There is a lot of speculation about the future course of small-cap stocks.  Of late, small-cap stocks have been lagging large-cap stocks and the broad market overall.

As you can see in Figure 1 below, while large-cap stocks (Top clip: Russell 1000, ticker RUI) recently touched a new all-time high, small-cap stocks (Bottom clip: Russell 2000, ticker RUT) have come nowhere close.  In fact, small-cap stocks have only retraced about 50% of the Aug-Dec 2018 decline.

Figure 1 – Large-cap stocks (RUI, top clip) versus small-cap stocks (RUT, bottom clip); 1989-2019 (Courtesy ProfitSource by HUBB)

This of course leads to a lot of prognosticating about “what’s next” for small-cap stocks.  One school of thought thinks small-cap stocks offer the best bargain right now, while the other school of thought claims that the weakness in small-caps is a sign of something worse for the overall market.

My “forecast”?  I don’t really claim to have one.  But I do follow a bit of market history.  And while history is by no means always an accurate guide, it can give clues.  These clues can be useful since a big part of investing success is putting the odds on your side as much as possible.

For what it is worth, history presently suggests that the odds may not favor an emphasis on small-cap stocks at the moment.

SSSSS

SSSSS is a little known (primarily because I just made it up) acronym for Smallcaps Seasonally Suck in Summer Syndrome.  To wit:  Figure 2 displays the cumulative % price gain for RUI (blue line) and RUT (red line) ONLY from the end of June through the close of the 6^th trading day of August every year since 1989

Figure 2 – Cumulative price % +(-) for Large-cap (blue) and Small-Cap (red) indexes from end of June through August Trading Day #6, 1989-2018

Figure 3 contains a few key pieces of info.

Figure 3 – Relevant Data; End of June through August Trading Day #6; 1989-2018

One thing that is important to note is that the implication is NOT that small-cap stocks are doomed to decline between now and early August.  For the record, RUT has showed a gain 52% of the time and a loss only 48% of the time during this period.  However, the average gain was +7.4% while the average loss was -9.5%.

The other key point to note is that large-caps have outperformed small-caps 68% of the time during (21 out of 31 years) this period since 1989.

Summary

The reality is that none of the above information should be construed to imply that large-cap stocks will do well and/or better than small-cap stocks and that small-cap stocks will lose between now and early August.

But, if one had to bet based on the historical odds, small-cap enthusiasts might consider containing their enthusiasm for just a bit longer.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Sometimes “all the pieces fall in place.”  Of course – and unfortunately – even then a profit is never guaranteed.  That is why the keys to long-term success are:

*Putting the odds in your favor on a regular basis

*Managing risk

Consider the biotech sector.  As you can see in Figure 1, the Elliott Wave count for ticker XBI is bullish.Figure 1 – Biotech seasonality is favorable (Courtesy Sentimentrader.com)

As you can see in Figure 2, right now is the beginning of a seasonally favorable time of year for the biotech sector. Figure 2 – XBI with bullish Elliott Wave count (Courtesy ProfitSource by HUBB)

In Figure 3, we see that the implied volatility on options for XBI are neither extremely high nor extremely low.Figure 3 – XBI with implied options volatility (Courtesy www.OptionsAnalysis.com)

When we put all of this together, we can make a case for a bullish trade in XBI.

Given the bullish Elliott Wave count, one possibility would be to buy a call option in hopes of maximizing profitability if the ETF does in fact soar to higher ground.  However, given, a) that options are not “cheap” (i.e., implied volatility is not extremely low) and, b) that Elliott Wave projections that call for large gains in a short period of time tend to be less reliable than projections that call for decent gains over a longer period of time, we will opt for a different approach.

A Bull Put Spread

What follows is NOT a “recommendation”, only an “example”.

The trade in Figures 4 and 5 is referred to as a “Bull Put Spread” because it is a position that profits from a bullish move (or at least NOT a bearish move by XBI) and uses put options.

The trade involves:

*Selling 1 XBI Aug16 79 put @ $1.50

*Buying 1 XBI Aug 16 77 put @ $1.10

Figure 4 – XBI bull put spread details (Courtesy www.OptionsAnalysis.com)

Figure 5 – XBI bull put spread risk curves (Courtesy www.OptionsAnalysis.com)

Note:

*The maximum profit on a 1-lot is $40

*The maximum risk is -$160

*The breakeven price at expiration is $78.60

*XBI is presently trading at $85.04

*The most recent low for XBI was $79.31

In a nutshell, the breakeven price for this trade is below the recent low of $79.31.  This means we don’t need to worry about stopping ourselves out if XBI merely comes down and tests support at $79.31.  We can set a stop-loss point somewhere near the breakeven price of $78.60 lower.

A trader might consider exiting the trade with a profit, if 80% of the premium is captured prior to expiration (i.e., if the spread can be bought back at $0.08 or less).

In Figure 6 we zoom in to find that if we place a stop-loss around $78 a share for XBI, the expected loss on our trade would be -$57.

