Possible Short-Inverse Set-Up Early This Week

Today stocks are off to a stronger start, but in the context of many things that I am looking at, this could be the last little rally before a strong sell-off resumes.

On a purely objective, back testing basis, a 2% + rally today on lower volume would really fit the bill of a high probability inverse/short set-up.  I have probably posted about these days before, but since most of the market time is not in high volatility down trends, this scenario does not come up often.

Now I won't have all the data until we see what happens today, but if today closes up 2-3% on lower volume, my suggestion is to BE OUT or GET OUT of this market if you are holding positions.

For those of you that are unaware, we currently are in the midst of a never-before-seen level of option speculation on further upside in the market.  In my experience, this speculation will always be unwound or punished.  It is just a matter of when.

Without getting into chart or numbers, I believe that a large amount of the stimulus $ created and distributed this spring and summer has found its way into speculative markets.

• There has been massive call option speculation 

•  This has created a probable "forced" stock buying in mass quantities by market makers who sold the options

•  As the options expire, there will likely be mass quantities of stock to be sold for market makers to get back to neutral positioning

• A huge volume of these options will expire this week, and so it would seem like there will be an underlying down pressure on equities as this week begins to wind down and move to next week. 

 Since this speculative option bubble is greater than anything seen before, the reaction and fallout from it, will likely be larger than what most historical corrections would be.

The call option orgy really got crazy from June through August.  

While it seems crazy, I think that it is very reasonable, and I would actually put greater than 50% odds that the stock indexes in general will fall back below the March lows before the speculative unwinding is complete.

Cycle analysis that I follow shows mid this week as a short and intermediate term cycle high, with a very strong downward phase projecting into mid or late October.

Pete

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

Click on Stats to Enlarge

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.


Pete

Short Term Option Profit Opportunity in SPY - Brief Rebound Likely Within the Next Week

Today I ran a scan for the following conditions going back to 1995:

• SPY closes down more than 2.25%
• SPY gapped down at the open
• Daily and Weekly MACD are in the down position

This describes Monday session.  If we add the condition that the next day gaps up, then the results are even stronger.

But this shows a very profitable short term option play by buying 1-2 weeks of time on the ATM option and setting a limit exit order at 40%.  The Kelly Bet fraction is very high at nearly 60%.  The win rate is very high at about 88% over the last 20 years.  This data is based on a model of option prices with some reasonable and maybe slightly conservative assumptions built in.  But the data shows a positive short term gain in the equities over the next 1-2 weeks.  And the average max gain over the next week is 4.7% in the equity and 6.2% over the next 2 weeks.

So the odds suggest high volatility, with a strong chance of at least a brief rebound which would produce a profit within the next 5 days.

I have an order a little below the market to buy the Oct 9 calls at the 189 strike price.  Then the limit order would be 40% to exit.  


Pete

Exit SPY and MU Call Options

If you took any of the trades suggested in the comments earlier this week, the SPY trades should be up in excess of 100% currently and I would recommend exiting today rather than wait for tomorrow.

The MU calls are also in a modest profit of around 50% and I would suggest exiting them with a market order currently.

My feeling is that we will see another pullback and retest of this week's bottom relatively soon, but I don't have the definite stats to suggest any trade here currently.


Pete

SLV Option Update Heading Into Jan 2015 Expiration

As a follow up again to the current call options I am holding in SLV, I have Jan 30 expiration $17 strike calls.  They were purchased for 0.13 per contract on 12/19/14.

I just exited about half of those contracts for 0.71 which is about 440% gain.  I am holding the other half with a limit order to exit at 1.43 currently.

Currently the hourly charts of SLV are demonstrating loss on momentum and some divergence.  And given the fact that SLV is not too far from the 17 strike, it would be a shame to hold the whole position and see a pullback into next week basically take at 400% gain down to nothing.  So by exiting here I have guaranteed a profit on the whole position, and am awaiting my limit order to hit or expiration to come at the end of next week.

I made a post here linking to a TradingView post I made about SLV noting that it may be set for a vertical rally.

I exited the other Jan $15 strike calls on expiration day for about 150% gain.  They were purchased for 0.75 per contract on 11/13/14.

I am just posting this here because for the individual trader, without automated trading decisions, it is times like these that will make or break the profit.  So hopefully by thinking through a scenario like this you can improve your own trade management ability and plan contingencies.

Pete

SPY Aug Call Options - Exit

Click Chart to Enlarge

This chart is a 15 min chart of SPY.  I have held a couple contracts of the Aug 191 calls on SPY based on the VIX and put/call extremes I have recently highlighted.

So now options expire tomorrow and so I am looking at fine tuning the exit.  What I show above is an external retracement of the decline from Monday to Tuesday as well as an external retracement of yesterday afternoon's mild pullback.  There is an overlap of a couple fibonacci levels at 195.35.

I have had a limit order to exit half the contracts at 4.25 which would roughly correspond with the 195.25 level on SPY.  So this short term analysis confirms that as a reasonable short-term target.

I have another limit order to exit closer to a fill of the gap at 196.98.  The limit order is for 5.40 which is about the middle of the gap down from 7/31/14.  That would not even take a 1% rise in SPY to achieve that level, so it is within reason that it could be hit within the next two trading sessions.

The set-up for taking a put or inverse trade is not yet developed, though as we move through expiration I will be keeping an eye on that possibility.

Of note here, while I don't have quantification of this idea, I have consistently noted a tendency in this bull market for prices to generally rise into options expiration, and to experience the most significant corrections following options expiration and into the 1st or 2nd week of the next month.  So, if this little rally here is a sucker rally in a larger scale correction, I would expect the move to the downside to pick up as this month ends and September begins.  Nothing magic here, just one of the cycle at play in the market that can fill out the picture of an otherwise appropriate technical set-up.