Dear Fellow Trader:
My indicators are giving bullish readings this week, an upgrade from last week’s bearish sell signals. Additionally, as money managers allocate capital to their funds at the beginning of the new month, this coming week should have a bullish bias, so we are squarely in the bullish camp. We are also approaching a holiday-shortened week, as U.S. markets will close early at 1 p.m. ET on Monday and remain closed on Tuesday for the Fourth of July holiday.
We’ve seen a lot of choppy action over the last few days, with the market posting one of its best days of the year on Wednesday before giving up all of those gains on Thursday. I believe part of the selling yesterday was due to institutional traders lightening up on positions before they go on vacation through next week’s market holiday, although buyers did step in and lift stocks off of their lows during the afternoon session.
The market has been surprisingly strong lately. Stocks fell as it was announced that the health care bill was being delayed until after the July 4 recess, but they popped right back up the next day as traders shrugged off that news.
I will say, though, that there are some signs that we could be approaching a longer-term top for the market. For example, even with the spike in the S&P 500 Volatility index (VIX) yesterday, it only closed at 11.44, which is still very low. This is telling me that investors are pretty complacent, and complacency is a classic sign of a market top.
Additionally, while yesterday’s gross domestic product (GDP) report came in better than expectations, the 1.4% growth reading was not really all that strong. Going forward, it will be even harder to generate more growth as interest rates rise.
Another sign I’m concerned about is that Nobel Prize-winning economist Robert Shiller, one of the economists I have a lot of respect for, said yesterday that his cyclically adjusted price-earnings (CAPE) ratio is currently at levels that have only been seen in the years 1929 and 2000. As opposed to a normal price-earnings ratio, the CAPE ratio uses average earnings over the past 10 years, adjusted for inflation, which he believes provides a much more reliable indicator for valuations.
One thing that is positive, however, which suggests that the market should continue to rally or at least stay near current levels, is that we do not have an inverted yield curve here in the U.S. An inverted yield curve, when short-term rates are higher than long-term rates, often precedes a recession, but we’re not seeing that right now. The yield curve in China inverted this year, but it hasn’t reached the U.S. yet.
The yield curve is actually steepening in the U.S. this week following the positive results of the Fed’s stress tests on the big banks, which is a good sign. Almost all of the banks passed, but I don’t put much faith in these stress tests. What I really think is keeping this market up is the hope that we will finally get the health care and tax reform bills passed, so that’s the real protection against more downside. However, if it starts to look like those aren’t going to get passed, we could see a larger correction.
Crude oil prices have recovered somewhat from their recent lows, but a barrel is still sitting around the $45 dollar level. Therefore, I think it would be a good idea to look at quality energy stocks for possible value plays. A lot of the bigger, more stable energy companies, such as Royal Dutch Shell (RDS), ConocoPhillips (COP) and BP plc (BP), were dragged down with the rest of the sector.
The key here is to look for companies with low debt-to-equity ratios, as I think these names could hold some opportunities for a longer-term recovery in oil. Elsewhere, I still think financials and drug companies have plenty of room to move higher, and you’ll see some new recommendations in those sectors listed below.
Overall, I think the odds for the market to drop are greater than the odds that the market will rise. However, we do not want to buck the trend, which, despite yesterday’s decline, is still to the upside. For that reason, I’m recommending three new call options and two new put options today.
This Week’s Trades
Every week, I scan thousands of potential option plays to develop your exclusive list of Power Options. These Power Options rely on a proprietary, scientific approach that removes the guesswork and allows my powerful software to identify the best option buys.
All of these short-term options are actionable for up to three days after they are recommended. You’ll need to watch the stock and option prices to ensure the trades are close to where they were when I made the recommendation. If after three days you still have not gotten the position filled, cancel the order and watch for my new recommendations, as the profit probabilities may no longer be valid.
Buy to open the Bank of America (BAC) Aug 25 Calls (BAC170818C00025000) at $0.55 or lower. After entry, take profits if the stock price hits $25.60 or the option price hits $1.20. Exit if the stock price closes below $23.70.
Buy to open the Bristol-Myers Squibb (BMY) Aug 57.50 Calls (BMY170818C00057500) at $1.40 or lower. After entry, take profits if the stock price hits $59.80 or the option price hits $3.60. Exit if the stock price closes below $53.80.
Buy to open the Akamai Technologies (AKAM) Aug 55 Calls (AKAM170818C00055000) at $1.20 or lower. After entry, take profits if the stock price hits $55.20 or the option price hits $3.30. Exit if the stock price closes below $47.70.
Buy to open the Costco (COST) Aug 150 Puts (COST170818P00150000) at $1.55 or lower. After entry, take profits if the stock price hits $150.40 or the option price hits $4.30. Exit if the stock price closes above $162.80.
Buy to open the Silicon Laboratories (SLAB) Aug 60 Puts (SLAB170818P00060000) at $0.95 or lower. After entry, take profits if the stock price hits $61.50 or the option price hits $2.80. Exit if the stock price closes above $71.70. Note: This is a relatively thinly-traded option chain, so you may need to be patient to get established at my recommended entry. Avoid buying a large number of contracts at once; instead, enter your orders in smaller lots of five or 10 contracts.
Remember, if a profit target is hit intra-day, exit and take profits immediately. Occasionally, if a sudden profit appears, we may recommend exiting a position early to capture the gains, and my team will alert you during the trading day via email or text message if you have elected to receive them.
If the position closes at or below the stock- or option-based sell signal price, exit the trade the next morning at the open.
Additionally, if an option or its underlying stock does not hit its target, or if the stock does not close at or below its sell signal price within three weeks of entry, close the position. I do not recommend holding an option play for more than three weeks.
As always, we’ll let you know when there’s a profit-taking opportunity, and we’ll be back with a look at all of our positions on Wednesday. Have a great weekend.
Ken Trester and the Power Options Weekly Team
Important Note: This sample issue was originally published several months ago. All of the trade recommendations are now out-of-date and no longer apply. When you're ready to get into the next trades simply click the button below.
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