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Trader Notes: Tips for Trading Options

As you know, the US main brokers (Ameritrade, Fidelity, Charles Schwab, eTrade) are now offering zero-commission in stocks, ETFs and options trading. A piece of great news, by far the best this year for retail traders.  It's a great opportunity to start trading options more aggressively, creating an options-based portfolio as now commissions are no longer cutting our profits.

1. Options as a substitute for Stocks: Delta > 0.80

Substituting stocks with options has two unique advantages: only options bring leverage and protection.

- Options provide tremendous financial leverage to users when they are used in a conservative way: you can control the same amount of shares with less money, and mainly, the % returns are much higher when you trade with options. This carries another advantage: with more money available you can diversify better your portfolio.

- And provide protection: with the appropriate strategy, in case of devastating fall of the stock, your maximum loss is always limited to the amount of the call purchase.  The use of stop-loss in stock trading works reasonably well but not always prevent losses due to frequently morning gaps. Stop-loss orders offer protection that is path-dependent (depends on the "path" the stock takes), while options offer time-dependent protection (and never trigger you out of the position just because of the path the stock, as stop-loss did).

Options are two-dimensional assets: you must guess correctly the direction and the speed of the underlying stock. When a stock-trader becomes an option-trader they often buy at-the-money call options (since they are cheaper) as a substitute for the stock. Doing so subjects them to a two-dimensional asset when they are used to trading stocks, a one-dimensional asset. When you starting out, buy short-term options in-the-money (ITM), calls with relatively high deltas in the 0.80-0.85 range and you will have an asset that behaves similar to the stock you are trading. They are more expensive but less risky.

The reason is that a call option with a delta of 1.0 is no longer considered an option, it's a perfect stock substitute. There is no time-premium there, and a lot of intrinsic value that we would rather not pay for. So you don't need to find a delta of 1.0 but should get close, and the 0.80-0.85 range will suit your needs. On the other side, if you buy a higher strike, there is too much time premium in the option and it may not respond to smaller changes in the stock price.

2. Use Credit Put Spreads

As you know, trade options are more complicated than with stocks. You need to guess not only the direction of the stock but also how quickly the stock's price will get there (the speed). We can combine two concepts for a solution, selling puts and the vertical spreads, to create a great strategy, the credit put spread.

- You can create a bullish trade not only by buying calls: you can sell puts. A short put, being on the opposite side of a trade of a long put, is bullish. Most traders, who are bullish, tempted to immediately reach for the long calls, also due to its unlimited gains, but they need the stock to move. A short put also makes money if the stock rises. And more important, also make money if the stock standstill. It's a big difference: by selling puts you don´t need the stock rise for us to make money; you just can't have it fall. You eliminated the speed component of the option.

- Sell puts creates an unlimited downside risk that you could control by creating an option spread, that's combining two different option strikes as part of a limited-risk strategy.  This called vertical spread, consider buying and selling a call, a call spread, or buying and selling a put, a put spread, of the same expiration but different strikes Essentially, trading put credit spreads is very similar to the short put. Preserves its advantages, but without its dangerous downside risk. And that's great!

A vertical spread can be bullish or bearish and can be for a debit or a credit. Let's review my favorite of all, due to its many great features, the credit put spread.

Click to enlarge.

Typical P/L (profit/loss) chart of a credit put spread. This month I'm bullish in silver (follow by the ETF SLV), now trading at $16.77. The spread was created with two legs: sell put 17 and buy put 16, for a net credit of $0.49. If SLV rallies, the put credit will decrease in value and result in a profit. Conversely, a sell-off results in a loss. As max-gain is similar to max-loss ($500), we had a good risk/reward ratio of 1. When the expiration date is near, the spread will benefit from theta decay, unless legs are completely ITM. 

As you verify in the chart above, a credit put spread has important features advantages against other option strategies. Let's summary them:

- Maximum profit: limited, and is the credit or premium received.
- Maximum loss: limited, and is the difference between the two strikes minus the premium received.
- Risk Level: low, if you use a Risk/Reward ratio near 1.0 or less. You could get it with ATM legs (that's one ITM and the other slightly OTM).
- Break-Even: is the strike price of the short pull minus the premium received.
- Environment: ideal when you have a bullish, neutral or slightly bearish position and don´t need a great move in the stock price.
- Legs: two, a bullish short put (the main) and, further away, a bearish long put (the protection).
- Goal: receive credit and hope both legs expired worthless, or the same, the stock price stays above the short put strike, as you can review in the chart above.
- Stock Volatility: as it affects both legs at the same time, its effect is mitigated.
- Implied Volatility: in terms of cost, for high IV, use the spread Buy OTM Put/Sell ATM Put. For low IV use the spread Buy ATM Put/Sell ITM Put.
- Time decay: acts in favor of a put credit spread, as short put gains with the passage of time, and its theta offsets the long option theta.
- Close Position: as other options, a spread could be closed at any moment, better prior to expiration if it reached its max profit. Sometimes you only need to close the short put since it can't gain more and leave the long put in case it rises. And if you reach the max loss, wait: always there's a chance that the position turn in your favor.
- Expiration Risk: be careful if the underlying expires within the short and long strikes, or the short ITM and the long OTM. You have the obligation to buy 100 shares of stock for each short put. If buying power isn't enough it will activate a margin call from your broker.

