The May 13th Couch Potato Market Summary mentioned "...most of the major indexes have sliced through their 20 and 50-day moving averages setting up prices to test the March/April lows â€“ if stocks break below this level the longer term trend converts from bullish to bearish...The most obvious question at this point is whether the current price pullback will evolve into a major correction in excess of 10%..."
Stocks are well on their way to correcting as the S&P 500 index is already down 7.3% in May. Prices crashed below most of the technical support levels including plowing through the March/April lows. The next downside demarcation point for the major indexes is their 200-day SMA's, if prices don't hold at that level the next support zone is the December lows.
Comments from the April 8th Couch Potato Market Summary "...After a spectacular first quarter the question is, are we in for a repeat of what happened in both 2010 and 2011? The yellow vertical lines in the SPY Heikin-Ashi weekly chart below highlight the how strong rallies topped out in the spring of both years and culminated in a dramatic downturn. As the market approaches what is historically the worst performing six months of the year, traders may be getting a little leery. Investment advisors are advising their clients to lock in profits as the low hanging fruit has been picked and stocks are at overbought levels. Remember, stocks started strong in 2011 but reversed course reacting to the end of QE2, high energy prices, the Euro-zone debt drama, and uncertainty about the domestic economy. This year, many of the same issues are in play as the end of the Fed's operation twist is approaching. Energy prices are rising and Spain's severe recession and rising bond yields are the latest episode in the Euro crisis...."
Following up on the April 8th analysis above, below is the updated S&P 500 Index weekly chart. Note the third yellow vertical line highlighting the beginning of what is becoming an annual springtime stock market ritual! Of course the obvious question at this point is where is the bottom? We commented in the past on how price corrections tend to be sudden, hard and ugly if you are not prepared, but like all trends, it will end eventually.
Note in the SPY and DIA daily charts down below how the RSI (Relative Strength Indicator) is flashing extremely oversold levels. Typically, from a technical analysis point-of-view one would expect a price recovery from being oversold. From a risk perspective, betting on further downside price moves could be riskier than expecting a recovery, especially in short-term. But what might be disconcerting to many technical analysts is how extreme stocks are oversold â€“ this might suggest that stocks downslide may linger longer than expected. For example, look at daily S&P 500 Index chart right below and notice how last August was the last time the index was as oversold as is now. Also, observe how it took several months of fluctuating prices for stocks to finally crawl off the bottom and recover. The point is that we need to step back to observe the technical and fundamental environment to be able to understand trade risk. We advocate trading what we see, not what we want, including making any necessary adjustments to compensate for perceived risks.
SPY Position Update
SPY closed at $129.74 on Friday â€“ the May iron condor is approx. $700 in the red
SPY is priced BELOW its current 14-day EMA (see SPY chart down below)
SPY is trading BELOW its 20-day Bollinger Band SMA (see SPY chart)
SPY is priced BELOW its 50-day simple moving average (see SPY chart)
SPY is ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) is extremely oversold (See SPY chart)
Moving Average Convergence/Divergence (MACD) is bearish (See SPY chart)
The May 15th Couch Potato published a June expiration SPY bull put spread (see tables below)
The April 18th Couch Potato published a May expiration SPY bear call spread
On May 7th we suggested immediately closing out the call spread for an approx. $1,000 gain (see tables below)
The April 18th Couch Potato published a May expiration SPY bull put spread
On May 17th the Couch Potato published a put spread trade adjustment rolling the $133 short put down to the one-week May 25th expiration $127 strike price and increasing the number of contracts
After the trade adjustment the put spreads should be approx. $1,700 in the red
The adjusted SPY put spread expires this coming Friday as we are betting on a possible 'dead-cat' bounce from the current extreme oversold positions. If the market does not pause before crashing further we need to exit the position to minimize the loss.
DIA Position Update ---------------------------------------------------------
DIA closed at $123.31 on Friday â€“ the May iron condor closed approx. $2,000 in the red
DIA is priced BELOW its current 14-day EMA (see DIA chart down below)
DIA is BELOW its 20-day Bollinger Band SMA (see DIA chart)
DIA is priced BELOW its 50-day simple moving average (see DIA chart)
DIA is ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) is extremely oversold (See DIA chart)
Moving Average Convergence/Divergence (MACD) is extremely bearish (See DIA chart)
The April 25th Couch Potato published a May expiration DIA bear call spread
On May 9th we suggested immediately closing out the call spread for an approx. $1,000 gain (see tables below)
The April 25th Couch Potato published a May expiration DIA bull put spread
On May 15th the Couch Potato published a put spread trade adjustment rolling the $127 strike price short put down to the May $125 strike price
On May 17th we suggested closing out the $125/122 put spread to avoid assignment
After the trade adjustment the put spreads are approx. $3.000 in the red
Stocks plunged during option expiration week and we exited all of our DIA positions to minimize the monthly loss
The May 13th Couch Potato Final Comment asked "... The next question is whether the current price pullback has legs and continues the downward trend or is this a head fake with stocks snapping back into another trading range?..." This question has been answered as the DOW Theory has signaled a primary bear market as both the DOW Industrials and DOW Transport closed below their closing lows of the previous four months. As we commented in the past, hard downside price moves is absolutely the worst trend for trading credit spreads. Even if you trade bearish call credit spreads, you are probably not going to get a good price, plus there is the elevated risk of a price recovery. And doing a put credit spread in this environment is like trying to catch a falling knife â€“ you never know when it will hit bottom. As traders, the amount of risk that we are willing to accept is really the only component that we can control in a trade; everything else is up to the market. As we have done in the past in these situations, now that we have an idea of what we are dealing with we can tweak our trading plan to minimize the risk.
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.