Murica ($SPY $QQQ $IWM $DIA)

Murica ($SPY $QQQ $IWM $DIA)

S&P futures higher by 1.7%: Trump and China President Xi agree to trade war truce; will delay rate increase to 25% from 10% on $200 billion tariff tranche for 90 days.

Trump will not raise the 10% tariff rate on $200 billion of Chinese goods to 25% on January 1 in order to allow further time to negotiate a settlement of structural trade issues between the two countries.  If an acceptable deal is not struck in the next 90 days, then the tariff rate will reportedly go to 25%.

The press has pointed out this morning that there are different narratives in the U.S. and China surrounding the Buenos Aires "agreement."  For instance, China has not publicized a specific 90-day time window.

The different narratives, it has been said, underscore the fundamental differences between the two sides that could make it extremely difficult to resolve the trade differences in the next 90 days.  Accordingly, there are contentions that the "agreement" is just a kick-the-can-down-the-road approach and that the stock market's positive takeaway from the "agreement" is an overreaction.

In the end, it will be actions -- or the lack of -- that speak louder than the hopeful-sounding words out of Buenos Aires. It’s fair to say now that investors are relieved at least that things didn't go further south at the dinner meeting with respect to trade issues.

That relief is reflected in the futures market.  The S&P futures are up 40 points and are trading 1.3% above fair value.  The Nasdaq 100 futures are up 148 points and are trading 2.1% above fair value.  The Dow Jones Industrial Average futures are up 437 points and are trading 1.7% above fair value.

There is a risk-on mindset for sure, which has also underpinned foreign markets.  China's Shanghai Composite surged 2.6% and Germany's DAX Index is currently up 2.1%.

The strong indications are apt to be fueling a FOMO on further gains and specifically a year-end rally, the prospects of which have seemingly been given new life in the past week with some seemingly dovish-sounding remarks from Fed Chairman Powell and  Trump's characterization of the closely-watched dinner meeting.

It is important to realize, however, that nothing has actually been settled on the policy path or China trade fronts, which is why the market could see a STFR mindset down the line.

Secondly, there is a good bit of attention being paid to the oil market today as well.  WTI crude futures are up 4.7% to $53.34 per barrel, bolstered by the risk-on mentality and news that the Canadian province of Alberta will be cutting its production by 325,000 barrels per day in an effort to curb excess supply.  On a related note, Qatar has announced plans to withdraw from OEPC.

Alberta's move comes just ahead of this week's OPEC+ meeting where it is thought an agreement will also be struck to lower production targets.  

That meeting is just one of several important events that will take place this week.  Fed Chairman Powell will appear before the Joint Economic Committee on Wednesday to provide his semi-annual testimony and the Employment Situation Report for November will be released on Friday.

In a statement from the White House:

"Trump has agreed that on January 1, 2019, he will leave the tariffs on $200 billion worth of product at the 10% rate, and not raise it to 25% at this time. China will agree to purchase a not yet agreed upon, but very substantial, amount of agricultural, energy, industrial, and other product from the United States to reduce the trade imbalance between our two countries. China has agreed to start purchasing agricultural product from our farmers immediately."

This will likely be positive for the following stocks: BA, GE, CAT, DE, UTX, BG, ANDE, ADM, LNG, GLNG, GLOG, TELL, EOG, OXY, XOM, CVX, COP.

"Trump and President Xi have agreed to immediately begin negotiations on structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture. Both parties agree that they will endeavor to have this transaction completed within the next 90 days (deadline March 1, 2019). If at the end of this period of time, the parties are unable to reach an agreement, the 10% tariffs will be raised to 25%."

The products in $200 billion tariff tranche:

Food ingredients, auto parts, art, chemicals, paper products, apparel, air conditioners, toys, furniture, and electronics (iPhones, smartwatches excluded).

This news is likely positive for: DWDP, KSS, WMT, TGT, NKE, SKX, KS, CLW, KHC, MGA, LEA, F, AAP, XRT, M, JWN, BBY, BID, AAON, FIX, LZB, MAT, HAS, AAPL, FIT.

