Back into an oversold state. Jump in VIX could make for some excellent premium plays.

All of the major benchmarks are now in an oversold state. The last time this situation occurred was during the February 27 correction and we all know what happened then. Given all of the indicators that I have given over the past few weeks I am not so certain that we are going to have a similar reaction this time around. The intermediate-term trend seems to be swaying towards the bearish camp.

I am a little hesitant at this juncture to play a short-term move. Our proprietary measures are nearing an extreme in the ETF Extremes strategy so there could be a signal there in the coming days. Our proprietary measures have been accurate roughly 92% of the time so, as always, we will patiently wait for the market to come to us. It has served us well since the strategy began.

One of the issues with tomorrow is that on a seasonal basis it is very bearish with the S&P finishing higher only 28.6% of the time. Next week brings, options expiration, which is typically bullish so this could make for an ideal entry into a short-term play. Although, I am not ruling out dipping my toes tomorrow even with the bearish seasonality especially if the market gaps lower at the open.  

As much as many of you want to deny it the summer doldrums are here. As I stated weeks ago, expect to see a trading range with slight expansion as we move through the summer months. With today’s sell-off the S&P (SPY) is now below where the major benchmark opened on the fourth trading day of the month, where the ”sell in May and go away” theory begins. If the trading range continues throughout the summer it will to bode well for our neutral-based SPX Short Iron Condor strategy.

Moreover, the VIX (a measure of the implied volatility of S&P 500 index options) has jumped to 17.06 which is roughly 4 points higher than when we established our June Condor spread. What does this mean? It means that the premium should increase significantly (if the VIX holds up of course) when we put on our new Iron Condor position. It also allows us to forfeit some of the extra premium for a wider range. Currently we are using a wide range of 140 points. As long as the underlying SPX (S&P) falls within our chosen range at option expiration (typically a four to five week period, although even in a five week period I usually only go out four weeks) the strategy is profitable anywhere from 5-10%, sometimes slightly higher/lower.

Overbought/Oversold levels for June 7, 2007