Continued Extremes Suggest Imminent Sharp (Short Term) Rebound In Stocks - 2/28/20

Some key data points from today are:

• 4 closes in a row below the lower bollinger band on SPY
• 4 closes in a row above the upper bollinger band on VIX
• 2 period cumulative WRSI2 less than 1 

The past history of SPY demonstrates extremely strong (~100%) past history of a high close than the trigger day within the next 5 days.

There was very strong tendency for the next day to close higher.

Also, today was 2 days in a row with gap downs more than 1%.  This also has led to strong rebounds.

• I looked at what happened in past times where the 1st gap down was NOT filled.  And even though prices went dramatically lower the second day, past similar instances suggest around a 50% probability of the 1st gap being filled within the next 5 days.
• That would put price back up at 311 on SPY.

From the most extreme similar instances, the MAX gains over the next 5 days were mostly clustered between 2.25 and 3.5 ATR's (10 period).

• This would suggest that the maximum gain over the next 5 days could be a very sharp rise to between 310-320 on SPY.
• The large gap down from Thursday is currently only 2 ATR's above Friday's closing price, so it seems that that gap fill would be a good target for this rise.
• Assuming we saw a rise and a close above the gap level at ~311, I think that would be an ideal exit time if it occurs.

Pete

Some Stats For Current Market Action

This morning I looked at several combinations of factors in the current market compared to past market data.  I will provide a few close estimates here and give an idea for a profitable course of action.

There is about 40% chance of today's gap down filling today
There is about 60% chance of today closing above the open

Given today's gap down in SPY of about 1.6% I look at what happened if SPY closes down more than 1%

Scan Criteria
Yesterday closed down 2% or more
Today gapped down 1% or more
Today closed down 1% or more

When I ran this scan, I got 19 instances back in the past 23 years.  All of them showed basically 100% loss of premium if selling an ATM put at the close with 5 days until expiration. 

So the market on average rallied significantly, and with elevated volatility it was a good time to sell options versus buying options.

Trade Idea
If today closes down (especially if 1% or more), a bull put credit spread with ATM strikes could be written with an expiration of next Friday.

Also, cycles I use are suggesting upside into mid December or longer.  And in the above scan, there was a very strong expected value by holding for 8-10 days from the close of the signal day

So a Dec 24th SPY expiration could be used as well for an ATM bull put credit spread

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