If you knew the market was going to turn in a week

[Smart Money]

Hey guys,

I have a couple friends at work who play with options. i think they are doing it through Robinhood or something. They quickly got burned doing it, and lost all their enthusiasm.

Here's my question. i am a Technical Analysis guy. I do OK at it, and make a little money over the long run.

Today, I stumbled on a T.A. method that seems to predict reversals in broad market indexes pretty well. What stunned me is that it seems to "see" a market reversal coming a week away. I know...I know...some of you are saying "B.S.". That's OK.

My question is this. Suppose I did find a way of spotting an upcoming broad market reversal a week in the future. I could buy leveraged ETFs to take advantage of it. But it seems that buying an option would make more sense since the best gains seems to be when you outguess the market, or catch a falling knife at the right time.

Have mercy on me, and understand that I know only a little about options. But if I knew (or expected) a reversal in the broad market, what kind of play should I make to take advantage of that? Like, let's say most everyone thought the market was going to move 2 percent lower over the next couple weeks, but I was pretty sure it was going to reverse. I guess I'd buy an option on a 3x ETF? Over what time period would I maximize my money? My method seems to forecast about a week into the future.

FWIW, I'm still trying to understand why this new method works, and I've been doing this for a couple decades now. I, myself, am skeptical, but it works in backtesting.

SM

 

[TheBigShort]

I think you should take some time to read about what options are first. This is way to general of a question to answer.

But in general if you think something will go up, buy the linear asset (futures, stocks, etfs)
If you think something will go up in x days by y amount and the option is priced favourably then you should use the option. So don't be too hard on your buddies who blew up, as you can see, much more challenging.

 

[Sprout]

Hey guys,

I have a couple friends at work who play with options. i think they are doing it through Robinhood or something. They quickly got burned doing it, and lost all their enthusiasm.

Here's my question. i am a Technical Analysis guy. I do OK at it, and make a little money over the long run.

Today, I stumbled on a T.A. method that seems to predict reversals in broad market indexes pretty well. What stunned me is that it seems to "see" a market reversal coming a week away. I know...I know...some of you are saying "B.S.". That's OK.

My question is this. Suppose I did find a way of spotting an upcoming broad market reversal a week in the future. I could buy leveraged ETFs to take advantage of it. But it seems that buying an option would make more sense since the best gains seems to be when you outguess the market, or catch a falling knife at the right time.

Have mercy on me, and understand that I know only a little about options. But if I knew (or expected) a reversal in the broad market, what kind of play should I make to take advantage of that? Like, let's say most everyone thought the market was going to move 2 percent lower over the next couple weeks, but I was pretty sure it was going to reverse. I guess I'd buy an option on a 3x ETF? Over what time period would I maximize my money? My method seems to forecast about a week into the future.

FWIW, I'm still trying to understand why this new method works, and I've been doing this for a couple decades now. I, myself, am skeptical, but it works in backtesting.

SM

If you are really smart money,
until you forward test it, then don't bet the farm.

 

[tommcginnis]

The options you're thinking of buying right now, have ZERO worth as their expiration draws nigh -- they will likely finish "out of the money."

There is no option that you can buy, that will not *decline* in value, as its expiration gets closer.

The ONLY way an option increases in value, from the time of its purchase THROUGH ITS EXPIRATION, is by a market move putting it "in the money." GETTING CLOSE won't do it.

If you spend $2 on an option, and the market eases towards that strike, you can easily see that "nice move" be 1-to-1 countered by the ticking of the clock -- and your option never changes value at all. (And as soon as the movement stops, the value streams out, like air from a balloon. )

If you have faith that the underlying will move faster than time will erode, then you might see the wished-for pop in option value, but be aware that the option IS a balloon, that the air is coursing out, and that its ending value will not have any *time* $$$ in it.

 

[Handle123]

...

Today, I stumbled on a T.A. method that seems to predict reversals in broad market indexes pretty well. What stunned me is that it seems to "see" a market reversal coming a week away. I know...I know...some of you are saying "B.S.". That's OK.

...
SM

Unless you have sample size of like 3,000, it no better than betting on red or black in Vegas imho. Our eyes often lie to us allowing us to bend rules, so hard coded then let it rip to find ultimate results.

 

[Lee-]

Options are generally priced based on the market's expectation of a move over a given time. Therefore, if you can predict direction, time frame, and size of the move, then you can find an options strategy to maximize that prediction. Unfortunately you've only given a time and direction. Using options in this case is effectively saying that you believe the size of the move is greater than the options market is predicting. With VIX up, the market is expecting an above average move. My point is, you can be right about time and direction, but if the size of the move is smaller than the options market is predicting, you'll still lose on an options play.

As such, being that you've not provided a size, I'd lean more towards shorting an ETF or futures unless you want to use the options for the purpose of limiting your losses, but as with all ways of limiting losses/hedging, reducing risk is not free.

