Trade Summary: February 10, 2014
February 10, 2014
Trade Rationale
We’re seeing something in the financial markets this year that we had almost no experience with in 2013… volatility. Unlike most of last year, investors are actually getting spooked by stocks these days.
In fact, the CBOE S&P 500 Volatility Index (VIX), the most well-known measure of market volatility, recently hit its highest level since December of 2012. The so-called “fear gauge” climbed as high as over 21 – a level higher than the historical average. For reference, the index never broke 21 in all of 2013 – and just breached 20 on two occasions.
It makes some sense. Emerging markets are definitely a concern. If China can’t be the consumer of goods that it’s been for the last few years, it could slow down the already sluggish global economy. Not to mention, the US economy has been hampered by the worst winter in decades. Bad weather certainly took its toll on the job market, with new hires seeing a significant decline in December and January.
And let’s not forget the government…
Congress may have actually come to an agreement on the budget, but there’s still the debt ceiling debate forthcoming. I don’t expect it to be as “civil” as the budget negotiations. Politicians certainly have a way of roiling the markets.
Plus, 2013 was such a great year for stocks, investors may just be looking for reasons to sell or diversify. That doesn’t mean a major selloff is justifiable. I happen to believe 2014 will be another decent year for stocks overall – not as good as 2013, but not bad.
Still, savvy investors need to be prepared for more volatile markets. And this week’s set of trades will do exactly that.
First off, we’re going to put on a pure play volatility trade. The single easiest way to bet on volatility is buy calls on the iPath S&P 500 VIX Short-Term Futures ETN (VXX). VXX is heavily traded and will definitely pop if volatility rises.
Next, we’re going to buy calls on a defensive stock, the kind of stock people will pile into if volatility ramps up. The best performing sector over the past few weeks has been utilities. Historically, utilities are the number one destination for stock investors during turbulent times. We’re going to buy calls on Exelon (EXC).
EXC is one of the biggest diversified utilities out there. It’s a $25 billion market cap company with a solid dividend. Nevertheless, the stock valuation is still reasonable and the shares are trading under the 200-day moving average.
Finally, we’re going to take the opposite position in a more speculative company. This is the type of company investors aren’t going to want to be exposed to in volatile market periods. For this trade, we’re going to buy puts in 3D Systems (DDD).
I do like 3D printing over the long-term, but DDD is just too speculative right now. It recently posted weak earnings, but is still trading at an extremely high 144x earnings. If things start to get hairy, investors aren’t going to want to be exposed to sky-high valuations and weak fundamentals.
Taken together, these three positions will put us in great position to capitalize from rising market volatility.
Trade Details
#1) Buy iPath S&P 500 Short-Term Futures ETN (VXX) April $60 Calls up to $2.50
Remember, we want VXX to trade higher. Our first profit point for conservative traders is up at $65. For aggressive traders, you can hold all the way to $70. Regarding risk control, the conservative exit level is $38. $35 is the final support level for aggressive traders.
#2) Buy Exelon (EXC) July $29 Calls up to $1.75
Like VXX, we want EXC to trade higher. Our first exit point for conservative traders is at $32. For aggressive traders, you can hold all the way up to $35. For risk control, the conservative exit level is $26.50. $24 is the final resistance level for aggressive traders.
#3) Buy 3D Systems (DDD) May $50 Puts up to $2.75
In this case, we want DDD to trade lower. Our first profit-taking exit point for conservative traders is down at $55. For aggressive traders, you can hold to $47.50. For risk control, the conservative exit level is $80. $90 is the final resistance level for more aggressive traders.
Category: AOA Trade Summary
