A ‘Rising Sun’ Pairs Trade

Before all else, we’re going to revisit and close down a profitable trade.

It’s a pairs move that we launched about six weeks back in a letter called Apples Fall and Cars Go Vroom!, in which we recommended he following action – buying TSLA April 230 CALL for $3.90 and selling AAPL April 135 CALL for $4.10. Every pair traded credited you $0.20.

Our thinking at the time was very simple – technically, AAPL was due for a slowdown, having just achieved ‘overbought’ status by striking the RSI 80 level. TSLA, by contrast looked to have bottomed after hitting long term support and seemed to be headed higher.

What happened since?

Our prognosis for the two stocks proved accurate.

Unfortunately, we didn’t give the set a long enough time horizon to diverge as we’d have liked. At the end of this week, both options will expire, and we’ll take in some cash – but it won’t be a wham-doggy affair.

The numbers look like this –

The TSLA CALL is currently at $0.19 and the AAPL CALL is trading for a mere pennies. Our advice is to take the $0.19.  As measly as it may sound, when you add it to the original $0.20 you took in at the outset, you still made a grand total of $0.39 per pair on nothing down.

We have strong doubts about Apple reaching the $135 level by this Friday, so we’re going to recommend you leave it to wither. The risk here is worth the taking, in our opinion.

VROOM

I’ll say.

Trading the New Week

Last week, we initiated a trade that matched a leveraged oil ETF (UCO) against the Japanese market (EWJ) using CALL options. We bet then that Japanese companies were profiting in exaggerated fashion of late precisely because of the ongoing global oil glut, but that any recovery in the price of crude would likely stifle further gains on the Nikkei 225.

A week later, those understandings still hold. Japan imports all its energy needs, so cheap oil will have a direct, positive effect on the bottom line of that country’s businesses.

Lower oil price =Nikkei strength. Higher oil =weaker Nikkei.

A simple, tradeable, inverse relationship. For now, at least.

This week we’re going to take a slightly different approach to the Japan/oil equation, but first some relevant commodity news and a bit of background information to help you understand the trade.

We’ll start with oil price projections.

Recent reports of OPEC nations easing their production numbers appear now to be a fantasy. As the chart below shows, Saudi Arabia is now claiming that March production levels were 10% higher than those averaged over the last year – numbers that were already at exaggerated levels (right side). The country’s oil minister recently stated that an additional 660,000 barrels per day would be brought to market on an ongoing basis, in what’s become a clear push toward seizing wider global market share.

US-CRUDE-INVENTORY

At the same time, we have the largest oil consumer on the planet (America) reporting ongoing, massive crude oil inventory-building. The left side chart indicates higher than expected stockpiling from the beginning of the year, a development that also speaks to a cap on any dramatic oil price rise in the near future.

Taken together, we get a picture of a growing bearish overhang on the supply side of the energy equation.

Now look at consumption.

US-CRUDE-CONSUMPTION

Here, there lies some hope.

With more Americans on their way to work as the economic gloom dissolves, we’ve got a growing driving cohort that’s also apparently driving farther than they have in the past. Vehicle miles driven have increased 4% year-over-year (left chart) and the U.S. Department of Energy is reporting gas consumption to climb by between 150,000 – 200,000 barrels per day for the year.

All that despite a 20% improvement in fuel efficiency in the light car market over the last decade.

Despite this, it’s hard to imagine the summer driving season making much of a dent in the nation’s supply. We’ll need massive new domestic and global demand in order to offset the glut that currently exists.

What’s this got to do with the price of stocks in Japan?

To put it simply, any rise in the price of oil should be marginal in the weeks and even months ahead, keeping Japanese investments from falling back too sharply to trend.

There’s a second background item that’s important for today’s trade, and that’s interest rates.

We fully expect the recent uptick in interest rates to continue, and we don’t expect it to impact negatively on equity prices. As the chart below shows, fourteen tightening cycles (going back over fifty years) have nearly all coincided with robust growth on the S&P 500.

DONT-FEAR-THE-FED

As the Fed now readies the market for its first rate hike in eight years, we should remember that, on average, tightening has led to average gains in excess of 20% during the span of the tightening.

And that’s very good news.

We should also be aware that the best sectors to own during a tightening cycle are the cyclicals, while defensive issues generally suffer.

The following chart offers a good look at sector performance in rising rate environments for the last twenty years.

SUBSECTOR-PERFORMANCE-SP500

It’s clear that tech has been the place to be, while historically rate sensitive issues like utilities have faltered.

It’s with all this in mind that we now return to Japan, where low oil prices and a soon-to-be rising global interest rate regimen should lead Japanese tech issues to outperform that country’s rate sensitive sector over the intermediate to long term.

Here is, specifically, what we’re thinking… And how we plan to profit –

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We’re going to be buyers of the Wisdom Tree Japan Hedged Tech, Media and Telecom Fund (NYSE:DXJT), and sellers of the Wisdom Tree Japan Hedged Real Estate Fund (NYSE:DXJR).

The former sells for $30.92, while the latter goes for $28.70. A board lot of each will cost you exactly $222, and you’ll profit if/as/when the tech sector outperforms.

Options Trader Elite recommends you consider the purchase of DXJT, and sale of DXJR shares, in equal numbers.

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We’re going to be buyers of the Wisdom Tree Japan Hedged Tech, Media and Telecom Fund (NYSE:DXJT), and sellers of the Wisdom Tree Japan Hedged Real Estate Fund (NYSE:DXJR).

The former sells for $30.92, while the latter goes for $28.70. A board lot of each will cost you exactly $222, and you’ll profit if/as/when the tech sector outperforms.

Options Trader Elite recommends you consider the purchase of DXJT, and sale of DXJR shares, in equal numbers.

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With love of the hunt,

Hugh L. O’Haynew

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