Last month, the market continued to shake off the rocky start of 2016.
Having fallen more than 10% since the start of the year, the S&P 500 finally gained 7% in March.
From its low on February 11, the S&P 500 has since regained an impressive 12%.
[ad#Google Adsense 336×280-IA]Market volatility, which has been elevated since last August’s flash crash, hit a six-month low last week.
From a technical perspective, however, this strong uptrend is losing some steam.
And while some investors may falter, I’ve got just the opportunity to profit on the coming pullback.
Signs of the Times
As you well know, the stock market never simply moves up and down in a straight line.
Price action moves in wave-like motion – up, down, and even sideways.
Technical analysts, such as myself, measure trend strength by reading momentum indicators in order to anticipate where price is headed next.
The S&P 500 has made major strides over the last few months, but the signs of a cool down are piling up. First of all, the momentum indicator, which measures the difference between a closing price and the price from 10 days prior, is falling.
Momentum tends to be a trustworthy gauge by which to predict oncoming market trends because its readings lead price action. So, when momentum falls as a stock’s price rises – it usually portends a pullback.
Further, the S&P’s 14-day Relative Strength Index also slammed against the overbought threshold of 70 last week.
And the index experienced a moving average convergence divergence (MACD) signal line cross to the downside this week, a divergence from the rising trend.
While MACD is a lagging indicator – meaning that its readings lag behind price action – divergence can signal a pending trend reversal.
In other words, we’re looking for a pause in the breakneck bull action as traders take profits and await first-quarter earnings.
Now, I’m very bullish on stocks long term, but a market cool down presents a compelling short-side opportunity.
A Better Option
I know what you’re thinking: Why not just buy an inverse S&P 500 ETF and close out after the pullback?
Unless you’re looking at a leveraged fund that’s predicted to return double or triple the inverse move, you’re not going to make much… unless the market absolutely tanks.
And if you’re wrong about the timing of a market drop, you could end up eating a significant loss to slippage due to holding an inverse fund for too long.
I don’t know about you, but I hate losing money!
I prefer SPDR S&P 500 ETF (SPY) put options to inverse S&P 500 funds.
These options are often cheaper than the ETFs.
Plus, you can tailor a trade to your own risk tolerance. You set the strike price and the time frame for the market to hit your target.
SPY is highly correlated to the S&P 500 and offers a deep options chain in order to do just that.
For instance, consider the SPY June $203 put options now trading around $5.40. These puts plummeted 44% as stocks surged higher last month.
As I sit here, writing this to you, the strike price is now about 1% below where the underlying SPY currently trades.
100 shares of the popular ProShares Short S&P500 ETF (SH) would run you around $2,052.
On the other hand, one contract of the SPY puts – worth 100 shares – costs just $530 before commissions. That’s a whopping 74% discount to owning SH shares.
In short, you bag larger – and potentially faster – profits on broad market drops with less of your capital at risk with SPY options.
Best of all, your downside risk is limited to the amount you paid to enter the trade.
Bottom line: Forget about leveraged inverse S&P 500 funds. If you want to capture short-term downside market moves, SPY puts are the way to go.
On the hunt,
Jonathan Rodriguez
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Source: Wall Street Daily