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The Standard and Poors 500 Index (SPX) has been locked in a sideways dance since June 25th when it closed at 2717. SPX opened this morning at 2734, and then plunged to 2716, below the the 50-day moving average (dma) at 2721. But then it rebounded and, as I write this blog, is trading up twenty points at 2734. The 50 dma has acted as a strong support level for the past couple of weeks. But these wide swings in price within a single daily trading sessions are unsettling. Monday morning's weak market tripped several stops in my positions, but by the end of the trading session Monday, the market had rebounded. Tuesday's market was exactly the opposite, opening positively and trading higher, only to give back all of those gains before the market closed.
I am sure I wasn’t alone in closing several positions Monday morning because the market was looking so weak. But then SPX recovered and traded up over 28 points to close for a nice gain. Tuesday was exactly the opposite: large positive futures leading to a positive open and a strong morning of bullish trading, but the last hour of trading gave it all back and SPX ended the day in the red.
The Russell 2000 Index (RUT) has traded much more bullishly than SPX most of this year. RUT didn’t pull back as far during the February correction and put on a remarkable run from the first of May through June 20th, gaining nearly 11% in eight weeks. The difference has continued this week with Russell posting nice gains in each trading session this week. RUT is currently trading at 1673, up 12 points. The Russell 2000 index is predominantly made up of domestic companies. These stocks may not be as spooked by the prospects of a trade war and that may explain this divergence of SPX and RUT.
The current sideways trend in the prices of the S&P 500 and the wide price swings we are seeing almost daily are more evidence of the indecision and uncertainty. Traders are nervous and they are running from one side of the ship to the other. Corporate earnings are setting records, beating analyst estimates at unusually high rates. Companies are even complaining of being unable to fill open positions! But you wouldn’t know that by watching the major market indices. Corporate earnings and virtually all of the hard economic data are very positive, but that doesn’t seem to assure traders. News is interpreted with the worst possible implications. The doom and gloom folks must be enjoying this moment in time.
The downside for those of us trading this market was illustrated Monday. The markets opened lower and continued lower, tripping several of my stops. Then the market recovered and thumbed its nose at me. Don’t let those events cause you to lose your trading discipline. Risk management is always the name of the game.
One of the characteristics of this nervous market is overreaction. A recent example is Chipotle Mexican Grill (CMG). Its new CEO revealed his turnaround plan for the company last week and the stock price plunged over 6% the next day. Contrast CMG with the overall market Monday and Tuesday. While the major market indices were giving back early gains, CMG gained 5%. I took advantage of that overreaction, going long CMG stock on Friday and selling a put spread on Tuesday.
This market presents many opportunities, but it remains an uncertain, nervous market. Keep your stops close.
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The Standard and Poors 500 Index (SPX) fell out of bed on Friday, reacting to news of new tariffs being applied to China. SPX traded as low as 2762 before bouncing to close at 2780. Interestingly, SPX opened on Monday at precisely 2780, so we closed the week absolutely flat. The trading volume spike Friday was due to options expiration, so that may be ignored. Trading volume remains lackluster, running near the 50-day moving average (dma) and trending slightly lower.
The Russell 2000 Index (RUT) followed its big brothers and traded down on Friday but recovered even more strongly than SPX. RUT closed Friday at 1684, down less than a dollar. Thursday’s close at 1685 was another all-time high for RUT and Friday’s close reaffirmed that high.
The NASDAQ Composite index also traded lower on Friday and then recovered much of its losses, closing down 15 points at 7746. NASDAQ set another all-time high on Thursday, closing at 7761, not too far above Friday’s close. NASDAQ turned in the strongest weekly return of the major market indices, gaining 99 points or 1.3% from Monday’s open to Friday’s close.
The S&P 500 index’s volatility index, VIX, closed Friday at 12.0%, roughly flat for the week (opened Monday at 12.4%).
The big question is the widely accepted rationale for Friday’s down day, trade tariffs and the fear of a “trade war”. Headlines from financial articles include, “Why the trade war is going to get worse”, and “the conflict will escalate into a technological cold war”. Those are scary headlines, but the market clearly doesn’t take it seriously. SPX recovered Friday’s losses nicely and the other major market indices remain at or near all-time highs. The low level of volatility doesn’t suggest much concern about trade wars on the part of the large institutional traders.
