Bulls Blast Into August
CNBC has revised their Option Action show which is aired every weekday night at 5:30. They have really beefed up the Friday show to the point that we think it is one of the best option oriented shows on the air. Check it out.
The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
| Strong earnings and an improving jobs outlook trumped investor concerns over spreading Covid variant cases this week and the major averages were able to punch new record highs. While the Dow Jones zig-zagged to a new high, the NASDAQ carried a four-day win streak into Friday before settling just below its all-time high from Thursday. Economic data was mostly better than expected with June Factory Orders and the ISM Services Index beating estimates while Friday’s Employment Report showed the economy created 943k jobs in July, while raising May and June numbers. The Unemployment Rate fell to 5.4%. Interest rates ticked higher on the reports and the yield on the 10-year Treasury finished at 1.30%, up from 1.13% earlier in the week and a two-week high. The US Dollar also firmed as rates increased. The rise in rates gave a boost to the Financial (XLF) sector which jumped +3.66% after new 52-week highs were hit by Wells Fargo (WFC), Morgan Stanley (MS) and Goldman Sachs (GS). Utilities (XLU), Technology (XLK) and REITs (XLRE) also outperformed. The Consumer Staples (XLP) sector was the only group finishing in the red on weakness in shares of Clorox (CLX), Kimberly-Clark (KMB) and Colgate-Palmolive (CL) after disappointing earnings. Not all asset prices moved higher however, as crude oil turned in its worst week since October falling back below $70 a barrel on demand concerns after China and Indonesia enforced new shutdowns to battle spreading Covid cases. Oil prices are down about -8.5% in the last month. Friday’s rally left several of the major averages at record highs going into the weekend including the DJIA, S&P 500 and NYSE. Next week we get another round of what should be better than expected earnings and that should keep equity prices nudging higher.
For the period, the DJIA gained 273.04 points (+0.8%) and closed at 35208.51. The S&P 500 picked up 41.26 points (+0.9%) and settled at 4436.52. The NASDAQ jumped 163.08 points (+1.1%) to close at 14835.76, while the small cap Russell 2000 traded higher for a third consecutive week adding 21.51 points (+1.0%) finishing at 2247.76. Market Outlook: The technical condition of the market improved this week as the moving averages looked to be beginning a fresh leg higher after a few weeks of consolidation. The technical indicators improved with MACD, a short-term gauge of the trend, crossing into bullish territory for the different indexes, while Momentum, as measured by the 14-day RSI, is bullish and getting stronger. The DJ Transportation Index and Russell 2000, which have been lagging the broader market recently, seem to be turning it around. The small cap Russell 2000 climbed back above its 100-day moving average (MA) and finished higher for a third consecutive week. The transports index remains below its 50 and 100-day moving average (MA) resistance levels however and will need to clear that area for the broader market to continue to punch new highs. In addition, the Philadelphia Semiconductor Index (SOX) and the iShares NASDAQ Biotechnology ETF (IBB) were the best performers this week and both hit new highs which bodes well for the market. Market technician’s like to see the secondary indexes show relative strength in sustained market moves. Finally, the Market Edge Industry Group Analysis, which monitors 91 Industry Groups, has improved to 39 groups rated Strong or Improving, up from 21 two weeks ago, which shows underlying strength in the rally. Internal breadth supported the move higher as the NYSE and NASDAQ Advance/Declines showed most stocks were under accumulation and the NYSE A/D line was nearing an all-time high. New 52-week highs vs. new lows also improved and the NASDAQ recorded more new weekly highs than lows for the first time in three weeks. Investor sentiment is still overly bullish but has backed off extreme levels seen a month ago. However, the pros seem to be counting on the rally to continue. The National Association of Active Investment Managers (NAAIM) Exposure leaped to 97.7 this week, up from 71.0 just two weeks ago. In addition, the ratio of Percentage of Bullish Investment Advisors to Bearish Advisors shows the Bulls outnumber the Bears 3.2:1. The VIX (Volatility Index) also shows investors are getting more comfortable with the rally as it fell to 16.15 on Friday, its lowest read since the first of July when the different indexes were all touching all-time highs. The stock market has several catalysts that can push prices higher into the fall. Friday’s jobs report showed that as stimulus checks fall off, people are going back to work. One of the Fed’s mandates to begin looking at policy change is an improving jobs picture. However, with the Covid variant threatening to slow global economies in the background, the Federal Reserve will error on the cautious side before beginning to taper or think about raising rates. That should push any significant change out to 2022, keeping rates lower for longer despite a stronger economy. Furthermore, the infrastructure bill that is floating on Capitol Hill will act as another round of stimulus as it injects $1.2 trillion into the economy and creates new jobs over the next five years. Finally, this week Goldman Sachs raised their year-end price target for the S&P 500 to 4900 saying, “the combination of higher-than-expected S&P 500 earnings and lower-than-expected interest rates drive our upgraded price targets. Relative to consensus, we expect stronger revenue growth and more pretax profit margin expansion as firms successfully manage costs and as high-margin