Options Trading With Steven Place

After an ugly quarter that included the CEO stepping down, the technical landscape on Twitter’s stock has vastly improved.

Watch the video below for a full rundown of how the setup is playing out:

Chinese stock investors have been hit over the past few weeks. We’re seeing individual stocks being halted and claims of the “bubble” finally popping.

All of that may be true, but on a shorter timeframe, there’s opportunity for the bold.

Below is a chart of FXI, the iShares 25 index:

There are three indicators underneath the chart: rolling returns studies.

These show us the percent gain or loss in a specific sampling window.

Here’s what they read:

5 day return: -10%

10 day return: -15%

20 day return: -20%

These levels are not unprecedented. Volatility in FXI can run very hot and the selling can be incredibly aggressive.

But in the instances where FXI sells off this much, there tends to be a pause.

And as option traders, we can take advantage of this.

Consider This Trade

Sell to Open FXI 39 Put at 1.00

This is a bullish bet on FXI that the selling will slow and the index will eventually bounce.

Here are the outcomes:

If FXI is above 39 into August options expiration:

You keep the 1.00 credit, which is a 2.6% return on capital. If you have 50% margin, then it’s about a 5% return on capital, for about a 45 day hold.

If FXI is below 39 into August options expiration:

You are assigned 100 shares of stock per contract at a basis of 38 per share.

If that happens, you can simply sell some calls against your position. You should be able to sell the Sep 38 call for 1.30.

If you could get that price, it would reduce your basis on the index down to 36.70 headed into the 4th quarter.

That’s about a 10% discount off the current price of FXI, which is already down 20% in a single month.

You’re Catching the Knife

It never feels comfortable putting on these kinds of trades. 

There are two major stories that are dominating financial headlines:

1. When is the Federal Reserve going to raise rates?

2. Will a Greek deal get done or will they exit the Eurozone?

The answer to these questions aren’t yet known, and the outcome will most likely cause the markets have a significant move.

Normally when there is event risk coming up, the options market responds with higher prices as investors look to hedge their risk against any kind of sharp move.

The Two Charts

In the currency market, there has been a sharp rise in the Euro VIX:

This is a weekly chart of $EVZ, which shows how expensive FXE options currently are.

Since the Summer of 2014, this market continues to price in more and more risk. As the summer continues on and European political shenanigans escalate, it would not be surprising if this reading continued higher.

But on the other side of the coin, we have the $VIX. You’ve probably heard of this one already.

The blue lines are the same reference points as seen in the EVZ chart.

See the difference?

In the past, when there has been a sharp rise in currency volatility, there has also been a move in stock volatility. It’s the giant macro conveyor belt that moves between risk on and risk off.

This is where it gets concerning:

There is a very large disconnect with the risk in the currency market compared to the risk in stocks.

Not just US stocks. Here’s a chart of VXSTOXX, which is the VIX for the Euro STOXX index:

The reasoning behind this disconnect isn’t known, but here are a few possibilities:

1. The actual volatility is different. Since 2014 there has been a very large move in the Euro from 1.40 down to 1.05, and the actual vol is back to levels not seen since 2011. 

During this same time, stocks have seen a very quiet grind higher with no large price swings.

2. There’s an assumption of central bank intervention. We’ve been conditioned to expect loose monetary policy in response to any stock volatility so there’s no need to aggressively hedge.

3. Investors are already overhedged. The VIX futures and options market continues to run hot and investors are continuing to use these instruments over more vanilla hedging devices like S&P puts.

Here’s a chart of the VIX of the VIX:

This shows us how “in demand” VIX options are, and the demand is still quite high here.

4. Investors are Not Pricing In Risk Correctly. This is a favorite narrative for the bearishly inclined. 

It’s possible that risk isn’t being properly priced into stocks. If this is some kind of complacency and we do get downside action based off the news, it could cascade as investors get stopped out or bail once they realize that yes, it is that bad.

Understanding the Motivation

To be a successful trader and investor, it’s not just about what you think will happen, it’s also understanding the motivations of the large institutional players and what they think will happen.

