April Credit Spread Mid-way Report

by Jay Pestrichelli on April 8th, 2013

On March 26th we wrote about our monthly high probability credit spread trade and after the choppiness we’ve seen since April 1st, we thought we’d give an update on our observations so far.
To review, we highlighted a credit spread on RUT at the 860/850 strike levels. Here’s a link to the post: April High Probability Credit Spread
Since that time the RUT started sliding downward and after the poor jobs report Friday it dipped down to 910 from 945 (-3.7%) and it volatility index, RVX, popped from 17 to 20. As a reminder only 8 trading days have passed. This is all considered normal market movement, but would have some investors spooked. However, with this trade, remember, it’s not about being right, just not being really wrong. I don't think anyone would consider -3.7% as really wrong.
In the earlier post we showed the probability curve of RUT and the limits we’re watching for when to exit. Below is an updated version and as you can see, the index still remains within the area of expected return.
The market decline has not broken through the purple curve and hence our exit alert has not been triggered. The yellow box labeled Spread represents the long and short strikes of the 860 /850 credit put spread, and one can see that the Index is still 7% above today's level.
The spread that was sold for 0.25 is currently trading at 0.20. This means that despite the market moving against the position AND volatility popping, the trade is still profitable. However, right after Friday’s open this was not the case. The spread had jumped to 0.60.  Our exit price is set at 0.70 so if we had hit that mark we would exited and took a loss of 0.45.

That level was set because it was our risk tolerance for the trade, though Individual ranges may vary. For us, we want to be able to offset the trade loss completely the following month and we think we can do that if we had to exit at 0.70.

We’re still on watch for this trade to move dramatically against us, but for now, the probability of success is over 98%, so we’re going to give it some more time to erode further to profit.

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