Crashing commodity prices and concerns over the plunging emerging market currencies sent the markets on a wild roller coaster ride on Wednesday.
Copper prices fell to a new six-year low. Crude prices declined $2 to $40.54. Energy equities imploded. The Dow only had two components that were positive. Those were McDonalds and Nike. Ten stocks lost more than $1 and three lost more than $2.
The Dow declined -238 to 17,282 before the FOMC minutes scheduled for 2:PM. Portions of the minutes were leaked and Bloomberg reported at 1:36 that "most Fed officials saw conditions for a rate hike nearing." The market began to rebound after the Fed realized its mistake and released the full minutes at 1:50. That sentence released by Bloomberg was in the minutes but it was out of context.
The Fed did see conditions nearing BUT they indicated the members were still looking for more confidence in the inflation outlook before raising rates. Also, while members saw progress in the labor market would like to see additional progress there before making a move. While one member was ready to raise rates now the majority agreed that the conditions for a rate hike had not yet been met.
The markets immediately rocketed higher with the Dow moving from a -238 low back to positive territory and then immediately reverse to close down -162 points. That was a huge swing and to have it erased even faster than the rocket rebound was a serious blow to sentiment.
During the day the S&P traded 7 points below the 200-day at 2077 but rebounded to close back over that average at 2079 with a -17 point loss. The Nasdaq dipped 8 points under 5000 but rebounded to close down -40 at 5020. The Russell 2000 dipped under critical support at 1200 and rebounded to close just barely over it at 1202.
All the major indexes are poised for breaks below critical resistance if we get another triple digit decline. That could set off some cascade selling as we head into the dog days of August.
However, a lot of the early weakness was related to commodities and emerging market currencies. Those types of moves tend to be sharp and painful but they are over quickly. Traders have a short attention span on commodity issues unless they continue to dive. Rarely do commodities decline sharply for days at a time. Oil prices are still hovering about where they closed at $40.50. The current contract expired on Thursday and that expiration pressure was part of the decline in prices today. The contract for October, which will become the front month after expiration, is trading at $41. That is not a lot of difference but it may be enough to ease the fears on Thursday.
The talking heads on TV blamed the drop in oil prices on an unexpected build in inventories of 2.6 million barrels. This is what you get when you read a teleprompter all day and do not trade the markets. A 2.6 million barrel build is not huge and this is the time of the year when inventories begin to rise. Gasoline demand is slowing now that summer is over and kids are going back to school. Refineries are starting to slow down and will be starting their maintenance cycle in about two weeks. There is plenty of gasoline in the system to get past Labor Day and the end of the summer demand cycle. I would expect oil inventories to build for the rest of the year with only a couple of weeks of declines.
How do we deal with multiple triple digit reversals in one day and the prospect for more volatility ahead? I really wish I knew. While the indexes look like they are about to break down the last two material declines were both met with heavy buying. We cannot guarantee that will continue. The Dow chart is ugly and more than half the components are already down more than 10%. There is no positive leadership and plenty of bearish charts.
If I had to pick a direction tonight, I would bet with the sellers. However, S&P futures are up +3.50 as I write this. That could be just a knee jerk reaction to the closing sell off rather than a sudden urge to buy the dip. If the Dow breaks below 17,300 again I expect it to keep heading south. That is a really ugly formation over the last two weeks. We have a series of lower highs and lower lows with today's close a six-month low.
More than 60% of the S&P-500 is in a correction. More than 66% of the Russell-3000, the top 3,000 U.S. stocks, are in a correction.
The extreme volatility over the last week knocked us out of three more short positions. I really hesitated to add anything new because of the volatility. The concept of this newsletter is to put on a low volatility position and let it expire worthless. There are no low volatility positions in the current market. A sector up today is crashing tomorrow.
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Items shaded in blue were previously closed.
Current Position Changes
Stop Loss Updates
Check the graphic above for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.
ESRX - Express Scripts (Stopped)
ESRX spiked $2 intraday on Tuesday on no news. The only news was that Jeremy Grantham sold nearly half his stake in ESRX. He sold 10.4 million shares. That should have tanked ESRX since a big name portfolio manager dumping 2.7% of his portfolio should have had investors heading for the exits. The spike stopped us out at $90.35. fortunately this was an August position and the option had already evaporated to nearly nothing. We escaped with a nice gain.
I am recommending we retain the long call because the current 2-cent value would cost us more in commissions to sell it. Also, you never know when an acquisition could appear and spike the stock. With only two days until expiration this is highly unlikely.
Stopped Aug $95 short call, entry .80, exit .13, +.67 gain
Retain Aug $100 call, entry .17, currently .02, will expire for -.17 loss.
Net gain 50 cents.
YUM - YUM Brands (Stopped)
YUM imploded -$9 on the currency devaluation over two days. I added YUM last Wednesday on what turned out to be the exact bottom of the decline. Analysts began upgrading the stock and reiterating buys the very next day saying the decline was overdone and a significant buying opportunity. Shares are up +$7 since we entered the position.
