Stock Option Trading Idea of the Week
Weekly Price Changes for SPY
Bid-ask spreads and volume for Weekly options on SPY and QQQQ were comparable to the regular June Quarterly options which expire on June 30th. Very little interest was shown in DIA and IWM options, and unless this changes dramatically in the future, these Weekly options are unsuitable for profitable trading.
We have found that the actual volatility of QQQQ has been greater than the implied volatility of the options, and that has made QQQQ unsuitable for our strategy. That leaves SPY as the primary underlying of interest to us.
We conduct 4 separate portfolios using SPY as the underlying. The Big Bear portfolio is designed to provide downside protection for investors whose other holdings do best when markets are higher, and the other 3 SPY portfolios do best in a flat or upward market.
Last Friday for the first time we traded SPY Weekly options in all 4 portfolios. We were a little concerned that Terry's Tips subscribers accounted for over 30% of all the Weekly options traded on that day for several of the most active strikes. However, we were able to get good executions, and we expect that volume will grow substantially in the future when more people become familiar with the Weeklys.
At the beginning of each week, we try to establish option positions which will make a gain in the next week if SPY fluctuates less than $4 during that week. Obviously, the important question is how likely SPY is to go up or down by that amount in a 7-day period.
Here are the results for the past 100 weeks, a period that included the extreme volatility in the fall of 2008 and early 2009:
Almost exactly half the time, SPY moved up or down by less than $2 in a single week. We expect our average gain during those weeks would be about 5%. Another quarter of the time, the weekly price change was less than $4. If we could create positions that showed a gain coming in one week if the stock moved less than $4, we would make a gain about 3 weeks out of every 4. This should be possible.
How much would we lose in the quarter of the time that the stock price changes over $4 in a single week? If we have a downside butterfly or condor spread in place that provides protection in that direction, the loss should be moderate for all the down weeks except those where the stock fell by over $10. In the 100-week period, that occurred twice, or 1 out of 50 weeks.
About 10% of the time, the stock rose over $4 in a single week. While we would most likely lose money in those weeks, the losses should be moderate (and easily covered by one or two of the gaining weeks). We should not worry about big upside moves except perhaps those where the stock rose more than $8 (which happens only about once a year even in volatile times like we have had the last two years). Most big moves inside one week are on the downside where we will have established some protection.
According to these numbers, we would experience a significant loss in a single week about one week out of 25, or about twice a year if the past two years were typical. (Since they were more volatile than most years, the chances of big losing weeks is probably less than one out of 25 going forward.)
In conclusion, we are very much looking forward to the profit opportunities that the new Weekly options series on SPY might provide. The next few weeks should be very interesting ones for us and our SPY portfolios.
Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.
You can see every trade made in 8 actual option portfolios conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?
I look forward to having you on board, and to prospering with you.
Terry
Andy's Market Report
The week June options expiration ended without much fanfare. Other than the rally on Tuesday the market basically traded in a tight range throughout most of the week. Tuesday's rally helped to push the market higher for the second straight week and back into positive territory for the year.
Tuesday's rally came on the heels of a bounce in the euro. The rally was enough to push the S&P 500 (SPY) above strong overhead resistance - the 200-day moving average. Since Tuesday's rally, the market has had difficulty deciding which direction it wants to move. Currently, the S&P sits in a short-term overbought state which is bearish, but the move above the 200-day is seen as bullish. When the market has experienced similar instances in the past we typically see SPY take a breather over the next 3-5 days. The two exceptions were March and July 2009 when the market continued a relentless surge higher.
The fact that the overall market has essentially been running in place since Tuesday's rally is a positive over the intermediate-term. However, over the short-term the biggest obstacle is the overbought nature of the S&P plus the overwhelming bearish seasonality that comes into play starting Monday. Moreover, the recent rally off of the lows has been on very low volume, so the conviction among the institutions just isn't there.
As I have mentioned several times over the past few weeks, over the past 17 years, the week after June options expiration has been positive only 29% of the time, and has been negative each of the past 7 years.
The debate is now focused on whether or not the so-called correction phase is complete. Remember, a correction is generally considered a drop of 10-20% from a recent high. The Dow (DIA) has moved higher 6.5% since its low established on June 7th, but is still 6.7% lower from its 2010 high.
"I don't know that we're totally through the correction," said Stu Schweitzer, global markets strategist at JPMorgan's Private Bank in New York. "I do expect markets to remain quite volatile all through the rest of this year, but I still expect that we're going to end the year higher."
Up until this week the S&P 500 (SPY) had been running into strong overhead resistance or the 200-day moving average at $110.80. The push through the 200-day held as the week progressed and the next level to watch is the 50-day at roughly the $115 mark. There is no doubt that if the 200-day can hold we could witness a decent summer rally that pushes the market back to the highs of several months ago.
However, before I can jump on the bullish bandwagon, I can't ignore the fact that the Russell 2000 (IWM) has shown relative strength against the other major market ETFs that I follow and this week it underperformed. Even though IWM was able to push through its 200-day moving average, it has yet to decisively clear the double bottom that it is in the process of forming. Considering that IWM has been a leading indicator over the past few months and its inability to clear this level because certainly a failure to do so would drag the rest of the market lower.
Looking forward, the major market indices remain vulnerable despite the progress made by the bulls this past week
Economic News at a Glance: Not many catalysts this past week
- Unemployment rate fell in 37 states.
"In general, the band of states between the Mississippi River and the Rocky Mountains are doing relatively well while the worst hit states remain the housing bubble states and manufacturing states around the Great Lakes," said David Wyss, chief economist at Standard & Poor's in New York.
The coming week brings readings on home sales and consumer sentiment. The Federal Reserve also will meet on interest rates.
Andy
Overbought/Sold Condition Report
Overbought/Oversold as of June 19, 2010
Major Benchmarks
- S&P 500 (SPY) - 73.6 (overbought)
- Dow Jones (DIA) - 76.1 (overbought)
- Russell 2000 (IWM) - 69.1 (neutral)
- NASDAQ 100 (QQQQ) - 76.8 (overbought)