Tuesday, May 27, 2008

It’s time to be cautious

As you can see from the picture below, IWM broke the up-trend line on 5/21 with pretty good volume.   (click on the picture to see it full-sized)

This likely signifies that the rally is over.  Typically, when uptrends like this are broken with big volume, the near-tern future trading is either sideways or down.  But, nobody can predict what the market will do next. (although many try) 

This is time to be cautious.  I am considering my next move to defend my positions if IWM drops drastically this week. 

I am considering buying a few close to the money Puts in IWM.  This is a good hedge against a drop.  If IWM trades sideways in the next week I can likely sell the purchased Puts for only a small loss.  If the market happens to move up, I may reach full profit in my positions by the end of the week.

Update on positions:

Short 64, Long 59 - Currently trading at .13, opened for .25 on 5/2, so I have a .12 gain so far.
Short 64, Long 61 - Currently trading at .10, opened for .17 on 5/12, so I have a .07 gain so far.
Short 66, Long 63 - Currently trading at .18, opened for .17 on 5/16, so I have a .01 loss so far.

Posted by Big R at 04:48:22
Comments

2 Responses to “It’s time to be cautious”

  1. Anonymous says:
    May 29, 2008 at 3:58 am

    Hello, Congrats on your profitable trading! I am looking forward to watching how your credit spreads turn out as that is a strategy that I am particularly interested in. Two questions I have for you: You seem to trade Puts most of the time, is there are reason for this as opposed to Calls? And second: Why have you settled with the IWM? I know a lot of credit traders trade the SPX and the RUT..

    Cheers,
    Chad
    theseareoptions.blogspot.com

  2. Anonymous says:
    June 1, 2008 at 2:22 am

    Thank you Chad.

    This strategy is excellent in terms of expectancy and ROC.

    I do trade Puts most of the time. Check out the “My Trading System” link at the left side of the screen. Scroll down to “Part 1 - Overview” where I talk a bit about why I trade Puts.

    The basic answer is that Puts are way overvalued compared to Calls…at least right now. When the market is volatile the traders holding big stock positions need protection. They look to purchasing Puts for this protection. I equate this to insurance. I sell this insurance. In the first half of this year demand for Puts was much higher than the demand for Calls and this is still the case. I have a spreadsheet that calculates ROC and expectancy for me. Selling Calls in the index ETFs currently has a negative expectancy and very low ROC because their values are not inflated. …just the opposite for Puts.

    I run most of the index ETF’s through my calculation each week. IWM comes out ahead every time. This means the IWM Puts are more overvalued than Puts in SPX and RUT, QQQQ, SPY, etc. Also, you need to be careful about liquidity. I stay away from options that are very thinly traded.

    Thanks for your comment, Chad. Do you trade options? spreads? credit spreads?

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