Selling options strategies with a favorable risk-reward and a high probability of success is the way an Income Trader works. Think like them and treat your portfolio as an insurance company: they live selling policies (options) for a premium, a successful business. The goal is to do the same: collect as much premium income as possible and never pay out the policies. So, maximize the number of credit trades, diversifying between index, ETFs and stocks, in different sectors, through bull or bear market conditions, analyzing only the stock direction. Now that brokers offer commission-free trades, it's perfectly possible.

In the next Trader Notes, we take a step forward with another popular risk-defined option strategy, the iron condor, that combines two verticals (a call credit spread and a put credit spread), for use when you have a neutral bias in the underlying.

This practical chart summarizes what options strategies work better depending on market direction and implied volatility size. Straddle, Strangles, Butterflies, and Calendars are not treated in this post, but in some next.

3. Best Options for Earnings Play

Buy a stock just before its earnings report is a bet: it can be highly profitable or devastating for your portfolio. You decide the risk you face. I always prefer to wait for the report, to compare their numbers with the estimates in EPS, sales, and guidance, review the conference call for some additional data and see the next day analyst's ratings, which usually increases or decreases their weighting and price target. Also, high-volume transactions with price and implied volatility moves, are guaranteed before and after the earnings date.

And, of course, you can use specific options strategies during these events. Let's overview some ideas as to choose the right strategy. You need to know the following principles:

-  A strategy that involves long options (been calls or puts) will typically gain value as IV increases and lose value quickly with IV decreases.
- On the contrary, a strategy that involves short options (been calls or puts) will typically gain value quickly with IV decreases and lose value as IV increases.
- During an earnings event, the implied volatility IV of the underlying usually increases some days before the report (due to typical great attention given by traders, creating orders like bets). And when the report was released it drops sharply.

Click to enlarge.

Thinkorswim includes this great feature in its platform, in which, at a glance, you could review the latest earnings of any stock, in this case, Disney DIS (my favorite 2019 stock), showing its price move and implied volatility before and after the event. 
Here is an example of what usually happens during an earnings event: despite the result (if the stock beats or miss EPS, sales or guidance), the implied volatility increases before the earnings date, and decreases quickly after it, the next day, hurting the premium. The goal is to take advantage of this movement.

If you decide your directional bias in the underlying near the earnings report, buy OTM calls (or OTM puts, depending on the direction) just before it, with cheaper premiums, looking for a big profit if the stock explodes after the report. It also works with spreads (OTM credit puts or OTM credit calls) for bullish or bearish bias, respectively. Traders love this simple strategy (really, it's a bet): low-cost, minimum risk but also very little profit probabilities in your favor. But it's valid: sometimes works.

If you have a neutral position or presume the underlying wouldn't have a sharp move before/after the earnings report, you could consider taking advantage just from volatility changes:

- Before earnings: entry long positions (long calls, long puts or ATM debit spreads) one or two weeks before earnings day, and then closing the position the day before the event, so to take advantage of the volatility increase mentioned above.

- After earnings: entry short positions (short calls, short puts, or ATM credit spreads) just before earnings, to take advantage of the volatility decrease mentioned above. The position could be closed just after the report.

As you see in the three option "tips" mentioned in this post, risk management is the main factor I consider in all of them.  Protect your portfolio and protect your gains is the key to become a profitable trader.

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A Decade in Charts

The ten years period, from  2010 to 2019, finished and leave us many transcendental changes in different branches, like the economy, technology, work, home, or retail. Let's review those moments through the way we love: charts.
Many of the charts and texts are taken from Morning Brew daily newspaper, definitely a great weapon for our Wall Street stock trading. Thanks, Brews!

Stocks (SP500 SPX and the Dow Jones DJIA) experienced the longest bull market in history, while Crude Oil /CL is still recovering from its 2014 dramatic drop. Gold /GC is still below 2011 and 2013 highs, while 10-year U.S. Treasury Bonds TNX swings during the decade in a range from 1 to 4%.

It's called the Tax Cuts and Jobs Act, and it reduced the corporate tax rate from 35% to 21%. Tax reform has led to a divergence in how much corporations earn and what they pay the government in taxes. A success from Trump's economic policies.

U.S. private equity deals have climbed steadily upward in both quantity and value, according to PitchBook. IT, healthcare, and B2B sectors made up the majority of deals.
From 2006 to 2017, the number of PE-backed companies increased by 106% while the number of publicly traded companies fell by 16%. In 2018, the number of private equity deals finally rose to pre-recession levels.

In 2019, U.S. venture capital (private equity and financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential) are expected to top $100 billion for the second straight year, according to PitchBook, with 185 deals above $100 million already recorded. The number of deals above $50 million has increased since 2012, though angel and seed rounds have been slowly declining since 2015.

NFLX In dollars, easier to view: the savvy investor who sank $25,000 in Netflix in 2009 would now be sitting on $1 million. Taken from @CNBC.

The FAANGs: in Aug. 2018, Apple AAPL became the first company in history to reach a $1 trillion valuation. One month later, Amazon AMZN joined the club (though it has since fallen back to the billions), and this April, so did Microsoft MSFT. But it's not just the number of 0's that has regulators and other businesses worried. These big tech companies have evolved from mostly singular missions (search engines, retail, phones) to businesses than span content creation, cloud computing, artificial intelligence, ad platforms, self-driving cars, and more.

