Total Put/Call Ratio Sell Warning Suggests Negative Returns Ahead

For longer term followers of the blog, you may recall my repeated notes on times when the total put/call ratio drop relative to its intermediate range.  The following chart shows the way I have tracked it for years.

Click on Chart to Enlarge

The 5 day average of the total put/call recently dropped to its lower 1 standard deviation band.  This indicates relative complacency compared to the recent range.

Now there is a seasonal tendency to lower put/call reading in December, though they still may be significant.  But today I looked at past instances where the reading came in the doldrums of the year - in this case either July or August.

It is well known that there is a seasonal tendency for increased volatility in the Sept/October time frame, and that many major sell offs historically have often been in Sept and October.  So I wondered if the current signal would reflect a tendency for subsequent market sell offs.

So I looked back through my data going back to 1995 and looked at all similar set-ups on the total put/call in July or August.  I removed any clustered signals after the first in a series so that all readings are "unique".

The short of it is that past signal did indeed lead to average poor performance and negative skews to forward price changes in SPY.

From the 1 month to 5 month forward looking time frames the average MAX loss was greater than 3 times the average MAX gain.

My options trading model shows the following data, suggesting a 200% limit order on an ATM put with 2 months until expiration would be a great option strategy.  And even better according to the past instances (only 9 instances), would be to buy an ATM put option with 2 weeks until expiration and hold until expiration.  In this case that would be basically August standard expiration.  Personally I would rather buy time into September because that is historically the most negative month for stocks.

Click on Table to Enlarge

Some additional data on the equity/ETF side of things.......

At the 1 month forward mark, 7 out of the 9 instances had maximum declines of 2.6% or more.

And at the 4 months forward mark, 8 out of 9 instances had maximum declines of 3% or more.

And using my trading strategy of an OCO limit sell order and stop loss order on an inverse ETF, the MAX return scenario would be to set an 11.25% limit gain per the SPY etf and an 11.25% stop loss.  Then exit at 4 months if neither order is filled.  That would be approximately November 24th.

Now the stats on the past instances justify using leverage of 3x or more on this move, in which case you would take the percentage numbers above for SPY, and then triple them for orders if using an ETF like SPXU to try to capture the anticipated move.

Let me know if there are questions or clarification needed here.  Volatility makes its seasonal lows around this time of year, so understand that it pays to position yourself for the times of year when the odds of a significant move are higher.  It may take a little time to unfold, but feel the indications are clear that downside risk is higher than upside potential here.

Pete

Bearish Trade Stats From Recent Set Up

Click to Enlarge Stats

On December 9th and December 13th a trade set up triggered which has had a consistent and marked bearish skew looking ahead a couple months or more.  I did not remark on it at the time because the technical analysis was pretty clear to me that any immediate pullback was likely to be modest and that further bearish divergence would likely develop.

However, I will now make not that this set up is active and still in a range where it could be acted on,

The scan is as follows:

• daily MACD position is UP
• daily MACD lines are both above 0
• SPY closes up for the day
• there is a total put/call "sell" signal (5 day average is below 1 st dev bollinger band)

I removed subsequent readings from clusters with multiple signals after the first in a 2 week period.

The stats above are for an ATM put option with 2 months until expiration if purchased at the signal, in this case on Dec 9th.  Past instances show peak expected value at 120% gain on the option, but the 90% gain mark puts the win rate at 67% with only a slightly lower expected value.  So that is the stat shown here.  The stats are nice here, and would suggest that a 226 to 228 strike SPY put could be purchased with a standard february expiration, and then set a limit order of 90% gain to exit.  There would be about 2/3 chance of winning based on the stats, and the expected value is around 26%.

Click to Enlarge Stats

In this case, the equity stats have a strong skew and a nice trade set up as well.  Using the simple methodology I have designed for trading these situations, you enter inverse on the set-up and then set and equal percent stop loss and limit gain order.  If neither are hit (which is MOST common) you exit the trade a predetermined time.  In this case it is a 2 month time exit from the initial entry, which would be Feb 9th.  

