Options Market Update: Short-Term Bullish

 
The snapback rally that began after the most recent disappointing Jobs Report continued, and the S&P 500 posted its strongest weekly gain of the year. For the week, the S&P 500 gained 3.26%, the Dow added 3.72% and the Nasdaq rose by 2.61%.

For the bulls, the S&P 500 is up 5% since the start of the new quarter, has advanced in eight of the last nine trading days, and has recovered nearly 8% since the August bottom. Fueling this advance is the continued belief that the first rate hike will be pushed back, as the market now sees a 39% chance of a rate hike in December and a 62% probability by March.

For the bears, it was a disheartening week as the market exploded higher from recent lows. However, many bears would point out that the recent rally was led by the “dogs” of the market, such as commodities and stocks with the highest short interest. The Federal Reserve continues to send mixed messages about the economy, and the future of interest rate hikes will likely continue to create concerning volatility in the bond and stock markets.

Volatility

The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 17.08, or lower by 19% for the week. This was the lowest level for the “fear index” since August 19, and the ninth straight day of declines—the longest such streak in more than four years.  

We may soon add a long volatility trade or a put purchase to our portfolio. While I’m not necessarily bearish on the market, such a hedge in our portfolio will allow me to add more bullish trades to our portfolio if the market continues to strengthen.

Events for the Week to Come


The market could be quiet today as the banks and the bond market are closed for Columbus Day.
This week is light on economic data, but full of Federal Reserve Member speeches and earnings announcements. Most of the major banks will be reporting earnings this week, and so will a handful of technology companies including Netflix.

As I do every earnings season, I’ll write to you with my thoughts on the major companies reporting earnings each day, and give a more detailed look at the major holdings of Cabot subscribers. If you have additional questions about stocks that I have not addressed, don’t hesitate to send me an email (jacob@cabot.net).

What Traders are Saying

The market’s explosion higher over the last eight trading days has been impressive. I was not bearish on the lows, but I was also not adding new bullish positions either. With the benefit of hindsight, of course, we should have added many new positions at the lows. But I’m not upset with myself because we didn’t sell out of any positions and didn’t go short.  

As I wrote amid the market selloff, I thought there was a chance that the market would take off. Many traders and hedge funds had either liquidated large portions of their portfolios or had gone short, fearing a major market rout. However, once the momentum turned, there was a great race to get back into the market—the fear of missing out can be a powerful force, especially when so many investors are short or underinvested.

It will be interesting to see how the market trades in the weeks to come. On the one hand, clearly market momentum is bullish in the short term. On the other hand, there could be a great deal of supply/sellers waiting to take profits or exit positions that they didn’t liquidate before the August selloff. It will also be interesting to see how commodity-related stocks trade, as many have gained 20% to 30% in just over a week.


Stock Picks

Tesla Motors

If Tesla ever begins to cut back on development and innovation costs, earnings will soar.

Alibaba

China seems to be raising up its very own version of Amazon in Alibaba (BABA.

Facebook

Roy Ward uses the PEG ratio to determine if the stock is undervalued or overvalued.

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