The US stock indices closed on a high, with the S&P and NASDAQ reaching new record levels. The Dow industrial average approached its record earlier in the week but fell back slightly.
All three major indices saw an increase over the week. A snapshot shows the Dow up by 208.01 points or 0.47% at 44,901.92, the S&P up by 25.29 points or 0.40% at 6,388.64, and the NASDAQ up 50.36 points or 0.24% at 21,108.32. The Russell 2000 rose by 8.93 points or 0.40% to close at 2,261.06.
Weekly Growth Analysis
Over the trading week, the indices saw growth, with the S&P index leading. The Dow was up by 1.26%, the S&P increased by 1.46%, the NASDAQ by 1.02%, and the Russell 2000 by 0.94%.
Given the new records mentioned by Michalowski, we believe the path of least resistance remains upward for now. Derivative traders should consider strategies that benefit from a continued, albeit potentially slower, grind higher. This means focusing on options that profit from either rising prices or a lack of significant declines.
To support this view, we note that the recent Consumer Price Index (CPI) reading for May came in cooler than expected at a 3.3% annual rate, easing inflation fears. The CME FedWatch Tool now shows a greater than 60% probability of a Federal Reserve rate cut by September. This macroeconomic backdrop provides a tailwind for equities and justifies a bullish stance.
Therefore, selling out-of-the-money put credit spreads on the S&P index could be an effective strategy to collect premium. With the CBOE Volatility Index (VIX) hovering near a low of 12, options are relatively cheap, but this strategy capitalizes on time decay and the market’s upward momentum. We would target strikes well below the current market level to build in a cushion.
Market Breadth Concerns
However, we must also acknowledge signs of weakness beneath the surface. Market breadth is a concern, with fewer than 50% of S&P 500 components trading above their 50-day moving average despite the index hitting new highs. This indicates the rally is being driven by a very narrow group of mega-cap stocks.
This concentration makes the market vulnerable to sharp pullbacks if one of the leaders falters. For this reason, we advise purchasing protective puts on the Russell 2000. This index of smaller companies has lagged the broader market and would likely be more sensitive to any economic downturn.
Historically, August and September can be periods of increased volatility and market weakness. Given that the S&P 500’s forward price-to-earnings ratio is elevated at over 21, traders should be prepared for a potential seasonal pullback. Maintaining some bearish positions offers a cheap hedge against this possibility.
