• This Week's Trade Ideas:
Bullish: None at this time.  We will keep an eye on the markets as this could change.

Bearish: Microsoft Corp. > MSFT – Buy the July 14th 71 Puts for $1.75 or less with a close or anticipated close below $69.90 in a down market with expectations for continued weakness.
(Trend Reversal Trade: SPECULATIVE!)

CSX Corp. > CSX – Buy the July 14th 53 Puts for $1.85 or less with a close or anticipated close below $52.00 in a down market with expectations for continued weakness.
(Trend Reversal Trade: SPECULATIVE!)

• Market Overview:
This is a very light week with respect to economic reports. As is often the case, the latter part of the week is likely to carry more weight if the markets decide to move in response to reports. While the week is light on releases, it’s very heavy in terms of FED members making speeches. The reactions to those speeches could provide the fuel for more movement than this week’s economics.

• Below the Radar:
Before we get into the heavy economic content, we’re going to start off with how the markets are and have changed and how that’s left many concerned.

• Options Academy:
During bull markets, especially the later stages of bull markets, the bullish reflex of active traders becomes very strong. This can often lead to an abandonment of risk aversion in search of even greater profits; greed takes complete control. A level-headed appreciation for risk becomes an afterthought during these phases. We’ve seen and heard some anecdotal signs of this recently…

Still following the Melt Up Script or will the Warning Signs finally matter?

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 crosscurrents in the markets are moving swiftly.  Many issues have run up to absurd new highs.  We find it difficult to consider long side ideas at this juncture.  The cycles work that we perform does not support it at present.

As usual, we’re still maintaining the “singles” oriented / risk-averse mindset and approach as we’ve been for some time and it’s with that in mind that we’ve generated the following ideas.  We may or may not be quick to take profits, should they develop.  It will depend upon the action in the stocks and markets as we observe them.

Bullish:

None at this time.  We will keep an eye on the markets as this could change.

Bearish:

Microsoft Corp. > MSFT – Buy the July 14th 71 Puts for $1.75 or less with a close or anticipated close below $69.90 in a down market with expectations for continued weakness.

(Trend Reversal Trade: SPECULATIVE!)

CSX Corp. > CSX – Buy the July 14th 53 Puts for $1.85 or less with a close or anticipated close below $52.00 in a down market with expectations for continued weakness.

(Trend Reversal Trade: SPECULATIVE!)

Outlook:

The melt-up has continued much as the larger picture charts suggested it would but we see the warning signs flashing more and more.

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:

Unfortunately, and once again, despite triggers that were close by, neither the ETFC or HAL ideas were able to fire.  The markets are now experiencing even more cross currents.  Many sectors and stocks have fallen off while other have suddenly found a bid.  A lot of action seems to be short lived with little sustained follow through on either side.  For example, the NDX and SPY remain below record levels while the DOW is setting new one.  Certainly, this action has been related to the FED release’s and economic reports but it also seems to be related to rotations of various kinds.  Valuations remain stretched according to many historical metrics.

This is a very light week with respect to economic reports.  As is often the case, the latter part of the week is likely to carry more weight if the markets decide to move in response to reports.  While the week is light on releases, it’s very heavy in terms of FED members making speeches.  The reactions to those speeches could provide the fuel for more movement than this week’s economics.

This Week’s Economic Calendar

The Atlanta FED’s GDP NOW forecast for Q2 is down yet again.    2.9% is the current forecast vs. nearly 4.5% that was being touted a little more than a month ago.  Q2 GDP may bounce back but the bounce isn’t looking nearly as strong as it recently had been.  Still though, that and nearly everything else economic seems not to matter, at least until it does… One needs to look no further than our SPYs chart discussion that follows…

The Wall St. gang got stocks off to a great start this week.  “On what?”, some may ask but the “what” matters little these days at the melt-up mindset and algorithms that feed on that mindset continue to help to prevent any meaningful corrections while slowly moving prices higher.  As we’ve mentioned here for the past several weeks, we seem to be in the midst of a slow-motion melt-up.  As that’s the case, 3 of our 4 notable lines above are bullishly oriented than bearish.  The yellow highlighted line is nearby resistance, and after holding support near the red highlighted line and not having to use much energy to get to the current line, the SPYs should have plenty left to attempt to breakout.  Should that be the case, the orange and green highlighted resistance lines and the upper Bollinger Band (red line) could be areas of eventual resistance.  Back to the red highlighted line as we conclude.  If that’s breached to the downside, that could be the first strong technical sign that equities are finally about to recognize mounting risks again.

