Jun 29, 2020
9 mins read
Last week, the "Second Wave" narrative kept the Stock Market mostly in check. Unfortunately, I'm expecting much of the same for this week as more negative news mounts casting doubt over the entire reopening process. While it seems that some states are experiencing setbacks and have "paused" their reopenings, we've heard from Trump and Mnuchin that we likely won't/can't go through another shutdown of the entire economy. And my gut tells me that we don't get another shutdown. But, that doesn't mean the market won't chop around or even drop a bit while the market tries to figure out its next move and investors grapple with establishing price targets in an incredibly volatile environment. That's why this week will likely be another week where I limit my exposure (maybe even sitting all cash) as I wait for the market to make a move versus me trying to predict it. I know the prospects of sitting cash is not exciting to many (and I'm a gambler, so trust me I'm right there with you!), but I feel it's important for me to help you learn options and maintain enough capital to keep you in the game versus suggesting you chase every shiny object we see. It seems we really have reached the point where option premium is just too high and too large of moves are "priced in" for most options to be profitable. It doesn't mean is will be this way forever. In fact, it could all change very quickly. But until further notice, I'll be sitting mostly cash to give myself plenty of dry powder when things heat up (or cool down) in a clear predictable direction.
Over the past few weeks, as the pump out of the V-shaped recovery has slowed, we've seen less and less broad market pump and a lot more hype of individual stocks. For a few weeks, that worked great from a bullish perspective as we were able to see massive gains as the market seemed to pump some of these hype stocks to irrational levels at time.
And now, we're starting to see that same "hype" or news-driven buzz work against stocks when they get any bad news. Two good examples of that last week were Facebook and Boeing. Both got marginally bad news, and it seemed to set off a landslide for each constantly slipping without being able to find their footing. How long will these slides last? It's tough to say. Are both of these stocks underpriced now after their respective selloffs? Probably. But, that doesn't always matter because again, we're dealing with WAY too much uncertainty right now. And even though we can all assume both stocks will be more expensive one day, it's impossible to know when the market conditions will give investors enough confidence to pump these stocks back up to where they were just a couple of weeks ago. Until that confidence returns (which will likely take several green days in a row or a major bullish news catalyst that I personally do not see coming in the next few days), these stocks with bad news have become just another target for short sellers. So, be careful!!!
Just a reminder of some assumptions I posted last week. Once again, all still apply!
We are going to slow down. Even if we continue to trend up, these 10%-20 weekly gains on an individual stock are likely over for the foreseeable future. Any major pumps will be more than likely met by quick profit taking, so we'll need to be more diligent in locking in profits. We'll also want to temper our expectations when selecting strike prices.
Overnight swings have been and will likely continue to be violent, so I'll be limiting my overnight exposure to protect my capital.
It's entirely possible that for the short-term we've reached a point where option premium is too high with massive (and unlikely) moves being "priced in". It doesn't mean we can't still make money with options. It just means we'll have to be more aware of the possibility that we are overpaying, and that letting the option run all the way to expiration may result in a choppy performance with lackluster profits (if any at all). This just takes me back to locking in profits quickly and not getting greedy. In a healthy market, buying and holding through expiration works just fine. But in a market that some are now referring to as a "kangaroo market", it's a true "see profit, take profit" environment.
That being said, we did have at least one bullish news catalyst on Friday which could play out well for one sector - Electric Vehicles. On Friday, California regulators approved new rules that would see a massive shift from conventional gas and diesel trucks and vans to ones powered by batteries and zero-emission hydrogen fuel cells. This should be plenty of news to start a nice sector frenzy in the coming days/weeks. Here are some of my favorite stocks to watch:
NKLA (Nikola Motors)*
Playing the Bearish Side
With all the "second wave" concerns, it's definitely possible we trend down. The fall could even be a rather severe one in a moment's notice, so we'll need to exercise more caution than normal. But just like last week, I still believe the powers at be will continue to keep the market afloat. It won't be as aggressive of intervention and pumping as we've seen lately, but I just can't see another fallout like we had when this all began.
There are two ways to attack this:
Target ETF's like IWM, DIA, SPY - This allows you to profit on the down trend without the risk of an individual stock getting bullish news and/or a big pump. One thing to keep in mind here is that option premium is still very high and big moves are "priced in", so you'll need more than just a small 1%-2% drop to make significant gains.
Target individual stocks that get bad news - While this strategy is definitely more risky, it's also much more rewarding. And given what we saw last week with Facebook and Boeing, it seems targeting these stocks with bad news may be the way to go.
Sectors that would likely get hit the hardest if second wave news gets worse:
The Continued Recovery Bull Run
For this to play out, the "second wave" narrative has to wave goodbye. We also could see a boost if we get more stimulus news. Unfortunately, once again there are no planned events that give me too much faith we'll get that news this week. But, you never know when Trump may drop a surprise tweet that eludes to a stimulus just enough to get the market in a frenzy. Still, I'm not betting heavily on a continued bull run until I get some confirmation.
But, IF we get hot again, I see a replay of what we saw a few weeks back on reopening buzz - entire sectors going on huge runs as they make their way back to pre-Covid highs. It's difficult to try to predict which sector will pop the hardest, so I'll just give a quick rundown of my sentiments on each.
Note: Just because a stock is on my watchlist, doesn't mean I'm buying. It just means that I'm tracking it's movement on a daily basis to try to learn it's patterns and time my entry (if I even decide to enter).
* Indicates favorites
While there were a few individual winners, the technology sector ended up just chopping along last week and I could see more of the same this week. Still, we may continue to see "stock of the day" winners and if so, I like the chances of those winners coming from this sector. Just be sure to temper your expectations when selecting a strike price and take profits early and often!
FB (Facebook) - bounceback candidate
NKLA (Nikola Motors)*
This sector is a new addition to the watchlist. In a bearish "stock of the day" type environment, these types of stocks could be exactly what opportunistic investors target.
GILD (Gilead Sciences)
While this sector can still run hot (even when the market is cold), I'm growing increasingly nervous due to second wave concerns. I'm still watching these stocks, but likely won't be targeting these for option plays early in the week. If we get a nice overall market bounce this week, watch for these to pop nicely since they were beat up so bad last week.
ERI (Eldorado Resorts)
PENN (Penn National Gambling)
The travel industry just can't seem to hold its gains, taking one step forward and two steps back regularly. My views haven't changed one bit since last week: I'm still long term bullish on these and don't hate them at all from an equity standpoint, but timing is key with options and these are just too unpredictable. But, IF we go on a big overall market rally for any reason, expect these to pop hard because they still have so much room between their current price and all time highs.
BA (Boeing) - bounceback candidate
DAL (Delta Air Lines)
RCL (Royal Caribbean)
SAVE (Spirit Airlines)
SPR (Spirit AeroSystems)
UAL (United Air Lines)
The Week Ahead
Unfortunately, it seems the "second wave" narrative is going to continue to linger. While I still don't foresee any major setback, I could easily see a repeat of last week: lots of chop, a few "stock of the day" winners, and a couple of stocks that get bad news and are heavily target by shorts.
One thing to note, on Tuesday Mnuchin and Powell are testifying before the House Financial Services Committee. It's difficult to predict what will come out of this, but the last few times we've had similar catalysts it hasn't been great for the markets (resulting in chop/drop for the most part).
Once again, my number one goal will be protecting capital until we get back to a market I feel confident in. I'll continue to post my sentiment and plays on Twitter as the market evolves this week. Good luck!
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Thanks for all the support!