Sometimes The Data Lies

July 18, 2023

As I sit here and look at an inverted yield curve, look at P/E ratios through the roof, and growth projections that can’t support current market prices, I look over at the trade screen and I continue to see day after day, the Russell 2000 ripping higher by 1% and the Dow 30 soaring another 1% in a day.

So the only logical conclusion is that sometimes the data lies. But why would it lead us astray? And what can we do right now?

As more computer-based trading comes out and algo bots head to the hands of retail traders hyper-focused on 0-DTE options, the decisions of people based on fundamental analysis are failing. The market isn’t behaving and following the same trends that it has before.

Look at the bear market of 2022 that was caused by a flooding of free capital, which drove up inflation, and ultimately led to the Fed raising interest rates. A bear market ensued.

But what happened since then has been anything but normal. The yield curve inverted which was supposed to be a sign of a recession, and yet the market has come more than 20% off its October lows, signifying a new bull market, even after the Fed continued to push rates higher.

Why is that?

One theory is that several (million?) baby boomers were forced into early retirement in the wake of Covid and elected not to go back to work. This helped unemployment stay at record lows with the number of open jobs outpacing the number of applicants.

While that may have led to wage inflation, the job market has still yet to crack. A strong job market has pushed off the impending recession.

So, you can say what you want about the market and where it should be. Maybe we are fundamentally overpriced. Maybe we are due for a pullback. But are you going to short this market?

How should this impact your trading? Enjoy the ride up to 4600 on the S&P 500, and keep looking for the dips for entry points. A recession may happen in 2024 or 2025, but I’d be less worried about a recession as long as the market stays above its 50-day and 200-day moving averages.

A 5% correction usually happens three times a year. Should that happen now, that would put the SPY down at $430, right on top of the 50-day moving average. Now, if we break lower than the 50-day, then we can start talking about a recession again.

This trade isn’t for everyone. I typically don’t trade pharmaceutical companies due to their big swings around news-related events. However, I’m going back to my roots with this one. See, a long time ago I once traded cheap pharmaceutical companies because of the premiums I could get selling covered calls. That was my way of making money quickly.

Apellis Pharmaceuticals (APLS) is now a $40 stock after a 23.75% plunge yesterday. Over the last two days, the stock lost 50% of its value.

Before you think I’m crazy for suggesting this one, let me give you some context, and remind you that this is a higher-risk trade idea.

The Waltham, Mass. -based pharmaceutical company said in a regulatory filing that the incidents of retinal vasculitis, or the swelling of blood vessels in the retina, occurred in roughly 0.01% of all injections.

Syfovre was approved in February by the U.S. Food and Drug Administration to treat geographic atrophy, which causes blindness.

The company said in the filing that 60,000 vials of Syfovre have been distributed and that there had been zero incidents of retinal vasculitis through all clinical trials.

Apellis said the FDA had reviewed each event and did not plan to take action.

It’s the last sentence that stands out to me. The FDA reviewed each event and does not plan to take action. Meaning, I think this will fall away in the news cycle.

If you’re worried that the stock will keep dropping, you can set an alert for the APLS to rise at least 1% off its recent low. That could indicate the bottom is in.

The 18-AUG 35 / 30 put spread is going for $1.15 – 1.75 in credit using pre-market prices. A fill of $1.50 or more on a 5-wide spread would give me the potential to make a 30% return on risk in one month.

What happens if it trades below $35? Look at the calls.

We could take the assignment of shares at $35 (or $3500) at the 18 AUG expiration and sell covered calls 30 days out to work down the cost basis. Let’s assume we were in that position today and we were just assigned shares. The 1-strike-out-of-the-money calls 30 days away are giving a premium of over 10%.

I’ll be looking to sell the put spread with the idea that the negative news will blow over and the stock will either remain flat or rise from here. A $35/30 put spread gives me room to the downside and with the stock being so cheap, I can adjust this position by accepting shares and selling premium-rich calls against it if needed.

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

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