Exploring Options Amid Rising Macro Risk

welcome back to another episode of in the money I'm Constantine Ropo with Fidelity trading strategy desk and with me as always Tony Zang Chief strategist at options playay Tony another week has gone by happy to see you how are you doing I'm doing well thank you so much for having me back KV uh Tony we've uh observed some emotional and fast trading conditions over the past week uh last week we were on at the same time together last Thursday um the S&P 500 was trading around 5500 and you've laid out your case for the potential of some additional downside um targeting you know potentially um prior August lows as a possibility uh the S&P 500 of course the following day on Friday traded down to 5400 or thereabouts that was 1.7% draw down in a single day um effectively closed on Friday on day Low's came back this week beginning of the week strong out of the gate um you know very volatile conditions throughout the week a lot of back and forth uh however uh the market is resolving higher I mean here we are sitting at around 5600 now so uh a trough to Peak reversal of about 3 and a half% to the upside so the sellers I think especially yesterday in the early morning the late sellers yesterday were caught off sides for sure that's how it felt here we are sitting at the highs of the day uh Tony the reason why I'm going through this strategically like this is because you and I are not going to be here uh for the next three weeks and what I wanted to do is make sure that our clients have some short to intermediate Med term targets some levels uh to be on the lookout for I mean you've discussed last week um very vividly that you would be looking at 5650 the prior swing high and maybe even above 5670 or so the prior alltime high in the S&P 500 as your uh overarching resistance Zone that the market would have to take out to the upside to switch uh that bearish to neutral buy a short term I'm wondering if you're thinking about it differently uh if you are spotting or eyeing uh different levels of of resistance relative to where we sit right now at 5600 and more importantly what are you watching going forward I know the market is repricing um every single data point that is coming out the market is very data dependent uh upon intended there just like the FED told us that that they're going to be data dependent I'm wondering what specifically are going to be the key drivers for you um and where the market is going in the in the next couple of weeks let's call it yeah thank you so much KV first of all I think it's great that you laid it out so strategically I think it's really important for a lot of investors right now that are trying to do that calculus of figuring out what is driving markets um to lay it out strategically to get a sense for uh you know a directional view so you know as you said you know we are trading higher than where we were last week but when we look at kind of the macro picture and you look at the economic picture here it actually continues to soften and the data that came out over the past week or so has not been particularly good for equities you know we start off with another payrolls disappointment on Friday that was part of why I took a bearish tone going into last week's um payrolls number was because I was expecting the labor market to come in softer we saw the S&P react as you said down 1.7% on Friday on that jobs number and then this week we had CPI come in a little higher than expected specifically that shelter component of it which cemented the fact that we were likely only going to see a 25 basis point cut here for September now that does for some investors uh you know create the view that right now the economy is fairly strong and that it can support only a 25 basis point cut lending ourselves to kind of the soft Landing uh view of the markets which is part of why I think we've saw that huge reversal yesterday on the back of what was initially all 11 sectors in the red right now when we're looking at the markets right now all 11 sectors in the green within just one trading session but I think we' also have to pay attention to some of the things that some of the companies have been talking about you know JP Morgan an ally over the last week or so have really started to report Rising delinquencies amongst their consumers and starting to dim their outlook for 2024 and 2025 and I think that we should be paying attention to that from from a economic perspective to see kind of the the shift in the the economy starting to soften starting to cool across the board now uh Tech has been the leader of this Market over the past few years certainly over the past couple of years with regards to uh the AI theme and that really kind kind of came roaring back here yesterday afternoon and continuing to push markets higher here today as semiconductors have led this Market higher so I do think it's important for us to be aware of the macro picture which clearly is starting to cool a little bit but we still have to pay attention to what's driving the markets right now and the productivity gains potentially from AI the uh continued cap huge capital expenditure that these tech companies can continue to spend on AI to try to gain dominance in this particular space is likely going to continue to drive sentiment over the the near future so you know when we talk about levels here on the S&P 500 5650 5670 is still the level that I'm looking out to the upside if that gets taken out to the upside uh we can't help but remain uh you know continue to take a bullish stance here in the overall markets uh but you know as things soften and and we continue to see economic numbers coming lower than expected the risk of the downside is still that 5100 level that I'm paying attention to on the S&P yeah Tony thank you so much for that I appreciate it I mean you know there there are so many variables uh to to be taken into consideration I think our audience would you know certainly appreciate your views especially given the fact that uh we'll we'll be away for a couple of weeks so given that complex backdrop Tony what uh what is your first trade idea of the week yeah uh the first one I want to take a look at is is more defensive in nature given the sort of volatility that I do expect from markets over the next few uh not only the next few weeks potentially next few months as we kind of navigate how the FED is going to cut rates between now and the end of the year we also have an election coming up so uh the trade that I want to take a look at is GSK which is formerly known as glos Smith Klein the biotech company because we've seen some strong Rel relative performance from the stock over the past couple of months and in the healthcare space we continue to see you know that