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.

Stocks and Options at a Glance

click on chart to enlarge

* 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.

Options Market Stages

Click on chart to enlarge

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…)

By Chris Ebert

Ever notice how the stock market seems to have a mind of its own, as if it is determined to separate you from your stock positions? If so, you are not imagining things. The stock market is indeed hunting you down; but don’t take it personally. It is simply the nature of the stock market to break the bonds between stocks and stockholders; and it’s called entropy.

Entropy is, quite simply, a tendency toward disorder. It isn’t confined to the stock market. Entropy favors an organized, predictable stock market as much as it favors a sand castle on the beach or a hot cup of coffee. Without outside influence, in time, each of these will return to their natural, disorganized state – the coffee’s organized collection of heat scattered haphazardly throughout the air just like the castle’s organized grains of sand on the beach or stock prices from any level that conveys certainty or order.

Some stock price levels convey more certainty for traders than others. Since the natural tendency is always towards a level of increased uncertainty and increased disorder, knowing which levels are likely orderly and which are prone to be disorderly man help a trader prepare for the next move.

Predicting order is nothing new. In fact, it is the basis for many common trading methods. From candlestick analysis to Darvas boxes, trend lines to Fibonacci retracements, the goal is the same – to search the market for fleeting moments of certainty and order, and pounce on them before entropy runs its course.

There are numerous ways a trader can analyze potential levels of order and disorder, the performance of some simple stock options being one of the simpler methods. An analysis of S&P 500 options may provide some clues as to when broad-based uncertainty and disorder is likely in the stock market as a whole, and when it is not. It begins with determining which types of common option trades on the S&P 500 are currently profitable.

Stocks and Options at a Glance

* 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 2 – the “digesting gains” Stage.

On the chart above there are 3 categories of option trades: A, B and C. For this past week, ending August 16, 2014, this is how the trades performed:

  • Covered Call and Naked Put trading are each currently profitable (A+).
    This week’s profit was +3.1%.
  • Long Call and Married Put trading are each currently profitable (B+).
    This week’s profit was +1.7%.
  • Long Straddle and Strangle trading is currently not profitable (C-).
    This week’s loss was -1.4%.

Using the chart above, it can be seen that the combination, A+ B+ C-, occurs whenever the stock market environment is (more…)

16
Aug

By Faces In Cabs

What an odd (and wonderful) price shock for bears on Friday. The news from Ukraine and Russia appeared to darken the recent clouds over the exuberant equity markets. The added drama that this event arrived on OpEx day created a significant reversal and scalping opportunities in the options markets. Furthermore, Friday was a re-balancing day for the $SPX. Clearly, there was a lot going on (mostly underneath the surface) in the equity markets. Here are some charts.

Dow Update (Dow retracement remains questionable)

DOW

S&P 500 ($SPX rejecting its 50 MA so far)

Nikkei and Dow (watching the Nikkei for its Sunday echo to $INDU price action)

Past Bubbles (NASDAQ is back in bubble mode – see blue line)

spx

NASDAQ Weekly (NASDAQ big picture)

Overall, in the equity markets, until the the $SPX can close above its 50 MA (which it rejected twice this last week), I continue to question the resumption of the 2014 rally. This move up remains a retracement until proven otherwise. Even with the obvious volume boost of OpEx and the Friday re-balancing, the SPX could NOT close above and reclaim the important 50 MA level. (more…)

Ask the Option Scientist

Do you haveoptionscientistthumbnail a question for the Option Scientist?

Email it to OptionScientist@zentrader.ca or enter it in the comment section below.

Today’s question: OptionScientist, do you have a chart of option performance going back several years? I would like to compare the current action to past stock-market corrections.

Answer: Long term charts can be difficult to read due to the high resolution required. But, the information they contain can be very valuable. Here is the chart of the Options Market Stages going back 10 years. A high-resolution version is available by clicking on the chart itself.

Options Market Stages 2005 to 2014

Click on chart for larger full-resolution version

It should be noted that only the Bull Market Stages have been shown (for clarity). A Bear market, shown as the (more…)