Cryptocurrencies were one of the best-performing assets this decade.
That's mainly due to bitcoin. Bitcoin is a digital currency created in 2009, and for the first half of the 2010s, it flitted between obscurity and heavy skepticism from consumers, the finance industry, and governments. Then all hell broke loose in 2017 when it shot up to nearly $20k and turned some early backers into millionaires. Now...some are comparing bitcoin to the financial bubbles of centuries past. 
But over the latter half of the decade, something happened. Cryptos like Ethereum, Ripple, Litecoin, and (yes) bitcoin gained more legitimacy. Wall Street started thawing, and this year Facebook FB corralled some of the biggest names in payments, banking, investment, and tech to back a cryptocurrency project, the Libra Association

The U.S. unemployment rate fell from almost 10% at the start of the decade to 3.5% at the Bureau of Labor Statistics' last count. BLS's 2009 predictions that employment growth would be concentrated in the services sector, especially professional/business services and healthcare/social assistance, were pretty spot on.
The chart above represents broad industry categories. While manufacturing technically posted a net gain over the decade, it was still home to some of the worst-performing sub-industries over the last 10 years, including many apparel manufacturing sectors.

                                                 FAMGA acquisitions since 1999

The FAMGA (Facebook FB, Amazon AMZN, Microsoft MSFT, Google GOOG, and Apple AAPL) has made over 750 acquisitions in the last 30 years. @CBInsights has a nice chart on the $1+ billion acquisitions from 1999 to 2019.

                                            Trades, a threat for the economy

In 2008, the majority of the U.S. people considered trade more of a threat to the economy than an opportunity. Now, 74% view it as an opportunity for growth.

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Trader Notes: Tips for Trading Stocks

Stock trading, through technical analysis, is an art. There are full of ideas, strategies, and tips for doing it. You need to be alert to all of them and choose the adequate before you trade. Here are some simple, but useful ideas, that can help in your daily work.

1. Fibonacci "Golden Zone"

Traders love Fibonacci retracements. They are easy to learn and draw, and certainly accurate as alert zones.  Obviously, it doesn't work all the time (there's no infallible indicator or strategy), but as many retail/professional traders and big banks use them, its lines become important levels of support/resistance to place or close trades as price reversals can happen there.

But not all Fibonacci levels have the same importance or attention from traders and investors: the area between the 38.2% and 61.8% is called the Golden Zone, since its the most powerful of all.  They are many (payable) strategies on the web, about this zone, all of them based on the same principle: is an area of a relatively big length and if the price trend not change its direction there, use the 61.8% level as a reversal alert zone.  Simply check different timeframe charts with its Fibonacci lines draw to verify that. So, when you detect a tradeable Golden Zone, use all your arsenal: price action, adequate technicals indicators, and fundamental analysis. Your possibilities for a successful trade will increase.

The Fibonacci retracement never works alone: you need to use other indicators. Notice in this weekly chart of XBI (the ETF that follows biotech companies) how the shares pullback from mid-2018 highs.  In November-December crossed the golden zone not changing direction until finding an important reversal alert in early 2019 when touched the 61.8% level and at the same time the MACD did a bullish crossover and also the key 3-year uptrend line support was touched. A real powerful technical signal: shares began to rebound.

2. Volatility VIX spiking

These days, when the SP500 is moving in all-time highs, all investors' eyes are in developments of the Trade War: the US planned on initiating new tariffs with China, with December 15th as the deadline decides by Trump. We have news from both sides: reports that China and US were unlikely to reach a trade deal this week, however today news of another delay in tariff give some hopes to Wall Street. The fact is that markets could see more volatility ahead of the weekend, especially on Monday when markets open. The stock rally will continue or a huge pullback could begin, probably no more flat sessions. So, VIX is a good instrument for a simple strategy next weeks only if markets fall and volatility spikes.

More than a strategy, its a tip when trading the VIX. In its daily chart notice the clear difference between its relative tops and bottoms: tops are spikes (rapid rise due to market fear), like an inverted V, while bottoms (more complacence due to market greed) are more rounded and full.

The diligent trader has already grasped the idea of this strategy: trade in the spikes of the VIX daily chart, operating shorts or puts. To find an acceptable entry point, the Bohlinger Bands are useful: waiting for the moment when the bullish candle leaves the upper band with some slack. Then expect a next bearish candle that wraps it completely (or almost) the previous bullish. This candlestick is known as engulfing. The open of the next candle is my entry point. However, there are a couple of undefined points in this strategy. One of them is not being clear about the exit. Perhaps the best idea is to set in advance a risk-reward, like the popular 1: 3 used by many traders, to determine the exit.

The other complicated point of this strategy is the location of the stop loss. The usual is that the VIX continues its fall the following days and is difficult it returns above the engulfing candle, however, it can happen. A double top would be formed, the most reliable figure in the technical analysis according to Alexander Elder, where we could confidently sell VIX. The best plan is to trial daily the stop loss to a safe level.

