Dan Passarelli, CEO - Market Taker Mentoring

 

 

Today was the big day when Jerome Powell and his buddies announced at the big Fed announcement how much they were raising interest rates. About a week ago it was looking like it was going to be 50 basis points. Today it looks almost certainly to be 75 and there was no surprise. And that is the topic of today's video.

I said in a video a few days ago that if the Fed came in right on target, what I think would be the most likely scenario is for the market to rebound a little. Even if they raise it 75 basis points, that the market would probably rise just a bit, being the most likely scenario. And that's what happened.

Let's go back on that logic and see why it played out that way. First of all, making the announcement and having it come out as expected as everyone was talking about, the market doesn't really like surprises and in fact, the market likes NOT surprises.

It's two different statements there and they're both important. Further, after the Fed announced the 75 basis point rate hike, they said that going forward they would either raise it 50 basis points or 75 basis points. Now, I believe that just giving that guidance and having everything come in line with expectations takes the jitters out of the market. Granted, the VIX fell about 10% today; it's below 30 and I think it's probably likely the VIX will start to come down a little bit. I don't think we'll see it south of 20 for a long time. It'll probably come off a little bit tomorrow, or on Friday.

Now that we have some visibility. Now that the Fed was openly talking about their expectations; kind of acknowledging they sort of had it wrong before and that they are going to do what needs to be done to fight inflation. It sounded a little bit more informed and open and believable and that's the thing that's good for markets.

Dan Passarelli, CEO - Market Taker Mentoring

Let's talk about where Twitter stock is heading next.

So I was talking with one of our 101 coaching students, I believe it was yesterday. You know who you are. I know you watch these videos, and we were talking about what the possibilities were for Twitter stock considering the Elon Musk potential takeover bid, for lack of a better way to put it.

So if Musk wants to buy the stock at $54 a share, then if that ends up being the number that finally is agreed on and he actually agrees to do it, then guess what? On the day he makes that announcement that is where the stock will jump up to, probably actually just a little bit shy of it, because there's always a little bit of risk of default in takeover situations like these stocks tend to always trade at least a little bit of a discount. But that said, if Musk comes out and he says, hey, you know what? Just kidding. I'm not going to buy this stock. Then it probably has a whole bunch of room to fall. Like a whole bunch of room to fall.

Because, look, if you look at some of the peers for Twitter, some of the social media names and that kind of stuff, they're all trading much, much lower from where they were back in, say, February. Right now, this stock is trading at a level pre-Musk announcement where it was trading around maybe March 23, where a lot of the stocks that we could look at in its peer group are trading much, much lower.

And so right now, Twitter stock is living in sort of a little bit of a hybrid world. It's trading at a fairly big discount from the potential buyout price because there's become a lot of risk of uncertainty there. But it's also trading much higher than it probably otherwise would be if Musk never made this announcement because all the other stocks are trading lower. So it's trading kind of in the middle. And so this ends up being a potential candidate, maybe for a straddle. We'll address that in a future video.

But when we finally get some visibility. And Musk said that he was going to address the employees of Twitter this week and personally, I don't see a whole bunch of actual information coming out of there. But we'll see. But if we ever get some very clear visibility on what will happen, we can see there's stock move a great deal higher or a great deal lower.

Dan Passarelli, CEO - Market Taker Mentoring

The market is back into a risk off sort of mood. The S&P 500 is down close to 4% today (6/13/22). Pretty big move in this bear market. And the question, of course, is, why? And the answer, of course, is that there are a number of thought leaders; market thought leaders, who are coming out, and they're saying that maybe there's a better chance of the Fed raising interest Rates 75 basis points at the next Fed meeting, which is in two days. Rather than the previously expected 50 basis points.

Now we've got a couple of tools that we can look at here, and one is this [see the video]: It is the countdown to the Fed which is published on the Cmegroup.com websites right now. The current target rate that the Fed Keeps for its interest rates is 75 to 100 basis points and these probabilities are based off the trading price of the Fed funds rate futures.

And so the folks who trade the Fed funds futures are basically pricing into those futures about a 71.6% chance of a 50 basis point hike and a 28.4% chance of that 75% rate hike. Now, what are the implications to this?

