Mar 11, 20236 min
Hi Wealth Builders! 👋
It's been another tough week in the markets with the latest collapse of Silicon Valley Bank scaring investors and making them wonder if this is just the tip of the iceberg of more problems ahead. I've received a few questions on this from our members so today I wanted to share my understanding of what happened:
Silicon Valley Bank (SVB) is a bank in Northern California that focused on servicing technology companies, venture capital groups, private equity firms, high net worth individuals, and other customers. Over the past two years, SVB experienced lightning paced growth which almost tripled its deposits to $189B so they had to find places to invest those funds, which they put into long term bonds.
As you all are well aware from our weekly updates over these past few months, we are currently in an environment of aggressive rate hikes so interest rates have been increased dramatically over a short period of time. For SVB, this had 2 impacts:
Higher interest rates led to less availability venture capital funding so many startups (a core segment of SVB customers) started drawing on their deposits
Higher interest rates means the long term bonds that SVB was holding was now priced lower (because investors can get a higher interest making long term bonds past years less competitive).
Both of these potentially impacts SVB's liquidity. However, yesterday afternoon when SVB announced they had sold some of their assets at a loss, this "potential" became reality in the investor's minds and catalyzed by many venture capital firms recommending their startups to pull out their deposits, SVB collapsed and is now in receivership with the FDIC.
Reflecting on this incident, I have two main takeaways:
Always do your homework. The impact from higher interest rates on SVB loan assets meant SVB had to report unrealized losses on their financial reports so some astute investors may have noticed that the losses are way to big for a bank of their size
Diversify! Mass media is currently saying that SVB failed because of its concentration on the technology industry. This is true but I think the bigger truth is what happened to SVB today can happen to another bank tomorrow focused on a completely different industry. It's impossible to keep an open eye on everything at all times so diversifying helps you manage your risk and limit your losses when events like this happen.
*There's nuance between AFS (available for sale) and HTM (held to maturity) securities which I'm happy to discuss in a dedicated blog post if anyone's interested!
Heat Map📈
Here's this week's heat map:
How's the S&P500 doing?📊
SPY
The S&P 500 close this week 4% lower with the decrease accelerating into the weekend. This was mainly driven by investor fears around bank liquidity (e.g., SVB collapse we discussed above). The hotter than expected jobs reports added to this fire as markets are gradually believing the Fed will increase rates even above what was previously expected.
Steve's Trades
1. AAPL Cash-Secured Puts:
Expiration Date: April 14, 2023
Step 1: Have $13,000 of cash as collateral
Step 2: Sell 1 $130 strike put option (delta -0.10) for $80
Credit/premium received: $80
This position expresses that you are willing to buy 100 shares at the strike price of $130. If the shares are assigned to you, we can start earning premium from covered calls on this new position.
2. AAPL Bear Call Spread:
Expiration Date: April 14, 2023
Step 1: Buy 1 $180 strike call option (delta 0.02) for $8
Step 2: Sell 1 $160 strike call option (delta 0.21) for $128
Step 3: Set a buy-stop order of 100 shares at $159
Credit/premium received: $128 - $8 = $120
Ask Steve 🤔
Q. My question is whether it's alright to go from a Bull Put Spread to a Bear Put Spread to keep the integrity of The Wheel Strategy. I've been looking online for an answer and I feel like I got this question wrong, but maybe it's because I clicked on a link with a similar but different question. I'm still a n00b and I'm going to start from Lesson 1 if that helps. Thanks! P.S. I think you're a brilliant teacher, thanks for everything! :)
A: Thanks for the positive words! A bull put spread and a bear put spread are different trades. If I set up a bull put spread, it’s similar to selling a cash-secured put, with the only difference of purchasing an additional further OTM put option. If I have the intention of starting a wheel and the underlying stock drops to the strike price of the sold put option on the day of expiration, I will want to purchase 100 shares at the designated strike. Once I am assigned the 100 shares, I will want to sell a covered call against my new 100 shares to continue to collect premium.
Q. When you go from a Cash Secured Put to a Bull Put Spread, isn't there a Bear Put Spread in between? So I'm saving a step and Averaging Down on positions I need to buy anyways, if my Wheel Strategy tanks with the Market. Essentially, I don't have to expect The Market to go up as much if I do it correctly. Is this the right mindset? On the Flip Side, I would be saving a move by Averaging Up on positions I need to sell anyways. Thank you
A: The difference between a cash-secured put and a bull put spread is that a bull put spread has one additional purchased put option. A cash-secured put is a 1-leg trade, whereas the bull put spread is a 2-legged trade.
Yes, you can average down your positions by selling CSPs. However, you may want to be intentional with buying another 100 shares at a lower price. Beware that if the underlying stock continues to drop, you will incur an unrealized loss since you will be holding on to multiple shares.
Q: Hello. When I set up a bear call spread, I read that step 3 is to set a buy-stop order of 100 shares. Does that mean I need collateral of however much 100 shares of that stock on hand in order to cover myself?
A: Correct! You must have enough collateral and be willing to purchase 100 shares at the selected buy-stop order to cover yourself just in case the stock rallies up and expires at or above your second leg of your BCS.
Side note: We typically pair our covered calls with a BCS in a 1:1 ratio and use margin to purchase the 100 shares at our buy-stop order. In theory, if our shares get called away from our covered call at expiration, this will release our capital which should cover and replace most of the margin we used to purchase 100 shares at the buy-stop order. However, there is a risk that the underlying stock may rise and trigger the buy stop order, but then drop below our covered call strike and expire there, leaving us with 100 extra shares bought on margin. It is important to understand the risks involved with margin and BCSs before executing a trade.
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Remember that we are a community of wealth builders at all different levels, so be positive, kind, and helpful to others, so we can help each other get to financial freedom much faster.
Have a wonderful weekend! It looks like we are slowly going higher! 😀
-Steve and the Call to Leap Team
The following article is strictly the opinion of the author and is to not be considered financial/investment advice. Call to Leap LLC and the author of this article does not claim to be a registered financial advisor (RIA) or financial advisor. Please visit our terms of service and privacy policy before reading this article.