By Chris Ebert
Last week’s market analysis concluded with a simple observation “… a move to 1988 or 1935, at any time in the next week or so, would be quite natural.”
Well, it’s now evident that the market chose 1988, not because that level is somehow magical, but because it represents a boundary between two different types of trading environments, just as 1935 represented a boundary.
Above 1988 is a zone known here as lottery fever for its feverish buying of stocks that drives prices higher without regard for fundamentals, economic news, or anything else that otherwise might cause prices to decline. Below 1988 is a zone of digesting gains, named for its methodical, rational consideration of economic developments that causes stock prices to take one step back for every two steps forward.
Although the S&P 500 closed a hair inside the lottery fever zone this past Friday, true lottery fever cannot be confirmed to have infected the stock market until the S&P has remained in that zone for at least a week. Every attempt to enter the lottery fever zone so far in 2014 has failed within a week. Therefore, if the S&P confirms lottery fever next week, it would likely indicate a major shift to bullishness, the likes of which have not been seen since 2013.
The last confirmed case of lottery fever began November 17, 2013 and ended on January 19, 2014. During that 2-month period, the S&P added nearly 100 points, which is not all that impressive a move on its own, but certainly is impressive considering it was on top of a 100 point move it had already made in the previous 2-month period from last September to November.
The following analysis is intended to help traders recognize and understand lottery fever, and thus avoid being unnecessarily frightened away from stocks just because indicators such as the RSI say stocks are overbought.
* All profits are calculated at expiration, as a percentage of the underlying SPY share price. SPY is an ETF that closely tracks the performance of the S&P 500, specifically the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). All options are ATM-when-opened 4 months (112 days) to expiration. (e.g. Profit of $6 per share on a Long Call would represent a 3% profit if $SPY was trading at $200, even if the call premium itself actually increased 50%, 100% or more)
You are here – Bull Market Stage 1 – the “lottery fever” Stage.
On the chart above there are 3 categories of option trades: A, B and C. For this past week, ending August 23, 2014, this is how the trades performed:
- Covered Call and Naked Put trading are each currently profitable (A+).
This week’s profit was +2.8%.
- Long Call and Married Put trading are each currently profitable (B+).
This week’s profit was +2.9%.
- Long Straddle and Strangle trading is currently profitable (C+).
This week’s profit was +0.0%.
Using the chart above, it can be seen that the combination, A+ B+ C+, occurs whenever the stock market environment is (more…)