Stocks have seen a pick up in volatility over the past week, and with good reason. Questions abound as to the Fed’s intentions and the strength of the global economy.
It’s very noticeable that the Dow Jones’ 200-day moving average is quite a ways below the index’s current prices and 50-day moving averages, a reflection of just how strong and persistent the recent rally has been. But even so, a fall to the 200-day averages would represent less than a 10% correction from the recent highs. And with central banks continuing to prime the liquidity pumps, it is just as likely that the indexes bounce off their 50-day averages and continue moving higher as it is they plunge to their 200-day averages.
The primary culprit behind the sudden weakening is what we have been mentioning for the past few weeks, that the global and U.S. economies are not as strong as many want to believe, and certainly not strong enough for central banks to make any significant changes to their current easy money policies. The past week has been somewhat of an awakening to that. The week began with traders worrying about the Fed “tapering” its bond-buying program, and morphed into worries that if months and years of easy money hasn’t yet performed the desired economic miracles, perhaps it never will.
The sudden change of heart is evident in the U.S. Treasury market. After falling sharply early in the week, the 20+ Yr Treasury Bond ETF (TLT) looks to have made a at least a temporary bottom in the $114 area. It would be beneficial for stocks for TLT to resume a bullish trend, as that would mean interest rates aren’t likely to rise any time soon. But TLT’s current bounce so far can only be labeled as temporary, and it remains in a downtrend relative to its key moving averages. And a downtrend in TLT means higher interest rates.
With our indicators weakening, options players should step up their use of bearish positions. That means buying puts in an equal amount to buying calls.
The best options play to get you started is Salesforce.com (CRM).
CRM is a leading application software company. The stock made a double top in the $46.70 area and has fallen sharply from there. It has fallen below its 200-day moving average and looks like it will continue heading lower if stocks continue to correct.
After taking the position, enter a good-til-cancelled contingent order to sell this option if the stock hits its target price of $34.30. That should give you an option price of about $2.80, for a 115% profit.
Close this position and cut losses if the stock closes above $40, when the option price should be about 80 cents. The stock is currently trading at $38.06.
All of our short-term options to buy can be taken for up to three days after they are recommended. Make sure the stock and option prices are close to where they were when we made the recommendation. If after three days you still have not gotten the position filled, cancel the order and wait for our new recommendations, as the profit probabilities may no longer be valid.
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