This disconnect shows that much more risk is being priced into currency movements right now, and perhaps it’s justified. But this is something you must continue to monitor as the summer wears on.

How To Trade It

On the retail side of things, there isn’t a clear cut strategy you could use to profit on this. 

On the institutional side, a volatility pairs trade is worth a look. 

A short volatility trade in currency risk paired with long volatility in stock risk has limited downside, and if the market really gets loose, will have a good payoff.

The chart in AMZN is forming what I call a “pop drop and chop” pattern.

Remember that technical analysis does not need to be any kind of voodoo. It simply is a representation of the motivations of market participants.

There are three parts to this pattern:

1. The Pop. This tends occurs on some kind of fundamental catalyst - earnings or an FDA event. Analyst upgrades are not considered for this pattern.

2. The Drop. After the current round of buyers are exhausted, the price of the stock will auction lower in order to find fresh buyers. If no buyers are to be found, then the stock can “fill the gap” and the pattern is no longer forming. However, if fresh buyers come in then a new support level is found. 

3. The Chop. Instead of seeing a hard bounce, the stock will create a range. There are prices at which dip buyers are willing to come in, and higher prices will bring in profit takers.

During this whole time, buyers remain in control. The fact that the stock has found new support at much higher prices means that there are no stockholders that are feeling the burn and could dump their stock out of fear. 

At some point, either buyers or sellers will run out and the range will break. If you see sellers run out, odds are that the market will auction higher, and the most recent “pop” high will act as a magnet.

Below is a 30 minute chart of AMZN with key levels noted.

The pop came on the earnings release in late April. From a fundamental standpoint, the company is doing great. The AWS numbers helped to boost the stock, and revenue continues to be solid.

After the large move higher, the stock then began to selloff as profit takers came in. After the stock had retraced 50% of the gap, that’s where the stock bounced as news overnight helped the stock run back from 415 to 440.

Since then, the stock has been in a chop phase, trading between 420 and 440. During that time, higher lows continue to be made, indicating that buyers are willing to pay up for higher prices.

If AMZN can break above 440, then it’s just a quick 10 points higher before new all time highs are met. The 450 level will become a magnet, as anyone who wants to sell their stock will wait until that level, and the momentum players will come back in looking for fast movement higher.

Earlier in May, it looked like Facebook was ready to give up the ghost. 

The stock had a hard rejection at 85, then sold off aggressively down to previous support at 77.50. 

The sellers attempted to take control and get the stock to breakdown below that level, but as we’ve seen before, the breakdown failed. 

When we see failed breakdowns, the stock will often go back to retest the other side of the range.

On May 14th, the stock had a massive move higher and has been resting since then.

When a stock compresses like this after a sharp move, it’s a bullish sign because these price levels are being accepted. If the stock can break above 81.85, then the 85 level that was rejected in late April becomes a magnet for price to trade into.

As long as FB doesn’t see any aggressive selling come into the stock, the odds favor a trade back up to 85. 

Have you been sitting on your hands waiting for the “right price” to buy BABA stock?

Have you been holding the bag since 100 and hoping for a turnaround?

Have you been sitting on some sweet profits on BABA puts but don’t know whether to take profits here?

If you can answer YES to any of these questions, it’s time to pay attention.

BABA is showing signs of a turnaround.

The Technical Bullish Case for BABA

There are a few things going on in the chart that show sellers are starting to lose control of this stock.

Keep in mind, technical analysis looks at the market structure of the stock, not the actual company. Sometimes price action reflects the fundamentals of the company, sometimes not. Consider this a trade idea, not investment advice.

1. The Stock Failed to Breakdown

Many eyes were focused on the post IPO pivot lows at 82.50. Earlier this month, the stock broke underneath that level but failed to find followthrough.

In fact, aggressive buyers started to show up as evidenced by the buying volume (not shown on the chart).

2. There Has Been Good Relative Strength

The entire month of March for tech stocks has been one of reversion and pockets of ugliness. The Nasdaq 100 ($QQQ) made a new lower low last week, but $BABA continues to make higher lows. 

This indicates that investors don’t care about overall market weakness and are willing to buy $BABA up in the face of heavy market selling.

