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9:05am (EST)
The bulls took another two steps backwards on Monday after failing to capitalize on Friday’s one step forward. We knew last week at some point there would be a “dead cat” bounce or a “short covering” rally but we didn’t expect one before the weekend. However, we had a feeling it would be hard for the bulls to carry forward any meaningful rally given the current trend.
The futures were pointing towards a slightly lower open yesterday but the selling pressure intensified late into the session which took the market to new lows. Volume was extremely light; in fact, it was one of the lowest volume days of the year as Wall Street takes the last of its summer vacations. This is usually a popular week to hit the beach so we are expecting much of the same with an increase in volatility. Hurricane Earl could also be a factor this week.
As a result, the Dow dropped 141 points, or 1.4%, to finish at 10,009. The bulls didn’t give back all of Friday’s gains and they still managed to hold the 10,000 level but it wasn’t pretty as the Dow got slammed in the last 15 minutes of trading. The bears will try to push for 9,800 and then 9,500 while the bulls try to hold support.
The S&P 500 fell 16 points, or 1.5%, and settled at 1,048. The index closed below our 1,050 target and will likely trade down to 1,020 if 1,040 is taken out. From there, we could eventually see the S&P at 950 by October.
The Nasdaq tanked 34 points, or 1.6%, to finish at 2,119. Tech remains the most volatile and support will come in at 2,100 and then 2,050 but we think a test to 1,900 could be on the way.
There is a ton of economic news due out over the next few days, including Friday’s monthly employment report, and the market will likely react violently to any surprisingly bad news.
Financial stocks continue to look weak and we have been saying the bulls cannot have a sustained rally without them. Wells Fargo (WFC, $23.25, down $0.75) is in a nosedive, Bank of America (BAC, $12.32, down $0.32) hit a fresh 52-week low and Goldman Sachs (GS, $136.66, down $2.74) is breaking key support levels.
Although some names in the sector are starting to look like real bargains, there is probably some more exposure to the downside before the group turns around. We are looking at some attractive LEAPs on a few Banking stocks but we think there is a chance we can get them cheaper. You can buy call options on stocks as far as a year or two out and we will be covering more about LEAPs in the Weekly Wrap in the future.
We wanted to take some time to talk about a strangle option trade this morning that we were going to cover over the weekend but didn’t. The stock we were going to cover is a good candidate because we are expecting shares to move at least 10% or more over the next few weeks.
To find an attractive candidate, you need volatility and Freeport-McMoRan (FCX, $70.36, down $0.84) fits the bill. The strangle option trade can be used for a stock that you feel will be making a big move but you are unsure of the direction.
If you look at a chart for FCX, you will notice shares are easily capable of moving $10 in a week and that is the action we are looking for. The company is mainly a Copper ETF but has some exposure to gold and although we are in a downtrend, we would use call options to protect us if the stock moved higher.
September options expiration is only 18 days away, so you could use the September 65 puts (FCX100918P00065000, $0.81, up $0.08) and the September 75 calls (FCX100918C00075000, $0.95, down $0.25) as a way to play a big move in the stock. If we let this trade run down to the wire we would need shares of FCX to be under $64 or over $76 for us to make a decent return. The goal would be to make enough on one side of the trade to offset the other side of the trade.
If the stock makes a quick 5% move either way, the calls or puts would double and hopefully give you an overall gain of 10% or more. Then you would have the other side of the trade to wait for a rebound and possibly get out of the other side with a profit. That is not often the case but it does happen.
These trades are also known as “chicken trades” or you can use the 70 strike price and make the trade a “straddle” option trade. This trade is not an official recommendation because we don’t like the risk/ reward setup for this one but we will track it to show you why it did work or didn’t. This trade is for educational purposes only.
As we head to press, Dow futures are lower by 35 points to 9,944 while the S&P 500 futures are down 4 points to 1,040. The Nasdaq futures are off by 9 points to 1,760.
We do have current trades that are official recommendations and they are inside our Members Area. Many of them made some nice gains yesterday as we remain on the short side and are using puts to play the current downtrend. Our Watch List also has a couple of earnings trades we are watching and we may be pulling the trigger on one or two of them if we see an opportunity. Subscribers, check for the updates.
Market Slightly Higher At Halftime
Tuesday, August 31st, 2010
1:05pm (EST)
There has been a flurry of economic news this morning that has moved the market and the bears were able to push the major indexes lower at the open. However, the bulls got some “better-than-expected” news and have fought back to take a slight edge heading into second half of action.
Here were the numbers:
The Consumer Confidence index for August came in at 53.5 versus estimates for 50.5, Chicago PMI for August was 56.7 compared to expectations for 56.0 and S&P Case-Shiller for June was up 1%, month over month.
The other big event to watch for today will be the release of the FOMC minutes at 2pm (EST).
And now for the good stuff…
This morning we profiled a strangle option trade and little did we know we would be doing an update 4 hours later. We mentioned shares of Freeport-McMoRan (FCX, $72.54, up $2.18) are capable of big moves and we targeted a quick trade to show you how you can use them in volatile markets. The stock opened at $69.87 this morning and this is what the options have done:
The September 65 puts (FCX100918P00065000, $0.50, down $0.31) opened at 87 cents while the September 75 calls (FCX100918C00075000, $1.51, up $0.56) opened at 80 cents. Your total cost of the trade was $1.67 or $1,670 for 10 call options and 10 put options.
Shares of Freeport are only up 3% but as you can see, the call options are up 60% and have traded as high as $1.72. In other words, they more than doubled.
This was the PERFECT scenario as you could have quickly sold the calls at $1.60+ by setting a limit order to close the calls when they hit this price in your brokerage account or by our Trade Alerts if this had been an official trade. This would have put $1,600 back into your trading account in less than 4 hours.
Now, here is the beauty of this trade folks. You would still own the September 65 puts which are at 50 cents so you could close them right now and put another $500 into your account. This would give you a net of $2,100, or a 26% return…in 4 hours.
You could also roll the dice and play the puts for the rest of the week. You could also close half of the puts and let a little ride. They would do well if shares stalled and retreated back below $70 but we would pull a Steve Miller by taking the money and running.
We are going to start covering more of these trades in our Members Area but we aren’t going to go overboard. We may, from time-to-time, do a strangle option trade or straddle option trade because it is our job to make you money but a lot of investors have trouble understanding these trades or putting them on.
As we head to press, the Dow up 26 points to 10,035 while the S&P is up a couple of points to 1,050. The Nasdaq is down 3 points to 2,144.
There is a lot to cover in our Members Area today so let’s get on it. We will be back in the morning with another full update.
Tags: chicken trades, FCX, option picks, stock options trading, strangle option trades
Posted in Market Analysis, Market Commentary, strangle option trades | Comments Off