Figure 6 – If XBI declines below support, stop-loss action may be necessary and may be able to limit loss to a reasonable amount (Courtesy www.OptionsAnalysis.com)

Summary

As always, I am not “recommending” the trade highlighted here.  It is presented simply as an “example” of a situation where all the pieces come together to create a potential trading opportunity.  In this example:

*Seasonal trends are favorable

*Price trends (based on Elliott Wave) may be favorable

*An option trade can be entered that may be profitable if XBI does anything besides drop a little over 8% in the next 50 days.

*The position has the “odds in its favor” and we have a plan to manage risk.

The reality is that XBI could fall apart quickly and this trade could turn into a quick loss (and the trader MUST be prepared to act to cut their loss in that event).  But under any other circumstance, a profit is a possibility.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Right off the bat, please notice that the headline reads “Summer Rally Zone” and NOT “Summer Rally”.  I don’t have crystal ball (I used to, or so I thought.  And believe me, in my youth I spent a lot of time staring into that da#$ thing before I realized it was broken) and cannot predict how things will work out “this time around.”  But I can state categorically that we are about to enter in “the zone”.

The Summer Rally Zone

Historically, the SRZ (at least as I see it) encompasses:

*the last 3 trading days of June and

*the first 9 trading days of July.

Figure 1 displays the growth of $1,000 invested in the S&P 500 Index ONLY during these 12 days every year starting in 1928.

Figure 1 – Growth of $!,000 in SPX during the Summer Rally Zone

The good news is that there is a clear long-term upside bias.  The bad news is that there is no real way to know if the Summer Rally Zone will see SPX post a gain “this time.”

Figure 2 displays the year-by-year % +(-) in column form.

Figure 2 – SPX in the Summer Rally Zone year-by-year (1928-2018)

For the record:

*# times SRZ UP = 62 (68%)

*# times SRZ DOWN = 28 (31%)

*# times unchanged = 1

*Average UP SRZ% = +3.0%

*Average DOWN SRZ % = (-1.9%)

*Largest UP = +8.8% (1932 and 1933)

*Largest DOWN = (-6.9%) (2002)

So statistically speaking, we have a win/loss ratio of 2.21-to-1 and a winner to loser ratio of 1.57.

Statistically these are good numbers.  But they certainly do NOT represent any kind of sure thing.

Summary

In 2019, the SRZ begins at the close on 6/25 and extends through the close on Friday 7/12.

If you are otherwise bullish on the market, this history suggests that now may be a good time to press your advantage.  Just don’t construe that as some sort of “prediction” on my part.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article I wrote about a simple trade using options on ticker GDX to alleviate “gold angst”.  For just a “few dollars” a trader could guarantee participation in the much anticipated “gold is about to soar” prognostications that seemed to be prevalent at the time.  And with over a year and half for things to work out.

Well, lo and behold, things worked out!  As you can see in Figure 1, GDX burst higher – rising 14% in just 8 trading days.Figure 1 – GDX shots higher (Courtesy ProfitSource by HUBB)

In Figure 2 we can see that the initial trade now has an open profit of +66.7%.

Figure 2 – Initial GDX call options position (Courtesy www.OptionsAnalysis.com)

This is great!  Except, now we have a new kind of “angst”.  Does one “let it ride”?  Or is it time to “take some chips off the table?”

In Figure 3 we are hit with the sober reality that – despite the nice rally – there is a lot of potential overhead resistance, so the idea of “ringing the cash register” is tempting.

Figure 3 – Potential overhead resistance for GDX (Courtesy AIQ TradingExpert)

The good news is that option trading offers a lot of possibilities.  The bad news is that there are no “right” or “wrong” answers.  A trader must simply decide where their priorities lie and craft a position to fit those priorities.

#1. Let it Ride

This one is simple.  It involves doing nothing.  The option doesn’t expire until January of 2021 so there is plenty of time for “the big move” to unfold.  Assuming of course that your priority is making as much money as possible from the big move.  In Figure 2 note that this position has

Delta=74.21

Gamma=3.367

Vega=$9.98

This means that if GDX keeps rising, this position – which is currently roughly equivalent to holding 74 shares of GDX – will gain $74.21 for each $1 GDX rises AND that delta value will increase by 3.367 for each $1 GDX rises in price. Likewise, if implied volatility rises by 1 percentage point this trade will tack on another $9.98 in profit.

Bottom line: this trade exudes profit potential.  The bad new is that the option could also still expire worthless resulting in a 100% loss of investment.

#2. Take the Money and Move On

This involves simply selling the call, taking the profit and moving on to something else.  The good news is you will have made money and there is no chance of giving it back.  The bad news is that you may once again experience the “gold angst” the prompted this trade in the first place – if gold and gold stocks continue to rally.

#3. Play for a Pause

For a trader who:

a) wants to retain a bullish position

b) doesn’t want to end up with a loss after registering such a quick profit and/or

c) is concerned about all that overhead resistance

…one possibility might be to “adjust” the trade by selling an out-of-the-money call.

