Options Related Article in October 2014 Stocks & Commodities Magazine

It’s self serving announcement time here at JayOnTheMarkets.com.  Please see my option trading related article in the October 2014 of Technical Analysis of Stocks & Commodities (www.Traders.com).

The article is titled “Introducing the Open Collar” which details a slight twist on the “collar” strategy, which is mostly used by traders to limit the risk on a stock position for a period of time – while also limiting the upside potential.  The “Open Collar” is an attempt to alter things enough to limit risk on the downside while also retaining unlimited potential on the upside.  If you have ever considered using options to hedge a stock position or portfolio you might find this to be a useful idea (NOTE: in the interest of full disclosure, yes, my opinion is slightly biased in this case).

Jay Kaeppel

Let It Rain…a Little…For Now

Well it’s raining like crazy here in the greater Chicagoland area (which reminds me, have we usurped the title of “Murder Capitol” from Detroit yet?  I digress) and the stock market is – of all things – kind of going down of late.  Who knew that that was still possible?  Of course the truth is that we can probably use both – the rain and a “pullback” in the market, that is (the Murder Capitol thing, maybe not so much).

I have been on something of a hiatus.  Have gotten some nice comments of late from people who used to read my stuff at Optionetics and just discovered my blog.  I appreciate the kind words.  It kind of makes me wish I could think of something useful and/or intelligent to say about the markets.  Around late August I simply fell into the “stocks go up, bonds go up, gold goes down, period, end of discussion” zombie-like line of thinking, and couldn’t really find anything new to say regarding those particular trends.  Sort of a “Lack of a need to do any analysis paralysis.”

September and After

The most bullish portion of the Decade cycle – i.e., the Mid-Decade Rally – starts at the close of trading on September 30th.  Rather than regurgitate all of the relevant numbers I will simply encourage you to review this article (September 30th – Mark Your Calendar!) to get an idea of how the stock market has tended to move during the 18 months smack dab in the middle of the decade (Hint: “Up”).                 

In the meantime, a pull back in the stock market during the month of September might be “healthy” in the long run.  Of course, we can also file this idea under the category of “Be careful what you wish for.”  On a certain level it sounds logical to say “hey if the stock market experiences a nice, neat 3-5% pullback during September it may very well set the stage for the net leg up.”  Unfortunately I have on several occasions in the past seen this type of thinking turn into “hey don’t worry, this current pullback is just setting the stage for…………AAAAAAAAAAAAAAAAHHHHHHHHHHHHHHH!!!!!!!

So like I said, probably best to take it as it comes for now….and be careful what we wish for.   I promise to start posting a little more regularly soon.

Jay Kaeppel


War, Genocide, Riots: Markets Say ‘Ho Hum’

Well I haven’t been posting much lately, but what’s new to say really?  This is getting really boring.  The financial markets I mean.  Oh sure, there’s no end to the apparent chaos going on around us – Wars, genocides, beheadings, riots, and so forth.  But the markets haven’t changed their tune one bit.

Stock market up, Bond market up, gold market down.  Repeat.

So despite all of the turmoil, 2014 is shaping up as one of the boring years in history for the financial markets.  Outside of the financial markets, American citizens are told to do exactly what we have been told to do since 9/11 – “just keep shopping.”   And the 50% or so of citizens who are not receiving government check s are trying their best.  Actually, the other 50% haven’t stopped shopping yet either.

While there are hints of seething rage and restlessness out there, in a nutshell “Hope and Change” has mostly morphed into “Mope and Complain” as “Jobs American Won’t Do” has morphed into a “new normal” of “Jobs Americans Can’t Find.”

But who are we investors to complain, what with the stock market and the bond market marching relentlessly to ever higher new highs?  For the record, I am predicting that the stock market will take a hit in the month of September (“Har, good one, Jay”).  Of course, for the record I also suggested that this would be a good year to “Sell in May.”  Of course – also for the record – I haven’t sold a thing (I am speaking here of investments, not short term trades).  The old trend-follower in me keeps whacking the side of my head and asking “what are you thinking about?”

