Advantage Point Newsletter - March 20th, 2018
A Week of Heaviness. A Prelude to More?
Or Mostly Over as the FED rides in (again) on a White Horse?
Bullish Ideas: None at this time.*** (FED Meeting etc. Many mentions below to have at the ready.)
Bullish Mentions: MOMO, TAL, CTRP, ADBE, MGM, MPC, APA, XRX, FDX*, CNQ, QSR, HFC, KBH*, PBF, ACN*, CGNX, CLR, CMI.
Bearish Ideas: None at this time.*** (FED Meeting etc.)
Bearish Mentions: TOL.
• Market Overview:
It’s really more of the same from recent weeks. We became short-term oversold and they held stocks on key support levels. What else is new? Now they’ll look with hopeful eyes towards the FED to keep the spice flowing for at least a little while longer. Our hands should be tied until that affair is in the history books.
• Below the Radar:
If the first 10 trading weeks of the year didn’t tip you off, let Morgan Stanley handle things instead.
https://www.marketwatch.com/story/the-stock-market-meltup-is-over-morgan-stanley-2018-03-19 It doesn’t get much more emphatic than that but what exactly does that headline mean? How about:
"We think January was the top for sentiment, if not prices, for the year. With volatility moving higher we think it will be difficult for institutional clients to gross up to or beyond the January peaks" - Morgan Stanley
• Options Academy:An interesting question came in from a client with regards to holding and rolling longer term calls. We decided the answer might be of aid to other traders and thus this week’s OA installment was born. This is a brief exploration into defensive trade management.
A client recently bought calls in INTC as he sold out his long stock position. The stock was trading $53.25, just below the recent high of $53.78. So…he had been holding the stock for some time and was quite happy with the profit. He was concerned with not being able to participate in the upside if the stock continued to move higher…so he bought some calls. Now he came to us with questions about the cost of these options and if there was anything he could do to offset the cost.
The simple answer is YES, you can sell an option against it to offset the decay.
A Week of Heaviness. A Prelude to More?
Or Mostly Over as the FED rides in (again) on a White Horse?
The Trade(s):
We’re noting this AGAIN!
… if you decide to become or remain involved, stay nimble!!!
With the FED now added to the mix this most definitely continues to apply! When volatility picks up, as it has, a great deal of movement is compressed into a very short period of time when viewed relatively. Adjustments and rolls need to be completed much more frequently than during normal phases of market price action.
We strongly suggest viewing this week’s Advantage Point Morning Call webinar for full details with respect to these idea(s), last week’s and options education.
Week 7 of our Special Note:
We’re sticking with it until the market settles down!
Things may yet sort out for the Markets and we’ll be back to All-Time Highs across the board an on our way to even more ATHs, but technical work remains to be done before we can issue the “All Clear”.
Realize that you may be operating in a fast-moving environment should you decide that to enter the markets.
We’re happy that we maintained this outlook as it has borne out. We’ll continue to reprint this note as long as the markets remain this volatile! So, once again, we offer:
….movement…is back in business it would seem. Act accordingly!
Bullish Ideas: None at this time.*** (FED Meeting etc. Many mentions below to have at the ready.)
Bullish Mentions: MOMO, TAL, CTRP, ADBE, MGM, MPC, APA, XRX, FDX*, CNQ, QSR, HFC, KBH*, PBF, ACN*, CGNX, CLR, CMI.
Bearish Ideas: None at this time.*** (FED Meeting etc.)
Bearish Mentions: TOL.
Outlook:
It’s really more of the same from recent weeks. We became short-term oversold and they held stocks on key support levels. What else is new? Now they’ll look with hopeful eyes towards the FED to keep the spice flowing for at least a little while longer. Our hands should be tied until that affair is in the history books.
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 yet another week in which we were mostly happy. Bullish mentions PLAY and SRE should have been avoided all week as the markets were heavy every day. However, SRE did move up somewhat and PLAY hung in there somewhat. But now, onto the bearish side.
Bearish idea XLF did trigger and fall and many of the bearish mentions fell off nicely too. C, BAC, DFS, JPM, GS, PNC, AIG, EFA, HYG, JD, XLI, DIS, MGM, COP, HD, EOG, and CBS fell to one degree or another. The FED meeting tomorrow saved the financials from further downside in our estimation and that’s exactly why we sent out our update to stay on top of closing and rolling as the Gang likes to square up before FED meetings, typically. V was the only name that really didn’t at cooperate at all.
