trades& tactics
DO DILIGENCE
QU I E T FOU N DAT I O N HELPS INV ESTO RS FIND NEW T RADING O P P O RT UN I TI ES
Essential Market Forecasting Tools Traders benefit from understanding market trends that repeat over time By James Blakeway
iShares Russell 2000 ETF bullish trade
hile the saying “history repeats itself” may seem like a nauseating cliche, it often holds true in economics, finance and trading. Take the example of positive drift in the stock market, which suggests that an aggregate index of stocks will continue to rally over time. Not every stock will increase in price, but a broad-based index will grow as innovation continues at new and established companies. Positive drift has generally held true since the advent of indexes such as the Dow Jones Industrial Average in 1882 and the S&P 500 in 1860. Another idea that tends to repeat itself is that fear is overstated in the markets. Financial assets with liquid options markets have implied volatility values, which can be utilized to estimate the magnitude of future expected movement. An asset should fall within the expected the expected range 68% of the time. But history shows that stock indexes stay within that expected range more often than anticipated. Take the iShares Russell 2000 exchange-traded fund (ETF) for example. It represents a portfolio of 2,000 small-cap U.S. stocks. Unlike
W
This trade has a breakeven price far below the current price.
IWM at $213.38 IVR: 57% Bullish to neutral
Jade Lizard
Buy 1 IWM 232.0 Call in February-18’22 (66 DTE) Sell -1 IWM 229.0 Call in February-18’22 (66 DTE) Sell -1 IWM 180.0 Put in February-18’22 (66 DTE) 240 230 220 210 200 190 Downside Breakeven Sep 15
Oct 01
Oct 15
Nov 01
Credit/debit: $3.16 credit
Nov 15
Dec 01
180
Dec 15
Estimated buying power reduction: $2,010
Max profit: $316.0
Max loss: $17,684
Downside breakeven: 176.84
Upside breakeven: No upside risk
Max profit zone: Between 180.0 and 229.0
iShares Russell 2000 ETF (IWM) Short 30 Delta Put backtest results Win rate
Average premium collected
Average profit per trade
Average profit per day
86%
$187.39
$32.73
$0.78
“Positive drift” means the overall stock market increases over time.
the Dow, S&P 500 and Nasdaq-100, the Russell 2000 holds no more than 1% of its portfolio in any single stock. From 2004 to the present, the Russell 2000 has landed within its expected 30-day range 82% of the time. Keep in mind that it’s only supposed to stay in the range 68% of the time. Thus fear—in either direction—is overstated. Benefitting from history Traders can begin taking advantage
of positive drift and overstated fear by investigating the short put strategy in index ETFs. The short put is a simple bullish strategy where a trader sells a single put option with a strike price typically below the current price of the stock or ETF. The strategy’s goal is for the stock or ETF to increase in price, stay the same price or not fall too much. For example, if XYZ stock is trading for $100 per share, a trader may look to sell the 95 strike to express the assumption that the stock will increase or at least not drop below $95. This trade wants the stock to stay above $95 and the 95 put to expire worthless, meaning the trader keeps the credit received for selling the put option. New traders who are learning about implied volatility and expected movement can use the delta values to help them pick their options strikes. The delta value tells a trader the expected probability that an option will not expire worthless. Think of the example above. If the 95 put has a delta of 30, then there’s a 70% theoretical chance the option will expire worthless. If the delta was 40, there’s a 60% chance the option will expire worthless. But because fear is overstated,
Data from lookback by tastytrade
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Luckbox | January / February 2022
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12/17/21 9:13 AM