The stats shown above would be for a short of SPY and then use a 6.25% limit gain and stop loss or exit Feb 9th.  Basis the SPY etf the expected value would be about 2.25%.  But the stats justify 3x leverage.  And so the theoretical stats there would be about 6.75% expected value.  That is pretty nice for an "equity" play when the market is anticipated to fall.

In this case in you buy a 3x inverse etf like SPXU then the stop would have to be 18.75% away from the entry and the limit order the same.

So these stats are certainly actionable by my criteria for trading.  And I also looked at times when there was a put/call "sell" signal at a new 52 week high, which also was the case in December.  And there was a bearish skew looking out 2 months, which also showed profitable stats using a limit order of 140% gain on the ATM put option.  I simply note this to say that even though stocks are at all time highs, the signal here still seems to be legit.  

And now that some time has burned away and some divergence has developed in the technical analysis, I think there is higher chance of stocks moving down with minimal time decay on the options.  In fact the option price is lower now than at that point, and so the value may be better.

That being said, I think it is likely that SPY could move higher for a couple more days to create an hourly time frame bearish divergence.  If so, that could be a fine tuned entry point.  I have a limit order to enter a position based on a move up to the 228 region in SPY.

Pete

Trade Stats for Bearish Set Up in SPY 4-19-16

 Click on Stats to Enlarge

So based upon the trade set up posted earlier for SPY, the maximum expected value for the equity side of this set-up based upon my simple trade method, would be to enter short SPY and set a limit order of 2.5% gain on the short position and a corresponding 2.5% stop loss on the position.  Then IF the orders are not filled in 1 month, the trade is exited at the market (after 21 full trading days).  The expected value of the trade is 1.48% on SPY, so this suggests a ~4% expected value over the next 1 month using the 3x leveraged bear ETF.

Seeing as the past stats on that system are so positive, the stats justify use of 3x leveraged funds with 100% allocation of the account.  That would still be well below 1/2 Kelly Bet on the risk.

Now SPXU is a 3x inverse fund to SPY, but understand that it won't trade perfectly in sync.  So I always suggest using SPY as instrument to track and slightly tweak the orders on the leveraged ETF to create the suggested risk reward profile.

Click on Stats to Enlarge

The MAX reward play on the options is as suggested in the last post.  Buy the May standard expiration at the money put option (209 strike) and set a limit order of 100% to exit.

The Kelly Bet % on the 15 historical instances is 33%.  So a 1/2 Kelly Bet of about 16% would be sensible for the money set aside for options trading.


Let me know if there are specific questions of how to apply this analysis to your situation.


Pete

Intermediate Term High Likely Completing In SPY 4-19-16

I ran a pretty simple scan today on the history of SPY (going back to fall 1995).  The criteria were as follows:

• VIX high is less than 15
• 5/63 day total put/call ratio less than 0.85
• Daily MACD is in bearish divergence position

The forward returns showed a nearly 2.4 times greater MAX loss versus MAX gain over the coming month.  And buying a 1 month until expiration at the money put option on SPY had a 2 out of 3 chance of at least doubling in price prior to expiration.  So that is a very profitable speculative opportunity to buy the put here and simply set a limit order to exit at 100%.  Let it expire worthless if it loses.  There is no stop.

Also there is a dual time frame (hourly and daily) MACD divergence on today's highs in SPY.  These types of set-ups have been highlighted many times on this blog and often nearly pinpoint a significant turning point for multiday or multi week changes of direction.

So the point here is that SPY is at a lower high than the last intermediate term high in November, and SPY is displaying the type of set up which indicates a completed rally.  So the easy money has been made.  The expected returns for the next several weeks are likely to be flat or negative based on what I have looked at.  

Let me know if there are any questions or specific scenarios you want further info on here.

Pete

Market Conditions Fit With Topping In a Bear Market Rally - 10-29-15

Today I ran a few scan and one simple one that stood out highlighted the time periods below.  They were basically during the last 1-2 weeks of rallies in the last couple bear markets.  The 2002 and 2003 instances were after the bear market low in Oct 2002, but the Nov 2002 high did lead to a major decline and retest of the bear market low.  Only the April 2003 instance failed to lead to a major decline in stocks.

