That was another extraordinary week, wasn’t it? The S&P 500 recorded a 50-point move from top to bottom last week during the course of three days.
Stocks lit up over the past week on substantial volume as investors cheered the Federal Reserve’s decision to go with a “taper lite” start to the wind-down of its quantitative easing program. The “taper caper” also got a boost due to the fact that it indicates the Fed sees a strengthening economy going forward, which is a view that was supported by positive new data points on enterprise technology spending along with an active M&A week.
The market was definitely surprised by the decision, as evidenced by the out-sized reaction. However, I find it odd, especially considering that traders had about six months’ time to think about tapering since Ben Bernanke first mentioned it in June.
One thing to note is this was actually the second time the Fed has gone against the conventional wisdom. It first happened in September when the crowd clearly expected tapering to being and it didn’t; last week was the second time, when the consensus didn’t expect a taper and it did get one.
In sum, the tendency has been for the consensus to be very wrong when it comes to guessing the Fed’s actions, so it makes sense that traders should have a differing point of view. In fact, I often apply that “go against the grain” thinking to my trades and it’s led me to a bullish position in defense stocks.
The budget agreement settled by Congress and signed by President Obama includes a lot of money for defense contractors, as always. Yet, it seems like traders were expecting some of that defense spending to be curtailed, which has somewhat depressed the aerospace and defense stocks recently.
However, taking a different stance than the crowd, I put on a bullish position in one defense name: Northrop Grumman (NOC). The Virginia-based Pentagon contractor specializes in fighter jets, space craft, high-energy laser systems and subsystems. Other divisions focus on intelligence and surveillance systems, battle management, strike operations management, electronic warfare and space exploration, and air and missile defense.
To play one of the strongest defense stocks, I recommend buying the NOC Jan. $110 calls up to $3.55. In short order, I expect the calls to reach my final target $6.10.
This option expires on Jan. 18, and the company is expected to report earnings on Jan. 30.
Jon Markman operates the investment firm Markman Capital Insights. He also writes a daily trading newsletter, Trader’s Advantage, and CounterPoint Options, a service geared towards helping individual traders make steady, consistent profits with volatility-related instruments.
Follow Jon Markman at Google+.