Dr. Duke's Blog

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Written by Dr. Duke

Created: 22 July 2009

Patience is a necessary attribute of good traders as long as we define it properly. Some investors sit on losing positions, hoping the market will turn in their favor - that isn't patience. My iron butterfly and iron condor positions have now been hedged against further increases in the Russell 2000 Index (RUT) for about ten days. For the past two to three trading sessions, our positions have been sitting near the "tipping point" - not quite at the point of closing the positions and accepting the loss, but not yet at the point of removing our insurance either. Once you have properly hedged your positions, it takes patience to then give the market time to establish a direction that will drive your decision. Patience allows you to trade what the market gives you, rather than jumping into a trade based on your prediction of the market's next move.

RUT closed at $528.70 today after running as high as $531. Pull up the RUT chart and note that the highs on June 8, 9, 10, and 11 were all in this $531-$532 area. So RUT is paused right at resistance. The SPX closed at $957, just above resistance at $950. Today's SPX candlestick was the classic doji, suggesting indecision or a relative standoff between the bulls and the bears.

I decided to add one more contract to my iron butterfly today: one contract of the $530/$580 calls at $14.00 and one contract of the $450/$500 puts at $5.50. This position now stands at a P/L of -$716, delta = -$79, and theta = +$103. My adding the 530/580 calls betrays my expectation that we will either trade sideways at this resistance level or pull back from it. But I still have a reasonable positive theta and a breakeven up at $544, so I have given myself room to be wrong.

My August iron condor position remains pretty much unchanged at a P/L of -$950, delta = -$35, and theta = +$46. So, we patiently wait.

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Written by Dr. Duke

Created: 21 July 2009

The markets continue to teeter on the edge; the SPX and RUT both appeared to be pulling back from resistance levels set in early June, but reversed course mid-day and closed near where they opened, with minimal net change. My positions are hedged against further upside movement, so I am simply waiting for the market to decide whether it will break resistance and set new highs or pull back.

My iron butterfly stands at P/L of -$797, delta = -$47, and theta = +$75; my breakeven on the upside is $542, so I have some room for this position to be profitable and a reasonable positive theta while I wait for the market to choose a direction.

My Aug iron condor stands at a P/L = -$740, delta = -$37, and theta = +$37. This is a minimal theta/delta ratio of 1:1, but the long Sept $530 calls have me effectively hedged up to about RUT = $540, so I can patiently wait.

At this point, either the market breaks to the upside and I close my positions for minimized losses due to the adjustments, or the market pulls back and I have the opportunity for these positions to play out for a profit. The adjustments allow me to patiently wait rather than trying to predict the market and hope I am right.

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Written by Dr. Duke

Created: 20 July 2009

The markets gapped up at the open and ran up, but then gave back all of those gains and appeared to be meandering sideways most of the day. The major indexes are flirting with the resistance levels set back in June (about $950 on SPX and $535 on RUT). By mid-day, I was thinking it may be time to sell the long September calls that are protecting my condor's call spreads; the thought was to take that profit today and wait for the RUT to drop tomorrow and then my condor would be back in good shape. But during the last hour of trading today, the RUT and SPX both started strengthening and even more so after 4 pm ET. That tells me some big money is expecting the market to push through these resistance levels. RUT closed at $526.96, just below resistance, and SPX closed at $951.13, right at resistance.

I decided it was better to leave my upside protection in place. The risk/reward curves for the next day or two are essentially flat with my Sept calls in place, i.e., I can afford to allow the RUT to continue upward to about $550 and my position P/L should remain contained to a loss of less than about $2000 (less than an average month's gain). The Aug condor stands at a P/L of -$880, delta = -$28 and theta = +$45. This is a weak theta position, although it is still positive. Clearly, this position is at the "fish or cut bait" stage - in the next few days, we will either close our call spreads or sell our Sept calls (or both).

My Aug iron butterfly now stands at a position delta of -$48 and theta = +$71. This theta/delta ratio is better, but nothing to write home about. To varying degrees, both of these positions are on the edge of being closed if this market continues its strong surge upward.

