Entry 27 Aug 22: The Formal Start of My Options Trading

Market Sentiment 27 August 2022

The primary purpose of this section is to first review the current market sentiment before the start of options trading at the beginning of the week.

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.

So, every weekend I review the current markets and the general mood in the world. I use this analysis to prepare new trades and evaluate trades still running. In addition, it gives me all I need to show off my deep knowledge of economics when I see my friends or colleagues again after the weekend 🙂.

1. Geopolitical Events and Economic Trends

This week’s big picture consists of the events and trends like breaking news, political machinations, Federal Reserve decisions, or trends on social media.

I monitor especially abruptly changing dynamics of the current markets that could lead to sociopolitical-economical shock waves and act like triggers for stock movements.

In particular, I need to answer what the main drivers for the overall market are. What has and is impacting the world’s economies, especially those of the US, Asia, and Europe? I have to shift through all the news to read the market sentiment in the world.

This week’s notable events and trends

• Stocks Walloped On Tough Talk From Fed Chair Powell – Fed Chairman Powell reiterated his prior view that the Fed will continue to raise rates to fight inflation – but with a more resolute tone saying the U.S. economy will need tight monetary policy “for some time” before inflation is under control, a fact that means slower growth, a weaker job market and “some pain” for households and businesses, he said in prepared remarks for a speech to the Jackson Hole central banking conference in Wyoming. The S&P 500 Index ($SPX) (SPY) on Friday closed down -3.37%, the Dow Jones Industrials Index ($DOWI) (DIA) closed down -3.03%, and the Nasdaq 100 Index ($IUXX) (QQQ) closed down -4.10%. 
• Russia intensifies attacks in parts of eastern Ukraine, Britain says – Ukraine war causing more and more economic woes, high costs of living due to inflation and other worries
• In Asian markets, on 26 August, The Nikkei Index rose 152 points to 28,641, the Shanghai Index fell -10 points to 20,170, and the Hang Seng Index gained 201 points to 20,170. In Europe, the German DAX is down about -44 points to 13,227, while the FTSE 100 is little changed at 7,482. Oil prices are higher, while gold is lower.

2. VIX Index

The CBOE Volatility Index, also known as the VIX, is an emotion gauge for the general investing population.

• A VIX below 15% is very low volatility. A VIX of 15% or below 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, it’ll 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 not adequate for short premium plays which require high volatility. This is where long calls and puts, and debit spreads may be set up. Only when VIX gets closer to 30% selling options become viable.
• A VIX at 30% or higher means higher volatility. When selling options, you want to be selling 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.

VIX for position sizing

Volatility and the VIX play a very important role in how I size positions and portfolio allocation. Since my focus is on short premium trading I must strike a balance between exposure to large losses and being able to reach sufficient occurrences.

With a VIX 0f around 25 my maximum portfolio capital allocation is 35% of net liq.

VVIX

The VVIX is another important data point about sentiment in the current trading environment.

In 2022 the VVIX Index (VIX Volatility Index) has also traded within a fairly reasonable range (roughly between 83 and 150). The VVIX is nicknamed the “VIX of VIX” because it is calculated using the implied volatility of options in the VIX itself. The index measures the “volatility of volatility, or the “vol of vol.”

These days, the VVIX is trading at about 91, which is still fairly close to its 52-week low.

3. Oil and Gas

The next sector I look at to understand market sentiment are, due to their huge impact on the global economy, financial markets, and industries, the oil & gas markets.

• Oil is higher
• UK: Gas prices are down, but Biden’s problem at the pump isn’t going away
• Europe: European gas prices surge as Russian pipeline maintenance fuels fears of a total shutdown

4. Gold, Silver, and Copper (Metals & Mining)

Due again to their impact on the economies, financial markets, and industries, I also track trends in the gold, silver, copper, other precious metals, and mining markets.

Gold is lower: Gold slides after Powell doubles down on tight monetary policy

Silver is lower: Silver Price Forecast – Silver Markets Continue to Plunge

Copper is lower: Copper speculators anticipate a downturn for market and the world

5. Yield Curves

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

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

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

Normal curves point to economic expansion, downward sloping (inverted) curves point to economic recession.

