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The British vote took the bookies and the market pundits by surprise. The bookies lost a bundle and now it's our turn. SPX lost $76 Friday and then gapped open lower this morning and dove to $2001, down $37 on the day. On Friday SPX broke down through the 50 dma and then broke a strong support level at $2040. Today SPX broke the 200 dma.
What about the small caps? The Russell 2000 (RUT) has fared even more poorly than SPX. That fact alone is a bearish signal. Small caps always lead, whether in a bullish trend or a bearish trend. RUT broke its 50 dma Friday and broke down through the 200 dma today, closing at $1090, down $38. But today's price action on RUT broke the August flash crash low. By contrast, SPX remains about $130 above its flash crash lows.
The question on many traders' minds is simple. Is there hard economic justification for this sudden plummet? My answer is no. The bulk of the analysis I am reading addresses the huge uncertainties and uncertain time frames for the effects to be known, much less work through the global markets. Certainly, financial stocks are taking it on the chin because of their currency exchange positions and the huge moves in the Euro and the dollar. But are all of the S&P 500 stocks suddenly worth 5% less? I don't think so. When traders are unsure of the risk and are hearing talk of the sky falling, their first reaction is to sell, watch and wait.
So how should we handle this situation? Even though I don't see the justification, I can't ignore price action. Many trailing stops are being hit. I closed the put spreads in my July and August iron condors today. When I see signs of stabilization, I will replace those spreads. Some have suggested selling call spreads above this market, but I think that is risky. Go back and study the corrections of October 2014, August 2015 and during the first quarter this year. In all three cases, the snap back rally was quick and steep. You don't want to find yourself in front of that train.
One of the things I watch is the long lower shadow on the candlesticks. That suggests many traders are buying the lows of the day and driving the price higher. But don't jump too quickly. Look back at January 20th. That was tempting, but it was a fake out. February 11th was the low. Then March was a strong month. You want to be a little late to this party. Today's lower shadow on SPX was pretty anemic. We may be in for an extended period of pain before the market calms.
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In my last blog, I outlined the trade that I had developed over the past week, the iron condor on SPX with the weekly options that expired today, the 2030/2040 put spreads and the 2130/2140 call spreads. I sold the 2030/2040 put spreads on Thursday of last week, based on the strong bounce off of $2050 that day. Earlier this week, that position looked very solid and I added the 2130/2140 call spreads. I was patting myself on the back. I was confident my put spreads were "money in the bank" and the 2130/2140 calls were far enough OTM to be quite safe.
But then the Brits surprised us and the markets went crazy. When I checked the S&P futures early this morning, they were around $2025. This was after a close at $2113 yesterday - wow! SPX opened this morning and traded down to $2056 in the first ten minutes of trading and the VIX spiked as high as 26% intraday and closed at 25.8%. But intraday trading in SPX was pretty steady and calm throughout the day. This was even more surprising when considering the huge volume spike, up over 100% on the NYSE and NASDAQ. If today had been a normal trading day, I could have easily closed those 2030/2040 put spreads this afternoon for a modest debit. But not today, the market makers didn't want to let me out for a reasonable debit. I would have closed at a loss.
My credit was $325 per contract, so breakeven for the entire position was $2036.75. At that price, my 2040 calls would lose $325 per contract and the position would break-even. About 2-3 minutes before the close of trading today, SPX was above $2040 and I was poised to achieve my maximum gain. I felt like Charlie Brown as Lucy pulled the ball away, and SPX traded down to $2037.41. My 2040 puts expired ITM by $2.59, thus leaving me with a gain of $66 per contract or +10%. That was frustrating, but on a day like today, a 10% gain is blissful.
The iron condor positions in my Flying With The Condor™ service were actually helped by today's pullback; both the July and August positions are up several percent. There is a lot to be said for trading far OTM iron condor positions with 60+ days to expiration.
Where do we go from here? I don't claim to be a global economist, but I don't see what substantially changed today. By Euro Zone rules, this British exit will take many months if not a couple of years. Maybe I am missing something, but I think it was the surprise that spooked the markets. If I'm right, we will see some buying opportunities over the next few weeks. But then, maybe the sky is indeed falling...
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After SPX bounced so strongly last Thursday, the markets appear to have stabilized. SPX has been gaining while RUT and the NASDAQ Composite have been more flat lined. SPX closed today up $6 at $2089 and RUT lost $4 to $1154. Volatility was essentially unchanged today with the VIX rising a tenth of a point to 18.5%. This is a relatively light economic data week, but any economic data is being eclipsed by the vote in Britain about continued Euro Zone membership. We should hear the results here before the market opens Friday morning. I regularly read many financial blogs and web sites, and listen to as much of the financial cable news as I can stomach (too much politics in all of them). My general impression is that everyone is freaked about the possibility of Britain leaving the EU. Of course, both sides have their horror stories if they lose - it isn't obvious to me who is correct. But I'm just a trader, not a macro-economist. What does concern me is whether this is just another "tempest in a teapot" or if the U.S. markets are likely to make a big move either way on Friday.
When the market bounced so strongly last Thursday, I sold the weekly SPX 2030/2040 put spreads, now up 6%. I will close that position tomorrow or Thursday at the latest. SPX at $2040 is strong line of support, but Brexit may test support. At a minimum, it all makes great theater.
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A short time ago, it seemed that the bullish mood of the market was being held in check by the prospect of another interest rate hike at this week's FOMC meeting. But the bears are taking control even in advance of the Fed announcement. SPX lost $17 or 0.8% today to close at $2079. Today's close was in the neighborhood of SPX's December high and just above the 50 dma at $2077. RUT closed down even more than SPX, down 1.1% at $1151. This breaks RUT's late December high and is just above the 50 dma at $1132.
Market volatility tells the story. The implied volatility on SPX, the VIX, closed today at 21%, up four points today alone. VIX opened last Thursday at 14%. From 14% to 21% in only three days is a big move. VIX rose last week as the SPX was still trading higher - a classic VIX divergence. This was the sign that weakness was imminent. Several of my iron condor positions were pressured on the top side last week, but I felt confident in not hedging those positions based on the VIX divergence.
Today's continued market weakness triggered IBD's Big Picture (Investors Business Daily) to move from Confirmed Uptrend to Uptrend Under Pressure.
No significant economic data were reported today. The big kahuna of economic data is the FOMC announcement Wednesday afternoon. Analysts are betting on the Fed delaying the next rate hike until later this year.
Let the Fed watch begin.
