Advantage Point Newsletter - December 19th, 2017
• This Week's Trade Ideas:
Bullish Ideas: Suncor Energy Inc. > SU > $34.55 Last. Buy the Jan. 19th 33.5 Calls for $1.50 or less with a close or anticipated close above $34.65* in an up market with expectations for continued strength in the major indices and the XLE. *$34.80 would be safer as a trigger but $34.65 is for the aggressive players among us 😊!
Bullish Mentions: GSK, MDLZ, HAL, SLB, NBL.
Bearish Ideas: None at this time.
Bearish Mentions: ADBE, CRM, PYPL, MA, MON, NFLX, MCD. – Take these with a grain of courage! All have slight to severe technical issues, but most would be risky counter-trend trades in a euphoric bull market!
• Market Overview:
There was a little curveball thrown our way but after that brief interlude things began to resemble what we’ve grown accustom to since this bull market was launched oh so many years ago. From last week: “So, as you can see, it appears to be full steam ahead and that’s been the case with nearly every FED meeting since 2009…”
They did get to full steam ahead status in a big way on GDP related and tax plan news, but things have softened a little as we write. Will the tax plan passage bring out the “sell on news” gang or is the holidays-aided euphoria merely taking a deep breath? That’s the question we’re asking ourselves at this moment.
• Below the Radar:
This week we’re starting out with the dominate theme of the year in BTR and in the markets as it is only fitting: The LACK of Volatility!
• Options Academy:
We’re heading back to last week’s “earnings plays” material to pick up where we left off. We’ll use a similar but enhanced version of the pic from last week to refresh our memory…
SPECIAL Ed Sullivan, Dwight Eisenhower and the Perfect Year Edition!
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.
Bullish Ideas: Suncor Energy Inc. > SU > $34.55 Last. Buy the Jan. 19th 33.5 Calls for $1.50 or less with a close or anticipated close above $34.65* in an up market with expectations for continued strength in the major indices and the XLE. *$34.80 would be safer as a trigger but $34.65 is for the aggressive players among us 😊!
Bullish Mentions: GSK, MDLZ, HAL, SLB, NBL.
Bearish Ideas: None at this time.
Bearish Mentions: ADBE, CRM, PYPL, MA, MON, NFLX, MCD. – Take these with a grain of courage! All have slight to severe technical issues, but most would be risky counter-trend trades in a euphoric bull market!
Outlook:
The FED aftermath was rather boring on Day 1 but then we went right back into Euphoria Mode on Friday and Monday but now we’re cooling back off. Conditions are very stretched yet they’re already residing on what could be a crucial support level when we view the SPYs. The overboughtness is registering historically at this point and that should mean extended breather or pull back but these aren’t normal times, are they?
Technicals:
Will be discussed in-depth in the Advantage Point Morning Call webinar.
Fundamentals:
These trade idea(s) and mentions 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:
Last week’s bullish idea in IBM, and the bullish mentions in the form of JNPR, CPB, SPG, SKT, DRI*, were nearly all colossal disappointments! They all had strong bullish gusts at their backs on Friday and Monday and did not really attempt to move higher save for DRI. DRI has zoomed up very nicely but readers will recall that it had the “*” next to it due to earnings being on the near-term horizon. The earnings reaction drove the stock up even more and with that news it has registered a new all-time high. Unfortunately, while it did move up prior to earnings, we’re not sure it moved up enough to stay in for the announcement and play with the “house’s money”. We probably can’t get too frustrated as the SPY is just about where it was during last week’s AP Morning Call webinar, so we’ve quickly gone nowhere! Still though, the lack of attempts by so many stocks that were cyclically primed to move doesn’t sit well with us!
The prior week’s bullish idea, INFY, didn’t have the wherewithal to break out beyond it’s secondary resistance and thus it too remains disappointing. If it ever does, we do believe it has significant upside, but we can’t wait around for that much longer and at this point will likely just set an alert to look at it again when it’s making an effort!
Bearish idea, OLN, did trigger and it is right near it’s trigger level as we write. We’re not shocked that it hasn’t fallen given what the indices did on Friday and Monday, but we won’t give it much more time or room to sting us if it makes a new recent high and leaves its channel to the upside.
Bearish mentions HPQ, XBI, and EZU were a mixed bag of nothingness but at least XEL, DUK fell off rather nicely and may have more downside if the markets actually pull back.
