• EDITOR'S CORNER: Change to the newsletter fulfillment
Your Advantage Point subscription is NOT ending! There will be no disruption to your service. You will continue to receive the weekly newsletter; there will continue to be a weekly webinar; you will still be able to access the Advantage Point archives; and your billing will not change.

• THIS WEEK'S TRADE IDEA:
Bullish: Ally Financial (ALLY) – Buy the March 20 Calls for $1.50 or less. Bearish: Tiffany (TIF) – Buy the February 17th Expiration Puts for $2.40 or less.

• MARKET OVERVIEW: Finally, a little volatility:
By some measures, the past month of trading has been the least volatile since 1970.

• *NEW* Below the Radar:
A focus on themes and concepts that we believe are under-discussed or appreciated at the moment.

• OPTIONS ACADEMY:
When discussing option’s strategies, the emphasis is normally placed on how to utilize each strategy when going on offensive… we’re going to briefly discuss playing “defense”.

Thank you for being a valued subscriber to the Advantage Point Newsletter! In last week’s issue, Todd Rich explained that there will be a few changes in the Advantage Point fulfillment. Unlike other services provided by Option Monster in the past, Advantage Point is NOT ending with E*TRADE’s acquisition of Option Monster Media, LLC.

There will be no disruption to your service. You will continue to receive the weekly newsletter; there will continue to be a weekly webinar; you will still be able to access the Advantage Point archives; and your billing will not change.

As of today, you will receive the newsletters and any updates from  alerts@advantagepointservice.com and you’ll now access the archived issues and webinars at www.AdvantagePointService.com. Your login credentials will remain the same.

If you have any questions or concerns regarding your Advantage Point subscription, please feel free to call customer support at (855) 637-6534 or email us at support@advantagepointservice.com.

Advantage Point Morning Call: Wednesday, February 1^st at 11:00am ET. Make sure to attend this valuable webinar where we’ll discuss ways to navigate these difficult markets, thoughts on where the markets may be headed and unusual trading activity.

Click the link to register for the webinar:
https://attendee.gotowebinar.com/register/6449584955832188673

We look forward to continuing to provide you with great content to help you navigate these challenging markets and reach your investing goals.

To your investing success!

The Advantage Point Team

A Key Market Inflection Point

The Trade(s):

Bullish: Ally Financial (ALLY) – Buy the March 20 Calls for $1.50 or less.

Bearish: Tiffany (TIF) – Buy the February 17^th Expiration Puts for $2.40 or less.

We strongly recommend that students attend or view tomorrow’s webinar before deciding on their own to act on these ideas.  Both of these trade ideas require a more detailed explanation that we will provide in tomorrow’s webinar.  We kept a close eye on both of these stocks throughout today’s trading but unfortunately both of them failed to cooperate fully into the close.  Additionally, with the markets finally experiencing some significant selling for the first time in nearly 3 months, this has brought the current trend into question.  This makes trading more difficult as we prefer trading with a trend intact or about to resume.  It’s too early at this juncture to be highly confident that the markets will breakdown further or if they’ll yet again hold the 20-day simple moving average support.  We plan to not only cover these 2 ideas tomorrow but also plan to provide updates during the week if conditions become favorable to initiate these trades from our perspective.

Outlook:  When various market cycles are at odds with each other that makes it more difficult to become very aggressive in positioning.  Combine that with a FED week, a great deal of employment data on the way after a weak Q4 GDP, not to mention 20% of the S&P 500 reporting this week, along with high investor sentiment readings and a market that hasn’t sold off in months and you have the recipe for a pickup in volatility and potentially choppy markets.  If things unfold in this way, it becomes even more important to be nimble and take what’s available.  This means rolling aggressively or settling for respectable but maybe not windfall profits if they’re there to be had.

