The most important thing to say about this month is that there’s a reason we have those trading rules! The Dow move of 300+ points on Tuesday caught just about everybody by surprise, and had we stayed in our positions instead of exiting on Monday, at least two of our positions would have switched from nice wins into infuriating losses.

Instead, the September expiration cycle was a much more stable one for us than August was. Recall that last month, we had to adjust each of our iron condor trades (which is something we never like to do), and were able to keep each trade profitable. This month was far simpler, and it’s worth mentioning that although our official profit target is just 10% per month - which should be plenty for any sane trader - since switching to ETF-based options in June our iron condors have averaged over 28% per trade! As you may know, all of our membership spots are full at the moment, but we do provide a waiting list if you’d like the chance to join us.

The Market

For most of September, the markets were relatively quiet and flat (although what counts as “quiet” is a lot different now than it was 6 months ago!). Obviously, expiration week saw the Fed announcement of a 50 bps rate cut, and a corresponding melt-up in the markets. The reason we were able to avoid the volatility-crushing craziness of this week was that we knew that anything can happen when Helicopter Ben gets behind the microphone and that it’s usually a good idea to sit out those sessions. Also, our trading rules dictate that we exit 4-10 calendar days prior to expiration, so we would’ve been out of our trades anyway.

The Fed action is concerning, as we wouldn’t have seen such a drastic move if the governors thought that the economy didn’t seriously need that shot in the arm. While fundamental economic theses don’t provide much in the way of trading opportunities (economic changes can take weeks, months, or more to have visible effects), an economy on the brink of recession isn’t good for anybody. We know you don’t read us to get policy or political opinion, but we can’t help but be concerned by a situation in which the economy looks this vulnerable and yet government policymakers continue to fund one of the most expensive (and most unsuccessful) wars in U.S. history.

Our Trades

Another month with no losers - with winners that far exceed our 10% goal! Still, there are some lessons to be learned here.

September QQQQ iron condor

Let’s start things off with the QQQQ trade. Result: We held this trade for 35 calendar days for a final net credit of $0.35 per position, which is a 24.4% return on capital risked. Clean and complete exit before expiration.

This is the second trade on the Cubes that we’ve done recently, and although it worked out much better this time, there were still occasions when we were sweating about the call side of the trade. The simple story is just that tech has continued to show strength recently, and when you combine a general market that is flat-to-up with a sector that is definitely positive, it makes sense that short calls will be threatened. What’s interesting about both this trade and the QQQQ position we entered back in July is that in both cases the market seemed to price in smaller amounts of volatility for the ETF, which meant that when the index showed strength as expected, we were hurt more on the call side than we would have been if there was more of a volatility premium buffer. The conclusion we draw from this is that it’s fine to keep opening positions in QQQQ, so long as we use the position to add some bullish-trending diversification to other positions based on indexes with downward biases, like IWM.

September SPY iron condor

Result: We held this trade for 43 days for a final net credit of $0.49 per position, which is a 44.5% return on capital risked. Clean and complete exit before expiration.

The Spyders continue to be our most reliable performer, and in this new volatility environment it makes even more sense to keep opening positions here. At $148.10, we still had three strikes of safety left, but we didn’t want to be exposed to any Fed surprises, plus our trading rules dictate that we exit no later than 4 calendar days prior to expiration.

September IWM iron condor

Result: We held this trade for 21 days for a final net credit of $0.32 per position, which is a 21.9% return on capital risked. Again, clean and complete exit before expiration.

The Russell 2000 continues to be a nice place to look for iron condor spreads: the premium is nice, and the $1 strike prices allow us to slice and dice moves in the underlying that would be more difficult to capture in some other ETFs.

Conclusion

We may look to the Diamonds (DIA) next month in addition to our usual candidates, and if we do see some sustained market strength over the next week, we may also be ready to take full advantage of the 3-5 trades our strategy allows us to enter every month: we’ve been trading three positions throughout the summer, mostly because this has been such an unsteady market environment. While we’re just as market neutral now as we have ever been, we’d like to see some real stability (note: as opposed to irrational exuberance) so that we can find a base from which to analyze the major indexes. As always, thanks for reading, and let us know what’s on your mind.

