preceded by a yield curve inversion.

Recessions don’t start immediately after the yield curve inverts, however. The inversion tends to precede the recession by 6 to 18 months.”

Source: SeekingAlpha

6. Producer Price Index (PPI), Consumer Price Index (CPI), Consumer Sentiment Index (CSI)

The Producer Price Index (PPI) program measures the average change over time in the selling prices received by domestic producers for their output. The prices included in the PPI are from the first commercial transaction for many products and some services.

Source: Bureau of Labor Statistics (BLS).

  • n/a

The measure that is most often used to measure inflation in terms of consumers is the consumer price index (CPI). Tens of thousands of items in several categories are tracked. The basket of products or services is considered each month, and economists and statisticians look for trends. If the CPI rises, prices could trend higher, with inflation on the rise.

  • n/a

A low CSI index reflects the general (dis-)satisfaction with managing U.S. economic policies. A high satisfaction rating suggests approval of the current policy management and implies market stability. 

Source: Surveys of Consumers (umich.edu).

  • University of Michigan sentiment 

7. Put/Call Ratio

  • Moving sideways
  • A Put/call Ratio of below .5 could mean the market is very bullish. Maybe too bullish. It could be an excellent time to sell stocks high.
  • Moving sideways if the Put/call Ratio oscillates between 0.5 and 1.0.
  • Between 1.0 and 2.0, the Put/call Ratio indicates a bearish market.
  • A Put/call Ratio above 2.0 could mean it is very bearish. It could be an excellent time to consider buying low.
  • The put/call ratio went below1.0, which indicates sideways movement.

Warning: previous research conducted by tastytrade revealed that the Put/Call Ratio is not a reliable trading indicator. Readers can check out this installment to review that research in greater detail this installment.

8. NASDAQ, DJI, SPX, Russel 2000 Indices, and Main Market Sectors

In general, I look at the leading indices DJIA, SPX, and Russell 2000 (IWM) and the level of volatility or ‘market thrashing’ (excessive volatility with significant rising then near proportionate falling in markets’ values within a trading period): above 1% in any or all of them might indicate indecision in the market.

NASDAQ, DJIA, SPX, IWM

Is: 24 June
Was: 10 June

Major Stock Market Sectors

I also follow the major market sectors in Barchart.

  • 5 of 11 sectors closed green.
  • Technology (+0.51%) led, and materials (-0.82%) lagged
10 June 2023
24 June 2023

Summary Market Sentiment

Bull market

Bullish

Neutral

Bearish

Bear market/crash

1. Geopolitical events and economic trends

Positive trends, stable supply chains

Minor market issues, minor supply chain issues

National events, market issues, bad economic data, mini-corrections

Negative indicators, international events, serious market issues, broader market correction (-10%)

The total collapse of the global market, deep recession

2. VIX (VIX)

<15

Lowest volatility, all comfortable

15-19

Market in ‘lull’ mode

20-29

Volatility high (down from above 30)

30-39

Volatility very high

>40

Volatility and fear levels highest

3. Commodities

Oil & gas (XOP), gold (GLD), silver SLV), and copper (COPX) stable

Minor market issues, minor supply chain issues

National events, market issues

International supply chain interruptions, high oil & gas prices

International conflicts involving US, Russia or China, and other main producing countries

4. Currencies & Crypto

Very weak dollar (DXY) versus other currencies, crypto (BTCUSD) crashing)

Weak dollar, Bitcoin

Neither weak/nor strong dollar, Bitcoin

Strong dollar, Bitcoin

Very strong dollar, Bitcoin

5. US Yield Curve s(T10Y3M and US10Y vs US02Y)

Considerably steep curve

Steep curve

Average but still positive curve

Flattening, inverting, and approaching zero

Inverted curve and negative

6. Producer Price Index (PPI), Consumer Price Index (CPI), Consumer Sentiment Index (CSI)

Lowest price level

High consumer confidence

Price level higher than normal

Consumer confidence is less high

Price levels rising fast

Consumer confidence going up and down from very high or up from very low

The price level is very high

Low consumer confidence

Highest price level

7. S&P 500 Put/call ratio (PCR)

Well below 0.5 (very bullish)

Close to 0.5 (bullish)

Between 0.5 and 1.0 (neutral)

Between 1.0 and 2.0 (bearish)

Above 2.0 (severely bearish)

8. Dow Jones (DJI)

S&P 500 (SPX)

Russel 2000 (RUT)

Major Market Sectors (XLE, XLF, etc)

Strong bull market
No real changes in an upward trend

Bullish market
Minor changes in an upward trend

Moving to neutral bullish/bearish market

Increased (positive/negative) changes and “thrashing”

Bearish market (with bear rallies)

In general, going down, many negative changes

Bear market

A deep recession or the market is collapsing, or already did so

Trading style

No restrictions on trading (except for VIX rules)

Closer watch and reduce trades

More caution needed and reduce trades further

Extreme caution and reduce trades even further

Look to close any open positions and no new trades

This Week’s Economic Calendar

  • Fed Interest Rate and FOMC on Tuesday !