3. The IPO Lockup Story Is Over

This is potentially a case of “sell the rumor, buy the news” in the story that new shares would flood the market and oversupply would lead to lower prices.

Seriously, everyone and their uncle was talking about this a few weeks ago. But we aren't seeing any more “fear” in the stock.

Most likely, that news event was already being priced into the stock as investors sold in anticipation of the event. 

This could be the case where it’s priced in and the stock is ready to move higher.

What Needs to Happen to Prove Buyers Are In Control

There is a key level at 87 that has been tested a handful of times recently, and that’s where sellers have stepped up to unload shares.

If the stock can get and hold above 87, then that is the signal that buyers are back in control. 

What will happen then is the technical and momentum traders will pop the stock up further, possibly to the next whole number at 90. 

If 90 is breached then that is when you’ll see the financial media create a new “turnaround” narrative that could attract fundamental investors back into the stock.

The Big Risk Ahead

There is the possibility that this is simply a pause in the context of a longer term downtrend. 

And that is possible too, that a new catalyst will present itself and cause long term holders to finally give it up and dump their shares on the market.

Maybe the IPO lockup will actually matter this time.

As long as you’re aware of that risk, you can figure out whether a long bet in the stock is right for you.

How to Trade It With Options

Relative to the past year, option prices are cheap. The current implied volatility is sitting at 30% and 29% seems to be a floor.

And since this idea is a breakout strategy, I am looking for large movement to the upside. 

So being bullish stock, bullish volatility means that long calls are a good bet.

They also offer a natural hedge in case the stock absolutely collapses to the downside.

Consider the May 85 call, currently going for around 3.60. 

The company reports earnings late April, so the call premiums should hold up well into the event. That means you don’t need to worry much about the time decay risk.

Breakeven at options expiration is around 89, which may seem like a stretch, but remember you can exit calls before expiration. 

If BABA were to run into the high 80′s you could also spread the options by selling the 92.50 call, which would reduce your risk significantly and cap your reward.

After being stuck in a 10 point trading range for nearly 6 months, FB stock has broken out to new all time highs and has seen a strong influx of buyers recently.

But three quantitative studies suggest that, at least in the short term, the rally in the stock will come to an end soon.

The Streak Indicator

One simple timing tool when looking for reversion is to see how many consecutive days the stock has closed higher.

If FB finishes at its current prices, the streak will be 7 days in a row of consistent buyers.

Since the stock started trading, there have only been two instances where the stock was up 8 days in a row.

Rolling Returns Indicator

Over these past 7 days, the stock has rallied around 8.5%.

How does that compare to previous “7 day windows?”

There have been instances in the past where FB has seen stronger movement in 7 days, so there is statistical precedence for a further squeeze higher. Nevertheless, this kind of movement does not happen very often.

Bollinger Bands Indicator

Bolliger Bands are an adaptive volatility envelope that show us where price should trade given the past volatility.

The stock has seen 4 consecutive days above the 2nd standard deviation Bollinger Band. This doesn’t happen often-- in fact it’s the only the third time in the history of the stock that there’s been this kind of upside action.

Manage Your Expectations

These indicators suggest that Facebook is due for a correction. That correction could be through lower prices or through time in some kind of range.

Expecting a pullback here does not mean you should expect the stock to run to 60 anytime soon.

It’s more about risk management.

If you’re long stock, you may want to tighten up stops, scale out, or convert your long stock to a call.

If you’re in cash, now is not a good price to chase. If any kind of pullback comes, it will most likely be constructive and will act as support. 

After a solid earnings report, $CRM gapped up to new all time highs. 

Investors responded in kind by aggressively taking profits, driving the stock back into the mid 60′s:

The stock is now back down into some key pivot levels.

The first level is 64.50. This is the previous resistance level back from November. 

Often when an obvious resistance level is broken and then tested, it becomes support as investors “anchor” off of that level as an excuse to buy the shares.

The second level is the earnings gap fill at 62.87. There’s no magical prophesy that says gaps must be filled. In fact, the longer the gap goes unfilled, the more bullish the stock becomes, because buyers are willing to be aggressive and pay up in front of another obvious level.