Last week the Gang opened the major indices higher nearly every day and then sold into them. That’s distribution, plain and simple. That’s not a very good sign. Not a very good sign at all. However… the selling is no longer fresh. The cycle is maturing. How much more can we expect for now? Downside that is. Especially when:
There are many levels of support just waiting to kick in and in various forms. We’ve got trendlines. We’ve got SMAs. We’ve got Fib levels. We’ve got confluence. We’ve got the FED (see below)!
We’ve maintained that we didn’t believe “it was over” for almost 2 months now. We still feel that way. That doesn’t mean that we expect more massive downside, it simply means that volatility is here to stay for at least a little while longer in our estimation. With the FED focus of this week and with a sell cycle maturing, we’d be surprised if US equity markets simply fell apart and tested the lows put in 6 weeks or so ago. A retest of the lowest lows would be quite a drop even from Monday’s lows. However, stranger things have happened. When we add Tweet Risk, “You’re Fired” Risk and “Investigation Risk” into the equation, things become even more difficult to predict moment to moment!
The DOW and NASDAQ have been doing their own thing lately with the DOW using good vibes from a few key stocks to remain levitated while the NASDAQ has feasted on investor’s love affair with tech, mainly semis and other related areas. Fund managers also seem to LOVE the Russell 2000 (IWM ETF) but they did give a little up in last week’s action. We’re sticking with the SPY as our proxy for now because it is what it is, and other World equity markets are acting much more like it than the others mentioned above. And on that note…
Last week we noted that European and Chinese equity markets, despite rallying the week before, still didn’t look very good. Well… they still don’t look very good!
The Euro Stoxx 50 ETF is at a critical juncture. The Gang is trying hold it above its 200 SMA in purple and they very well may. If they do, it could easily pop through the red down sloping resistance line and try to make a higher high. If it doesn’t hold there, it could go back to a retest of both “non-overshoot lows”. If it doesn’t hold there??? Watch out below!
China on the other hand, looks a little better. It has a confluence of trendline support and at least 3 SMAs in the vicinity that could provide support. That confluence would help the cause significantly in most cases. We’ll see soon if it does this time around…
And now…back to the USA…
Above is a snapshot of the VIX. So far, it doesn’t appear as though fear has taken over. Despite over a week of heaviness and greater uncertainty seemingly across the board in many respects, investors aren’t sweating it nearly as much as they have been in the more recent past. We’ll likely find out soon if someone blinks but most are keeping their cool as we write.
The early part of the week is mostly silent in terms of economic releases. Things do pickup somewhat but all in all it is a light week. HOWEVER, there is an FOMC announcement on Wednesday followed by Powell’s presser. Obviously, that is the main focal point and could be the juncture are which even more volatility is introduced into the markets. Thursday and Friday have some typically weighty numbers, but the FED fallout could still overhang the markets for few days beyond Wednesday. Buckle up!
If the first 10 trading weeks of the year didn’t tip you off, let Morgan Stanley handle things instead.
https://www.marketwatch.com/story/the-stock-market-meltup-is-over-morgan-stanley-2018-03-19 It doesn’t get much more emphatic than that but what exactly does that headline mean? How about:
"We think January was the top for sentiment, if not prices, for the year. With volatility moving higher we think it will be difficult for institutional clients to gross up to or beyond the January peaks" - Morgan Stanley
A meltup is an unexpected rise in asset prices as investors surge into the market on fear of missing out.
“When we look at our internal data combined with industry flows and sentiment, we think there is a strong case that January was the melt-up, or at least the culmination of it,” Wilson added.
Which means…the easy ride the rocket ship higher money has/had been made. 2018 isn’t going to be like 2017, at least as they see it.
The over-leveragedness in the markets late last year and early this year that we wrote about many times, seems to sharply reversed along with the selling we’ve seen since January closed out. The one side of the boat boys were forced to capitulate:
It’s difficult to precisely define “Euphoria” but as was suspected at the time, the average guy along with the average hedge fund trader got in too big, too deep, and all together. What we’re contending with now is likely, at least partially, still fallout from those recognizing that the greed and hubris fest may be over for now. And let’s not forget that Morgan Stanley’s “base case” for 2018 isn’t very exciting to begin with:
If earnings fail to deliver, this year could really be rough…
Marketwatch is where we’ll remain for now as suddenly, risk is one again becoming fashionable content there after a very long hiatus. https://www.marketwatch.com/story/this-political-risk-gauge-just-hit-a-15-year-high-heres-what-it-means-for-the-stock-market-2018-03-16
As even die-hard Trump supporters are likely to acknowledge, there’s rarely a dull moment:
The problem is, the markets like dull moments! And now, if Morgan Stanley didn’t get the job done for you, allow Goldman Sachs to finish things. They’re concerned about the markets themselves causing the next crash!:
The piece isn’t very long and for those wanting to better understand the inner workings of the modern market and how the scales can be tipped in ways that produce avalanche-style selloffs, take the time and read it thoroughly.
