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.

Taking Profit out of Diagonal Call Spread to Increase Leverage and Time to Expiry

Stock options are a leveraged trading vehicle for traders. There is a specific term that measures the level of the leverage. It is called Omega. Omega measures the relative percentage changes between the stock and the option, and is used as an elasticity measure for the option.  The formula to calculate Omega is given below.

Omega = Option Delta * (stock price / option price).

As the stock price rises, the value of the long call option increases. The Delta of the long call also increases up to a maximum value of 1 eventually. Once the Delta approaches 1, the most significant contributor to the option leverage level is the option price as it changes in larger percentages than the stock price, according to the above formula. Therefore, the leverage of a call option decreases as its stock prices rise to deep in-the-money (ITM). 

In a similar principle, the option leverage decreases for diagonal call spreads when the stock prices go further deep ITM while the short call strike remains out-of-the-money (OTM).  This is exactly what happened to my QQQ Diagonal Call Spread.

To keep sufficient option leverage, I rolled out the long call from July to September and reduced the Delta of the long call from 0.9 to approximately 0.65, which is my initial long Delta at the entry of my diagonal call spreads.  On Tuesday May 30th, I sold the original long call and bought a new call for a credit of $2.82.

The rolling adjustment to the diagonal call spread allowed me to take a profit of $2.82 and extend the life of my diagonal spread by more than 2 months. I can use the extended time to sell call options a few more times and receive additional premiums when needed to compensate for the option time decay.

The adjusted diagonal call spread also reduced its position Delta from 0.6 to 0.4. This was desirable for a stock that had risen consecutively in the last 7 days and I expected a pull-back soon. The pullback would cause less profit drops as the Delta was reduced. In the meantime, if the stock price continued to climb, the profit increase would be less as well. This scenario could be changed with the uncovering (buying back) of the short call though.

The QQQ diagonal entry and rolling history up to now is shown in the table and marked in the stock chart below.

Date	Spread	Side	Exp	Strike	Price	Net Price	Pos Effect	Total Cost
4/5/2017	SINGLE	BUY	21-Jul-17	130	5.86	5.86	TO OPEN	5.86
4/12/2017	SINGLE	SELL	5-May-17	133	0.8	0.8	TO OPEN	5.06
4/24/2017	DIAGONAL	SELL	19-May-17	136	0.58	-1.14	TO OPEN	4.48
		BUY	5-May-17	133	1.72	DEBIT	TO CLOSE	6.2
5/1/2017	SINGLE	BUY	19-May-17	136	1.86	1.86	TO CLOSE	8.06
5/17/2017	SINGLE	SELL	9-Jun-17	139	0.85	0.85	TO OPEN	7.21
5/25/2017	DIAGONAL	SELL	16-Jun-17	143	0.57	-2.05	TO OPEN	6.64
		BUY	9-Jun-17	139	2.62	DEBIT	TO CLOSE	9.26
5/30/2017	DIAGONAL	BUY	29-Sep-17	135	8.86	-2.91	TO OPEN	18.12
		SELL	21-Jul-17	130	11.77	CREDIT	TO CLOSE	6.35

In summary, the leverage of options is related to the strike price compared with the stock price:

• Deep ITM options have less leverage than ATM & OTM options
• ATM options have less leverage than OTM options and more leverage than ITM options
• OTM options have more leverage than ATM & OTM options

Increasing leverage usually means taking more risks for stock investments. However, this is not necessary true with the rolling diagonal spread trading strategy, as described in the example of this post. The main reasons are outlined below.

1. The rolling of the long option takes some profit out and leave less money on the table.
2. The rolling of the long option gives the position more time for selling additional premiums.
3. The rolling of the long option reduces overall position Delta and makes it less susceptible for stock price drops and smoother for profit gains.

The catch is that the new position will profit less before the long Delta approaches 1 again. This scenario happens with less probability though.