Posted on Mar 09, 2023, 09:05 by Dave Toth
While the market has yet to confirm a bullish divergence in daily momentum by a recovery above 24-Feb’s 112.03 corrective high discussed in 01-Mar’s Technical Blog, the combination of waning downside mo and the market’s proximity to the extreme lower recesses of the past five months’ range presents favorable risk/reward metrics for a cautious bullish punt heading into tomorrow’s key nonfarm payroll and unemployment reports. As discussed in recent updates, it is indeterminable whether Oct-Jan’s recovery attempt is a complete correction that warns of a resumption of the secular bear market straight away OR the A- or 1st-Wave start to a larger-degree correction or reversal higher.
The former bearish count would likely see tomorrow’s report prompt continued impulsive weakness below 02-Mar’s 110.125 low and an eventual break of 21-Oct’s obviously pivotal 108.265 low (above 4.091% and eventually 4.337% highs on a yield basis below). Conversely, a recovery above our short-term risk parameter at 112.03 (below 3.852%) would confirm a bullish divergence in momentum, break the relapse from 19-Jan’s 116.08 high an expose at least another intra-range recovery and possibly resurrect a broader base/reversal count. In effect, we believe the market has identified 112.03 and 110.125 as the short-term but key directional flexion points heading forward.
Knowing that the nonfarm payroll and unemployment reports are one of the key monthly economic reports, tomorrow’s update on Feb’s data is likely to “move” this market one way or the other. Given the technical factors cited above, we believe the Mar Week-3 111-1/2 / May 113.00 Call Diagonal Spread presents a favorable risk/reward way to speculate on at least an intra-range corrective rebound. This strategy involves buying the Mar Week-3 111-1/2 Cals around 32/64s and selling the May 113.00 Calls around 32/64s for a net initial cost of “even” and provides:
- a current net delta of +14%
- an acceptable gamma ratio of 2:1
- negligible risk if we’re totally wrong on at least an interim intra-range recovery and the underlying Jun contract gets smashed
- profit potential of 1-1/2 full points ($1,500 on a 1-lot position) on a sustained recovery above 113.00.
As always with such long-gamma diagonal strategies, time decay (theta) presents the biggest risk. This strategy is structured specifically for this market to MOVE, one way or the other, from current 111-1/4-area prices as a direct result of tomorrow’s key nonfarm payroll report. A total dud of a report and flat-lining price action will work against this strategy as the long Mar Week-3 111-1/2 Calls will then have to potential to erode to zero over the remaining seven days (from tomorrow) to expiration. Gamma overperformance of such near-term, closer-to-the-money calls comes versus deferred-month, farther-out-of-the-money calls comes in exchange for theta risk. And if non-movement in the underlying Jun contract causes this week-3 call to erode to zero, that would leave a naked short position in the May 113 calls and expose infinite risk. Correct management of this effective strategy never lets it get to that point.
If the market doesn’t move sharply either way as a result of tomorrow’s nonfarm payroll report, by early next week this strategy should be covered for what should be a small loss. Should the market rally as a result of tomorrow’s report and confirm a bullish divergence in mo above 112.03, this strategy should perform nicely.
Please contact your RJO representative for an updated bid-offer quote on the Mar Week-3 111-1/2 / May 113.00 call Diagonal Spread and good luck on tomorrow’s numbers.