COVID-19 Coronavirus Portfolio

This is a COVID-19 coronavirus portfolio of trading ideas generated in the last two months. The portfolio aim is to identify and invest in new trends in commodities or sector ETFs generated by either government policy monetary policy response or “shelter in place” lockdowns.

Covid-19 coronavirus portfolio - world map - 20200416

This collection of trading ideas was setup somewhat quickly as a tactical portfolio in response to the COVID-19 Corona Virus situation. The fundamental portfolio theme is that the market has been almost instantly split into winners and losers, Some industries have simply been decimated overnight that they can’t function as viable businesses for the immediate future. For example, even Warren Buffet completely sold all Berkshire Hathaway’s US airlines in April 2020. The aim of this tactical portfolio is to think about trading ideas that can generate winners in the “new normal”.

COVID-19 coronavirus portfolio – Option Volatility

Volatility is very high in most commodities and sectors, so it is critical to use option trading strategies for high volatility environments. Specifically Implied Volatility Rank (IVR) is in the range of 75% to 100% for many ETFs this month. Simple one leg option strategies such as buying out of the money calls in high volatility products will likely not do well. The “go to” trade on ETF options has typically been to buy long dated deep in the calls (LEAPs greater than 9 months out). This means that the majority of premium paid is intrinsic not extrinsic (time) value – the extrinsic value will likely reduce over the course of several months as the current volatility premium likely goes lower. To help with any downside, call spread overwriting and put butterflies on the same ETFs. There was also call spread overwriting in major tech indexes to hedge some downside in tech ETFs that do not have any options. Where no ETF options were available, actual ETF equity positions were taken, but sized appropriately at less than 10% of portfolio size.

COVID-19 coronavirus portfolio – Trade Ideas

The exact thinking behind the ideas need more detailed separate blog posts to fully justify their inclusion. However this tactical portfolio blog post is just to give the trade ideas, their high level implementation and any hedging strategy. This following ideas show the sector, idea rating (buy/hold/sell), the conviction level (low/medium/high) and a high level idea description.

New trades with “Buy” where started in the last 45 days. If a “Hold” is included in this portfolio that means it was already owned, but think performance would improve because of COVID-19 Corona Virus environment. The aim would be to hold most of these for 2020, or until stopped out.

Each paragraph describes a trade idea within a sector (including trade direction), rating (Buy/Hold/Sell) and overall conviction level.

Real Estate and Liquidity

Real Estate (Long). Hold/Buy. Medium. Select international opportunities mostly due to strong USD creating weaker local currencies and lower prices on local real estate. Here “local” means local to a target country in question, specifically Canada and UK whose currencies have been beaten up quite a bit due to flight to safety buying of USD. Keeping liquid in USD to maybe a currency conversion later in 2020 for a property purchase. Not rushing into anything. Actively writing a new Ebook for US investors on future opportunities with international real estate in 2020 and beyond.

Metals

Gold (Long). Buy. High. Gold is one of the best performing assets YTD in USD, and rebounded very quickly with after an initial March 2020 sell offs. The rebound was a direct response to the FED stimulus packages for the general economy. Gold is trading at 7 year highs in USD (near $1700) but importantly gold has made already made new all time highs in just about every other major currency such as Euro, UK Pounds, Canadian Dollars (etc). Select currency and 20 years on this Bullion Vault to chart historical gold price in each currency. Bought deep in the money calls on physical gold ETF (GLD) with an approximately 90 delta for Jan 2022. Aim is maintain a gold position, to ultimately replace with some actual physical gold, when the current spot to physical price premium subside. Aside from just the physical metal, gold miners should benefit from lower oil prices and therefore have reduced input costs, that should increase earnings per share in 2020 and beyond. Gold miners are up about 30% since purchase of Jan 2021 deep in the money calls in both major (GDX) and juniors (GDXJ). These are potentially multi year longs.

Silver (Long). Buy. High. The gold/silver ratio is at about 113 which means that silver is historically very undervalued compared to gold. Interestingly the silver price is approximately tracked the Dow (DIA) year to date, being down about 15% – so it does have more of an industrial market supply and demand component. Gold tends to function as a true safe haven, but silver can influenced by industrial supply and demand from economic conditions. Silver can definitely sell off in a general market downturn, where as gold is holding its value better. However if there is to be a significant gold bull market, silver will tag along for the ride, but may take more time to turn around. Trade was bought physical silver and silver metal (SLV). Bought deep in the money calls with an approximately 85 delta for Jan 2021.

Uranium mining stocks (Long). Potental new uranium bull market for 2020s. Uranium producers and explorer stocks have been one of best performing sector and are up YTD – beating general indexes. Uranium equity could definitely get caught in a wide market downtown, but has tracked higher physical uranium prices that have increased from low $20 to $32 in last month. Ideally this is a very specific sector mining play that should be a play on the physical price of uranium, and should not be correlated to the general market. We play this with a small position in a very small ($4 million market cap!) and brand new ETF of uranium producers URNM. This could be a multi year trade, but the risk reward setup seems good.

Energy

Oil drillers (Long, short vol). Buy. High. Added new full size positions in OIH. Made bullish call last month on OIH was trading at around $4. In OIH sold cash secured $3 puts in July 2020 and Sept 2020, because the implied volatiliy was insane (over 100%), and combined with half a position in long OIH stock. This position bounced nicely, so bought back the short puts for good profit, then hedged the remaining stock with a wide put bufferfly in July 2020. Sold 40% out of the money call in July 2020 to help finance the put butterfly a bit. This is neutral to long ish bias on OIH until July, but it has run up a lot in April so it is sells off in May (seems likely to take a break) then the put buttefly will make some good money, even if the OIH stock loses money. Note that OIH has had a 20:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 20 to compare to a current OIH chart.

Oil explorers (Long, short vol). Buy. High. Added new full size position last month on XOP (same timing as OIH trade). Bought a deep in the money for Jan 2021, then overwrite with call spread for May 2020. The call spread recently had both legs in the money and was only 2 weeks to go to expiration. Therefore overwritten call spread was rolled to Jun 2020 for a minor debt. The aim is to maintain the deep in the money Jan 2021 call, and keep overwriting for the rest of the year. If XOP goes up a lot we will capture majority of move. If stays same we can get some income from the high volatility in the call spreads (if they expire worthless). If goes down we will lose, but much less than stock. One advantage is if XOP price goes down fast the implied volality will go up, and so the deep in the money call will stay bid. Note that XOP has had a 4:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 4 to compare to a current XOP chart.

Natural Gas (Slightly long, short vol). Hold. Medium. The natural gas etf (UNG) is hard to hold long stock for several months, due to the current contango in natural gas futures. Contango is when near month natural gas futures trade lower than far month future prices. (UNG) maintains its natural gas price exposure by constantly rolling contracts – specifically buying more expensive far month futures contracts, by selling the expiring (and cheaper) near month contract. This enforced rolling built into the product, creates a long term drag on prices while natural gas is in contango (look at any multi year chart of UNG). This is a less extreme version of the same problem with USO contango this week – when the oil price went negative (!). Since owning (UNG) stock is not a good idea, the setup is usually buy a long term calendar call spread, and also selling near dated call spreads on (UNG). This takes advantage of high implied volatility with limited risk, but can still benefit if prices are higher or neutral. This does sacrifice large profits if (UNG) spikes higher quickly and cannot roll fast enough into the price increase.