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Written by Dr. Duke

Created: 17 July 2009

As I watched the market basically trade downward and sideways most of the morning, I was somewhat encouraged (because that favors my current positions). But, as the day wore on, the market struck me as holding up pretty well on increased volume. Thus, I re-evaluated my positions.

Around mid-day, my iron butterfly stood at a delta = -$69 and theta = +$72 - a pretty weak position. If RUT moves up only $1, I stand to lose all of the money I gain in one day from time decay. That's too much price risk, so I closed my two remaining $510 calls for $23.31 and sold two $530 calls for $12.51. By not rolling the long $560 calls upward, I reduced my upside profit potential but I also reduced my upside risk substantially. So the iron butterfly position now looks like this: one $520/$570 call spread, two $530/$560 call spreads, two $440/$490 put spreads and one $450/$500 put spread with a position delta of -$29 and theta = +$71. So I am back in my comfort zone of about a two to one theta/delta ratio.

My Aug iron condor is also hanging off the edge of the cliff, hedged by the long Sept $530 calls, but theta had deteriorated to low levels and I decided to make further adjustments rather than expose myself to any more risk. I closed 10 contracts of the $530/$540 calls for $4.10 and sold 10 contracts of the $570/$580 calls for $0.70, for a net $3.40 debit or $3,400. This boosted our theta back up to +$53 and reduced the position delta to -$14. At this point, my adjustments have greatly reduced my profit potential for this position, but I have also reduced my loss potential dramatically.

For those of you new to options spread trading, don't despair. You can start small, use simpler adjustments and build your experience over time. Understanding the various risk management techniques is crucial to successful options trading.

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Written by Dr. Duke

Created: 16 July 2009

Confidence in the economy continues to grow and feed the rally in the markets. The Russell 2000 Index (RUT) closed up at $522.02, surpassing the recent high of $520 on July 1, and closing in on the high of $535 set June 5. I began hedging my Aug iron butterfly at 440/490 and 510/560 by rolling one of the pairs of spreads up one strike to 450/500 and 520/570 (closing one contract of the call spreads and one contract of the put spreads and opening new spreads one strike upward). This moderated the delta somewhat to -$69 with theta = +$68. I am not optimistic that RUT will break this next resistance level, so I didn't roll more than one strike upward. If I am wrong, then I will either roll further upward or close the trade.

My Aug iron condor stands at a P/L of -$880 with a delta = -$61 and a positive theta of $44. Our Sept $530 calls are effectively holding our losses in check, but our theta position is deteriorating. If theta goes negative or RUT breaks $535, I will close this position for a loss.

Note that hedging our position does not turn the trade into a winner, but it holds our losses to a reasonable number (our goal with the condor is to hold our loss to less than the original credit of $4,000, and buy us time for the market to pull back).

Losses are a necessary part of trading; learning the techniques to control and minimize the loss allows you to stay in business.

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Written by Dr. Duke

Created: 15 July 2009

The market took off to the races today, buoyed by Intel's better than expected earnings announcement and favorable forecast for the third quarter. The FOMC minutes from June were released and the committee thinks the economy will be shrinking slower than previously expected - that's good news? The volatility of this market continues to amaze me. One day, it's doom and gloom and the next day everyone is optimistic and buying across the board. The RUT gapped open this morning and raced up over $19 to close at $515.64.

My iron butterfly is starting to feel the heat with a position delta of -$63 and theta = +$50; the break-even is $533. I set it up this way because we have resistance levels at $520 and $535.

My Aug condor is also feeling the strain. I purchased an additional Sept $530 call for $14.90 today. The position stands at a P/L of -$190, delta = -$59 and theta = +$50. Those September calls are minimizing our loss while enabling us to see if the RUT will break resistance at $520 and $535 before we "throw in the towel".

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Written by Dr. Duke

Created: 14 July 2009

Trading volume was low today; stock trading results were mixed with modest increases across all of the market indexes. RUT closed at $496.52, up $3.21. This market is still quite volatile and capable of large moves in either direction on the quirkiest of data points, so you must watch your positions carefully. But, in general, we are trading in a choppy, sideways market - ideal for delta neutral income generation options trading.

