June 23, 2017

Time to Sell a Few Bear Call Spreads?

Many of the ETFs I follow for my options strategies remain in a short-term overbought state. And the shortest time frame I follow (not shown in the chart below) still shows a plethora of ETFs in an extreme overbought state. Typically, when we see this type of reading the market experiences a short-term reprieve over the next 1-5 trading days.

The reason I follow my overbought/oversold indicator is because I believe in the power of mean-reversion, particularly at extremes. Moreover, I am a firm believer in using statistics, not gut instinct, to make trading decisions. As we all know emotions, while difficult to avoid, are a true detriment to self-directed investors.

If I see a short-term overbought state like we are currently witnessing in the QQQ’s, I will use an out-of-the-money bear call spread as my strategy of choice.¬†More importantly, I use what is known as the probability of success to create favorable odds for my position. This concept is foreign to many investors. Most are accustomed to taking advice from a stranger who statistically speaking has no better than a 50% chance of success…essentially a coin flip. Those type of odds don’t work for me.

The bear call spread gives me a margin for error just in case the trend continues higher. But again, the most important aspect of a credit spread (bear call spread, bull put spread, iron condor, etc.) is that I have the ability to choose my own probability of success, thereby defining my own risk.

You see, investing using solely fundamental or technical analysis is a thing of the past. Yes, I use what some consider to be a technical indicator, but in my book it is no more than a mean-regression model. I am not basing a trade based on chart formations, aka “cup and handle”, “doji formation”, etc., I do not use cash flow models to guess where a stock or ETF is headed.

Statistical analysis is the wave of the future. In my opinion, it is the only way a self-directed investor stands a chance to beat the market on a consistent basis.

These aren’t the options strategies learned by most retail investors. I am not buying puts or calls in an attempt to make outlandish gains. This is the strategy that has given options a bad name.

I am using highly-liquid ETFs to sell out-of-the-money credit spreads with a high probability of success.

I realize this is a fairly short post on the topic and admittedly I hit a lot of highlights, but I intend to discuss the power of probabilities and how to use them to your advantage ad nauseum . Stay tuned!!!

High-Probability, Mean-Reversion Indicator 11-26-12