Answer:  I’m not sure I agree that Iron condors are good for uptrending markets.  Iron condors have both a short put and a short call and we want the underlying stock or index to stay above the short Put and below the short Call through expiration.   In general, with the 90% probability type of credit spreads that we open, we can handle the underlying index moving around 9%, but that’s about it….so it could be trending UP or DOWN, up to 9%,  but after this we’ll have to make an adjustment.

Right now, we’re not feeling comfortable in opening the June bear call spread since the market recently corrected 15% and it could rally hard if some good news comes in.  We just don’t know, but when a market pulls back so hard, it could also rally hard.  This is where I’m using more of the volume based indicators to help me gauge the prevailing trend and to predict trend reversals.  I’m feeling more comfortable in opening the June bull put spreads right now on the Russell 2000 index, RUT, as long as they are down several strike prices below the 200 day SMA and below the Feb low.

Answering your questions specifically, when sentiment/fear makes a market correct, like it just did where it recently pulled-back 15%, this is when we make some of our best returns;  and we primarily focus on one side, the bottom bull put spread.  If the volume based indicators continue to show choppiness over the next week, where it’s not showing a “go long” signal, we might consider opening the top spread….but not sure yet.

Answer:   You could if you wish, but I don’t recommend it.  In order to buy back the short leg it will be really expensive.  And, I’m not convinced that the market will climb any more.  On the other hand, if I thought the market was going to continue to rally for the next week, this would be a good strategy.  Let’s look at the numbers as of March 11, 2010:

 To close out the RUT Mar 680/690 bear call spread it would cost a debit of $2.55

To BTC the 680 leg it would cost a debit of $3.85

To STC the 690 leg we would collect $1.30 credit

3.85-1.30=$2.55

 You can see that if we just hold onto the long 690 call, it will cost us $1.30 and the RUT would need to continue to rally in order for this long 690 call to pay off.

Response:   I would wait a touch longer before jumping into the bear call spreads, if at all.   For the RUT, it would be wise to set our short call at 650 or higher, which is the Jan high.  It’s pretty easy to get burned on the top spreads…so we need to be careful. 

Question:  But it’s interesting to notice with today’s market that even though the DOW is up almost 200 points, NASDAQ 30+ point, and S&P 500 is up 16+, the Call options on these indexes aren’t moving up much.   Why isn’t there much premium on these call options?

Response:    A lot of it comes down to supply and demand and currently there are few speculators that want to buy calls on the major indexes, and rightly so since we might still be in a correction, so the premiums that they are willing to pay are low.   Premiums are low anyway for OTM calls, especially when we’re down to the last 10 days of trade or less before expiration.    We know that  it’s difficult to push a boulder uphill and if we ‘re able to move it, it will move slowly;  however, if we let go it will start to roll down the hill quickly and momentum will build as gravity takes over.   Because the stock market is similar to a boulder on a hill,  we can charge the speculators more for Puts because there is more potential to make money on them if the market has a correction, versus the lower premiums that we are able to charge for the Calls.

Answer:   In a very rare occasion that we get stuck with ITM credit spreads, we will usually roll them and keep them alive….and eventually get 50% to 70% of our money back.   Unfortunately, and fortunately, I’ve become an expert on rolling because some of my spreads went ITM during the Oct 2008 crash, and after rolling them I got back 65% of my maintenance.   Not bad for a total melt-down.  (Just as a side note, most credit spread traders, including editor-in–chief’s from other credit spread newsletters don’t have experience in rolling because most just throw in the towel and let their subscribers take a total loss.  I personally hate to lose money and will fight to the end to get back at least some of my money) 

Answering your question specifically, if some of our spreads went ITM and we didn’t want to roll them but just let them expire, the credit spread on the RUT and SPX (classified as broad based indexes) are cash settled, so cash would be withdrawn from our account.   If the spread went completely ITM and we let it expire, we would lose all of our risk capital, which is the required maintenance less the premium collected.

Per options on the SPY and IWM (which are ETFs that track at 1/10^th the value of the S&P 500 and Russell 2000 indexes, respectively) the ETF shares would be PUT to us where we have to buy the shares at the strike price and the shares would be deposited into our account.

