TS + SPY

Directional Option Trading the SPY using TradeSpotting (TS) (Friday 17/08/12)

Background
My TradeSpotting (TS) system can be applied to trading directional Options on the S&P500 ETF, the SPY, as well as to trading Options on stocks. I have been monitoring my TS system against various Option trades since finishing chemo in late 2011. I live in the Asian trading region so can really only trade SPY Options, or any Options, from an 'end of day' perspective. The following information describes how I would apply my TradeSpotting (TS) system to trading SPY options. This method is identical to how I monitor and trade Stocks and Stock Options though.

This material is not  offered as trading advice in any respect and is reported here, purely, for my own clarification and for my own educational purpose. The focus of this information is to show how I can apply my TS system to the trading of SPY Options. This material does not offer detailed coverage of Options trading or any Options education. It is assumed that the reader has an understanding of trading US Options.

SPY ETF Options:

Movements in the broader S&P500 market can be captured in many ways using different trading instruments. One method is a directional trading method using the purchase of Put and Call Options on the SPY ETF:

• Up movement in the market can be captured by buying SPY Call options. The value of the Call option should increase as the market moves higher.
• Down movement in the market can be captured by buying SPY Put options. The value of the Put option should increase as the market falls lower.

The maximum risk for each trade is clearly defined and limited as it is equal to the amount of money spent to purchase the Option. Some traders see this as a benefit of using the purchase, rather than selling, of Options for their directional trading in that the full risk of the trade is clearly known and defined from the outset of the trade. This type of trading does not appeal to everyone though and this is why it is important to have a good understanding of your own 'risk tolerance'. From an understanding of your 'risk tolerance' you would then devise your personal trading goals, strategy and plans. These plans will largely depend on the size of your trading account as well. Traders should follow their prepared trade and risk management plans as with any form of trading.

Directional Option trading of the SPY ETF using my TS system can be approached from either an end of day, or from an intra-day, trading perspective. 

• End of Day SPY Option trading with TS:  

I monitor the trend in the S&P500 on my end of day Profit Source charting platform. I prefer to watch this chart than the chart of the SPY ETF itself. Some may have an opinion about that and you're welcome to e-mail me: 

I have been noting how my TS system is able to help me identify medium length trends on the S&P500 and, thus, how this may help me to identify periods of time when it is appropriate to trade directional Options on the S&P500 ETF, the SPY, by way of buying Puts or Calls. The following chart shows the daily trend since the beginning of 2012. I have shaded regions of the ADX where I believe that it would have been most appropriate to purchase either Put or Call options. Note how July and August have been choppy and there was no valid TS signal from the ADX:

Up trend or TS 'Long Call': essentially what I am looking for here with the ADX is for the ADX to be trending upwards and for the +DMI green line to be above 20 and the -DMI red line to be below 20. A cross of these DMI lines would be an exit signal. I would look to buy a near the money Call Option, at least 3 months out, on a TS uptrend signal.

Down Trend or TS 'Long Put': essentially what I am looking for here with the ADX is for the ADX to be trending upwards and for the -DMI red line to be above 20 and the +DMI green line to be below 20. A cross of these DMI lines would be an exit signal. I would look to buy a near the money Put option, at least 3 months out, on a TS down trend signal.

This chart shows how for the 8 months so far this year in 2012 there were really only 3 time periods where Option trading on the SPY was appropriate using my TS end of day trading system. I am monitoring this chart on a daily basis now and will trade the SPY ETF when I see a trade entry signal. I will discuss these on this blog site. 

• Intra-day SPY Option Trading with TS:

I reside in the Asian trading zone so I'm not able to day-trade the SPY ETF during the US session. My discussion below is how I would apply my TS trading system to day-trade Spy options if I was residing, or able to day trade, in the US time zone.

Traders who are able to day-trade through the live US market would be able to trade SPY options from an intra-day perspective. For intra-day trading I would need to use intra-day charts and, for me,  I would use the S&P500 charts on my MT4 platform as I am happiest with my template on this platform.

Examples of Intra Day Options trades are detailed below:

Example 1: SPY intra day TS trade: Thursday 16th August 2012.

