Bought Call on STLD for a 6 week trade

STLD rose above prior week high in a bullish pullback pattern with higher than average volume at this point. Entered a May 18, 2018 36 call position for a 6 week trade before its earning announcement around middle of January, 20018.

The stock has no weekly options. The call option Delta was 0.64 and the spread of the bid/ask price is around 10%. The material section XLB was performing OK recently compared to SPX.

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Failed Head and Shoulders Breakdown on FXE

Interest rate sensitive stocks reacted to dovish FED meeting minutes in the last few trading days. In general, 30 year bond ETF TLT rose and broke its head and shoulders bearish pattern. Its stock chart did not confirm the head and shoulders breaking down either, as the Euro currency ETF FXE did. However, FXE's breaking down was short-lived. It started to stabilize and generated a sideways and upward bias as shown in the chart below. Although I got a chance to hedge the changing of direction with a short put and collected a small premium, FXE shot up on last Friday, forcing me to exit this trade as it broke above my stop loss point.

Other banking stocks were a bit weak as well. BBT fell below its lower up-trending line support as well. So I decided to exit last Friday.

Removed short call hedge on QQQ as market rises

Market had a couple of strong rises after I bought Dec 8 $155 call on QQQ. I bought back this option to make the QQQ Long position naked. I also took similar action on the SPY short call today.

Each moment in the market is unique and market can give ramdon wins or losses for each trade. The goal is to have long term profits with reduced risks of this type of diagonal spread positions. The targeted hedge cost is under 20% of profits.

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Long entry on XLB from a bullish pullback

Market remained bullish after the strong rise last Thursday. XLB has performed well after rebouncing back from a day below 50 day moving average. It formed a bullish pullback pattern since last Friday. All the secondary indicators in the chart also turned bullish. So I bought the June 15 $56 call with an initial stop at 57.10 for an intermediate term play.

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Bought back BBT short call

Market is rising sharply with the small caps gaining highest percentage. Banking stocks is not the leading sector today. But it had performed well in the last 4 days or so. I closed the short call on KRE 2 days ago as posted in the blog: https://smoothprofit.blogspot.com/2017/11/bought-back-kre-dec-1-58-call.html

Today, my BBT continued its rise along the lower support trend line. I closed the short Dec 15 $48 call to unlock its potiential for large gains. In its rapid sell-off in the last week, I had sold Dec 15 $50 call first then rolled down the call to $48 after Dec 15 $50 call premium made big drops.

The chart pattern of the stock looks interesting. At the entry point, the pattern was a narrower up-trending channel, as shown in the green dotted lines. During the sell-off, it changed to the wider and slowly-moving up-trending channel. I did not sell the stock since it did not close below my stop loss point.

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Hedging under weakening market and more distribution days

Since last week, the stock market showed some weakening signals:
1. SPY & QQQ prices drops
2. 7 distribution days on Nasdaq
3. Stock market leaders FFTY continued to retreat
4. New highs - new low index topping
4. MACD/STO signals dropping

The SPX prices have not broken the up-trend yet. So I decided to hedge with short calls on my SPY & QQQ long call option. The short Delta of the call were raised to 0.33~0.34 as the probabiliy of a significant pullback is a bit high.

The chart shows the selling of the DEC 8, 2017 $155 CALL.

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Bought back KRE Dec 1 $58 Call

The long term LEAPS position on KRE Jan 18, 2019 $55 call was entered about 2 weeks ago as KRE broke out of horizontal resistance of $57.38. But it turned out to be a fake breakout as its price fell back to the consolidation zone in the next day.

A short call Dec 1 $58 was entered to hedge when KRE broke the near term up-trending channel. The price continued to drop and touched the 200 day moving average., where I tried to roll down the short call. But the order could not be filled due to a couple of cents of difference in my limit order.

Today, as the KRE continued to bounce on the 200 DMA support and the bullish MACD histogram and STO, I decided to close the short call for a small profit.

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Bought back time decayed short call to close hedge on XLV Call

Since the entry of XLV June15$79 Call 6 weeks ago, XLV reached its top uptrending line in about 3 weeks, then quickly pulled back. The drop passed a few support levels, based on which no short calls were entered to hedge the naked long position.

