Thursday, January 7, 2016

Probable Bullish Opportunity In SPY Call Options Here - Also Bullish ETF Trade Ideas

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There have been 2 consecutive days in a row with a greater than 1% gap down.  Going back about 20 years, that has happened 29 other times.  And based on the historical stats on this, it shows a very probable short play on the weekly call options, in this case the ATM call expiring next Friday.

Some further refinement of these scenarios shows that 20 out of 29 times, the next day showed at least some intraday loss.  However, the average gap up the next day was 0.86%.  So that tells us that it has been pretty common place for these market environments to show a gap up followed by a quick sell off to retest the low, and then a sharp 3-4 day rebound rally to follow.

I also ran some scans looking at times when SPY closed below the lower bollinger band 2 days in a row, and when daily stochastic was oversold with a "panic selling" environment, and they all showed bullish trade opportunities on the historical stats with the 1 week time frame being the greatest reward to risk opportunity in the options.

So it seems that the play here would be to set a limit order to buy a SPY Jan 15 expiration option 192 or 193 strike call.  Set the limit order a little below today's closing value.  I would suggest the 193 strike call with a 2.75 limit order.

Then based on the stats a limit order of 40% gain could be used to exit the trade.  That order provides the optimal expected value.  The Kelly Bet % is very high at about 50% of the account value.  But the number of instances is only 29, so I would reduce that fraction to about 1/3 of 50%.

For the EQUITY side of the trade.  The optimal play would be to buy tomorrow, probably with a limit order about 0.5% below today's close, and then set a 7.25% stop loss level and a 7.25% limit order to exit at a profit.  Even though the losses maximum loss would be as big as the maximum gains, the skew is so positive that it creates a very favorable time to enter on the long side.

A 4.75% limit order and stop loss would have an expected value that is not very much lower, but the loss limit is smaller and may be another option depending on your management parameters.

The trade stats are so positive here that this trade could justify entering the whole account in a 3x long ETF.  The historical stats suggest that.  Obviously that creates the possibility of major drawdowns.  But it produces the optimal account growth for a positive system.

Let me know if there are any questions here.


1 comment:

  1. The equity trade should be exited by Wednesday's close whether or not either stop or limit orders are hit.