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How Far Could Amazon Fall?

Just recently, Amazon reported earnings and the stock faded hard.

The next day, the stock gapped down, and since then it has failed to find enough buyers for any kind of decent bounce.

The long term trend is still intact... yet it's possible to see a little more downside action.

Question is-- where should we expect the stock to find stronger buying support?

Step 1: Key Price Levels

Ever since AMZN had a mini-flash-crash in June, I've been keeping my eye on that day's low to act as a key support level. Combine that with a few other price supports and we have a clear area around $950 where we should expect buyers to step in.

Step 2: Moving Averages

The current price is below all short term moving averages, which shows us that sustained selling pressure in on the stock from traders.

The next long term moving average is currently at 956... the 100-day moving average. We've got more evidence that the 950 area will be a high-odds level where buyers step in.

Step 3: Turning Point Indicator

The Turning Point Indicator is a powerful tool to give you probabilities of future price movement. It allows you to be proactive with your trades, instead of using indicators taht only look in the past.

Click Here to Get Free Access to the Turning Point Indicator

The 10-day TPI shows a move of -5%, which is already oversold on a short term basis. The fact that there was no aggressive bounce once we came into that -5% level tells us that longer term market participants are involved in the stock and we'll have to use a different timeframe.

The 20-day TPI puts a key level at -6%. In fact, it's very rare for the stock to selloff more than 8% in a 20 day timeframe... but this is also because the stock has been in a solid uptrend.

Do some quick math. The gap down open from July 28th sits right at 1014. If we were to have another 6% drop off that level, that gives us a downside target of $953.16, which is right at the beginning of the support range we've pointed out already.

How To Trade This

With options trading, it's not just about where you think the stock is headed... it's where you think it isn't.

We know that key support starts at 950, and we also know that to see a move to that level would be statistically stretched to say the least.

A good trading strategy would be to start scaling into put credit spreads if the stock manages to find fresh sellers and it breaks down below its near term range. Of course it's possible that a new catalyst brings in more sellers and the stock tanks... but we're dealing with the odds, and the odds are good to start placing bullish bets onto a second leg lower.

 

Still A True Believer in Twitter? Here's an Investing Strategy

When a new technology comes along, it can sometimes be hard to explain it.

Google uses a "web spider."
Amazon has a "cloud."
And twitter... well, twitter is twitter.

The best product analogy I can think of for twitter is cigarettes.

We hate that we use 'em. We know it's toxic. Yet every 15 minutes, like clockwork, we get an "itch" to take a twitter break.
Just one more for today, I swear.
Just one more hit.

That's why I'm long term bullish on TWTR. Yet, there is a difference between a company and a stock. You could love eating at Chipotle but that won't help you when the stock gets cut in half because they don't sell queso.

Timing matters. And I do think we're coming into an inflection point for the stock.

My Original TWTR Call

In April of 2016, I made a call that we were nearing a bottom for TWTR stock and that the narrative would follow something along how YHOO traded a few years back.

I even made this sketch of how I thought the stock would trade:

And here's how the stock has traded so far:

That's kinda close, right?

Anyways, the trade thesis still holds true. The stock of TWTR is, until proven otherwise, dead money. It probably won't go bankrupt, but it won't be a shining momentum star anytime soon.

So if you plunk your hard-earned cash into the stock, it may be a while for it to realize significant gains... unless you're actively trading against it. You've gotta be pretty spot on with your timing and know when to take some profits.

The Best TWTR Option Strategy

My favorite strategy? Taking the low end of the current trading range to sell puts into it.

Here's an example of this exact trade setup:

That trade ended up profitable, with about a 10% return on margin over the course of about a month.

I'd like to share with you a similar trade, but first-- a disclaimer. You and you alone are responsible for your gains and losses. I'm not your broker, and you should know your financial needs before you even read investment blogs. This is for educational purposes only. Batteries required.

Now we got that out of the way... let's take a look at how TWTR is trading right now:

Nasty move on earnings, breaking some key support levels, and there is a huge area right around 15. We can use that to our advantage.

