This blog is taking a quick break from LICs to focus on this year’s annual report awards, annual report competition and annual report contest — the world’s largest of its kind.  (This refers to, of course, the 2009 Vision Awards Competition hosted by LACP.)  See you after the competition!

As I wrote on Sunday, my concern this week has been the call-side spread of my October Long Iron Condor (LIC). After today’s 1.73% lift in $SPY, I’m glad to have profitably offloaded 2/3 of this side of the position before the big run-up.

So, what about the remaining 1/3?  Moving from 109.32 (today’s closing price for SPY) to 110.00 (the inner leg of my call-side spread) could easily happen tomorrow.  The break-even level for this spread–at 110.23–isn’t too much further away and remains well within one standard deviation of today’s closing price.

While history hardly repeats itself exactly, it can rhyme.  And with that idea in mind, I offer a day-to-day comparison of October’s performance for SPY versus September’s.  I’ve aligned these two charts (top, Sep.; bottom, Oct.) by options expiration dates:

October reflects September for SPY

In brief, there’s a remarkable similarity.  Today, just like last month’s Wednesday during options expiration week, jumped over 1% (1.73% vs. 1.15%).  Today’s lift adds to a 7-of-8 day up-trend during the first half of the month…just like September’s aligned 8-of-9 up-trend.

In September, such an eventful Wednesday was followed by modest profit-taking through options expiration.  I wouldn’t be surprised if that translates over to this month as well–or at least give us a fighting chance to stay under 110 through Friday.

So, I am keeping my finger on the trigger to dispose of the remaining third of this spread, but I’m not too worried yet.  One advantage of waiting to dispose of the last part of this spread is time decay–my new break-even point is moving from Wednesday’s level of 108.25 to 108.7 tomorrow.  At the start of Friday, that’ll be 109.3…and 110 at the end.  So, if it seems that there’s a fair shot at the waiting game paying off, I’ll keep doing that.  If we see a steady ramp-up in price tomorrow, I’ll probably exit early.

As usual, watch for updates and commentary during the week by following me on Twitter.

The past five trading days were a mirror image of the week prior–instead of fearing a market pullback, we transitioned to a very bullish outlook by Friday.  In my last update, I mentioned a number of factors that could introduce renewed market confidence, and most or all of them did indeed contribute to the reversal we just witnessed. Now, instead of worrying about an impending market drop, we’re looking at upside risk as options expiry week begins.

OPTIONS EXPIRY WEEK GAMEPLAN

At face value, we look well positioned to ride out the end of the October Long Iron Condor (LIC) without having to close either of the call- or put-side spreads (legs).  After all, the set of calls @ 110 that we’ve sold are outside the first standard deviation, assuming a volatility all the way up to 20%.  That translates into a mere 12% chance that we’d find the 110 calls exercisable at the end of the week.

However, the standard deviation belies the market’s momentum, which has been steadily up for the past five days.  If you’re into daily MACD histograms, we’ve just passed an inflection point that could lead to continued upside in the market.  Further, SPY rose 4.2% in the past week, and while a repeat performance is arguably unlikely, we only need to see a bullish push at 60% of last week’s strength (2.5%) in order to reach 110 by options expiration.

So, while I’d love to play the odds and ride through the next week without closing my call spread, I don’t want to jeopardize my profits, especially when the ‘real life’ odds are arguably less advantageous than what the computer spits out. 

I’ll be watching to see how my resistance level of 108 holds and whether we can stay under that level (I hope it does!), and if it is indeed broken, I’ll watch to see how quickly that will occur.  Roughly speaking, the break-even levels for the call spread of this LIC are 107.65 on Monday, 108.05 on Tuesday, 108.45 on Wednesday, and 108.85 on Thursday. 

I will not hesitate to pull the trigger and break down the call-side spread if/when a) SPY sustains itself above 108 and/or b) there are no indications early in the week of profit taking or a re-emerging bearish sentiment.  Our best hope for a market retracement is a stronger dollar, which seems to be the only catalyst that effectively pushes stocks down nowadays.

Also of note this week:

MONDAY: History tells us that the eighth market day in October is most likely down, but the bulls might have something to say about that.  Expect volume to be light with Columbus Day being observed in the U.S. (how are we supposed to celebrate that holiday, anyhow?), which has played to the longs’ benefit in recent months.

