Yes, once again, we are having a retracement, and once again, though most analysts won't have any idea about why or where it's headed, there is a very clear reason for this pullback. It has everything to do with Monday's gap-up openings, and it has almost nothing to do with anything else.
Oh yes, I know what you are being spoon-fed by the media. And I wonder, if the market had been going up today instead of down, if they'd be giving you the same story or another one to explain the move in the opposite direction. Actually, I don't wonder. Not at all.
Note that on Monday, the market opened sharply higher, with gap-up openings across the board. Well, almost across the board. In the SPX (the cash) there was no gap showing. But it was obvious that there should have been, and yesterday's pullback made that very clear. You see, Friday's close in the SPX was 1397.11, and that's where the gap should have been if it showed up as it should have. It didn't show up at all, but yesterday's pullback made it clear that the market knew the gap was there, even if the charts didn't show it.
Late yesterday, the SPX bottomed where? It bottomed at 1397.20, just 0.09 (that's 9/100ths of a point) above Friday's close. From there it popped back up in the final minutes to close at 1405.54. At that stage it was looking like that was that. The "hypothetical" gap had been filled or almost filled, and the market bounced off of it as it should have. No big surprise, and it looked like it had marked a short-term buying opportunity, and accordingly, I had done some buying for my option accounts. And I thought I was pretty smart when the market popped off of that level, as expected.
All was good till this morning, when the market took out those lows. So I had to ask myself, what is this about? I thought, how about the Nasdaq Composite? So upon closer inspection I saw to my surprise that not only was there a gap from Friday's close at the 3068 level, an island that had formed, tied to last Thursday's gap-down opening from 3075. That created a bullish island reversal at 3075.32 to last Wednesday's close down to 3070.93, which was last Friday's high.
OK, so bear with me one more minute. What we often find, and something I have written about often, is that the island portion of the gap gets filled, but a tiny sliver of the gap remains intact. That's what has happened so far today. The island has been aborted, and a tiny sliver of the gap remains, as the low so far of 3069.81 is in between the bottom of the island at 3070.93 and the bottom of the gap from Monday at 3067.92. How 'bout that?
The point is that for now, that's the spot to buy, as it marks the perfect level for a short-term low. And that's what I've been doing this morning: buying the SPX at Rydex and writing iShares Russell 2000 (IWM) and SPDR S&P 500 (SPY) puts as that island in the Nasdaq has been revisited.
Yes, I have been adding to bullish positions in the SPX and Russell 2000 because, for one, they have ETFs that I can trade. Second, they aren't as hyperextended as the Nasdaq indices are. And third, I don't really want to be buying Apple (AAPL) here. In fact, I have orders in place to sell short some June calls on Apple. And if you buy the NDX or QQQ, you might as well just be buying Apple.
But the Russell 2000 is another story, and a very tradable one at that. As I explained in Tuesday's column, I had just sold some positions in the Russell 2000 as it had scored new 10-month highs. I certainly wasn't interested in buying new highs and was looking for another pullback. This pullback, which went well below Monday's gap, will suffice for now. I used the weakness to write some distant IWM May puts.
I also added to my positions in the SPX this morning, buying the SPX Fund at Rydex (now Guggenheim Funds) at the morning pricing of 1394.40.
As for the indicators, at least they are improving a bit. The McClellan Oscillator settled yesterday at an almost oversold -81, and if the market closes anywhere near current levels, it should be back below the oversold cutoff of -100.
As for the VIX, it's still nothing to write home about, but the gap-up opening and the pop above 17 are encouraging for the short term. No doubt that gap gets filled in the days ahead. And when it does, I'll become a bit more circumspect about the market, perhaps looking to take some profits in recently added positions. I'm currently holding mutual funds up to 55% invested levels.
Long SPX, high yield bonds, Russell 2000 and precious metals funds at Rydex up to 55% levels. Long junk bond funds at Fidelity up to 20% levels; holding bullish credit and debit spreads in SPY and DIA options; holding bullish credit spreads in IWM puts and bullish short puts in the GLD. Short distant April and May calls in the SPY (a bearish position).