Use Options To Cash In On The Next Selloff

| June 6, 2012 | 0 Comments

Stocks have been bruised and battered by a barrage of negative news lately.

The S&P 500 is down 10% from the bull market high of 1,422.  And it’s in danger of falling much lower.

You see, the S&P closed below a key technical support on Friday.  And the last time the large cap index fell below this support, it fell more than 14% in a matter of days.

It’s safe to say stocks are on shaky ground this week.

Take a look at this chart…

S&P 500 Large Cap Index Chart

The support zone we’re looking at is the 200-day moving average (red line).

As you can see, the S&P doesn’t cross the 200-dma very often.  It’s only happened twice in the last year.  And each time it led to a major move in the index.

At the beginning of the year, the S&P broke out above the 200-dma and rallied more than 12% over the next few months.  Clearly, breaking above this level was bullish for stocks.

However, the last time the S&P fell below the 200-dma was in August of 2011.  And it quickly fell an additional 14% after breaking this support zone.

In other words, if the S&P doesn’t snap back above the 200-day moving average in the next few days, we’ll likely see stocks move lower in a hurry.

The question everyone is asking is how far will the S&P fall this time?

A quick look at the chart reveals technical support at 1,250, and 1,200.  So we could see the S&P bounce back after falling another 1.5% to 5.5%.

S&P 500 Large Cap Index

But don’t forget, the last time the S&P broke below the 200-day moving average it sliced through multiple levels of support without even pausing.

If we get a similar result this time around, the S&P could plummet back to the October low around 1,100.  That’s a massive 14% drop from here.

Simply stated, breaking below the 200-dma is bearish.  And it has a history of happening before a major stock market selloff.

Here’s the thing…

Right now market volatility is at its highest level since December.  That means it’s expensive to buy options. So don’t run out and buy a bunch of put options on the SPDR S&P 500 (SPY).

Wait for the S&P to rally.  If it fails to get back above the 200-dma, take a look at buying put options on SPY.  You should be able to buy the SPY options at a better price and that gives you a better chance of the trade working out in your favor.

Good Investing,

Corey Williams

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Category: Options Trading

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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