The short call was entered after XLV fell below its 50 day moving average on Oct 30. Since then, it moved about 2+ weeks and the short call Nov 24 $83 reached about $0.04 as a result of time dacay. So, it was bought back as XLV sits on the major support around $80.82. No new calls were sold due to the support line and the rising MACD historgram and STO.

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Is market approaching a top?

The general market SPX has been going up since August 21 for about 2 months now. Although it had rested two times (in which each lasted only 1 week) since then, this 2 month period probably outlasted the average 1 month rising period this year. There is no major sign of a market top at this point, as the SPX price continues to grind up and market distribution days are rare. However, the MACD indicator is showing losing momentum.

Based on the behavior of small upward daily movement of the SPX prices since last week, the indicators and the higher than average number of rising uptrend days, I'm preparing for the end game for this market cycle for my positional trades. Basically, it means watching stock prices closely with relatively tight exit points to take profits and waiting for a market rest before fully entering new positions. According to Mark Douglas's book titled "Trading in the Zone", one of the seven principles of consistency in winning stock market is "I pay myself as the market makes money available to me". This is similar to my posting before on winning altitude. Therefore, I need to take profits gladly for this market cycle, as a number of stocks in my portfolio gained within or beyond my expectations.

In general, the last 4 weeks were probably very good time for most traders, since the market kept moving up. All of my positions are doing well except a couple of them that got stopped out. The only bearish trade (HOG) that I entered while market gave some bearish signals ended as a loser as market resumed uptrend within a few days after my entry. The Indian stock ETF EPI was a biggest percentage loser in over 1+ year's trading for me. It was the worse case scenario in my stop rule if the stock kept gapping down for more than 2 days. Looking it at the probability point of view, one big loss trading is still OK as my winning and losing distribution is quite normal up to now. I'll present more statistics later.

I also closed two positions which were big winners last Friday. NFLX was doing well up to one day before the earnings announcement. My exit rule requires me to exit before earnings day to keep my P&L smooth. So I was happy to take the good profit percentage. PYPL reached my target area as the high of the day and retreated from there. Considering its earnings announcement is coming soon, I decided to take profit off the table.  The PYPL chart was posted on StockTwits and is shown below.

My other stock positions include BIDU and EDU. Their earning announcement days are coming next week. So I need to take them off soon as well.

The only new position I entered after the last post was the XLV June, 2018 $79 call for a cost of $5.88 on 10-2. I felt health care could resume its recent uptrend after some rests, if the market rotates to sectors that made less progress this year. So I bought the call after XLV rebounded from a major support level around $81 as shown in the chart below. However, it hit the prior resistance at $83 and started to retreat. I could have sold a short call as a hedge yesterday after a two day declines in a roll. But it was actually trading higher when I was watching the stock price yesterday. Since XLV shot up to form a new ascending triangle breakout today, I don't need to short the call any more.

Middle Game Review of Bullish Portfolio Positions

It looks to me that the positional stock trading has similarities to the chess games. Position entries are like the chess opening. Position management after that is like the middle game as the market battle unfolds with various types of market and stock signals. Profit or loss taking is like the end game of chess where the individual game completes. This process should continue for a long time for consistent traders.

Since market hit its intraday bottom at August 21, there were a few bullish signals shown by the SPX chart pattern. I have switched to bullish outlook as mentioned in the last blog post. In the subsequent weeks, I entered a few more bullish positions. I think that’s enough for my portfolio for now. The opening game is done. Let’s have a review of the current positions as a middle game assessment.

On the HOG trade, it’s interesting to see two bearish patterns got invalidated and the stock refused to go down. However, the stock has yet to rise beyond my original stop point of $48.27.  With 2 days to expiration, I bought back the short September 15 $46 put contracts for $0.06/each today to take a profit of $0.48 (=0.54-0.06) on the short put. I need to change my stop point to $47.85, somewhat above previous high after I entered the trade based on its resilient behavior.

On September 1, I entered March 16 $220 call on BIDU as mentioned in the last post. Since then, it was doing well as shown in the chart below.

On September 7, I entered a long call January 19 $57.5 on PYPL for $6.75 as it was breaking above a 6 day high base within an up-trending channel as I posted on StockTwits. In the last couple of days, it pulled back to touch the high base again. If it fells tomorrow, it will trigger my signal to sell a short call.