The third level is 60. That coincides with an intermediate term breakout from late February and is the last significant support level until 55.

Simply put, if you want to be bullish on the stock, you want to see stabilization here with a failed attempt to fill the earnings gap. If that happens then momentum will take hold again and the stock will run into the high 60′s.

But if the stock fills its earnings gap and makes a lower high, it will probably be a failed breakout. That doesn't mean the stock is in a downtrend, just that the “trendiness” of the stock will have disappeared and more reversion will be on deck.

A good options trade here if you think these levels will hold is to sell the May 57.50/55 bull put spread for 0.40, with intent to add at 0.65. 

Stocks move in cycles.

Buyers come in, then sellers come in.

But it’s more than that.

There’s something called a volatility cycle.

Where a stock is very volatile, most likely due to a news catalyst...

... and then it gets quiet. Sometimes, too quiet.

About a month ago, LNKD had earnings, and the market responded positively. The stock ramped up from 230 to 260.

And for an entire month, the stock has been in a 15 point trading range.

The chart above shows the price action in LNKD, with a Bollinger Band envelope. Bollinger bands are an adaptive volatility indicator that shows when volatility is expanding and contracting.

And the bands are really pinched in, indicating a big move is about to happen.

To get more sophisticated, we can look at the historical volatility (HV), which is a way to see the magnitude of price action without caring about the trend.

The one month HV is sitting right around 15. This is the lowest reading... ever.

Consolidation and compression like this cannot persist indefinitely, and the current readings show that a big move is due for the stock. 

If you want to bet on a big move without having to pick a direction, then consider a straddle buy, which is the combination of a long call and a long put. 

There's a nice combination of fundamentals and technicals setting up in GNC.

Last month the company reported pretty good earnings, with revenue and earnings beating expectations. 

In response to this, investors piled into the stock as it ran from the mid 40's all the way up to 49.

And for the past two weeks, the stock has been dormant.

This setup is a combination of post earnings announcement drift (PEAD) and a bull flag continuation pattern.

If the stock can get back above 49 and hold that level, it will mean a new wave of buyers will be ready to get into the stock again.

The first upside target is 52.50 which is a gap fill from February of last year.

Take a look at this chart:

This shows the relative performance of DBA to USO since 2007.

DBA is an agricultural commodities etf that has exposure to things like corn, wheat, and soybeans.

USO is an oil etf that, roll yield cost aside, tracks the crude oil market.

So why are we looking at the relative comparison here?

I have a theory called the "squeezed dictator" trade.

You see, it's hard running a managed economy in a country with not the best track record in human rights.

How do you manage the populace?

By subsidizing some of the costs that they have. Namely food.

How do you pay for this subsidization?

By exporting oil and getting paid.

The problem is...

... if oil prices are too low relative to the cost of food, it becomes difficult to keep this play alive.

The dictator is then "squeezed" and introduces price increases into the country.

Which leads to unhappy people, and potential geopolitical instability.

It's happened before- there was a ton of bad actions by Arab States on their people, but it wasn't until food prices ramped higher that the Arab spring actually happened.

The short term volatility ETP is due for a retest of its recent lows.

Remember, the VXX isn't just a "short S&P" kind of trade. The actual holdings and operations of the fund show us that the path of least resistance is clearly lower.

Here's why:

1. We already know the bad stuff. It's mainly energy related, with a smattering of "ugly" economic data and some Greece news.

If all the bad news is known, it's probably priced in. And as ugly as the news has been, the market has not even completed a 3% pullback from all time highs.

2. The BoJ has our back. One of the main drivers of this market rally has been the liquidity driven by the Bank of Japan.

As long as the USD/JPY stays bid, this market will roll higher.

3. Holiday Volatility Will Get Crushed. Currently, the spot VIX is sitting in the 16's. The VIX looks 30 calendar days ahead, and that window of time currently includes holiday trading, which tends to be at zero (because the markets are closed) or close to zero.

