Now, something very similar is also happening. We have increased volatility on the SPY, now that we have reached these higher levels, and we have decreasing volatility on the SDS. It’s a matter of just choosing and watching for this rounded bottom to start taking place in the SDS, and seeing if the volatility will start leading to lower prices on the SPY.
This is an incredible way to trade. I have to tell you, though, that this type of trading only came around in the last couple of years. The only reason that I found out about this type of trading at all was because I happened to meet a trader from Goldman-Sachs. He was discussing some of the trading strategies that Goldman-Sachs was using.
I don’t know if you recall, but back in 2008, 2009, and 2010, Goldman-Sachs had tremendous records of trading profits. It was just amazing and astounding, the trading profits that they had. I can’t tell you for sure that this is the exact strategy that they used. However, the strategy was taught to me by somebody who was involved in the market at that time, doing trading strategies for Goldman-Sachs.
They used what they call – it’s a George Sorlos term, as well. It’s called “reflexology.” Reflexology means that the markets tend to snap back to equilibrium levels after being over-sold or over-bought. In this case, I put 2 and 2 together, and I started coming up with this idea that it was the SPY and the SDS, and a number of other markets in which we had short ETFs for the index, ETFs that you could trade – that sought out these equilibrium levels.
Like I said, it’s because they are traded instruments, and the computer algorithms are constantly monitoring these ratios of short and long ETFs, that I think makes this type of trading possible. It’s very interesting. This equilibrium level is at $105.87. I didn’t come to that when they crossed. I actually came to that as the difference between the high and the low spread.
In this case, it was about $42.50 and $110, so it was about $105. In this case, you can take a look at the waves in the spread here. The spread here is $20 and $132. You get a difference there of about 110 points, so the equilibrium is going to be… I have a couple of different ways to measure it.
Number one is, I measure it by the difference in these two peaks that are close to each other. I try to center that, as well as the last point in which they crossed, creating a new equilibrium point. At this time, it’s at about $91.51, for the SPY. We are at $125.76.
Not only is this equilibrium point at the point at which I would look as a target, if I was shorting the SPY, that’s the point at which I would take myself out of the market. If I shorted at $125.75, I would look at my first target, which is $91.51. I would tighten up my stop on that trade, to see whether or not it would cross, or look for further indication that the SDS was starting to go into a volatile period, and then get out of the position altogether.
Now, there are a couple of different ways you can trade this. Number one is, you can simply trade the short side of the SPY by buying in the money puts. Remember, we talked about the fact that as we trade, we want to try to participate as much as possible, using the leverage of options, in order to trade the markets. I always like to buy a Delta of 85 or higher. That gives us the highest participation.
It may not be the highest leverage, but it is the highest participation in the market, dollar-for-dollar, for any decline in the SPY. I like to buy in the money options. I like to sell premium for options. I do not like to buy premiums. I like to buy in the money.
Now, one fallacy that a lot of people have about the options market is that you can buy a cheap option, and that it can make you a fortune. That might be true in the same way that if you buy a lottery ticket, you can probably win as well. It generally does not happen. You can buy a lot of cheap options and never make a dime, and just see the premium eroded in those options.
If you really want to be a professional trader, you want to buy in the money options. You want to buy as much Delta as you possibly can, probably around the 85 to 90 level. Stay with the trade until the trade tells you to get out.
In the next video, we’re going to wrap up this workshop with an overview, and some additional information that you need to trade both safely and profitably.