Monday, February 13, 2017

Expectations Tipping To Short Term Sell Off - A Day Trade Perspective 2-13-17

Currently stocks have been rising on low volatility and hitting new 52 new highs for a few sessions in a row.  This post will look at a set-up which is occurring today that can be used as a day trade, but also gives further clarification as to what may occur during this week.

I made a scan this morning looking at the past performance of the following set-up:

  • new 52 week high
  • yesterday gapped up and closed positive on the day
  • today's price opened outside of the upper bollinger band
  • today gaps up more than 0.2%
So the idea here is a market that has been strong and hits a new 52 week high on a modest (or larger) gap up.

The short of it is than the intraday downside risk was about 4 times as big as the upside potential after the open (which would be today in our example).  And the average open to close change was -0.6% roughly, with data going back to Sept 1995 in SPY.

So plugging this into a trading strategy it is pretty simple to see that shorting or inversing at the open had a positive expectation in the past.  My method for the trade involves looking at not just the open to close change, but also the drawdown and run up during the open time of the trade.  In this case the expectation was increased by setting a profit limit order of 1.75% to 2.5% gain.

Also the average forward returns were negative on a closing basis for the 3 days beginning with the trigger day/today.  10 out of 16 instances showed 1% or greater max losses over the next 5 days after the CLOSE of the trigger day/today.

So from today's opening value it appears that the downside risk is predominant throughout the remainder of the week.

As a side note, with stocks gapping up today and moving up a bit in the morning after the open, the VIX has not followed its normal pattern of declining.  In fact it was up nearly 5% in the opening hour of trade today.  I have showed in the past that when the VIX pops higher, while the SPY also rises, the forward returns have been skewed to the negative in past instances.  

The skew in MAX loss to MAX gain has been about 2:1 over the following 2 weeks after a signal like this.  Currently the day hasn't closed, so I am not saying the study is active, but it has that look to it so far.  

But a simple and profitable trade strategy in the past would have been to enter short/inverse and set a limit profit order basis the SPY etf of 1.25% gain and a stop loss of 1.25% loss.  Then exit at the end of the time period in question if the trade had not filled an exit already.  The maximum profit on a closing basis would have been at 8 days forward of the signal day, or next Thursday's close.

Now the stats on these etf trade are such that a large amount of leverage could be used correctly based on performance stats, so a 3x inverse etf or a deep in the money option are other possibilities to take advantage of the set-up here.

I know this is looking at short times frames and low volatility moves, but the example shows how profits can be potentially made with consistency when the time is right.  We will see what happens.


Thursday, February 9, 2017

Put Option Trade Opportunity in SPY, 2-9-17

Click on Table to Enlarge

Currently with today's action I have run some scans and there is a significant opportunity here, though with a smaller sample size on the past instances.

The scan criteria was:

  • SPY at 52 week high
  • VIX closes less than 15
  • VIX closes down 5% or more on the day
Only 11 instances show up, but the skews over the next couple weeks are negative and provide profit opportunities.  8 out of the 11 past instances showed gains of 80% or more over the next 5 trading days, when buying an ATM option with 5 trading days until expiration.  This is based on the model I have programmed, NOT on actual past contract data.  But the model is probably slightly conservative on average in the theoretical returns calculated, because almost the entire time value of the option is stripped out of the result.

So a simple trade opportunity here on the options would be a SPY 231 put option with a Feb 17th expiration.  Limit order for entry 1.00.  Exit limit order 1.80 after entry.

All 11 instances in the back test traded higher the next day relative to the closing value.  So expect there to be at least a very small drop in the option value tomorrow relative to today's close.

Another point of note here, even a couple instances on the list where the decline was only about 0.5%, showed a 80% gain in the option value.  So the implication is that with the VIX this low, even a small drop could pop the VIX a few points.  And by the numbers on it, SPY would have to decline less than 0.5% to reach the break even point.  7 out of the 11 past instances declined over 1% which would be ~100% gain or more on the option.

The ETF side of trading also shows a profit opportunity but the volatility being so low, the absolute return expected is rather marginal over the short term.  Looking out 2 months though, given that the downside risk is anticipated to be greater than upside potential, a conservative play here would be the inverse ETF play.

Basically, setting a 3.25% limit gain on a SPY short along with a 3.25% stop loss on it, and exiting at 2 months from the open of the trade if not already exited by the limit orders, would produce about a 1% expected value on SPY.  Using a 3x leveraged ETF may increase the expected value by around 3 times, but the stop and limit orders would have to be adjusted by 3x% as well.

But let's say the market does falter 3% in the coming couple months, the 3x ETF could rise 9-10% while the market turns negative.  That would be a very nice swing in an account versus just holding.

Let me know if any other info is desired here.


Put/Call Ratio Analysis Helps to Identify Stock Price Tops and Bottoms

Click on Chart to Enlarge

The chart above is a slightly different version of one I have shown many times over the past several years.  This chart is a 7 day average of the total put/call ratio with some standard deviation bands around it.

