By Chris Ebert

inputIt can be fascinating, yet horribly frustrating, to realize that stock prices are not a mathematical function. If stock prices behaved as a mathematical function, there would be only one outcome for a given set of conditions. For example, if a stock price fell to the 200-day simple moving average, and always moved higher immediately afterward; the bounce higher would be a function of the simple moving average.

Output is, in reality  not a function of input for stock prices. Stock prices are always stochastic no matter how deterministic their appearance.

While it is true that there are times that stock prices tend to behave as a function of certain technical indicators, there are also times when those technical indicators fail miserably. No technical indicator works 100% of the time. If it did, there would be no need for human involvement in the stock market; computers could handle every trade with 100% efficiency.

In fact, it is quite possible that 100% efficiency would eventually lead to one huge stalemate, in which no computer could gain an edge over another, and all trading would cease as if in the middle of an un-winnable chess game. Thus, the fact that trading has not yet reached such a stalemate justifies the conclusion that the stock market is not yet 100% efficient. As such, human interaction still plays a role, and it will continue to play a role as long as prices remain stochastic and not deterministic.

The emotional aspect of human interaction is important; greed and fear still have a measurable and noticeable effect on stock prices. After all, the effect of human emotions is why indicators such as the S&P 500 Volatility Index (the VIX) are ubiquitous these days. The effect of emotion, as big as it is, is sometimes overshadowed by the effect of price manipulation.

Manipulating stock prices isn’t necessarily an evil act. It’s human nature. Who among us would not manipulate the price of a stock if we had such power? To believe that stock-price manipulation is not ongoing, moreover that it is not rampant, is naïve. To believe that others would not manipulate stock prices for their own benefit, when we would do it ourselves given the opportunity, is hypocritical.

How then, does one detect the effect of manipulation? In some ways, detecting manipulation can be achieved in much the same manner as one detects the effect of emotion – through a study of traditional technical indicators. However, when one gets down the rabbit hole far enough, it becomes evident that traditional indicators themselves could be targets of manipulation.

It is not out of the realm of possibility that an everyday occurrence, for example, a bounce higher off the 200-day simple moving average, or a sell-off from the RSI 70 level,  could each be a scripted event. While the event may be scripted – intentionally caused by those who would benefit from it – some of the effects of that event are not so easily written into the script.

Changes in option premiums occur as a result of such events. Those option premiums are not so easily scripted or manipulated as the changes in stock prices. Options traders, by nature, assume that stock prices are stochastic; and by assuming they are stochastic, generally make accommodations for everything except for intentional, outright, off-cue price manipulation.   Thus, it is entirely possible that options, viewed in strict and disciplined manner, have the ability to indicate periods of time in which stock prices have gone off the expected script – when stock prices are being manipulated excessively.

The following analysis is presented here weekly, and may prove effective in identifying stock-price manipulation.

Click on chart to enlarge

Click on chart to enlarge

* All profits are calculated at expiration, as a percentage of the underlying SPY share price. SPY is an Exchange Traded Fund (ETF), the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) that closely tracks the performance of the S&P 500 stock index. All options are at-the-money (ATM) when-opened 4 months (112 days) to expiration.
EXAMPLE: If Long Call premium paid is $2 when SPY is trading at $200, the loss is 1% if the option expires worthless.

You are here – Bear Market Stage 6 – the “Phew!” stage.

On the chart above there are 3 categories of option trades: A, B and C. For this past week, ending November 8, 2014, this is how the trades performed on the S&P 500 index ($SPY or $SPX):

  • Covered Call and Naked Put trading are each currently profitable (A+).
    This week’s profit was +2.7%.
  • Long Call and Married Put trading are each currently not profitable (B-).
    This week’s loss was -0.0%.
  • Long Straddle and Strangle trading is currently not profitable (C-).
    This week’s loss was -2.6%.
Options Market Stages

Click on chart to enlarge

The combination A+ B- C- occurs whenever the stock market is at Bear Market Stage 6, the “Phew!” stage, which gets its name from the collective sigh of relief from stock owners during the first dead-cat bounce higher for stock prices which occurs immediately after the first major sell-off of a new Bear market.

