From the August 01, 2011 issue of Futures Magazine • Subscribe!

Option spreads in the dog days of summer

But while a 200-day indicator provides the big-picture analysis that is necessary for this trade, it is an imprecise timing tool. Thankfully, the researchers also found that using a short-term relative strength index (RSI) helped identify short-term oversold/overbought areas in the stock's price action (see "Support bounce," below).

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To further increase the odds of a winning spread trade, use key readings of a three-period RSI at the point of entry at support/resistance levels. You gain an edge by exploiting the price reversals as price snaps back in the direction of the dominant trend as indicated by which side price is trading on the 200-day SMA.

Look for readings below level 10 on the three-period RSI at price support for a bullish trade and above level 90 at price resistance for a bearish trade.

The approach is defined as follows:

  1. Based on historical market behavioral tendencies, this trading approach is designed to work best from the beginning of May until mid-August.
  2. Use the 200-day simple moving average (SMA) to tell you whether the market has a bullish or bearish directional bias.
  3. Look for points of price support or resistance to set up a bullish put spread or bearish call spread.
  4. At the point of entry, the three-period relative strength index (RSI) must be below a reading of 10 for a bullish trade or above 90 if it is a bearish trade.
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