Lede
Last time we wrote How to Trade the Magnificent Seven: “Not That Bearish” is Profitable, in an effort to construct an historically profitable strategy when the stocks had fallen into correction (down 10% or more) in the last 30-days where the speculation benefitted simply by either the stocks not going down very much, or going up.
Today we get more constructive, and look for a bullish strategy with different rules but also looking for an oversold situation.
The Set-up and Results
I’ve heard arguments for and against technical analysis but one of the few triggers that has back tested exceptionally well across 10-, 5-, 3-, 2-, and 1-year has simply been when RSI dips below 25 in large cap stocks.
Once that oversold level is achieved, the next 30-days tend to be quite constructive for the stock.
In fact, before we turn to options, we can use TradeMachine® to do a one month backtest in the (current) magnificent seven stocks when the RSI dips below 25.
Here is the open trigger:
It waits for RSI to dip below 25 and for the stock to be down on the day (any amount).
The closing rule would be one-month (22-trading days), or when RSI creeps back above 40, whichever happens first.
We call this strategy “Buy the Sell-off” in our scanner and the results are available across all companies in TradeMachine®.
And here are the stock returns for those companies over the last decade.
It has only happened 31 times in the last ten-years in total for these companies, but yeah, the next month was higher 28/31 times and on average the stocks rose 5.5%.
Alright, well, let’s turn that reality into an option strategy.
In this case, we will test getting long an at-the-money call (50 delta) with 60-days to expiration and getting short an out-of-the-money (20 delta) call with 30-days to expiration; a calendar call spread.
The trade closes when either (i) the RSI rises back above 40 or (ii) the short-dated option expires, whichever happens first.
And here are the results over the last decade:
We see 26 wins against 5 losses (84% win rate), and that 5.5% average stock return has been leveraged into a 37.15% average option trade return.
We can look at the last 3-years as well:
Over 3-years, we see a 78% win-rate and an average return of 28%.
Finally, we look at the last year:
Over the last year, the deeply oversold condition happened just four times, all four were a winner with the diagonal call spread, and the average trade returned 65%.
Taking it All Together
We can reprise the totality of our strategies for the magnificent 7 (over the last 3-years).
- Pre-earnings Diagonal Call Spread (magnificent 7 + 4 mega banks)A speculation designed to benefit from pre-earnings optimism while avoiding earnings risk and leaning on 1-year kurtosis greater than 1:
- “Not That Bearish”1x2x1x2 Ratio Spread
- Buy the Sell-off
In total, we’re looking at 99 trades in 3-years, so about 33 trades a year, or 3 trades a month.
The total win rate is 74 wins and 25 losses or 75%, and the average weighted trade was 22%.
That’s a nice portfolio of trades, some of which sell vol, and some buy vol. Some surround earnings, some use short-term options, and some use medium-term dated options.
And if this is what we can find in just these seven (or eleven) companies, then imagine the portfolio of alerts and trades TradeMachine® members can compose for their days. months, years, and career.
Or don’t imagine, and just do it.
Conclusion
There’s a difference between wanting something and liking the idea of something.
The difference is that one is for day dreams and the other is effort.
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