options

Volatility Is Back, Q3 Earnings Reporting Season On Deck…

Posted on by George Mahfouz

After being in hibernation for most of the year, volatility is back at the forefront of the markets. The Volatility Index Symbol: VIX (chart) has spiked about 50% over the past couple of weeks which is a clear indication that investors are starting to get a bit nervous and fearful of the markets. The VIX demonstrates the next 30-day expectation of market volatility by calculating the implied volatilities of both puts and calls options of S&P 500 companies. Even the Dow Jones Industrial Average (chart) have experienced intraday triple digit swings over the past several trading days, something we have not seen in a long time. I think it is safe to say that the increase in vol is due in part to the markets continuing to post record highs, the fact that the federal reserve will be ending its asset purchase program this month and seemingly everyday now headlines of geopolitical uncertainty are abound . Furthermore, with the third quarter of the year now in the books, earnings reporting season is upon us. I don’t think it’s a coincidence that volatility has increased with all of the aforementioned factors in play. In fact, this particular earnings reporting season will  most likely be put under the microscope like no other recent quarter. Stocks have enjoyed the the accommodative policies of the Fed for the past several years and now one of the key components of the stimulus program will end here in October. As I mentioned in my previous blog, it will be up to corporate America to stand on its own two feet and begin to demonstrate top-line growth as they grow their earnings. Over the past couple of years many corporations have grown their bottom line by way of becoming more efficient, reducing their workforce and implementing stock buyback programs. I believe going forward financial engineering and in-house efficiencies won’t be enough to satisfy investors appetites.

As the third quarter ends and technically speaking, the Dow Jones Industrial Average (chart), the Nasdaq (chart), and the S&P 500 (chart) appear to be finding some support at their respective 50-day moving averages, however, the small-cap Russell 2000 (chart) continues to lag the big-caps and trade well below its 50-day and 200-day moving average. That said, what is impressive to me is even though volatility has picked up steam, most every pullback is met with support from willing buyers and sell-offs appear to be short lived. The concern I have is whether or not this pattern of support continues. As mentioned, Q3 earnings reporting season is on deck and I do not believe companies will be given free passes anymore to modest top-line growth. If you are a trader, this is type of environment that you have been waiting for. However, if you are an investor with a longer term view, then it is time to look at the intrinsic value of your holdings to reduce the impact of a higher vol environment. Also, options premiums tend to increase along with higher volatility which could bode well for option sellers. Whatever the case is, as we enter the last quarter of the year, I expect volatiily to continue and at points increase, which could create some panic selling and create great opportunities with the right companies. I am looking forward to this upcoming earnings reporting season and will look for oversold conditions to act.

Have a great October 🙂

~George

 

Stocks and Indexes Continue to Set Records!

Posted on by George Mahfouz

The month of October proved to be yet another record setter with a number of stocks from a variety of sectors hitting all time highs and the S&P 500 (chart) setting a new record high of 1775.22 on Wednesday. The Dow Jones Industrial Average (chart), the Nasdaq (chart) and the small-cap Russell 2000 (chart) all hit 52 week highs as well on Wednesday. This seemingly unstoppable bull run is unprecedented with gains of over 20% on most of the key indices year to date. I think it is fair to say a pause is overdue and would most likely be very healthy for the overall market.

In last month’s opening blog, I discussed how selling options premium can be beneficial in times of increased volatility, and in particular the “covered call” strategy. Today I would like to cover “selling puts” as a way to create options premium income. Unlike the “covered call” strategy where you must own the underlying security in order to “write or sell” a covered call, selling a put does not require you to own the security. However, by selling a put, you are potentially obligated to purchase the security should it close below the strike price you chose on its expiration day.

