UPDATED April 21, 2020
Key bearish technicals that shan't be ignored:
1) BREAKDOWN FROM RISING WEDGE + BREAKOUT OF VIX DESCENDING WEDGE
2) OPEN GAPS BELOW PRICE.
3) RSI ON SPY HOURLY MAKING FIRST SET OF LOWER LOWS = DOWNSIDE MOMENTUM
4) ISLAND BREAKDOWN NOW FORMING ON DAILY & HOURLY
1) BREAKDOWN FROM RISING WEDGE + BREAKOUT OF VIX DESCENDING WEDGE
The SPY is now breaking down from that rising wedge & is now showing confluence with a breakout on the VIX's descending wedge. So the bullish complacency is waning & protective aggression in the options market is ramping back up. This is important to distinguish here.
So after roughly 8-days of dojis, reversals and consolidation, the SPY has finally taken a first push to the downside now breaking below that bearish rising wedge with 2 main open & unresolved gaps below price.
2) 2 LARGE OPEN GAPS BELOW PRICE
Those 2 large downside gaps will need to get filled. Now I get that not all gaps get filled.. but most do, right? In what kind of reality where there are 22 million unemployed do those 2 downside gaps not get filled?
I keep going back to this very simple thought:
On January 1st, if I would have told you that the entire economy would be shut down by mid-April, 22M people would lose their jobs in a month, and over ~43,000* would die of a mysterious virus, would you buy the S&P only being down -13*%? Then why are you buying it now?
Smart money is not going to be buying SPY @ $290 $280 or $270 ....they're going to do their buying much lower than here @ these levels.
3) RSI ON SPY HOURLY MAKING FIRST SET OF LOWER LOWS SINCE THE BEAR MARKET RALLY HAS OCCURRED
So after roughly 8-days of dojis, reversals and consolidation, the SPY has finally taken a first push to the downside. It's still way too early to see how far this goes. Again, our expectation is that the SPY will retest the lows in a second leg lower. That's why we are sitting roughly 65-15% cash-short in the folio. If the SPY gets back down to its lows, that's a 30% total portfolio return we should generate off of our January SPY puts on a 2x That would then put us in a great position to roll into some long-term Apple leaps or cal spreads if Apple also pushes down to its lows. So far today is a good start in that direction.
So as of now it really does look like the SPY has broken down from that rising wedge finally. We will need to see follow through obviously. Keep in mind that some chart formations are far less reliable with regards to their intended outcome than other patterns. Also as a forecasting tool usually oversold & overbought indicators tend to take weighting precedence over just patterns alone in helping detect breakdown & breakout directions. The key is to look @ those holistically in tandem. And even then, some chart formations are are more reliable than others. Like there are times when we see clear-cut bullish pennants forming in a bullish environment and those tend to breakout very often. We get double-bottom set-ups & inverted head & shoulders set-ups. Those are also pretty reliable. Rising wedge and bear flags are not as reliable to be perfectly honest. That's what we have here. We have a rising wedge (bearish) breaking to the downside. We'll see if it continues...notice here on this hourly chart the relationship to the SPY & it's RSI. You now have RSI making it's first lower low since the recovery period began.
Now the SPY is getting very close to oversold territory on the hourly chart. If we get down to a 20-RSI, it may be worth selling some near-term premium against our core SPY January puts. So instead of selling, I think it would make sense to create a calendar spread. We could sell weeklies against the position to reduce our cost-basis. I would need to see the SPY get down to a -20 RSI to even consider it. And even then we would be taking risk. Look at the first leg down in the chart above. The SPY went sub-20-RSI for a good full week of trading. It sat at a 20-RSI or below on the hourly. Still, in most cases, if the SPY hits a 20-RSI, it tends to see a good sized rebound even during a correction. So we'll play it by ear. But we might sell premium if things get very oversold this week. If we can get 2-3 points, it's definitely worth it. That's a huge reduction in cost-basis. Unlike with common stock, when you sell premium against leaps, you get more leverage. That's because we can buy 150 contracts of SPY leaps for $400,000. To get the same number of shares, we would need roughly 10x that amount or $4.3 million.
That's why selling premium against a leap position is generally very productive. Especially if you hold those leaps long-term. Consider it like this: Suppose we buy Apple $250 2022 Leaps for $25.00 when Apple is at its lows. Say we buy $1M worth or 400 contracts. If we write covered calls for $2.50, it will have paid for 10% of the entire position. If you do that 10 times throughout the year, you will have paid for your ENTIRE POSITION. It will be a free position. What that would take is 10 very well timed trades. You would want to sell that premium in situations where Apple was way over-extended or where it started to slow or when the market looked toppy. There are any number of circumstances that will open up that opportunity.
Furthermore, if you have a good amount of cash on the sidelines, you could always cover a bad trade to preserve long-term capital gains treatment of the leaps.
Who wants to ignore this? Is AAPL's production in trouble?
If so, when does the media or Apple let us know? Are you willing to wait until the media or Apple or some hedge fund officially lets you know?
APRIL 17, 2020 POST
On January 1st, if I would have told you that the entire economy would be shut down by mid-April, 22M people would lose their jobs in a month, and over 36,000 Americans would die of a mysterious virus, would you buy the S&P only being down -11%? Then why are you buying it now?
