January 17, 2024

Dear Friend,

It may be a little late, but Happy New Year! I haven’t sent an issue for a while because the credits for our weekly trades weren’t close enough to my target entry prices. As you know, I will not send an issue with a trade you have no chance of entering. This week, however, the credit is higher than when I sent the trade to our premium subscribers, meaning your maximum profit is now greater.

This is my first chance to tell you about the amazing profits we racked up last year. Our QQQ portfolio gained more than 90% for the year, while our MSFT portfolio brought in 70%. We’re on some kind of roll with MSFT, averaging gains of more than 100% over the past 5 years. And 2024 has started the same way … in the profit column.

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I look forward to having you join in the fun and profits! Now on to the trade ...

United We Fall

Earnings season started this week, though the number of reports was limited. Big banks dominated the headlines, but I didn’t see anything tradeable there. And I was looking for a bearish play to diversify a portfolio that will be all put spreads after this coming Friday.

So, I went with a company that’s bigger – by market cap – than any bank: UnitedHealth Group (UNH). The company reported on Friday, beating expectations for both revenue and income. But a key metric – the medical cost ratio – came in well above estimates. And that proved to be UNH’s undoing, as the stock slumped 3.4% on Friday.

UNH has a half-trillion-dollar market cap, so it gets a lot of analyst coverage. But oddly, there wasn’t a peep from the analyst community on Friday -  no ratings changes and no target price moves. Perhaps they were mulling over their overly bullish stance toward the stock.

According to Yahoo! Finance, all 22 rating analysts consider UNH a buy or strong buy. The average target price is around $600, which is 15% above Friday’s close and 7% above the stock’s all-time high, set in October 2022. And it’s not like UNH set the world on fire in 2023. In fact, the stock closed the year a few bucks lower. Maybe we’ll start seeing some analysts ease back on the throttle and temper their targets and ratings, which could put some pressure on the stock.

The price drop on Friday pulled the shares below both their 20-day and 50-day moving averages. For the technical purists, the 20-day (blue line) bearishly crossed below the 50-day (red line) at the end of last year.

I’ve also noted an interesting pattern with UNH. Whatever the stock does the day after earnings tends to be the path for the next several weeks. After the past two earnings reports, the stock gained after earnings and continued to be higher through the subsequent five weeks. The two quarters before that, it was the opposite story – lower the day after earnings and five weeks after earnings. So, if history holds, UNH may find some rough sledding for the next few weeks. Plus, it will have to overcome its short-term moving averages, which are both headed lower.

This week’s bearish call spread has a short strike at the 540 level, which is above both the 20-day and 50-day moving averages. It also sits in an area where the stock has struggled to consistently stay above. Note that this is a 10-point spread because that is the strike increment in the 16Feb series. We’re going with the monthly series because UNH’s weekly options have poorer liquidity. Thus, these spreads will require more buying power, as noted below.

If you agree that the stock will continue to struggle after its earnings slump, consider the following credit spread trade that relies on UNH staying below $540 (green line) through expiration in 5 weeks:

Buy to Open the UNH 16 Feb 550 call (UNH240216C550)
Sell to Open the UNH 16 Feb 540 call (UNH240216C540)
for a credit of $2.20 (selling a vertical)

This credit is $0.10 less than the mid-point price of the spread at Friday’s $521.51 close.   Unless UNH falls sharply at the open on Tuesday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $218.70. This trade reduces your buying power by $1,000, making your net investment $781.30 per spread ($1,000 - $218.70). If UNH closes below $540 on Feb 16, the options will expire worthless and your return on the spread would be 8% ($218.70/$781.30).

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Happy trading,

Jon L