Advantage Point Newsletter - February 6th, 2018
Bullish Ideas: None at this time.
Bullish Mentions: MU (Yes, believe it or not, that one has flip-flopped on our scans).
Bearish Ideas: None at this time. Too many stocks are already too crushed.
Bearish Mentions: None at this time. Too many stocks are already too crushed.
• Market Overview:
The last few weeks’ we’ve sounded “ONE NOTE” but that’s our job! We’ve got to call it like we see it and then recall it another way if conditions change.
• Below the Radar:
This week’s BTR will begin with a Public Service Announcement. This won’t revival the Keep America Beautiful campaign of the early 70’s but it is still pretty darn important! Thank you.
• Options Academy:
What’s that old saw about the visually impaired squirrel or something or other??? It doesn’t matter, we should be talking about his cousin the racoon, aka the “bandit”. Why? Because AAPL straddle buyers made out like one! We knew that things could really heat up in terms of volatility, but when we embarked on this Apple Trilogy, we didn’t expect AAPL to fall all the way to $160.00ish by the time our theoretical Feb. 2nd ATM straddle expired, but it sure did.
Volmageddon Episode 1
Volatility Strikes Back - The Great Global Melt-Up has finally Awoken the Sleeping Giant
Conditions remain Extremely Challenging!
Wipeouts have already occurred:
The Trade(s):
Last week we noted:
WARNING: Volatility has awoken from its slumber and this may be one of the most action/news-packed weeks of the year, potentially speaking. The Bond Market and the USD somehow seem to be mattering again. Aside from those, the FED meeting pensiveness will likely dominate until Wednesday and the fallout from it could dominate after. There could be a lot of dips and rips and they could come with little notice. In other words, if you decide to become or remain involved, stay nimble!!!
It’s the same this week but only more so! If you venture into these markets know in advance that it could be a very wild ride. There’s no telling how slowly or quickly this volatility surge will simmer down.
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.
Special Note:
Not knowing if we’re in the beginning, middle or end of the volatility maelstrom, we’re going to tread ultra-cautiously for the time being. Situations such as this one can cause collateral damage to financial institutions which is essentially “blood in the water” which then leads to even more panic once the media picks up on it. That type of news can hit the tape at any time and throw a monkey wrench into the best laid trades.
We’ll start out with a Market Overview in our webinar tomorrow and a brief review but then we’re going total request after that. Then we’ll be re-scanning the markets for opportunities as the day and week press on. We believe that this is the proper way to handle something as potentially dangerous as what might be coming.
Bullish Ideas: None at this time.
Bullish Mentions: MU (Yes, believe it or not, that one has flip-flopped on our scans).
Bearish Ideas: None at this time. Too many stocks are already too crushed.
Bearish Mentions: None at this time. Too many stocks are already too crushed.
Outlook:
Here we normally allude to news expected for the week, earnings, etc., but that type of stuff goes back-burner when all Hell breaks loose as it has at this moment. Where and when it stops nobody knows. We don’t expect that the major indices will simply crater, and then crater more, and then more, all the way into bear market territory. In most cases, there is at least a bounce off the initial lows and then an attempt is made to rally back towards the highs before failing. HOWEVER, if there’s ever been a time when cascade selling all the way into a BEAR MARKET is possible, it’s NOW. We’re not predicting that mind you, we’re simply citing the factors that are in place that we’ve covered here very closely for the past few months. The extreme stretch and extreme shorts of volatility along with the extreme long positioning and the extreme psychology produced extreme euphoria and now we’re witnessing would could be an extreme aftermath. Here’s the best visual we could find to illustrated how crowded or one-sided the short volatility trade had become:
By the way, if you’re wondering what “cascade selling” looks like, the last 3 weeks in PG fits the bill:
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 was even unique for us. After placing warnings in the AP Newsletter to be prudent, and spending our Morning Call webinar on Wednesday preaching prudence, we then updated on Thursday morning with this:
Yesterday’s trading closed out rather indecisively. So far today, things have been indecisive and a little more volatile than what we’ve come to expect courtesy of 2017’s relentless grind higher. We get the sense that, after a hard to believe January, things are becoming more dicey. We’re going to approach things cautiously until clarity improves. Our ideas have and haven’t triggered this week thus far. What does that mean? Well, the stock prices have moved beyond highlighted trigger levels but the major market averages are still swinging back and forth. Discerning the dominant “force” at present is difficult since the markets haven’t fallen much lower than Tuesday’s low nor have they rallied back in a meaningful way. We will track the ideas but we want to reiterate that we’re erring on the side of prudence until things sort out.