The "VIX spike strategy" works best in its daily chart. Every year happens, few but powerful. In this chart, taken from 2015, we noticed two big spikes overcoming the upper band of the Bohlinger Bands (mid-October and mid-December, in the yellow circle), both followed by an engulfing candle that generates the quick and important reverse. Two more spikes happen in January and February 2016 (also in a yellow circle) but in both cases, its price didn't overcome the BB, so its reverse isn't as powerful as the 2015 spikes. Finally, in the pink circles, we had two spikes that haven't an engulfing candle enveloping them, so the reverse seems very unclear.

3. The feared Opening Gaps: Buy the Close, Sell the Open

A simple rule: is better, statistically, buy stocks at the close of the session and then sell in the morning of the next session. It's far profitable than "buy the open, sell the close"Bespoke Investment analysts compared both cases with the SP500 since 1993 when it was incepted. The charts and numbers are shocking, check it:

A $100 investment in 1993 using the "buy close, sell open" rise more than 480% to $587, while "buy open, sell close" lost near 20% ($79) in the same period. Of course, this is just statistics, didn't happen every session, but gives an interesting idea: if you are a swing trader who wants to follow the trend but you are afraid of the frequently opening gaps, don't close your position, hold the gap: you can get a decent trade. Finally, remember, in the long-term, the best odds are in your favor.

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Two Post-Earnings Stocks for December: AMBA and ROST

In these tense weeks on Wall Street, where on one hand we have the indexes in all-time highs, and on the other a series of fundamental problems (Trade War with no-solution yet, global economic slowdown, possible recession in 2020, negative interest rates, investment of the yield curve, etc.), an attractive investment to refine the short-term side of your portfolio is to observe stocks with good recent earning reports positive ratings from the analysts but, for "strange" reasons (of course, market manipulation from smart-money), their shares can't get a trend, keeping up the expectation to go up.

As I commented earlier, buy and hold a stock before its earnings report is a bet: can be highly profitable or devastating for your portfolio. You decide the risk you face.  Personally, I always prefer to wait for the report, to compare their numbers with the estimates in eps, sales, and guidance, review the conference call for some additional data and see the analyst's actions the next day, which usually increases or decrease their weighting and price target. I search for the stocks that beat estimates but didn't react well. I wait for its behavior in the next days, in which high-volume transactions and implied volatility move, ideal factors for trading, are guaranteed. It is not an infallible method (there is none in stock trading), but for one who handles low-risk management, it is the most advisable.

Two stocks that recently reported earnings, are taking my attention, due to its price action: the semiconductor design company Ambarella AMBA, and the retail stores Ross Stores ROST.

1. Ambarella Inc. AMBA, $55.205

Click to enlarge.


Ambarella 2020 Q3 ER highlights, was better than forecasts: EPS $0.32 beats $0.20 estimate, above $0.21 a year ago. Sales $67.9M beat $65.03 estimate, an 18.6% increase year over year. Guidance Q4 sees sales $55-59M, inline. The company "envisions automotive and security to be down sequentially while other revenues to be flat to slightly up sequentially. It predicts consumer electronics revenues to be persistently soft, declining as a percentage of revenues over the next two to three years".  For sure, a Trade War resolution could send this stock again to $80 levels, as in 2017.

The stock's initial reaction in extended hours was a 7% spike to $63.5 highs. After Conference Call, from CEO and founder Fermi Wang, shares decrease slightly to $54 when closes the next regular session on Tuesday. Also, volatility closes in 34% from 56% before the earnings report. Next day, analyst publishes its ratings and price target, and, as you see, with no upgrades but a generally positive view for AMBA, as all of them raised its price target

- Morgan Stanley: maintains Overweight rating. Price Target. $60 > $61
- Roth Capital: maintains Neutral rating. Price target: $55 > $60
- Craig-Hallum: Reiterates Buy rating. Price target: $62 > $70
- Deutsche Bank: maintains Overweight rating. Price Target. $50 > $55
- Stifel Nicolaus: maintains Hold rating. Price target: $54 > $55
- Bank of America: maintains Underperforming rating.  Price Target. $50 > $53


With shares ranging since October, Ambarella needs more signals for a bullish bias, as overcome the Ichimoku cloud, its SMA50 and 100 averages and the November month pivot at $55.31. Stochastic at lows is a good signal for a buy-the-dip trade. I presume a slow recovery, ideal for speculation, could begin next week if the technicals mentioned above are achieved.

2. Ross Stores ROST, $ 116.33

Click to enlarge.


Session post-earnings open at lows $109 but thanks volume increasing during the day, shares finally close at $111 and next day a slow but firmly bullish rally was seen, sending the stock to $116.33 at the close.

Ross Stores 2020 Q3 ER was, as usual, better than forecasts, as the company always gives low guidance: EPS $1.03 beats $0.97 estimate, above $0.91 a year ago. Sales $3.85B beat $3.77B estimate. Also, show increases in comparable-stores sales (5%) and operating margin (12.4%), both above-plan, and expecting a nice $1.25 for the next quarter, as told its CEO Barbara Rentler in the Conference Call. Good numbers, confirm with the many analyst rating:

- Wells Fargo: maintains Outperform rating. Price Target. $116 > $125
- Wedbush: maintains a Neutral rating. Price target: $110 > $115
- Nomura: Reiterates Neutral rating. Price target: $110 > $113
- Deutsche Bank: maintains Buy rating. Price Target. $118 > $120
- Morgan Stanley: maintains an Overweight rating. Price target: $104 > $113
- Bernstein: maintains Outperform rating. Price Target. $118 > $125


ROST is moving in a powerful bullish channel since March, above main moving averages and Ichimoku cloud. With the current  ER is likely this rally will continue in the mid-term. As it is now trading at all-time highs, a good idea is to verify when it reaches its next resistance is in the upper line of the channel, at $118.40. With volatility at year lows (20%) a good opportunity is seen here for trade calls ITM or bullish spreads in this, now oversold, stock when a little pullback from highs occurs, likely next week.

