Why Euphoria is worse than Fear

The S&P made new, all-time highs today, and it’s shown its resilience and strength as it catapulted off of the June 3rd lows. The manner in which it traded through overhead resistance, at the 8, 21, and 34 EMAs, and then broke and closed above the 50 SMA, was indicative of how strong the rally was.

Last week was tricky — because of the tight ranges, and price trading between support and resistance. A news-related catalyst was what we were waiting for… but, like every good news-related catalyst, while you can guess where it’ll come from (the Fed, President Trump, China news) you never know exactly what it’ll be.

So, what do you do? Well here are some options (no pun intended)…

Neutral & Conservative Options Strategies

Well, you use the same technical parameters you always do, keeping eyes wide open for the possibilities. I like to keep position size small until I have a bit more confirmation of the direction.

You can also focus on neutral strategies, or strategies in which you can profit if the market moves in a variety of ways. Here’s an example, Henry’s unbalanced butterfly strategy OR his new class on ratio spreads.

Fun Fact: he’s teaching that class this Saturday, if you want to jump in here.

Options expiration in particular has been the main focus in our trading room, and we’ve been looking at pinning plays for Triple Witching tomorrow.

Historically, we usually get a slow grind higher into expiration (we have) and tight ranges (this has been true, depending on the stock you’re looking at).

While this context is important, the question is always…

Where do we go from here?

The S&P has recovered resistance — and my target is $3,000, and then $3,100. The Nasdaq (better known as the ‘modern day industrials’) that typically outperforms, was unable to make a new, all-time high when the S&P did today. For me, this was a surprising development, but with ADBE, MSFT, and ORCL all making new highs, the Nasdaq shouldn’t be far behind.

But… we must remember, the market typically doesn’t go straight up or straight down. And one key market internal I always keep an eye on is the put/call ratio.

The put/call ratio is an important reading that demonstrates market sentiment.

If it’s too low, that means market participants are overwhelmingly bullish — and are loaded up on long calls. If it’s too high, then it’s demonstrating that market participants are overwhelmingly bearish — and a short squeeze is likely coming soon. Remember the rally that began June 4th?

Talk about a beautiful short squeeze… we want to know when it’s coming, so that we can make money off of it! A fierce rally like that, can make up an entire month of sideways action in a few days.

The key piece about the put/call is that it’s not definitive — it’s a great ‘heads up’ — but it doesn’t tell you the exact day it’s going to kick in. But, right now, it’s giving us a heads up. Why is this important?

Right now, the put/call is giving us a heads up that the market is lopsided to the long side — and coming soon, we will have a reversion to the mean.

Be Fearful… When Everyone Else is Greedy

Here’s a daily chart of the SPX and the $PCALL.

If you notice, the PCALL spikes the highest at the lows in the market, and is the lowest, right before the market hits a top. This chart goes all the way back to last year, but you can use this on an intraday basis and shorter term time frames to see the data more clearly.

So, how am I preparing?

I’m trimming off longs, as this is a great area to take profits. I started placing a few bearish butterflies on the indexes (focusing on the SPX, since it has a history of faltering after making a new, all-time high), and if momentum begins to slow and I get some additional triggers, I’ll add some more bearish trades in the indexes.

Right now, my main focus is watching IYT, the transportation ETF, and the Nasdaq (NDX), for any sign of a faltering market.

Remember how I said, ‘euphoria is worse than fear?’

Well, that goes back to the bullishness of the overall market, and market sentiment. When traders get incredibly euphoric, that’s typically when the other shoe drops, and the market corrects… in a big way. I don’t see that quite yet, but we’re close, and I’m watching out for it. The key here is to know that’s how it works, and once you begin feeling euphoric, as if the market will never pullback… that is usually when it does!