For anyone that would care, we’re including this “side note”: https://www.marketwatch.com/story/alan-greenspan-says-there-are-two-bubbles-in-stocks-and-bonds-2018-01-31
If anyone should know a bubble when they see one it should be Mr. Bubble-Creator-Himself – Alan Greenspan.
Stay Nimble!
That update was followed by a Friday update, a Monday update and a Tuesday update! Yes, it’s been a very busy week but more on that later…
Getting back to the trade ideas… Trades probably shouldn’t have been taken until Thursday or Friday and with us breaking below our key support line and failing to rise back to it, the only trades that should have been taken, following the “rules”, would have been bearish ones. Here is an abbreviated reminder on the simple rules that we follow aside from trigger points:
“…with a close or anticipated close below $00.00 (a trigger level) in a down market with expectations for continued weakness in the major indices and a willingness to contend with potential volatility!
Even with that being the case, we tracked all 3 ideas assuming that some folks may have jumped the gun and gotten in too early. In the end, that didn’t matter much as all hell broke loose late on Friday and then Monday, well that was a disaster. Still though, to sum up…let’s assume that we took all three trades ideas:
Bullish Ideas:
Nisource INC > NI > $24.55 Last. Buy the Feb. 16th 24 Calls for $.70 or less with a close or anticipated close above $24.60 in an up market with expectations for continued strength in the major indices. Could get caught up in defensive rotation into utilities. Dividend 2/8. Earnings Release 2/20*
Toronto Dominion Bank > TD > $60.62 Last. Buy the Feb. 16th 60 Calls for $1.15 or less with a close or anticipated close above $60.65 in an up market with expectations for continued strength in the major indices. THE FED fallout needs to be factored in obviously! Without the FED distraction this would be very clear cut!
Bearish Ideas:
Global X Lithium Battery ETF > LIT > $37.65 Last. Buy the Feb. 16th 38 Puts for $1.10 or less with a close or anticipated close below $37.40 in a down market with expectations for continued weakness in the major indices and a willingness to contend with potential volatility!
Had a trader taken all 3, let’s assume that the $1.85 combined outlay for the calls in NI and TD went up in flames entirely. That leaves the LIT puts to save the day. Fortunately, they did and then some (at the time of this writing or even earlier)! The $1.10 LIT 38 puts were in the money by nearly $5.00 given the low recorded so far in LIT. Even if they were sold for a mere $4.10, that would be a $3.00 profit in there vs. the $1.85 loss in the bullish ideas leaving a $1.15 profit.
This “balanced” approach is one that we’ve been trying to emphasize for months given the euphoric state of the stock market and even if we were too aggressive in getting in to bullish ideas despite key support giving way, it still would have saved our bacon and allowed us to buy some too!
The last few weeks’ we’ve sounded “ONE NOTE” but that’s our job! We’ve got to call it like we see it and then recall it another way if conditions change. Last week we concluded with graphic and comments that follow in italics, but we’ve added BOLD for emphasis:
The SPYs have clearly broken below the orange support line we’ve been working with for the past several weeks (see orange arrow). However, there could be many levels of support all the way down should the SPYs selloff to the point at which they broke out which produced the most recent leg higher. The RED arrow highlights just how many potential support levels are in place. Additionally, it is our experience that major indices will typically take another shot at rallying back to a high before failing. There is no rule that states that a rally must occur, it is more a case of our observations over the past quarter century. With this week set to be news-rich, there’s a good chance that news could provide rally fuel if the powers-that-be should need it. All in all, this juncture remains one to watch and if volatility is likely to make its long overdue return, this would be the week that it could be most easily achieved. In other words, there could be a lot of “back and forth” given how much they’ll have to work with. We’ve got all that and the FED! We can’t leave that flock of doves out of the equation. Obviously, the FED could ignite things in either direction as well. “I gotta tell ya, this is one power-packed week!”
