Dark Days Ahead?

Cheat Sheet #19

It’s Your Move

Remove and save this page!

Trading platforms offer built-in tools that point toward expected stock prices

By Mike Hart

The market is defined from moment to moment by every single decision made by each trader—combined with all of the decisions made by all of the other traders—and instantly processed and displayed.

With each tick up, down or sideways, the winners and losers prepare for their next trade. For most traders, that preparation centers on forecasting future movement.

While some traders rely on instinct to predict the movement of the market, others improve their odds of success by using tools built into their trading platform.

Those tools can do the math and point to the expected movement of a market over a given period of time. Then the tools take another step and determine the probability of a future move and the probability of touch.

The probability of touch is the likelihood that a stock will trade up or down to a strike price at some point between now and expiration. But it may not stay at that level.

Using options, traders can estimate the movement of a market over a given time period. They can take that another step further and determine the probability of a future move, including when it may occur. They can also determine the probability of touch.

Mike Hart, a former floor trader at the Chicago Stock Exchange and proprietary futures trader, specializes in energy markets and interest rates. He’s a contributing member of the tastytrade research team. @mikehart79

Great expectations

1

Determine a short option’s probability of success by choosing a delta and subtracting from 100.

2Most trading platforms determine the expected move. The tastyworks platform displays this in two different ways. The first is by looking at the far right of the options trade page. There you will find a +/- expected move. Another way is looking for the orange-brown line on the trade page. Finally, you can use the equation below for the expected move.

The expected move = Price of an at-the-money (ATM) straddle x 60% + Price of strangle one strike away from ATM x 30% + Price of strangle two strikes away from ATM x 10%

Delta To calculate Probability of success

16 (100 – 16) = 84 84% 30 (100 – 30) = 70 70% 40 (100 – 40) = 60 60%

Date

Days

Jan. 21, 2022 44 Feb. 18, 2022 72 March 18, 2022 100 April 14, 2022 127 May 20, 2022 163

Apple Inc. (AAPL) $174 Implied volatility Expected move

33.5% ±$11.76

35.8% ±$16.94

35.1% ±$20.01

35.2% 35.2% ±$22.72 ±$26.72

3

The probability of touch is the statistical likelihood that a strike price will be reached at some point prior to expiration. It is useful to consider because it gives context to expectations for a trade.

Delta To calculate Probability of touch

16 Multiply by 2 32%

trades&tactics

actionable trading ideas

CHERRY PICKS RIPE & JUICY TRADE IDEAS

Seeking Diversity

Rather than seeking to predict the next big thing, consider buying any of these 20 tickers to diversify a portfolio in the new year

By Michael Rechenthin

W

hen all of the stocks and exchange-traded funds (ETFs) on a portfolio page are colored either green for profit or red for loss, those holdings aren’t diversified.

But diversification is worth pursuing because it generally strengthens a portfolio by combining a variety of companies, components and strategies. It often reduces risk without reducing returns.

While simply adding stocks generally helps diversify a portfolio, it doesn’t if they all come from the same sector—such as technology, for example.

That’s where data science can come into play. Traders can easily scan the most liquid stocks and ETFs to diversify a portfolio that’s heavy in the S&P 500 Index.

The table tracks 20 tickers and ETFs that have been trading without correlation to the overall market, as measured by their six-month historical relationship with the S&P 500.

For many traders, the easiest way to diversify is by purchasing shares. But another method calls for buying 100 shares of the underlying and then selling a covered call against the shares held. That has the advantage of increasing “cash flow” because the money received for selling the call acts as an extra dividend to the portfolio.

On their own

Buying these equities, which have not been moving in sync with the markets, could diversify a portfolio.

Symbol Name

BDX Becton, Dickinson and Co.

