Dear Momentum Options Subscriber,
The bulls started last week off with a strong performance that pushed the market’s upper resistance levels and tried to establish fresh support, but the bears took advantage of the sketchy Fed-speak on Tuesday and Wednesday to keep the two-month trading ranges intact. This was expected, as the Brexit vote was also an overhang going into Thursday. However, what wasn’t expected was a push past resistance ahead of the news.
The rally on Thursday was the perfect setup to get short, as most of the suits-and-ties had no worries and were feeling comfortable that the United Kingdom would stay in the European Union (EU). In a vote that flip-flopped into the event, Britain decided to leave the EU, and Wall Street got rattled. Friday was a wreck, but backup support levels held to give the bulls footing for a rebound rally once the dust settles.
The Dow tanked 610 points, or 3.4%, to finish at 17,400. The blue-chips opened at 17,946 before falling below two layers of support at 17,800 and the 50-day moving average, as well as the 17,600 level. The two areas now represent short-term resistance. The intraday low of 17,356 held backup support at 17,400-17,350 and the 100-day moving average. A move below the latter could lead to 17,200 and the 200-day moving average, and it could stretch to 17,000 this week.
The S&P 500 sank nearly 76 points, or 3.6%, to settle at 2,037. The index opened above the 2,100 level at 2,103 before easily fading below 2,075-2,070 and the 50-day moving average within minutes. The only question would be if 2,050-2,040, which is now resistance, and the 100-day moving average would hold. It dipped 4 points below that level to reach a low of 2,032. There is near-term risk to 2,025-2,020 and the 200-day moving average, as well as the 2,000 level on a move below the latter.
The Nasdaq stumbled 202 points, or 4.1%, to close at 4,708. Tech folded like a cheap lawn chair after closing below three layers of support at 4,850, 4,825-4,800, 4,750 and all of the major moving averages. The stretch to 4,698 and close above 4,700 was hardly a bullish sign, but it is a backup support level that held. There is risk to 4,650-4,600 this week on continued selling pressure. Short-term resistance is at 4,725-4,750.
The Russell 2000 tumbled 44 points, or 3.8%, to end at 1,127. The drop below 1,140 and the 50-day moving average was a sure sign that 1,125-1,120 would come into play, and these are levels I was looking to see hold on Friday. The bears pushed a low of 1,123. There is still risk to 1,115-1,110 and the 200-day moving average, followed by 1,100 and the 100-day moving average on further weakness. Resistance is at 1,135-1,140.
The S&P 500 Volatility Index ($VIX, 25.76, up 8.51) zoomed nearly 50% following the bears’ push to 26.24 intraday. I talked about risk to 25 if 22-22.50 was breached, and the close above this level gets 27.50-30 in the mix over the near term. Support is at 25-24.50, followed by 22.50-22, which are levels the bulls need to recover this week. I will talk more about the VIX below.
Some of the early bullish clues I mentioned I would be watching last week were the action in the VIX, the financial stocks, the transports, the small-caps and the Monday/Friday closes on the Dow. Monday and Thursday’s opening gaps higher were unexpected by the suits-and-ties, while Friday’s selloff sent many of the pros home to head out on early vacations.
The market is closed next Monday for the July 4 holiday, so I expect trading to be light this week and next. With second-quarter earnings season just two weeks away, the fireworks should be dynamic for a major pullback or another run to all-time highs.
The dust from Friday’s shock may take a week or two to settle, but a rebound rally after the July 4 holiday is possible. While the bears currently hold the momentum, it remains to be seen if they have the strength to push the market down to the February lows.
The Dow and S&P are holding their up-trending 100-day moving averages, and the 200-day moving averages are sloping higher as well. However, there will likely be a test to backup support and the 200-day moving averages at some point this week, and these levels will need to hold.
The Russell 2000 closed below its up-trending 50-day moving average and is holding the flattening 200-day moving average. The 100-day moving average just under 1,100 is in a strong uptrend. As for the Nasdaq, the close below the slightly rising 100-day moving average was a bearish development. Additionally, the 50- and 200-day moving averages are starting to trend lower.
There are a hundred ways I could breakdown the Brexit news, but I don’t want to spend too much time on the subject. While many of the critics say it was and is a bad decision, the U.K. has the second-largest economy behind Germany. This is an important fact and, in my opinion, it was the right move for the longer-term.
The U.K. has been with the EU for 43 years and will remain in the EU until its exit is legally negotiated. Prime Minister David Cameron was forced to resign, but he will stay on through September. I expect that Germany’s Angela Merkel could be the next political head to roll given the turmoil her country is in and the fact that other countries are lining up to leave the EU as well. The process to finalize a departure could take up to two years. In my opinion, the short-term impact is outweighed the long-term benefits of the U.K. leaving the EU, and the market overreacted.
The British Pound fell to a 30-year low on Friday, overseas markets were down 7%-8% on Friday and the major indices here in the United States were down 4% on average. My initial outlook is that there is another 2%-3% of possible downside action before a July rebound rally ensues. There are only four trading days left in June, and the first trading day of July is this Friday.
The action in the VIX has pushed volatility towards its highest levels of the year. The Feb. 11 high reached 30.90, and the Jan. 15 peak reached 30.95. A close above 31 would be a very bearish development and could lead to 35-40. The 52-week high for the VIX is just north of 53.
