Bulls Charge Into New Year
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
A rocky start to the New Year ended with the major averages at record highs as investors digested Georgia’s Senate runoff and political unrest on Capitol Hill. Rising Covid-19 cases weighed on global markets on Monday as the UK announced additional shutdowns to corral the virus. Travel related stocks led a decline of -1.5% in the S&P 500. Better than expected manufacturing data on Tuesday helped the different indexes erase most of Monday’s selloff as investors waited on results from Georgia’s election. The stock market surprised market participants on Wednesday after Democrats managed to match Republicans in the Senate and the DJIA surged 437.80 points (+1.44%) and closed at a new all-time high. The NASDAQ however, finished lower on weakness in big cap technology and FAANG names on regulation fears. Financials, Infrastructure and Alternative Energy names led the charge as investors shook off protests in Washington. Equities rallied for a second day on Thursday in a broad based move led by gains in Technology (XLK), Consumer Discretionary (XLY), Energy (XLE), Financials (XLF) and Communication Services (XLC). The Dow Jones crossed above 31,000 and every index settled at new record highs but overbought. Choppy trading on Friday left the market mixed as a disappointing jobs report saw a drop of in non-farm payrolls of 140k, while analysts were looking for a gain of 70k. Crude oil prices rallied during the week crossing above $50 a barrel for the first time since February. That helped the Energy (XLE) sector spike +9.33% during the period. Yields also moved higher and the yield on the 10-year Treasury nudged above 1%, ending at +1.11%. That weighed on rate sensitive sectors and REITs (XLRE), Consumer Staples (XLP) and Utilities (XLU) were the only market sectors to finish in the red. Energy (XLE), Materials (XLB), Consumer Discretionary (XLY), Financials (XLF) and Healthcare (XLV) outperformed, leading the major averages to post new record highs led by a +5.9% move in the small cap Russell 2000.
For the period, the DJIA finished higher for a third consecutive week adding 491.49 points (+1.6%) and closed at 31097.97. The S&P 500 gaining 68.61 points (+1.8%) and settled at 3824.68. The NASDAQ was also higher for a third week jumping 313.70 points (+2.4%) to 12888.28, while the small cap Russell 2000 outperformed picking up 116.80 points (+5.9%) and finished at 2091.66.
Market Outlook:The technical condition of the market improved this week as the major averages were able to touch new record highs across the board. The technical indicators are bullish with MACD ST, a short-term trend gauge crossing into bullish ground for the major averages. Momentum, as measured by the 14-day RSI, is also bullish. The DJIA and S&P 500 broke out above a defined upward channel during the week, while the NASDAQ has been trending higher since the election and higher prices look to be in store. This week’s rally was led by the small cap Russell 2000 and DJ Transportation Index which bodes well for the market moving forward. In addition, the Philadelphia Semiconductor Index surged +5.0% which is a plus for the market, with Materials (XLB), Consumer Discretionary (XLY), Industrials (XLI), Healthcare (XLV) and Communication Services (XLC) all hitting record intraday highs. The rally did leave the market overbought however. The S&P Short Range Oscillator (SRO) hit +4.12% on Thursday, and 90.2% of stocks were trading above their 200-day moving average (MA). Furthermore, the S&P 500 is trading about +16% above its 200-day MA which could lead to some back and forth trading in the coming weeks while prices consolidate. Internal breadth was bullish with the number of new 52-week highs expanding and the new highs on the NASDAQ hitting the highest number of new highs since January 2018. The NYSE Advance/Decline line, a leading indicator of market direction, hit several record highs during the period showing strong accumulation in shares. Investor sentiment remains too bullish and is rising again after being reined in over the holidays. While extreme readings require some caution, it’s doubtful that the current sentiment is signaling a correction. Upside targets for this bullish cycle are 32,135 for the DJIA, 3900 for the S&P 500 and 13,700 for the NASDAQ.
This week wrapped up the ‘January Effect’ which as noted by the ‘Stock Trader’s Almanac’ has an 85.5% accuracy rate of calling the yearly performance of the stock market for the year. In pre-presidential election years, the Almanac notes, “this indicator has a solid record. In the last 17 presidential election years 14 full years followed the direction of the First Five Days.” While the overbought condition of the major averages may lead to some consolidation over the near-term, with a coronavirus vaccine rolling out, a sizeable amount of cash on the sidelines, ultra-low interest rates and a record amount of stimulus in play this bull market is still in the early days.
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 +9, unchanged from the previous week. Cycles B, C, D and E are bullish, while Cycle A is bearish. The CTI projects a Bullish market cycle through January.
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 +7, up three notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line added 1745 units while the number of new 52-week highs out did the new lows on all five days. Breadth was also positive at the NASDAQ as the A/D line gained 3860 units while the number of new highs beat the new lows on each session. Finally, the percentage of stocks above their 50-day moving average rose to 84.7% vs. 81.6% the previous week, while those above their 200-day moving average inceased to 90.2% vs. 89.2%. 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 1/06/21 shows outflows of $5.4 billion. Currently, the Sentiment Index is Negative at -4, 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.
| Market Timing Models | Current Reading | Prior Week | Connotation | ||||||
| Cyclical Trend Index (CTI): | 9 | 11 | Positive | ||||||
| Momentum Index: | 4 | 6 | Positive | ||||||
| Sentiment Index: | -3 | -3 | Negative | ||||||
| Strength Index – DJIA (DIA): | 55.2 | 44.8 | Positive | ||||||
| Strength Index – NASDAQ 100 (QQQ): | 61.5 | 56.3 | Positive | ||||||
| Strength Index – S&P 100 (OEX): | 50.5 | 38.7 | Positive | ||||||
| Dow Jones Industrial Average (DJIA): | 30606.48 | 30199.87 | 1.3% | ||||||
| S&P 500 Index: | , | 3756.07 | 3703.06 | 1.4% | |||||
| NASDAQ Composite Index: | 12888.28 | 12804.73 | 0.7% | ||||||
| **Connotation is Positive or Negative Divergence from the DJIA |
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.
