Trade The Journey

Trade The Journey

Reflection post

Top of the Morning! I hope everyone is enjoyed their weekend. I received another lesson in trading, picking stocks best suited for butterfly and iron condors’ strategies. Butterflies and iron condors are option trades focused on stocks, indices, currencies, etc. that are in a sideways trend. The objective of these strategies is to find a stock that isn’t moving much.

With butterflies, the maximum profit is earned if the stock finishes at a specific price point while an iron condors’ maximum profit is earned if the stock finishes between two price points. So far, I’ve traded weekly options meaning I have a week’s time to forecast where the stock price will be. In my first few trades, I ended the week with a profit, however, the last two weeks have been a bit more challenging.

The only good thing about losing trades is the lessons they provide for future trading. I’ve read more than my fair share of options books, but nothing equates to learning options trading by application. Meaning that to learn how to trade options, you have to place real trades with actual money on the line.

So far, I’ve learned that:

  • Options can move in ways that can surprise you.
  • Butterflies and Iron condors’ strategies require a firm understanding of technical analysis
  • It takes “time” for both these strategies to reach maximum profit.
  • Pin risk is a real concern
  • Options trading is a challenging field to participate in

Last’s weeks’ trade was a slightly bullish butterfly option trade on MO (Altria). Typically, I don’t look at the fundamentals of the stock I am placing an options trade on, only the charts. Before placing the trade, I look for any upcoming news or earnings releases that may increase the volatility of the stock. I also look for any economic events that could cause the stock or industry to move.

MO recently hit a low in early June after falling from around $51 to $41, making the $41 price area the new low. Since that time, MO hasn’t been doing much in terms of trending. Its implied volatility has hovered around the same level since its fall and its historical volatility is still high probably because of its fall in early June.

I placed a slightly bullish butterfly trade in which I selected a $42.50 call as the body of the trade. The $43 and $42 calls served as the wings of the trade.

Butterfly options trade on MO:

  • Buy the $ 43 call
  • Buy the $42 call
  • Sell the $42.50 call

The price of MO when I placed the trade was around $42. For this trade to work, MO had to finish the week at $42.50. When I checked the probability analysis for MO on the week, I had about a 50% chance of the butterfly on MO ending in the money.

MO fluctuated a bit at the beginning of the week but retreated once the price hit the 50-period simple moving average. MO never regained any momentum and ended the week near $41.99. I exited the trade a day before the contract period ended with a 66% loss on the butterfly trade. Luckily, the loss only amounted to $12. I believe it best to keep my risk within reasonable limits as I learn the mechanics of options trades. Below you will find a chart and table of the trade:


Economic review:

Every time the CPI report is about to be released; analyst holds their breath. Are we finally reaching peak inflation? Some seem to think that inflation is reaching its peak level, others aren’t too sure. The latest release on CPI showed that it rose on the year by 9.1% and rose by 1.3% in the month of June. The largest increase in prices was in gasoline, shelter, and food indexes.

All the indexes rose slightly in the month except for fuel oil, new vehicles, used cars and tricks, food at home, food away from home, and shelter stayed about the same. The food at home index has risen over 12% over the year and the food away from home rose 7.7% over the year. The gasoline index rose 11.2% in June. From the report, there are few places the consumer can hide from higher prices, however that hasn’t stopped the consumer from spending.

After the report was released, news began to circulate that a possible 100 basis point rate increase may be on the table for the next Fed meeting. Originally, markets assumed that 75 basis points were the next increase for the Fed. As a result of the latest inflation report release, the Fed may have to be even more aggressive to help prevent stickier inflation.

Producers also face higher prices as final demand increased 1.1% in June. On the year, the PPI has increased by 11.3%. Nearly all the increase can be attributed to prices for final demand energy, more specifically gas prices. Final demand services rose 0.4% in June mostly attributed to margins for food and alcohol retailing. By removing food and energy, the PPI for final demand fell by 0.1%. Trade also decreased by 0.2%. Transportation and warehousing services for final demand services fell by 1.9%.

For intermediate goods, prices for processed goods rose 2.3% and unprocessed goods increased 9.5%. Processed goods for intermediate demand rise can be attributed to a 13.9% rise in gas for the month. Almost 60% of the rise in unprocessed goods is due to natural gas. By excluding food and energy, prices for intermediate goods fell by 1.4%. Food and feedstuff fell by 0.9%. Energy materials for unprocessed goods have remained high for the last two months, rising 3.7% on the month.

Intermediate demand for services was unchanged on the month. Securities, brokerage, dealing, investment advice, and related services fell by 4.4% on the month. Producers are still facing price pressures that have yet to be alleviated. With higher interest rates almost certain and prices steadily increasing, companies are facing tough times ahead.

The NFIB small business optimism index featured little optimism from small business owners moving forward. The index fell 3.6 points as it remains lower than the forty-eight-year average of 98. Expectations for better business conditions have fallen each month with inflation being a top concern. Filling job openings is still a challenge for small business owners as their expectations for real sales strongly declined from May. Inventory increases also fell on the month with supply chain disruptions continuing to constrain their business. Due to the negative outlook, businesses are hesitant to increase their inventory.

Some of the businesses facing challenges hiring workers include construction, manufacturing, services, and retail sectors. The report also stated that labor quality is another top concern behind inflation. A looming recession is on everyone’s mind and small business owners are no exception. With unemployment still low and job opportunities still available is still hard to call this a recessionary environment but that doesn’t mean the future will be the same.

With rent steadily rising, the housing market is still chugging along. Mortgage applications decreased on the week as did mortgage loan application volume. The refinance and purchase index both decreased from the previous week. Purchase applications declined across all loan types. Adjustable-rate mortgages share of the loan applications continued to increase. The average rate for 30-year fixed rates conforming (less than $647,200) mortgages ended the week at 5.37% and jumbo loan balances (greater than $647,200) ended the week at 4.89%.

This past week the Fed released its beige book which is a summary of the economic conditions in the twelve districts. Districts reported a slow down as the risk of a recession is steadily increasing. Most reported that consumer spending is slowing due to higher prices eroding consumers’ ability to spend on discretionary items. Loan demand was mixed. Labor supply and supply chain disruption remain a challenge. Future growth is muted for mostly all the districts. Job growth in manufacturing and construction is facing a challenging period.

All the indices ended the week on a semi-strong note. Earnings season began last week, and market participants are eager to see how companies are faring in the current economic environment. One interesting development is that banks are increasing their loan reserves preparing for possible defaults on housing loans which is not a good sign. The yield curve is still inverted with short-term maturity yields steadily above the ten-year yield with the five-year close to rising above the thirty-year yield. The fed fund futures rose a bit with it forecasting a 3.45% rate.

I’m still a bit fuzzy on interpreting the Fed fund futures rate. It’s evident by the reports and markets, that a slowdown in growth is here with a possible recession not too far behind. With the earnings season upon us, we’ll get a good idea of how companies see the future progressing.

This past week in review:

This coming week, I begin a new career. I am excited and nervous at the same time. A part of me feels I should have remained at my last job but the opportunities for growth were limited. This next step is a big step for me. Last week, I did an okay job managing my finances and this coming week, I plan to slow down spending to save money to buy a townhouse.

I see a fall in the housing prices coming and I want to be prepared to take advantage of the opportunity. It’ll be some time before the Fed must pull back on rates. All in all, I am in a great position moving forward.

Grade: C

Reason: Continued improvement

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