The chart below shows the 30 min chart of the S&P500 from my MT4 platform. This snap shot was taken on Friday 17/08/12. A look at the chart shows how the S&P500 moved little during the Asian and London Thursday16/08 session, as would be expected. A TS signal to trade 'Long' on this index was received during the early US Thursday 16/08 session though and is noted with the vertical line:

An observed TS signal to trade 'Long' would then equate to a signal to buy a Call option on the SPY. The aim would be to buy a Call Option and hold it until later in the day and, then, to sell it back, hopefully for some profit. There are many and varied opinions about how to assess which strike, and which month, Option to buy. I am definitely no expert here but I would look at the strike nearest to the SPY price and to either one or two months out as you would only be holding the Option for the day anyway so you don't want to pay for too much time value in the Option. The calculations below show possible results for a one month and two month Option for this intra day trade:

The Sept $140 Call: On Thursday 16/08/12 the September $140 Call started at $2.98 and closed the day at $3.53. That represents a gain of 0.55 cents. Thus, for an outlay of roughly $3 a gain of up to 0.55 cents may have been possible. This is assuming that one bought in at the low of the day and sold at the high of the day which may not be the case but I am using the available data that I have simply to illustrate this example.

The maximum Return on Risk for this trade was as follows = (0.55/$2.98) x 100 = 18.4% ROR!

The following snap of Morningstar shows how I obtained the data for this Sept SPY Option pricing:

Oct $140 Call: One could also look out to a further dated option for October. On Thursday 16/08/12 the October $140 Call was at $3.88 and finished the day at $4.44. This represents a gain for the day of 0.56 cents. 

The maximum Return on Risk for this trade is = (0.56 /$3.88) x 100 = 14.4% ROR!

The following snap of Morningstar shows how I obtained the data for this Oct SPY option pricing:

I consider these to be very healthy returns for a relatively small financial outlay.

Friday 17/08/12: A look at the 30 min chart of the S&P500 for the following day reveals that no new TS signal was observed during the US session. Thus, there would be no intra-day option trading for that day:

Example 2: Intra Day trade on 06/09/12

There was another possible Call Option trade on the intra day charts last night; last night for me that is. The S&P500 gave a TS 'long' signal on the 30 min charts. This really started off in the London session on some up beat momentum from some ECB news rumours:

The S&P500 was trading at around 1407 before the signal so, if I was looking to buy a Call Option, I would have looked at a SPY $141 Call. The September 141 Call was trading at around $1.73 yesterday. This is approximated though as I am working backwards from today's updated data. This Sept 141 Call finished the day at around $3.33. That was an increase of $1.60. This data was taken from Morningstar:

Thus, the maximum possible return from this trade was as follows:

Initial Bought SPY 141 Call= $1.73
Final Sold SPY 141 Call     =  $3.33  An increase of $1.60
Return on Risk = ($1.60/$1.73) x 100 = 92% ROR for 1 day!

Example 3: Intra Day trade on Thursday 27/09/12
The currency markets have been a bit choppy this week so this has given me an opportunity to look back at possible SPY Put trades for the US session. There was a great opportunity this week during Tuesday's US trading session. I received a ST signal to short the S&P500 on my trading platform and this would have been an excellent time to buy SPY Puts. One day I'll move to this trading zone and get an opportunity to trade these!

Example 4: Intra Day trade from Friday 28/09/12
It has been a choppy week for currency trading but there were some good opportunities to day trade using SPY options. Friday 28/09/12 was another example. A TS signal to short the S&P500 was given early during the US session. This signal is noted with a vertical pink line through the signal candle:

This is then a signal to purchase a SPY put for the duration of the trading session. The signal came at an S&P500 value of 1437.72 so I would look at the SPY Nov PUT $144. Looking into this data on Morningstar I see that this Put increased in value by 0.35 cents during the trading session. Thus, working backwards:

Initial: Buy SPY Nov $144 Put = $2.56
Final:  Sell  SPY Nov $144 Put = $2.91. An increase of 0.35 cents.
Day Trading result: (0.35 cents/ $2.56 risk) x 100 = 13.7% ROR (max possible)

NB: This data reflects the maximum possible return on such a trade based on available end of day data. Actual returns would most likely be lower though as you would never get into, and out of, the Put trade with the maximum yield. The %ROR is a guide though to show how this type of Spy Put day trade can be profitable though.

Example 5: Wednesday 10/10/2012: Another great intra-day SPY trade opportunity
The US session on Wed 10th October provided another great low risk opportunity to trade the SPY ETF intra-day on the S&P500. A clear TS signals to ‘short’ the SPY came during the US session when price was at the 1432.50 level. Thus, I would then look to buy a November $143 PUT. The PUT cost was $2.23 and this closed at $2.53, an increase of 30 cents. This represents a ROR gain of 13.5% for the short trade.

• Initially:        Buy Nov $143 Put at $2.23
• End of Day:  Sell Nov $143 Put @ $2.53
• Profit = 0.30 cents

ROR = profit/risk
ROR= (0.30 cents/ $2.23) x 100
ROR= 13.5%
NB: This represents the maximum possible gain on this $143 ETF for the day. I have used ‘end of day’ midpoint data to illustrate this example.

