Is The Bear Market Dead?
Well, it is certainly not looking too healthy! It looks from the chart below that though we may get a golden cross this week. That is a ‘may’. We’ve been here before in August and November, and each time it turned out to be a bull trap and the down trend continued.
What will happen this time? I don’t know, no-one does. We just have to watch and see what the market is telling us. As yet, the golden cross hasn’t happened and the downtrend has not been broken and at time of writing (10 hours before market open) the futures are down.
Where is ITM now?
We exited our bear trade on the 11th January and have been on the sidelines since. As I said in the special blog post, just because we have exited a bear trade does not mean that we enter a bull trade. We have to wait for the Bull IN signal, and although it looks close it is not here yet. This may be another bull trap. I will be monitoring the chart and will post here if the bull signal occurs. We’re just coming to the end of earnings season, so the market may settle down a bit and give us a clearer direction. However, this week has quite a few big results including MSFT, TSLA, BA, IBM, and VISA.
Best Loser Wins
Last update I mentioned that I was reading a book that I was very impressed with. It is called Best Loser Wins by Tom Hougaard. He explores why the vast majority of traders, professional and private, lose money and what they should do differently. He sees the market (as I do) as a mass of traders, who are making decisions based on emotions, and all behaving in much the same way. His views on the market and how it works are remarkably similar to mine. I am really glad that my book was published first, otherwise I may have been accused of plagiarism!
It is the best book on the stock market that I have read since Reminiscences of a Stock Operator by Edwin Lefevre. I highly recommend it for the insights into why people trade the way they do and why they lose money, and, most importantly, what to do about it.
Live Trading Experiment
I checked out the author, Tom Hougaard, before I recommended the book to you. He has a live trading channel where he trades live for about four hours per day, so you can follow his trades and his reasoning, free. He trades CFDs, which are illegal in the U.S., but (I think, you should check this) it is not illegal for U.S. residents to trade CFDs overseas. Anyway, he live trades currency pairs and indexes, with a day trading strategy where you may stay in a trade for only a few minutes, and a longer term forex strategy where you may stay in for a few days.
As you know from the books, I have previously been burned on both forex and CFDs, but, hey, you always have to be open to new information. His results looked very good (they are documented), so I have opened a new CFD account on the trading platform that he uses, and put a few thousand dollars in it, so that if I blow it up it is not the end of the world. I’ll look on it as a tuition fee! Last week I was getting used to the platform with a demo account (it is not very intuitive) and will start trading for real this week. Will keep you posted on how it goes, but in the meantime I highly recommend the book for its insights even if you are not planning to day trade.
Well, I think a lot of people must have had ‘this year I am going to make money on the stock market’ as one of their new year resolutions as I am being inundated with questions. Quite a lot of questions are about the same subject, so I have doubled up on some of them and it may not exactly answer your question. If you have further queries, please send them to me via the online forms (that way they don’t get lost).
Q. Heather, I read your comments and have read several books about the “Wheel” trade. The books I’ve read DO NOT describe the Wheel/Ricochet trade as it was originally done regularly by CBOE guys many years ago. The key is sell Puts on 1/2 the desired position. When assigned, sell a Covered Call PLUS sell another Put. When eventually assigned the 2nd put, sell 2 Covered Calls. When eventually assigned the calls, lose stock, start over. When the Wheel/Ricochet is done with some downside stop loss rules in place it is very profitable as proven by my results after trading the strategy for over 30 years.
A. Hi Gregg, I have googled to find the original wheel/ricochet strategy and couldn’t find anything about it. (I did find a Ricochet Rabbit – who knew?) So, I think you are saying that the original strategy was (if you wanted to buy 200 of stock XYZ):
- Sell cash-covered put on 100 XYZ
- When assigned sell covered call against 100 XYZ AND sell cash covered put on 100 XYZ.
- When put assigned, sell 2 covered calls (but you only have 200 XYZ and you have already sold 1 cash covered put? So just one cash covered put?)
- When assigned sell and start over at 1.