Last week’s Market Commentary:

“The gang was able to hold the indices above some support levels last week despite the tech carnage.  If tech recovers and the FED provides the customary boost, the SPYs are set to challenge the nearby resistance just above and possibly move higher in another wave upward.” 

More or less, that’s where things seem to stand at present.  The FED boost came a little late but the attempt is being made.  So far things are acting as they have so many times over the course of this bull market so the pattern remains in place.  We must be on guard if the indices cannot break out or if they do but fail to hold above resistance.  With the bigger picture charts still looking fine, we have to continue to lean with them.  Hopefully, only a little more time will tell if a new upside leg is in the making…or if a failure is occurring.  With stock values so far detached from so many things, it wouldn’t be odd at all if we finally witnessed a pullback of some meaningful degree, machines permitting…

Before we get into the heavy economic content, we’re going to start off with how the markets are and have changed and how that’s left many concerned.  We’ll turn to Bloomberg first:

https://www.bloomberg.com/news/articles/2017-06-15/it-s-a-quant-s-stock-market-as-computer-programs-keep-on-buying

As can be seen, a lot is different from even just two years ago in 2015.  Humans aren’t doing nearly as much right-clicking.  Can it be as simple as cold, bloodless machines run amok?  Noted money manager Doug Kass seems to think so.  He of many decades on Wall St., authored in several news articles over the past few weeks…

Kass began one with the paragraph that follows with our bolded emphasis added:

"Let's consider that statement. In the last 20 years the VIX closed lower than 10 on a total of 11 days, and 7 of those days were in the past month. Think about that - over the past 2 decades, was the last month the most benign macro environment? (e.g. last week: Comey testimony, UK elections, ECB, geopolitical uncertainty, Qatar, FANG flash crash, etc.)." - Marko Kalonovic, JPMorgan's head quant

So, NO, you’re not alone if you think something extremely strange has been present in US equity markets of late.  Kass’ piece also included this key paragraph:

"The combination of central bankers' unprecedented largesse (and liquidity) when combined with mindless quant strategies and the enormous popularity of ETFs will, as night follows day, become a toxic cocktail for the equity markets. While we live in an imperfect world, we face (with valuations at a 95% decile on a number of metrics) a stock market that views the world almost perfectly."

Kass referenced the Twilight Zone to begin to describe things and more on the perils of machine domination can be found here: http://realmoney.thestreet.com/articles/06/14/2017/something-out-twilight-zone-market-about-machines?cm_ven_int=homepage-latest-headlines

Kass wasn’t done and followed it up with this, of which of few choice snippets follow the link:

http://www.zerohedge.com/news/2017-06-14/doug-kass-not-even-algo-creators-know-what-going

“Listen Luddites, for the stock market, too, it's a thing about the machines. 

Throw away your fundamental analysis, your price charts, interest rates and economic growth forecasts, as the market has lost its moorings. 

It is no longer a pyramid of fundamental and technical analysis nor is it a response to changing investor sentiment.” 

For the record, we’re with Kass and as he concluded, the type of action we saw in the recent tech plunge out of nowhere is likely to become the first of many.  The machines, maybe with assistance from the invisible hand, seem to believe that stock prices shouldn’t suffer corrections.  Even earnings growth, (the heavily massaged kind of course) no longer seems to matter, especially in NASDAQ Mania 2.0:

And not to be left out, the entire market when viewed through Shiller’s CAPE Ratio.  The ever-popular cyclically adjusted price-earnings ratio metric. (CAPE is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10):

Yep, that’s a match of 1987!

