The Fed Is Done With Hikes

April 13, 2023

Or at least that’s what many believe will happen after the Producer Price Index (PPI) came in much lower than expected. The PPI measures price changes over time in the prices received by domestic producers of goods and services. In other words, it measures changes from the perspective of the seller.

That doesn’t always mean the savings get passed on to the buyer though. That’s typically why the Fed pays more attention to the Consumer Price Index (CPI).

The market rallied all day after seeing the PPI drop dramatically. Every category came in less than the prior reading and less than the consensus range.

Combined with a jobless claims report that came in higher than expected, that was enough for the market to take off with the assumption that the Fed is done with hikes. 

I say, ‘assumption’ because the Fed has yet to signal rate cuts. The Fed doesn’t want to cut rates and watch inflation climb back higher.

Meanwhile, Gold has climbed to a 13-month high. Gold Shares (GLD) and VanEck Gold Miners (GDXJ) made a new 20-week high. Mining stocks are on the move as well. Anico Eagle Mines (AEM) also made the 20-week high list.

The major banking stocks will kick off earnings season today. Citigroup, JPMorgan, and Wells Fargo are first up to tell us just how strong the financial sector will be. I’m not convinced the financials are ready to go higher. Deposits in the banks are safe – the U.S. government has made that clear, but higher interest rates are going to be sticking around and that’s going to continue causing issues for the foreseeable future.

While tech stocks are once again on the rise, I do want to highlight that they are coming into resistance.

The Nasdaq 100 (QQQ) is stalling out around $320, even though it had a great day yesterday.

A break higher will require some of these top stocks to break through their resistance levels.

Microsoft (MSFT)

Alphabet (GOOG/L)

Apple (AAPL)

Keep in mind that some mega-cap tech companies will be reporting earnings in the coming week. Look out to see if tech can show an improvement in advertising dollars, a cut in expenses (headcount), and can convince the market that they are doing something productive with AI that will increase revenue.

Today’s trade is on the S&P 500 (SPY). I’ve had broken-wing butterflies on my brain lately, so let’s look at a 21-day trade on the SPY. Now, this is another situation where this trade can change depending on where the market opens and how it handles earnings, but here is the premise.

Going 21 days out gives us the 5-MAY expiration. I want to be out of this trade no more than 7 days to expiration, so I’ll be looking at expected moves of the SPY based on 4/28.

Using the implied volatility, I can see the market is expecting that SPY will move +/- $10.51 by 4/28.

Save that for later. Now, let’s go to the 5/5 expiration chain.

I’m setting up the trade as follows:
Buy to open 1x 5-MAY 407 put
Sell to open 2x 5-MAY 405 put
Buy to open 1x 5-MAY 401 put
Credit of 0.31

This is a bullish trade on the SPY and we’ve set up the spread so that even if SPY moves down to its lower expected move, the trade can still be positive if you hold it through expiration.

I mentioned I wanted to be out a week before though. If I use the time tool and move out to 4/28 and look at the lower end of the expected move, this trade would have a loss of about $34.

I’m looking to collect a credit of 0.31 (or $31), so this trade has a near 1:1 risk-to-reward ratio and is risk-free to the upside. If I can buy this spread back for 0.02, I will exit the trade.

The trade requires $200 in buying power, but minus the $31 in credit, you’re looking at roughly $169. If we can close the trade and keep about $30 in profit, that’s a 17% return in two weeks for a trade that has a 75% probability of closing higher than $403. The breakeven of this spread is $402.68, so we’re just outside of the expected move range.

This trade is net positive theta, so you will have the potential to take advantage of theta decay with every passing day.

I hope you had a great trading week! I see you back here next week!

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. 

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