I think it’s about time we start talking about dot plots again.  The markets are in an uptrend and they have been quite resilient to every piece of negative news so far this year.  Is the Producer Price Index report the straw that breaks the camel’s back?

Producer prices in January rose far more than expected, which brings inflation and Fed Funds rates and dot plots back into everyone’s minds.  The December PPI dropped -0.5%, but January’s reading skyrocketed to a positive 0.7% change month-over-month.  

Even the year-over-year numbers finished higher going from a 5.5% reading in December to a 6.0% reading in January.  

The only number that came out remotely good was PPI excluding Food, Energy & Trade Services year-over-year.  

It wasn’t that long ago that the Fed reduced rate hikes to 0.25 basis points, but now Cleveland Fed President Mester said she saw a compelling case for a +0.50 basis point rate hike.

And now the dot plot of the Fed Funds rate will probably edge above 5% before all is said and done. But is this news really affecting the market?

Even though the market sold off yesterday – the S&P 500 (SPY) lost over 1% – we’re still holding the long-term trend that started before 2023. Sure, we need a higher high soon, but right now we’re still holding the trend line.

If we zoom out to the weekly chart, we can see that we’re still in the uptrend that started in October of last year.  I’m looking for the 400 level to hold (4000 on SPX).  That’s only about 2% away from current levels.

And if we go out even further to the monthly chart, we can see a similar support line at 400 and possible resistance around 415 and then up at 430. 

So, while the news seems a bit bearish, the reality is the market needs a pullback from current levels, but the positive trends are still in place for the time being.

With that, let’s see if we can find something to trade…

With the market being closed on Monday, this is a time that I like to use the calendar and diagonal trades to take advantage of time decay. Using a combination of short-dated options and longer-dated options usually works well in this situation.

This time around I’m looking at something called a double diagonal trade. As the name suggests, it’s simply two diagonal trades using the same ticker.

I’m going to use the S&P 500 (SPY) because it’s cheaper to set up the trade. You can certainly use the SPX but just remember it’s 10x larger than the SPY and if this is your first time trading a diagonal or double diagonal, well, you should do it in a paper trading account first, but certainly not go right to the SPX.

I’m going to set up my short strikes by looking at next Friday’s expiration. Next, I’m going to look to sell a 0.30 delta call and a 0.30 delta put. I like waiting until the afternoon to place the trade, so everything I show you here is for educational purposes only. I’m looking at pre-market deltas, which will shift as soon as the market opens.

Here are the two options that I’m looking to sell (again, based on pre-market deltas, so I will be trading different strikes than what’s listed here).

STO 24-FEB 414 call
STO 24-FEB 402 put

The trade as it stands has unlimited risk since you’re selling two ‘naked’ options, but I know plenty of traders who do this trade in a portfolio margin account. You can see that it looks a little similar to an iron condor. The market can move in either direction by 2% and the trade is still profitable at expiration.

But I’m trading in an IRA account and I don’t like the phrase, ‘unlimited risk’ so I’m going to create a double diagonal position by purchasing two options to offset the options I’m selling.

I’m going to add 14 days from the expiration date of the options I’m selling, to find the options I’m going to buy. That means I’m looking at 10-MAR expirations.

Because I want to keep costs down, I’m going to buy a call and put one strike price further out of the money than the options I sell. If you were doing this on the SPX, I’d look for 10 strikes higher and lower.

These are the options I’d look to buy.

BTO 10-MAR 415 call
BTO 10-MAR 401 put

To enter the trade, you can enter all legs at once:
STO 24-FEB 414 call
STO 24-FEB 402 put
BTO 10-MAR 415 call
BTO 10-MAR 401 put
Net debit: 4.62 + $100 in margin, so a total buying power reduction of $562 to place the trade

Here’s the risk graph of the entire position.

The current price is in the middle of the tent and the SPY can move as low as 399 or as high as 417 by expiration and this trade will be profitable.

Since the market is closed on Monday, I want to get out of the trade when it opens on Tuesday. Using the simulated profit/date of 2/21/23, this is what the risk graph would look like, assuming SPY stayed at 407.

That’s potential to make $71 on a $562 investment by taking advantage of the market being closed an extra day. That would be a 12% gain in three calendar days.

It’s not likely to stay right in the middle, so with these trades, I tend to set a profit target of 10% of the debit price. In this example, that’s a $46 profit target, but you can certainly push for more. Your mental stop would be if the underlying trades above or below the breakeven points.

That’s it for me this week. I hope you had a good week of trading. We will be back on Tuesday for another week of market stories and educational trade ideas!

If you have any questions, comments, or anything we can help with, reach us at any time.
Email: [email protected]
Phone: (866) 257-3008

Jeff Wood
Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.