The bulls haven’t backed down, but troubling price action below key resistance in the S&P 500 remains supportive for limited-risk credit spreads in the S&P 500 ETF (SPY).
Two weeks have passed since the S&P 500’s historic “mini flash crash,” as some have called it. Others, like myself, have different descriptions for what I personally see as an utter failure of Rule 48 and market regulators in price action which resulted in a massive and irresponsible V-bottom formation.
In the here and now, active, self-directed traders should focus on shorting the S&P 500. With SPY up against key resistance area during the market’s historically weakest calendar month — and after catapulting from an equally notorious and weak V-bottom — shorting makes a good deal of sense.
S&P 500 ETF Daily Chart
Looking at the daily chart of SPY, we see that bulls have a lot of work to do.
Prior lateral price supports from December 2014 to February 2015 and March through July resulting from large congestion areas isn’t going to be easy to overcome. Remember the technical tenet that what once was support becomes resistance.
Furthermore, the S&P 500 has been tightening into one of the most grueling trading ranges witnessed in the past couple decades. This price support occurred after six years of an extended and historic bull market and ultimately failed, which means bulls in the S&P 500 ETF face an even more challenging technical obstacle.
We also can’t ignore the formation of a death cross that has developed since the mini flash crash and price action that has been stuck between the SPY’s 38% to 62% resistance levels. That former support is putting up fierce resistance against the S&P 500 ETF.
S&P 500 ETF Weeklies Bear Call Spread
As we’ve discussed, trading in the S&P 500 from the short side should provide the path of least resistance while also netting you some tidy profit. But the market remains very volatile, especially ahead of this week’s long-awaited September FOMC decision.
Due to existing market volatility in the S&P 500 and an event that, however unlikely, could always throw a monkey wrench at bears, a SPY limited risk vertical is a smart way to position.
The SPY Weeklies, some of the most liquid options in the market, allow for an incredible range of bearish verticals using either puts or calls.
To capitalize on the described resistance zone in the S&P 500 and be able to take in a profit over a range of price values, even if the SPY ETF moves higher, I recommend an out-of-the-money call credit spread.
Reviewing the SPY options board during Monday’s first half, the Weeklies September 30 $202 / $204 bear call vertical is priced for a credit of 35 cents with the SPY ETF trading for about $196. For traders wanting to short the S&P 500, this is one attractive way to establish just that sort of position with much stronger risk management and higher odds of profitability.
This vertical’s 35-cent credit is kept if SPY remains below $202 at expiration, which is nine trading sessions out. Unlike with short stock or a bear put vertical, this means the S&P 500 can still move up by 3.40% and this bear will realize a profit.
If by chance bulls in the S&P 500 get “Fed up” with the FOMC’s directive or some other market elixir works prompts an even more substantial move higher; the vertical’s max loss is contained to $1.65.
The limited risk feature of the vertical spread is a huge benefit. But if technical doubts for the bear case are raised by convincing bullish price action in the S&P 500 and last beyond the initial Fed day reaction, consider re-evaluating and taking a smaller loss.
Disclosure: As of this publishing, investment accounts under Christopher Tyler’s management do not own positions in any of the securities or their derivatives mentioned in this article, but may initiate in the future at their discretion. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