If we do get that (what was previously thought to be a surprise) 75 basis point hike? There's a couple of things. Clearly, they're raising that rate to try and fight inflation. And what that does is it cools down the economy. It stops people from all the money that's out there, people spending it aggressively, driving prices up higher, so it's basically a tool to fight inflation.

But when it comes to the stock market, the implications there are: what's priced in? Right?

Because if we look back to just last week, last Thursday or so, we're trading up around 414. And today, just four sessions later, we had a couple of gaps lower, busting through the 20 day moving average, and we made a new low of 373.

So is the market pricing in a 75 basis point hike? Well, we're going to find out after that number is released, because if the Fed does raise interest rates 75 basis points, then I believe that a lot of that is priced in and the market may not fall that much. All right. Now, we could have a knee jerk reaction where the market kind of drops right afterwards, but I would not be surprised to see it kind of hang in there and possibly even be up on the day if that happens.

Now, that said, if the Fed only cuts by 50 basis points, I would expect to see the market rise a great deal unless that is immediately followed by guidance of the Fed saying that they plan to get yet more aggressive in the future.

So that said, we've got some exciting stuff to watch here. And it's all coming to a head in less than 48 hours. We've got the VIX at 34 points. Could be an interesting case for some put credit spreads for folks who are in the same camp as what I just said. Possibly leading to a more bullish bias given the two potential outcomes.

Dan Passarelli, CEO - Market Taker Mentoring

The CPI number was released this morning at 8.6, the highest since 1981, really much hotter an inflation figure than many people were expecting.

Let’s take just a minute to explain what inflation is, and what some of the challenging things in fighting it are and just what implications this can have for us.

To illustrate, I was talking with a friend of mine who's not a financial person at all, and she was asking, what is inflation? I said, that's when prices go up. And she's like: what do you mean?

And so, to explain, just imagine that if you wanted to buy a small house for $100,000, let's just say nice round number, and that house is for sale for $100,000 right now. And you happen to have that in the bank. Well, you could just go and buy that house right now. But if you waited a year, that $100,000 wouldn't be able to buy that house. If all prices across the board rose by 8.6%, that house would be worth $108,600, and you wouldn't have enough money.

Or let’s say you budget your groceries at $100 a week. On January 1, you put $5,200 in the grocery savings account in your bank and the plan is to spend only $100 a week. You wouldn't be able to buy as much as the year goes on because the prices of those groceries would get more expensive, the $5,200 would run out, and you'd be hungry the last month or so of the year.

So that's what it is in a nutshell, just to kind of break it down. The Federal Reserve tries to fight that because that can promote lots of different problems. And what they do is they raise rates to try and prevent that.

Now, before we even get into exactly why that is and how that works: Let’s talk about some of the challenges that come along with a high inflation number. It actually can kind of turn out to become a little bit of a self-fulfilling prophecy that can spiral and can get really difficult to fight because Social Security checks are indexed based on inflation. And so those checks are going to be bigger, pumping more money into the economy.

The interest rates of I-bonds are attached to the inflation rate. Those are going to be bigger payments, pumping more money into the economy.

Those figures affect everything! I'm currently in the process of trying to hire somebody and in wage negotiations, people say, hey, no, I can't work for that amount because inflation is higher. So it's going to have to be higher wages.

Once it gets out of control, it becomes really hard to get back into control. I mentioned before that the Fed’s tool for fighting this is raising interest rates. Here's the thing: if you think of it from the fact that the more money someone makes, the more money someone spends because that's kind of part of the problem.

The more money that things cost, they have to pay more and so they get higher wages and then they spend more. When they raise interest rates, they're doing two things at once. They're basically making it more expensive to borrow money so that maybe people choose not to buy some of these more expensive items. And what that does, in effect, is: cooling down the economy.

Cooling down the economy, (slowing down the economy) is actually the tool for fighting inflation.

That becomes a pretty tricky dance. Do we slow down the economy just enough, the exact perfect amount, just to bring inflation under control and everything works perfectly??...

Or is there too much of a fudge factor and eventually slow it down too much: that can put us into a recession or worse yet: if the inflation is just too far out of control, (does raising interest rates put us into a recession??) and we still have inflation which is a situation called Stagflation which is the worst case scenario of the scenarios out there.

Hopefully, this overview helped to give a deeper understanding of how this all works. And why it's such a big deal. And why the fed looks at numbers like CPI and PPI and some of the other numbers that they look at as well.

