by Tyler Craig | October 16, 2012 8:10 am
From a pure performance perspective, last week’s 2.2% fall in the S&P 500 Index was the worst weekly drop since the summer rally found its footing in June. No doubt the bulls are nervously trying to reassure themselves that the bout of weakness is nothing more than a speed bump. And yet, damage has been done, particularly in the Nasdaq and cult favorite Apple (NASDAQ:AAPL)
It appears the bearish continuation pattern highlighted in my recent post “Beware the Bear Flag in IWM” proved prescient. As is usually the case with a bear flag, a drop in price was indeed in the offing. Of course, the market exhibits a certain ebb and flow, rarely rising or falling in a straight line. If Monday’s respectable bounce is any indication, it appears a short-term recovery might be commencing.
With the iShares Russell 2000 Index Fund (NYSE:IWM) ending the day with a bullish hammer candle, let’s investigate the current status of the bear call spread highlighted in the aforementioned article, as well as a potential trade adjustment.
The original recommendation was to enter a November 86-91 bear call spread for a credit of 80 cents. Given the recent decline in IWM, the call spread has fallen in value to 39 cents, generating an unrealized profit of 41 cents per spread. Traders confident that IWM will remain below $86 regardless of any short-term bounce this week could maintain the position as is and allow time decay to eat away at the remaining value of the out-of-the-money calls.
One potential adjustment worth consideration for those looking to create more of a neutral position on the IWM is adding a bull put spread. For example, traders could enter a November 79-74 bull put spread for a credit of 50 cents or better. The position is initiated by selling the Nov 79 put and buying the Nov 74 put. The reward is limited to the initial 50-cent credit and will be captured provided IWM remains above $79 at November expiration.
Click to Enlarge In the event IWM rises this week, the gains from the new put spread will help offset any unrealized gains that are given back in the existing bear call spread.
What’s more, with the addition of the bull put spread, the position has been modified from a bearish-leaning short call spread to a more neutral iron condor position that profits as long as IWM remains between $86 and $79.
The accompanying chart displays the range IWM would have to remain in for the iron condor to realize its max profit.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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