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Breakout Sectors for next X'mas Rally (if happens...)

It all depends on Trump-Xi decisions in the next weeks. Let's check some popular sectors with its shares near to make a breakout:

1. Semiconductors ETF SOXX, $234.74

Since May, the popular Semiconductors sector (really a subsector, not properly a GICS sector), followed by the ETF SOXX, was ranging forming an ascending triangle with a strong resistance that finally breakouts last week at $221.40. And was a successful breakout as you verify its daily chart, with its three phases clearly distinguish: action, reaction, and resolution, all of them with its volume requirements. Technically, its shares may begin to rise, despite being in all-time-highs, as all technicals signals are very bullish now. Shares are above the three main SMA averages, above the Ichimoku cloud and its pivot line at $219.26.
But be careful with two details: as usual, the Trade War developments (a bad or no agreement will be devastating for Wall Street), and next Qualcomm QCOM and Nvidia NVDA earnings, two giants of this sector that could reverse the chart if its reports don't satisfy investors. I wait for a little pullback, due the stock is overbought now, and then enter long.

2. Biotechnology sector XBI, $83.14

The biotechs, follow by the popular ETF XBI, seems to be a great bet for these months. Now trading at the same levels of November 2018. Since April its shares were trading in a bearish downtrend channel as shown. Finally, last week overcome the key SMA200 average, and the upper channel line, but needs to retest it or could be a false breakout. On my radar: there is a long bullish road to go here for this industry.

3. Russell 2000 Index ETF IWM, $159.15

Not properly a sector, but an index, the small caps stocks are followed by the Russell 2000 index and its  ETF IWM, and of course the popular, and very volatile, ETFs TNA and TZA. Technically, its daily chart shows the same patterns as the XBI chart above: a bearish downtrend channel, with a recent breakout of the upper channel that needs to be confirmed in these days. Also, this ETF is on my radar, waiting for a long trade. If Trump and Xi decide to finish their war, the sky is the limit for all the markets and especially for this index.

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My Stock Watchlist for November-December 2019

November- December 2019

On my Thinkorswim trading platform, I manage several watchlists, differentiating them according to the instruments it contains. There are stocks, futures, ETFs, sectors, and indices.

My different ETFs watchlists (not shown below) usually keep the same symbols in time, diversified by sectors, industries, countries, commodities, both at 1X normal speed and 3X triple speed, combining long and short positions. My indexes, sectors, and futures watchlists (also not shown) are also fixed, covering the main index and commodities in Wall Street and major foreign exchanges, the usual managed by all traders.

Those that do change, usually weekly, are the symbols of my Main watchlist, shown below, 18 stocks which I follow on a daily basis, due to my own research, that consider both fundamental and technical analysis, news topics or popularity. Over time, it appears in the list a new stock, disappear other, according to the importance they are acquiring, in my opinion.

Keep in mind, it's a watchlist (longs and shorts), not a "Buy" Lists. My suggestions, charts, and ideas regarding these stocks, in which I'm long, short or neutral, I do in the blog posts. And more fresh data and news in my daily tweets through Twitter or StockTwits, which are much more friendly and dynamic platforms for a chat and get feedback from traders.

Image was taken on November 3rd, 14:22 EST.
Favorite 18 stocks that I'm following during November-December 2019.
Important notes:

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Trader Notes: Are Buybacks driven the Stock Market Rally?

Definitely, YES. And they have the main credit for the stock market's rally since the 2009 crisis, and especially the latest years as they been reinforced during Trump's government due to the Tax Reform. It is enough to watch buyback' charts prepared by investment analysts to verify it, I add some of them below. 

Briefly, let's define the stock buyback. And what a better way to explain it that Investopedia, which defines that "a buyback, also known as a share repurchase, is when a company buys its own outstanding shares to reduce the number of shares available on the open market. Companies buy back shares for a number of reasons, such as to increase the value of remaining shares available by reducing the supply or to prevent other shareholders from taking a controlling stake." In days of a struggling economy, where get growth and profit increases are difficult, buybacks seem a good reason for companies to artificially inflate their share price.

Example of a Buyback

A simple numeric example, the best way to understand this, also taken from Investopedia: "A company's stock price has underperformed its competitor's stock even though it has had a solid year financially. To reward investors and provide a return to them, the company announces a share buyback program to repurchase 10 percent of its outstanding shares at the current market price."