TUESDAY:  A historically bullish day.  Intel and Johnson & Johnson report earnings.  I might be willing to wait until here to see if either disappointing financials or a stronger dollar helps the market take a pause.

WEDNESDAY:  Another historically bullish day, highlighted by J.P. Morgan’s quarterly results and the release of various macroeconomic data from the government.

THURSDAY:  Results from Citi, Goldman Sachs and Google.  By now, I’ve either broken down the call-side spread or am seeing SPY remain under 109.

FRIDAY:  GE and Bank of America Results.  As an options expiration Friday, there’s about a 50/50 chance of being bullish/bearish, historically speaking.

For what it’s worth, about 64% of the last 30 October options expiry weeks have seen overall market gains.

For the November LIC, I don’t plan adding to the position anytime soon unless we see a spike in volatility.  Both options expiry week and the succeeding week tend to see deflated options pricing, so it’s better to wait for conditions to improve in late October.

CURRENT POSITIONS

October 2009 SPY Long Iron Condor

To consolidate the Twitter-based updates from the past week, here’s where things currently stand:

A 100/98 put spread, originally priced at a net credit of $0.16 and now worth $0.03–a 6% gain.  (19% of Oct. LIC)

A 100/97 put spread, originally priced at a net credit of $0.39 and now worth $0.04–a 13% gain.  (38% of Oct. LIC)

A 112/110 call spread, originally priced at a net credit of $0.16 and now worth $0.15–a 0% profit.  (38% fo Oct. LIC)

A 112/111 call spread, originally priced at a net credit of $0.45 and now worth $0.05–a 12% profit (3% of Oct. LIC)

That puts overall profitability through today at 9%, possibly 11% if SPY moves back to around 106.  Peak available profitability for this LIC stands at 14% on October 17, assuming we can remain between 100 and 110 by then.  (23.7% total including the 9.7% already realized.) 

For those who are interested, the current annualized yield for this sort of condor is 837%–higher than normal due to not being delta-neutral and that there will be a lot of time decay (theta) in this options expiry week.  On a $100,000 investment in this LIC, you’re earning just over $1,240 a day in time decay.  Not too bad.

November 2009 Long Iron Condor

I’ll talk more about the November LIC next week, but it’s pretty much on the back burner as I simply try to close out the October LIC as profitably as possible.  For what it’s worth, this LIC is already up 2% since inception last week.

As usual, watch for updates and commentary during the week by following me on Twitter.

The past week brought a tide of change to the stock market.  The “window dressing” that pushed stocks higher in the twilight days of September gave way to profit-taking and anxiety about future economic conditions in October.  So, what can we expect between now and October options expiration, just twelve short days away, and what does that mean for our October Long Iron Condor (LIC)?

First, the good news, which might push stocks higher:

1) Earnings.  Yes, it’s earnings season already.  Look for results from Alcoa, Mosaic, and Yum! Brands–among others–to potentially reassure investors that profitability is still in vogue and keep us from having to exit the put side of our LIC.

Daily Reading of the NYSE McClellan Oscillator

2) Oversold conditions.  If you look at $NYMO  (see right), we are heavily oversold, reaching levels (-80) not seen since late June and early September.  In both cases, the market quickly rebounded, which will hopefully buy us enough time to maximize profitability for our LIC.  Further, we’ve had a weekend for nerves to settle and have plenty of money coming in from 401(k)s and related ‘automated’ investments that needs to be put to work, given that the market is now 6% off highs from two weeks ago.

 3) Historic strength of October.  Contrary to the perceptions of many investors, October typically is a very bullish month and serves as the gateway to a six-month rally that lasts through April.  Further, it has been the best performing month for the S&P 500 since 1993, excluding the aberration of 2008.

However, the market does roll over soon, I plan to buy/close the sold 100 and 99 puts at their respective market prices and ride the corresponding puts that I have purchased for as long as possible, should things continue to deteriorate.