‘Traders’ And ‘Investors’ Results
| ‘Traders’ Results | 21st Century Covered Call Results | ||||||
| Performance Since Week Ending 1/04/19 | Performance Since Week Ending 11/06/17 | ||||||
| S&P 500: | 01/04/19 | 2485.74 | S&P 500: | 11/06/17 | 2591.10 | ||
| S&P 500: | 01/08/21 | 3824.68 | S&P 500: | 01/08/21 | 3824.68 | ||
| S&P 500 Points Gain/Loss: | 1338.94 | S&P 500 Points Gain/Loss: | 1233.58 | ||||
| S&P 500 % Gain/Loss: | 49.0% | S&P 500 % Gain/Loss: | 47.6% | ||||
| Risk Capital: | $15,000 | Risk Capital: | $100,000 | ||||
| Optionomics Traders $ P/L: | $9,399 | Optionomics Covered Call $ P/L: | $32,825 | ||||
| Optionomics Traders % P/L: | 62.7% | Optionomics Covered Call % P/L: | 32.8% | ||||
| Last Week’s Traders % P/L: | 3.3% | Last Week’s Covered Calls % P/L: | 1.1% | ||||
| Put-Call Hedge Results | The Billionaire Risk Reversal Results | ||||||
| Performance Since Week Ending 1/26/18 | Performance Since Week Ending 04/12/19 | ||||||
| S&P 500: | 01/26/18 | 2872.87 | S&P 500: | 04/12/19 | 2907.41 | ||
| S&P 500: | 01/08/21 | 3824.68 | S&P 500: | 01/08/21 | 3824.68 | ||
| S&P 500 Points Gain/Loss: | 951.81 | S&P 500 Points Gain/Loss: | 917.27 | ||||
| S&P 500 % Gain/Loss: | 33.1% | S&P 500 % Gain/Loss: | 31.5% | ||||
| Risk Capital: | $100,000 | Risk Capital: | $50,000 | ||||
| Optionomics Put-Call Hedge $ P/L: | $41,330 | Optionomics Billionaire Trade $ P/L: | $247,720 | ||||
| Optionomics Put-Call Hedge % P/L: | 41.3% | Optionomics Billionaire Trade % P/L: | 495.4% | ||||
| Last Week’s Put-Call Hedge % P/L: | 0.9% | Last Week’s Billionaire Trade % P/L: | 30.2% | ||||
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| The option ‘Trades’ and ‘Strategies’ offered by the Optionomics Group are unique in that they all have limited risk while creating great leverage. Our basic Bullish – Bearish Credit Spread Trade lets you control 100 shares of a $200 stock, a $20,000 position for less than $500 or 40:1 leverage. Your maximum risk is always limited, and our strategies produce winning trades in three out of four possible outcomes.
Optionomics let you become the casino whereby you have a mathematical edge that enables you to grind out consistent returns. These strategies are designed to produce good returns over short to intermediate-term time frames in any type of market environment. Optionomics offers a FREE Two-Week trial to its entire web site with no cost or strings attached. Each of the strategies are explained in a 5-7 page booklet and a video which includes detailed explanations and sample recommendations. During the trial, you can paper trade the various strategies and get a feel for the deal without risking a penny. Simply click on the appropriate tab on the Optionomics’ Home page to access the informative booklets and then sign up for the trail. As a special offer, you can download a FREE copy of my latest book, “Trading Options My Way”. I doubt that you have ever read anything like this. The ‘Traders’ Subscription Includes The Following: · The Bullish – Bearish Credit Spread Trade: A basic strategy to trading weekly credit spreads. · The One Day Wonder Trade: A one day trade with great consistency and upside potential. · The Blow Off Top – Bottom Trade: A lot of action and big moves too. · The Earnings Season Trade: Potential big movers with little or no downside risk. The ‘Investors’ Subscription Includes The Following: · The 21st Century Covered Call Strategy: A modern day alternative to the old-fashioned covered call strategy. · The Low Cost Put-Call Hedge Strategy: Sleep at night knowing your portfolio is protected for little or no cost. · The Billionaire Risk Reversal Strategy: Big time leverage – small time risk. Each Monday morning by 11:00 EST, the recommendations for each strategy are posted on the Optionomics’ web site. In addition, the updated results from the previous week are posted on the Optionomics’ Scoreboard. You can subscribe to either the Traders or the Investors plans at an introductory special of only $39.95 each per month on a month to month basis with no contract or strings attached. That’s $10.00 off the regular monthly subscription rate ($49.95). If you subscribe to both it is only $64.95 per month. I think you will agree that this is a super offer so give it a try. Go to www.optionomicsgroup.com and get started today doing what the pros do – “Don’t Buy Them – Sell Them” Mr. Seifert
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