How to Trade SPY Through the CPI — 11 Charts, SPY Technical Analysis

Rebel Hub Education

by

Justin Nugent

August 8, 2023
at 5:47 PM

KEY POINTS

Several technical patterns and indicators point to stocks moving modestly lower in August — last week’s bearish engulfing candle on all four indices, and the break of an uptrend established this Summer in SPY and the QQQ are front of mind examples.
Stocks are somewhat oversold (particularly Apple — the largest constituent of both the S&P and Nasdaq), and even with the bearish indicators, bull market pullbacks often come packaged with dead-cat bounces.
SPY has gaps above ($455.49-$453.52) and below ($444.94-$442.97), and with an important CPI coming in on Thursday morning, it may be best to wait and see what the market’s reaction is to the CPI before making a directional trade.
If the CPI is a bullish, cooler-than-expected surprise, you could consider making a short-term bullish options trade in the SPY with upper targets of $455.49 (the top of the upper gap) and $459.44 (the 52 week high).
If the CPI is a bearish, hotter-than-expected surprise, you could consider making a short-term bearish options trade in the SPY with lower targets of $442.97 (the bottom of the lower gap) and $431.72 (the August 2022 high).

Despite today’s small pop in the market, there lies a potential to head lower from here throughout August — with of course a few tradeable bounces in between (one of which may come toward the latter half of this week if the CPI comes in cooler-than-expected). Let’s talk about the technicals we’re seeing. First, I’ll note that the SPY, QQQ, DIA, and IWM all closed with bearish engulfing candlesticks of increasing volume last week. Additionally, we’ve seen bearish unusual options activity building in each of the indices targeted around September — which is likely where this short-term bearish trend could extend, considering September is historically the market’s worst-performing month.

We aren’t alone in our short-term bearish view — one of the market’s best-known bullish analysts, Fundstrat’s Tom Lee, sees a pullback in the cards for August.

In technical analysis, we often look for more than one signal to confirm our thesis. Likely for us, we have plenty in this market. As one example, let’s look at the breakdown in the daily uptrend dating back to the Summer in the SPY and the QQQ.

Notably, this isn’t a break in the yearly uptrend, and this isn’t a sign that we’ve hit the high of the year. It’s simply a time to look for some bearish trading opportunities. And we can do that by looking at technical levels in the market, darkpool trading activity, the VIX, RSI, and more. Let’s get a little deeper into some individual charts that might help us chart our path through the August trading environment.

The VIX — The “Fear Gauge”

Before we talk about the SPY, I want to talk about the VIX. After consolidating in the 13-14 range for a long period of time, the VIX has broken higher. However, there’s an obstacle in the way that I expect to impede the VIX’s rally, at least for a time: an area of resistance around 17.25. This zone has acted as a support or resistance 9 times since the Summer began, and while I do think it will ultimately break through, I expect the VIX to test this area and then be rejected from it before it can do that. Additionally, the RSI for the VIX is reaching an overbought level not seen since before the Summer.

When it does ultimately break through, I’m looking at 20 as the next level for the VIX to rally towards. 20 is a considerably stronger level for the VIX that has been tested time and time again throughout this year, and through prior years as well.

The VIX is important because it often runs in reverse correlation to the SPY and the broader market. When the VIX is rising, the market is (usually) falling — and vice versa. So whether you’re trading the VIX directly or using it to guide your trades, you’ll want to keep these two levels in mind, with the 20 level being a great place to take profit on short SPY trades or long VIX trades and then reassess the technical landscape.

In my view, it’s easier to use the VIX as an additional confirmatory tool in trading the SPY, so on that note, let’s look at a few SPY levels.

SPY Levels

Before we talk about technical levels, I want to draw attention to something that’s at least moderately bullish — huge dark pool dip buying.

On Friday, we saw a ridiculously large dark pool buy at the $449.03 level — from a single buyer — for a total value of $5.6 billion. We talked last week about how a dark pool print above $2 billion is notable, so keep in mind, a print of $5.6 billion is exceedingly rare. Dark pool activity is about more than simply indicating the potential directional appetite of institutional traders — it’s about identifying big areas of supply and demand in a particular stock. When the stock is above the print, these zones can act as demand zones — areas where there is demand for a stock at a certain price, creating a form of support. When stocks break below these areas, they can turn into supply zones, which could act as a form of resistance. Notably, we’re currently hovering about $1 above the dark pool level identified above. These aren’t as key as firm areas of support and resistance, but as unusual options activity traders, we think dark pool trades are at least interesting enough to keep on your radar.

Outside of that, there are a few other levels in the SPY to keep an eye on. Most notably, there are two unfilled gaps in recent trading: One between $444.94 and $442.97, and another between $455.49 and $453.52.

As we’ve discussed before, gaps can act as magnets for stock market price action, and are very commonly filled as time goes on. Eventually, I expect both of these gaps to be filled in short order. If the lower gap is filled, I expect that $442.97 level to act as a form of resistance for buyers who were waiting for this gap to be filled before diving into a dip buy. However, if the Thursday CPI comes in with a bearish surprise (that is, hotter-than-expected inflation numbers), there’s a very important lower level that I believe we could retest: $431.73.

This level is really important for two reasons. The first one is simple — it acted as the bottom-level resistance in the cup and handle pattern that formed in late June, which helped lead us higher.