CURRENT POSITIONS

To consolidate the Twitter-based updates from the past week, here’s where things currently stand:

A 100/98 put spread, originally priced at a net credit of $0.16 and now worth $0.43–a 15% loss.  (22% of Oct. LIC)
A 100/97 put spread, originally priced at a net credit of $0.39 and now worth $0.58–a 7% loss.  (17% of Oct. LIC)
A 99/97 put spread, originally priced at a net credit of $0.40 and now worth $0.34–a 4% profit.  (9% of Oct. LIC)
A 113/110 call spread, originally priced at a net credit of $0.16 and now worth $0.10–a 4% profit.  (29% fo Oct. LIC)
A 112/111 call spread, originally priced at a net credit of $0.29 and now worth $0.03–a 35% profit (23% of Oct. LIC)

October 2009 SPY Long Iron Condor

That puts overall profitability for today at 1%, possibly 6% if SPY moves back to around 105.  (This comes after cashing out the 116/113 call spread for a profit of 8% for the capital involved–or 2% of overall profitability.)  Peak available profitability for this LIC stands at 20% on October 17, assuming we can remain between 100 and 110 by then.  (22% total including the 2% already realized.)  There is only a 2% chance of closing at or above 110 (outside the second deviation of probability), so the primary focus is on downside risk.  Currently, a 23% probability remains that the market may close at or below 100, just within the standard deviation through this time period, which currently stands at 99.13.

For those who are interested, the current annualized yield for this sort of condor is 604%–skewed considerably higher due to the fact that pricing has moved away from the center of the LIC at the moment.  On a $100,000 investment in this LIC, you’re earning just over $730 a day in time decay, including weekends.  Still the best money you can earn in this environment.

As usual, watch for updates and commentary during the week by following me on Twitter.

October 2009 $SPY Long Iron Condor

Today, I closed out the 95/92 put spread (net debit $0.08, 22% profit in 31 days) from my October 2009 Long Iron Condor (LIC) and re-deployed the capital into a 100/97 put spread (net credit $0.23) for the same period.  The rationale is that, with the 1.79% gain in SPY today, there was very little upside left for this position ($8 of potential profit per unit) given the amount of capital required.

So, with the new position, the same capital exposes us to $23 of potential profit per unit with not much risk (now 8% vs. theoretically 0% in the old position).  Further, if the market does roll over from here, we’re able to more quickly capture upside from this development by buying back the sold puts @ 100 and enjoying the apprecation of the bought puts @ 97.  However, I wouldn’t pull the trigger on such a move until SPY moved significantly below 103.85, where my first buyback of sold puts (@ 101) is positioned.

So, after cashing in the 22% profit and enjoying a weekend of time decay, here’s where we stand in terms of both positions and profit/loss:

A 100/97 put spread, originally priced at a net credit of $0.23 and now worth $0.24–a 2% loss.  (22% of Oct. LIC)
A 101/98 put spread, originally priced at a net credit of $0.43 and now worth $0.30–a 4% profit.  (27% of Oct. LIC)
A 116/113 call spread, originally priced at a net credit of $0.20 and now worth $0.11–a 2% profit.  (24% fo Oct. LIC)
A 114/111 call spread, originally priced at a net credit of $0.46 and now worth $0.31–a 5% profit (8% of Oct. LIC)
A 112/111 call spread, originally priced at a net credit of $0.27 and now worth $0.15–a 8% profit (17% of Oct. LIC)

Altogether, that’s a current 3% in unrealized profit with the ability to reach 14% by October 17, if we can stay between 101 and 111 on SPY.  We’re also earning an annualized yield of 260% with a time decay payoff of $533/day per $100,000 invested.  Keep your fingers crossed!

What a week it has been!  I’m somewhat stunned that my predictions for the past week were so accurate.  (See here.)  To recap, I was expecting an opportunity to move out of the November Long Iron Condor (LIC) as the market moved temporarily lower. 

My target date for a significant market reversal was Thursday, September 24, and that’s exactly when it arrived.  In the interim, I’ve re-invested the proceeds of the November LIC into additional October LIC positions, which will be detailed later in this e-mail.

SPY Performance -- November 2008 - Present

Heading into the week of September 28, there are some interesting choices that the market will be making.  Here’s a recap of the possibilities.

A key resistance level on the SPY is right around 103.9–it matches up with August highs and provided support twice earlier this month.  It’s also near the bottom of the current wedge we’re in.  See chart on right for details.