Again, in general with this situation, and this is only for the emergency case where the stock market crashes 12% or more in just a few days and we get stuck with ITM bull put spreads, we will roll our spreads month to month and there is a very good chance we’ll get back at least half of our money, and more like 60% to 70%.

Buy to open RUT May 560 call 

Sell to open RUT May 550 call  -   For a credit of 40 to 65 cents.

Then it goes on to say:   If the market continues to climb, and if this spread is now filling for 68 cents, for example, we would suspend fills on this spread, per the directions in the advisory above, and we would ”click-up” to the RUT May 560/570 bear call spread and repeat the process of “collecting” premium on the days where it’s filling for at least 40 cents, but no more than 65 cents.   But are you not then overlapping this new spread with the previous one and thus opening up a 20 point spread of May 550 / May 570 ? The May 560s will cancel each other out.  Would this then require trading in 2 separate accounts ?

Response:    Yes, when trading 10 point wide spreads, like what we do with the RUT, we need two accounts.  That is, we need two accounts if we want to be nimble and click-up and click-down our strike prices as the underlying index moves, which ultimately reduces our risk.  Some credit spread traders/newsletters don’t click-up/down during the month, which is rather unfortunate because this increases risk, and you wouldn’t need two accounts.  Per how we do it at MCTO, we do recommend for our subscribers to have two accounts. 

One way of eliminating the need for two accounts is to mix RUT credit spreads with IWM credit spreads.   The IWM is an ETF that tracks at 1/10^thof the RUT.   For example, if we recommend the RUT 570/580 bear call spread (which is a 10 point wide spread…i.e. 10 points between the buy and sell legs), the IWM 57/59 bear call spread (which is a 2 point wide spread) has almost the same risk/reward profile.  So for example, let’s say we first open the RUT 570/580 bear call spread.  One week later the RUT rallies and we decide that we need to click-up to move further away from the underlying index.  Because we want to do our best to maintain 10 point wide spreads in our account, we shouldn’t put the RUT 580/590 into the same account that already has the RUT 570/580 since this would create a RUT 570/590 bear call spread, which is 20 points wide.  So an option is to put the IWM 58/60 bear call spread into the account.  Then if the RUT continues to rally and we decide to click-up again, we go back to the RUT and put the RUT 590/600 in the account…..etc.  We also call this “layering” our spreads.  The disadvantage, however, of opening 2 point wide spreads is that higher commissions eat into our returns, so it’s best to use low cost options brokers, like eOption or TradeKing.

Answer:   Periodically, we’ll have a short term spike or sell-off in the underlying index in the last two weeks of trade before expiration giving us a final chance to open some additional spreads.  So in the last few weeks of trade, I continue to show the currently recommended strike prices and price ranges, even though there is a low probability that we’ll have another opportunity to open more spreads.  In general, when we are down to the last 2 weeks of trade before expiration, premium usually dries up and we won’t have the opportunity to open additional credit spreads.  (especially for the top spreads)    We do monitor the recommended strike prices and credit price range daily and we’ll move them up or down, or remove them completely when the risk/reward characteristics of the trade no longer make sense.    

Per opening credit spreads that are 5 weeks in duration, yes, it usually works and you can bring in excellent levels of premium.  However, just due to how the market has been behaving in the last 4 months, I’ve shied away from 5 week trades and have focused on 2 to 4 week trades to reduce the time exposure risk.  We are also able to open shorter duration, 2 to 4 week credit spreads because volatility, VIX, is elevated making them more expensive and allowing us to bring in higher levels of premium.

Answer:   As long as the recommended spread is filling for between 45 and 70 cents, we open the recommended spreads using the price that it’s currently filling at on that particular day, and we use about 20% of the available cash for that day.  We then pause and wait for the next day when it’s filling again betwen 45 and 70 cents.  (i.e. we collect premium over time, which helps reduce risk)    If at any time it starts to fill for 71 cents or more, the spread no longer has a 90% probability of expiring OTM and profitable, but it has an 83% (just a guess…but probably close)  probability of expiring profitable.   Because we have the goal of opening 90% probability credit spread options, we then would move our strike prices away from the underlying index ”one-click” so we can bring the probability back to the 90% level.

