My inbox this week brought a mail relating to what technical techniques might be useful in such a strongly trending market with few large back and forth price swings, followed by a few weeks of range-bound trading that might be top but probably just a consolidation in an ongoing bull market.
QUESTION: "In your chart or analysis techniques over the past few months, what's been useful in getting into and out of option trades? I'm not trading all the time, but I can't just buy and hold like in my investment accounts. The market doesn't seem to get oversold so those indicators don't help much in deciding on call entry. Put trades for more than a few points in the indexes are few and far between. Besides stocks, I try to find occasional trades in the OEX and sometimes NDX."
I was busy as a bee recently, moving from my California coastal home back to the Rocky Mountain shores of the snowy front range. Back to the white stuff, nice for skiing and snowmen.
Investors of course today decided to gobble up tech stocks, catalyzed by strong earnings of one of my favorite bellwether Nasdaq companies, Cisco Systems (CSCO). Now we can more easily see how the broader S&P 500 and the overall NYSE index can keep chugging along since technology stocks caught some bullish fire too.
What has been 'WORKING' so to speak over the past few months in technical terms (as in technical analysis not tech stocks), in terms of highlighting the periodic important or key highs and lows has been the use of trendlines and specifically trend CHANNEL lines, as the market has been in a well-defined (up) trend. If you can use in your charting application or method longer range (weeks and months) hourly charts, the hourly trendlines, along with a 21-hour ('length' setting = 21) hour RSI even has pointed out some good areas to buy calls and occasionally make a decent put trade that is more than jumping in one day and out the next.
Also, in a bull market, we are of course anticipating the better/'safer' trading opportunities to come on the long side, buying calls on pullbacks to the low end of an index's uptrend channel. Most of whatever I say on trend channels applies to individual stocks, but my examples will be drawn from index daily and hourly charts. The Relative Strength Index that IS useful in a market that never seems to get 'oversold' (not on a daily chart basis), is the 21-hour RSI on the hourly chart, especially used in conjunction with the hourly manifestation of the uptrend channels there.
I can't show you hourly chart channels that go back to say last July/August due to the limitations of how much data I can show you on a column width. But, if we first look at a multimonth uptrend channel on a DAILY chart, then switch to a multiweek uptrend channel on the hourly charts, we can see that the hourly charts are the most useful in trading in and out of this market. AND, there have been the occasional put trade that was associated BOTH with the hourly pattern up at resistance implied by the top end of the channel AND with an overbought reading on the 21-hour RSI, defined as a reading at or above 70. In a bull market, the usual '30' to define 'oversold' should be bumped up to '35' for the lower level line.
The best trading opportunity in a bull trend usually comes with a retreat to the up trendline or low end of the uptrend channel, accompanied by an oversold reading that comes along with or has PRECEDED such price action on the hourly chart (length set at '21').
The second best opportunity comes with a retreat to the lower trendline period, since price action is the determining factor, not concepts of 'overbought/oversold'.
The third best opportunity will come on the put side with a move to resistance implied by the upper end the uptrend channel AND an hourly 'overbought' reading (70 or above). I don't like trading against the trend unless both aspects line up.
S&P 500 (SPX) Daily and Hourly Charts:
Potential put opportunities suggested on the daily chart at points a, b and c were followed by fairly shallow and short-lived corrections. The third time (c) that SPX rallied to its upper trend channel boundary was the charm as the correction was deeper, making SPX puts more profitable. Points d and e, were good entry areas for calls. There was NO oversold reading seen during the chart period shown below, even on the longer 21-day RSI, not untypical of strong bull market trends.
Points a and b on the hourly SPX chart below and highlighted in yellow, saw both a line of resistance at the upper trendline AND overbought readings that slightly preceded the trading where SPX was repeatedly stopping at the upper channel line. The combination of the trend channel analysis and the overbought condition, although more short-term in nature, did suggest potential trades with decent risk to reward. The 'risk' point is to exit puts on a rally that carries above the upper trendline by a few points.
There was a reasonable entry point suggested for calls at point c, although the retreat was only to the approximate low end of the channel. The RSI came close to fully oversold as defined here, at points c and d. Point d offered the best technical criteria for call entry as SPX came down to the lower channel line and 'worked' around in that area, showing buying interest/support there.
Not much difference is seen in points a, b and c relative to the 500 (SPX) daily chart. One interesting aspect of the daily OEX chart below at point 'a' is that the RSI kept 'confirming' each higher high in price, making a short or exiting calls at point a not advisable. IF there had been a move to higher (price) highs accompanied by lower relative highs in the RSI, exiting calls might have been a good precautionary move as such divergences can forewarn of a top that is followed by a retreat to at least say the lower trend channel boundary.
Point 'a' seen below on the hourly OEX chart wasn't a high-candidate put purchase from the standpoint that the move to the upper hourly trend channel boundary was not accompanied WITH an overbought extreme in the 21-hour RSI. Point 'b' offered on the other hand some potential in that the move was to near the upper channel line along with a preceding 'overbought' reading on the hourly RSI. Point 'c' offered a high-potential call entry in that OEX held, over a number of hourly lows, the low end of the bull channel AND saw an oversold hourly RSI (35 or under).
The Dow has traced out a well-defined uptrend channel over the past few months. Points 'a' and 'b' were not high potential places to go into Dow Index (DJX) puts, but did suggest areas where at least a minor pullback could follow, offering an opportunity to BUY calls on another dip. Points 'c' and 'd' were good entry points for calls. Those areas, after the lengthily sideways trend really shows the value of constructing a trend channel like this, since you wanted to re-enter calls when the 'meandering' trend had some potential to over and another rebound to begin, so there was less erosion of time premium after (long call) trade entry by the Index going sideways.
NASDAQ COMPOSITE (COMP) DAILY AND HOURLY CHARTS:
Points 'a' and 'b' offered opportunities for a very profitable buy and hold in calls and a decent opportunity in puts respectively; or, AT LEAST a suggestion it was TIME to take profits on calls at point 'b'.
On the hourly COMP chart below, point 'a' was interesting for buy side entry given the oversold RSI reading. Overbought point 'b' in the RSI was followed by an inability for COMP to pierce the upper channel line suggesting to exit calls, and possibly buy puts. Point 'd' was showing the beginnings of an oversold market in terms of the hourly RSI. Point 'e' below, while not accompanied by a move to resistance (implied by the upper channel line), WAS accompanied by a small rounding top in the hourly chart, and is even better 'defined' on the NDX chart shown further one. Point 'f' on the COMP hourly chart was the best new call buy opportunity seen for the period shown. You could have looked for promising Nasdaq option plays at that juncture, especially in the big movers in tech that had pulled back to support.
Points 'a' and 'b' below reflect the same dynamic in terms of the broad uptrend channel formation and the lack of much movement in the DAILY RSI in terms of extremes, completely similar to the broader Composite chart shown above.
The time frame shown at point 'a' on NDX' hourly chart offered a classic example of a move to higher highs price-wise, while accompanied by a DECLINING (21-hour) RSI. The 'oversold' RSI reading at point 'd' was accompanied by the clearly defined 'rounding top' pattern. Point 'e' offered the prospects of a decent rebound developing, by the way in which hourly lows held the lower trend channel boundary accompanied by the oversold reading on the RSI. Being long NDX calls from this point (e) on has not set the world on fire. Nasdaq option opportunities have been better in individual stocks!
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