Two Steps Forward, One Step Back

The old adage describing how a frog climbs out of a water well provides an apt analogy for the S&P 500 over the past year. We've seen seven mini-rallies averaging 8.3 percent, followed by seven mini-declines of 4.9 percent.

Technicians refer to this ebb and flow as "backing and filling" or "digesting the gains." It's generally considered healthy action. Here's what it looks like. First the rallies:

And the pullbacks:

The S&P 500 Index has managed to rise 24.6 percent since October of last year because the average gain of 8.3 percent has exceeded the average decline of 4.9 percent. We can expect more of the same, advises Technical Strategist Chris Verrone of He tells clients this morning: "Some consolidation is warranted after a 130 point advance in just a little more than two weeks, particularly with indicators like skew and put/call ratios reflecting some complacency."

Pullbacks have provided entry points for buyers over the past year, and profits for options traders. With the CBOE volatility Index hovering near multi-year lows at 13.75, options are cheap. We favor buying an at-the-money November put in order to capture a possible pullback. If we pay $2 for a 176-strike put, and the S&P 500 declines 4.9 percent as it has previously, we can potentially earn $7 ((176-2) - 167 = 7).

Pay $2 to make $7... we like these odds (3.5 to 1). We also like sleeping at night while staying long stocks, especially at a moment when the market may need a breather.

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.