G20 OIL:

Members at the G20 summit supported the idea of WTO reforms in official communique. This stance was echoed in the minutes released from the summit:

“We welcome the strong global economic growth while recognizing it has been increasingly less synchronized between countries and some of the key risks, including financial vulnerabilities and geopolitical concerns, have partially materialized. We also note current trade issues. We reaffirm our pledge to use all policy tools to achieve strong, sustainable, balanced and inclusive growth, and safeguard against downside risks, by stepping up our dialogue and actions to enhance confidence. Monetary policy will continue to support economic activity and ensure price stability, consistent with central banks' mandates. Fiscal policy should rebuild buffers where needed, be used flexibly and be growth-friendly, while ensuring public debt is on a sustainable path. Continued implementation of structural reforms will enhance our growth potential. We reaffirm the exchange rate commitments made by the Finance Ministers and Central Bank Governors last March. We endorse the Buenos Aires Action Plan."


SEMIS:

In addition to the above commentary, in a statement from the White House, China President Xi is open to approving previously unapproved QCOM -NXP (NXPI) deal should it again be presented to him. This potential M&A headline will likely spark the semi’s as the overhead risk appears to have subsided.

 

Wednesday, December 5, has been declared a national day of mourning.  Per tradition, the market will be closed that day.

Winding Down (SPY IWM DIA QQQ)

Winding Down (SPY IWM DIA QQQ)

CLIFF NOTES:

  • Market Volatility has been fueled by a changing landscape for the larger management models and has been aided by political, fundamental, and technical factors.

  • Oil has been pressured by compressing crack spread readings, but OPEC and Shale production cuts could help to forge support.

  • Sentiment data around extremes in hedging suggest the there is a potential for a “Max Pain” rebound into year-end.

  • China may not want a trade agreement?

During this bull market, because of an overextended period of historically low interest rates, and concerns about deflation rather than about inflation, more and more “managed money” has migrated into a “risk parity” model. That is, stocks and bonds are presumed to be mutually protective hedges for each other, and risk covariance remains under 1.00 for those diversified in both asset classes.

With the breakout higher in interest rates at the long end of the treasury curve in late September (a move that was not caused or accompanied by a breakout of higher equity prices), this risk parity approach (typically a 70/30 Stock and Bond portfolios) was hammered mostly due to model-based managers having to raise their guards about risk on the bond side while and decreasing their confidence in the belief of negative risk in their overall portfolios. The way to actually prepare for circumstances like this one is to increase the cash on hand.

In simple terms, when the yields on the long end broke out and equity prices did not, the traditional stock/bond portfolio model that a majority of fund managers have been using as their bread and butter had to be altered. The viable way to remedy the risk appetite in an instance like that is to increase cash levels.

Given that there’s near a half-trillion dollars managed in the above risk parity strategy, the impact of a widespread failure of the model has relatively dramatic consequences for equity prices. My belief is that this is the primary driver behind the initial downside momentum we saw in early October.

Another major factor likely contributing to the downward momentum is the rising expectations for direct supply in the bond market in 2019. Currently the supply is around $1.5TRILLION. This comes as a consequence of “yuge” anticipated budget deficits and the Fed’s plan to roll $500 billion off its balance sheet during that same time. These issues suggest to managers that the failure in the model for risk parity is likely not going to be “quick fix.”

In addition, likely helping to undermine the market over the past 6 weeks are two other big factors.

  1. Q2-Q3 of this year is a strong candidate for cycle highs in both earnings and economic data due to the initial psychological impact of the sense that fiscal stimulus measures “are having a greater impact than anticipated” as noted by the Fed earlier this year.

    That suggests extremely difficult comps on the way in 2019.

  2. Now that the elections are over, Democrats are taking over leadership in the House of Representatives. The implication is such that if the market was counting on Trump to push for further stimulus next year to inflate the market and economy into the campaign season ahead of the next presidential election. With the House in control of the Dem’s, Pelosi and Democrats will likely present obstacles on that path that will be difficult to hurdle. This further suggests rough comps ahead, as argued above.

As we know, the market does not simply move on the economy being great, reports of what has happened, or random upgrades/downgrades. The market is a function of future earnings growth relative to expectations. In order for sustained moves to continue, the growth has to maintain up and to the right relative to the risk and expectations. We also know that the higher the bar is, the more difficult it is to jump over it. So with this insight, we know how difficult 2019 could be.

Some weakening in Q4 guidance from big-cap tech over recent weeks has certainly done nothing to temper this new bearish tone in the tape.

We may be in a pattern currently that acts as a doppelgänger to the fall of 2015, where we see a beta chase into the end of the year, but a swift resumption of risk-off activity in Q1 2019. This time around however, we likely won’t have a massive safety net of fixed income money coming over into the stock market as we did in early 2016 when 70% of global sovereign debt in the developed world was trading at negative yields.