Natural Gas Producers (Long). Buy. Medium. US natural gas equities have been beaten up in 2020. Clearly there are is a huge over supply of natural gas and a massive worldwide demand shock for energy. (FCG) tracks an equal-weighted index of US companies that derive a substantial portion of their revenue from the exploration & production of natural gas. Approximately 15% of its portfolio is in MLPs and the remaining 85% to equities. Interestingly the (FCG) attempts to recovers some of its 0.6% management fee by securities lending, and it does have a dividend yield but that will likely disappear to much smaller amount in 2020. However to place this in some historical context, many US natural gas equities are trading at the lowest price for 20 years. For example, buying natural gas producers index (FCG) for $5.50, when its all time high is about $155 in July 2008. The US natural gas producers sector at these prices is low enough to be a binary trade. Either the majority of the US energy complex is going bankrupt and this is a slow grind lower for many years (“lose”). Alternatively some energy demand returns, the survivors consolidate and a restructured sector operates at higher price levels at some point in the next few years (“win”).

Equity

Cloud Computing (Long). Buy. Medium. More e-business activity (e.g. Shopify) for starting new businesses and tools for people working for home. This is long equity ETF but focusing on cloud technology (CLOU). Actively trying to ignore struggling parts of economy (e.g. airlines, manufacturing, automative, consumer financing etc). Positions in CLOU and other tech ETFs will be actively hedged with QQQ OTM call spreads.

Mortgage REITs (Long). Buy. Medium. MReits were trading at significant discounts to book value in April 2020 This was definitely a speculative buy with high yields around 11%, especially because dividends could be heavily reduced in next year. However if MReits can simply maintain their value, and allowed to DRIP for a number of years (even at these levels), then they can add some welcome yield and maybe some capital appreciation. MReit ETF (MORT) is a high yield trade great for a portfolio position in an IRA, because it can be allowed to DRIP long term. This is relatively risky play, and only medium conviction. There is no simple way to hedge this using options, so will only take a half position size to manage the risk.

Solar ETF (Neutral). Sold. Medium. Fortunate enough to sell Solar ETF (TAN) around $34 after the bounce back up to $37 in early March 2020 (not the top, but about 20% off the high the way down). This was a risk off trade, which preserved some capital initiate some of the other new ideas in this portfolio.

Emerging Market Equity (Short). Buy. High. Emerging market companies that have debt denominated could have a hard time paying it back, with economic shutdown and currencies depreciating against USD. Emerging market equity like Brazil (EWZ), Mexico (EWW) and India (INDA) have not bounced back as fast as the main US equity markets. For example Brazil has traded in an approximate range of $21 to $26 over last month, down from a Feb 2020 peak of (this is a “L” market chart, not the “V” market chart). Two trades here were 1) out of the money Long Put EWZ butterfly in May 2020, fully financed with short call spread on India market (INDA). This was neutral to bearish. 2) in the money Long Put EWZ butterfly in May 2020 for a debit, and no short call spread. This was more bearish. Brazil equity market has proven to be weaken than India in April 2020 so that seems like a good trade choice approaching May 15th 2020 expiration. INDA trade should expire worthless. Brazil trade already in the money and likely to still be there closer to expiration.

High Yield Corporate Debt (Short). Buy. High, now Medium. Corporate credit quality is being impacted by an unknown amount due to corona virus shutdowns, so that uncertainty would cause high yield corporate bond ETFs to trade significantly lower in the next couple of months. Entered an in the money (ITM) put butterfly as a limited risk reward way to short high yield bond ETF (HYG) on 17th March. HYG was at about $77 then went down 10% in a hurry to around $70. The risk was managed with the limited risk trade structure of an ITM put butterfly, but still got “taken to the cleaners” by the announcement that the FED would be buying junk corporate bonds. This policy announcement caused a huge HYG rally in April from about $70 to $80. Unless there are signs a sharp move down in high yield this week, it will be closed this week approximately 10 days before 15th May expiration – losing about two thirds of original trade capital this week. This is to preserve one third of the remaining principal from a losing trade, as a put butterfly that is now out of the money will decay much faster into expiration. A classic example of a good initially profitable good trade entered for the right reasons, but taken out by unprecedented policy decision. Trade was a loser, but have successfully managed the short risk by not having an unlimited short risk trade on.

Crypto

Cryptocurrency (Long). Hold. High. Bitcoin (BTC) and other alt coins (e.g. XMR). Holding not adding any more.

Liquidity and Hedging

Peer to peer lending – Lending Club (Neutral). Sell/Hold. High. Already dialed back risk here several years ago due to lending club management issues. However this month turned off auto re-investment of cash into new notes. Definitely do not want any more exposure to consumer credit for next year or so. Peer to peer is a small position, but turning off re-investment seems prudent until can figure out what is going with the general consumer lending (does not look good in short or medium term).

Cash (Long). High. Long USD for investment opportunities and saving up to get properties with low LTV. On existing international property businesses we are looking to open small home equity line of credits on properties with low LTVs in local currency (assuming local bank allows it). A small amount of debt exposure in local currency is effectively a long USD position (since we are based in USD). If the local currency for a country where we own property declines significantly we may consider paying down mortgage principal from USD cash.

Hedges (short, combined with underlying positions). Buy. High. Index call spreads overwriting out about 2 months. similar idea to covered covered calls, but with limited risk reward so that if the market does go massively higher are not losing so much (and can probably roll out of it in following months). Selectively combining put butterflies with hedges.

COVID-19 coronavirus portfolio – Summary

This tactical portfolio was created relatively quickly. The main themes were long metals and energy, with some technology and potentially some real estate later in the year. There are also some relatively aggressive hedging and other complimentary short positions. This is a long/short portfolio, that would be much more heavily hedged if world goes “risk off” again. Having good entry points in April 2020 should definitely help holding positions for longer term. The other main theme is keeping very liquid and not over allocating to make sure money is available for opportunities. In summary, only trade if you want to, not because you have to.

Emerging Markets Iron Condor

This is another bread and butter trade with an emerging markets iron condor, going out a bit further in time to October with 78 days to expiration (DTE). Emerging Markets ETF EEM has sold off rapidly due to market tariff and rate cut talk this week, which has provided inflated volatiliy. This is a limited risk range bound trade for EEM with the expectation that the market maintains its position over the next two months and that volatility contracts.