While we were stopped out of the short side the very next day for a minor loss the long side has nearly doubled to put us into a profitable position with a month to go. We could end up doing very well on the long call if the market cooperates.
Closed Sept $85 short call, entry $2.15, exit $2.33, -.18 loss
Retain Sept $90 long call, entry .64, currently 1.15, +.51 gain.
QRVO - Qorvo Inc (Stopped)
Qorvo was crashing with the chip sector and gave really lousy guidance with earnings. Shorts were piling on until the company announced a new $400 million share buyback program. Shares spiked $3.50 the next day to stop us out before resuming their lackluster performance.
I am not confident enough on the direction to reenter the short side. If shares decline back under $54 I will try to add that short position since we already have the long side. I would like to try and win back some of the premium we lost on the spike.
Stopped Sept $60 short call, entry $1.29, exit $2.39, -1.10 loss.
Retain Sept $65 long call, entry .54, currently .35, -.19 loss.
ZOES - Zoes Kitchen (Put Spread)
We were previously stopped out on the short side on ZOES and reentered the position and recaptured our loss. With ZOES still declining I put a profit stop on the long put at 25 cents in the last newsletter. ZOES declined -$2 on Tuesday and the option hit our profit stop. This turned a losing play into a breakeven. With only two days until expiration we can't complain.
Stopped Aug $35 long put, entry .34, exit .25, -9 cent loss
Previously closed Aug $40 short put, entry $1.39, exit .45, +.94 gain
Previously closed Aug $40 short put, entry $1.02, exit $1.85, -.83 loss
Net gain 2 cents.
GPRO - GoPro (Bear Call Spread)
The GoPro recommendation from last week gapped up to the stop loss at the open on Thursday and was not opened. That spike on Thursday was the high for the week so anyone that opened the position despite the gap higher would have had a good play. As a matter of course any recommendation that moves against us by more than $1 at the open the day after the newsletter should not be entered. We need to use common sense when entering these positions.
BABA - Alibaba (Bear Call Spread)
Alibaba posted disappointing earnings and slowing sales growth. Shares dropped sharply. The rebound over the next two days came on the announcement of a big buyback program, which Jack Ma would personally buy additional shares. However, the rebound was short lived. Alibaba has a lockup expiration of 1.2 billion shares on September 20th. That is the Monday after expiration. There are 2.5 billion shares currently outstanding and that lockup represents nearly 50%.
Sometimes a lockup expiration fails to push shares lower right at the expiration date because the news has been known for a long time and investors planned accordingly. However, 1.2 billion shares is a huge number. Those holders have seen their shares decline from $120 to $73 and they are probably just waiting for the opportunity to sell.
The weak economy in China is not helping. The daily news about the yuan and the economic conditions is another weight on the stock.
Earnings Nov 4th.
Sell short Sept $77.50 call, currently .65, stop loss $75.45
Buy long Sept $82.50 call, currently .15, no stop
Net credit 50 cents.
BITA - Bitauto Holdings (Bear Call Spread)
Bitauto provides Internet content and marketing services for the automobile industry in China. Shares have fallen for 8 consecutive weeks as the slowdown in Chinese auto sales accelerates. The company warned that revenue growth will slow for a fourth consecutive quarter in Q3. The slowdown in auto sales is forcing BITA to spend a lot more money to shift its strategy to offline car sales as well. This advertising effort is an unknown and analysts don't know how this will translate into revenue. The company said it is being forced to spend more on advertising to strengthen its brand in the declining market.
The China Automobile Dealers Association said in July that annual sales in China could fall for the first time in 17 years as a result of the stock market crash. Sales in June posted the first decline since February 2013. Chinese consumer confidence is plunging as the pace of economic expansion is the slowest in 25 years. The drop in the equity markets wiped out the equivalent of $4 trillion in market value. An analyst at 86Research said the new focus by BITA will crimp its margins. "They can drive transaction volume and cultivate buying habits, but incur substantial losses" at the same time.
Earnings Nov 5th.
Sell short Sept $30 call, currently .95, stop loss $28.85
Buy long Sept $35 call, currently .35, no stop.
Net credit 60 cents.
Existing Play Recommendations
Links to original play recommendation
TIF - Tiffany (Bear Call Spread)
LULU - LuluLemon Athletica (Bear Call Spread)
XOP - Oil Exploration ETF (Bear Call Spread)
YUM - YUM Brands (Bear Call Spread)
NFLX - Netflix (Bull Put Spread)
ZOES - Zoes Kitchen (Bull Put Spread)
GLD - Gold ETF (Bear Call Spread)
ESRX - Express Scripts (Bear Call Spread)
HOT - Starwood Hotels (Bear Call Spread)
QRVO - Qorvo Inc (Bear Call Spread)
GPRO - GoPro Inc (Bear Call Spread)
YUM - YUM Brands (Bear Call Spread)
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.