This Dog Won’t Hunt For the Moment
Dear Big Money Options Traders,
On April 24, Apple (AAPL) was trading at about $560 per share. On its earnings report, the stock raced ahead to an intra-day high of about $617. Our expectation was that AAPL would sniff out a bull market and lead the way. It couldn’t catch a scent, turned tail and came right back home to about $560 per share.
With AAPL sitting near where it was pre-earnings, there is no bull market in sight currently. The S&P 500 has slipped back into a range of about 1,350 – 1,410 where it has been trading for two months.
If you evaluate the market on the basis of: 1) rate of change in the macro-economic fundamentals, 2) bond market signals as measured by the yield curve and 3) what is working, stocks may remain in a trading range for a few more weeks.
The economic fundamentals are showing some signs of fading. U.S. retailers reported sales up on 0.8%, versus the 1.5% expected. Last week, 103 companies reported Q1 earnings with only 58% exceeding EPS expectations. This brought the earnings season beat rate to date (403 total reports) from 77% to 72% (earnings growth, however, climbed from 6.2% to 6.4% last week).
April U.S. nonfarm payrolls were 115,000 versus the consensus estimates of 163,000. April auto sales were flat. While a double-dip recession is not likely given that growth rates remain positive, the recent data underscores the reality that recoveries from debt/financial market induced recessions take a long time to repair the damage done.
The yield curve looks like this: The three month Treasury yield is essentially zero. The two-year note yields 0.26%. The five-year note yields 0.78%. The 10-year note is now 1.88%, down about 50 basis points from its March peak. The Fed is targeting 2% inflation. Assuming the Fed makes its inflation target, investors are willing to accept a negative real return in United States. Treasuries. Investors only accept a negative real return if they believe the expected returns elsewhere are worse. Low absolute yields and a flattening of the yield curve is not bullish for stocks in the short-term.
Capital preservation continues to be the dominate theme over capital accumulation. What is working in the very short-term is bonds, not stocks. While we believe U.S. Treasury rates, which are near 50-year lows, are more likely to rise than fall over time, the mood at the moment is safety first. Put another way, risk aversion has been trending higher. As investors’ risk appetites shrink, stock P/E ratios also shrink as investors demand better prices and higher expected returns before they are buyers of equities.
This is a short-term phenomenon. In the bigger picture, equities have appreciated by more than 100% from their March 2009 lows. They continue to sell at a significant P/E ratio discount to their five- and 10-year average P/Es. With Q1 coming in better than expected, E is rising, which further reduces the P/E. The market is self-healing, and the healing process is underway through both time and price.
In options, we live in the short and intermediate term. In the short-term, we are moving fast to collect winners where possible and close near-dated positions (last week we closed EMN, THOR and TEX).
We are opening new positions judiciously, in an effort to reduce our overall exposure. When we do open positions, our preferred method is to include some selling of options premium (last week we opened a put spread in Cigna (CI) which involves buying a put and selling a lower strike put). With risk aversion on the rise, options premium is becoming more expensive. When prices are high, we like to sell. This is especially the case when the market is trading within a range.
The majority of our open positions expire in August or later. The macro market trend continues to be bullish, and we believe our longer-dated positions will work well.
While Europe is capturing much of the attention currently, Asia is showing strength. The Shanghai Composite Index has just closed above its 200-day moving average for the first time in almost a year. The stock markets of India, Japan and South Korea have already cleared this threshold. Chinese stocks appreciated 5.9% in April and the Hong Kong Hang Seng Index is up 14.4% year-to-date. One might argue that the Asia growth engine is more important than the more mature economies of Europe. Additionally, it is not uncommon for the U.S. economy to show some seasonal slowness at this time of year. These periods are often followed with a summer rally.
REVIEW OF TRADES/POSITIONS
The full details of each trade are shown on the Big Money Options website.
Cigna (CI) – On May 4, we recommended to ‘buy to open’ the CI Oct 43 Puts (CI121020P00043000) for approximately $2.50 and simultaneously ‘sell to open’ the CI Oct 38 Puts (CI121020P00038000) for approximately $1.00 in a 1:1 ratio for a net debit of $1.50 or less. Options money flow has turned bearish. We continue to like this trade.
