On the Eve of Options Expiration…..
January 20, 2012
I am always amazed how large the opportunity to “make it big” factors into the great magnetism of the market. The belief that anyone, from any background can be successful and make tons of money has quite the allure. But, in all of this euphoria people neglect to think about all of those that failed before them. And believe me the failure rate is high. Yet, investors/traders continue to choose the most difficult of investments to trade – stocks. Stock-only traders are at a complete disadvantage because they have no way to trade the randomness of the market. They have a 50/50 chance of success for each and every trade.
Bottom line – stock investors/traders are truly at a disadvantage.
Again, stock investors only have two ways to make a profit: buy a stock or short a stock. And most retail investors are not willing to short a stock, so basically they are only able to profit in one direction – up.
Another characteristic that stocks have is that they don’t have an expiration date like options. I know some of you are probably rolling your eyes right now. How could something that expires be more attractive than something that can be held to perpetuity?
Well, we all know about the marriage that many of us have for our beloved stock positions. A plan to end the investment/trade often doesn’t exist because the stock goes up and you hold it and then it goes down and you hold it even longer and if it continues to go down you hold it for that much longer hoping that your position will eventually come back to break-even and even then most decide to exit the position.
Just think of all the missed opportunities. It drives me absolutely insane to think about it. Your capital could have been used for so many other opportunities. Also, an expiration date forces options traders to truly think about the risk/reward of each and every investment /trade. Furthermore, it forces the options trader to think about the future in greater detail.
Remember, when you buy a stock, you have the entire amount of your capital at risk and more importantly you have dedicated a large portion of capital to the trade. With certain option strategies you could have a tenth of the capital tied up with the same risk.
Of course, there will always be the foolish guy who has dedicated as much on one options position as they would in a stock position., They don’t understand the importance of position-sizing. And position-sizing is THE key to being successful trading – PERIOD.
A basic rule that I like to use is that if I become too emotional about a losing trade then I have too big of a position on.
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Up, Up and Away? Not If History Has a Say.
January 18, 2012
The market rallied hard making it the 9 out of 11 tradings days with positive gains. SPY has made since 4.2% during that time, but over the past month SPY has made a staggering 8.7%. And as expected, now we are seeing sentiment change.
But, I am not completely sold on the rally yet.
Why? Well, other than the overbought to very overbought readings in most of the ETFs I follow and all of the reasons mentioned in my post yesterday, we are also entering into the weakest period of the month of January. Just look at the DIA chart below for percentage of times positive over the next five trading days.
courtesy of Sentimentrader.com (click to enlarge)
If you look at the ETFs I follow in the High-Probability, Mean-Reversion Indicator you can see that almost every ETF I follow is in a short-term extreme. Extremes that have not been seen in quite some time. I can’t remember the last time I saw all four major market benchmarks in a very overbought state. The decline is coming and soon. The question is how long will it last? Will it be long enough to close the gap from 1/3 or will it be a another one hit wonder. We shall all see soon enough.
I also came across an interesting article written by James Kostohryz wrote on Seeking Alpha which mentions three handy tools for investors to identify the characteristics of a bear market rally so as not to be lured into one. Interesting reading indeed.
How to Recognize a Bear Market Rally
1. Fundamentals: The first challenge in determining if a rally is legitimate or not is to address the fundamentals of the bear market. Are they still in play? “Stocks will often rally on relatively insignificant news during a bear market rally – news that in no way negate causes of the original decline. However, in a bear market rally, fundamental deterioration continues beneath the surface despite rising stock prices.”
Given that troubles in Europe helped spark the market decline, we can say these fears still hold. In fact, the likelihood of an economic collapse in Europe seems more likely today than it did on October 4th. The same can be said of America’s political and budget-cutting issues.
2. Low Volume Advances: “Bear market rallies are characterized by extremely sharp advances on relatively low volume. Such advances are driven by price-indifferent purchases by short sellers, put buyers and call sellers that are aggressively executing stop-loss orders,” writes Kostohryz. “Furthermore, in bear market rallies the sharpness of the price increases indicate price indifference on the part of long investors.”
With regard to this element, market actions since October 4th have been sharp and on low volume.
3. Sentiment: Rallies are fueled by a reversal of pessimism and skepticism, explains Kostohryz. “Extremely bullish sentiment suggests a high probability that reasonably foreseeable positive factors are already almost entirely discounted in the price of stocks.”
If you haven’t already, don’t forget to sign-up for my :
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Was Tuesday the Top?
January 17, 2012
Numerous downgrades, more European woes, news of inevitable Greek default, financial sector struggles among other bearish news led to a lower, oops, higher open today? Yes, higher.
It has indeed been rather frustrating as a short-term bear since the gap open on 1/3. But, oftentimes when you are a contrarian and you make your livelihood on fading short to intermediate-term market extremes you often get into positions early. Any professional with any cred will tell you the same. It is to be expected. However, we are now nearing the area of max pain. While I thought we would see an immediate push lower after the first week of the year, I was willing to accept a push up to 1300 on the S&P or roughly $130.00 in SPY. We hit that level today and after the bulls pushed and pushed they failed miserably by the end of the day.
I mentioned in earlier posts about the weakness that the end of January brings and I am still under the assumption that the market will indeed move lower to close the 1/3 gap unless SPY breaks the 1300 level and holds.
If you were not privy to the stats provided by the wonderful sentiment analyst Jason Goepfert of Sentimentrader.com he recently stated the following:
Starting around the 2nd week in January, stocks have had a consistent tendency to weaken. Or at least not show much strength. Especially technology.
I don’t want to hammer on this too much. Seasonality is a tertiary indicator at best, and can easily be overwhelmed by fundamental developments, technical breakouts and changes in sentiment.
The performance of various sectors since the day honoring Martin Luther King, Jr. became an exchange holiday in 1998. The performance of QQQ was positive only 1 out of 11 years into the end of the month.
He goes onto to provide a wonderful chart that shows sector performance after the MLK holiday and the Nasdaq 100 only has a 9%, yes 9% chance of closing higher than its price level before the holiday.
Furthermore, 24 of the indicators he follows are reading bearish, not a single one is bullish. Some of the indicators include Rydex Bull/Bear RSI Spread, Put/Call Ratio – OEX Open Interest Ratio, every Put/Call RAtio including Equity Only, Total of All Options, Equity Moving Averages, Liquidity Premium QQQ and SPY, AAII Sentiment Survey and the list goes on and on. So, I think you get the picture.
1/3 gap here we come.
If you haven’t already, don’t forget to sign-up for my :
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Theta Driver Options Strategy (limited room available): Free 30-day trial
Also, for those of you who live on Facebook. You can access my info there as well. Just click on LIKE.
