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Rookie Blog: The Torture of Consolidation

March 25, 2021

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Hey Rookie Bloggers! Coach Holmes coming to you with the next edition of the blog. If you have been following the markets recently you may have noticed that we are going through some pretty decent swings intraday but are really not achieving much in the way of a solid direction. Check out this chart of the S&P 500 futures and you will see what I am referring to.

These kinds of markets can cause heartburn for both the Bulls and the Bears alike. Of course the cashflow traders are loving this recent price action. This change in market action can sometimes be confusing from a timing perspective and this brings a question from most traders. That question is “how do I know when to adjust my stance in the market?” Ultimately, our position in the market is what brings long term successes. Much like the markets we need to be able to change posture when the market shifts. The question becomes how do we shift and how much do we need to shift?

There are three things that need to be considered when adjusting your stance on the markets.

BIAS

One needs to determine a new bias from the existing market conditions. For example, if we look at the way the market behaved last March the market went straight from a strong Bull market to a strong Bear market in a heartbeat. Check out the chart below for reference. You can see where I circled the market action and you can clearly see that it was an abrupt change in market conditions.

This change could have taken one’s bias from a +3 to a -3 in very short order. This would have required a different adjustment setup than what we are looking at in today’s market conditions. Take a look at the chart below and you will see the area I have circled is very different in makeup from that of last March.

As you can see the aggressive nature of last year is not really presenting itself with these current conditions. Therefore the change in posture would not be the same as last year either. That brings us to the second thing that needs to be considered and that is posture.

POSTURE

How we are postured or positioned in the market dictates the damage or the gain we can expect from the market movement. If we are postured bullishly and the market abruptly turns bearish as it did last year then our portfolios can suffer greatly if we do not make immediate adjustments. If the market goes from bullish to somewhat neutral as we are seeing now then not making adjustments may be ok depending on the type of trading we are doing. For example, cashflow type trades like covered calls and naked puts may still be ok in this current environment but in the previous year’s environment would have been in jeopardy. The question is how do we know what our current posture is? This is where our portfolio delta comes in handy and more importantly our beta weighted portfolio delta. Looking at this number can give us a good indication of where we stand in relation to the current market bias. If our bias is natural, let’s say zero to +1 and our delta stands at 1200 then we are probably way too bullish in posture and may need to adjust the portfolio. This brings us to the third consideration and that is the degree of adjustment and type of adjustment technique.

DEGREE

Using our two examples, the one from last March and the current conditions, we would need different degrees of adjustments as well as different types of adjustments. Let’s take last March, just adding a few covered calls or some naked puts would most likely not be enough to trim our 1200 delta into a bearish delta large enough to offset the damage to the portfolio and give us an opportunity to possibly prosper from the bearish movement. We would need to be as aggressive as the market movement itself because our BIAS would have changed so drastically. This would have required some serious hedging or closing of many bullish positions to ensure that we had the right POSTURE in the market. This may have required going short with futures contracts or putting on bearish spreads or just outright hedging with puts although that would have most likely been problematic as the volatility spike would have skewed the pricing of the protection. With today’s conditions a simple addition of covered calls and maybe so OTM puts would most likely have enough bearish delta to get more inline with the new POSTURE of the market.

So when the market decides to get a little funky and change its tune we need to take into consideration BIAS, POSTURE, and DEGREE and then make our adjustments accordingly to stay as close as possible in line with the overall market and this way we can save our portfolio from major damage and keep that equity curve moving in the right direction.

Trade Well,

Coach “Old Money” Holmes

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