May 22, 2017

Extreme Overbought Territory

I stated in the last trade alert today (subscribers only) that as a high probability, mean-reversion trader I thrive on situations where the std. deviation has pushed to extremes. Well, almost every ETF I follow has moved into a short-term extreme after today’s rally. The tech-heavy QQQQ’s have pushed to 99.9 on the RSi (2). As you can probably guess, a short-term reading this extreme does not occur often.

Admittedly, my current position is nearing the max pain area, so I could potentially close out the position (most likely the prior two trades with lower deltas) for a loss if the indice keeps pushing violently high. When exiting a trade I typically look for a  fade of the current direction to a critical area of support/resistance and then I look for a continuation of the fade. If we see a bounce instead, I will  look to exit the trade.

However, even though I am near the max pain area, I really like the probability that a short-term reversal is  close (1-4 days) which could bring the current SPY position into a profitable trade. I will probably take a loss on the first trade of the position, but I expect a decline will allow today’s trade, Dec10 114 puts, and possibly the Nov10 113 puts to move into a profitable state. I would actually expect the Nov10 113 puts to move back to a  break-even state, but I would certainl take some profits if they were around.

I increased my contract size slightly due to the extreme readings in all of the indicators I follow. Bearish seasonal tendencies are also still upon us. The next four trading days are historically weak which increases the probability slightly for a short-term reprieve. Typically, when we see a short-term ‘very overbought’ reading in every major benchmark coupled with historically weak seasonal conditions the market takes a break. The gap at the $111.61 should also weigh on the market over the short-term particularly given the extreme readings and should give me a nice area to take a bit, if not all, of my position off the table.

Again, all of the aforementioned led to the increase in my position-size, which is roughly 75% of my overall options portfolio. I can’t emphasize this enough. You must always consider the size of your position and how much risk you are undertaking with each trade. Position-size is VERY IMPORTANT and should never be taken for granted.

Moreoever, the actual options that I chose have delta around $.50 which means that for every $1.00 the underlying ETF goes up/down the option price goes up/down by roughly $.50. Of course, other greeks must be considered, but this is typically a decent indication of how the option price will move. Anyway, I mention this because, by choosing the delta I can gauge what my gain/loss will be before I place the trade. This is just another way (among others) that I use  to control risk on each and every trade.

As I always state, trading is a marathon and not a sprint.