The options market will soon realize that since all the bad news is priced in and we're coming into slow Christmas trading, there's no reason to be buying protection with a duration of 30 days. If anything, commercial hedgers will buy protection 60 days out.

4. The Vol Curve Is Steep and Will Remain So. This one is a bit tricky if you don't understand how volatility trades in the market. Here's a chart of the volatility futures curve:

This is a "normal" vol curve, meaning that the short duration volatility contracts have a lower price than longer term.

The way that VXX works is that it takes exposure in short term contracts and then has to roll those contracts out in time. Since they have to sell low and buy high, there is a "roll cost" that causes VXX to not do well in this environment.

This is a chart of GPRO with a Bollinger Band envelope on it.

Bollinger bands are an adaptive volatility envelope that can show when volatility in a stock has been very high (expansion) or low (contraction).

For the past 2 months, GPRO has been in a tight trading range between 65 and 85. The Bollinger Bands continue to tighten as there hasn't been any trending price movement.

Odds are that will change before the holidays are up. GPRO is a brand in which the holiday season will have a distinct impact on investor's outlook on the company.

Simply put, I'm looking for at least a 10 point move in either direction between now and December options expiration. 10 points make sense from a technical standpoint because there are two very obvious levels that will act as magnets as the stock starts to move.

With options trading, you can structure a trade that makes money as long as GPRO sees a large move in either direction.

Have a look at the December 75 straddle. This is a combination of buying the Dec 75 call and the Dec 75 put.

This trade makes money as long as GPRO moves at least 8.5 points away from its current price. 

Considering the stock moves about 4 points a day, you simply need two days' worth of movement in one direction for this trade to be profitable.

The main risk here is that GPRO doesn't move at all and the stock stays rangebound for the next few weeks. I think that's an unlikely scenario because of the event based risk around the holidays and the natural volatility in the stock. 

It's not been a good year for the Russian stock market.

Charts from TDAmeritrade

As much of the economy is oil based, the drop in oil has led to continued selling in stocks like Gazprom, and the Ruble has continued to weaken.

But it's about time to be a contrarian here and bet on Russia for a few reasons:

1. The Short Trade is the Obvious Trade

The "Russian Problem" has been making headlines for some time now, and with the OPEC production news coming out last Thursday, the most recent gap lower looks to be exhaustion and capitulation rather than a continued expansion in momentum.

2. Expect New Year Reversion

There's a tendency for the worst performing areas of the markets to see reversion headed into the first quarter as asset rebalancing occurs. Two great examples this year were the performance of coal and gold miners during the first few months of 2013.

3. It's Statistically Significant

The RSX (a Russia ETF) is currently over 10% below its 50 day moving average.While it has been worse in the past, this tends to be a level where the selling abates.

How to Trade It

Quick disclaimer: you're responsible for your own trades, profits, and losses. I'm not trying to force you into any trade.

My favorite Russia ETF is RSX. It's very oil-heavy and not a proper proxy for the entire country, but it is liquid and has a good options board.

The timeframe for this trade is 3-6 months, and I'm willing to be a little early and scale in further.

What I would not do here is start off with straight up long stock. My long exposure instead will come in the form of put sales.

Sell to open RSX Jan 19 puts for 0.95

Basis: 18.05

Return on basis: 5.26%

Risk profile from TDAmeritrade

There are 2 outcomes here at January Opex:

1. RSX is above 19

The put expires worthless and you keep the credit.

2. RSX is below 19

You either roll the sold put out in time, or take assignment of RSX stock with a basis of 18.05.

If you do take assignment, what you can then do is sell a Feb call against your position, and then sell a Feb put. This is known as a covered strangle and is a great way to further reduce your position in the trade.

I like this trade over long stock because it can make money even if RSX stays rangebound or sells off a little bit more.

Before I even get started with this, I'm going to put out a disclaimer:

What I'm about to do is the same thing as standing on the shoulders of giants and shooting spitballs into their ears. I respect the fact that this criticism is targeting very very smart and successful people. I can't wait to read my copy of Tony's new book, and Ray Dalio is one of the smartest investors out there.

Right. So. With that out of the way, I want to talk about Ray Dalio's "All Weather" Porftolio.

