All eyes are on the negotiation seeking a deal to avoid the fiscal cliff of tax hikes and spending cuts that will get underway at the White House next week. On Friday President Barack Obama requested a meeting of bipartisan congressional leaders, business and labor heads to discuss proposals on how to deal with the $ 1 trillion dollar deficit. Talks with congressional leaders start on November 16th and most pundits are betting a compromise will be reached. It is pretty obvious that a dominant personality trait of President Obama is compromise and conciliation as he has never ever really exhibited any type of backbone for a tough fight. You can argue that the President is simply playing politics but has he yet exhibited any semblance of core values that he would go to the mat for? The point is that the President is generally regarded as being weak and he probably does not have the 'guts' to play hardball in negotiations and if he remains in character a deal on the fiscal cliff will be made. The major impediment to a quick deal will probably come from the President's own party as Senate Democrats have already expressed dismay at talk of cutting social security or Medicare. Last year Vermont independent Sen. Bernie Sanders formed the Defending Social Security caucus in the Senate where 29 senators who signed a letter in October opposing any reduction in Social Security benefits as part of a grand bargain. And very few of the Democratic Senate winners will feel like they owe their victory to President Barack Obamaâ€™s coattails, and there is no indication the Senate feels obligated to follow his lead. If fiscal cliff talks turn cantankerous expect the market to react accordingly.
The November 4th Couch Potato stated "... The column of 'O's on the far right of the updated chart below confirms stocks current short term downtrend. Also note that the S&P 500 index is approaching its longer term uptrend (blue) line. As it has done for the past year, there is a high probability the index price will bounce off the long term uptrend line to start a new trend higher (column of 'X's)...If the unexpected happens and the S&P crashes through the longer term uptrend line, look out below because the market will be in full blown correction mode..." As confirmed in the updated chart below, for the first time since the current P&F long-term uptrend started over a year ago, the S&P 500 index dropped below the uptrend line. As noted above, past downtrends always bounced off the uptrend line to a price recovery. The current downtrend is considered a serious breach and observe how the chart now has a red line to denote the beginning of a long term downtrend.
Following up on the S&P 500 index P&F chart analysis above, take a look at the daily chart below. Notice how the index has pulled back below its 200-day SMA line for the first time since the beginning of June. The yellow circle highlights how the relative strength indicator (RSI) became extremely oversold in May and after breaching the 200-day SMA the index began the intermediate term uptrend that just ended. The green circle notes the current RSI oversold condition. The obvious million dollar question is will prices recover from this point like they did in June, or are we headed down further to full correction?
Another component to take a look at is the Volatility Index (VIX) chart below which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". You can see that VIX is approaching the upper level of its recent trading range which coincides with triple digit daily price moves we have been getting lately. Stocks had been trading in a relatively tight range prior to the recent downturn but 'fiscal cliff' concerns are making traders nervous. Don't be surprised if we get triple digit daily price gyrations through the end of the year.
The most recent weekly American Association of Individual Investors (AAII) survey below suggests there is still room for the market to pull back further before sellers are exhausted. The AAII survey is considered a contra indicator and if the vast majority of the respondents were bearish that would signal a possible bottom and imminent price reversal. The almost equal number of bullish and bearish percentage means that if stocks continue to crash there are plenty of individual investors who will probably sell shares and push prices even lower.
The market is in the midst of the first serious price breakdown since this past May and now the question is where will prices bottom out. The May price pullback resulted in a full blown price correction and if stocks fall a little further the market will be in that mode again. The next week or so should tell the story, as discussed above, the equity indexes are in process of crashing through significant support levels. If the current trend continues it could get ugly as investors start selling out to lock in gains to keep from showing losses for the year.
SPY Position Update -------------------------------------------------------------
SPY closed at $138.16 on Friday â€“ the November position is approx. at breakeven
The October 17th Couch Potato published a November expiration SPY call spread
On October 23rd we suggested closing out the call spread for an approx. $900 gain (see tables below)
The October 11th Couch Potato published a November expiration SPY put spread
The put spread is approx. $900 in the red (see tables below)
$138 strike price short put delta is -.4755 (52% probability this position will be profitable)
SPY Risk Analysis
The SPY price encroached on our $138 strike short put as stocks crashed after the presidential election. November options expire this coming Friday and we need to be prepared for a trade adjustment if the S&P 500 index does not recover.
TLT Position Update -------------------------------------------------------------
TLT closed at $125.98 on Friday â€“ the November position is approx. $1,800 in the black
The October 11th Couch Potato published a November expiration TLT call spread
The call spread is approx. $700 in the black (see tables below)
$128 strike price short call delta is .2054 (79% probability this position will be profitable)
The October 22nd Couch Potato published a November expiration TLT put spread
On November 7th we suggested closing out the put spread for an approx. $1,100 gain (see tables below)
TLT Risk Analysis
After closing out the TLT put spread the only risk is traders continuing to move money out of equities into treasury bonds and threatening our $128 strike price short call prior to option expiration on Friday.
GLD Position Update -----------------------------------------------------------
GLD closed at $167.82 on Friday â€“ the November position closed approx. $300 in the red
The October 11th Couch Potato published a November expiration GLD put spread (see table below)
On November 7th we suggested closing out the put spread for an approx. $300 loss (see tables below)
GLD Risk Analysis
Gold prices crashed through near term support and triggered the exit rule for our $165 strike price GLD short put. Prices recovered this week and we closed out the put spread to eliminate the potential for a large loss if prices continued downward.
As mentioned above November options expire this Friday and if the S&P 500 index does not bounce we expect to adjust Our SPY put spread prior to expiration. Also, we need to keep close tabs on the TLT call spread in the event traders chase treasury bonds higher.
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.