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Chart Advisor: Tapering to Begin

Posted November 4, 2021 at 3:16 am
Gordon Scott

Wednesday, 3rd November, 2021

1/ Indexes closed higher even as Fed announces tapering 

2/ CVS beats estimates, raises guidance 

3Traders buying call options before earnings

4/ The bottom line

1/ Indexes Closed Higher Even as Fed Announces Tapering 

Stocks moved higher after the Federal Reserve announced it will soon start to reduce its monthly bond purchases. Tapering of the current $120 billion per month of bond purchases is the first step in reducing the massive amount of aid the central bank has provided markets and the economy to spur economic recovery of the COVID-19 pandemic.  

The chart below compares State Street’s S&P 500 Index ETF (SPY) with iShares’ 20+ Year Treasury Bond ETF (TLT). Stocks and bonds tend to have an inverse relationship as higher-yield bonds make for an attractive investment, so investors may sell stocks in favor of bonds. However, this happens more often during times of economic recession, when consumer spending drives down corporate profits and lower-risk bonds appear more attractive.  

This chart illustrates exactly when the Federal Reserve released their statements on Wednesday. Investors sold off bonds and piled into stocks, as the tapering of bond purchases, coupled with relatively strong earnings overall for the third quarter, indicates a healthy economy. 

An analyst might normally expect that news like this from the Fed would dampen investor enthusiasm for stocks. Investors instead bought more shares, showing a vote of confidence for the Fed’s decision. 

2/ CVS Beats Estimates, Raises Guidance 

Investors bid up the share prices of CVS Health Corporation (CVS) after the company exceeded expectations for the fiscal third quarter. Analysts forecast CVS to announce $1.78 in earnings per share (EPS) and $70.49 billion in revenue. CVS reported $1.97 in EPS and $73.79 billion in revenue, receiving a boost as consumers came to stores for COVID-19 tests and vaccines. CVS also raised its full-year outlook. CVS shares surged more than 5%. 

CVS has recently moved ahead of its sector, as illustrated on the chart below, which compares the recent performance of CVS with State Street’s Healthcare Sector ETF (XLV). CVS’ recent upward trend shows that investors were anticipating a positive earnings result. The company had recently been in line with XLV coming out of September. Over the last year, XLV has gained 27% while CVS has added 61%. 

Option traders could be anticipating CVS shares to continue rising in the near term, as the stock did after its earnings report last quarter. Option trading volumes on Wednesday favored call options over puts more than 7-to-1. 

3/ Traders Buying Call Options Before Earnings 

Optimism appears to be growing toward the third-quarter earnings of Uber Technologies (UBER). Investors bid up the share prices 6%, one day before the company is expected to announce results for the quarter. Analysts expect the ride-sharing giant to report a net loss per share of $0.31 and $4.5 billion in revenue. 

Option traders appear to be positioned for the stock to rise in the near term, as the open interest for UBER shows over 1.6 million call options against 1.1 million puts. Trading volumes on Wednesday favored calls over puts more than 4-to-1.

Despite the skew toward call options, puts remain slightly higher priced after accounting for intrinsic value. This could mean that option traders are taking the opportunity to sell call options while premiums are unusually high before earnings. 

Option traders and investors could be anticipating similar post-earnings moves for UBER as for competitor Lyft (LYFT), which rose 9% the day after reporting better-than-expected earnings and revenues for the third quarter.     

4/ The Bottom Line 

Stocks moved higher after the Fed announced it would begin tapering its bond purchases later this month. Investors considered it good news, buying up stocks such as CVS and UBER. CVS turned in a good report today, and Uber reports tomorrow. 

Originally posted on 3rd November, 2021

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