So, if we do move past 103.85 next week, I will most likely buy back the sold puts at 101 (SWGVW) and ride the bought puts at 98 (SWGVT) as the market moves lower, keeping a tight stop on selling the second leg of this position in order to maximize profits.  (I’m thinking a $0.05 trailing stop, which would give up $500 on 100 options but provides enough latitude to allow a significant move lower.)

The market can, of course, also move higher for a number of reasons.  First, the “buy the dip” crowd may re-emerge after a weekend of sobriety.  Also, it’s end of quarter, and many institutional folks may be eager to play catch-up in their holdings as client reports are about to be generated.  Additionally, Yom Kippur traditionally marks the beginning of a mild bullish slant to the market.  Finally, aside from Wednesday, every day of the week holds a historically bullish slant, offering a daily probability of 57% (Thu.) to 66% (Tue.) of moving higher.

CURRENT POSITIONS

To consolidate the Twitter-based updates from the past week, here’s where things currently stand:

A 95/92 put spread, originally priced at a net credit of $0.62 and now worth $0.12–a 19% profit.  (22% of Oct. LIC)
A 101/98 put spread, originally priced at a net credit of $0.43 and now worth $0.51–a 5% loss.  (27% of Oct. LIC)
A 116/113 call spread, originally priced at a net credit of $0.20 and now worth $0.07–a 3.5% profit.  (24% fo Oct. LIC)
A 114/111 call spread, originally priced at a net credit of $0.46 and now worth $0.21–a 8.5% profit (8% of Oct. LIC)
A 112/111 call spread, originally priced at a net credit of $0.27 and now worth $0.10–a 19.5% profit (17% of Oct. LIC)

October 2009 Long Iron Condor of SPY

That puts overall profitability for today at 7%, possibly 8% if SPY moves back to around 106.  Peak profitability for this LIC remains around 18.5% on October 17, assuming we can remain between 101 and 110 by then.  The nearest short-term threat is the downside risk of the 101/98 put spread, which I’ll be exiting if SPY reaches too far below 104–again, my tentative trigger is 103.85.  The upside risk is minimal at the moment, but I’d re-examine things if SPY shot up to 108 or so.

For those who are interested, the current annualized yield for this sort of condor is 321%.  Of course, we can’t maintain all condors through options expiration every month, but it’s a nice, aspirational target that isn’t reliant on market direction.  On a $100,000 investment in this LIC, you’re earning just over $400 a day in time decay, including weekends.  And that’s the kind of dividends that I’m happy to be invested in.

Next week will be very pivotal for both the October and November Long Iron Condors (LICs) I’m holding in SPY.

In brief, we’ve seen the market push aggressively higher over the past few weeks, despite September’s reputation for stocks selling off.  In fact, SPY was up more than 2% since Monday.

With November – January a traditionally bullish period, I wouldn’t be surprised to see markets jump the gun and continue adding to gains before then.  October is now the best month for SPY over the last 15 years (excluding 2008), so I have concerns about crossing our upper curb of 109 on both condors in the weeks ahead.

S&P 500 Technical Indicators, Early July 2009 - Present

The good news is that there are a number of positive technical factors heading our way that could lead to some form of a correction.

First is the twelve-day MACD Histogram–the blue bar chart in the middle of the graphic (right).  We very well might have peaked in the near-term and are heading towards some sort of sell-off, probably mild to modest.  Other technicals are also “rolling over” to suggest a change in sentiment.

Further, September 24 is one of the most bearish market days–only 38% of them in recent years have yielded gains.  And prior to then, Monday-Wednesday are each positive only 43% of the time.  The week after September options expiry is just traditionally bad, plain and simple.

If I had to prioritize my moves, the October LIC is most important because its profit and loss (P&L) slope is the steepest.  In other words, if the markets sell off, we’ll profit more quickly in this condor than November’s.  But since both condors hold the same targets, I’m most interested in dissolving both and re-establishing new positions.

