Options Market Update January 18, 2016

 
The ugly start to the year continued last week, and the Dow has now lost over 1,400 points since the first trading day of the year. For the week, the S&P 500 lost 2.17%, the Dow fell by 2.19% and the Nasdaq dropped 3.34%.

For the bulls, it was a challenging week as several attempts at rallies were sold into and failed. Sentiment and dire predictions of a precipitous market fall have swung wildly bearish, which is often a great contrarian signal. Also, Small Business Optimism and Consumer Sentiment beat expectations.

For the bears, it was another near-perfect week, as stocks are off to their worst start to the year ever. Also, earnings from companies such as Intel (INTC), Wells Fargo (WFC) and Citigroup (C) were met by intense selling, and former market leaders such as Facebook (FB) and Amazon (AMZN) continue to get hit extremely hard. In addition, China’s Shanghai is now in a bear market as it has fallen 20% from its recent highs, Retail Sales were a big disappointment and Industrial Production and Business Inventories also came in worse than expected. These misses and the market action now have some traders fearing that the U.S. economy could be headed into a recession.

Volatility

The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 27, virtually unchanged on the week. While some would expect the VIX to be much higher, especially in light of another awful week for the market, for now, it seems like an adequate level to me.

The VIX is many things to many traders. But to me, it’s essentially a gauge of how much the market is expected to move in a given period of time. For example, when the VIX is trading at 14, it might be implying the S&P 500 will move 0.50% a day. However, when the VIX is trading at 27, it might be implying that the S&P 500 will move 1.5% a day. Essentially, with the VIX trading as high as it is, the market is pricing in the current extreme volatility. Clearly, the VIX could go higher if the market really unravels, but for now, it appears that the options market has raised its expectations for volatility, and is now “comfortable” with options prices given current market conditions.

Events for the Week to Come


Please note the markets are closed today in celebration of Martin Luther King Jr. Day.

The release of economic data will be relatively quiet this week. However, earnings season ramps up significantly, with reports from companies such as Bank of America (BAC), Delta Airlines (DAL), Morgan Stanley (MS), Netflix (NFLX) and Goldman Sachs (GS).

While earnings season is always dicey, especially during challenging market environments such as these, it also creates many opportunities. As I have said in the past, earnings season is a great time to find the next leaders for the market. For example, if the market is down 1% on the day, but stock XYZ reports great earnings and surges higher, it could be a new star amid the market mess. So while I hate to see the market fall apart like it has, in some respects, it’s ideal for finding the next great trade.

What Traders are Saying


This is a trading environment in which EVERY trader and investor can look like a fool and a hero many times over. Timing this market is impossible; there’s likely to be some sales at the bottom and buys a couple of days too early. It’s just the reality of a volatile market such as this one.

For example, I was extremely confident in my trade recommendation of Kroger calls recently. The stock was one of the few whose chart was unbroken, and it looked great for days following my recommendation as the rest of the market unraveled. My thesis was working perfectly—it seemed an American company that sells groceries would be a great place to “hide out” if the market were to fall apart on international concerns.

Unfortunately, selling pressure became too much, and on Wednesday, the selling moved to the “safe stocks” as well. On the close of trade on Thursday, my stop was tripped and we sold half our position on Friday morning. Clearly, selling could prove to be a mistake. Trust me, there will be plenty of mistakes in times like this.

That said, there will also be plenty of opportunities to be a hero. While things currently look dire in the market because of this extreme volatility, opportunities are becoming more and more prevalent, and there will be home runs. The current market selloff looks very similar to the market environment that opened up great trades in August and September in Starbucks (SBUX) Activision Blizzard (ATVI) and Adobe Systems (ADBE), and I’ll be looking for those types of new leaders in the days and weeks to come.


This is an excerpt from Cabot Options Trader, which features the most profitable investment strategies in any market. It’s your guide to quick profits using puts, calls, spreads, straddles, iron condors and other options trades. Analyst Jacob Mintz explains and recommends diverse investing strategies for big gains with controlled risk.

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