sector play defense and I think given the current volatile environment it's time to take a look at some of these types of stocks for your portfolio if we take a look at a chart here of GSK it's been trading in a range between 37 and 45 over the past year or so but it's starting to outperform the S&P over the past couple of months within that trading range and starting to Target the upside of that of that range around 4 5 and a half and that's really my upside Target and what we see is that a potential breakout above that and continue highing higher above that for long-term investors and more importantly if you look at the fundamentals here that's really what I think is attractive for GSK going into kind of this these types of more volatile times is the fact that it only trades at about nine and a half times forward earnings which is a pretty substantial discount to the industry average was around 17 and a half times forward earnings and if you especially if you consider consider the fact that the expected growth rates for GSK is actually higher than the industry EPS expectations are about 14% year-over-year growth versus only about 8% for the industry and their net margins are higher than the average for the industry so they are more profitable and the fact that you add another 3 and a half% dividend yield on top of that makes this look fairly attractive as a long-term investment so the trade structure that I want to use uh for this is to actually utilize options to take advantage of the current volatility and try to collect some income to potentially own this stock for the long run so I'm going to sell a cash secured put going out to the October expiration selling the $43 put that's effectively the at the money put earlier today you can collect about 95 cents for that cash secured put now when you sell a put like this you have the obligation to own to buy 100 shares of that stock for every contract you sell um if the stock is below the strike price the $43 strike price on October expiration you're collecting 95 cents per share on this particular stock so that means if the stock gets put to you you will effectively own the stock at about $425 now just to put into context 95 cents worth of income for a uh $43 stock equates to a little over 2% that you're going to earn in about the 30 days between now and expiration a little over 30 days now keep in mind this stock earns about 3 and a half% dividend yield which is quite attractive but here you're earning about 2% in just 30 days versus 3 and a half% over one year that's the type of yield that I'm looking for in this type of environment to sell a cash secured put and the overall risk that I'm taking here is similar to owning the stock for every 100 shares or every put contract that I sell I'm taking on about $4,200 worth of risk but keep in mind that that risk is if the stock declines to zero between now and and if the stock declines is zero which in this particular case I think is fairly unlikely so uh collecting 95 cents worth of income here I think is a good way to take advantage of some of the volatility that we see here in the markets and play a more defensive play in this uh type of Market environment very interesting straightforward trade structure there um you know neutral bullish premium selling type of an idea uh Tony what I do want to point out uh for our audience numbers is that GSK as the stock over the past 90 trading sessions has traded on average 3.6 million shares a day the options Market the options trading equivalent of course is um not uh as deep in terms of liquidity so less than 3,000 contracts per day over the past 90 trading sessions have traded uh on average so wider bid offer spread s in this particular name doesn't mean that it's not tradable uh what it does mean however is that if you are deciding to take this trade I would certainly it would make sense to be prudent utilize a limit order uh when executing it for a credit especially if you're GNA decide to do this particular strategy in size um time to take a look at the second trade idea Tony what do you got yeah the second trade idea I want to take a look at reflects the cooling economic picture sure that we continue to see and what you know what we're hearing from CEOs such as uh Jamie Diamond talking about their expectations going into the second half of this year and into next year with regards to consumer spending and the consumer spending habits starting to show some delinquencies so the the trade that I want to take a look at here is Amazon because we actually took a bearish trade here in Amazon back in July and we're back at a level similar to when we took that trade that I think is worth paying attention to here again because the the challenges that's that consu you know as a more as consumers become more selective in their spending and a labor market that's starting to slow those are the types of conditions that will likely weigh on sort of e-commerce type stocks and Amazon generates 65% of their revenue from their e-commerce business their aw AWS business is incredibly strong and I think will uh continue to perform quite well but when you have the 2third of your Revenue generated from e-commerce that's really where I see some risks here to Amazon especially when we look at the valuations now if we first look at a chart here for Amazon we brought this trade uh back in July when it was trading just around that 180 level prior to that earnings announcement and the stock broke below that support level uh on that earnings announcement and we just managed to trade back up to that 180 level and actually just based on yesterday's price action and today we broke back above 180 however I do think that that 180 185 uh support level is now going to likely act as resistance and potentially provide a bit of a short-term cap as far as how much higher the stock can go from here so if you look at the fact that momentum right now is still fairly negative here on on Amazon I think that the 180 185 level is likely potentially a a level where we could potentially reverse lower and the risk reward actually favors adding some bearish exposure at these particular levels and more importantly I think it's really the fundamental picture that that that drives my thesis on this particular trade Amazon trades at 31 times forward earnings which is nearly 50% higher than the average S&P 500 stock from a valuation perspective and then you look at the fact that um Amazon's net margins are only about 7% meaning Amazon actually doesn't generate a lot of profits and a lot of that comes down to the e-commerce business operates on extremely thin margins and that's really some of the downside risks that I see here with this particular stock NOW Amazon is expected to grow EPS by a pretty