For those of you who day trade or swing trade, it is helpful to get a gauge on the market’s expectations for price movement.  I’ll share a simple method that I use for my own trading, and I’ll provide some additional thoughts to consider when you plan your trading day.

We’ll start with the inputs, and we’ll use the e-mini S&P (ES) product.  Since the CME has listed ES options for every trading day, it is easy to get the one-day straddle price.  I prefer to use the next day extrinsic straddle price (at-the-money straddle price minus any in-the-money premium) on the 5pm CST market open.  The Average True Range is widely available on charting platforms, and I use the 5-day ATR to get the price action over the past trading week. The daily ATR is the high/low range but adds any gaps from the previous closing price.  We will use the ATR/straddle ratio for the following analysis, and we will assume that the 5-day ATR would be the following day range.

The logic behind the ATR/straddle ratio is very straight forward.   We’ll use an example with an ES closing price of 4200, the ES 4200 straddle is worth $50, and the ATR is 120 for a 2.4 ratio.  If the ATR is 120 over the next trading day, and the ATR is evenly distributed around 4200, the 4140 low and 4260 high levels would allow the owner of the straddle to exit the trade outside of the straddle price range, and the trade would be profitable.  If the ES 4200 straddle was $100 and the ratio was 1.1, the 4140-4260 range would be inside the straddle range and a short straddle position would be profitable.

With these two scenarios, the outcomes change if the ATR range is distributed directionally away from the closing price.  Let’s say ES opened at 4200 and then it moved the entire ATR distance for a 4080 or 4320 print.  The long straddle for $50 would be profitable, while the short strangle at 100 would be a losing trade. Empirically, an ATR/straddle ratio over 2 favors a long straddle position since an ATR range equally distributed around the prior closing price is profitable, and a ratio of less than 1 favors a short straddle position because movement of the entire ATR range away from the prior closing price would still be profitable. Option premium decay is a major benefit for a short strangle, so the ratio us usually greater than 1.  For my own use and based on my observations, a ratio less than 1.25 favors a short straddle, between 1.25-2.25 is neutral, and greater than 2.25 favors long straddles.

Another way to look at the ratio is that the market is expecting a decrease in ATR with the ratio over 2 and an increase in ATR if the ratio in closer to 1.  For example, the day before a scheduled data release or before a market holiday may have a reduced expected range and the ratio may be higher for that reason.  Also keep in mind that there are several ways to manage an option position, and the profits or losses from the straddle would change based on the position management process.  The goal of this analysis is to use the information from the ATR/straddle ratio along with these considerations to gain an edge while examining the markets.

Below is a four-hour chart of ES from May 5^th.  On May 4^th, ES made a strong rally towards the 4303-resistance level after the FOMC announcement.  At 5pm on May 4th, the at-the-money 4290 straddle was $48.25, and the five-day ATR was 125 which is a 2.59 ATR/straddle ratio.  If ATR remains at 125 through the next session, a long straddle position has good odds of being profitable.  The market is also expecting ATR to drop significantly following the major FOMC event, and the rally calmed the market’s nerves.  For the “art” portion of the analysis, it is clear that 4303 is a significant resistance level for ES as it has been tested multiple times recently, and a breakout or failure could see a decent move from that level.  With this information, a trader could buy the straddle with the expectation of ATR maintaining its level, or a trader could reduce some short gamma exposure in their option portfolio since the ATR/straddle ratio is skewed towards a large than expected market move.  On May 5^th, ES made a very steep decline, and the 5-day ATR jumped to 141.

Like every technical analysis methodology or trading tool, the ATR/straddle ratio analysis doesn’t work every time, and no one could have predicted the magnitude of the ES price move on May 5^th.  However, the ATR/straddle ratio did provide some valuable information on May 4^th about market range expectations for the next trading day.  I hope that you can apply some of these ideas to your own trading plan.

Well, Crude price has been all over the place in the last couple of years. In the year 2020 we saw a major crash with negative rates on WTI Crude. Fast forward now to current Russia-Ukraine War where we saw WTI Crude test the highs near $129 which is about $20 away from the highs made in 2008. In the meantime, Brent Crude touched $138 which is nearly $10 away from the previous life time highs.

Current Market scenario is quite dynamic where every day we see new updates on the China Lockdown, OPEC+ supply outlook or any development on the War. This has actually opened up a range of scenarios and it is crucial to remain objective rather than follow the crowd.

To understand the broader picture, we are looking at a Log Scale monthly chart of Brent Crude Oil. At times just by switching from arithmetic scale to a Log scale, many things clear out. Below we have shown the Elliott wave theory application with Channeling technique which indicates that the breakout has just come through.

Brent Crude Oil (Log Scale) Monthly chart:

As we know, technical analysis is all about probabilities and based on the use of various technical tools we try to arrive at the higher probable scenario. Thus, we are showing 2 high likelihood paths and key levels which will give vital clues to gauge the major trend and objective outlook.

Scenario 1 – Bullish – High Probability:

Channels and Fibonacci: It is imperative to look at the channeling technique which is an integral part of Elliott wave analysis. Here prices are intact in an upward rising channel since the year of 1960. The low made in the beginning of 2020 tested the channel support and resumed the major uptrend. The entire corrective move started in 2008, tested the 61.8% Golden ratio of the prior rise from $10.50 to $147.50 levels. Moreover, post that, prices broke out from the downward sloping red channel which suggests the next bull run is underway.

Elliott wave pattern: The channelized nature of up move since the year of 1960 suggest that Complex correction pattern is under formation (W)-(X)-(Y)-(X)-(Z). From the lows made in 2020, prices are in intermediate wave (Z). This wave (Z) is likely to move higher towards the channel resistance level, if the prices manage to surpass the key resistance zone of $145-150 with strong momentum, then next key level can be expected near $210 level where 78.6% of the prior rise is placed. This possibility will remain alive as long as $90-85 zone is protected on the downside.

Scenario 2 – Bearish – Low probability:

As discussed, it is important to keep the other possibility in the loop to avoid any kind of surprises. From here on, if prices struggle to take out the zone of $145-150 levels, then it will increase the probability of a Double Top formation where we might see the ongoing rally fizzle out near all-time highs. Keep in mind there is no indication of a Double Top pattern yet, but just a probability which we are not ruling out.

In this case, we will expect prices to retrace around 61.8% of the entire rise seen from the lows made in the year of 2020 which comes close to $67-62 levels.

In a nutshell, the price structure on the Log scale monthly chart indicates that a bullish breakout is being witnessed from the downward sloping red channel. In case of a bullish scenario prices are likely to test $145 followed by $210 levels whereas an alternate scenario will lead price towards the support of $67-62. Surprising times are ahead definitely!