Such a trade appears in Figure 4.  This trade involves selling one Jan2021 27 strike price call for $3.52 (the midpoint of the bid/ask spread).Figure 4 – Adjusted position in GDX (Courtesy www.OptionsAnalysis.com)

As you can see in Figure 4 there is good news and bad news.  The good news is that this adjusted position cannot turn into a losing trade if GDX subsequently falls apart.  The bad news is that it has a lot less upside potential than the original position (Delta=20, Gamma=-.45, Vega=-$2.66).

A trader choosing this approach might be looking for a pullback in GDX and for an opportunity to buy back the 27-strike price call at a lower price in order to generate an interim profit and to re-establish the naked long call position.

Another possibility is “rolling up”, which means selling the 22-strike price call and buying one at a higher strike price at a lower cost.  The purpose of this adjustment is to “lock in a profit” while still retaining a bullish position.  Unfortunately, at the moment, with GDX at $26.16 a share , a trader who sold the 22 call with a profit of $232 would have to go up to about the 31 strike using the Jan 2021 calls (currently at $2.16 bid/$2.42 ask) in order to lock in a net profit.  One can do this, but it involves buying a call option that is presently 18% out-of-the-money.

Summary

Jay’s Trading Maxim #45: The good news about option trading is the same as the bad news about option trading.  The good news is that there are so many choices.  The bad news is that there are so many choices.  This is why traders who are successful using options are those who:

*Decide what their priorities are

*Craft a position that plays to their priorities

*Simply “deal with it” when things don’t work out (i.e., they don’t kick themselves or second guess)

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The U.S. stock market has in recent years enjoyed an incredible bull run.  In the process it has left the rest of the world(‘s stock markets) in the dust.  And as usual, the longer any trend persists the more investors en masse take it for granted that it will go on forever.  As a result, it is pretty hard for investors to get excited about international stock market exposure.

Given the trend over the past decade, this is perfectly understandable.  And probably a mistake.  Because nothing lasts forever in the financial markets (except of course for the aforementioned tendency for investors to extrapolate a trend).

Figure 1 displays the cumulative growth of a $1,000 investment in the S&P 500 stock index (SPX) and the MSCI EAFE Index (EAFE) since the end of 1972.  Through 1990 the EAFE outperformed, then the SPX charged into the lead.  By the bottom of the 2008-2009 bear market the gap had narrowed.  Since then the SPX has vastly outperformed.

Figure 1 – Growth of $1,000 in SPX vs. EAFE; 12/31/1972-5/31/2019

Most investors look at Figure 1 and immediately conclude that U.S. stocks are “better”, despite the “ying” and “yang” that actually took place.  Figure 2 displays the rolling 5-year return for both indexes.  

Figure 2 – Rolling 5-yr. returns for SPX and EAFE

Figure 3 displays the net difference between the two.  When Figure 3 is positive, EAFE outperformed over the previous 5 years and when it is negative SPX outperformed.

Figure 3 – EAFE 5-yr return minus SPX 5-year return

The only real useful conclusion one can reach from Figures 2 and 3 is that sometimes EAFE leads and sometimes SPX leads.  There is no permanent advantage in one over the other.

Figure 4 displays the ratio of EAFE divided by SPX along with a 10-month exponential moving average (technical note: the ratio tracked is the ratio of the cumulative growth of $1,000 in EAFE divided by the cumulative growth of $1,000 in SPX and NOT the price of EAFE/the price of SPX).

Figure 4 – EAFE cumulative return divided by SPX cumulative return; 1972-May-2019

Figure 5 displays the ratio in Figure 4 minus the moving average in Figure 4.  Positive readings favor EAFE, negative readings favor SPX.

Figure 5 – EAFE/SPX ratio minus 10-month EMA of the ratio; 1972-May-2019

Trading Rules

Because we are using total monthly return data, and because that data is typically not available until sometime during the next month, we will use a one-month lag in terms of generating signals.  So here are the rules:

*Indicator = Latest EAFE/SPX ratio minus 10-month EMA of EAFE/SPX ratio

We start with $1,000 on 12/31/1972

*If Indicator rises above 0, sell SPX and buy EAFE

*If Indicator falls below 0, sell EAFE and buy SPX

Example: So let’s say we get total return data for May on the 5th of June.  And let’s say that when we do the update for May we find that the Indicator went from negative to positive. Then at the end of June we will sell SPX and buy EAFE.

SPX/EAFE “Switch” Index is traded using the rules above

As a benchmark we will use the following:

*SPX vs. EAFE “Split” Index = Start with $1,000 on 12/31/1972.  At the start of each year, the portfolio is rebalanced to a 50/50 split between SPX and EAFE.

Figure 6 displays the cumulative growth of both the “Switch” Index and the “Split” Index.

