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Market Update 11/29/2024
Happy Thanksgiving Everybody!
The stock market keeps going higher and let’s be thankful for that (unless you are short). Technical indicators continue to be solid, but a bit overbought short-term. Sentiment is getting a bit exuberant, but it is kind of obvious, because the market rarely declines in November and December.
Here is one little long-term concern: The following chart is the ratio of S&P 500 index Vs. Equal weight S&P 500.
When the market advance gets too selected, it warrants paying attention. I’m afraid we will run into some problems next year. What can cause it? Three things:
- Simple overvaluation. It is not a market timing tool, but eventually it starts to matter. That is why Mr. Buffet is holding a record cash level in his portfolio.
- Reduced government spending. They are badly needed to reduce our huge debt, but they will cause substantial layoffs and restructuring, which in turn may cause an economic slowdown as a side effect.
- They are designed to boost domestic manufacturing, which I agree with, but they may cause inflationary pressures and some supply disruptions.
Let’s keep an eye on those developments early next year.
Meanwhile, the next few weeks should be ok, which may include minor selloffs and pull backs, which I expect to be bought.
One sector that caught my eye lately is Semiconductors. See the chart below:
It has been struggling lately. Right now it is sitting at the 200-day moving average. Note the last two times it got there, it served as a launching pad for strong rallies. I think this time will be no different. There is nothing to worry about from the fundamental standpoint yet, and technicals are telling us that we are a support level.
Let’s buy some calls:
SMH January 240 Calls (slightly in the money) can be bought below 12.
I expect SMH to at least bounce to the next resistance level around 263. If it does, these calls will double.
I think it is a gift.
@TraderLeontyev
Market Update 11/02/2024
The only certainty is volatility. This week is all about the Nov. 5 U.S. presidential election and the Federal Reserve policy decision on Nov. 7. In other words, the market will move all over the place. It is hard to predict what the market is going to do, but my sense is it is going to find a bottom at lower levels IF there is no disputed elections. Go out and vote! Let’s get a clear winner and move on!
Here is a 30-minute chart of SPY over the last 5 weeks. There is clear resistance at 574-575 zone.
We are long SPY puts. We took a profit on half of the position and will be looking for an exit depending on the action over the next couple of days.
The following chart is VXX, which tracks VIX futures. Currently the implied volatility (VIX) is a lot higher than the real volatility. This is called volatility premium. The premium is huge, which is understandable considering the election uncertainty.
VXX will move! It is probably going to move down after the dust settles, but the better strategy it to buy strangles. November 15TH 50 puts are trading just above $1.00, which is really cheap. Meanwhile, 65 calls are trading at $2.50, which is expensive, but I would like to own them as well.
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MARKET NEUTRAL TRADE:
Any market-neutral strategy aims to find highly correlated securities and act upon their convergence or divergence. It is evident that securities in the same sector (energy, interest rates, indexes…) have similar chart patterns. If the sector rallies, while most of its components go up, some securities go up more and some less. The same is true during declines. In other words, there is usually a price correlation between securities in the same or different sectors. Implementing the strategy means finding a pair of markets, which are correlated on a long, medium and short-term basis (depending on profit objectives and risk tolerance), and buying (going long) one market and simultaneously selling short another.
The strategy is called long/short or pairs trading. Sometimes, it is referred to as statistical arbitrage.
Our trade idea is to pair Gold (GLD) with the gold stocks ETF.
We are interested in their relative performance. The chart below shows how GDX and GLD performed against each other. It is the ratio between the two, created by simply dividing GDX by GLD.
GDX is trading at 39.85
GLD is trading at 252.50
39.85 divided by 252.50 = 0.158
That is what the following chart shows:
When this ratio goes up, GDX outperforms GLD regardless of the direction. In other words, I would like to bet that the ratio will advance. It can be accomplished by buying GDX and selling short GLD. It must be done in a dollar-neutral manner, meaning that for every GDX share we buy, we short 0.158 shares of GLD (you can round it up to 1X2).
This is a typical hedge fund pairs trade. Please don’t confuse it with me being bearish Gold and bullish Gold Stocks. All we care about is the rate of change. This ratio has been in a perfect range. My bet is this is going to continue.
@TraderLeontyev
Market Update 10/20/2024
Hedge funds have existed for over 70 years. It all started after WW2 when traders figured out that instead of buying stocks or commodities or shorting them, they could pair one security against another, therefore creating a market-neutral trade.
Any market-neutral strategy aims to find highly correlated securities and act upon their convergence or divergence. It is evident that securities in the same sector (energy, interest rates, indexes…) have similar chart patterns. If the sector rallies, while most of its components go up, some securities go up more and some less. The same is true during declines. In other words, there is usually a price correlation between securities in the same or different sectors. Implementing the strategy means finding a pair of markets, which are correlated on a long, medium and short-term basis (depending on profit objectives and risk tolerance), and buying (going long) one market and simultaneously selling short another.
The strategy is called long/short or pairs trading. Sometimes, it is referred to as statistical arbitrage.
In today’s report, I would like to compare two sectors and pair them against each other.
