Hey There Income Hunter,

Fear is back, baby!

And the bears are attempting to come out of hibernation.

This  is a critical pivot area in the market and a mistake in positioning here could be costly.

Longer-term the bulls are still in control, but yesterday’s VIX eruption signaled interest in buying protection. That means buying puts below the market as an insurance policy on negative news for markets. 

Next week is big with a massively important CPI on Tuesday and a large option expiry on Friday.

It’s time to plan your trade and then trade your plan … 

Today, I’ll share the fundamentals, technicals and option positioning that led me to my plan.

Fundamentals

I pay close attention to CEO surveys because they are the most forward-looking indicators for taking the temperature of economic activity.

The chart below illustrates the CEO Confidence Index measured by the Conference Board. 

The most recent jump from 32 to 43 has resurrected the survey from levels that have triggered recessions in the past (shaded areas).

Technicals

For every trade you execute, you should have the fundamentals, technicals and option positioning align on your side. 

So far, the fundamentals are bearish but may be turning more positive. As you can see below, the short-term technicals are bullish but longer-term are bearish …

Key Technical Indicators

• • • The 20 month moving average, which is above at 4220. The rally into August of last year breached the 20-month MA but failed and traded back down to the uptrend line (pink). SPX is just below it now. 
    • The trendline breakout occurred at 4000, so a backtest of that trend is possible before heading higher.
    • The breakout coincided with a cup-and-handle breakout, which is a very bullish pattern. 

Option Positioning

Option positioning is measured by analyzing gamma, which is the change in delta for a 1% move in stock. 

When traders buy and sell options, option dealers take the other side and delta-hedge their option exposure with the underlying stock. 

So depending on the gamma risk in their trading book, dealers must rebalance their delta hedges. This can have a large impact on equity prices. 

The chart below shows the current absolute gamma at each strike for SPY. The larger the gamma risk is at each strike, the larger impact that strike will have on trading. 

In other words, the largest gamma strikes act as a wall for stock prices and become excellent support and resistance levels. Once breached, momentum can accelerate, providing fast profits.

Notice the size of the 400 and 410 strikes. These two strikes provide major support and resistance heading into the CPI report on Tuesday. 

The 400 strike coincides with the SPX cup-and-handle breakout level. A couple of closes below 400 would turn technicals decidedly bearish.

Then if the CPI report on Tuesday reveals higher inflation, we will have the three indicators align on the bearish side …  

The Bottom Line

• • • Fundamentals are bearish but turning less so
    • Technicals are medium-term bullish but long-term bearish
    • Option positioning is neutral 

I believe these offsetting conditions will resolve themselves in the weeks ahead. My plan is to have long energy and metals positions expiring in May (long-term) and short Equity index trades expiring on Friday (short-term). 

Yesterday I executed a SPY FEB17 put spread near the 408 level.

I think the market may trade down on Monday, but Tuesday’s CPI report could be a game-changer.

Stay tuned next week for a recap on CPI and a review on option flows and macro market movers.

Until then …

Live and Trade With Passion My Friend,