If the start of this post sounds familiar, well it is, its the exact post prior to the trade idea we just detailed in Starbucks (SBUX), but in this trade idea we are going to use The Home Depot (HD):
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Remember the Flash Crash back on May 6th 2010? I do. The S&P 500 opened at 1164, unchanged from the prior session, traded down nearly 100 points to 1065, and rallied back intra day to close at 1128, down 3.25% on the day :
The causes for the precipitous decline on May 6th, 2010 have been debated ever since, with no shortage of scapegoats… high frequency trading, fat fingers, poor liquidity and a deeply bruised investor base all suspect. Regardless if there was a main culprit or it was a combination of all those things, the one day price action was not natural. The crash came and went in a flash, (flash crash!) with many trades near the lows forced to be broken afterwards, leaving investors with the sense that the flash crash was a mirage.
But what’s interesting is what happened afterwards. The losses of the flash crash were made up within three trading days, but over the next few weeks the Flash Crash low was violated:
The Flash Crash low became a target.
Which leads me to last week’s low of 1867 in the S&P 500. The panic opening last Monday quickly reversed. Eerily similar to the Flash Crash. But once again, those lows seem like a target, now just 3% below current levels. The bounce in the major indices started fierce, but since reversing, now seems tepid at best.
The moves of some of the largest stocks in our market on Monday Aug 24th was staggering. Apple (AAPL) opened down 15%, Disney (DIS) opened down 9%, Home Depot (HD) opened down 20%, and Starbucks (SBUX) opened down 20%. All but HD are above their Friday Aug 21st close. What I find most interesting about last Monday’s price action in these stocks is that two months ago these would have been the last 4 stocks in the entire world investors would have expected to see this type of panic in.
But investors have shown their hands. If the downward volatility is to continue I could see the Monday Aug 24th opening as a decent target for these stocks: AAPL $95, DIS $93.50, HD $110 and SBUX $48.
I suspect the SPX to break last week’s lows in the coming weeks. And I expect that the large cap stocks that made last week feel so panicky will retest at least their Aug 24th opening prices (maybe not the session lows). Targets have been placed.
The other thing is I would be very surprised if the SPX were to make a new high this year. There’s just too much uncertainty and rallies seem to be finding aggressive sellers. With that factor combined with the heightened levels of implied volatility, call sales against existing stock holdings, call spread sales to express bearish views, or risk reversals where one sells an upside call and buys a put makes a ton of sense either against stock as a collar or an outright bearish play. All that said in a few of these names I like the risk reward, even with heightened options prices of placing long premium bets in the event of a retest of the Aug 24th lows.
It’s hard to make bearish long premium bets into a long weekend on a day that the SPX is down 1.6% as I write, and down 3.6% on the week, which is why I am going to wait for a little bounce.
Home Depot is a bit of a different animal than SBUX as most of their sales come from the U.S., intimately linked to one of the few perceived bright spots in the U.S. economy, and aside from Monday Aug 24th has shown very good relative strength.
If I were long HD I might consider using elevated options prices to selling short dated options to potentially add yield and create a buffer to the downside.
1 – Yield Enhancement:
Hypothetical trade: Against 100 shares of HD long at $114.20 – Sell to open 1 Oct 115 call at 3.60
Break-Even on Oct Expiration:
Profits: between 114.20 and 118.60, stock called away at 115, but have effectively sold it at 118.60.
Losses: of stock below 111.40, if stock is below 115 then take in 3.60 in call premium which provides, no protection below there but have mitigated 3% if potential losses.
OR given the fear of the stock having another mini crash like it did on Monday Aug 24th look for crash protection:
2- Protection – Collar:
Hypothetical trade: Against 100 shares of HD long at $114.20 Buy Oct 120/110 Collar for $1
-Sell to open 1 Oct 120 call at 1.50
-Buy to open 1 Oct 110 put for 2.50
Break-Even on Oct Expiration:
Profits: of stock between $114.20 and 120, stock called away at $120
Losses: between $114.20 and and $110 lose up to $4.20 plus the $1 premium, protection below $110.
Or if I thought the stock had another sharp decline in it in the next 6 weeks:
3 -Outright Bearish Trade:
Hypothetical trade: Buy HD Oct 120/110 Risk Reversal for $1
-Sell to open 1 Oct 120 call at 1.50
-Buy to open 1 Oct 110 put for 2.50
Break-Even on Oct Expiration:
Profits: below $109
Losses: of up to $1 between 109 and 120, lose 1 for 1 above 120.
I BET YOU CANT GUESS WHICH TRADE WE LIKE 😉