Oversold Does Not Mean Buy

Oversold Does Not Mean Buy

Posted On March 1, 2022 3:56 pm

After Friday’s huge reversal, which seemingly confirmed the wisdom: “buy on the sound of cannons,” stocks have struggled with no “trumpets of victory” heard.  Instead, the situation in Ukraine’s getting more complicated, resulting in market-moving inputs such as inflation, interest rates, and investor/consumer sentiment becoming increasingly muddied. 

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What once seemed like a clear-cut Fed plan to begin a normalizing rates policy and withdrawing liquidity has become a twisted path. When Chairman Powell initially laid out his plan, the market welcomed it as if to say, “it’s about time.”  But, the prospect of the Russian invasion and accompanying sanctions will drive inflation higher (specifically energy and food), potentially making the rates-raising prospect into a global economic slowdown — unattractive to put it mildly. 

On Friday, I discussed how even though I thought the market would make new lows in the coming months, Options360 was still making some bullish trades. However, as I noted, I was taking a tactical approach by using credit spreads. In fact, the bull put spread in Twilio (TWLO) I mentioned in the article was closed yesterday for a 45% return during the three-day holding period; representing 75% of the potential return. Remember, credit spreads often have a higher risk than reward and are in keeping with discipline to close credit spreads once at least 50% of the maximum profit is achieved. Again, in credit spreads, you don’t want to overstay your welcome and try to squeeze out the last penny at expiration. 

Anyway, back to what Options360 is thinking and doing now. Currently, our only open positions are iron condors in the SPDR 500 (SPY) and Facebook (FB).  Again, I’m trying to take advantage of the elevated premiums during this high volatility period.  The SPY position expires tomorrow and FB expires on Friday. But, I may close SPY today and FB today or tomorrow to lock in gains.

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Now, the market will have me looking for more aggressive bearish positions.  I don’t like how poorly the financials have acted over the past few weeks with major banks such as JP Morgan (JPM) hitting 52-week lows. That tells me the market sees a significant slowdown in business lending and spending in its future.  Full disclosure: Options360 just closed a bullish position in Capital One Financial (COF) for a 47% loss.  

From a technical standpoint, the Relative Strength Index (RSI), on January 26th had a reading of 24.1, its lowest since February 2020. Both times provided a viable short-term buy signal.  

A reading of 32 was hit last week, again giving a short-term buy signal. But, it was weaker and shorter-lived, and not confirmed by new peals in the VIX or the put/call ratio.  

Many technicians also believe that the ability of a selloff to produce an oversold reading is actually confirming the downtrend’s strength. There’s a Wall Street saying, “when the SPY’s RSI produces an oversold reading that doesn’t mean the selling is over.”

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.