Updated: Dec 6, 2018
* VTS Discretionary Strategy trade today for those following.
For the forth time this year the S&P 500 is coming in for a test of the 2780-2800 level.
It's been a pretty weak year so far in 2018 with the S&P up about 4%, and the vast majority of those gains have come from just a handful of tech names. Remove those and pretty much all the gains vanish. For example the Dow Jones is less tech heavy and it's flat for the year.
Anyway this is a pretty important level that needs to be cleared if the markets are going to make new highs and it provides us with a trade opportunity. We've done one of these trades already this year but let's go through the fundamentals again of the long Straddle.
It's a simple construction: - Long Call and Long Put opened simultaneously - Same strike price - Same expiry date - Delta neutral (market neutral) - Vega positive (profits from rising volatility) - Theta negative (daily decay will hurt the trade)
* My article elaborating on the Options Greeks is here.
So there's two ways this trade can profit, or a combination of both:
1) A strong price move in either direction. Since we are buying a long call and long put at the same time, we're indifferent to the direction of the market (delta neutral). Up or down can be profitable for us, it just has to be a significant move. And when testing an important resistance area like we are now the odds of that are decent. If we break higher my guess is we'll retest the all time highs fairly soon. If we fail we could see a pretty steep drop back down to that 200 day moving average.
2) A rise in volatility. Since our trade is vega positive we will gain value as volatility rises and lose value if volatility falls. However since the VIX index is already right near it's lows since the end of January below 13 we are a little more insulated from the negative vega effects which means it's a good time to take this trade.
The Trade:Long Straddle on the SPY (S&P 500)
BUY to OPEN 3 x 21 Sept 18' SPY 279 CALL BUY to OPEN 3 x 21 Sept 18' SPY 279 PUT expiring in 73 days Current debit: ~ 11.17
* remember prices will change throughout the day so just do the best you can. The lower the price you can get the better.
Margin requirement: - Margin for long straddles is just the cost of the options - 1 option contract = 100 shares - $11.17 price * 100 = 1,117 margin per contract - 3 contracts = 3,351 margin required
The VTS Discretionary model portfolio is at 26,846.48 - 3,351 is 12.48% of the model portfolio
* You can scale your trade to roughly 10-15% of available capital
Stop-loss: - We always use a 10% stop-loss for this type of trade - 1,117 margin per contract * 10% = 111.70 - If the trade is down more than 111.70 per contract we'll stop out - Since the model portfolio will open 3 contracts 335.10 is the stop
Future action: I've chosen the September expiry to reduce the daily theta decay a little bit so we can allow this trade some room to run. We will honor the stop-loss no matter what but like I said if we break higher or fail and go lower, it's possible the subsequent movement could be significant so I do want to have the choice of keeping it open a week or two if necessary. We may not, sometimes these are quick 2-3 day trades but it's market dependent so we'll see...
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