Trade entry Emerging Markets Iron Condor

Here is the trade entry for EEM iron condor:

Contracts  Expiry Date  Strike   Price   Amount   Trade
-------------------------------------------------------------
+5         Oct 18 2019  45.00  C $0.05   $ 52.69  Buy to Open
-5         Oct 18 2019  42.00  C $0.74  -$372.25  Sell to Open
-5         Oct 18 2019  38.50  P $0.76  -$317.20  Sell to Open
+5         Oct 18 2019  35.50  P $0.35   $122.79  Buy to Open
-------------------------------------------------------------
Total    	                        -$513.97 (credit)

On trade entry on 2nd August there were 78 Days to expiration DTE through to option expiration on 18th Oct. According to the 30 day rule this means that can consider exiting the trade on or after 2nd Sept. On 2nd Sept this would still leave approximately 48 calendar DTE, so there is plenty of time to adjust or exit. The following table sounds the future trade lifecycle dates when trade exit or trade adjustments could be optionally applied:

Trade Lifecycle for EEM Iron Condor

Trade Date
Trade Lifecycle (Optional)
Days to Expiration
(DTE)
2nd August 2019Trade Entry - enter Iron Condor according to original trade above78
2nd September 2019(Trade Exit) - optional earliest possible date for a full trade exit according to 30 day rule.48 to 1
13th September 2019(Trade Adjustment) - latest possible date to do a trade adjustment using the same Oct options (trade adjustments must be at least 30 DTE)78 to 30
18th October 2019Trade Exit - latest possible date to exit original Iron Condor with any optional trade adjustments that were added.1
Note: Trade Lifecycle actions that are optional are in brackets like this (Trade Adjustment) or (Trade Exit).



The option deltas sold on each side are approximately 35% on the call and 25% on the put, so there is approximately a 70% chance that the call will be touched, and a 50% chance that the put will be touched anytime between now and Oct expiration. Therefore it is likely that the short options at $42 and $38.5 will be tested at some point on this trade, but it can be held due to the limited risk. The breakeven points of $43 and $37.5 are at the high and low ends respectively of the trading range price action for the last year, so we can be reasonably confident that at some point in the next couple of months EEM could return to the the middle of this range – even if there is likely to be some short term volatility, possibly with the short options being touched.

Trade Summary

The aim will be to close the trade for a $100 to $250 profit after 30 calendar days have elapsed, but this could require being patient and waiting for volatility to come in a bit and the trade to move back into the middle of the range around the $40 mark.

Mexican Bearish Put Butterfly

This trade idea is a trade adjustment to a currently open bearish trade on the Mexican Market ETF (EWW). The strategy ultimately converts the existing bearish diagonal spread into a bearish Put Butterfly.

Trade Update for 30 July 2019

A trading update on July 30, 2019 shows that the ETF has brought the speaking been in a range for the majority of the month around the $42 mark. However with the federal reserve rate cut announcement there was a drop off on the afternoon of 30 July that has caused for the ETF to move down beneath the $42 strike in August. This means that the August short put is now ITM and needs to be managed accordingly however this is being fully offset by the $43 port in the September cycle. The aim here would be to maintain the position slightly closer to expiration to allow any time premium to drain out of the August cycle, and then either close the position or do a short put roll into September.

The rolling options are to either roll the $40 put into either a $41 or lower put to maintain the bearish position into Sept 2019. Alternatively the put could be rolled to create a September butterfly by selling twice as many puts and adding a down side put for protection. This would create a butterfly that can be held into September expiration. Ideally this would be done into a higher volatility environment to get as much juice as possible into the September options.

Long Mexican EWW Bearish Put Diagonal Calendar Spread - Trade Update Chart - 20190731

The position has approximately $120 profit and long as the etf stays under the $42 level this profit is not at risk. The 30 day calendar period has elapsed so the position can be closed or adjusted anytime. Therefore position can be maintained for a few extra trading days and monitored for a good Time to roll into September once even more time value has drained out of the August short put. Currently there is still approximately $0.50 time value (or about $300) left in the August short put, so this is a potential time profit that can still be extracted from the position.
Ultimately no adjustment was done today.

Trade Update for 1 August 2019

On 1st August 2019 in afternoon trading the Trump administration announced more tariffs against China. This somewhat spooked the markets triggering a fairly swift sell off in markets especially those effected by tariffs. This meant that the August short put at $42 has gone significantly ITM. With Mexican ETF EWW trading at approximately $40.75 the put had only about $0.20 extrinsic value, so it was a good candidate for rolling.

The sell off generated increased volatility in a short amount of time and ATM put premium in September looks quite attractive to roll into. This was an opportunistic trade due to the swift selloff, so the decision was taken to convert the position to buy September butterfly.

The August $42 put was brought back (buy to close) for a $450.71 loss, and was replaced with 12 contracts of $41 puts sold to open in September, followed by 6 contracts of $39 puts bought to open. The existing $43 put in September was maintained and not changed as part of the position. This converted the entire position into a $43/$41/$39 September butterfly. The entire new position result in a $288.67 credit, so the most that can be lost on the trade is now -$450.71 (from the losing $42 august option roll) plus the $288.67 credit received for Sept butterfly – so max position risk is now only $162.04. This roll was all completed in one trade ticket with one set of commissions.

This table gives the new position below. The top two options rows are option roll described above. The last option row is not a new position, but simply maintaining the original long $43 put from the original trade entry.

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
01-Aug-2019
Income
Buy to Open Long Put
Put  EWW  39.00 EXP 20-Sept-2019
EWW190920P39.0
6.0
0.66
-$393.35

01-Aug-2019
Income
Sell to Open Short Put
Put EWW  41.00 EXP 20-Sep-2019
EWW190920P41.0
-12.0
1.33
$1,596.32

01-Aug-2019
Income
Buy to Open Long Put
Put EWW  43.00 EXP 20-Sep-2019
EWW190920P43.0
6.0
1.52
-$914.30

TOTAL
-$288.67

 

This roll exchanged approximately $0.20 of time value in the August cycle for approximately $2.00 time value remaining in the September cycle. If there is a large move either way over for example $43 or $39 then the maximum amount will likely be lost. The optimum trade scenario would be to close around $41 at September expiration. Because the trade is a butterfly trade it will benefit from a decrease in volatility and from the waiting until expiration. Given the low risk in this trade it would be fine to wait until very close to September expiration. Even if Mexican ETF EWW moves around a lot there will likely not a significant profit/loss changes until closer to expiration.

Summary of Mexican bearish put diagonal spread (converted to butterfly)

The Mexican ETF EWW will likely be volatile over the next week or two and may well move outside the ideally trading range of $39 to $43. But the approximate $41 target for September is on the low-end of the historical trading range for the last six months (a historical support line) so it is possible that becomes resistance with a move down in August and subsequent rally back up in September. However the trade will be held and re-evaluated in 30 calendar days - basically a low risk trade waiting for lower volatility and getting closer to September expiration.

Trading Gold Long Term Diagonal Spreads

This trade idea shows how to approach trading gold with long term diagonal spreads. The trade example shows how a bullish multi month GLD long call diagonal spread was entered and managed. This trade was IRA eligible so using multiple option legs does not generate lots of complex tax reporting, and there was no issue of paying extra capital gains if the trade is ultimately successful.