The combination A+ B- C- also occurs at three other stages: Bull Market Stage 3 “resistance” which only occurs during a minor pullback in an otherwise roaring Bull market, Bull market Stage 5 “all clear” which occurs after a healthy Bull market correction, and Bear Market Stage 9 “bargain” which only occurs after a mature Bear market has neared its bottom. None of those other stages is applicable today, with the possible exception of Stage 5, which is improbable yet possible and therefore requires attention.

Bull Market Stage 3 only follows Stage 1 (which is so bullish that Long Straddles are profitable) and Stage 2 (which is moderately bullish, so that Long Calls are profitable). Neither of those types of trades has been profitable for several weeks. This is clearly not Bull Market Stage 3.

Bear Market Stage 9 only follows Stage 7 (Stage 7 is so extremely bearish that Long Straddles are profitable) and Stage 8 (which is ridiculously bearish, so that Long Straddles are extremely profitable). Neither of those has occurred recently; Long Straddles have not been profitable. This is clearly not Bear Market Stage 9.

Bull Market Stage 5 only follows Stage 4 (in which a healthy correction either does not become so severe that Covered Call trading turns unprofitable, or else Covered Call losses are insignificant). Since Covered Call trading has recently suffered two consecutive weeks of significant losses, it is improbable that this is Bull Market Stage 5, yet not entirely impossible.

The Goal of the Manipulator

Perhaps the best way to understand the plight of a manipulator, and thus understand the manipulator’s needs, is to put oneself in his shoes. Imagine what it would be like to hold billions of shares of stock. Such large positions cannot be traded without manipulating the share price. Anyone can trade a lot of 100 shares without much effect. But, when one dumps a large position it pushes prices lower.miser

Large positions not only cause dips in prices when they are put up for sale, they hold support for prices when they are not for sale. It is possible for a trader with an absurdly-huge position to help keep a stock price from falling, simply by not trading any of those shares.

The goal of the manipulator, therefore, is to find the path of maximum profit for the stocks that are held.

Path of Maximum Profit

The path of maximum gains is not necessarily a straight line up. It is inevitable for anyone holding such huge positions, that stock prices will eventually reach a maximum. The manipulator can certainly hold on to a large unrealized gain, but such a gain is nothing more than an illusion until it is realized (when the stock is sold). As long as a large position is held, for example, the stock price may remain near its all-time high. But the moment those large numbers of shares are put up for sale, the tendency will be for the stock price to fall.

There often will not be enough buyers to scoop up all the shares at the asking price, but more buyers are usually waiting with bids to buy at a lower price. Dumping a large position requires careful timing and control of the number of shares put up for sale at any given moment, lest the shares get scooped up at lower and lower bids. Dump too many shares at once and it may scare away bidders altogether. Then, what is the giant stock owner left to do with the remaining shares when there are no bidders?

It makes sense that a giant of stock ownership would benefit the most from a carefully controlled path of stock prices, in which the most shares could be unloaded at the highest gain. It also makes sense, therefore, that large stockholders would manipulate the stock price, to the extent they have the ability to manipulate it. Large stockholders attempt to write the script that determines the most beneficial path for their position.

The Role of Options

As with all forms of technical analysis, options can be used as a means of identifying changes in the script – things that deviate from what was expected. When the unexpected happens to a stock price, it could be from unexpected news or events, or it could be from outright manipulation. Either way, when something unexpected happens, it is sure to affect those with extremely large positions.

Discerning the unexpected is therefore the goal of the technical analyst. The unexpected reveals a change in the script – a change in the way the stock price is being manipulated. Some simple options strategies have historically been very good indicators of identifying the unexpected. These strategies have been discussed in the past, but their importance bears repeating:

  • Covered Calls do not expire with losses in a Bull market
    (especially broad-index options opened at-the-money several months to expiration)
  • Long Calls do not expire with profits in a Bear market
    (especially ATM 4-month broad-index options such as $SPY)

OMS 11-08-14b

When either one of those events occurs, it is important for traders to pay attention. It means something has changed. It could mean the market has simply experienced an unexpected shift due to some unexpected economic news. But, stock prices that are being manipulated more than usual are also a possible cause. Strong manipulation will very often cause one or the other or both.

