Condor Options

It’s been an interesting couple of weeks since our last market analysis, to say the least. After three days closing in the 950–956 resistance zone, the S&P 500 index rallied to new 2009 highs, consolidated for less than a week, then broke higher on very heavy volume yesterday morning—only to give back almost half of its intraday gains, mostly in the last half-hour. If recent history is any indicator, that sharp end-of-day drop on extreme trading volume (nearly 40 million SPY shares and well over 320,000 S&P futures contracts were traded in the final 30 minutes) foreshadows follow-on selling this morning and a close under yesterday’s high.

Some further bearish signs: Our extra-slow (15,10,5) stochastic, applied to the SPX daily bars, closed over 97 Tuesday. That’s happened three times in the past 20 years, and each time the market reached at least a short-term peak within a month or two. The biggest closing-price gain after crossing the aforementioned threshold was 2.5%, which would put the near-term ceiling for SPY at about $100.40. The upper channel line (orange) and resistance at SPX 1007–1008 from last November’s high are consistent with that upside range. MACD is approaching overbought extremes, and the 14-day RSI is back in overbought territory after a brief dip Wednesday.

Nevertheless, it’s important to remember that one of the worst mistakes a trader can make is to cling to the belief that an overbought/oversold market can’t go any higher/lower in the face of a strong trend. Here’s the bullish case:

• Momentum is still positive – None of our main indicators—stochastic, MACD or RSI—is flashing a sell signal on the daily chart;
• Price can keep going higher even after the indicators turn bearish;
• Last Thursday’s breakout completed an inverse head-and-shoulders pattern with an intermediate- to long-term bullish target over SPX 1200 (which is why this week’s chart shows such a long time period; the pink line is the head-and-shoulders neckline).

Either way, a retest of SPX 980 (and perhaps the 950–960 area) is likely before the S&P makes a sustained push over 1000. But regardless of which direction the market takes from here—up, down or sideways—our strategy includes rules for limiting risk and maximizing the odds of outperforming a buy-and-hold strategy over the long-term.