When traders are just beginning their journey, they often find themselves overwhelmed with the many indicators that exist.

Depending on what you read or who you speak to, one indicator might sound superior to another. However, the truth is that there is no right or wrong indicator. There is just one that makes the most sense to you and enables you better to understand the price action and potential trade opportunities.

I thought I would spend some time going over some of the most popular trading indicators, and hopefully, one or two resonate with you.

Moving Average (MA)

The moving average, also commonly referred to as the Simple Moving Average, is an indicator traders use to identify the overall trend.

Depending on what parameters you use, the moving average paints an overall picture regarding the direction of the stock.

The most popular moving averages, such as the 50 day and 200 day, often act as significant resistance or support levels.

The distance of the moving average to the most recent close will typically vary depending on your chosen data. For example, a 50 day MA requires 50 days of data and will be closer to the stock’s current price than the 200 day MA.

For example, in the above chart of SPY, I have placed two moving averages on the daily chart. The blue line is the 200 day, and the pink is the 50 day. From these indicators, I can see that the market has been in a clear uptrend. The chart also clearly shows that the 50 day moving average has acted as key support on more than one occasion.

Relative Strength Index (RSI)

Traders widely use this indicator to help identify possible oversold and overbought situations, market conditions, and momentum.

The RSI indicator is expressed as a number between 0 and 100. A stock near or above an RSI level of 70 is considered overbought, while a stock near or below 30 is considered oversold.

Traders use this indicator across various time frames.

For example:

Notice in the above chart of GILD, that when the stock achieved an RSI of 70 or higher, it marked the short-term top. Similarly, each time the RSI neared 30, It marked a short-term bottom.

The above example shows the usefulness of the RSI intraday. Off the open, KPLT traded lower, and the RSI got below 30 momentarily, which signaled the bottom. Shortly after that, the RSI touched 70, which signaled a short-term top.

Average Directional Index (ADX)

The ADX shows the strength of the price trend. The ADX is used by traders to help identify whether a trend is likely to continue. The indicator has a scale of 0 – 100, and a stock with an ADX reading over 25 is considered to have a strong trend.

The Bottom Line

I have just scratched the surface with the above examples, as these are just a few of the most popular indicators that traders use.

Other popular indicators include VWAP, Standard Deviation, Fibonacci Retracement, and Bollinger Bands, to name just a few.

The indicator you use will be based on various factors, such as your time frame, trading style, risk parameters, and stock selection preferences.

Indicators can be used in conjunction to help you better understand the overall trend of the stock and potential opportunities.

Stocks with these characteristics (low float and high short interest) can have major moves to the upside to wipe out stubborn shorts before falling back to reality. And that is exactly what we saw: an almost 300% move in 2 days followed by a 55% sell-off in 3 hours.

But what to do when there are no shares available to short at your broker due to the high demand? If the stock has tradeable options, you can take a position using call options.

First, let’s run through how the setup occurred and then how we could have structured the trade.  

Daily Chart of SPRT

Setting Up The Squeeze

Taking a look at the daily chart, there are a few things that we notice that made a short squeeze possible. On the 13th of August 2021, we saw SPRT gap up and make a 52 week high on volume of 83.5 million shares traded.  After opening at $9.77, making a high of $10.88 the stock was unable to hold gains for new investors buying on this day, closing at $8.10.

Now the stock traded more than 5 times its 15.08 million share float. This usually occurs when algos buy and sell to each other to create liquidity to exit a stock. This type of volume at the highs is sometimes known as a liquidity event, where insiders can cash out of their positions. And when it fails on volume, it can also mark a blow-off top, in which case a stock should steadily sell off back to where the move started. However, this did not happen, and when new shorts pile into a stock with an already high short interest, fireworks can ensue.

After a stock has a liquidity event, as we stated earlier, it should sell off in the coming days. Instead, SPRT consolidated for 4 days around the $7.50 to $8 area right at the 13 days moving average. From a technical analysis standpoint, it was still trending higher, making a higher low. The stock failed to sell off and continue lower on numerous occasions i.e. after 20th, 24th, and 25th of August. On each of these occasions, if it was a weak stock, it “should have died,” it did not.