Covered Calls, opened at-the-money 4-months to expiration recently experienced losses on the $SPY. Absent some huge, unexpected economic development (war, natural disaster, financial trouble, political turmoil) this almost always happens due to large positions of stocks being dumped on the market too fast for smaller investors and traders to scoop them up at the ask prices.

These specific Covered Call trading losses have not occurred for nearly 3 years on $SPY. It is not an event that can be simply ignored as an anomaly. Someone or some entity dumped huge numbers of shares of stock on the market, so quickly that the market could not absorb those shares without reducing them at bargain prices. The fact that stock prices quickly rebounded quickly afterward simply indicates that such selling is not ongoing. It does not mean the selling is over. It could be over, but it is quite possible it is not.

Accumulation and Distribution

The giants of stock ownership need to accumulate shares when prices are falling, and distribute shares when prices are rising. When distribution is taking place, as long as it is done in a controlled manner, stock prices can continue to rise. However, Long Call options have historically been quite a good indicator of this otherwise-invisible distribution.

Long Call options typically do not return profits when distribution is taking place.That’s not because there is something magical about Long Calls; rather it simply turns out that stockholders with giant positions typically have found the most beneficial path to unloading the largest number of shares is to do it in such a way that allows stock prices to rise, but to rise in a limited manner. If stock prices rise too slow, big positions could tip their hat when they distribute large blocks of shares.

If stock prices rise too fast, big positions will kick themselves for not having unloaded more shares. The point at which Long Calls break-even typically coincides with the level of the most efficient distribution of large numbers of shares of stock, If stock prices reach the break-even level for Long Calls, as they did this past week, but go no higher, it can be inferred that stocks are in the midst of a huge distribution.

Bull Bear 2005-2014


The fact that the S&P 500 fell below the red line in the chart (Covered Calls became unprofitable) is strong evidence that large positions of stocks were unloaded onto the market, as typically happens at the very beginning of a Bear market. If the S&P 500 fails to make it over the yellow line, it would be strong evidence that giant manipulators are continuing to unload their shares, but doing so in a way that historically proven to be the most efficient path for profits.

If the combination of the recent dip below the red line and failure to climb above the yellow line is an indication of manipulation, stock prices would be in for a very large decline in coming months, more than at any time in the past three years or more. It is always possible the manipulators are experimenting with new tricks. But why would they?

Manipulators have a proven path that has worked well, time after time. It works so well that the Elliott Wave is essentially devoted to showing the path, and it often does so quite accurately. Manipulation can only work, though, if it is cloaked in secrecy. Therefore, traditional indicators, such as the VIX, RSI, and common moving-average analysis must be suspect, as they could themselves be manipulated, just like stock prices. Options, being more difficult to manipulate, can serve as a harbinger of major manipulation when they perform unexpectedly, as those options have done in recent weeks.

The following weekly 10-minute 3-step process provides further analysis.

Weekly 3-Step Options Analysis: 

On the chart of “Stocks and Options at a Glance”, option strategies are broken down into 3 basic categories: A, B and C. Following is a detailed 3-step analysis of the performance of each of those categories.

STEP 1: Are the Bulls in Control of the Market?

The performance of Covered Calls and Naked Puts (Category A+ trades) reveals whether the Bulls are in control. The Covered Call/Naked Put Index (#CCNPI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames.

Most important is the profitability of these trades opened 112 days prior to expiration, which balances sluggish responses of longer expirations with irrelevant noisy responses of shorter expirations.

Covered Call Trading

Covered Call trading did not experience a single loss in 2013, and the streak endured until October 11, 2014, ending a streak of nearly lossless trading extending all the way back to late 2011. That means the Bulls were in control continuously for nearly 3 years.

The Bears have now taken control and will likely remain in control for many weeks or months in spite of temporary rallies, no matter how bullish those rallies may appear. Historically, once the Bears have taken control, they do not relinquish that control until they have overstepped their authority over the stock market, as indicated by the Long Call/Married Put Index (#LCMPI) and Long Straddle/Strangle Index (#LSSI), shown below.

