Why The Option Deviation Index (ODI) Beats Typical Technical Analysis


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Chris Marczak

11 Mar, 2016

in Technical Analysis and 1 more

In September 2014, we introduced OMI (Option Mobility Index), an analytical tool measuring trending potential of the S&P500 index, which supplemented the ODI (Option Deviation Index) concept published in 2005. It didn’t take long to prove its usefulness, as the market ended its over 5-year bullish run and turned into a sideways moving phase, which for this index is very common.

Traditional trading using futures contracts for low-trending market conditions is a challenging task, as even though the market may stay within a certain range, its turning points usually flip through various levels within the channel. But for any market condition there is always an options strategy which may be applied.

As trading conditions get tougher, trading psychology becomes more demanding. Changeable market cycles create a challenging environment, where repeatability of many patterns shrinks, and so does profitability of the models based on them. Emotional factors come into play, affecting rational, and thus analytical thinking. Hence algo-trading is not necessarily the solution. Computer systems are free of emotions, but humans following their results are not. And while under typical market conditions, limited control over the trading process brings certain discomfort, the latter builds up when market environments change and the performance signals the possibility of reaching maximum historical drawdown.

We believe that statistical ODI is a better solution than typical technical analysis from the psychological point of view, because of full engagement in the trading process and limited possibility of over guessing one’s own trading decisions. Market action analyzed by the ODI shows a simple combination of market cycles, periodically perturbed by chaos. There are fewer ways of predicting and fewer points of view. It is simple, so it may be simply more accurate.

Another advantage of using ODI is low dependence on precision. While for traditional buy/sell futures trading, calculating anticipated trading range is crucial, using ODI for options does not require high precision. There are a number of option strategies with the risk defined once a position is established, so there is no need to arrange stop loss orders. Profitability of such a position depends on matching option spread strategy to anticipated movement.

In this article we are going to use the most recent data, however the choice is purely random. Any period of time may be used in the same way, using the same methodology. We believe that the idea of the ODI method can be caught clearly and by comparison its advantage over traditional technical analysis may be more visible.

On an option expiration day,  October 16th 2015, the S&P500 index closed at 2033.11, which in comparison to the beginning of the cycle starting Monday September 21st at market open – 1960.84 (following immediately the previous September 18th expiration) accounted to 3.69 % growth. Analyzing the  market situation on that day (Fig.1) could bring many confusing ideas, while many patterns could be seen at that time – breaking through the channel, moving sideways continuation and, still vibrant at that time – fear of the “death cross”. While only major technical ideas are being mentioned here, there were a number of other interpretations, and contradictive opinions were fairly shared among traders and analysts.


Fig 1

At the same time our ODI view (Fig.2) looked quite simple. The market recovered gradually from negative movements during the previous two cycles, so there were no other ODI periods closed in the negative area. Applying the value of the S&P500 at market opening on Monday October 19th (2031.73) and thus building what we call “The ODI tree” (Y axis values) showed a good chance of the advance to  the 2090-2110 area (3.5-4%). Longer ODI bars signalled that market mobility increased, so there was a chance of stronger than average trends. We are referring to “mobility” here as mentioned in the beginning of this article, because market volatility measures were not very helpful at that time – the VIX index continued to decline slowly, giving not much indication about the market sentiment. At the same time ODI showed a somewhat different view.


Fig 2

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