After what has been a poor start to 2022, markets have rebounded sharply in the last week or so, as waves of short covering has pushed prices almost back to the all time highs and also the levels pertaining prior to the invasion of Ukraine.
The “most shorted” stocks in the US saw a 17% gain in one week, testifying to the extent of bearish consensus that had built up. VIX, the Index volatility indicator, also plunged, leaving it 7 points below the level it traded before the Russian invasion.
It is almost as if none of this military action happened!…
…But of course it did and even if Putin backs down and oil prices ease, the long term issue of inflation will remain.
The Fed is, belatedly, looking to raise rates, up to 7 times in 2022, which, if it happens (extremely unlikely), will have a crushing effect on equity valuations, as the tailwinds of Quantitative Easing become severe headwind and the West would be back in a recession, though without the tools (i.e. QE) to confront it.
Prices appear to have stabilised in recent days, as bears are now reluctant to short, clearly fearful of being steamrollered again.
This presents a relatively low risk opportunity to prepare for the next downturn, as not much, (apart from prices), has changed in the past 10 days or so. A re-test of the lows around 4100 seems very likely, though probably not before June.
The obvious chart resistance above is around the 4574 level, which would represent an 59 point risk of loss, which is too high for comfort; but it can be mitigated using options. As of today (25th March) option volatilities have fallen below 20%, which in the current context, looks cheap.
A ratio calendar spread would involve buying a 4575 put (currently at 194) and selling a 4450 put at 145 and selling another put with a 4100 strike at 69.6.
This gives a net profit of 19.5 points, provided that the Index does not go below the lower strike (4100 on the S&P) by mid-June.
Any expiry between 4200 and 4400 generates a return of between 195 and 200 points with losses beginning below (4100-69.7 =) 4030. If the markets rise above the 4580 resistance level, the investor will keep the net 19.5 credit, though selling the long put position might be indicated by this move.
This may not be profitable in the very short term, as it often takes traders a while to adjust positions and re-establish short positions.
But the speed of that rise strongly suggests that there are very few left who are positioned for a renewed fall (i.e. short), which might mean little resistance to lower prices.
Although there is a support line around 4270 (see above), the real test comes at the 4100 lows- a break below there and things will get “interesting” very fast.