As we can see, there were sustained increases in volume day by day and finally, when SPRT could not continue to sell off after the 24th of August, again on volume of 80 million, shorts were in big trouble. The sharks smelled blood in the water, and we saw a 300-400% move in 2 days indicating that some stubborn shorts were forced to liquidate and cover at any cost. This type of price action is unsustainable and eventually led to a blow-off top on Friday the 27th of August.

The Blow-Off Top

Let’s drill down to a lower timeframe to see how a blow-off top trade is set up.

Now a blow-off top usually begins with a large gap and ends with an explosive move higher that cannot be sustained. Trying to short the front-side of a move as a stock is exploding higher is not a great idea, in my opinion. It is very difficult to control your risk, and emotions can kick in as a trader might think a stock is too high, but it can keep going much higher. I like to wait until a stock makes a lower high that is clear for all traders to see so that I have a spot where I can define my stop loss. That was evident just after 2:10 pm to 2:20 pm.

From a psychology perspective, we can think of it this way. The stock is up 300-400% in 2 days, not to any particular change in fundamentals but because a short squeeze is at hand. After 2 pm we are heading to power hour, and we would expect one of 2 things to happen. Either the stock will continue higher and continue to give shorts hell, or market makers will sell a bunch of calls, and the buyers behind the squeeze will use this opportunity to exit their trades. Either way, this is a great spot with good risk/reward to bet on smart money call sellers, who have been selling calls all day. But how to structure such a trade when shorts are hard if not impossible to borrow?

Structuring the Trade

On a stock such as this when options are available, the strategy is to sell calls against a resistance point and stop out if it breaks higher. It is a different way to bet against a stock without shorting it. Coming into 2:20 pm when SPRT failed to break above $56 and is smacked down to $50 that is the point I would consider selling $65 and $85 calls to be ready for the opportunity of dumb money retail bets and shorts that are in deep trouble who are buying calls to hedge.

The most important part about this trade is to have a defined stop. In this case, the high for the day was $59.69 and the stock was at $50. A break and hold above $60, I would be forced to stop out and buy the calls I had sold. If the stock broke down again, I could always re-enter the trade. It is okay to be wrong, but it is not okay to stay wrong. After the stock broke $50 it trended down the rest of the day to close at $26.33.

One more thing to note; the stock traded in the afternoon very similar to how it traded in pre-market. In pre-market action, SPRT failed at $52 and traded to $30. Often pre-market resistance is a great area to trade against during market hours. Stocks have a character and sometimes, the stock will show its hand in pre-market action.

Bottom Line

When big traders are stuck on the wrong side of a stock, great trading setups can form. Selling OTM calls on a very extended stock that is going parabolic is one of my favorite trading strategies. It is also something traders should consider when finding locates to short stock are hard to borrow. On this setup, it is imperative that a stop loss is defined and a lower high that is clear to everyone trading the stock is formed. A great example was SPRT from Friday. The smart money who sold OTM calls were able to collect premium from $85 to $30 after 2 pm, as demand for stock waned after stubborn shorts were taken to the cleaners.

]]> https://ragingbull.com/total-alpha/parabolic-squeeze-shorting-call-options-when-you-cant-short-stock-in-support-com-sprt/feed/ 2 93356 https://ragingbull.com/total-alpha/gamma-squeeze-and-short-term-market-tops-a-case-study/ https://ragingbull.com/total-alpha/gamma-squeeze-and-short-term-market-tops-a-case-study/#respond Mon, 16 Aug 2021 18:13:01 +0000 https://ragingbull.com/?p=92439 The market continues to march higher and higher, day after day, week after week. Fed asset purchases and fund inflows continue to bid up the market. And with trillions of savings still on the sidelines, there seems to be no end in sight in this roaring bull market. 

Until fundamentals change and we see hyperinflation, as the Big Short’s Dr. Michael Burry has already warned about, and/or interest rates rise, there is no reason for the market not to continue higher.

However, in every bull market, there are healthy corrections. Over the past few years, a great leading indicator of an upcoming pullback has been the Gamma Squeeze. Legendary investor Warren Buffett once wrote, “A bull market is like sex. It feels best just before it ends.” And this is exactly what we’ve seen. 

