The stock market today tends to operate in one of three modes: bullish, bearish or neutral — or what we refer to as structurally fair. We were first introduced to the term “structurally fair” by Tom Dorsey, a famous point-and-figure chartist, and while it may not be the easiest market mode in which to make money, it is certainly a mode that provides a lot of opportunity.
A structurally fair market is a market in which each stock is judged based on the individual merits of the company it represents and not by the overarching sentiment of the market at the time. This is quite different from a bullish market, in which it seems all stocks — regardless of how fundamentally sound they are — seem to move higher together, and a bearish market, in which it seems all stocks seem to move lower together. Naturally, it is easier to feel like a genius when you take bullish trades during a bullish market and bearish trades during a bearish market, but it becomes a little more difficult during a structurally fair stock market today.
We anticipate there are going to be plenty of opportunities in the structurally fair market that has developed during this earnings season to take advantage of both bullish and bearish trades. Some of those trades will play out in the run up to an earnings announcement, some will play out immediately after the earnings announcement and some will take a while after the earnings announcement to fully develop.
One trade we think you should act on now to capitalize on the stock market today is a bearish play in Arch Coal (ACI) following the terrible earnings report from Kansas City Southern (KSU). The railroad blamed much of its underperformance on the fact that utility-coal has not bounced yet and natural gas is still gaining in the sector. As a result, coal prices and several international coal companies have broken support (or continued a recent break).
ACI itself inched below support recently, but we think this stock will break down in the very short-term as traders try to prepare for its own report on Feb. 4.
‘Buy to open’ the ACI March 4 Puts for a maximum price of $0.35.
Our initial downside target is $3.60-$3.70, which could easily happen before the earnings report. That may give us the opportunity to close the trade before earnings as implied volatility (and the option’s price) inflates.
In addition, ACI has a history of massive negative surprises, and forecasts are already looking for a significant loss for the quarter. Growth estimates for the current quarter are -164% and for the year are an astonishing -1377%. It should be noted that the end of 2013 saw two top executives unloading shares.
While we think the potential of this trade is very attractive, please note that this is a low-priced option on a smaller stock, so using a limit order to enter the trade is absolutely imperative to prevent slippage.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.