SPY Bearish Options Play

I entered a bearish vertical option spread today (it's a DEC 2016 211/203 SPY put spread). I'm betting that the SPY will close below 203 by 12/16/2016. If it does, I gain a max profit of $630/contract with a risk of $170/contract, for a risk:reward ratio of 3.7.

So what makes me think this is likely? Let's start with the big picture.

The chart above shows the 10 year monthly chart for SPY. Note that the Elliot Wave pattern indicates that a 5th wave could be close to complete. MACD divergence is clear, and the biggest volume months in the past year or so have been down-volume. All these signs tell me that the market is reaching exhaustion point.

From another perspective we can see that Dow Jones Industrials have been out-performing Dow Jones Transports. The two indices haven't confirmed each other and this is a bearish sign according to Dow Theory.

Finally, zooming in to the SPY daily chart, you can see that price is tracing out a pretty clear ending diagonal pattern. I love this pattern because it usually resolves in sharp counter-trend moves that often retrace the entire height of the diagonal. A one or two month move down to 1800 would not be out of the question, hence my reasoning for buying a bearish Dec, 2016 SPY put spread.

I plan to hold until expiration but I would sell early if we got a drop to 1800 at any point before then.

Why I’m Wary of the Gold Bull

Gold bugs are still raging. Someone mentioned that because gold has formed such a massive base between $700-$1,000/oz, it can’t go back down. Take a look at the charts below:

 

The first chart above is the Dow from 1974. In 2000, it topped out and dropped, but then recovered, forming a very strong base out of which is subsequently broke to the upside. Well, now we know that this base did not prove to be much in terms of support.

Now look at Gold’s chart since 1997. I believe we are in a 5th since the ‘99 low. You can see that gold formed a similarly massive base and has just broken out. I could see one more new high, but I think this base could prove to be very weak, too.