I can see that it is more of a wheel and am glad that you have been profitable over 30 years – well done. Just curious – how do you select the stocks to do it on? Or do you use the same stocks every time? If you could let me know that would be great. Thank you! (and here’s Ricochet Rabbit!)
Q. Hi Heather, I know bear markets can be frustrating with its ups and downs, that’s why I have been enjoying getting dividends from my portfolio, it makes the gyrations a bit easier to tolerate.
A. Hey Jim, yes, bear markets are totally frustrating, especially this one! I know that I am way too dismissive of dividends, it’s a bias of mine because Australians are obsessed with dividends and don’t care that the stock is plummetting as long as they get their fully franked dividends. Its probably a big blind spot of mine that I should revisit. But glad to hear that you are enjoying them!
Q. I am a beginner to the ITM strategy. For my first trade should I wait for entry signal (10/200 Golden cross)?
A. YES. It hasn’t happened yet, but watch for it and make sure that it is a real cross not just a touch and bounce off. There should be white space between the SMAs to prove that it has actually crossed. I will post here when it happens.
Q. During the year once we get death cross (exit) and then golden cross (entry) then what should be expiry of new trade. For example if we get golden cross in November then what should be expiry of new trade?
A. The ITM Bull book recommends getting an option with around a year to expiry, so if you got the signal in November 23 then look for options expiring in November 2024. However, if you are prepared to keep a closer eye on your account you could use nearer-dated options just make sure that they have more than 6 months to expiry, and be careful to roll them at least 30 days before expiry.
Q. Do you have any articles back testing the effectiveness of the 10/200 sma cross? Thank you!
A. Hey Michael – all the backtesting can be found here, there is a link on the footer on every page. Every trade is documented, along with the reason for getting in and getting out, plus a running total of the account balance.
Q. What do you do if you can’t find a call price that falls within the 1% threshold? I’m looking at the 19-Jan-24 Calls and the closest I can get is 1.8%. Example is 230 Strike which has a mark of 176(effective 406 which is 1.8% away).
A. Yes, options are terribly expensive at the moment, a lot more expensive than when I wrote the book. (see the later question for more detail) Hopefully they will normalize soon, but until then we have to work with what is there.
January 2024 has a limited range of options, with the lowest strike being 180. They must have decided on this range when SPY was up at 470, I think. And today the 180 bid/ask is 218.43 / 221.50 the mid-point of which gives an effective price of 399.97 which is 1% away from the current price. The problem, of course, is that you are getting slightly less than 50% leverage.
What I would suggest is to go for a nearer expiry date, like September 2023. The 200 strike, which will give you just over 50% leverage, has a bid / ask of 198.86 / 200.72 which is within 1%. Of course, you will have to make sure that you roll the trade at least 30 days before expiry.
Q. Do you have a particular time of day to trade?
A. Because I live I Australia and spend the summers in Europe, my trading is largely determined by the time difference. Having said that, I have always noticed that the first half hour of the day frequently goes against the trend for the rest of the day. If the market spikes up on open, then if I am buying I will hold off trading until it has settled down after 10AM, if I am selling I will put in a hopeful price and see what happens! However, I mostly work to the rule: if you have decided to get into (or out of) a trade just do it! Don’t muck around waiting for a better price. Most times when I have waited I kick myself for being greedy and missing out.
Q. I do have a question about effective price. My takeaway from the bull market strategy back test is that the purchase rule was 60% of the SPY value without a test of effective price (think it was stated that they generally coincide). Since it appears we may be near a golden cross, I checked options prices today. The SPY is at 398.50. At 60% we would want an option around $239. On my screen the bid/ask for $240 option is 164.95/168.04 making the midpoint $166.50. That makes the effective price 406.50 or 2% above the market – twice the limit stated in the book. Even the $200 strike has an effective price 1.3% above the market. What’s your strategy in this case – forgo the trade or ignore the effective price or some other choice?
A. Hey Rob – please see Q6 above. The 60% rule is just not working at the moment because options are so expensive right now. Hopefully it will settle down soon. I would suggest the Sep 2023 $200 which just makes it into the 1% rule.
