When we trade stocks, we make money when we correctly predict the direction that the stock is going to move. When we trade options, we need to be directionally correct within a specified timeframe. In other words, we need the underlying stock to move in the right direction between now and the expiration of the option contract, by an amount large enough to overcome the premium we paid.
Long calls and puts, as well as many debit spreads, experience time decay. If nothing else changes, they will lose a little bit of their value with each passing day. Therefore, we often want to trade these positions when a significant price move is imminent.
By now, you’re probably becoming familiar with our newest indicator, ConnorsRSI. If not, you can download our exclusive guidebook: Options Trading with ConnorsRSI. All of the strategies that we’ve published to date that utilize this indicator calculate the value of ConnorsRSI from the daily closing prices of the stock or ETF. Low values of ConnorsRSI indicate oversold conditions, while high values indicate overbought conditions.
How often do stocks reach extremely oversold conditions? To find out, we ran a scan on all stocks that are members of the S&P 500, starting on January 1st, 2001.* That gives us approximately:
500 stocks x 252 trading days/year x 12.25 years = 1,543,500 ConnorsRSI values
Next we looked at how many times we observed ConnorsRSI values below an extremely oversold threshold. The number of observations for ConnorsRSI values 1-5 is shown in the table below:
* Please note this article was originally published July 2, 2013.
An At-the-Money (ATM) call with approximately a month left until expiration will typically experience a 20% – 40% increase in price if the underlying stock price rises by 1%. Therefore, we next checked how many of the S&P 500 stocks with low ConnorsRSI values experienced a maximum price increase of at least 1% over the following five days. The expanded table below shows these results.
The table tells us, for example, that S&P 500 stocks closed with a ConnorsRSI value below 2.0 a total of 1461 times since 2001. On 1284 of those 1461 occasions, or approximately 88% of the time, the stock experienced a price increase of more than 1% over the next five days. Since almost all stocks included in the S&P 500 offer options, that means there were over 1200 opportunities to collect a return of 20% or more on ATM calls.
If you’ve looked at the free Trading Markets Analytics page, you know that the value of ConnorsRSI for a stock fluctuates throughout the day. We often refer to this as the Intraday value of ConnorsRSI, or sometimes just Intraday ConnorsRSI. It’s the ConnorsRSI value computed from all the previous closing prices of the stock, plus today’s current price. Sometimes the Intraday ConnorsRSI value will reach oversold extremes, before reverting to a less oversold state by the end of the day.
How often do these extreme Intraday ConnorsRSI values occur? The table below is similar to the previous one, except that we used the Intraday ConnorsRSI value instead of the end-of-day value to signal our oversold conditions.
Using the same threshold of 2.0 with the Intraday ConnorsRSI, we can see that there are 3240 occurrences over the past 12+ years, with 2745 of those producing gains of 1% or greater over the next five days. That equates to over twice as many opportunities for outsized gains on ATM calls, while still maintaining a success rate of nearly 85%.
We see similar behavior at the high end of the ConnorsRSI spectrum. The table below shows the frequency of 1% price drops measured from the closing price of the signal day to the lowest low over the next five days:
So how do you find intraday ConnorsRSI values that have reached extreme levels? One of the easiest ways is to use the new Trading Markets Live Screener. On the “All” tab, you can define the parameters that will be used to filter your results. To find interesting candidates for bullish option trades (buying calls or selling puts), I typically use three filters:
- Average Volume of 1M shares or greater
- Price Above $10
- ConnorsRSI of 10 or Below
For bearish option trades (buying puts or selling calls), simply change the ConnorsRSI filter to “90 or Above”. Depending on your trading style, you may also wish to filter on Equity Type and/or Index which will limit your results further. Or, maybe you’ll use additional filters that correspond to your favorite strategies.
Once the Live Screener presents you with a short list of trade candidates, you can use your trading platform to validate things like open interest, volume, and bid/ask spreads on the option contracts that you’re considering. If everything checks out, you’re ready to make your trade.
Learn how to Trade Options Using the ConnorsRSI Pullback Strategy. Download Options Trading with ConnorsRSI today.
