As I rough out this article on Labor Day weekend, I'm thinking ahead to the October option expiration cycle. Many other options traders might be doing the same, especially if they trade credit spreads. The last several weekend Trader's Corner articles discussed determining support and resistance. My search for possible resistance into October provides an opportunity to pull together all the information in those previous articles.
For those options traders who do not trade combination trades, a little explanation may be in order. A credit spread of the type I trade is composed of either two calls or two puts. One is sold to collect premium, and another, further out of the money, is bought to hedge the play. For example, I could (but wouldn't) sell an SPX Oct 1340 call and buy an SPX Oct 1350 call. As of the close Friday, September 1, my quote source notes that the bid/ask for the 1340 was 8.90/9.90, and for the 1350, 5.60/6.30. As of the close that Friday, I could presumably have sold the 1340 for at least $8.90 and bought the 1350 for no more than $6.30.
I wouldn't have done that although the premium collected was attractive, and there's at least a slight possibility that it would end up being profitable. With seven weeks to go until October's option expiration as I type, and with the SPX closing Friday, September 1 at 1311.02, that 1340 strike is far too close to the action for me to consider selling it, even if hedged. A bear call credit spread, the type I would be initiating, would experience a loss if the SPX closed the October expiration cycle above the 1340 strike plus the credit I collected, minus commissions, and it would experience its maximum loss if it closed above 1350 at October's option expiration. With September and October often known for their volatility and with an important FOMC meeting due in September, I wouldn't have dared to get so close to the action.
So, on Labor Day weekend, my search begins. I am looking for resistance that might be strong enough to hold back the SPX into the October expiration. Because I'm a fan of nested Keltner channels, a topic touched upon in last weekend's Trader's Corner article on support and resistance, that's where I'll start. I'll begin with the 240-minute chart.
Annotated 240-Minute Chart of the SPX:
This chart tells me that 1336-1337 could be fairly strong resistance, but there's plenty of time before October opex to nudge that line higher, too. Although it's possible the SPX would turn lower at or below that level and never move above it before October's option expiration, obtaining a modicum of safety requires other resistance levels above that first strong resistance level. I don't want to sell an option with a strike barely above the first identified long-term resistance, not with so many weeks to go before October's expiration. The weekly nested Keltner chart will help me pinpoint those other resistance levels.
Annotated Weekly Keltner Chart for the SPX:
As explained in a prior article in this series, I like to combine two kinds of channels: one pinpointing where support or resistance is likely to lie, such as these Keltner channels, and one pinpointing where historical resistance has been found. Since 2004, the SPX has been climbing in a rising regression channel. During that long trending move, the SPX has found resistance at the midline or top of that channel.
Annotated Weekly Chart of the SPX, with Regression Channel:
Although it's longer than a month until option expiration, I also like to look at the monthly average true range to get an idea of how much the SPX has been moving over a month's time. This indicator, sometimes shown as ATR, is available on many charting services.
Although it's possible that the SPX could just climb for six straight weeks, it's likely that prices will retrace sometime during that period, so ATR at least gives me some idea of the amount the SPX has lately been moving in a month to six weeks.
As this article was prepared on Labor Day, ATR was 47.16, and had been about that level the whole time the SPX has been climbing within that rising regression channel. Adding that amount to the SPX's close the Friday before Labor Day gives me a figure of 1358.16, so that's another figure I'll keep in mind. Remember, however, that the end of a rally sometimes produces a straight-up move, so that the SPX could exceed its monthly ATR if it should see a buying crescendo.
I typically also look at moving-average support or resistance. As this article was typed, the SPX had moved above most important moving averages, so there's nothing above to restrict its movement, at least from a moving-average standpoint, on daily or weekly charts.
Annotated Weekly Chart of the SPX:
My next search is for historical and/or trendline resistance, with that augmented by Fibonacci studies. The regression channels have already helped me determine one type of trendline/historical resistance, but there may be important others to note.
Annotated Monthly Chart of the SPX:
As I study this chart, I note that the SPX has retraced more than 61.8 percent of its decline off its 2000 high, but a quick calculation reveals that it hasn't yet retraced 2/3 of the decline. That would be at about 1355, if my calculation is correct. Many market pundits believe that it's normal to retrace 1/2 to 2/3 of a prior movement, without that movement necessarily being reversed, so the possibility exists that 1355 or so could also present some resistance. I tend to watch the Fib lines shown here more than a 2/3 resistance level, but its close proximity to a 1350 round-number resistance, as well as to that ATR + Friday-before-Labor-Day-close is intriguing, too.
Just to add one more fillip to my search, I check a point-and-figure chart, and find that the SPX, as of Labor Day, had an upside target of 1480. Whoa! Fortunately, the SPX is unlikely to get there before October option expiration, because there's not a chance I'm going to get a spread above that level! As of Labor Day, no options existed that high for the October expiration cycle. However, this is important information, because it tells me that I need to be particularly careful with identifying resistance levels. While I don't trade off P&F charts, I do take a look at them as background information on overall trend.
What about historical patterns for September and October, with weakness often appearing into October? Do I factor that seasonal pattern into my reasoning and my choices for resistance? I do note that the SPX was outstripping its 200-sma as of Labor Day, and that sometimes means that a pullback is due. However, while acknowledging that distance from the 200-sma, the bearish price/RSI divergence on some charts and the often-seen dip in the fall season, those bits of evidence are more than balanced by that strong P&F target. While I'm not building an expectation that 1480 will be hit, that target does warn me to be careful about the placement of my credit spreads.
As I study the charts and calculations above, I see a number of resistance levels coming together in the 1347-1355 range. That's still too close, though, not even quite equaling the sum of the close on Friday, September 1 added to the monthly ATR. I see some resistance coming together in the 1365-1367 level, but I'm also still aware that if the SPX does nothing more than stay within that rising regression channel in which it's traded since 2004, it could be hitting 1376-1377 on weekly closes (and perhaps higher intra-week) by October's option expiration.
I'd prefer my bear call credit spreads to be established above 1376-1377, with the sold call at least an October 1375 call and preferably a 1380 one. As of that weekend, I am uncertain as to whether I could get enough premium to establish a trade with a sold call with a strike at or above 1380. It seems unlikely. I must consider whether I'm willing to risk establishing credit spreads with sold calls as low as 1350, 1355, 1360, 1365, 1370, and 1375.
That was my thinking on Labor Day weekend. Ultimately, on September 6, I was able to establish SPX bear call spreads with the sold call at 1375 and the hedging long one at 1390. A day or two later, at the suggestion of Mike Parnos of Couch Potato fame in an email that went out to his subscribers, I established a few credit spreads by selling the 1365 and buying the 1380. That one was only a partial position, because of the greater risk I perceived and my own comfort level. The 1365-1367 resistance level had the advantage of being above that 1347-1355 level, but was below the 1376-1377 level that represented where the SPX could be on October's option expiration if it just climbed straight through that rising regression channel, defying both gravity and the seasonal pattern.
When I began this series on support and resistance, I noted that even seasoned traders sometimes liked to look over the shoulder of another trader and note the indicators that trader used and learn something about that trader's thought processes. I hope this look over my shoulder has provided some insight for newbies and at least fodder for thought for more experienced traders. Perhaps, depending on how the SPX moves into October's option expiration, it will become an example that even careful consideration sometimes results in losses on positions, but I'm hoping that's not the kind of lesson it provides.