Big Cap Tech Gains Send NASDAQ to Record
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).
| The back-and-forth rotation from growth to cyclical flipped back to growth stocks this week after Fed Chair Jerome Powell’s dovish outlook for tapering bond purchases the previous Friday. The S&P 500 and NASDAQ pushed to new highs to start the week as Apple (AAPL), Alphabet (GOOGL), Facebook (FB) and NVIDIA (NVDA) recorded new highs of their own. In a case of bad news is good news, weaker than expected job reports during the period held interest rates low and put downward pressure on the US dollar which gave an additional boost to growth stocks. Small caps outperformed and the Russell 2000 hit its highest mark since early July. Earnings were strong but traders focused on forward guidance leaving reporting company stocks mixed. Shares of semiconductors Ambarella (AMBA) and Broadcom (AVGO), and apparel maker PVH Co (PVH) were sharply higher, while Chewy (CHWY) and Zoom Video Communications (ZM) dropped double digits. The markets rotation could be seen in the performance of the different sectors which finished mixed with rate sensitive sectors outperforming. REITs (XLRE), Healthcare (XLV), Utilities (XLU), Consumer Staples (XLP), Consumer Discretionary (XLY) and Communication Services (XLC) led the market to new highs, while cyclical sectors Financials (XLF), Energy (XLE), Materials (XLB) and Industrials (XLI) were all lower. Crude oil prices flirted with $70 a barrel on a bigger than expected drawdown in inventory, and after stockpiles hit their lowest level since October 2019. The Dow Jones Commodity Index (DJCI) punched a record high on Friday. The bulls took an early vacation day to close out the period leaving the major averages mixed as the week ended. The S&P 500 and NASDAQ were able to nudge higher for a second straight week, but the DJIA finished the week modestly lower.
For the period, the DJIA lost 86.71 points (-0.2%) and closed at 35369.09. The S&P 500 picked up 26.07 points (+0.6%) and settled at 4535.44. The NASDAQ jumped 234.02 points (+1.5%) to close at 15363.52, while the small cap Russell 2000 closed higher for a second straight week adding 14.90 points (+0.7%) finishing at 2292.05. Market Outlook: The technical condition of the market improved this week with several of the major averages once again able to notch new record highs. The technical indicators for the different indexes were mostly in bullish ground and Momentum, as measured by the 14-day RSI, is positive and mostly moving higher. The DJIA was the exception as its momentum slipped back into neutral ground. The DJ Transportation Index showed some negative divergence as it rolled lower for the second time in three weeks and remained stuck trading between its 50 and 100-day moving average (MA). The other secondary indexes moved higher led by a +2.3% spike in the NASDAQ Biotech Index. The small cap Russell 2000, which has been in trading range since February, was nearing the high end of its range. A break above 2350-2360 resistance for the index would be a big plus for the broader market and possibly trigger a melt up in prices. Internal breadth was bullish this week and the NYSE Advance/Decline line, a leading indicator of market direction, was close to hitting a new high which bodes well for stocks going forward. The NASDAQ A/D line also improved gaining more than 10,000 units in the last two weeks showing more stocks are under accumulation. New 52-week highs are also supportive of higher prices and have been expanding for the last two weeks. The Market Edge Sentiment Index has moved into neutral ground but overall, investors are still bullish. The American Association of Individual Investors (AAII) survey jumped to 43.4% for the bulls this week, the most bullish retail investors have been since the first week of July. That points to more investors wanting to buy the dips. In addition, the National Association of Active Investment Managers (NAAIM) Exposure Index shows the professionals are 93.9% invested, expecting the market to move higher. While September has an ominous reputation for the market, the major averages rolled into the month at record highs looking to extend their gains. We may be lacking a catalyst for stocks to move much higher, but the next FOMC meeting isn’t until September 21-22 and with economic data, especially jobs, weaker than expected, it is unlikely the Federal Reserve will be able to do much to rock the boat over the near term. The Federal Reserve won’t meet again until the first week of November which should keep a firm floor under the market and push a timeline for tapering out to the end of October. That should allow the different indexes to notch more record highs over the next few weeks. However, on Thursday, the Market Edge/S&P Short Range Oscillator (SRO) hit +5.03%, the most overbought the market has been since April 15. Historically, the market has needed to consolidate gains when that widely followed indicator hits that level. As Wall Street comes back from summer break after the long, Labor Day weekend, we could see some backing and filling next week to work off that overbought condition as portfolios get adjusted. 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 +12, down two notches from the previous week. Cycles B, C, D and E are bullish, while Cycle A is bearish. 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 Positive at +6, up six notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line gained 1135 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 added 1867 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 jumped to 63.9% vs. 49.6% the previous week, while those above their 200-day moving average rose to 69.6% vs. 65.1%. Readings above 70.0% denote an overbought condition, while below 20% is bullish. Sentiment Index (SI): Measuring the market’s 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 9/01/21 shows inflows of $12.7 billion. Currently, the Sentiment Index is Neutral at +0, up a notch 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 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. By David L. Blake, CMT
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Ask Mr. Seifert
What is Implied Volatility?