Figure 6 – Cumulative growth of $1,000 invested using “Switch” strategy (blue) versus the “Split” strategy (orange)

For the record:

*The “Switch” strategy grew +22,719%

*The “Split” strategy grew +6,350%

As with anything in the financial markets, it is not like the “Switch” strategy always outperformed the “Split” strategy.  But the long-term trend is pretty clear.  Figure 7 displays the cumulative “Switch” strategy divided by the cumulative “Split” strategy.

Figure 7 – “Switch” strategy cumulative return divided by “Split” strategy cumulative return

When the line in Figure 7 is rising it means the “Switch” strategy is outperforming the “Split” strategy.  As you can see, there are times when the line dips or moves sideways.  But again, the long-term trend is unmistakable – over time, switching makes more than splitting.

The Long-Term Picture

Figure 8 displays the rolling-5 yr. return for the “Switch” strategy (blue) and the “Split” strategy (orange).

Figure 8 – “Switch” strategy 5-yr return (blue) versus “Split” strategy 5-yr return (orange)

Figure 9 displays the difference between the two.  Above 0 means the “Switch” strategy has outperformed over the past 5 years and vice versa.

Figure 9 – “Switch” strategy 5-yr return (blue) minus “Split” strategy 5-yr return (orange)

Now let’s talk about the realities of investing.  As you can see, the “Switch” strategy usually outperforms the “Split” strategy – BUT NOT ALWAYS.  Now consider you were using the “Switch” strategy – which requires you to update data and monitor results each and every single month, and also requires you to make a trade whenever a switch is needed, versus the “Split” strategy which requires you only to make one trade a year.

Now let’s say you go to the trouble of using the “Switch” strategy and after 5 long years of dutifully following your “system”, the “Switch” strategy has actually underperformed the “Split” strategy.  What will be your reaction?

Will you:

*Say “well, I knew that this can and will happen from time to time but the long-term odds still favor the “Switch” strategy, so I am going to stick to it

OR

*(like the vast majority of investors) Say “this strategy sucks, I need to move on”

One’s answer to this question is important because the need to persevere in light of underperformance is pretty much one of the requirements of long-term success.

Figure 10 displays the relevant comparative facts and figures.

Figure 10 – “Switch” versus “Split”; 12/31/1972-5/31/2019

It is extremely important to note that while the “Switch” strategy vastly outperformed in terms of return, it still entailed alot of volatility and risk.  It also had a higher annual standard deviation (i.e., it is more volatile) and experienced a drawdown of -54%, which was slightly greater than that of the “Split” strategy.

Bottom line: do NOT make the mistake of thinking of this strategy as “easy money”.

Summary

As always, this is not a “recommended” strategy.  It is presented merely as “food for thought”.  The article is simply intended to highlight that:

*Sometimes U.S. stocks outperform the rest of the world and – absolutely, positively sometimes vice versa

*It may be possible to take advantage of switching between U.S. and international stocks

*No strategy outperforms all the time.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

One of the best pieces of advice I ever got was this: “Don’t tell the market what it’s supposed to do, let the market tell you what you’re supposed to do.”

That is profound.  And it really makes me wish I could remember the name of the guy who said it.  Sorry dude.  Anyway, whoever and wherever you are, thank you Sir.

Think about it for a moment.  Consider all the “forecasts”, “predictions” and “guides” to “what is next for the stock market” that you have heard during the time that you’ve followed the financial markets.  Now consider how many of those actually turned out to be correct.  Chances are the percentage is fairly low.

So how do you “let the market tell you what to do?”  Well, like everything else, there are lots of different ways to do it.  Let’s consider a small sampling.

Basic Trend-Following

Figure 1 displays the Dow Industrials, the Nasdaq 100, the S&P 500 and the Russell 2000 clockwise form the upper left.  Each displays a 200-day moving average and an overhead resistance point.

Figure 1 – Dow/NDX/SPX/RUT (Courtesy AIQ TradingExpert)

The goal is to move back above the resistance points and extend the bull market.  But the real key is for them to remain in an “uptrend”, i.e.,:

*Price above 200-day MA = GOOD

*Price below 200-day MA = BAD

Here is the tricky part.  As you can see, a simple cross of the 200-day moving average for any index may or may not be a harbinger of trouble.  That is, there is nothing “magic” about any moving average.  In a perfect world we would state that: “A warning sign occurs when the majority of indexes drop below their respective 200-day moving average.”

Yet in both October 2018 and May 2019 all four indexes dropped below their MA’s and still the world did not fall apart, and we did not plunge into a major bear market.  And as we sit, all four indexes are now back above their MA’s.  So, what’s the moral of the story?  Simple – two things:

1. The fact remains that major bear markets (i.e., the 1 to 3 year -30% or more variety) unfold with all the major averages below their 200-day moving averages.  So, it is important to continue to pay attention.
2. Whipsaws are a fact of life when it comes to moving averages.

The problem then is that #2 causes a lot of investors to forget or simply dismiss #1.