On September 11, I entered a December 15 $57 call on XLK at a cost of $2.90 for a near term trade as it bounced back from support level as shown in the chart below. It looked like a bull pull-back trade on top of an ascending triangle breakout. My plan is to trade the larger ascending triangle pattern. I also entered longer term trade with June 15, 2018 $56 at the cost of $4.95 in a different account.

Yesterday, I bought EPI Jan 19 $26 call for $1.50 after it broke out of a 6-day high base within an upper trending channel as shown in the chart below.

Overall, the market has been bullish for the last 3 weeks. However, it should be noted that the market rose for about 3 to 4 weeks then pulled back in the last 6 months. It happened 3 times in this time frame signaling some fatigues of the long bull market since the up run could not last longer. We’ll have to see what market signals tell us next as the middle game continues. 

Stock Market Showed Continuation of Bullish Signs Last Week

After I reported volatile market actions on August 9th post: Trading stocks in Turbulent Market Days, the stock market had 2 sell-off's within a week. Since the drops were accompanied by higher volumes and the decline of new highs - new lows indicators of NYSE & NASDAQ, I went to bearish outlook for the intermediate term. I tried to initiate bearish trades at the time. However, I was not able to find a candidate that could meet my bearish trade criteria until August 18 which coincided with the bottom of the SPX pull-back in last 4 weeks.

On August 18, I was glad to find HOG forming a picture-perfect descending triangle break-down with high volume as I posted on StockTwits. I bought Nov 17, 2017 $50 Put for $4.80 for this consumer sector stock as consumer sector performed poorly in those days. The stop loss point was set at a recent high around $48.27.

However, the stock pulled up along with general market in the next couple of days. Hence, I had to leg into a diagonal put spread by selling Sept 15 $46 put as shown in the chart below. Since then, the stock price has not been able to rise more than 2 days in a roll and formed another lower high at $48.12. The pricing pattern is not a descending triangle any more, but looks like it may be forming a low base pattern. I have to face it: any outcome is possible with all the trades I put on as my trading is a probabilistic game. This is one piece of fundamental truth of trend trading.

On August 22, the market rose strongly along with higher volume. I felt it could be the 2nd confirmation day to signal the continuation of the bull market. I noticed EDU (a Chinese company) was breaking out with high volume along with outperforming emerging & Chinese markets. So I entered an aggressive bullish position on EDU as shown in the chart posted on StockTwits in the middle of the day. The mental stop loss was set about a few cents below prior low of $74.98. I planned to stop out if the price drops below it or the Chinese ETF FXI breaks down somehow.

A few days later on August 28, EDU got sold off heavily. I had to sell a Sept 15 $85 call which had a Delta of 0.20 which was in the lower end of my typical short Delta. This was because that EDU had limited option strikes and I felt the volatile stock could bounce up to recent highs around $85. The next day, it briefly broke down below my stop loss point soon after the open but it was going up when I started to monitor my positions at my routine trading hour. The FXI was still looking bullish at the time. So I decided to keep the position for that day and waited to see if it would break down again. The market happened to be very resilient on that day and kept rising for a few days now.

One more day later, I started to feel more bullish about a bullish flag pattern of SPX and posted the following chart on StockTwits.

On August 30, I entered a long Dec 15 $165 call position on NFLX as it was bouncing up from a recent test of 50 day moving average line and seemed to form a bullish flag pattern. I also bought March 16 $220 call on BIDU as it broke out of a high base chart pattern. I'll post more about this trade later.

Trading Stocks in Turbulent Market Days

The market is a little bit turbulent in these two days, after a very rare (low probability event) 10-day consecutive rises of the DOW Industrial Average Index which is consisted of a small number of large companies. The major indices are presenting some weakening signals but not enough for me to consider a bearish market turn yet.

The Nasdaq is weaker than the SPX and its new highs – new lows accumulative index is turning down today. If the same index for NYSE also turns down for a couple of days as explained in my previous post, I would consider an intermediate bearish turn of the market and start trading with bearish positions. 

In the meantime, the volatility index VIX is jumping relatively high when compared to its high at early July. This is not a confirmative posture for a real down turn of the general market since it indicates a lot of people are already in fear even though the price has not dropped much.

Yesterday, I closed my EPI position by selling it at $26.66 as shown below and posted the trade in my StockTwit. The profit taking decision was based on my analysis of the target price of the stock chart mainly. 

