A breakout in the major indexes, with a last-minute recovery in the market's breadth and rising bond yields, made for a mixed options expiration week. But, in the end, stocks once again dodged a bullet, as a recovery in the market's breadth saved the day for the bulls, as I discuss below.
Still, even as the bullish trend remains in place, this remains a tricky trading environment. As a result, savvy investors will need to stay flexible in both their perceptions and trading strategies. Keep these factors in mind:
- The Fed is fine tuning its expected rate cuts to the 3rd quarter of 2024. That's a long time from now;
- Sentiment remains too bullish. The CNN Fear/Greed Index closed at 72 on 1/19/24, remaining well in the GREED zone. The longer these readings remain in place, the bumpier the trading action will remain;
- The CBOE Put/Call Ratio closed at 0.91 after its recent high of 1.25 – the bears are losing their grip; and
- The CBOE Volatility Index (VIX) failed to rise above 15 – as call option buying is increasing.
It all adds up to bumpy, stock-specific trading. Here's a roadmap:
- Stick with what's working; if a position is holding up, keep it; (see section on homebuilders below);
- Raise cash by reducing position size;
- Consider short-term hedges;
- To reduce risk of loss, consider trading options instead of stocks;
- Look for value in out-of-favor areas of the market that are showing signs of life, but build positions slowly; and
- Protect your gains with sell stops and keep raising them as prices of your holdings rise.
Using Options Ahead of Earnings
In a market where risk of loss is above-average, especially ahead of scheduled events such as earnings reports, options can be useful risk management vehicles. A good hedge when to guard against negative news, such as a negative earnings surprise, is to buy a protective put.
Here's a good example of how to make this strategy work. RV manufacturer Winnebago (WGO) shares were rallying into its earnings report in late December 2023. Investors were betting on a beat of the expected results. The stock got well ahead of itself, as evidenced by its closing above its upper Bollinger Band on 12/19/23. That was a sign that the stock was vulnerable and that the earnings report had to be perfect. As it turned out, the shares got clobbered as the company missed its earnings estimates. A protective put was a good idea.
It's prudent to check the company's record on earnings. Indeed, WGO had beaten expectations for the prior fourth quarter, which meant that selling the shares ahead of the earnings may not have been the best thing to do. But a stock which rises dramatically will usually have inexpensive puts available for purchase, which keeps costs down with the potential for outsized upside potential.
A close look at the ADI and OBV lines suggested that the gains in the stock ahead of the earnings report were more due to short covering (rising ADI) than actual buying (flat OBV). That was a sign that there wasn't solid interest in the stock, and that some sort of protection was warranted.
In this case, buying a protective put, such as one with a strike price of $70, made sense. I chose $70 because that was where a VBP bar was located. That meant that if the stock was going to hold a decline, that might be a place where it would happen.
My latest Your Daily Five video offers details on the successful use of put options in real time. Check it out here. For details on my latest option trades and on which areas of the market make sense currently consider a FREE Trial to Joe Duarte in the Money Options.com.
Bond Yields Creep Higher, but Potential Merger Wave Holds Homebuilders Up
Even in the face of rising bond yields, homebuilder stocks held up well last week, buoyed by the merger of Japanese homebuilder Sekisui House (SKSHY) with U.S. homebuilder MDC Holdings (MDC), which I reported on in this post. This may be the first of many mergers in the sector, as cash-rich homebuilders and private equity funds look to expand their exposure to the housing market, especially into the southern U.S., which continues to grow as populations shift from the coasts toward areas of higher economic growth.
The U.S. Ten Year Note yield (TNX) crept higher, ending the week above the 4-4.1% yield range. Lucky for investors, TNX ran into resistance at its 50-day moving average and stopped climbing. On the other hand, if the move above 4.1% continues, it will eventually weigh on stocks.
Homebuilder stocks bucked the trend in TNX as investors weigh the possibility that the buyout of MDC could be signaling a takeover frenzy in the sector. The SPDR S&P Homebuilder ETF (XHB) saw some aggressive short covering on the news (rising ADI line), while OBV looks set to join the rise. A further rise in OBV would signal that the smart money is betting on an acceleration of the merger dynamic.
QQQ Breaks Out
The Invesco QQQ Trust (QQQ) delivered a breakout last week, as the semiconductor stocks rose after Taiwan Semiconductor (TSM), a stock I recommended before it beat earnings expectations and offered bullish forward guidance, broke out in a big way after the announcement. Under the hood, both ADI and OBV for QQQ kept their upward bias, with short sellers bailing out (rising ADI) and buyers putting their money to work (bottoming OBV). This action confirmed my expectations for a short squeeze, which I described here over the last couple of weeks.
Ahead of the TSM report, there was a quietly bullish rise in On Balance Volume (OVB), which suggested the smart money was expecting good news.
I am keeping my eye on the SonicShares Global Shipping ETF (BOAT). The situation in the Red Sea is still unfolding, with U.S. flagged ships coming under attack. BOAT was in a consolidation pattern last week as traders consider the potential effects of the shipping disruptions and rerouting of boats. Global shipping giant Maersk (AMKBY) recently announced its expectations for the Red Sea situation to remain in place for several months as it reroutes its ships accordingly. Reports of Israeli airstrikes on Damascus surfaced early Saturday morning.
If you saw this post, you would have been prepared for the rally in the shipping stocks. If you missed the TSM trade, I have just added a very undervalued technology stock to my model portfolio. You can check it out, along with my latest homebuilder and shipping stocks, with a FREE two-week trial to my service by clicking here.
Market Breadth Survives Scare; NDX Cracks 17,000
The NYSE Advance Decline line (NYAD) found support at its lower Bollinger Band after breaking below its 20-day moving average. This is an encouraging development, as it depicts what seems to be a functional market.
The Nasdaq 100 Index (NDX) broke through the 17,000 resistance area emphatically, as the short squeeze I predicted here two weeks ago continued. Note the rise in ADI (short sellers covering) was joined by OBV as buyers moved in.
The S&P 500 (SPX) confirmed the breakout in NDX, with the 4800 resistance area now becoming support.
VIX Fails at 15
The CBOE Volatility Index (VIX) ran into resistance at 15. This, for now, remains a bullish factor for stocks. If VIX remains subdued, more upside is possible.
A rising VIX means traders are buying large volumes of put options. Rising put option volume leads market makers to sell stock index futures, hedging their risk. A fall in VIX is bullish, and it means less put option buying, eventually leading to call buying. This causes market makers to hedge by buying stock index futures, raising the odds of higher stock prices.
To get the latest information on options trading, check out Options Trading for Dummies, now in its 4th Edition—Get Your Copy Now! Now also available in Audible audiobook format!
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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.
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