We have seen some extraordinary price action since the onset of the virus. Initially, stock indexes and crude oil saw steep declines while interest rate ETFs and futures accelerated higher. When markets move quickly either up or down, they frequently leave gaps in their wake. Gaps are areas that are void of volume. They form when bid offer spreads widen due to an unexpected event. The funny thing about gaps is they are usually revisited. Gaps are less frequent in futures markets, which trade nearly 24 hours a day. Stocks and ETFs do not have overnight sessions, so gaps are more prevalent.

The first SPY graph shows a few gaps and the yellow box covers the area that was essentially void of volume when the indexes began their unprecedented dive in late February. Low volume pockets often become high volume areas when retested. It is within these areas where trade becomes choppy and trendless. Short options trades usually pay well under this scenario because premium decays (theta) as volatility falls from extreme levels. The second graph illustrates this phenomenon. Note the lowest volume zone in the first graph eventually became the area with the highest concentration of trade over the past month. Trades where time passing benefits a position are short straddle and strangle, long butterfly, and credit spreads.

Sometimes the past helps us design trade strategies. Learn to identify low volume pockets when volatility is high. Time decay or theta trades should pay well in this environment.

John Seguin, Market Taker Mentoring