Covering your bases

Ethanol producer Green Plains (GPRE) may have come to the attention of traders on Thursday because of its 13%-plus intraday rally, or because its call options volume was around 14 times average—or because it announced earnings, which was presumably the catalyst for its heightened trade activity.

While GPRE’s gain was more than four times the size of its average earnings-day move (+/-3%), the stock is no stranger to post-earnings rallies—it’s pushed higher after 72% of its announcements since 2017. What some traders will really notice, though, is that the stock bounced off a well-defined support level:

Meanwhile, the rally had the expected effect on call prices—around noon ET, a roughly at-the-money December $30 call was trading 47% higher on the day.

Traders considering short-term “covered call” positions in this type of situation—buying the stock while selling an out-of-the-money call—face the conundrum discussed in “Covered call prescription.” When a trader buys the stock and sells the call simultaneously, it’s difficult to get “good” prices on both parts of the trade: A sharp up move that inflates call prices means the stock is high (at least relative to the recent past), while a cheaper stock price makes the call less valuable.

That’s why traders who expect a strong stock move to partially reverse sometimes consider “legging” into a covered call trade—that is, selling the call when the stock jumps, but waiting to buy the stock on a pullback. (Alternately, a trader who thinks the stock will continue to rally in the short term may buy the stock first and sell the call later.)

Like any other strategy, this approach has risks (e.g., getting stuck with a “naked” short call), but in the right situation, some traders may find they are balanced by potential upside.

Election check-in. Although 2022 has been an exceptional year for the market in many ways, stocks followed the standard playbook in at least one respect (admittedly, in extreme fashion): the tendency toward stock market underperformance in the first 10 months of midterm election years.

It remains to be seen whether the companion tendency plays out—better-than-average returns in the 12 months after the midterms. Morgan Stanley & Co. recently discussed how Republican or Democratic control of Congress could impact fiscal policy, the Fed’s inflation fight, and the markets (especially the bond market).¹  We’ll begin to understand which way those winds are blowing by Tuesday night.

In the meantime, here’s something for traders to chew on—the stock market’s performance during midterm election weeks. It’s just a small sample—the past 10 midterm elections, dating back to 1982—but the results have been fairly consistent. The chart shows the S&P 500’s (SPX) median returns for each day, along with its total return for the week (final column):

The SPX rallied in nine out of 10 midterm weeks, with a median return of 0.98%—more than three times the size of its average one-week return (0.31%) over the past 40 years.² The majority of the gains tended to occur in the first three days of the week—Monday was especially strong, closing higher nine times with a median return of 0.78%. The notable exception to the bullish pattern was Thursday, which closed lower six times out of 10 and had a negative median return.

Today’s numbers include (all times ET): Employment Report (8:30 a.m.).

Today’s earnings include: Dominion Energy (D), DraftKings (DKNG), Hershey (HSY).

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¹ MorganStanley.com. Preparing for an Uncertain Election. 11/2/22.
² All figures reflect S&P 500 (SPX) daily and weekly closing prices, 10/2/1982 – 11/30/18. The “midterm election week” return refers to the SPX’s change from the close on the Friday before the election week to the close of the following Friday. Supporting document available upon request.