Earnings and Dividend Calendar

In general, I tend to avoid earnings or dividends (and other major events within 30 days of opening a position). Earnings are somewhat out again (start next month).

Portfolio allocation

See above: I need to start working on a balance between defined and undefined risk strategies to be added to my playbook.

This Week’s Guidelines

Positions at Beginning Of the Coming Week

I now have 8 positions which is a below the average I need to have running to maximize my portfolio allocation at 2-3% position sizes and 50% overall allocations.

I am now at 30% buying power usage of which most is for short premium strategies. I have set the maximum allocation at 50%, so I need to add new positions quickly (this is NOT what tastytrade advises).

I can exceptionally go up to 70% but I want to have at least a minimum of 30% in cash at all times, so can use 20% more in my account for emergencies or opportunities (so now 35% short premium and 15% debit/long strategies and 20% for emergencies).

Goals and Schedule for this week

Sunday: set up options strategy ideas and perform backtesting; select at least two options strategy ideas.

Until Tuesday: open one more vertical spread or iron condor and a long position.

Rest of the week: start looking at strategies involving buying bills or bonds for the remaining 10% of the 50%.

I need high IVR underlyings and underlyings trading in ranges with apparent resistance and support areas for short premium strategies.

Underlyings Selected for Trading This Week

And during the week, I will monitor stocks going into earnings.

For this week, I will continue applying my underlying selection rules and focus on high volatility (IVR >40) and higher premium underlyings that have no significant events (like earnings < 30 days) coming up.

My expectation (or rather: hope) is that this week’s volatility will increase again.

Options Buying Power and Portfolio Allocation This Week

Based on my current buying power and portfolio allocation rules, I determine whether I can open new positions to maximize such portfolio allocation.

I use VIX to determine the allocation percentage for short premium strategies. Since I until now only opened short strategies, this still applies to my whole portfolio.

However, with VIX going down to under 15, I should consider using a higher % of my total NetLiq for other strategies.

Allocation based on VIX (for short premium strategies)

VIX

< 15

15-19

20-29

30-40

>40

Volatility

Lowest volatility, all comfortable

Market in ‘lull’ mode

Volatility high

Volatility very high

Volatility and fear levels highest

Maximum portfolio capital allocation

25%

30%

35%

40%

50%

I must use Buying Power (NetLiq) to allocate portfolio capital. I will use average, rounded numbers from now on.

Cash Balance

$10.885.04
(was $11.009.27 )

Buying Power/Net Liq

$11,013.04
(was $11,100.27 )

Max Portfolio Capital Allocation Short Premium (Cash Available for Trading)

30%

$3,400 (rounded)

Max Portfolio Capital Allocation Other (low risk, long positions)

20%

$2,300 (rounded)

Average Max Position Allocation (BP)

3%

$340 (rounded)

I am now under-allocated for short premium, so need to add new debit position (s).

Portfolio allocation undefined vs defined risk

All my plays are ‘defined risk.’ I need to add undefined risk positions at a later stage. I will explain why in my blog post on constructing trades.

Since my average maximum position allocation is up to 3% and close to $340, I need to look for higher priced underlyings or increase the number of contracts per position.

This Week’s Rules

This week, I will start a post with my entry, adjustment, and exit rules per the options strategy. I will describe how I set up a playbook with all the strategies I want to deploy.

Conclusion

To continue to work on: weekly reminder: I still need to get more mechanical and disciplined in entering and adjusting the positions and remembering why I (or the platform) close positions.

With each trade, I need to detail the time, make a screenshot of the market on the relevant timeframes, detail my reasoning for entering, the reason for stop placement, the reason for taking profit level, etc. So when, in a few months, I look over my trades, I begin to notice patterns in my losing trades and winning trades. Over time I can fine-tune your edge.

The same for exiting. The focus is now on learning Python and quant finance to further improve my options trading.

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