For the record, you don’t want to know.

In the Meantime

While waiting for something to break the mind numbing doldrums presently unfolding in the markets, the focus is on shorter-term trading opportunities.  In recent articles (http://tinyurl.com/mzhstm2) and (http://tinyurl.com/p4ve6z8) I talked about a simple method for attempting to play short-term bearish situations.  Similar things can be done on the bullish side.

One simple method for finding potential opportunities involves:

1. Stock or ETF trading above 200-day moving average

2. Stock low price touches lower Bollinger Band (using moving average of 10 and multiplier of 2)

3. Stock subsequently exceeds high from previous trading day

4. At least a 1-day bullish divergence forms using the 3-day RSI

OK, that sounds like a lot to digest, so let’s break it down a little bit.spy 821 1Figure 1 – SPY trading above 200-day moving average (Courtesy: AIQ TradingExpert) spy 821 2Figure 2 – SPY low price touches lower Bollinger Band (Courtesy: AIQ TradingExpert)spy 821 3 Figure 3 – SPY high exceeds previous day’s high (Courtesy: AIQ TradingExpert) spy 821 4Figure 4 – Bullish divergence using 3-day RSI (Courtesy: AIQ TradingExpert)

On 8/11 a trader might have considered buying a call option on SPY as a low dollar risk speculation on a bounce in price.

Using the “Percent to Double” routine at www.Optionsanalysis.com yields the following possibility.spy 821 trade 1 Figure 5 – Long SPY Oct 197 Call (Courtesy: www.Optionsanalysis.com)spy 821 trade 2Figure 6 – Long SPY Oct 197 Call as of 8/21 (Courtesy: www.Optionsanalysis.com)


The seeming disconnect between the goings on in our little world versus the actions of the financial markets is at a level that I personally cannot recall.  When something happens that you have not experienced before there is a tendency to want to “do something” – usually something very out of the ordinary – in response.  But history shows that for investors and traders, developing and adhering to a well thought out trading plan – and not twisting and turning in reaction to every outside event – is the real key to long term trading success.

Which reminds me of:

Jay’s Trading Maxim #3:  If you are going to develop an investment plan, you might as well make it a good one. And if you have a good trading plan, you might as well go ahead and follow it.

Jay Kaeppel


The RSI 3 Strikes and You’re Out Play (Part II)

In my last article (http://tinyurl.com/mzhstm2) I wrote about a simple entry method I have dubbed “The RSI 3 Strikes and You’re Out Play” or TSYO, for short.

The RSI 3 Strikes and You’re Out Method is a good candidate for option traders as it offers the potential to “make a few bucks” when the market experiences a pullback.  So this week I want to offer a few examples.

In the interest of full disclosure I had planned to do it last week, but once my family and I arrived in Aruba I quickly settled into the “Sleep Late, Run on the Beach, Lay on the Beach, Swim in the Ocean and the Pool, Shower, Go to Dinner, Repeat” routine.  And in the midst of that “busy” schedule I found little time to write.

TSYO Examples

I have a list of stocks and ETFs that I follow for option trading purposes.  Not necessarily the “definitive” list but a good mix of tickers that trade lots of option volume.  The list in Figure 1 displays some recent TSYO signals for some of the stocks on my list. 

*The first column shows the stock ticker. 

*The second column shows the date of the “Alert” signal (i.e., the 2nd non confirmation by RSI). 

*The third column shows the date that the stock or ETF takes out the low of the previous three days. 




3-Day Low





































Figure 1 – TSYO Alerts and Triggers

For the purposes of this article we will assume that a put option is bought at the close of the “3-Day Low” day.  For deciding which put option to buy we will use the “Percent to Double” routine found at www.Optionsanlysis.com.

One note, while I will highlight the profit potential for each trade reviewed, I will not detail any specific “exit criteria”.  My goal is to highlight the entry signal and not necessarily create a mechanical “system”.  I also think that each trader should do some thinking and consider their own criteria for when to take a profit or cut a loss.

