Advantage Point Newsletter - August 22nd, 2017
• This Week's Trade Ideas:
Bullish: Micron Technology > MU. Buy the Sept. 22nd 29 Calls for $2.40 or less with a close or anticipated close above $30.60 in an up market (QQQ/NDX) with expectations for continued strength in equities markets.
Bearish: None at this time as very few appeared on our scans and ZERO of those met our qualifications.
• Market Overview:
For the second week in a row the absurdities we’ve been covering here in AP stepped aside again for a brief period in time. The VIX spiked again and we actually witnessed a little more selling. This has been long overdue and it keeps things healthy in the markets when it is allowed to happen.
• Below the Radar:
The sketchy-at-best valuation levels remain in this marketplace for the time being. That is our simple backdrop and it’s been in place for a while accompanied by all sorts of financial engineering etc. That we know. When it matters? That’s what matters. Until it does, it doesn’t. But, knowing the degrees and lengths of the shenanigans only helps us keep proper perspective and helps us to avoid getting lazy with respect to rolling. If for only those reasons, we press onward…
• Options Academy:
This week we’re keeping it simple. We’re going to focus on the simple long call or long put strategy that we employ so often here in Advantage Point. With the summer months closing out, we thought this would be a good time to revisit our “default position” to explain how it became just that.
Erasing the Recent Past at Record Speed
The Trade(s):
We strongly suggest attending tomorrow morning's Advantage Point Morning Call for full details with respect to these idea(s), last week’s and options education.
The “monkey wrench” scenario attempted to unfold AGAIN last week and in the process, bring the earnings-induced euphoria under control. However, we’re seeing “concerns” erased nearly as quickly as they take hold. They’re trying to close out the summer without a rumble but they’re not quite there yet:
Even though a few indices have fallen below intermediate term support lines, the gang has managed to keep them propped up above the 100 SMAs. The rescue scheme is playing out so far in this young week having been aided by “tax reform” chatter and increased probabilities that we’ll see it. Of course, this can all change with a tweet or speech and it can change quickly. We’ll have to wait a little longer to see if it sustains or fizzles depending upon what news comes our way next. The last several years and thus the trend would suggest that the bulls come out on top with little to no effort. Many more stocks are flashing short-term bullish signs but we need to see the indices close out the deal to keep stocks levitated longer.
Bullish:
Micron Technology > MU. Buy the Sept. 22nd 29 Calls for $2.40 or less with a close or anticipated close above $30.60 in an up market (QQQ/NDX) with expectations for continued strength in equities markets.
Bullish Mentions:
AMAT
QCOM
BMY*
WBA
ESRX
All have unique qualities that we’ll touch on in our Morning Call webinar.
Bearish:
None at this time as very few appeared on our scans and ZERO of those met our qualifications.
Bearish Mentions:
None at this time.
Outlook:
August hasn’t been a good month for SPYs thus far and there’s little time remaining. June wasn’t all that great either but the bulls came back big in July with the “earnings beat” scenario played for full effect. Bulls need to keep August from worsening or they’ll invite more selling as many technically oriented investors will spot a loss of momentum after a big run, and react to it. Odds are the bulls pull it off because that’s the trend. That’s what we’ve seen time and time again.
Technicals:
Will be discussed in-depth in the Advantage Point Morning Call webinar.
Fundamentals:
These trade idea(s) are technically-driven.
(Editor's note: This trade idea may be updated periodically, in keeping with market conditions. It is intended solely for educational purposes.)
Recap of Last Week:
Our lone bullish idea last week in TSM had no chance to trigger as the markets weakened.
On the bear side, we head 3 mentions in ETFC, ABBV and RH. RH was our top pick for the bear side but it was smashed last Tuesday which made the reward to risk ratio much dicier. We listed it as a mention as we believed it was in serious trouble potentially. RH, (of course!), fell $4.00 more dollars as we provided updates for those that followed it. ETFC and ABBV remained weak while the markets were weak but didn’t crack as much and naturally they were bought up somewhat when the “buy the dip” gang arrived at the station. We’re really in a wait and see mode for all 3 mentions and their fates depend upon the lifecycle of the bounce we’re watching at the moment.
For the second week in a row the absurdities we’ve been covering here in AP stepped aside again for a brief period in time. The VIX spiked again and we actually witnessed a little more selling. This has been long overdue and it keeps things healthy in the markets when it is allowed to happen.
We now have to wonder if “that was it?” until after Labor Day. If so, the volatility crush scenario we mentioned last week could set in soon. It really depends on the sustainability and degree of the bounce that we’re experiencing.
The SPYs briefly cracked below the orange support line and we’re in wait mode at the moment. Can they get back “above trend” and stay there? We expect a solid attempt to be made at the least. If this doesn’t happen and we roll over again, it could get very serious fast as we’ll then have a lower high, a possible break of trend and a retest of the recent lows most likely.
