SPX Week of 5/16

Update on two pre-existing trades.

1) 2090/2095 1.65cr. expiry Wed 5/18, 8 DTE. This trade expired worthless. Collected full 1.65 credit.

2) 2105/2110 1.60cr. expiry Wed 5/31, 21 DTE. Closed this on 5/19 for 15c. Gain of 1.45

New Trades.

3) On Monday 5/16 I entered into a 2080/2085 SPX call spread for 1.70 5/27 expiry (11 DTE). Rationale for entering was because SPX was up +20 Monday morning on absolutely nothing. My motto is SELL RIPS as structurally the market is behaving like a bear. I entered when the index was ~2065. The index proceeded to rip to 2072 and I almost stopped myself out of the spread as it reached a high of 2.25. I told myself 2.40-2.45 was my danger zone point and where I would likely trim half the position. Luckily, the index reversed and began to drop. So on 5/19 with the index around 2030 I trimmed half my position for 65c and am now holding the rest to expiry, which should result in "max gains". 

4) On 5/18 I put on a iron condor of 2035-2040 2060-2065, I received a credit of 2.90, thinking SPX would pin between 2040-2060 for Friday am settlement. On Thursday, there was a huge shakeout and the index dropped to an intraday low of 2025. With one day remaining til expiry, I would have likely taken a full loss with the index below 2035, so I stopped out for a 10c loss (lucky, I know). This is where the psychology/conviction comes into play, Do you sit tight, incur the loss, hold, do nothing? Little did I know, that the SPX would rebound rest of the day and that the final settlement Friday am would be ~2048. I do not recommend this type of trade to anyone, but the odds of a 2050 OPEX pin seemed highly likely and if I had just sat tight it would have been max profit. This is why conviction is very important.

5) Entered on 5/20 a 2075/2080 SPX call spread for 1.70 5/31 expiry (11 DTE) when SPX hit 2058/SPY 206 resistance. Motto = Sell RIPS. 50dma of 2060 was also rejected hard. 

Looking forward to next week, the SPX neckline was broken at 2040 (dark blue line) on Thurs and then it had a reflexive OPEX bounce back to 2050. I believe next week we re-visit and break the neckline and close below 2040 for good. Friday, the 50DMA at 2060 was also rejected (light blue line). Much damage was done to bulls this past week and they are likely spooked.

SPX Credit Call Spread - 3/14/16

On 2/28/16 I published the following update about the Credit Call Spread -- "On 2/22, the SPX (S&P 500 index) was up against resistance around 1940 and I filled a 1990/1995 Credit Call Spread for a credit of 1.25 expiring March 11th or 18 days til expiration.

In terms of defense, I will close the spread for a loss if either 1) the SPX crosses 1970 or 2) the spread gets to about 2.10-2.25. If the SPX drops, and the spread gets to about 20-30c anytime this week, I will also close out the spread early for a "win"."

Update: On 3/2/16 the SPX crossed 1970, and I closed out my spread at 1.95 for a 70c loss. Today, 3/14/16, the SPX closed at 2020, that means with about 4 days to expiry if I held the spread I would be close to taking a full loss. 
Lesson -- the days to expiration was only 25 days. Safer spreads are typically found between 40-60 days.  

It's important to realize as a trader, CAPITAL IS YOUR INVENTORY. SMALL LOSSES need to be taken in order to ensure that you can make the next trade.

Therefore, on March 7th, I re-entered a 2080/2090 credit call spread when the SPX was ~2000 for a 2.10 credit this time with about 46 days to expiration. 


On March 10th, the SPX dropped intraday to 1970 and the spread went to 1.30, I didn't close it expecting theta to continue to eat into the spread. However, on Friday, 3/11, the SPX ripped 32 points to close at 2022. My spread went from 1.30-->2.90 in one day. My emotions changed quickly, and I considered closing the position but because of resistance at the 200DMA, I decided to hold on.

As of the close on March 14th, my spread closed at 2.55 and the SPX closed at 2020. As every day passes, theta will eat into my credit call spread (a good thing- position is theta positive). My current break-even for tomorrow (3/15) is if the SPX gets to 2010, then my spread will get back to ~2.10. 

In terms of defense, I will close the spread for a loss if either 1) the SPX crosses 2045 or 2) the spread gets to about 3.40-3.60. If the SPX drops, and the spread gets to about 20-30c anytime, I will also close out the spread early for a "win".

