May 4th 2023

Rally Fades As Fed Doesn’t Signal For A Pivot Just Yet

Another Fed meeting and another negative reaction to end the trading day after the initial announcement.  Like we’ve seen in the past, there was a post-meeting rally, and then someone had to get in front of a microphone and say the magic words that tank the market.  

This is something that John Hutchinson went over in this past session of Options Testing Lab and it’s something I wrote about the other day in this newsletter.

The market was expecting a Fed pivot and instead, they got, Fed Chairman Powell saying, “In determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

The issue is that Powell didn’t signal for a rate cut or any type of pivot.  He said what he’s been saying all along – we will keep an ongoing assessment of rates.

Remember, the Fed has mentioned time and time again that they will leave high rates in place for longer – most likely through the end of 2023.  Investors are the ones insisting the Fed will soon pivot and then react poorly when the Fed doesn’t comply.

With new jobs slowing down, I am left to believe the unemployment rate is next.  After all, companies typically slow down hiring before they lay off existing employees, so I’m not surprised to see the JOLTS employment number fall before we see the unemployment number head higher.

With interest rates at the highest rate since 2007 and a slowing workforce, I’m more bullish on commodities and alternative investments than stocks – at least for the next quarter.

The S&P 500 (SPY) can’t seem to cross 4200 and even if you believe the market will continue its upward momentum, I still think there’s more risk of a downside move in the near term.      

Today’s trade idea is on Johnson & Johnson (JNJ).  There was a recent gap up and now the stock is stuck in a trading range with $160 acting as support.  The 50-period moving average is right under there, sitting at around $157.50.

Sometimes when the market is acting up, I like getting into the defensive stocks with a covered call position, but not just any covered call.

There are many ways you could trade this, but today’s focus is to let you know that you can still make money doing a covered call, even if you set up the trade with the intent of getting called out.  

Let’s look at the May 19th expiration date and the $157.50 calls, which are selling for a mid-price of $6.35.  The current stock price is $162.87.  If I buy 100 shares at the market value and immediately sell a $157.50 call, I will collect $6.35 in premium.  That would bring my cost basis down to $156.52 (162.87 – 6.35).

If JNJ is trading above $157.50 at expiration, my shares will be called away and I will sell them at the $157.50 price.  

The profit is the sold price of 157.50 – the cost basis of 156.52, which equals 0.98. Take 0.98 and divide by the cost basis of 156.52 and you have about a half percent.  While that may not seem like much, that’s half a percent gain in half a month.  If you continue to do that, you’d have a 24% annualized return.  

And what if JNJ doesn’t close above $157.50 in the next 15 days?  Well, your cost basis is still $156.52, so you can sell another call against your shares.  Could JNJ keep going down?  Sure, but I picked this stock because I think it has support at around $160.

If it has support at $160, why not sell the $160 call?  Because in this particular example, I picked a strike price where you have a 78% chance of having the stock called away, meaning you have roughly a 78% chance of making your half-percent gain in 15 days.  

If you have any questions, comments, or anything we can help with, reach us at any time.

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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.