Weekly Market Outlook – On The Verge Of A Bigger Pullback?

The market may have started the previous week on a bullish foot, but it certainly didn’t end the week on one. Not only did the S&P 500 (SPX) (SPY) log three straight losing days to end last week’s trading, but it broke below a key support level it couldn’t really afford to break. Stocks still aren’t past the point of no return yet, but it’s alarmingly close.

We’ll dissect the odds below after running down last week’s and this week’s major economic headlines.

Economic Data

Not a lot of economic news worth exploring from last week. The only items of real interest were both unveiled on Friday… last month’s producer price inflation rate, and April’s retail sales.

As for producer inflation — which will serve as something of a preview for this week’s consumer inflation news — wasn’t quite as brisk as supposed. Overall PPI was up 0.2% versus expectations for a 0.3% uptick, but core PPI (sans food and energy costs) was only up the expected 0.1%. On an annualized basis, overall PPI is only 0.1%, and a mere 0.9% on a core basis.

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Source: Thomson Reuters

As for retail sales, April’s consumer spending was a pleasant surprise. Spending grew 1.3% overall, and was still higher by 0.8% after taking automobile sales out of the equations. Retail sales are not growing “leaps and bounds,” but they are making steady forward progress in all categories, now including gasoline/filling stations. 

Retail Sales Chart

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Source: Thomson Reuters

Everything else is on the following grid:

Economic Calendar

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Source: Briefing.com

This week will be a little busier, and Wednesday’s release of the minutes from the most recent FOMC meeting will likely be the centerpiece. It’s not a scheduled interest rate decision date, though Janet Yellen could use it as such if merited. It’s not apt to happen though. If anything, Yellen is apt to be looking to delay a right hike as long as possible because … last month’s consumer inflation rate is apt to be on the tame side. The pros are calling for a 0.4% increase overall, and a 0.2% increase on a core basis. Annualized inflation rates are now 0.85% overall, and 2.2% on a core (ex-food and ex-energy) basis. More

Sometimes It’s Best to Sit Back and Wait

As traders, we make our living each and every day trying to find the best trading opportunities.  For some, daily profits are the lifeblood of their existence not just feeding the ego but also paying the rent, putting food on the table and paying the bills.  This of course is the wrong approach for anyone who really chooses this career, as the timeframe chosen is critical as is the amount of capital in reserve.  Most of us realize the best possible position is to be well-capitalized, have expenses in reserve and come in each day without the daily pressure of needing to make your ‘nut’.

But what about the times when the market dictates you do absolutely nothing?  Does the trader who needs to make a living acknowledge when this is appropriate, or continues to trade when results are unlikely to be positive – pushing on a string.  Currently, volatility indices are still in relatively low territory, still under 16%.  This smacks of complacency of course, and is a danger sign.  We are still in a stock picker’s market, but there are some cracks showing.

Why so much complacency after a 3% drop from the mid-April highs?  Market player have become conditioned to expect the Fed and other central bankers to come in and ‘save the day’ when markets swoon.  That is the observation of many data points, but is truly the ‘lazy man’s approach to analysis.  The ‘Fed put’ on the market is alive and well, they will save the markets every time, right?  That happened just recently.

We are only a few months removed when we witnessed the markets falling hard, the worst six week start ever for a calendar year in history.  While it was certainly opportunistic to play for some downside or pick up bargains in the January hail storm, it was best served just to wait it out until it passed.  Our first instinct is always to dive in and grab stocks or options that drop sharply, but not knowing where that bottom lies is akin to grabbing at falling knives – you’ll get bloodied.

So, while today we are not in that situation we do have some warning signs.  Breadth figures have come back from elevated level in early April, when we saw some outstanding numbers.  Put/call ratios have become elevated once again as players are buying protection, but then the VIX is not portraying very wide move on the horizon.  However, the oscillators are very oversold and about to flash a reversal buy signal.  The bullish percent index for the Nasdaq fell below 50 (a key level), a red flag – while the SPX and NYSE are still well above that key marker. The most important indicator is price action – which has been poor for a couple of weeks.  Price rules the day, while volume tells us the market is still under distribution.  Hence, a very mixed but murky picture.

