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Market Prep + Thesis Development

Updated: Mar 17

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Congratulations on surviving another frothy Options Expiration (OpEx) Week. Who's ready for FOMC?! Truthfully, I am not. I'm admittedly distracted by the "bigger picture." While others appear to be content enjoying the current stock market euphoria, I can't stop thinking about what things will be like later this year after the US Elections. This week's Market Prep post is going to be a little different. I'd like to briefly acknowledge where the market currently is and how I plan to approach it this week, but I'm going to spend most of this article building out a hypothetical trade thesis in order to ensure I'm prepared for whatever happens later this year. I'm growing increasingly concerned about a peaceful transition of power. Whether that's a continuation of the current administration or a party change, as traders/investors there's reason to suspect the current partisan division in the United States could get worse and since trading is a forward-looking activity I'd like to spend some time looking forward at sectors/trades that could position me well in the event of civil unrest.

 

I turned bearish this year after SPX finally hit 5000. My futures trading wasn't going very well, so I closed the ES DOM to take a step back and focus on my swing trading. After missing much of the AI-driven rally off the October lows, I became determined not to miss another major narrative-driven move again. My thesis for flipping bearish involved 2 major assumptions:

  1. The AI-fueled euphoria is closer to finished than beginning

    1. I'm speculating that AI will unfold like the "DotCom Bubble" did; the real work in developing AI will occur while the AI stocks decline over a period of many years due to Wall St. already "pricing in" future returns.

  2. Market and Social Volatility will increase as the election nears

    1. While the market is currently uninterested in downside protection, I do not anticipate that will remain the case prior to such a unprecedented election (i.e. lack of traditional debates with frontrunners, increased censorship, the unrest in the prior election reaction, etc.)


While we are seeing more signs that Assumption 2 is holding steady, Assumption 1 is a major unknown for me. Therefore, as a technical trader I need a "Line in the Sand" for myself to know when the market is telling me I'm wrong...let's address this first:

Both the Nasdaq and the S&P500 have been battling with a key technical level going back to the highs of the DotCom Bubble. The Nasdaq in particular has spent the last 5 weeks trying to break above this line:

The S&P500 is +2.35% from when I flipped bearish in my swing account and I've done pretty well trading around that short position recently, but now that OpEx is over and FOMC is on deck, I need to take into consideration Assumption 1 being wrong. Any time we're doing long-term technical analysis like this, we should normalize with log scale to see if we're missing something important:

The same analysis on a log scale shows the S&P500 with a little more breathing room up towards the 5400s (red line), while our initial regular-scale line (green) drops down to become support. If you want to take things farther back, you could even anchor your trendline on a log scale to the start of the Great Depression:

...but that might be a bit of a stretch.

No matter your preference for trendlines, we can summarize the above charts like this:

On a regular scale, the market is currently struggling with trendline resistance; on a log scale the market has room to run a few hundred more points before hitting resistance. The question is do I want to hold a short position for a few hundred points of potential pain? Answer: No lol

The charts above will most definitely change on Monday now that OpEx is over, but as of right now I will be using SPX 5200 as my "Line in the Sand" for holding swing shorts into the elections. My reasoning is how skewed the gamma appears to be at that level right now. Looking at the above chart on the left we can see the characteristics of a classic "Call Wall," meaning price is more likely to reject 5200 than accept higher prices. If that wall doesn't hold, the conditions could be ripe for more "melt up" and being short would make no sense. The chart above on the right shows price currently VERY close to the Gamma Flip point, which would change market dynamics forcing dealers to generally "Buy Highs, Sell Lows," exacerbating volatility.


The Put/Call Ration remains shockingly low, which does tend to make me lean bearish now that we have this odd inverse relationship between the PC Ratio and SPX.

OpEx Friday finally caused ES (S&P500 Futures) to close below the bullish channel it's been trading in since January. While it's easy for me to get excited about this, I also recognize it's a cardinal sin in trading to read too far into sentiment during options expiration week as many of the transactions are forced (e.g. contract rolling, position rolling/closure). I'd like to say Monday/Tuesday this week will be a better indication of what the market actually wants to do from here but we have FOMC on Wednesday so it's likely the market doesn't do much prior to the Fed's decision.


In terms of preparing for the trading week ahead of me, I plan to use ES 5205.25 as my Weekly Pivot (last week's midpoint), favoring long trades above and short trades below. The chart above shows extensions of last week's trading range in 0.25 Fib increments. I plot these levels because statistically it's very rare to see the market trade past the +1 or -1 Extension from the prior week's range. This week, the +1 could take us to 5300, and the -1 has us retesting the 5100 area. This would be a slight contraction from the prior week's range, but not by much.


So, let's pretend for a minute that both of my Assumptions are still in tact and the market is indeed beginning to roll over...what now? As a trader, if I think this year's election is going to be an unprecedented disaster what plays could enhance my current positioning besides just shorting the market? These are the questions I'd like to explore in the rest of this article.

