Williams %R, uptrend and bear call spreads

Option spread trading involves determining where a price for a stock may NOT be in a particular time. There are strategies and spread structures that involve aiming for a particular price point upon expiry or at least a particular move in a set time...but those are for another time.

Considering that I need to place a spread where the price will not be seems odd, but easier than forecasting amplitude, direction and timing .

Building on my previous post regarding W%R (using stacked 5 and 20 day periods) and the state of trends leads to some very interesting trade ideas.

UPTREND

W%R can indicate nice entries for long trades in an uptrend which leads to a nice support levels developed along the 50 sma line.

Here is the chart for the S&P500 (SPX). I placed a linear regression tool that started near the bottom of the uptrend with a standard deviation of 1. The upper and lower deviation lines have remained on the same slope for most of this trend so they have been good channel indicators.

The red arrows above the price would indicate points to place a bear call spread and the red arrows below would be points to place a bull put spread.

For anyone who has happened to have followed anything I've done in the past this looks exactly like my old Counter Trend Positioning strategy...except I was trying to buy and short sell stocks to capture the actual moves. This method lets me just bracket the expected moves instead.

The bear call spreads are placed based on the idea that the price is extended (over bought) and would be expected to top out near the deviation line.

Following the first trade set May 8th or 9th for the May expiration, (3rd Friday or EOM), as the SPX is around the 920-930 level. Setting a spread above this at about 5 or 10% puts the short call at 975 to 1020. I do not know what the value of that trade was as historical options pricing is tough to get and tough to use without a paid service. I expect that at 5% I might see a 5% Return on Risk or at 5% above maybe 10% ROR. The closer to the price the short call is the higher the ROR.

The SPX never reached those levels until late July so the trades were profitable. In fact, every trade indicated was profitable and these are basically trading against the trend.

The lower arrows could be placed the same way or using the W%R as if a long stock trade was taken. Rather than tying the puts to the calls and forming an iron condor I would choose to just set put spreads on their own.

For risk management I could choose to increase the size of the position or decrease the proximity to the level to increase either the ROR or increase the absolute dollar return respectively. I could also run different expiries by entering a short term trade very close and a long term trade farther out but still keeping trades no longer than 30 days. I could also add trades as the expiry approached if it looked like the volatility was up at the time...volatility is a whole other topic but was a prime consideration when I placed the spread trade on Friday.

PERFORMANCE

12 trades, possible 5 to 10% ROR so I use a 7.5%. Only two trades concurrent so splitting my S&P allotment (another topic) would be in order. I would have trades on either side about 75% of the time or better...about 5 of 7 months. Simple returns are in the 45% neighbourhood. From a cashflow perspective this is $3 per day, on average, for every $1000 I invest in the plan. Interestingly this is an annual money doubling rate.

Seeing as this is an uptrend I might ratio my trade to favour the put side by 2 to 1 and keep the trades at the farther distance from the price levels. This idea keeps the risk low but bumps up the absolute profits rather than raising the risk to raise the profits. More to play with in future.

VOLATILITY

A VERY brief comment on volatility. Friday the volatility index (VIX) jumped 5 points as there was a gap down in price of SPY (SPX index being the S&P 500) and the price headed up to close some of the gap. This spike in volatility from about 20 to 25 drove the price of options up a bit making the selling of options more profitable. As the volatility drops off the option premium also drops off which secures more of the profit from the spreads. Sell when volatility is high and buy when it is low. I specifically liked the trade due to this setup as I doubt that the VIX will stay high.

Of interest to note my Optioneer trade lost some value (slight reduction in profit, not a loss created) as a result of this spike in VIX. The Monday trade is a higher value trade as a result as well so if the VIX drops right off that trade may not fill.

Jeff.