Here is my advice: Don’t be one of those people.  While a drop below a specific moving average by most or all the indexes may not mean “SELL EVERYTHING” now, it will ultimately mean “SEEK SHELTER” eventually as the next major bear market unfolds.  That is not a “prediction”, that is simply math.

The Bellwethers

I have written in the past about several tickers that I like to track for “clues” about the overall market.  Once again, nothing “magic” about these tickers, but they do have a history of topping out before the major averages prior to bear markets.  So, what are they saying?  See Figure 2.

Figure 2 – SMH/Dow Transports/ZIV/BID (Courtesy AIQ TradingExpert)

The bellwethers don’t look great overall.

SMH (semiconductor ETF): Experienced a false breakout to new highs in April, then plunged.  Typically, not a good sign, but it has stabilized for now and is now back above its 200-day MA.

Dow Transports: On a “classic” technical analysis basis, this is an “ugly chart.” Major overhead resistance, not even an attempt to test that resistance since the top last September and price currently below the 200-day MA.

ZIV (inverse VIX ETF): Well below it’s all-time high (albeit well above its key support level), slightly above it’s 200-day MA and sort of seems to be trapped in a range.  Doesn’t necessarily scream “SELL”, but the point is it is not suggesting bullish things for the market at the moment.

BID (Sotheby’s – which holds high-end auctions): Just ugly until a buyout offer just appeared.  Looks like this bellwether will be going away.

No one should take any action based solely on the action of these bellwethers.  But the main thing to note is that these “key” (at least in my market-addled mind) things is that they are intended to be a “look behind the curtain”:

*If the bellwethers are exuding strength overall = GOOD

*If the bellwethers are not exuding strength overall = BAD (or at least not “GOOD”)

A Longer-Term Trend-Following Method

In this article I detailed a longer-term trend-following method that was inspired by an article written by famed investor and Forbes columnist Ken Fisher.  The gist is that a top is not formed until the S&P 500 Index goes three calendar months without making a new high.  It made a new high in May, so the earliest this method could trigger an “alert” would be the end of August (assuming the S&P 500 Index does NOT trade above it’s May high in the interim.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

For the record, “tutorial” may not actually be the right word. The word “tutorial” implies that “this is how you do something.”  In reality, when it comes to trading options, there is no “one way” to do anything.  So, think of what follows as more of an “example of one way to play” and NOT as the “only or best way.”

For Openers: Catalyst and Expectation

We will walk through an example that buys a call option on ticker CGC.  For openers, when looking to buy a call option on anything you will ideally have two “thoughts” in place:

*A “catalyst”

*An “expectation”

A “catalyst” is simply something (anything) that prompts you to want to take a trade in the given underlying security in the first place.  Be it overbought/ oversold, trend-following, Elliott Wave, reversion to the mean, an indicator crossover, an indicator/price divergence, etc., (the potential list is essentially infinite).  But the point is, you need something that says to you, OK, now’s the time.”

An “expectation” involves any thoughts you might have regarding how far you expect the underlying security to move and any timeframe you might have in mind.  For example, if you expect the underlying security to “rally 2% in the next 5 days” that is a different proposition than saying “well I expect it to trend higher in the months ahead”.

Month and Strike Selection

The next step is to select the option that offers the preferred tradeoff between reward and risk given your particular “expectation”.

In the first instance, you can buy the shorter-term option that offers the maximum return if the underlying does indeed rally 2% in 5 days.  In the second instance, you would likely need to buy a much longer-term option and will need to consider carefully which strike to buy (to mitigate time decay, etc.)

Trade Management

Once a trade has been identified and entered the trade needs to be managed (for the record, the trade management plan should already be figured out before you actually enter the trade).  This basically involves setting parameters on:

When you will take a profit:  If your expectation is that the underlying security will rise 2% in 5 days and it rises 2% in 5 days you should (presumably) just go ahead and take the profit.

When (and if) you will cut a loss: A long call (or put) can lose no more than the premium paid, so depending on how you size your trades it may not be necessary to cut an open loss.  However, in many cases, if a trade is not working (ex., the underlying security is not moving as expected) out it makes sense to have some plan to conserve some capital by exiting rather than just sitting around waiting for the option to lose 100% of its premium.

When you might consider adjusting the trade (typically to improve the overall reward-to-risk profile): If you buy 10 calls and get a nice profit it can make a lot of sense to sell some of those calls to lock in some profit and then “let the remaining position ride” in hopes of the “Big Score”.

Example

We will look at ticker CGC.  Figure 1 displays a bar chart from ProfitSource by HUBB with a Bullish Wave 4. The target range is $56.86 to $63.50 by August 28^th.

(click to enlarge any of the Figures below)

Figure 1 – CGC with Elliott Wave count (Courtesy ProfitSource by HUBB)

IMPORTANT: There is NO GUARANTEE that any “wave count” is going to pan out as projected.  As such, please note that while I do use and heartily endorse ProfitSource, I am not suggesting that this signal (or any other signal) generated will lead to a profit and of course – as always – I AM NOT “recommending” the example trade that follows.  All of this is presented merely as an “example” of “one way” to play.

