Above The 40 – An S&P 500 Attitude Adjustment And A SNAP Judgement

AT40 = 58.5% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 68.0% of stocks are trading above their respective 200DMAs
VIX = 11.8 (volatility index)
Short-term Trading Call: neutral

Commentary
And this is why I appreciate hedging…and using Caterpillar (CAT) as my most common hedge was particularly fortuitous today.

Caterpillar (CAT) sank 4.3% as federal agents executed search warrants at CAT facilities.

On Thursday morning (March 2nd), I dutifully doubled down on my put options on Caterpillar (CAT) based on the hedging I explained on Monday. I felt justified as CAT approached resistance at $99/share. A few hours later, I was alerted that my limit order to sell all my put options triggered. I was so shocked, I thought a market crash was underway. While the S&P 500 (SPY) was indeed struggling, the extra pressure on CAT was strictly company specific. From the company’s press release titled “Caterpillar Continues to Cooperate with Law Enforcement.”:

“On March 2, 2017, law enforcement authorities entered three Peoria-area Caterpillar Inc. facilities, including the corporate headquarters, to execute a search and seizure warrant. The warrant is focused on the collection of documents and electronic information. Caterpillar is cooperating with law enforcement.

While the warrant is broadly drafted, we believe the execution of this search warrant is regarding, among other things, export filings that relate to the CSARL matter first disclosed in Caterpillar’s Form 10-K filed on February 17, 2015, and updated in Caterpillar’s most recent Form 10-K filed with the SEC on February 15, 2017.”

Given prior disclosures, I am guessing that the selling was overdone. However, this is the kind of sharp and violent reaction that can happen when notably negative news disturbs the general complacency in a stock or index. This complacency comes in the form of ignoring or downplaying downside risks. This dynamic makes hedging against complacency particularly potent. In this case, it turned a good amount of red into a very profitable day.

Seeing the poor performance of several other trades on a day when the S&P 500 “only” dropped 0.6% woke me to the fact that my neutral trading call did not prevent me from getting bloated with long positions. I hope to make the proper adjustments in the days and week to come. This adjustment is important because, as I noted in the hedging I explained on Monday the sharp rise in rate hike expectations is forcing some quick market adjustments. The U.S. dollar (DXY0) should rise at least into the March Fed meeting. I imagine there are many market participants that are making similar adjustments. I am not surprised that part of the adjustment included profit-taking as the odds of a March rate hike surged even higher from 66.4% to 77.5%.