The second reason is more important: This lines up with the August 2022 high that occurred immediately before Powell’s legendary Jackson Hole speech, roughly a year ago today.

Before the market broke above this level, many analysts predicted that the market would top out here. That didn’t happen, however with the level of importance the market placed on this area over the past year, this would be a very reasonable place for the SPY to retest, and possibly bounce. With that said, even with a horrible CPI, it likely won’t happen in a straight line. In a bull market, you can expect a few short-lived 2-5 day rallies to come in when we get oversold, leading to some short-covering-fueled bursts higher. It’s inevitable, and if you’re looking to make a bearish trade, you’ll want to know where these rallies could take us. Notably, if the CPI comes in cooler-than-expected, you can be sure we’ll be seeing one of those bounces immediately.

I believe the current high of the year, $459.44, will likely be retested when and if that short-term rally takes place, filling the gap between $455.49 and $453.52. That’s about 2% off from where we’re at currently — more than reasonable for a quick rally. You’ll need to be agile here — if we close a weekly candle above that high, it’s possible that we simply continue to rally, invalidating this short-term bearish thesis. However, I think it’s far more likely that we test and reject off of that level, forming a short-term double top, and head lower from there. In other words: A rejection off of the $459.44 level (a red daily candle that reaches that level and then closes below it) would be a great place to enter a bearish options trade in the SPY — but you’ll want to be agile in a trade like this, and pay attention to whether or not the market chooses to respect this area as resistance by monitoring the daily and weekly candles.

The Road Map: How to Trade SPY (Use the CPI)

You have to play with the cards you’re dealt. For me, that means waiting from here to see what hand the Thursday CPI report deals us. Here’s how I’ll be trading the two possible outcomes:

Possible CPI Outcome #1: Cooler-Than-Expected

If the CPI shows lower-than-expected inflation, that would be very bullish. Every CPI report matters in a Fed-driven environment, but I believe this one matters more than usual. Why? Take a look at the CME FedWatch tool, which is a representation of the market’s expectations around future Fed rate hikes and cuts.

Source: CME

The market currently sees an 86.5% chance of a Fed pause in September. As you pan out to the later months, the market predicts that the Fed will begin cutting rates in 25 basis point increments at the March meeting, and then again at the May meeting. However, as anyone who pays attention to this tool will tell you, these predictions are not set in stone. A CPI that comes in cooler-than-expected will likely seal the deal on the prospect of a pause in September, and will likely convince the market (at least until the next FOMC) that those March and May rate cuts are more likely. This would be bullish for a stock market that cares very much about where rates go, particularly since this could be the end of the Fed rate hike cycle.

The trade I would make: If the CPI comes in cooler-than-expected, I will likely enter 8/18 SPY call options slightly out-of-the-money, targeting the $455.49 level (the top of the upper gap) and the $459.44 level (the 52 week high). Depending on the speed at which those targets are reached, I would likely trim or roll the position to take some money off the table, and reassess the technicals.

Of course, there’s another possibility, which would (in my opinion) lead to a larger move in the market:

Possible CPI Outcome #2: Hotter-Than-Expected

I believe a hot-CPI result (a CPI result that shows inflation above expectations) would likely lead to a much larger market move than the first possible outcome I discussed. It’s likely clear why — the technicals are already pointing lower, we’re in the weakest historical period of the year, the market expects a relatively dovish future from the Fed in which September sees a pause in rate hikes, and moreover, the market is close to pricing in no more rate hikes at all for the foreseeable future. A hot CPI would (at least until the next FOMC) likely reverse that expectation.

In other words: If there’s one thing the usually market hates, it’s a surprise. With that said, here’s what I would do if the CPI comes in hot.

The trade I would make: If the CPI comes in hotter-than-expected, I will likely enter 8/18 SPY put options slightly out-of-the-money, targeting the $442.97 level (the bottom of the lower gap) and the $431.72 level (the August 2022 high). I would likely roll or trim the position at $442.97 in preparation for a possible bounce at the bottom of the gap — but if CPI is particularly bad news, I think it’s highly likely that we retest the $431.72 August high, and that’s what I would be positioning for in my trades.

Two Rules to Trade Smarter

Here’s an important caveat I add every time I talk about a particular trade I’m considering: discipline is the number one most important thing to arm yourself with when considering an options trade.

For me, discipline means having a plan before I click “open” on a new position. A plan on when to sell for a profit, and a plan that tells me when I’m wrong, and need to cut my losses and move onto the next trade. For me, I often roll or trim a position at 100% profit, and I often cut the position at a 50% loss. In other words, when a position doubles — I take the money I started with off the table, and continue trading with house money. And when a position is cut in half, I don’t wait around to see if the position will improve — I take the half that’s left, and move on, because I know there will always be another trade. These two tips have helped keep me alive throughout my trading career.

Additionally, a trading plan should also tell you exactly how much of your portfolio you’re willing to risk on a particular trade. A common figure used by professional traders is the 1% rule — meaning no more than 1% of your portfolio should be risked on a single position. For some people with smaller accounts, maybe that’s 5%, or 10% — that’s okay, it’s just important that whatever that figure is, you stick to it. Being consistent is how professional traders make a living — and it’s how you can trade smarter.

Above, we talked about how the smart money was positioning into put options in three of the indices targeted for September, with all three tickers trading above where they are now. Want more unusual options alerts, trade ideas, and technical analysis every week? Try a month of UOA below.

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