How do you know when a consolidating market is about to trend? Consider using the TTM Squeeze indicator to help you decide if a market is going to switch.
It’s the eternal question. You’ve got a setup that you like on an index that you follow. Now ... do you go directional, or do you sell some options premium?
To answer that question, you may need to know if the market is consolidating or trending. If it’s consolidating, you could consider selling some premium. If it’s trending, and the market has just pulled back to support, you could go either way. For example, you could buy a 0.70 delta call for an in-the-money directional trade, or sell an at-the-money put vertical spread. Both trades make sense.
But what if a market is about to switch from a consolidation to a full-on trend? This may be obvious in hindsight, but it could be too late. Luckily, there are tools on the thinkorswim® trading platform from TD Ameritrade that can help detect when such a switch might be near.
Figure 1 shows a stock price chart with the TTM Squeeze indicator displayed in the bottom pane. The TTM Squeeze indicator looks at the relationship between Bollinger Bands® and Keltner Channels to help identify consolidations and signal when prices are likely to break out (whether up or down). This colorful indicator is displayed as histogram bars above and below a horizontal axis. The red dots along the horizontal axis indicate that the stock is “squeezing” out the last bit of consolidation from a period of sideways price action. It then starts to build up energy to shift to a trending market. The market trends until the momentum starts slowing down—a sign the trending action may be coming to an end.
The first green dot after the series of red dots suggests the squeeze is on, and this market is ready to move.
In this case, with the histogram above zero, a bullish options strategy might make sense. Decision time: do you go directional or sell some premium?
For example, you could consider legging into a bullish call vertical spread. Initially, you could buy in-the-money calls. If you want to get price movement that closely mimics the underlying, you could look at options with a delta of at least 0.70.
Then you wait ... and wait ... for the momentum on this trade to end. That happens when the momentum on the histogram changes color (in this case, from light blue to dark blue), indicating that the trending price action is reaching a conclusion.
This is when you might sell some at-the-money calls close to expiration to complete the vertical spread.
Log in to the thinkorswim trading platform and select the Charts tab. At the upper right of any chart, follow the path: Studies > Quick Study > John Carter’s Studies > TTM_Squeeze.
A best-case scenario at this point is a market that goes back into a choppy consolidating phase. Under these circumstances, your long in-the-money calls hold mostly intrinsic value and suffer minimal premium decay. The short call, on the other hand, starts losing premium at a quick clip.
The TTM Squeeze indicator represents a unique moment in the life of the underlying asset—right before it moves out of a consolidation range. The key is to identify that critical moment and utilize delta in the options to maximize the potential opportunity.
The TTM Squeeze indicator was developed by John Carter, who is a recognized authority on technical analysis but is not a representative of TD Ameritrade.
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