By Chris Ebert

Lottery Fever is well underway in the stock market. It is one of the defining characteristics of Lottery Fever that buyers overbid – they enter orders to buy stocks well above what would be considered a fair value. They do this because stock prices are rising, so their main concern is not getting a fair value, but getting in on the rally in prices.

bob barker1

On the television game show “The Price is Right” the entire premise was to place bids, and be the closest without going over (the fair value).

Unlike the Price is Right, there is no closest without going over in the stock market. As long as there is someone willing to place a higher bid, a trader wanting to sell can make an offer and settle at the bid price. It is often difficult to discern whether overbidding is taking place. Yet there are indicators that may help provide such a signal that traders are overbidding.

The Options Market Stages have been reliable indicators for several decades. During periods when stock prices are being overbid, depicted here as Lottery Fever, there eventually comes economic news that acts as a catalyst to end the overbidding. Sometimes it takes days, sometimes weeks; and the overbidding can cause stock prices to continue to rise despite being overpriced.

But eventually that sad trombone will play and Bob Barker will say “I’m sorry, you’ve all overbid, let’s start the bidding over again”. Unfortunately, stock traders do not have a sad trombone player sitting by, so the Options Market Stages might be the next best thing.

oms 03-21-17

Anytime the S&P 500 gets into the green zone it is considered Lottery Fever – runaway greed in which traders are overbidding for the sole purpose of getting in on the rally, not necessarily because corporate fundamentals are looking better. But all traders know that at some point it will end and they will hear Bob Barker’s voice.

The following chart helps define the mood in each of the Options Market Stages.

Options Market Stages

Click on chart to enlarge

The preceding is a post by Christopher Ebert, co-author of the popular option trading book “Show Me Your Options!” Chris uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. Questions about constructing a specific option trade, or option trading in general, may be entered in the comment section below, or emailed to OptionScientist@zentrader.ca

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Traders occasionally become disenfranchised. They feel like they have become disconnected from the market – that the trading environment has changed so drastically that they cannot make a confident interpretation. That tends to happen when the S&P 500 Temperature reaches extremes.

Any Temperature above +200 or below -200 is considered extreme. Extreme low Temperatures are associated with intense Bear markets, and it is obvious that traders would feel disenfranchised then. But traders can become just as disenfranchised when the Temperature in a runaway Ball market rises to the extreme levels seen recently.

Options Market Stages S&P 500 Temperature1

Currently the Temperature is well above 200. That means the stock market is very hot; and it explains why folks who own stocks are (more…)

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Covered Call trading is often touted as a great way to earn income from stocks that a trader already owns. The trader sells a Call option on the owned stock and collects a fee known as the option premium.

The problem with selling a Covered Call option is that it limits the profits on the stock if the stock price rises. When the stock price rises above a certain price, known as the option strike price, all profits beyond that point are lost and go to the buyer of the option.

Option trading can seem daunting to those who have never done it. But Covered Call trading is relatively simple. A trader who owns 100 shares of stock can sell what is known as a Call option, which essentially gives up the right to profit on that stock. In return, the seller collects capital in the form of an option premium. Most brokers can walk a trader through the process; many traders qualify with a simple request to their broker to trade Covered Calls.

Selling Covered Calls is generally not a good idea in a strong rally, because the buyer of the Call option is reaping huge profits while the seller is getting just a small premium. Exacerbating the situation is that when a strong rally is in progress, implied volatility is low – and implied volatility is a measure of option premiums. Quite simply, when there is a rally in stock prices, option premiums tend to decrease, so that sellers of Covered Calls are collecting very small premiums yet giving up huge profits to the buyers of the Calls.

SNP Temperature 219

One way of gauging a good time to sell Covered Call options is to look at the S&P 500 Temperature. When it is above 200 it means the stock market is (more…)

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Measuring how hot or cool the S&P 500 stock index is can be done by studying some commonly traded stock options known as Covered Calls. Covered Calls almost always return a profit outside of a Bear market, so conversely, if expiring broad-based $SPY Covered Calls are returning a loss, the market as a whole has likely switched to a Bear.

While there are millions of possible options, the ones used to determine the S&P 500 Temperature are specifically designed to be the most indicative of the state of the moderate-term outlook (4 months) for most stocks traded in the S&P index, opened at-the-money 4-months prior to the current week’s expiration.

”The level of the S&P can then be compared to the level at which Covered Calls would break even. The distance from the break-even point then determines the Temperature. Right now it is hotter than it has been in many years. The following chart shows the cyclical nature of how extremely hot Temperatures tend to lead to a cooling off period.

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