Friday, April 10, 2009

S&P Rally Unexpected, Still Needs Selloff; April 9, 2009

The stock market rallied ferociously again today, unexpectedly, on strong breadth and technicals like has been for the past few weeks which supports the idea that a significant bottom is in the stock market (S&P cash 666) and the larger trend is up. But it's way too late in the game to get bullish now and momentum is severely diverging to where a large correction is needed in order to alleviate this overbought condition before it's safe to get in big on the long side. Because the larger trend is up, I dont' want to establish a large short equity position where I can lose my entire position if the market keeps charging higher for some reason. So I'm using SPY bear spreads (buying May $85 put and selling $80 put) on the S&P ETF with a May expiration now as a way to short this market. This way I risk a much smaller amount and just have to sit and wait for the market to correct. Being so aggressive as I am I'm willing to try and catch a top and reversal, even though it's against the larger trend. Someone who is more conservative might just want to wait for the selloff to occur so they can become a buyer at that point. But waiting weeks for that is not my thing. So I'll risk a small amount on bear spreads to try and catch this large selloff that should occur soon. I remain short various tech stocks, the XLF, and the SPY through option bear spreads.

I was asked a question today by a reader which is a very good one. When is it time to get in and get short? Because the larger trend is up, it's very difficult to get a definitive answer because it depends on the person's strategy. If someone's shorting using pure equities or futures, then I would wait for weakness to occur, then short and put a stop loss at the last high. But if using options like I am, it's okay to just short now with bear spreads and wait. When the market reaches a peak and sells off, I can buy back the put options I sold that were in the process and just have a naked put option there to profit from the ensuing decline. So I can profit when it rallies, then close that profitable position and let the other position get into the profit as the market falls. The fact that the S&P broke 850 today and the fact that earnings are going to come out in full force soon, may give a que that this market is ready for some profit taking. I think a lot of this rally is just a buy and hope rally for overly aggressive and hopeful bulls who don't want to miss the next bull market (which we are not in by the way). But with earnings coming out here soon, and having the run up we have already in stocks at this point, it seems fairly obvious to me that the market will selloff as companies report earnings in order to take in profits. So the market is rallying ahead of earnings only to sell off during the actual earnings. That's my view.


Michael K. said...

Hey Todd,

Long time no talk, I been quite for a while now but I do read your post. I am glad you are still short XLF because I am shorting the financial too, damn WFC first-quarter earnings pre-announcement. Anyway, GL next week and happy Easter.

Todd S said...

Hi, Michael, good to hear back from you. Yeah, unfortunately I'm still short XLF through put options. Happy Easter to you too!