I think the large and rapid drop of the US Dollar in the last month also played a role for me to consider exiting the emerging market for now. I felt the USD’s fall contributed to the dramatic rise of the emerging market ETF’s. These profitable rises for my EEM & EPI positions were nice in the past month. But USD, as an intermarket signal, seemed to start a turning process after the over-sell condition. Therefore, the USD price action and the rare consecutive rises of the DOW Industrial average make it easier for me to take profit when the emerging market ETF’s reached the price target.

My portfolio is on the light side as I sold most of my short near and intermediate term bullish positions. I’ll need to build up new bullish positions when the market gives bullish continuation signals. Yesterday, I entered a long term bullish position for REM with a purchase price of $46.83, a mortgage REIT ETF that provides good dividends (> 6%). I intend to hold this long position for a long time, unless it signals break-down of long term bullish trend. This ETF follows TLT trend in general, but outperform it with a large degree.

Closed EEM Long Calls to Take Profit as the Option Delta Reached Target

Yesterday, I closed the EEM long call (2018 January 19 $38 LEAPS) when EEM was dropping near its $44 resistance after I found out its Delta reached 0.86 which was over the target of 0.80 as described in the original post (Bought top performing emerging market ETF) when the position was entered over 3 months ago.

I did not roll out the long call to take profit and to remain in the position, because EEM had been rising in the up-trending channel in the last 5 months as shown in the chart below. I’d like to wait for the next EEM opportunity when it rests for a while.

Looking at my last trades on EEM, I had got out of a short call July 7 $41.5 on June 26 as it popped out of an ascending triangle as I described in a chart of a prior post and shown below. Since then, EEM pulled back to the triangle but did not trigger a new signal for selling another call. So, I was lucky to capture fast move of EEM in the last 4 weeks.

For EPI long stock position, I’ll continue to follow my plan to exit when it breaks 20+ day support that I identify along the way and the profit target exit will be the uptrend shows signs of ending or when the general market start to show weakness.

During my multi-week summer vacation, I had a few trades on the SPY & QQQ while I kept a minimal number of positions. I’ll document those trades later and look to expand my positions as market conditions allow since I’m back and able to handle the portfolios actively.

Taking profit on ascending triangle breakout trade in choppy market

General market $SPX continued to drift down in the last 3 weeks while Nasdaq fell below its 50DMA this week and it made a lower high/lower low bearish pattern in last 4 weeks. In this choppy market environment, my trading style requires low market exposure and lower number of trades to control risks.

Today, market is rebounding up with lower volume. My ascending triangle breakout trade on C diagonal spread showed some profits after the price of C got close to target price of $69.19 in one month, which was much faster than expected. Considering I have to take a multi-week vacation and the choppy market, I decided to close this positional trade for an acceptable profit.

Also on yesterday, the short call July 7 $244.5 on SPY reached $0.02 to create a good profit as $SPY moved sideways most of time, as shown in the chart below. So I bought it back and sold a new July 28 $244 call for a credit of $1.02. I plan to hold this long term diagonal unless SPY 10 week EMA crosses down 40 week EMA.

Now, I have closed all of my near term trades in preparation for the vacation in which I'll have much less time to watch over market. The remaining open positions are longer term and I'll continue to sell calls or buy protective puts should the market turns bearish.

Reducing bullish positions amid weakening market postures

QQQ had turbulent 4 days after I uncovered its short call on last Friday June 23. On the subsequent Monday of June 26, QQQ presented a bearish dark cloud cover candle and fell hard for the next day. It tried to rebound on the 3^rd day /w lower volume. On this 4^th day, it got hammered again on high volume and undercut the support line around $137.

Looking at other QQQ chart indicators that I use typically, MACD turned down for the again but the new high – new low indicator is still up. Since QQQ showed me the bearish chart pattern, declining MACD and the distributive volume behavior, I decided to sell to close my QQQ September 29 $135 call in my shorter term trading account today for $5.73. For my longer term trading account, I sold the July 21 $140 call for $1.01 against the long option.  The short call strike had Delta around 0.30 which reduced the position delta as a hedge procedure.

 

On the SPY side, it was sold off today too. However, it had not broken down the lower support line of the up-trending channel yet. I have a July 7 $244.5 call which still has a value around $.20. I plan to roll down if SPY continues to fall tomorrow. It’s not a complete market plunge as the financial ETF’s XLF/KRE did rise.