We’ve yet to get that bounce-back attempt and stocks did easily shred their way through multiple would-be support levels. Our best guess is that the sentiment and extreme volatility shorts combined with extreme long exposure of many groups quickly converted into a very strong fear cycle. To wit…
One “PRIME DIRECTIVE” of the Advantage Point Newsletter is to help folks better understand how to operate in the trading markets, mainly the equity markets but with options as our investment vehicle. PLEASE allow the last few months of content to guide you in the future as there will be other phases like this one. We’re not trumpeting anything here, we’re simply noting that when things become very extreme, as we made it a point to note in dozens of ways, that it should guide our risk appetite and advise our trade management. We can still trade during risky times, but we must be even more prudent and less cavalier when most are acting quite the opposite. But now, we’re onto NOW:
We’ve overlaid the yellow arrow line on top of a former support line and please note that if the SPYs fell to that point they’d be right near their 200 SMA. That would bring us near about $253.00ish. We believe that the $249.00 level is key in this market, a little below $253.00 obviously. Should that give way, we believe more selling would be triggered. With the DOW and the Q’s acting in near lock-step, this SPYs chart fits us just fine at present to evaluated “the market”.
If we were to try to “nutshell” the recent develops, we do it this way:
The market is simply falling back to trend, albeit, very rapidly and very fearfully.
Naturally, we’ll discuss this and more in our Morning Call webinar on Wednesday morning.
To wrap up this section, we present the calendar. It’s very light this week especially when compared to last week’s bonanza of news. As usual, we expect it to be used to fuel movement and provide cover if they need it. The cover could be fleeting but they’ll use the news to their ends, that we know. This is really a week where the markets must sink or swim on their own accord except for the helping hand they may receive from the President’s Working Group aka the “Plunge Protection Team”. It could be a very interesting week to say the least.
This week’s BTR will begin with a Public Service Announcement. This won’t revival the Keep America Beautiful campaign of the early 70’s but it is still pretty darn important! Thank you.
Last week we really got on a roll in Below the Radar. This is a section of Advantage Point that we’ve had to fight to complete many times over the past year almost knowing that the information presented would likely not matter at all at the time of publication. How did we “know” that? Well… we didn’t exactly know it as we’re not all-knowing, all-seeing, but, you get the idea. We ALMOST knew with 100% certainty that given the charts and the “market action”, the Warning Signs we try to keep folks apprised of would simply be signposts on the way to even higher highs. Why? That was the trend and we remain in a Bull Market for the Ages! The charts kept painting that picture week in, week out, and that’s simply the way it goes. We pulled a few quotes of ourselves from last week just to emphasize how absurdly euphoric and stretched the indices had become relative to historical precedent:
RECORDS WERE BROKEN:
First off, the record books must be updated! The Great American and Great Global Melt Ups have smashed prior records of up, up and away (without a 5% correction):
IT WAS INCESSANT LIKE NEVER BEFORE:
While those records are impressive, if you truly want to appreciate this mania, especially the “unprecedentedness” aspect of it all, then behold:
No other market in the past century of trading even comes close to the incessantness of this mania. Keep that in the mind at all times!
HOUSING AND EQUITIES WERE PARABOLIC VS. REALITY AND…WELL…ODD LOTTERS:
If your takeaway is the Household Net worth is marked into orbit right now and people hate the idea of saving money simultaneously, you are correct! This type of situation hasn’t ended well in the past! And this time, well…the gang really has everyone levered up:
Nearly everything is ratcheted “to the hilt” as some would say, and, thus, there’s real trouble in store if this thing begins to unravel. “Cascade selling” – could become a household phrase and we must not forget how overly shorted volatility is at this juncture. All this certainly forms a massive time bomb but we know not the length of the fuse…
So, for now, we present the cherry on top! The “odd lotters” are more in love with future stock prices than they’ve ever been!:
The cascade-selling we feared seems to have appeared which is why we’ve printed something like this nearly every week:
Remain Vigilant Friends!
Bank and Roll like your success depends on it!
We almost always include a closing of that sort for the BTR section of AP and there’s a good reason for that. Things had been very stretched and largely untethered from realities for a long stretch and MOST IMPORTANTLY, no other investment vehicle that we know of allows you to Bank and Roll as options do. This is an incredible advantage relative to all other investment vehicles and we must utilize it and especially so during blow-off/parabolic phases much as the one we’ve just seen. This let’s us continue to bank profits while sleeping at night with no chance of giving all the profit back if we’re diligent!