Ticker AMGN

As you can see in Figures 1 and 2, AMGN triggered an “Alert” on 7/3 and made a new 3-day low on 7/8.amgn tsyo bc Figure 2 – AMGN (Courtesy: AIQ TradingExpert)

What followed was little more than a modest short-term pullback.  Still, as you can see in Figure 3, if a trader bought the October 120 put option on 7/8, by 7/17 he or she would have had an open profit of +40.5%. amgn tsyo

Figure 3 – AMGN Sep Oct 120 put option (Courtesy: www.OptionsAnalysis.com)

Ticker AMZN

In this example waiting for a 3-day low before entering actually worked against a trader because on 7/25 AMZN gapped significantly lower as you can see in Figure 4.amzntsyo bc Figure 4 – AMZN (Courtesy: AIQ TradingExpert)

Nevertheless, if a trader had bought the September 320 put option at the close on 7/25, by 8/1 he or she would have had an open profit of +69.4%.

amzn tsyo

Figure 5 – AMZN September 320 put option (Courtesy: www.OptionsAnalysis.com)

Ticker F

The example that follows for Ford (ticker F) highlights two things:

1. The ability to essentially “bet” on a short-term pullback while risking a relatively small amount of capital

2. The above average profit potential associated with trading options.

Ticker F triggered an “Alert” on 7/24 and made a new 3-day low on 7/25.f tysobcFigure 6 – F (Courtesy: AIQ TradingExpert)

If a trader had bought the September 17 put option at the close on 7/25, by 8/1 he or she would have had an open profit of +103.6%.f tsyo Figure 7 – F September 17 put option (Courtesy: www.OptionsAnalysis.com)


So once again, the point of all of this is not to attempt to promote the “be all, end all” of trading.  Because the TSYO method is most certainly not that.  But it can do a pretty decent job of identifying opportunities (especially after the overall market has experienced an extended run up and may be running out of team near term).  For traders who are willing to consider alternative (though simple) strategies such as buying put options, a method such as this can offer the potential to make money even as the overall market pulls back.

No one should go out and start making trades using the method I have detailed here without doing some further study/analysis/etc.  But the real point of all of this is that it is possible to use relatively simple ideas and relatively little capital to achieve trading success.

Jay Kaeppel

The RSI 3 Strikes and You’re Out Play

Please note the use of the word “Play” in the title.  Note also that it does NOT say “System” or “Method”, nor does it include anywhere the words “you”, “can’t” or “lose.”  So what is the distinction in all of this?

The use of the word “Play” is meant to denote that this should not be considered an “investment strategy”, nor even as a “trading method”.  In all candor it should basically be considered as a potential trigger or alert for traders who are willing to speculate in the market.  A few relevant notes:

1. Contrary to what many will tell you, there is nothing wrong with “speculating” in the financial markets.  There is a lot of money that can be made by doing so.

2. The key is in limiting the amount – and/or percentage – of capital allocated to each such trade.

3. Call and put options offer a great way to engage in this type of trading, because by their nature they allow you to “play” while using only limited sums of money.

Think about it this way.  Let’s say you “get a hankerin” to take a flyer on say a rally in the bond market.  Sure you could go out and buy t-bond futures contracts.  As I write they are presently trading north of 138.  At $1,000 a point, that means that the contract value is roughly $138,000.  You only need to put up margin money of about $3,000 in order to enter the trade.  Of course, if t-bonds decline from 138 to 135 then you have lost $3,000.  Good times, good times.

As an alternative you might have bought a call option on the ETF ticker TLT, which tracks the long-term bond.  As I write TLT is trading at $115.51, so to buy 100 shares would cost $11,551.  However, a trader looking to “play” could buy say a September 115 call option for all of $182.  If TLT rallied to say $118 by September expiration the 115 call would be worth $300, which would represent roughly a 65% gain.  And just as importantly, on the flip side, if TLT falls apart the most the option trader could lose would be $182.  Which reminds me of:

Jay’s Trading Maxim #312: If losing $182 on a trade is too much for you to bear – or will cause you great angst or to lose sleep or to beat yourself up – the “trading thing” might not be for you.