Technicals:  A snapshot of the “big picture” market momentum still looks solid but the “here and now” is starting to look vulnerable.  The markets ran strongly post-election and have barely given any of the gains back in the form of a retracement.  NOW though, some of the shorter-term momentum cycles have shifted to favor sellers as the rally has seemingly exhausted itself for now.  However, we’ve yet to see technical failure but we may have seen a false-breakout and what may appear to be a double top in retrospect.  Finally, negative divergence has persisted for a while so all things considered, a minor selloff is somewhat overdue.

Fundamentals:  Financials have been very strong with the exception of the past few days.  ALLY just reported so that’s out of the way.  The stock showed very good relative strength today (Too Much!) and it closed very strong.  Retail on the other hand has been a mess.  Things haven’t sparkled at Tiffany from a fundamental view point but despite consumer discretionary being a little weak today, Tiffany was able to hold key support and closed well.  Additionally, Valentine’s Day is just around the corner.

(Editor's note: This trade idea may be updated periodically, in keeping
with market conditions. It is intended solely for educational purposes.)

Finally, a little volatility.

By some measures, the past month of trading has been the least volatile since 1970.

The post-election rally stalled somewhat in the early stages of 2017 but there was a little left in the tank to recently push the S&P 500, the Nasdaq-100 and the Dow Jones Industrial Average to all-time highs.  Not surprisingly the VIX was trolling multi-year lows in the aftermath of a month of tedium and the brief push to record highs.  Traders seem to be fixated on supporting the major indices whenever they sell off to near the 20 day SMA.  This has really kept things bottled up…

In related news, a few recent investor sentiment readings have shown relatively high degrees of optimism.  As many know, overly-bullish and overly-bearish sentiment readings are viewed as contrarian indicators.  Thus, the belief is that they’re inversely related to the market performance that follows when extreme levels are reached.

So, maybe not so surprisingly, the markets started this week off with a thud lower.  As the commentators are wont to do, they naturally assigned the reason for the selloff to the administration’s temporary immigration ban.  The claim is that this sent shockwaves around the world etc.  There may be some truth to this but another way to look at it is that it provided cover for sellers and Wall St. operators to take stocks down a little bit in front the FED meeting and the plethora of earnings reports due out this week.  This week is chock full of earnings releases with roughly 20% of the S&P 500 companies reporting this week.

When we combine the current political news, with the media climate, along with the FED meeting, the deluge of earnings reports, an extremely low VIX and relatively high investor sentiment readings, it’s likely that we’ll finally see at least a little more volatility in the markets.  This can be typical of the month of February.  Quite often volatility picks up in February as January’s gains are “digested”.

Aside from the FED monster in the room midweek, there’s quite a few key releases on the economic calendar this week.  Last week we learned that Q4 GDP wasn’t all that spectacular and with quite a few employment-related reports due out in the second half of the week the groundwork could be in place for a little more selling if the numbers disappoint.  The rally has been very strong since the election and hasn’t given much back to this point.  More disappointing news in employment circles after the weak GDP number may provide the cover sellers have been waiting for to step in more aggressively.  It may be helpful to keep an eye on the daily chart in hopes that a double-top may not be forming…

(This section of our newsletter plans to focus on themes and concepts that we believe are under-discussed or appreciated at the moment.  Our hope is that we’ll be able to consistently uncover material of long term value for our readers that mainstream commentators may be missing.  Since most news outlets maintain a perpetually bullish bias, it’s likely that this content may provide a consistent counter to that bias, however, there are bullish themes that emerge that do not get much coverage at times and we hope to bring those to light as well.  This is not meant to provide a source of worry, it’s more about being fully-informed and prepared.)

Many clients that we work with 1-on-1 and within our weekly webinars have marveled at the market's ability to avoid a significant and somewhat lasting correction for some time.  We'll often point out the dichotomy between the technical state of the market, remaining bullish, while other seemingly key data remains at odds with further upside.  A fine example of this may be seen in the accompanying graphic that shows the S&P 500 overlaid against S&P earning performance.  Something would seem amiss!

