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In this article I will analyze a famous ETF - SPDR S&P 500. It is very popular and doesn’t have any problems with liquidity in the underlying as well as in the options. Moreover, ETFs are low-volatility financial instruments and option selling strategy can result in a real bargain. As we can see from the chart, during the last 16 trade days SPY was in a sideway trend and 35-day EMA (Exponential Moving Average) marked with white helps us to get sure in that. Moving average indicator doesn’t work in sideways trend it is just an indicator of a current trend situation in such case. So, if MA is flat then there is a true sideway trend on the chart. But all this should end but everything depends upon timing. Yes, timing. Flat trend should end in some time and then the stock price will soar either higher or lower. That’s the second important question. A wonderful chart pattern - descending right triangle helps us to get answer for that question. Such chart pattern is very bearish and is especially effective when underlying has been trading on the range for 2+ weeks (16 days for SPY). Descending triangle formation is also followed by descending implied volatility. You know that if IV is low, it should increase some time. I am 90% sure (statistics, statistics) that implied volatility increase will be followed by price decline. Now, we should define the target price. As we know, the target range is defined by the widest distance of the pattern. Here it is 5.24$ (131.57$ - 126.33$). Now, subtract 5.19$ from the resistance price (126.33$).Here we come to the target price of 121.14$. In other words I predict 5.82% decline form the current close price - 128.63$.
I like selling options. According to the statistics 70% (someone say 80% or even 90%) of options expire worthless. I suppose that the most efficient strike to sell call option in this case will be 132.00$. Call option price with strike 132.00$ equals to 1.17$. So 1 option contract costs 117$. Open interest for this contract equals to 14,494. You option may be exercised when price goes beyond the breakeven point which equals to 133.17$. The price should go more than 3.53% up. If you’re afraid sell 133$ call option.
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August 29th, 2008 at 7:42 pm
Great analysis. I got into some Bear call spread on the SPY. Thanks !
September 4th, 2008 at 6:37 pm
I am a value investor and not using tech Analysis as a tool to analyze the stock I am going to invest. But as a blogger, I required enough knowledge to this technique and that will add knowledge to me. Your posts showing the various sides of TA and I can move forward with this information to learn about TA more. Thanks Andrew.
September 5th, 2008 at 9:50 pm
One slight mistake in your write-up. Someone who buys a 132 call option will exercise at expiration at any point above 132 to recoup at least part of their initial outlay. Granted, in a perfect world it would go over 133.17 so a profit is made.