Example 6: Wednesday 17th October 2012
This was another fantastic opportunity for an intra-day SPY ETF trade. A TS 'LONG' signal came in the late London/US session and yielded a clean, low risk 100+ pips. 

This TS 'LONG' signal came through when the S&P500 was at $1436.23. Thus, I would have looked to buy the Nov $144 Call Option. This Option increased by 90 cents overnight! It opened at $2.43 and closed at $3.33. See below:

The maximum possible Return on Risk for this trade, for just one session, was a whopping 37%. see below:
ROR = (0.90/2.43) x 100 = 37%! For just one trading session and a low risk trade!

Example 7: Friday 20/10/12:  77% (maximum) possible on a SPY 'short' day trade:
There was an amazing opportunity for a low risk, intra-day trade on the SPY last night. There had been little movement on the S&P500 for the previous two nights and, add to this, some poor Earnings news, and you had a perfect set up for a SPY 'short' trade.

A TS signal to go 'SHORT' came through during the US session when the S&P500 was at $1444.68:

I would then have looked to buy the Nov SPY $144 Put @ $1.51.

This Put Option increased in value throughout the trading session to up to $2.67. This represents an increase of $1.16:

The Return on Invested Capital for this trade was an amazing 77%:

ROIC = ($1.16/ $1.51) x 100 = 76.8% For just one trading session!

I have sometimes referred to this gain as ROR, Return on Risk. This is not entirely accurate though. Whilst I imagine it would be 'possible' I do suspect it is very unlikely that an Option would ever fall to a value of 'zero' during one trading session. Thus, whilst the purchase price here of $1.51 is 'at risk', it is unlikely that you would lose the whole $1.51 in one day if the trade went against you. Sure, you could easily lose 0.50 cents which would represent a risk, and subsequent loss, of around 30% but I would most likely close the trade at that point, if not before.

I am not in a position, just yet, to day trade the S&P500 and I would need to determine clear and concise 'stop loss' exit values for trades that do not work out.  The ADX would be my guide here, as always though, but you can see on the above chart that the ADX did not stop to draw a breath on Friday!

I need to also stress here that I working with back data and these values represent a maximum possible gain as it is unlikely that one ever gets in at the extreme top and bottom of a particular move.

Example 8: Thursday 01/11/12
There was another great intra day trade on the SPY ETF possible on the first day of the month for November. Statistically the first day of the trading month is more often positive than not and some traders use this knowledge as a basis of their trading. A very low risk: high return trade it was indeed. I got a TS 'LONG' signal on the S&P500 during the US trading session when the index was at $1406.14:

Thus, I would have looked to buy the Nov $141 Call Option. This opened at $1.98 and closed at $3.03. This was an increase of $1.05: 

The return on invested capital was therefore:   

ROIC: ($1.05/$1.98) x 100 = 53%!

This is the maximum possible gain as it would all depend on the ETF price at the time of purchase but I think you get the picture here!

Example 9: Tuesday 20 (9 am) S&P500 intra day trade gives possible 70% ROIC!

The S&P500 ended up yielding a maximum of 160 pips overnight. There was a TS signal to 'LONG" just before the US session. This signal came through when the index was at $1368.17:

Thus, if I was able to trade this, I would have bought the $137 Nov Call Option. This Option opened at $1.56 and closed up $1.11 to finish at $2.67: 

This represents a return on invested capital of around 70%!

ROIC= ($1.11/$1.56) x 100 = 71%

This trade came with the added confluence that price had bounced of the bottom trend line from the daily chart trading channel:

Example 10: 23/11/12
The S&P500 also yielded a great 144 pip move and a possible 67% ROIC SPY trade today:

This TS signal came when the S&P500 was at $1392. Thus, I would have bought the $139 Nov Call Option.

This Option has increased by $1.05 to finish at $2.60. The Option opened at $1.55. The ROIC for this possible SPY trade was 67%

ROIC =($1.05/ $1.55) x 100 = 67%

Concluding Notes:

I consider myself to be a novice with the trading of Stocks and Stock Options. I had some success before becoming ill last year but I'm only just getting back into this form of trading now. I am now monitoring my stocks watch list and the SPY on a daily basis for future trading potential. I participate in Option trading groups where there are traders with vastly more experience than myself. These groups are fantastic places for the sharing of ideas, experiences and information. I have gained a lot from participation within these groups:

• http://coveredwriter.blogspot.com.au/:  Run by Mike Artobello
• An Aussie based group called The Spartanzz.