February 15th, 2023

Elevated CPI Levels Worries Investors

As expected, the markets had a volatile day of trading following the Consumer Price Index report that came out before the market opened.  Consumer prices rose 0.5% month-over-month, while the year-over-year number fell slightly to 6.4% from 6.5%.  The issue is the consensus of the market was that we were going to come in around the low 6% range.  

This will keep pressure on the Fed to keep rising interest rates.  But this market is resilient and it’s enough to make your head spin.  You’d think this news of potentially increased interest rates would send the tech sector down – it didn’t.  You’d think the market would sell off overall – it didn’t.  Yes, it finished lower, but not nearly as bad as it could have been.

Here’s a chart of the S&P 500 (SPX) at 15-minute intervals.  The market retreated in the morning session, but rebounded nicely in the afternoon and is sitting at yesterday’s resistance.

This Thursday we have the forward-looking Producer Price Index (PPI) coming out at 8:30 am EST. The forecast calls for a price increase of 0.2% month-over-month. Sure, it doesn’t sound like much, but it’s also showing that prices aren’t going down at present, and that could mean problems down the road.

I would say a number that comes in much hotter might push the market lower, but it seems like the bulls will only allow an intraday move lower before regaining momentum.

Two weeks ago the tech sector was leading the other sectors. Last week we saw defensive sectors take the lead, and so far this week the Ark Innovation ETF (ARKK) is up over 3%, implying that riskier stocks are rebounding.

What that means to me is the market is still trying to identify a trend. Part of that is due to earnings. Palantir (PLTR) rose over 21% yesterday after a positive earnings report. That certainly helped the Nasdaq, but what will that index do without help from earnings?

I’m looking at T-Mobile (TMUS) based on their positive seasonality, with an 80% track record of closing higher between now and 8 weeks from now. Historically, it has an average gain of about 10% during that time frame. Here’s the weekly chart, showing a nice uptrend and we’re near the bottom of the channel.

As an options trader, I might want to buy a call with enough time to cover the historically positive timeframe. Just in case I need more time, I’m looking at an expiration that is about 12 weeks away. The problem is that the 19 MAY at-the-money call of $145 is going for $9.55 per contract.

If I want to reduce the cost of the contract, I can sell near-dated options against the longer-dated call.

I went out to each expiration of the next few weeks and looked to sell a .15 delta option, but I wanted to see which option would give me the best potential return.

This table shows that with a current price of $147.49, I can go out and buy the 19-MAY $145 call for $9.55 and I can sell the 17-MAR $160 call for 0.28. Now, while 0.28 in credit may not seem like much to reduce the cost of the long call, it does present the best mix of credit and total gain from the underlying.

This is called a diagonal spread – sometimes called a poor man’s covered call, because you’re using the long option to replicate owning 100 shares of stock and you’re selling a call against the long call, similar to how you would sell a call against 100 shares of stock.

A diagonal is significantly less expensive than buying 100 shares and selling a covered call and reduces the amount of money you have in the market, while only limiting the profit by a small percentage. This options strategy is flexible and can be adjusted easily as the market moves.

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Jeff Wood

Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

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