Another Low Probability Setup

The S&P 500 has been in a strong downtrend along with almost every stock trading on the NYSE. Many stocks are down in excess of 50% so there’s been a lot of damage done. I’ve been trading profitably to the short side for awhile now and I continued to maintain short SPX Deltas as of the close of this week. While I remain short Deltas I dramatically reduced that level prior to Friday’s close because one never knows when a ‘rip your face off rally’ is coming next! In fact, since I already have the potential profits to the downside covered with my positions I’m spending time this weekend looking for long Delta candidates. You know, that strategy of Delta Hedging my portfolio thing that I do! When I’m bearish I look for bullish trades and when I’m bullish I look for bearish trades to offset my overall risk. As I was looking through the charts I came across AMZN. I see the potential for a long Delta trade there for the coming week or two. Look at the chart below and see if you see anything potentially bullish there. Remember, on Friday, SPX made the lowest intraday low going back many months! AMZN didn’t. 🤔

AMZN should have made a new low on Friday but buyer’s stepped in showing at least a decent amount of motivation. The 8 SMA bands are still declining but since price didn’t make a new low, a close back above the upper band would look quite bullish! Also, a rally above Friday’s 2197.96 high without dropping below Friday’s 2100.19 low first would give Monday’s candle a higher high and higher low which is one simple definition of an uptrend. I could see price rallying to around 2300-2400 before it encounters resistance from the 20 SMA bands. Last month’s 2432 low could also be the target of a rally. It’s not the highest confidence setup I’ve ever seen but since I’m looking for some long Deltas it’ll do! Below are the low probability trades that I’d consider. Why low probability trades? I trade chart setups, not probability setups! Low probability trades offer the best risk/reward payouts because they’re cheap! I want to risk less to make more, how about you?

Below is trade #1 I’m considering. It’s an OTM Call Vertical debit spread. The grey shading on the black background of the risk profile represents a 1-standard deviation move in the stock price by the trade’s May27 expiry. As you can see, it’s a very low probability trade! Of course, that’s why it’s so cheap!

So do I just buy this and hope AMZN gets above at least the breakeven price of 2307 by May27 expiry? Absolutely not! Give me one day of an uptrend in AMZN and I’ll get all of the initial risk out and maybe even lock-in a small profit. Take a look below.

If AMZN could put together a 2% rally up to 2200 I could likely sell that custom order. Look it over carefully so you understand exactly what I could potentially do. It’s hard to visualize what that would do to the position if I made that adjustment on Monday so I’ll show you in the risk profile below.

Not too bad, right? A 2% (or greater) rally on Monday should allow me to carry a small profit through the remainder of the week with a potential lottery type of winner! I can take additional profits through the week if AMZN continues to rally by narrowing the width of the Condor. That involves selling a Condor. See the risk profile below.

The current value of selling that Condor is a $.95 Credit but if AMZN rallies early next week then that value will continue to rise.

There are way too many other variations of this type of Delta Hedging that are available to anyone trading AMZN so I’ll just mention a couple of them. I could do the exact same trades and adjustments in a different expiry such as Jun3. That extra time increases the probability of success but that comes with a higher cost (of course). I could also initiate the position as a Condor instead of ‘legging into’ one and then use the technique of narrowing it to reduce/eliminate initial risk if AMZN rallies. That would be much cheaper than initiating the trade as a Vertical spread. Experiment with different risk profiles yourself and discover a new world of trading options!

Questions and comments are welcome here or @VegaOptions on twitter. And before anyone asks me what my stop on this trade would be I have two answers. One, I could put this trade on for such a cheap price my stop could be no stop at all. If I can comfortably lose the entire amount of the initial trade I don’t have to exit it if price turns lower on Monday. If I keep my size small that’s one option. The other is I can exit if the chart setup fails to follow thru higher on Monday. Finding price acceptance or closing below Friday’s low would invalidate the bullish setup for me.