Answer:   Yes, you can use our analysis and signals on the RUT (Russell 2000 Index) to trade the IWM (and ETF that tracks at 1/10th the value of the Russell 2000 index – RUT).     Just make sure you select the same short leg.    For example, if we issue a signal to trade the RUT Dec 650/660 bear call spread, you could also trade the IWM Dec 65/67 bear call spread and the risk/reward profile for both trades is very similar.   It’s best to stick with 2 point or 3 point spreads on the IWM.   (i.e. either a 65/67 or 65/68 bear call spread….per this example)    For more on why we use 2 point or 3 point spreads on the ETFs, please go to the Monthly Cash Thru Options Learning Center at  http://www.monthlycashthruoptions.com/LearningCenter.htm   and read the entry  “why we usually open 3 point spreads on the SPY”

Question:  Which one do you prefer to write credit spread and iron condor options against….the SPY or IWM?

Answer:    Both have similar risk/reward profiles.   Sometimes, however, we can get better placement for our strike prices on the IWM, but it does vary from month to month.  That’s why we have to analyze the trades on each underlying ETF each month to see which underlying offers the best placement of our strike prices.

Response:     I understand your concern.  In general, because we open very far out-of-the-money (OTM) 90% probability credit spreads, we tend to have enough time to close out our bull put spreads and/or make adjustments to cut our losses in the case of a market meltdown.   99% of the time, even when the market pulls back hard, we have time to get out and cut our losses, and we have a 5 year track record of keeping our losses below 10%, which is pretty good.

However, the October 2008 crash was different where we unfortunately ended up riding a few of our spreads down to where they went in-the-money (ITM).  This happened because in addition to the major indexes violently selling-off 3% to 5% per day, volatility also rapidly spiked up to record levels making it very expensive to get out of our spreads. We therefore decided to hold-on hoping for a short lived bounce so we could get out, but unfortunately that never happened as we all know.   So during the Oct ‘08 crash, we actually made very few adjustments to our bull put spreads, thus they they went ITM, and we were able to eventually get back 65% of our original risk capital purely by rolling our ITM spreads month-to-month, rolling down the strike prices of our spreads lower and lower each month, and waiting for the market to rebound a little.   This Oct ‘08 crash gave the MCTO team a good case study on what it takes to roll spreads and to recover a large % of risk capital after a massive crash.  It was painful to go through, but I’m somewhat happy that it forced me and my partner to become experts on rolling in order to preserve capital during a crash.

So per your concern of a one day, 15% or greater stock market crash where our bull put spreads immediately go ITM, we have a lot of experience with what it takes to roll spreads and we are confident that we can get back at least 60% of our risk capital, and possibly as high as 80% of our risk capital, depending on how fast the markets recover.  (An example of an event that would cause a one-day 15% crash is something similar to 9/11, or worse, the detonation of a  nuclear device in a US city by terrorists, which is the type of event that could take the markets down 15% or more in a single day)

Please keep this in mind as you interview other credit spread advisory publishers. Very few, if any, credit spread newsletter editors have experience in rolling.  Most don’t bother with rolling and just throw in the towel and let their subscribers lose 100% of their risk capital.  For us, that’s unacceptable and we fight to the end to preserve our capital using advanced rolling techniques that we practiced and refined during the Oct ‘08 crash.

Answer:   Rolling-up by taking the profit of a spread that already generated profit and rolling the profit into a new spread that has strike prices closer to the underlying index can be a good strategy.  However, the new spread is a separate trade and it has to make sense per all of the analysis that we do.  So when you ask the question -  “Does rolling our profitable spread into a new spread that is closer to the underlying index increases risk?”, as long as the new spread stands on its own per fresh analysis, the risk/reward will be balanced and acceptable.

For me personally, when I feel confident that the underlying index will hold above, or below, my short strike prices of my spreads, and if I have reasonable buffer between the short leg and the underlying index, and if I don’t need to free up the cash, I’ll just let the credit spreads expire worthless.   But if I have any hesitation at all, I’ll close them out early to take the profit and to reduce risk.   Therefore on this trade, I’m probably going to hold onto my SPY Nov 92/94 bull put spreads, and I’ll start bringing in additional premium with the new SPY Nov bull put spread that we recommended in the November 6th advisory