Let’s look at an example of selling a put on a given stock and like last month I will use Facebook (NasdaqGS: FB) as the example. Facebook is currently trading around $50 dollars a share. In looking at the options chain on Facebook and its current pricing, the December $48 puts are bidding around $2.00 dollars per contract. If an investor were to sell 10 December $48 dollar puts on Facebook for $2.00 per contract, that investor would bring in $2,000 dollars in premium less transactions costs. If Facebook closes above $48.00 dollars a share on expiration Friday in December, the investor would keep the entire premium he collected. However, by selling the 10 put option contracts, the investor has the obligation to purchase 1000 shares of Facebook should Facebook close below $48.00 per share on expiration Friday in December. It’s important to note that before considering and implementing a “selling put” strategy you must be willing to own the stock at the strike price you sold the puts on and in this Facebook example, that would be $48.00. However, your cost basis would not be $48.00 because you received $2.00 in premium when you sold the puts, therefore, your cost basis would be $46.00 per share less transactions costs.

Please also note this is not a recommendation to sell puts on Facebook or any other asset or index. This is merely another example of how an investor can capitalize on selling options premium. In closing and as I always suggest, please consult with a certified financial planner(s) before making any investment decisions.

Have a great weekend 🙂

~George

Despite a Partial Government Shutdown, Stocks Rally…

Posted on by George Mahfouz

No matter what has been thrown at this bull market over the past few years, nothing seemingly can slow it down. After the key indices finished the month of September with unlikely gains, stocks continued their upward trajectory today even though Congress couldn’t agree on a short term budget deal to keep our government fully operating.

For the first day of October, the Dow Jones Industrial Average (chart) finished up 62.03 points, the Nasdaq (chart) +46.50 points, the S&P 500 (chart) +13.45 points and the small-cap Russell 2000 (chart) closed the day up 13.64 points. Pundits are speculating that with the government in a partial shutdown, Congress will now have to address the debt ceiling and budget at the same time which a likely compromise will come forward on both issues, hence, bullish for stocks. Not sure if I fully agree with that thesis. Furthermore, the bulls make yet another case that by having this budget and possible debt ceiling impasse, this will keep the Federal Reserve in full accommodative policy mode. Now this in my opinion would be a more bullish thesis. However, lets not forget we have now entered into the fourth and final quarter of the year and third quarter earnings reporting season is on its way.

Needless to say, the markets have a ton to digest over the coming weeks including Q3 earnings reporting season and I am expecting volatility to continue to increase. From a technical standpoint, the Nasdaq (chart) and the small-cap Russell 2000 (chart) stunningly hit new 52-week highs today and continue to outperform the Dow Jones Industrials (chart) and the S&P 500 (chart). The Dow and S&P did bounce off of key support levels yesterday and have resumed their uptrends, at least for now. In addition, both the tech-heavy Nasdaq (chart) and small-cap Russell 2000 (chart) are once again approaching overbought territory heading right into earnings reporting season, which could be of interest to the bear camp.

As volatility increases, one strategy that can potentially bode well is to sell option premium on select indexes or stocks in order to capitalize on the increased vol. This strategy is not for the novice and one should consult with a certified financial consultant before implementing any strategy, especially options strategies. But for the more advanced investor or trader, this type of environment is almost perfect to participate in a “selling option premium” program. Option premium is essentially income generated by an investor who sells premium to another party and hopes to keep the entire premium without having the option exercised. Let’s look at one example of a “selling premium, covered call strategy”. Let’s assume you own 1000 shares of Facebook (NasdaqGS: FB) at $50 per share. You can choose to “sell” a.k.a.”write” a covered call option on the Facebook shares you own. If you take the monthly October $52.50 calls that are currently trading for $1.20 and sell/write them against your position, you would take in $1,200.00 less transactions costs. This is the premium you would receive for writing/selling this covered call. If Facebook closes below $52.50 on expiration day you keep the entire premium as well as your 1000 shares. If Facebook closes above $52.50 on expiration day you still keep the entire premium earned, however, your 1000 shares of Facebook would be called away at $52.50 because you sold your rights to the stock you own to another party for $52.50. If this is the case, you would be a not only be benefiting from the options premium income, but also a stock appreciation outcome for in this example the initial cost basis for the Facebook position is $50.00 per share. So you would gain an additional $2.50 per share in profit. Please note that a covered call strategy is typically a bullish strategy and again this is just one example of how “selling options premium” can work. In closing, this is not a recommendation just an illustration on how an investor or trader can potentially benefit with option premiums. Please remember it’s always best to consult with a certified financial planner(s) before implementing any investment strategy.

Good luck to all 🙂

~George