Traders Edge Blog

Half Ugly—But Not Butt Ugly…For Now

Well, you can dress it up anyway you want and attribute the post-election activity to myriad factors, but whatever your thoughts and outlook, price action on the broad US indices has further retrenched and found itself back to some seriously important support levels. Not a stretch to call it ugly.

Both the INDU and SPX have retraced just over 6 percent since their Sept. highs and more than 3 percent post-election. Both now sit on critical mid-channel support. Truth be told, Thursday’s close on the INDU puts that index below key support ever so slightly.

The SPX actually held its key support in Thursday’s action, but that’s looking tenuous at this point.

Given the recent swoon, it’s accurate to label recent activity as ugly…but for now I’d call it half ugly. If we slip from here, it’ll get butt-ugly quickly.

Looking ahead, it’s fair to expect we’re due for a “plus” day or two to staunch the bleeding. That said, it must be noted that the VIX ain’t exactly screaming “watch out—this is waaaaaay overdone.” In fact, the current level of 18 is not that far north of the lows (below 14) that prevailed during the listless activity of months recent. Read into that what you want, but it reconfirms to me that we haven’t moved off the mark by much…the consolidation and coiling I’ve written about with frequency in the last several months remains in play.

Key for now is whether the indices are able to gain some legs and start back up off the aforementioned critical support levels at the mid-points of their respective channels. Such price activity would conform the side-winding patterns that have served to coil both indices tightly…the result of which is that both indices are screaming for resolution in either direction.

Breakdown from here and both indices are looking at tests of the lower support levels of the channels created off their March 09 selloff lows. If we visit those levels (approx 12k and 1220, respectively) the INDU would have retraced approx 13 percent. Such a move would be even more pronounced for the SPX—a retracement of roughly 18 percent.

As for what this translates to from a trading standpoint, aggressive traders are looking to play this short to the channel bottoms…and there is certainly room to justify such a play.

Alternatively, the present levels offer a perfect turn point in the market, given the significance of the channels both indices have faithfully maintained since their formation in March 09. Personally I’d wanna see some confirming signals before establishing a new long or adding to existing positions.

If we do head south from here and go on to test the channel-bottom lows, which would be likely, there is a big-question you need to ask yourself…Relatively speaking and short of a nuclear conflict, are we really headed back to the dark days of just the past several years?

If you think the wheels are coming back off, then we are likely to see the channels broken and the 09 levels tested. Color me a little skeptical at this point. The market has had everything, including the kitchen sink, thrown at it and it still showing relative strength…so much so that both the INDU and SPX remain in relatively close proximity to their respective record highs…

Tis fair to say that a whole lot of peeps will view a channel-bottom test as a huge long-side opportunity…with lots of upside potential.

For now, we’re left still looking for the resolution breakout that is growing all the more likely….

We shall see…

~LH

Ask the Crew:
Crew members tackle questions submitted by readers each month

Q: Could you explain how money is made on straddles and strangles? They seem like they would just cancel each other out and break even no matter what the stock does.

A: As one side gets deeper in the money the delta strengthens. As the other side gets further out of the money the delta weakens. In other words, one side gains much faster than the other side loses.

Q: My trading platform does not have a list of earnings dates. It is only on individual charts. Is there a free source for a list of earnings dates?

A: Yes, go to www.rttnews.com. There is an earnings calendar, free of charge. (Direct link to page: http:// www.rttnews.com/earnings/earningscalendar.aspx )

Q: Can you explain why one would want to be slightly delta short on the forward ratio spreads? Why not delta neutral or slightly delta positive? I’m not sure that I understand the logic. Also, what is an acceptable amount of delta upon entry of the trade and does this number need to be maintained throughout the life of the position? (Just to clarify the “slightly negative delta”… If I cap the trade with a long call on the upside, can I assume that delta (which will be small) gets factored into the entire delta count for the position, which I am trying to maintain at 0.01-0.05 negative delta upon entry… correct?

A: You can approach it in two ways.
1- You simply do not factor in the delta of the bought call and go into the trade fully expecting to lose whatever you paid for the call.
2- You factor it in and manage the sold call as you move your trade down. I favor option one.

Q: Novice question! How do I go short when I don’t have a big account? Do I buy puts? I thought being short meant selling puts or calls?

A: Yes! Puts are how we go directional to the downside.

Q: How do you evaluate a good “forward spread” candidate? Can this be done on an index?

A: You could do it on an index, but I favor doing it on a stock that has a big spike in Implied Volatility.

Our goal is to cover ground that will benefit the entire community…so get busy sending in those questions…