The March 1st deadline is coming up and on this date, unless Congress does something, the automatic spending cuts that were originally scheduled to take effect at the beginning of this year kick in. The idea behind this legislation when it was signed by the President in August of 2011 was to force our elected officials to cut the federal budget in a more efficient manner.
But the equity market has not seemed to be too upset with the uncertainty. Well, not yet. The S&P 500 (SPY) keeps grinding higher on very low volume. Investors are focused on economic data and that the Federal Reserve is likely to keep interest rates near zero for the foreseeable future. Given those factors, the market has been taking the path of least resistance. The question is, what is drastically slowing the momentum of the rally?
Although the S&P 500 is up 6.6% already in 2013 after being up 13% in all of 2012, the momentum has drastically slowed, and I believe it is possibly being caused by uncertainty creeping in because of the lack of resolution throughout Congress.
Monday of this week, the S&P was down approximately 1 point, followed by going up approximately 2.5 points on Tuesday. On Wednesday, it closed up approximately 1 more point, and Thursday was relatively the same. Although the net changes have been small, the trading ranges have been even smaller relatively. Monday there a range of less than 5 points, Tuesday just over 6.5 points, followed by around 9 points Wednesday and Thursday. These are historically narrow trading ranges. In fact, the S&P has had a smaller trading range than Monday only 11 times in the past 5 years.
These small trading ranges and the lack of both volatility and momentum signal to me that a top might be in the extremely near future. At the very least, I think the risk to the downside far outweighs the continued potential gains. There is no denying the strength in the market as of late, but taking some profits, trailing some stops or buying some put options could be prudent.
I am playing the potential market top at these levels by buying a bear calendar put spread in the Emini SP futures options markets. One of the most difficult things to do in any market is predict an exact top or bottom. Plus, I do not anticipate the market free falling if and when it starts to decline. The key is having the time on your options to catch the potential move. Therefore, I am buying June SP 1300 puts (17.50 points current price) and selling April SP 500 puts (7.00 points current price) for a total debit of 10.50 points for a total of $525 (+ 2 commissions & fees). For those traders not comfortable with selling options or doing spreads, outright buying the SP June SP 1300 puts for 17.50 or $875 is also an recommended strategy. If the market does continue to move higher and you take profits or buy puts at these levels I believe a pullback sometime is inevitable and will give you an opportunity to get back in at lower levels. Markets rarely go straight up or straight down, and it is hard to argue that the daily chart is representing overbought conditions.
Disclosure: I have no positions in any stocks mentioned, however, I may initiate positions in SP puts at any time.