The markets fell about 2.5% last week while our composite portfolio value gained by 2.9%. It was one of those weeks when we were delighted to have an options portfolio in place rather than the next best investment alternative (broad market index funds).
This week I would like to talk a little about maintenance requirements, and how they impact our trading portfolios, especially at thinkorswim.
I would also like to remind you that we will have a booth at the Money Show in Orlando on February 4 -7. It would be good to meet any of you who might be attending the show. Please stop by and say “hello”.
When we exclusively held calendar and butterfly spreads, we never incurred maintenance requirements that come into play now that we have added short iron condor spreads to our arsenal of tactics. Remember, a maintenance requirement is not a loan like a margin loan, but rather money that must be set aside and not used for buying other options or equities. Because it is not a loan it can be used in an IRA account.
Maintenance requirements come into existence when you sell an option at a different strike than the option you are holding as collateral for the short option. For example, if are long a 90 call option (regardless of which month it is as long as it is equal to or has more months of life than the short call you are selling), if you sold an 88 call against it, you could conceivably lose $2.00 ($200) if the underlying fell below $88. The broker requires that you set aside $200 in case this happens.
When we sell an iron condor spread, we create a maintenance requirement for a put spread as well as a call spread. As long as the difference in strike prices is the same for both the put and call spreads, the maintenance requirement is only charged for one of the spreads because you can’t lose money on both of them.
At times, maintenance requirements are calculated that are difficult to understand because of the manner in which the broker’s software matches up long and short positions. At thinkorswim, they have what is probably the absolutely best matching software of any broker. It is designed to create as low a maintenance requirement as possible so that you have as much free cash to invest as you can. The primary mechanism the software uses to minimize maintenance requirements is to establish butterfly spreads even if you did not specifically place a butterfly spread. Oftentimes, the software creates weird butterfly spreads with partial options covering other options at different strikes. It becomes quite confusing at times.
When we have both calendar spreads and short iron condor spreads in place in the same account (as we currently do in most of our portfolios), sometimes a maintenance requirement is established that is different that it would be if the spreads were matched up as we had placed them. Fortunately, there is a way to see how the matching takes place.
On the Monitor Tab on the thinkorswim trading screen, click on the far-right number that is listed just under the BP Effect title under POSITION STATEMENT. That number is the maintenance requirement for that underlying in your account. When you click on it, a drop-down screen appears which is titled Explain Margin. If you scroll down this screen, you will see how everything is matched up.
The historic, holiday shortened week was filled with excitement, with Barack Obama being inaugurated the 44th President of the United States. However, the positive sentiment on the political scene did not transfer over stock market. The bears managed to push the S&P 500 lower -2.1%. Moreover, the tech heavy NASDAQ finished the week down -3.4%. Uncertainty in the financial sector (lower -7.1%) was the chief contributor to the majority of the declines, but Microsoft’s poor earnings certainly did not help any bullish attempts.
This past week was a sobering reminder to market followers that an economic recovery was not right around the corner. Several major companies, namely GE and Microsoft, reported disappointing earnings. Microsoft posted a drop in profits of more than 11% and in response the tech behemoth announced thatit would be cutting 5,000 jobs. More troubling is that the company would not give per-share earnings projection for the remainder of 2009 due to the uncertainty in the U.S. and global economy.
“While we are not immune to the effects of the economy, I am confident in the strength of our product portfolio and soundness of our approach,” said CEO Steve Ballmer.
Lackluster numbers from GE managed to keep the industrials down as the company lost of 11% Friday alone. A cut in their dividend (which at this point seems inevitable) and concern over its coveted AAA
credit rating led to the declines.
Weakness in the global economy was also evident this past week. China and the U.K. reported a 2.2% and 1.5% decline in GDP, respectively. Loan loss reserves continued to plague the global banking industry.
As for the U.S. economy, housing starts fell to the lowest levels on record (50 years) and initial jobless claims jumped to an unexpected 26-year high. “It is clear from the latest numbers that the underlying trend in claims is still upwards and we have no hope that the peak is anywhere near,” said Ian Shepherdson, Chief U.S. Economist with High Frequency Economics.
Next week the economic picture should become clearer as 137 members of the S&P announce earnings, an FOMC meeting mid-week and a plethora of economic reports that are expected to be grim.
On the technical side of things, well, it is a toss-up. All of the major benchmark ETFs that I follow are back in a neutral state and the S&P seems to be stuck in a range between 800 and 850. I expect price
action to be much the same until we see a definitive break outside of the range and then a successful retest of the break. Volatility, or should I say the VIX has managed to hover around 50 for well over a
week with an established range between 40 and 60.
"The market has really become susceptible to traders’ whims as opposed to investors' actions," says Michael James, managing director Wedbush Morgan Securities. "As traders have become more active in
exchange-traded funds, their more aggressive actions have had a snowballing effect on the market direction, exacerbating the magnitude of the moves in both directions." Traditional institutions are less
involved in the market, which is creating less liquid markets and more dramatic swings, he says.
As I have stated over the past few weeks, I think we will see range-bound conditions for quite some time, but slowly extending the range as time passes. Furthermore, I would not be surprised to see a retest of the lows established back in late 2008.
Overbought/Oversold as of January 23, 2009