Dr. Duke's Blog

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Written by Dr. Duke

Created: 21 June 2013

That is the question being debated today. Yesterday's huge decline spooked traders, especially after the S&P 500 index broke through support at $1600 and plunged in afternoon trade. My read, for what it's worth, is that traders have been working in an unfamiliar environment for the past several years. They know the FOMC is and has been supporting the market, but that is a new and unprecedented factor to consider in their trading strategies and analysis of the markets. This is uncharted territory. Add on this incredible rally since mid-December and traders start to get nervous about losing those big gains. Hence, we have everyone overly focused on Bernanke and the FOMC this week. I would argue nothing new was said, but once a few traders started pulling their gains off the table, it started a panic run for the exits. In a strange environment where I have little or no experience to draw upon, I can reasonably conclude that a safe course of action is to go to cash and do it early.

The futures were positive this morning, but weakened as the market open drew closer. Trading was choppy all day. SPX managed a small gain of $4 to close at $1592 and RUT gained $3 to close at $964. SPX managed to get close to resistance this afternoon, trading as high as $1599. The VIX dropped 1.6 percentage points today, closing at 18.9% after running as high as 20.9% (yesterday's VIX was over 21% at one point). This drop in VIX was reassuring and serves as at least one data point suggesting the worst is over. I am inclined toward the view that we will see a choppy sideways market for the rest of the summer. The basic economic data have not been stellar, but they are slowly improving. And Bernanke has made it clear that stimulus will be withdrawn only as stronger employment data are reported. So the sky isn't falling.

Trading volume was huge today, due to quadruple witching: the simultaneous expiration of stock index futures, stock index options, stock options, and single stock futures. These four product expirations occur together once each quarter. Over 4.1 billion shares of the S&P 500 stocks traded today; trading on the NYSE increased 46% and volume increased 35% on NASDAQ. The negative trading earlier this week probably also contributed to the volume spike today as people bailed out of positions this morning.

My June iron condor on RUT at 890/900 and 1030/1040 will expire worthless tomorrow for a gain of 5.2%. RUT's settlement price is $964.44. I hedged the call side once and rolled the call spreads higher twice and rolled the put spreads higher once during this position's life, so we did well to salvage a small gain. My July condor stands at a net gain of $1,260 or +7.5% with position delta = $32 and position theta = +$74 on 20 contracts. For those of you trading SPX, it settled at $1599.93, an unusually large move from yesterday's close at $1588.19. The average differences between Thursday's close and settlement last year were $5.95 on SPX and $4.46 on RUT. So far this year, those differences are $4.69 and $2.42, respectively. I would not recommend carrying short index option spreads into expiration that were anywhere near that close to the index price, but there is the data, for your consideration - different stokes for different folks.

Enjoy the weekend.

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Written by Dr. Duke

Created: 19 June 2013

All eyes were focused on the Fed today. The official policy statement was essentially the same as last month: the economic recovery continues slowly, interest rates will remain low and the bond buying programs will continue. Bernanke attempted to communicate the Fed's "game plan" in his news conference, but reporters were naively looking for more specificity. To my mind, Bernanke communicated as well as possible given the unknown future circumstances: QE may begin to be reduced late this year and could end as early as mid-2014, but that depends on the measures of a healthy economic recovery, most notably a lower unemployment rate. Interest rates will remain low until inflation becomes a concern and that could be as late as 2015. What do Liesman and the rest of the CNBC bunch want? Do they seriously think the Fed can lay out a definitive time line without knowing where various economic indicators might be later this year? I might expect freshman college students to be this naive, but not mature adults. Perhaps this is indicative of the general trend in our country to want Big Brother to take care of us and eliminate all risk and uncertainty.

SPX traded down after the Fed announcement, closing down $23 at $1629. RUT lost $13 to close at $987. VIX dropped and then rose, ending the day unchanged at 16.6%.

My June position stands at a net gain of $821 or +4% with position delta = -$11 and position theta = +$266. The July position stands at a net gain of $1,240 or +7% with position delta = -$11 and position theta = +$121. I will be watching the charts closely tomorrow to see if the markets trade lower or just start to chop sideways a bit. It often takes a couple of days for traders to absorb the implications of the Fed announcement.

