February 9th, 2023

A Big Tech Company Releases A Dud

Mixed Earnings. A hawkish Fed. A big tech company releases a dud. It was a busy day for the markets that ultimately led to the S&P 500 losing over 1%.

Lumen Technologies is part of the S&P 500 and closed down more than 20% to help lead the index lower. But Fortinet (FTNT) gained more than 10% after announcing strong future guidance. It’s easy to forget about earnings since some of the biggest names out there are done. The good news is this is pumping some volatility back into the markets, which is what option sellers want to see.

I’m not sure it’s fair to say that the Fed made hawkish comments during recent speeches. They said what they said all along. No rate cuts are planned in 2023. Investors haven’t listened, but don’t blame that on the Fed. They are sticking to their plan.

The biggest disappointment came from Alphabet (GOOG) after they released their version of an AI bot and it gave an inaccurate response in a public demo. The stock fell over 7%. To be fair, OpenAI’s ChatGPT isn’t perfect, but it’s not a good look for the company that has been seemingly caught off guard and is scrambling to compete.

Now, we can sit here and talk about all the news stories from yesterday, but what’s really going on in the markets from a technical analysis perspective? For all of you indicator lovers out there, let’s take a look at three of the most common.

Here’s a chart of the S&P 500 (SPY):

First, we had an inside bar candlestick, so we’re seeing indecision in the market. Next, I threw on the momentum indicator, Williams%R (10). I always say, “overbought doesn’t mean over”, meaning an overbought (or oversold) indicator doesn’t mean the trend is over. We’ve all seen indicators pegged at the top (or bottom) of a range when the market kept moving.

So the market could certainly keep going higher from here, but the momentum indicator is seeing a period of exhaustion, which means you have a greater probability of a lower move.

Next, everyone’s favorite is the Relative Strength Indicator. Yes, it was originally designed for commodities, but everyone loves it for stocks. It’s another momentum indicator and it is also showing an extended period in overbought territory.

The last indicator is the good old Moving Average Convergence Divergence (MACD). We typically look for divergence between the MACD and the price, meaning if the MACD is making a higher high, the underlying should be doing so as well. The divergence between the two would mean a potential change in trend. This one is too close to call, but it’s been above 0 for quite some time, and looking like it’s flattening.

While overbought doesn’t mean the trend is over, the short-term risk is to the downside and it would be healthy if we had a pullback from here.

Let’s see if we can find something to trade.

I’m looking at the SPDR Trust Healthcare ETF (XLV). The ETF has been in a downtrend since the new year and has been one of the worst-performing sectors in the last week. I’m looking for this to continue lower and will be looking to set up a neutral to bearish position.

I’m looking at a Skip-Strike butterfly (aka Broken Wing Butterfly) position. The risk profile looks like this:

And the trade details (BUY +1 BUTTERFLY XLV 100 (Weeklys) 24 FEB 23 130/131/134 CALL @-1.16 LMT MARK) look like this:

I’m looking at pre-market prices, but you can see that I’m placing the trade for a credit of $1.16 and the trade requires $201 in margin per contract. It is a short vega trade, which means that an increase in volatility will hurt the trade, but getting the correct direction will still overcome an increase in volatility.

Going back to the trendlines on the chart, I’m seeing a price range between $129 and $132 by expiration on February 24th. Going to our risk graph, that means we could see profits of $116 if the ETF is trading at $129 or profits of about $105 if the ETF is trading as high as $132 at expiration.

I’d look for a profit target of anywhere between 50 – 80% of the initial credit you take in for the trade. My stop loss is based on the graph. I’m out of the trade if I read the chart wrong and the ETF breaks out above the downtrend channel.

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Jeff Wood

Editor, Filthy Rich Dirt Poor
Trader, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.