Bullish Set-Ups Continue Based on Historical Data

SPY prices broke below the late September low on Friday, as well as below the August closing low.  This may mark a point where a short covering rally begins by the smart money.

Stats for gap downs greater than 2% show a profitable 1 week call option purchase at the close of the 2% gap down day.  The win rate is about 66%.  Kelly bet % is around 20%.  The limit order to exit the trade for maximum expected value is 70% gain.

The equity set-up is also bullishly skewed.  Paired stop loss and limit gain orders of 6.5% show a 5 day expected value of 1.39% on historical data if exiting at the close 5 days ahead if the orders are not hit.  Kelly Bet stats justify full 3x leverage on the bullish trade.  So the expected value with full 3x leverage would be about 4% for the upcoming week.

Based upon the pattern develop here in stocks, I think stocks could rally from here and then meet resistance in the 199-204 level on SPY.

Let me know if there are any questions on this analysis or your specific trade situation.


Pete

Today's Action In Context - SPY Down 3% After a 2% Gap Down

Click on Stats to Enlarge

This table looks at previous instances of days when SPY gapped down 2% and then closed down greater to or equal than 3%.  Data goes back 20 years and does not include August of this year (which wouldn't change it).

What we see is consistent/profitable bullish opportunities on average.  In this case, the stats look at a 5 days hold, which is the maximum closing return on average.  77% close higher 5 days later, with the average gainer up more than 4%.  The average total expected value, including the losers, is 2.7%.

The few instances that were losers were basically in the waterfall declines preceding sharp bounces. So they still had 3-8 days before bottoming out in the short term and putting in a sharp rally.

So the stats here don't add that much to the earlier post.  If tomorrow gaps down, I would expect an even stronger stat profile, but obviously instances are getting fewer as well.

Again this is short term info in the context of a probable continuing downtrend.


Pete

SPY Gap Downs of Greater Than 2% - Short Term Bullish Option Play

Today SPY gapped down over 2%, and so I looked at other times when SPY gapped down over 2% while the weekly MACD was down.  The short term stats show a clear upside bias for about a week.  The peak closing gains in the short term were 6 days out.

Looking at the options part of the assessment, based on my pricing model, an ATM call option purchase with 2 weeks until expiration would provide the maximum value play.  The maximum expected value would be to enter the trade and set a limit order of 160% gain to exit.

Local maximum expected values occurred at 40%, 80%, and 160% limit orders.  The stats below show the overall trade stats.  Given the current market environment, I feel that the 40% or 80% limit order would be more appropriate for the market overhead resistance.

Which ever the case, they are positive EV plays, and the position sizing would vary depending on the exit limits.  The Kelly Bet % will give guidance on that.  And psychologically, an 80% win rate trade like the 40% limit order is nice in that it gives frequent wins and reinforces sticking to solid trades and planned exits.

This shows the stats for a 2 week till expiration ATM call exited with a 160% gain limit order.  This gives the maximum expectation at 30% per trade.

This shows the stats for a 2 week till expiration ATM call exited with a 80% gain limit order.  This has a higher win % at 66% but a little lower expectation.

This shows the stats for a 2 week till expiration ATM call exited with a 40% gain limit order.  This gives the maximum win rate at 80% but a lesser expected value of 12-13%.

I personally took the trade and have the 40% limit gain order in place to exit, which would happen on only a partial fill of today's gap down within the next couple trading days.