Q. The effective price rule seems restricting with no stated alternative. Perhaps the VIX is lower now than when you wrote – or your ideas have been accepted enough to push up the option premiums for DITM – or now is just unusual?
A. I am finding the current situation very unusual. The VIX is not high right now, at 20, and anything lower than this is considered to be a low volatility market. It has been high quite recently (almost 35 in October) so perhaps the high option prices are a hangover from then. I am irritated by the current situation, but the market does what the market does. It looks like in the short term we will have to accept 50% leverage rather than 60%.
Q. Does a low Open Interest matter? Compared with SPY, DITM options on SPYG are very sparsely traded, with low OI on most of the longer dated strikes.
A. I think there are 2 aspects to your query:
1. Will I always be able to sell my options and
2. Are the spreads bigger on strikes with a lower OI?
Firstly, the role of the market makers is to always ensure that there is a bid / ask for every strike, so you will always be able to sell your option(s).
Secondly, reviewing the DITM strikes for June 2023, as with all options the spreads become more significant as the strikes become higher. For example, with SPYG currently rading at $52.16 the 30 strike has an OI of 31 and a spread of 60 cents which is 2.6% of the option price. The 35 strike has an OI of 5 and a spread of 70 cents (3.8%).
As you move into the higher strikes the spreads become smaller, but that is because the options become cheaper. For example, the 56 strike has an OI of 93, and a spread of 30 cents (18%).
What I am trying to point out here is that the spreads don’t vary with the OI, they vary with the strike and the cost of the options. Most DITM options have a lower OI than OTM options, because we know that 80% of options are OTM and expire worthless. Not sure if I have explained that very well, I hope that you understand it!
Q. On page 171 of ITM, it gives an example where the entire account is spent on SPY. Do you often recommend this? I’ve read not to place more than 20% of your account in options at one time.
A. I am not a financial adviser, and in Australia there are draconian laws against giving financial advice if you aren’t one, so I will just make some general comments here.
Firstly, 20% of your account in options – if they are talking about ATM or OTM options I would drop that to 5% or less. 20% is WAY too dangerous. As I mentioned above 80% of options expire worthless, and buying ATM and OTM options is a quick way to the poorhouse!
Re DITM options, it depends on what leverage is right for you. If you do the basic doubling of the market return then buy at 50% of the current price which is a strike of $200. This means that if SPY goes up 5% then you gain 10% – but if it goes down 5% then you lose 10%.
Only you can decide if this is acceptable to you, and you should take into account that the ITM rules will get you out before the diwnturn really starts to bite.
Towards the end of the Bear book (ITMB) I discuss taking some of the leverage off the table – so put, say, 50% in straight SPY shares and 50% in DITM options.
Q. When someone is using ITMS for small accounts would they follow the same moving average crossover signals for SPY that are used in the ITM strategy? Or, rather, would they use those some moving average crossover signals for SPYG instead? Would they use the Golden Cross for SPY or for SPYG for a buy signal for their account? At present it appears that soon SPY will signal a buy signal for the ITM strategy if the market continues its current trajectory. However, SPYG is still some distance away from its crossover buy signal for the 10 day and 200 day moving averages.
A. The SPYG backtesting was done on the SPYG SMAs. The stocks that make up SPYG are not the same as those that make up SPY so we can’t use SPY signals for SPYG. I have just had a look at the SPYG chart and it has to rise by around 8% before we get to the cross. I would keep an eye on the SPY chart as well as the SPYG chart, but only act on the SPYG signal if you are trading SPYG because that is what the backtesting is based on. Plus, please see next question on the same subject.
Q. Trading SPYG. So we invest in the continuing success of the U.S.A. using SPY as our S&P500 vehicle. But if we traded SPYG is it better to use SPY or SPYG 10/200 ma crosses to trade? I take the SPY cross as reflecting a healthy overall market. SPYG lags behind SPY – we could be waiting some time for the SPYG signal. Would we be missing healthy gains?
A. Hey James, please see previous answer, which is that we use the SPYG SMAs. However, I thought I would separately answer your questions about missing gains waiting for the SPYG signal.