And now, back to our regularly schedule programming…
Leading things off, this, which is about what’s really going on aside from too much “one sidedness”:
If rates rise, the effect will be felt more now than ever before:
Bridgewater Founder Ray Dalio warns today, Via LinkedIn.com, what we are seeing is typical late-cycle behavior, though more exaggerated because the durations of investment assets (i.e., their sensitivities to interest rate changes) are greater.
Here’s what happened, Dalio explains:
Over the past week or so, we had reports of strong growth and rising wages (good things!), which sent bonds and stocks down (bad for most investors) due to justifiable fears that the Fed will tighten faster than is priced in the credit markets.
The surge in growth and wages came because of both the fiscal stimulation and the rekindling of animal spirits, thrusting the economy into late-cycle capacity constraints, which is leading to the expectations of faster Fed tightening.
In other words, fiscal stimulation is hitting the gas, which is driving the economy forward into the capacity constraints, which is triggering interest rate increases that are hitting the brakes, first in the markets and later in the economy.
This confluence of circumstances will make it difficult for the Fed to get monetary policy exactly right.
This is classic late-cycle behavior (when it’s difficult to get monetary policy exactly right, which leads to recessions), though it is more exaggerated because the durations of assets are uniquely long, which means that when interest rates are low, prices of assets are more sensitive to changes in interest rates than when interest rates are high.
And now two visual tales of Then vs. Now:
Dalio noted that there’s a lot of cash sloshing around out there and thus things are likely to stabilized along the way down, at times. Cash on the sidelines may not be alone when it comes to supporting equity markets:
https://wolfstreet.com/2018/02/01/feds-qe-unwind-accelerates-sharply/
Naturally, we should expect the FED to step in as they did from 2009 through 2017! However, note as per the above graphic, they’d be reversing their QE unwind that has been accelerating. Why would they need to? Isn’t everything great? It seems that way, but suddenly big players are reversing their thinking:
That’s right, the interest rate cycle that we’ve all known about and dismissed has suddenly become are main source of concern! The media sure do have a deft touch! One moment good, next moment bad.
However, it is true that rates matter, at least they have in the past and changes in rates matter more, again, at least in the past:
Higher interest rates attract capital. That’s it. If enough gets attracted away from other assets, well…
And we can’t close out without another bit on the levered-up nature of this market:
Finally, Carl Icahn must be really short stocks because he’s about as bearish as we can remember:
"There is going to be a major, major, major correction."
"This is a manifestation of a real deep problem we have in our markets."
"There is a huge bubble of passive money flowing in... a sort of euphoria and a lot of people are going to pay the price just like in 1929."
"Eventually, there's going to be a bigger problem than 2009 and 1929, eventually. A major storm is coming, could be 5 years, could be 5 months."
Act prudently! Like it is late Summer 1929!
Last week’s portion of original Options Academy content concluded with this:
With the overflowing cornucopia of news that’s to be made this week, which includes the FED and AAPL’s earnings report, the past two days may only be the start of bigger things! (more volatility) We’ll keep an eye out it to see if we can wring out any more noteworthy items.
What’s that old saw about the visually impaired squirrel or something or other??? It doesn’t matter, we should be talking about his cousin the racoon, aka the “bandit”. Why? Because AAPL straddle buyers made out like one!
We knew that things could really heat up in terms of volatility, but when we embarked on this Apple Trilogy, we didn’t expect AAPL to fall all the way to $160.00ish by the time our theoretical Feb. 2nd ATM straddle expired, but it sure did.
Our trilogy odyssey started a few weeks when we observed that the AAPL earnings straddle (Feb. 2nd expiration) at the $177.50 strike was trading for about $8.00ish and thus we presented this graphic at the time:
Apple’s ATM earning straddle forecasted and $8.00 move away from the $177.50 strike at the time, but it ended up delivering a lot more as the stock price fell nearly all the way to $160.00! A full $8.00 more than the straddle “foretold”!
We’re not big fans of buying ATM earnings straddles especially when they’re expensive, as this one was at the time. However, there’s no denying that this straddle nearly paid off with a 100% return in just a few weeks. But…let’s get back to the “forecasting” abilities of the straddle. In this case, the straddle predicted only half the movement that we observed. That’s not very close to being accurate, is it? The straddle didn’t predict as much movement as what we witnessed. We point this out frequently, but we feel the need to do it again here and now:
There may not be one Silver Bullet!