Figure 2 shows that implied volatility for CGC options is on the low end of the historical range.  This suggests that options are “cheap” and may be conducive to buying call options.  CAVEAT: CGC has only been around for a short time so the historical IV range could certainly expand (higher or lower) in the future.Figure 2 – Implied volatility on CGC options is “low” (Courtesy www.OptionsAnalysis.com)

Figure 3 displays an input screen from www.OptionsAnalysis.com.  In this example we are looking for the call option with “Highest Probability of Touching it’s % to Double Price” (i.e., how far does the underlying stock have to move in price in order for the option to double in price AND what is the mathematical probability of the stock hitting that price).

Figure 3 – Looking for Highest Probability of Touch % to Double price at www.OptionsAnalysis.com (Courtesy www.OptionsAnalysis.com)

Figure 4 displays the output screen and lists the October 42.5 call as the top choice.  The next to last column tells us that the stock must rise +23.76% by 30 days prior to option expiration in order for this option to double in price.  The far right column tells is that there is a 36.56% chance of this happening.

Figure 4 – Probability of Touch % to Double Output (Courtesy www.OptionsAnalysis.com)

Figure 5 displays the particulars for this trade.  Note that the entry price is $4.75.  If we place a market order we would presumably get filled at the “ask” price of $4.95.  So, this example assumes that we used a “limit order” to buy at the midpoint of the bid/ask spread.  Traders need to remember that a “market” order guarantees a fill, but likely at the highest possible price.  A “limit” order can allow you to buy the option at a lower price, however, there is no guarantee that you will be filled at your price (or at all).  Just one more decision a trader must make.

One tip: If a trader absolutely wants to enter a trade, one possibility is to place a limit order to try to get filled at a better price, and if not filled near the end of the day to cancel the limit order and (bite the bullet) and buy via a market order (in order to avoid missing the trade altogether).

Figure 5 – CGC trade particulars (Courtesy www.OptionsAnalysis.com)

Figure 6 displays the risk curves through October expiration (the black line represents the expected P/L at the time of October expiration).  The most obvious thing is the “unlimited profit potential/limited risk” nature of the trade.

Figure 6 – CGC call option risk curves (Courtesy www.OptionsAnalysis.com)

A mentor of mine – a gentleman named Mitch Genser – was fond of pointing out the importance of looking more closely at “where this trade lives.”  Let’s consider that concept here.

On the downside, the reality is that if CGC drops to say $35 or below the likelihood of things working out profitably are quite low.  So, we might consider using that as an arbitrary “bail out” point.

On the upside, the Elliott Wave count in ProfitSource showed $56.86 a share as a target.  The count also suggested the move  if it is going to happen – should happen by August 28^th.  So, Figure 7 shows us “where this trade lives”, i.e., between $35 a share and $56.86 a share through August 28^th.

Figure 7 – CGC call option risk curves through August 28^th (Courtesy www.OptionsAnalysis.com)

When analyzed this way, this example trade basically comes down to giving CGC roughly 2 ½ months to move higher to $56.86 – which would generate a profit in the $1,000 range – or to drop down to $35 a share – which would result in a loss in the -$420 range.

Summary

The purpose of this article is NOT to suggest that you trade options on CGC nor is it intended to suggest that you should rely solely on Elliott Wave projections to target trades.  The purpose is simply to highlight one example of a set of steps that may help traders improve their odds on a trade-by-trade basis:

*A trading catalyst

*An expectation regarding the underlying security

*Identifying the option that offers the best tradeoff between reward and risk based on one’s “expectations”

*Deciding how to enter a trade (market versus limit)

*A plan to manage the trade once entered (i.e., when to take a profit, cut a loss, and/or adjust the initial position)

*The emotional wherewithal to follow the plan

In the immortal words of Sean Connery as Malone in the Untouchables, “Here ends the lesson.”

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

If I had a dollar for every time I’ve heard “gold is set to soar in the coming days/weeks/months/years ahead” since I started in this business, Jeff Bezos would be bringing me coffee.  You would think at some point investors would just tune out all the gold hype and move on.  Yet the allure remains.

And now here we are again.  Go onto any financial news aggregating site and you will find plenty of “gold is ready to move” material.  Actually, it seems to usually appear with a question mark attached, as in “Is Gold About to Soar?” (reminding us once again of that important market forecasting adage which states: Nobody knows anything”) rather than in declarative form, i.e., “Gold is Set to Soar.”  But it doesn’t rally matter, the effect is the same.  Call it “Gold Angst”.  Investors sit there and wonder “should I or shouldn’t I” take the plunge?