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

Source: Investopedia

I track two yield curves.

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.

Today’s 10 Year-3 Month Treasury Yield Spread is at 0.15. The long-term average is 1.20. So mfor some time now the indicator has been predicting a recession.

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

The 2-year/10-year yield curve spread inverted on April 1, 2022, for the first time since 2019.

6. Producer Price Index

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).

It is a measure of inflation at the wholesale level that is compiled from thousands of indexes measuring producer prices by industry and product category.

• Producer prices decline 0.5 percent in July, another sign of slowing inflation

7. Consumer Price Index (CPI)

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, it is an indication that prices could be trending higher, with inflation on the rise.

• Consumer prices rose 8.5% in July, less than expected as inflation pressures ease a bit

8. Consumer Sentiment Index

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

9. Put/Call Ratio

If I add up all the put options contracts bought today and compare it to the total of all the call options contracts bought, I should be able to assume what the current market’s sentiment is right now.

When the ratio between put options bought versus call options bought is above 1, the market is buying insurance to what they may see as declining markets (or a pending market collapse).

Vice versa, when the Put/Call Ratio falls below 1, there is a general sense that the broader markets will increase, and more investors are buying more than selling.

Here are some assumptions when considering the Put/Call Ratios when trading stocks. I can then divide the number of put options contracts bought by the number of call options contracts.

• 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.
• 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.
• Moving sideways if the Put/call Ratio oscillates between 0.5 and 2.0.

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

10. DJI, SPX, Russel 2000 Indices, and Main Market Sectors

DJIA, SPX, IWM

In general, I look at the main 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.

Major Market Sectors

I also follow the major market sectors in Barchart.

11. USD

With the DXY, the symbol for the US dollar index, I track the price of the US dollar against a basket of six foreign currencies. This indicates the value of the USD in global markets.

The basket of currencies essentially consists of nations 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.

• Dollar Climbs On Hawkish Fed

12. Bitcoin

Finally, I also track Bitcoin and other cryptocurrencies and the general emotional opinions and attitudes of investors toward the asset.

At this stage, I mainly use it for stocks of blockchain companies I trade like RIOT which are highly correlated to Bitcoin.

Other Indicators for Reading Market Sentiment

TLT

But I also want to pay attention to the iShares 20 Plus Year Treasury Bond ETF (Nasdaq: TLT) — the long bond. People told me it’s important to keep tabs on the TLT because the broader market gets its clues from the bond market. I will have to better understand this.

Summary Market Sentiment 27 August 2022

This Week’s Economic Calendar

Earnings and Dividend Calendar

I will each week keep track of earnings and dividends related to my selected underlyings.

Financials

Cash Balance 27 August

Options Buying Power

I will here keep track of my Options Buying Power

This Week’s Guidelines

Due to a short trip to The Hagues and since my formal start is 1 September I will most probably not have time to enter a trade this week.

Here below you will find an overview of how I intend to structure the rest of my trading journal.

Goals and Schedule

Each week I will here fill in the goals and schedule for the week.

This Week’s Rules

This section will contain the entry, adjustment, and exit rules for this week per option strategy

Vertical Bull Put Credit Spread

Vertical Bear Call Credit Spread

Vertical Bull Call Debit Spread

Vertical Bear Put Debit Spread

Short Iron Condors

Short Straddles

Other Strategies

This Week’s Playbook and Selected Underlyings

Active Positions

Each week I will here report on running positions.

Positions Closed Last Week

Here I will give an overview of positions closed in the past week.

Positions Opened Last Week

The same for positions opened

The Underlyings I have Selected to Open and Options Strategies I Intend to Use

Each week I will here list the positions I want to open during the week.

Conclusion

Maintaining a trading journal will be quite a task, so my goal is to see how I can reduce the effort by eliminating all ‘nice-to-haves’ and focusing on the ‘really needed’ in my trading journal.

If you would like to leave a comment or have some advice for me, please do so here below!

Thanks,

Nic