Max Pain

One reason it’s possible to see “Max Pain” type upside into year-end is due to something called the “Equity Hedging Index” put out by SentimenTrader.com. This measure takes into account six different hedging factors:

  1. Cash levels

  2. Put buying

  3. Inverse ETF buying

  4. Inverse mutual fund buying

  5. Short interest in equity index futures

  6. Long interest in CDS markets

The Equity Hedging Index compares each of those six factors to its historical average, and then constructs an overall score from those relative scores. It has been a good guide over the years, marking points when too much cash is saved due to a concentrated belief of sudden bearishness.

Right now (as shown below in the chart) this index is scoring at levels that have marked major bottoms during the bull market. The last time it scored this type of level and the market did not immediately move to new large timeframe trend highs was in early 2008 (when it hit 85 in mid-March 2008 on the Bear Stearns collapse).

It hit 86.5 at the lows in late October, two weeks ago.

Just to be clear, only this measure and the “Hulbert Stock Newsletter Sentiment Index” are showing significant bearish consensus extremes right now.

Equity Hedging Index. Source: www.sentimentrader.com

It is important to note however, at that time in mid March 2008, it did mark a low that was followed by a strong two-month rally that saw over 13% in upside for the S&P.

SPY 2008 13% Rally off the sentiment lows.

Crude Oil and Energy Complex (USO, UGA, BNO, CRAK)

Recent sharp selling in crude oil is likely the product of the build-up of a glut in gasoline levels at major refiners. The best way to see this is in the contraction of the gasoline crack spread – the difference between the input cost of crude oil and the output selling price of gasoline (The margin for gasoline refining).

Below is a chart of the price of a barrel of gasoline minus the price of a barrel of oil, which approximates this idea very well. This suggests that oil prices have been falling in anticipation of a big drop in demand for oil from refiners on the way. 

Russia is also allegedly buying Iranian oil and selling to the world. This is softening the “supply-destruction” impact of the Iran sanctions being enacted and enforced by the Orange Man. OPEC is attempting to curb this as talks of production cuts have surfaced.

As far as key levels, the stars have aligned very nicely and we’ve seen a sharp puke down under $60 on aggressive selling. The $58 area, where we found support in February, has been breached. As of now we are on “oversold levels” and hanging on to a small uptrend.

That $58 area represents extra importance because it also lines up with what’s widely understood as the common line in the sand for whether or not US shale producers can profitably operate. That industry has become the most flexible in terms of shutting off and turning on supply centers. Therefore, it represents the potential to cut US production if the threshold is taken out to the downside. (A takeaway here is that the longer we stay under $58 the easier it is to short/sell US Shale stocks)

Gasoline/WTI Crude Equal Volume Price Spread

WTI Crude Oil (USO)

Brent Crude Oil (BNO)

Refiners ETF (CRAK)

The EU and Italy (FXE, EWI, VGK)

If Italy exits the EU and “redenominates” its debt into Lira, the actual value of that debt will plummet in spectacular fashion as it will no longer be supported by the stool of the EU and the far stronger economies up north. Those holding that debt will only be able to hedge the risk of this event by owning the 2014 minted Italian debt CDS contracts. This is akin to the 2008 MBS crisis.

As of yet, we haven’t seen a big divergence in these contracts, which suggests the world is not yet taking the current spat as a risk to Italian membership in the EU. 


The Euro Continues to Tumble.

Euro (FXE)

European Equities (VGK)

China and the Trade War


The Trump/Xi meeting is set to take place in Argentina toward month end at the G-20 summit. Trump has suggested that the meeting holds “great potential” for a trade deal with China. Trump is likely full of shit, per usual.

I believe that China does NOT want a trade deal with the US.

China wants a long-term change in the protectionism rhetoric and China-hawkishness in the US. The only way to accomplish this is to sit through the storm and use stimulus and currency devaluation until the Trump administration is out (potentially) of office in two years. 

The important factor here is that Xi is a "Leader for Life" in China. The power structure in Beijing is not remotely vulnerable at this point. In other words, the people making the calls are not suffering in the least and will remain in charge long after the 2020 US presidential election barring any “accidents.” Unlike the Orange Administration, the Chinese don’t have to worry about public perception or public approval politics, they can sit out as long as they deem necessary.

As we saw in the mid-term elections, the ability of the GOP to generate powerful support from its largest donors was hampered. The likely the reason for this is because its largest donors hate the trade war and want the tariffs to end. The GOP is a split party, with some of it following the populist tradition of Trump's lead and some of it belonging to a more corporate, free-trade philosophy that has been offended by the trade war from day one.

