Earnings season begins next week and a slew of disappointing results could remind investors that the economy is still very fragile. Many analysts are expecting profit warnings from bellwethers along with lower revenue. The S&P 500 index gained 5.8% in the third quarter primarily due to aggressive world-wide central bank intervention. The market was moved by excess liquidity and stocks rallied even as there were signs that businesses are struggling. Analysts are forecasting a 2.4% decline from last years third quarter, which if true, would be the first earnings decline in three years according to Thomson Reuters. In the coming weeks if earnings results lead to reduced future sales and revenue expectations, it is reasonable to expect stocks to pullback from recent highs. Thomson Reuters estimates a 9.5% fourth quarter profit gain from a year ago, but that projection may turn out to be too high depending on what companies report for the third quarter. Revenue growth has been sluggish and U.S companies have been beating Wall Street earnings expectations in recent quarters primarily by cutting costs. Most of the low hanging fruit has been picked as companies have made the most obvious cost cuts and of course they have not added many employees since the recession started.
Even if market strategists are correct and third quarter earnings disappoint, that will probably not lead to a market correction. Remember that stock valuations have been out of synch with revenue and profit results for a long time. The best bet is for stocks to trade range-bound during earnings season and then move out of the range as traders speculate on what the Fed will announce at their next meeting in early December. The blue boxes in the SPX chart below highlight the S&P 500 index during the recent first and second quarter earning seasons. Notice that on both occasions' stocks remained in a trading range and moved out of the range as earnings season ended. In fact, stocks have already been range-bound since the second week of September.
The September 30th Couch Potato suggested "...The best bet is to expect prices to settle into a trading range with resistance at the recent 52-week highs..." The updated SPX chart below confirms stocks have traded in a relatively tight range since the beginning of September. The support and resistance levels are clearly defined on the chart with trading volume consistent on both up and down days.
The September 30th Couch Potato also mentioned "... Until the P&F chart post an 'X' to signify a new uptrend, the near term trend is down..." In the updated SPX Point and Figure (P&F) chart below we have the trend reversal to a new uptrend. The P&F chart supports the analysis above suggesting a near term trading range. We will probably get alternating columns of a few 'X's and 'O's until prices break out of the range.
TLT Position Update -------------------------------------------------------------
TLT closed at $121.15 on Friday â€“ the October position is approx $1,700 in the black
The October 1st Couch Potato published an October expiration TLT bear call spread
Unless Treasury prices recover when trading resumes on Tuesday we plan on closing out this position for an approx. $1,100 gain as soon as the trade is available (see tables below)
The September 20th Couch Potato published an October expiration TLT put spread
The put spread is approx. $700 in the black (see tables below)
$117 strike price short put delta is -.1205 (88% probability this position will be profitable)
TLT Risk Analysis
As you can see in the TLT daily chart above, the day after we executed the call spread treasury prices crashed and triggered our exit rule to cash in gains from this trade. As mentioned above, unless prices immediately recover the plan is to close out the call spread. If we successfully close out the call spread the only risk would be Treasury bonds crashing further and threatening the October $117 strike price short put.
GLD Position Update -----------------------------------------------------------
GLD closed at $172.62 on Friday â€“ the October position is approx. $1,500 in the black
The September 20th Couch Potato published an October expiration GLD bear call spread
The call spread is approx. $600 in the black (see tables below)
$179 strike price short call delta is .1102 (89% probability this position will be profitable)
The September 20th Couch Potato published an October expiration GLD put spread
The put spread is approx. $900 in the black (see tables below)
$165 strike price short put delta is -.0720 (93% probability this position will be profitable)
GLD Risk Analysis
As indicated in the GLD chart above, gold prices have stabilized to relieve overbought conditions. Price stabilization near resistance is considered bullish and until there is a confirmed downtrend the most probable risk is GLD setting 52-week highs and threatening our $179 strike price short call.
As discussed above with the TLT call spread, the exit rule for this trade is triggered and unless Treasury prices recover when trading resumes next week, we will try to close out this position.
Anytime the market maker is willing to accept a limit price of less than .10 on one of our short strikes, buy back all the short contracts and sell the long positions on the same spread. However, if it is a week or so prior to the expiration date, we may be able to hold out for a .05 (or less) bid.
If one of our short strikes is penetrated (closing price above a short call or below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.