Gold market and GLD volatility overview

In March 2019 FED was signaling a rate pause which could be bullish for gold prices. This is an example of using options to express a “long gold” opinion in a portfolio, in this case using the physical Gold precious metal ETF (GLD)

In March 2019 Gold volatility was approximately 9%, which was in the lower quartile (lowest 25%) for the last six months – having had a range of approximately 12% in Dec 2018, down to 8.5% in Feb 2019. Low volatility generally makes a better trade entry for long term calendar diagonal spreads. Importantly saying that “the volatility is cheap” only means relative to its own recent history in the last few months for this particular ETF or commodity. This does not mean that the underlying will not move around, because trading gold is historical volatile. This only means that the debit on trade entry is cheaper, simply as you don’t pay as much option time premium for the longer dated call (because the market is currently pricing less of an expected move by Sept 2019).
The chart below shows the GLD volatility chart for several months before and after trade entry on 22nd March 2019.

GLD July 2019 1 year volatility chart
trading gold - Long GLD Diagonal Calendar Spread - Volatility chart with Popup Balloon - 20190729

Trade Entry in March 2019

Having made a decision to long gold for 2019, the next step is to structure a suitable risk/reward trade within the 30 day rule. Here is the original trade entry when GLD closed at $123.97 on 22nd March 2019:

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
22-Mar-2019
Portfolio
Sell to Open Short Call
Call GLD 128.00  EXP 17-May-2019
GLD190517C128
-6.0
0.77
$464.65

22-Mar-2019
Portfolio
Buy to Open Long Call
Call GLD 128.00  EXP 20-Sep-2019
GLD190920C128
6.0
2.70
-$1,622.29

TOTAL
$ 1157.64

 

This trade was OTM so had approximately a 30% of being ITM at expiration - it was therefore a lower probability trade, but high conviction portfolio position ("long gold for next 6 months"). Losing the entire trade premium (defined at trade entry) was acceptable risk for the overall portfolio - but the payoff was potentially large for the relatively small initial risk, so it created the right risk profile to express the trade idea. Initially selling the shorter dated call help finance the longer dated call, and reduce the overall risk in the position. The intent is to avoid this shorter call being assigned and roll it multiple times over the summer to gradually chip away at the premium paid for the longer dated call.

Here are the main high level scenarios for the trade outcome - GLD stays in a range, goes up a lot or goes down a lot (just about covered all scenarios in finance there!):

If gold stays the same or rallies slightly towards but not through the short call, it can likely be bought back for less than it was sold for - this helps to reduce the basis on the original longer dated option. If this can be done over a few months rolling option calls can nicely reduce the basis on the original longer dated option. Usually selling the 30 delta OTM call is a decent starting strategy initially, but once the position basis is reduced then selling calls that are more than 30 delta OTM is ok.

If gold rallies strongly in the next month, it maybe difficult to roll the short call at a profit. This is a risk of the calendar spread strategy - the market call is "right" but gold rallies too fast, and the position makes little money. This happens because the negative delta of the short call becomes similar to the positive delta of the longer dated call - so the overall position can become delta neutral or even negative delta (short underlying) in a strong rally. On average though the short call can be managed with month to month adjustments.

If gold tanks in the next month, it maybe difficult to roll the short call to get any reasonable premium in the same strike in the next month. However if any premium is available in the next month call, then it can be sold at the same strike. In the situation where gold goes down, one luxury of any calendar spread strategy is to simply sit on the trade and hope it comes back. This is "ok" as a strategy with calendar spreads because the limited risk was defined at order entry.

Trade Adjustment in May 2019

The trade adjustment that was chosen in the end, was to let short call expire worthless and simply hold the longer dated Sept 2019 call option. This has keeps the trade risk to approximately $1150 but there is still now no upside cap and still plenty of time for the trade thesis to play out. The trade is now $464 better off than if we had just bought the long dated call for $1622. Sometimes doing nothing can be the best option.

Option Skew in July 2019

As of 29th July, the Sept 2019 Option premiums are indicating that the market is pricing in significantly more upside than downside for gold in the next 7 weeks. Looking at the option chain below shows the distance of both 30 delta OTM put and call options from the underlying GLD price.
trading gold - Long GLD Diagonal Calendar Spread - Option Chain Skew Sept 2019 - 20190729

GLD is traded at $134.53 as of the NY close on 29th July 2019. Going 53 days to expiration on the Sept 2019 option chain, shows that the $139 call (with a delta of 0.2998) has approximately the same delta of the $132 put (with a delta of 0.2963). This means that market is assigning the 30% probability that GLD is $4.50 higher by Sept 20th 2019 expiration and a 30% probability that is $2.50 lower. That appears to be a huge bullish skew indicating that the market is still expecting higher prices in the medium term - despite the recent rally. If that bullish skew starts to disappear in the next few days, then would consider closing the long position, but for now content to hold until closer to expiration - especially because the option position only has a relatively small amount of remaining extrinsic value (time premium).

Specifically the extrinsic value (time premium) on our long dated call option is only approximately $0.65, with the majority being intrinsic value. Extrinsic value was calculated by adding the mean bid/ask for the option price ($7.175) to the option strike ($128), then subtracting the actual GLD market price ($134.53) = approximately $0.645.

Importantly this now means that the option delta is over 90%, so the position is trading like a stock position in the underlying. Since 6 calls $128 Sept 2019 are held, that representing a 6 x 100 x option delta = 600 shares x 0.9088 position = approximately equivalent to a 545 GLD share position. That represents a notional position of approximately 545 share equivalent x $134.53 = $73,318. There are some slippage in option bid/ask spreads and the option will move as GLD moves around - but that does give a good approximation of the current position size.

Trade Update in July 2019

This is the current GLD price as of 29th July 2019, and the position has made nice progress after the trade entry on 22nd March 2019:
trading gold - Long GLD Diagonal Calendar Spread - Price chart - 20190729

The current unrealised gain loss on the Sept 2019 call position $2727, added to the $454 from May 2019 expired call, gives a total gain for the overall position of approximately $3181. This is approximately a 276% return on capital so far.

These are some possible exit strategies as the option call is getting closer to Sept 20th 2019 expiration date:

Exit long dated call at a profit - simplest technique, but does not maintain any portfolio gold exposure which will likely be a good idea in a rate lowering environment. This can be done by either just simply selling the call, or by selling dated Sept 2018 ATM calls and hoping to deliberately get called away.

Roll long dated call up and out to a higher strike - this will depend if volatility is still high (over 10%) then this would be an expensive trade. Specifically because if the long option is significantly ITM and getting closer to expiration date (Sept 2019) - it will not have a lot of time premium left in it. Rolling the call up to several months out further out will likely incur some higher than desired premium (due to the high volatility environment). However rolling out could remove all risk from the position (if done for a $1150 credit) and would maintain a multi month GLD position into 2020.