At this point, we would be served best preserving our capital and waiting for the clouds to clear.  While we are often late to the party because of the speed this market it seems being patient and waiting for the right pitch is the right move here.  The market won’t take off without us.

BL

 

Weekend Review – VIX Options and Futures – 5/9 – 5/13

After starting the week off on a bullish note, the S&P 500 finished out down just over a half a percent for the week. VIX was up just a bit more than 2%, most likely being held back by weakness that was associated with the S&P 500 moving higher on Monday and Tuesday last week.

The spread between the May VIX future and spot index is pretty narrow finishing Friday at less than a point. Not only did the spread between the May futures and spot VIX index narrow, but a portion of the curve actually dropped. June through October futures were lower despite the rise in VIX. The result is a slight flattening of what has been a pretty steep curve over the past few months.

VIX Curve Table

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Weekend Review – Russell 2000 Index and Volatility – 5/9 – 5/13

According to some of the headlines I came across this week, stock market participants are worried about economic growth. This concern about growth showed up in the relative performance of the Russell 2000 (RUT) and Russell 1000 (RUI) this week as RUT was down twice as much as RUI (-1.10% versus -0.54%). This places RUT down a little less than 3% for the year and RUI precariously in the green by a single basis point.

RUT RUI

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Russell 2000 Futures vs. Short Call Spread from Last Week

Every weekend I write a brief blog discussing the performance of the Russell 2000, how the CBOE Russell 2000 Volatility Index is reacting to market conditions, and pick out a RUT trade or other piece of market information that looks interesting (at least to me). Last week I noted a bear call spread using Russell 2000 Index Options that sold a deep in the money call and purchased a slightly out of the money call, both of which expired this week. The specific trade involved selling the RUT May 13th 1050 Call for 67.00 and purchasing the RUT May 13th 1125 Call for 5.50 and a next credit of 61.50. The payoff for this trade turned out to be 9.82 based on the closing level for the Russell 2000 on May 13th (1101.68). The full blog from last week describing the details of the trade may be found at the link below –

http://www.cboeoptionshub.com/2016/05/07/weekend-review-russell-2000-options-volatility-52-56/

I also noted that the ‘cost’ of this trade was equal to the maximum potential loss of $1350 per contract. This led me to take a look at shorting a Russell 2000 Mini Futures contract on the closing price Friday, which was 1113.90. The margin requirement for being short a futures contract was $5940, according to the ICE Futures website. At the end of last week’s blog I said I would track the daily profit at loss of the bear call spread and a short futures position. The table and chart below are the result of my side by side paper trading.

RUT PL Table

Although the futures short would have beaten the option trade, there are some reasons that the option trade may have been the better choice. At least it may have been the less gut wrenching trade. On Monday both trades were down slightly as the Russell 2000 moved up a bit. Then on Tuesday, things got a bit hairy for both trades. The Russell 2000 was up over 10 points on the day and this placed both trades significantly in the loss column for the week. However, note the futures position was four points lower than the option trade based on Tuesday’s closing prices. Remember the option position had a maximum potential loss of 13.50, regardless of how much the Russell 2000 move up, so holding tight with the call spread may have been an easier prospect than maintaining a short position in the futures contracts.

As we all know, the outlook for stocks turned negative from Tuesday’s close to Friday’s close. This resulted in a paper profit for a short futures position of 13.40 while based on cash settlement for the RUT options, the profit would have been equal to 9.82. In the end shorting futures was the better trade, but again, the higher margin requirement and potential for substantial losses might make a trader consider an option spread as an alternative to a directional futures position.

The Weekly Options News Roundup – 5/13/2016

The Weekly News Roundup is your weekly recap of CBOE features, options industry news and VIX and volatility-related articles from print, broadcast, online and social media outlets.

VIX FIX – Tepid Volatility

For weeks, market enthusiasts have braced themselves for a resurgence in volatility that has yet to materialize. The Dow Jones is ending the week slightly lower, while the CBOE Volatility Index continued to venture lower, dropping below the 14 level mid-week, before slightly rebounding later in the week.  Stocks and volatility both remain tepid, but for how long?

