• EDITOR'S CORNER: Trump talks, Markets react
Are you ready for the new normal? We don't know what he's going to say, and we never know when he's going to say it.

• THIS WEEK'S TRADE IDEA: Trading Exxon (XOM) 
Buy the February 90 calls for $0.60 or less.

• MARKET OVERVIEW: Stocks tread water before inauguration
The S&P is little changed in the last week, but the Nasdaq and international stocks have been strong.

• OPTIONS ACADEMY: From the AP Archives: Volatility and the Option Pricing Model
Options are derivatives of underlying assets and can be boiled down to a mathematical formula. As such, the value of an option is determined by a formula called the Options Pricing Model.

EDITOR'S CORNER

Trump talks, Markets react
By Todd Rich

Are you ready for the new normal? We don't know what he's going to say, and we never know when he's going to say it.

Whether it's off-the-cuff remarks, or during a scheduled interview, or a heat-of-the-moment Tweet, the president-elect likes to toss out random thoughts whenever. Last week, during an interview with the Wall Street Journal, Trump announced his belief that the U.S. dollar was "too strong". That sent the U.S. dollar into a nose dive with a corresponding rally in gold. Clearly the markets are listening, and reacting very quickly, to whatever comes out of his mouth. Words to the wise: like the Boy Scouts say, "Be prepared".

Also, of note, remember that we are at the front end of a new earnings cycle. A lot of companies (specifically members of the S&P 500) are announcing their quarterly earnings. Over the next two weeks, not only will we have the inauguration of our next president, we will also be getting a lot of economic news as companies announce their earnings. It should be a very busy couple of weeks in the markets!

Tomorrow we invite our Advantage Point subscribers to join our Market Action webinar. In this webinar, we will discuss ways to navigate these difficult markets. The webinar will be on Wednesday, January 18 at 1:15 pm ET. You will get thoughts on where the markets may be headed, hear about unusual trading activity, and have the opportunity to ask about your favorite stocks.

Registration for this event is FREE via this link: https://cc.callinfo.com/r/1hooet034q9al&eom

We look forward to having you join the Market Action webinar tomorrow!

Trade Smart,

Todd Rich
President, OptionMonster

THIS WEEK'S TRADE IDEA

Trading Exxon (XOM)
By David Russell

The Trade: Exxon Mobil (XOM) - Buy the February 90 calls for $0.60 or less.

Outlook: XOM is a blue-chip energy name poised for a bounce. It's sitting at a good level two weeks before earnings, and with crude poised to work higher.

Technicals: The stock has been making higher highs and higher lows since late September, and is now back near the bottom of that upward-sloping trend. The $86-88 price range that was resistance in October and November is now becoming support. This is a classic "buy the pullback" entry near the 100DMA.

Fundamentals: XOM tracks the broader Energy sector, the market's best major segment over the last 12 months. Crude oil has been showing real signs of a turnaround as the global economy improves and the Saudis honor their production quotas. Given the positive momentum and broadening demand for inflationary/"weak dollar" assets like commodities, odds favor continued upside.

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

MARKET OVERVIEW

Stocks tread water before inauguration
By David Russell and Mike Yamamoto

Stocks remain rangebound near highs as traders wait for more earnings and Donald Trump's Presidential Inauguration.
The S&P 500 is little changed since our last edition of Advantage Point, while making incrementally higher lows. Some chart watchers may consider that a bullish ascending triangle, with potential for further upside. The Nasdaq-100 has outperformed during the same period, while small caps have lagged.

Dollar weakness has been the main theme in the last week as traders fade the greenback's sharp fourth-quarter rally. That's lifted metals like gold and silver miners, steelmakers and iron-ore producers. Global stocks have also gained. Financials, the top performers into yearend, have born the brunt of profit taking. (See our proprietary ResearchLab market scanner for more.)

More than 40 percent of companies in the S&P 500 will report earnings in the next three weeks, spearheaded by financials. Attention will also focus on Thursday morning's European Central Bank's meeting and Chinese economic data the following evening. There are several housing numbers, as well, plus Trump's swearing in the next day.
Aside from the run in weak-dollar stocks, ResearchLab shows investors continuing to favor airlines and starting to nibble in software companies. Energy, the best sector in the last 12 months, is also trying to stabilize.

OPTIONS ACADEMY

From the AP Archives: Volatility and the Option Pricing Model

Options are derivatives of underlying assets and can be boiled down to a mathematical formula. As such, the value of an option is determined by a formula called the Options Pricing Model. While there are different variations of the Options Pricing Model, there are a few basic variables that are always taken into consideration.

There are six inputs to the pricing model: the stock price, the strike price, days to expiration, dividends, interest rates, and volatility. Of these, volatility is the one true variable component.

Volatility is the only true variable between the buyer and the seller. Think about it: at the time of the trade, the stock price is the same for both parties. So are dividends and interest rates. Additionally, the buyer and seller obviously had to agree on the month and strike. That leaves volatility as the last component in the decision to make a trade, and this is exactly where a difference of opinion arises; otherwise, there would be no trade.

This concept of volatility is by far the hardest one for individual investors to understand. The word itself evokes a bit of fear. Yet we have been successfully teaching options to professional on-floor market makers, institutional traders, and now individual investors for quite some time. The key is explaining the Option Pricing Model before introducing volatility.

By starting with the Options Pricing Model, it becomes apparent that much of the difficulty with volatility lies in the fact that it involves an element of prediction. This is because volatility is concerned with a period of time (life span of the option in question). Therefore, the volatility input is a prediction of volatility of the underlying stock (or other asset), essentially asking you to look out into the future. This forces many new students out of their comfort zone.

Move from prediction to math, and now you are downright scaring people. Yes, volatility involves mathematical computations. Think of all of the mathematical terms surrounding volatility. Terms such as variance, standard deviation, mean, mean reversion, mode, square root, and normal distribution. This terminology can be very intimidating to the newcomer and, when combined with prediction, often creates a mental obstacle.

It is usually at this point that the student says, "I give up." However, once you become comfortable with the concept of volatility, you will be well on your way toward understanding the valuation of options. It then becomes second nature to understand the impact that time and volatility have on intrinsic and extrinsic value, as well as how to quickly calculate both.