Options traders are likely to encounter some enhanced volatility next week as a wide variety of market indicators are scheduled for release. Given the sharp price moves we have seen in recent week, this sets up the possibility for some major corrective retracements if these data releases fail to match market expectations. Specifically, most of the major indices are trading close to multi-year highs, with the S&P 500 pushing above major psychological levels at 1500, the FTSE reaching highs above 6250, and the German DAX overcoming resistance at 7800.
Both the Dow Jones and the S&P are trading at levels not seen since the end of 2007, and these moves are largely coming as a result of improvements in macro data and corporate earnings that were not expected by most market analysts. Broadly speaking, 76% of the reporting companies in the S&P 500 have posted fourth quarter profits that were higher than the initial estimates, US Jobless Claims this week hit their lowest levels in 5 years, and legislative agreements were reached to temporarily raise the Debt Ceiling.
All of these factors are supportive for stock markets and high yielding currencies and this has created a 5.5% gain so far for the month of January. But even with these rallies, the index is still trading below 15 times earnings, which is lower than the 50-year average of 16.5. This means that additional gains are possible despite the overbought nature of short term price activity.
Many Event Risks to Watch Next Week
Looking ahead, next week will be action-packed, with a large number of economic indicators and earnings reports scheduled for release. Currency traders should be preparing for the monthly US Non Farm Payrolls, Durable Goods Orders, and 4th Quarter GDP. We will also have Unemployment figures for the Eurozone and an FOMC rate decision to guide traders. NFPs are expected to show a gain of 168,000 jobs (a modest improvement from the 155,000 jobs added last month). The rate decision is not expected to show any major changes but if we see the Fed discuss potential ending points for its stimulus programs, expect a negative effect to filter over into stock markets.
For stock traders, the earnings reports scheduled are numerous. Topping the list will be Boeing, Amazon, Caterpillar, Pfizer, Exxon Mobil, and Facebook. Traders watching the broader indices will probably see two-way movements given the sheer number of majors releases on scheduled. These types of environments actually favor short term trades as there is simply too much information to commit to weekly positions.
My Trading Recommendations in 50 Words
1. Recent earnings strength is likely to support stock prices longer term, and here we will look to avoid next week’s volatility by using monthly options. First selection is a monthly CALL in McDonald’s (MCD) at $93. MCD is trading nearly 10% below its intrinsic value and its dividend yield of 3.5% should remain a supportive factor.
2. Second selection is a Monthly CALL in CSX Corp. at $22. Last week’s earnings report passed analyst expectations and technical formations remain constructive, suggesting a bull run above $25. The company is a transportation supplier and likely to benefit from last monthly improved holiday shipping conditions.
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