If the S&P falls below 1923 over the upcoming week, Covered Call trading (and Naked Put trading) will become un-profitable, indicating that the Bears retain control of the longer-term trend. Above S&P 1923 this week, Covered Calls and Naked Puts would be profitable, which is normally a sign that the Bulls are in control. However, such control is usually only temporary as long as the Bulls lack strength and confidence.

Profitability of Covered Calls and Naked Puts during a Bear market is not by itself evidence of a flaw in the analysis that determined a Bear market was underway. Profitability is only evidence of a flaw if it coincides with either Long Call profits or with excessive Long Straddle losses, as set forth in the descriptions of the Long Call/Married Put Index (#LCMPI) and Long Straddle/Strangle Index (#LSSI), shown below.

A level above 1923 this coming week would actually be quite within normal expectations for the early stages of a Bear market, specifically described as Bear Market Stage 6 in the chart above. The classic “dead cat” bounce creates temporary profits for Covered Calls and Naked Puts (#CCNPI) but not Long Calls or Married Puts (#LCMPI). A textbook “dead cat” bounce will also fail to exceed the level at which Long Straddle losses exceed 6% (#LSSI).

The reasoning goes as follows:

  • “If I can sell an at-the-money Covered Call or a Naked Put and make a profit, then prices have either been going up, or have not fallen significantly.” Either way, it’s a Bull market.
  • “If I can’t collect enough of a premium on a Covered Call or Naked Put to earn a profit, it means prices are falling too fast. If implied volatility increases, as measured by indicators such as the VIX, the premiums I collect will increase as well. If the higher premiums are insufficient to offset my losses, the Bulls have lost control.” It’s a Bear market.
  • “If stock prices have been falling long enough to have caused extremely high implied volatility, as measured by indicators such as the VIX, and I can collect enough of a premium on a Covered Call or Naked Put to earn a profit even when stock prices fall drastically, the Bears have lost control.” It’s probably very near the end of a Bear market.

STEP 2: How Strong are the Bulls?

The performance of Long Calls and Married Puts (Category B+ trades) reveals whether bullish traders’ confidence is strong or weak. The Long Call/Married Put Index (#LCMPI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames.

Most important is the profitability of these trades opened 112 days prior to expiration which balances sluggish responses of longer expirations with irrelevant noisy responses of shorter expirations.

 Long Call Trading

Losses on Long Call trading occurred in recent weeks for the first time in several months. Long Call trading became unprofitable this past March, Those losses intensified during April and early May before reverting back to profits for much of the summer. But the winning streak ended in mid-September. Losses for Long Calls are a sign of weakness for a Bull market. Such weakness can be dangerous because it lowers the perceived reward potential for stock owners, which makes stocks less attractive, in turn lowering the prices that stock-sellers are able to obtain from buyers.

As long as the S&P closes the upcoming week below 2034, Long Calls (and Married Puts) will remain un-profitable, suggesting the Bulls lack confidence and strength. Above 2034, Long Calls and Married Puts would become profitable for the first time in several weeks, which would suggest a significant shift in sentiment, notably a huge return of confidence by the Bulls.

Confidence and strength show up as a “buy the dip” mentality, while a lack of confidence and strength produces a “sell the rip” sentiment that tends to create brick-wall resistance, since each high is perceived as a rip to be sold. In a true Bear market, the Bulls will never be confident and strong; thus, Long Calls and Married Puts will never profit during a Bear market.

Profitability of Long Calls and Married Puts during a Bear market is therefore evidence of a serious flaw in the analysis which determined that a Bear market was underway, since it obviously is not underway if these trades are profitable. Covered Calls and Naked Puts sometimes profit temporarily during Bear market bounces, but never Long Calls and Married Puts.

The reasoning goes as follows:

  • “If I can pay the premium on an at-the-money Long Call or a Married Put and still manage to earn a profit, then prices have been going up – and going up quickly.” The Bulls are not just in control, they are also showing their strength.
  • “If I pay the premium on a Long Call or a Married Put and fail to earn a profit, then prices have either gone down, or have not risen significantly.” Either way, if the Bulls are in control they are not showing their strength.