Preceding the biggest corrections in recent times, we’ve seen major euphoria and Gamma squeezes in stocks that have gone way further than most people thought possible. The top in these runaway stocks usually marked the short-term top in the market as a whole, where a significant correction followed.

Conditions for a Gamma Squeeze

For a Gamma Squeeze to occur, certain conditions must be present. A Gamma Squeeze is a short squeeze but on steroids.

1. First, we need a high short interest in a stock.

For a squeeze to occur, sure market participants must be stuck, in this case, stubborn shorts. A squeezing stock can continue to do so until stubborn shorts can no longer take the pain and forced out of their position.

Short interest of over 10% gets my interest, but anything close to 30% or above can fuel a significant move.

2. Second, we need options activity.

A Gamma squeeze is also fueled by options activity— this is what gives the short squeeze added “juice”.

It works like this: People who are short the stock hedge their positions by buying out of the money call options sold to them by market makers. Usually, the smart money has every incentive to have the options they sold expire worthless to pocket the premium.

For the most part, they can do this. After all, if they are the house and well, the house should win most of the time. The fun starts when the smart money gets trapped, and a vicious cycle ensues.

A Vicious Cycle

As the Gamma squeeze begins and a stock continues higher, bears pound the stock short because they see the move as irrational expecting it to go down. In order to control their risk, they buy out of the money calls to hedge their short position.

So as new shorts enter selling the stock short, there is also added out-of-the-money call buying when the stock goes higher against them.

This is where things can get out of hand. Once the market makers who have sold calls at levels of high open interest can no longer hold the price below that level to collect their premium, they must hedge their short call sales by buying back the stock.

So, for example, if there is 30k of open interest at $300 calls, once the price holds above that level, market makers are buying stock to hedge those calls sold, providing extra demand to take the stock even higher.

But then new shorts come in and buy the $400 calls to hedge. Once the price gets above $400, market makers are forced to buy stock to hedge the calls that they sold, sending it even higher.

To add fuel to the fire, you have speculators who understand this rare situation and buy out-of-the-money calls and shares with size. 

You also have retail apes piling into YOLO (You only live once) calls. This puts even more pressure on shorts and market makers— with substantial open interest in calls that cannot be contained for the time being.

This vicious cycle can continue longer than most participants think and usually goes on until a lot of short-sellers are forced out of their positions, pushing prices even higher as they cover at any cost, or sometimes a hedge fund or big trader blows up. The top is usually marked by a rapid, unsustainable rise in price known as a blow off top. Let’s look at a few examples. 

Tilray INC (TLRY) was a low float Marijuana IPO with a short interest of over 30%. In the space of a month, it rose from $30 to $300, leading the charge for the Weed sector coming into Canadian legalization.

The blow-off top occurred on the 19th of September 2018, where the stock opened at $233.58 after closing the previous day 154.98. It began to skip prices and accelerated to hit a high of $300, before having a circuit halt down and closing the gap back to 154.98 before recovering to close at 214.06 that same day. It proceeded to sell off towards $100 over the following weeks and fell below $20 the following year. 

The top in TLRY also marked the short-term top in the SPY.  

After the 19th of September blow off top in TLRY the SPY consolidated at its high for another couple of weeks. It made a high of 279.03 on the 21st of September, tested it on the 3rd of October, failing at 279.02 and making a double top. The SPY proceeded to sell off 20% over the next three months. Market exuberance in TLRY was a warning for the major selloff to come.

The next stock Gamma Squeeze stock we want to look at is Beyond Meat INC (BYND). This was another low float IPO with eventual short interest of greater than 30%. This was the first company to list in the “plant-based meat” sector. It ran from $46 to $239.71 in the space of 3 months. It made its high on the 26th of July 2019 before a capital raising on earnings day led to a selloff. Over the next few weeks, it fell to $140 before finishing the year at around $75.

The top in BYND coincided with the top in the SPY. Following an all-time high on the 26th of July 2019 in SPY of 291.75 (this may be dividend-adjusted as some platforms show 302.23), the SPY fell 6.6% over the next six trading days. 

