TC + SPY

Directional Option Trading of the SPY ETF using TradeCharting (TC) 

(First posted on Friday 17/08/12)

SECTION 1: Background

My TradeCharting (TC) 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 TC 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 TradeCharting (TC) 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 TC 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’ before choosing any trading instrument. From a clear understanding of your own ‘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.
 

 

SECTION 2: End of Day SPY Option trading with TC: 

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 TC 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 TC 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 TC 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 TC 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 TC 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.

 

SECTION 3: Intra-day SPY Option Trading with TC during the US market:

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 TC 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 TC 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 TC 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 TC 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. I would look to buy the Option with the strike nearest to the SPY price.  I would look to buy an Option 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 TC signal came through when the S&P500 was at $1408. I would look to buy either the September $140 or the $141 SPY Call option.

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 Invested Capital for this trade was as follows = (0.55/$2.98) x 100 = 18.4% ROIC!

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 Invested Capital for this trade is = (0.56 /$3.88) x 100 = 14.4% ROIC!

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 TC 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 SPY intra day trade from the S&P500 on the 06/09/12. The S&P500 gave a TC ‘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 $1412 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 Invested Capital = ($1.60/$1.73) x 100 = 92% ROIC for 1 day!

These are very healthy returns for low risk intra day trade set ups during the US markets. I will continue to post examples of SPY trades using my TC system in the ‘TS + SPY examples’ page.