January 17th, 2022

Smoother Sailing in 2023

Nothing has changed since the end of 2022, yet traders have already decided that this year won’t be as bad as the last. Bulls have been piling into stocks since the beginning of January. China is reopening at an accelerated pace and could be the key to heading off an impending global recession.

Despite the news that investors reacted to, or over-reacted to last year, investors are largely shrugging off the news to start this year. Nothing has changed, and yet the market gained an average of 1% a day last week.

Earnings season kicked off already and I think you’re going to see a mixed bag for this earnings season. I think you’ll see a return of stocks being pummeled for poor earnings or skyrocket if there’s a sense of positive momentum.
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Goldman Sachs (GS) closed down more than 6% after reporting weaker-than-expected Q4 net revenue. Yet Morgan Stanley (MS) rallied more than 5% after the company reported stronger-than-expected Q4 net revenue.

I’m still looking at the Volatility Index (VIX), which has traditionally performed inversely to the broad market. The VIX just put in a new 52-week low, suggesting that investors are willing to add risk to their portfolios. We’re getting a bit far away from its moving average, so I am counting on a reversion to the mean – I’m counting on the VIX going up a little from here, which should mean a slight pullback in stocks.

Why is the VIX dropping? Investors are waiting for the February Fed meeting to see where interest rates will go. Despite an earnings season that is supposed to be filled with warnings about a future recession, investors seem willing to shrug that off in favor of looking ahead to the Fed.

The catalyst to start the next leg higher will be if the Fed gives the market a .25% basis point increase, a drop from the 0.50% increase the previous time.

Just remember, the Treasury Secretary is warning of a coming U.S. Bond default, saying the government will run out of money by June. The House of Representatives will need to raise the debt ceiling before then. How many votes did it take to get a speaker? The debt ceiling will be raised and we will likely avoid a default, but it could be rough sailing for a bit until then. Smoother sailing in 2023 doesn’t necessarily mean smooth sailing the whole time.

Today’s trade is on the once self-named, “King of Beers.” Anheuser-Busch (BUD) has been on a run since mid-October, going from roughly $46 to $61 in a few months.

I like trading credit spreads for income because they give you the potential to get direction slightly wrong and yet you can still make money. Let’s look at the chart.

We’re flattening off here and while we could be consolidating and prepping for another run higher, I think the market is overbought and I think BUD rose too high, too fast, and is set for a pullback. We can still trade BUD and have it go slightly higher, as long as it doesn’t go above the brown line on the chart above.

By trading options that expire in 45 days, we get a mix of time premium and room to manage the trade. This is a bearish trade idea for the King of Beers.

Sell to open the 3 MAR 64 call
Buy to open the 3 MAR 69 call

The net credit is roughly 0.95 and the risk is $405 per spread traded. Your stop loss is if the stock trades above the short strike ($64). If that happens today, the max you’d lose on this trade is about $80.

The profit target is a standard 50% of the potential max profit. On credit spreads, I like to see the profit goal * 1.6 < stop loss. This is pretty close. 1.6* (95/2) = 76, which is close enough to that stop loss of $80 if BUD reaches the short strike today.

The risk profile looks like this:

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Jeff Wood

Editor, Filthy Rich Dirt Poor

Trader, Options Testing Lab