Christmas came early for the market last week after the Federal Reserve announced that it does not plan to raise interest rates anytime soon. Following a big market pullback on Tuesday due to the oil and Russia crises, the Street rebounded strongly, with the S&P 500 locking in its biggest weekly gain in nearly two years.
Not surprisingly, the market has been relatively calm today as we begin this holiday week. Trading volume will definitely be light. You can still have sharp moves in lower volume, but it does make it tougher to confirm trends, and as you know, that’s the way we prefer to trade. So when we have a period of lighter volume, we have to be very selective and may not put on as many trades.
I expect the dominant force this week to be end-of-year window dressing and gamesmanship, which means we’ll focus on names that should see money flow and finish the year strongly. Among the possibilities is Facebook (FB), which has been trading well after its long consolidation, bouncing from $75 to $82 in less than a week. The stock hit a new all-time high today and we could see it continue higher thanks to year-end money flow.
I’m also still watching Alibaba (BABA) and the iShares Russell 2000 ETF (IWM). BABA held up amid the volatility last Tuesday, and while it did pull back slightly on Friday due to the release of a small lockup of shares from the IPO, it still closed nicely above its lows of the day. IWM is also trading very well and is almost back to its year’s high.
Another trade set-up we like is when I spot unusual activity in options, and I’m seeing that now with McDonald’s (MCD). The stock is down 3% for the year, but option trading has picked up and there have been rumors of an activist investor jumping in on the stock. I am always on the lookout for certain calls or puts that are lighting up the board on no identifiable reason for activity. Usually when there’s smoke, there’s fire, but even if there’s not, the activity can give us an opportunity to get in and out quickly and make some fast money. I’ll continue to watch MCD options and be in touch right away if we can get the right action at the right price.
Using Limit Orders to Get Full Value
Last week, our trades in Alibaba (BABA) and the iShares Russell 2000 (IWM) were both good reminders of why we need to sometimes use limit orders to make sure we don’t get mistreated when we sell our calls.
Last Wednesday, after the Fed’s announcement sent stocks soaring, I wanted us to take our profits in the BABA calls. As you’ll recall, we bought the $100 calls, so with the stock trading around $108-$110, they were deep in the money. Deep-in-the-money calls are less risky, but there can still be some gamesmanship from time to time with the spread between the bid and the ask prices, and this is something I watch closely.
When we own deep-in-the-money calls, I want us to at least get “parity” or “intrinsic value.” In this case, we owned the BABA $100 calls, and with the stock trading at, say, $109, we could in theory call the stock for $100 and turn around and sell it on the market for $109, so the intrinsic value would be $9.
With BABA last week, I noticed in all of the movement after the Fed announcement that the specialist on the calls had the bid price about $0.30 below intrinsic value. If we had sold at market prices and not used a limit order, the sells would have filled at the lower bid price. Instead, we picked a price I was confident we could get, $9.30, and waited until that price matched the ask price or the last trade, and that’s when I sent the Trade Alert recommending you put in your order. At that point, I was confident that somebody would see the orders for $9.30 and buy the calls from us, even if it was not the specialist.
We won’t always need to use limit orders, especially on more liquid options. In fact, I was a little surprised that we saw the specialist bidding below intrinsic value on the BABA calls. Still, I always watch the bid/ask spread carefully in case something funny is going on and try to protect us by using a limit order.
Review of Our Current Position
We bought the AAPL January $109 calls this morning (if you missed the alert, you can read it here), leaving us with one other open position. Let’s take a closer look at it now.
Bank of America (BAC) rallied nicely following the Fed statement on Wednesday, and continues to strengthen today. I’m watching our call position closely, and if the option fails to make another move higher by Wednesday, we’ll look to exit the trade or roll it into a different strike price and expiration. For now, continue to hold the BAC December $16.50 calls (@BAC 141226C00016500) and I’ll be in touch when it’s time to take action.
Overall, as I mentioned, I expect this to be a quieter week for us, so we’ll continue to take each trading day one day at a time. And don’t forget that the market will be open until 1 p.m. on Wednesday and closed all day on Thursday.
I hope you have a lovely holiday weekend!
Sincerely,
Hilary Kramer
Editor, High Octane Trader
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