(Daily Chart of TSLA needs to be adjusted for 5:1 split i.e., multiply prices by 5)

The next Gamma Squeeze we will take a look at is Tesla Inc (TSLA). Following the release of the Cybertruck, TSLA had a major squeeze into the new year right into corporate earnings, trading from $350 to $580 coming into the release. Many traders and funds were shorting into this rise. Moreover, around 30% of the float was already short.

After a profitable quarter, TSLA held the gap and consolidated at $650. Even after the SPY was selling off due to the beginning of Covid in China, TSLA remained relatively strong, shorts were trapped, and there was major out-of-the-money call buying. 

The blow-off top took two days, with the stock running from $650 to $970 as shorts were forced to liquidate, market makers forced to hedge, and speculators kept buying calls. The blow-off top was on the 4th of February where in the final 15minutes TSLA sold off from $970 to close the day around $900. The following day TSLA sold off to $700. 

After a bounce to $900 over the next few weeks, TSLA made a lower high on the 19th of February and then sold off to $350 during the Covid market crash of 2020 into March as its factory was forced to close for a while.

The top in the SPY was made on the 19th of February, two weeks after the blow-off top in TSLA as Covid spread to Europe and the United States. Over the next month, we saw a selloff of 35% in the SPY. 

In January 2021, GameStop Corp (GME) had a memorable Gamma squeeze, forcing Melvin Capital out of their short position and losing billions in the process. In the space of six trading days, GME traded from $43.03 to a high of $513.02 pre-market. The same day GME topped out at $513.02, it traded as low as $112.25, which was on the 28th of January 2021. It traded back to $50 over the next few days.

While GME was squeezing the SPY fell 4.6% from the 26th of January to the 29th of January, perhaps due to the fact that some funds short GME had to liquidate their larger blue-chip holdings that they were long. Three weeks after the blow-off top in GME, there was a 5.4% selloff in the SPY from the 16th of February to the 4th of March.

From the examples above it is evident that there is some correlation between major Gamma Squeeze events and subsequent market selloffs. 

Bottom Line 

Gamma Squeeze events typically occur near short-term market tops. They signify excess euphoria in the financial markets as retail investors and funds pile in at frothy levels. When prices move in an unsustainable fashion and then collapse in these larger capitalization names, wiping out billions in days, if not hours, the broader market tends to sell off not long after. 

As Warren Buffett aptly wrote, “A bull market is like sex. It feels best just before it ends. Perhaps the next Gamma squeeze will signal the beginning of the next market pullback. For now, we keep grinding higher. 

Today we’ll talk about just that. 

You see, you’re only as good as the stocks you trade, and developing a process to find the right ones for an opportunity is a vital part of becoming a professional trader.

Every trader needs to develop a process to find the right stocks to trade. It takes a lot of time and hard work to figure out which types of trades suit you best, and today I will discuss a number of ways to find stocks with opportunities on any given day.

Largest Percentage Gainers and Losers

An essential tool to finding stocks is a market scanner. I want to know which stocks are moving more than most on a particular day and why. The obvious place to begin is with percentage gainers and losers. Before, during, and at the end of every trading day I run through all the biggest percentage movers for the day. 

Obviously, these are the strongest and weakest stocks of the day, and I look at charts and study the news and fundamentals of all of them to see which of them might be setting up for a continuation. I then set alerts at price levels on the stock that I want to be watching. 

If the stock had some fantastic news which changes its fundamentals, I might look to join the breakout as this type of stock might run much further in the short run as investors re-rate their valuations of the company. 

On the other hand, if the stock has excellent news and I like its prospects longer term, I might wait for a pullback to more reasonable levels in the short term if I think traders have gotten carried away. Sometimes algo’s might need to shake the tree to get rid of people who chased the stock at frothy levels. Making these types of distinctions on strong stocks is what separates great traders from the rest.

Relative Volume (Rvol)

I will also look at relative volume (Rvol). Rvol is the current volume divided by the average volume. The greater the Rvol, the greater the likelihood of a range expansion on a particular day in a stock. For example, if a stock has a Rvol of 7, it means that on this particular day, it is trading 7 times its average volume. This is likely due to some sort of news catalyst.

