Yesterday just before noon, I filmed my weekly In The Money segment with Fidelity Investments. Click below to watch and see my notes below the video:
Here are my notes from today’s show:
Macro: Interest rates are rising with increased confidence in vaccine rollout and further fiscal stimulus and possibly an infrastructure bill as bond investors are getting in front of what they perceive will be the Fed’s need to take their foot off of the pedal on easy monetary policy for fear of letting the economy run too hot. While traditional inflation gauges are not yet flashing warning signs, or at least the ones the Fed quotes, we are seeing sharp increases in commodity prices which companies who use as inputs will need to either pass through higher costs to customers are risk them weighing on profits.
The 10-Year US Treasury Yield yesterday made a new 1yr high, at just 1.30% up from its all-time lows near 50 bps in August:
The 10-Yr Yield is now approaching the 1.4% level which was thought to be a “generational low” in 2012, 2016, and 2019, until the pandemic.
If yields go too far too fast it could cause equity investors to rethink valuations a bit, especially after such an epic run for stocks.
Those with large gains in single stocks might consider hedges like a collar
Trade Idea #1: MSFT has broken out to new highs, showing strong relative strength to AAPL and AMZN, both down about 8% from their highs. The stock chart appears to be defying gravity:
MSFT trades at 33x earnings which are expected to decelerate meaningfully from the mid-20s to low teens next year. The chart could spell risk in market sell-pff back towards $210 near the low end of a 6-month uptrend and 200-day moving avg.
Longs should consider collars, selling an out of the money call, and using the proceeds to buy an out of the money put, allowing for gains to the short call strike and losses down to the long put strike, for instance:
vs 100 shares long of MSFT at $243, Buy April 225 – 260 collar for even money
-Sell to open 1 April 260 call at $3.80
-Buy to open 1 April 225 put for $3.80
Break-even on April expiration:
Profits of the stock up to 260, stock called away at 260 (long holder could always buy to cover short call on expiration or prior to ensure the long stock position stays intact), so gains of up to $17 or ~7% in two months.
Losses of the stock of up to 18 down to $225, but protected below.
Rationale: this hedge allows for nearly 7.5% of gains in the stock between now and April expiration, limits losses to $18 or ~7.5% of the stock price between now and April expiration.
Trade Idea #2: Short Homebuilders and related stocks… via XHB, S&P Homebuilders etf. Rising rates should slow down housing activity and the XHB chart is extended and if it were to test the recent uptrend, could retrace to its breakout level near $50:
Bearish Trade Idea: XHB ($63.20) Buy June 62 – 50 put spread for $3
-Buy to open 1 June 62 put for $4
-Sell to open 1 June 50 put at $1
Break-even on June expiration:
Profits of up to 9 between 59 and 50 with max gain of 9 at 50 or lower
Losses of up to 3 between 59 and 62 with max loss of 3 at 62 or higher
Rationale: this trade idea risks 4.5% of the etf price and has a max potential gain of about 15% if the etf is down 21% in 4 months.
Lookback: Last week I detailed a near-term yield enhancement strategy in shares of Disney (DIS)
DIS ($186.50) Sell 1 March 210 Call at $3.15 vs 100 shares long
The stock is in nearly the same place, and earnings came and went, but the call has lost two-thirds of its value… look to cover when offered at 50 cents so. This chart of the price of the March 210 call shows the vol crush that happens in options after events like earnings.