In my opinion, we have an interesting market. On the one hand, it doesn’t seem like we have fully recovered from the February correction. The market remains nervous, expecting the other shoe to drop. On the other hand, the trading action is decidedly bullish. Even on days like Friday, where it seemed like a very negative day, most of the losses were recovered and volatility remained flat.
How should we trade this market? For your non-directional trades, position the trade with more safety margin to the up side, and take more risk on the down side. This takes advantage of the largely sideways trading pattern, but counts on the underlying bullish trend.
Our Conservative Income service remains up about 12% for the year, so there is a lot to be said for conservative option selling. In this market, the turtle beats the rabbit.
For all of your trades, position your stops close. This is a “better safe than sorry” market.
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The Standard and Poors 500 Index (SPX) turned in another sideways performance this week, opening at 2726 and closing at 2721, down five points for the week. I have drawn a downward trending line on my SPX chart, starting with the high on January 26th and then touching the March 13th peak. Many analysts had concluded that the bull market was over and were pointing to this trend line. But then SPX broke through that trend line on May 9th and even gapped open higher the next day, and that price action appeared to confirm that the bull market was alive and well.
I drew a new trend line on my SPX chart this week that tracks this bull market back to November 4th, 2016. That trend line remained unbroken until the February 8th correction this year. On May 11th and then again on May 14th, SPX closed above that long term bullish trend line. But then we started treading water. In the next trading session, May 15th, SPX opened at 2719, only two points below today’s close. SPX remains above the recent bearish trend line, but SPX is also below the long-term bull market trend line. The market has just wandered sideways for nine trading sessions and is in what I am calling “no man’s land” – not bullish and not bearish.
Trading volume is an important technical indicator that we may understand in a very pragmatic sense. When we see trading volume spike higher, it reinforces the price direction. Increasing volume on a price spike higher accentuates the bullish nature of that price move, and conversely for price declines. The recent trend in trading volume confirms the sideways, non-directional nature of this market. Trading volume for the S&P 500 companies has been well below the 50-day moving average (dma) for the past sixteen trading sessions. In fact, if we exclude just five days of above average trading volume, this low volume trading market is in its eighth week.
The Russell 2000 Index (RUT) has traded much more bullishly than SPX most of this year. RUT didn’t pull back as far during the February correction and has put on a remarkable run from early May through this past Monday, gaining nearly 6% in less than a month. Conventional wisdom ascribes this difference to the fact that the Russell 2000 index is predominantly, if not entirely, made up of domestic companies. These stocks may not be as spooked by the prospects of a trade war and may explain the divergence of SPX and RUT.
The S&P 500 index’s volatility index, VIX, opened the week at 13.4%, and closed today at 13.2%, essentially unchanged for the week. These markets and the accompanying volatility remind me of Goldilocks – not too hot and not too cold.
This is an unusual market in my experience. Corporate earnings are setting records, beating analyst estimates at unusually high rates. Companies are even complaining of being unable to fill open positions – what a change! But you wouldn’t know that by watching the market recently. News is interpreted with the worst possible implications. The doom and gloom folks must be enjoying this moment.
ABMD, HFC, and NFLX continue to trade higher this week in this sideways market.
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Many conservative investors are scared away from options because of the horror stories and the "get rich quick" schemes. But even the most conservative stockholder should learn about using put options to protect the stock portfolio. Buying a put option to protect a stock position before the company’s earnings announcement constitutes a prudent management of risk. One may also buy index put options to protect the entire portfolio when a market correction appears likely. Some conservative investors maintain a small ongoing position of index put options as “portfolio insurance”.
Selling options as a method for generating income is well known, but largely misunderstood, because of the marketing hype and the horror stories of misuse. The covered call is created when one sells a call option against the trader’s stock holding and is widely considered the safest of all options trading strategies. In fact, some brokers only offer covered calls to their clients who wish to trade options.
Selling put options has a notorious reputation. Like many things in life, selling puts may be dangerous in the wrong hands. Following three simple rules opens selling put options to the conservative investor:
1. Only sell puts on solid blue-chip stocks.
2. Always have the cash available in the account to buy the stock if the put is exercised.
3. Always have a contingent stop loss order entered that will execute automatically if the stock pulls back below the break-even price.