You can read the full post here, but I'll summarize a bit:

The goal of this portfolio is to maximize returns and reduce volatility, with an asset allocation strategy that anyone can understand.

The assumption here is that economic conditions consist of a mix of inflation/deflation, and rising/falling economic growth.

With that in mind, you can construct a portfolio with these components:

30% Stocks

15% Intermediate Term Treasuries

40% Long Term Treaasuries

7.5% Gold

7.5% Commodities

With those holdings, rebalance every once in a while and you're set.

All things considered, it's not a bad strategy. Here are the results:

Around 10% annualized

Max drawdown around 4%

Standard Deviation of 7.63%

Not half bad, considering if you were 100% long stocks there have been a few times where your max drawdown was well under 30%.

So what is the problem here?

I think there's a bit of sampling bias going on.

The results come from what Tony calls the "Modern Period." That's from 1984 to 2013.

What I'm going to do is show you a chart of 10 year bond yields, starting in the early 80's.

Do you see where I'm going with this?

The sampling window just happens to include a 30 year secular bull market in treasuries.

I'm sure we could construct a similar portfolio that is overweight stocks, that includes the period 1980 - 1999 that would have amazing returns with low drawdowns.

The problem I see with this portfolio is the super cliche phrase:

Past returns are not indicative of future performance.

In my opinion this kind of portfolio will have trouble managing those kinds of returns because yields are near a floor. You can't have significant price appreciation in this asset.

The funny thing is, that is obvious. And way too many people tried to take the other side, getting short bonds and the treasury market had a flash crash last month. So the trade is doing fine.

What would I change?

Again, I'm just throwing spitballs here. My timeframe rarely goes past 2 months with my trading style. All things considered it's a fine portfolio for someone that wants to be super passive.

I think that a good idea here is to replace some of the direct treasury exposure with TIPS (Treasury Inflation Protected Securities). If we actually do see some proper wage growth, and if central banks (heaven forbid!) start to raise rates, the TIPS will get you a little bit better risk-adjusted returns.

If the only volatility instrument you've heard of is the VIX, then you're about to be introduced into a whole new universe.

Practically every major asset class has a corresponding volatility index:

One asset that had been missing was treasuries.

After all, it doesn't seem like you'd need a VIX for treasuries, because when investors buy treasuries, it's with safety in mind and there isn't a high perception of risk.

But knowing what has happened recently, you'll see why it's crucial to know the perception of risk in the treasury options market.

What Is A Volatility Index?

When we look at a price chart of a stock, we are viewing the collective supply and demand for the stock over time.

But what if we want to view the overall demand for options?

This is important because when people are buying options, then it means there is fear in the market and investors are demanding protection against their assets.

A volatility index looks at all the options in a specific timeframe and does some fancy math to get a volatility reading.

For more detail, check out my in depth look at the VIX.

One major difference in the VXTYN is that the options are futures options instead of equity options.

Why a Treasury VIX is So Important

This is the part that throws most investors off.

When you think of risk, you probably think of stocks selling off. That tends to be the most obvious and most present risk.

But there is also risk to the upside.

Think about this-- if you have been 100% cash and the S&P 500 rallies 5%, then you missed out on the upside. 

There was an opportunity cost, which can also be called the upside risk.

And here's the kicker: different asset classes have different perceptions of risk.

This is much more evident with commodities like gold and oil.

Some investors don't like oil selling off, and some investors (and institutions that have exposure to oil) don't like it when oil rips higher.

Risk can be bi-directional.

Treasuries are the same way.

Take a look at the VXTYN, which is the new VIX for 10 year treasuries:

See that massive spike higher? If this were the S&P VIX, this spike would probably be accompanied by a massive selloff.

But the perception of risk in treasuries is to the upside. When investors are buying a bunch of treasuries and driving yields lower, it is generally a fear based move.

And that's what happened in October. There was a move equivalent to a flash crash in bonds as way too many people took the short bond trade in 2014 and got blown out.

In response to that move, people started buying a ton of protection in bond options via calls instead of puts. That move is increased demand in options which is reflected by a spike in the Treasury VIX.

