An options hedge on the stock market if the Santa rally fails to continue
First, we’ll discuss FedEx and how we got that trade idea wrong this week. Then we’ll review what I think will happen into year end and a possible market hedge idea. Charles Dow, founder of The Wall Street Journal created, through a series of articles, what is now known as “The Dow Theory”. One of the tenets attributed to those ideas is that the transports are a leading indicator. Its a simple and logical idea. If transportation companies are shipping less goods, than perhaps fewer goods are being made and sold. FedEx gave us a sense of how things are looking when they reported earnings Tuesday evening, and it wasn’t good. Headwinds, challenges, slowdown, cut forecasts… These aren’t the words one wants to hear out of earnings. We got all of them out of FedEx earnings, they hit a dinger, in a bad way, which disappointed the Street to say the least. FedEx management used the word “headwind” or “headwinds” 10 times during the earnings call, but the statement that got my attention was the CEO’s response to a question from Ken Hoexter from Bank of America who asked why margins “are stubbornly so low…what does it take to get the structural margin out of this low bar?” Recall in my earlier piece that I had highlighted the companies cost-cutting initiatives “DRIVE” and “Network 2.0”. Still margins didn’t expand. Why? FedEx President and CEO Raj Sumbramaniam responded to Ken’s question by saying “we’re dealing with several headwinds” before adding “we have seen now the market demand weaken primarily because of slowdown of industrial production across the world… ” (emphasis added) Put differently, the company can cut costs, but if a global slowdown hits the topline, than margins get squeezed from above. Let’s get this out of the way first. We own FedEx. I’m not going to sugar-coat it. I don’t like what I’m hearing. Neither did everyone else judging by the price action. The stock fell 12% close-to-close. The only good news for those who followed the call spread idea I wrote about only two days ago , the losses on the option trade were only 4% of the current stock price, considerably less than one would have lost holding the stock itself, as we do. I recognize that “losing less” isn’t much of a consolation. The call spread was a loser. FDX 5D mountain FedEx 5 days In our case, FedEx impact on the portfolio was about 30-35 basis points so far, less than the hit the impact we took in September 2022 on earnings, but the big difference this time around is that I’m looking beyond FedEx wondering what’s the next shoe to drop? (1 basis point equals 0.01%.) Market downside reversal I was surprised when, after dipping slightly on the open the Dow Jones Industrial Average rallied mildly. Just before 1 p.m. ET it was up more than 20 basis points from Tuesday’s close. I can understand how a few idiosyncratic tech stocks might shrug off the FedEx news, but the Industrials include Goldman Sachs, Home Depot, Caterpillar, Boeing and Honeywell among its largest constituents. Unlike the Nasdaq 100 or the S & P 500, Apple isn’t even in the top 10 largest components. Caterpillar interestingly hit an all-time high before closing down 1.1% from the prior day, putting in a downside reversal, much like the Industrials themselves. A downside reversal takes place when the price runs up to fresh all-time highs, but closes the day lower. Generally I tend to get most pessimistic when a price gaps sharply higher off the open before closing lower, in this case it was not so pronounced, and one could argue after such a stellar couple weeks that the market was significantly “overbought” by metrics such as RSI, Bollinger Bands etc., but I admit when combining it with the comments from FedEx it makes me considerably more uneasy. On Monday when asked I told a colleague I was pretty confident that the S & P 500 was likely to hit or exceed the all-time highs (non-inflation adjusted) from early 2021 within the next two weeks, a view I believe many share, but this has shaken that belief somewhat. That all-time high is clearly in play. Wednesday’s decline could be a much-needed pause after a stellar rally. But what if it isn’t? Does it make sense to play for the obvious 1-2% rally without considering locking in some of the incredible gains we’ve seen since the beginning of November? Hedge The S & P 500 SPDR Trust (SPY) January $460 puts were $2.98 as of the close Wednesday. That’s over 0.6% of the current level of SPY. Those would be profitable if SPY fell to levels seen just 14 days ago and have 30 days until expiration. The SPY was trading around $471 during Thursday’s session. My guess was the Santa Claus rally would last at least until after the ball falls in Times Square, as it did in 2020-2021, but am I not willing to buy a little insurance in case I’m wrong? I was wrong about FedEx. It happens. Incidentally, 240,045 puts traded in FDX Wednesday – that’s more than 32 times the 20-day average put volume. We weren’t among those buying them, but it would seem that some options traders are concerned the swoon could get a bit worse. We didn’t buy the puts, but we weren’t adding to our stock position either. One of the worst things a trader can do is make excuses for a stock and adjust one’s rationale for owning it after bad news comes out. Today’s wasn’t good for FedEx and it wasn’t good for the economy. First loss, best loss. DISCLOSURES: (Long FDX) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . 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