Wilshire Analytics published a study that compares the buy and hold strategy on the Standard and Poors 500 companies with selling covered calls and selling cash secured puts on those stocks. Over a period of thirty years, the selling cash secured puts strategy outperformed the buy and hold strategy. More importantly, the risk of these option selling strategies, as measured by the standard deviation of the returns, was over 30% less than the risk of the buy and hold approach. The maximum account drawdowns over this thirty-year period were about 30% less for the options strategies, and the recoveries from the drawdowns in the options strategies were almost half that of the buy and hold. Many academic studies have confirmed these results.
Have I piqued your interest? Come to the Traders EXPO on July 22nd in Chicago and hear my presentation, How Conservative investors Use Options. Introduce yourself. Maybe we can get a cup of coffee and discuss trading.
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The Standard and Poors 500 Index (SPX) opened the week at 2675 and trended down all week, losing almost 2% at yesterday’s close. However, today’s market was a different animal, with SPX trading higher by 34 points, or 1.3%, to close at 2663. But before we break out the champagne, it is worth noting that SPX remains down nearly one percent for the year.
2018 has been a rough ride. The February correction took us down by 10.2% and then the April retest of the correction was severe on its own at -7.5%.
Trading volume in the S&P 500 companies has remained relatively low since the February correction, rarely bouncing above the 50-day moving average (dma). Today’s strong move higher was not as positive as it might have been since it occurred on volume of 1.9 billion shares, well below the 50 dma at 2.3 billion shares.
The positive news for this market has occurred over the past two weeks of trading. SPX has traded down close to the 200 dma on four occasions, including today, but has managed to bounce higher each time. My rose-colored glasses were smashed earlier this year, so I don’t think I am imagining this positive signal. The 200 dma is acting as a solid line of support. That is a strong rebuttal to all of the doom and gloom voices that are all too common these days. In fact, I have to wonder if we aren’t talking ourselves into a bearish view of the markets. This market’s squeamish behavior is inconsistent with the economic data.
The analysts at FactSet published a report this week on the occasion of 50% of the S&P 500 companies having now reported earnings for the first quarter. 74% of those companies beat the revenue estimates of the analysts and 79% beat the earnings estimates. This is the best rate of earnings “beats” since FactSet started tracking these numbers in the third quarter of 2003. Today’s jobs report included a new low in the unemployment rate, down to 3.9%, the lowest since the year 2000. The unemployment rate among blacks is the lowest ever recorded. Doesn’t that make you wonder what’s going on with this market? Have we just fallen victim to the negativity that seems so common?
The Russell 2000 Index (RUT) consists of largely domestic companies that are much smaller in capitalization than the blue chips of the S&P 500. These are the so called “risk on” stocks. Thus, it is ironic that this index has performed better than SPX all year. The February and April corrections broke the 200 dma on SPX and SPX has been bouncing off its 200 dma for the past couple of weeks, but trading in RUT this week has been around the 50 dma, not flirting with the 200 dma. RUT closed today at 1566, up 19 points or 1.2%.
The NASDAQ Composite closed at 7210 today, up 121 points or 1.7%. Much of that spurt was fueled by Apple and that price spurt was fueled by Buffett’s investment in Apple. NASDAQ broke through its 50 dma today, but the trading volume remained below the 50 dma.
Early in my market training, I was frequently told that the market is essentially a present value calculation, so it is always looking forward and attempting to price assets on the basis of their future prospects. On that basis, it is hard to rationalize this market. We continue to see economic data and corporate earnings setting records, but it seems as though the market is preoccupied with prospects of doom and gloom at every turn.
I also learned long ago not to trade my carefully analyzed predictions in the face of a market going the other way. I may see many reasons why this market’s nervous oscillations shouldn’t be happening, but they are. It is what it is.
I have pared back on my positions. In my Conservative Income service, I have a preponderance of covered call positions on industry sector ETFs to minimize single stock risk during this earnings season. That probably explains why we are up 8% this year while the S&P 500 is down almost 1%. I am now looking for stocks that are boringly trading sideways during this market’s whipsaws. Calendar spreads placed after earnings announcements on those boring stocks are relatively safe trades, but also with relatively low returns. Iron condors on the large market indices are also becoming more attractive.
Above all, manage your risk.