My belief is China may well believe that it's “one down and two to go” with respect to the House, Senate, and White House over 30 months of withstanding the tariffs -- given that the White House hawks will need Congressional support to enact domestic policies capable of painting a positive narrative into the 2020 campaign to garner enthusiastic support from the same base that drove them into power two years ago.

The price to be paid over this 30 month stretch is the toll that comes with potentially avoiding decades of US hawkishness against China. This US hawkishness is a real danger that may follow if they “reward” the White House tariff strategy with a big win.

If any of this is occurs or has the potential to occur, then at some point, the Orange Administration sees the threat and starts to look for a way to make its biggest potential donors happy well ahead of the next election by backing out of tariffs. 

This feeble attempt could come in the form of one last very hardline attempt to force its preferred conclusion with China. Likely a dramatic increase in tariffs packaged with a compromised trade deal offer. A bogus “Art of the Deal” move that the Chinese would likely balk at. Seeing how there has been no true “plan” at some point the bluster will be forced to reconcile with action.

Shanghai Index (ASHR)

Environmental Evolution

As a final thought, I want to visit an argument I read about and suggest it may be a real factor in the mix going forward.

Imagine a mountain top Lake. The water collecting in the lake is entirely salt free. The life that has evolved to live in the environment of this lake would be life evolved entirely around the premise of an aqueous environment containing no salt. Everything that evolved into the niche of that environment would be of a physiology predicated upon no salt.

Now compare that with a fringe environment that exists on the border of freshwater and saltwater – something like a tide pool just inside of the contours of the saltwater beach.

Life forms there that have evolved to live in this environment would have a physiology predicated on withstanding a dramatic variation in salt levels over time.

The question here is what would happen if you take a fish from the mountaintop lake and release it into the estuary.

The metaphor here relates salt to the cost of money, or interest rates. Our current market cycle and business cycle was very slowly baked with unprecedented artificial suppression on interest rates. 

Typically, there is always a stage of a market cycle that is like the mountaintop lake (interest rate suppression). But it’s normally over quickly as the salt volatility of the estuary leaks into the picture with strong signs of early cycle growth.

This time around though, the mountaintop lake remained in place for nearly a decade. This has been enough time for someone in high school to go to college, join a frat, get a girlfriend, get blackout drunk and get alcohol poisoning, cheat on his girlfriend, join a rock band, contract an STD, break up with his girlfriend, get a DUI, decide to change his life, get into a finance program, talk to his rich uncle in investment banking, get an MBA, go to Wall Street, intern at a fund, get good at networking, raise enough capital to start a small fund himself, and get a few years under his belt sending out investor letters as though he’s a professional. Whole funds have risen and fell all inside the mountaintop lake context. The STD, however, remains. Sorry Chad.

That is extremely strange historically. It suggests a compounding development of “fragility” as we now migrate clearly into the fringe environment. The fact that over $500 billion has been in the hands of risk parity managers (and much more if you take into account those managing their 401k’s with robo-advisers which use basically the same strategy) is a testament to this odd evolutionary situation we now face in global finance. 

There are plenty of people cumulatively managing massive amounts of money who don’t have any direct experience in anything other than the mountaintop lake. To suddenly be dropped into the fringe environment is a truly dramatic moment. 

Add to that an insane person who holds the fiscal balance in his stubby orange paws and it likely spells out serious consequences for the path moving forward

SHAMLESS PLUG AND POD

For the sake of clarity and for the sake of fun, I will be releasing a podcast soon. If you have any ideas for topics or names please message me using the contact page on my site.

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Booked (BKNG Earnings)

Booked (BKNG Earnings)

Booking.com (BKNG) is set to report Q3 results tonight after the close with a conference call to follow at 4:30pm ET. 

Father (BABA Earnings)

Father (BABA Earnings)

Alibaba (BABA) is set to report earnings tomorrow before the market opens with a conference call to follow at 7:30am ET.

Crisp (AAPL Earnings)

Crisp (AAPL Earnings)

Apple (AAPL) will report fourth quarter earnings this afternoon at 16:30. The conference call is scheduled or 17:00.

Roll The Dice, Risking Less to Make More

Roll The Dice, Risking Less to Make More

Whether you’re trying to make some (extra) cash or growing your account there will almost always come a period of time where you want to take on a little risk to accelerate those profits.

With options, this risk comes in the form of leverage. On opex (options expiration) this leverage is further compounded as you get the opportunity to own ever more leverage for less premium. This premium doesn’t come without a price. More often than not this premium expires worthless and you wonder why you even bothered.