Here is one way to get the whole gold angst thing off your plate:  Buy the January 2021 GDX 22 strike price call.  Now – and as always – this is not an actual “investment recommendation”.  I have no firm opinion as to whether or not this position will ultimately make money.  But here is what it does do:

*It gives an investor a position in gold (OK, sort of, since we are merely buying shares of an ETF that tracks gold stocks)

*It gives gold about a year and a half to decide whether or not it finally wants to make a move.

*It doesn’t cost very much

As you can see in Figure 1, the implied volatility for options on GDX is still at the low end of the historical range.  What this means to option trader is that the time premium built into GDX options is relatively low, i.e., options are “cheap”.  If volatility picks up  at some point in the next year and a half, the time premium built into the options will increase, which could boost the profitability of a long position (or at least reduce the downside loss in the interim).Figure 1 – Long Jan2021 GDX 22 call (Courtesy www.OptionsAnalysis.com)

Figure 2 displays the trade particulars and Figure 3 displays the risk curves.Figure 2 – GDX Jan 2021 22 call (Courtesy www.OptionsAnalysis.com)

Figure 3 – GDX Jan 2021 22 call risk curves (Courtesy www.OptionsAnalysis.com)

It’s pretty straightforward.  If gold does not rally in the next year and a half this position can lose up to $348.  If gold does rally in the next year and a half, this position can make good money – potentially a lot if the people screaming “Gold is About to Soar” ever actually turn out to be right.

Summary

Bottom line: Gold has rallied many times in the past several years only to peter out and sink, so there is reason to doubt the recent “pop” in price.  What happens from here?  I am offering no opinion.  So, don’t go out and buy GDX options solely because you read this article.

But if you find yourself suffering from “Gold Angst” do consider the possibilities.  By buying a cheap call option (risking maybe 1% to 3% of one’s investment capital) an investor has a position in gold and the “should I or shouldn’t I jump into gold” angst is relieved.  If the bullish forecasts actually turn out to be correct in the next 19 months the possibility to make a decent return exists.  And if not, the investor has sacrificed 1% to 3% of his or her investment capital.

In sorting things out, this simple two question quiz may help:

1. Are you feeling angst because you think gold may make a big move and you will be left out?
2. Do you have $348 bucks?

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

There sure are a lot of ETFs out there.  I mean let’s face it, the marketing and product development people stay up late.  If they discern even a hint of potential interest in a small-cap growth fund that invests only in marijuana companies whose ticker symbol starts with the letter “A” then by god, there will be an ETF that “affords investors the opportunity to invest in this unique niche” (those marketing folks sure can turn a phrase can’t they).  They might even create a “series of ETFs” – POT-A, POT-B, POT-C, etc.  Then another ETF provider will copycat and launch BUZZ-A, BUZZ-B, BUZZ-C and so on.  Next comes the large-cap, value and dividend-paying versions.  You get the idea.

So, the reality is that there are roughly – and I am just spit-balling here – a bazillion ETFs in existence now.  And the reality is that alot  of them never gain any real traction and fail to garner any meaningful trading volume.  And sometimes a nugget gets lost in their midst.  Take ticker SDYL for example.  But first…

The S&P 500 High Yield Dividends Aristocrats Index

The S&P High Yield Dividend Aristocrats Index (apparently the folks who create indexes are staying up late too) is comprised of the 50 highest dividend yielding constituents of the stocks of the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years.  Data for the index goes back to January 2000.  Figure 1 displays the theoretical growth of $1,000 invested in the index versus the growth of $1,000 invested in the S&P 500 Index starting in January 2000.

Figure 1 – Growth of $1,000 invested in the S&P High Yield Dividend Aristocrats Index and the S&P 500 Index; 12/31/1990-5/31/2019

As you can see, since inception the index has significantly outperformed the S&P 500 Index, posting a gain of +551% versus +173% for the S&P 500.  Of course, you can’t trade an index, you must trade a fund or ETF that attempts to track the given index.  So, we turn our attention to…

Ticker SDY

Ticker SDY is the SPDR ETF (SPDR S&P Dividend ETF) that tracks the S&P High Yield Dividend Aristocrats Index.  The first full month of trading for SDY was December 2005.  So, Figure 2 displays the growth of $1,000 invested in ticker SDY starting in December 2005 versus the growth of $1,000 invested in ticker SPY – an ETF that tracks the S&P 500 Index.

Figure 2 – Growth of $1,000 for SDY and SPY since 11/30/2005

Since SDY started trading it has slightly outperformed ticker SPY (+201% verus +189%).  Combined with the index performance prior to SDY inception, this is pretty good all by itself.  But it’s NOT good enough for the marketing person in the wee hours!  And then it hit them – what we need is a leveraged version!  Which leads us to…

Ticker SDYL

Ticker SDYL is the ETRACS Monthly Pay 2xLeveraged S&P Dividend ETN, an Exchange Traded Note linked to the monthly compounded 2x leveraged performance of the S&P High Yield Dividend Aristocrats® Index (the “Index”), reduced by the Accrued Fees. The first full month of trading for SDYL was June of 2012.  Figure 3 displays the growth of $1,000 invested in SDYL, SDY and SPY since 5/31/2012.