Continue: "The company had $1 million in earnings and 1 million outstanding shares before the buyback, equating to earnings per share (EPS) of $1. Trading at a $20 per share stock price, its P/E ratio is 20. With all else being equal, 100,000 shares would be repurchased and the new EPS would be $1.11, or $1 million in earnings spread out over 900,000 shares. To keep the same P/E ratio of 20, shares would need to trade up 11 percent, to $22.22"

That's the reason:  no pay dividends, I prefer a share repurchase, which artificially raises the stock price. Great earnings season forever. Abnormally high levels of buybacks in the latest years generate an SP500 rising every year, despite real macroeconomic problems behind (incoming recession, Trade War and Brexit with no solution, inverted yield curve, manufacturing+services sector' contraction, negative interest rates, bond bubble, and so on). Investors, traders, people, Trump, and all Wall Street living a false illusion today, happy and carefree, hovering around its historical all-time highs. 

Check the chart below: this 2019 was especially aggressive in stock repurchase (yellow columns) above the 2010-2018 average (black columns). But, the year 2020 seems unpredictable. Probably the next US recession halts this situation as this can't hold forever.

Let's watch more crazy charts

In the following chart, Ned Davis Research measures the impact of share repurchase over the last nine years and found a significant effect. One of its four scenarios "buyback funds used to pay dividends" is shown above: watch that the SP500 would have been 10% lower. Given that growth stocks with high momentum have powered market gains since 2010, buybacks have been a particularly efficient strategy for creating shareholder return during this period.

In the next chart, Goldman Sachs compares the accumulated flows for different cases since the subprime mortgage crisis. Amazing the spread: yellow line shows money from SP500 stock repurchases (now $5 trillion!) growing every year since 2009, while other instruments as households, foreigners, and funds exhibit disappointing numbers. But, be careful, a recent report from the same Goldman Sachs warns that corporate buybacks are “plummeting” as companies tighten their purse strings, and it could have a big impact on the market. The boom may begin to slow in 2020: time for look for high-dividend stocks? Is the end of the bull market?

And last week finished the Buyback Blackout...

It is a usual theory on Wall Street that the market indexes dip during the days in which companies can't buyback its shares (usually a few weeks prior to reporting earnings and ends a few days after it). That period is called the blackout. It's incredible how the SP500 chart really whipsaws or corrects during the blackout periods, creating so a great key for well-informed traders.  

For short-term investors and swing-traders this chart is gold: shows that the buyback blackout period began to ease since mid-October, and today many companies are ready to repurchase its shares. And matches with October 26th, according to Seasonax, the historically day when begins the usual Christmas rally (if this year comes) and, seasonally, the best bullish weeks in Wall Street.

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Gilead, Illumina and Twitter Q3 Earnings this week

Three companies from my stock watchlist report Q3 earnings this week, all on Thursday 25 at the close of Wall Street's session: Gilead, Illumina, and the popular Twitter.

Traders love earnings' days. It's the right moment in which stocks get momentum and volatility, ideal for a quick day trade or a swing trade. One of the first rules of risk management in stock trading is don't traded longs or shorts before the ER, because it's just as gambling. Don't hurt your portfolio with bets. In that case, better use option spreads like the popular straddle ATM or buy a cheap call (or put) OTM, risking little capital with minimal, but existing, chances of a great profit.

The other way is taken by cautious traders: previously check chart trends, latest news of the company for key data, recent earnings surprise, insider trading, volatility, market sentiment, short-interest, and so. When earnings are published, checks and analyze quickly the main lines of the report (EPS, sales and guidance, if they beat or miss the estimates), buybacks and sensible data of the particular stock. Look at the trend in a tick-chart, read traders sentiment through chats (like Twitter or StockTwits) and wait for the conference call, usually an hour after the report, for more key information. A conference call could easily revert the stock trend and liquidate a hurried trade. The next day at the opening is a good idea to wait for analysts' reports and ratings: upgrade, downgrade, price targets, based on results. With all this information in our hands, it is more simple get a profitable trade.

Technical analysis seems unnecessary before an earnings report, but that's not true. Traders, investors, and smart-money always are looking at the charts for the previous levels and trendlines as a guide to limit the upside move ahead a good report, and similar for the downside. Let's review these three stocks:

1. Gilead Science GILD, $65.86

What an amazing and "clean" chart! The support at $61.40 is really strong, near six touches in this year. And above a clear resistance in its uptrend line. And today the price touching it again for 4th time in the year, and also at its SMA200 average! Depending on earnings, the price could explode and break any of the levels of this year-descendant-triangle pattern, easily $70, only in case of a positive report.

2. Illumina Inc. ILMN, $309.05

Since reach year lows in September at $263, Illumina began a decent technical recovery and now is t$309, the same level at which its huge gap closes in mid-July. Near $70 to fill that and its Q3 earnings could be the way for. The stock is gaining momentum last two weeks since the recent partnership with Qiagen QGEN to deliver in-vitro diagnostic tests. Take note that the biotechnology sector (followed by IBB ETF), saw some strength last week. Positive clinical readouts, a couple of M&A deals and hopes of drug companies clinching a broader opioid settlement worked in favor of the sector. A good earnings report could send this stock to $325-335, above the 50% of Fibonacci retracement.

3. Twitter Inc TWTR, $38.81

Ambiguous sentiment is perceived in this stock before its earnings report tomorrow, despite today is breaking down its strong support in the uptrend line shown, with increasing volume. I'm expecting great volatility, and prefer to wait tomorrow for deciding a trade. Usually, many analysts publish their ratings on this popular stock that finally decide the stock trend. Bad earnings report could send the stock to $36.90, its SMA200 average.