tech companies become a larger share of the index While market volatility will increase as Fed officials comment on policy changes, especially leading up to the Jackson Hole Economic Symposium August 26-28, look for dips to be bought as the major averages continue to push higher. A chart of these indicators can be found by going to the Market Edge Home page and clicking on Market Recap, which is on the right-hand side of the page just below the Second Opinion Status numbers. Cyclical Trend Index (CTI): The underlying premise of the CTI is that the market, as measured by the Dow Jones Industrial Average (DJIA), tends to move in cycles that often resemble sine waves. There are five identifiable cycles, each with different time durations at work in the market at all times. Currently, the CTI is Positive at +14, unchanged from the previous week. Cycles A, B, C, D and E are bullish. The CTI is projected to remain in a positive configuration into the fall. Momentum Index (MI): The market’s momentum is measured by comparing the strength or weakness of several broad market indexes to the DJIA. Readings of -4 and lower are regarded as bearish since it is an indication that a majority of the broader based market indexes are weaker than the DJIA on a percentage basis. Conversely, readings of +4 or higher are regarded as bullish. The Momentum Index is Neutral at +2, up two notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line added 1115 units while the number of new 52-week highs out did the new lows on all five sessions. Breadth was also positive at the NASDAQ as the A/D line gained 617 units while the number of new highs beat the new lows on each day. Finally, the percentage of stocks above their 50-day moving average eased to 47.2% vs. 48.2% the previous week, while those above their 200-day moving average fell to 71.4% vs. 75.8%. Readings above 70.0% denote an overbought condition, while below 20% is bullish. Sentiment Index (SI): Measuring the markets Bullish or Bearish sentiment is important when attempting to determine the market’s future direction. Market Edge tracks thirteen technical indicators listed below that measure excessive bullish or bearish sentiment conditions prevalent in the market. In addition, we track money flows into and out of Equity Funds and ETFs which as of 8/04/21 shows inflows of $2.0 billion. Currently, the Sentiment Index is Negative at -2, unchanged from the previous week. Market Posture: Based on the status of the Market Edge, market timing models, the market Posture is Bullish as of the week ending 7/30/2021 (DJIA ñ 34935.47). For a closer look at the technical indicators and studies that make up the market timing models, check out the tables located below.
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Ask Mr. Seifert
How does a short-term (one week) long/short stock trading strategy compare to selling bull/bear credit spreads?
Forecasting short-term price movements in stock prices is a tough proposition. However, it can be done with some sort of consistancy and when successful can be a very profitable endeavor. There are five possible scenarios that can occur when implementing a long stock trading strategy. Following is the outcomes for each scenario. Short trade results would be a mirror image of these scenarios.
Possible Scenarios Results
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- Stock closes up by lot above the open price. Unlimited % Gain
- Stock closes up a by a small amount above the open price. Small % Gain.
- Stock closes unchanged. No % Gain/Loss
- Stock closes down by a small amount. Small % Loss
- Stock closes down by a large amount. Unlimited % Loss
As can be seen from the table, only two of the possible scenarios result in a gain when trading stocks while a large, adverse move can result in a significant, unlimited loss. While the last scenario can be hedge somewhat by the use of stop loss orders, there is no guarantee that you can limit your downside.
Next we will take a look at the likely outcomes of a one-week trading strategy which involves the selling of bull/bear, vertical credit spreads. Like above, this strategy has five possible scenarios but there are favorable results in four of the likely outcomes. The following are the possible scenarios of selling a weekly, bullish put-credit spread. The opposite scenarios would apply for a bearish, call-credit spread strategy.
- Stock closes up by lot above the open price. Full Win – Full % Gain – Limited
- Stock closes up a by a small amount above the open price. Full Win – Full % Gain – Limited
- Stock closes unchanged. Full Win – Full % Gain – Limited
- Stock closes down by a small amount (less than 1%). Part Win – Small % Gain
- Stock closes down by a large amount. Full Loss- Full % Loss – Limited
As can be seen from the table, four of the five possible scenarios result in a gain. In addition, if the stock closes down by a large amount, the loss is always limited to the width of the spread minus the credit amount. Finally, the credit spread strategy, whether long or short can be profitable in any type of market environment.
Ironically, option trading is typically regarded as a risky proposition. The fact is that selling credit spreads can be a lot less dicey than trading stocks which have unlimited risk. Credit spreads have a defined maximum loss which is the width of the spread minus the credit amount. If a big loss occurs while trading stocks, it could take a long time to get back in the green while the option strategy keeps chugging along. Plus, a trading strategy that produces 60% winners will work great when selling credit spreads but not necessarily when trading stocks because of the unlimited loss potential. Finally, selling credit spreads provide three more profitable outcomes than do trading stocks.
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