There are those times where you are blessed by the fortune gods and granted an opportunity to make serious bang for your buck. This typically occurs when the confluence of Friday expiration meets a catalyst that provides you an opportunity to leverage wonderfully for sizable returns.

Personally, my first experience with “Friday Lottos” occurred nearly five years ago when the stock ripped nearly five percent to close out a Friday. I was a member of a chat at the time and “made my name” that day by turning ~$250 into north of $15,000 in just over 45 minutes. I’ll admit, I didn’t truly know what I was doing back then and the probability of what I was doing coming to fruition was infinitesimal. In fact if memory serves me correctly, I believe I bought a strike $1 farther out of the money than I should have and could have made more by buying the closer strike.

Since those days, I’ve had my fair share of trials and failures alike. Mostly failures. That said, I’ve learned that when opportunity presents itself alongside a catalyst it is typically worth the risk to try your luck so long as you are only risking an amount that you are willing to lose.

In Action

I’d like to take a moment to show the above in action and show three (successful) scenarios when buying yourself some leveraged lottos would have resulted into significant returns.

Before I dive into the details, I want to stress these types of trades are complete risk trades. For all intents and purposes these trades are lottery tickets. You don’t want to put real capital to use and you don’t want these types of trades to be the primary types of trades you take in your account. These trades should account for a small portion of your overall trading and should not be anywhere near the bulk of your trading. Secondly, I want to stress that taking many trades like this will most likely results in real losses. Lottos are only lottos when they are a small percentage of your overall trades and account. The moment you start taking lottos more frequently than you should is the moment that you will start to suffer real losses.

Derivative Lotto

The most effective use of a lotto comes when there is a catalyst behind it. Without a catalyst the odds of profiting go down significantly.

The first scenario I want to highlight is a derivative lotto. This is when a competitor company/stock issues some news that has a material impact on itself and other stocks/competitors. In this case, I’d like to highlight the AMD backlash after the INTC headlines that broke on Friday.

On Friday morning, INTC issued a statement suggesting that their chip supplies are tight and that they were investing a record in capital expenditure in 2018. Specifically the comment went as follows:

"The surprising return to PC TAM growth has put pressure on our factory network. We're prioritizing the production of Intel Xeon and Intel Core processors so that collectively we can serve the high-performance segments of the market. That said, supply is undoubtedly tight, particularly at the entry-level of the PC market. We continue to believe we will have at least the supply to meet the full-year revenue outlook we announced in July ($68.5-70.5 bln vs Capital IQ consensus of $69.54 bln), which was $4.5 billion higher than our January expectations."

  • To address this challenge, they're taking the following actions:

    • "We are investing a record $15 billion in capital expenditures in 2018, up approximately $1 billion from the beginning of the year."

    • "We're making progress with 10nm. Yields are improving and we continue to expect volume production in 2019."

    • "We are taking a customer-first approach. We're working with your teams to align demand with available supply. You can expect us to stay close, listen, partner and keep you informed.

As you can imagine, this headline sparked some incredible buying in INTC stock. Shortly after 11am the stock took off like a bat out of hell and rallied nearly 2.5% in short order (pictured below).

As you can see, INTC took off shortly after the headlines broke and did not stop until it hit its major downtrend.

If you were fortunate enough to catch the headline the moment it happened, the obvious trade would have been to buy INTC that very moment. If you were like most however, you likely missed that rush to buy and the risk premium would not have been in your favor.

That said, if you’re familiar with the space and read the statement you got a little insight that gave you a pretty easy derivative trade. In the statement, INTC stated the following:

“We're making progress with 10nm. Yields are improving and we continue to expect volume production in 2019."

With that statement, the headline in INTC sparked buying across the sector with the exception of AMD which many believed had been gaining market share on INTC due to INTC’s missteps in the 10nm chips.

As you’d expect, AMD’s stock started to break exactly as the INTC news hit the wire. Unlike INTC though, it gave you a perfect trade setup if you knew what to look for. You didn’t have to catch the first five minute trade in order to capitalize on AMD. AMD’s stock had been stuck in a wedge since breaking higher yet again on September 12th. Upon first reaction of the headlines, AMD’s stock had found support at the bottom trend of the wedge. It continued to oscillate in an intraday bear flag for nearly 15 minutes before subsequently beginning its free fall.

Above you see the first reaction to the INTC news followed by the subsequent break of the the wedge.