Reading too much into any one thing can be very dangerous in the financial markets. We believe that every situation is somewhat unique. To wit and on the other hand…
Had we stuck with the Technicals only, we can see that AAPL broke many forms of support and now may be on its way to closing the gap (white circle highlight). Why not just trade the way we normally would and exit just prior to the earnings announcement? What’s so bad about that? 😉
We’ll conclude our coverage of Apple with this, which is simply our preference:
Earnings straddles can be very risky and by owning them and trying to “have it both ways”, we pay a premium of which at least one side, if not two, can work against us. We’d rather stick with the charts, trade with prudence and adjust nimbly. That’s just how we roll, and that approach may not suit all but that’s what works for us and traders need to find what works for them and let it work for them!
We may perform this exercise again next quarter but perhaps in another high-profile stock.
We’re reprinting the prior two weeks of OA below so that folks can follow along or refresh if needed.
If you have questions, ask away in this week's Advantage Point Morning Call webinar.
Last Week’s Options Academy (for reference)
Last week we spent time here in OA covering AAPL’s aka Apple’s Feb. 2nd ATM straddle price (the “earnings straddle”). We did so because the “earnings straddle” is often cited as a means to forecast the magnitude of movement expected by the options markets surrounding the release of that quarter’s earnings. We alluded to following-up on it and thus we’ll do that this week. We’re going to include last week’s OA again this week for reference (far BELOW) but we need this piece to get started:
And now, here’s an update on things from this morning from a weekly perspective:
Please note that AAPL fell as low as $164.70 which is a full $4.30 below the $169.00 level that the straddle was “forecasting” last week. Interestingly, the implied volatility of the straddle was elevated when viewed vs. the prior years implied volatility range, which is to say, market participants were “paying up” to own AAPL options. It seems to have paid off for them as AAPL has already moved far beyond the $8.00ish forecasted move (by the earnings straddle), and, there’s still time to go with earnings due out in a few days.
Last week we noted that a lot can change with that much time remaining until the earnings release and it certainly did. All kinds of stories hit the tape with respect to AAPL’s issues and issues within the markets themselves.
Additionally, political issues crept into the market discussion as well. Other interesting things developed too…
Of technical note, AAPL has broken not one but two support levels as of now and should it close that way, things could become even more dicey. Another interesting technical development is the new high being registered at $180.10 recently, only to be followed by the quick two-week plunge to the mid $160.00’s. That’s fairly volatile movement and one heckuva false-breakout the gang pulled off a few trading weeks back!
With the overflowing cornucopia of news that’s to be made this week, which includes the FED and AAPL’s earnings report, the past two days may only be the start of bigger things! (more volatility) We’ll keep an eye out it to see if we can wring out any more noteworthy items.
Two Weeks Back Options Academy (for reference)
The fascination with earnings releases seems almost limitless so we’re going to tackle a very common question that crops up quite frequently during “the season”.
Earnings reports are in full swing and we know that well as the majority of folks that attend our live weekend events tend to remind us of that fact, albeit, inadvertently. This week brought the ever-popular: “I heard something about a money straddle on TV that can tell you how far a stock will move when the earnings come out. What’s that all about?” Which was quickly followed by: “I’ve heard that before too, can you cover that for us?” We can, and we shall…
Through the software magic of “ThinkBack”, behold Apple’s Feb. 2nd ATM straddle price with the stock closing at $177.00 on the button yesterday:
Now, the ATM strike is actually $177.50, and that ATM’s straddle value is about $8.20, and there’s more than a week’s time to the earnings release in early Feb., however, we’re just going to round things off and summarize things succinctly for those that share this curiosity with respect to earnings moves by way of this graphic:
Well…while intentionally avoiding mathematical precision, look at it this way, the options markets are thought to be forecasting a little over an $8.00 move between now and with the earnings release in AAPL from the $177.50 strike price. We arrive at that conclusion based on the observation that the markets are willing to pay $8.20 for the aforementioned ATM straddle in focus. They wouldn’t pay that much (or so the thinking goes), if they didn’t believe a move of that price magnitude was not only possible but looming. The options markets are presumed to have a “built in intelligence” and ability to forecast such matters.
Anyway, this is how it’s done, but in reality, we should wait until we’re much closer to read into the divinations of the ATM earnings straddle. We’re too far away and much could change between now and then. When we’re right on top of earnings, that’s when the straddle will really be all about the post-earnings release reactions. Until then, let’s see how things play out in AAPL between now and the earnings date which will be upon us shortly.