For October’s LIC, peak profitability is currently at 102.5 for SPY and sliding towards 103.25 by next Friday.  In a perfect world, we’d see these targets hit, but I won’t get too cute in this trade due to the increased pressure of a steep profit/loss slope.  The call side of this condor breaks even at 105.5 next Friday, so if I can get near that, I’ll be content, and then I’ll see for how long I can hold the put side until the position turns disadvantageous–stay tuned, I’ll provide updates as the situation develops.

November’s LIC isn’t terribly different–peak profitability with SPY at 101.25 followed by a 101.5 level on Friday.  The P&L curve is still relatively modest, so I’m able to take a bit more risk here.  In fact, if the market does correct significantly–e.g. past 101.25 and down to as low as 98.5–I’d be willing to hold the condor ‘as-is’ and enjoy a (hopefully) modest recovery through October.  Note that peak profitability at the end of October lies at around 102.5, which could nicely match a market rebound through the upcoming month.  But there I go, wandering off into the theoreticals…

I feel comfortable waiting for a mild sell-off through next week; it’s a fair argument to say that the odds are more on the bears’ side through Friday than the bulls’.  In any case, even if we approach next Friday at around the same levels as today, we’ll see a nice profit.  Currently, both condors are up a total of 4%–despite the runaway market–and seven days from now, we’ll be looking at 8% gains.  If we manage to get out next week at peak profitability, we will have pocketed 14% profit for the past few weeks.

 

October 2009 $SPY Long Iron Condor

I’m not a big fan of adjustments to existing condors, but given the straight, six-day rise in $SPY, I think now is a good time to take preventative measures as technicals point to a potential breakout for the index.

In brief, I’m rolling the call side of this long iron condor from 106/109 to 109/112, taking a net debit of $1.06 on the former and net credit of $0.53 on the latter. This leads to a near-term loss of 5% but overall gain of 17%.

I still look to hold this position through the end of September, at which point I’ll tighten my stop losses considerably in order to lock in gains.  My only stop loss, at the moment, is to buy back the sold puts at 101, at which point I plan to earn extra income in the (very) short term by delaying the sale of the purchased puts for this condor.

RATIONALE

As you can see from this chart, we’re approaching the same price level as the bottom of the October 2008 gap in the S&P 500.  Technically speaking, this is the last significant near-term resistance level for the index before “clear blue skies” up above.

One of two outcomes will occur:

a) The market “bumps” its head on the resistance and stays below it.

 

b) This resistance level is overcome by market forces, at which point we’ll most likely see a considerable rally.

 

Given the slight pullback of today’s market ($SPY down $0.49 as of this writing), now’s a great time to re-adjust targets.  Since all sales and purchases–both opens and closes–are taking place at the same time, the affect of volatility on pricing is negligible.

 

CONCLUSION

 

With this additional 3% in buffer, we should be OK through the end of the month.  One standard deviation from current $SPY levels reaches to 99.55 and 108.21, while the probability of ever touching 109 is calculated to be 19.6%.  Probability of finishing above 109?  11.9%.  Peak profitability on September 30: 36%.  Those are probabilities that I can live with quite comfortably.

Figure 1: Recent AAPL Performance.

I’d like to introduce a simple and straightforward way to use options to inexpensively protect an investment.  This method–known as the collar–essentially establishes a trading range for a stock in your portfolio, which is good over a period of time of your choosing.

Suppose you own 100 shares of Apple Computer (AAPL) stock and have realized a very nice gain.  You are tempted to now take profits but believe that the upcoming Christmas season could push the stock higher.  On the other hand, something disastrous could happen (e.g. Steve Jobs heading to that great big Macintosh in the sky), which could suddenly and swiftly punish the stock, leading you to believe that protection from such a liability is warranted.

It’s always a good idea to first see what a stock’s recent price action can teach us.  In Figure 1, we see that the shares have enjoyed a very nice gain (priced at $170.31 as of Sep. 4, up 99% for the year) and find support at $160 (green line).

The conventional approach for protection is to establish a trailing stop sell order–in essence, you pick an amount of decline you’re willing to accept in a stock, and anything more than that triggers an immediate sell.  The upside to this approach is that if the stock continues to rally higher, the point at which your sell order will be realized rises in tandem with it.  For example, if you set a sell order for AAPL with a trailing stop at $10, the stock will sell as soon as it hits $160.31–but if the stock moves to $180, your new trigger is $170.

