[Corporate bond in Wikipedia]
LQDI shall use the SEP series of options, which trades for the last time 46 days hence, on Sept. 16.
Ranges
Implied volatility stands at 8%, which is 3/5ths of the VIX, a measure of volatility of the S&P 500 index. LQD’s volatility stands in the percentile of its annual range. The price used for analysis was $123.32.
| Week | SD1 68.2% | SD2 95% | Earns |
|---|---|---|---|
| Upper | 126.68 | 130.04 | N/A |
| Lower | 119.96 | 116.60 | N/A |
| Gain/loss | ±$3.36 | ±$6.72 |
by Guy Cohen |
The Trade
LQD began a long run up on Feb. 16, peaking on July 11. It has subsequently formed what looks to be a nearly completed cup-and-handle pattern, conventionally taken as a sign that the uptrend will continue.
The MACD histogram, a momentum indicator, has been below the zero line for nearly two weeks and is showing no clear trend toward a fresh break into bullish territory.
LQD and the MACD indicator are at odds, calling for a direction-neutral strategy.
Which proves to be impossible on this grid because of spotty open interest, a measure of liquidity.
The put side is OK. It's the call side that presents the problems.
The following chart shows the first four out-of-the-money strike prices on calls for LQD, the strikes I would look at in building an iron condor.
| strike | prob. of expiring OTM | open interest |
| 124 | 64.58 | 504 |
| 125 | 78.05 | 104 |
| 126 | 88.42 | 62 |
| 127 | 95.21 | 0 |
I like to build my trades with around an 80% probability of expiring out of the money for maximum profit (the second column). So I would pick the $125 strike for the short call leg of the iron condor, and then move out a strike to the $126 strike or $127 strike for the long call.
Which breaks my liquidity guidelines, since the $126 strike has open interest of 62, well below my 100 minimum, and the $127 strike has no open interest.
That moots the possibility of trade. I shall now break off and go directly to the decision, which is no doubt blindingly apparent already.
Decision for My Account
Robert Bringhurst, the author of the fascinating and wise book The Elements of Style, published in 2012, wrote: "By all means break the rules, and break them beautifully, deliberately and well. That is one of the ends for which they exist."
Of course, we then must define "beautifully, deliberately and well". I see nothing beautiful in a trade that lacks liquidity in some elements, although were I to break it, I would most certainly do it deliberately and well.
But an options spread with illiquid elements simply results in longer times to fill the order and wider bid/ask spreads, making the entire structure less attractive as a trade.
A structure with several parts is only as strong as its weakest.
Therefore, I pronounce this proposed trade to be ugly and reject it on aesthetic grounds. No. trade.
-- Tim Bovee, Portland, Oregon, Aug. 1 2016
References
Tradecraft: Playing the odds to build winning stock market trades from options, a description of how I trade, can be read here.
Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.
Alerts
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Disclaimer
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.License
All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
Based on a work at www.timbovee.com.
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