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.

Another Rebound Likely In Store Over the Next 1-2 Weeks In Stocks

Click on Chart to Enlarge

This table shows statistics of 2 trade set-ups that are in play as of this past Friday's closing action in stocks.

The left hand column shows trade stats over the next 5 days after 6 consecutive closes below the open in SPY.  The expected value of all trades is 1.24% gain closing the trade 5 days after the trade triggers (Friday's close).

The right hand column shows times in the current and in the prior bull market when a "3 month low" buy signal was triggered in my bottom spotting algorithm.  Now currently the SPY is not triggering the signal, but the DIA (Dow 30 ETF) is triggering it.  So I am suggesting here that using the stats from the SPY trading history will be appropriate for estimating the forward returns.

The expected value of all trades is 2.21% when closing the trade out 10 days after it triggers.  Actually 9 days appears to have an even higher expected value.  So if entering, the trade is planned to close on Aug 20 or 21st.  Also note that the win rate is in excess of 75%.  The average winning trade is 3.4%.  If that average were to occur here, it would put the SPY up to about 215.00 in the coming 2 weeks.


ITM options could be used for some leverage here.  I would suggest SPY strikes 204 or lower and still exit at the same time frame.  If a rally does unfold, a few simple indicators could be used as contingent exits.  I will discuss this as the trade unfolds.

I personally am going with a SPY Aug 28 expiration 204 call on this trade.


Pete