The iron butterfly I initiated yesterday is sitting essentially at break-even with position delta of -$16 and theta of +$76.

My Aug iron condor stands at a small profit at this point; by all measures this position should be in adjustment mode: the delta of the short $530 calls = 23 and the debit to close the calls stands at about double the original credit. Buying the two Sept $530 calls yesterday was the right move. It was $1,920 well spent for insurance. This buys us time to see if this market is going to continue upward or not.

As you can see from following these trades, three attributes of the delta neutral options trader are essential: 1) patience - much of the time you are just waiting for time decay, 2) specific rules for adjustments, and 3) the discipline to follow your rules.

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Written by Dr. Duke

Created: 13 July 2009

Strength in the financial sector appeared to boost the entire market today. The S&P 500 and the Russell 2000 indexes bounced strongly off the support levels they were toying with for the past few sessions. RUT closed at $493.31. I will be watching the next levels of resistance on RUT around $520 and $535. I re-established the call spreads for my August iron condor this morning. I would have preferred the 540/550 strikes, but I have another position with long $540 calls, so I dropped down to the $530/$540 call spreads for $1.40 (or $2,800 for 20 contracts). As it turned out, the market continued up strongly all day and I hedged my position by buying 2 Sept $530 calls at $9.60 in the early afternoon. This hedge will hold my position loss to less than $1,000 up to around $525-$530 on the RUT. This buys me time to see if the RUT bounces off its resistance levels at $520 and $535 before I pull the plug on this trade. At the close, the iron condor position stood at a gain of $280, delta = -$15 and theta = +$95.

I also established a new iron butterfly position late in the trading day with the $440/$490 puts for $13.70 and the $510/$560 calls at $9.55, for a total credit of $6,975 on 3 contracts ($8,025 of capital at risk). I positioned this butterfly with some bullish bias (positive deltas) because the RUT bounced so strongly off support today. I will plan to be in this position for two weeks or less.

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Written by Dr. Duke

Created: 10 July 2009

Trading today was choppy with mixed results; there were some bright spots in tech stocks, but otherwise, it was sideways to downward for most stocks. Overall trading volume was low; maybe traders are waiting to see what the earnings announcements look like next week. RUT is holding at the support levels of mid-May, closing at $480.98. I am still waiting for a strong day in the market to re-establish the call spreads of my Aug iron condor. That position now consists of 20 contracts of the Aug 420/430 put spreads and 1 contract of the Sept 430 puts. The position delta stands at +$50 while theta = $26. This position now stands at a net profit of $345; my options analysis software predicts I could tolerate a move down to about $460 and hold the position loss under $1,000. So we continue to wait and see if the markets break support and drop toward the March lows or meander sideways from here (a rally doesn't seem probable).

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Written by Dr. Duke

Created: 09 July 2009

The major indexes all traded close to sideways with lower volume today. The Russell 2000 index closed at $479.27. I took advantage of the little bit of upward motion this morning and closed the put spreads remaining from my July iron butterfly; I closed the 450/480 put spreads for $7.85 for a $1,750 loss. I had closed the call spreads for a $3,300 gain Tuesday; so the net gain on the position was $1,550 or 17%.

I also closed the 570/580 call spreads in my Aug iron condor today for $0.25 or a $1,600 gain. If we have a strong day in the market within the next few days, I will re-establish my call spreads. I don't feel too exposed with the put spreads since I have the long Sep $430 puts as a hedge.

It is interesting that the RUT has paused here in the neighborhood of support levels formed in early May. If we have some definitive moves upward from here, I will breathe a sign of relief and re-establish new call spreads for my condor. If it breaks support, we may be in for a severe leg downward. Those of you who follow chart patterns may see the head and shoulders pattern on the RUT and the SPX. That is traditionally seen as a topping pattern, so that would predict breaking support and forming another leg downward. But if that happens, I am hedged and will close the remaining spreads of my condor for much less than an average month's credit. That is risk management and it's essential for managing iron condors.