By Josip Causic, Online Trading Academy Options Instructor
Recently I wrote the article, Where is the Santa Clause Rally?, in which I have disclosed a type of trade that I usually place during the very last week of the year. In this article, I will examine this trade in greater detail and explain it.
For those readers who have actually taken time to read the article, it was clear that 2009 was unlike any of the years that I have done back-testing on. In that article, I looked at the last six years (2003 to 2008) and there was only one instance of the so-called Santa Rally. Well, hindsight vision is 20/20, so we could now, with certainty, make a claim that 2009 did indeed have the Santa Rally - on the QQQQ. As a quick reminder, the ETF (exchange traded fund) that tracks the NASDAQ has been the strongest for the entire year. If we look at the three charts below, we could examine, technically, the candle formations for the month of December on the DIA, SPY, & QQQQ in greater detail.
Figure 1 Notice that the December candle on the DIA, the ETF which tracks the Dow Jones Industrial Average, is a red doji indicating indecision. There was no significant lift on the DIA during the month of December. SPY (the middle chart), the ETF which tracks the Standard and Poors 500, looked very similar to the DIA, while on the QQQQ (the right chart), the December bar is a strong bullish candle with a decent size body. SPY looked very similar to the DIA. The main difference between the two is that the SPY's doji is green while the DIA's is a red doji. Either the green December doji or red represents indecision. Hence the rally on one ETF (QQQQ), the strongest one, does not mean that there was a Santa Clause rally on all of the others.
An additional conclusion which could be made by looking at the three charts is that there should not be any bearish trade placed on the strongest of the three majors, namely the QQQQ. Out of the three, the weakest one was the DIA; yet going into the last week of the year, I placed the Bear Call on the weeklies on the XEO.
There are a couple of reasons for this. The first reason is that the XEO is the Standard and Poors 100 index with the European-type of options that also has the weekly options listed on them. The last week of December was a shortened week by a day, and the weeklies were trading only from Monday the 28th to Thursday the 31st. The second reason for selecting the XEO is that it looked weaker that the actual S&P 500. The chart below shows the daily candle chart of the XEO prior to my entry. I have marked the 520 area as a strong area of resistance.
Figure 2 Once the level of resistance is identified, then the options need to be selected, too. I have selected for my Bear Call the 520 call as the short, and 525 call as the long. In other words, I anticipated that the XEO price action on Dec 31st would be below 520. However, I did not want to have the naked calls with the unlimited exposure, so I bought myself some protection by purchasing 525 calls. The exact math of the trade was as follows: BTO + 11 December5 (5 stands for the 5th week) 525 call @ 0.57 and STO – 11 December5 520 call @ 1.92. The chart below presents the math visually.
Date @ Time |
Action & Contracts |
Option Strikes & |
Premium |
12/28/09 @ 12:55 PST |
BTO + 11(XQG LE) |
DEC5 525 call |
0.57 (debit) |
12/28/09 @ 12:55 PST |
STO – 11 (XQG LD) |
DEC5 520 call |
1.92 (credit) |
|
|
Maximum Profit |
1.35 |
Figure 3
The spread was five points wide (525 call minus 520 call) and the maximum loss is calculated by subtracting the credit from the spread width, or 5.00 – 1.35 = 3.65. The breakeven point is calculated by adding 1.35 to the sold call, or 1.35 + 520 = 521.35. Next, let us look at the chart to see if the XEO price action has come to 521.35 after my entry into it on Monday just before the close of the day.
Figure 4 On the 15 minute chart below, I have used the vertical lines to separate the calendar days, and to make the things even more obvious, I have typed in the actual dates for them. The entry was made at Monday's close while the price action was below 520, so at that point my trade with 11 contracts and maintenance of $5,500 might have seemed an aggressive trade. However, the fact is that the 520 strike price was not in the money (ITM); the 515 was ITM. Notice on the chart that the trade has gone against me by 50 cents on Tuesday at one point; the horizontal line is marking that area so it could be visually seen. My (BEP) breakeven point was 521.35 and that is where I had my emergency exit in place. However, the price of 520.50 was not the closing price for Tuesday but only the high of the day. Notice that on Wednesday the price did not come to that area of 520.50, and on the last trading day of the year, the XEO closed at below 515.
The last figure actually presents the three separate Time and Sales. The one on the left is for the 520 call and it shows my trade of 11 contracts on it. The middle one is the XEO, and the Time and Sales on the right is for the 525 call. The snapshot was taken at the close of Dec 31st.
Figure 5 Taking the closing price of 514.09 into consideration, one could say that my Bear Call selection of 520/525 was not an aggressive but a conservative trade. As I mentioned above, in hindsight, vision is 20/20. Selecting the 515/520 would be the home run, yet the price action would have to drop significantly down. My selection of 520 really did not require the XEO to do anything, but just to stay below 520 which is exactly what it did. I had a plan for the trade and I traded the plan. Just as I mentioned in my earlier articles, there tends to be sell-off at the year's end. This year, it came at the very last hour of trading.
In conclusion, I have examined the Bear Call trade that I placed during the very last week of the year in greater detail. For those unfamiliar with the vertical spread strategies, I suggest going through the archive section of our website and rereading any of the previous articles on that topic such as Bear (Call) at Work. Have green trading.
- Josip Causic
|