Implied Volatility (IV) is the rate at which the price of a security increases or decreases for a given set of returns. It is derived by calculating the standard deviations from the current mean. To the average investor that definition doesn’t mean that much but if you watch your portfolio you should notice that when we are in a high volatility environment and when volatility is low. As a rule, volatility will go up when the market is breaking down and will be down when it is rallying.
Since most option trading volume usually occurs in at-the-money (ATM) options, these are the contracts generally used to calculate IV. Once we know the price of the ATM options, we can use an options pricing model and a little algebra to solve for the IV. For those of you who snoozed through Statistics 101, a stock should end up within one standard deviation of its original price 68% of the time during the upcoming 12 months. It will end up within two standard deviations 95% of the time and within three standard deviations 99% of the time.
To option traders, implied volatility is more important than historical volatility because IV factors in all market expectations. If, for example, the company plans to announce earnings or expects a major court ruling, these events will affect the implied volatility of options that expire that same month. Implied volatility helps you gauge how much of an impact news may have on the underlying stock. With an option’s IV, you can calculate a published range – the high and low of the stock by expiration. Implied volatility tells you whether the market agrees with your outlook, which helps you measure a trade’s risk and potential reward.
Let’s assume a stock trades at $50 with an IV of 20% for the at-the-money (ATM) options. If we assume a normal distribution of prices, we can calculate a one standard-deviation move for the stock by multiplying the stock’s price by the IV of the at-the-money options. For example, if the stock is trading at $50 with an IV of 20%, there’s a consensus in the market place that there is a probability of a one standard deviation move over the next 12 months which would be plus or minus $10 since 20% of the $50 stock price equals $10. Simply put, the market thinks there’s a 68% probability that at the end of one year, XYZ will wind up somewhere between $40 and $60. By extension, that also means there’s only a 32% chance the stock will be outside this range. In addition, 16% of the time it should be above $60, and 16% of the time it should be below $40.
All implied volatilities are quoted on an annualized basis, which means the market thinks the stock would most likely neither be below $40 or above $60 at the end of one year. Statistics also tell us the stock would remain between $30 and $70 (two standard deviations) 95% of the time and would trade between $20 and $80 (three standard deviations) 99% of the time. Another way to state this is there is a 5% chance that the stock price would be outside of the ranges for the second standard deviation and only a 1% chance of the same for the third standard deviation. Knowing the potential move of a stock which is implied by the option’s price is an important piece of information for all option traders.
Since we don’t trade one-year options contracts, we must break down the first standard deviation range so that it can fit our desired time period (e.g. the number of days left until expiration). As a short cut, divide the quoted IV by 19, which is a whole number when solving for the square root of 356 to get the weekly IV. It can’t be emphasized enough, however, that implied volatility is what the marketplace expects the stock to do in theory. And as you probably know, the real world doesn’t always operate in accordance with the theoretical world. In the stock market crash of 1987, the market made a 20 standard deviation move. In theory, the odds of such a move are positively astronomical: about 1 in a gazillion. But in reality, it did happen. Not many traders saw it coming.