There was a little curveball thrown our way but after that brief interlude things began to resemble what we’ve grown accustom to since this bull market was launched oh so many years ago. From last week: “So, as you can see, it appears to be full steam ahead and that’s been the case with nearly every FED meeting since 2009…”
They did get to full steam ahead status in a big way on GDP related and tax plan news, but things have softened a little as we write. Will the tax plan passage bring out the “sell on news” gang or is the holidays-aided euphoria merely taking a deep breath? That’s the question we’re asking ourselves at this moment.
We’re keeping it very simple this week via the SPYs. There’s a lot of support out there!:
We’d be very surprised if the indices succumbed to a significant selloff as there is much in the way of support nearby. However, the degree of overboughtness is truly historic. So…one can never know. There aren’t any problems yet but…
Once again, the only outlier, and it is a big one, is FAANG:
FAANG, while it is doubtful, COULD be double-topping. If late in the year victim-of-its-own-success selling arrives just in front of the new year, this could roll over hard and let’s not forget that it has gaps galore below. There’s much in the way of support, and we’re not making this call at all (right now), we’re simply saying that a problematic reversal pattern MAY be taking shape….
If the leaders roll over then many other stocks could follow. We shall soon see!
Very much like last week, the economic calendar will become heavier mid-week and beyond. Certainly, there are some big numbers due out but to speculate that the numbers will be spun in any way other than being “good news” is not the kind of speculation we engage in. For a change, the news may actually be good news as they’re telling us it is good news! If the shenanigans that occur as these numbers are comprised were no longer there, we’d feel even better about them! We simply do not expect anything but “good news”, massaged or otherwise. The question is: Will even good news jack us up even higher?
This week we’re starting out with the dominate theme of the year in BTR and in the markets as it is only fitting:
The LACK of Volatility! - It’s “Ed Sullivan” Historic at this point!
“For a U.S. stock-market investor, the most remarkable thing that happened in 2017 may have been the fact that so little happened, at least from the point of what used to be normal day-to-day fluctuations.
In perhaps the most unexpected trend of the year, U.S. stocks shrugged off all manner of political and economic uncertainty over the past 12 months, demonstrating basically nothing in the way of volatility or market pullbacks.
How quiet were things on Wall Street? Let’s put it this way: they haven’t been this quiet since the Beatles made their debut on The Ed Sullivan Show on 1964.
According to the WSJ Market Data Group, the absolute daily percentage change for the Dow Jones Industrial Average (DJIA) was 0.31% in 2017. It was 0.3% for the S&P 500 (SPX) In both instances, that represents the smallest absolute daily percentage in 53 years.
For the Nasdaq Composite Index, the absolute daily percentage change was 0.44%, the smallest since 1989.
“Risk was the dog that didn’t bite this year,” wrote Hamish Preston, senior associate of index investment strategy at S&P Dow Jones Indices, who noted that the average observed one-month volatility in the S&P 500 was lower than any other year since 1970.”
The only “volatility” has been nearly unceasing upside movement that’s produced a record number of records!:
All of which, and let’s not forget this, leaves us only 2 trading weeks away from a “Perfect Year”:
It’s too early to say and there are many other factors to analyze but long winning streaks are normally followed by pronounced losing streaks and low volatility periods are often followed by high volatility periods. Will we soon witness a marked change? Is it different THIS TIME? Tune in to find out in January 2018! However, keep this in mind, Morgan Stanley thinks this time IS different:
One of the most notable characteristics of the U.S. stock market in 2017 was how quiet it was, with major equities hitting a record number of records on little volatility. This environment has been very good for investors, and it may not end soon.
The “exceptionally low volatility” seen over 2017 “is reflective of the fundamentals driving volatility rather than investor complacency,” Morgan Stanley wrote in a note to clients. While some of the factors that contributed to the quiet market—including accommodative Federal Reserve policy and secular stagnation—are ending, in the point of view of the investment bank, traders shouldn’t necessarily expect 2018 to be altogether too different from this past year.
“We expect higher bouts of equity volatility next year. but it may take many years to fully normalize,” it wrote.
He added, “It seems incredible to us how the markets have moved into Taylor Swift mode of ‘shake it off’ in terms of any bad news.”
The low volatility seen this year is just the latest example of a more longstanding trend. So far, this decade (since the start of 2010), the annualized volatility for the Dow has been 13.7%, according to data from Morgan Stanley. That’s below the long-term average, since 1900, of about 18%. “Realized volatility today is at the very low end of the past 120 years,” the investment bank wrote.
