Last week the market broke up from, what I think, was a very short consolidation pattern. After the big rally sparked by a better-than-expected CPI report last week, the markets stalled and traded sideways for a few days. This happened right under the major resistance at 4,525. So, the question appeared, was this going to hold or were we doomed and headed to bouncing down again? I bet, many bears who were predicting doom and gloom all year long were wishing for a crash. But today, the markets broke above that consolidation and spiked higher. Unfortunately, the consolidation was not very strong so the subsequent rally may not be very strong either (the longer the market stays in a particular pattern, the more meaningful it becomes). Moreover, we are probably going to see the end of the year rally (Santa Claus rally).

This trend helped our trades. Last Friday, we placed a new “Crumbs Iron Condor” with today’s expiration. We had 4,465/4,470 puts and 4,580/4,585 calls and we collected 0.30 ($30) credit. This trade provided 102% annualized return as it expired worthless for a full profit.

We also rolled some older SPX call spreads into put spreads in expectation of an end of the year rally.

We think the markets will continue going higher as inflation will be easing more, and FED will start cutting the rates. I recommend stop listening to all the talking heads and doom and gloom predictors predicting their end of the world. They were predicting the market crash since 2009 and they were 99% wrong. And they will always be wrong.

Tomorrow, we will get the FED’s FOMC meeting notes that will come under scrutiny from investors seeking a clue whether there would be any hint of rate cuts next year. I think, it is foolish but short-sighted Wall Street does that. I think we will not see anything different from what we already know. The FED would probably stay a bit hawkish and the markets may shrug it off and continue higher. If they see a hint of rate cuts, expect the market to blast off. We are also heading to a short week due to the Thanksgiving Day, so on Thursday, the markets will be closed and on Friday the markets will close early (at 1 pm ET). This is typically a quiet week and markets tend to drift higher.

After the October CPI report, the markets saw a strong rally, which helped our struggling puts but hurt our calls. We opened a few Iron Condors a few weeks ago, and when the market rallied, we rolled those calls into puts. But soon after we did that, the markets sold off again, and the puts got in the money. It took three to four weeks to get out of the mess.

But last week, we received an October CPI report, after which the markets had a strong rally again. That saved our puts. Unfortunately, I also opened a few call spreads, and the rally was too strong. I feared I would have to roll those calls into puts again, staying in trades I wanted to finish.

Months of heavy selling was undone in three weeks. It was a crazy move! In the last two weeks alone, the markets rallied almost 7%! That is a typical annual return of the SPX… done in two weeks! After the CPI report, the market jumped 2.4% only that day!

But, in the last two days, the markets stalled and remained flat, which helped our trades. All these trades expired worthless, but it was close! We had a 4510/4525 call spread, which expired yesterday. The market finished at 4,508.24 that day. Today, we had another call spread with 4,560/4,565 strikes. I feared that if the market resumed the craziness, I would have another “hot” trade.

Fortunately, the markets stayed flat after the strong rally, but what does it mean now? Is it just a consolidation of the gains or are the bulls exhausted, and this is just a calm before the storm? If you look at the chart, the markets just reached the resistance, and it is prone to collapsing. Maybe. We have to wait and see. We may have Santa’s rally for the rest of the year.

When buying stocks in a cash account, you can go all in and be fully invested. But when you are buying stocks on margin and, on top of that, trading unsecured options, proper options portfolio management is a must.

I learned my lesson the hard way when, during the raging bull market, I invested everything in stocks and sold naked strangles. Then, the market turned bearish, and I was sweating to keep it afloat. And it cost me a lot of money!

Portfolio management doesn’t have to be complex. It is simple. What is difficult is the self-discipline to follow the rules.

When trading options, you will need a margin account (unless you plan to trade only basic strategies such as covered calls and cash-secured puts). And margin will throw a wrench into investors’ simplistic thinking. It all suddenly becomes complex and scary.

If you decide to trade SPX trades with us (subscribe) or on your own, you will need a set of rules to follow, such as allocation, positioning, cash management, and scaling the trades.

Here are the rules I set up for our portfolio (though I must admit, in 2021 mania, I too became reckless, and I am still cleaning up the mess):
 

Options Portfolio Management – Cash allocation

Cash allocation in portfolio management was my most significant issue. I hated to keep cash in a brokerage account, earning nothing. This drove my urge to be fully invested, although I knew it was wrong.

The rule is to keep 30% of the entire portfolio in cash but invest in a cash equivalent ETF. Some brokers, such as Fidelity, offer suitable money market ETFs that earn a good interest (currently up to 4.25%, not much, but better than nothing). Others don’t provide anything, and the cash makes zero return.

In this case, I use short-term bond ETFs such as ICSH and SGOV. They hold value during turbulent times and pay a decent yield.