I like trailing stop sell orders, but I only use them when exiting a position with no plans to re-enter the stock.  That wouldn’t serve my needs in this case since my hypothesis is that AAPL might rally through the Christmas season.  If AAPL even simply hit a period of volatility (it is a high beta stock, after all), my trailing stop sell order might be prematurely fulfilled.

Establishing a collar guarantees a floor and ceiling on the share price through the expiration date of your choice.  Expiration dates are typically on a monthly and/or quarterly basis, occurring on the third Friday of the given month.  So, if I’m looking for protection today through Christmas, I might consider the January 16, 2010 options expiration time period.

Options are typically offered in units that each cover 100 shares of stock.  So, my lot of 100 AAPL shares will nicely match up with one call and/or put, depending on what I’m trying to do.

A put is a contract entitling me to sell a stock at a certain price through the expiration of the option.  So, I might buy one put (which covers 100 shares of stock) for AAPL in the January ’10 expiration period with a strike price of $160.  That means that no matter how low AAPL’s stock is on January 16, 2010, I can still sell it for $160.  Did it fall 100 points to $70/share?  Fine with me–I’m still selling at $160, since that’s the floor established with my put purchase.

Of course, if AAPL closes out January 16 at $300, my put is worthless.  The current market price would be far above the strike price, so I’m better off holding onto my stock than exercising this option.  (Most brokers will automatically make the best choice for you, while you retain the option to give them instructions that override their judgment.)

To get this put–essentially, guaranteeing me a floor of $160 for my 100 shares of AAPL stock through the January 2010 expiry, I have to pay $1,050.

Sticker shock!?  Most likely.  While my 100 shares of AAPL are worth $17,031, paying 6.1% of their value to protect them against a 5.8% move for a finite period of time may seem like a bad deal.

Part of what makes the deal worthwhile is the fact that you can sleep well each and every night while under put protection, not having to worry about what tomorrow will bring.  Think of how many folks wished, in hindsight, that they had purchased puts for their stocks before the 2008/9 market meltdown.

In any case, the better news is that financing is available.

A call is a contract entitling me to purchase a stock at a certain price through a certain time.  So, if I buy a call for AAPL stock with a $180 strike price and January 2010 expiry, I’ll be able to purchase 100 shares of the company at the given price at any time between now and expiration.  AAPL trading at $300 on January 16?  Great–that’s a $120 discount that I’ll enjoy.  What about AAPL at $70/share?  I simply don’t exercise the call option, and I can buy the stock at that day’s lower market value.

In the case of a collar, instead of buying a call (I already own the stock, after all), I’ll sell a call.  That means that I’m willing to part with my shares once the stock rises above a certain price point.  Since AAPL is at $170.31 today, selling a call against my shares with a $180 strike still allows for a potential 5.8% profit while collecting the guaranteed premium from selling the call.  And how much is that premium?  $1,082, thank you very much!

Hmmm…so we just looked at holding 100 shares of AAPL stock, buying insurance for $1,050 to guarantee a floor of $160 on the stock price through expiration, and then selling possible upside on the stock for $1,082, which caps our profit if/when AAPL moves beyond a $180 share price.  Minus commissions, that’s just about break-even. ($1,082-$1,050-your broker’s transaction fees=$0ish.)  Congratulations, you’ve just established your first options collar!

To get a better feel of what happens to your investment, I’ve posted some charts to walk us through profit/loss scenarios.  Owning the stock without any options play looks like this:

Figure 2: Owning 100 shares of AAPL stock.

The dashed lines walk us through time. “Time decay” is essentially the effect of an investment losing value over time. An extreme example is owning a 2008 Ford F-150 pick-up truck–I guarantee it’s not worth as much as when you bought it. (Someone please tell those folks who sell their year-old vehicles in the Classifieds.) Owning the stock while simply buying the aforementioned put results in this:

Figure 3: Straight AAPL ownership (green) vs. stock & put (blue).

The green lines show us, again, the results of simply owning stock from now until January 16, 2010, while the blue lines highlight a stock plus purchased put combination.  Notice the floor that’s established at the $160 price point–you cannot lose more than that.  Notice, however, that your break-even line shifts from the present value of $170.31 to $182.74–ouch!  Better look at selling some calls to get this picture back in order:

Figure 4: Straight AAPL ownership (green) vs. stock & put (blue) vs. collar (red).