BIO Bio-Rad Laboratories Inc. Class A

Industry IV Rank Expected volatility 3-month price change 12-month price change

Surgical & medical instruments & apparatus 28% Medium -5% 1%

Laboratory analytical instruments 35% Medium -9% 32%

CPB Campbell Soup Co. Food & kindred products CHD Church & Dwight Co. Inc. Soap detergents, cleaning preparations, perfumes, cosmetics CLX Clorox Co. Specialty cleaning, polishing & sanitation preparations 28% Medium 0% -9%

18% Medium 15% 11%

18% Medium -1% -17%

CMS CMS Energy Corp. Electric & other services combined 16% Medium -2% 5% CAG Conagra Brands Inc. Food & kindred products 25% Medium -3% -9%

DG Dollar General Corp. ED Consolidated Edison Inc Retail trade 30% Medium 2% 8%

Electric & other services combined 36% Low 11% 13%

ES Eversource Energy Electric Services HOLX Hologic Inc. X-Ray apparatus & tubes & related irradiation apparatus 57% High -1% 2% 36% High -7% 1%

SJM JM Smucker Co. Canned fruits, vegetables, preserves, jams & jellies 27% High 10% 15%

K Kellogg Co. Grain mill products 23% Medium 0% 1%

KMB Kimberly-Clark Corp.

Converted paper & paperboard products (No containers/boxes) MRNA Moderna Inc. Biological products 24% Medium -1% 0%

30% High -43% 63%

NEM Newmont Corp. Gold & silver ores

18% High -2% -5% PKI PerkinElmer Inc. Laboratory analytical instruments 22% High 0% 28% PFE Pfizer Inc. Pharmaceutical preparations 60% High 16% 28% GLD SPDR Gold TR Gold SHS ETF 16% Low 0% -3%

KR The Kroger Co. Retail grocery stores 40% High 4% 42%

Michael Rechenthin, Ph.D., aka “Dr. Data,” is the head of research and development at tastytrade. @mrechenthin

For more information on this quantitative way of trading, subscribe to cherry picks and market insights at info.tastytrade.com/cherry-picks

THE TECHNICIAN A VETERAN TRADER TACKLES TECHNICALS

Dark Days Ahead?

Technical analysis of stock prices indicates the markets’ “everything bubble” may burst in 2022

By Tim Knight

U

nhelpful pundits often make technical analysis seem terribly complicated. But the basic tenets of good charting focus on supply, demand, support, resistance and trend lines. Using a limited palette of tools, a skilled chartist can glean great insight from long-term charts about possible directions and their likelihood.

One interesting twist to the world of charting is using those tools and techniques on ratio charts instead of standard charts. Traders can distinguish between a standard chart and a ratio chart by the number symbols used to construct it.

If a single symbol is used (such as AAPL for Apple or MSFT for Microsoft), then it’s a standard chart. If more than one symbol is used—sometimes dividing one by another—then it’s a ratio chart. In other words, it displays the ratio of the first symbol compared with the second.

Any given financial instrument can be divided by another. The resulting chart might be interesting, but it might not be useful. For example, one could divide the price history of Apple on a daily basis for the past 40 years by the price data for wheat over the same timespan. But as unrelated as those two things are, the resulting chart would likely be pointless.

There are, however, ample opportunities to create ratio charts from instruments that have powerful, long-term relationships. Let’s examine a variety of such charts and determine what they suggest for the year ahead.

A down period

A long-term view shows prices stayed relatively low during the 1970s.

1959 1969 1979 1989 1999 2009

The money supply

The S&P 500 did not ascend in a financial vacuum. Instead, stocks increased in price in recent years thanks to a tidal wave of liquidity provided by an endlessly accommodating Federal Reserve. Thus, traders could create an honest picture of the performance of the S&P 500 by simply dividing the value of the daily data of the S&P 500 cash by the level of the M2 money supply, as reported by the Federal Reserve. The resulting chart is called “Mostly upward. ”

The second chart accompanying this article, “A down period,” above, goes back farther in time than the first. The second chart begins in the 1950s and breaks down into some broad component parts: Phase One: This is the steady descent of equity markets through the 1960s and 1970s. Even though the nominal value of the S&P didn’t take on the appearance of a quarter-century bear market, in reality, that’s what was happening beneath the surface—if one measures the stock market through the lens of the money supply. This relentless grind lower ended in the middle of 1982.

Phase Two: This was when the last long-term organic bull market took place, and it was gargantuan. From 1982 until early 2000, the stock market roared higher. The fact that the M2 money supply was changing through this period is taken into account by virtue of the fact this is

0.30 0.28 0.26 0.24 0.22 0.20 0.18

0.16

0.14

0.12

0.10

0.08

0.06

2019

slopecharts.com