Tom’s Weekly Newsletter September 14th, 2022

Tom Gentile

Posted in Newsletter

By: Tom Gentile on September 14th, 2022 • 11 mins read

Originally published via our newsletter previously. Subscribe for early access!

Dead Cat Bounce? Or is this a More Meaningful Bounce for the Stock Market?

Image 40

At the time of this writing the NASDAQ, as well as the Dow and the S&P were trading higher and looking like they will close as such.

For the NASDAQ it ended a 7-trading day slide.

If you’ve never heard of the term Dead Cat Bounce let us quickly write what that is, (and we did not make up the name and don’t advocate cruelty of any kind to animals).

Here is what or how it is defined:

A recovery, albeit temporary,  in prices of securities after a substantial fall.

It is said to be caused by speculators buying in order to cover their positions (and maybe doing some dollar-cost averaging).

Take a look at the next panel as we show a key Fob support zone was hit today and note that many investors believe as I do that the market is oversold.

It stands to reason a bounce was due to come our way, the question is going to be can this be sustained or is it just a bounce?

Right now, if we were to initiate long call option trades they would be of a very short-term time frame until expiration

Tom Gentile
C1P: Chief 1-Percenter

Four Corners of the Market

SPY – SPDR S&P 500

Image 41
Image 42

TLT – iShares 20+ Year Treasury Bond ETF

Image 43

TLT is my representation of bonds and the bond market.

Bonds tend to trade inverse to equities.

That being the case one could have expected TLT to trade lower on the day with the SPY (my representation of equities) trade higher on the day.

Just goes to show this inverse correlation doesn’t happen 100% of the time as TLT traded higher on the day.

The bullish da wasn’t as robust as it was for the SPY, but it did happen.

Couple that with a Darknet B (Bullish) Darknet signal and TLT may be due for a pop.

There are times the two move in unison and though this may bounce it may not ne able to pop high enough to have an option pay off really well, but one can paper trade if they like.

UUP – Invesco DB US Dollar Index Bullish Fund

Image 44

Today’s Japanese Candlestick couple with the one from yesterday is forming what’s know as a Bearish Engulfing Pattern.

Image 45

The formation is important and just as important is where it is on  chart for the stock.

It should happen at the end of an uptrend or at a resistance area, which seems to be the former if you look at the chart image above.

It gives indication the bulls may have run out of steam for the moment and prices may trade lower from here. One can read more about Japanese Candle patterns in the tools by going Stocks > Stock Rankers > Candlestick Doji’s.

Click the Help?? Button.

USO – United States Oil Fund, LP

Image 46

I have been referencing the sideways  or box range on USO for a couple of weeks now.

Even though the longer trend seemed bearish there was the chance USO could breakout to the upside of the shorter-term sideways range.

That did not happen.

Today USO broke down out of this range and that is a bearish indication of potential, further lower price action to come.

Not only did it break down and close below the support of the box range, USO also closed at or near its low of the day.

One can anticipate a price move lower by taking the width of the range and whatever that amount is deduct that from the break down price and that is potentially a price point USO could trade down to.

GLD – SPDR Gold Shares

Image 47

This chart of GLD looks similar to the one for TLT.

This chart shows a potential double bottom support at 158. What is missing from this chart that the one for TLT had is a Darknet B (Bullish) signal.

What it does have is a Bullish Engulfing pattern over the last two trading days.

This is the opposite of the Bearish Engulfing pattern highlighted in the UUP discussion in that it is a bullish indication prices may trade higher from here.

Again, the location of the pattern is just as important as the pattern itself and its ideal when it happens at the bottom of a trend or at a support level, which it looks like it is at.

Once more, to read more on these candle patterns go Stocks > Stock Rankers > Candlestick Doji’s.

Click the Help?? Button.


From the Desk of a CMT –  Continued Education and RS Case Study

Option Spreads & Slippage

Last week we used Relative Strength (RS) to identify weak sectors which were confirmed as bearish. Materials were ranked eighth of nine sectors when adjusting or not adjusting for volatility. By scrolling through the component stocks of XLB, we noted that Vulcan Materials (VMC) had a bearish set-up with a little room to go before potential technical support at the 38.2% Fibonacci retracement level and/or the 50-day simple moving average (SMA).