 

[Reformed Trader]

Here's a list of some of the possible ways to take a directional opinion, from what has historically worked best to the historical worst:

Selling front-month out-of-the-money options (in limited quantities)
Selling front-month at-the-money options (again, in limited quantitites)
Buying low-beta (low-volatility) stocks
Buying long-dated options expiring one to two years out (limited quantities)
Buying an index fund (trading off leverage for diversification)
Buying high-beta (high-volatility) stocks
Buying a leveraged ETF (yes, this is worse than buying stock due to volatility decay)
Buying front-month at-the-money options
Buying front-month out-of-the-money options

The list above is based on tests AQR has done. Buying stuff with the most obvious high leverage, like OTM options, leveraged ETFs, and volatile stocks, delivers the worst returns, presumably because most retail traders and fund mangers can't borrow at Treasury rates (or don't know how to do it using synthetic relationships) and try find leveraged substitutes out in the market.

AQR also found that Warren Buffett does the opposite: he buys safe, low-leverage stocks and sells those pesky OTM puts. He then leverages up his portfolio by investing money that he'll have to eventually pay out later through insurance claims - it's a cheap way to borrow.

Betting on Beta
We present a model with leverage and margin constraints that vary across investors and time. We find evidence consistent with each of the model’s five central predictions: (1) Since constrained investors bid up high-beta assets, high beta is associated with low alpha, as we find empirically for U.S. equities, 20 international equity markets, Treasury bonds, corporate bonds, and futures; (2) A betting-against-beta (BAB) factor, which is long leveraged low beta assets and short high-beta assets, produces significant positive risk-adjusted returns; (3) When funding constraints tighten, the return of the BAB factor is low; (4) Increased funding liquidity risk compresses betas toward one; (5) More constrained investors hold riskier assets.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2049939

Embedded Leverage
Many financial instruments are designed with embedded leverage such as options and leveraged exchange traded funds (ETFs). Embedded leverage alleviates investors' leverage constraints and, therefore, we hypothesize that embedded leverage lowers required returns. Consistent with this hypothesis, we find that asset classes with embedded leverage offer low risk-adjusted returns and, in the cross-section, higher embedded leverage is associated with lower returns. A portfolio which is long low-embedded-leverage securities and short high-embedded-leverage securities earns large abnormal returns, with t-statistics of 8.6 for equity options, 6.3 for index options, and 2.5 for ETFs. We provide extensive robustness tests and discuss the broader implications of embedded leverage for financial economics.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2179396

Buffett's Alpha
Berkshire Hathaway has realized a Sharpe ratio of 0.79 with significant alpha to traditional risk factors. However, the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.7-to-1 on average. Therefore, Buffett’s returns appear to be neither luck nor magic, but, rather, reward for leveraging cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3197185

 

[lindq]

I, myself, am skeptical, but it works in backtesting.

SM

Long options don't play well with broad market indexes, except in the rare event that you get an explosive market move near term. But that isn't the game you're playing.

If you have confidence in your system, you're better off with leveraged ETFs. But you also need to prepare for a move against you, and have tested stops in place. If your system has a problem with stops...then I suggest you move on, and keep looking.

 

[murray t turtle]

Unless you have sample size of like 3,000, it no better than betting on red or black in Vegas imho. Our eyes often lie to us allowing us to bend rules, so hard coded then let it rip to find ultimate results.

%%
And @ least Op did note ''seems to predict'';
many call 7 market turns + confuse that with a prediction. LOL And make sure it includes Bull + bear markets.

 

[Epicurus]

Hey guys,

I have a couple friends at work who play with options. i think they are doing it through Robinhood or something. They quickly got burned doing it, and lost all their enthusiasm.

Here's my question. i am a Technical Analysis guy. I do OK at it, and make a little money over the long run.

Today, I stumbled on a T.A. method that seems to predict reversals in broad market indexes pretty well. What stunned me is that it seems to "see" a market reversal coming a week away. I know...I know...some of you are saying "B.S.". That's OK.

My question is this. Suppose I did find a way of spotting an upcoming broad market reversal a week in the future. I could buy leveraged ETFs to take advantage of it. But it seems that buying an option would make more sense since the best gains seems to be when you outguess the market, or catch a falling knife at the right time.

Have mercy on me, and understand that I know only a little about options. But if I knew (or expected) a reversal in the broad market, what kind of play should I make to take advantage of that? Like, let's say most everyone thought the market was going to move 2 percent lower over the next couple weeks, but I was pretty sure it was going to reverse. I guess I'd buy an option on a 3x ETF? Over what time period would I maximize my money? My method seems to forecast about a week into the future.

FWIW, I'm still trying to understand why this new method works, and I've been doing this for a couple decades now. I, myself, am skeptical, but it works in backtesting.

SM

It sounds like you can pick reversals in the market with some accuracy, but guess that your method doesn't tell you how far or fast the move will be.

My suggestion would firstly be Bull Put spread for long or Bear Call Spread to go short. With these you are simply betting that the price will be above or below a particular price at expiry. You can go a little ITM to get more value out of them. It won't maximize you profit per bet, but probably will maximise returns over a series of bets as it seems to reflect the extent of insight gained from your TA. If your TA is any good then no problem doing multiple trades.

I don't trade in one week timeframes so don't know what sort of premiums you'll get.

A good alternative might be a directional butterfly, setting the body 2% OTM or whatever distance you think your TA reversal is telling you. Possibly the best risk/reward with these but I'm a bit new to them so others could comment further.

I'm also quite expert on TA and your technique may be plausible, but I'm skeptical that it has a high enough win rate over short one week time-frames. You should measure that anyway before selecting a trading strategy to exploit it.

Interested in the general type of technique you're using and I might be able to comment further (you don't have to give away your I.P., just general approach).