The RSI Three Strikes and You’re Out Play

So we will use the 3-day RSI indicator as a trigger to alert of a potential top.  Note the use of the phrase “potential top.”  Note also that nowhere do the words, “pinpoint”, “market” or “timing” appear.  So here is how it works:

1. (Day x) Price and 3-day RSI make a new high for a given move.

2. (Day y) After at least one intervening down day, price makes a higher close than on Day x BUT 3-day RSI stands below its level on Day x.

3. (Day z) After at least one intervening down day, price makes a higher close than on Day y, BUT 3-day RSI stands below its level on Day y.

4. After Day z the entry trigger occurs the next time price drops below the 3 day low.

To put it another way, after Day x price makes to higher closing peaks (with at least one down day between these peaks), while RSI on Day y is below RSI on Day x and RSI on Day z is below RSI on Day y.  OK, that’s as clear as mud.  So let’s go the “a picture is worth 1,000 words” route.

In Figure 1 you can see two examples of this “play” using ticker IWM, the ETF that tracks the Russell 2000 small cap index.  iwm rsi3Figure 1 – The RSI 3 Strikes and You’re Out Play using IWM (Source: AIQ TradingExpert)

In both cases the same scenario plays out.  Price makes two subsequent higher highs while RSI registers two subsequent lower highs.  The signal to buy put options comes when price takes out the three day low.

In the second example a trader could have bought a September 116 IWM put for $2.96 (or $296).  Eight trading days later that put was trading at $5.43 for a profit of $83%. iwm outFigure 2 – IWM put option using the RSI 3 Strikes and You’re Out play on IWM (Courtesy: www.OptionsAnalysis.com)


No one should get the idea that this simple “play” is the “be all, end all” of trading.  I specifically have not included any ideas on when to exit this type of trade so that no one gets the idea of trying to use this as a mechanical trading system.  Some traders may use a profit target, some may use an indicator, some may adjust the trade or take partial profits if a certain level of profit is reached, etc.

Like virtually any other trading idea, sometimes things will work out as hoped and sometimes they won’t.  The bigger lesson is that it is OK to speculate in the markets provided you do not expose yourself to large risks.  Which seems like good time to invoke:

Jay’s Trading Maxim #1: Your most important job as a trader is to make sure you are able to come back and be a trader again tomorrow.

Jay Kaeppel

Check the Dow on August 1st

Wow, that sounds pretty ominous and self important doesn’t it? (Hey, I gotta get people to click on the headline somehow!)

I will keep this short.  As I have been saying for some time, in my own mind I am scared to death that the market is getting far too overbought, the investing public is getting far too complacent, and the supposed “professionals” are getting far too bullish.  And for my own reasons I keep expecting something bad to happen between now and the end of September (followed by something good).

But despite all of this, I still haven’t sold a thing, for the simple reason that I am primarily just a dutiful trend-follower and the stock market just keeps moving relentlessly higher.  So who am I to say that the party is over?

But I am keeping a close eye on the weekly MACD for the Dow Jones Industrials Average.  Rather than going into a detailed explanation regarding “why” I will simply encourage you to review the material in this article – A Warning Sign to Watch.  (Hey, I did say I was going to keep it short, remember?).

In any event if and when the Weekly MACD for the Dow drops to negative territory, a more defensive stance may be in order.

djia macd


Figure 1 – Keeping an eye on Dow Weekly MACD (Courtesy: AIQ TradingExpert)

Jay Kaeppel

A Simple, Aggressive Approach to Large-Cap versus Small-Cap

Certain “arguments” just seem to last.  Since I started in this business (As best as I can recall, stock prices were reported on an abacus at the time) there has always been someone willing to pursue the “large cap versus small cap” and/or “growth stocks versus value stocks” argument.  Early in my career “everyone knew” that “in the long run” (usually defined – incorrectly – as the most recent 2-5 years) small cap stocks “outperform” large cap stocks.

