Sideways chop continues

By Jani Ziedins | Intraday Analysis

Oct 07
S&P500 daily at 1:07 EDT

S&P500 daily at 1:07 EDT

Stocks slipped in early trade following an unproductive weekend in DC.  While the market is disappointed by the lack of progress, stocks only gave back Friday’s gains before finding support.  As uncertain as the headlines appear, up to this point the market is content trading sideways near previous highs.  The market is holding the widely followed 50dma, but failing to hold this the next major level of support is the August lows.

Stocks are chopping sideways as neither bounce nor breakdown attracts follow on buying/selling.  This is consistent with the wide expectation the political drama will stretch to the 11th hour, but ultimately get resolved.  A Yahoo Finance poll shows the overwhelming majority expect a protracted debate, but a resolution prior to default.  This outlook supports prices as most owners are unwilling to sell the headline noise since they view this as temporary drama.

Over the last four-years, traders suffered flashbacks to the 2008 Financial Crisis and predicted doom and gloom around every corner.  They were trading like it was 2008 in 2010, 2011, and 2012.  This lead to sharp selloffs following every hiccup, but over time traders realized this was not 2008 and every bump in the road did not smother the recovery.  This is why recent events are not nearly as volatile as they were a couple of years ago.  What was a 15% crash three years ago is a 3% dip today.  Owners have come to the realization the budget and deficit are simply temporary roadblocks and not a major structural deficiency.    When looking ahead six-months, it is easy to for bulls to ignore the near-term noise and continue holding in spite of the immediate headline risk.

Source: Yahoo Finance 10/7/2013

Source: Yahoo Finance 10/7/2013

The sideways chop comes from short-term, headline driven traders who buy good news and sell bad news, but since they are such a small piece of the overall market, their buying and selling stalls quickly.  The more interesting dynamic revolves around the expectations of a resolution and limited weakness leading up to this widely expected event.  With so few people selling the headlines, there will be fewer traders to buy the resolution.  No doubt we are 3% lower on the uncertainty and a resolution will remove that, but it is setting up an interesting “Black Swan” trade.  While the high-probability outcome is a resolution and modest pop, on the off-chance our politicians screw this up, that would trigger a dramatic sell off.  Black Swan trades are akin to playing the lottery.  Most of the time you lose, but when you win, you win big.  The best way to take advantage of a Black Swan opportunity is buying cheap, out-of-the-money options as a hedge for a long position, or an outright bet.  Protracted negotiations are already priced in, but a default is not and that creates a trading opportunity.

Expected Outcome:
The high probability trade is sideways chop until a resolution and then a modest pop on the elimination of this uncertainty.  Since the selloff has been so modest, the expect rebound to be equally modest.  Most of the buying will come from short covering and then we resume the previous debate over Taper, economy, and earnings.  Since we are in a bull market, that trend will likely continue into the end of the year.

Alternate Outcome:
There are no guarantees our politicians will get it right.  Since the US Govt has never defaulted on its debt, no one knows what to expect and that will lead to weeks uncertainty and fear of the worst case.  Not paying bondholders will create a liquidity crisis as some employers are unable to make payroll and banks are unable to lend money.  Even a few day delay will ripple through the economy and  no doubt going forward investors will no longer look at US Treasuries with the same sense of security and negligible risk.  This will affect our Govt’s ability to borrow money and the interest rates we pay on that debt.  Things will get ugly if we default and will likely trigger a swift 10-15% selloff

Trading Plan:
The market is trading sideways waiting for a resolution.  While the high probability outcome is a modest pop when a deal is reached, there are opportunities for a Black Swan trade using out-of-the-money options to hedge a long position or make an outright bearish bet.  At the current time, the market is stable and scary headlines are not triggering an avalanche of selling.  That likely means the spring is not coiled to the downside and shorts are better served locking in recent profits.

TSLA daily at 1:07 EDT

TSLA daily at 1:07 EDT

AAPL is stuck in between the 50dma and $500.  Virtually all of the major bullish catalysts are behind us, a new iPhone and increased the dividend.  About all we have left before year-end is an expected refresh to the iPad lineup.  It is hard to be long or short the name in no-man’s land and a trader should wait for a breakout/breakdown.  For the time being, AAPL is mostly dead money as it continues its transition from beloved growth stock to boring dividend stock.

TSLA is currently the hottest momentum stock  and recovering nicely from a viral car fire video that spread through the internet and mainstream press last week.  So far the company has responded well to this situation and it is not a risk to future sales.  Those that want to buy a Tesla will still buy one.  The bigger question is how deep this pool of buyers is.  While we’ve seen long wait-lists for exciting new cars like Toyota’s FJ Cruiser and Ford’s redone T-Bird, sales of both of these vehicles eventually tanked  because there was little demand after the core group of buyers got theirs.  $100k is a lot of pay for a 3rd car and will be a major hurdle once all the rich early adopters have theirs.  TSLA is on to something here, and there is a lot of excitement around the brand, I just wonder how many of the people who gush about the car can actually afford one.  At this point, the biggest risk to the stock is a sales plateau once the backlog is caught up and is the most likely event to burst this bubble.

Plan your trade; trade your plan


About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.