The interpretation of the chart is pretty standard for technical analysis.  I like following this data because it is not looking at price.  It looks at a measure of underlying "sentiment" as evidenced by large scale options transactions.  So price is an effect of other underlying causes in the crowd.

I have made a mental construct over the years which likens the movement of market prices to physical movement.  Once a direction is set, there is an inertia, and other than UFOs, we typically see a process of slowing or momentum changing prior to a shift in direction of the object.

That "slowing" before a change of direction is evidenced by divergences.  So we have a situation where the direction of the market in this case is still "up", but the put call ratio is showing a marked divergence indicating that the underlying sentiment or driver of prices higher is actually slowing down.

As noted on the chart with red and green lines, the general idea here is to look for an extreme data reading, outside the bollinger bands indicating that the trend may not be sustained at that rate.  These extreme points are typically NOT final highs or lows.  The actual end of a move, will most often occur after a divergence develops, with new price extremes, but often markedly non-confirming put/call ratio readings.  And the reading at the end of the move are usually well within the deviation bands, and so do not appear significant on their own.

My point here is to give a little perspective but to make note of the classic divergence pattern here in the sentiment which has put me on alert that we are near the end of this rally since November.  And we are likely to see at least a minor correction occur of the uptrend.  It has been ~2 months since the extreme reading in the put/call ratio occurred.  And my observation of this types of divergences is that a trend often persists for several weeks after the extreme before a final price high or low.  If I had to make a guestimate of the average, it would be about 6 weeks.  So here we are at about 8 weeks since the extreme, and I believe that markets are likely to peak any day now.


Thursday, January 26, 2017

More Signs That a Sell Off Is Looming in SPY - 1-26-17 Stock Market Update

With the break to new highs in SPY, there are now some intermediate term bearish divergences which are prominent.  My perspective here is that stocks have more downside risk over the next couple months in comparison to upside potential.  With that said, the most comparable environments that are showing up in my scans are environments where stocks may spend more TIME in a general uptrend, but there may be a rapid sell off which more than wipes out the lazy gains which occurred preceding it.

Click on Table to Enlarge

The table here shows the results of a scan with the following filters:

  • New 52 week high
  • Close > upper bollinger band
  • VIX high is < 12
  • VIX close is < 11
Then subsequent readings (3 of them) which occurred in clusters after the first reading were removed.  This left us with basically 2 past market periods.  
  1. Very late 2006 into early 2007 - which resulted in the very sharp sell off right at the end of February and into mid March.
  2. Mid 2014 from late June to July - which was followed by a somewhat similar brief, but sharp drop into August 2014.
Looking at the table shows a strong downside skew over the near term, however, with volatility being so low, that does not really portend a big move.  Even looking out to 2-3 months the skew is negative, and still relatively strong at 2 months.

Another notable part of the info in the table, is the very large skew in the MAX gain/loss of the VIX.  There just has not been much history of the VIX staying at 10 or 11.  So if you trade volatility, there may be an indication for action here.

In fact the expected swell in the VIX may be the most significant aspect of this set up.  There is a profitable option play on my model based on this scan.  Buying an ATM put with 2 months until expiration and using a 50% limit order gain after entry worked well on average.  But there are only a couple similar instances.  The point is more that, even a moderate 1-2% decline, in combination with a possible larger % increase in the VIX at the same time, could give the put options a boost to those levels of paper profit.

Part of the question is then WHEN a decline would be anticipated since these lazy markets can go for weeks without much downside.  I am not an independent expert on cycles, but some of the information which I have followed for long enough to feel there is some pragmatic use in, suggests that the upward current could crest somewhere around next week.  Then there may be more downward current (or at least less upward current) into early March.

So my general take here is that there will not likely be much further % gain in SPY over the next couple weeks, and then there may be a sharp but brief sell off in the Feb-March time frame.  Given the low volatility and the couple past comparable time periods, if a decline occurs, it may be expected to be mild, like 2-5%.

I am choosing to make an option play here, but certainly a paired limit/stop order on a SPY leveraged ETF, or even on a VIX tracking ETF could be very sensible given the skews in the data over the next couple months.  

If there are further specifics on trade orders for the ETFs, comment or reply, and I could get something up here.


Monday, January 9, 2017

Bearish Trade Stats From Recent Set Up

Click to Enlarge Stats

On December 9th and December 13th a trade set up triggered which has had a consistent and marked bearish skew looking ahead a couple months or more.  I did not remark on it at the time because the technical analysis was pretty clear to me that any immediate pullback was likely to be modest and that further bearish divergence would likely develop.

However, I will now make not that this set up is active and still in a range where it could be acted on,

The scan is as follows:
  • daily MACD position is UP
  • daily MACD lines are both above 0
  • SPY closes up for the day
  • there is a total put/call "sell" signal (5 day average is below 1 st dev bollinger band)
I removed subsequent readings from clusters with multiple signals after the first in a 2 week period.

The stats above are for an ATM put option with 2 months until expiration if purchased at the signal, in this case on Dec 9th.  Past instances show peak expected value at 120% gain on the option, but the 90% gain mark puts the win rate at 67% with only a slightly lower expected value.  So that is the stat shown here.  The stats are nice here, and would suggest that a 226 to 228 strike SPY put could be purchased with a standard february expiration, and then set a limit order of 90% gain to exit.  There would be about 2/3 chance of winning based on the stats, and the expected value is around 26%.

