The January 22nd Couch Potato Market Summary mentioned "...Traders may be beginning to lose their appetite for risk... volatility as measured by the volatility index (VIX) has been bouncing off established support levels...The VIX is trying to climb while most of the major stock indexes are in overbought territory...We should find out pretty quick whether the past week was an aberration or a true change in sentiment..."
Right on queue volatility picked up with the VIX rising 24%, the largest gain since last May. The major indexes plunged from extremely overbought conditions and U.S. Treasuries and the dollar rallied. On Friday, for the first time in a very long time, traders did not step in to squeeze the shorts when prices dropped â€“ note in the 15 min. chart below how prices headed down immediately and stayed down. Also worth noting is the trading volume was the highest of the year.
A lot of pundits have been predicting a sell-off for a while but the market refused to oblige. And just when retail investors start showing some interest along with analyst and other talking heads trumpeting the next bull leg, the market disappoints once again. Recent earnings reports and economic data have been mixed, plus investors pretty much heard what they expected this week from President Obama and Fed Chairman Ben Bernanke. The civil unrest over in Egypt might be an excuse for traders to sell and lock in profits after an 18% market rally since September. The Saudi stock market is crashing this weekend and futures are pointing to further downside when other markets resume trading on Monday. But one bad day does not constitute a correction and as seen in the charts below the DOW is still trading above most of its moving averages. Plus a minor shake-out should be considered a good thing for the long term bullish trend as it relieves overbought conditions and presents buying opportunities. At this point we don't know yet whether this is the beginning of a change in the trend, or just a pause for the charge through the next resistance level.
DIA Position Update
DIA closed $118.02 on Friday â€“ the February position is approx. $300 the black
DIA is priced at its current 14-day EMA (see DIA chart down below)
DIA is trading ABOVE its 20-day Bollinger Band SMA (see DIA chart)
DIA is ABOVE its 50-day simple moving average (see DIA chart)
DIA is also ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) is neutral (See DIA chart)
Moving Average Convergence/Divergence (MACD) is neutral (See DIA chart)
The January 20th Couch Potato published a February expiration month call spread
This spread is approx. $300 in the black (see tables below)
$120 strike price short call delta is .2903 (71% probability this position will be profitable)
DIA Risk Analysis
The near term trend is still bullish until we get a confirmed change. Until we can execute a put spread the only risk is that prices will push back up toward our $120 short call.
The rules for exiting the DIA call spread are:
Anytime the market maker is willing to accept a limit price of less than .11 on our short strike, buy back all the short contracts and sell the long positions on the same spread. However, if it is a few days prior to the expiration date, we may be able to hold out for a .05 bid.
If our short strike is penetrated (closing price above our short call) AND after market close, if the delta associated with the short strike is .65 or higher, we will look to close out this spread (buy the short contracts, sell the long) and roll it out to higher short strike price.
Friday's price action was the first significant pullback since November and overnight futures indicate more downside on Monday. It appears that we finally might have the opportunity to do a bull put spread. It would be wise if we exercise a little caution before executing the spread, it was around this time last year that we got a correction. Corrections tend to be hard and fast, it should not hurt to wait a day or so to get a certain level of confidence that support will hold.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.