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Written by Dr. Duke

Created: 18 June 2013

All eyes and conversations are focused on the Fed and tomorrow's announcement and news conference. So why did the bulls go crazy in the markets today? Beats me. I suppose one has to conclude that the consensus is that the Fed will not say anything to suggest a discontinuation of quantitative easing anytime soon. I think this market action just makes it even more likely that we will see extreme volatility in the markets after the announcements tomorrow. SPX gained $13 to close at $1652, but RUT was even more bullish, rising $12 to close at $1000. VIX decreased a touch to 16.6%. Trading volume declined with 2.1 billion shares of the S&P 500 trading. Volume decreased 6% on the NYSE and decreased 1% on NASDAQ.

If we look for economic data to explain today's huge bullish run, we will be disappointed, or at least perplexed. CPI came in for a modest 0.1% increase in May, which is good news on the inflation front. But economists expected 950k housing starts and received 914k. 974k building permits were issued in May, as compared to 1005k last month. So this crop of data just reinforces the now familiar "not too bad, but not too good" theme of the past several months.

My June iron condor on RUT stands at a net gain of $780 or +4% with delta = -$21 and theta = +$118. The July position stands at a net gain of $1,160 with delta = -$49 and theta = +$103.

The bullish nature of the markets this week has me very concerned. I think we are now positioned where even the slightest frown from Bernanke will send the markets tumbling. This Fed announcement and news conference has attracted more attention than any previous meeting, and that sets up the possibility of extreme reactions on the basis of virtually nothing substantive - be careful.

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Written by Dr. Duke

Created: 17 June 2013

Traders appeared to be assuming that the Fed isn't likely to change its accommodative posture later this week as they traded the market higher this morning. But the Financial Times reported around 2pm ET that Bernanke will announce that the Fed will begin to taper their QE soon. The selling quickly took the S&P 500 index down $15, but then it recovered somewhat into the close at $1639, up $12 on the day. RUT gained $6 to close at $988. The VIX rose about a third of a point to close at 16.8%.

The bulls were encouraged by two economic data reports this morning; the Empire manufacturing survey came in for June at 7.8, up from a negative 1.4. The NAHB housing market index reported at 52 for June, up from 44. It is telling that an opinion expressed in a publication seems to carry as much weight as economic facts in this market environment. Wednesday afternoon could be a real roller coaster ride.

My June iron condor position on RUT stands at a net gain of $735 or +4% with position delta on 20 contracts at -$19 and theta = +$156. The call spreads are over two standard deviations OTM, so I will allow both the call and put spreads to expire worthless this weekend. The July position stands at a net P/L of +$1,100 (+6.5%) with delta = -$14 and theta = +$106.

Be careful this week; this market is touchy.

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Written by Dr. Duke

Created: 14 June 2013

I was surprised by the huge recovery spike upward yesterday. If that was surprising, then today's move back down, wiping out almost half of yesterday's gains was equally surprising. SPX closed down $10 at $1627 and RUT closed at $981, down $8. Last week's jobs report was the most closely watched jobs report in some time. Next week's FOMC announcement and Bernanke's news conference will also be very closely watched. Every word of the announcement will be studied and compared to the last announcement. Bernanke's news conference will be recorded and replayed many times, looking for clues. But this may be similar to people playing the Beatles' records backwards in the sixties, looking for some hidden message. I don't think the message is there.

Bernanke has made it clear that he is looking for significant improvement in unemployment before withdrawing stimulus. If unemployment is improving, it is miniscule at best. In any case, the bottom line is this: 1) I don't expect much movement in the markets between now and Wednesday afternoon, and 2) the latter part of next week could be a wild ride depending on the market's interpretation of the FOMC announcement, rumors, and crowd psychology.

Today's economic data supports the mediocre, muddling along viewpoint of the economy. PPI rose 0.5% in May and industrial production was unchanged. Capacity utilization was flat at 77.6% and the University of Michigan consumer sentiment survey dropped to 82.7 for June from 84.5.

My June condor stands at a net gain of $540 or +3% with delta = -$13 and theta = +$159. I decided not to close the June 1030/1040 call spreads today. They remain not quite two standard deviations OTM. My July position stands at a net gain of $1,040 or +6% with delta = -$3 and theta = +$89 (each position consists of 20 contracts).

