Despite solid data this week, keep your eyes on earnings … how to make money in a go-nowhere market … the nuts and bolts of the Strategic Trader market approach … a key S&P level to watch
This week’s good news began with a cooler-than-expected Producer Price Index (PPI) report.
This measure of inflation notched its smallest increase since July of last year, and came in lower than forecasts.
That same day, the Fed released its Empire manufacturing report. While most analysts expected to hear that manufacturing activity had contracted, the numbers showed expansion.
Then came the retail sales report. We learned that core retail sales (excluding food and energy) climbed 1.3% on a month-over-month basis. That towered above estimates and showed a U.S. consumer still opening their wallet.
Put it all together and these are encouraging numbers. They suggest the “soft landing” that the Fed is attempting to engineer isn’t out of the question.
So, why aren’t our technical experts John Jagerson and Wade Hansen more bullish and more aggressive with their trading positions?
From their latest Strategic Trader update:
The data is good; it’s good enough to justify our forecast that support on the major indexes is still solid.
However, a big bullish trend needs stronger growth numbers.
According to FactSet, average analyst expectations are set that the companies of the S&P 500 will report a -1.00% contraction in earnings in the fourth quarter.
If we exclude the energy sector, which has enjoyed windfall profits this year, the S&P 500 already posted an earnings-decline in the third quarter.
John and Wade write that if Q4 turns out to be the low point for earnings growth rates and outlooks improve in January, that’s when broader bullish bets would make more sense.
But until then, what trading style works in a sideways market?
Generating cash in a market that’s going nowhere
Many Digest readers find our Friday Digests some of the most valuable because we often feature John and Wade’s market analysis that highlights various indicators, ratios, and metrics providing valuable clues about market direction.
But as to how John and Wade actually trade the markets, that’s still a gray area for many readers.
In short, they use options.
If your immediate reaction to “options” is negative, that’s understandable. In many investment circles, they’ve developed a poor reputation for being a fantastic way to lose lots of money in short order.
But that’s an unfair characterization.
It’s a bit like concluding that all vehicles are terrible and should be avoided because some people are bad drivers, resulting in wrecks or even death.
Similar to a vehicle, an option is nothing more than a tool. Whether its impact is good or bad depends on the user of the tool.
Think of it this way … how would you like to be able to do the following things:
- Generate income in a market that’s going nowhere. I’m talking 20%ish annualized returns (sometimes far more) from quality companies
- Buy blue chip stocks at a price that you identify ahead of time and consider a good bargain – and get paid to buy at that price
- Earn additional income on a stock in your portfolio that’s already climbing
- Hedge your broader portfolio
These are all things any investor can do using options.
Thanks to the versatility provided by options, John and Wade write:
We don’t need a bull trend to make profits.
So, what exactly is the strategy? How does it work?
Let’s start with what not to do.
The way most gamblers use stock options, it increases their risk. They buy options, betting on a big payday when an underlying stock moves in the direction that they want.
Yes, this bet can result in a big payoff.
But all too often, the opposite outcome plays out. There’s a huge loss of capital when the market doesn’t behave.
John and Wade’s technique is the opposite.
Instead of buying options, they sell them. In other words, they play the role of the house.
While others are gambling, John and Wade are the casino.
Let’s look at a simple example.
Say that Jim holds a big chunk of Microsoft in his portfolio. The company announces earnings soon, and Jim is worried about a miss. He fears Microsoft might sell off on the news.
So, he finds Mary and offers her a deal…
If Microsoft’s stock price falls below a set price (called a “strike price”) at any time within a specific time period, then Jim can sell his Microsoft shares to Mary for an agreed-upon price. Mary will buy those Microsoft shares for that price — even if Microsoft’s market price at the time is lower.
Basically, Jim is anticipating that Microsoft’s price will drop. Because of this, he’s purchased an insurance policy.
Now, that’s obviously a good deal for Jim. But what does Mary get out of this?
In exchange for making this deal in which she plays “the house,” Mary receives cash from Jim, paid up-front, which she gets to keep — regardless of whether Microsoft’s stock drops or not.
That means if Microsoft comes out with better-than-expected earnings and the stock soars, it will never dip below the strike price. And that means Mary walks away from this deal with nothing but a new wad of cash in her pocket. Jim continues to own all his original Microsoft shares.
The option just described is a “put” option. And with John and Wade’s strategy, they play the role of Mary.
Now, if you’re thinking, “this could mean I might have to buy a stock at some point” then you’re right.
That’s why John and Wade only make these deals on world-class companies, the type of market dominating stocks we’d want to own anyway. For example, just yesterday, John and Wade took profits on three trades on fantastic companies: Bank of America, Ford, and Southwest Airlines.
It’s also important to note that our example only covered a “put” option. “Call” options provide investors with a powerful cash generation strategy if they end up buying a stock.
By the way, since you’re likely wondering, of all John and Wade’s closed trades here in 2022, 95% of them have been profitable.
With that simplified strategy explanation behind us, let’s return to the today’s market conditions.
What are John and Wade watching to give them an idea of where stocks go next?
That’s the key level to watch for the S&P.
This has been a resistance point for the S&P, but last week, the index finally broke above it. The issue now is whether bulls can transform this level from resistance into support.
Here’s John and Wade with more:
We would be a lot more confident about a short-term bullish forecast if prices treated former resistance as support with a bounce this week.
The more positive economic news is released, the more likely the market is to confirm the breakout.
As I write Friday, the S&P trades at 3,959, so about 1.5% above this key level.
Here’s John and Wade’s bottom line:
Our position over the last few months has been to remain cautious and focused on income during this period of market volatility.
Although economic announcements the last two weeks have been positive, the outlook for growth is still very weak.
This situation isn’t all bad – it means support is strong and we can use the price channel to increase the income we can harvest from our long positions in the portfolio.
Wrapping up, if today’s Digest has increased your interest in options, legendary investor Louis Navellier recently took a spin with John and Wade’s options system. Better still, he created a video about it.
To watch Louis dive into more details, as well as past trade performance, click here.
In any case, keep your eye on 3,900 in the S&P. If we hold and bounce, we’re likely in for more near-term bullishness.
Have a good evening,
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