UPDATED - April 30, 2020
The pull-back in the SPY today makes sense given yesterdays' strong push into overbought conditions. Given the overall momentum, it's reasonable to expect another hard push to the upside. That being said, we're still going to wait this out. I do think the best way to exit this position that we're holding is to either dollar cost average the position at $300 or simply wait for the inevitable correction to come – whichever comes first. First, we can wait for the SPY to make its attempt to break $300 on the next up cycle and then buy when it becomes overbought again. Then when the SPY inevitably retraces back to the low $290's due to overbought conditions and earnings season getting behind us, we exit the entire position at even or with small gains. The overall cost-basis of our trade is just under $27.66. Right now the the position is trading at $23.35 at $290 exactly. If we bought at $18, it would reduce our cost-basis down to $23.50. Our position pushed as high as $24 at the lows today. So I'm thinking we should be able to exit with minimal damage if we go that route. The other way to exit is to just wait. Remember, the SPY is up almost 35% in 26-27 days. That's a MASSIVE move to the upside even with the crash. We will eventually retrace some of that due to the short-term nature of the rally. That's even if the market decides to go full v-recovery which is just unfathomable. But let's assume that's the case. Let's assume the market decides to completely ignore all economic data and pretend Covid never happened and let's assume the market sees 0% risk with a second wave of Covid once the economy reopens. I don't know how anyone can think that, but let's assume the absolute fantasy land best case for bulls. Even in that best case scenario – like we saw in 2019 – there was a pretty substantial correction that hit the market in May-June 2019 after it bottomed in January and went on a 4-month tear back toward the highs. Remember, in the fall of 2018, the market had a mini-crisis of confidence in the Fed, the Fed's interactions with President Trump and with the ongoing trade war. That SPY correction went for 20%+. Apple went down 40% on that correction. The SPY ultimately bottomed right at the turn of the year. Literally bottomed on the first trading day of 2019. It then recovered all of the losses before peaking at the end of April and then giving back 30% of the gains. That was a much much smaller correction though. It took the market FOUR months to rally 26.6%. Here, the market has rallied 35.32% in 5-weeks. After the market rallied 26.6% over four months, it sustained an 9% correction. If the SPY did the same thing here and had the same sized correction relative to the size of the rally, it would be the same as the SPY falling to around $265 from $300 or about 11.7%. Again that's assume the best case scenario V-shaped recovery. If the SPY went all the way back to its highs and then sustained the same correction as we saw in 2019, then it would be the same as the SPY rallying to $337, peaking and then falling to $290. Either way you look at it, this market is going to retrace some of these gains. A big rally like this in such a short period of time always sees a retracement of some kind. Again, that's assuming the best case V-shaped recovery with no retest or double-dip of any kind. No second wave. No market reaction to bad economic data that keeps coming in worse than expected. We're assuming none of that here. Just a normal post-v-recoery correction. For example, even after the market bottomed in 2009 after a 1-year bear market, the SPY sustained a 10% correction in June-July 2009. This is after the market bottomed in March 2009, went on that big rally between March and early June 2009 and then had a summer blip. But I would say that recovery was very different than there. In the financial crisis, the market peaked in January 2008, had a very volatile year and hit its lows in March 2009. Think about that. That's 15-months from peak to trough on the S&P 500. And what's more, the S&P 500 ended up being down 52% from its peak. That was a real bear market. So tough to compare to this 25-day rebound after a 21-day crash. Thus, I think even if the market continued to move higher, there will be better or roughly equally opportunities to exit our position. Even if the market moved back toward its highs, there will be another substantial correction regardless of the context. What we should see in reality is a retest of the lows. We should have seen the market peak at the 50% retracement point and then sustain a second deeper leg lower. The SPY should have fallen to a low of around $180. We should have then bottomed around those levels, set up for a new bull market and then taken about 15-months to get back to the highs. That's how this should have played out. As it happens, that's not how things went. The SPY recovery went way further than expected – to the 62% retracement level now – but that doesn't mean that the entire bear thesis is now lost. No. Even with a bullish 62% retracement, we should still see a big 2nd leg lower. The expected lows of that leg just move up. Instead of new lows, we might now see a double-bottom or a slightly higher low. This is exactly what the chart should look like. Something like this:
UPDATED - April 29, 2020
With the SPY nearing $295, we're down about -21% on the trade overall or about 12-13% -- that's typical for our trades. We have average entry at around $27.66 and the contracts are now trading near $21 or so. We're not really ready to exit the trade just yet. We're going to wait for now. We may trade around our position to reduce our cost basis, but we're not quite there yet either. So for now we're sitting tight. Need to see more trading action in the market. I'm not quite ready to increase our exposure to this short trade but not ready to exit either. We will eventually want to trade around our position to reduce our basis, but given how the market responded to Google's earnings, we need to wait and see. One thing worth noting is even if we completely discount the entire Covid-19 pandemic as never having happened at all -- what the market seems intent on doing here -- the market is still up way too far too fast. For example, in just the 16-days alone, the S&P 500 is up 20%. And in the last 25-sessions, it's up 34%. Those are ridiculously big numbers without a retracement in its own right. Meaning, the rally itself needs a retracements even if this is a new bull market. That would make the Covid-19 bear market the shortest bear market in history at only 21-days. Still, even if this were a new bull market, at a 34% jump in 5-weeks, a retracement is due. So there are good reasons, beyond even if the economic impact and the threat of covid going into the summer to continue to hold our position.
