May 2nd, 2022

Fed Meeting – Rebound Coming?

The Fed meeting is this week and most are expecting a .50% increase to combat inflation.  Will the Fed surprise the markets and offer up .75% instead?  It’s doubtful as the Fed seems to want to deliver what the market already expects to happen.  What does that mean for the markets ahead? 

We’re going to look at the performance of the SP500 for the 5-day period prior to Fed meetings and compare it against how the market responds during the 5-day period after the meetings.

So far we’ve sold into the meeting, only to have a slight rebound after the meeting.  Remember in last week’s issue I said several indicators are showing the market is oversold?  I’m cautiously optimistic about a short-term rally after the meeting this week but make no mistake, I’m not saying it’s the end of the bear market.

I think the market can defend one or two crises at a time, but there’s an overwhelming amount of negative data out there.  I’m still not packing it in and going away, but I’m not willing to say it’s time to load up on the portfolio either.  I think any rally we see here is short-lived as we still have worsening PE ratios, negative forward earnings outlooks, etc.  

I reached out to an old colleague of mine, who is an ex-hedge fund guy, and asked him when he thought this selling pressure would be over.  He said, “When people start buying more.”  Hmm. If only market timing was that simple.

TRADE IDEA

With the large swing down over the last couple of days, volatility has spiked.  If we see a volatility crush after the Fed meeting, the cost of puts should decrease quickly.  We don’t know what reaction the market will have after the meeting, but we want to take advantage of heightened premiums in the options market, so an iron condor on the SP500 ETF (SPY) could work here.

Ticker: SPY

Current Price: $411

Expiration: June 17, 2022

Sell to open $444 call

Buy to open $452 call

Sell to open $378 put

Buy to open $370 put

Total credit: $3.03 or $303

Buying Power Reduction: $497

It’s a longer-dated iron condor, which may take longer to come into profits, but it also gives plenty of time to recover should it be tested on either side.  

If we see the market rally after the Fed meeting and then turn around and head back in its downward direction, we could find ourselves right back at this same price a couple of weeks from now, so let’s see if we can make time decay work in our favor here.

MARKETS

The following relative performance charts say it all – it’s ugly out there unless you’re on the bearish side of things.  Even the Energy sector took a hit this past week but remains near the top on the 1-month and 3-month performance charts.

TRADING EDUCATION

How many have heard of or have used point-and-figure charts before?  Upon first glance, it’s a mess of seemingly confusing information.  

A p&f chart looks to remove the “noise” of a chart by only charting the close and only when the close moves by a certain amount.  Each box on the chart is set to a certain dollar increment based on the cost of the stock.  For example, the chart for SP500 (SPY) looks like this:

Each box on the chart represents a $4 move (the numbers on the right side of the chart).  A stock like Alphabet (GOOG) might have each box represent $10. 

The latest price action is represented in the right-most column of the chart.  A column of X’s represents when the price moved up, whereas the columns of O’s represents a downward movement.

Unlike a traditional price chart were the open, high, low, and close are charted each day, a p&f chart only gets a new X or O when the price of the stock moves by the amount assigned to each box.

A reversal (when a column of X’s change to O’s or when a column of O’s change to X’s) occurs when a price moves in the opposite direction by 3 boxes.  That means you can stay in a column of X’s (or O’s) for weeks or even months as long as the stock doesn’t reverse direction by more than 3 x $box value.

For example, the current price of the SPY if $412 and the right-most column is currently a column of O’s.  Each box on the chart represents a $4 move, so should the SPY trade below $412, a new O is drawn lower beneath the right-most column.  If the SPY closes between $412 and $416, no new box is drawn.  If the price of SPY drops down to $404, two new O’s would be drawn in the existing column.  That could be tomorrow or over the next week.  Time doesn’t matter.

Point and figure charts remove a sense of time from the chart since columns represent price action and a new box doesn’t have to be drawn each day or week – only when prices pass through dollar amounts.

Remember that a reversal occurs when three boxes can be drawn in the opposite direction.  Right now, SPY is in a column of O’s and the lowest box is $412.  That means for us to create a new column of X’s, we need to be able to draw 3 boxes in the opposite direction.  Since each box is $4, that means we won’t draw a column of X’s unless SPY reverses by $12 (3x$4) and goes up above $424.  In which case, three X’s are immediately drawn in a new column to the right.

Lucky for us, stockcharts (there are other sites too) does the work for us and all we have to do is enter the ticker symbol.

Similar to any price chart, you can identify points of support and resistance.  On the SPY chart, there have been several attempts to get past $460, but each time the market hit that level, it turned around and reversed.  Likewise, do we see an area of support at $412?

Jeff
Editor, Wealthy Investor Society