Stock Market Options Hedge if Santa Rally Fails

This week's evaluation begins with an analysis of FedEx and the erroneous nature of the recent trade idea. Subsequently, the discussion delves into the outlook for the remainder of the year and introduces a potential market hedge strategy.

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Charles Dow, the founder of The Wall Street Journal, established "The Dow Theory," emphasizing the significance of the transportation sector as a leading indicator. The premise is straightforward: a reduction in shipping activities by transportation companies may signify a decline in the production and sale of goods. FedEx's recent earnings report, disclosed on Tuesday evening, provided insights into the economic landscape, and the revelations were far from positive.

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Terms like "headwinds," "challenges," "slowdown," and "cut forecasts" dominated the language used in reference to FedEx's earnings, signaling unfavorable developments that disappointed investors. The company's management repeatedly mentioned "headwinds" during the earnings call. Notably, the CEO acknowledged a structural challenge when questioned about persistently low margins. Despite cost-cutting initiatives like "DRIVE" and "Network 2.0," margins failed to expand, primarily due to a global slowdown in industrial production affecting market demand.

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It's essential to clarify that the author holds FedEx in their portfolio, and despite the unfavorable news, they express discontent with the current situation. The stock experienced a 12% decline from close to close. However, for those who followed the previously suggested call spread idea, the losses on the option trade were only 4% of the current stock price, offering a mitigated impact compared to holding the stock.

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Acknowledging the influence of FedEx on the portfolio, constituting approximately 30-35 basis points, the author expresses concern about what future challenges may arise. Unlike the earnings impact in September 2022, this time, there is a heightened awareness and anticipation of potential forthcoming obstacles in the market.

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The narrative then shifts to the broader market scenario, specifically the unexpected rally in the Dow Jones Industrial Average (DJIA) despite FedEx's adverse news. The DJIA, which includes major constituents like Goldman Sachs, Home Depot, Caterpillar, Boeing, and Honeywell, experienced a modest uptick, contrary to expectations. Caterpillar, despite reaching an all-time high, closed down 1.1%, signaling a downside reversal.

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A downside reversal occurs when the price attains fresh all-time highs but concludes the day lower. This phenomenon, combined with the market's overbought conditions by metrics such as RSI and Bollinger Bands, raises concerns, especially in light of FedEx's comments.

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The author reflects on their earlier optimism about the S&P 500 reaching or exceeding its all-time highs within the next two weeks. However, the recent developments have cast doubt on this outlook. While Wednesday's decline could be a natural pause after a robust rally, the author contemplates the possibility of a more significant downturn. The question arises: Is it prudent to expect a 1-2% rally without considering safeguarding the remarkable gains accrued since the beginning of November?

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As a potential hedge, the author suggests considering the S&P 500 SPDR Trust (SPY) January $460 puts, which were priced at $2.98 as of Wednesday's close. Representing over 0.6% of the current SPY level, these puts could turn profitable if SPY retreats to levels observed just 14 days ago, with 30 days until expiration. The SPY was trading around $471 during Thursday's session.

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The author acknowledges their initial anticipation of a Santa Claus rally lasting until after New Year's but emphasizes the importance of being prepared with a hedge in case of an unexpected downturn. Despite the recent miscalculation regarding FedEx, the author recognizes the necessity of learning from losses and not making excuses for a stock's performance after negative news emerges. In the current scenario, the news wasn't favorable for FedEx or the broader economy, emphasizing the principle of "first loss, best loss."