Uncertain Markets Make Certain Trades Stand Out

Gordon Scott  |

A good trader knows that sometimes it is a good idea not to expect too much out of the markets. This week’s market activity features a schizophrenic mix of signals. It is as if the market can’t decide what it wants to be—a bear or a bull. On the one hand, volatility persists, the energy sector stocks are surging, and the financial sector is making new lows. This combination of trends usually presages the beginning of a bear market.  But on the other hand, we see that dividend yields have eclipsed bond yields—a bullish event rarer than a blue moon—and the likes of Dallas Federal Reserve President, Richard Fisher, said the risk of another recession “is negligible” and that the US economy is “poised for growth.”

Are There Any Certain Trades Amid Uncertain Signs?

Warren Buffett certainly bought enough of IBM (IBM) to tip his hand about which of the two market personalities he thinks will emerge in the coming quarter or two. Meanwhile as the headlines regarding Eurozone sovereign debt woes worsen, the markets twitch with nerves. This all adds up to uncertainty, but not outright panic. Rallies remain hesitant, while selloffs seem unconvincing.  What kind of trade could be useful in this environment? What about a conservative, intraday-trading strategy tailored for option-expiration Friday’s?

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Here’s how it might work: Since the third Friday of each month is the day options expire, it stands to reason that there are many in the markets with significant risk of loss if the markets make larger-than-normal moves.  Perhaps that is why the market indexes show a significant reduction in volatility on expiration days. Whatever the reason for it may be, the evidence is worth noting: 75% of expiration days over the past 5 years have shown a range smaller than average when compared to a 14-day Average True Range measure.

If you were looking from the perspective of Thursday Nov. 17, it would imply that for Friday Nov. 18, SPDR S&P 500 (SPY) would not travel further than the upper most lines shown here in this figure below.

If the prices remained within these bounds, you could use this information for intraday trading to determine reversal zones. For example, SPY is unlikely to travel more than $2.77 (it’s current ATR[14] measure) from Thursday’s close.  So you could use a slightly smaller range, say $2.50, and divide that in two to mark a distance in each direction from Thursday’s close and thus establish reversal zones like this:

If the market were to stay above Thursday’s close, then traders would expect to see the days’ high contained within the range of $123.50 to 124.75.  Conversely, if the market, moves bearish and stays below Thursday’s close, the low for the day would likely fall between 119.50 and 120.75.

Another tactic for option sellers might be to consider collecting a single day’s premium outside these ranges. With a 75% predictive rate, there may be many possibilities to consider for future expiration Fridays.

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