There are early signs that the initial panic that has caused the global markets to lose trillions in value since February may beginning to ease. Normally, it’s relatively easier to pick bottoms that tops, but there are times where the usual indicators are a little early. This has certainly been one of those times.
One of the best indicators to use during corrections is the VIX term structure. Since options have expirations, looking at the average implied volatility of each expiration tells a story. This is particularly true for the S&P 500 Index (SPX) options. This is because institutions use SPX options, future, VIX options and VIX futures as a means of hedging risk. Keying off their movements is generally very important when identifying market tops, but especially bottoms.
In normal, bullish times, seeing longer-dated option implied volatility falling below shorter-dated option volatility (called strike skew) is a good sign of a near-term bottom in the market. For VIX futures, it is called backwardation. In times like these, that signal has long come and gone without much of any reprieve. However, the past couple days has done a lot to flatten the volatility curve as implied volatilities across expirations are similar. This is an indication that we may be normalizing.
In an environment like we’re in, normalizing doesn’t instill a lot of confidence, but the opportunities to make money early can come and go so quickly, it’s important to begin taking some risk when it appears the market is ready to reward you for it. Leading into the correction, the most crowded trade involved tech stocks and there is a tendency on the part of investors to go back those same names following the type of correction we’ve experienced. Since many of these names are the largest companies in the world, as money comes back into funds, they will be bought as well.
While this isn’t the most creative list, it is the list that will likely move higher with the broader market because of their sheer size.
Recovery Stock #1: Apple Inc. (AAPL)
On March 13, AAPL was upgraded to Overweight by Wells Fargo and reiterated as a buy at Canaccord Genuity. These recommendations didn’t exactly provide price targets for AAPL that would test new highs. They’re essentially looking for the price to retrace into its February range. That type of estimate seems like a reasonable approach to take, given we’re not out of the woods yet.
A simple option strategy that can be implemented that has defined risk and an excellent return-on-risk is a long call vertical. It is a strategy where a slightly in-the-money call is bought, and an out-of-the-money call option is sold for a net debit. This trade benefits by a rise in AAPLs share price and a drop in implied volatility.
For AAPL, the 17 APR 20 240/250 long call vertical can be bought for around $5.70. That provides a maximum gain of $430 a contract, 75% ROR, if the stock closes above $250 be expiration. Consider closing early if the spread can be sold for $8.30 or more.
Recovery Stock #2: Microsoft Corp (MSFT)
MSFT has had a number of fits and starts throughout March without staging a really strong advance. Similar to AAPL and others on this list, fund redemptions directly affect it because it is so widely held because of its market cap. If the liquidation is about to abate, it may allow some of the fundamentals to take hold. One of these fundamentals is the fact that MSFT is in the middle of the work-from-home trend with many of its products.
For MSFT, the 17 APR 20 140/145 long call vertical can be bought for around $2.50. That provides a maximum gain of $250 a contract, 100% ROR, if the stock closes above $145 at expiration. Consider closing early if it can be sold for $4 or more.
Recovery Stock #3: Facebook Inc (FB)
FB saw some upside buying action on Thursday as volume started to come in. Similar to MSFT, people being quarantined or hunkering down in their home is a positive for FB in the near-term. That allows current ad-based revenue to expand as people continue to post meme’s and communicate with friends and relatives using their platform.
For FB, the 17 APR 20 150/155 long call vertical can be bought for around $2.50. That provides a maximum gain of $250, 100% ROR, if the stock closes above $155 at expiration. Consider closing early if it can be sold for $4 or more.