Last week I made a few highly profitable trades by shorting the QQQQs at the upper trend line via August puts, and covering that position at the lower trend line. Yet, the same trade can be made on the SPY and DIA, but I choose to trade the cubes due to the more reasonably priced short-term options.
This week, we’re seeing a very similar set up as the market approaches the upper trend line. In fact, I have already assumed half my position at the close yesterday in light of short-term overbought conditions, and to get ahead of any potential premature breakdown of the trend as we approach resistance. Here’s how the basic trade sets up under a few different scenarios.
Scenario 1: If the market hits the upper trend line as anticipated, I’ll be taking the other half of my September $45.00 puts on the quad-Qs. I’ll hold that full position until the market pulls back to the lower trend line of the rising wedge. I’ll automatically sell half of my position at the lower trend line, and see how the market trades at its 1-month support line.
If the market breaks down below the wedge line, then I’ll hold my remaining position as I think such a breakdown likely signals a retest of the correction lows. If, on the other hand, the market bounces off the lower trend line, then I’ll dump the other half of my position at the first sign of strength in the markets. The whole trade from upper trend line to lower trend line is likely a two-bagger. (Click to Enlarge)
Scenario 2: Now lets suppose the market doesn’t even make it to the upper trend line permitting me to take the second half of my position. In this scenario, I already have the first half of my position I took at the close yesterday thus allowing me to participate in the trade. That’s why its key in these scenarios to take half of the position near the top of the trading range rather than waiting for the market to rally to the exact top of the upper trend line.
So now that I have at least half of the position I originally wanted I can profit from the pull back by holding to the lower wedge line. In this scenario, I’m still going to sell half of my position and analyze how the market trades at the support line. If it fails the support line, I’ll hold for a 3-5 bagger. If it rallies off support then I sell that other half position for an overall very healthy gain. (Click to Enlarge).
Scenario 3: Whenever taking any position in the markets its also always important to remember that losses often can and will happen from time to time. So in this scenario we consider loss mitigation. Lets suppose that the market reaches the upper trend line as expected, and that after taking the second half of my position the market breaks out above the upper trend line on convincing volume.
Under this set of circumstances, I’ll immediately dump my puts for a very small loss. Yet, if the market break above the upper trend line on very unconvincing volume or on sideways action indicating an attempt to shake out the shorts, then I’ll taper down my position to the original half and continue with the trade until I see a clear break. (Click to Enlarge).
These are basically the three scenarios I see playing out from here making this trade a really easy set up to take advantage of the day to day fluctuations in the market. As I noted above, the same trade can be made on the SPY and DIA as the same rising wedge is set up on both of those ETFs as well. Happy trading.
Disclosure: At the time of this writing, the author holds September $45.00 puts on the QQQQ. The information contained in this column is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.