When a stock trades multiples of its average volume, its range or Average True Range (ATR) is likely to expand. For example, on a day with corporate earnings, a stock trading with an Rvol of 5 may often move 2 or 3 times its ATR. So, if a stock usually moves $3 on an average day, on a day with high Rvol it may move $6 to $9 from low to high. This is the type of volatility day traders love. And it helps swing traders like me find great stocks that I can stalk for potential opportunities in the days to come.

Financial Publications

I also do a lot of research when preparing for and after the trading day. I do a lot of reading from financial publications, scan media such as Twitter, StockTwits, and Reddit to gauge market sentiment, which I will often fade if it is too one-sided. This also helps me to identify new trends or themes in the market. You see, often, certain sectors will get hot coming in and out of fashion as funds rotate throughout the market. Having 1000 eyes on the market is better than 2, which is why I make use of the trading community and the contacts I have developed throughout the years.

Corporate Earnings & Press Releases (PR’s)

Most importantly, I read corporate earnings reports, conference call transcripts, and Press Releases (PR’s) from the companies. The bulk of PR’s begin to trickle out at 7 am daily when the market is open, and they are put out every half an hour until the market opens at 9.30 am.

Being fast on the trigger in pre-market when vital news in a stock comes out is an important strategy many intra-day traders use. I keep up with as much news as I can to be as informed as I can be in the stocks I am looking to trade. Fundamentals play an essential part in my decision-making as well as technical patterns. 

Scans & Strategies

Other scans I use on a consistent basis to find trade ideas include:

• New 52-week highs (stock price)
• New 52-week lows (stock price)
• New 52-week highs (implied volatility)
• New 52-week lows (implied volatility)
• Technical breakouts
• Technical breakdowns
• Big spikes in stock volume
• High option volume
• High put activity
• High call activity
• High open interest
• Price gainers
• Price losers
• Big increase in implied volatility
• Big decrease in implied volatility
• Companies about to report earnings
• Companies that have just reported earnings
• Companies about to declare a dividend
• Companies that have just gone ex-dividend
• Companies that have just announced a reorganization
• Companies that have just announced a merger
• Companies that have just announced an acquisition
• Companies that have just announced a divestiture
• Analysts’ new buy recommendations
• Analysts’ new sell recommendations
• Stocks with gap openings up
• Stocks with gap openings down
• Large put-to-call ratio
• Large call-to-put ratio

You could build an entire trading system out of any one of the conditions listed above.

Bottom Line 

You are only as good as the stocks you trade. Finding the stocks that can give you an opportunity is a vital part of a professional trader’s process. It takes a lot of time and hard work to sift through stocks to find the right ones that might set up for a great trade. As a minimum, I run through scans of the biggest percentage gainers and stocks with high Rvol to find the biggest moves daily. This gives me an understanding of the stocks with the highest interest among investors and any changes in company fundamentals. I also read financial news publications and check social media sentiment to keep abreast of all the latest themes and trends in the stock market.

Most importantly, I keep up to date with company news and corporate earnings reports to understand the fundamentals of the stocks I am looking to trade. On top of this, I also look at stocks making new 52-week highs and lows as well as options activity, among other things. There are many different ways to find opportunities in the market for all different types of traders; the main issue is to get past the learning curve and live to fight another day!

What Is a Stock Option?

Image via Flickr by mikecohen1872

Stock options are contracts that give investors the right to buy or sell stock at a specific price within a certain timeframe. Stock options give you the ability to earn great returns on very small investments. However, just as stock options give you the ability to earn money in a stagnant market when your stocks aren’t really earning you money, some of the strategies that involve stock options carry substantial risks.

A call option gives you the right, although not the obligation, to buy a specific stock. A put option, on the other hand, gives you the right to sell. The price that you lock in with these contracts is called a “strike price” and you have the right to either buy or sell based on the type of options contract you own.

Understanding the Benefits and Drawbacks

Before I delve into how you can use an options profit calculator, it’s first important to understand the benefits and risks that you accept when you complete different kinds of trades with stock options.

