First and foremost, we’re well-positioned for current market conditions. In the half-hour before yesterday’s close, our August trades were showing a loss of less than 2% on total capital at risk, with plenty of time left before expiration to cross over into the black. Yes, we’ve spent a lot on commissions with five adjustment trades; nevertheless, we stand a very good chance of more than making up for that cost, in a cycle that started almost precisely at the beginning of the kind of one-month rally seen only once or twice in a decade. Here’s how our individual positions looked near the close yesterday:
SPY August/September Calendar Spread #1
(89 Calls, Adjusted to 94/98/100/103)
Even though it’s taken four adjustments to keep a rein on this perfectly ill-timed trade, we currently have a manageable paper loss of about 17%. As shown in the position risk profile posted Wednesday, our chances for making a profit on this trade are only about 30%, but the odds of being able to offset any loss with one target profit are more than 60%—and our adjustment strategy, combined with portfolio-level risk management, greatly increases those odds.
SPY August/September Calendar Spread #2
(94 Calls, Adjusted to 94/102)
Our current unrealized loss on this position is about 8%—but we have more than a 60% chance of turning a significant profit if we consider our other positions between the 94 and 102 strikes. And, again, those odds are increased by the possibilities for further adjustments (only if necessary, of course).
SPY August/September Calendar Spread #3 (99 Calls)
This is our current profit engine, with a paper gain of nearly 23%. Depending on whether the market, and implied volatility, goes up, down or sideways, we’ll be looking to lock in that profit or hang on to this position either for its profit potential or as a hedge.
Altogether, we have a pretty attractive portfolio P&L curve (below) at this point. Our breakevens widened to about 95/102.90 with yesterday’s 3.3% increase in implied volatility (which will vary, of course). As discussed Wednesday, we could lock in a profit and flatten out our portfolio risk curve if SPY hits $99, or roll that theta up or down as needed.
Down But Not Out
As we noted more than two months ago, it was likely that the 14-day RSI would have to become overbought before the intermediate-term rally topped out. After a brief flirtation with overbought levels a week before, the daily RSI crossed over 70 last week, and then produced a sell signal yesterday. However, we’re taking that bearish sign with a grain of salt, considering historical precedent.
There’s no doubt that we’re near an intermediate-term top—what we don’t know is where and when it will occur. Based on the historical record, with such strong momentum the S&P could go as high as 1025 or 1050 before pulling back (this morning’s unemployment report set off a bullish bomb in the the futures market). Or it might drop 50 points in the next week or two. One last blow-out rally to scare the pants off traders who are short would be no surprise, but as the daily chart below shows, any lasting gains would definitely be an uphill battle:
The S&P is at a major convergence of resistance, from its November 2008 high and the uptrend channel line, in the 1005–1010 range. If that range is taken out, the 38.2% Fibonacci retracement for the entire bear market (from the October 2007 high to the March 2009 low) poses another barrier at SPX 1014. After that, there’s no significant resistance up to 1050.
On the downside, we have support at the last two major levels of resistance, around 980 and 950, with the 20-day moving average and broken head-and-shoulders neckline (shown in pink) in between. By the time the S&P might have a chance to reach 950, the 50-day MA should be right there too, supported by a major uptrend line. Add in the strong momentum on the weekly chart, and it seems unlikely that we’ll see a huge correction anytime soon, even as a prolonged consolidation is becoming more and more probable.