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Weekend Market Commentary 1/15/2016 – $RUT, $SPX, $RVX, $VIX, $VXV

Big Picture:

It goes without saying that 2016 has been challenging for most non-directional, short gamma traders.

trainAnytime you’re short premium in front of a freight train, things can get dicey.  If you don’t know when to step off the tracks, you’ll eventually get hit.  The market is not, “Out to get us,” but we do need to recognize favorable and unfavorable environments.  For many short gamma traders, this is just an undesirable environment.  Eventually it will pass.

Just because short gamma strategies have had a challenging start to 2016, it doesn’t mean that the strategies are “bad” or don’t work.  It does, however, mean you need a plan for controlling your risk to maintain consistency.  One of the big mistakes traders make in the face of adversity is switching strategies.  Switching from strategy to strategy will not bring about consistency.

No strategy (short of maybe high frequency trading) makes money every day and there will always be desirable and undesirable market environments.  Some of the income strategies we’re trading have very high win rates, but that doesn’t mean they can’t take a loss.  If it’s time to take a loss, just take the loss.  Taking the loss gives you the opportunity to come back tomorrow and go back to trading.  You can also use that experience to refine the strategy and your risk management rules.

Big market moves tend to flush out inexperienced traders and weaker hands.  You are much less likely to get flushed out if you’re actively managing your risk when the market moves against you.  Also keep in mind that controlling risk isn’t a one day event.  When you control risk today, all that means is that you get to stick around and do it again tomorrow.

Volatility And The State Of The Decline

Last weekend we took a look at a divergence in volatility.  Specifically, I said that we haven’t seen the explosion in volatility that typically accompanies a decline.  That divergence continued this week and volatility still hasn’t reached panic levels.  The VIX:VXV ratio actually declined and both VIX (30 day IV) and VXV (3 month IV) remained essentially unchanged.  The relative complacency in volatility suggests that participants are largely hedged, steadily selling premium, or not that concerned about the decline yet.

From a price standpoint, the S&P 500 hasn’t broken the 1850 level.  While volatility has been under control through this stage of the decline, breaking and holding below that level is likely to trigger a significant increase in volatility (both implied and realized).  However, the price action towards the end of this week suggests that we might need to wait a bit longer for the panic decline to play out.

This week both the Russell 2000 and the S&P 500 slowed on the downside.  At the same time, they began to display some signs of balance or consolidation.  The range is pretty wide, but some of the price action we’re seeing is more constructive than what we saw the week before.  If we do see the market pause or turn higher next week, it’s important to recognize that any move higher is likely to fail.

Intuitively, many market participants are still long or have been buying on the way down.  One of the big signs that participants are still long is that we haven’t seen the capitulation that typically accompanies declines or an explosion in volatility.  Volatility is under control and nobody has panicked yet.  Additionally, we know that stocks tend to have an artificial buy side pressure.  In other words, people are generally net buyers of stocks.  While sellers have been aggressive over the past two weeks, heavy, panic selling hasn’t hit yet.

If the market moves higher in the near future it’s likely to draw in some of the BTFDers while other participants use the opportunity to reduce their long exposure and/or get short.  If enough participants begin to sell long positions, price could begin another leg of decline where it falls through the recent lows (1850ish on the SPX).  More energetic selling and a significant increase in volatility are likely if the market breaks through on the downside.

Sure, the market could also stabilize and continue higher from this level, but technically broken markets don’t tend to stage major rallies until more damage than we’ve seen is done.  Obviously we can’t predict where the market is going, but there are structural reasons for concern and rallies should not be trusted in this environment.

Have a good, longer weekend.  The markets need the rest.

Market Stats:

1.15.16marketstats

Levels of Interest:

In the levels of interest section, we’re drilling down through some timeframes to see what’s happening in the markets.  The analysis begins on a weekly chart, moves to a daily chart, and finishes with the intraday, 65 minute chart of the S&P 500 (SPX) and the Russell 2000 ($RUT).  Multiple timeframes from a high level create context for what’s happening in the market.

S&P 500 – $SPX (Weekly, Daily, and 65 Minute Charts):

1.15.16SPX.weekly
1.15.16SPX.daily
1.15.16SPX.intraday

Russell 2000 – $RUT (Weekly, Daily, and 65 Minute Charts):

1.15.16RUT.weekly
1.15.16RUT.daily
1.15.16RUT.intraday

Live Trades . . .

The “Live Trades” section of the commentary focuses on actual trades that are in the Theta Trend account.  The positions are provided for educational purposes only.

——————————

This coming week I’ll be opening the March 2016 CIB.  I realize we’re stepping into some hot water to put on a new position so I’ll be getting involved carefully and watching to see how the market opens and trades on Tuesday.  I still expect a flush lower in price and the real question is whether we see some stability with a move higher first.

