Market Stats:

Big Picture:

One of the truths of markets is that we don’t get to choose the market environment.  Investors want markets that go up all the time, traders usually want volatility, and premium sellers want implied volatility higher than realized volatility.  Not all of those environments exist simultaneously and diversification helps us manage different environments.

Even though it seems like trading another equity market shouldn’t have a huge impact on performance because of market correlation, the reality is that the results can be significant.  To take diversification a step further, when we start adding additional strategies across various timeframes, it can really help smooth the equity curve.

One of the big issues with diversification is managing our emotions and holding true to a strategy or market that has been challenging to trade.  It’s temping to look at your diversification, pick what has worked recently and reallocate equity.  If we make that choice, we effectively remove the diversification that helped in the first place.  Additionally, shifting strategies makes an assumption that what has happened recently will continue.  In behavioral finance speak, we’re falling prey to recency bias.  It’s important to keep in mind that what happened recently is not necessarily what will happen next.  Sure, it might be . . . but it might not.

Diversification relies on the assumption that we don’t know the best choice for a given set of conditions or we don’t know with enough certainty.  If we did know or had a structural advantage (think HFT, GS, or the Fed), there would be no need to diversify.

I will be the first to agree that pretty much any non-directional strategy in RUT has been challenging this year.  That doesn’t mean that we should stop trading RUT or go on the endless hunt for some new trade.  What we need to do is evaluate what’s been working, what hasn’t been working, why, and what it all means.  It’s not always fun, but digging into the details of what we’re doing is where we find answers.

This week we had a healthy move up in the equity markets and my timing on the $RUT July CIB was impeccably poor.   At the same time, the trade size was small and there was no way to predict that move.  Combined with several BWB trades at different maturities and in different underlyings, the impact of the poor entry timing was manageable.  The point . . . diversification of strategies and markets works.

Volatility:

Volatility was hit hard this week and went into the weekend near the lows.  Short term implied volatility fell more than longer term volatility in confirmation of market calm.  The CBOE short term volatility index ($VXST) headed into the weekend at the lowest level since July 2015.  In other words, the last time things were this calm was right before last August!  (that’s sarcasm, not prediction)

The wide spread in implied to realized vol narrowed this week as implied fell and 20 day realized rose.

The VIX:VXV ratio dropped considerably this week.

Levels of Interest:

In the levels of interest section, we’re drilling down through some timeframes to see what’s happening in the markets.  The analysis begins on a monthly chart, then weekly chart, moves to a daily chart, and finishes with the intraday, 65 minute chart of the S&P 500 (SPX)).  Multiple timeframes from a high level create context for what’s happening in the market.

S&P 500 – $SPX (Weekly, Daily, and 65 Minute Charts):

Live Trades . . .

The “Live Trades” section of the commentary focuses on actual trades that are in the Theta Trend account.  The positions are provided for educational purposes only.

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From a trade activity standpoint, I was fairly active this week.  The Results sheet is updated as of the close on Friday.  In the retirement account, I covered the short put in $KO (Coca-Cola) and sold a put a $XLF.  The annualized returns on put premium in $KO were a little low for my taste.

I’ve been forced to chase the market higher with the fast move up this week.  The trade was opened with RUT around 1100 last Friday and RUT went into the weekend around 1150.  The market closed right at the upper expiration break even and I chose to hold over the weekend rather than make an end of day adjustment.

$RUT July 2016 Core Income Butterfly Trade:

 

If you want to learn a safer, less painful way to trade options for income, check out the Core Income Butterfly Trading Course.

Looking ahead, etc.:

With the markets back up towards the early April highs, it will be interesting to see how things play out.  For now it seems like the shorter term sentiment is more bullish, but we’ll need to see continuation above the range.

Have a great weekend and please share this post if you enjoyed it.

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