The market rallied off of earnings news from FedEx and Nike, but let’s see if there’s anything behind this rally.
First up is FedEx. Remember on September 15th when they withdrew their guidance for the rest of their fiscal year? That signaled to the market that a global recession was looming around the corner. The stock gapped down on the news (arrow to the left). Since then it’s been steadily rising and then yesterday they announced they beat earnings.
But look closer. On a day when the Dow Industrials went up over 500 points, FDX fell from the open. Yes, the close was higher than the previous day so they still logged a 3.4% gain, but the stock couldn’t keep up the momentum, and yet the overall market was up over 500 points in response to an earnings beat. Hmmm…
Nike (NKE) was the other big winner, closing up over 12% in a day due to a beat in earnings. Nike does seem to be starting a new uptrend, but I’m concerned that it came up to its 200-day moving average, came back down, and then suddenly popped up 12% in a day. That’s not the normal bullish behavior I’d like to see, especially not when the market is looking at these two stocks and using that as a reason to be rally.
The 1-day rally thus far is nice, but we’re not exactly breaking records with volume.
Which one of these strong-up days is not like the others?
After the sell-off we had last week, it’s not surprising to snap back a little. It’s a movement like this that makes up the heart of the 4-Day Income Trade that I teach in Options Testing Lab. We’ve had a great couple of months, closing 95% of trades for a profit. If you want more information about the service, reach out to our support team. You can email them at [email protected]
Today’s trade idea is another spread trade. Why a spread? With the upcoming holiday, we have lower volume and some extra days when the market is closed. So I want to see if we can take advantage of theta decay.
What the heck is theta decay?
Selling options involve selling at a specific time and a specific price. Theta is a metric that looks to measure the time decay of that option.
Since options have an expiration date, the value decreases with time. Let’s say a full gallon of milk is $3 and it expires in two weeks. The same full gallon of milk shouldn’t be worth the same value if it is going to expire in 1 day. A store might have to sell it for less to move it off the shelf.
Options are the same way. With more time, an option seller can ask for more premium from the buyer. The closer the option is to expiring, the less it is worth (assuming the stock price is below the strike price near expiration).
Theta decay is a measurement of how much the option should decrease each day. As an option seller, we’re selling premium and trying to take advantage of theta decay.
Let’s look at Alcoa (AA). The stock has been trading in a range since November and is bouncing off the lower part of that range. It’s been trading between $42 and $51 per share.
The 27 JAN 23 42/37 put spread gives you a net credit of $1.26. Meaning for each spread, your max gain is $126 and your max loss is $374. I wouldn’t advise holding to a max loss – you know that support is around $42 so you can close the trade if AA trades below that support level. If you do that, your max loss is $60 as of pre-market pricing.
The option strike you’re selling is about 6% away from the current price so as long as AA doesn’t move down more than 6% by expiration, you can potentially profit from this trade. That means this trade can be profitable if AA moves up, sideways, or even down slightly (less than 6%) by expiration.
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