Here's How to Get Ready for Every China Trade Deal Outcome

There's a lot to like about this market...

It's technically strong, and leadership among the sectors hasn't changed. This is good.

The Nasdaq Composite and Russell 2000 indexes are out above their 200-day moving averages as of Friday; all four of the major indexes are back above this key trend line. The CBOE Volatility Index (VIX) has settled below the critical 15-point level and was last seen headed south. I'm lovin' it.

And of course, more than 80% of the S&P 500 has reported earnings. Seventy percent of 'em beat earnings expectations, and 60% trounced revenue expectations. Phenomenal.

Finally, a raft of weak-ish economic data had traders taking some profit off the table last week, which, in conjunction with a sagging VIX, suggests we're done with the selling for the time being.

The trend is your friend, I always like to say, and the trend is "up."

But we still have to make it past the China trade deal - or lack thereof.

This isn't necessarily all that scary. In fact, the way I see it, three things could happen, two of which could be really profitable, if you're prepared...

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This Reminds Me of an Old-Time Street Hustle

Have you ever seen a game of three-card Monte on the streets?

You know, that game where the "dealer" shows you all three cards and then goes about shuffling them all over the table or box and then asks you to "find the lady."

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If you're able to follow the sleight of hand and tune out distractions, you might be able to point at the queen and win some money. Pick the wrong card, though, and you lose your money.

That's what we've got going on with this trade deal.

Stocks shot higher yesterday on news that Trump pushed back the March 1 deadline for a deal, sidelining - for now - the prospect of big new tariffs.

As of now, the market appears to have priced in the potential that a deal will be done...

The thing is, there are a lot of potential outcomes that aren't being priced into the market's current value.

For instance, we're starting to hear some decidedly "hedging" language on the trade deal; the White House moving the deadline could be more of that. That suggests to me that we could see a partial, less than totally comprehensive deal announced. That's something that the market may not take in stride.

Another option is no deal or a "kick the can down the road," where the parties either punt to another deadline date or, worse, simply up and walk away.

Given that investors appear to be acting like the deal is done, it's going to be wise for you and I to be a little more cautious as the deadline approaches. Let me explain...

Here's How This Could Shake Out for Investors

Let's say there's no deal made and no can-kicking.

As I said, as of today, it appears that most of the value of a deal has been priced into the market. This means that no deal would cause a fast and, to put it mildly, aggressive sell-off.

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If you made me guess, we're looking at a 10% drop in stocks if no deal is announced and the U.S. puts the proposed tariffs in place immediately. In this case, SPDR S&P 500 ETF (NYSEArca: SPY) puts are your best bet. If the worst happens, you clean up, and even if they expire worthless, it'll have been good insurance. Be ready to pounce on any bargains, too.

On the other hand, we could see a partial deal reached, with a date to complete other items of the total deal, and - this is key - without the initiation of new tariffs.

This scenario will probably see a quick pullback in the market, which would ultimately result in a tasty buying opportunity as the market heads into a seasonally strong March and April. SPY calls for these months are a good way to make some money in this eventuality.

Of course, we could always see a deal get done. In that event, the market will likely continue to move higher.

The most important thing to remember here is that the value of a "done deal" is already "baked into the cake." The upside potential in a deal isn't as powerful as the downside risk.

As of now, we've still got a market where the right stocks are moving in the right direction for the right reasons. The S&P 500 has transitioned into a sustainable bullish trend, with leadership coming from the right sectors. And we're not seeing signs that the "crowd" has become too bullish.

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About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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