Risk On, Risk Off

Dear SlingShot Trader Subscriber,

As the stock market has been shifting back and forth between bullish runs and bearish pullbacks, analysts and commentators have struggled to find the best way to describe what’s happening and why. We all know that the U.S. economy seems to be limping along, with high unemployment rates and lackluster growth. We all know the sovereign debt crisis in Europe continues to smolder and expand. And we all know that even growth in China — along with some other emerging economies — is slowing down a bit. But how does all of this come together to drive market prices?

The best phrase we’ve heard to describe the overarching phenomenon is “risk on, risk off.”

 

“Risk On”

During “risk on” periods in the market, traders seem to have more certainty about what’s happening right now and what appears to be coming down the tracks in the near future. This gives them the confidence they need to make investment decisions that they feel they can stick with for a while. It doesn’t even seem to matter if the prospects for the future look shiny or grim. So long as there isn’t a heightened level of uncertainty, traders feel comfortable taking on more risk.

So what does that mean for us?

As we look across the spectrum of available investment opportunities that traders have, it ranges from cash and U.S. Treasurys on the conservative end, to stocks in the middle, to leveraged futures contracts and other derivatives on the aggressive end. When traders are in “risk on” mode, they tend to be more willing to take the money they have invested at the conservative end of the spectrum and move it toward the aggressive end.

Now, as stock market traders (via leveraged options), this is a good time for us to be on the bullish side of the market because the more money that comes out of cash and U.S. Treasurys and flows into stocks and more aggressive investment vehicles, the higher the prices of those assets will go. It’s simple supply and demand. As demand goes up, so does price.

 

“Risk Off”

During “risk off” periods in the market, traders seem to have more uncertainty about what’s happening right now and are even more concerned they don’t know what’s coming down the tracks in the near future. This robs them of the confidence they need to make investment decisions because they worry they’ll have to make quick changes in the near future to react to whatever new piece of information hits them in the face. This feeling of uncertainty and nervousness prevents traders from taking on additional risk. Instead, it drives them to look for ways to protect their capital.

So what does that mean for us?

When traders are in “risk off” mode, they tend to be less willing to take the money they’ve invested at the conservative end of the spectrum and move it toward the aggressive end. In fact, they often take some of the money they’ve invested at the aggressive end of the spectrum and move it back toward the conservative end.

For us, this is a good time to be on the bearish side of the market because the more money that comes out of stocks and futures and moves back into cash and U.S. Treasurys, the lower stock prices will go. Once again, it’s simple supply and demand. As the supply of stocks on the market rises because more and more investors are selling them, the lower the price will go.

 

So … Are We “Risk On” or “Risk Off” Now?

The natural question that comes out of this conversation is, are we currently in a “risk on” or a “risk off” trading environment? Here’s how we would characterize it:

We are in a “risk off” market that desperately wants to be “risk on.”

So what does that mean? You don’t have to look any further than today’s Treasury International Capital (TIC) data release to see that everyone still is flocking to U.S. Treasurys — a sure sign we’re still in “risk off” mode. According to the September data, China increased its U.S. Treasury holdings by $11.3 billion, Japan increased its holdings by $20.2 billion, and the United Kingdom boosted its holdings by $24.4 billion. Many other countries, such as Canada and France, also increased their holdings. There is a lag in this data released by the Treasury, but it lays the foundation of where we are.

However, even with all of the flocking to U.S. Treasurys, we still see incredible signs of life on Wall Street. Whenever there’s good news that comes out of Europe, stocks take off. This tendency has pushed us up into a new higher consolidation range on the S&P 500 (SPX). That’s why we say traders desperately want to be “risk on.”

During “risk off” periods, traders don’t tend to make as much money as they do during “risk on” periods. After all, leverage seems to be the key to big bonuses on Wall Street, and leverage is a dirty word when the market is in “risk off” mode.

 

The Bottom Line for Next Week

Look for traders to continue to push stocks higher whenever we get signs of life coming out of Europe, when we get exceptional earnings announcements and when we get better-than-expected economic announcements in the United States. However, remember the underlying fears that still are prevalent can snap prices back down in a hurry. So for the time being, we’ll actively jump in and out of trades as we try to stay one step ahead of the volatility.

 

This Week’s Events

Here are some of the news events that we may trade in the next week or so. We’ll discuss some of these in tonight’s webinar.

11/17 – Housing starts
11/17 – Weekly jobless claims
11/17 – Buckle (BKE) earnings announcement
11/21 – Existing home sales
11/21 – Tyson Foods (TSN) earnings announcement
11/22 – Gross domestic product
11/23 – Durable goods orders
11/23 – Personal income and outlays
11/23 – Weekly jobless claims (not on Thursday due to Thanksgiving)
11/23 – FOMC meeting minutes
11/24 – Thanksgiving

 

TRADE REVIEW

When it’s time to open or close a trade, we’ll send you alerts via email. 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 portfolio here. You also can see more trade-specific details by clicking on the trade links below.

 

Positions Opened

These are the SlingShot Trader positions we opened during the past week of trading that we have not yet closed.

Buckle (BKE)On Nov. 11, we recommended you to “buy to open” the Dec 40.25 Puts for $1.50 or less. We entered the trade for $1.38. We still like this for new entries up to our limit price.

Lowe’s Companies (LOW)On Nov. 14, we recommended you to “buy to open” the Dec 23 Puts for 73 cents or less. We entered the trade for 71 cents. Hold.

Tyson Foods (TSN)On Nov. 16, we recommended you to “buy to open” the Dec 19 Puts for 60 cents or less. We entered the trade for 60 cents. We still like it for new entries up to our limit price.

 

Positions Closed

These are the SlingShot Trader positions we closed during the past week of trading.

Cisco Systems (CSCO)On Nov. 10, we recommended you “sell to close” the Dec 18 Calls. We closed the position for $1.19, for a profit of 29.35%.

J.C. Penney (JCP)On Nov. 14, we recommended you “sell to close” the Dec 36 Calls. We closed the position for 71 cents, for a loss of 21.11%.

 

Top Trades Now

These are the current SlingShot Trader positions that we still recommend getting into now, assuming you haven’t already bought a full position.

Buckle (BKE) See Positions Opened above.

Tyson Foods (TSN) See Positions Opened above.

 

Webinar Preview: Join Us Tonight at 6 p.m. ET

Every Wednesday at 6 p.m. ET, 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 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 johnandwade@slingshot-trader.com. (Please send any questions about the status of your subscription directly to Customer Service at service@slingshot-trader.com.)

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
Editors
SlingShot Trader