The TWTR Sep 15 Put is currently going for 0.35. This means when you sell it, you take in a credit of 0.35. If TWTR is below 15 into September expiration, then you get assigned the stock at a basis of 14.65.

A .35 credit on a basis of 14.65 is a return of 2.39% in about a month. Annualized, thats 28%... double that if you assume 50% margin. If you get assigned, then sell calls against your position, then sell puts... basically converting your trade into a covered strangle.

Simply put, into any blood, selling options in TWTR seems like a good bet to me. It's a dead money trade and will most likely be rangebound for quite some time.

There are risks here-- namely if TWTR goes bankrupt. That's basically it. However, if you think this stock is rangebound for a while, then consider strategic plays in the options market.

The Broken Volatility Markets

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I've been avoiding this for a long time. I didn't want to touch this topic.

Why?

First, I didn't want to seem like some Chicken Little who was claiming the sky was falling and that there is structural risk to the markets.

Second, I thought I'd be early. I've been thinking about this since the beginning of the year, but I've kept my head down and just traded.

The VIX is now getting down to levels not seen... ever. The way we're going, we could see an 8 handle before Labor day.

And it's looking awfully dangerous.

Let's look at some key charts and I'll build out the case for how the volatility markets are broken and it poses a structural risk to stocks.

The Current VIX Chart

Last week, the VIX had its lowest close ever.

Part of this makes sense. The S&P 500 is hitting all time highs, and the actual volatility of the market is low. The trading range has been incredibly tight, and there's no signs of weakness out there. US stocks don't look like a top... and even if it was a top, it's a process that takes months before we turn into a cyclical bear.

However things start looking a little "screwy" when we take a look at a different market.

The Current VXN Chart

The VXN is like the VIX... but instead we're looking at the Nasdaq 100.

Spot the difference?

While the VIX is making new lows, the VXN is making higher lows.

What we're going to do now is compare the two.

VXN Relative to VIX

Right now, there is a massive divergence between the two values. The risk premium available in $NDX options is much, much larger than the premium available in $SPX options.

Correlation Between NDX and SPX

One of the reasons I first thought that would be the cause of this risk premium would be a breakdown in correlation between the two markets. And while there has been separation in the past,

Aside from a few times, the Nasdaq and the S&P 500 are strongly correlated. This makes sense

Since I noticed this divergence in June, I've been racking my brain as to why there is such a large risk premium in the Nasdaq. There was a pretty ugly selloff yet the Nasdaq has since broken to new all time highs.

And it's possible that much of that premium is due to earnings coming up in big movers like AAPL and AMZN.

Yet, I'd like to propose another theory...

Structural Risk in Vol Products

There are a few dozen ways for investors to play volatility outside of the VIX.

VIX futures. VIX options. ETPs like VXX and XIV.

All of those are derived somehow from the VIX.

And, from what I can tell, there is no way for investors to gain exposure to VXN outside of trading the actual options market.

All of these derivatives-of-derivatives are driving the VIX down.

Let me explain...

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How The Tail Wags The Dog

Say you're an investor looking for a new stock to buy. So you run a performance screener and look for stocks that are up 30% on the year... yes, you're chasing momentum.

Yet in this screener you forget to look at only stocks. So a few ETP's pop up, and you see XIV.

The XIV is an inverse VIX product. This year it's run from 60 to 90... not a bad return.

So you go out and buy some shares.

Now I don't want to get into too deep with the mechanics of this trade, but when you open a new trade, the market maker on the other side goes out and shorts the VIX futures market.

And the market maker for the VIX futures market, who now has long VIX exposure, will go out and trade options to hedge it off.

Which then increases the number of option sellers, and it drives down the spot VIX.

Now multiply that kind of trade hundreds of thousands of times...

And you've got a massive weight on the VIX that is holding it down.

This is A Structural Risk

Tell me if you've heard this story before.