Again, play defense and set stop limits!!

Is the SP 500 Overvalued? Part II

As a continuation from the previous post, I will now share the SP 500 juxtasposed with GAAP Reported Earnings by Quarter (not by Trailing Twelve Months). All of this data can be found here http://us.spindices.com/indices/equity/sp-500

The SP 500 was loosely tracking GAAP EPS each quarter and then in late 2014 a large divergence developed between the SP 500 index and the Quarterly GAAP EPS. As a side note, **Reported earnings = Income from continuing operations GAAP (Generally Accepted Accounting Principles) and includes corporate (M&A, financing, layoffs), and unusual items. At the quarter close of 9/30/2010 the SP 500 was around 1140 and the GAAP EPS # was similar to today's GAAP EPS #. 





Is QE and ZIRP to blame for the divergence? Was this EPS drop a one quarter anomaly? One thing is for certain, central banks have caused MASSIVE DISTORTION in Markets. If the SP 500 index actually traded based on fundamentals and earnings power, the index *should* be much lower than where we are today.

Lastly, I found a graphic from the St. Louis Federal Reserve which depicts merchant wholesales inventories-to-sales ratio. When inventories rise and/or sales decline, this ratio rises. This ratio has not been this high since the 2009 financial crisis! Will central banks ever allow markets to focus on price discovery or will they forever coordinate a stimulative illusion? Central Banks around the world seem to be delaying the inevitable day of reckoning, because today the distortions don't support reality.

Semper inops quicumque cupit - Whoever desires is always poor. 

Is the SP 500 Overvalued? Part I

Good Evening.

I was recently asked what is the fair value of the SP 500 and how could one value it? 

After digging into the SP 500 reported earnings for the past 5 years from here - http://us.spindices.com/indices/equity/sp-500 
I was able to correlate the TTM (trailing twelve months) GAAP Reported Earnings with the Index. As reported earnings = Income from continuing operations, also known as GAAP (Generally Accepted Accounting Principles).

Throughout the past 5 years, the SP 500 has had a positive correlation with the TTM GAAP Reported EPS. However, over the past year a divergence developed between the TTM GAAP Reported EPS (orange line) and the SP 500 (black line).

Here is the end of quarter 1) Reported TTM GAAP Earnings, 2) Closing Price of the SP 500 and 3) P/E Ratio. Highlighted you will notice that for 2011-2012, the Reported TTM GAAP EPS was between 86.50-88.54 & the SP 500 closing price by quarter was between 1253-1598.

The Reported TTM GAAP EPS for the most recent Q4'15 was 87.14 with 94.3% of the companies within the index reporting their earnings. 
So why is the SP 500 around 1940?  

If one thinks the future will be better than the present (China CAIXIN PMI missed forecasts, U.S. Services/Manufacturing PMI readings below 50, possible deflation, record low Oil prices, Shiller Housing Index declining, etc.) then perhaps it's possible to justify the 22.36 current P/E ratio. However, for most of the past 5 years, the Median P/E of the SP 500 has been ~18.  

With a P/E=18 and current EPS=87.14, the SP 500 would be ~1569. Does the index deserve to be valued this highly right now? 

Can TTM GAAP EPS rise to 105-110 (happened once in the past 5 years)? It's certainly possible, but based on weak economic readings and the Federal Reserve's rate normalization policy it appears very unlikely. Can the SP 500 rise to 2100+? If QE4 is enacted, yes, it's possible asset prices may once again divorce from reality.

Further, even with threats of QE4 and NIRP, what policymakers fail to recognize is that Monetary Policy is simply an illusion. Asset prices such as housing and equities were inflated as the money supply expanded, and a few lucky ones felt the positive wealth effect.

However, there must be organic economic fundamentals to support inflated asset prices once the monetary policy accommodation is removed. As the Federal Reserve attempts to normalize monetary policy, assets must reprice. Did the Federal Reserve leave rates low for too long? Did they enable malinvestment? Many signs point to yes. Will these opinions become facts? Time will tell. Based on the weak GAAP EPS readings today, the SP 500 appears to be overvalued.

Here is a chart of the SP 500 juxtaposed with the blue line (P/E=20) and the red line (P/E=15). Sometime in early 2015, the SP 500 surpassed the blue line and the index valuation became stretched. With earnings declining, does the current price of the index belong here? You decide.

Caveat Emptor.