Balancing Our Deltas In Oil With OIH Call Spread

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Call spread: Just real quick before we get into the actual trades that we’ve made for today, I wanted to give you guys a heads up. I’m hopefully crossing my fingers. We’re going to launching the podcast before the end of this month. It's been a huge undertaking. We’ve got five episodes already published. We’ve got a lot that are still working with audio and all that stuff, splicing everything together.

We should by the time that we actually launch have about 10 to 15 podcast that are ready to go. And the first five obviously will come out on the first day. That way, you guys can go through a bunch of them, see if you guys like it. Well, we’ve got this whole new podcast page where it’s all intuitive. You can just click right through all of the different podcast right from one page. You don’t have to click on different shows obviously.

And we’ll have show notes where there’s links and tutorials and videos and stuff like that and guest that we have on, we’ll have all their information in actual blog post. But as far as actually listening to the podcast, you’ll be able to grab it on iTunes and SoundCloud and Stitcher and everything else that you’re used to grabbing on. I’m very, very happy and excited to get this off the ground. I think it’s going to be just a huge content generating system for us and the ability to connect with you guys. 

If you are interested in possibly being on the podcast, and you’ve got an interesting story or how you came up in trading or how you progressed, I'd love to hear about it because I'm definitely looking to interview people that are just like you, so traders that have either started trading or been trading for a while and just help grow this area of the market, just help start and continue to grow this dialogue with options trading and figuring out how to make smarter trades, and that's what we’re going to be all about. Podcast launching before the end of the month so is on the lookout for that. I’m very, very excited for it.

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Alright, as far as the trades that we have for today, we had two new opening orders, good trades, I like these trades. One, a big calendar in CMG after earnings, and then we did have a decent amount of closing trades, just some of those weeklies that we’re rolling off. I want to go over the closing trades first, and I’m going to start with IWM. IWM, we’ve traded successfully this year, and I feel like we should be trading just IWM as much as we traded it and at how successfully we’ve been trading it.

But at the bottom of the market just a couple of days ago when things were low, we went ahead and sold a put spread well below the market, the 101/99 put spread, and it’s now decayed more than half of its value that we’ve sold it. We’ve sold it at about $.40 for each of these, it's gone back down to about $.18, so there’s no use in holding it, we’ve hit our target in that about 50% of max gain or over that, and we’ve made a nice $66 profit in that.

When I go to the chart of IWM, we had two things that worked perfectly in our favor. The market went up which was great and implied volatility dropped, and both of those right now contributed to such a fast gain in this spread. And between now and expiration which is all the way out to November, all we’re going to get is another $.18 in premium, and that's mostly just a lot of time value built into this spread.

You’re not going to see a decay as much because we’ve got so much time. It’s going to decay maybe $.1 or $.2 a day depending on where the market goes, so at this point, it’s not worth holding, we just want to go ahead and get out of that trade and take our profit.

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Alright, our Apple earnings trade was a pretty decent trade. I like the trade. I wish we could’ve held onto it a little longer. Should we held onto it all throughout the day, it would’ve fully realized its profit potential. But we were able to close out and buy back our three iron condors in the Apple weeklies. These are the front month contracts.

Just as a heads up, this OCT4, whenever we send out an alert that says OCT4, OCT2, whatever, that is the fourth week in October. Just be cognizant of that. That’s how the exchanges look at it. They look at it NOV2, NOV3, OCT4, OCT3. That’s the fourth week in October, so it happens to be the weekly contracts that expire this week. We went ahead and bought back that Apple earnings trade.

Apple did rally after earnings but did not go beyond the one standard deviation that we had setup this trade at, so we bought all these spreads back for about a $.15 debit across the board on each of these, so we took in a nice $60 profit on Apple. The same thing happened with Apple as IWM. And let me see if I can… I’m clicking too fast here. With Apple, the stock did make a huge move higher, so it did trade up about 2.5% today.

You can see that big gap in earnings as it had better than expected earnings and guidance, but just look how quickly implied volatility has dropped after this earnings announcement. You can see that that’s the driving force here behind why the value of these options decayed so fast. And this is what irks me about earnings trades with guys that try to email people and me on the website that say, “Kirk, why don’t you just buy a strangle and go long an option on the put side and long an option on the call side?”

Well, even if you're right and even if you thought that Apple is going to move higher and even if it did move higher and it gapped higher a couple of dollars in your favor, you’d still end up losing long-term because of this implied volatility drop. You’re paying for that premium in advance and then after the earnings event, that premium gets sucked out of the value of the options and now you’re just left with hopefully Apple makes a big, big, big move that’s beyond that expected move, something like Netflix that’s very rare to have such a huge move after earnings. Apple was a good trade; we got out of it early, and we could've made all of that, most of that money back, but that’s okay.

Same thing with MCD. We did buy back our one McDonald's earnings trade and that was the strangle that we had. We had the 93 call and the 89 put. McDonald’s opened down a little bit lower, had bad earnings. We were able to buy it back for a $.35 debit and take in a nice little profit on a one lot strangle, just keeping these things small of $37.

When we look at MCD, the stock opened a little bit lower, rallied up towards the end of the day and ended up closing a little bit higher than its open, but you can see implied volatility is just absolutely crushed in McDonald’s and still remains pretty high. It’s still above the 51st percentile, but since these are weeklies, we don’t want to run that risk of just running up to the last moment here near expiration. It was a good trade, we made a little bit of money, closed it out and move onto the next one, it’s a very small lot trade.