Citigroup popped out of recent range along with its peers in high volume. I rolled up the July 7 $66 call to July 21 $69 Call for a debit of $0.94, rather than make it naked. My thought was that the weak market may limit the rise of financial stocks as well.

For MU diagonal spread, I exited the position for a credit of $5.32 two days ago on Tuesday June 22, after it touched the recent high and pulled back. My rule is to exit before its earning’s announcement which happens to be today. This rule is used to reduce risk of my portfolio.

For EEM, it broke out of resistance on Monday, June 26. I bought back the short call July 7 $41.4 for $0.60. Since that, it pulled back but the MACD hasn’t dropped for 2 days in a roll yet. I may have to short another call if EEM price drops tomorrow.

Trades for the last 2-week side-ways market and current outlook

In the last couple of weeks, the stock market experienced a NASDAQ sell-off, followed by some recovery days. The SPX moved sideways mostly. Overall, the general market looks bullish as the up-trends are still in place. Even with the 2-day big Nasdaq selloff, the NASDAQ New highs – New lows index remains rising.

As explained in my post about my usage of this secondary confirmation index before, I decided to uncover the QQQ July 07, 2017 $142 Call for a price of $0.98 on Friday, June 23 based this and the following bullish signals.  The chart indicated rising MACD and QQQ also successfully bounced off the support line around $137 two times.

Looking further back on Monday, June 12, QQQ continued to sell off after its prior Friday’s plunge. The short call of June 16 $143 sold on May 25 as a hedge reached most of its profit as its price reduced to $0.12. Therefore I rolled it out and down to July 07 $142 Call which was sold for $0.84 as shown in the chart below.

 

Now QQQ sits at the same price level as that in 4 weeks ago. I’m glad that I followed my rules to take some profits off the table and used short calls to hedge for a possible change of uptrend in this period. It was not easy actions for me since they were done in the middle of strong uptrend.

Taking profits for positional trades are necessary and takes the greedy part of trading psychology out of the trading process.

However, I was not as quick on the NLFX & MU trades as I did for QQQ before the Nasdaq sell-off. A couple of days before the sell-off, the Delta’s of long calls on these stocks reached slightly higher than 0.80 as well.

My trading rules specify that rolling for long term trades and closing for near term position trades when the Delta reaches over 0.80, not necessarily at 0.80 though. I was hoping to get Delta’s rising to 0.85+ level amid the strong market trend. So I did not take any profits off for these positions and saw the profits evaporated during the sell-off.

On Thursday June 15, NFLX dropped intraday to undercut the prior 3 day lows which caused me to sell the long call of September 15 $154 for $13.2. It was bought on April 25 for $15.60. So the net loss excluding short call and its rolls on this position held for about 2 months is $2.40, down 15%. I’ll have to calculate the actual loss later when time allows.

At present, I still have the following open positions. I plan to close MU before its June 29 earnings announcement date this week as my rule does not allow holding the earnings date in general.

Stock	Existing Position	Note
SPY	Long Jan. 19, 2018 $220 Call LEAPS, short July 7 $244.5 Call	Sold short call on June 15 for $0.76 as SPX & Nasdaq sold off.
QQQ	Long Sept. 29 $135 Call	Uncovered short call on June 23
MU	Long Oct 20 $27 Call, Short July 07 $33.5c	Sold short call on June 15 for $0.83 as Nasdaq sold off.
EEM	Long Jan. 19, 2018 $38 Call LEAPS, short July 7 41.5 Call	Sold short call on June 15 for $0.25 as Nasdaq sold off.
C	Long Sept. 15 $60 Call, Short July 7 $66c	Sold short call on June 15 for $0.54 as Nasdaq sold off.

Ascending Triangle Breakout Trade on Citigroup & Current Market Outlook

On Thursday, the general market was moving sideways for the 4^th day. But the financial stocks were the best performing sector mid-day. The financial ETF XLF broke above the 50 day moving average with high volume after living under it for over 2.5 months.

Citigroup C was a member of the ETF. I noticed it was a leader in the group a couple of weeks ago since it seemed to be in the process of forming an ascending triangle pattern while other financial stocks were trending lower and testing lower support levels. On Thursday, C broke out of the resistance level around $62.65 with high volume.