Investors, reaching for yield, discover a suite of products based on the pricing of other products, based on the pricing of risk that they probably don't understand.

Ring a bell?

Remember this scene?

That's right. I went there. I referenced "The Big Short." I compared the current vol market to the 2008 financial crisis.

Now before we move on, I want to make something clear. We're in a secular bull market. Volatility products represent a tiny fraction of what goes on in global finance. Any comparison to 2008 is fractal in nature.

Yet, here's the problem with what we have right now in volatility land.

Say the market dips, just by a normal amount... maybe 3%, nothing big.

And some investors get skittish. They stop buying XIV, maybe some go out and buy SPX puts, maybe some VIX calls.

This causes an uptick in the VIX and VIX products. Maybe some other traders get stopped out of their short vol positions.

Pretty soon, this cascades into a full-blown panic underneath the surface of the market.

Think this is crazy? It's happened multiple times over the past two years.

The VVIX

The VVIX is a reading of the risk premium in VIX options.

While the VIX continues to make lower highs, the spikes we see in the VVIX are about the same height.

Think about this!

The S&P 500 has seen no proper selling in 2017. At all. Yet any time we get just a tiny blip lower, the VVIX spikes to nearly the levels we saw headed into Brexit and the US election.

What happens if we get a normal selloff?

Just a run-of-the-mill 5% pullback?

Here's the Rundown

I know I've covered a lot in this post. And it's kind of a complex topic to understand but it's important, especially as we get out of the summer doldrums and head into the fall.

Here's a summary of what you need to know...

  1. The VIX, a measure of risk premium in the S&P 500, is hitting all time lows.
  2. The VXN, a measure of risk premium in the Nasdaq 100, is making higher lows.
  3. There is a statistically significant divergence between the VIX and VXN.
  4. The VIX has a large amount of products tied to it.
  5. The VXN is a volatility index unadulterated with any other products besides the options market.
  6. The VIX is very low, partially because of the low volatility in SPX, but also because of the increased supply of volatility-sellers.
  7. There exist a significant population of investors who have no idea what's going on behind the scenes in the volatility markets.
  8. There have already been mini-panics in the volatility market on very small SPX selloffs.
  9. If the SPX sells off a "normal" amount, a structural instability may manifest that leads to a cascade in all the volatility shorts.

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How to Trade It?

I suppose this is where the rubber meets the road. After all, it's one thing to analyze the market, and another thing to create trades to profit around it.

Let's take a look at some ideas.

First, a quick disclaimer... I'm not your broker, and these trades are educational in nature. With that in mind...

1. Long SPY Straddles

Right now, you can buy an Aug SPY Straddle with an implied volatility of about 6.5%. I've never seen that before.

The Aug 248 straddle is currently going for 3.41.

To put that in context, for you to be profitable, the SPY needs to move 1.37% over the next 3 weeks for you to profit on this trade.

If you think the S&P can see a 30 handle move sometime soon, this is a good trade.

2. Long VIX Options Delta

With the spot VIX at 9, and the VVIX at 6 month lows, it makes sense to start looking at making a bet that we'll see at least some selling headed into the fall.

Keep in mind, if you trade VIX options, your underlying is not the spot VIX... instead it's the VIX futures market. And the October VIX is currently at 13.20, so there is a decent amount of premium there.

If you want a "moonshot" trade, you can buy the VIX Oct 20 call for 0.65. A 3% selloff should get you at a double.

If you want a more conservative bet, here's something I like:

  • Sell to open VIX Oct 12 Put @0.80
  • Buy to open VIX Oct 15/20 Call Spread @0.60

This puts you at a small credit. Now if the VIX stays at 9, then the trade will lose about 300 per spread. I don't think that's likely, headed into October. You'll want to scale out of this trade into any move higher in the VIX.

3. Fade The VIX Pop

Short volatility strategies will probably continue to work... it's just a matter of timing. Instead of forcing your way into a trade late, why not wait for the move?

There's a few conditions to look for...

