This week’s market plunge has dealt some damage to the trend structure of the S&P 500. Even a novice chartist can spot the pair of peaks now sitting atop the chart of the SPDR S&P 500 ETF (NYSEARCA:SPY).
The February rally in SPY sputtered to a stop in the $212 zone. The March rally was only able to climb to $211 before succumbing to gravity’s pull. Though the twin tops didn’t peak at the exact same level, their failure areas are close enough to qualify as a potential double-top pattern.
While the pattern is short term in nature it’s worth considering the implications.
The last time the SPY formed an equal pivot high was in late December (labeled with a red “1” in the chart below). That particular pattern ushered in a six-week trading range before we finally broke higher.
Maybe we see something similar this go around. Or, perhaps we see a larger downturn before the bulls are able to wrest back control and negate the double-top.
Bear in mind the SPY needs to break support at $204 before the topping formation is completed and confirmed. If the recent weakness continues I suspect this will come sooner than later.
Bottom line: until the SPY ETF is able to take out the resistance zone in the $211-$212 area, caution is warranted.
SPY Bearish Option Trade
Whether you think the SPY is beginning a larger correction or that prices will be relegated to a trading range for a spell, now maybe a great time to consider selling bear call spreads. By using out-of-the-money options we can structure a trade that will profit as long as SPY doesn’t climb above the major resistance zone around $212 that we’ve highlighted.
Sell the May $213/$217 call spread for 70 cents. Consider it a bet that SPY remains below $213 for the next 49 days, which it should if the potential double-top pattern completes and a new downtrend emerges.
The maximum reward is limited to the initial 70-cent credit and will be captured if the calls expire out-of-the-money at expiration.
The maximum risk is limited to the distance between strikes minus the net credit, or $3.30, and will be lost if SPY rises above $217.
To minimize the loss in the trade consider exiting if the double-top pattern fails. This would occur if SPY breaks above the resistance zone at $212.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