Like PCE, for example, that's their preferred inflation gauge so I hope that helps.

Dan Passarelli, CEO - Market Taker Mentoring

With the VIX still above 20, it's at about 24.65 at the time I'm shooting this video here on Thursday. A lot of people are talking about volatility as if it's high. And to be fair, we have seen the markets moving around quite a bit lately, having a lot of that higher volatility. We have the VIX over 20. People tend to say that the long term average for the VIX is 20.

It's been above that for a while. So it seems like volatility is really high. Which would imply maybe it's a good time to sell options. But in fact, in a lot of cases right now, at this time, it's just the opposite. I found many, many cases where implied volatility is actually underpriced, which makes for really good long option trades. Take Meta, for example. First of all, Facebook changed its name to Meta awhile back. Now, if you look at Meta, nevermind the stock price chart, but let's look at the volatility chart. The historical volatility is 53. What that means is that the stock's annualized standard deviation is 53. And so what that implies is that if we were to buy, say, a straddle today that had three weeks to expiration, if implied volatility stayed exactly where it is at 53 and we bought that straddle at a 53 volatility, we'd typically break even. Now, that's a little oversimplified, but it's about right.

Now, here's the thing, though. We can actually buy this straddle at a much lower price. If you look at the options again, 53 is the historical volatility. The options, if we go out to 36 days here, they're trading below a 43 volatility, a full 20% lower, ten volatility points lower. That means that buying a straddle is a really great deal in Meta (facebook) right now. Now that said, Facebook is not the only case. If we go to, for example, Chewy. That is another one where if we look at the historical volatility, it's 127. Now, that could be this rather larger move here that was a result of earnings. So even if we just removed that bump up in historical here, it's at least a 110 historical volatility.

You can buy options in the high eighty's with eight days, in the low eighty's with twenty two days to expiration. So you can find a lot of examples like this. And buying underpriced straddles just simply means that the time decay is going to be lower for you, which makes it less punitive if the stock doesn't move. And in a market like this where the stocks are moving a lot, it's just more likely for it to be a winner. It's a low risk trade, and I've been looking for a lot of straddles lately.

Dan Passarelli, CEO - Market Taker Mentoring

Hey, Dan Passarelli here. I said at the beginning of this year that this is going to be. The year of the straddle. And man has it shaped up that way. And guess what?

Straddles are still in play. And I want to share with you one that I did today. So in our group coaching class, I was looking at Facebook, now called Meta platforms, of course, and I was looking at the chart here. Let's pull up the chart first.

Let's see, this is from, yeah a six month chart. And let's pull up a year chart. Just to give a little bit more context. So two earnings ago, Meta just got annihilated. They went from about 320 something down to 240 something. And it's kind of traded in a little bit of a range since then. A little bit of some lower highs. But we've definitely got a level of support that was formed here. A double bottom. Meta has been changing their strategy, of course, moving a little bit away from the ads that there's been a lot of litigious activity around. Personal data stuff. To the Metaverse and some of that. And all the things that can be done with that.

It's pretty interesting, but it's a big transitional period for them. So that's part of one of the reasons why I think we've been stuck in this range.

But at some point we kind of have to break out. And if you look and let's go back to the six month chart here. If you look at where historical volatility is, it's down fairly low. If we erase these mesas, it's down kind of in where it's been for the past five months or something like that. And the implied volatility is trading really decidedly lower than that. If we consider the historical volatility, let's just rounded down to 51. When we go a month out, we can buy it like a 41 volatility.

That's a very very low volatility. And the stock is definitely moving at more than a 41 vol. I mean, that's lower than the historical volatility has been for the past five months overall.

So that being said, we're getting a really good value from a volatility standpoint on buying options in Meta. And further. If we just look at how much one could pay, I believe I paid 21 point $45 for the 200 straddle earlier today.

I mean, look, we've been above that point just a few weeks ago and below that point just two weeks ago. So this ends up being a really nice set up. This is something that I talked about at our retreat. I did one section of my Greeks and modeling class all on this, and that one particular section I did talk about Straddles. And these are the two ways we always need to look at it from a volatility standpoint. And then just from a good old traditional break even standpoint, this is a trade that I really ended up liking today. I hope that helps.

This Is Dan Passarelli Trade Smart.