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TFC Commodity Trading Forum

Traders Radar: Putting It to the Test

Chris Tyler, Optionetics.com
March 21, 2011

Is it me or do bulls have a knack for “turn up the volume” whining when markets go down in a less-than-constructive manner? On the other hand, it’s amazing how quiet those same investors seem to get when prices go up just as quickly; like there was no other choice in the matter.

Such is the case after last week’s technical fallout in the broader market. With less than two hours left in Monday’s session and with the SP-500 (SPY) up about 1.60%, the market’s broadest market average has managed to rally 3.60% over the course of its three day bout of bargain hunting from extremely oversold lows struck last Wednesday.

Of course bulls will quickly tell you the news justifies the reaction. Japan’s nuclear threat is looking less ominous. Military action by UN forces is viewed as a positive factor as bulls anticipate a quick victory despite Libya’s insistence otherwise or maybe are just being appreciative of past wars, which have proved bullish for equities historically. Bulls can also toss in some Merger Monday magic to support market prices with AT&T’s (T) substantial $39.0B wireless deal with T-Mobile, in the spotlight.

It certainly sounds reasonable, but as traders that have been around the block more than once should realize, the voice of reason isn’t a trademark for the movement of market prices. The market moves just as easily on “profit-taking” during periods of good news and can also climb the proverbial wall of worry in the face of seemingly horrific catalysts. Charts on the other hand, while also far from perfect, do seem to offer a more honest assessment of both the movement of the day and looking forward.

Figure 1: Ultra SP-500 (SSO) Daily

With the SPY at 129.70, prices have filled the gap from Tuesday’s financial tsunami and are now pressing against 50SMA, 1300 and 50% Fibonacci resistance. As the price action follows an uptrend line breakdown and a “devilish” two year double from the March bottom of 666; I’d say the bears aren’t done enjoying their version of March Madness. Shown above is the Ultra SP-500 (SSO) which seeks to more or less double the fun for bulls and bears looking to participate in the SPY.

In conjunction with market premiums ($VIX) at fairly affordable levels following their own pullback from fearful extremes; bears have what looks like a decent opportunity to buy resistance in a more constructive manner than their optimistic brethren; namely with a long put strategy.

Figure 2: SP-500 (SPY) 5 x April 127 Put

In the likes of the SP-500, one idea which looks interesting for additional homework is the use of the April 127 put. The contract is Monday’s most active with more than 50,000 trading compared to open interest of 185,000. A long put purchase would require a move to the downside of 4.50% by expiration in order to realize a double in its current premium of $1.62 to a market price about $3.25 per contract. Shown above, we’re illustrating the long put with a position sized at 5 contracts, which for a $20K model portfolio would amount to risk of 4%.

By using this method, the trader is aligning him or herself more aggressively with the downtrend, should it resume its course but at the same time is accepting more risk than the standard 2% to 3% many traders look to use. However, by using a discretionary / managed stop such as a close above the 50SMA line; any potential losses will likely be limited to an amount closer to 1%, barring a substantial gap, and half of what the less proactive trader might eventually realize by simply holding on when conditions no longer warrant being a bear.

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site