It has been a bad time to be a market bear with most of the major indexes exploding over 20% in the last month. The last time stocks surged this strong was back in 2009 and before that 1998. The upward momentum could continue into next week as market participants' return for the last trading day of October riding four consecutive weekly gains and setting a pace to be up 13% for the month which would make for one of the stock market's best monthly performances on record. Also, we have the highly anticipated Groupon IPO along with the continued flow of earnings reports. I doubt if many people expect volatility to dissipate any time soon but as confirmed in the VIX chart below, volatility has dropped down to a level not seen since the beginning of August â€“ the risk on trade is definitely in play.
Stocks roared on Thursday following an announced bailout agreement by European Union leaders to increase the eurozone bailout fund to 1.4 trillion, recapitalize banks and cut Greece's debt obligations by 50%. Traders apparently liked what they heard even though economists suggested this is not a permanent solution and the plan lacked the detail needed to ensure the debt crisis won't resurface to threaten other major eurozone economies, such as Italy or negatively impact the regions banks. What is interesting is that even though we had a slew of earnings reports, most of these announcements were an afterthought to the eurozone bailout episode.
As confirmed in the SPY weekly chart below, the major indexes have broken out above their two-month long trading ranges. Even though we have a confirmed price breakout there still appears to be significant bearish sentiment. The persistent bearish sentiment might suggest prices could easily go higher as we don't seem to have the bullish exuberance or overbought conditions that many consider a sign of a market top. Some of the recent price action can be attributed to short sellers 'getting squeezed' and chasing after higher prices to close out short positions. Also, we have the late arrivals to the party who are worried about missing the next big move â€“ especially with the year end approaching, money managers don't want to have to explain sitting on piles of cash as the market surges. Note in the SPY daily chart down below we have had a series of bullish accumulation days (up days on higher than average volume). This is considered a sign that institutional traders are accumulating shares. Probably the best bet is that stock prices will settle into another trading range with resistance from the previous trading range converting to a support level as the market moves higher.
SPY Position Update
SPY closed at $128.60 on Friday â€“ the November position is approx. $2,100 in the red
SPY is priced ABOVE its current 14-day EMA (see SPY chart down below)
SPY is trading ABOVE its 20-day Bollinger Band SMA (see SPY chart)
SPY is ABOVE its 50-day simple moving average (see SPY chart)
SPY crossed ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) is bullish (See SPY chart)
Moving Average Convergence/Divergence (MACD) is bullish (See SPY chart)
The October 18th Couch Potato published a November expiration SPY bear call spread
This call spread is approx. $2,100 in the red (see tables below)
$129 strike price short call delta is .4875 (51% probability this position will be profitable)
SPY Risk Analysis
This week's stock price surge already pushed the SPY above our $129 strike price short call before pulling back. We should presume the current bullish move will continue and plan on doing a trade adjustment.
As with initiating the trade, the decision process for exiting our November SPY bear call position will be simple:
Anytime the market maker is willing to accept a limit price of less than .11 on one of our short strikes, 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 one of our short strikes is penetrated (closing price above our short call ) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
As mentioned above in the Risk Analysis section, the market's extraordinary run over the past few weeks has put our SPY short call at risk. Despite the torrid pace of the recent price advance, we expect to do okay for the November option expiration as there are still three weeks left to do trade adjustments. A lot of market pundits are expecting a price pullback for a variety of reasons and of course this would resolve our concern about the SPY short call. But regular Couch Potato subscribers are familiar with our mantra 'to trade what we see, not what want'. As seen in the charts above, what we see are stock prices moving higher and until the trend changes, we have to react accordingly. One reason we thus far only published the one November trade was to allow for the probability that prices would continue to move higher and we wanted keep some of our bullets (trading capital) in reserve for trade adjustments. Stocks can't maintain the current pace much longer, and with plenty of time and trading capital available we expect to initiate more trades over the next few days.
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.