S&P 500 In 'Buy The Rumor, Sell The Fact' Mode

Includes: SPY
by: Robert Schroeder

The S&P 500 (NYSEARCA:SPY) is 90 points off the 1340 low it made on Nov 16. What has really changed since then, though? Well there is the "Santa Claus Rally" that we hear about every December, but mostly, the S&P 500 is trading directly off news on the Fiscal Cliff.

The Fiscal Cliff would result in roughly 600 billion in tax increases. While optimism remains that a deal will get done to avoid going over the cliff, whether it does or not, I believe the market will correct and the result will be an aggressive selloff over the next few months. Of course, if there is not a solution or if they "kick the can," it is just delaying the inevitable, since the problem is most likely only going get bigger. I think almost everyone agrees that no solution is bearish for the stock market. Either way the fundamentals are set up for a significant change in trend no matter what the outcome is, in my opinion.

On a chart the S&P 500 is also running into resistance at its current level of 1430. There were 3 tops made over the last 2 months near these levels, on Oct 23 (1433.25), Nov 2 (1431.50) and Nov 7 (1431.75). All 3 times the market traded at these levels, it failed and resulted in a selloff. I am looking for the same thing to happen again.

I understand that going short the stock market is not for everyone, and should only be considered by the more sophisticated and experienced investor. However, I am recommending to my clients that are currently long the stock market to consider going flat. In almost every trade, a client should consider risk and reward. Right now I believe that the risk is larger on the downside than the potential profits from these levels.

A specific way I am playing this forecast is the following option strategy in the Emini S&P Future Options (ES options). I am going to sell a Jan strangle and use that money to buy a March put. Specifically, I am selling both a Jan ES 1350 put @ 7.50, Jan 1475 call @ 7.00 & buying a March 1350 put @ 21.00. If filled at these current prices, the total cost is 6.50 points ($325). However, please keep in mind the ES call is completely naked and has unlimited risk to the upside. Personally, I am comfortable being short futures from 1475, as at that level I believe the S&P will be severely over bought. Lastly, this spread trade involves 3 different options which results in 3 separate commissions. Please consider these risk before you place the trade. Feel free to contact me with any questions or comments.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.