The pattern before the breakout lasted about 11 weeks. So I added a couple of weeks more for the expiration date and chose September 15, 2017 Call with a strike of $60 which had a Delta of 0.70. It was higher than my desired Delta of 0.62 but it was the next higher Delta that was above 0.62 for the September call options. I started with limit order at $4.78 and watched the price going higher. I kept raising my limit order little by little and eventual got filled with $4.85 within 10 minutes.

My mental stop loss point was set to $59.78, which was slightly below the swing low 7 days ago and the 50 day moving average. My target prices of the stock was $62.56*(1+10.6%, percentage of the rise in the pattern) = $69.19. The calculated Reward/Risk ratio was close to 2 for the stock trade. When the stock prices reach these points, I plan to take actions to sell the call option. As usually, I will leg into a diagonal from this naked long call when the stock shows the signal of pulling downwards.

Overall, I’m still mildly bullish for the general market, even with the huge sell-off in the NASDAQ today. The 2.5% plunge of QQQ today was much larger than that on May 17, about 3 week ago on the scare of presidential impeachment. Friday's tumble was accompanied by the largest volume since the starting of this round of uptrend in December, 2016. This is a serious concern for the market health.

However, the SPX and Russel 2000 indices were still doing OK on Friday. There were other sectors (XLE, XLF, etc) rising significantly. So it did not look like a broad market sell-off yet. The accumulative new highs – new lows indicators mentioned in my previous post did not drop yet. If there are more bearish signs on the market next week, I’ll take necessary actions.

My positions in different accounts are all bullish at the moment, although I kept my open positions relatively small for now. I also have short calls on my SPY & QQQ long calls as hedges as described in my previous posts. Now, I felt compensated on my action to follow my trading rule and to take some profits on June 2 when the markets broke above the upper line of the trading channel as I describe in my post: Closing Trades to Take Some Profits as Market Broke above Upper Boundaries.

Since the SPX had already rested and moved sideways from early March to early May for 2 months, I think it could continue to advance for another month which is July, unless market shows other signs of a major top.  I plan to have a vacation in July. So I need to keep the number of positions small for now from this perspective.

Closing short near the Money Call to Reduce Gamma Risk on EEM Diagonal Spread

EEM has been performing OK relative to the general market last week. My EEM diagonal call spread was working fine. The short June 9 $42 call option that was sold 3 weeks ago for $0.27 was approaching its expiration date with 3 days left from Tuesday, June 6. It was near the money as EEM price was around $41.72 and Delta was around 0.46. The position had relatively high Gamma risk which could turn the short call into a significant loss in a couple of days even though the EEM price just increased a little bit to above $42. Therefore, I bought back the short call for $0.10 to eliminate Gamma risk and to lock in a profit of $0.17 on the short call on Tuesday, as I twitted in my StockTwits message.

After that, I have EEM long call January 19, 2018 $38 naked. Since it seemed to form a small ascending triangle pattern with MACD turning up and travelling in the upper trending channel as shown in the chart below, I did not sell another short call. I’ll short new calls when the stock movement provides the signal to sell.

 

The option’s Gamma risk could have a big impact on option strategies that include short options when the expiration date is coming closer. This is because option Gamma increases dramatically as the option approaches expiration, particularly for options At-The-Money (ATM). Therefore, many option strategies that sells options for protection and/or for benefit of time decay need to watch for Gamma risks as the expiration comes closer. This and the definition of option Gamma are very well explained in the article on Understanding Gamma by Dough.com. I also had a study on the option Greeks in my previous post: A Summary of Effects of Prices, Time, Volatility on Option Greeks.

The diagonal spread involves short options and therefore need to take Gamma risk into account in its option adjustment rules. There are two major impacts on diagonal spreads due to the characteristic of option Gamma. We already discussed the first impact near the expiration. This results one short option closing rule that it should be closed in the last week when the stock price is close to the option’s strike price.

The second Gamma impact on the diagonal spread is the possibility of Delta inversion. Since the option closer to expiration has higher Gamma than that of the option that is far from expiration, the Delta changes faster for the option closer to expiration as well.

Thus, the short option in a diagonal spread which is closer to the expiration may have its Delta changing quicker than that of the long option which is farther away from expiration. When the short option’s Delta exceeds the long option’s Delta, it’s called a Delta Inversion. The wider the expiration dates of the short and long options, the more frequently it’s likely to happen.