Options Portfolio Management – Options position sizing

No matter how much money you have in your account, set a realistic position sizing. If we keep 30% of our portfolio in cash, then put 20% of your portfolio for options trading.

If 20% appears to be too large for you and you feel scared to deploy it, then go smaller. You can always scale up later.

Once you have the amount set, determine the trades you would trade. I decided to sell one Iron Condor contract with 2 DTE and $5 wide spread, one Iron Condor contract with 7 DTE and $5 wide spread, and one Iron Condor contract with 30 DTE and $5 wide spread.

That means over a month-long period, I trade 13 trades and risk no more than $1,500 on any given day or week. And I keep trading these positions again and again. I open new trades only when the old ones expire (or if I have to roll them, then after they finish, too). Do not scale the trades!

Options Portfolio Management – Scaling up

Do not scale trades up! At least not initially. Keep trading the same trades repeatedly, and do not use proceeds from your previous trades to open more trades! This is a common mistake and a trap everyone can easily fall into. Look at it this way: you trade Iron Condors, and you are successful in 9 trades, but the 10th trade can wipe out those trades if something goes wrong. And if you scale your trades up, you can wipe out not only the previous nine trades but your entire portfolio.

Instead, use your proceeds to buy other investments.

When can you scale up? Once all your allocations are met, then you can scale up.

Options Portfolio Management – Equity Allocation

Start building your portfolio base by buying good companies. Use proceeds from the options to buy stocks. Do not gamble with these stocks. Do not buy penny stocks or high-flying growth stocks. This should be your base, not a roller coaster. Since you will purchase these equities in a margin account, stock market fluctuations will still give you a headache, even with these lazy, good-quality stocks. But if you blow your options trading, you will not blow your entire account!

I blew my account many times, and this strategy saved my account often. After I wiped out cash for options trading, I still had enough equity in good-quality stocks.

I keep 50% of my account in dividend-paying stocks as my base.

Options Portfolio Management – Summary

To summarize these rules, this is what I do in my accounts:
 

• Build and keep 30% in cash equivalents such as ICSH or SGOV ETFs. When the markets rallied, I added more cash to stay at 30% or buy long-term equities. When the markets crash, I start selling ICSH or SGOV to release cash and buying power to avoid margin calls.

• Build 50% of the portfolio in long-term, good-quality stocks. I prefer dividend stock, so they also generate cash. I never sell these positions unless I must satisfy margin requirements. But once the margin requirements are satisfied, I immediately buy these positions back.

• Use 20% of the portfolio for options trading. I do not necessarily use it all, but start small and add slowly.

• Use proceeds from options trading to buy cash ETFs and dividend stocks.

• Scale your options trading up only when your other allocations are met. You have 30% in cash, 50% in equity, and more cash on hand. Then, slowly add more trades.

• Scaling up options trades could be widening the spreads (for example, going from a $5 to $10 spread) or adding more contracts. If you are unsure and not ready to scale up, keep unused funds in cash. For example, I “save” all unused funds and proceeds from options trading in the ICSH fund, while I save 30% cash in the SGOV fund.
   

Following these rules will save you a lot of headaches when the markets crash or go into a bear market. You will also have enough cash on hand to buy stocks if a great opportunity arises (and lately, there was a lot of opportunity, but I was out of money).

When you try to force on the market any agenda you may have, the market will react. And usually not the way you want. We have seen this in 2020 when politicians decided to shut the markets and the entire economies down. They distorted not only the markets but the entire economies.

People get this wrong. They think that everything we are experiencing with the stock market results from a lousy economy due to too much money in the system. It is true, but partially. The primary reason is elsewhere. The primary cause is the abrupt stop of the world economy. The rest are consequences, like a domino.

First, they stopped the markets. Then, they had to pour trillions into the markets to save them. The pendulum was pushed toward one side. Because of the trillions in the system, people went on a spending spree. That raised inflation. Did it hurt businesses? No, companies made trillions in profits! Everyone was happy, and everyone was spending like crazy.

Inflation was rising, and politicians and FED got worried. But even during high inflation, people kept spending like crazy. Airports were full. Vacation destinations were booked months ahead. Some restaurants were booked weeks ahead (check Texas Roadhouse, for example). And politicians were worried, so they swung the pendulum in the opposite direction. And to the other extreme. Now, we have high inflation and the risk of halting the economy once again.

But the markets will react and resist the force. The question is how and which direction it will resist.

And the recent force on the markets we saw was EV. During the hype, everyone was about electric cars. Tesla was going to the moon. California applied another force on the market, approving a bill to go full electric by 2030 (or so).

The pendulum was moved to another extreme. Today, the EV pushers are surprised that no one is buying electric cars. Tesla is forced to lower prices, narrowing its margin beyond sustainability. GM just announced suspending manufacturing of EVs whatsoever, and Ford is following suit.