“Here’s Why the VIX has Been on the Retreat Lately” Michael Santoli, CNBC

http://cnb.cx/1THl5rv

“This Sleepy Stock Market is About to Get a Wake-Up Call” – Michael Sincere, MSN Money

http://bit.ly/1QXeEyN

“Volatility Update: How Low Can VIX Go? Historical and Implied Vol” – Frederic Ruffy, The Ticker Tape

http://bit.ly/1qhZw9g

“Critical Zones for the SPY and VIX This Week” – Todd Salamone, Schaeffer’s Investment Research

http://bit.ly/24IgQUn

“Volatility Could Get Wild This Summer” – Kirk Spano, Seeking Alpha

http://bit.ly/1TavJed

“Bank of America Strategist Warns of Imminent ‘Vortex of Negative Headlines’ to Send U.S. Stocks Plummeting” – Joe Weisenthal, Bloomberg

http://bloom.bg/24JWSfp

“Twisty Tuesday – Markets Gyrate Wildly While VIX Stays Low” – Phil Davis, Huffington Post

http://huff.to/24VVeYp

“Take the Long-Term View To Manage Volatility” – Tom Lee, Seeking Alpha

http://bit.ly/1TatJCP

“Good ‘Out of Sync’ with VIX, Takes Lead from USD/JPY” – Ivan Delgado, FX Street

http://bit.ly/224nLpt

Earnings Next Week – 5/16 – 5/20

Next week is all about retail which should be interesting since Macy’s (M) woes were a big focus this week.  As always the data below is based on the last three years of earnings results, unless the data is in italics.  In those cases less than three years worth of history is available.  The columns show the biggest rally, biggest drop, average move, and what the stock did last quarter in reaction to earnings.

Earnings

Are Options a Core or Satellite Component of Portfolio Management?

Today I had the pleasure of moderating a panel at the OIC Financial Advisor Forum which was running concurrently with the 34th Annual Options Industry Conference. My panel was on the presidential election cycle and market volatility with a combination of a political expert and two individuals involved in money management. I enjoyed the challenge of trying to integrate the markets and politics into a single common themed discussion. Despite being immersed in thinking about my own moderating duties today, there was something that I heard a couple of times from other presenters that has me questioning where institutional use of options falls on the spectrum of commonality.

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A Walk Through the Maze

Let’s detail a story of the last two weeks, in which I stumbled through a maze in search of the reward at the other end.  I’ve made some wrong turns and backtracked a few times, but I think I smell the cheese ever stronger, ever closer to me, right around the next corner.

On April 28th I started with nothing but an idea, so I set it in motion as such:  With SVXY trading at $56.63 the moment I spied it, I sold ten SVXY 56 strike puts for the May 6th (six trading days away) expiration for $1.70 premium received on each.  All costs or amounts received take into account commission, so if you notice my figures not adding up by eight or fifteen dollars, rest assured I had to pay someone to move all this around for me.  The amount received for this transaction was $1,685.22.

Two minutes later I put through the order I already had worked up:  Ten calls sold at $1.40 each for the same expiration at the 57.50 strike.  The amount received for this transaction was: $1,385.22.

One trading day later, on Monday, May 2nd,  SVXY traded around $52.15 bright and early as the day got underway.  Call premium had really taken a hit, and I could not resist the prices being asked for 57.50 calls.  I decided to close out my short calls by buying them back for $0.19 each.

The closed transaction detail looked like this:

At this point I no longer had a short strangle; I only had short puts.   And expiration day quickly approached.  Over the course of the last five trading days of this contract’s life, SVXY slipped below my put strike price of 56 and appeared to want to stay there.  The price to buy back the option was too high for me to stomach, so I planned for the eventuality of being assigned shares over the weekend.  Then, during the last trading minute of the contract’s life, I sold to open ten calls to expire the following Friday, at the same strike as the price at which I would be assigned, for $1.50 per contract. My intention was to create, through the call sale and the assignment over the weekend, a set of covered calls.

