Tom’s Weekly Newsletter August 23, 2023

Originally published via our newsletter previously. Subscribe for early access!

Options Traders Want to Know How Far the Rollover Will Go

Market in Focus

Rather than highlight one major index or sector ETF, we are showing the Year- to-Date charts on the ETF for the Dow (DIA), the NASDAQ (QQQ) and now, below, the S&P 500 (SPY).

This is not a market call stating the markets will retrace to one of the Fibonacci retracement levels shown, but simply where those Fib levels live.

All three major averages fell for a second straight day.

The primary catalyst being written as the cause for this is intimation the Fed is not done raising interest rates as inflation concerns are still there.

A pull back, even one to just to the 38.2 Fib level might be looked at as manageable as investor and options traders may find securities on a decent sale price at that point in time and start redeploying their investment and trading capital again at that level – if not sooner.

From the Desk of a CMT – Sector SPDR Review: XLE Case Study

Running through sector charts on tomsoptiontools.com can be grounding when you have a bit of sideways action and some shorter-term bearish activity. The ETFs below provide a nice cross-section of S&P 500 sectors and can be saved in a list to allow a quick review of both stock charts and IV charts.

XLB XLE XLF XLI XLK XLP XLU XLV XLY SPY XLRE XLC

It didn’t take long to find a potential bearish short-term move for XLE when using Fibonacci levels with the chart.

Keeping things simple and managing trade size and your risk holds a lot of value.

In this case, clear price levels offer an objective assessment of price confirming the trend or alerting you to problems.

Note the recent divergence in the Percent Change indicator.

Increased volatility is generally associated with declines, and you can see that short-term implied volatility (IV) is just turning up now.

This case study has a short-term time horizon, so a bear put spread will help mitigate time decay for the approach.

Always a favorite, the Smart Search (Searchers Multi-Strategies Smart Search) will provide a few choices for us.

With a personal preference for odds greater than 1:1, the relatively larger spread was selected.

Figure 5 provides the risk graph for this particular strategy. In this case, there’s also a Kelly Bet Fraction greater than 0.

The spread cost is $219 as of the close on Tuesday, 8/15/2023, and this case study will use 4 contract per leg as follows:

• Buy puts to open: 4 Sep 01 2023 90 put @ $2.94
• Sell puts to open: 4 Sep 01 2023 85 put @ $0.75
• Net debit: $219 x 4 = $876

Since this amount is above the max risk generally used for the case studies, if the spread quote moves to $0.94, it must be exited.

As always, we can’t expect the markets to be static from Tuesday evening to Thursday morning, so these case studies generally serve as a paper trade to track. In some instances, you can select different strike prices or other minor changes, but it may be harder with this given the time horizon and position of XLE between the Fibonacci levels. The risk-reward proposition will likely be different.

For now, Fibonacci levels will serve as exits for an expected gain ($84.82) or loss ($89.90). Additionally, the strategy has a timed exit of one day before expiration (Thu, August 31, 2023) so the position is actively managed, not left to market conditions on September 1st. This provides four different exit signals.

It feels like summer vacation time in the market the last few days. Monthly options expiration is his Friday which may increase volume a bit. We’ll see if the 0dte traders (zero days to expiration) take time off or if some bullish influence comes into the market at week’s end. Have a great week.

Regards, Clare White, CMT

Thanks, Clare!