Thursday’s stock swoon dealt quite the damaging blow to equities across the board. What’s worse, the dramatic drop occurred on higher-than-average volume, making it qualify as a distribution day, which suggests institutional selling.
For those counting at home, this is the first distribution day we’ve seen in over six weeks.
Not surprisingly, the break of the S&P 500’s support level at 1685 caused the coroner to pay a visit to the hallowed halls of the NYSE to declare the short-term trend officially dead. Although it treated the bulls to a rapid 9% rise since springing forth in June, its life was cut short just shy of its two-month birthday.
With a full-fledged correction now upon us, caution is warranted. Sure, we’re only down 3%, but remember: Every single major market swoon since the beginning of time started as a minor pullback before transmogrifying into a vicious, destruction-sowing, bull-killing super-bear.
Besides, the market gods usually smile upon those taking defensive measures sooner than later.
As long as the market remains in correction mode, consider using rallies as an opportunity to lighten up on bullish positions that are giving you grief, and perhaps look for low-risk entries into short trades.
Rather than being feared, market corrections ought to be embraced. Often hidden within the volatility are clues that reveal which stocks are likely to lead once the bears have been vanquished. During the latter stages of a bull run, many of the junkier stocks tend to catch a bid as the rising tide truly does lift all boats. Sadly — for those who own these securities at least — once the correction commences the market has its own little “emperor with no clothes” moment. As traders realize these less fundamentally fit companies were rallying on vapors, they quickly jettison them from their portfolios.
While the junk gets taken out to the trash, healthy stocks whose price increases were built on a strong foundation of earnings growth, sound valuations or one of a variety of other positive fundamental factors weather the downturn relatively unscathed. If I were inclined to enter bullish trades amid the tumult, these would be my go-to plays.
Although we still might be in the early stages of the correction (who knows?) here are a few such candidates: Apple (AAPL), Priceline (PCLN), LinkedIn (LNKD) Chipotle (CMG), Netflix (NFLX), MasterCard (MA), Facebook (FB) and Under Armour (UA). Virtually every one remains above their rising 20-day moving averages, and many are providing potential dip-buying opportunities.
Click to Enlarge Here’s a potential play on Priceline, which just filled its earnings gap and is attempting to turn back up.
Sell the Sep 875-865 put spread by selling the Sep 875 put and buying the Sep 865 put for around a $1.30 credit. Consider it a bet that PCLN survives the ongoing correction without breaching its rising 50-day moving average, which resides just above the short strike price of the spread ($875).
The max reward is limited to the $1.30 credit and will be captured at expiration if Priceline sits above $875. The max risk is limited to the distance between strikes minus the net credit, or $8.70.
To reduce the risk, you could exit if Priceline breaks below $875.
As of this writing, Tyler Craig was long AAPL.