Mid January 2001
Mid May 2001
Aug 1 2001
Mid Nov 2001
Mid Nov 2002
Mid April 2003
Mid May 2008

The scan conditions were:

• 63 day EMA< 252 day EMA (basically long term downtrend in force)
• 5/63 total put/call ratio less than or equal to 0.83 (recent put/call complacency relative to trend)
• VIX closes below 25 (this will exclude rallies that are in major fear/decline environments toward the middle of the bear markets)

Buying an ATM put with 2 months until expiration on this signal led to average return of nearly 200% gain at expiration.

So it is certainly possible that the dramatic sell off in August was a blip in a bull market, similar to the August 2011 sell off, the bull market is in a later stage now and it is possible this is the first major rally of a larger bear market.

A low-low-high time cycle comes in next week on Nov 3rd relative to the August and Sept bottoms on the recent decline.  

The daily upper bollinger band (20,2), is currently sitting at about 210 which is 0.5% above the current highs.  It may be ideal to see a brief sell off followed by poke to new highs and a touch of the upper bollinger band before the rally completes and a significant retracement or leg down starts.  I also feel that program trades are likely to sell or profit take on a touch of the upper bollinger band.

Pete

Another Scan Suggesting Profitable Opportunity for Buying Puts 9-18-15

Click on Stats to Enlarge

I ran a scan tonight looking at times since Sept 1995 in SPY similar to our current market indicator set up and trend.  The filters were:

• 63 day EMA is down
• 252 EMA is down
• Weekly MACD is below signal line (sell configuration)
• Daily % D stochastics is greater than 75
• Today is a cross down of %K below % D in the daily stochastics (14,3,3)

Looking at the 2 month future results, the MAX loss was greater than 2 times the MAX gain in SPY.

And in the options, buying an ATM put option and holding until expiration would have been a winning play with a few real big winners which basically occurred in the context of bear markets, where a rally had occurred and stocks sold off hard in a continuing down trend.

The EV of the 2 months ATM puts was 45%.  So this fits right in line with the recent scan I showed where the stochastics was overbought in a downtrend.  

So basically from the stats there seems to be a roughly 50/50 chance of a substantial sell off.  If there is a sell off, it may be substantial.

In follow up to the recent comparison of our markets to past "crash" markets over the last 20 years, there has been a pretty consistent time pattern of the post crash retest of the crash low.  And it has occurred in about 5-7 weeks in the 5 instances I highlighted in the linked post.  That time frame would put us in mid October, right around options expiration.  And that time frame would fit with an ideal seasonal bottoming time frame.

Given the technical indicator set up, it may be expected for a sell off to new lows below Aug 24th in SPY, followed relatively quickly by a rally attempt.  I would anticipate the 177 level on SPY as being a Fibonacci support level if 8-24-15 low is broken.

Pete

Complacency In Market Suggests Downside Skew Over Next 2 Months

Click on Chart to Enlarge

The chart above shows times since 7-1-2007 where my proprietary real money daily sentiment gauge was at a relatively extreme low level which correspond with Friday's level.  Notice that all of the data points occur in this bull market, and most towards the later stages.

In any case here the point is that in the current bull market, when the levels of real money fear has been this low, there has been a marked downside skew moving forward over the short to intermediate term.  In fact, over the next 2 weeks. the next month, and even over the next 2 months, the max downside was over twice as large as the max upside.

The only cluster that showed an immediate upside skew was really the May 2013 period right as stocks were breaking into a new all time high after a sideways consolidation.  That is similar in context to where the market is right now, so maybe that is significant.  But after that instance, price chopped slowly high for 2 months, and then sold off rapidly in 2 weeks back to the exact level of the beginning of the cluster of complacency readings.

Basically there are 8 relatively unique clusters within this selection of filtered data.  And only the May 2013 cluster ( 1 out of 8 ) was not a solid intermediate term exit point for stocks when looking out 2 months.

Also the average maximum gain of an at the money put was 4.5 times as great as the max gain of an at the money call.  These are with expirations exactly 2 months from the day of purchase.

The average maximum gain on the put was 150% if only buying at the first signal of a cluster and including the "loser".

Basically 3/4 of the instances increased over 100% max gain for the put.

