Without further ado:
SPY Double Top? (Click on image for higher resolution)
This is SPY, the ETF (exchange traded fund) for the S&P 500 index. You can see on the upper right it looks like it’s turning downward (called a double top pattern). And this presents a great trade opportunity for a bear call spread right above the resistance, around $135/136 or higher if you’re more conservative. If you’re not familiar with bear call spreads, as long as SPY is below $135 at expiration (third friday in may), you make full profit. So SPY could crash down or stay where it is and we make full profit. Of course there’s always a chance of SPY breaking up through of the resistance, but what is it? Let’s calculate…
- Probability Calculator
- Probability of SPY going naughty (Click on image for higher resolution)
What we care about is where it says Probabilities at the Future Date of the Underlying. So we see the probability of this trade going perfect is 71%, with a 24% chance of failure? Actually if the trade goes against us (SPY goes up above $135) we can undo the trade for a loss, and as SPY goes up further we’ll make all our money back since we still own the $136 call. The danger zone is the 4.6% chance of that it stays in between 135/136. That’s a really small chance. Additionally this calculator doesn’t factor in anything besides volatility and std devs, aka it doesn’t account for technical analysis. That’s what humans are awesome at. And considering there’s a HUGE resistance at $134, that’s in your favor. Some more green lights:
- Bearish volume the past few days (bottom right of first chart image)
- Stochastic indicators pointing down (see below)
- MACD indicator pointing down (see below)
- Parabolics just flipped over
The first indicator below price action is stochastics (StochK and StochD), the one on the bottom is MACD. See how they just crossed over and are pointing down? That's a bearish signal (Click on image for higher resolution)
Now how much money will this make? Well let’s take the SPY $135/136 Bear Call Spread. The spread between the 135 Ask and the 126 Bid price is .30, multiplied by 100 is $30. So $30 is the profit you’d be making. Your risk is $100 (136-135) * 100. But you get $30 as profit, so your actual risk is $100 – $30 = $70. So your ROI is $30 / $70 which is 42%! Expiring on May 21st, that would be an excellent ROI. However it is over a month away from expiring, and personally I like to do my spreads with 3 weeks left, so I might wait a bit if this was me. However placing the trade now and just closing it out early is always a possibility and is a very valid strategy.
So people that say you can’t make money in the stock market…there you go…proof that you can. I do this every month, and when a trade really stands out at me, I blog about it. A 70% success rate making 42% on your money. See this post about long term trends with these percentages and what can realistically be achieved. I left out a lot of more detailed technical information, so if you have any specific questions please leave them in the comments and I’ll respond. Also in case your wondering, I’ll be posting a followup to this trade after it expires, or if something drastic happens in the mean time.