As can be seen, the S&P 500’s earnings per share peaked out late in 2014.  This may help to explain why the index was unable to make and hold any new highs in the 2 years that followed.  It wasn’t until late 2016, in the post-election euphoria, that the S&P was finally able to climb to new highs.  Yet, it’s clear that EPS performance is still lagging.  Divergences between index levels and key metrics can persist for long periods of time but eventually something must give.  It would seem that a more serious correction than what was permitted should have occurred in either 2015 or 2016 but after each significant selloff we witnessed “V” shaped recoveries.  In fact, V shaped recoveries have been the calling-card of this bull market.  They’ve appeared at rates that are many factors higher than have ever been registered before.  Of course, this means that selloffs become erased very rapidly which is quite curious from a historical perspective.  It becomes even more curious when one views this bull market’s underlying GDP performance and the well-documented lack of a true recover on “main street” USA…

Another graphic that caught our eye was this one:

Now there are many metrics that are currently very “stretched”.  This isn’t the only one but it is impactful.  It’s clear that GDP is dramatically lagging the Net Worth of US Households.  In other words, the central bankers’ scheme has worked exceptionally well in terms of asset inflation but no so much in terms of real economic output.  If this resolves itself as it has in the recent past, the equities and housing markets will experience a significant correction.  That doesn’t have to happen however but certainly the possibility exists after this 8-year march higher.  The current bull market is very long in the tooth.  The average bull market in the 20^th century lasted about 5 years.  Clearly, we’re well beyond that and we do not have the GDP support currently to justify it.  GDP has to pick up or the central bankers will have even more heavy lifting to do in the near term.

If the material above piqued your interest, you can read more along these lines here in this interesting piece that pulls the curtain back a little as to why the markets have been so "resolute".  Perhaps the markets have been aided by more than “animal spirits” or the ever-popular “rising tide that lifts all boats” or the always reliable “wind at its back”.  Maybe the asset inflation scheme we’ve witnessed that commenced just around the 2009 lows is more “broad minded” than most of us have suspected??? http://www.marketoracle.co.uk/Article57953.html

Along the same lines, you may find it even more interesting to read about Janet Yellen's views on central banks purchasing equities. (YES, Purchasing Stocks!)  Something that went under-reported coincidentally, or maybe not...: http://www.wsj.com/articles/fed-committed-to-diverse-workforce-and-senior-leadership-yellen-says-1475179202

Let’s wrap up with something more concrete.  Many individual investors tend to become extremely stock-focused.  They dedicate a lot of time and energy to keeping up on the news and developments of many companies.  They tend to view the stock market as a group of individual stocks as opposed to a hierarchical view, which is probably the way in which most professional money managers view it.  It’s in that vein that we offer up this suggestion as an alternative.  Another way to approach the markets is to observe what's working and then participate.  This obviously differs a great deal from the “value” / “fundamental” approach that’s espoused by so many as it relates to the individual investor.  Actually, the “what’s working” approach is pretty simple stuff really but many are at a loss on how to start.  Typically, we try to guide investors by suggesting they keep a close eye on sectors.  Find a sector ETF that's working and then seek to become involved in several of the components that comprise that sector ETF.  To that end, if you're interested, take a look at this extremely detailed analysis of the Basic Materials Sector (XLB) that goes well-beyond “Trump wants infrastructure and Schumer does too”.  Obviously the current political climate has already helped to drive this sector higher but there may be more to come.: https://rambus1.com/2017/01/25/wednesday-report-153/

When discussing option’s strategies, the emphasis is normally placed on how to utilize each strategy when going on offensive.  The focus is mainly about making profits by employing a strategy in an appropriate environment on a suitable underlying stock.   Strategies are covered in this idealized way to demonstrate how they can best be applied and under what conditions they’ll deliver the best results.  There is nothing wrong with this approach.  It’s an academic approach and it’s probably the right way to get started when students are trying to learn about options theory and application.  As many readers already know, there’s a great deal to learn in the first place and that makes it very difficult to cover every nuance of every strategy the first time through.  The reality is that there are so many possibilities that can arise in the real world of dynamic markets that covering every possibility in the “classroom” is simply not realistic to begin with.  It’s with this background in mind that we’re going to briefly discuss playing “defense”