Sell long date call, and switch to using "high volatility" strategy to maintain a long gold position - e.g. bull put spread

Summary of trading gold with long term diagonal spreads

In summary on 29th July the call option position represents an equivalent $73,318 long GLD position, that was acquired with about $1150 of risk. With this strategy there was initially a 30% chance of GLD finishing in the money above $128 by expiration (based on the option delta). The probability of a touch is defined as double the initial option delta - so that also means that over the trade lifecycle there is a approximately a 60% probability of GLD touching $128. To word that in a different way it means that at some point between Mar and Sept 2019 in all likelihood there will be about a 60% possibility of taking at least some profit from the trade. Additionally because we thought GLD would go up in 2019, then we also are thinking that the stated probability was under priced. That meant that using our bullish opinion on trading gold from the macro fundamentals has given us the opportunity to put the odds on our side.

Importantly this wasn't just like a lottery ticket style infomercial that says "I make 500% a week buying options" - where the stated returns are often from buying lottery ticket way OTM options that only make that "big" money occasionally, but on average is a losing option strategy. In summary the GLD strategy had:

  • a defined theoretical probability in advance
  • limited risk/reward
  • time for the investment idea to play out

This trade shows the power of option leverage, and why it is always a good idea to structure your portfolio to respect it - even if we just happen to be on the right side of it this time. This trade is still ongoing so no decision has been made yet, however it shows how to get to good risk adjusted returns using a relatively small amount of capital.

Mexican Bearish Put Diagonal Spread

This trade idea shows how to approach trading the Mexican Market ETF (EWW) with a slightly bearish bias. If EWW maintains its position or goes down slightly over the next month, then this position is likely a winner. The strategy will only make a limited amount of money if a large sustained selloff occurs immediately. The only main directional risk to the trade is a large rally higher. This trade was IRA eligible so using multiple option legs does not generate lots of complex tax reporting, and there was no issue of paying extra capital gains if the trade is ultimately successful.

Mexican market and volatility overview

Mexico has been in the news recently due to a lot of tariff talk. This has meant that the Mexican stock market has been trending down since April 2019. EWW has had a high of $47.18 in April 2019 and a low of $41.77 in March 2019. For the majority of 2019 the ETF has been in this trading range between approximately $42 and $47. This relatively confined range and lower volatility makes it a good candidate for a diagonal spread. The trend since April 2019 has been slow ping gradually down so rather than buck the trend we can enter a slightly bearish put calendar spread to take advantage of any ongoing minor sell off.

Mexican Bearish Put Diagonal Spread- Trade Entry Chart - 20190628

The volatility chart for the last year shows a very wide range of implied volatility there was a huge spike up to approximately 43% in December 2018 when the tarriff talk was at its height. They implied volatility has moved down a lot since then six months later and by the end of June 2019 is approximately 18% which is one of the lowest readings for the year. Therefore it is a good relative volatility level to enter a put diagonal spread that will benefit if volatility increases. We can continue to express a slightly bearish opinion without over paying on trade entry for option premium.

Short EWW Bearish Put Diagonal Calendar Spread - Volatility chart - 20190628

Mexican ETF Trade Entry in June 2019

The trade entry was on 28th of June 2019 as shown in the trade below:

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
28-Jun-2019
Income
Buy to Open Long Put
Put EWW 39.00  EXP 20-Sep-2019
EWW190816P42
-6.0
0.72
$434.64

28-Jun-2019
Income
Buy to Open Long Call
Call EWW 43.00  EXP 20-Sep-2019
EWW190920P43
6.0
1.52
-$914.30

TOTAL
$ 479.66

 

Summary of Mexican bearish put diagonal spread

This trade was OTM so had approximately a 40% of being ITM at expiration - it was therefore a lower probability trade. Initially selling the shorter dated put help finance the longer dated put, and reduce the overall risk in the position. The Mexican ETF EWW will hopefully drift lower over July without any major move either way.

Run your own fixed income annuity

Fixed Income Annuity - 19th Century Book - 20200504

Sometimes you just want to make the guaranteed risk return with the possibility of some upside, but with a guaranteed return of principal. This is typically where fixed annuities come in, however they can be expensive with up front load or annual management fees. Fixed annuities can also be structured in an opaque way where it is not clear exactly what investments the product has bought and how they are managed (e.g. trade turnover etc) – in short they are not very transparent.

Please note: A fixed income annuity is a very complex contract between you and the insurance company. Therefore it is not perfectly compared with the actual investments described in this blog – but this is a starting point to see if the flexibility of doing it yourself might give you some more transparency.

So … is it even possible to run your own fixed income annuity style investment ? Preferably with minimal management, without all the fees and long lock up periods. This blog post is a look back at an annuity style strategy that has been executed for the last few months.

Lets assume we’d like to do this with a lump sum principal of $100,000 USD. It is pretty easy to create medium term US treasury portfolio which is close to the risk free return – lets assume we can construct an equal weighted multi year duration portfolio of treasuries up to 5 years out. Technically there is some duration risk on the longer dated treasuries, but it’s decent proxy for a stable risk free return portfolio. A few months ago in Feb 2019 this had a blended rate of approximately 2.5% – yielding about $2500 a year in interest. See this table for the basic treasury portfolio construction:

Price Date
US Treasury Duration
US Treasury Yield (annualised)
Principal Amount
Yield Amount (annualised)
TOTALS$100,000$2,528
13th-Feb-20196 months2.51$20,000$502
13th-Feb-20191 year2.55$20,000$510
13th-Feb-20192 years2.53$20,000$506
13th-Feb-20193 years2.52$20,000$504
13th-Feb-20195 years2.53$20,000$506
See prices from US Government Treasury website

Managing interest rate risk

However over the next few years, rates might go up or they could be cut. Ideally when each treasury expires we’d like to be able to roll into a new treasury bond with a similar or higher interest rate. However by the time that happens the interest rate market could have moved. So how to manage that interest rate risk without risking any principal?

Since Bond prices will increase when interest rates go down some hedge needs to be provided against falling rates. More simply – something that makes money when rates go down.

In March 2019 we started adding to the above treasury portfolio, by using limited risk bullish short put spread in TLT options. In theory TLT should go up if FED was to cut interest rates and go down if rates rise. TLT contains bonds that have an approximate 17.8 year bond duration, so it is not a perfect proxy for own mini fixed income portfolio that has an average duration of about 2.5 years – however it should be correlated at least. Plus TLT does have very liquid options market that is a couple of pennies wide and can often get filled at mid price, so we can be confident of getting liquid fills on the option trades.

This TLT “short interest rates” trade can be done fairly simply using an ATM bullish put spread, with a slight time decay in your favour on trade entry. There appears to nearly always be a small amount of extrinsic value in an ATM put spread appears to be consistently available, because TLT itself has an actual yield – so you would expect to get paid something for holding it for 90 days even if (all other things being equal) the price never moved. For example if the market is $125, you can sell 5 contracts of $126 put and buy 5 contracts $124 put 90 days out for a credit of $1.05. That would give approximately $0.05 of extrinsic value with $1.00 of instrinic value. If TLT rallies over $126 by expiration can make $550 for that quarter, if it closes below $124 lose $450 for that quarter. Obviously if rolling the put options is considered this becomes way more complex, but waiting to close until near expiration is the simplest case.