After a certain point, there is just very little excitement to buy AAPL & the SPY @ $300 in this environment. That’s why ultimately this cycle will run it’s course as the value proposition of being buyers becomes less & less attractive. And when they can't run it higher, they will run it lower. That's called buyers exhaustion.
The market didn't perform anywhere remotely close to as well as expected. In fact, today was sort of a dud considering the news. I was expecting pure delusional euphoria at this point in the session. That hasn't happened and so we're going to continue to hold our SPY short position. The SPY is still bearish tilting on the intermediate-term as the chart is concerned. This week has actually been very net negative for the SPY. And if we happen to close with another doji or black bar on the session, it will be a really bearish way to end the week. Remember, even after Covid-19 is behind us, the market still has to deal with the lagging uncertainty of the economic impact of Covid. We really don't know what the permanent job loss picture looks like. And remember, once we start to see any amount of jobs permanently lost, it is an inherent negative feedback loop. If people have less money due to lower jobs, that means less growth and fewer future jobs than there otherwise would be. We get a near permanent hit to growth anytime the economy loses a job. What's more, many of my observations are lining up with what I'm reading regarding the Paycheck Protection Program which is the backbone of the $2 trillion stimulus package. I live in Santa Barbara here in So Cal and I know quite a few people who run small business around here. And I'm hearing the same thing. The entire process to get a loan has been a total mess. It is taking forever to get the lifeline that many of these business need. Consider a private preschool for example. I know one locally that has 10+ employees, and given the state-wide mandate for school closures, there is no income whatsoever. No one is going to pay a preschool tuition if their child isn't attending school. Preschools are mostly about early socialization and childcare for parents who need to work. If the parents aren't getting childcare, they're not going to pay for that (in most cases). So when no tuition money is coming in, the school has to figure out a way to pay or layoff its employees. The payroll for 10 employees can easily push $50,000-$75,000 a month. Eventually the business owners of the preschool won't be able to pay their own bills. If enough time passes and there's no lifeline, this is the exact thing that can force a business to shutter. And that means those 10+ jobs are permanently lost. The Paycheck Protection Program is aimed at alleviating this exact type of stress. But if the process is completely screwed – as everyone should know by now that its would be given our imbecilic bureaucracy – and if the school doesn't get its lifeline on time, they'll eventually be forced to shutter the business. But the point is that we have a lot of small business in the same same predicament right now and the PPP has been very slow getting the capital out to those small business owners. The biggest problem is there's no triage here. It's all first come, first served. And who wouldn't take advantage of a 1% interest rate loan? That was a huge mistake. What they should have done is made the interest rate 5% and completely forgivable if the business doesn't lay off any of its employees. It would prevent people who have no economic impact from applying for the attractive 1% interest rate. It becomes a self triage. But because of the attractive interest rate and the first-come-first-served process, the business with the greatest need could very easily find themselves at the back of the line. It is sort of a disaster. Anyway, the point here is this. There is UNCERTAINTY when it comes to the economic impact of Covid-19. We don't know how bad it will be. That uncertainty will be a drag on the markets in the future. Once this sugar high is over and the market comes back down to earth, that overhang will be like the greek debt crisis. It will have repeated impact on the markets.
The fact that the market didn't explode higher today – Apple was sitting at $296 in after-hours trading yesterday – gives me a lot of faith that the market has not entirely lost its mind. In fact, the market really hasn't gone that much further than the expected peak of $277.68. That's the 50% retracement mark. The S&P 500 has only gotten as high as $285.68. That's a mere $8.00 above the 50% retracement. That's only 2.8% higher than expected. So we're going to continue holding our short position for now. If the $SPY had gapped up to $288 or something and then went to $290, we would might have really considered to sell our position and just sit in cash. But since the market came to its senses today, we're still in a bearish set-up in the SPY. So we're going to continue to hold our position for now. Again, we're sitting mostly in cash at the moment 15% short and 65% cash.
Now just to give an idea of what we would have done today if the SPY pushed to $290, we would have sold our position and actually bought a leveraged long position in Apple common stock. That is if Goldman Sachs hadn't downgraded Apple. We would have bought Apple at $293 or something and then placed a stop-loss at $288. If Apple then rallied to $300, we would have moved that stop loss up to $293 – break even point. If Apple broke out above $300 and continues its mindless run, we would move our stop loss up to $295 and then $300 etc. The point is this. I think rather than sit in cash, we're going to start employment momentum trading strategies to capitalize on the sugar highs when there's nothing else to do. It's actual a rather low-risk, and high reward strategy. It's exactly what we should do when we're in cash.
Instead of sitting in cash, we should have been leveraged long the SPY with trailing stops. That’s neither here nor there @ this point. I think it was prudent to just sit tight & take a more wait & see approach during this time. We’ll inevitably get some strong setups as stocks cultivate more of a pattern in defining their range-highs & range-lows. Patterns will emerge & that’s always where we’ve been the strongest @ exploiting. It will happen again no matter.
“So many strategists are calling for a retest that Mr. Market will try to embarrass the greatest number of strategists at any one point in time,” said Stovall.