April 26, 2017

Bulls Beware…Major Indices at Historic Extremes

Yes, the market has rallied in the face of, well, almost everything.

While I have my doubts about the sustainability of the current rally I’m not going to give you the reasons why…because it’s only my opinion and as we all know when using a statistical approach towards investing/trading opinions are essentially useless.

The Russell 2000 (IWM), S&P 500 (SPY) and Dow (DIA) have recently pushed to all-time highs which has pushed our High-Probability, Mean Reversion indicators to extreme overbought states.

Moreover, if you look at the RSI over various timeframes you will quickly notice that most of the ETFs I follow are pegged right now. Typically, when this time of reading occur we see a decent decline short-term decline going forward.

But there’s something different this time around. First of all we have the VIX near   historical lows. Will we see single digits in the investor’s fear gauge? Secondly, the longer-term picture, at least from a mean-reversion perspective looks ominous for the bulls.

Just look at the RSI (14) on a five year chart for the S&P 500.













As you can see the indicator has pushed into an overbought state for only the second time in the last five years…and the last time was in early 2011 when SPY fell from $130 to $110.

It’s been a rough few months for those of us who sell credit spreads for a living. But, when you make 80-85% trades every expiration cycle you should expect to see a few losers in the mix. I currently have a few credit spreads that are not going my way, but given the short-term extremes I am still confident in positions with the exception of a fairly aggressive (68% chance of success) trade I made in the Theta Driver strategy.

Of course, only time will tell, but by the looks of it the bulls should be running out of steam very soon. Typically expiration week sides with the bulls. We have seen this over the past year with 9 out of 12 expiration weeks reaping higher returns, but we haven’t seen the market in such a precarious overbought state.

Situations like what we are seeing in the market are what I thrive on as a statistically-based trader. I use only highly-liquid ETFs to take advantage of short to intermediate-term extremes in the market and pounce on those opportunities using statistically-based, high-probability trades. My strategy of choice of course is credit spreads, Verticals, condors, etc. you name it, I sell it. I always want to take the other side of a highly-speculative trade and in this environment speculation has become robust. Now its time to take advantage of those options buyers who are taking 15% chances on a trade. Let me have the other side and the 85% chance of success to go along with it. I will win out every time over the long run. It’s just a matter of staying the course and keeping position-sizes within a reasonable level. The latter is by far the most important factor in the longevity of a trader.

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If you are a believer in a statistical approach towards investing please do not hesitate to try one of my options strategies. I use simple mean-reversion coupled with probabilities for each and every trade. Give it a try, it’s free for 30 days.