The red designates the collar (note the floors and ceilings) while the green and blue represent the previously disclosed stock-only position and stock-put combination, respectively.  A little more cleanly, at expiration, the setups would look like this:

Figure 5: Straight AAPL ownership (green) vs. stock & put (blue) vs. collar (red).

Note that the profit/loss line is now nearly identical between straight stock ownership and owning the collar.  The only material difference is that floors and ceilings have been introduced.  Finally, the collar all by itself:

Figure 6: AAPL January 2010 Collar

Note that the change in valuation to this collar occurs more dramatically the closer time approaches the expiration date.  This means that if AAPL stock enjoys a sudden rally to $180 in the next week, it may be worth sliding your puts and calls accordingly to lock create new upside targets.  The cost should be nearly negligible.

Also, note that I can adjust my strike prices for my collar according to what kind of risk I’m willing to take.  While the $180/$160 collar we’ve reviewed effectively pays for itself, so does a $190/$150 collar.  Or, let’s say you don’t mind paying a bit more now not to limit your future upside, you can set up a $190/$160 collar for a cost of about $310.  Again, options are like LEGO–build with them what you want.

A few extra notes: most stock brokers (E-Trade, TD Ameritrade, et al) require approval to trade options, and they’re offered in four steps.  “Level 4” is most desirable, but you can also do the most damage to yourself, so upgrades typically come only every 90 days.  The upshot is that if you ever think you’ll trade options, start requesting options upgrades now.

It’s also important to note that Level 4 also requires margin.  So, if you’re trying to use options in your IRA or 401(k) account–where margin isn’t available–so Level 3 is as high as you can go.  For the most part, this isn’t terrible, and the rule is in place to ensure you’ll have something left for retirement.  Contact your broker to learn more about what each of the limit levels entail.

Further, keep in mind that a lot of these trades can be made in tandem–collars, call/put spreads, etc…  So, in the case of our collar, instead of having to first pay $1,050 for the put and then collecting $1,082 for the call,  you can simply specify the desired spread between the two that you’re willing to pay or receive in payment.  (At your broker, this is called net debit or net credit.)

In any case, I encourage you to evaluate your portfolio–especially as we enter into the historical “scariness” of September and October market drops–and see how collars can keep you safe during this spooky season.  Happy trading!

Aggregate of October and November 2009 Long Iron Condors for SPY

It has been a wild week for the market, but our bet on the S&P 500 tracing lower has paid off as the October and November Long Iron Condors bounced from one side of the peak profitability bubble to the other.

As of now, we’re up 5% since the initial establishment of the October (August 14) and November (August 26) condors. More importantly, we remain within about one point of peak profitability.

Individually, the October condor is up about 9.5% while the November condor is up about 3%.

On the call side, there is not much worry: both upside spread curbs (106 for October and 109 for November) are outside the first standard deviation of potential market trajectories. Personally, I don’t have a stop loss on these at this time, simply because I have doubts about a spontaneous 6% market rally occurring before I have a chance to get to the computer in the morning.

On the put side, I’m a little more cautious. I’m tentatively holding stop limits for the sold puts at 98. In a perfect world, I’d buy those back early in the day and/or week and then try to ride the purchased puts as the market moves lower. This, of course, is risky, and requires strict supervision of minute-by-minute market conditions, with plenty of trailing stops set to cover potentially sudden changes in momentum.

Financial Armageddon: The Argument in Favor of Buying Back Sold Puts First

To help explain why I favor a two-part breakdown on the put side in case of a market collapse, consider the following scenario, assuming the sold puts were repurchased today at current levels:

Should SPY move to 95, an immediate 63% profit would result. At 92, a 100% profit is realized, and 200% total profit is found at around 86.25–close to the recent market bottom in July. Sure, the odds are against such a dramatic and profound move, but there are a lot of perma-bears out there who will argue that such a scenario is rather plausible for any number of reasons.

That’s it for tonight. Watch carefully on Friday during the jobs report. If things don’t melt down, enjoy the earnings from time decay (theta) over the long weekend.