In January, it took the VIX just nine trading days to recover the 20 level after the push past 30. The February push past 30 saw a recovery of the 20 level just six trading days later.
In a perfect scenario, I would love to see the VIX make an intraday test to 30 this week and then close below this level. If so, it might make for the perfect VIX trade, and here is how we could play it.
The best way to trade volatility is by using the iPath S&P 500 VIX Futures ETN (VXX, 16.92, up 3.31). The VXX highs in mid-February and late January reached 30.85 and 29.71, respectively. The correlation between the VXX and VIX has widened, and this is the main comparison I want to point out. While I do expect the VIX to test 30, I’m looking for VXX to hold 17.50-20 this week.
An intraday test to and close below 20 would have me looking at put options to play the VXX. The VXX July 17.50 puts (VXX160715P00017500, $2.35, down $2.30) tanked 50% on Friday and could get cheaper this week if VXX continues to rise. The VXX August 17 puts (VXX160819P00017000, $2.65, down $1.85) fell over 40% on Friday.
Both options will be on my watch list and could possibly be added to the portfolio as official trades, although I like the August puts more because they provide more time for the trade to play out. Regular July option expiration is less than three weeks away, while the August options have nearly seven weeks of time premium. I often refer to the three-week period before option expiration as the “danger zone” due to time decay, as it rapidly starts to erode during that time frame.
Gold ($GOLD, $1,319.10, up $59.80) surged to a two-year high following Friday’s nearly 5% gap past the $1,300 level. With gold at $1,250 earlier this month, I thought that there would likely be a $50 move towards $1,300 or a pullback to $1,200 this month. As you can see on the chart, the run to $1,300 came mid-month before the backtest to $1,250 through Thursday’s session.
The SPDR Gold Shares (GLD, $126.01, up $5.90) traded to a fresh 2016 and 52-week peak on the move in gold, and it looks poised to push the $128-$130 levels on continued buying. The GLD July 130 calls (GLD160715C00130000, $1.34, up $0.96) zoomed 253% and traded to a high of $1.64 on Friday. Volume was nearly 6,600 contracts, but I doubt I will chase these options.
Instead, I could wait for GLD to test $128-$130 before possibly going short. I have the GLD July 125 puts (GLD160715P00125000, $2.14, down $3.12) and the GLD August 120 puts (GLD160819P00120000, $1.34, down $1.86) on my watch list if GLD stalls at current levels or $128-$130.
The S&P 500 hadn’t moved 1% in more than 54 trading sessions before Friday’s drubbing. The pullback has put the index in negative territory for the year by a six-pack. The Dow is down 25 points year-to-date, and the Russell 2000 is off 8 points. The big concern is that the Nasdaq is now lower by 300 points year-to-date after coming into the year at 5,007.
The short-term technical picture has the bottom of the mid-March trading ranges in play. I have written about this continued trading range since the beginning of April and, while I was hoping for a breakout to fresh all-time highs by mid-June, I did prepare us for a possible selloff. The severity of these types of pullbacks is hard to predict, but I believe much of the short-term pain came when the Band-Aid was ripped off on Friday. The market hates uncertainty, but it can now focus on the upcoming earnings announcements to determine the trend for July and possibly the summer.
There are a number of New Trades I’m looking to get us into this week, but I don’t want to rush the action until I get more bullish or bearish clues over the next day or two, so please stay patient. The action is playing out just like I have been planning for.
From desk to press, futures look like this: Dow (-117); S&P 500 (-14); Nasdaq 100 (-34); Russell (-13).
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All prices given in this update are current as of 8:00 a.m. EST.
I hereby disclose that I will be participating in the following trade(s).
Microsoft (MSFT, $49.83, down $2.08)
MSFT July 48 puts (MSFT160715P00048000, $0.64, up $0.47)
Entry Price: $0.71 (6/16/2016)
Exit Target: $1.45
Stop Target: $0.10, raise to $0.25 (Stop Limit)
Action: Raise the Stop Limit from $0.10 to $0.25.
Friday’s close below $50 was a beautiful sight, as is the downward-sloping 50-day moving average. Continued weakness and a move below the 200-day moving average would form a “death cross” on the chart. Support is at $49.50-$49. Resistance is at $50-$50.50.
Morgan Stanley (MS, $24.52, down $2.77)
MS August 28 calls (MS160819C00028000, $0.24, down $0.58)
Entry Price: $0.79 (6/23/2016)
Exit Target: $1.50
Stop Target: None
Action: Support is at $24.50-$24 on continued weakness. A move below the latter will likely force us out of the position. I went with the August options to give the trade plenty of time to play out, but Friday’s pullback was damaging. Resistance is at $24.75-$25, followed by $25.50 and the 100-day moving average.
Viavi Solutions (VIAV, $6.71, down $0.38)
VIAV September 7 calls (VIAV160916C00007000, $0.37, down $0.18)
Entry Price: $0.55 (6/23/2016)
Exit Target: $1.10
Stop Target: None
Action: Support at $6.80-$6.75 has been stretched, and there is risk to $6.50 and the 50- and 100-day moving averages on continued weakness. However, a mini “golden cross” between the two is close to forming. Near-term resistance is at $7-$7.25.
Editor and Chief Options Strategist
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