Economic Uncertainty Grips Markets
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
The major averages endured a rough week as a bevy of concerns on both the economic and political fronts kept investors on the sidelines as they continued to rotate out of growth names. Global markets opened the week with positive economic news as new orders for durable goods surpassed pre-pandemic levels but a rise in the 10-year Treasury bond yield saw the NASDAQ finish in negative territory. The major averages did a complete about-face on Tuesday as a combination of the 10-year Treasury yield surging to a high of 1.56% and a spate of bad economic news spooked investors further. The DJIA lost -569.38 points (-1.6%), but the NASDAQ was an even bigger loser, shedding -423.69 points (-2.8%) as the technology laden index posted its worst one day drop since May. Market participants were looking for some good news from Fed Chairman Powell’s speech on Wednesday, but didn’t get it, as the ongoing supply chain bottlenecks looks to keep Treasury yields at elevated levels into 2022. That extended the NASDAQ’s slide to four straight sessions. On Thursday, the market initially shook off a third straight weekly increase in jobless claims to a seasonally adjusted 362,000 but the rally did not last. A dire earnings report from Bed Bath & Beyond (BBY), took all the retail names down with it as the growing supply chain headwind continued to hamper stocks. On Friday, encouraging news from Merck (MRK) concerning a Phase 3 oral antiviral treatment that could reduce Covid-19 deaths by half coupled with reports of U.S. consumer spending increasing in August led to a rebound as the session ended higher. The only sector in the green for the week was Energy (XLE) as crude oil prices rose as high as $76 before easing at the end of the week. All the other sectors were in negative ground led by the riskier Technology (XLK) and Health Care (XLV) names that were down more than 4% for the period. With volatility increasing, the major averages closed the week on the downside.
For the period, the DJIA shed 258.42 points (-0.7%) and closed at 34326.46. The S&P 500 declined by 75.95 points (-1.7%) and settled at 4357.04. The NASDAQ tumbled by 477.27 points (-3.2%) to close at 14566.70, while the small cap Russell 2000 eked out a small gain of 4.76 points (+0.2%), finishing at 2241.63.
Market Outlook: The technical condition of the market declined significantly last week as most of the major averages finished in negative territory. Most of the technical indicators for the various indexes ended in bearish territory as several of the averages are now testing key moving average (MA) support levels. Both the S&P 500 and NASDAQ continue to trade around their 100-day moving average while DJIA broke below its 100-day but ended the week clawing back towards that level. The small cap Russell 2000 continues to trade in a tight range but remains below its 200-day MA while DJ Transportation Index has some work to do before it can get back to its 200-day MA. Both Financials (XLF) and Energy (XLE) are the only sectors trading above their 50-day moving averages, while all the other sectors are struggling to hold support around their 100 and 200-day moving averages.
Internal breadth was negative for the NYSE and NASDAQ as the Advance/Decline line, a leading indicator of market direction, was lower during the week. New 52-week highs contracted for both the NYSE and NASDAQ as new lows beat out new highs throughout the week. Despite the wild swings volume was somewhat contained throughout the week.
With the major averages trading back-and-forth during the week, it closely mirrored the ongoing tug of war between what the Fed is saying regarding monetary policy and what investors believe is an economy running too hot with elevated levels of inflation. Even Fed chairman Powell expressed his frustration with supply chain disruptions and labor shortages. There is a growing concern that inflation is not a short-term phenomenon, and the market is adjusting for that uncertainty as growth may be contained over the short to intermediate-term.
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 +10, unchanged 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 +3, down one notch from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 2889 units while the number of new 52-week lows exceeded the number of new highs on four of the five sessions. Breadth was also negative at the NASDAQ as the A/D line lost 2540 units while the number of new lows out did the new lows throughout the week. Finally, the percentage of stocks above their 50-day moving average declined to 32.7% vs. 47.8% the previous week, while those above their 200-day moving average eased to 52.1% vs. 59.6%. 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. The Sentiment Index is Positive at +3, up one notch from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 9/29/21 shows outflows of $9.3 billion. Of particular note this week was the Investors Intelligence report which showed that the Percentage of Bullish Investment Advisors, a contrarian indicator fell to 46.5% which looks to be headed towards the May 2020 low.
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).
Ask Mr. Seifert
Question: What is exercise and assignment and how does this come into play when trading the Optionomics’ strategies?
Answer: When you short (sell) an option (put or call), there exist the possibility that you could be obligated to buy (short put) or sell (short call) the shares of the underlying stock on any business day. This is known as assignment.
When you are long an option (put or call), you have the right to exercise your option and either buy (long call) the underlying stock away from the owner or sell (long put) the stock to the guy that sold you the put option at the specified strike price.
Options can be exercised any time before the expiration date. One can never tell when an assignment will take place. Options are usually exercised when they get closer to expiration. The reason is that it does not make much sense to exercise an option when there is still time value left. It is usually more profitable to sell the option instead. Over the years, only about 17% of options have been exercised. However, it does not mean that only 17% of your short options will be exercised. Many of those options that were not exercised were probably out-of-the-money to begin with and had expired worthless. In any case, at any point in time, the deeper into-the-money the short options, the more likely they will be exercised.
All of the Optionomics’ strategies involve the sale of some sort of weekly credit spread which results in you being long and short either a put or a call. This ensures that you have limited risk since you never will be selling naked options. Most of the spreads will either expire worthless on the expiration date resulting in no action and a 100% winner. Sometimes they will settle with a small or a full loss which may require some action on your part. This could be simply closing the spread before expiration or you may be assigned your short option and having to exercise the long option in the spread to zero out the position.
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