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Market Indicators give divergent signals

Although denied by several media, its macro data and yield curve say so: the US economy is entering a cooling cycle, a slowdown that is not yet a recession. The last data of Retail Sales was devastating: there fell the last hope of a stable economy after the Manufacturing sector's last readings confirm its contraction of several months, while the Non-Manufacturing is in a limit of 50.

While the US and China have achieved a commercial truce, which does not eliminate the uncertainty between the two countries, the above factors probably stimulate the Fed to reduce its interest rate at its next session. Add to this fact, that the end of the stock repurchase blackout is this week (the real engine of the stock rally). All this makes Wall Street live a false illusion today, happy and carefree, hovering around its historical all-time highs. Investors and cautious traders have already become aware of this panorama and are changing their portfolios, not closing positions but being more defensive. It is clear the situation does not only affect the US, but it is global: the Trade War is passing a very high bill to the global economies.

Some private indicators are reflecting this particular situation, markets high in a pre-recession economy, and are mostly neutral at the moment, although with a bias to change trends for the medium and long term.

Three indicators, different signals

1- The popular indicator 'Fear & Greed' of CNN Money identifies the emotion that drives the market. And today it's exactly neutral, increasing its value 8% since the previous reading. It works also as a contrarian indicator, that is, excessive greed is a bearish signal. It uses seven indicators in its calculation, one of them being notorious this time: this last week the volume of puts dropped to its lowest level in two years, a sign of extreme greed by bulls investors.
Another similar, the Bull & Bear indicator from Bank of America, not shown, this week rises its value to 1.9 from 1.2, being now in the limit between Buy or Sell signal (value= 2). Usually very accurate and follow by the smart money, the message is clear: don´t buy, just hold positions.

2- The last weekly survey of the AAII American Association of Individual Investors, showed a strong migration from bears to bulls, although this is still below average. This reads as optimism for the next 6 months. As it has historically proven to be also a good contrary indicator, higher increases over the current 33.6% can be interpreted as a medium-long term bearish signal.

3. This graph of The Conference Board chart reads alone: it shows that the CEO level of confidence in the economy behavior was below the 50+ positive level, reaching its lowest value since 2008. Usually, this happens during recession months (shaded in gray). Could it be that CEOs see economic problems before individuals of the AAII?

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Volatile days until Trade War meeting this Friday

After multiple downbeat economic reports earlier in the week, the SP500 SPX finally recovered little to finish the week down only 0.3%, thanks to Friday Jobs Report. Early week, poor numbers out of the manufacturing and services sectors, pushed the SPX down more than 1% for consecutive sessions for the first time this year. Friday’s jobs report showed that the U.S. economy added 136,000 jobs in September which was slightly below expectations, and the jobless rate dropped from 3.7% to 3.5%. This marked a 50 year low in the figure.

ISM index drive the markets

We already knew that the manufacturing sector has been struggling. Still, the ISM came in at 47.8, which is worse than expected. It’s the lowest number in more than 10 years, but not yet a recession (comes below 45). But last week it seems there was a "contagion". The ISM Non-Manufacturing Report was also below expectations. The reading was 52.6, which was the lowest in three years. Wall Street had been expecting 55. Since it’s above 50, we know that the Non-Manufacturing is still expanding, but it challenges the theory on Wall Street that the consumer is holding up the economy while the factory sector is in a recession.

This ISM Services number initially sent stocks sharply lower, but then quickly rebounded to finish higher on the day, when the SP500 touches its SMA200 average. Some felt that the recent data was bad enough to induce the Fed to lower rates twice by the end of the year (thanks to this week’s news, the odds of a rate cut are now up to 88% from 40%) making the bizarre case that Wall Street rallies on bad news.

According to Nomura Bank, usually very accurate in their technical analysis, the action level for the algos in the SP500 chart is setting this week in 2,970 for buy orders and 2,858 for sell orders and open shorts, that's near the SMA200 average. Today SPX is dropping 0.8% but is still ranging between those levels, waiting Trade War decisions, likely on Thursday.

Trade War: key to defining a future recession

The markets will be patiently awaiting the results of the US-China trade negotiations on Thursday and Friday. And it is all very clear, it is now up to Donald Trump to decide what will happen with the trade agreement, with the exchanges, and with the economy.

The Chinese have changed their attitude and now they see Donald Trump in a weak position, because his economy is already affected, because financial markets threaten to give problems, because they know he may have re-election problems if a recession is reached before the elections, and of course because he has many political problems (impeachment).

The Chinese Trade Minister has made it clear that they will not make any concessions. Without any doubt, they will not accept any of the great reforms that the United States poses. He has even expressly said that intellectual property laws will not change, one of the most conflicting points. But on the other hand, they have made it clear that they are willing to sign an interim or a "mini-agreement" immediately.

So, the definition is clear: Trump admits a "mini agreement" or there will be nothing. And evidently, the Chinese will stop buying agricultural products. If Trump accepts it, Wall Street will rally, but if Trump does not accept we can get into another descent of great proportions as much as he responds aggressively to all this.

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Rotation: Value Stocks are overperforming in September

In a week plenty of important economic news (Fed rate cut decision at Wednesday, Trade War concerns, Crude Oil price /CL spike after a drone attack, the recent ECB stimulus, the Friday Quadruple Witching, the huge spike in Repo Market rates yesterday), one is going unnoticed and I think it's crucial for exchanges in the mid-term: the "Great Rotation", as it has already been baptized by investors.