Playing “defense” when actively investing with options is a subject that largely goes under-discussed.  Taking defensive measures when the markets aren’t cooperating with currently held option’s positions is something that professional contend with regularly.  Many, when asked, would probably concede that their ability to play defense, aggressively when need be, may be the main difference-maker between success and failure.  It may also be the main separator between how pros manage risk vs. individual investors.  If we contemplate things for a moment, a few key thoughts should come to mind:

1. Even professional traders are on the “wrong side” of trades frequently
2. Pros do not remain idle and simply accept that they’re “losing”

What follows is this:  Active options investors can expect to be on the wrong side of trades just as the pros find themselves.  HOWEVER, once the individual investor accepts this reality, they can then take the next step and begin to play smart defense when circumstances call for it. So what is “smart defense” and how do we play it?

Let’s look at the calendar spread.  The calendar spread is typically taught as premium collection spread that can be employed with capital efficiencies.  It’s used to collect decay with a minimum capital outlay.  It’s normally covered in way that suggests that the nearer term at-the-money option is sold and the same strike price a little further out in time is purchased as a hedge.  Since the nearer term option decays more rapidly the spread’s prospects benefit from the passage of time as the investor remains hedged.  All is well and good in this scenario except for the fact that the stock needs to remain relatively still for profits to accrue.  This is because the calendar spread is worth the most when the stock price is at the strike price of the spread.  Another way to understand this is to realize that if the stock price moves away from the strike in focus, the calendar spread begins to lose value for the owner.

There are other ways to use the calendar spread however.  We’re interested in using it to our advantage so we’re going to start out by NOT using it!  Just as an entirely hypothetical example, let’s assume that we’re bullish on Apple (AAPL) with an investment horizon of a few months.  AAPL stock is trading near $120.00 at the moment and a quick glance at the March expiration shows that we can buy the March 110 calls for a reasonable price while we acquire high delta exposure (90).  In other words, the March 110 calls are a good stock replacement type call.  Assuming we buy 10, that would provide us with 900 long deltas in the aggregate.  Obviously, just like a stockholder, we’d do very well if the stock price were to rise and we wouldn’t be very happy if the stock price were to decline.  But remember, we can play defense!  So, to that end, let’s assume that a story has just hit the newswire and it seems material and thus it legitimately concerns us.  We still believe in AAPL over the next few months but we also know how investors can overreact in the short run.  Just like a pro we’re not going to sit there and let the ensuing mini-panic “beat us up”.  We’re going to hedge our long delta for the time being.  A quick glance at the AAPL February 110 calls shows that they have nearly the same delta, 90, as our long March 110s.  Thus, if we sell 10 of those, we’ll add -900 deltas to our current +900 delta position via the March 110s and we will thereby neutralize our delta risk.  In the process of doing this we just backed our way into a calendar spread, an in-the-money one at that.  The interesting thing though is that, although we’ve capped our upside potential temporarily, we’ve now protected ourselves quite well even if AAPL were to experience a significant drop over the next month.  In fact, we may actually profit somewhat if AAPL falls to $110.00.  Why?  Remember, calendar spreads are worth the most when the stock price is at the strike price in focus and we own the spread!  Additionally, we’ve brought in capital and reduced decay instead of adding decay to hedge while outlaying even more capital!

Another nice feature about this is that we’re not locked in to this forever!  We can lift our hedge at any time and reestablish our long March 110 call positions when the dust settles.  This can be thought of as hitting the “pause” button if done correctly.  Pause and Unpause!

We encourage you to model this type of scenario on the Options House platform in TradeLab > Spectral Analysis.

Additionally, tune in for our Advantage Point Webinar this week and time-permitting we’ll cover this technique in-depth as there are a few more tidbits that we can highlight.