The main problem we encountered was an extremely wide bid-ask spread. Figure 1 displays the case study that was contemplated, then discarded due to the spread which was 17% of the ask level ($11.60 – $9.60)/$11.60 = 0.172. This was partially attributed to the market close for quotes but lack of familiarity in the name created a shift to XLB, the material ETF. There, a similar problem was encountered.

Figure 1: Risk Detail for Nov 170 Put – Note the Bid-Ask Spread (8/30/2022)
Figure 1: Risk Detail for Nov 170 Put – Note the Bid-Ask Spread (8/30/2022)

Before showing you one way to assess what’s “normal” for option spreads on an unfamiliar stock, it’s important to quantify the impact of a wide bid-ask spread. Individual call or puts can pose more of a problem than spread strategies such as a bear call spread, bull put spread, …. A spread position is naturally hedged for you and the machines accepting the orders, and as a result, are far more attractive for institutional traders. There can be more leeway with such orders. 

Slippage represents the cost associated with the spread that must be overcome when trading.

If the VMC Nov 170 put was purchased at the ask of $11.60 and you decided to immediately sell it at the bid of $9.60, little likely changed in the underlying or the market, but you just lost 17% or your funds before commissions. If you hold the position after buying it at the market price (the current ask) you need it to move 17% in your direction before it yields profits … that’s a tall order.

Although this is a bit of an extreme case, the bid-ask spread is an important item to assess when considering a trade. In the case of VMC, if we could cut each side of the quote by $0.15, it’s still a $1.70 spread and a 14.8% deficit to overcome ($1.70/$11.45). 

Assessing Spreads for Less Familiar Names

This exercise prompted me to view individual option charts in Tom’s Option Tools to get a sense of whether this was a system quirk (after hours quote feed) or just the nature of VMC and XLB. Starting with the Nov 2022 option chains for each security, I looked at the put options with the highest open interest (OI) within 20% of the underlying for each. As of 9/6/2022, this included the XLB Nov 69 put (OI: 8961) and VMC Nov 180 put (OI: 235). We’ll look at both.

Figure 2a: XLB & VMC Nov Puts with Highest OI (9/6/2022)
Figure 2a: XLB & VMC Nov Puts with Highest OI (9/6/2022)
Figure 2b: XLB & VMC Nov Puts with Highest OI (9/6/2022)
Figure 2b: XLB & VMC Nov Puts with Highest OI (9/6/2022)

With XLB @ $74.12 the 69 put is out of the money (OTM) while the VMC 180 put is in the money (ITM) with VMC @ $164.41. This explains the $0.80 bid-ask spread for both options despite the significant price difference.

To determine what’s more normal for the bid-ask spread when you are assessing a less familiar name, click on the option itself so you can view key option chart data for it. Figures 3 & 4 provide the Bid and Ask Quote Chart, IV(%) Chart, and Delta(%) Chart, respectively for XLB and VMC.

Figure 3: XLB Nov 69 Put, Select Charts (9/6/2022)
Figure 3: XLB Nov 69 Put, Select Charts (9/6/2022)
Figure 4: Risk Adjusted ROC RS (9/6/2022)
Figure 4: Risk Adjusted ROC RS (9/6/2022)

The 26-week measure has more persistency in rankings, as expected. It’s slower and historically has performed well. The shorter timeframe for the 4-week, 8-week, and 12-week blend is better suited for shorter time horizons and will jump around a bit. Stock mean reversion can be stronger than relative strength over the 4-week and 8-week periods so be prepared to be more agile with these.

Building towards a more automated approach, we’ll focus on bearish strategies and high-ranking RS sectors when the overall market is bearish and bullish strategies and low-ranking sectors when the overall market is bullish.

For now,

  • Bearish = SPY price below its 65-day SMA (approximates the 13-week SMA)
  • Bullish = SPY price above its 65-day SMA

This will be improved over time, but for now it reduces subjective assessments. Figure 7 displays the SPY daily chart with 130-day (approximates the 26-week SMA) and 65-day SMAs.

Figure 5: SPY Daily Chart with 65-day and 130-day SMAs (9/6/2022)
Figure 5: SPY Daily Chart with 65-day and 130-day SMAs (9/6/2022)

Next, we’ll once again load the ETF component list in the stock chart, then scroll through charts for the individual stocks in the sector. I selected Stock Chart Fibonacci and 550 Trading Days to capture the bullish move since 2020 and potential retracement.

