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Is It Time To Sell SPY, Or Perhaps Just Buy SPY Put Options?

Jul. 15, 2013 4:43 PM ETSPY, VIXY, SPLV, SPYG, SPYV, XIV
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So, S&P500 (SPY) closed at an all-time high again on Friday, Earning guidance revisions by S&P500 companies are near a historically negative record, and yet pessimism as reflected in the AAII sentiment indicator is at the lowest level in a year and a half, interest rates are still near 30 year lows and by most accounts we have started our (multi-decade) interest rate tightening cycle, VIX volatility is at a 6 week low and certainly at historically low levels.

Lets unpack the numbers:

  1. S&P500 has closed at an all-time high again both Thursday and Friday - this does not mean you should buy or sell, but is often a good time to take some profit or to hedge against taking profit.
  2. The Forward P/E of S&P 500 rose to 14.3 on Friday only 5% away from the 15.1 pre-2009 crash Forward P/E of S&P 500 on the October 14, 2009.
  3. Pessimism has now reached its lowest level since Jan 2012. Normally the AAII Sentiment Survey is a contrarian indicator meaning you should do the opposite of what general sentiment tells you to do.
  4. Quantitative Easing is soon to move to a tapering phase, which means the trend of easy money and low interest rates for consumers is likely to be reversed at some stage soon, this is typically negative for both company earnings and the Price/earnings ratio.
  5. The sector forecast to have the highest earnings growth rate in Q2 is Financials which often have earnings that move in synergy with the market.
  6. The recent trend in revenue and earnings guidance for Q2 and Q3 has been bearish. As of Thursday, for Q3 2013, 8 companies have issued negative EPS guidance and no companies had issued positive EPS guidance.
  7. Company issued guidance is near the most negative level on record this also ties to the record high number and percentage of S&P 500 companies issuing negative EPS guidance for Q2.
  8. Based on corporate commentary, much of these downward revisions is due to problems overseas, particularly in Western Europe and the big emerging markets. These results are likely to weigh heavily on many of the S&P500 companies for the forward quarter.
  9. From a technicals perspective, trend lines and the MACD indicators are still positive, but the RSI at 65.08 appears overbought, on Friday which is a leading indicator of a potential profit taking dip.
  10. The (VIX) index, which in a nutshell measures the aggregate 30 day premium of the out of the money S&P500 (SPY) options is at a historically low level, which means that the market has discounted the premiums of out-of-the-money options and is not expecting wild fluctuations in the S&P 500.

Based on the above, although the market can remain irrational far longer that we would often expect, from a fundamentals and short term technicals perspective, I would continue to remain cautious of the potential downside, and limited upside to the S&P500. At this point rather than short SPY, it may be worth hedging your bets by purchasing a couple of the out of the money put options. Judging by historical VIX levels, these put options are trading at lower premiums than the norm, and give one extremely large upside if markets do turn negative.

Right now, the SPY $167 August 16 Put options are trading at a level of only 1.94 - in my opinion, definitely justifying the premium, but time will tell!

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