SPY - S&P-500 ETF - ETF Profile

The SPDR S&P 500 ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500 Index.

The market is nearing a top. When and where, nobody knows for sure. However, there are calendar and headline events in our near future that could trigger a significant decline.

The market has posted a remarkable string of gains with the Dow making a new high close on 14 of the last 22 sessions. The S&P has rallied 171 points in 22 days or roughly +8.2%. The Russell 2000 has rallied 20.1% over the same period. Those would be good annual gains but to do it in 22 days has moved the market into very overextended status. And, it may become even more overextended before the bubble pops.

The market typically rises in the two weeks before Christmas and has a mixed record for the days after Christmas. The direction in the post holiday sessions normally depend on the market in the weeks before the holidays. If the market is up strongly, then traders begin to short the market in anticipation of a January decline. If the market was only slightly bullish then window dressing tends to lift the indexes in the post holiday sessions. Those trends are not what we are worried about today.

There are three basic problems. The first is Dow 20,000. The odds are good we will hit that milestone over the next ten days and that could be a very obvious sell the news event. Large round numbers tend to be psychological targets and they do not get much larger and rounder than 20,000. When the target is hit, quite a few traders may decide to take profits and shut down for the rest of the year. Dow 20K could be a bump in the road but probably not the biggest obstacle.

The second problem is the monster market gains in the post election honeymoon phase. Fund managers are putting every penny they can raise into the market in order to leverage as many gains as possible before the end of the year. They are competing with their peers and to keep their jobs and collect their bonuses. This suggests the rally could continue in some fashion until after Christmas. The problem for the next two weeks is the lack of cash. Analysts claim most funds have run out of cash because of their efforts to leverage the gains for the rest of December. That means the withdrawal cycle in January could result in a lot of selling in positions that have exploded higher over the last month.

While there is a lot of end of year retirement money hitting the funds they are investing every penny. Once January arrives and we are in a new tax year, there is no longer any reason to hold grossly overextended positions. Traders and portfolio managers will want to capture the gains and then invest the money for the next year before being forced to pay taxes. That makes January potentially rocky after a big year-end gain.

Remember January 2016? The Dow dropped -1,850 points in just over two weeks.


Lastly, there is the January 20th inauguration and the associated event risk. With more than one million people attending and hundreds of thousands more lining the parade route, the potential for a terrorist attack is very high. I am sure quite a few investors will want to lock in profits and raise cash before that event risk.

So, there are multiple reasons why the market could decline over the next five weeks and very few reasons why it should continue making new highs.

I am recommending we protect ourselves from potential loss by hedging with some puts on the SPY. The ETF closed at $226.50 on Friday and futures are up strong on Sunday evening. We could see a continued rally this week but this rubber band is just about stretched to its limit.

This is not a LEAPS position. This is insurance. I am using the February puts. I am going to start with an entry trigger at $224.50 and then move the trigger and strike up if the market continues higher. I am also recommending we enter with a touch of Dow 20,000. Enter on whichever occurs first. The SPY has initial risk to $219-$220 and secondary risk to $216.

With a SPY trade at $224.50 or a Dow print at 20,000

Buy Feb $221 put, currently $3.11, no initial stop loss.