Market Commentary: Major Market Warning Signal Fired

Within the last two weeks, a warning shot was fired by one of the market’s leaders. All of a sudden, Apple broke from the pack, and fell post-earnings.

Word seemed to get out that the stock wouldn’t rally on earnings because it broke a major technical support level by the close of day, right before earnings was released.

Since then, the stock has continued to fall.

When Apple broke the key support line it had hugged and held since the start of the year, a shot rang out to eagle-eyed investors that a character changed had taken place in the market. No longer was the leader in the market rallying on so-so earnings, but now it was taken out by the woodshed and proverbially shot.

It was worth paying close attention to because now, finally, the market has followed by breaking below its own staunch support line. The S&P 500 convincingly fell below its long-trending support that has held firm for months.

Now What?

If history is a guide now, we shouldn’t expect a strong plunge lower but rather a rally back to test the old support line and see if it can hold as resistance. If the line can be recaptured in the next 2-3 trading days, expect an even stronger rally back to higher highs.

Failure, however, to breach and close above the support line – now resistance – would signal that this market has confirmed a meaningful character change from bullish to bearish, and lower prices should be anticipated.

How To Trade It

Should the market fail to recapture its former support line in the next 2-3 trading days, 3-4 month index put options at-the-money are likely to print.

It’s generally best to wait for the test and failure versus buying in the hopes of the bearish confirmation. From time to time the market will dip below a support level, and rally back quickly just to fake out trigger-happy traders. And if it does recapture the broken technical level, a furious rally could eviscerate put premiums. So the next couple of days is the time to watch and wait, and when confirmation is given, then the time to pounce is nigh.

One way of lowering the risk and cost of the puts is to establish bear puts. On the SPX, a 300-point wide strike spread would be a reasonable separation between the long and short put strikes. For example, 4400 long puts, and 4100 short puts could work well without incurring the cost of long puts alone.