Favor Calls, But Don’t Forget Puts

by Ken Trester | October 19, 2012 12:57 pm

If our indicators are any … well, indication … we’re still looking at a bullish-to-neutral environment, unchanged from last week.

The primary culprit for any downside is the Nasdaq, which continues to tread below its 50-day moving average. On the upside, the Dow Transportation Average has improved and is trading above its 200-day MA — but the Transports have traded back and forth around the 200-day MA for several months, so a more pronounced uptrend needs to be established before Dow theorists can rest easy.

We’re also seeing a bullish bias in the major indices, including the 200-day Moving Averages Index, the Advance/Decline Index and Cumulative Volume Index. Eight of nine industry sectors are bullish, too, with only the technology sector (not surprisingly) showing some weakness.

The next hurdle the markets need to clear is a resistance level that is showing signs of developing into a “triple top” chart formation[1]. For the Dow, that means moving decisively above 13,610, and the S&P 500 above 1,465. If that happens, the all-time highs for each will be within reach.

One reason for the bullishness in stocks is a rotation out of “safe haven” assets. U.S. Treasuries — which we track using the iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT[2]) — have been mired in a “lower highs” trading pattern for more than two months. More noticeable, on Thursday, TLT broke below its 200-day MA. The U.S. dollar — as represented by PowerShares DB US Dollar Index Bullish ETF (NYSE:UUP[3]) — remains deep in a bearish trend relative to its key moving averages and is a long way from reversing that. Bearishness in TLT and UUP generally signals a bullish “risk-on” attitude in the market.

While it would be nice if the major indices could convincingly break out to the upside, that might not happen until after the upcoming U.S. elections, if at all. So options buyers should continue to favor calls over puts, but don’t disregard puts entirely. Volatility is extremely low right now, making put options inexpensive to buy as portfolio insurance.

One of those inexpensive puts is on Textron (NYSE:TXT[4]), a diversified company that just reported earnings[5] on Wednesday. It slipped on its earnings estimate, and my Power Options system shows it going down.

Recommendation: Buy TXT Dec 24 Put options at 65 cents or lower, when the stock price is at $25.80. After entry, take profits if the stock price hits $23.40. Option prices should be around $1.60 then, giving you a 146% potential profit. Exit if the stock price closes above $27 or the option price dives below 40 cents.

Ken Trester[6] is editor of the popular Maximum Options[7] program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.

  1. “triple top” chart formation: https://investorplace.com/2009/08/triple-top-signal-points-to-downtrend/
  2. TLT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TLT
  3. UUP: http://studio-5.financialcontent.com/investplace/quote?Symbol=UUP
  4. TXT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TXT
  5. just reported earnings: http://investor.textron.com/phoenix.zhtml?c=110047&p=irol-earningsPressArticle&ID=1746304&highlight=
  6. Ken Trester: https://investorplace.com/2011/06/author/Ken-Trester/
  7. Maximum Options: https://order.investorplace.com/index.jsp?sid=WRC177&uid=

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