We’re now going to turn to familiar ground and provide graphical updates on some of the important themes and areas we consistently feature in BTR so buckle up:

We’re following up the Atlanta FED’s GDPNOW with the NY FED’s NOWCAST (above).  Q2 GDP estimates continue to trail off and finally starting to come in line with the US Macro data we’ve been tracking down for the past few months.  Of course, and as we’ve noted many times, stocks (the machines) seem not to care:

Something is truly amiss when what was a strong correlation breaks down as much as US Macro has when compared to the performance of the S&P 500.  The current divide is glaring!  We saw something similar in the “soft data” vs. “hard data” reports over the past few months and then this began to happen:

If your eye has picked up on soft data’s round trip to pre-election levels then you’re onto something!  Obviously hard data is dropping precipitously and is approaching 2 year lows.  Can history, recent history, guide us at a juncture like this?  Perhaps…:

Last time Macro data crashed this hard the FED soon after rolled out Operation Twist.  This time around they’re raising rates and claiming that balance sheet unwind is on the way later this year.  Hmmm…  It would seem the FED’s plans, as they stand now, are virtually the opposite of Operation Twist which was conceived and executed to drive down interest rates.  Recent history has taught us that what central planners give they can also take away:

Hopefully the graphic above provides enough perspective to “speak” for itself.  Let’s not forget who their policies have benefitted either as that may at least somewhat explain the widesrpread frustration and anger that seems to have spread across the continental 48:

Another graphic that says it all or at least most of it.  The two prior graphics if upated to current day would likely only worsen, considerably…

We haven’t checked out what “money” is doing of late or how it’s been trending.  Let’s go ahead and guess that the velocity of money is slowing given all the other indications of slowdown that we’ve chronicled…

Our guess turns out to be spot on not only in the US but in the EU and Japan as well.  Servicing mountains of debt sure takes a bite!  Of course, this will only worsen as rates are moved higher as Yellen and co. would have us believe they will.  The more important question may be “When?”  “When” in terms of when it will matter to the machines.  The machines didn’t like Goldman’s tech notes release and all hell broke loose!  We seem to be marching towards another widespread round of the same thanks to the obliviousness of the machines with respect to ancient notions rooted in centuries of economic history.  But, it doesn’t stop here!...

That’s a reprint from last week’s newsletter.  Commercial loan creation is cratering.  We’ve already seen how bloated debt levels are at this juncture and how backed up things are in autos, housing and retail in general.  NOW we’re adding rising rates to the mix?  Either the FED knows A LOT that we don’t know about rapidly improving yet hidden economic activity or rate increase probabilities are due to fall in a big way… UNLESS of course, the FED actually wants to bring asset inflation under control, suddenly…

http://www.zerohedge.com/news/2017-06-19/bofa-has-fed-become-concerned-about-surge-stocks

Back to Doug Kass, who we cited above, who isn’t alone this week in believing that the markets have become unhinged, perhaps mirroring the mainstream media!  Anyway, and moving on, in an attempt to tie these graphs and trends together to weave something more concise, we’re going to turn to a recent David Stockman interview.  This time Stockman is back with some pound the table warnings and with those and all the accoutrements, that’s a wrap for BTR this week:

“Markets go up on an escalator, they come down on an elevator. This is the most hideously overvalued market in history.”

David Stockman is a former Cabinet member where he served as the Director for Office of Management and Budget under President Ronald Reagan. Ranging from 1976 to 1981 Stockman also served in the U.S Congress.  He went on to be a senior managing director of The Blackstone Group. The economic and financial analyst is now a best-selling author where his most recent book, Trumped! A Nation on the Brink… And How to Bring it Back explores what he believes the current White House must do to correct the economy.

Stockman carried on with his call to the markets, and in particular his focus on the S&P 500, noting, “It is trading today at twenty-five times the hundred dollars a share that the S&P 500 earned in the period ending in March. Now, I go back ten years to June 2007 and the S&P 500 earned $85 dollars a share. That’s 1.2% growth, nominal in ten years.”