Market Overview

There was a major selloff on Friday for whatever reason(s). The general picture is becoming clearer: this economy might actually be on the edge of a recession or worse. The housing crisis isn’t going away - a recent Goldman Sachs report said they think it may take “several years” for housing prices to adjust down to fair value. And let’s remember that without housing, our economy isn’t really worth talking about. In the short term, Bernanke’s rate cut may boost the markets if he opts for 50bp, rather than the 25 basis points already assumed. But a little extra cash isn’t going to solve what are fundamental structural (Greenspan-induced) problems.

Positions Overview

We don’t like excitement. And so far in this cycle, only one of our three positions has been a cause of any excitement: the QQQQ trade. Our short call at 50 was touched intraday on Tuesday, but went right back down and now the index sits at 48.23. It would take an unprecedented move for QQQQ to bounce back up above 50 before expiration, and we’re very confident in this trade.

As for our SPY and IWM positions, the indexes are almost exactly at the midpoint of our trades, right where we like them. The nice thing about iron condors is that when they work, they couldn’t be any easier to maintain - you just let them sit! So there’s not much else to say about these positions except that so long as we don’t see a big crash or some kind of financial absurdity (i.e. a 1.25bp rate cut) before expiration, we should be sitting pretty.

Late last month, somebody asked whether tech was safer.  For those of you playing along at home, the correct answer was, and is, “Yes.”

Today, the Nasdaq 100 continued to do what it does, and the QQQQ closed up 1.6%.  We currently have an iron condor position open in QQQQ, and the index actually (though only briefly) kissed our short call strike of 50 today, before a little afternoon selling showed up.

Rather than speculate about today’s action, we’ll leave you with the fact that the 2-day RSI on the cubes sits at 94.10, which is obviously not the absolute max, but is pretty darn overbought.

Oh, and the VIX is meanwhile getting ready to test its 50-day moving average.  A bounce in volatility would be kind of expected, but a continued drop would not necessarily mean all that much, since we kind of just skipped the whole 15-22 range back in late July.

Nice little story in the Times this morning about hedge funds and the people they’ve hurt. As everybody should know by now, you’re really no better off, on average, in a hedge fund than in any other investment vehicle. In this article, we get the story of one man who lost his 250k investment in the Bear Stearns blowup.

The most striking thing about the behavior of hedge funds over the past few months is that they’ve made perfectly clear that while they are increasingly willing to accept investments from non-institutional clients, they are not interested in serving the interests of those non-institutional clients. Incorporating and shielding assets in the Caymans isn’t a rare or shocking tactic, but misleading people about the quality of the structured debt you’re carrying should be both rare and shocking to anyone who cares about a sound financial system.

Another noteworthy aspect of this story: the investor wasn’t exactly looking to get rich quick:

Mr. Greene, a former engineer, said he invested in several hedge funds in recent years, aiming to preserve his principal. Most of the funds have worked out well, he said, producing slightly better-than-market returns with little volatility. He estimated that he has $600,000 to $800,000 invested in hedge funds. He invested in the Bear Stearns fund in October 2005, and he said the fund appealed to him because its returns of about 1 percent a month did not seem to fall into the too-good-to-be-true category.

So a wealthy individual looking for 1% monthly returns puts some cash into a hedge fund, the fund blows up, and the individual is probably left with nothing (he will be the last to get paid). You know who else sought very modest investment returns, watched their assets disappear almost overnight, and was pushed to the end of the line when settlements were paid? Enron employees, that’s who.

Maybe it sounds a little hyperbolic to compare Bear Stearns to Enron. But as far as we’re concerned, financial institutions have the burden of proof to demonstrate that they’re not crooks, and so far many hedge funds have not met that burden. Hedge funds abuse their use of leverage, they mislead investors about the dangers and details of their activities, and most importantly, they completely fail to do the one thing for which they were created: they don’t hedge risk! A hedge fund that takes on absurd levels of risk (as so many seem to do) is nothing other than an unregulated pool of casino money.

One reason we started this site and our iron condor newsletter was to teach individual investors to take control of their own financial future. In all honesty, we would prefer a regulatory regime and a political environment that didn’t simply hand unlimited power and infinite protection to the wealthiest and most powerful elements of corporate America. But regardless of whether hedge funds even learn to govern themselves, or continue to act irresponsibly (forcing someone else to govern them), the same conclusion holds for individuals: you’re better off either trading conservative strategies like ours, or in hands-off index funds.