Even though I remain bullish on the market, buying puts, put spreads or diagonals (which can be spanned out in time) is a good way to profit from temporary declines. At present in First Solar, Inc.(NASDAQ:FSLR), momentum indicators are way overbought, sentiment is at highest in 12 months and implied volatility has dropped to 35% ( well below its 12 month average). Many traders do not like debit put spreads or diagonals because they involve a debit from ones account but in periods of low volatility, selling options is not an attractive strategy. Furthermore when volatility is cheap, buying put options are less expensive plus they have infinite profit potential not like when selling a spread instead of buying one.
Volatility On The Floor
Sentiment At Annual Highs
Caterpillar Inc.(NYSE:CAT) is trading north of $99 a share after reporting a seemingly impressive earnings report. Sentiment in this stock has been fueled by the meaningful earnings beat in the first quarter plus the improved guidance for fiscal 2017. Nevertheless both numbers are non GAAP but the real number (GAAP earnings) will end up being lower than originally envisioned for 2017. Why aren’t investors taking note of this ?
Well the backlog increase definitely helped but the restructuring charges are going to continue as more manufacturing facilities are going to be closed this year. Why such lofty sentiment levels if more facilities are going to be shut down ? The company’s growth story definitely is taking center stage at the moment but if this growth stalls in coming quarters, I believe investors will be scrutinizing earnings far more closely. Analysts have some lofty earnings projections earmarked for this stock and I still remain in doubt if these numbers can be achieved.
In saying this, Caterpillar could easily end up rising with rising commodity prices and a rising stock market. I would only play Caterpillar on the short side against a long position in a commodity ETF or stock. At present, Caterpillar’s implied volatility is very much on the low end so buying option premium would be favored over selling. I would be waiting for crude to bottom here and maybe buying a diagonal debit spread against this long position to ensure the overall trade had positive delta.
Source : Sentimentrader.com
Sometimes I favor diagonal call spreads over taking hold of stock due to the considerable buying power reduction and return on capital. So basically instead of buying stock, one can buy call spreads where the long call is a good 6 to 12 months out and in the money and the short component is usually only one month out of the money. I like to buy these spreads in stocks that have ultra low implied volatility, depressed sentiment and are oversold from a momentum perspective. Furthermore, Nike (NYSE:NKE) is a company with strong competitive advantages so if this position was to go against us initially, one could roll down the long call and keep selling short premium against this position to reduce the cost basis over time.
The critical issue with these spreads is that you must allow yourself enough time to be right. The long call has to be far enough away to ensure you are giving the spread enough time to work. Low volatility is your friend in diagonals as when it invariably rises, the positive delta of the spread will ensure that the long call will increase in price much quicker than the short call.
Crude oil (NYSE:USO) sold off aggressively today as it lost over 5% to finish at around the $45.50 level. Therefore we have confirmed that a new intermediate cycle has not begun yet as the March lows ( where some analysts believed that these lows marked the beginning of a brand new intermediate cycle) have been breached. This is where things get interesting. Why? Because the November lows definitely marked the last intermediate low and this support level is at around the $42 level in crude oil. If these lows get breached, then this would mean that this particular intermediate cycle will not be making higher highs which would mean the bear market in this asset class is not over yet.
Energy bulls have a nice setup here as the risk is pretty small if we get more weakness. By buying here and placing a stop at the November lows, one would be risking a small amount percentage wise to potentially make a lot. In the current intermediate cycle, crude got to the $55 level. If the bull remains intact, these highs should get taken out over the next cycle.