Delta inversion causes originally bullish diagonal call spreads to lose money if the stock prices continue to go up as expected. It also causes originally bearish diagonal put spreads to lose money if the stock continues to fall.

For example, a short call option may have a Delta of 0.50 while the long call option may have a Delta of 0.70. As the short option gets closer to expiration and near-the-money, its Gamma increases faster. If stock price increases $1, the Delta of the short call option may increase faster to 0.75 while the Delta of the long call option may increase slower to 0.72. So, the composite Delta of the diagonal call spread changes from +0.20 (bullish) to -0.03 (0.72-0.75, bearish). The originally bullish call diagonal spread starts to lose money if the stock prices increase as the trader expects in the beginning of the diagonal trade.

Therefore, diagonal spread management rules are required to avoid the Delta inversion in order to trade the strategy profitably. What I’ve leant is that the short option should be rolled when the composite Delta of a diagonal spread gets closer to 0.15 area, or the short option’s Delta get above 0.60. If we roll up or roll out the short call that is likely to cause Delta inversion, the composite Delta gets expanded wider to have more profit room for stock price increases. If the stock prices reverse direction from here, we can keep selling new options as well.

Closing Trades to Take Some Profits as Market Broke above Upper Boundaries

The stock market continued to show bullish strength today by crossing the 2 month long upper line of the up-trending channel by SPY & QQQ and above the upper Bollinger band, as shown in the charts below. The NYSE & NASDAQ trading volumes were lower than those in yesterday. It was a difficult time to take profits since there were no visible signs of market weakness based on price patterns.

 

However, the exit rule of my diagonal spread for my positional trades was met today for some of my positions. Basically, the rule specifies that when the Delta of the long option exceeds 0.80, the diagonal spread can be closed for profits for positional trades and rolled out for longer term trades.  The high Delta value and the crossing of the upper boundaries made me to decide to close some SPY & QQQ positions for profit. I’ll wait for a few weeks to see if there are new entry points on these ETF’s and manage remaining positions as market evolves.

The entry, rolling adjustments, and exits of the QQQ December 29, 2017 Call which was a position in a different account from the last post is shown in the chart above. The summary of the QQQ diagonal trades is listed in the table below. In reviewing the trades, it’s obvious that I had held the short calls for too long such that the overall profit was 28% only while the targeted profit could be 50% or more.

Date	Spread	Side	Exp	Strike	Price	Net Price	Total Cost
4/5/2017	SINGLE	BUY	29-Dec-17	127	10.63	10.63	10.63
4/12/2017	SINGLE	SELL	5-May-17	133	0.79	0.79	9.84
4/24/2017	DIAGONAL	SELL	19-May-17	136	0.58	-1.14	9.26
4/24/2017		BUY	5-May-17	133	1.72	DEBIT	10.98
5/1/2017	SINGLE	BUY	19-May-17	136	1.81	1.81	12.79
5/17/2017	SINGLE	SELL	9-Jun-17	139	0.83	0.83	11.96
5/25/2017	DIAGONAL	SELL	16-Jun-17	143	0.49	-1.92	11.47
5/25/2017		BUY	9-Jun-17	139	2.41	DEBIT	13.88
6/2/2017	DIAGONAL	SELL	29-Dec-17	127	18.03	16.86	-4.15
6/2/2017		BUY	16-Jun-17	143	1.17	CREDIT	-2.98

In the meantime, I decided to keep 1/3^rd of the QQQ diagonal spread for longer term trade. Since the December 29, 2017 $127 Call has its Delta about 0.82, I rolled out 3 more months to March 16, 2018 and raised strike price to $136 which had Delta around 0.65. As explained in the previous post, the rolling reduced the overall position Delta. I might need to adjust the short June16 $143 call if QQQ keeps rising.

On the SPY bullish positions, I sold diagonal call spread September 2017 $229/June 2017 244.50 Call for $15.31 as the long call had Delta over 0.80 as well. I’ll analyze the SPY diagonals in the future in a trade review.

My other diagonal call spread on MU was adjusted as well since the short call Delta reached over 0.65 and MU price action was strong. Thus, I bought back the June 9 $30.5 call and left the October 20 $27 call which was bought around May 11th naked. The MU stock chart is shown below.