Options Trading Insights: Market Breadth Worsens. A “Blow Off Top” Anyone? 2-5-24

A “staying the course” FOMC mantra goes ignored, market breadth worsens. A “blow off top” anyone? 

Saw this funny cartoon on Hedgeye and had to share:

This pretty much sums up the feelings I have about the markets currently.  We continue to see all time highs, but with overall market breath standing at 60% above the 50-day moving average (see below). 

For markets to remain at all time highs this number should be quite a bit higher in my opinion.  Without better market breadth, corrective price action can turn more violent than we want it to be when buyers eventually run out.

Another thing that happens when markets reach all-time highs is its tendency to attract the short selling crowd.   Those counter trend traders who think they know better than the overall market and try to short a market that is surging to the upside.   

This can cause something called a “blow -off top”,  where markets turn parabolic, gap higher, cause capitulation among the short sellers,  and eventually crash in spectacular fashion see below.  We are obviously not there yet but it is something to watch as we make new highs and enter later innings.

When I first began trading over 25 years ago,  there were many times when I viewed economic data and scratched my head as to which direction the market decided to go in.  Is good news good news?  Is bad news bad news?  Or…is good news bad news or is bad news good news?   It all can be quite confusing sometimes!  

The hot payroll data (see below) would suggest a market sell-off due to the thought of rates remaining higher for longer. The market, however, seemed to shrug off the fact that March is pretty much off the table for a rate cut. The market chose to look at the overall economy and give it a thumbs up.

If the US treasury’s rise, which they did on Friday to 4% and move higher, that could put equity markets in jeopardy because it all goes back to where do institutions place their money for the least amount of risk possible and for satisfactory returns for their shareholders.  

If they could do this at the risk free rate and earn a decent return they will do so and  reduce equity exposure in the process. The 10-year treasury yield is currently starting an early stage uptrend, as well as the VIX refusing to make new lows, this tells me to be bullish, but cautious, and to be realistic about how much further we can push to the upside (see below). 

10 Year bounced to 4% again this Friday and that level remains “sticky”

If the market made a new high why didn’t the VIX put in a new low? 

When these subtle warning signs begin to show, it is not time to be bearish, but it is time to be smaller in size and a bit less bullish.   For an options trader this means a few different things. 

Continuing my “B “ grade on the market, adding bullish names into pullbacks, but keeping bearish names in my portfolio with conservative targets is the right strategy for this week. If the market was to break higher I can add more bullish exposure,  conversely if the market moves lower I could simply add more bearish exposure.

With Industrials having a really good week,  I’m going to look towards this group for potential bullish trades.  One name in particular is TXT ( see below).

With earnings past in a nice move to the upside,  the stock is now in a high type base in a market that is poised to move higher as well as a sector that is doing well. If the basing continues I can lose money on straight call options because of time decay so I will be looking at the following type of trade:

Calendar spread:

BUY TXT 85 Calls DTE 3/15.

SELL TXT 85 Calls DTE 2/16.

A trade like this would allow for an entire 2 weeks of non-movement,  with the potential for a Breakout.  This trade would  still be profitable if the stock move is very little in the next couple of weeks.

Another name in the industrial space to take a look at is LHX,  which just performed a bit of a pullback right into its 20-day moving average and also has earnings that have already passed.  

If this name confirms on Monday to the upside, it could potentially make new highs along with the rest of the market (see below).

Diagonal spread:

BUY LHX 200 Calls DTE 3/15.

SELL LHX 210 Calls DTE 2/16.

This trade is similar in style to the calendar spread but allows for a slightly higher target of $210 by February 16th. From February 16th onward you are left with a straight call that could potentially break out to new highs.

I’ll be watching the regional banks for potential short opportunities.   There was some chatter this week that some of these smaller banks remain in bad shape and the entire group has come under pressure in light of the New York Community Bank fiasco(see below).

Since markets are bullish and sentiment is high,  I will place bearish trades but with low expectations and conservative targets if I place them at all. Since rigorous research is not my cup of tea I will look to Screeners to do the heavy lifting and find the names that I want.  Two possibilities are WBS and ZION (see below)  as potential short candidates.

This week’s economic data is fairly light so expect some movement from earnings moves in the middle of the week.  With sentiment remaining strong  but internals slightly weaker, I will remain somewhat bullish but can’t ignore the fact  that we are starting to get into innings.