This abbreviated trading week has nevertheless been a volatile one for Wall Street. But amid the chaotic behavior, it’s time for traders to play the S&P 500 ETF (NYSEARCA:SPY) short with the option to reverse and go long the SPY ETF. Let me explain.
It all started well enough for market bulls on Monday. The SPY ETF began the week up 1.3% following the G-20 Summit and word of a 90-day moratorium on tariff increases between the U.S. and China.
For its part, the S&P 500 index even gapped and held above the closely-watched 200-day simple moving average on the news. It also marked a third attempt by the SPY to move back into bull territory since the broader market’s correction began in early October.
Alas, the third try wouldn’t be the charm for bullish investors in the SPY ETF. Tuesday proved to be a decisive, heavier and above-average volume retreat back into bear territory below the SPY’s long-term trend-line.
So what went wrong? SPY stock’s 3.24% tumble was attributed to a couple factors. Trade war worries were reignited by Trump’s twitter feed and the words, “Tariff Man.” Also weighing on the broader market, the 10-year has dipped near two-year lows at the same time a yield curve inversion is hinting strongly at an economic recession. To say the least, it’s not a match made in heaven for S&P 500 bulls.
Lastly, toss in a lousy report from home-building giant Toll Brothers (NYSE:TOL), as well as investors already questioning a bull market nearly 10 years in duration, and Wall Street had all it needed to turn Monday’s cheers turn into Tuesday’s jeers. And so far it looks like Wednesday will continue the trend.
SPY ETF Daily Chart
Click to Enlarge
Tuesday’s third reversal of the 200-SMA wasn’t a good sign for SPY ETF bulls. Making matters worse is the bearish price action has taken on a triple top pattern. Both factors put today’s market weakness at much greater risk of failing and larger losses than 2018’s technically sturdier correction from early February to late March.
So, what now? The interpretation is the SPY ETF is a short until proven otherwise. Heading into early next year, I’d estimate $250 would be a good initial price target on shorting the S&P 500 ETF. That’s roughly where the 38% retracement level from 2016’s market correction to this year’s high comes into play.
The Bottom Line for the SPY ETF
At the end of the day, traders willing to position short or long in the SPY ETF need to recognize an incredibly volatile market can lead to much larger losses than an idealized stop-loss. With that caveat in place, I’d start with an initial stop above $277. The stop level incorporates a blend of the technical while keeping losses smallish and trying to avoid being chum for predatory algorithms.
I’d also consider using $277 as a level to reverse and go long the S&P 500. The technical assumption is a fourth move above the 200-SMA isn’t likely at this point. But should this type of price movement occur, it’s likely to be the real deal as most bulls will be skeptical after three failures.
Alternatively, for like-minded options traders that wish to set their risk to a defined dollar amount while reducing risks associated with owning or selling puts or calls, the February $265 / $255 put spread for up to $2.65 offers a nice risk-to-reward profile.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. 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 options-based strategies, related musings or to ask a question, you can find and follow Chris on Twitter @Options_CAT and StockTwits.