In an instance like the above, we have a very defined range, a catalyst to drive the price of the stock, and a technical breakdown that gives us an opportunity to capitalize on the confluence of events. Unlike INTC and the others, AMD gave two opportunities for capitalizing on the “bad” competitor news.

At around the time of the breakdown, AMD’s 31.5 weekly expiration puts were going for 0.12-0.17. If you felt like this was an opportune moment to take a gamble you could have (hypothetically) filled your lotto puts prior to the break down. If you wanted a little more confirmation (like I did) you could have filled the break for ~0.22-0.25.

On the break down, AMD’s next level of support set itself up at around 30.5 with round number support sitting at 30. In this example, the risk reward premium told you that if you bought lottos, you were willing to take the risk in order for these puts to potentially triple in value (if not more). Additionally, with a scenario like this, you’d know almost instantaneously if it worked out or not. In this case the trade worked and the options nearly returned 5x their original value in a matter of 10 minutes.

Below you’ll see the daily breakdown along with the trade that worked on AMD. You’ll notice the breakdown highlighted by the blue trend line and the blue arrow, the daily chart breakdown, and the trade netting roughly 4.5x it’s initial value in a matter of 10 minutes.

In the above, a simple $110 bet would have resulted in ~$480 when it was all said and done. Not bad for ten minutes!

Direct Catalyst

In the above, we went over what a derivative trade would look like when a derivative catalyst takes precedent. Now I’ll go over what happens when you get a direct catalyst and how powerful that result can be. In this instance, I will focus on FB.

Shortly after the AMD trade we were blessed with another catalyst driven trade opportunity when FB announced that nearly 50Million users information may have been compromised.

I want to point out that FB had been acting notably week all day Friday after rejecting its major trend tests the previous day. (Shown Below)

FB D

FB D

As you can see above, FB rejected its previous uptrend and the new downtrend simultaneously the previous day. As stated above, FB had been acting weak all day Friday as well. In this particular case, FB broke its ORB range shortly prior to the headline and presented an opportunity to take a short position. In our case, we took flyer lottos on the 165 strike prior to the announcement specifically to try and capture any further downside after the range had broken. Again, in the case of lottos, you are to risk what you are willing to lose and no more. Approximately 15 minutes later FB announced that their data had been compromised providing further opportunity to leverage the trade. (See Below)

Since FB has been a “weak” stock since their disastrous earnings report it has been in “shoot first, ask questions later” mode. With yet another downside catalyst, the stock presented further opportunity to leverage positions and potentially give further downside. As is often the case with stocks, when selling takes hold they usually take the elevator down. In the case of FB the drop was precipitous. In a matter of five minutes, puts that were worth a quarter were north of $2. Next week puts that were going for <$1 had more than doubled. On the catalyst break, we leveraged our positions and added to our puts and were fortunate enough to profit extensively. The blue arrow below signifies where the leveraging took place.

As you can see, I was able to leverage my small put position and turn it into a sizable lotto that resulted in nearly 10x in a matter of four minutes.

Put into perspective, a $100 resulted in over $1100 in a matter of five minutes.

Intraday Breaks

The last setup I want to cover is pretty basic. After a catalyst drives a stock up or down a range will be set. When the catalyst is after hours the same rules will apply. So during market hours it is important to take note of both ranges. The first range being the range that occurs during market hours and the second being the range from the premarket.

Once one range is broken, it will typically create enough room to test the other range (assuming that second/premarket range is higher or lower than the intraday range). Once the premarket range is snapped further room to the upside/downside is generated (depending on the direction of the break). This sounds complicated, but it’s really kind of simple. On Fridays i like to draw out my support/resistance lines and account for premarket ranges. I especially like doing this after a catalyst occurs.

In Action

Let’s take a look at the above in action with the help of TSLA. On Thursday afternoon, the SEC charged Elon Musk with Fraud and the headlines sent the stock into a spiral. TSLA closed north of 300 on Thursday plunged to a low of 265 prior to bouncing around. In its fall the stock broke a multiyear uptrend. (Pictured below)

TSLA D Broke

To start the day, TSLA rallied off the open and made a few attempts at reclaiming its multiyear trend line. As the day went on and the stock failed to reclaim the line it was important to note the daily ORB low and the premarket levels. To start, you could have bet against the 275 level with the notion that the stock would continue to reject the trend line and that would have been a safe idea. Secondarily, and more easily, you could have waited for the days lows to break and understood using the premarket lows (265) would be tested and in the event of the premarket lows breaking you would have further downside.

