Is It Time To Hedge?

As we remain in one of the strongest bull markets ever, is it time to hedge? Whoever has tried to short the market this year or for that matter the last nine years understands this has not been an effective strategy to say the least. However, as we are now entering the height Q3 earnings reporting season and as I mentioned in my previous blog implementing a hedge strategy could provide continuing beta should the bull market carry on yet offer profits in the event stocks or indexes go down. The strategy I am referring to is an options strategy called a “straddle”. A straddle is when an investor buys a call and a put option with the same strike price and expiration date with the selected strike price as close as possible to the current stock price of the underlying asset. Let’s take Intel as an example: Intel (NasdaqGS: INTC) closed on Friday at $39.67 and is scheduled report their earnings results on October 25th. Taking a look at the November $40 strike price on Intel, the call option is approximate $0.83 per contract and the put option is approximately $1.34 per contract. So if an investor/trader decides to put a straddle on Intel at this particular strike price, the total cost of the straddle is $2.17. You arrive at this number by simply adding up the cost of the put and call option. Where you profit from this trade is if Intel trades north or south of $40 by more than the total cost of the trade and before expiration.

One of the reasons why straddles can be effective during earnings reporting season is that earnings can be a huge catalyst for stock price movement. This especially rings true when a company surprises to the up or downside. With a straddle it does not matter which direction the underlying asset moves, so long at it moves greater than the total cost of the straddle. The risk with the straddle is if the underlying asset does not have a big move in either direction before the straddle expires. Options do have an expiration date so you have to make sure that the catalyst occurs before the expiration date and even then allow yourself time for the full potential to play out. I also look for the historic movement of a stock or index to see if it does move greater than the cost of any given straddle regardless of a “catalyst”. That said, options and options strategies are extremely risky and volatile and you should always consult with a certified financial planner before considering any new strategy. Good luck to all ūüôā

~George

Are Stocks Poised To Breakout?

After an early November sell-off, the major averages could be on the verge of a breakout, at least from a technical point of view. The noticeable dip in equities that occurred recently was met with strong support and now stocks have rallied up to key resistance levels. The Dow Jones Industrial Average (chart) closed the month of November at 17720, the Nasdaq (chart) closed at 5109, the S&P 500 (chart) closed at 2075 and the small-cap Russell 2000 (chart) closed the month of November at 1198. As you can see by their charts the three top indices have resistance levels of 18,000, 5175 and 2125 respectively while the small-cap Russell 2000 (chart) is seemingly on the verge of breaking out. That said, it takes more than a day or two trading above a resistance level with strong volume to confirm a breakout. What could be in favor for a breakout with all of the aforementioned indexes is the seasonality of the markets a.k.a. the Santa Clause rally. This could very well be the catalyst for a year-end rally.

What could get in the way of a potential Santa Clause rally?¬†One example could be¬†if the technical resistance line(s) holds true to form and the key¬†indices cannot breakout¬†with conviction above these marks . There is also the risk of China’s market¬†continuing to abate as¬†regulators are cracking down on¬†trading practices of major Chinese brokerage firms. The China weakness¬†can spill over here to our shores even if it is only a short-term consequence. Of course there is¬†always a geo-political risk that could weigh in on market sentiment and behavior.¬†And last but not least, the Good Ole Federal Reserve and whether or not they would implement their first rate hike in almost a decade when they meet later this month.

That said and¬†notwithstanding any of these risks, we have seen stocks incredibly¬†resilient during this multi-year bull run and¬†I would not be surprised if we indeed breakout and experience¬†a year-end rally that could¬†challenge the all time highs. Good luck to all ūüôā

~George