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Less than 12 months ago, making money in the market seemed so easy. Straight calls, calendar spreads and call ratio backspreads worked quite well when the VIX hovered around the low teens. Time brings change and trading the markets with options over the past six months has been quite tricky for many students. These same strategies have been underperformers to say the least. So which strategies have been working?

Many people may refer to their notes to identify which strategies can be applied during times of high IV, including debit spreads, credit spreads, butterflies and condors. In theory, these strategies should work just fine (well, perhaps not the last two unless you are trading with a bearish bias). But when you pull up a chain on the stocks that your system highlighted, you notice a very wide bid/ask spread that makes option prices expensive. This is due to the high implied volatility [IV] of the options. If you try to trade a strategy with two or more legs using options with a wide bid/ask spread, you will undoubtedly experience massive slippage. And if you just can’t win right, it’s best to sit out on the sidelines.

Regardless of whether you are just starting out or if you’ve been trading for a while, there’s nothing wrong with taking a step back. Sometimes paper trading and working away at your options education is a good strategy to follow until the market either returns to the “good old days” or you’re confident enough to tackle the beast.

Thankfully, there is at least one stock out there that is still tradable as it won’t be too far behind the eight ball from slippage (the difference between the bid/ask spread). Citigroup (C on NYSE) is the world’s largest investment bank. This company has been heading down since May 2007 and is in the midst of the sub-prime mortgage debacle. It also happens to have a very nice setup in January this year.

As with all other big financial institutions such as Deutsche Bank, Merrill Lynch and Bear Sterns it has been getting walloped. Why is this so? The firms take positions in the market that we can’t comprehend. When the sub-prime problems emerged, the liquidity evaporated and these companies are locked into trades worth billions and billions that they can’t unwind. Each day the market moves against them they take another big hit. This is why they continue to report large write downs.

Since Citi is one of the world’s largest companies, a lot of stock, as well as options (~200,000 contracts), are traded each. There are so many buyers and sellers that even though the IV is very high, the bid/ask spread is still tight. This provides us with an excellent opportunity as we are close to breakeven upon entry. Figure 1 shows a recent option chain of Citi. Take note of the bid/ask spread volume and open interest.

Figure 1: Citi Option Chain
(source: Platinum)   

When a stock is in a strong trend, a call credit spread can be a profitable strategy to employ. Why? Since there’s no need to question where the stock is going, but we do need to know is where it isn’t going. Figure 2 below shows a stock chart of Citi.

Figure 2: Citi Daily OHLC chart
(source: ProfitSource)

From your Home Study Course and 2-Day Seminar attendance, you may recall the old adage “bottoms become tops” (support becomes resistance) and “tops become bottoms” (resistance becomes support). The low in November 2007 at $29.50 stands out. If you look back overtime, you will see that the price level (~$30) has acted as support on several occasions (April-June 1998, March & June 1999, March 2003, November 2007, and December 2008 for a couple of days). When it broke through and closed below this level on three occasions, it was time to look for a trade on the pull back. This occurred on January 10 as this strong area of support is now likely to become resistance. Selling a call at this level and buying the next strike up as protection formed a very nice looking call credit spread. Figure 3 specifies this trade.

Figure 3: Citi Feb08 30/32.5 Call Credit Spread Risk Graph
(source: Platinum)

You can see with a little shaving, there is only $6 in slippage. This trade has a max profit/max risk of 27% that will be achieved should Citi close below $30 on February 15^th expiration. With credit spreads, always look to trade options with less than 45 days until expiration and aim to hold the position through so that both options expire worthless.

Citi is approaching its 2002 lows. Since the tops in 2000 and 2006 came in at similar prices, it wouldn’t be too unrealistic to expect the lows to do the same. If it breaks through $24.48 (2002 low) with momentum, then the next stop could well be ~$15 mark. As homework I suggest you look at the turning points since October last year and see whether these price levels coincide with significant turns since the late 1990s. Those with access to the Platinum site can also test to see how trading some of the other high IV bearish strategies would have performed on Citi.

The current market volatility has changed the trading landscape from a year ago. As traders, we have to adapt to the new environment. I hope this article has given readers a stock to explore if they have been a little at a loss of late. It is amazing how history repeats itself!

Happy Easter to all of you and remember never to put all your eggs in one basket!


Guy Halpin
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

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