Options Insights: Change and Trend Alert

Change and Trend Alert:  The long uptrend that began this year is officially broken the question is where do we go from here?

All good things must come to an end including bull markets.   What I am telling people in our community now is that I can officially say the long-term uptrend is officially broken from the beginning this year. (see SPY below).  

The other thing that I tell people, which often goes misunderstood,  is that a  broken uptrend does not a new downtrend make!  Three segments forms a trend, what we have so far is one nasty leg down:

We have seen enough technical damage in the indexes to say that the uptrend is broken but what we have right now is a bearish pullback and unfortunately an unconfirmed direction.  These can be truly challenging for trend Traders because they’re simply isn’t a “confirmed” trend right now, just a dead uptrend, 

Yes it is true that we are below moving averages, but it is also true that we can bounce any time and break this new early down move.  

Afterall, the economy remains relatively strong. We can move sideways for quite some time and form a base,  or a new catalyst can enter the market out of thin air to bring us much higher or much lower. We simply will not know for quite some time,  perhaps another week or two.

If you have been reading the past few newsletters I was warning against being overly bullish, particularly in technology, and if you remained balanced with both bulls and bears in your strategy like our coaching students have been doing, this time period should have proved to be very rewarding.  It is now time to be prepared to pivot.  

In transitional  times like this it is extremely important as an options Trader to use all the tools in your toolbox at your disposal.   In Bull markets for instance, you ideally hold on to winners and the few bearish trades that you have are either quick and fast or low-size, low-risk credit spreads that have defined  parameters.

We now have to shift gears just like the market did.   Bearish trades must be longer and more thought out, but also fast in profit-taking on any market bounce since the largest rips to the upside occur in down markets.  

Sideways trades are important in markets like this because just like the market is waiting to show its TRUE direction, it is important that you put together trades that match this indecision.   

Calendar spreads that have “eventual” directional bias and pure sideways butterflies are great tools for this which we teach our Traders how to use effectively every single week. (see HUM below).

Despite the bearish price action we’ve had this week, There’s usually always a bullish area of the market and this time is not an exception. Energy has been extremely strong and Healthcare is holding up particularly well.  As an options Trader with a basket of different strategies holding on to those Bulls to stay balanced is extremely important.  I mentioned APA a couple weeks ago, and it performed very well (see below).  

Also it is not too late to find bullish-to-sideways trade setups for both COP and LLY to get some exposure in these better-performing corners of the market (see below).

Important things to keep an eye on that will help you judge direction are: 1) the volatility index or the VIX (see below) as well as 2) the 10-year treasury yield. If the VIX becomes complacent again and drops quickly back to its levels from two weeks ago at the same time the 10-year drops below 4.10% and stays there,  this could indicate market strength. 

If the VIX remains elevated and the 10-year stays stubbornly high above 4.25%, then we may be in for further corrective action as institutions thirsty for yield simply find it in risk-free assets

Ask yourself this:  If your big hedge fund that you run is already up 20-30% this year,  why would you risk your entire year to chase risk assets? That’s how THEY think, that’s how WE have to think!  I’ve been there, and can hear their voices in my head.

We did see a small bounce on Friday in the afternoon and based on the price action that I see, it looks as if it was simple short covering going into the weekend. 

This may continue as markets try to test resistance levels up near the 50-day moving average (see QQQ below).  If those two factors that I mentioned earlier remain too high, I will be shorting into that rally expecting further decline. 

As of right now however,  I will be positioning my portfolio with  Bulls in energy and Healthcare,  some sideways trades to sit through any uncertainty,  and adding bears into small rallies in prices if overall weakness continues.   

The great thing about trading is that you can make money in any direction as long as you’re not a slave to your emotions and simply make adjustments in real time to what is going on.   

We coach this stuff every single week in order to drown out the noise and to just see what’s going on in front of us.   It’s not rocket science, it’s just consistent discipline!