In our case the second of the two is how we played TSLA. We simply waited for the daily low to be broken and took our bet understanding that 265 would be our next level of interest. A breakdown of that level would potentially result in a 260 test. Fortunately for us, that is exactly how it played out.

As you can see from the above pictures, A break of the premarket lows of 265 accelerated the stocks flush (highlighted by the blue arrow). You can also see the stock rejecting the previous trend on the daily. Finally you see the logic in advance of the move. The break of 265 flushed the dip buyers and gave an opportunity to nearly triple your money quickly. If you’d front ran the 265 break and simply entered on the ORB breakdown you would have been able to collect nearly six times your money.

Put into perspective, a $144 bet resulted in nearly $400 in a matter of 10 minutes.

Takeaways

I want to stress one last time that though these trades did work out that is typically not the case. That said, it’s important to know your levels and understand when it is prudent to place bets such as these as they can be a great way to grow your account quickly. It is also equally important to note when that sort of trade is not appropriate. For example, if I am down to my max loss threshold on the day or close to it, I don’t typically want my final trade(s) to be lotto trades. Using this type of common sense and understanding the situations presented can go a long way to help you grow your funds.

SHAMLESS PLUG

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Just Do It (NKE Earnings)

Just Do It (NKE Earnings)

Nike (NKE) will report Q1 earnings after the market closes today (16:15 ET last quarter) with a conference call to follow at 5PM

Stick to the Path, A Lesson About Leverage (FB)

Stick to the Path, A Lesson About Leverage (FB)

The internet, specifically FinTwit, is full of charlatans and snake oil salesmen telling you that their magical tricks will get you to your wildest dreams. The reality is most are average at best and don't espouse any real tangible knowledge or give you an edge. So it is because of this, and because when markets get rocky my inbox blows up, that I wanted to take a moment and give my personal insight on the most common question I get asked. 

As someone who has been trading transparently for three years now I often hear the same questions. No question is more prevalent however than "How do I know how much to put on a trade?" 

As a part of my "service" we offer individuals a spreadsheet that gives them an idea of what their overall risk tolerance should be dependent on their trade size. The spreadsheet also works in reverse. This is predominantly "basic math" but let's just go over it quickly. For example, if I am okay with losing $250 on a position and the options price is going for $1.00 my position sizing/risk tolerance will be the following according to my parameters set above: 

5 Calls 50%

10 Calls 25%

20 Calls 12.5%

25 Calls 10% 

50 Calls 5%

Obviously, the larger the position size the more you have to "thread the needle" for that position. 

The second most common question I get:

"How do you know how far out your options should be?" 

Absent of allegations of fraud or takeover noise, there is no "sure fire" way to tell just how far a stock can go both up or down. There are however tools/edges at your disposal to give you a sense of when you can/should leverage or when you can expect the potential for an outsized move. Notice I said "potential" in the above sentence. At the end of the day regardless of expectations or rationale, the market is irrational, and more often than not that is costly to your bottom line. 

In simple terms, your options should be how far you perceive the move in question will in fact travel. Take into account that you want to be reasonable with your assessment and try keep your price objective within the measured move of the stock.

With the above diatribe over with, I want to share an example the above in action. Specifically how you can leverage father out of the money on major breaks (up or down) to get outsized returns on your capital. For the purposes of this exercise I want to highlight Facebook (FB). 

SEND IT

There are particular times when it is prudent to take stabs at exaggerative moves in the market. Though every trend book will tell you buy the breakouts and sell the breakdowns and you'll make money easily, that is not always the case. There are some key factors that can help you with your decision making process. Specifically I've found the following three items to consider prior to taking a potential trade.

  1. The Overall Market

  2. Catalyst

  3. Stock's Trend

Overall Market

The first item I consider when taking a trade is the overall market. The questions being, what is the stock market currently doing? How is it preforming relative to the position I want to enter? 

Put in layman's terms; do I want to short or go long? Is the overall market suggesting I should short or go long?

If you think of stocks as boats and the overall market as the river they flow on, you predominantly want to be in a boat attempting to go with the tide.

Since 70% of stocks tend to move with the overall market trying to move in the opposite direction is not prudent for your overall success. If I can put this scenario in a blunt image for you, don't be the stray gazelle in the Serengeti. We all know how that ends. 

Don't Get Slaughtered

Don't Get Slaughtered

Catalyst

When taking a position, it is important to take note of if there is a catalyst at play for your move. Though not always necessary, if there is a catalyst, it does bolster the chances of our thesis coming to fruition. If we're using the boat analogy from above, a little wind in the direction you're going definitely gets your sailboat moving more quickly. Conversely, if there is an opposing catalyst, your chances for may be impeded. 