I’ve been exploring and experimenting with some OTM Broken Wing Butterflies, but it’s still too early to share much.  I’ve included a couple of positions below to illustrate what I’m working on.  The trades below began recently as BWB’s with 25 Delta shorts.  The market has not been favorable for the positions, but they’ve held up fairly well.  The starting structure I used for the trades was discussed in this post.

SPX BWB (Slightly over 30 DTE with 25 Delta shorts at entry):

SPX.FebBWB

SPX BWB (Slightly over 60 DTE with 25 Delta shorts at entry):

SPX.Mar.BWB

The Results Spreadsheet is up to date as of Friday.  Both positions above show small open losses and I took a small loss on a RUT BWB yesterday (Friday) with the persistent move lower.  All of the trades mentioned there are actual trades that I’ve taken.  There are no paper trades or fuzzy fills, they’re all real.

If you want to learn more about how I trade, check out the Core Income Butterfly Trading Course.  The course covers my primary strategy in detail.

Looking ahead, etc.:

This week I’ll be entering the March Core Income Butterfly Trade.  I’d really like to see some movement higher before getting involved, but obviously we don’t know how things will play out.  Generally speaking, I’m doing my best to keep directional risk and gamma as low as possible.  Stay safe out there and control your risk.

Have a great weekend and please share this post if you enjoyed it.

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  • Betel Geuse

    This is really great post! my idea exactly about the market. It is not panicky enough yet. I don’t have much experience in market so don’t know how to explain this but like you said, real panic may not even started yet.

    What I am curious about is also volume. If you look at the long term chart of SPY, volume actually decreases (10 year chart). 2007-2009 (or previous corrections) wasn’t like this at all. Volume and price movements were together in general, but not recent 6 years bull market. I don’t know what it means, but this divergence is not a good sign, and makes me worry.

    But in the short term, definitely market is very oversold and angle of descent is too steep, this is also not sustainable in my opinion. But again, who knows?

    • Dan

      Hi Betel and thanks for the comment! Thanks for the observation on volume as well. One of the things we see at market bottoms is a significant increase in volume and, as you’ve noted, that hasn’t happened. It’s funny to think that this correction is just controlled selling or a steady grind lower, but that’s really what it feels like so far.

      We’re all in the same boat so we’ll just wait and see what happens next! Thanks again.

      Dan

  • I love today’s commentary. You are able to articulate a lot of what I am feeling. I like what you said here:

    “Just because short gamma strategies have had a challenging start to 2016, it doesn’t mean that the strategies are “bad” or don’t work. It does, however, mean you need a plan for controlling your risk to maintain consistency.”

    No strategies work all the time. Most novice traders, like you said, will think the strategy is broken and move quickly to something else. Hopping from strategy to strategy is what dooms most traders to mediocre performance or blowing up their accounts.

    • Dan

      Thanks Jonathan! In all honesty, the reason I know that jumping from system to system doesn’t work is because I’ve done it! Over time if we recognize our behaviors we can learn from them and improve.

      You’ve done an excellent job of following your plan this year even though the market has been far from favorable. Once things settle down (and they will) you’ll be in a position for that to pay off. As you mentioned in your email today, those who don’t control their risk will eventually take that max loss.

      I will say that I’m glad I wasn’t selling naked premium when the market seemed oversold a week and a half ago . . .

      Dan

    • Aditya Nandy

      I(novice trader) completely agree with you – I am a beginner options student and am yet to make my first real money trade. With several products on the internet claiming to be a fool proof/holy grail strategy, I appreciate that you guys are being honest and are providing direction to beginner traders like me. I will need to come to the realization that no strategy is fool proof and at times markets can and will go against you, and I should be disciplined and mechanical with risk management and not jump b/w strategies.
      I hope to continue to learn from your blogs/posts and soon get into real money and trade with realistic expectations.
      Thanks again for the knowledge

      • Dan

        Hi Aditya and welcome! You’ve made a great observation that there are no holy grails or perfect strategies. Everything (especially in options) has tradeoffs and, yes, at times the market goes against you.

        Experimenting with a few different strategies when you’re starting out is a great way to understand what you like and don’t like about different strategies. Over time, you’ll be able to figure out how to move in some direction, but I think the process of exploration is an important part of developing. A good example is that Jonathan and I both like low gamma strategies. At the same time, we express that preference a little differently. Jonathan uses longer dated spreads and hedges while I like to use Butterflies that are constructed in a low gamma way.

        Don’t hesitate to get in touch if you have any specific questions and thanks for the comment!

        Dan