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Beware of what you’re seeing with small-cap stocks, says Todd Gordon of TradingAnalysis.com, because the group is pointing to trouble ahead for the broader market.
While the major market indexes have rallied to numerous all-time highs this year, small-cap stocks have been stuck in a bind. The Russell 2000-tracking ETF (IWM) may be up 3 percent year to date, but small caps have actually been caught in a tight range since December while large-cap stocks have left them behind.
That has left Gordon with an “uneasy feeling,” especially on a day like Tuesday when it seemed that only big-cap tech stocks were moving. The lack in movement from the small caps could suggest that the market rally may not be as broad based as investors may think.
“When you don’t get small caps confirming where large caps are going, that’s a problem, and not many people are talking about it,” he said Tuesday on CNBC’s “Trading Nation.”
Since small caps are stuck in such a tight range, Gordon believes that trading the long-term-bond-tracking ETF TLT would actually be a better way to profit.
“[We could short the IWM], but I am concerned from a trading point of view, our ability to time the breakdown of this range, so that’s a low probability trade,” explained Gordon. “So I think what we can do is use a risk-aversion vehicle that’s already in motion, which is TLT.”
To determine the levels for the trade, Gordon connected the lows and the highs of TLT over the past few months to create a “parallel channel.” He determines that if TLT were to keep following the channel, it could return to its pre-election highs near $128.
As a result, Gordon wants to buy the June monthly 126-strike calls in TLT and sell the June monthly 128-strike calls for a total of 50 cents, or $50 per options contract. If TLT does close above $128 on June 16 expiration, Gordon would essentially quadruple his money by making a maximum profit of $150.