hefty margin relative to the S&P 500 but I think that if you look at the macro headwinds that we're starting to face with with the cooling markets and and consumers becoming a lot more selective and potentially uh you know credit card delinquencies continuing to rise I think that valuations here are a little bit harder to justify in this type of Market environment so the trade structure that I want to use here is to sell some premium here I'm going out to the October 25th weekly expiration and I'm selling the 185 20000 call vertical what I'm doing here is I'm selling the 185 calls but if I were to just sell the 185 calls naked I'm taking on unlimited risk and would require a lot of margin to sell that 185 call to take a neutral to bearish view here on Amazon so instead what I'm going to do is I'm also going to buy a $200 call against it and what that does is it certainly reduces the amount of net credit that I receive on this uh on this trade but what it does is substantially reduces the amount of risk that I'm taking it limits the amount of risk that I'm taking and reduces the amount of margin that's required to get into this trade so earlier today you can collect about $5.70 for this $15 wide credit spread and this is a trade that's going to offer about $570 of potential premium or potential reward per contract if Amazon stays above below 185 between now and that October 25th expiration and risking about $930 per contract if Amazon is above $200 at expiration if it's above $200 I would say My overall bearish thesis here is incorrect and I would likely get up prior to hitting 200 but those are some of the levels that I'm paying attention to here right now and by entering right around that resistance level my risk reward is going to be quite favorable here yeah Tony uh just a little better than 2:1 uh risk reward on this trade um Amazon as as a stock and the options Market in Amazon uh in terms of liquidity are about as good as it gets uh so nothing to worry about there I mean still makes sense uh and is always prudent to utilize limit orders but uh uh the bid offer spreads are are much tighter in Amazon than it is in GSK however one of the things Tony I wanted to ask you maybe you could elaborate on this particular point for clients in the audience um how does one gauge the probability of uh not just being in or out of the money but the probability of a trading strategy potentially being profitable uh do you have uh you know a a go-to shortcut rough math uh sort of thing that you normally utilize to figure that out yeah absolutely now there are obviously most platforms will be able to calculate for you exactly based on historic based on implied volatilities uh roughly what the probability of profit based on kind of History would look like down to you know the the exact decimal point but for a lot of traders who are looking for some of the back of the envelope math you know one of the best ways to do that is to use Delta of the strike prices to gauge the the probability of the stock being above or below that strike price at expiration so when you're collecting about a little over $5 here on this 18520 call spread that gives you a a break even price just around $19 so what you can do is you can take a look at the 190 strike expiring on October 25th and look at what the Delta of that uh of that option is so if you're looking at the Delta earlier today it's probably around 43 44 or so and what that equates to is about a 56% chance that the stock will be below $190 at expiration or 44% chance that the stock will be above $190 at expiration so you can use that as a quick and dirty back of the envelope way to gauge roughly what the probability of profit on a trade like this which in this particular case it's a little higher than 56% because the break even price is actually a little higher than 190 it's around 1970 but that's close enough I think for a lot of traders who are looking for some backof the envelope math love it Tony thank you uh that's that's a great tip to keep in your pocket if you're a Trader um lastly we have a look back that I think requires some management uh it's a trade uh that went in our favor and then reverse so let's talk about that one Tony yeah so a few weeks ago I laid out a bullish thesis here for Autodesk um we bought the September 257 and a half 275 call vertical this was an earnings play and on earnings the stock actually reached that upper strike price around 275 uh the day after earnings now for some of you maybe you took profits on that particular trade and if you did good great you know that's that was an awesome trade uh we bought this for about $7 but the stock is you said has collapsed since that uh earnings announcement it's trading back up to around that 260 level here right now a little bit below the break even price and we are approaching expiration we're about less than 2 weeks away from expiration so I do think that if you missed out on an opportunity to take profits on this particular trade I do think it's time to manage this trade at this point we bought this for around $7 right now it's trading about $465 which represents about a 33% loss on this debit spread and I think again if you have not taken profits on this particular trade or cut losses on this trade yet this is a good time to actually do that you're not losing a lot on this particular trade only 33% of the premium that you pay so we haven't even reached a stop loss level but I do think that at this point the the the the probability of the stock reaching back up to 275 by next Friday is somewhat unlikely and it's better off to save the other 2third of the premium that you paid on this particular trade for your next trade rather than hold on to it and hope that this trade will turn out to be a profitable trade at expiration yeah Tony as we like to say on a trading strategy desk hope is not a strategy um very important to remember that folks this brings us to a close I want to thank all of our viewers for tuning in today uh again quick reminder uh Tony and I um or any other Fidelity hosts are not going to be back for three weeks uh the next show that you should be tuning into and looking forward to is going to air on October 10th um don't forget of course the trading strateg desk does do a follow-up session to this particular show it happens every Friday FR at 1:30 Eastern Standard Time uh you can um sign up for for that class by going to fidelity.com in the money followup uh we also offer a Fidelity active investor newsletter you can find that by going to fidelity.com slactive investor weekly um we will see you back in about three weeks Tony it's been an absolute pleasure thank you so much uh for bringing us new and fresh and interesting ideas as always thank you K it's pleasure to be here