Two key sectors within the markets, the transports and the financials, are both flashing warning signs. Their trend is in jeopardy and they remain further from their highs than say the DOW or SPYs. So… things are still intact but teetering. With that, a few “FAANG” members have been under pressure, if they crack further the indices likely follow however they’re holding where they need to, at the moment, and if the “buy the dip” money managers start to scoop them at current “bargain levels”, new highs could easily be made and quickly. Stay tuned…
We have a fairly light week on tap with respect to economic data. It’s hard to see what the gang will try to seize on if anything. They may be happy just to have light trading with light news. “Never short a dull market” is an old market adage and our guess is that bulls will be fine with that sentiment and that alone.
The sketchy-at-best valuation levels remain in this marketplace for the time being. That is our simple backdrop and it’s been in place for a while accompanied by all sorts of financial engineering etc. That we know. When it matters? That’s what matters. Until it does, it doesn’t. But, knowing the degrees and lengths of the shenanigans only helps us keep proper perspective and helps us to avoid getting lazy with respect to rolling. If for only those reasons, we press onward…
This week’s BTR is “lite”. It seems that even Wall. St.’s critics like to holiday in the second half of August. We dug up what we could…
A harbinger? “Subprime? Not again!” – probably nothing…
While we’re on international banking, let’s touchdown briefly in China where things may get murkier in the second half of the year. But just as a reminder, this is the global credit impulse data we’ve provided in BTR a few times of late. Things aren’t “swell” to be sure and now read what follows:
There is just one problem: there very well may not be much where it came from. In fact, according to analysts, there may be almost nothing left.
Reuters reports that following 7 months of blistering credit creation in terms of both new Loans and Total Social Financing, Chinese banks are set to see a slowdown in lending growth in the second half of the year, having exhausted most of their annual credit quota, in the process raising the spectre of corporate defaults as financing costs climb further in the world’s second-largest economy. The math is disturbing: only six months into 2017, banks have already used 80% of their yearly credit quota over January to June, versus the usual 60%, amid the abovementioned regulatory push to bring shadow financing activities to the main loan book, and Beijing’s crackdown on riskier lending.
While "loan demand is strong throughout the whole year”, as the second chart from the top shows, “the core conflict in the second half is loan quota – whether banks will be able to extend more loans than they originally planned" said Ma Kunpeng, chief financial industry analyst at China Merchants Securities, quoted by Reuters.
While it remains to be seen if Beijing will allow banks to breach their quotas, a sharp slowdown in new loan issuance is expected in either case: as reported last week, China saw a 12.9% growth in outstanding yuan loans as of the end of June. Nomura China economist Wendy Chen expects this to slow to 12.6% in Q3 and to 12.4% in Q4, more than 1% decline from 13.5% in 2016: a substantial hit to China's overly credit-reliant economy.
Adverse impact on the economy aside, the sharp contraction in bank loans in Q3 and Q4 means that “corporate defaults will rise if the availability of finance is further restricted. This could become a threat to economic growth ... especially if defaults are concentrated in labor-intensive segments like steel and coal,” Moody’s said.
China’s central planners will need to determine if the remaining 20% will be enough for their economy in the second half or if they’ll need to fire up more presses. China’s economy is obviously important to the world economy as is the USA’s. Let’s not forget that we’re supposed to see higher rates and balance sheet normalization here. With all things so credit dependent…who knows what happens???
We often refer to and cite valuation metrics in BTR with respect to the current valuations levels in the stock market. But what of the housing market? Here’s a link to and a few graphics from a piece that caught our eye and held our attention. “Bubble 2.0” is well-inflated in key cities across the good ole USA. It is worth reading but here’s the gist: https://mhanson.com/8-21-hanson-house-price-bubbles-2-0-pictures/
Bottom line: HOUSE PRICES and end-user, shelter-buyer fundamentals have never been further apart in key, economically significant cities.
The two charts presented in this note highlight just how diverged HOUSE PRICES have become from end-user, shelter-buyer, employment and income fundamentals in the most populated, economically significant US cities.
It appears that we’re right back to where we were as expected. They’ve fomented enormous bubbles in housing markets in key cities around the country and, as a result, income levels can’t support prices. We can think of a few questions: Then what will? What must? How does this all end? Where have we seen this before? Does anyone care? Are we really making the exact same mistakes all over again?
Just remember, this won’t matter until it matters and that’s the case with the automakers as well. Their stocks have been under pressure but the slowing they’ve been experiencing has barely registered in the minds of the “buy the dippers.” At some point, they could matter beyond just to themselves. As we noted way, way back, things were expected to worsen significantly in Autoland and they have: http://www.zerohedge.com/news/2017-08-21/heres-how-much-youve-lost-your-used-car-so-far-2017-hint-lot
The link above will bring you to a quick read but we extracted 3 key graphics anyway:
The first 2 above, tell the tale regarding the degree of “pancaking” that we’ve seen in only 1 year’s-time along with the segments that have fared best and worst. We saved the worst for last however. The “live large on lease” craze is about to intensify the situation. 2018 may set a record for cars coming “off lease”:
Since we’re bringing back nearly all the “oldies but baddies”, why not “Cash for Clunkers 2.0”?