Alright, and then the last one that we closed out of, this one is really interesting and I wish, I’m biting myself right now because I wish I would've waited all the way to the end of the day, but you just never know what's going to happen with the VIX, if it’s going to go down or up or whatever the case is.

But in the middle of the day, in the middle of the morning, the VIX was down near 17, so we just decided to go ahead and close this out because we did have other VIX positions that have behind it. We’ve got a lot of November VIX positions that will overshadow this loss and then some, so we’ll definitely make money as long as the VIX stays low. And we decided to go ahead and buy back our five vertical spreads in the VIX, the 17/18 call spread for about $36.

We separated it out in orders and it about $36, $36.5, so we did lose $75 on this particular trade. But what’s interesting about the VIX and just generally what happened is that you'll notice how quickly the VIX has recovered down to the 16 range. It’s only taken four or five days for it to go from 16 to 30 and only four days to go from 30 to 16.

And I’ve said this time and time again. I’m just going to keep harping on this. When the markets become irrational like this, it is only a matter of time before they become more stable. And as quickly as the VIX rallied, it completely got crushed back down. And you see this across the board with a lot of securities. I’m trying to think of one right now that pretty much recovered all of its losses in just a matter of days. I think it was UPS.

No, it’s not UPS. Sorry, hold on. Just bear with me here. No, it wasn’t USO. Anyways, I know it was a stock out there that just had absolutely been annihilated and has seemingly recovered practically all of its trade in just a couple of days. It was Yahoo. Now, we try to get into Yahoo, but it wasn’t Yahoo. I can’t find it right now. But a stock that was down 10%, 15% and then now is up 10%, 15%.

A matter of five or eight trading days, this thing has gone almost 30% roundtrip, almost 15% down, 15% up in a matter of five to eight trading days. And it just goes to show you that the markets are completely random, completely cyclical. I bet you no one expected the VIX to come down as quickly and I bet you no one expected the market to rally as strong as it did over the last couple of days with the S&P practically wiping out a lot of the losses that it had towards the end of October expiration.

We’ll see where things go from here. It might settle into a little bit of a range. We need to hold this level right now in the S&P before things get really, really bullish. But the markets are very, very cyclical and always surprising which is why we love them. The two opening trades that we had today, one was in OIH. If most of you notice with the email alerts, we now added a section where I’m adding a couple of comments about the trades.

Just a couple of quick remarks if there are any for the trade. With OIH, one of the comments that I added was that this is a trade to add some negative Delta to our portfolio. In the case of OIH, we went ahead and sold the 47/48 call spread and did so and took in about $.27 in credit. I’ll go over this one in depth a little bit more. But generally, the reason that I did this trade, and you can see implied volatility is still very, very high. It’s coming down from its peak, but it’s still very, very high for OIH. And by doing this, I’m basically trying to even out our distribution on trades for the oil sector.

We’ve got XLE and we've got USO and we’ve got OIH and XOP, we’ve got a lot of them and we need to even things out and get some negative Deltas for that particular sector. It’s a good time to bring this up because sometimes, even though your portfolio as a whole might be balanced, you might be lopsided in one sector or another, so maybe Tech or Solar or social media stocks, Facebook, LinkedIn, Yelp, etcetera.

And with oil, we were a little bit too bullish which has served us well, we’ve recovered a lot of gains and paper losses. We’ve now whittled those down as oil has rallied, but we don’t want to get over zealous that the market in oil is going to continue up like this all the way through November expiration, so we wanted to balance out our oil positions by adding this trade above the market.

And you can see that no matter where you add this trade, you can basically place the same probability of success trade on either end. With OIH, we went all the way out to November options and you can see that we went ahead and sold about the 30% probability of success level. That right here is our first short strike. It’s right about the 30% probability of success level. That’s where it was today. If you don't want a bearish position in oil, then all you have to do is replicate this exact position down below the market at a very similar strike price.

You can see if you wanted a bullish trade in oil, you go ahead and sell the 43/42 spread below the market and you get a very bullish trade, but it's almost the same probability of success as the trade that we’re making today. That’s why market direction is pretty meaningless when it comes to just picking a trade. It's much, much more about balancing out your portfolio and your Deltas, not being too lopsided one way or the other.

Alright, and then the other trade that we made today is the calendar in CMG. CMG is a trade that I really like because it did have earnings and implied volatility got crushed, it’s lower, but it did gapped dramatically lower. CMG has headed lower as its earnings have come about and we think that it's going to continue to float just a little bit lower as it heads towards November expiration.

When I actually go to the chart here, the profit and loss chart of CMG, you can see here that… And let me take off this simulated trade. You can see here that our profit window for CMG is around 610, just over 615 to about 545 or so. That’s really the range that we need CMG to trade in. A pretty massive range, it's a very expensive trade at about $450 plus, but you can see with our profit window, about 548 all the way up to about 611 or so gives us a very huge range for CMG to trade.

It’s somewhere in this range all the way up to about 611, a very nice wide range, just enough for CMG to continue to move lower as it heads towards November and possibly as it does head lower, we might see an uptick in implied volatility. Those were all the trades that we’ve made tonight. As always, if you guys have any comments or questions, please add them below and we’ll get back to those tomorrow before the open. Happy trading!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.