What Tuesday Wrought (SPY,XRT)

What Tuesday Wrought (SPY,XRT)

 

Could it be…?

 

Has it happened…?

 

Are we now entering the post-Trump corrective phase…?

 

And will it presage a thoroughgoing purge of the market bulls…?

 

Are we now at THE crossroads?  The end of the line?  The selling moment par excellence?

 

IS IT ALL DOWNHILL FROM HERE!?

 

Read on, friends… and avail yourselves of any medications you may require to see yourself through, because the next fifteen minutes of your life could be positively thermo-pneumatic!  And we take no responsibility for any seizures or crying fits, be they large or small.

Let’s look at the daily chart of the S&P 500 since it offers the worst technicals of the major market averages.

 

And we’ll preface our discussion of the chart with just a few words of introduction.

 

They go as follows –

 

  • First, Tuesday’s 1.24% decline on the S&P 500 was the first 1%+ drop on that index since before the election. That’s a five month wait for a phenomenon that historically occurs on a slightly more than weekly basis!

 

  • Second, the decline on the NASDAQ and DOW Industrials brought those two indexes to rest ever so delicately on their respective short term moving averages, whereas the S&P broke through her line with full zest and cohones, as you’ll see below.

The technical damage here is clear, and as the S&P 500 is the most representative of all the indexes, it behooves us to pay special attention to its action.

 

To wit –

 

As mentioned above, price sundered the short term moving average (in blue), at the same time breaking below recent support at 2355 (red line) and creating the possibility of a decline toward the 137 day moving average, now at 2240 and rising (black box).

 

The last technical cluster in the 2260-2280 range – what’s often referred to as a congestion pattern (green box) – is, in our view, the location of the next likely bottom – IF, INDEED, THE CURRENT DECLINE PERSISTS.  For it’s equally possible that we’ll get an almost immediate bounce here, erasing Tuesday’s decline and sending the indexes toward their former highs.

 

We’ll know in the next day or two which it’ll be.

 

We’ll also be watching volume figures closely, because Tuesday’s dump brought a goodly number of sellers into the fray (black oval).  If that number grows alongside any further decline, we’ll also have an indication that downside momentum is gathering.

 

And finally, we’ll have an eye on the RSI and MACD indicators (in green, at bottom), the former of which moved sub-waterline bearish with Tuesday’s selling, and the latter of which could confirm that bearishness by early next week, if we get continued weakness.

 

We should add that if both indicators go sub-waterline,we’ll very likely see extended weakness for the market.

 

If not, it’s again time to buy the dip.

Before we get to this week’s trade, we have a single open initiative to take care of.  It’s from our September 8th letter called Who’s the Genius?  In that letter we urged you to buy the XRT March 44 CALL for $2.54 and sell the XRT March 44 PUT for $2.55.  Total credit on the trade was $0.01.

 

And now?

 

As of last Friday’s expiry, the CALL ended out-of-the-money, but the PUT was ITM, which means we own a lot of XRT at $44.  And with the stock now trading for $40.90, we find ourselves $309 in the red – including the initial credit.

 

So what do we do?

 

Two things.

 

First, we sell the January 19th 41 CALL for $2.99.  Should XRT rise above that level by expiry, we’ll be out exactly ten bucks.

 

After that, we’ll sell the May 19th 40 PUT for $0.84, the better to cushion any downside that may befall us in the next 60 days.  Our breakeven at the low end will be $39.26.

 

And a look at the chart below shows that strong support emerges in the $40 range.

 

Look here –

This is the weekly paste-up of XRT stock for the last four years, and it clearly shows a stock experiencing topping action, in the form of a long duration head and shoulders top.  Whether that leads to further declines is still an open question, as the pattern has yet to be completed.

 

What’s interesting to us, however, is that price has now touched the 274 week moving average for the first time in seven years (in blue).

 

And that’s an historic occurrence.  It also very likely means that we’ll get some sort of bounce before investors figure out what to do with the retail group.

 

And that’s why we’re comfortable selling the 60 day, May 40 PUTs, as they come in just under strong support at $40.70 (and rising).

 

We would add that while both RSI and MACD indicators are signaling further declines (in green), our experience is that a brief bounce could still comfortably occur within those parameters, however negative they may be at the moment.

We move now to the issue at hand, and that’s our trade for the week, a task we approach with trepidation because the market is extraordinarily volatile at the moment, and won’t likely settle anytime in the near term.

 

And that means anything could happen.

 

So…

 

We’d like this week’s trade to account for that set of circumstances, but we also want to undertake it without a great deal of cost.  That is to say, a straddle would be the perfect call at the moment, except for the expense we’d have to undertake because of the ocean of implied volatility now priced into the options.

 

So we’re going to opt for a calendar play, one that allows us to both buy and sell volatility in an offsetting manner, and avoid any unnecessary outlay.

 

Our plan is to buy short dated PUTs and sell longer dated ones, as we lean toward a dip occurring in the short term, followed by a quick recovery.

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SPY is now trading at 234.28.

 

Many happy returns,

 

Matt McAbby

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