  • a VVIX above 95
  • VIX futures backwardation
  • VIX/VXV above 1

These are all sufficient to consider entries. My favorite instruments are XIV long and VXX puts.

This kind of trade will be frustrating because I'm going to be early on this call and it will be another month before sellers step in.

4. Nasdaq/S&P Dispersion

This is a little more of an advanced trade. The basic idea is you want to sell vol in the Nasdaq, and buy vol on the SPX.

Here's an example of how this would look:

Sell 2x NDX Sep 5350 Put @15.60 (IV: 20%)
Sell 2x NDX Sep 6240 Call @9.10 (IV: 10%)
Net Credit: $4940

Buy SPX Sep 2475 Straddle @57.40
Net Debit: 57.40

This bet assumes that the NDX strangles will decay faster than the SPX straddle. You'd want to be in this for a few weeks, and you'd need to move your deltas around using the futures market.

It's capital intensive, and if you want to cut your margin, you could do something similar using the ES and NQ futures market.

5. QQQ Ratio

If you think we could pullback but the Nasdaq vol is too high, you could put this trade on:

  • Buy 1 Sep 139 put
  • Sell 2 Sep 136 put
    Credit: 0.43

With this trade, you're covered all the way down to an 8% correction in the Nasdaq.

6. Buy Calls on Your Favorite Stocks

Odds are, this rally is going to continue. And individual stocks are going to run-- this is some of the cheapest premium I've seen.

Right now, it is a much better play to buy calls compared to owning stock. It's much more capital efficient, and if we do tank your risk is limited to much less than what a pullback would cause in a long stock portfolio.

I'd also look into converting any winning stock trades into long call positions. You can take cash off the table, still let the winner ride, and have deployable cash ready in case a dip does happen.

A Final Warning

It's easy to create a narrative that would make you want to go out and buy gold, guns, and ammo.

If I did that to you with this post, then I made a mistake. While I believe a structural risk does exist in the volatility markets, there is no evidence that US stocks are in or approaching a bear market.

Yet it is time to give serious thought as to how you want to play the next 6 months. Volatility moves in cycles, and we're probably near a low. Trade accordingly.

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The Costly Iron Condor Trading Mistake You Must Avoid

It sounds sexy, doesn't it?

Put on a weekly iron condor trade... one per week, then let it expire and send the cash straight to the bank.

Yet from many clients I've worked with, they've been burned on this exact trade...

What's going on? Why does it seem like such a "layup" trade until you actually try to do it in real life?

Let's take a look...

It's a Crowded Trade

Since weekly options were introduced, more and more trading volume continues to shift towards shorter duration options.

A lot of people out there chasing short options.

And when you get a lot of people leaning one way, it drives the premiums on those options lower and lower.

That means you, along with countless others, will be chasing smaller rewards and taking larger risks.

So the question you need to ask yourself...

Is the "juice" worth the "squeeze?"

A Real World Example

Let's take a look at a weekly iron condor trade:

With about a week to go, this iron condor trade gives you .70 of credit for 4.30 risk.

And as long as the market stays above 2385 and below 2460, then you make money.

Seems fair, right?

Well, let's think about this for a second.

You've got about 30 points of upside buffer, and then about 45 points to the downside.

Right now the market is trading about 14 points a day. So all you need is a 2 day rally, and you're nearing your upside risk limit. And all it would take was one more pop and you'd be in serious trouble.

If you want to earn faster returns with iron condor trading, there is a way...

...but you have to be smart about it.

A Better Approach

Weekly options give you the promise of "instant profits" with a hidden cost.

What if I told you there was a better way to earn quick profits?

Allow me to introduce you to the KISS Iron Condor.

This is a short term iron condor with an embedded stop inside of it.

Unlike many iron condor traders out there, we believe that iron condors aren't just "set and forget" trades. You need to have some kind of risk management setup.

Basically, we look at putting on an iron condor about 30 days out, and look to hold onto it for 2 weeks.

