1.CURRENT MARKET OUTLOOK: "Do you see much of a downturn here or the market just marks time and no big moves for now?"
2.IMPLIED VOLATILITY AND STRATEGY: "... a question regarding call options and implicit volatility. I have read that you should not buy call options when volatility is high because the option price will be expensive. But I have also read market experts say: 'The vix has peaked ...load up on options'. So my question is: Is there a time when I should buy calls when VIX has peaked and what type of calls should be bought. I would be grateful if you can refer me to any articles that can help answer my question."
3.LESSIONS FROM 'LEGENDARY' TRADERS: " I was trying to hunt down articles and books about Mark Weinstein and i came across your (the OIN) website and have been enjoying the various trading strategies article inputted here.. though my curiousness of Mark Weinstein is definitely still apparent within me.. I was just wondering if you can expound on his theory of gut feel? (also noted as 'experience' or 'Gut feel' of the market). Did he talk about what he was waiting for before a momentum change would happen?"
1.CURRENT MARKET OUTLOOK:
This market is so far 'resisting' much of a decline due to steady ongoing buying interest. The Market should correct so to speak based on what we see in an 'average' year; i.e., a more 'typical' market year where there are BOTH up and down price swings that could be traded. This as opposed to the more unusual 'super' bull or bear market that is just up, up and up, then more up OR down, down, down, then more down.
However, ALL trends have corrections of one type or another. There are three 'trends' as I define them: up, down and sideways or lateral. Others will say there are only up, down or 'trendless' moves. By 'trendless' is meant sideways/lateral. A lateral trend ALSO has a direction, it's just sideways.
The 'purpose' of any correction is to consolidate the prior trend by making an adjustment; e.g., a bull move gives back some the gains as profit taking selling sets in, bearish traders short thinking top, etc.
A bull or bear trend may also 'consolidate' prior gains or declines by going sideways; marking time for awhile as investors make assessments of how much further stock P/E ratios can rise or decline, etc.
Technically, we could also look at lateral moves as a time correction. This versus a counter-trend price correction. In terms of technical indicators, a so-called time correction will ALSO cause models of 'overbought' or 'oversold' to adjust and fall, or rise, from EXTREMES. Mark Weinstein (more on him shortly) taught me that "time corrections 'throw off' overbought or oversold extremes". Price givebacks or counter-trend moves do this more QUICKLY. Sideways/lateral moves are more slow to see such overbought/oversold indicators adjust but they do. The IMPORTANCE of this? Always, with my trading mentor it was about renewed trading opportunities; e.g., a major index that is no longer at an overbought extreme will more likely be a (relatively) safe re-entry buy.
When looking at either the S&P or Nasdaq charts, we see the prior 'overbought' Relative Strength Index (RSI) coming down even though there's very little price change. It's the nature of these indicators. These indicators look at prices over some time frame or other; e.g., the length input for an RSI indicator can be set for whatever number of 'bars' (a day in the case of a daily chart). If that number is 13 and if the market goes up steadily for 13 trading days (2+ weeks) or 13 weeks, that stock or index is considered to be overbought. If then the stock or index in question marks time (little price change) for another 10-13 days or for several weeks, if looking at a weekly chart, then the prior extreme moderates or comes down in the case of an overbought extreme. Illustrations follow:
My highlights on both the S&P 500 daily chart and the Nasdaq 100 chart that follows illustrate the way that a sideways move coming after a prolonged advance will cause the Relative Strength Index or RSI (or Stochastic or MACD indicators) to pull back from registering a HIGH reading, considered to indicate an overbought 'extreme', down to a moderate ('neutral') or even slightly low (beginning of an 'oversold') level.
A risk-adverse but skillful trader (and most of the very successful traders always look at how much they could lose in a trade and are more 'risk adverse' than you might think) will consider buying back in to a bull move more readily if the market hasn't just been going UP for the last umpteen days or weeks.
2.IMPLIED VOLATILITY AND STRATEGY: Regarding the question of "... a time when I should buy calls when VIX has peaked and what type of calls should be bought."
The question of buying index calls when VIX has 'peaked' is an interesting one and instances of a 'typical' low level of the S&P 500 volatility index (VIX) versus what seems to be a 'high' VIX reading is illustrated in my next chart.