“You want to pay twenty-five times earnings going into a world where the Fed yesterday said ‘we’re going to shrink the balance sheet by $2 trillion over the next several years?’

Where we have a government that is in total chaos. A president that they’re trying to unseat. A debt ceiling that can’t be raised. A tax bill that will never pass. Going into all of that, to say nothing of the red Ponzi in China that one of these days will spill its guts all over the world economy.

And you want to pay twenty-five times earnings for today’s stock? Be my guest. This is a mania.”

http://video.foxbusiness.com/v/5472530022001/?#sp=show-clips

https://dailyreckoning.com/stockman-most-overvalued-market-history/

And volatility couldn’t be cheaper… Be careful out there!

During bull markets, especially the later stages of bull markets, the bullish reflex of active traders becomes very strong.  This can often lead to an abandonment of risk aversion in search of even greater profits; greed takes complete control.  A level-headed appreciation for risk becomes an afterthought during these phases.  We’ve seen and heard some anecdotal signs of this recently…

Over the past few months, we’ve received several emails regarding “other” options strategies.  “Other” in these cases meaning not only non-textbook but in all cases thus far, riskier.  Apparently, folks are bored with run-of-the-mill bull market type profits and need MORE!

This mindset is what’s behind questions about “lizards” and “broken wings” etc.  Keep in mind, these are not related to zoology but instead are actually options focused!  Given that this trend seems to be picking up steam, we decided to delve into it briefly this week.

Let’s pick up with our featured strategy from last week, the Iron Condor…

The Iron Condor (IC) is constructed as follows, all within the same expiration:

Sell a Vertical Call Spread

Sell a Vertical Put Spread

The spread between the strike prices is typically kept equidistant on either side of the ATM strike price.

We’ll use our SPY Iron Condor from last week again this week but with slight modification.  The SPY is right near $244 so an Iron Condor could look like this according to textbook application:

Call Side: Buy the June 30^th 248 Calls and Sell the June 30^th 246 Calls for a credit.

Put Side: Buy the June 30^th 240 Puts and Sell the June 30^th 242 Puts for a credit.

With the traditional construction approach above, we can see that there’s balance in the risk we’re willing to take to either side (directionally speaking).  These days, however, quite a few folks are wondering why they’ve been taught to “waste money” buying the 240 put in our example.  The thought process seems to flow as follows and it’s quite difficult to blame them given the unnatural proclivity of the market to avoid any correction of any degree for any length of time:

“I know the IC is supposed to be done as a fully hedged strategy but I keep wasting money by buying the downside protective put.  It never comes into play and it’s costing me on commissions too.  If I’d have just skipped that step I’d be up another 8% this year alone!...”

It certainly is true that performance can be improved by eliminating the purchase of the downside put and instead opting to simply short the slightly OTM put when trading Iron Condors.  Of course, they’re no longer ICs at that point and hence that’s where “lizards” and other names come into play.  Regardless of whatever the new name may be, the greed-driven transition from a fully hedged premium collection strategy to one that exposes the options trader to practically unlimited losses, is not merely one small step.  Graphics are powerful so let’s get to them.  Imagine how we’d have been feeling had we gotten away from being hedged to unhedged:

It took one unexpected release from Goldman Sachs with respect to the high flyers to produce severe selloffs.  Those stocks have recovered to a degree but those initial moves could have easily wiped out months of short premium returns in just a few hours.  These stocks, and a few others, are considered the “best of the best” and typically have excellent stock and options market liquidity.  So, essentially, this can happen to any stock at any time out of the blue.  It can even happen to major market ETFs at times.

If you’re considering getting away from boring “Iron Condors” and other hedged strategies in search of even more return, it may be worth remembering that repositioning your hedge into something less costly but that still maintains a true hedge may not be a bad middle ground to arrive at.  As for Advantage Point, we prefer to stay with what’s working that still lets us sleep at night and think clearly by day.

Please attend our Advantage Point Morning Call webinar if you have any questions!

Have a great week!

The Advantage Point Team