Figure 3 – Growth of $1,000 for SDYL, SDY and SPY since 5/31/2012

Since 5/31/12:

SDYL = +418%

SDY   = +143%

SPY   = +148%

So does this mean SDYL is the best choice?  Not necessarily.  While it has made more than twice as much as the other 2 ETFs, that performance comes at the price of an average standard deviation and a maximum drawdown that is also twice as large. So, the risk factor is something to consider.  But that’s no even the real problem.  The real problem is that SDYL barely trades at all.

As you can see Figure 4, SDYL has failed to gain any traction with investors and holds only $16.6 million in assets and trades a paltry 1,734 shares a day.  SDY trades 332 times as many shares per day as SDYL and SPY trades 42,302 time as many shares per day as SDYL.

Figure 4 – $’s in assets and average daily trading volume

Summary

For investors looking for profit potential, SDYL – at first blush looks – terrific.  But will enough investors ever take notice enough for SDYL to trade with any real volume?

I don’t know.  Maybe the marketing people need to stay up even later and figure out how to whip up some interest.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Options are foreign to many investors.  And yes, there is a degree of complexity and a necessary learning curve involved.  But understanding  even a few basic option strategies can open a world of opportunity.

In a nutshell I typically describe options as offering 3 basic avenues:

*Expressing a market opinion (i.e., profiting if a security moves in the direction you think it will go), typically at a fraction of the cost of trading shares of stock

*Hedging an existing position or portfolio (i.e., the ability to protect yourself without having to sell your stock holdings)

*Taking advantage of unique situations (selling premium to make money in a neutral market, buying a straddle to profit if a move takes place in either direction, and so on.)

What follows is NOT a recommended trade or opportunity.  It is simply an example that compares buying stock versus buying an option to illustrate the relative pros and cons.

Ticker CMCSA

According to the Elliott Wave count from ProfitSource by HUBB, Comcast (CMCSA) is setting up for a Wave 4 advance in price.  Now the caveats: I like and use ProfitSource and I find the built in Elliott Wave count to be useful.  That being said, no given “setup” or “Wave count” is EVER guaranteed to pan out.  I have no idea whether this latest count for CMCSA will ultimately be a good one or a bad one.  In this instance I am simply using it as a potential catalyst for a hypothetical trade for illustrative purposes.

Figure 1 – Potentially bullish Elliott Wave count for CMCSA (Courtesy ProfitSource by HUBB)

This wave count is projecting that CMCSA will rise to somewhere between $45.67 and $48.30 by the end of July.

Let’s assume that we believe the wave count in Figure 1 will play out and that we want to speculate on this opportunity.  The simplest approach would be to buy 100 shares of CMCSA stock.  With the stock trading at $41.40 a share, this would involve spending $4,140 to buy 100 shares.  This position appears in Figure 2.  Note that for every $1 the stock goes up the position makes $100 and vice versa.  A 100 shares of stock position has a “delta” of 100.

Figure 2 – Buy 100 shares of CMCSA (Courtesy www.OptionsAnalysis.com)

Another possibility (among many) would be to buy the September 37.50 strike price call for $470.  This is only about 10% of what the stock trader must put up.  This trade appears in Figure 3.

Figure 3 – Buy 1 Sep2019 37.5 strike price call (Courtesy www.OptionsAnalysis.com)

A few things to note:

*The worst-case loss for the option trade is -$470

*The trade has a “delta” of roughly 78.  While delta value can and will change over time, for now it means that this position is essentially equivalent to holding 78 shares of stock.  In other words, the option buyer in this example buys 78 deltas for $470 versus the stock trader who buys 100 deltas for $4,410.

How will this all play out?  It beats me (and remember I am NOT suggesting that CMCSA is bullish nor am I recommending either of these positions).

Figure 4 displays the expected dollar profit or loss from the two positions at various prices for CMCSA stock as of the end of July.

Figure 4 – Expected $ P/L at various price at end of July

Note that at higher price the call option makes almost as much total $ return as the stock position while committing 90% less capital.  Likewise, as price sinks progressively lower the stock position just keeps losing more and more, while the option position cannot lose more than $470.

While the number are helpful, still probably the best way to illustrate the relative tradeoffs is to overlay the two position on one chart.  See Figure 5.

Figure 5 – Comparative Risk Curves for stock versus option (Courtesy www.OptionsAnalysis.com)

Summary

So, is better to buy the call option than the stock shares?  That’s for each trader to decide in each situation.  While in this illustration the option appears to have some advantages, another scenario involves the stock “going nowhere” for a while before making a move higher.  In that scenario the stock trader can simply hold the stock shares and wait.  The option will expire in September and the option trader will have to make another trading decision.

In any event, remember that the purpose of this article is NOT to prompt you to take action regarding CMCSA.  The purpose is simply to illustrate the relative pros and cons of options versus stocks in certain situations.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.