As to the 'type' of calls to be bought, there's no one right answer on that. Presumably we are looking at or hoping for a substantial rally. My preference in that case is to go out at least 6 weeks in terms of call expiration. Moreover, I myself will buy at the money (ATM) or just slightly out of the money (OTM) calls. I'll buy a lesser number that way but perhaps am less inclined to 'over commit' in options relative to the size of my account.
In recent months at least VIX peaked twice in the 20 area and it did correspond quite closely to lows at points '2' and '4' in the broad advancing trend in the S&P 500 (SPX) . I would NOT rely on just the turn down in VIX to 'time' call purchases but would also note that both pullbacks were at or near SPX's multimonth up trendline and a 'confirming' buy so to speak. Moreover, in both instances the RSI was registering a low 'oversold' extreme, so this indicator 'confirmed' both a chart/trendline aspect for being long calls and the peak VIX level. A 'peak' VIX level in the SECOND instances of a peak VIX reading of just over 20 gave us more to go on as suggesting a high, perhaps peak, VIX.
A low Volatility reading has tended to be seen in this period with VIX around 12. In instances noted at # '1' and # '3' on the above SPX chart there were CHART patterns that suggested tops in both instances. I could not and would not rely on the VIX index ALONE to pull a trade trigger on exiting calls and/or buying puts.
In trade situation labeled '1', there was a key 'downside price reversal' that occurred as noted on the chart. The high in question ALSO was a time when an overbought extreme was seen in terms of the RSI indicator:
In the situation notated as trading situation '3' seen illustrated in close-up below, there was not only a low VIX reading at 12 (but not 'enough' for trading timing purposes), but most importantly to me, a classic three top pattern of the Head & Shoulder's variety. Once the 3rd rally attempt didn't lead to a new up leg, this was a reliable sign of a downside correction to follow. Note that the RSI was AGAIN at a high/'overbought' extreme, which provided a secondary input for at least an interim top. Along with the relatively low VIX reading. Traders get complacent at tops and expect the rally to continue on into the future, hence low implied volatility readings captured by the VIX index.
As to the related question I was asked "â€¦ can you refer me to any articles that can help answer my question?"
I would refer to our Options 101 series written by OIN's Linda Piazza. Linda indicated on this question the following:
"I haven't written about the questioner's topic specifically, although I did recently touch on a related theme. I have written about extrinsic value and why an options trader might need to understand something about it.
In that discussion, I touched on the role that volatilities play on extrinsic value and how options can be considered "cheap" or "expensive" based on what's happening with volatilities.
Two of my (Options 101) articles considered whether one would want to buy an so-called expensive long option when extrinsic value is plumped up due to higher volatilities or whether you might want to consider spreads at those times, while buying a long option might be more a more viable choice when volatilities are low and options are cheap.
I used the RUT's (Russell 2000) volatility index, the RVX, to illustrate some of the points."
This discussion made in Linda Piazza's Options 101 prior archived articles on "buying options when 'extrinsic value' is pumped up due to high volatilities versus times when buying a long option might be a better choice when volatilities are low" can be found by clicking HERE and HERE.
3.LESSONS FROM 'LEGENDARY' TRADERS:
The question here was " can you expound on Mark Weinstein's theory of gut feel? (also noted as 'experience' or 'Gut feel' of the market). Did he talk about what he was waiting for before a momentum change would happen?"
My answer is yes he talked about 'gut feel' in the context of knowing the markets through years of prior trading and AFTER he (Mark) studied all aspects of technical analysis, both what I knew of from 'standard' technical analysis and what I didn't know.
What I knew included chart pattern analysis and things like overbought/oversold indicators but Mark taught me much more: about volume patterns ("volume 'precedes' price"), reading the 'tape', cyclical patterns as mastered by George Lindsay, option volatilities, Elliott Wave patterns, trader sentiment as measured by the CBOE equities daily call versus put volumes and some other more minor aspects of technical/market analysis. Also, Mark was always very focused on buying index calls or puts at absolute lows or highs but then leaving himself 'enough' room in trading capital to price average an equal number of calls or puts up to two times, if price momentum carried farther than anticipated.
Mostly, it was the mastery of putting all of these elements TOGETHER into a certainty that is was time to pull the (trade) trigger. This certainty of all things points to a low or a high that was his 'gut feel'. There was not ONE thing I can point to that is the key element Mark was 'waiting' for. It was all things coming together and by a master at understanding all those ways of analyzing a trend. I wish there was a magic one thing!
GOOD TRADING SUCCESS!