I do not say that there is no market for the EVs. There is. But we are not ready for it. The electric grid is not prepared for it. The charging system across the country is not ready. And customers are not prepared to pay horrendous money for overpriced cars. We need to grow to it naturally and not by the dictate of politicians (Communists tried this in their central economies and failed miserably).

Apply force on the market, which will do the opposite of what you wish for.

Two months ago I started trading the Crumbs strategy against SPX spreads. The strategy is to move short strikes so low that the trade will be very safe and a likelihood of getting busted is lowered to a very minimum. This type of trading has 97% to 98% probability of profit. Only a black swan event would go and bust it. And today I decided to expand this trading to regular stocks and trade naked puts.

 

Source: Pixabay
 
Trading naked puts with Crumbs strategy is safe. Relatively. It increases the POP to almost 100% (99% to be exact). The premium is very low. I will collect $21 bucks premium ($19.87 after commissions and fees) but it is almost a sure profit. Unfortunately, the capital requirements are a lot higher than with spread. Traders may consider this not worth it.

Today, I opened a new trade against Amazon (AMZN). I sold a December put contract with 115 strike price and collected $21 premium. The capital requirements or buying power is $1,150 and a total risk is $11,500.00 (that is in case the stock goes to zero). So you may think that this is not worth it – risking 12 grand to make 21 bucks? Go figure!

Well unless you can repeat this over and over every month with peace of mind sleeping well every night knowing that your trades will most likely expire worthless for a full profit. Of course, if you want a thrill and excitement of being in a roller coaster, raise your strikes up and collect $200 of the premium (or sell at the money puts). But be prepared that you may get assigned if the trade goes against you.

This strategy is to generate income, not to buy the underlying stock. If I want to buy the underlying, I would go closer to the money to collect nice and juicy premium and buy the stock for a better price. But I consider this strategy to generate income and not interested in owning the stock and in this case, I want it to expire every month worthless.

Last week we experienced an incredible market rally. The S&P 500 rallied from a several weeks long bearish craziness to a bullish madness by 5.86%. What is crazier is that this, almost, 6% rally took just 5 days to happen. On average, this rally consisted of a 1% a day move. And now, the question is, is this market rally sustainable?

This crazy move could be just a relief rally before we resume bearishness, but we need to wait to see what happens next. Why? So far, we only reached the previous support which now acts as a resistance, and we may bounce from there down.

I was thinking what has changed in the market? Well, the answer is simple: nothing. Let’s review:

The bearishness was based on silly behavior from investors who were scared of a known event – interest rates. But that fear was irrational. Everyone knows that the economy is still strong, that the labor market is still strong, consumer spending is strong, and inflation is easing. Yes, in September and October we saw an uptick in inflation but that was a very small uptick. It didn’t change the trend. Yet, the investors freaked out and kept selling. And the selling lasted for two months!

But last week, the GDP came in lower than expected, Jerome hinted longer pause in hikes, and these same investors who were panicking for the last two months started buying like crazy.

Interestingly, last week’s rally caught a few big hedge funds with pants down causing them losing a lot of money.

So, are we out of the woods? I think not. This type of violent rallies are usually overblown and attract sellers. But we need to put this into perspective. People fail to do it. They look at today’s or yesterday’s price action and make conclusions.

A good way to determine if the market rally is over and we are in a bear market again, is to zoom out:

Are we in a bear market? No. Was last week rally just a bear market bounce? No (twist it anyway you want, it was not a game changer). The longer-term market still shows very clearly that we are in a secular bull market.

Will it last?

Yes, the market will go up. But maybe not next week. This rally was not sustainable, and I expect some type of a correction. I think, we will bounce down on Monday or early next week. But eventually, earnings will win this over and we will resume uptrend.

The market lost 9.94% since the end of July this year. It was a brutal decline. Selling had only a few bounces but new sellers came in and pushed the markets lower pushing it into a correction territory.

It is perfectly normal and to be expected correction. Too soon after a recovery from the not so distant bear market, but still normal. The question is, will we stop here? This may turn into deeper declines and turn the recent rally into a bear market bounce erasing all bulls hopes.

Economically, this makes no sense. The US economy shows strength and growth. GDP growths, retails sales grow, consumer confidence grow, the labor market is strong (not a recession when everyone loses jobs, not gains them)… so the only reason for this selling is the fear of “higher for longer” interest rates. That is not sustainable and at some point this fear will go away. In the meantime, we have to wait this out.

How frustrating this is compared to easy market in 2021, right?

Tomorrow, we will see a report on the current inflation, so be prepared for another market’s haphazard reaction in any direction. If the repost shows easing inflation, the markets will rally. If not, more selling will come.