March Heads Out Like a Lion
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Coming off their best weekly performance since November 2020, the major averages consolidated the gains in back and forth trading this week before finishing higher. Investors struggled with rising rates and oil prices as analysts trimmed growth projections stemming from additional sanctions on Russia but have now erased the losses brought on since the Russian invasion. The DJIA snapped a five-day win streak to start the period as oil prices jumped +7% after more countries suspended oil and gas imports from Russia and shares of Boeing (BA) plunged after a 737 crashed in China. Despite hawkish comments from Fed Chair Jerome Powell that the Federal Reserve would raise rates 0.50-point if needed to battle inflation in May, investors bought the dip and sent the NASDAQ up almost +2% on Tuesday. Another spike in oil prices sent stocks reeling on Wednesday with the Dow Jones tumbling 448.96 points (-1.29%) before a better-than-expected jobs report on Thursday rallied the different indexes led by a +5.13% surge in the Philadelphia Semiconductor Index (SOX). A brief move above 2.5% in the yield on the 10-year Treasury weighed on investor sentiment ahead of the weekend and stalled an early bounce leaving the market mixed. Stocks were buoyed by a +7.61% surge in the Energy (XLE) sector over the five-day stretch, followed by strength in Materials (XLB), Utilities (XLU), Technology (XLK) and Financials (XLF). Healthcare (XLV) and REITs (XLRE) lagged the broader market with Healthcare finishing lower. The major averages weathered volatile trading and shook off inflation headwinds to close in the plus column for a second straight week.
For the period, the DJIA added 106.31 points (+0.3%) and settled at 34861.24. The S&P 500 picked up 79.94 points (+1.8%) and closed at 4543.06. The NASDAQ jumped 275.46 points (+2.0%) finishing at 14169.30. The small cap Russell 2000 eased 8.16 points (-0.4%), finishing at 2077.98.
Market Outlook: The technical condition of the market improved and remains positive. Following a strong rally, the different indexes consolidated the gains and finished the period higher for a second week. The technical indicators for the major averages are bullish with MACD, which gauges the short-term trend, in positive ground and Momentum, as measured by the 14-day RSI, bullish. The different indexes ended the period at a crossroads of sorts as the rally paused at key technical levels. The DJIA has retraced 50% of the Jan-Mar decline, crossed above resistance at a downward sloping trend line and is trading above its 50-day MA but the blue-chip index was unable to push above its 200-day MA on Friday. Historically after retracing 50% of a decline, it marks the end of a selloff and a stock or index will continue higher. The S&P 500 has crossed above its 50 and 200-day MA but ran out of steam at its 100-day MA and 61.8% retracement level on Friday. The NASDAQ rally stalled at the 50% retracement level of the Jan-Mar decline and remains below that mark measuring the Nov-Mar decline off the previous high. The DJ Utility Index was able to post a series of new record highs during the week. Secondary indexes the small cap Russell 2000 and Philadelphia Semiconductor Index were unable to retrace 50% of the previous declines but are trading above their respective 50-day MA. The DJ Transportation Index and the DJ Utility Index have recouped all losses since the start of the year but the transports remain below its record high from November. Nonetheless, this positive divergence bodes well for the broader market as strength in railroads and trucking stocks signal solid economic activity. The current target for the DJIA is 35800-36000, while the upside target for the S&P 500 is 4650. Failure to reach those targets would be considered bearish and could induce another round of selling in equities.
Underlying breadth improved with the NYSE and NASDAQ Advance/Decline lines, leading indicators of market direction, moving higher for a second consecutive week. The Market Edge Strength Indexes, which measure accumulation in the indexes, jumped to their highest readings since last Novemeber. In addition, the NYSE was able to post more new 52-week highs than lows for the first time since the first week of January. Unfortunately, the NASDAQ hasn’t been able to record more new highs than lows going back to early November 2021, but the number of new lows did contract. Investor Sentiment improved with last week’s rally bouncing off extreme levels of bearishness. The Market Edge Sentiment Index returned to a neutral reading, but investors remain cautious. The most recent American Association of Individual Investors (AAII) poll shows retail investors are split about 50/50 between bears and bulls. The National Association of Active Investment Managers (NAAIM) Exposure Index rose for a third consecutive week, but the professionals are only 52.7% exposed to equities. Finally, the VIX, which is sometimes referred to as the ‘fear index’ fell to its lowest level since early February showing traders are becoming more comfortable with the Fed’s shift in monetary policy and the fighting in Ukraine.
Market participants are trying to balance a strong economy and jobs market with soaring yields to fight inflation and the global disruption in supplies due to the Russia-Ukraine conflict. Investors have every reason to be cautious as the market hates uncertainty. While the stock market can handle gradual increases in rates, the assent and speed of the rise can give the market pause. As of Friday, the CME FedWatch now predicts a 72.7% chance of the Federal Reserve hiking rates 0.50-point at the May FOMC Meeting and puts the chance of another 0.50-point rate hike in June at 64.3%. That’s likely to add to market volatility and investors will need to closely watch changes in the yield curve. If the yield curve inverts, it is indicative of a less vigorous economy one year forward and at times a predictor of a coming recession. The Federal Reserve Bank of New York prints a table titled “Estimated Recession Probabilities for Probit Model Using the Yield Curve Spread”. It currently estimates the likelihood of a recession in February 2023 at only 6.14%. While I like the odds, it might reward investors to keep tabs on the yield curve over the coming weeks as the Federal Reserve accelerates increases in rates.
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 A, B, C, D and E are bullish. The CTI is projected to remain in a Bullish configuration until June.
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 +11, up five notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line gained 225 units while the number of new 52-week highs exceeded the number of new lows on three of the five sessions. Breadth was mixed at the NASDAQ as the A/D line added 263 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 jumped to 54.4% vs. 46.9% the previous week, while those above their 200-day moving average increased to 40.9% vs. 39.9%. 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 marketís 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, down four notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 3/23/22 shows inflows of $11.3 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 3/18/2022 (DJIA – 34754.93).
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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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