The plan was a good one, but unfortunately I made what amounted to a bookkeeping error, and I’m still cringing.  I was, of course, assigned 1,000 shares of SVXY at $56 each, since that was the contract I wrote and I had to make good on it.  So on Monday morning (today, May 9th as I write this), I was the owner of those shares plus the short calls (now covered calls) for the 56 strike expiring on Friday, May 13th.

I envisioned my shares being easy-come, easy-go; put to me for $56 via a contract and called away from me for $56 via a contract (assuming share price would dictate that, of course), with premium collected by me on the buying and the selling side; elegant and engineered to be profitable.  Of course, the other possibility would be that I’d just continue to own the shares after expiration,  but either way I’d keep the entire premium received from what was, for one minute, a naked call but became a covered call over the weekend when I was assigned.  The proceeds from the call-writing were $1,485.20.

However, I must not have had enough coffee or something, because I didn’t go over the math and I took my broker’s bookkeeping on faith without comparing it to my own method.  I’m still not sure what happened; I tried to untangle it but ultimately decided that I’d rather just watch my own math more carefully the next time.  Before stretching this out into details that would give everyone hives, so let’s shorten this portion of the story and say that I was under the impression that selling my shares would bring in a profit of high-several hundreds of dollars that I could use to offset (with profit leftover) the subsequent unprofitable closing of the short calls.  Instead of waiting one week for the short calls to expire and the shares to be called away, I set out to book what I thought would be a loss on the calls and a larger profit on the shares (refer back to a brain blip on my part wherein I didn’t look closely enough at my cost basis in the shares and the profit/loss on liquidating them.) So I embarked on what I thought would be not a genius move, but a modestly-more-profitable three-part move.

In reality, what happened was that in a double whammy I bought the calls to close and booked a $330 loss, as such:

The big stinger, though, was that the $56,000 (gulp) worth of SVXY that I had blithely unloaded without fully opening my eyes yet that morning was sold at $54.34, and with my buying price of $56.00, that’s what I consider a loss of $1,693.17.

To wrap up the mess above, it should be noted for the tally that the first figure mentioned in this post, $1,685.22 brought in for selling short puts, did offset the losses on the liquidation of the assigned shares (described in paragraph directly above) associated with that trade.  If the short puts, the share purchase and sale, and both sets of short calls are all taken together, it looks like I came out $843 ahead from the start on April 28th.

On a different track now but not derailed, I went ahead and completed the next part of my plan, which was to sell SVXY puts now that I was freshly free of any shares and also of any covered or briefly-naked calls.

As of this writing on Monday afternoon, May 9th, I am short ten SVXY puts for the March 13th expiration at the 54 strike, sold at $1.40 per contract, or $1,385.22 received.  I can either buy these puts back before Friday or accept assignment of shares at $54.

No arrow illustrates the fate of the 56 strike puts which expired worthless on May 6th and resulted in assignment to me, but otherwise the option entry and exit points are shown below:

Grapes Fix

Weekly Market Outlook – May Rally?

The market may have finished last week on a bullish note, and started the week on a bullish note.  The middle of the week, however, was rough enough on stocks to leave the S&P 500 (SPX) (SPY) down 0.4% for the five-day span.

On the other hand, when push came to shove at a critical line in the sand, the bulls were doing more pushing and shoving than the bears were.  Friday’s gain – small as it may have been – happened in such a way and in such a place that there’s a decent chance the market may be headed into a decent May rally after all.

We’ll show you how Friday’s small victory may not have been so small after we run down last week’s and this week’s major economic headlines.

Economic Data

Last week’s economic dance card was plenty full, but there’s little doubt as to the highlight…  Friday’s employment report for April.  It wasn’t great.  Rather than the 207,000 new jobs economists thought we’d add, we only ended up adding 160,000.  That’s the lowest reading in seven months, extending a downtrend.  The unemployment rate stood at 5.0% even though the number of people with jobs actually slumped a bit.  How so?  The number of people who consider themselves in the labor force (working or not) also contracted.

