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Market Update 09/29/2024
It is popular to criticize the Federal Reserve and other central banks. We hear it constantly: The Fed is behind the curve; The Fed is causing bubbles and crashes; The Fed is political; The Fed only reacts, not anticipates; The Fed prints too much money… Yes, sometimes it is true. But for once, I would like to thank them for doing a masterful job of fighting inflation without causing a severe recession. Raising rates steadily from zero to over 5% caused inflation to decrease from 9% to almost average (2%). And there is no recession yet.
Inflation was caused by our government’s and the governments around the world’s overreaction to COVID by printing way too much money to keep the economies functioning. The supply chain disruptions didn’t help either. It takes time for all those trillions of dollars to slash through the economy. It seems to me that the inflation story is nearly over. Yes, it will pop up here and there in the future, but overall, I no longer view it as a systemic risk.
The Fed Funds rate usually follows the Two-Year Note. The 2-Year is yielding 3.6%, while the Fund Rate is right under 5%. This is a big difference. That is why the Fed Funds Futures project at least a 0.75% cut by the Fed over the next three meetings. The main story is to keep the economy away from recession. We are no longer fighting inflation.
It is not just about the short-term rates. The longer-term maturities are expected to come down as well. Take a look at the 10-Year Note Futures Commitment of Traders report. The commercial traders (bankers in this case) are heavily long. In fact, they are as bullish as I have seen in many years.
TLT (20-Year Treasury ETF) has been in a steady uptrend—two steps forward, one step back. I expect this trend to continue.
The support area is between 96 and 97.50. The 50-day moving average and a prior low are in this area. I expect it to hold and serve as a launching pad to the new trend highs.
TRADE:
I will be shopping for TLT January 98 Calls at 3.40 or lower.
Some important economic reports this week, including the always-important non-farm payroll, will undoubtedly create volatility in the markets, which should allow us to scale into this position.
A few words about the stock market:
Even though the market is slightly overbought, all the charts and breadth indicators remain positive. There is one warning sign, however: last week, SPY was up, and so was VIX. This rarely happens. Just about every time it happens, the market suffers at least a short-term pullback. This is not necessarily a sell signal. This is a caution: do not be too greedy on the long side at the wrong time.
We are long USO call spreads. I remain very constructive on Crude Oil and Energy stocks.
We are long puts on SPY and VXX as a pair trade. Either the market will pull back, or the volatility will collapse.
Dennis Leontyev
@TraderLeontyev
Market Update 09/22/2024
The stock market had a nice rally over the last two weeks. It started as anticipation of FED’s rate cut and then a confirmation of a 50-basis point reduction. In other words, the market got what it wanted and then some.
From a technical standpoint, the charts keep looking bullish. Conventional technicals confirm the up trend and they are getting just slightly overbought. Internal indicators show broad participation where most of the sectors are advancing, which is much better than narrow-based rallies we had in the past driven by a handful of tech and AI stocks. Bear markets don’t start like that. We are still in a bull market, but a short-term seasonality is rather negative and there is nothing to get too excited about. The end of September and early October historically bring some volatility.
Thus far, traders haven’t shown any concerns about the elections, but this day is getting closer. Elections is uncertainty, which will prevent the market to pick a trend. It is not a reason to sell off. We may settle into some sort of a range where arbitrage is the way to pay my bills.
As traders we rarely make a killing. Most of the time we have to make a living. So, let’s pay those bills.
As the chart below illustrates, VIX is trading at 16.15. Meanwhile the futures are in a flat contango, where the October contract is at 17.90 or about 10% premium to cash. This is normal, considering three to four weeks till expiration. As we know, VXX (VIX short-term futures ETN) is constantly losing value as long as the futures are in contango (futures are higher than cash). So, for example, if VIX stays at the same level by October expiration, the October futures contract will fall 10% just to catch up with the VIX on the downside, which in turn means that there will be a lot of downside pressure on VXX.
The following chart of VVIX (VIX of VIX) illustrates that the options on volatility products are not that expensive. VVIX has been declining.
The reason I’m analyzing the market and its volatility is because I have a trade in mind where we can set up a market neutral options pair trade. The thinking is that either the market will have a meaning pull back / correction or the volatility (VIX and its derivatives) will decline. After all, VIX has a 72% negative correlation to the S&P.
Therefore I would like to buy the October puts on both SPY and VXX.
SPY October 570 Puts are trading just under $8.00
VXX October 47 Puts are trading under $3.00
BUY 3 VXX puts and simultaneously BUY 1 SPY put.
Treat it as one trade (get in at the same time and exit at the same time). Most likely one will make money while the other one will lose. We don’t care which one. The idea is for the winning one to outperform the losses on the other.
Open Trade update:
If you are long a USO call spread from our last recommendation a week ago, consider taking a profit if USO gets to the 75 area.
Dennis Leontyev
@TraderLeontyev
Market Update 09/15/2024
While the stock market awaits the Fed decision next week, I would like to analyze important commodity markets in this report. Let’s concentrate on Crude Oil and Gold.
Crude Oil
The chart below illustrates a wide range over the last two years, with a support zone in the mid-60s and a resistance zone in the mid-90s. The latest decline took crude oil to the support zone just above 65. Note the MACD indicator at the bottom of the chart; every time it reached current levels, it produced short-term or intermediate-term bottoms. The RSI indicator (top of the chart) also became oversold.
Implied volatility analysis shows that options on USO (US Oil Fund ETF) are relatively expensive. Spikes in implied vol are usually associated with reversals.
Most importantly, the commitment of trades report (COT) should be examined. Those reports are helpful when they show extremes. The red line at the bottom of the chart shows how commercial traders (smart money) are positioned. The green line indicates other traders. As you can see, every time commercial traders’ positions were at the current levels, Crude Oil bottomed out. This is not a short-term indicator, but I view it as a condition indicator.
Gasoline COT positioning confirms the same view. The chart below (10-year history) shows the same extremes in Gasoline.
A combination of the short-term technical picture and COT’s intermediate-term position paints a bullish picture for the commodity. I believe Crude Oil is beginning a bottoming process. The latest correction is primarily based on fears of a recession leading to lower demand. Concern is certainly warranted, but I believe any further decline will prompt production cuts, which will propel Crude Oil a lot higher. Right now, my expectation is for prices to stabilize and then head to the 75 – 80 area at minimum.
Options Trade:
As I mentioned, the options on USO are a bit expensive. Instead of buying a call option, I prefer to buy a call spread. Let’s give ourselves four months, which means the January options will do the trick. USO closed at 69.84.
BUY January USO 68 Call
Sell January USO 78 Call
Try to buy the spread for 4.20 or lower (it is a $10 spread). Risk $420. Max reward $580. If USO declines first, cover the short option for a profit and keep the long option.
GOLD
I remain a long-term gold bull. I’m long GLD and GDX. However, there is a canary in a coal mine. The commitment of traders’ report is flashing a warning sign. Commercial traders’ positions vs. other traders’ positions are becoming too lopsided.
Every time it happened, gold found either a short-term or intermediate-term top. I will keep my long positions, but some hedging is in order. Any further strength in gold next week will prompt me to sell covered calls. Let’s not get too greedy.
Dennis Leontyev
@TraderLeontyev
https://www.linkedin.com/in/dennis-leontyev-457a4a32