The SPY is now trading at a 72.4 RSI on the hourly chart. The last few times we pushed to overbought conditions on the hourly, we got some pretty sharp pull-backs in the market. I think we're at a critical point in the market in terms of both sentiment and price. Apple's earnings tomorrow is of monumental importance to the stock market. I think the first shot the SPY takes at $300 will probably fail because it will be too far too fast. The SPY was at $272 just 5-6 days ago. That's a $28 move up 10.3% in just 5-6 days. That's way too much as the entire index is concerned. If the SPY does continue to move higher and takes a straight shot at $300 extremely overbought, I think we will aggressively add to our position with the goal of existing our entire position on a pull-back to $290. So for example, if we can buy another 15% tranche position at around $17-$18 and then sell that entire position at $23, we will have mostly mitigate all of the losses. At that point, we would just wait for the next setup. As this trade is concerned, it was a well reasoned trade. It made perfect sense given reality. The market sold-off -36% in just 22-days on the back of Covid-19 pandemic & accompanying economic collapse. The market then retraced 50% of those losses as it rallied nearly 30% up to $278 on no news at all. That made perfect sense. It had done this in virtually every previous bear market. We bought around the $278 area and the trade went against us. But the basis of the trade was very sound. However, at SPY $300 a share, the market is basically telling us that Covid-19 and the accompanying impact is all behind us. That the bear market lasted only 21-days and that all is well now. Whether the market is right or not makes no difference at all. The SPY going to $300 is the market telegraphically communicating pretty clearly that it's going back to its all-time highs. It's only a chip-shot away from $300. It can get to its all-time highs with a 2-weeks of hitting $300. Same within Apple. While we may be back to where we started before the virus even high -- overvalued -- that's nevertheless what the market wants to do. As we are concerned, we will wait for the next opportunity to make money if that happens. One thing we might do after exiting this trade is this. We may consider putting on an 80-20 trade with Apple to the long side for one big reason. One of two things is likely to happen from here. Either the market continues along in fantasy land and will continue to rally higher; or the market will come back to reality and we get our high volatility. That works well in the 80-20 trade set-up. I don't think we are headed to a sideways market. I think given the shock to the economy we've seen, we're very likely headed for volatility -- sharp up or sharp down. And the good news is that the timing couldn't be better. Remember, the Apple 80-20 trade is best placed right after earnings. February 2008 represented the absolute best option prices and conditions we've ever seen. We were able to hedge for cheap -- and since earnings was behind us -- we were able to buy intermediate-term options without overpaying for an earnings premium. For example, after Apple reports earnings, we could buy July spreads that expire more than 2.5 months from now but without having an earnings premium. So we may shift to an Apple trade after Apple reports earnings. There's also another really good reason to go into an Apple trade once we exit this trade. If Apple goes higher on earnings and breaks above $300, it's pretty much going to all-time highs. So we can ride that momentum train back to the highs. For example, if Apple reports earnings and pushes to $305+, then we're going to the highs. There's no chance Apple is going to rally from $212 to $305 and then stop there. That's not going happen. So an 80-20 trade makes sense from multiple points of view. The VXAPL is only at 38 now. While it's high from a "normal" environment standpoint, the index is now more than 60% below its highs of ~100. Also, a 38 on the index is just about where the VXAPL trades going into earnings. Usually when we get a good response to Apple's earnings, the index collapses. A really low price for the index would be sub-20. That's when the options prices tend to be very optimal. Now the flip side to all of this is if the market moves lower. If we don't get a surge to $300 on the SPY on the back of Microsoft, Facebook and Apple's earnings, then we will continue to hold our position. I think $300 is basically the line in the sand for the market. If the SPY goes above it, bear market is over. If it doesn't, then there' still life in the Covid-bear trade.
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