 

Before I get in to specific trade ideas, I'd like to address one elephant in the room. I've received several questions from people confused about my bearish election year thesis. Here's an example:



The elephant here is the belief that election years are bullish. That's not necessarily true...


According to a recent article from JP Morgan, returns don't really differ much in election years vs. non. Regardless, I've seen several video clips and financial hot takes circulating the internet stating how crazy bullish election years are. I think it's safe to say the current sentiment & positioning in financial markets could be described as "irresponsibly bullish." So if the prevalent narrative that elections are bullish is overstated, is there a contrarian trade here? Let me first say I sincerely hope not.


I honestly hope nothing I'm about to share is relevant a year from now. I hope the US Elections go smoothly and both sides accept the results, congratulate the winner, and work together to improve our nation. This would be the most ideal scenario for every citizen. Unfortunately, only being prepared for the ideal scenario is poor risk management when it comes to trading and I believe there's reason to explore trade ideas for a scenario where civil unrest in the USA increases from here (which would be a continuation of the current momentum, in my opinion). A couple years ago I noticed a disturbing trend: Civil War headlines in the media. I made some jokes and observations about it on Twitter (as was my style), but the already unfunny topic of Civil War became more concerning as the headlines wouldn't stop. Why was the media becoming so obsessed with discussing something so remote and unlikely? After all, people have been warning about another Civil War since the first one so there's no point listening to the "doomer" headlines, right? Right.


But this time the headlines kept coming and the social media posts kept getting more intense:

Now, as we near the election, the posts are just getting more and more unhinged:


We're also seeing more and more posts that are being faked yet receiving widespread engagement as if they are real. I saw this fake tweet on 3 different platforms:

I don't know about you, but I'm having a hard time envisioning a scenario where there isn't some sort of public reaction to the election based on a dangerous cocktail of truth and dis/misinformation. So if things continue to get more divisive from here, what trade ideas should I consider besides just shorting the indices? (which may not work at all due to a variety of reasons... [cough] concentrated index weightings [cough]). Let's dive in to some charts to answer the following question:

Disclaimer: I am not a permabear nor a doomer. The following analysis is purely hypothetical and only valid if things get considerably worse in the US due to the elections. I am not currently positioned for this scenario other than being short SPY. This is a brainstorming exercise which is part of normal trade preparation and portfolio risk management. I am also neither a Democrat nor Republican, this analysis has nothing to do with party politics and everything to do with a divided and irritable populace.


Due to the incredible positive correlation across financial markets, I'm not sure there's any truly "safe" sector to allocate to in the even of civil unrest, but let's start with the sectors that would likely perform better on a relative basis if things get ugly:

  • Defense and Aerospace

  • Precious Metals

  • Utilities

  • Consumer Staples

  • Satellite Communication

  • Healthcare (already bullish XBI, not covered in this article)

  • Bonds (not covered in this article)


 


Let's start our analysis with the Defense sector. Why? Human psychology. If we get some degree of civil unrest in the USA, it's probably safe to assume market participants trying to capitalize on the situation will naturally flock to companies they are already familiar with in sectors they naturally associate with unrest. Whether it makes sense or not for civil unrest, I still think we'd see increased allocation to the Defense sector. The problem for me is the defense sector is already extremely correlated to the S&P and near all-time highs:


...so is there a better trade for me within the Defense sector? I like the pairs trade here, short ITA and long RTX.



While some of the top holdings in ITA have already ran pretty hard YTD, RTX remains a laggard, yet along with Lockheed Martin (LMT) it's arguably the most recognizable company name in the sector. Remember, this is all hypothetical analysis: If things really "hit the fan" in this country I do believe most market participants would seek exposure in the names they know and hear the most in the media and RTX would benefit from this. If nothing else, I think RTX has room to run up to the descending trendline before it's "decision time."


When we look at the nextSignals' AVWAP Indicator, RTX is technically breaking out to the upside over the Anchored VWAP Sell Line, which supports the bullish thesis.


Another company related to the Defense Sector that would benefit from obvious brand recognition during a period of unrest would be Smith & Wesson (SWBI). The stock is currently grossly overbought on the daily and weekly RSI, but it would nonetheless be a ticker to seriously consider on pullbacks.


We have to talk about precious metals next. As with the Defense considerations, I do think people will tend to flock to the obvious trades in times of panic. In this case that would be gold.


I recently landed a nice little short trade on gold off the descending trendline rejection; however, if civil unrest increases in the US I would definitely want long gold exposure. The chart above shows Gold Futures on a daily timeframe and price is holding up considerably better than I thought it would with the strength we saw in the US Dollar last week. While I prefer owning physical gold over paper gold, I would have to get long gold this year if we close above the descending trendline pictured in the chart. Considering how volatile Gold Futures can be, I would prefer to express a bullish gold trade in GLD options, limiting my maximum risk.