The first one is XLF (Financial Sector ETF). It has been having a wonderful year, as you can see on the year-to-date chart below. It has had a nice rally with occasional pullbacks, but now it is getting a bit overdone.
Another sector I’m exploring is XLE (Energy Sector). The chart below shows an impressive rally into April, followed by a multi-month corrective activity and range trading. However, it still looks bullish. It just underperformed the market over the last few months.
We are interested in their relative performance. The chart below shows how XLE and XLF performed against each other. It is the ratio between the two, created by simply dividing XLE by XLF.
XLE is trading at 90.34
XLF is trading at 47.62
90.34 divided by 47.62 = 1.90
When this ratio goes up, XLE outperforms XLF regardless of the direction. XLE was much stronger earlier this year but has lagged the financials over the last several months. At this point, I believe the energy sector will start doing better than the financial sector. In other words, I would like to bet that the ratio will advance. It can be accomplished by buying XLE and selling short XLF. It must be done in a dollar-neutral manner, meaning that for every XLE share we buy, we short 1.9 shares of XLF (you can round it up to 1X2).
This is a typical hedge fund pairs trade. Please don’t confuse it with me being bearish Financials and bullish XLE. If the market keeps going up, both sectors will probably advance. If the market goes down, both sectors will probably decline. All we care about is the rate of change. I think the XLF is a little tired, while XLE is under-owned by Wall Street. I would also consider using options on the trade, like buying XLE calls and selling XLF calls, but for now, let’s keep it relatively simple. For example, if the ratio advances from 1.9 to 2.1, it will represent a return close to 10%. More trades like this are to come.
@TraderLeontyev
Market Update 10/14/2024
I’m not going to sugar code it: What the hell is going on? I have back tested it, and it has never happened before. I have been trading volatility all my life. Look at those charts.
The stock market is doing just fine, trading at all-time highs and the VIX is in backwardation.
Backwardation is when futures on any underlying security is above its spot (cash). Contango is the exact opposite of that. VIX futures spend most of the time in contango. Backwardation usually occurs during bear markets or corrections.
There are two possible explanations:
- Elections are coming up. OK. Not the first elections ever. We have presidential elections every four years, and the VIX behaved in a normal manner. Why now? While the two candidates have different economic policies, their policies are equally bad. Trump’s tariffs ideas are inflationary, and Harris’s policies are restrictive. And none of them even mention the budget deficits. Nobody will ever address the budget deficits because in order to tackle this problem, you have to cut spending and raise taxes. Both will cause an economic slowdown, which will never get you reelected.
- Israel – Iran conflict, which can potentially turn into an outright war. Potentially scary.
So why are the derivatives traders are concerned and the equity traders are not? Well, one group is wrong. Which one? I’m afraid that the equity traders are a bit too optimistic.
The stock traders like to follow a trend. As long as there is an uptrend, they keep buying. The derivatives traders don’t think like that. They actually think of different scenarios and think of potential risks. I trust them more.
I bought some November SPY puts and now I would like to buy some longer-term puts. Let’s find at-the-money March puts just in case. Something is not right around here.
I’m travelling. This is a short update. More to come in a couple of days when I get back.
@TraderLeontyev
Market Update 10/07/2024
The stock market has been quiet lately. Despite multiple economic reports, the war in Israel, hurricanes, elections, interest rate policy changes, the market is sitting at all time highs. So far, every little pull back is being bought. One major concern is VIX. While the market is not doing much, the VIX is going straight up. That never ends well. Implied volatility is considerably higher than historical (real) volatility. The month of October is known for surprises and emotional movements. I will be surprised if the market doesn’t move soon. I’m afraid the move will be down. It may be a short-term affair, but I think the VIX is telling us the move down is unavoidable.
The chart above is SPY. There is a minor divergence on the RSI indicator. Meanwhile the chart below is VIX. It went from 15 to 23 without any market movement. This is bazaar.
Let’s buy SPY November 570 Puts just in case.
It could act as a hedge to your portfolio or a small speculative position. The initial target is the 50-day moving average on SPY.
As you probably noticed, the crude oil went straight up last week. The move has lifted all the energy related ETFs and most energy stocks. A couple of stocks caught my attention – they are OXY (Occidental Petroleum) and HAL (Halliburton). Those two stocks have been in a doghouse for a long time. The charts below look very similar, both showing a clear bottoming pattern with divergencies on RSI and MACD followed by an impressive lift off on expanding volume.
I want to own these companies. I believe this is the beginning of a longer-term advance for both of them. The first target is their respective 200-day moving averages. Depending on your approach to trading you can either buy those two stocks outright at current prices or sell naked slightly out-of-the-money puts on them about a month out. As I always say, selling naked puts is a horrible idea if you are not prepared to own an underlying security, but it is a wonderful idea if you want to on them. I do want to on them, therefore I’m selling puts. Either they go up and I get paid because those puts will expire worthless, or those stocks will be put to me at lower prices if they experience a pullback. I will be happy either way.
Last week we made a nice profit on USO call spread.
Dennis Leontyev
@TraderLeontyev
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