Is this actually true?  The answer is “Yes, but only sometimes.”  The same answer holds true or growth versus value.  In short, no matter what you hear (at least in my humble opinion) there is no compelling evidence that large-cap stocks inherently perform better or worse than small-cap stocks nor that growth stocks perform better or worse than value stocks.  That’s the bad news.

The good news is that the interplay between large-cap and small-cap (and growth versus value) fluctuates – or more accurately, trends – over time.  In other words, it is not uncommon for large-cap stocks to outperform for awhile and then for small-cap stocks to outperform for a good long while.  If one can identify a trend then an opportunity exists.

One Simple, Albeit Aggressive Way to Play

The method I am about to describe is really pretty simple, however, it does involve risk as the method uses a leveraged mutual fund.  As a preface, the “safe” news is that this method is in the market only about 44% of the time (and is safely tucked away in cash the other 56% of the time). The “dangerous” news is that when it is in the market it is in a leveraged mutual fund that tracks large-cap stocks.  So, bottom line: it is not necessarily for the faint of heart.  More to the point though, it may be ultimately be useful to traders who are willing to invest a certain percentage of their capital in more “volatile” investments in hopes of an above average longer-term return.

So here are the steps:

A = Closing price for ticker RUI (Russell large-cap)

B = Closing price for ticker RUT (Russell small-cap)

C = 252-day % Rate of change for ticker RUI ((A / A 252 trading days ago)-1)*100

D = 252-day % Rate of change for ticker RUT ((B / B 252 trading days ago)-1)*100

E = (C – D)

If E > 0 this indicates that large-cap stocks have outperformed over the previous 252 days, and vice versa.

Trading Rules

If E > 0 today then buy ticker ULPIX (Profunds UltraBull) tomorrow and hold until E < 0.

If E < 0 today then sell ticker ULPIX and hold cash until E > 0

OK, not exactly “sophisticated”, still as a proud graduate of “The School of Whatever Works” (all hail good old “SWW”), I am far less interested in “process” as I am “results”. Which leads us directly to:

The Results

The test I ran started on 10/15/2001 when ticker ULPIX first began to trade.  The equity curves for the method described above versus buying and holding ticker RUI appear in Figure 1. jotm2014-0724-01Figure 1 – Growth of $1,000 using Jay’s ULPIX Method (blue line) versus buying and holding ticker RUI (red line); 10/15/01 through 7/23/14.

In a nutshell, $1,000 invested using the system grew to $4,257 versus $1,932 using a buy-and-hold approach.  The year-by-year results appear in Figure 2.














































Std Dev






Figure 2 – Annual Results; Jay’s ULPIX System versus Buy-and-Hold

As you can see in Figure 2, since 2002 the system has averaged 13% annually versus just +4.5% for buy and hold.  It should also be noted that the standard deviation of annual returns was lower for the system.

On the downside investors should be sure to note that despite the fact that the “system” showed a gain for 2008, it nevertheless experienced a -42% drawdown during 2008. So just, repeating now, this method cannot be characterized as “low risk” in any way shape or form.

It is also worth noting that the annual system results versus buy and hold is all over the place.  So anyone looking for an endless string of “out performance” year after year, will definitely need to look elsewhere.  The proper perspective is this: when the system is in the market it occasionally makes a lot of money.  When it is out of the market it doesn’t make much at all – even if the stock market overall is rising.

For the record the system has been in ULPIX since the close on 5/7/14 and shows no immediate signs of getting out.  As of 7/23/14, RUI is up 17.8% and RUT is up 10.1% over the latest 252 days.  So “Value E” from above is +7.7%.  The system will continue to hold ULPIX (for better or worse) until Value E once again falls into negative territory.


As always, I am not recommending that anyone rush out today and jump into large-cap stocks just because the method I have described is presently bullish.  Nor am I even suggesting that anyone should adopt this system.  Before anyone engages in any type of trading that involves the use of a leveraged mutual fund, there are a few introspective questions to be asked and answered regarding one’s own tolerance for risk, what type of asset allocation is reasonable, and whether The School of Whatever Works offer classes online? (OK, just kidding about the last one).

