Options Market Update February 15, 2016

 
The market looked to be on the verge of a major breakdown on Thursday, as the S&P 500 again tested the January lows. However, with the aid of a well-timed oil-related rumor, the market was able to stabilize on Thursday afternoon, and finish the week with an impressive Friday rally of 2%. For the week, the S&P 500 lost 0.81%, the Dow fell by 1.43%, and the Nasdaq dropped 0.59%.

For the bulls, the action on Thursday was extremely concerning as the S&P 500 was again testing the January lows and had closed down for five straight days. However, led by the beaten down financials and oil stocks on Friday, the three major indexes exploded higher into the three day weekend. Oil’s 12% rally was probably started by another rumor of potential output cuts from OPEC. The financials rise was likely aided by oil’s rally, JPMorgan (JPM) CEO Jamie Dimon’s purchase of $26 million of his company’s stock, and Deutsche Bank’s (DB) $5.4 billion debt buyback plan.

For the bears, while Friday’s rally was not ideal, the trend in the market continues lower. And while Friday’s rally was sharp, the bears would point out that some of the market’s largest rallies have been during bear markets. Also, the odds of a global and U.S. recession continue to tick higher as economic data weakens. In response, the yield on Japanese 10-year bonds fell into negative territory for the first time ever. There’s also rising consensus that there may not be any more interest rate hikes in the U.S. this year, and there’s the potential for U.S. interest rates to go negative as well.

Volatility


The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 25.40, higher by 8.5% for the week. At the market lows of the week, the VIX again traded just below 30 as traders raced for puts/protection.

The VIX at 25 is without question a historically elevated level. However, in light of the recent volatility in the market and dire predictions for a global recession, buying puts/volatility against a portfolio seems to be a prudent tool even at these levels.

Events for the Week to Come

Please note the market is closed today in celebration of Presidents Day.

As earnings season begins to wind down, the focus of trader’s attention this week will be on Federal Reserve member speeches. With weakened economic data in the U.S. and around the world, and interest rates negative in a few countries, traders are again becoming fixated on the potential for U.S. interest rate hikes or even cuts.

According to Bloomberg, “at one point Thursday, the market was pricing in an 8% chance that the Fed will lower rates by the end of 2016, compared with a 4% chance it will raise them.” This is a shocking change from what was expected to be four rate hikes in 2016. And because of the deterioration in the markets, as well as economic data, traders will be closely listening for hints from the various Fed speakers this week.

What Traders are Saying


As I’ve noted recently, it will be impossible to pick the absolute bottom in this recent market correction. Cabot Emerging Markets Investor Chief Analyst Paul Goodwin recently wrote about trying to call a bottom in a Cabot Wealth Advisory called The Gold Star and the Falling Knife. Paul wrote, “My favorite maxim about trying to predict a market bottom is this: “If you think it’s a bottom, you’re too early; if you know it’s a bottom, you’re too late.” Paul’s then went on to say “Translated, that means: Don’t look for market bottoms in your windshield; they only show up in your rear view mirror.”

Perhaps the bottom was on January 20 when the S&P 500 traded as low as 1,812. Or perhaps it was this past Thursday when the market very briefly traded as low as 1,810. Or perhaps we are on the verge of a much greater correction. Only time will tell—and I’m not making any predictions. That said, there were some trades made on Thursday that brought me back to my time on the trading floor during the financial crisis.

In the “third inning” of the financial crisis, I was making markets in Lehman Brothers on the floor of the Chicago Board of Options Exchange. At the time, the stock was trading around 50, and big traders starting buying doomsday puts—aggressively buying the 20- and 15-strike puts. I couldn’t sell them fast enough as the possibility of the stock falling that far was inconceivable. We now know it was a possibility, and became a reality. So when a trader bought 10,000 Bank of America (BAC) January 5 Puts (exp. 2017) on Thursday, my radar certainly went up. I’m not predicting another financial crisis, but I will be keeping an eye on such extreme put buying.


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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