Eastman Chemical (EMN) – On April 25, we recommended to “buy to open” the EMN Jun 55 Calls (EMN120616C00055000) for $1.60 or less. Earnings did not provide the catalyst to and on May 1, we recommended to close the position for $2.05 or more for a 26% gain.
Terex Corp (TEX) – On April 19, we recommended to buy open the TEX May 26 Calls (TEX120519C00026000) for $1.25 or less. With options money flow turning negative and time running out on these near month options, we recommended closing this position for $0.10 on Friday, May 4.
Thoratec (THOR) – On April 11, we recommended to “buy to open” the THOR Jul 33 Calls (THOR 120721C00033000) for $3.20 or less. On May 2, we recommended to close this position for $4.00 with the stock spiking on earnings for a 25% gain.
Our Top Trades — the trades that we recommend you enter now if you haven’t already — are marked below with an asterisk.
*Acme Packet (APKT) – On April 19, we recommend a bullish combo (aka bullish risk reversal) on APKT: buying the APKT Aug 35 Calls (APKT 120818C00035000) and selling to open the APKT Aug 25 Puts (APKT 120818P00025000) for a net credit of $0.05. The company’s quarterly report provided a brief pop, but the stock sold off with the market. As of Friday’s close, this trade could be done for a $1.50 credit. Options money flow is bearish. We recommend holding the position.
Array Biopharma (ARRY) – On Feb. 14, we recommended to “sell to open” (short) the ARRY June 2.50 Puts (ARRY120616P00002500) for $0.25 or more. As of the close Friday, these options were trading at $0.05. We recommend holding this position.
Beam Inc. (BEAM) – On March 13, we recommended to “buy to open” the BEAM June 65 Calls (BEAM120616C00065000) for $0.70 or less. On Friday, these options closed at $0.35. Money flow improved this week as the stock bounced on a solid quarterly report. We recommend holding this position.
Beazer Homes (BZH) – On Feb 22, we recommended a couple of bullish trades on BZH: “buy to open” the BZH Aug 3.5 Calls (BZH 120818C00003500) for $0.60, or “buy to open” the BZH Aug 3.5 Calls (BZH 120818C00003500) for $0.60 and simultaneously “sell to open” the BZH Aug 3 Puts (BZH 120818P00003000) for $0.55 for a net debit of $0.05. On March 9, we recommended closing half of the combo for $0.30. As of Friday’s close, the calls were trading at $0.20 and the combo could be put on for a $0.35 credit. The stock sold off on their quarterly earnings report. We recommend holding this position.
*Cigna (CI) – see Positions Opened above
Energy Transfer Partners (ETP) – On Jan. 27, we recommended to “buy to open” the ETP June 52.50 Calls (ETP120616C00052500) for $0.30. As of the close Friday, these options were trading at $0.20. The stock gave back recent gains at the end of the week after the dividend was paid out. Options money flow fell into bearish territory but it bounced off lows on Friday. We continue to like this trade.
Maxim Integrated Products (MXIM) – On Feb. 16, we recommended to “buy to open” the MXIM May 30 Calls (MXIM120519C00030000) for $0.90 or less. As of the close Friday, these options went back to zero bid after a recent $0.45-bid. With the May expiration the near month, we look to close on any strength.
New York Times (NYT) – On Apr. 3, we recommended you “buy to open” the NYT Oct 7 Calls (NYT121020C00007000) for $0.75 or less. This position closed at $0.35 on Friday. Options money flows is bullish but waning. We continue to like this trade.
Office Depot (ODP) – On March 20, we recommended you “buy to open” the ODP Oct 4 Calls (ODP121020C00004000) for $0.50 cents or less. On Friday, these options closed at $0.05 cents. The stock sold off on earnings. Options money flow fell into bearish territory.
Royal Bank of Canada (RY) – On April 11, we recommended a “bearish put spread” on RY Jul 55/45 Puts for $2.00 or less: “buy to open” RY Jul 55 Puts (RY120721P00055000) and “sell to open” RY Jul 45 Puts (RY120721P00045000) in a ratio of 1:1. As of Friday, it cost $2.00 to put this trade on. Money flow in the options has been waning and turned bearish on Friday. RY reports May 24.
