Smoke ‘em if You Gottem (DIA)

There’s a good bit of evidence that the run-up we’ve experienced over the last two months is about to take a smoke break.

 

A goodly number of S&P 500 companies are trending above their 50 day moving averages, an indication that has been associated with near term tops in the market in the past.

 

Have a look –

Peaking Chart

Nearly 90% of the biggest big caps are back in the saddle.  And that warrants a measure of caution.

 

Does it mean that the bull market is over?

 

No.

 

Does it mean that we go back to the last retracement bottom to test the lows?

 

Not likely.

Fat guy

Well, y’old cod-fodger… it means that we’ll likely see a week or ten days drift until the overheated indicators flash lukewarm again, and then we’ll be off.

 

But it’s unlikely in the extreme that the major threshold support lines we passed through on the way up will be traversed again.

 

Have a look at a chart of the Dow –

DJIA chart

First things first.  The Dow looks very much like both the NASDAQ and the S&P 500.  In all three, strong support appears at the bunched long term moving averages, seen above in yellow and orange.  That puts support for the Dow at 17,400, roughly one percent below today’s action (in green).  Additionally, the weekly support line (not seen here) comes in at Dow 17,000, some three and a half percent below today’s trading level.

 

Altogether, that means we could see a slide lower in the near term that doesn’t meaningfully impinge on the current bullish trend, but rather affords the indexes a bit of rest before their next push higher.

 

Our conviction that we won’t see any meaningful decline is based on our experience that it’s extraordinarily rare for a set of moving averages, in the process of unfurling, and all trending higher, to backtrack at this stage and make a turn for the worse.

 

Look also at the following chart of NYSE short interest, now trending at all-time highs and ready, all-too-ready to be pricked and squeezed and sent into a liquidation frenzy.

NYSE Short Interest

As you can see, the level of short interest has been hovering at historically bloated levels for nearly a decade.  But the last three years in particular have seen a steady climb higher alongside the rise in the indexes – a clear sign that trust in the longevity of the bull has been lacking.

 

And that distrust has grown manically in the first months of 2016, to the point where, according to Bloomberg, there’s just under $1 trillion that’s net short!

 

But shorts eventually have to cover – just as longs have to sell.  And right now the two are locked in a death match over who is going to blink first.  And it’s going to be a helluva struggle when decision time comes, because as our partner-in-crime, Hugh L. O’Haynew, pointed out earlier this week, all the major indexes are just off their all-time highs. So all those short sellers are either already underwater, are very close to taking on water, or are careening headlong toward the dreaded iceberg – which they can now see.

 

Someone is going to start trading very soon, and we believe that could cause an historically unprecedented buying wave that not only sees short interest drop, but pulls in massive Main Street and fund money on its way.

 

In the meantime, the current breather offers all a chance to calmly take to the lifeboats, before the inevitable burst to new highs sends them plunging, breathless to the bottom of the ocean.

 

The pain of 100 billion gallons of water on your chest!

 

Our position is clear.  The new highs will be attained.  The shorts will be forced to cover.  And the market will soar.

 

Now is the time to buy.

Black and White guys

That ‘smoke break’ gives everyone enough time to pull together all his investable funds and make a commitment to getting richer.

 

This Week’s Trade

 

In the meantime, let’s offer those who are already in the game a new means of making some cash.

 

We’re going to do it using a strategy called a ‘ratio call diagonal calendar spread’, a very complex name for a trade that’s ideal for a market that has stalled for the near term, but is due for a rise thereafter.

 

How does it work?

 

The idea is to sell near term calls for a lot of cash, and then, as the market dilly-dallies sideways, watch them expire worthless.  The cash taken in by the short calls is simultaneously deployed in the purchase of longer-dated calls that profit as the market gets back its mojo and pushes them deep-into-the-money before expiry.

 

If we can, we write the trade for an initial credit.

 

That’s the way it’s supposed to work.  But real life, of course, is never so simple.  Everything depends on timing.  If we get it right, the money flows thick as honey, honey.

Fat girl

The details go like this –

 

The stock we’re going to use for the trade is the selfsame Dow Jones Industrial Average mentioned above – or, at least, a proxy thereof – the SPDR Dow Jones Industrial Average ETF (NYSE:DIA).  It currently rests at $175.

 

The strikes we’re selling are the 180s, set to expire in two weeks.  On the chart above, you can see that’s where overhead resistance lies (equivalent to the former highs at 18,000).  On the long side, we’re buying the 185’s with a May 20th expiry.  That, we feel, will give us a good window for the stutter we expect in the coming weeks, and the rapid rise we foresee thereafter.

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Options Trader Elite recommends you consider buying ten (10) DIA May 20th 185 CALLs for $0.13 each, for a debit of $1.30, and selling the ten (10) DIA April 22nd 180 CALLs for $0.18 each, for a credit of $1.80.  Total credit on the trade is $0.50.

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We’ll monitor this one closely, and will look to close if at any point before the first expiration DIA moves toward 180.

 

Many happy returns,

 

Matt McAbby

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  1. Johng156

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