Every once in a while, we will experience months when the markets change only moderately in price and we do not make the gains that the risk profile graphs indicated at the beginning of the expiration month. This was one of those months.
The Boomer's Revenge portfolio is a perfect example of what happened. Going into the month, the risk profile graph showed a double-digit gain coming at any ending price between $110 and $115. SPY ended up right in that range, and the portfolio was absolutely flat (gaining only $7). The explanation of what happened is simple - VIX fell about 20%, pushing down the values of our long positions.
For example, the Dec-10 call that we are long has a delta of 57. The stock rose $3.43 over the course of the month, so this option should have gone up by $1.95 ($3.43 x .57) less theta decay of about $.30. Instead of rising $1.65, it only rose $.50. That is a huge difference, over $100 per spread, and we have 18 spreads in this portfolio. Falling VIX was the entire explanation of why we had a flat month when we should have had a great one.
Next month, we could easily see VIX increase, especially if the stock falls. If that happens, the reverse of our experience this month might well occur. Even if VIX stays flat (which is the more likely scenario), Boomer's Revenge is facing a double-digit gain over the next 5 weeks over a fairly broad range of possible stock prices.
A Prediction: After studying the risk profile graphs at length, I would like to stick my neck out and predict that at least half our 8 portfolios will enjoy a double-digit gain in value in the next 5 weeks. It is highly unlikely that VIX will fall much further, and it could easily go back up if the market becomes more volatile or if it falls.
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The 7 straight positive trading sessions ended Tuesday as the market hit a short-term overbought state. However, the selling ended quickly as Wednesday and Thursday the market moved higher to fresh 52-week highs. Although, Friday the market sold-off on the news of JP Morgan's disappointing earnings.
Typically the day after options expiration is bearish so I would not be surprised to see a follow-through of Friday's decline, but that should certainly push the major indexes back into a short-term oversold state. If that does occur and the earnings next week are somewhat positive we could see another surge to fresh 52-week highs.
Alcoa started the fourth quarter earnings season off on Monday and the results were less than stellar. The stock lost 11% as a result. However, later in the week Intel had a wonderful earnings report. After the bell, Intel reported a profit for the fourth quarter of $US2.28 billion ($2.47 billion), up a stunning 875 per cent from a year ago and better than analyst forecasts.
"This should give investors a good gauge on the strength of the global economic recovery and an update look at technology spending," Fred Dickson at DA Davidson & Co said.
"Revenue growth will be more important than ever as investors are becoming anxious to see the reported top-line revenue growth needed to sustain an economic recovery and eventually drive employment growth and consumer spending."
Next week, there will be an abundance of earnings reports to give market participants a clearer picture on where the market is headed during the fourth quarter earnings season.
Several of the companies to report are Citigroup, IBM, Bank of America, Morgan Stanley, Wells Fargo, eBay, Starbucks, Goldman Sachs, American Express, Capital One, Google, General Electric and McDonald's.
Technically speaking, the market has pushed back near an oversold state. As I have stated earlier, the trading day following options expiration is overwhelmingly bearish. If this bearishness does occur I would anticipate a move back down into a short-term oversold state which would most likely lead to another snapback move to the upside. If this occurs we could see another surge higher to fresh 52-week highs.
Andy
Overbought/Oversold as of January 19, 2010
Major Benchmarks
As always, I enjoyed reading your Saturday report this week. It was encouraging to see how deeply you are digging into the stats and historical data to see what you can learn. As I have often heard stated, "We don't have problems, we have encountered opportunities." And I am sure you will make the best of these opportunities.
Keep up the good work. I am a new subscriber, am happy to be with you and am learning a lot.
- Richard