Considering the utilities sector is already attempting a bullish breakout, I'd be inclined to just own the XLU ETF in the event of increasing civil unrest:

As I've demonstrated recently with trades like XLE, retesting a descending trendline after the initial bullish breakout is not typically bearish. Here we see XLU setting up for the same trade and it's been added to my "Civil Unrest Watchlist" (yes I actually called it that because why not).

Like RTX, XLU is also trading above it's AVWAP Sell Line, which is traditionally quite bullish.



So far we've briefly discussed the 3 most obvious sectors for unrest or social uncertainty (Defense, Metals, and Utilities) and I did not cover them in detail because I believe in a time of true unrest investors will likely default to the obvious trades in those sectors, like gold, Raytheon or even just the entire sector ETF (as in the case of utilities). Now the trade ideas start to get a little more speculative, but we can apply the same logic to some other sectors that could outperform during civil unrest. I think there's opportunity in the Consumer Staples sector as there certain things people will need (and likely hoard) no matter what is happening around them. Once company that makes a boatload of essential "hoardable" consumables is Procter & Gamble:

Procter & Gamble (PG) has a series of poor highs at the $165 level. The daily chart above shows us a backwards Cup & Handle, with the handle appearing first. Should PG trade above $165, I have alerts set now for another potential bullish leg above that critical resistance level. Again, this is another company that would benefit simply from "name recognition" during times of panic; however, it should be noted that PG typically has a high positive correlation to the S&P which would be risky if you're bearish the index like I currently am.


If the PG/SPX correlation makes you uneasy, Philip Morris International might be a better option for civil unrest outperformance as it's currently negatively correlated to SPX. Not only would PM also benefit from brand recognition, it's also currently setting up a bullish breakout scenario from a technical perspective. Another thing to consider would be the impact of generalized stress, anxiety, or trauma on the nature of addiction. Philip Morris sells nicotine products and I'd be willing to bet sales would increase during a prolonged period of national unease.

PM is also now trading above the AVWAP Sell Line, supporting the current bullish views.


Finally, let's talk about a couple plays that I would consider the most speculative...and the most depressing should they be end up becoming relevant. In the event of extreme civil unrest, we'd need to consider how communication could be impacted. If you live in rural America like I do, you may be aware that our above-ground powerlines and electrical grid often disappoint us during normal times, I fear what could happen during a more chaotic era. Should parts of our country ever need to rely on satellite communication, there's a couple solid yet beaten down names in the sector I'd be interested in.


Iridium Communications Inc (Ticker: IRDM) offers a smorgasbord of GPS trackers and communication devices that your weird "Prepper" friends probably already know about, including a variety of satellite phones and broadband services. Iridium operates low earth orbit (LEO) satellites to provide global communication services for voice and data connectivity. The stock has fallen from grace, but the bullish Price/RSI divergence on a daily timeframe (shown above) is notable as IRDM approaches it's highest volume node.

While I think Iridium has the advantage with their LEO satellites, ViaSat is another competitor worth considering. There's definitely some overlap, but VSAT appears to be more focused on residential and commercial applications while Iridium is more focused on government/military/Internet of Things use cases. I'd argue there's a place for both names in a portfolio looking for exposure to satellite communication technology.


 

Thanks for reading this unusual Market Prep. If you're new to Traderade, I've always done this prep for myself on Sunday's to get ready for the trading week. Now that I'm doing far less day trading, I have more time to think about "big picture" scenarios and how I'd like to position my portfolio in specific situations. The situation we discussed today is NOT a likely one, but I think it's more likely than it should be right now and worthy of consideration either way. I don't know what is going to happen in financial markets after the elections, I don't have a crystal ball, but I do know I've never made money on a trade I didn't take...preparation is a critical part of longevity as a trader. I hope you have an excellent FOMC Week. Thanks for reading and happy trading!

Horse

4 Comments


I have a basket of stocks that is ready to buy like an etf when disaster strikes. It was a selection by Dr Jin. It’s macabre, but the basket trade did very well when Ukraine kicked off.


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Horse
Horse
Mar 20
Replying to

I forgot about DFEN! Solid list thanks for sharing.

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Thanks for jarring us a bit. Reality can indeed bite. How about cybersecurity companies? I’m sure malevolent bots and no good nicks will be active during this period.

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Horse
Horse
Mar 18
Replying to

Great question. I thought about including a cybersecurity section but Mayhem covers this sector in far more depth than I could ever hope to! This article marks the start of my brainstorming, it's certainly not the end and I plan to explore this topic more if the pulse of the country justifies it as we near the elections. I agree with your thought though, cybersecurity companies are likely to have their hands full this year!

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