I have been in search for a signal I could use for a short vertical spread or naked short option strategy. So my main concern has been to find a level, which will most probably not be penetrated over the next few bars.
This is what I came up with.
Support and Resistance
We are all familiar with oscillators like the RSI indicator. It gives an idea if the market is oversold or overbought.
The chart gives a basic idea of the signal I am looking for. Once the indicator is leaving the overbought / oversold area, there should be a good chance that the market actually stays above or below it’s previous high or low. If this probability is high enough, it would be a great signal for a short vertical spread or to sell a naked put / call option. (be aware of the unlimited risk in the naked short trade!) Both strategies win, if the selected level is not penetrated at expiry.
What is manually drawn on the chart above can also be done automatically. The following chart shows how it looks like if you use the code given at the end of the article.
Every time the RSI leaves the extreme zones the indicator will draw the previous high or low for a given prognosis interval. To enhance the chances and not to get too many signals in a trending market I also made use use of the ADX indicator. So to see a signal on the chart, RSI has to leave the extreme level while ADX signals a sideway market. This should give the best signal quality.
The three signals shown would have resulted in a winning trade as the market did not cross the shown support / Resistance levels. But how does it work out in the long term?