The Chart That Says It All

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Unlike most traders, I had the great fortune to learn trading from two lifelong traders. One was a 20-year bond trader for Goldman Sachs who recently retired from a successful hedge fund and the other was a Chicago Board Options Exchange (CBOE) floor trader in the late 1970s early 80s who has traded options off the floor ever since.

Both shaped me into the trader I am today with a few simple, but key lessons.

Here are a few of their key insights:

• Keep it mechanical: take the emotion out of the game.

• Always, always, always use position-sizing wisely.

• Use a few choice high-probability strategies.

• Patiently wait for an extreme to enter the market and fade the extreme.

Well, today I found an opportunity that fits my trading criteria. I watch about 50 of the most highly-liquid (tight bid-ask spreads) ETFs on the market and wait for certain triggers to occur. Today, one such trigger occurred in the VXX.

As you can see in the chart below, VXX peaked about 10 days ago before falling off a cliff. As a result, the volatility ETF has pushed into a short-term oversold extreme with an exceptionally low RSI (2) of 0.2. Moreover, the gap from 8/18 closed today.

Couple extreme oversold conditions with the close of a four month gap and the probability of a short-term bounce increases dramatically.

So, as a trader how can I take advantage of this scenario.
 

1. I could buy the ETF outright for $33.76. Buying the ETF outright gives you duration, but this is a short-term swing trade, so should duration really be a factor? Buying VXX would require a large capital outlay and the statistical chance of success is only 50%.

2. I could buy a call. My capital outlay would be far less than that of the underlying and my risk-would be defined by the premium I paid for the call. But, time decay would be working against me and the statistical chance of success is basically the same as buying the underlying outright.

3. I could sell a credit spread, namely a bull put spread. Unlike the first two choices, by selling a credit spread I am able to create my own probability of success while at the same time defining my risk. Moreover, selling a bull put spread allows for a margin of error. As long as VXX closes above, say the 28 strike (see trade below) the trade is profitable.

Which one would you choose and why?

I would love to hear your thoughts on the trade. I think a follow up discussion with your questions could be extremely educational and more importantly, help you to grow and prosper as a trader.

Email me at OptionsAdvantage@WyattResearch.com with your insights.

Kindest,

Andy Crowder
Editor and Chief Options Strategist
Options Advantage and The Strike Price