Market Drop Was Right On Cue – Here Is How I Am Trading Options Today

August 19, 2021

Posted 9:30 AM ET – The market was poised for a drop and I have been urging readers to trim long positions heading into options expiration. The FOMC minutes will be blamed for the market decline, but the signs of selling pressure were present Tuesday and Wednesday before the release. I updated the day trading section below, but the general comments from this week are unchanged.

The last leg of this rally has come on very light volume and those gains can easily be stripped away. August is a seasonally weak month. This year I have noticed that we typically see selling into the monthly options expiration (Friday) and I believe that trading programs have been able to successfully force put sellers to cover positions. A daily SPY chart reveals that when the market has floated to a new high and the daily candles are small, we see a quick round of profit taking that tests the 50-day MA.

China’s economic numbers are soft and the PBOC is going to ease in Q4. Ships are cued up in China waiting to come to port and new Covid regulations are dramatically slowing the cleaning process. Part of China’s market decline can be attributed to the Chinese government regulating tech companies and there was negative overnight news on that front. China is the “canary in the coal mine” and I am watching their headlines closely.

The Delta variant is spreading rapidly in the US and vaccinated patients are catching the virus. Many states/cities are shutting down and the travel/restaurant industry is restricting service for non-vaccinated patrons.

Corporations are flush with cash and on average they have 45% more cash holdings than they did a year ago. Almost $7 trillion sits on the sidelines and that tells me that they are preparing for a soft patch.

The Fed does not plan to reduce asset purchases until the middle of 2022 and that is extremely dovish.

Should longer term swing traders buy puts now? No. Swing traders who have followed my advice are sidelined. The best trade will come on the long side after the market has pulled back and established support. We do not want to short a 15-month bull market rally when central banks are dovish. The market drops have been fast and furious. They do their damage and only last a few days. The snap back rallies have been violent and shorting is only for nimble traders. Stay sidelined and wait for that market drop. I believe the table could be set for one of those quick market drops. Swing traders who have been selling bullish put spreads (or who have long exposure) should exit those trades now.

Day traders should look for a test of the 50-day MA before the close Friday. Yesterday the FOMC minutes revealed that members had discussed a reduction in asset purchases. Was this really a surprise? For all of the reasons I have been mentioning above, the table was set for a drop. In my comments yesterday I mentioned that the most likely scenario was an early rally that would test the high from Tuesday. A failure to fill the gap from Tuesday would result in selling pressure and bullish speculators would get flushed out. This morning the best scenario is an early bounce that tries to recover some of the losses overnight. If this happens I suggest looking for stocks that have breached major technical support overnight and that are substantially below that support. That is where sell stops will be triggered and those stocks are likely to see sustained downward pressure. Those key support levels are typically where traders sell out of the money bullish put spreads. Once that support is breached, traders will be forced to cover (buy back the put spreads). This will fuel the move lower in those stocks. If we get the early market bounce above SPY $436, wait for signs of resistance and start buying bullish put spreads that are ATM and that expire Friday. I suggest not paying more than 35% of the difference in the strike prices. This will give you a chance to make twice as much as you are risking on the notion that we will see the 50-day MA tested on the SPY. This is how I am playing it today. There is no way that the market fills in a 35 point overnight gap. The downside will be tested today.

Support is at SPY $433.30 and $436. Resistance is at $442.
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