The election results and FOMC decision are looming, and markets are preparing for the unknown.
The unknown leads to uncertainty in markets, and we’ve certainly seen that in the form of choppy trade between investors looking to reduce risk and investors looking to take advantage of small dips in the market.
What is known is that the unknowns will be knowns soon – the election may or may not be called on Tuesday or Wednesday, but as the ballots are counted, the results will become clear, and the market will digest the information. The FOMC will announce their decision on Thursday after a 2-day meeting, and then we will know how they are evaluating the current economic landscape.
And as these unknowns in addition to earnings announcements are digested by the market, new trends will form. For now, we are seeing a lot of trendless behavior, as can be seen in the S&P 500 and NASDAQ 100 charts:
After the fall on Thursday, we have a rally on Tuesday to negate much of the drop. The market is forming support and resistance levels that will have big technical significance for the next trend, but we should keep in mind that historically we do see a grind higher in the markets to end the year after an election is concluded.
So, what stocks can I look for that may have significant upside and defined risk if I execute the trade with options? That’s the big question that I’m consistently looking to answer, so I’ve looked at more charts than I’d like to count and found something that looks particularly interesting. That interesting stock is Wayfair, symbol W:
As we can see, Wayfair was slightly weak on earnings this past Friday, but the move was minor relative to expectations. And now, we are seeing bottoming action as implied volatility (the input projecting future movement) continues to fall in W. This traditionally occurs when panic of the downside subsides. All in all, this is starting to look like a strong support level has been found just below current market levels. With that, I can structure a trade that looks particularly strong in terms of the risk/reward profile by defining my risk to recent lows and targeting a move to the resistance formed in July and late September/early October by utilizing a call debit spread.
That’s the great thing about options – if I can find a good technical and options setup, I can leverage it with options and generate a significant return utilizing a combination of multiple market edges. If I’m right and the stock can rally 20+% while defining my risk to 10% of downside in the stock, I’ve already got higher reward than risk. Adding in the embedded leverage and defined risk of options, I can potentially find even better expected value in this trade!
If you’d like to get a list of more ideas and setups just like this that could be of interest for trading opportunities, check out my Outlier Watch List.
And as always, please go to http://optionhotline.com to review how I traditionally apply technical signals, volatility analysis, and probability analysis to my options trades. And if you have any questions, never hesitate to reach out.
Keith Harwood
Keith@optionhotline.com
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