If you want to replicate a true fixed annuity with no risk to principal, you’d have to be careful size each trade to not risk too much on each TLT put spread. Lets assume we will do one put spread per quarter, and risk $500 per quarter per spread – that would mean in theory we could lose $2000 ($500 x 4 quarters) on the spreads. However since we gain $2500 in treasury interest, so we’d still be $500 ahead for the year. Not great obviously, but that is the theoretical worse case scenario and if we want guarantee to maintain principal then we have to be cautious with the risk. This is an annuity strategy where aim is to take some market risk but only with money gained from interest payments, never from the principal.
If you wanted to take equity risk as well, this could be applied using SPY option spreads, but recognize that is obviously not as tightly correlated to US treasury rates as TLT.
If you did lose money on the TLT spread, that would be an advantage to you when you come to re-invest any expiring fixed income, because the treasury rates would be higher.

To clarify the idea here are a couple of actual trades to show the principal. One is a simple bullish put spread. The second one was a combination of bullish put spread with a bearish short call spread sold against it.

TLT bullish put spread

This trade was entered into in March 2019, then exited closer to May 2019 expiration on 1st May. There was a $369 profit as TLT had traded up slightly. This took approximately 50% of available profit.

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
21-March-2019
Hedging
Buy to Open Long Put
Put TLT 121.00  EXP 17-May-2019
TLT190517P121
5.0
0.88
$434.64

21-March-2019
Hedging
Sell to Open Short Put
Put TLT 124.00  EXP 17-May-2019
TLT190517P124
-5.0
2.36
-$1,182.24

TOTAL
-$ 747.60

 

TLT bullish put spread with bearish call spread

A couple of days later on 3rd May a similar bullish put spread trade was opened June options, but this had an overwrite with a call spread to give the trade some option premium to sell. Normally trades would be rolled the same day, but there was a couple days in between trades because the earlier trade was trigger by a limit order (and didn't notice position was exited).

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
01-May-2019
Hedging
Buy to Open Long Put
Put TLT 121 EXP 21-Jun-2019
TLT190621P121
4.0
0.49
$194.24

01-May-2019
Hedging
Sell to Open Short Put
Put TLT 125 EXP 21-Jun-2019
TLT190621P125
-4.0
2.24
-$896.79

01-May-2019
Hedging
Sell to Open Short Call
Call TLT 126 EXP 21-Jun-2019
TLT190621C126
-4.0
0.60
-$241.75

01-May-2019
Hedging
Buy to Open Long Call
Call TLT 127 EXP 21-Jun-2019
TLT190621C127
4.0
0.45
$178.24

TOTAL
-$ 766.06

 

This trade was entered into on 1st May 2019, then exited closer to June 2019 expiration on 3rd June. This holding period fits with the 30 day rule. Unfortunately selling the call spread did not help the position here as it lost $345.97. If TLT had been flat to slightly down then the call spread would have made money. Fortunately the bullish short put spread made most of the profit ($694.02) because TLT had traded up significantly higher. Exiting the bullish short put spread and bearish short call spread together as a combination though made a total profit of $348 ($694.02 - $345.97).

For reference here is an interactive price chart for TLT that can be used to see the prices from Feb 2019 to June 2019. On chart use minus (-) zoom control to zoom out, then click, hold and move mouse to the right to navigate back to 2019.

Fixed Income Annuity - Summary

This blog post showed how it is possible to take small profits out of TLT to increase yield, but with limited risk if TLT goes down. In this real life example TLT went up, so the May and June spread trades added a few hundred dollars in yield. However if TLT did go down that would be an advantage to the main US treasury principal because new bonds could be bought with higher yield to expiration. This might need some tweaking to make into a better results, but it demonstrates the idea. There is approximately 30mins monthly effort required to analysis, enter, monitor and roll the TLT spreads. Running your own "annuity" product is potentially a lot cheaper than an traditional annuity that charges upfront load fees and annual fees.

Exiting Bitcoin Investment Trust due to Premium

This trade exit on GBTC describes how exiting Bitcoin Investment Trust due to premium was decided. The original GBTC position was purchased in March 2017. To recap the GBTC is an investment trust whose price is tied to bitcoin. The historically high premium to the actual underlying bitcoin price is the main reasoning for selling our GBTC position and replacing it with bitcoin and etheruem products that can replicate similar exposure (without that premium). This trade was IRA eligible so there was no issue of paying extra capital gains by selling after 11 months (instead of waiting for 12 months for long term capital gains to kick in).

Exiting Bitcoin Investment Trust due to Premium

The charts below compares an European based Bitcoin fund SE:BITCOIN.XBT (as a proxy for Bitcoin spot price) with GBTC. This clearly shows that throughout 2017 people have been prepared to pay a huge premium to own bitcoin in their US based brokerage account.

GBTC Feb 2018 1 year trailing premium
Bitcoin Investment Trust GBTC Trade Exit - Feb 2018 1 year trailing premium - 20180215

GBTC Feb 2018 3 month trailing premium
Bitcoin Investment Trust GBTC Trade Exit - Feb 2018 3 month trailing premium - 20180215

Combined with bullish Bitcoin 2017 price action and inflated premium, the GBTC price has moved up strongly. The above charts and Bloomberg show how the GBTC premium has moved for the last 12 months in a trading range of 50% to 120%. In only the last 3 months the GBTC premium has been as high as 120% in Dec 2017 and low as 30% in early Feb 2018. The premium trades aggressively higher on rallies and lower on sell offs. This behaviour has the effect of amplifying trading extremes, but increasingly makes it a less reliable buy and hold product.

As a recap, when the trade was entered in March 2017 GBTC premium had shrunk down to about 8% because there was the belief that a new Winklevoss Twins bitcoin ETF was about to be allowed by SEC. Once that was announcement was negative, the GBTC premium returned with a vengeance.

According to Bloomberg the average trailing 12 month GBTC premium was 53% (on 16th Feb 2017). By comparison the Bitcoin tracker fund premium was 0.08%. Additionally there is a 2.0% management fee associated with GBTC which is used to help manage the cold storage and security of the underlying bitcoin asset – so any premium paid on the actual GBTC spot price would seem to be excessive. The Bitcoin tracker fund management fee is 2.5% (higher) but since it trades at only 0.08% premium to NAV it is a relative “bargain”.

On 16th Feb 2017 GBTC had a 1 year performance return of 1,574.75% that more than double the Bitcoin tracker fund 1 year return of 774.33%. This is amazing given that the stated aim of the products is identical – the GBTC out performance results are exclusively due to premium.