As you know, the Value stocks are those with low PE (Price/Earnings) and very stable fundamentals, and are opposite to the Momentum (or Growth) stocks, more focused on the aggressive growth of its value in the mid and long-term. This last, that have driven the bullish Wall Street rally for almost 10 years, is followed by the iShares Edge USA Momentum Factor ETF MTUM and includes giants companies such as Visa V, Mastercard MA, Microsoft MSFT, Disney DIS, among others. Meanwhile, the value stocks are followed by the iShares Edge USA Value Factor ETF VLUE which portfolio contains stocks like AT&T T, Intel INTC, IBM, and Bank of America BAC. Its average PE is 11.47 vs. 18.40 of the SP500. That's very undervalued, as you can verify in the chart above, a comparison between both ETFs performance in the last 5 years.

While MTUM has outperformed VLUE in the last 5 years, that began to change in August and VLUE's rally has accelerated month-to-date, as its risen 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM.

What happened?

However, the previous week a great move was seen in the positions of the "smart money", the great investors that drive the stock market. Their portfolios have moved (rotate) from active momentum to value stocks, and in an abrupt, almost atypical way. Why? Only they know... 

The fact is that these changes (the last rotation was in 2011) always impact in the markets, although we don't know the direction it will take. In numbers: while MTUM has outperformed VLUE in the last 5 years, but since August' last week the VLUE's rally has accelerated month-to-date, rising 7.4.%, versus a 2.8% rise for the SP500 and a 0.2% decline for MTUM. Here more technical details, with amazing charts.

Already some investors fear a downturn soon. But the fact is that this data only suggests that momentum stock are ready for a correction, and a rally in value stocks, but only depending on the economic behavior and next Fed decisions. A recession, or a slowing economy until 2020 invite the Fed to more rate-cuts to boost the economy and steepen the yield curve.

Russell 2000: time for an entry?

This rotation explains the divergence between the main indexes of the market: the last days of the Russell 2000 RUT, plenty of value stocks, has shown, by far, a much better performance than their pairs SP500 and Nasdaq. Undoubtedly, the Trade War affected and continues to affect much more these small companies with their production costs increase to the detriment of their margins and profits, but the index increase is there and seems nice.

On the other hand, the next sure Fed' rate-cut this week, which will reduce loans, will also favor Russell companies. This is understood as investors consider that increase in interest rates is especially expensive for smaller companies that tend to receive financing through adjustable-rate bank loans, rather than fixed-rate debt financing at which larger companies can access through capital markets. Their balance sheets may be adjusted in the short-term, and thereby improve the price of its shares and then the whole performance of the RUT index that in its last 52 weeks is still down 4.5%. These facts make IWM and IWN, ETFs that follow the Russell, great candidates for a buy in a mid-term, considering that, unlike the previous ones, they haven't reached their previous highs.

Technical analysis also helps the Russell 200 stocks: the daily chart of the IWM shows its price is breaking the resistance of a strong 52-week down trendline with heavy volume. Now above its 3 main SMA averages and the Ichimoku cloud, only need to retest this line at $155 to confirm the bullish breakout. Keep an eye on IWN, the ETF that follows only value stocks from the Russell. I presume a better performance there.

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World Economic News, at a glance

- Retail Sales just doubled estimates at 0.4% along with a bonus revision in the month previous to solidify the overall staying power of the consumer.
- The good news may be enough to inch the SP500 SPX closer to its all-time high of 3,027.98 which is now less than 20 points away.

- The ECB announced plans to cut its bank rate by 10 basis points to an unfathomable 0.50% yesterday as stagnant growth persists in much of the region.
- Monthly QE purchases will begin in November at a rate of 20B Euros in an attempt to jumpstart the latency.
- European markets appear to be ending the week on a positive note other than the UK which is off modestly as the Brexit hash-out continues.

- Encouraging news on the trade front indicated that China just exempted some agricultural products like soybeans and pork from enforceable tariffs as sure appeasement to further negotiations. The largest soy purchase since June was also ordered which will hopefully open the floodgates to more sizeable purchases.
- The Japanese Nikkei has approved of the latest efforts considering a 9th straight winning session now secured.

- Overall, volatility has contracted measurably over the past weeks with a 14 handle, registered in today’s session for a 4th consecutive drop in the CBOE Volatility Index (VIX).

- The yield on the 10-year Treasury Bond TNX continues to snap back with a current reading of 1.836% after the latest economic figures broke. A higher close on the day would mark a 5th straight jump in rates after bottoming at 1.429% just last week.

- Oil futures /CL remains little changed with crude sitting at $55.50 a barrel despite agreements from major producers to keep production in check ahead of the weekly rig count.
- Gold /GC has held its ground the last few sessions with a minuscule gain appearing ahead of the open as central banks grapple with the reality of negative rates.

(Text is taken from TradeWise Market Blog.)

Is this the main reason for the latest, and desperate, Trump tweet "rate cuts to zero"? A recession is likely coming, and could cost its re-election next year. Now he is open to an interim trade deal with China, and markets react positively with that news, touching the SPX its all-time highs.

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