A Trade to Protect You if the Market Crashes

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Editor's Note: Sam Collins will be on vacation through June 25. Filling in for him are two other top technical analysts, Chris Johnson and Jon Lewis. 

The market couldn't be more fickle during the last few trading days as the bulls and bears are locked in a low-volatility game of "chicken." The benchmark indices finished the day mixed as the Dow Jones Industrial Average ( DJI ) finished higher, and the Nasdaq ( NASD ) and S&P 500 ( SPX ) ended the day lower.

As has been the case all week, the major sectors were mixed, with five ending up and five down. The strongest sectors, relatively speaking, were the telecom (+0.6%), consumer staples (+0.3%) and materials (+0.1%).

As sad as it is, the FOMC meeting results was the best chance that the market had to grab a catalyst to rally today, though we will see some actionable reports tomorrow before the open as we'll get a look at durable goods orders (consensus expects -1.3%), durable goods orders ex-transportation (consensus expects 1.3%), initial unemployment claims (consensus expects 460,000) and continuing unemployment claims (consensus expects 458,000). 

With market sentiment taking a negative tone, a mix of in-line reports would be enough to get this market to poke back above the critical technicals it recently dipped below. In case that's not the outcome tomorrow, let's look at the likely downside scenario.

The SPX failed to move back above the psychologically and technically significant 1,100 point today, increasing the odds that a trip back to the 1,050 level (some 12% below today's close) may be in the cards. These odds are now on the rise as a few of the pre-earnings season reports are hitting the tape, with little to be bullish on.

After Wednesday's close, Bed Bath & Beyond Inc. (NASDAQ: BBBY ), Herman Miller, Inc. (NASDAQ: MLHR ) and Paychex, Inc. (NASDAQ: PAYX ) were trading lower on earnings results. Not a good start to the pre-season reports. We expect to see an increase in the pre-season announcements next week, adding to the volume and volatility in the market.

OK, so where does this market appear to be headed? Well, the downside risks are now growing, which means that the options traders in the crowd should be considering some put protection. 

What do I mean by that? Well, by purchasing puts on the SPDR S&P 500 (NYSE: SPY ), PowerShares QQQ Trust (NASDAQ: QQQQ ) or iShares Russell 2000 Index (NYSE: IWM ) shares we can effectively hedge a portfolio against market declines over the short run.

In today's case, I would suggest that options traders look to leverage the potential 10% decline in the S&P 500 over the next few weeks by purchasing the SPY July 107 Puts ( SPY   100717P00107000 ), which closed the trading session on Wednesday at $1.84. This option would provide a degree of leveraged protection against a move by the SPX to the 1,050 or lower levels.

We're starting to prepare for the worst, while trying to expect something better. On that last point, it is not out of the possible outcomes that we could see the SPX break back above the 1,100 point tomorrow, which would excite the sideline buyers. This backs up our perspective of the current technical picture as "trading in no man's land" for now.

The bottom line is that we need a decisive move, to the upside or downside, over the next few days to provide the indication of whether the next 10% move in the market will be higher or lower. Tomorrow may be the day to provide this directional move.

We're certainly standing at the ready to initiate a new string of option positions to benefit from the impending move in stocks. We'll do our best to keep you under our wing as we open these new positions. Trade well.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks


Sam Collins

Sam Collins

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