Dow Down on Rate Jitters
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 bull struggled this week as several of the major averages punched new record highs before the different indexes finished the period mostly lower. Despite a dovish forecast on interest rates from Fed Chair Jerome Powell coming out of the March FOMC Meeting, yields on the back end continued to tick higher leading to weakness in equities. That raised inflation concerns and the yield spread between the 5-year and 30-year Treasury Bills hit 1.59, its biggest gap since 2015. Technology stocks were slammed on Thursday as higher yields led to valuation concerns and the NASDAQ tumbled 409.03 points (-3.02%) to 13116.17, its biggest one-day drop since a 478.54-point (-3.50%) on 2/25/21. Tech shares bounced on Friday but the NASDAQ remained below resistance at its 50-day moving average as the week ended. The market sectors were mixed as Communication Services (XLC), REITs (XLRE) and Healthcare (XLV) were able to post positive, but Energy (XLE), Financials (XLF), Technology (XLK) and Materials (XLB) closed in the red. The Energy sector was hit by a drop in crude oil prices on dwindling demand concerns and oil briefly fell below $60 a barrel after peaking at $66.09 the previous week. Investors picked up shares in lagging sectors on Friday, but the major averages carried minor losses into the weekend and snapped a two-week win streak for the DJIA and S&P 500.
For the period, the DJIA slipped 150.67 points (-0.5%) and closed at 32627.97. The S&P 500 fell 30.24 points (-0.8%) and settled at 3913.10. The NASDAQ lost 104.62 points (-0.8%) to close at 13215.24, while the small cap Russell 2000 dropped 65.24 points (-2.8%) finishing at 2287.55.
Market Outlook: The technical condition of the market was mixed last week as the DJIA, NYSE, DJ Transportation Index and Russell 2000 all touched new record highs before finishing the period mostly lower. The technical indicators remain in positive ground, while Momentum, as measured by the 14-day RSI, is bullish except for the NASDAQ. The tech heavy NASDAQ slipped below support at its 50-day moving average (MA) and momentum slowed moving into neutral ground. Despite weakness in the NASDAQ, the Philadelphia Semiconductor Index pulled out a +1.6% gain. The DJ Transportation Index continues to lead the broader market higher and rose +0.2%, but the small cap Russell 2000 underperformed this week after spiking +7.3% the previous week. Breadth was mixed this week as the NYSE and NASDAQ Advance/Decline lines worked their way lower, but the number of new 52-week highs remained bullish. Investor sentiment saw bullishness increase but remains well below extreme levels seen a few weeks ago. The stock market went into the weekend mildly overbought with the S&P Short Range Oscillator (SRO) closing Friday at +4.34%, which could lead to more consolidation in the coming week.
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 +8, down three notches from the previous week. Cycles A, B, C and E are bullish, while cycle D is bearish. The CTI is projected to remain in Bullish Territory into April.
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 +1, down a notch from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line lost 1420 units while the number of new 52-week highs out did the new lows on all five sessions. Breadth was also mixed at the NASDAQ as the A/D line dropped 1410 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 fell to 65.5% vs. 70.5% the previous week, while those above their 200-day moving average eased to 86.4% vs. 87.7%. 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 3/17/21 shows inflows of $18.3 billion. Currently, the Sentiment Index is Negative at -2, down 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 11/13/2020 (DJIA – 29479.81). For a closer look at the technical indicators and studies that make up the market timing models, check out the tables located below.
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
- 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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