You can access component names for each sector from the select sector website. Here is the list for XLF as of 8/30/2022:

JPM BAC WFC SPGI MS GS SCHW BLK C AXP MMC CB PGR CME PNC TFC USB AON ICE MCO MET COF AIG TRV AJG MSCI PRU AFL ALL MTB BK AMP DFS FRC TROW STT SIVB FITB WTW HIG NDAQ RJF RF NTRS HBAN CFG PFG KEY SYF FDS CINF BRO WRB CBOE SBNY L CMA RE MKTX GL AIZ ZION LNC BEN IVZ

Hopefully, you can just cut and paste this into a new Selected Stock List (you can navigate to this as follows: Web Site > Lists > Edit List).

Here is the rhythm we’ve been following:

  • Scroll through the charts to find a bearish scenario with some room to the downside (Fibonacci level or SMA)
  • Favor a component stock with nearby upside resistance (Fibonacci level or SMA)
  • View the IV charts for the underlying using a term that is appropriate for the time horizon searched (you can look at monthly expirations for the 26-week RS measure)
  • Use Smart Search (Searchers à Multi Strategies à Smart Search) to search for a bearish strategy appropriate for IV conditions and your personal style
  • Assess the results to see if a strategy suits your risk preferences
  • Check the spreads for the results listed

You always need to consider your exit before making a final determination on pursuing a particular strategy.

  • Timed exit: if you’re long premium (debit) identify a timed exit (usually 30 calendar days) to reduce accelerated time decay. Deep ITM options are an exception to this 30-day requirement, but all strategies require a time strategy with max risk.
  • Identify a stop price for the option using your max risk, keeping in mind the bid-ask spread can significantly impact your ability to exit at a desired price
  • Identify technical stops for an exit, if these don’t provide a firm price (i.e., cross of an SMA) then identify a price for the underlying using basic technical levels such as support/resistance, gaps, or the most recent peak/trough that reflect your time horizon (may need to use a weekly chart for longer-term horizons).
  • Identify a profit target (or two if partial profit taking suits your style). Here again, wide bid ask spreads will add a challenge to profitable trading
  • Don’t forget to check for earnings timing and IV seasonality for shorter-term IV’s

I so wanted to provide a case study last week but these things (slippage) you encounter as you navigate your searches are really important. There is definitely some good liquidity in financial stock options. If you wish to bring the time horizon in a bit, consider tracking shorter-term SMA’s when scrolling through the names in the XLF component stock list.

Manage your risk and make this approach your own with appropriate tweaks. 

Regards,

Clare White, CMT


Disclaimers

Stock and options trading has large potential rewards, but also large potential risk.

You must be aware of the risks and be willing to accept them in order to invest in the stock and options market. Do not trade with money you cannot afford to lose.

This is neither an offer to buy/sell/ or recommend a particular stock or option.

Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been actually executed, the results may have under or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with hindsight.

No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

Disclaimer of Warranties and Liabilities Tom Gentile and TomsTradingRoom, LLC including employees, consultants, and editors (“Publisher”) cannot and do not warrant the completeness or accuracy of the content found in our areas, or its usefulness for any particular purpose.

Tom Gentile and TomsTradingRoom, LLC also make no promises that our content or the service itself will be delivered to you uninterrupted, timely, secure, or error-free. Under no circumstances will Tom Gentile and TomsTradingRoom, LLC be liable for direct, indirect, incidental, or any other type of damages resulting from your use or downloading of any content on our site.

This includes, but is in no way limited to, loss or injury caused in whole or in part by our negligence or by anything beyond our control in creating or delivering any portion of Tom Gentile and TomsTradingRoom, LLC.

You are agreeing that you bear responsibility for your own investment research and investment decisions. You also agree that Tom Gentile and TomsTradingRoom, LLC will not be liable for any investment decision made or action taken by you, or others based upon reliance on news, information, or any other material published by Tom Gentile and TomsTradingRoom, LLC.

Tom Gentile and TomsTradingRoom, LLC relies on various sources of information that we believe to be accurate and reliable. However, we make no claims or representations as to the accuracy, completeness, or truth of any material contained on our site.

Tom Gentile and TomsTradingRoom, LLC are educational portals, providing content for educational and informational purposes only. Neither Tom Gentile nor TomsTradingRoom, LLC are a broker/dealer. Investors need a broker to trade stocks and options and must meet certain requirements. All securities, futures, and investments data and ideas are offered to self-directed investors. All prices in USD unless noted otherwise.

A full disclaimer can be found here:  http://www.tomgentile.com/legal_disclaimers.html.