We pulled a few of our favorite graphics from the piece. Longtime readers will realize why. (Hint: Manipulation of various kinds and the behavior that it conditions.)
And finally, this one is from a little way back but if you’ve got time to kill and the machines and markets themselves causing the next crash hasn’t terrified you sufficiently, read all about market fragilities that few are contemplating and even few are concerned with:
https://www.zerohedge.com/news/2018-02-03/four-pillars-holding-market-are-cracking
There are several interesting graphics in the article and really help to frame just how concerned we should all be and for many, many reasons. We can’t include them all but here’s a little visual motivation to tackle the balance of the content:
We’ve got to Keep on Banking and Rolling!
An interesting question came in from a client with regards to holding and rolling longer term calls. We decided the answer might be of aid to other traders and thus this week’s OA installment was born. This is a brief exploration into defensive trade management.
A client recently bought calls in INTC as he sold out his long stock position. The stock was trading $53.25, just below the recent high of $53.78. So…he had been holding the stock for some time and was quite happy with the profit. He was concerned with not being able to participate in the upside if the stock continued to move higher…so he bought some calls. Now he came to us with questions about the cost of these options and if there was anything he could do to offset the cost.
The simple answer is YES, you can sell an option against it to offset the decay. The long answer is a little more complicated because it involves his opinion of what will happen in the stock.
Unfortunately, the market has moved a little lower in price ($51.37) and he is not as confident as he was when the stock was trading above $53.00. He asked about his choices in being able to sell an option if the stock is down slightly from where he bought, but he wants the upside if the market rebounds then INTC should test the highs.
This situation really comes back to outlook vs risk. The options are simply a tool for you to use to achieve leverage for appreciation and/or premium collection. When all things are equal, and if you are entering a trade at the same stock price with the same perceived risk then it is much easier to price out a trade. When you buy one on one day with a certain perceived risk and then several days later want to adjust your risk based on a new perceived outlook, you then have to expect things to have changed.
As the stock price has moved down, there is an incurred loss. He now wants to limit that loss as much as possible but still have the upside. Unfortunately, we can’t do both without adjusting strikes as the stock price moves higher (rolling). When he is already at a loss, the nearer terms options have decreased in price vs what he could have sold them for at the date of the long call entry. So…by selling a call against his long call now, he can only hope for one thing, which is counterintuitive. He wants the stock to trade up to the strike he sells and stay at that price until expiration or until he decides to roll. That scenario permits the sold option to expire worthless and he can capture the full premium he sold. He can then elect to sell another option against the one he holds at some new expiration date. This rarely ever happens to work out perfectly, so to be prepared, he needs to understand his risk and what he must do when and if the stock comes back to his short strike.
The easiest trick we teach is to compare your equivalent stock price of each option that you trade so you don’t get inverted on accident. This is done by adding the premium of the option to the strike price. Remember, buy low and sell high. If we buy a $50.00 strike with premium of $1.00 then our equivalent price is $51.00. If we sell a $52.50 strike for $0.40 then our equiv. price is $52.90. There will be times like his INTC trade where we are at a slight loss on the original purchase but still want to sell something against those contracts although we may not be sure what expiration, or which strike to select for sale. We can then use the equivalent stock price to make sure we are not selling something that would get us into trouble if the stock did run back up quickly. (That’s Inversion! We’re bulls and we lose on a bullish move higher!)
As we mentioned above, we need to know what to do when the stock reaches our short strike. First off, we would need to assess our outlook again, if it has changed for the positive (higher prices in the future), then we may simply want to buy back the short option and leave on the original long option. If our outlook has not changed (more sideways action), then we can roll our short option out to another expiration and stay at the same strike or we can increase or decrease the strike and corresponding premiums we select to sell to fine-tune for our outlook.
The moral of the story is, if your perceived risk changes and you simply want to offset the risk of the long call, then you can start to get a little more aggressive with selling and not worry about the equivalent stock price as your main goal is to collect premium against the long call. If our INTC investor had said “I am ok with being more aggressive when selling”, then he could start to sell something below his stock equivalent price of his long option to try to collect a higher premium to offset potential risk while buying time to further evaluate matters as they unfold.
In the end, if you don’t like a position, the easiest thing to do is to get out quickly and minimize your loss. If the momentum comes out of the position, then the risk increases of your long options decay hurting your position over time. Remember, there’s no rule against re-entering the trade at any time. In fact, that’s an unkept secret that far too many overlook.
If you have questions, ask away in this week's Advantage Point Morning Call webinar.