The real point of this piece is twofold:

1) To dismiss the notion that large cap stocks are inherently a better investment than small-cap stock, or vice versa and;

2) To illustrate that with a little bit of analysis and effort it may be possible to come up with simple methods that take advantage of trends in the marketplace.

Now if you’ll excuse me, I have to get back to class.

Jay Kaeppel


Everything You Need To Know About the Stock Market in 2 Charts

I have been a little “quiet” lately.  Kind of unusual for me, granted.  But what can I say really that’s new?  The stock market’s moving higher – blah, blah, blah.  The bond market keeps trying to creep higher – sure, interest rates are basically 0%, so why not?  Gold stocks keep trying to grind their way higher after putting in an apparent base.  But who the heck ever knows about something as flighty as gold stocks?

So like I said, not much new to report. 

So for the record – one more time – let me repeat where I am at:

-As a trend-follower there isn’t much choice but to say that the trend of the stock market is still “up”.  So as a result, I have continued to grit my teeth and “ride”.  And let’s give trend-following its due – it’s been a good ride. 

-As a market “veteran” I have to say that this entire multi-year rally has just never felt “right”.  In my “early years” in the market (also known as the “Hair Era” of my life) when the stock market would start to rally in the face of bad economic times I would think, “Ha, stupid market, that can’t be right.”  Eventually I came to learn that the stock market knows way more than I do.  And so for many years I forced myself to accept that if the stock market is moving higher in a meaningful way, then a pickup in the economy is 6 to 12 months off.  As difficult as that was at times to accept, it sure worked. 

Today, things seem “different”.  By my calculation the stock market has now been advancing for roughly 5 years and 4 months.  And the economy?  Well, depending on your political leanings it is somewhere between “awful” and “doing just fine.”  But in no way has the “old calculus” of “high market, booming economy 6-12 months later” applied.

Again depending on your politics leanings the reason for this lies somewhere between “it is entirely Barack Obama’s fault” to “it is entirely George Bush’s fault.” (I warned you there was nothing new to report).

From my perspective, I think that the charts below – the second one of which I first saw presented by Tom McClellan, Editor of “The McClellan Oscillator” (which he presciently labeled at the time, “The only chart that matters right now”) – explains just about everything we need to know about the stock market actions vis a vis any economic numbers.

So take a look at the two charts below and see if anything at all jumps out at you.

spx mnthlyFigure 1 – S&P 500 Monthly (Source: AIQ TradingExpert)


Figure – Fed Pumping (Quantitiatve Easing “to Infinity and Beyond”) propelling the stock market

I am not a fan of using the word “manipulation” when it comes to the stock market.  But I am a strong believer in the phrase “money moves the market.”  The unprecedented printing of – I don’t know, is it billions of trillions of dollars – has clearly (at least in my mind) overwhelmed any “economic realities” and allowed the stock market to march endlessly – if not necessarily happily – to higher ground.

Thus my rhetorical questions for the day are:

“What would the stock market have looked like the past 5 years without this orgy of money?”

“What happens to the stock market when the Fed cannot or will not print money in this fashion?”

Because this is all unprecedented in my lifetime (as far as I can tell) I don’t have any pat answers to these questions.  But I some pretty strong hunches.

My bottom line: Err on the side of caution at this time (http://tinyurl.com/p6zrqby).

Jay Kaeppel


Crash Insurance

Well it finally happened.  The stock market actually got “spooked” for a couple of days.  It’s been awhile.  And that kind of has me “spooked.”  Before I go any further I should state the following:

1) I am expecting some “trouble” between now and the end of September

2) However, as a dutiful trend follower I have yet to really act on those fears.

So when I write an article titled “Crash Insurance”, I am not necessarily suggesting that everyone rush out and buy some.  I am more or less just “planning ahead.”

I found the following link quite interesting (The 23 Charts Prove That Stocks Are Heading For A Devastating Crash) and suggest you give it a thorough read.  Although I don’t necessarily endorse the headline I do think something very unpleasant is quite possible, and the information contained flashes some clear warning signs.