*Taser International (TASR) – On March 28, we recommended you “buy to open” the TASR Sep 5 Calls (TASR120922C00005000) for $0.55 or less. On Friday, these options closed at $0.50. Options money flows are bullish, we like this trade.
Xerox (XRX) – On Feb. 23, we recommended to “buy to open” the XRX July 9 Calls (XRX120721C00009000) for $0.35 or less. As of the close Friday, these options were trading at $0.08. The stock has traded sideways for the past two months and fell to recent lows last week. With recent money flow bullish, on April 25, we reiterated our buy on the calls and for those that can, we recommended to ‘sell to open’ the XRX July 7 Puts (XRX120721P00007000) for $0.12 to pay for the additional calls purchased for a net credit of $0.03.
Yahoo! (YHOO) – On Feb. 7, we recommended a bullish combo in YHOO: “buy to open” the YHOO July 17 Calls (YHOO120721C00017000) for approximately $0.95 or less, and simultaneously “sell to open” theYHOO July 14 Puts (YHOO120721P00014000) for approximately $0.75 or more for a net credit of $0.20 or less. As of the close Friday, this combo was trading at $0.06 net credit. We continue to like this trade.
Telefonica (TEF) – We were put the stock in December, and we have recommended selling the TEF Jun 17.50 Calls (TEF 120616C00017500) in a 1:1 ratio against a long stock position for $1.25 or more. Between now and June, you should collect about $1.00 in dividends and $1.25 in options premium. If the stock appreciates and is called away, your effective selling price will be roughly $19.75. If the stock continues to trade below the $17.50 strike price, you will have lowered your stock cost by about $2.25. The company pays its dividend twice a year, in May and November. This is a repair position.
Parting Shot – Must It Be So?
It seems intuitively straightforward that if the Eurozone is in recession, there is a good chance the United States and China will follow. The basic argument is that growth in the United States is so slight that the recessionary drag of the zone will reduce our growth rate into negative territory. For China, the argument is that they are an export economy. A recession in Europe has a direct linkage to China’s manufacturing output.
Must it be so that a Eurozone recession creates a global recession? The answer is no. This happened in 1993.
In 1992, 10 million Americans were unemployed, the country faced record deficits, and poverty and welfare rolls were growing. Family incomes were losing ground to inflation and jobs were being created at the slowest rate since the Great Depression.In 1993, the deficit reduction plan was enacted which included $500 billion in deficit reduction. America went on a growth run that concluded with a balanced federal budget by the end of the decade.
While the recession in the United States began in 1990, the recession in Germany and much of continental Europe only began in the middle of 1992. Japan also fell into recession by the end of 1992. The cyclical recession in the countries of continental Europe bottomed out in late 1993 or early 1994. Unemployment was more than 11% in the EU by the end of 1993, and was set to exceed 12% during 1994.
What allowed the United States to show growth in 1993 was its enhanced competitiveness in manufacturing. Favorable exchange rates made U.S. goods competitive. Labor costs were relatively attractive. These attributes are alive and well today.
Last week, the ISM manufacturing index rose to 54.8 with especially large pickups in new orders and production. Productivity and labor cost measures are showing strong output at a competitive cost. In addition to becoming more competitive in our manufacturing, the long duration of the downturn has created a significant amount of pent-up consumer demand.
Beyond 1993, growth in the 1990s was driven by low interest rates, easy lending terms and an improving federal government balance sheet. Today, Fed Chairman Bernanke has promised us near zero short-term interest rates through the middle of 2014. As banks are beginning to stabilize from both the 2008 credit crisis and the European sovereign debt disaster, they are slowly becoming more willing to lend out their excess reserves. The presidential election cycle is likely to bring some sort of deficit reduction activity going forward.
While it is hard to imagine that the rest of this decade will look and feel anything like the boom times of the 1990s, which culminated in a Nasdaq 5,000 bubble, many of the same elements are in place. For now, however, we are focused on the short-term, which is all about taking profits fast, keeping exposures in-check and opening positions that take advantage of the high options premium and trading range action of the stock market.
Have a great day trading!
Nick Atkeson and Andrew Houghton
Big Money Options
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