Strategy
After the Apple Inc. (AAPL) drubbing along with some other recent momentum favorites it is becoming apparent profit taking in anticipation of higher capital gains tax rates in involved. There are several companies in the consumer discretionary sector due to report this week and if tax selling is a factor then those with large year to date gains should be most vulnerable.
Since we are expecting the decline to increase, we suggest employing more hedging strategies using sector ETFs or individual stocks.
More Hedging
PowerShares QQQ (QQQ)
Two weeks ago, we offered a hedge conditioned upon a close below support at 65 and last Wednesday it fulfilled the condition, so here is an updated version.
The current Historical Volatility is 15.88 and 12.97 using the Parkinson’s range method, with an Implied Volatility Index Mean of 18.87, up slightly from 18.26 last week. The IV/HV ratio is 1.19 and 1.45 using the range method to calculate the HV. Friday’s put-call ratio at .85 was bearish while the volume was 578,692 contracts traded compared to the 5-day average volume of 396,720.
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With a slight volatility edge, the debit is 29% of the width between the strike prices giving it a favorable risk to reward ratio. Use a close back above 65, the prior support, now resistance, as the SU (stop/unwind) in the event the decline is near completion.
The Home Depot, Inc. (HD)
With respectable recent gains, it looks vulnerable to selling after reporting 3Q earnings on Tuesday before the opening. The consensus estimate is .70 per share with a whisper estimate of .73 per share.
Although it advanced on Sandy news, it did not exceed the now broken upward sloping trendline from the July 23 low at 49.77. While any extra earnings due to Sandy will not be included in this report, no doubt management will make some comments. Further, the housing sector seems to be slowing in what may only be a seasonal decline, but a decline nevertheless.
With a weak market, there are many put spread alternatives available, but this one also has good options volume making it easier and less costly to implement spreads.
Since they report Tuesday before the opening, it needs doing today.
Here is the options data.
The current Historical Volatility is 19.98 and 16.00 using the Parkinson’s range method, with an Implied Volatility Index Mean of 23.17, up from 22.64 last week. The IV/HV ratio is 1.16 and 1.45 using the range method to calculate the HV. Friday’s put-call ratio at 1.80 was very bearish before the earnings report while the volume was 17,870 contracts traded compared to the 5-day average volume of 16,410.
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With a good volatility edge and only 16% of the distance between the strike prices, it has a very attractive risk to reward ratio, but it is a long way out-of-the-money and there is support right at 57.50. Use a close back above the most recent pivot at 62.50 the SU (stop/unwind).
Seasonal Gold
While it certainly did not happen last year, there is a seasonal tendency for gold to rise from early November through December that occasionally extends into January. However, the euro is also a factor since dollar strength is not friendly to gold, but there will be a lot of chatter about the fiscal cliff over the next few weeks, which will add to the uncertainty, and could add support for gold.
SPDR Gold Shares (GLD)
When we last suggested a gold trade in Digest Issue 35, it was advancing from the July lows. Now after correcting we think there a reasonable chance it could resume the advance and eventually exceed the October 4 high of 174.07.
Here are the relevant option numbers.
The current Historical Volatility is 12.80 and 8.05 using the Parkinson’s range method, with an Implied Volatility Index Mean of 14.53, down from 14.70 last week. The IV/HV ratio is 1.13 and 1.81using the range method to calculate the HV. Friday’s put-call ratio was right on the bearish dividing line at .70, while the volume was 168,563 contracts traded compared to the 5-day average volume of 245,770 contracts.
Consider this long call spread suggestion.
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With a slight volatility edge and good risk to reward ratio, use a close back below the last pivot made on November 2 at 162.30 as the SU (stop/unwind).
All of the suggestions above use the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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Summary
The November 7 decline eliminated the last ray of sunshine for the bulls and now most all of the major indexes appear headed lower for the immediate future, with gold being one of the possible exceptions.