So it seems that if the market dynamics are similar here to what they have been during this bull market, it would be a solid trade to buy the put here and set and 100% limit exit order.  Now I think that using my bottom spotting indicators the exit could be more fine tuned, but for simplicity it seems like the simple 100% profit target would be a strong positive expectation speculative play.

As an alternative, for the investor, a put option hedge could be placed here if holding a heavily long portfolio of stocks.

I am already positioned with a downside bias here and don't plan to add on this signal.  But it seems likely to me that the Nasdaq Composite will run up a couple percent and eclipse the 2000 high before a possible significant decline.  So that is another factor here to follow.  Watch for a top reversal candlestick or possible failed breakout on the Nasdaq at which point to initiate the hedge or put option.

Pete

LB Puts

Click on Charts to Enlarge

Today I purchased a couple contracts of LB Sept 62.50 put options on LB, Limited Brands.  Typically I like to purchase a longer amount of time, but on this trade I am looking at a potentially competed rising wedge in LB, in conjunction with a short term overbought general market with some hourly time frame divergences.  I am setting a limit order of just over 100% gain to exit the trade, which may only take a 3-4% move down over the coming week.

I entered the trade in the afternoon for 0.95 per contract.  I am setting a limit order of 2.00 to exit, GTC.

The charts above are weekly, daily, and hourly.  The weekly stochastics is in the overbought position below the recent bull market high.  The daily stochastics is in the overbought position.  And the hourly momentum shows a bearish divergence between the current highs and the highs last week.

The chart pattern appears to be a rising wedge and contracting triangle.  The current move has over thrown the upper boundary of the wedge, and from a charting standpoint, this is the type of action often seen at the end of a pattern.

It is interesting to note the key points in the pattern.  In the current move up over the last month, the sales report came out and led to a gap up in the stock on 8-7-14.  Then today, earnings was released, and there was very mild movement to the upside in conjunction with the hourly chart divergence.  So it seems that the price driver to the upside has probably already occurred, and now the last weak move on earnings may be an exhaustion point.

Particularly with the broad market appearing to be on the verge of a consolidation or pullback for at least a few days, I believe this stock has the ability to decline back into the $60 region within the next few weeks.

This trade example is for learning purposes only.  And being an out of the money option trade, if the trade does not go as planned, it will result in 100% loss of capital.  So I have that factored into my trade size here.  I only purchased a couple contracts, and can stand to lose the whole amount within my money management plan.

FL Dual Time Frame Put Option Set-Up

Click on Chart to Enlarge

This is a daily chart of FL, Foot Locker.  Notice the daily stochastics in the overbought position at a lower high and the more time consuming and overlapping rally off the 7-17-14 low, in comparison to the prior decline off the high.  This creates a nice price logic set-up for a short sale or put option trade.  Now let's move down to an hourly chart to focus in on a trade entry for the set-up

Click on Chart to Enlarge

This hourly chart shows a recent momentum peak at the upper end of the recent range of the momentum indicator.  Now we are seeing price to push to higher highs, but the momentum indicator is reaching a lower peak.  The indicates a slowing down of the current action, with the distinct possibility the price will soon reverse to the downside.  So from this point, on a trading basis, an objective method is needed to enter, or simply enter during the divergence and place a stop above the resistance level which would be the highest point on the chart.

HOWEVER, the earnings release is next week, and so the potential exists for a significant gap or price movement.  So in this situation my reasoning is that making a trade just before earnings is essentially a gamble, and if the earnings moves the stock up rather than down as the technical analysis suggests to me here, then I basically have a coin flip in risk versus reward by shorting the stock.

But in terms of options, if price moves up and no significant decline materializes, the max loss is 100% of the option value, but if earnings comes out with a gap down and break of the recent July support, the option could very reasonably move 200-300% or even more over the next couple weeks.  So in this situation I am electing to try to purchase a put option as prices hit this resistance area, with the reasonable probability of a 3:1 reward versus risk on a Sept 50 put option.

I currently have an order to buy the put at a limit of 1.40.  The spread is about 0.20 on the option, and it appears that price would have to move another 20-30 cents up before the order would fill.

Please note that this is for education, and that you will lose 100% of the money in this trade if the trade is not successful.