On Tuesday, we identified a possible trade in SPY, with the most highly traded ETF sitting on a knife’s edge. Following several massive darkpool trades, we were looking at an hourly close below $452.49 as the catalyst for a bearish put trade into a possible gap fill. That gap: $444.91 through $442.97. Today, at 10:30 EST, we saw our opportunity.
Pictured above: Two key levels of support, and a gap between $444.91 and $442.97.
As a recap, more than $10 billion dollars of darkpool activity was tied to the $452.49-$452.45 price point late last week. This creates a massive supply zone, which can be used to trade off of. In other words — if bulls are in control, this should act like a level of support. However, bears won that battleground today, following a downgrade in US Credit from Fitch. Now, it’s time to capitalize on the magnetism of gap fills.
What Are Gap Fills?
Imagine this: A $100 stock reports subpar earnings — almost immediately, shares fall 10% in after hours trading. The stock doesn’t recover by the open of the next day. Instead, they open at $90: The stock gapped down. This happens all the time, and a common theme in charting is the idea that stocks have a propensity for filling these gaps. In this case, filling the gap would be the stock trading back up from $90 through $100 during regular market hours.
Gaps act as a magnet for price activity, drawing buyers and sellers back into a battleground where they weren’t able to participate prior. As a rule, gaps fill about 80% of the time.
So one more time: what is a gap? A gap is a difference in price between two periods of time, where trading did not occur between the two prices. Here’s an example of several gaps in Apple getting filled back-to-back-to-back.
Admittedly, gaps are more commonly filled in individual stocks than in ETFs. However, the SPY ETF is the most highly traded and closely watched ETF in the US market. And as a rule, technical analysis works best when more people are trading on it. With so many eyes on the SPY, and on this gap, we believe this gap will likely fill before the next round of hedge fund dip-buying occurs (which, let’s be honest — probably will happen.)
Yesterday, we noted that you could consider using August 11th $450 strike SPY put options to capitalize on this potential gap fill. Those put options closed yesterday at a value of $1.26. Currently, they trade for $3.03. If this gap is filled by that date, these put options will be worth an intrinsic value of $7.03, plus additional extrinsic value if there’s time left in the trade.
Before you jump in, here is the caveat:
Standing in the Way: Apple and Amazon Earnings
This trade is made a bit riskier because of the variables here. Those variables both start with A, and they’re both two of the most highly weighted names in the SPY ETF. We’re talking of course about Apple and Amazon reporting earnings after the bell on August 3rd. An excellent report from these tech titans could be all it takes to send the SPY back through our $452.49 level. If that happens, and you’re still in the trade — you’re going to have to take a page out of O.T. Genasis’ book and cut it.
However, remember this: It’s never about the earnings result. It’s about the market’s reaction to the earnings result. Just as likely as these earnings sending the SPY higher, is the probability that these earnings are the nail in the coffin for the SPY to fall into the gap.
In short: That means you could gun for SPY to fall during the next 29 hours before these stocks report, or you could wait and see what Apple and Amazon have to say before you judge the market’s next move.
As always, exercise discipline, don’t trade with a high percentage of your portfolio, consider rolling down or trimming a position when you reach 100% profit, and know when to quit if this trade goes against you.
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