Andrew Keene, of AlphaShark, offered CNBC's Trading Nation
a daily chart showing why he thinks the SPY ETF is overbought.
The chart shows two rallies off of August lows, with the July lows now offering resistance, and he expects the market to head lower.
Next is a weekly chart showing the potential for a breakdown in the 50-week moving average. Keene says his downside target is 194. The trade he recommends is a put spread composed of the purchase of the Jan 200 SPY put and the sale of the Jan 195 SPY put for a net of $1.20. Thus the risk is $120, and the potential reward is $5.00-$1.20 = $3.80, or $380.
He points out that if the SPY ETF gets to 195 or lower, the return would be 300%. Keene is not predicting a huge market correction, but he thinks the market is overbought short-term.
This writer would point out that Keene is not, in fact, shorting stocks, but rather adopting the conservative strategy of using the SPY ETF to define his risk so that he can’t lose more than $120 if he is wrong. If, for example, a trader shorted the S&P 500, s/he would face an unlimited risk of loss if the market rallied strongly, with only limited potential for gain.
Here are some reasons to question Keene’s strategy. One is that strong Apple (AAPL) earnings may set the tone for a year-end rally that Wall Street would dearly love to have in order to support generous year-end bonuses and maybe save some jobs of portfolio managers who have underperformed this year.
Another is that other commentators have observed that formations such as the one Keene displays are often resolved to the upside. An argument in favor of Keene’s position is that while a handful of tech leaders has reported strong earnings, the breadth of the market has been quite narrow, so that it is vulnerable to a correction.
Thus, part of the reasoning process should be to look for a bull strategy and see how it stacks up next to Keene’s idea.
In the future, I will look at the bull case, and nothing precludes a trader from trying both.
There is even time for both to work before January expiration or to consider a February put spread to allow more time.
There could be a year-end rally followed by a correction after the seasonally strong period that ends around January 5.
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