Job Growth, Unemployment Rate Chart

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Source: Thomson Reuters

Employed, Unemployed, Not in Labor Force Charts

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Source: Thomson Reuters

That being said, jobs weren’t the only economic news worth a closer look from last week.  We also heard about both ISM Indices – manufacturing and service.  The ISM Index, which measures manufacturing activity, fell from 51.8 to 50.8, rolling in below expectations.  Any reading above 50.0 technically indicates growth, but the index has been in a ” just barely” position for a while.  As for the ISM Services Index, it grew from 54.5 to 55.7, underscoring the economy’s ongoing transition from a manufacturing-based one to a service-based one.

ISM Index Chart

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Source: Thomson Reuters

Everything else is on the following grid:

Economic Calendar

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Source: Briefing.com

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Bonds, Stocks and Gold – Oh My!

With all due respect to Dorothy from the Wizard of Oz, the title of this article should tell us we have some worries and fear about investing in different asset classes. To be sure, there is some fear permeating, investors are wondering if they should pull the plug after prolonged bull markets in bonds and stocks, or just buy gold and other precious metals. Equities have enjoyed a bountiful time since the financial crisis, a bullish run of seven years literally uninterrupted (on a longer time frame).

Bonds have been in a generational bull market, rising sharply since the early 1980’s and with little inflation to speak of. Gold has also had its moments in the sun, peaking a few years back but it has come back in style for 2016. We have started to see some inflation come back into the economy around the world, albeit small. What trends should take place if we see little growth and some inflation?

MW GLD

Lately we have seen a move toward bonds, yields dropping sharply. But we just stated there is some inflation coming into the system, with rising metals, crude and other commodity prices. If there is one thing bond investors hate it would be inflation — nothing else matters. So, bonds are going up? What gives? Simply put there is a divergence of opinion here on whether growth is going to accompany the inflation (often times it does, and bond yields would rise).

In this case, the bet by the bond market is not the same encouraging message from the Fed. However, if yields drop too much (nearly 1.7% on the 10 year bond) then we assume risk is too high for fixed income and a move to an alternative class may take hold (this happened in early February, money moved from bonds into stocks).

Stocks have enjoyed a solid run since the bottom of 2016 this past February, only recently giving up about 3% of a very sharp 14% gain over a 10 week period. Breadth has started to weaken, put/call ratios are rising and the McClellan oscillators/summation index have rolled over. The death of equities here? Heck no, but we have to be cautious and have one hand on the door just in case things happen as I pointed out here.

Finally, gold has dusted off some the bearish sentiment over the past couple of years and has been a stalwart asset class in 2016. The GLD etf is up more than 20% so far this year, looking to stretch out those gains. That would be tough to do but the metal is showing some great momentum to the upside. The perception of higher inflation has been good for gold, and a drop in the dollar certainly hasn’t hurt either. But the Fed will only tolerate so much inflation, and they still control the game board. Hence, the rise in gold and other commodities may have ‘front run’ the markets here, where the easy money has already been made. That said, late investors may be coming in as they gravitate to the ‘whatever is hot’ play. Always a dangerous move.

Weekend Review – Volatility Indexes and ETPs – 5/2 – 5/6

The S&P 500 was down 0.44% last week which places the index up only 0.65% for the year. Three out of the four S&P 500 focused volatility indexes were also lower last week, despite the drop in the S&P 500. I find the longer end of the curve holding up like it has for most of 2016 interesting as well as worrisome, at least if you are bullish on stocks.

VXST VIX VXV VXMT Curve

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Weekend Review – VIX Options and Futures – 5/2 – 5/6

VIX dropped last week, with a big part of the drop coming Friday afternoon. Note the futures followed suit, but specifically note that the front month May future gave up a little more ground than spot VIX. This is sort of common when we have an employment number. Also note how flat the curve is from July through November – the theory is that the Fed is out of play between the conventions and the election which may result in relative calm for the financial markets.

VIX Curve Table

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Weekend Review – Russell 2000 Options and Volatility – 5/2 – 5/6

Small cap stocks get so close and then seem to fall back when reaching unchanged on the year or catching up with the performance of large cap stocks. This week the Russell 2000 (RUT) dropped 1.44% while the large cap focused Russell 1000 (RUI) lost 0.49%. This places RUT in the red by 1.86% for 2016 while RUI is still up 0.55%.

RUI RUT

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