In hindsight, everything looks clear; we beat ourselves up because we didn’t buy at the bottom of the market and ask ourselves how we could have missed the opportunity. But at that time we couldn’t see what was going to happen the next day and the next. We’re all fabulous traders in hindsight!
We have to remind ourselves that SPYG and SPY are quite different animals. Growth stocks are more volatile. If we look at the performance of SPYG this year:
- High: $73.48 on 3rd January 22
- ITM OUT: $66.36 on 31st January 22 (drop of 9.7%)
- Low (to date): $49.17 on 3rd November 22 (drop of 33%)
- Current price: $52.16 on 22 January 23 (drop of 29%)
So you can see by the numbers above that althought the trend has been the same SPYG has behaved quite differently to SPY, so we can’t use the SPY signals for SPYG.
Q. Regarding money management, is this a strategy you would consider putting the majority of retirement funds in or do you recommend just a certain portion while using other strategies within the portfolio. I’ve contemplated ideas such as selling cash secured puts and or writing covered calls but your DITM ideas really resonate.
A. Hi Joe, I can’t comment on your particular situation as I am not a financial adviser. But speaking generally, ITM was meant to replace all the fussing around with covered calls (which always seem to ensure that I miss out on the gains of the really good days and have to buy back at a higher price) and cash-secured puts (which seem to get exercised just when there is some bad news and I am left holding a lemon).
The deeper DITM you go the safer you are. You work out what your leverage is and see if you can live with the downside, always remembering that the ITM signals will get you out before the worst happens. Like I discuss in ITMB (the bear book), you might want to consider putting, say, 50% of your portfolio in straight SPY shares, and the rest in DITM options. It really comes down to your time horizons and your risk tolerance.
Q. What broker do you use?
A. I have many accounts with many different brokers (I hate closing them because it is such a hassle to open them again!) but the ones I use most are on Charles Schwab because their platform SSE (StreetSmart Edge) is excellent (and no, I am not getting paid to say this! I am totally independent.)
Actually, I do have a few bad things to say about them and their nanny approach. They insist on the account in my retirement fund’s name has a lower rating than the one in my own name. There are strategies that I can do in my individual account that I just can’t do in my retirement account. It doesn’t matter that I have been trading with them for 20 years, some administrator who has probably never traded in their life has decided I cannot be trusted to manage my own account. So, while I approve of their platform I do NOT approve of their attitude to customers. So not all rosy. OK, rant over.
A. Heather- In accounts < $10K, would you recommend buying puts on SPYG in a bear market?
Q. Hey Steve, I haven’t tested ITMB on SPYG – it is quite a different beast to SPY so I would not recommend using the SPY signals to enter a bear trade on SPYG. However, it is an interesting thought and would be good to check out – except that right now I am totally over backtesting. Just been doing it for the latest books and I need a break from it!
Q. Are we out of the bear market yet?
A. Technically no, we are still in it and have quite a way to go before we are out. Bear markets end when we are up 20% from the lows. The lowest point (to date) was $356.56 on 12 October 22. That means that we will exit the bear market when it starts trading above $427.87. In other words, we still have a way to go to climb out of the bear market.
Other Queries Via Emails
I know that I have had some other queries that have come directly into my in box – but of course when I look I can’t find them, there is so much stuff. Anything that comes through the website forms goes into a database and can’t get lost, so please contact me through them, I don’t like the idea that some things go astray and people are waiting for an answer.
Timing the Market
The new book is called Timing the Market, and I think that I am on the final stretch. Publication will be before the end of the month (now that I have declared that publicly I have to do it). It isn’t adding to the ITM strategy, just exploding a very prevalent market myth that has caused lots of people to lose lots of money. I hope that in some small way it stops that.
There is going to be a series of ‘short reads’, each on particular stock market topics. They are designed to be read in an hour and concentrate on a particular subject. I currently have 14 titles planned, but am open to suggestions.
This is the provisional cover – any feedback? Please let me know.
Or should that be the Bultimeter? Well, its undecided! Right now, if you are following the market you should not be in any trade, bull or bear.
Special ITM Update
Watching and waiting to see what the market is going to tell us. Futures are down slightly. I will post here when a signal has happened.