STEP 3: Have the Bulls or Bears Overstepped their Authority?

The performance of Long Straddles and Strangles (Category C+ trades) reveals whether traders feel the market is normal, has come too far and needs to correct, or has not moved far enough and needs to break out of its current range. The Long Straddle/Strangle Index (#LSSI) measures the performance of these trades on the S&P 500 when opened at-the-money over several time frames.

Most important is the profitability of these trades opened 112 days prior to expiration, which balances sluggish responses of longer expirations with irrelevant noisy responses of shorter expirations.

 Long Straddle Trading

The LSSI currently stands at -2.6%, which is normal, and indicative of a market that is not in imminent need of a major breakout from the trading range of the last few months. Negative values for the LSSI represent losses for Long Straddle option trades. Small losses are quite normal and usual for Long Straddle trading. Large losses are not.

The 3 unusual conditions for a Long Straddle or Long Strangle trade are:

  • Any profit
  • Excessive profit (>4% per 4 months)
  • Excessive loss (>6% per 4 months)

Long Straddle trading (and Long Strangle trading) will not be profitable during the upcoming week unless the S&P closes above 2089 or below 1868. Values above S&P 2089 could only occur during a Bull market. Values below 1868 are certainly possible in a Bear-market environment, and should those values be reached it would suggest an oversold market poised for a bounce.

Excessive Long Straddle trading profits (more than 4%) will not occur unless the S&P either exceeds 2168 or else falls below 1789 this week. Values above 2168 can only occur in a roaring Bull market. Values below 1789 are certainly possible in a Bear-market environment, but would suggest that stock prices have fallen too far too fast for the rate to be sustainable, thus needing to correct higher, at least temporarily, in order to return to sustainability for the downtrend.

Excessive Long Straddle losses (more than 6%) will not occur unless the S&P moves to very near 1970 this week. Since excessive losses tend to coincide with a desire for traders to make stock prices break out, either higher or lower than the boundaries of their recent range, a level of the S&P near 1970 would likely bring a snap-back rally or else a violent resumption of the recent downtrend.

Breakouts in true Bear markets are always to the downside. Therefore, a continued move above 1970 in the coming week would indicate a serious flaw in the analysis that determined a Bear market was underway. Any level above 1970 is ‘clear and convincing’ evidence of such a flaw. That evidence becomes ‘beyond a shadow of a doubt’ if accompanied by confirmation of Long Call profits, at or above S&P 2034 as shown by the #LCMPI above. A major move below 1970 this week would serve as confirmation that a Bear market was well underway.

The reasoning goes as follows:

  • “If I can pay the premium, not just on an at-the-money Call, but also on an at-the-money Put and still manage to earn a profit, then prices have not just been moving quickly, but at a rate that is surprisingly fast.” Profits warrant concern that a Bull market may be becoming over-bought or a Bear market may be becoming over-sold, but generally profits of less than 4% do not indicate an immediate threat of a correction.
  • “If I can pay both premiums and earn a profit of more than 4%, then the pace of the trend has been ridiculous and unsustainable.” No matter how much strength the Bulls or Bears have, they have pushed the market too far, too fast, and it needs to correct, at least temporarily.
  • “If I pay both premiums and suffer a loss of more than 6%, then the market has become remarkably trendless and range bound.” The stalemate between the Bulls and Bears has gone on far too long, and the market needs to break out of its current price range, either to a higher range or a lower one.

*Option position returns are extrapolated from historical data deemed reliable, but which cannot be guaranteed accurate. Not all strike prices and expiration dates may be available for trading, so actual returns may differ slightly from those calculated above.

The preceding is a post by Christopher Ebert, co-author of the popular option trading book “Show Me Your Options!” He 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


 Related Options Posts:

Options Give Perma-Bears Shadow of Doubt

Options Define Limit of “Dead-Cat Bounce”

Hitchhiker’s Guide to Bear Markets


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