Have a nice weekend.

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Written by Dr. Duke

Created: 13 June 2013

Apparently I was naive to think yesterday's reversal was unusual volatility - today's moves made that look like a walk in the park. Early this morning, the S&P futures were very negative and SPX opened at $1612 and traded down about $4 before starting a steady run upward and never faltered for a moment. SPX closed at $1636, up over $24 - wow! RUT followed suit with a gain of $17, closing at $990. Trading volume was mixed with 2.2 billion shares of the S&P 500 stocks trading (still below the 50 dma); trading on the NYSE increased 8% but trading volume decreased 2% on NASDAQ. VIX dropped off by over two points to 16.4%.

So what incredibly good news prompted this huge move upward? Initial unemployment claims came in this morning and decreased 12 thousand from last week. Continuing claims decreased two thousand out of three million. If you have followed this data, you know that neither of these moves are significant; the trend in unemployment claims has been essentially flat for several months. This report came out well before the market open, so that wasn't the source of the big bull run upward that started about an hour after the market opened this morning. Retail sales reported an increase of 0.6% for May which was a bit better than the previous month's 0.1% increase, but again, that report doesn't seem likely to have unleashed the bulls on a rampage.

Today's candlestick on SPX is the classic bullish engulfing pattern and suggests a reversal of this downward move of the past couple of weeks. However, I find this market's reversals back and forth to be rather erratic and I wouldn't bank on any one signal. The recent price swings defy any common sense. I can almost hear some of you saying that's typical of the markets, and I agree to some degree, but the recent volatility is extreme by any measure and normally the stimulus behind the move is obvious. I believe the source of this extreme volatility is the strong presence of the Fed in today's markets. Traders are left guessing whether Bernanke is about to withdraw the quantitative easing next month or next year. So if you think Ben is staying with us, you go all in, but if you think he is planning his exit, you take your money off the table. That leaves us subject to crowd psychology and rumors as traders run from one side of the market to the other and then back again.

My June position stands at a net gain of $280 or +2% with delta = -$18 and theta = +$207. The July condor position stands at a net gain of +$520 or +3% with delta = -$26 and theta = +$110. The theta/delta ratios of both positions are very strong. I will apply the Two Sigma Rule to the June position tomorrow, and it looks likely that I will close the June call spreads.

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Written by Dr. Duke

Created: 12 June 2013

The S&P 500 opened up this morning and quickly rose $7 to $1638, but then turned and dropped to $1617 - a $21 swing before noon! Then SPX steadily declined to close at $1613, down $14, and near the low of the day at $1611. RUT lost $9 to close at $972 and volatility rose almost another two points, with the VIX closing at 18.6%. This is getting serious. SPX bounced off the 50 dma at $1611 late this afternoon, but appears to be setting up to challenge support at $1600 tomorrow.

The fascinating part of this story is the reasoning given by all of the talking heads: they claim traders are concerned about the Fed reducing its stimulus programs. It seems to me that Bernanke has been extraordinarily open about the criteria for withdrawing the quantitative easing, citing an improvement in unemployment to 6.5% or better. Since unemployment stubbornly remained high and even ticked up a bit in the last report, why the panic? I don't know. It is true that the market is always discounting the future, but this seems extraordinary. Well, we can check the unemployment claims data in the morning, but I doubt that we will see that number of claims have suddenly dropped from last week.

My June condor stands roughly at break-even with delta = +$22 and theta = +$192. The call spreads are slightly less than two standard deviations OTM and the put spreads are over two standard deviations OTM, so this position is quite safe with just over a week to go. The July position stands at a net gain of $620 or 4% with delta = +$5 and theta = +$84. So now we wait to see if SPX bounces off the 50 dma or heads lower. Perhaps the long awaited correction is here.

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Written by Dr. Duke

Created: 11 June 2013

The Bank of Japan disappointed traders by failing to augment its stimulus programs, so markets around the world sold off. Heaven help us when the Fed announces they are withdrawing! SPX opened and traded down as low as $1623 and then recovered nearly all the way to $1640 by noon, only to sell off and close near the lows of the day at $1626, down $17. RUT lost $11 to close at $981. As one might expect with these wild swings, VIX increased by nearly two points to close at 17.1%.