For reference here are the Bitcoin and Ethereum products available that trade in Europe but can be traded in a US based brokerage account. These products do not have a huge premium to spot bitcoin and are IRA eligible. Bizarrely the swedish Krona product has the higher volume, over the Euro based product. All of these fund products introduce some currency risk exposure, but that is likely less to be way less variable than the GBTC premium risk.

Coin
Currency
Info
Bitcoin Swedish KronaCOINXBT:SS
Bitcoin EuroCOINXBE:SS
Ethereum Swedish KronaCOINXBE:SS
EthereumEuroCOINETHE:SS

A Good Trade but Poorly Traded

This GBTC trade was ultimately a great investment, but one that was traded frustratingly poorly.

A small tranche was sold in May 2017 to cover the risk on the original position and the rest was left to run as “house money”. Clearly with hindsight that was the “wrong” thing to do, but is it good risk management on a very volatile product – and allows staying in the trade for a much longer amount of time. This risk management part was not poor trading, but the management of the resulting price action in 2017 can be improved – as discussed below.

The final run up into Dec 2017 was not well traded, and therefore missed the significant peak at $39, and survived the drop to $10 in Feb 2017, so decided to exit with some value still intact at $18. This is a very hard trade to take psychologically because of the anchoring to the high point at $39. However the 1300% returns in less than a year is still amazing, yet disappointing from a trading perspective. The split adjusted entry point was $1.44 so clearly this was all “house money” but some exit trading at higher prices should have been achieved into the Dec 2017 peak. This is not purely hindsight – it was clear the short term nature of the blow off top, even during Dec 2017. This does not mean the end of the bitcoin “bubble” – just a medium term trading top that should have been taken advantage of.

Bitcoin Investment Trust premium – Trade Exit

GBTC premium expands on rallies (up to 120% in Dec 2017) and contracts on huge sell offs (down to 30% in early Feb 2017). On trade exit at about $18 that is approximately an average 80% premium, which is somewhere in the middle of the range extremes for the last year. On trade exit with bitcoin at approximately $10k, the book value (or NAV) of GBTC was about $10, therefore there is approximately $8 of premium to nav (or about 80%). Therefore about 1800 shares of GBTC buys approximately one bitcoin, but the book value is about 1000 shares. Clearly there is a convenience premium, but 80% over book value is very high. That does not mean GBTC price cannot rise further, or the premium increase more in 2018. However if the premium ever shrinks to say 30% then it is quite possible to lose money in GBTC even if the bitcoin price goes up. When you buy GBTC at $18 about 45% of your purchase is premium (or “fluff”) over the price of the underlying bitcoin. That is a very hefty premium to spot.

Trade Entry was at GBTC split adjusted $1.44 (actual pre split price at that time was $131) in March 2017 when bitcoin was approximately $1250. Trade exit was $17.96 when bitcoin was about $10025 in Feb 2018.

Trade Replacement

The GBTC investment can be replicated without premium using the Bitcoin tracker funds. Since 1000 shares of GBTC represents approximately 1 Bitcoin, these trading approaches could be taken:

1. Sell 1000 shares of GBTC ($18,000 USD) and purchase $10k Bitcoin tracker fund – this maintains exactly 1 Bitcoin exposure. The remaining $8000 premium can be maintained as cash for future purchases if there is a pull back or for other investments. This maintains bitcoin only exposure.

2. Sell 1000 GBTC then purchase $10k Bitcoin tracker fund and $8k Etheruem tracker fund. This gives exactly 1 Bitcoin exposure but allows using the GBTC premium to buy a new Etheruem position. This has created a slightly more diversified crypto portfolio – but still fully invested in crypto, with no cash on hand.

3. Sell 1000 GBTC then purchase $6k Bitcoin tracker, $6 Etheruem, and keep $6k cash. This gives a less aggressive portfolio because it keeps some cash on hand in case of a pull back.

4. Sell GBTC and maintain cash to wait for a big pullback to invest. If you are a believer in the long term crypto currency bull, this is arguably the biggest opportunity risk – crypto prices are hard to predict and can be notoriously bubbly – so it having exited once at lower prices it is hard to reestablish at significantly higher prices.

These reallocation strategies are all tax optimal in an IRA.

Summary

There is a significant chance that if there is a bullish BTC price march in 2018 towards $20k again then GBTC will do very well. Indeed one day later BTC is already trading 10% higher at $11,000 (so clearly this is proving a badly timed exit). However there need to be discipline to recognize when that the GBTC trade now has premium risk outside of just Bitcoin spot price risk. That risk can be resolved by selling GBTC and buying bitcoin tracker funds.

This is not necessarily a price extreme for bitcoin, but a potentially a premium extreme in GBTC. Still bullish on bitcoin and crypto assets for the next few years, however GBTC may not prove to be a good long term buy and hold product (due to the premium).

In summary this is not purely a bitcoin play, but has become a play on the premium investors are prepared to assign for the convenience of exchange traded bitcoin product. Importantly selling GBTC is a not a bearish call on bitcoin or crypto in general, just trying to avoid being the last one out when playing musical chairs with the premium trade.

Oil Futures – Trade Exit – 29th Aug 2016

We can use Futures Options to enter a bullish oil trade using Crude Oil /CL Bull Call Spread – this gives a slightly bullish bias in oil. The Bull Call Spread is a limited risk reward trade with typically a one to one risk reward. The specific trade was entered on 29th July with $41 / $42 bull call spread when Crude Oil /CL was around $41.5 – essentially attempting to exactly middle the spread around the current price, but still defining the amount of risk to take. The trade cost $5.4, simply $540 per Crude Oil /CL contract. At expiration it could be exited for a max amount of $10 ($460 gain) or expire worthless for $0 ($540 loss). This was slightly worse than our typical 50/50 bet (about a 46/54 bet!) but it was close enough to get the trade executed, without having to wait too long for the market to position itself exactly in between the strikes.

Trade Entry

This shows trade entry prices:
CL Jul 2016 Bull Call Spread trade entry - 20160729

Looking at our portfolio, we also have on a post Brexit short CAD call spread that was acting as a nice counter balance to this trade. The Canadian Dollar /6C and Crude Oil /CL prices are positively correlated, meaning most of the time if oil prices go up, then Canadian Dollar would also rally.

Trade analysis

On 26th August /CL closed at $47.29 which is about $5.29 (12.6%!) over our max profit strike, which is very likely to realise the maximum profit of $460 if held all the way to expiration. The current open unrealised profit is $350. The blue rectangles on the Crude Oil /CL option chain below highlight the $41 and $42 strike options that make up the trade. The red circles highlight the strike and delta for the $42 call. This shows that the $42 call has about a 76 delta which meant that it had about a 76% chance of the spread being in the money by expiration (and making the maximum profit).
CL Jul 2016 Bull Call Spread option chain analysis - 20160826

However the 30 day rule period will be up on Monday 29th August, therefore we set the limit profit order to trigger at $400 profit or $9.5 limit (which is 85% of max profit). We would like $400 out of the trade, so we have to set the limit $0.1 higher to allow for commissions. With no commissions $400 profit would be $9.4, but including commissions it is $9.5. Technically there is $60 extra to make in this trade by holding all the way to expiration, but that would be about $940 risk to make $60 over 20 days into expiration so probably worth just closing it. It could be left to expire for next 20 days, but according to the option market there is a still a 25% chance that oil crashes to our higher $42 strike by expiration – so it is safer to exit on Monday for most of the profit and not have to worry about it.

