U.S. equities surged on Monday, led by an epic rally in Chinese stocks. It marked the fifth consecutive day of gains for the S&P 500 ETF (NYSEARCA:SPY) and pushed the large-cap laden index above the significant $3,150 resistance zone.
Skeptics will point toward the concerning rise in coronavirus cases as a reason for caution, but so far, it’s been foolish to bet against bulls. Today we’re investigating why the path of least resistance remains higher, and how you can profit with a cheap options trade on the SPY ETF.
Price Trumps All
The news has served up an endless drumbeat of ominous headlines in recent months. From the resurgence in novel coronavirus cases in states like Florida and Texas, sky-high unemployment numbers, to the increasing social unrest and gloomy growth forecasts, bears have a mountain of data to support their cause. As always, arguing for caution and pessimism is intellectually satisfying. Not to mention, it makes you feel smart.
And yet, pointing to the ugly headlines and using them as an excuse to stay on the sidelines hasn’t helped you make a dime. Not recently, at least. Instead, it’s kept you from participating from one of the fastest rebounds in history, particularly in sectors like technology.
The same could be said for large-caps in general which continue to outperform their smaller brethren. Intellectual bears are experiencing some serious cognitive dissonance these days. Reconciling booming stock prices with the dour data can be challenging. It underscores why I’m such an unabashed fan of following price and price alone. And it’s why technicians like myself preach the practice of trading what you see versus what you think.
It’s simpler and requires far less brainpower. It’s also faster and quite a bit more objective than wading through the deluge of economic data and news dumped on participants every day. Let’s look at the message being broadcast by the price of the SPY ETF right now.
Hint: it’s bullish.
SPY ETF Stock Charts
To bring ourselves up to speed, let’s begin with a five-year weekly chart. Heading into 2020, stocks found themselves in one of the best bull markets in history. All was well until Covid-19 took the nation by storm and created the fastest bear market ever. Fortunately, the direst predictions never came to pass thanks to a rapid response by the two biggest actors in our economic system — the government and the Fed.
Thanks to trillions in stimulus, a deeper and more long-lasting crash was averted. While opinions still vary about the shape of the economic recovery, the stock market rebound has been one of the “V”-shaped variety.
The ascent carried SPY back above every major weekly moving average, forcefully reasserting buyers’ dominance. With the trend now pointing higher, it’s impossible not to lean bullish. The past five weeks of chop have allowed the market to digest gains and work through overbought pressures.
On the daily time frame, we can see how the short-term trend turned higher first in April. This is shown by the rising 20-day moving average. By late-May, the intermediate trend, or 50-day moving average, started trekking higher. Though the past few weeks of chop have crisscrossed these smoothing mechanisms a few times, Monday’s rally officially vaulted price back above all of them. The SPY ETF also closed above range resistance ($315), signaling a breakout.
Even if the initial breakout bid fails, the strength of the weekly trend suggests the path of least resistance is higher. With the wind at its back, it’s only a matter of time until SPY revisits its $339.08 peak.
Bull Call Spreads
If you’re willing to bet on this eventuality, then bull call spreads provide a cheap way to do it. To increase the odds, we’ll use longer-term contracts to provide plenty of time for SPY to make its move.
Buy the October $320/$340 bull call spread for around $9.25.
The initial cost of $9.25 is the risk and will be forfeit if SPY sits below $320 at expiration. But, if we can rise above $340 by October, then you’ll capture the max reward of $10.75.
By risking $9.25 to make $10.75, the spread offers a potential return on investment of 116%.
For a free trial to the best trading community on the planet and Tyler’s current home, click here! As of this writing, Tyler held bullish positions in the S&P 500 ETF.