Two weeks ago, I pointed out what appeared to be the early stages of a new trend of outperformance by the financials and suggested they might be primed for a move higher to rescue the stumbling stock market. Right on cue, money rotated back into financials and we saw the Dow Jones US Financial Index rally nearly 10% in one week, breaking out above its May highs. That spurred the S&P 500 to its highest level since mid-October 2008. Therein lies the problem. We've now retraced much of the collapse from late September and staying aggressively long at key resistance is not a good reward to risk proposition in my opinion. The S&P 500 may ultimately break out and move higher, but let's deal with that when and if it happens. For now, check out the resistance on the S&P 500 chart below:
In addition to the price resistance, I've also plotted the 5 day moving average of the equity only put call ratio at significant short-term tops and bottoms in the S&P 500. Any time this average drops below .60, a red flag is raised in my view. It doesn't mean the S&P 500 will top as complacent readings have erred in the past. However, it does make me aware of a possible short-term trend reversal. Given the critical price resistance that the S&P 500 is battling right now, the significant number of net in-the-money calls that exist just one week before options expiration, and the rather complacent equity only put call readings of late (just hit .56, a 2009 low), we removed all exposure on the long side on Thursday and actually began shorting using a juiced ETF. I feel the timing is right because we're at critical price resistance. If the S&P 500 breaks out, it's a quick minor loss and we'll be back to cash looking for other opportunities.
Every month at Invested Central, we host a "max pain" chat the Sunday night before options expire. This Sunday is no different. Because there are so many stocks currently trading above their "max pain" levels, we'd like to invite anyone interested to join us as we discuss the theory behind "max pain" and its usefulness in trading during this one week free-for-all. If you'd like to join us Sunday night, simply click here.
Happy trading!