… … … … NO? OK then…
Moving on…
As we close things out, we wanted to include this visual reminder we came across that “explains” why we do what we do in BTR but also to note how quickly things can change at times and how quickly markets can fall after rising for extended periods. Simply put, this is why we try to stay on top of the “background radiation”
We’re going to finish by moving from a fall of a technical kind to another type of fall…
We found it interesting that several writers and commentators referenced the last days of Rome, as in the fall of Rome, this week. Bill Blain is getting that feeling and much of it has to do with Central Banks reaching the endgame of normalization: http://www.zerohedge.com/news/2017-08-22/bill-blain-there-last-days-rome%E2%80%9D-feel-news-these-days
Blain wasn’t alone in Rome but we can’t include everyone! So… and simply, here is a link to Charles Hugh Smith’s recent ruminations on fiddling and burning. It’s a good, short read that explains the obvious Roman tie-ins with respect to our collective situation:
http://charleshughsmith.blogspot.com/2017/08/are-we-fiddling-while-rome-burns.html
This week we’re keeping it simple. We’re going to focus on the simple long call or long put strategy that we employ so often here in Advantage Point. With the summer months closing out, we thought this would be a good time to revisit our “default position” to explain how it became just that.
Many, many moons ago in the early 90’s, we experienced our first exposure into real-world application of options strategies. We were already intrigued by the incredible potential of calls and puts but naturally, we had to learn “them all” if we were to compete in the professional arena. Our task masters exposed us to all the well-known strategies and lesser-known variations of some and others that aren’t really viable beyond the professional realm. At various times, we became proponents of one or another of the well-known option strategies seeing their assorted merits over the course of time in evolving market environments. However, and maybe more importantly, this stream of experience also highlighted their limitations. As humans, we naturally wished we’d had “X” on as strategy when “X” would have performed best and “Y” when… you get the point. After a little time had passed, it became clear that the lowly long call or long put, when utilized properly, was all the power we’d need…
As we’ve noted before, there are a few great “givens” that we all take for granted when it comes to long calls or puts. We’re not going into detail but here are the essentials:
- Max Loss Pre-Defined - cuts losses short
- Practically Unlimited Profit Potential
- Controlling 100 shares (normally) for a fraction of the cost of stock shares
- Get in and get out anytime we’d like – can cut losses short
- The potential to roll – bank profits yet keep position intact to ride winners longer
We could add to this but certainly you’ve got the big picture, however, we want to hone in on our “65-70 delta” preference. Higher delta options help to avoid the big problems that plague new-to-options investors so they’re a good starting point for “stock investors looking to become options-based investors”. But, for more active and timely trading, we like the “65-70” and with this visual aid of calls about a month out on America’s Stock, AAPL, we hope to show why:
We tried to use coloration to assist here but we realize that things are busy to say the least. Notice first how they 85 delta call is trading for about $14.50 (take our word for it!, couldn’t get cooperation from our system) while the 67 delta call is going for $7.25ish. (Compare the 146 strike to the 155 strike). Yes, we cherry-picked it but the bottom-line is that it is double the cost. Granted, you pick up 18 deltas (white column) but are those 18 deltas worth double the capital on a swing trade idea at this stage of the game? That’s our simplistic way of looking at it. If you take a look at the (red column) gamma, the 67 delta call has a little more, while theta (blue column) is nearly the same too. So, there’s not much of a difference but in terms of (orange column), the 67 delta call has more vega exposure. This doesn’t trouble us much as we’re not going out that far in time typically and we ALWAYS CHECK IV levels vs. history prior to our trades.
Furthermore, we know, going into it, that since we are buying more extrinsic value we’ll have more vega exposure and ultimately more theta to face if we hang on to it. We like the idea of halving our capital at risk yet still playing the game confidently in a market that’s treading in high valuation waters and is long overdue for a more significant pullback. We also like the idea that if we’re right about our entry, in a few % points to the upside, we’ll be getting paid around a 75 delta clip while if we’re wrong on timing our entry we’ll lose less with less exposure to boot. If the current state of affairs didn’t require practically inconceivable amounts of various forms of engineering to persist, we’d feel differently and proceed as such. BUT…until things “normalize” (if that still means anything), we’re contented to keep half our capital under our mattresses.
Finally, let’s not leave without stating the obvious. We have practically unlimited profit potential for a fraction of the cost at a time when we want it (our timing method/our terms) and in the end, if you think about it, we’re only renting the option for a brief period of time until we bank and roll, close or cut and run.
If you have any questions please bring those to our next Advantage Point Morning Call webinar.
Have a great week!
The Advantage Point Team