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.
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.
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.
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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