In short, yes, there seems to be a very bullish head and shoulders formation in the short term. The chart below displays the head and shoulders, the white oval is the head and the rectangles are the shoulders. The period after the right shoulder is still to be determined; but if the left shoulder is an indicator, which the pattern suggests, the market is in for a 3.5% rally. The end result of this formation may put price at a very opportune selling point however. The debt ceiling playbook instructs traders to sell at prior highs. The chart below indicates that after the market hits prior highs it will bounce around for a few days then crack lower, but what else should market participants know before we fall off the cliff?
According to Barclays, “some policymakers appear less worried about this [fiscal cliff] outcome, in their view…economic damage will initially be limited while any equity market sell-off will spur a resolution.” It is too bad it takes a mini crash to get government working, but if that is what it takes traders might as well join in and short. The other side to this trade is a rather ominous one. Many folks in the financial world have been comparing the debt ceiling chart to today’s action. Straddles perform best in a down market with lots of uncertainty, should government actually fix the problem the market could actually get squeezed higher. If the market moves enough, straddles could still perform, for the downside in implied volatility is limited. University of Penn’s Wharton School of Business Prof. Jeremy Siegel claims that the Dow Industrials could rally 1000 points on a fiscal cliff deal. Either way, straddles win, as long as it is a big move.
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Author: salernoma@mx.lakeforest.edu