If nothing else see the following:

Chart #4) QE to Infinity and Beyond qe

Figure 1 – QE to Infinity and Beyond (Chart Source: Forbes.com article “The 23 Charts Prove That Stocks Are Heading For A Devastating Crash” by Jesse Colombo)

This chart explains as plain as day why we have been in an endless bull market for years now (i.e., money moves the market, and when the Fed provides an endless supply, well, you get the drift).  When this chart turns down, be prepared to – all kidding aside – RUN LIKE HELL!

Chart #5) NYSE Margin Debt margin debtFigure 2 – NYSE Margin Debt (Chart Source: Forbes.com article “The 23 Charts Prove That Stocks Are Heading For A Devastating Crash” by Jesse Colombo; Chart generated by Doug Short at DShort.com)

In the 1975 classic “Market Logic”, Norman Fosback first noted that rising margin debt is bullish for the stock market (once again, money moves the market).  He also noted that when margin borrowing gets overdone and then turns down, it’s not such a happy thing for the stock market.  As you can see in the chart, the previous two spikes occurred during the run up to the 2000-2002 and 2008 bear markets.  The current level has recently declined from a new all-time high.  If this downtrend continues it will constitute an important warning sign for investors.

How to Buy “Crash Insurance”

In college I took a class on Insurance (Wow, was I a fun guy or what?  I digress).  What the teacher taught us was to “spend a little to cover alot.” In other words, spend a small sum of money to cover worst case calamity scenarios (granted this is different then what insurance has evolved into today whereby everyone wants everything to be covered and then wonders why the premium is so high…..but again, I digress).

SPY Put Option

One of the simplest way to “insure” against a market crash is to buy a put option on ticker SPY, the ETF that tracks the S&P 500 Index.  As I am looking for a bullish phase to begin on October 1st I need to go out to October options.  In Figure 3 we see the “Probability Calculator” screen from www.OptionsAnalysis.com.  Highlighted are the potential -1, -2 and -3 standard deviation price levels.

spy prob

Figure 3 – Probability Calculations for 9/30/14 (Source: www.OptionsAnalysis.com)

The October SPY put option with the lowest “Percent to Double” is the October 198 put option.  As I write the option trades at $5.79 (or $579).  The risk curve for buying one October 198 put appears in Figure 4.  The lower boundary is set to the -3 standard deviation price shown in Figure 3 (166.10).spy put Figure 4 – Risk Curves for October SPY 198 put (Source: www.OptionsAnalysis.com)

As you can see in Figure 4, if by chance SPY does fall apart between now and October expiration, this option will gain a lot in value.  Of course if the market moves sideways to higher instead this option could expire worthless and the buyer would lose a maximum of $579.


I am not suggesting that now is the exact right moment to consider buying a put option on SPY.   As always I am not “recommending” the trade above.  The example I’ve shown is simply intended to give you the idea of how to use put options as a potential alternative to “selling everything”.  You should also be aware that via the use of options there are other more “sophisticated” strategies available.  Buying a put option to hedge is sort of a “hammer to nail” approach – crude but effective.

In any event, as indicated in the Forbes article in the link above, there are some “clouds beginning to build”.  Which leads directly to:

Jay’s Trading Maxim #102: It is better to know where to find shelter now  in case an actual storm breaks out than to have to “run for cover” somewhere down the road.

Jay Kaeppel

The Tempting Siren Song of Gold Stocks

If you are a “chart” guy or gal you may have taken notice of some interesting developments in gold stocks over recent months.  A strong argument can be made that a “bottom formation” has – well – formed and that price is now in the early stages of a new bullish trend.  Is this an accurate picture?  Let’s take a closer look.