Benefits of Trading Stock Options

One of the benefits of trading stock options is that there is a lower upfront financial investment since you’re not actually buying the stock. The price of buying the option is far less than what you would spend if you were buying the shares outright.

If you’re an options buyer, there’s limited risk. Even if you buy a call or put options contract, you are in no way obligated to take any further action and could simply choose to let the option expire. That means that the greatest risk for options buyers is the amount of money they invest in the option to begin with.

In addition, an option offers built-in flexibility, as the investor can choose to exercise the option and buy the shares, buy them and immediately sell some or all of them, sell the options contract to another trader, or sell an out of the money contract to another investor before it expires, making back some of their money.

Options trading gives traders the opportunity to earn income in a market that is stagnant, where their stock isn’t earning them money.

Risks for Trading Options

As I said above, the risk is extremely limited if you are buying an options contract. The same cannot be said for the seller, or writer, of an options contract. When a seller writes a call or put, they are then obligated to buy or sell within that time frame if the buyer exercises the option, even if the prices are unfavorable for the writer. While the stock can only go as low as zero dollars, there’s no limit for how high the prices can climb.

A trader may sell a call option because they think the price of the stock will stay below the strike price at which the contract is set. The options seller receives a premium payment and hopes that the option will be allowed to expire, worthless. However, if the price goes up without you owning the underlying stock and the buyer exercises the option, the risk is truly unlimited because there’s no limit to how high the market prices can climb and you are obligated to sell the buyer the stock at that price. There is far less risk if you already own the stock, which is called a covered call. You may be forced to sell the shares when you don’t want to but you at least won’t be subject to high market prices.

Investors sell puts when they think that the shares of stock will stay above the strike price. However, if the buyer decides to exercise their option, then the put seller is obligated to purchase shares of the stock, potentially experiencing significant losses when they must turn around and sell the shares at a much higher price than they purchased them at. The only benefit of a put option over a call option is that the stock can only get down as low as zero dollars.

How to Use an Options Profit Calculator

N ow that you fully understand the possible risks of different types of options trades, you better understand why it’s important to use an options profit calculator. This can help you fully understand the potential gains as well as potential risks that could accompany a trade prior to actually taking any risks.

Where to Find Options Profit Calculators

There are a lot of options profit calculators to choose from online. You can also use this options profit calculator for a unique way to view potential returns of different options strategies. There are many others available as well, which you can uncover with a simple online search.

How to Calculate Options Profit

To calculate the return on stock options, you first need to know the premium price for the options contract. You also need to know the value of the asset and the number of contracts you plan to purchase. After that, the steps apply for both call and put options.

1. Subtract the Value of the Asset

Start by subtracting the initial value of the asset in your options contract from the current sale price on the market. For example, if you paid $15 for the contract and you can sell the same asset for $22, the calculation would be $22 – $15 = $7.

2. Multiply By the Total Number of Shares Purchased

The next step is to multiply the value you determined in step one by the number of shares you’re purchasing the option for. For example, if you bought options for 200 shares, the calculation would look like 200 x $7 = $1,400.

3. Subtract the Premium

Next, subtract the cost of the premium you paid. For example, let’s say that you paid $250 for the option to buy the shares. The calculation for this would look like $1,400 – $250 = $1,150. This final amount represents the total profit/loss that could result from the sale.

Other Considerations for Options Profit Calculators

It’s important to note that this is a very basic overview of how you could calculate potential profits from an options trade. The calculator listed above allows you to explore more advanced options trading strategies. It’s also important to remember that the numbers above rely on the assumption that you exercised your option. If you didn’t exercise your option and instead allows the option to expire worthless, then the loss would be the cost of the premium.

There are a few other considerations you should keep in mind as well. First, profit and loss calculations assume that you’ll hold the option position until it expires. However, you can typically close short or long option positions before they expire by selling them. Probability calculations for options profit calculators are also based on the assumption of stabled implied volatility values. If the market is volatile, it could dramatically change the prediction for the options trade.

If you’re trading options, it’s important to start to use an options profit calculator to fully understand the potential gains and losses you could see from a trade. It’s also important to adopt and stick with a particular strategy or set of strategies. Stock options are great for allowing you to earn a strong income through the stock market, even when the market is relatively stagnant.