So while weekly option traders are trying to force profits out of a 1-week trade, we can get better risk/reward by stretching it out a little more.

Our goal here is to take about 80% of the credit of the trade, and we set a stop at twice the reward.

Here's a live trading example:

This is an iron condor for a credit of 0.90.

Our profit target is to pull out 0.70 of the credit, and a hard stop is placed if we hit a loss of 1.40. That will happen if the market rallies to 2490 or sells off to 2340.

We want to be out of the trade in about two weeks.

Here are the results from some of the trades beginning in 2017:

This was from just one iron condor, and this setup can easily scale up to 20 iron condors.

The math ends up being simple. If we risk 2 to make 1, and our odds are above 75%...

Then it's a system with the odds on our side.

Learn More About Iron Condor Trading

We've put together a free iron condor toolkit for you, so you can see our approach to income trading and you'll get some of the resources that we use on a daily basis.

Click Here to Get the Iron Condor Toolkit for Free

Nailing the Top in Mastercard (MA)

Trying to short a stock that's in an uptrend can seem like a dangerous idea.

Yet, if you choose the right option strategy and are very selective about where you put on risk, there are always a few setups that give you profitable opportunities.

Let's step through a recent example in Mastercard (MA) so you can see how to add this setup to your trading arsenal.

Key Fundamental Indicators

When it comes to analyzing the market structure of a stock, size does matter. The kinds of market participants and liquidity is completely different in a stock like GOOGL or GS compared to a highly shorted small cap stock.

If you want to short a stock in an uptrend, the fundamentals of the company actually do matter. You want a stock that can see growth... but not explosive growth.

And you definitely don't want the company to be a buyout target.

The best way to find stocks for this setup is to go with established, name-brand companies that have very large market caps and shares float.

Quantify Your Levels

It's not enough to eyeball a chart and place some trendlines on it.

You need to have some kind of statistical backdrop for your trade. If you don't, you may allow your ego to get involved in the trade, and odds are you'll be too early on the short side.

I have a cusom indicator called the IWO Turning Point. It allows you to get a statistical view of the rate of change on a stock.

Let's take a look at how MA was set up:

Over a 10 day window, the stock had rallied over 7.5%. This was coming into a 3rd standard deviation move relative to the past 3 months of price action.

Now this kind of move has happened in the past, but it tends to occur only after strong downside moves. To see this kind of extension into new all time highs was statistically significant and warranted a short biased trade.

Pick the Right Strategy

I would never want to go short stock straight up on a trade like this. I'd rather limit my risk, increase my odds, and get paid for taking risk off of someone else.

This is where a bear call spread comes into play, also known as a call credit spread.

A bear call spread profits as long as the stock sells off or drifts sideways. This is a great strategy for shorting large cap stocks because often times the stock doesn't actually sell off hard, but simply drifts sideways.

Get Good Executions

On a trade like this, it's foolish to go "all-in" when you first spot a short setup. Instead, focus on scaling into the trade.

That way if the stock continues to move against you, risk can be added to the trade without a ton of stress.

Sure, this means that you may miss out on going full size on a trade, but it also helps you sleep at night.

Here was the original trade setup I shared:

The stock is up 7.5% in a 10 day period, which doesn't happen often into range extensions. Expect this to correct and consolidate.

Trade Setup

Expected Price: 127

Sell to Open MA Jul 130/135 Call Spread

Tier 1: Open at 0.70, Close at 0.20

Tier 2: Open at 1.00, Close at 0.70

Tier 3: Open at 1.30, Close at 1.00

The next day, the stock stretched just enough to get a Tier 1 fill. And then over the next week, the stock corrected hard into 120 per share, allowing an exit at 0.20.

That's a .50 gain on a risk of 430, for an 11% return on risk within just one week.

Keep It Simple

If you want to sell credit spreads successfully, it comes down to a few simple ideas:

  1. Pick your levels.
  2. Use limit orders.
  3. Scale in.
  4. Scale out.

With that framework, you can earn consistent returns in the market without losing sleep at night.

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