A Pollyanna Market
Dear Slingshot Trader Subscribers,
If there were such a thing as the “glad texts” of the market, they would be found in the way put options are skipped over. Like Pollyanna, the young girl who steadfastly refused to see the bad in the world, the market showed remarkable signs of optimism leading up to today’s Federal Open Market Committee (FOMC) announcement. It is as though the market wanted to be bullish so badly that it refused to acknowledge the possibility of any bad news. Here’s how you can tell.
The market’s history shows us that when prices go down, people buy put options. The lower prices go, the more put options they buy. When prices stop going down, people stop buying put options. That’s the standard pattern. But on a few occasions, option buying behavior diverges from the standard pattern. Sometimes investors won’t hedge their positions and speculators won’t forecast collapse, even though prices are still in a bearish trend.
It is important to pay attention when such conditions occur, because they may be signaling that the market’s participants are looking for opportunities to buy, rather than worrying about the need to sell. Such conditions often precede bullish moves, though because they occur when the market is bearish, it is difficult for traders to feel comfortable following such signals.
The S&P 500 Volatility index (VIX) is the best known measure of market pessimism. When the VIX is rising, we know that investors are worried about, or are preparing to take advantage of, falling prices. Conversely, when the VIX is falling, it signals that investors are less worried about prices falling and don’t feel the need to buy more put options (see Figure below).
In the 12 trading sessions leading up to the Fed announcement, the VIX fell 38% – breaking the neckline of a head-and-shoulders reversal pattern. It is hard to interpret that data in any other way, except to say that investors simply refused to consider that the FOMC would bring bad news. In fact, the behavior of the VIX was so optimistic, investors started to wonder whether the market may simply have been in a buying mood, no matter what the FOMC announcement was going to be.
Unfortunately for the market, the FOMC did bring bad news – sort of. The FOMC did say it was going to extend its “Operation Twist” through the end of this year, and expand its spending by $267 billion, but it did not say it would be engaging in any further quantitative easing at this point. So with a market hungry for QE3, this announcement was a bit of a disappointment.
Stocks started to fall on this news, but quickly recovered – showing Pollyanna is alive and well.That being said, we are still leaning bearish with an eye open for upside opportunities where they occur, such as the Adobe (ADBE) trade closed for a gain earlier this week.
Bottom Line for Next Week
We know traders have been able to claw back from big losses today after the FOMC announcement, but we’re still dubious this rally on Wall Street can continue with the Fed not really stepping up to the plate in a significant way and with the continued turmoil in Europe.
Here are some of the news events that we may trade in the next week or so. We’ll be discussing some of these in tonight’s webinar.
June 20 – RedHat (RHT) Earnings – After Market
June 21 – Existing Home Sales
June 21 – ConAgra Foods, Inc. (CAG) Earnings – Before Market
June 21 – Philly Fed Manufacturing Index
June 22 – Meeting in Rome w/ German, French, Spanish and Italian leaders
June 25 – New Home Sales
June 26 – Housing Starts & Building Permits
June 26 – CB Consumer Confidence
June 27 – Core Durable Goods Orders
June 27 – Pending Home Sales
When it’s time to open or close a trade, we’ll send you alerts via e-mail. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here and view our portfolios here.
These are the SlingShot Trader positions we opened during the past few weeks of trading that we have not yet closed.
Goldcorp Inc. (GG) – On May 29, we recommended you to “buy to open” the July 37 puts for $2.39 or less. If you are not in this trade, wait to enter it until we notify you.
Banco Santander (SAN) – On June 11, we recommended you to “buy to open” the July 6 puts for $0.60 or less. If you are not in this trade, wait to enter it until we notify you.
RedHat (RHT) – On June 18, we recommended you to “buy to open” the July 57.50 calls for $2.70 or less. We still like this trade and recommend entries at our maximum price or less.
These are the SlingShot Trader positions we closed during the past week of trading.
Adobe (ADBE) – On June 19, we recommended you to “sell to close” the July 32 calls. We closed the position for $1.97 per share for a gain of 57.6%.
ConAgra Foods, Inc. (CAG) – On June 20, we recommended you to “sell to close” the July 25 puts. We closed the position for $0.70 per share for a gain of 9.67%.
Kroger (KR) – On June 14, we recommended you to “sell to close” the July 21 puts. We closed the position for $0.24 per share for a loss of 52%.
We regret the error in citing the timing of the five-day Indian festival of Diwali as beginning in June rather than the correct date in November. (Perhaps we were simply overly eager for all the fun to begin!) We appreciate the feedback we received from all of you.
Webinar Preview: Join Us Tonight at 6 p.m. ET
Every Wednesday, we host our live webinar, in which we’ll review this weekly newsletter, discuss coming events in more detail and walk through our Top Trades. We also encourage you to submit your questions live during the session. We want to do everything we can to help you become a successful options trader, which is why you’ll have live access to us for an hour every week.
And if you have any questions or comments you would like to send us in advance of the live session — or anytime during the week — you can write to us at firstname.lastname@example.org.
If you can’t attend the session live, you can watch the archived version on our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.
John Jagerson and Wade Hansen