"The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder." – Complexity Labs
Grinding markets can be exasperating and financially difficult times for active traders. But there are ways to manage these periods. For one, by incorporating option strategies into trading routines, investors can hedge their bets as well as produce income. For another, it's important to know that, eventually, a sideways trend will break to the up or down side, thus creating trading opportunities on the long or short side.
Still, option traders may have an advantage in the next few weeks, due to uncertainty regarding the Fed's next move on interest rates and QE, as well as the repercussions engendered by those actions for MELA – the complex adaptive system composed of the markets (M), the economy (E), people's financial decisions (L) and the algos (A). In fact, it is that uncertainty that is tied to the major advantages of options strategies: risk management via hedging opportunities and the ability to trade the markets with less capital exposure than that required for individual stocks or ETFs.
With that in mind, here is where we are as we start the month of August. The major indexes are grinding sideways with a slight upward bias. The market's breadth is decidedly lacking, although it is not falling apart altogether. And the options market is leaning slightly to the bullish side. In other words, everyone is waiting for something bullish to happen while hoping to be on the right side of whichever way things actually break.
And, as it has been for the last eighteen or so months, most of what happens in the financial market will develop based on whatever the Federal Reserve says and does. Moreover, with the economy showing signs of both inflation and now a blockbuster employment report along with falling consumer confidence, whatever the Fed does will likely be amplified multifold by the algos.
In other words, aside from earnings reports and the general state of things in Washington, whatever the Fed says about its future plans in its Jackson Hole Wyoming soiree in late August will likely shape what stocks do for the rest of 2021.
Nevertheless, from a trading standpoint, it makes sense to reduce exposure slightly and to hedge via income-producing options strategies at the moment. I recommend checking out which strategies work best when bottom fishing in beaten-up stock sectors in my latest Your Daily Five video.
Patience and Options May Well Pay Off in Housing/Lumber Complex
Over the last few weeks, I've been writing about the interconnected housing and lumber sectors. Of course, neither sector is particularly sexy. But, until proven otherwise, they both have one big factor on their side: the fact that the supply and demand equation is tilted favorably toward them.
That's because, despite housing sales data suggesting that the top in housing is in, supply still dwarfs demand and home sales are likely to rebound, especially when homes are selling within days of being listed. And that's the macro recipe for a bull market. Certainly, cost is an issue, with many potential home buyers being currently priced out of the market. And if the Fed raises rates, that will put a damper on things.
Think Supply and Demand
Still, as long as mortgage rates remain close the all time lows and there is no widespread economic issue – such as inflation getting completely out of control or the jobs market falling completely apart as in March 2020 – there is no major change in the wishes of many to move, either out of cities or into new states. And that means demand for housing is, at its worst is likely to remain stable but, more likely, rising.
As a result, it makes sense to keep a close eye on the homebuilder stocks (XHB) and to consider being patient with the shares, barring a clear breakdown of prices. At the same time, by applying well-selected option strategies, investors can manage both time and potential price risk, as I describe at the end of this section.
So, as I stated last week, XHB has been consolidating and flirting with a breakout. Support remains in the $72 area with resistance at $76. A move above $76 could take the shares to $80 in a short period of time. Meanwhile, LPX is still in a basing pattern, with resistance near $60.
Meanwhile, LPX seems to be getting to a point where short sellers are having to cover as Accumulation Distribution (ADI) is heading lower – a sign of active short sellers – and On Balance Volume (OBV) is moving higher – a sign that algos are buying on dips as the number of shorts is starting to decrease.
If this pattern remains in place, it will mean that the odds of LPX moving higher over the next few weeks will increase, barring an all-out market meltdown.
In addition, the tiebreaking vote in whether the homebuilder-lumber complex can deliver a strong enough turnaround to make me turn all-out bullish is what happens in the bond market, where the U.S. Ten Year Note yield (TNX) looks to still be testing its own important resistance at the 200-day moving average.
And while bond yields rose on the better-than-expected new jobs number released on 8/6/21, while yields are now testing the 200-day moving average near 1.3%, the real test will come if and when TNX approaches the likely true decision point, the 2-2.1% yield band.
So what's a good way to manage lumber and housing stocks in the current market? A Buy Write (selling covered call options) strategy may make sense. That's because if XHB and LPX stay in consolidating price patterns, you can collect a premium for waiting for them to break out. If the stocks break out, you can always buy the option back and ride the uptrend. And if your sell stop gets hit, you can close out the position. In other words, you can get paid for being patient while managing your trade via clearly defined exit parameters; something not available to investors who don't trade options.
Of course, this strategy requires management, which is why a FREE trial subscription to Joe Duarte in the Money Options.com may be worth considering. (Click here for more information.)
I own shares and have open option positions in LPX and XHB at the moment.
SPY Options Retain Slightly Bullish Stance
Last week, in this space, I noted option players were becoming a bit more bullish. Well, that general bent seems to have remained in place, as call option buying increased toward the 8/6/21 expiration, spilling into Monday's daily expire. The call volumes increased at the 442-443 area near the closing price for SPY, which suggests traders are still betting on slowly rising stock prices.
In conclusion, the options remain more bullish than bearish and the bullish sentiment seems to be rising – slowly for sure, but still rising.
To get the latest up-to-date information on options trading, check out Options Trading for Dummies, with its 4th Edition releasing on August 17, 2021 – Reserve Your Copy Now!
Market Breadth Retains Bullish Bent with New All-Time SPX Highs
The New York Stock Exchange Advance Decline line (NYAD) showed some improvement last week as it closed above its 50-day moving average, while its RSI moved above 50 simultaneously. That combination, at least for now, negates what had been a potential sell signal.
So again, the market gets the benefit of the doubt. But it remains a somewhat soft benefit, as the longer the indexes make new highs without confirmation, the more likely the odds of a decline.
The S&P 500 (SPX) and the Nasdaq 100 (NDX) held up fairly well, with SPX delivering a new high and NDX remaining not too far behind.
So, for now, the bullish bent in the market, albeit somewhat softened, remains in place.
Good news! I've made my NYAD-Complexity, Chaos chart (featured on my YD5 videos) and a few other favorites public. You can find them here.
Joe Duarte
In The Money Options
Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.
The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as a Washington Post Color of Money Book of the Month.
To receive Joe's exclusive stock, option and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
