By Chris Ebert

It will come as no surprise to most traders that recent stock prices have been going nowhere fast. The S&P 500, for example, has mostly hovered within approximately 20 points either side of 2180 ever since July. That’s a mighty tight range by historical standards; generally the S&P tends to have much wider swings. So, such a tight range for such a long period of time can be surprising.

From an option standpoint, however, such a tight range is not unexpected.

There are only four basic trading environments during a Bull market, each of which correlate fairly closely to the profitability of simple option strategies.

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  1. Lottery Fever – essentially a euphoric buying frenzy (green zone)
  2. Digesting Gains – in which every rally tends to end with profit taking (blue zone)
  3. Resistance – in which the S&P has hit a brick wall it cannot easily cross (yellow zone)
  4. Correction – a pullback that generally leads into the next leg up (orange zone)

In July the S&P entered the Digesting Gains stage, as defined by the profitability of certain Long Call and Covered Call options on the S&P 500. It’s generally not that the options themselves have any effect; rather the profitability of those particular options has tended to correlate with an environment of digestion over the past years and decades. The options can be considered to be a technical indicator of sorts, much like a moving average or any other type of indicator a trader might employ.

The S&P moves by the path of least resistance, so it can go pretty-much anywhere. It all depends on the news of the day – catalysts that propel stock prices one way or the other. But the overall reaction to such news can keep the S&P stuck in a rut in certain environments.

That’s the environment the market is in right now. It’s certainly still a Bull market, but it’s not quite bullish enough for a euphoric Lottery Fever buying frenzy. That doesn’t mean a catalyst won’t come along and ignite Lottery Fever. But, it does explain why the S&P has gone almost nowhere since July – it is sitting quietly on the sofa, digesting a rather large meal.

The preceding is a post by Christopher Ebert, Chief Options Strategist at Astrology Traders (which offers subscribers unique stock-trading perspectives and options education) and 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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