This Week in Episodic Pivots: May 14, 2023

Follow these explosive setups for profits

This is one of the most boring markets in the past few years.

The indexes aren’t going anywhere. And that’s despite the fact that all signs are pointing towards a recession in the second half of this year…. Oh yeah, and the U.S. may reach its debt ceiling in a couple weeks.

Look what I mean. Hasn’t gone anywhere for a couple weeks now.

The reason for the rather sanguine markets likely has to do with the options market. Derivatives are growing in popularity because people want to make more while risking less. Options allows that.

But also we have a growing phenomenon of the 0 days to expiration options (0DTE). Every day the S&P 500 and Nasdaq have options that expire on the futures market and on their major ETFs (SPY and QQQ).

Almost half the trading volume of options occur in the 0DTE options the day they expire.

That sounds crazy, but there is a logical reason for this. A common strategy to generate extra yield is for people to sell covered calls against their holdings. So if you hold 1,000 shares of SPY, you could sell 10 calls against it and take in a little bit of income.

Investors used to sell these covered calls a month out and that would generate an extra 1% or so of yield that month.

The problem with the strategy is if the market surged higher, they would get their shares called away. This strategy limits the upside.

Now to generate the same 1% or so on the entire position, these investors can just sell 3 0DTE calls every day. And then only 30% of their position has a capped upside.

So that is why investors are using these options.

Now you might be wondering who is buying all these options these investors are writing. And no, it’s not the WallStreetBets crowd of retail investors YOLO’ing into positions.

These options have market makers which guarantee to make a market. But the thing is, market makers tend not to bet on the direction of the stock.

What happens is the market makers will buy the call contract from seller, but they will hedge that long exposure by shorting shares.

And as the price of the index goes up, these market makers have to short more shares to remain properly hedged. In Wall Street jargon, they want to remain “delta neutral.” But that’s a topic for another article.

So as the price of SPY goes higher, the SPY options market makers are selling shares of SPY. This creates a headwind in the price of shares. And as the price of SPY goes down, the market makers will end up buying shares of SPY. This helps support the price in downturns.

For the markets to break out of this range, we will need a major news event…. And there are a few on the horizon that we’ve talked about earlier.

 Portfolio Update

The portfolio has chopped around a bit in recent weeks too. It’s hard to get a sustained move when the markets are in a constant state of flux.

I’ve talked to a couple active traders in the past week who are beginning to think trading is a waste of time. And they are thinking of taking a break for a bit. Not a terrible idea for a choppy market.

But this talk also only happens right as markets are about to make a big move. So I think the time is getting near.

This past week, we got stopped out of THCH for a max loss. Unfortunate, but we must respect our stops. This should have been sold Friday at the market open. I’m marking the sale at $3.75, but it did bounce a bit in early trading. You may have gotten a better price.

We have a couple others close to stops, like BFLY. But we just avoided hitting our stop in this one after earnings. It dipped, although earnings weren’t that bad. We’ll see if it can catch a bid this week.

If the markets look like they’re going to turn down, be ready to act quickly. We want to cut our losses and then get ready to add more positions after a bottom.

But we have a couple new positions we can add to our portfolio this week if you’d like.

Unity Software ( U 0.00%↑ )

Unity helps companies develop 2D, 3D, and augmented and virtual reality worlds displayable on just about every kind of screen. This was a big metaverse play back in the excitement of virtual worlds in 2021.

But they have recently laid off people which suggests they are switching focus away from metaverse development. And they are moving their focus to artificial intelligence and digital twins. This is likely more monetizable immediately. And investors liked the switch in focus.

That announcement during U’s earnings call, led investors to buy shares in extremely high volume. And then on Friday, shares pulled back. This nearly closed the earnings gap and gives us a low risk, high reward entry into shares of Unity.

We’ll use a hard stop of $25 for our initial stop loss.

IAC Inc. ( $IAC)

IAC is a holding company consisting of hybrid media/electronic retailing company. They currently hold business like Angi Inc, Dotdash Meredith and Care.com among others.

But the company is most well known for its previous spinoffs which include the Home Shopping Network (now Qurate Retail), Live Nation, Match.com, LendingTree.com, etc…

After a small hiccup last year that sent free cash flow and EBITDA negative, IAC looks to have rebounded. They beat their revenue and profit targets this past quarter. And guided inline.

They appear to have turned the corner here and are primed to go higher. For the first time in over a year, the price jumped above its 10, 50, and 200 day moving averages. This is a bullish sign.

I wouldn’t be surprised to see IAC retreat back to the breakout level. But we have another nice entry here with a small, defined stop with the 50-day MA. We don’t want to miss a potential move higher trying to get a 3% better entry price.

And that’s all for this week.

Happy Investing!