Tuesday, July 7, 2015

Bullish Short Term Divergence at Today's Reound Attempt In SPY - Forward Results Suggest 3-10 day Rally In Store

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Today's upside reversal in SPY comes in conjunction with a pronounced bullish divergence on the hourly MACD, and pronounced bullish divergences in VIX and put/call ratios.  The stage is set for a rally attempt that could be substantial based on past instances.

The signal generated today is a "3 month low" in my bottom spotting algorithm.  Times since 1995 which have occurred in a rising bull market moving average (1 year average is up) are highlighted above.

Of note is the 2 week time frame after the signal which shows an average max gain to max loss of about 2.3:1.  11 out of 15 instances showed 2 week max gains of more than 3%.  8 out of 15 showed 2 week max gains greater than 4%.

If buying ATM options with 2 months until expiration, the max gain on the call was also about 2.3:1 versus the put.  And the average max gain was 168%.   About half the instances made max gains in excess of 150%.  So if you do the math on that, it would be a very profitable trade over time to buy the call and set a limit sell order of 150%

Since the max rate of gain here is within the 2 week time frame, it seems that buying an ATM call, and setting the 150% limit order would also be a profitable trade with pretty quick expected turnaround time.

The possibility is certainly that the market will rise rapidly to fill last week's gap down, and there may be no retest of the lows today.  However, the tail is so long on today's candlestick, that from experience, I would think that a retest of the mid point of the tail on today's candlestick is probably as or likely or more likely than not.

So my strategy here is to place a limit order of 2.50 to purchase a July 31st SPY 208 call.  The ideal would be for a choppy retest of today's low over the next couple days, followed by a surge higher to above 210 at minimum.

When the signal is filtered for a down trending 1 year moving average, the 3 day time frame shows a 2.85:1.85 max gain versus loss, still suggesting a probable 3 day potential rally.  After that, all time frames displayed greater max losses than gains for those time frames shown.

So another option here would be to simply open a near-the-money trade, and close it before Friday's close. 


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