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.