Trading volume increased with 2.4 billion shares of the S&P 500 stocks trading. Trading volume increased 17% on the NYSE, but only increased 1% on NASDAQ.

There was no economic data of any significance reported today.

My June iron condor stands at a net gain of +$180 or +1% with delta = -$9 and theta = +$163. The July position stands at a P/L of +$740 or +4% with delta = -$11 and theta = +$89. Today's increase in volatility pushed the P/L of these positions lower (iron condors are negative vega positions), but the health of these positions is nearly ideal (note the small deltas).

What surprises await us tomorrow?

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Written by Dr. Duke

Created: 10 June 2013

The markets opened positively this morning on news that Standard and Poors had revised the outlook for our treasury debt from negative to stable. Then the major indexes dipped but  stayed in the black most of the morning. But the bulls couldn't make the gains stick. The major indexes chopped sideways most of the day and SPX closed at $1643, down $1 for the day. By contrast, RUT gained $5 to close at $993. Seeing small caps outperform the blue chips is encouraging, but the negative sign was volatility rising to 15.4%; it only rose about a third of a point, but that is clearly the wrong direction if indeed we are firmly back on the bullish track. Trading volume fell off significantly with only 2.1 billion shares of the S&P 500 stocks trading today. Trading volume on the NYSE was down 15% and volume on NASDAQ dropped 6%.

We may not have the incredibly bullish market trend of the past few months, but I have been impressed with this market's resilience in the face of all challenges. It seems as though the closest thing to a correction this market can sustain is a minor pull back or just some sideways consolidation. But it remains a nervous market, so be careful.

My June iron condor position on RUT stands roughly at break even with position delta of -$47 and position theta of +$209. At this point, it appears likely that my Two Sigma Rule will close the call spreads of this position on Friday; currently the delta of those short 1030 calls = 6, so it is reasonably safe at this point. The July condor stands at a net gain of $880 or +5% with delta = -$26 and theta = +$85. This position is essentially delta neutral with the delta of each short option at 7-8.

There wasn't any significant economic data reported today (outside of the S&P announcement). Later in the week, we will check up on inflation with the CPI and PPI numbers. The consumer sentiment numbers, industrial production and capacity utilization reports come out Friday. Barring any surprises in this data, I don't see any market-moving events upcoming - but those are always the famous last words before the surprise. Stay alert.

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Written by Dr. Duke

Created: 07 June 2013

Everyone was focused on the jobs report this morning, and this was even more the case than usual because of the recent market weakness and the whole Fed tapering discussion. The Nonfarm Payrolls report came in with 175k jobs and unemployment increased slightly to 7.6%. Apparently this was weak enough to convince traders that the Fed won't be withdrawing anytime soon, so the buying resumed. SPX gained $21 to close at $1643 and RUT followed suit a little more weakly with a gain of $8 to close at $988. SPX gained almost $10 during the last hour of trading, so traders were gaining enthusiasm as the trading session came to a close. Trading volume dropped off with 2.4 billion shares of the S&P 500 stocks trading; volume fell 5% on the NYSE and decreased 8% on NASDAQ. Volatility dropped off significantly with the VIX closing down 1.5 points at 15.1%.

This week of trading underscored how nervous this market is, given the knowledge that the Fed is supporting the market and perhaps responsible for much or all of the bullish run. That results in traders running for the exits on the slightest rumor. The normal uncertainty associated with trading has been exaggerated. Plus, this is new territory; we aren't accustomed to accounting for Fed stimulus in our analysis of the markets.

However, don't let down your guard; we may not be out of the woods yet. Don't be surprised if the market "changes its mind" Monday.

My Jun iron condor on RUT now stands at breakeven with position delta = -$15 and position theta = +$146. The July condor stands at a P/L of +$800 (+5%) with position delta = -$18 and position theta = +$80.

Enjoy your weekend. It almost feels like spring here in Chicago with temperatures in the sixties. I just paid my property taxes this week: $4.40 per square foot. Do the math; I will be surprised if your taxes are higher. Why do I stay here?