14 Trading Days Left

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So as I’m sure everyone noticed, price sped up a bit this past week. It might have taken some of us (including myself) by surprise, but in the bigger picture, ever since Nov 9th kicked this rally into full gear, price has been fairly relentless ever since.  Just take a look at the 100MA deviation envelopes.

161210 - SPY 100MA deviation

I reference this chart every day, but it’s been a while since it has been worth displaying. It is well within norms for the S&P500 to gyrate between 5% above to 5% or more below its daily 100MA. Price has nearly reached that limit again currently around approximately 2275. There’s no guarantee it will hit, but it suggests where this move may possibly find some resistance.

161210 - SPY daily channel

I use channels a lot in my trading and I have found them to be very helpful for defining targets and potential entry zones. Judging from the high resistance of the daily channel on SPY, the price target should be approximately $229. Now that we’ve looked at price structure, let’s take a look at some related market conditions.

161209 - VXV vs VIX

Once again this ratio absolutely nailed the low in early November. But now, three month volatility is once again priced to a high ratio level over front month volatility, mostly due to the absolute crushing of the VIX (front month) that’s been happening recently. At the moment, this ratio is over 1.2 which tends to indicate a ceiling is near in price.  Most of the time, it results in either a flat, choppy trend or a quick pullback. On the rare occasion though, price keeps on advancing.

161209 - Put-Call Ratio

I’m not sure which, but either calls have become extremely popular or puts have become very unpopular. The put/call ratio is now below the 100day envelopes I use to measure extremes (100EMA with 10% deviations). The results of reversion to the mean on this ratio have been mixed, sometimes a reversal is imminent, but just as often (and much like the VXV:VIX ratio) price either flattens out or on the rarer occasion continues to rally.

161209 - Dec30th ATM Calls and Puts with labels

For example, here is how the options board looks for Dec 30th (21 days away with weekends).  You can see the difference in price between the calls and the puts. Under more balanced conditions, usually the put and call are approximately the same price.

Don’t forget that a lot of bollinger bands have been violated in bursts to the upside over the past month. More often than not, this tends to lead to steady, months long, relentless uptrends.

THE TRADE

SO……14 trading days. That’s all that’s left in 2016. So where is the opportunity now? Technically, we have 10 days before Christmas is upon us and the big boys pack it up for the rest of the year and hand the controls over to the “B” traders. Given the contexts above, I see no reason to believe at this time that we’re in for any significant selling. It’s more likely we grind the rest of the year out to new highs. I think that means price will be somewhere between here and $229 by Dec 30th, 2016.

Due to the extremely low volatility (an important factor with this strategy), an options calendar (also called a time spread) is a low risk high reward trade with a wide profit zone. You can read about it here.

Assuming an at-the-money placement at $226, I can create a calendar either with the calls or with the puts. It really doesn’t matter too much, but it’s good to check both out because they can differ widely in price and risk/profit potential.

See for yourselves…here is the call calendar with a single contract spread.  It has only a $4 profit zone over the next three weeks and is limited to $72 max profit (which may become more or less by expiration due to volatility adjustments).

161210 - Call Calendar

Now check out the put calendar (also with a single contract spread).  It has an $8 profit zone with a potential gain of $142.50 (with give or take due to volatility).

161210 - Put Calendar

The put calendar has the best numbers so that’s the one I placed on Friday.  Option calendars are one of my favourite strategies. And remember, just because the max loss on the put calendar is $91 doesn’t mean I have to lose all of it before I stop out. The expiration breakeven is at $222, an entire $4.50 below Friday’s closing price so there’s a lot of cushion there for the next two weeks (after which volume will be minimal and unlikely to sell off). If I choose my stop to be just below that breakeven point, I could be risking only a $30 loss to make potentially $140 (or more if volatility picks up and inflates the value of the January leg). Not a bad risk:reward.

Anyways, I’ll be in the comments with updates on the position.  Good luck!

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