Staying Calm and Trading One Stock at a Time

11/26/2020 10:01 am EST

Focus: MARKETS

Joe Duarte

Editor, Joe Duarte In the Money Options

The stock market continues to move steadily higher, albeit in a volatile rising channel, as the bullish combination of a major wall of worry and easy money until the cows come home from the Federal Reserve continue to move money toward equities, states Joe Duarte of In the Money Options.

On the downside there is still the overhang of uncertainty from Covid-19, the election situation, and of course, the lack of fiscal stimulus. Indeed, it is this combination of factors that continues to create volatile intraday trading as the news cycle unfolds.

Certainly, finding stocks that seem poised for long-term breakouts and heady momentum runs is getting harder. Moreover, this type of volatile and choppy trading action often signals that a bull market is getting old. Yet, despite all the factors, which anyone could use as an excuse to avoid trading stocks, the general action remains positive. Therefore, the only conclusion for now is to look for stocks that meet precise trading criteria and buy measured amounts with adequate sell stops.

Covered-Call Writing Review

In my recent visit to Dave Keller’s The Final Bar, I described the basics of the buy write–covered call option strategy, which can be a useful income producer especially during the current times where interest rates are low. Here are the basic tenets of the strategy as illustrated by a trade based on Gilead Sciences (GILD) that I described on the show:

  • Choose a stock forming base with upside potential such as Gilead Sciences. 
  • Sell Volatility. In this example the setup was favorable as the historical volatility (HV) was 18 and the implied volatility (IV) was 30.27.
  • Choose a slightly out-of-the-money strike price such as Gilead’s December 31, 2020 $63 call option (GILD_12312020_C63).
  • Use options that are at 45 days or less to expiration. When this example was described there were 43 days to expiration.
  • Check out the max gain, which in this example was $302 and a break-even price: $59.98 (GILD).
  • Use the breakeven point as your sell stop.
  • If the underlying stock’s price remains below strike price at expiration, consider rolling to the next 45-day time period.
  • If the option is in-the-money, consider closing both legs of the position or keeping the stock as you buy back the option depending on odds of assignment and general market conditions.

Here are two other key points to consider:

  • The upside potential for the buy-write strategy is limited. In this case the maximum gain for the trade was around $300.
  • The limited upside is balanced by the income potential of the trade if the two legs of the trade (the underlying stock and the option) are properly chosen and the trade proceeds optimally.
  • The downside potential can be substantial, which is why it is worth considering the closing out of the position when that maximum gain is reached or when your sell stop gets hit.

On the bright side, option trading software will give you all the key parameters of the trade before you pull the trigger. So as long as you know the basics before you trade you can just check off the boxes and make your decision.

New Wrinkle in MEL: Homebuilders Adapt to Changing Homeowner Expectations

As Covid-19 continues to deliver chaos, it seems as if the behavioral changes in the complex adaptive system comprised of the markets (M), the economy (E), and people’s life’s decisions (L) are evolving further. As I noted here last week before November 3 there were three major trends:

  • Population shifts from high-tax to low-tax states
  • A boom in housing fueled by low interest rates and the above migration and
  • The dominance of the 401 (k) plans as the focal point of MEL

Specifically, when it comes to housing, prior to Covid-19 there was a shift toward downsizing as empty nesters readying for retirement and millennials coming of age were looking for smaller homes. This led builders to shift gears away from building larger homes and increasing production of smaller models. But of course, when complexity and chaos collide things change, and in this case, it looks as if homebuyers are now looking for bigger homes.

Interestingly, the new dynamic has emerged because of quarantines, stay-at-home orders, and work-from-home requirements. Perhaps the whole concept jells best when we examine the latest building-permit data, which shows rising permits for single-family homes and falling permits for multiple-family dwellings (rentals) while at the same time the number of mortgages for home purchases is on the rise.

So, at this point it’s becoming clear that while the housing market may be changing, those builders who can adapt the best are likely to continue to do well, as I describe directly below. This is a great time to have your own set of go-to indicators at your fingertips.

Bigger is Better Again? Hovnanian Adapts to Changing Homeowner Expectations

I recently recommended purchasing shares of homebuilder Hovnanian Enterprises (HOV) based on a bullish chart pattern, but as I dug into the company, I found that HOV may be better suited for the next leg of the housing market than some of its competitors like Lennar (LEN) and KB Homes (KBH) whose shares have fallen lately.

hov

Specifically, after digging through HOV’s most recent earnings call I found several bullish nuggets:

  • The company is building bigger houses to accommodate changing tastes such as requests from purchasers for more indoor and outdoor space in order to adjust to the new Covid world.
  • They have raised prices, and no one seems to be complaining and
  • The current building data—i.e., the number of homes being built at the moment is still a fraction of the number of homes built during previous “bubbles,” a fact that suggests that the current trend in homebuilding is sustainable due to low interest rates.

But perhaps the diamond in the call was the statement from CEO Ara Hovnanian that because of regulatory burdens it takes a long time now to buy and permit land and to go through the process of building a home. So, while that’s not convenient for buyers, as long as demand keeps outpacing supply, this building cycle can and likely will be extended.

Technically, the stock is in a rising channel with reliable support at the 50-day moving average, which can be used as an entry point on dips if the stock holds there. Accumulation Distribution (ADI) and On-Balance Volume (OBV) suggest some short-term distribution but volume analysis and Volume by Price (VBP) suggest there is low risk as long as the stock remains above the 50 day moving average.

Moreover, aside from good support at the 20- and 50-day moving averages there is little overhead resistance. If the company continues to outperform expectations and there are no major roadblocks, especially on the political front, HOV is likely to continue its steady climb as it has adapted better than its competitors to the evolving marketplace.

NYAD Hovers Near New Highs

The New York Stock Exchange Advance Decline line (NYAD) made a couple of new highs lately and has been hovering near the new high ever since. We are, however, still looking for confirmation for the new highs on NYAD from the S&P 500 (SPX) and the Nasdaq 100 (NDX).

Still, even as NYAD remains well in the complexity zone trading above its 20,50, and 200-day moving averages and the general tone of the market remains positive, there are some subtle hints in the indexes, which are worth watching.

nyad

Specifically, the Accumulation Distribution (ADI) and On-Balance Volume (OBV) indicators for the S&P 500 and the Nasdaq 100 indices are somewhat cautionary as is the ROC. Together these three indicators suggest that there was some selling going on as the week progressed.

spx

By the same token, the issues with ADI, OBV, and ROC seem to be short term in nature, at least for now since these indicators remain above key support levels. However, if this trend accelerates and NYAD starts to break down we may see some aggressive selling.

ndx

The bottom line is that the market, for now, remains in an uptrend for the intermediate term but the short term shows that there is some doubt creeping into the bullish trend.

The stock market remains in a long-term uptrend, but given the uncertainty of the moment, the short term is likely to remain choppy. In other words, as we’ve been for the past few months the news cycle will be all about the election and Covid-19.

This means that intraday volatility will continue. And while we can’t ignore the volatility there is one effective way to filter it: monitor each portfolio position individually. If the market is falling but your stocks are holding up the chances are good that when the next news item hits, and the market bounces back, your stocks will participate in the new rally.  

To learn more about Joe Duarte, please visit JoeDuarteintheMoneyOptions.com.

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