That's the kind of relationship you'll see in VXTYN, and why it's so important to watch it. 

How to Trade This

There are profitable trading setups to consider using a combination of price and volatility analysis.

First, a quick note: you cannot trade volatility indexes. These are statistically based and you can't buy or sell them.

There may be derivatives that are based off the readings but it's impossible to get pure exposure to the VIX or any other volatility index.

With that in mind, here's the dirty little secret about volatility indexes:

they are mean reverting.

This makes sense if you understand the market. If a bunch of players are buying options to hedge, they won't buy those again. The demand for option premium can run out faster than the actual move in the underlying market finishes.

If you are a more passive investor, then I consider augmenting your portfolio with covered calls.

Let's say you own a good amount of treasuries through TLT or IEF. If you see a significant move higher in VXTYN, then you may want to condier selling calls against your position to take advantage of the high option premiums.

Don't want to trade options? You could also use large moves in volatility readings to time your rebalancing.

If we are seeing a massive spike in VXTYN, it generally means treasury yields are dropping hard as people flee into safety. It probably also means stocks are getting hit hard as those people who are fleeing into safety are probably fleeing out of risk.

Assuming you have a portfolio that has a mix of bonds and stocks, that would be a great time to sell some of your bonds and buy some stocks. 

In other words, timing your asset rebalancing when the perception of risk is high will give you better entries and outsized returns than a more passive approach.

Let's talk more about option setups...

My favorite trade then is to wait for a parabolic spike in both treasuries as well as the treasury vix. From there, consider an option trade that gets you net short the underlying as well as net short the volatility.

Yes, I think the VXTYN will be tremendously useful, but for me personally there are some drawbacks.

First, the underlying is based off of futures options. These don't really have the best liquidity to begin with, so I'm not sure these would be super actionable.

Instead, I would focus trading on TLT. This is an etf that looks at longer dated bonds (20+ years) instad of the 10 year treasuries. This options board is much more liquid.

And here's the dirty little options trading secret: you can construct your own volatility index for any asset class that has options. It's called an implied volatility reading:

The chart below shows the implied volatility and the acutal volatility of TLT.

If you want to get access to this custom study, go here.

So instead of using the brand new volatility index, I could just as easily stick to the IV30 reading of TLT to get the necessary information.

A Recent Trade Example

During the upside flash crash in TLT, I took a "scaling butterfly" trade.

If you've never seen a complex options trade before, don't worry too much about it - just look at the pictures to get a feel for the payout.

During the first part of the move, I purchased the December 113/118/123 put calendar for 1.40.

This is a limited risk, limited reward trade that makes money if TLT goes lower and if the implied volatility goes lower.

Knowing that I am early, I don't put on full size on the trade.

Once TLT spikes up higher, I add to the trade by purchasing the December 118/123/128 put butterfly for 0.90. By adding more capital to the trade, I am widening out my breakeven, increasing my odds, and reducing my maximum reward.

Here is what the position risk looked like after the adjustment:

After a hold over the weekend, I was able to exit for a 20% return on my capital.

If we ever see treasury yields tank and TLT spike like that again, I'll take this trade every single time. It is a complex option spread but once you put on these kinds of trades often you'll see how well they work when the asset class pulls back along with a drop in volatility.

The selloff in October was the largest we've seen in quite sometime. 

So it makes sense that the snapback rally moves harder, faster, and further than what everyone is expecting.

A combination of a massive shakeout, capitulation in the short bond trade, good corporate earnings, and the Bank of Japan keeping the liquidity spigot turned on provided a massive bounce.

Is the market overbought? Sure. Can it stay overbought? You bet.

But the odds are starting to favor reversion.

This is a chart that shows the number of days the SPY has stayed above its 5 day moving average. The market is currently at 15 days in a row with no close under its 5 DMA.

Here are the takeaways:

1. Large "moving average streaks" tend to occur after hard selloffs. This makes sense as market V-bottoms have been working since 2011.

2. When the streak gets this high, it doesn't mean the market is at a top. Instead, look for a correction. This correction can occur either through time or price.