Click to Enlarge Stats

In this case, the equity stats have a strong skew and a nice trade set up as well.  Using the simple methodology I have designed for trading these situations, you enter inverse on the set-up and then set and equal percent stop loss and limit gain order.  If neither are hit (which is MOST common) you exit the trade a predetermined time.  In this case it is a 2 month time exit from the initial entry, which would be Feb 9th.  

The stats shown above would be for a short of SPY and then use a 6.25% limit gain and stop loss or exit Feb 9th.  Basis the SPY etf the expected value would be about 2.25%.  But the stats justify 3x leverage.  And so the theoretical stats there would be about 6.75% expected value.  That is pretty nice for an "equity" play when the market is anticipated to fall.

In this case in you buy a 3x inverse etf like SPXU then the stop would have to be 18.75% away from the entry and the limit order the same.

So these stats are certainly actionable by my criteria for trading.  And I also looked at times when there was a put/call "sell" signal at a new 52 week high, which also was the case in December.  And there was a bearish skew looking out 2 months, which also showed profitable stats using a limit order of 140% gain on the ATM put option.  I simply note this to say that even though stocks are at all time highs, the signal here still seems to be legit.  

And now that some time has burned away and some divergence has developed in the technical analysis, I think there is higher chance of stocks moving down with minimal time decay on the options.  In fact the option price is lower now than at that point, and so the value may be better.

That being said, I think it is likely that SPY could move higher for a couple more days to create an hourly time frame bearish divergence.  If so, that could be a fine tuned entry point.  I have a limit order to enter a position based on a move up to the 228 region in SPY.


Multiple Time Frame MACD Divergence In SP500 - Correction Or Bull Market Top Ahead?

Click on Charts to Enlarge

The charts here are the SP500 cash for the top three (monthly, weekly, daily) and SPY for the bottom chart, which is 60min candlesticks.

The monthly, weekly, and daily time frames are all currently displaying bearish divergence at the recent high on Friday.  Given the confluence and time scale of these divergences, I believe that price may be near a crest.  While tops can be sloppy and drawn out, we have already been seeing that for about 2 years.  

Rather than prognosticate on causes and projections and patterns, what we objectively are seeing is a divergence which truly indicates a "slowing" of the trend.  And the divergences so often occur preceding major changes in direction.  So I imagine that like a ball thrown up into the air will gradually slow before it reaches its peak and then begins to travel back down, the rising market will experience progressive slowing down, until it reaches a peak and turns down.  The smaller time frame divergences, I imagine to help identify the finer timing or reaching of the zenith in price.

So much for theories.  But what has happened in the past under some similar circumstances?

I ran a scan on SPY going back to late 1995 where there was a weekly, and daily time frame MACD bearish divergence concurrent with, or within a month after a put/call ratio sell signal like happened a couple weeks ago in the current market.  I also went through and excludes most days after the first signal day if there were a cluster within a 2 week period.

There result is that there was a negative skew in forward return looking out for a couple months.  It was not real lopsided, but in anycase it does support the idea that stocks may be near a relative top.  From a probabilistic standpoint is the only way we can meaningfully approach it for trading.

The skew is not real strong but is most prominent looking ahead about 3 days and at 1 month.  At 1 month after the past signals, the average closing return has been a mild negative at -0.25%.  And the MAX loss has been about 1.3 times the size of the MAX gain.  The numbers here are not strong enough for me to suggest an inverse trade based on those stats alone.  

So there is not a lot actionable here from the trading front.  But for those who want a larger market context for incorporation into trade selection, hopefully this helps.


Tuesday, December 13, 2016

Further Signs That The Current Rally Is Mostly Done

The last couple sessions have showed what I call a total put/call ratio sell warning.  I have shown the chart many times, but the 5 period total p/c ratio is below the 1 standard deviation bollinger band.
I added several other concurrent filters to the data, and they basically all suggest a negative skew over the next couple months.  It appears most strong looking out about 2 months.

I also looked at time only in December when the signal occurred.  It was less bearish compared to the total sample.  The skew still went negative at the 1 month mark, but was positive for a couple weeks after the signal.  That would fit our current situation where we have no bearish divergence in daily MACD, and Christmas is yet ahead of us and the seasonality is still positive.

I also looked at the signal in December when the weekly MACD was above 0 versus when it was below 0, meaning the market was recently selling off.  When the signal occurred above 0, as it is currently, it was more bearish, but not many instances were present.

The FOMC meeting announcement will be tomorrow.  I think it possible that markets sell off a bit, but then still end up making more new highs.

In any case from my perspective here, I dont anticipate much further price gains in SPY for the next couple months.  Some of the stats that have showed up on the back tests are compelling for an inverse position being established here.  From the option standpoint there are profitable plays as well on the puts, but my personal assessment of the market position is that it will likely be a couple weeks or so until markets are ready to top or start to roll over.