Using Options To Trade Counter-Trend Rallies

How to Trade Rallies in a Market Downturn

Volatility often discourages traders from entering new positions, but even in a downturn, tradeable rallies can offer profitable opportunities. A key strategy in these conditions is to identify short-term rebounds and capitalize on them while maintaining a disciplined exit plan.

Spotting and Trading Short-Term Rallies

When markets experience sharp sell-offs, certain stocks become oversold, leading to short-term rebounds. These bounces create opportunities for traders who know what to look for:

1. Identify Oversold Stocks with Strong Fundamentals And Technicals

• Look for stocks with an RSI (Relative Strength Index) below 30, indicating oversold conditions.
• Evaluate technical indicators (e.g., moving averages, MACD) and fundamental ratings from tools like Chartmill, or look for top ten names from Portfolio Armor.
• Prioritize stocks with solid business fundamentals that may recover once the selling pressure subsides.

2. Time Your Entry Based on Market Sentiment

• Monitor fear indicators such as the VIX or put/call ratios to gauge market sentiment.
• Consider entering trades when markets show extreme fear but technical indicators suggest stabilization.

3. Use Options to Limit Risk While Maximizing Upside

• Buying near-the-money call options provides high reward-to-risk ratios.
• Short-term expirations (one to three weeks) are ideal for targeting quick rebounds.
• Scale out of trades in stages to lock in gains while maintaining exposure to further upside.

Recent Example: Spotify's Tradeable Bounce

To illustrate this approach, consider a recent trade on Spotify Technologies S.A. SPOT. The stock had been heavily sold off, with an RSI near 28, yet it maintained strong technical and fundamental scores. Recognizing a potential bounce, we executed the following trade:

Trade Setup and Execution

• Entry: Bought $530 strike SPOT calls expiring March 14th for $2.40 when SPOT was trading at $487.
• Exit (First Half): The next day, SPOT bounced, and we sold half at $6, securing a 150% gain.
• Exit (Second Half): Later that day, we sold the remaining position at $6, fully locking in profit

This disciplined approach—identifying an oversold name, entering on a high-probability setup, and selling into strength—demonstrates how short-term opportunities can be executed effectively.

How to Apply This Strategy in Future Trades

Going forward, traders can apply this framework to similar setups by:

✅ Screening for oversold stocks with strong fundamentals.
✅ Entering positions when fear levels peak but technicals suggest stabilization.
✅ Using options to define risk while maximizing potential gains.
✅ Selling into rallies instead of holding too long in uncertain conditions.

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And if you want to add some downside protection during the next market rally, you can download the Portfolio Armor optimal hedging app by aiming your iPhone camera at the QR code below (or by tapping here, if you’re reading this on your phone). Our app can help you find the least expensive hedges given your risk tolerance and time frame.

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