Nightmare Before Christmas
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).
A volatile week ended lower as investors digested the Federal Reserve’s game plan to ward off inflation against a background of increasing coronavirus cases that threatened to slow down global economies once again. The week opened on a sour note after several countries announced new restrictions on travel and a -3.65% drop in the US Global Jets ETF (JETS) kept pressure on the broader market. Stocks were mostly lower again on Tuesday after a hotter-than-expected PPI put more pressure on the Federal Reserve to dial back stimulus. The November Producer Price Index spiked +9.6% YoY, the fastest pace on record, vs. +9.2% expected, and jumped +0.8% MoM. Equities nearly erased the week’s losses on Wednesday after the FOMC Meeting Announcement showed the Federal Reserve wasn’t going to overreact to rising inflation. Investors cheered that the Fed was going to stick with its script for three rate hikes in 2022 and dial back its bond purchases to neutralize monetary policy. The major averages soared with the NASDAQ leading the rally jumping 327.94-points (+2.15%). Investors went back on defense as the week ended however, with the different indexes giving back the previous day’s rally and then some. Investors rotated into defensive sectors as Healthcare (XLV), REITs (XLRE), Consumer Staples (XLP) and Utilities (XLU) finished positive for the period, up more than +1%, while Consumer Discretionary (XLY), Energy (XLE) and Technology (XLK) dropped more than -4% each. The major averages tumbled into the weekend with the Dow Jones down for the fifth time in six weeks and the S&P 500 and NASDAQ down three of the last four.
For the period, the DJIA fell 605.55 points (-1.7%) and settled at 35365.44. The S&P 500 lost 91.38 points (-1.9%) and closed at 4620.64. The NASDAQ dropped 460.92 points (-2.9%) finishing at 15169.68, while the small cap Russell 2000 slipped 37.88 points (-1.7%), finishing at 2173.93.
Market Outlook: The technical condition of the market was mixed this week as the back and forth trading left the major averages lower but the indexes were able to hold above the previous week’s lows. The technical indicators are neutral to negative with MACD, a short-term trend gauge, in bearish ground for the different indexes and Momentum, as measured by the 14-day RSI, mostly neutral but slowing. The major averages tested key moving average (MA) support levels during the week and there are signs that support areas are being defined. Negative divergence remains evident in the underperformance of the small cap Russell 2000 and DJ Transportation Index and this week, the Philadelphia Semiconductor Index (SOX) also was a laggard, down -3.9%. These indexes tend to lead the market higher and lower and aren’t showing signs that market weakness has ended. Underlying breadth remains negative with the NYSE and NASDAQ Advance/Decline lines showing most stocks remain under distribution, while the number of new 52-week lows continue to trounce the number of new highs. In addition, the number of new lows continues to expand and have outnumbered new highs for the last five weeks. Investor sentiment is neutral as both retail investors and hedge funds continue to lighten up on equity exposure.
Everyone’s wondering if ‘Santa’ is on his way or is Fed Chair Jerome Powell going to be the Grinch for another Holiday season. I say ‘another’ because in December 2018, Powell and the Federal Reserve were contemplating a quarter-point rate hike and the DJIA fell from a high of 25980 on December 2, to a low of 21712 on December 23. That was a decline of 4267.68 points (-16.4%). Back then, as now, the small cap Russell 2000 and DJ Transportation Index were both leading the market down. At the time, rather than Covid overhang, it was lingering trade issues with China that threatened to slow economic growth. Big cap tech names like Apple (AAPL) and Facebook (FB) were falling sharply on growth concerns. Fed Chair Powell did in fact raise rates a quarter-point, and despite then President Trump calling for the Fed Chair’s head, the major averages turned on a dime and the major averages had some of their better yearly returns in years. The point is, there will always be something that market participants predict will crater the stock market. The Federal Reserve intends to raise rates due to strengthening economic conditions that are causing inflationary pressures on prices and as of Friday, the CME Group Fed Watch places the odds of a quarter-point hike in May at 68% and June at 86%. That still leaves plenty of time for concerns of how the Omicron variant plays out on global economies and whether inflation will subside as supply chain issues are eradicated. A quarter-point hike sooner than later may keep a cap on market gains over the near-term, but, as in 2018, it is not likely to derail a longer-term rally as the economy continues to reopen to pent-up demand.
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, unchanged from the previous week. Cycles A, B, C, D and E are bullish. The CTI was reset to a positive configuration after last week’s low and is projected to remain positive the remainder of the year.
Momentum Index (MI): The markets 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 four notches from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 2456 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 dropped 4010 units while the number of new lows out did the new highs on each day. Finally, the percentage of stocks above their 50-day moving average fell to 33.4% vs. 38.8% the previous week, while those above their 200-day moving average eased to 47.0% vs. 50.0%. 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 markets 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 Neutral at +2, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 12/15/21 shows outflows of $1.3 billion.
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
What is Pin Risk and how do I deal with it?
Answer: When the weekly options expire each Friday, the profit or loss in the spread is calculated by subtracting the credit or debit from the strikes used in the spread. The resulting number is the profit or loss. Even using $1 strikes there is a 99% chance that price will not settle exactly on a strike. If you are using $5 wide strikes there is a 1 in 500 chance it will settle on a strike, but from time to time it will happen. If you have either a debit or credit spread in place, it could settle on either the short end or the long end of the spread. If it settles on the short end most likely you will be assigned 50% of the shares, and vice versa if it settles on the long end you should exercise 50% of the shares.
Why 50% of the shares? Because there is the “other side of the trade”. Remember when you are short an option someone must be long the option. So, they have same problem that you do, and most logical solution is for them to exercise 50% of their options. Does it always work perfectly? No, nothing works all of the time, but it gives you the best mathematical solution to end up without having stock in your account on Monday. If you do end up with stock on Monday you will either take delivery or buy or sell the shares to get flat the market. In my 35 plus years of trading options I have found that this trade, although scary, has ended up being a scratch in the long run!
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