Be Wary Of The Disingenuous Hug

Summary

• The stock market seemed to express acceptance of the notion that an interest rate increase could be announced in just a few weeks.
• The last time the market came to embrace that idea, it ushered in a 10% correction.
• With the Volatility Index at a 2-year low, this could be a signal that the past week's embrace is again ready to herald a "sell on the news" decline.

We've all been part of one of those really disingenuous hugs.

Whether on the giving or the receiving side, you just know that there's nothing really good coming out of it and somehow everyone ends up feeling dirty and cheapened.

Every now and then someone on the receiving end of one of those disingenuous hugs believes it's the real thing and they are led down the wrong path or become oblivious to what is really going on.

This week, the market gave a warm embrace and hug to the notion that the FOMC might actually be announcing an interest rate hike as early as its June 2016 meeting.

The chances of that even being a possibility was slight, at the very best, just 2 or 3 weeks ago. Since then, however, there has been more and more hawkish talk coming even from the doves.

The message being sent out right now is that the FOMC is like a hammer that sees everything as a nail. In that sense, every bit of economic news justifies tapping on the brakes. Traditionally, those brakes were there to slow down an economy that was heating up and would then lead to inflation.

Inflation was once evil, but now we recognize that there are shades of grey and maybe even Charles Manson had some good qualities.

With the market's deep hug of affection, the S&P 500 ended the week 2.3% higher, seemingly sending the message that investors had grown up a lot in the past week or so, and were now able to realize that another small increase in the interest rate was a reflection of an improving economy.

That should be good for everyone, right?

Hugs all around.

So before anyone gets too giddy, it may be worthwhile to look at that last embrace that the market gave when it suspected that an interest rate hike was imminent.

That was in December 2015.

The market started to act in a matured fashion in what would turn out to be 5 days in advance of the FOMC's December 16th announcement.

click to enlarge)

Maybe in what is best an example of "buy on the rumor and sell on the news," the market started a swoon that was far in excess of the climb.

The first 6 weeks of 2016 were as bad as the first 6 weeks of any preceding year.

In the nearly 4 months since the market's post-interest rate increase correction, we are left barely 1.5% away from the S&P 500's all-time high level.

Whether the FOMC's read on the economy is correct or not, having now made that embrace, the market is likely at some kind of an inflection point heading into the June meeting.

I'm not entirely convinced that the hug this week was entirely disingenuous, after all, what were the other choices left to investors? Continue following oil for the wrong reasons?

As usual, the week's potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or "PEE" categories.

In the "Comments" section of last week's article a reader asked about my opinion on iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX). I've scanned my computer for malware to see if he had been reading my draft for this week. I think that malware may have placed the "Charles Manson" reference earlier.

For those that do look at volatility and various volatility instruments, there can be lots of risk and potentially reward in being on the correct side of a bet.

A bet. Not an investment.

In this case, there is simply the question of where the market is going and in how big of a leap and bound.

I think that the next leg is lower, although that next leg may not start for another few weeks. However, I generally like to consider the use of iPath S&P 500 VIX Short-Term Futures ETN in advance of those moves.

In a very superficial explanation, the volatility, which is a measure of uncertainty, generally moves lower when the market heads higher and reverses course as the market reverses course.

"The VIX" is now at a 2-year low after having hit a nearly 1-year high on February 11, 2016. If you believe in coincidences, that happened to be the market low point for 2016.

What "The VIX" really offers, as a result of its own volatility is an attractive option premium, whether buying shares of the ETN and then selling calls, or selling puts. It also tends to have great liquidity, which is especially important if faced with a move that goes counter to your expectation.

At this level, with an expectation that the market could be heading lower on a "sell on the news" reaction, I would expect "The VIX" to head higher.

If buying shares and selling calls, I might consider using the June 2016 expiration, while I might use the weekly expiration if selling puts. In the latter case, I would be prepared to roll over those puts if faced with assignment and then might elect to do so using that same monthly expiration date.

As long as I'm considering a bet, this may also be a good time to add some shares of Las Vegas Sands (NYSE:LVS) to my existing shares that are in deep loss territory.

It's hard to know what Las Vegas Sands really has going for it, as the story for the past few years has been entirely focused on Macau and Sheldon Adelson's politics. What has kept me holding shares has been the dividend and the belief that there will be either a reversal of fortune in the long term in Macau or official Chinese government economic data will give an impression of a resurging economy in the short term.

With an ex-dividend date coming up on the first day of the July 2016 monthly option cycle, my preference would be to steer clear of the long term and hope for some short-term reward.

With the appearance of some base forming at its current level, I might be interested in buying shares and selling either an extended weekly call on a date after the ex-dividend date or simply going to the July 2016 monthly option contract.

In the years that I have been offering this weekly take, I've never included a stock position that I had absolutely no intention of buying, but this week, I do like Bank of America (NYSE:BAC). I like it for the obvious reasons.

As long as the market continues embracing the idea that an interest rate increase is a good thing, then financial sector stocks may be a reasonable place to park money. In Bank of America's case, it is also ex-dividend this week. However, instead of considering selling an in-the-money weekly option in an effort to get some of the dividend subsidized by the option buyer, I would rather try to get some stock appreciation and the dividend, in addition to the option premium.

The reason I won't be buying shares is that I already own 3 lots and I trade with a particular set of rules. One of those rules is that I not hold more than 3 lots of any stock.

Someday I may fine tune that to give me some more flexibility, but as long as it is still a rule, I follow it and try to stay away from making decisions on the fly.

Finally, I never like Abercrombie & Fitch (NYSE:ANF) as anything other than a chance to make, hopefully, a quick trade.

Oftentimes, that's not how it works out for me, but I insist on going back for me, over and over again.

This time, it's hard to ignore the steep decline after earnings. That's true, despite the fact that a steep decline after earnings shouldn't be anything exceptional when it comes to Abercrombie & Fitch.

What attracts me to it is that it is back below the last price that I purchased shares and also happens to be ex-dividend this week. For my temperament, that's a good combination when faced with the "hot mess" that Abercrombie & Fitch shares have been for quite some time.

The option market clearly has low expectations for Abercrombie & Fitch this week as the in-the-money call premium, in what is a holiday shortened week, is really very high, particularly with the dividend factored into the equation.

Can those shares go substantially lower?

If you don't know the very probable answer to that question, this is one stock and call sale you should avoid, just as Abercrombie & Fitch did strive to avoid a certain "uncool" demographic.

That demographic certainly included me and maybe nearly everyone I have ever known and that turned out to be a problem when your accountant doesn't really care where the money is coming from.

But I hold no grudge as those shares, beaten down as they are, may offer a reward far in excess of the slight that Abercrombie & Fitch cast toward my people.

Maybe it's time for that mutually rewarding embrace.

Traditional Stocks: none

Momentum Stocks: iPath S&P 500 VIX Short Term Futures ETN, Las Vegas Sands

Double-Dip Dividend: Abercrombie & Fitch (6/1 $0.20), Bank of America (6/1 $0.05)

Premiums Enhanced by Earnings: none

Remember, these are just guidelines for the coming week. The above selections may become actionable - most often coupling a share purchase with call option sales or the sale of covered put contracts - in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.

Disclosure: I am/we are long ANF, BAC, LVS, VXX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.