Well, this week has started quieter than last, but as traders, we need to watch a little longer before we get a better sense of whether the sudden and sharp moves we saw last week will become less frequent. Stocks did open lower this morning after IBM (IBM) reduced its earnings forecast, but they came back and both the S&P 500 and Dow are positive at the moment, but the Dow has borne the brunt of the pain because IBM is heavily weighted on the index.

The rest of this week will be influenced by earnings, including Apple (AAPL) after the close today, with more big names on tap the rest of the week like Coca-Cola (KO), McDonald’s (MCD), Microsoft (MSFT), Amazon.com (AMZN), Procter and Gamble (PG), and many, many more.

Despite last week’s crazy action, there were a few positives I took away from it as they relate to us as traders. First, we saw more of the rally in small-cap stocks. The Russell 2000 was up for three days before pulling back, and is now up again. When investors regain their appetite for small caps, it’s a bullish sign overall, and it’s also one factor that would point to the selling being overdone. While I’m not going to sit here and tell you that the market bottomed last week, it is a healthy sign that investors are moving into small caps and momentum names instead of defensive stocks.

Still, volatility is a big part of the current environment, and one bad headline could make investors nervous again. This means a few things for us as traders: First, we’ll continue to look for opportunities in both calls and puts. My sense today is that we’ll see more long opportunities in calls, but puts remain a very viable trade in broken stocks.

Second, we’re going to continue to take our trades day-by-day and see what the market gives us. We saw stocks all over the place last week, so you have to be careful going to long or to short. I know of some traders that were heavily short last week and got killed, so caution remains smart when it comes to managing risk. We didn’t put on a lot of trades in last week’s action for that reason, and we’ll continue to be smart this week, being very selective in the trades we put on while keeping our finger on the pulse of the overall market.

A Look Back

I wanted to take a momentum to discuss a couple of our trades from last week that I got some questions about: the TWTR October $47 calls and the BABA November $80 calls. We exited both positions with negative returns, and I wanted to explain why we cut our losses rather than hold on through this week.

Alibaba (BABA) had traded well and was really setting up nicely for us when we opened the trade on Monday, but it got caught up in all of the market’s crosscurrents. This is a stock that was also impacted by hedge funds doing a lot of selling. Most hedge funds have significantly underperformed this year, and they’re gunning it here in the fourth quarter to try to close that gap. BABA is one of the names they had turned to, and as the market got volatile, they were reducing their exposure to stocks and building cash, selling a lot of names in the process. BABA was one of those being sold, and given how volatile the market got and how quickly options can move down, I felt it was best for us to be disciplined and close out the trade. BABA has acted better in the recent strength, and I continue to watch it closely for a chance to get in there and make our money back and then some.

Twitter (TWTR) also got bounced around in the volatility. When we got into the TWTR calls, I was looking for a solid break above $50, and it did tick above that price on Wednesday and very briefly early on Friday. It looked as if our calls would hit our $4.10 sell limit Friday, but TWTR weakened as the day went on Friday amid a strong market, which concerned me. The stock is moving higher today, and in hindsight I obviously wish we had kept the calls, but I felt it too risky to go into the weekend in a very volatile market holding options that expired this week. I also knew we may well get another good chance in a better market, and like BABA, I continue to watch TWTR for a new opportunity to make back our money.

I want to stay vigilant about limiting losses as best as we possibly can while investors have itchy trigger fingers. Whenever calls or puts turn against us and we’re down 30%, I generally will want us to cut our losses and move on to a fresh trade. However, especially in choppy markets, there are times when we may hold for a bounce and a better exit point. The HSY calls are a good example of a case in which we held (which I’ll talk more about in just a moment). If a trade is down 30%, I will make sure to post an update on it in the Update Center, so don’t forget to check there for additional posts on the options. And if we do need to sell, I will also be in touch by email and text message with a Trade Alert to tell you exactly what to do.

Review of Our Current Positions

With some of the previous momentum stocks showing life again, I recommended the FB October $75 calls just this morning. (If you missed the alert, you can read it here.) We have two additional open positions, so let’s take a closer look at each now.

Hershey (HSY) has been relatively steady amid the market volatility and is up again today. The company is due to report third-quarter earnings next Wednesday, and I want to see how the stock acts ahead of its earnings release. As I mentioned before, while some investors are concerned over Ebola affecting HSY’s cocoa supply in Africa, management has stated that they are fully sourced through 2015. While the calls did fall below our 30% re-evaluation point, given the longer-term expiration and the more defensive nature of this stock, I want to give HSY more time to strengthen. Continue to hold the HSY January $90 calls (@HSY 150117C00090000).

SanDisk (SDNK) is up today on the heels of IBM (IBM) shedding its costly chip business. I have been watching to see how the stock trades, and while the puts are currently past our 30% stop loss, this is another case where I want to continue to hold the SNDK October $85 puts (@SNDK 141024P00085000). The stock is off its highs of the day and has faded. The overall trend remains negative, so I want to see how much trouble it has maintaining its momentum. As always, I am watching our position closely and will be in touch when it is time to take action.

Sincerely,

Hilary Kramer
Editor, High Octane Trader