How I’m Playing The Surge In High Beta Stocks
Tim Knight | Oct 02, 2013 12:39AM ET
Over the past several weeks we have seen the S&P 500 (SPY) and Dow (DIA) push lower while the higher beta indexes Nasdaq 100 (QQQ) and Russell 2000 (IWM).
As you can see in the table below, both ETFs are now in a short-term overbought state.
There are a few ways I might play the overbought readings in IWM and QQQ.
First, I could buy a put. This would, of course, be a fairly risky trade as it would be very directional with duration working against the position. I would prefer to see a reading above 85 before I truly pursued buying a put. Moreover, due to the directional nature of the trade I would keep my size smaller than a normal spread position. Furthermore, along with an overbought reading above 85, I would prefer to see my short-term readings, say the RSI (2) above 95.
Let’s take a look at the current state of IWM:
As you can see, both time frames are in a short-term overbought state. But the problem is the readings still aren’t as extreme as I would prefer on a short-term basis, especially for a directional trade. So, with that being said, I want to wait another day or two to see how IWM reacts. If it happens to move higher and push its short-term state into “very overbought” I would place a trade. It takes great patience to wait for true extremes to hit, but it’s often worth the wait.
But that’s why we have credit spreads, more specifically in this case, a bear call spread.
With IWM currently trading at $107.85, I might sell the Nov13 113/115 call spread. The spread gives us a 82.6% probability of success and a margin of error over 4.8%. Good luck finding those odds trading stocks…which is why I prefer to trade options. In all but those few extreme cases I want to be the house, I want the odds in my favor, I want to sell speculators options with a low-probability of success. I can attest that this is the true formula for success in trading.
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