Time to “Sow” Those Credit Trades Again – Part 2
My last blog was at the end of January when the markets were in pullback mode. The pullback that started at the beginning of the year was quick and sharp, paralleling the “few and far between” pullbacks this bullish market has experienced for quite some time now. We saw the S&P 500 fall from its all-time high near 1850 to a low of 1740 representing just under a 6% correction. It took a mere 8 days to lose over 60 days’ worth of gains! The velocity of price action during this correction caused the VIX – the “fear gauge” – to increase precipitously. In my last blog, I talked about taking advantage of this increase by selling options that have “inflated” premiums due to the fear premium being larger than what had previously been priced in.
Like many others involved in the options market, I like to create trades where my short option acts as the “driver” or money-maker in the trade. Knowing that the result for many options across a chain is complete worthlessness, I want to be on the winning end of the trade by selling options that finish worthless allowing me to keep the premium that I sold as profit in the trade. It stands to reason that if I am able to generate these trades at a time when premiums are elevated, then I will create a greater level of profitability for the risk I am taking in the trades. The recent quick selloff provided me just such an opportunity.
I began selling bull puts on the SPY – the ETF I use as a proxy for the overall S&P 500 – in late December/early January. Levels of IV were relatively low – 11% or so in the conglomerate – across the options chains for the SPY. The reason I started to enter the trade at that time rather than wait entirely for a pullback was due to the velocity of the bullish move at the end of 2013 and the idea that it could continue unabated through the first quarter of 2014. I didn’t want to sit in cash and miss a continued bullish trend. I knew that if a pullback were to occur, I would be able to average into this trade at better and better credit amounts to ultimately establish my desired full position. I started with a credit of $1.10 on a $10 wide spread with strikes that were over 15% out of the money for January 2015. As the SPY experienced bearish price action, levels of IV did in fact rise to a high of just over 18% (this is the conglomerate value across all the chains). When the SPY bottomed at 174, this same credit spread reached a value of $1.84. I used each day during the pullback to “dollar cost average” in on this long term credit spread at better and better credit levels. As the SPY has regained bullish momentum, currently sitting at $184.71, these credit spreads are valued around $1.18 (the midpoint between the bid and the ask values). With my average credit of $1.50/ bull put, I could close these out now for a profit of $.32 representing a return of 3.7% in around 52 days (the time from which I slowly started building the position). This annualizes to a return of 25.9%. With the S&P 500 looking like it wants to break out to the upside, I am currently staying with this trade for potential further gain. Should the SPY resume its longer term bullish trend, I will look to “follow” that price action by moving these bull puts up to higher strikes – trailing the movement you could say – while still remaining at strikes significantly away from the at the money position. The overall idea is to look at “opportune moments” during pullbacks for trades that can work – and work quickly – to your advantage. Perhaps the greatest investor of all time – Warren Buffet – gives sage advice in this arena. He advises investors to be “greedy when others are fearful”. That fear is what creates the “opportune moments” in the markets. I seized mine.