Fading the Momentum

• stevenplace
• May 4th, 2009

Reading the title you might think that this is going to be a bearish blog post, but it’s not; we’re going to be on a different axis here. Instead of thinking bull-bear (direction), think trend-range (momentum). Right now we’re seeing a lot of momentum– emotionally based trading is coming into the market so as to not get “left behind.” So instead of being contrarians with respect to direction, let’s consider contrarianism with respect to momentum.

Let’s assume that while we can go significantly higher, odds are that we’ll settle into a range for a couple weeks. This has already happened in a couple of sectors. The chart of the XLF proves my point:

While we have been in an “uptrend,” we actually established price ranges and stayed within those ranges for multi-week timeframes. I’m anticipating a breakout higher and then settling into a third range, with odds for a pullback after that one.

So how can we play the contra-momo trade? Well what I’m doing is sticking with individual names and sectors that are doing well (Nat Gas, Ags), whilst getting into IC’s on the market. Here’s a trade I like:

SELL -10 IRON CONDOR SPY 100 JUN 09 95/97/85/83 CALL/PUT @1.10 LMT

Here’s the risk profile:

This assumes that by June expiration that we’ll be in a price range of 84 and 96. The implied odds of that happening are around 40%.  Now go pull up a daily chart and see if that is reasonable. I think so as we have major price resistance coming in from December and January, and it gives room for a significant pullback– so the odds according to the options are undervalued, thereby making this a good trade.

Do note that if the overall direction of the market changes and momentum remains, you’ll have to hedge probably by buying insurance.

I think this is a good “set it and forget it” trade going into the summer trading session.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: spy

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