TREND

This one is quite simple. Is there a particular trend for your stock? Or is it just dead money? It is more likely for your position to be accurate if you are trading either with the trend or when the trend breaks. 

If you are trying to go long a stock, more often than not, staying with the uptrend for that stock will be beneficial for your overall success. That is of course unless the overall trend breaks. In that particular case trying for the opposite could prove to provide more bang for your buck. 

As a general rule, the longer a trend the harder it is to break. Secondly, most trends don't break on their first attempt, but rather after multiple attempts at breaking.

In Action

I want to give an overall picture of the above in action. For this I will focus my attention on this week's FB trade. Going into the week FB had not traded particularly well as it finished August below its major MA's without the ability of breaking out. 

FB Daily

FB Daily

As the above shows, Facebook was unable to break above a downtrend set prior to its blowoff top prior to earnings. 

This next image shows how FB had been holding 170 as support after it's earnings report. 

FB 170 support

FB 170 support

With the above in consideration, let's zoom out and consider any long term trends for FB. 

FB Weekly

FB Weekly

Taking a look at the above, we notice that FB has been in a 4 year channel from April 2014. Like clockwork, the buys have come in on the bottom and the sells on the top. This channel was defended recently as well following a disastrous earnings report. That being said, FB had been acting weak and they were slated to present in front of congress again. The overall market wasn't helping either, as buyers abandoned ship yesterday seemingly being topped out by the AMZN $1T rejection one day prior. 

Let's Highlight: 

  1. The overall market was weak

  2. FB was in front of congress again

  3. The recent trend was downward and reaching a critical point on the overall long term trend

In Action:

As the above was taking place we began stalking FB in the chat yesterday. I first highlighted it around 10am EST and gave the chart for the wedge it had formed and the long term trend. I then followed it up with an alert, taking the out of the money weekly 165P's as the stock hung precariously on the edge. Since the trend line in question is a four year trend line, I found it appropriate to leverage with farther out of the money puts in this case. Though this is how I chose to take my first attempt at this trade, this is not a practice that I encourage typically. More often than not, being too far out of the money will result in you wasting your money. 

This position ended up working out for us immediately once the 170 level broke as the stock careened into 167.5 before finding some floor with the overall market. Unfortunately however, the stock did in fact find a floor and I was stopped out of a majority of my original position as it started to rebound. The stock started to form a new range between 167.5 and 169. It was important to make not of the breakdown level from that point on to decide whether or not to re-enter a position into the close. Secondly, it was important to note as a break of the lows would create further selling pressure. As the stock broke the intraday lows it was prudent to reapply my short of the stock; and thats exactly what we did. 

With the stock selling into the close and breaking a multiyear trend, I found it prudent to put on an overnight position for the hopes of further selling and I'd make note of the previous days lows to get more aggressive with the stock should those lows continue to break. (highlighted below)

FB would be back on the top of my watch list yet again today. Within minutes, the overnight put position was in my favor and I could rest easy and raise my stops. From that point on, I made note of the previous day's close and the opening range lows as another catalyst point for selling as shown below. 

The stock attempted to find a floor in the first half hour and subsequently attempted a run at the days opening price. A failure of that price suggested that any break below the opening range would result ini further downside. This was a safe bet as the stock had already broken a multiyear trend and closed on the lows just one day prior. With that in mind, and with a breakdown of the ORB I found it prudent to get more aggressive. I raised my stops on the overnight position again and added more puts (highlighted by the arrow below). 

As you'll notice, once the position was on, the stock never recovered. It continued its escalator down until it came close to the 160 round number. By that time, we were all out of our puts and had rolled down our winners. 

As a rule of thumb, I like to sell ~50% my winners once I see a 2x return. This allows me to avoid micromanaging the position and allows me to let it run its course to completion. All in all this trade worked out and was quite lucrative. 

Some of the FB profits

Some of the FB profits

CLOSING

I opted to write this post primarily for two reasons: first, because I thought I'd finally put some of the "rules" I follow in writing to help answer some of the recurring questions I see/hear. Secondly, as I stated above, during times of market volatility my inbox blows up. This is an easy way to address all the common concerns and questions in one swoop. If you found this post helpful, please like and share it. If you'd like to learn more about how we trade feel free to reach out to me using the contact link on my website. As I stated, more and more people contact me during volatility. It is important to state, not all markets behave the same and this is not some cookie cutter method. 

SHAMLESS PLUG

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