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Risk Reversal - In The Money

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Shortly after the open today, I filmed my weekly In The Money segment with Fidelity Investments. Click below to watch and see my notes below the video:

Risk Reversal - In The Money Player

 

Here are my notes from today’s show:

Macro: For the first time in many years investors in the stock market are left to contemplate what a rate hiking cycle means for the valuations of risk assets and the potential to slow economic growth. In a healthy economy, While the words “down on the year” have been foreign to investors for some time, it makes sense to take stock of just how much we are off from the highs, and how far we have come over the last year! The S&P 500 (SPX) remains in the well-defined uptrend it has been in for more than a year and is only down 5% from recent all-time highs made in the first week of the year. Next week the Fed will meet, it would take a meaningful sell-off in a short period of time for them to change their course, but it may feel like an eternity between then and their next meeting in mid-March, where CME’s Fedtracking tool is pricing in a quarter-point rate increase of Fed Funds. A lot can happen between now and then on the earnings front and possibly geopolitically.


Trade Idea #1: Short Energy Stocks, Despite lots of trepidation about equity valuations and rising rates, there seems to be universal optimism that the price of oil should go up when omicron is over and the looming threat of a geopolitical dust-up between Russia and Ukraine or between China and Taiwan could cause further price appreciation in Crude oil. Well, all i know is that the last time the Fed was ending QE and raising rates in 2014/15, the dollar rallied hard, and oil got hit very hard. The XLE that tracks large oil companies, with XOM and CVX making up 43% of its weight is the best performing sector year to date, up 16% and up 25% in a straight line over the past month. I think you fade this move, with defined risk.

Bearish Trade Idea: XLE ($64.50) Buy March 64 – 56 put spread for ~$2 

-Buy to open 1 March 64 put for $2.80

-Sell to open 1 March 56 put at 80 cents

Break-even on March expiration:

Profits of up to 6 between 62 and 56 with a max profit of 6 at 56 or lower

Losses of up to 2 between 62 and 64 with a max loss of 2 above 64

Rationale: this trade idea risks ~3% of the ETF price and breaks even down ~4% with a max potential gain of 9% of the etf is down 13% in a little more than two months,


Trade Idea #2: Long Biotech (XBI) – Despite the debt of gratitude the world owes to pharma and biotech companies who developed covid vaccines, the sector is one of the worst-performing groups in the S&P 500 over the last year, with the ETF that tracks the group down 10% on the year and down nearly 35% from its 52 week highs. I think you play for a near-term bonce to the breakdown level near $120:

Bullish Trade Idea: XBI ($96) Buy March 97 – 117 call spread for ~$5

-Buy to open 1 March 97 call for $6

-Sell to open 1 March 117 call at $1

Break-even on March expiration:

Profits of up to 15 between 102 and 117 with max gain of 15 above 117

Losses of up to 5 between 102 and 97 with max loss of 5 below 97

Rationale: this trade idea risks ~5% of the ETF price and has a max potential gain of ~15% if the etf is up nearly 20% in two months


Lookback – Last week when the QQQ the ETF that tracks the Nasdaq 100 was $390 I detailed a bearish trade idea:

QQQ ($390) Buy Feb 390 – 360 put spread for $7

Now with the QQQ ~$374 the 30 wide put spread that cost $7 is worth about $13, nearly a double, it makes sense to either take half off or roll the strikes down, by closing the existing put spread and using some of the proceeds to buy a lower strike put or put spread.

The NDX’s weakness is nearly double that of the SPX, down about 10% from recent highs, below its 1yr uptrend, and very near its 200-day moving average.