The Chart Picture

The great thing about looking at price charts is that you can see pretty much whatever you want to see in them – er, I mean, there are many different possible interpretations.  In Figure 1 we see a weekly bar chart for ticker GDX – the Market Vectors ETF that tracks a gold stock index.gdx weekly Figure 1 – GDX Weekly Bar Chart with Support, Resistance and Triangle pattern highlighted (Courtesy: ProfitSource by HUBB)

As you can see there is a (OK, somewhat subjectively drawn) support and resistance range between roughly $20 and $32.  There is also a triangle pattern forming as price consolidates into a more narrow range.  Now for the record I got burned by incorrectly guessing the direction of a triangle breakout in ticker GLD recently (link), but I am not much of a “Once bitten, twice shy” kinda guy.  For me it’s more like, “Fool me once, shame on you, fool me twice – damn! I fell for it again.” Cest la vie.

Still, the point is that price action seems to be “coiling” within a larger trading range, so now is the time to start planning what action to take, if any.

In Figure 2 we see a weekly bar chart for ticker GDX with the Weekly Elliott Wave count plotted, as calculated objectively by ProfitSource from HUBB. gdx ew Figure 2 – GDX weekly with Elliott Wave (Courtesy: ProfitSource by HUBB)

As I always I should point out that I do not “blindly trust” Elliott Wave counts.  Sometimes they play out with “uncanny accuracy”, other times, well, not so much.  Still, for what it is worth, the current count is projecting a potential move from $26 to roughly $38 to $42, potentially by the end of this year. 

So this raises two questions:

Question 1: Do you think there is a chance that gold stock prices will advance in a meaningful way between now and the end of the year?

Question 2: Are you willing to risk a couple hundred bucks while waiting to find out?

Option Plays in GDX

As is always the case when dealing with options, the possibilities are limitless.  One possibility is to use the “stock replacement strategy”.  With this approach a trader buys a deep-in-the-money call option that will emulate a stock position at a fraction of the cost.  For example:

*To buy 100 shares of GDX would cost $2,645

*To buy one December 20 GDX call would cost just $675

The Dec 20 call has a “delta” of 93 which means it will act like a position holding 93 shares of GDX, but will cost only 27% as much as buying the shares.  The particulars for the Dc 20 call trade appear in Figure 3. gdx dec 20Figure 3 – Long 1 Dec 20 GDX call @ 6.75 (Source: www.OptionsAnalysis.com)

An alternative would be:

*Buy 6 Dec GDX 28 calls @ 1.43

*Sell 6 Dec GDX 33 calls @ 0.32

This trade would cost $666 and the particulars appear in Figure 4.gdx dec 28 33 bcs Figure 4 – Long 6 Dec GDX 28-33 bull call spreads (Source: www.OptionsAnalysis.com)

This trade has a delta of 170, which means it will act like a position holding 170 shares of GDX, i.e., up to a point it can make money much more quickly than the Dec 20 call position for the same investment $.

Comparing the Two Trades

Figure 5 displays the two trades (one Dec 20 GDX call for $675 versus six Dec 28-33 GDX bull call spreads).gdx overlayFigure 5 – GDX Dec 20 call versus GDX Dec 28-33 Bull call spread  (Source: www.OptionsAnalysis.com)

The Dec 20 call enjoys unlimited profit potential and eventually could make more than the Dec 28-33 bull call spread.  However, based on the earlier Elliott Wave analysis, we are looking at (OK, hoping for)  a move to the $38-$42 range (which would be a huge move).

So if GDX does in fact rise between now and December the Dec 28-33 bull call spread enjoys better profit potential. 


As always, there are many ways to play just about anything in the financial markets, particularly when options are involved.  Also as always, I am not “recommending” either of these trades.  The purpose here is simply to highlight:

*One way to trade options instead of stock shares and get essentially the same position at a fraction of the cost (i.e., the Dec 20 call).

*One way to create greater upside potential for the same cost (i.e., the Dec 28-33 bull call spread)

Finally – and also as always – there are tradeoffs and caveats to keep in mind.  In this case, two that come to mind are:

1) GDX MUST move higher for either of these trades to make any money.

2) YOU MUST be patient and wait for the move to play out (assuming it does) over a multiple month period of time.

Which leads us to close with:

Jay’s Trading Maxim #57: When patience is required in trading – the urge to become impatient suddenly tends to surge.  So prepare yourself mentally to fight the “urge to surge.”  

Jay Kaeppel