The following chart shows the full trade life cycle marked up with our comments:
CL Jul 2016 Bull Call Spread chart trade analysis - 20160826

Oil Futures – Trade Exit

In the slight oil rally on 30th Aug the limit order was triggered and trade exited. This shows trade exit prices:
CL Jul 2016 Bull Call Spread trade exit - 20160830

In summary we made almost the full profit available in this trade, and exited as soon as possible after the 30 day rule allowed, but still let the market trigger the limit order for us to get the target $400 – this was a solid 74% profit on capital risked (profit $400 / risk capital $540 = 0.74).

Gold Futures – Trade Exit – 15th Aug 2016

Gold Futures – Trade Exit on 15th Aug 2016. We can use Futures Options to go through Bull Call Spread example. We originally entered a gold Bull Call Spread with a slight bullish bias in Gold, but mostly just to get some trades on. The Bull Call Spread is a limited risk reward trade with typically a one to one risk reward. Typically we would pick the options on futures that expire 45 to 60 days out. This gives plenty of time for the trade to move in the expected direction. This means that you don’t have to monitor the trade too closely throughout its lifetime, with is important with a 30 day rule.

However even if the trade is totally wrong, then can likely salvage a bit of value to either exit, or re-establish in the next monthly cycle. e.g. if the trade was placed for $500, it might only be worth $250. At that point could sell the whole spread, then do the same trade at the same strikes for the following month – this simply allows time in the trade if you still like the trade idea.

Gold Futures – Trade Exit

The specific trade was entered on 14th July with $1325 / $1335 bull call spread when /GC was around $1330 – essentially attempting to exactly middle the spread around the current price, but still defining the amount of risk to take. The trade cost $5, simply $500 per /GC contract. At expiration it could be exited for a max amount of $10 ($500 gain) or expire worthless for $0 ($500 loss).

This shows trade entry and exit prices:
GC Aug 2016 Bull Call Spread trade exit - 20160815

On 15th August /GC was about $1345 which is about $10 (0.75%) over our max profit strike, which is not a lot distance for the several days remaining in the trade. The trade had a profit of about $200 out of a maximum of $500, but clearly was only slightly out of money so that could be erased with a swift down move. However on investigating the delta of $1335 call gave about 63 delta which meant that it had about a 63% chance of making money by expiration. However we also know the probability of a touch at a higher strike is much higher than the probability of finishing at a particular strike at expiration. To define that another way – although this was currently looking like a marginal trade, there was still a high probability of exiting with a 50% of max profit ($250 profit target out of a maximum $500) between now and expiration.
There we set the limit profit order to trigger at $250 profit or $7.6 limit. Technically this would be $7.5 limit, but we set an extra $0.1 on the limit price (or $10 value) higher over our profit target to allow for commissions. The commissions on this trade are 2.31 for each option leg for entry and exit, which is $9.24, which is over time this adds up, so moving the limit by $0.1 covers those commissions nicely.
We then went to sleep, and luckily in the morning the limit had been filled due to a nice rally.

The following chart shows the full trade life cycle marked up with our comments:
GC Aug 2016 Bull Call Spread chart trade analysis - 20160825

In summary there was more profit available in this trade that ultimately we didn’t take, however we did make a solid 50% profit on capital risked. Also the trade reversed recently in the last week, meaning that if we had held on into expiration we would know be looking at -$200 loser (using today’s prices). The difference between taking the $250 or waiting for the -$200 loser is $450, so that is a significant swing for the trade size. Therefore taking the profit on the profit target was the right decision, and consistently taking profits on the winners helps balance out any future losing trades. We are getting better about not being disappointed with not making the “maximum” each time, and now we try simply moving on to the next trade.

Brexit exit iron condor

The pound has been relatively flat for a month after the initial Brexit trauma, so we are considering a “Brexit exit” on our existing iron condor. Currently the iron condor is in the middle of it’s range, as the FXB is at $129 and the mid point of our iron condor is $130. Volatility has contracted from 30% on the brexit announcement to around 15% and trending lower towards the original pre brexit range of 8% to 10% implied volatility.

FXB volatility

Looking at the historical FXB implied volatility chart clearly shows the huge peak for Brexit

Brexit exit FXB Aug 2016 Adjusted Iron Condor Volatility Analysis - 20160801

Given that our continued assumption is bearish on the pound, it makes sense to exit the iron condor before it sells off any further. Also the implied volatility contraction from a peak of 30% down to about 15% makes it more attractive to buy back the short option premium.

From our previous post the original trade was an iron condor at $149/$144/$130/$125 was placed on 16th June (pre brexit). Iron condor was adjusted on 27th June (FXB adjustment is in section “Brexit trading update – Monday”) by adding bull call spread $148/$143 and short call spread $135/$130.

FXB trade exit

The $130/$135 short out spread was slightly ITM giving the trade a slightly bullish deltas, and since our assumption is still bearish we are ok to close out the entire trade for a profit. Given that FXB moved more than 15% after brexit, this is definitely a good result. We could leave on the short call spread $130/$135 to keep short position on the table. However we are trying to more disciplined with our trading approach of “on as a package” and “off as a package” for option strategies. Adjustments to strategies in mid trade are ok, but fundamentally it is cleaner to exit and entry all option legs together. This ATM spread that had been already adjusted on with a short call spread vertical $130/$135, was taken off for a loss of -$73.

Brexit exit FXB Aug 2016 Adjusted Iron Condor ATM trade exit - 20160801

The call spread structure at $140 level is mostly worthless now. The generated a $216 profit and can be easily bought back for $50. It probably would be more logically to let the whole thing expire worthless because it’s way out of the money now, but in the interests of housekeeping we will exit now (on the same day the other side is exited). You could easily back an argument for doing nothing with this side of it, but we don’t have the patience to wait 40 days for it to expire to make only $50. All option legs of the entire OTM spread including the long call spread adjustment at $148/$149 was taken off for a gain of $216.

Brexit exit FXB Aug 2016 Adjusted Iron Condor OTM trade exit - 20160801

Brexit exit trade summary

In summary entire trade was exited for a $144 ($216 – $72) total profit across all options legs, but only with $200 at risk after each trade adjustment was applied (so it was a very safe trade). Without a trade adjustment this would have been a $36 winner, however with the potential max risk of approx $600. So in this case the adjustments ultimately made more money due to selling premium and importantly lower the overall max risk on the trade. This shows how in a volatile trading environment adjusting spread by selling premium, can both reduce risk and manage trade profitability. This was only a small profit, but it does show how to manage an option trade successfully even with a 30 day rule.