The all one-way-ness of volatility has produced the most overbought reading in the S&P 500, when measured by the RSI Indicator, that we’ve seen since the Eisenhower years!:
On a related note, we’ve reached a new peak for US Equities relative to US government Bonds by surpassing the late 1999 high!:
Everyone it seems, is ALL ABOARD the STOCKS Train!
Meanwhile, on the other side of the tracks, we’re witnessing the fastest collapse of the yield curve we’ve seen since 2007!:
As readers will likely recall, that didn’t end well:
Keep in mind that this is happening while GDP estimates are rocketing up even faster than tech stocks from the 3’s to the 4’s and in some cases beyond.
We must conclude that something is amiss, and our gut tells us that stocks have raced too far ahead on “good news” and that most of it may be priced in at this point. The “little guy” really seems to have piled in too (not a good sign historically) and is largely looking to handle matters himself:
Finally, we really wanted to end this week’s BTR on a cheery note, but this Bloomberg piece just wouldn’t let us! https://www.bloomberg.com/news/articles/2017-12-15/how-america-s-inequality-machine-is-firing-the-dow-into-orbit
At this time of the year, there’s often a party on Wall St. but just as often folks tend to reflect on what’s going on beyond Wall St. We thought that may be appropriate here and now as the media hype machine seems to largely have overlooked a few things with the main one being that the “new normal” isn’t getting it done for everyone:
Let’s not forget how much of this euphoria has been achieved, aside from the FED:
Happy Holidays and Bank and Roll like a good elf!
We’re heading back to last week’s “earnings plays” material to pick up where we left off.
We’ll use a similar but enhanced version of the pic from last week to refresh our memory:
Please do not let the many added arrows confuse you! As you can see, we’ve added blue and red arrows to accompany last week’s yellow arrows.
The blue arrows highlight a spike in implied volatility (light blue line) and the red arrows highlight the all but certain drop that follows earnings. Yellow arrows highlight the disparity between implied volatility and historical volatility (purple line) just as they did last week.
What we’re hoping to highlight is that the fairly-reliable cycle that produces a spike in implied volatility pre-earnings, followed by the post-earnings cratering of implied volatility can provide an opportunity. How can we use this to our benefit? We believe the answer is: “In several ways”…
Here are a few observations along those lines and in this case “arrows” 😉 :
- As we noted last week, there isn’t always an earnings reaction in terms of stock price. Sometimes there is and sometimes there is not. However, in every case there is a significant rise in implied volatility levels prior to the earnings release.
- There is also a steep fall in implied volatility post-announcement.
- We can thus:
- Buy IV well in advance of earnings
- Sell IV just prior to earnings
- Avoid holding it after earnings
Effectively, this is a different style of trading that is often referred to as “volatility arbitrage”. It’s not pure arbitrage but rather is classified as “risk arbitrage” (it’s not instantaneous) and in this case, it is fairly-straightforward. We see the IV cycle, it’s very reliable, so we inventory “earnings options” (buy cheap “vol’) and sell out that inventory just prior to the earnings release (sell high “vol”) and then we kick back and enjoy having “bought low and sold high” in terms of implied volatility. It gets a little more complicated than that, but the concept is as described. Naturally, we have a holding period that we must contend with from when “vol” begins to ascend until it reaches its apex. With that we’ll have to contend with decay if we only own earnings options. But what if we don’t “only own earnings options”? Could we sell options that expire prior to earnings to hedge our long “earnings options decay”? We sure could! There are many other things that can be done and most of them are more suitable to be done within a professional account rather than a retail account, but the IV cycle isn’t the only cycle that’s reliable…
Many stocks tend to rally or sell off to a significant degree in front or earnings. This is what we call the “pre-earnings run”, and it too is simple to approach. If a stock has tendencies prior to earnings, we simply wait for those tendencies to emerge and then get aboard with them as long as the chart work confirms the move. It’s not very sophisticated and it may not produce a “windfall” profits like pure earnings speculation can at times, however, it can be a consistent and bankable source of profits with far less risk than the “coin flip” that earnings outcomes often represent.
Can we combine the two approaches? Why “yes”, yes we can! We can buy options early to benefit from the price of options rising and from cyclical pre-earnings directional movement. What’s most important, however, is to not hold options after earnings unless we’re already playing with the “house’s money”. As can clearly be seen, IV levels plummet without exception as the uncertainty of earnings is no longer present.
If you have questions, ask away in this week's Advantage Point Morning Call webinar.