Fiscal Cliff No Match For Covered Call Trading

zentrader.ca / By Chris Ebert / December 29, 2012

Option Index Summary

In the most recent Option Index Update the following conclusion was made:

From an option trading perspective, a big change in the market seems very probable now. It might not be tomorrow, it might not be next week. But the options are indicating 2013 will quickly reveal itself to be a much different trading environment than 2012. S&P 1400 and Dow 13,000 will soon become memories.

Not only is that statement still true this week, but the performance of certain option trades provides even more evidence in support of it.

The Long Straddle/Strangle Index (LSSI) tracks the performance at expiration of an option combination formed by buying a call option and a put option (a long straddle or long strangle), with a strike price at or near the share price of an S&P 500 ETF such as SPY (NYSEARCA:SPY). Of particular importance is the performance of those trades opened 112 days prior to expiration, because such trades tend to react quickly to changes in the market while smoothing out short-term changes that tend to create useless noise.

The 112-day LSSI dipped to -7.7% this week, well below the limit of -6% considered normal. This condition has occurred in the past, and each time it was followed by some violent moves.

• July 15, 2011 -7.9% was followed by a wild August with the S&P down 200
• Dec. 16, 2011 -10.5% was followed by the 2012 Bull Market
• June 1, 2012 -7.9% was followed by a nearly 200 point gain in the S&P
• Aug. 24, 2012 -6.7% was followed by a September rally
• Nov. 16, 2012 -7.1% was followed by a late November rally

There is no way to predict with certainty which way the move will be the next time it occurs. There are still signs of bullishness in the Covered Call Naked Put Index (CCNPI). Covered call trading has remained consistently profitable recently. Not even the looming U.S. Fiscal Cliff has had an effect on covered calls. Generally, when covered call trading is profitable it means the bulls are in control. The CCNPI shows continued bullishness this week.

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