Options Trader Wednesday Outlook: Will We Hold It?

Includes: DBA, DIA, FAS, SKF
by: Philip Davis

Yesterday was way too easy.

It’s what Cap calls a "Free Money Day" in the markets, where you have some obvious good news and everything goes straight up all day, rewarding all participants with a shower of cash. It was certainly just what we needed after a relentlessly bad month. We flipped more bullish with full covers on our long puts in our 10:07 alert, using the very aggressive DIA $70 put as a cover at $3.23. Hopefully, these will expire worthless and offset the majority of the loss on the June puts, which are down about $2 on yesterday’s action. While we stayed fully covered into the close (60% bullish), we also took advantage of cheap rolls to improve our long puts - this lets us be a little braver letting our upside ride, since they are well protected.

Note that we say 40% bearish but, if we hit those covers right on our long puts, we actually lose very little on the bear side of the portfolio. You can construct a bearish portfolio and do the opposite, cover with DIA calls and sell calls against those and achieve the same effect, but ours is laid out (as we discussed over the weekend) to take full advantage of days like this. I couldn’t be more pleased as every single play I discussed on Friday’s Livestock show already paid off. In the case of the SKF puts, it paid off very handsomely as that ETF fell from just over our upside goal of $250 on Friday all the way down to $180 yesterday and should follow through lower this morning. I know I went on and on about SKF puts and FAS and FAS calls like a broken record last week but this is why - it was a fantastic opportunity to catch a massive move on the rebound.

We liked FAS so much that I was still picking it as my favorite play in our 12:38 Member Alert at $3.60 with a hedged entry that bought our net down to $1.45/1.97. FAS tacked on another 10% from there and finished the day at $4. We used the 5% rule to stay bullish all day and we have learned to ignore the pullbacks at 11 am - what we now call the "Kudlow Crash" as the storm of negative energy that erupts from CNBC every morning on the hour when Kudlow appears has been very tradeable. While most of CNBC seemed beside themselves with confusion yesterday, weathervane Cramer turned ultra-bull last night and I just give up on this guy as it now scares me that he has flipped to my side of the fence, perhaps he finally got around to reading my weekend post as he even echoes my Dick Shelby reference from that article.

Despite Cramer now being on the same side, I’m going to stick with yesterday’s premise that we expect a follow-through to 7.5% on the major indexes today, from there we expect a pullback to the 5% line and holding that will keep us bullish (but a nasty drop while we wait) and, of course, moving over 7.5% without the pullback would be very bullish and have us looking forward to a possible 20% bear market bounce in the very least. Off our rough bottoms the 5% (we are past them) and 7.5% levels (today’s goals) are: Dow 6,825/6,987, S&P 706/721, Nasdaq 1,344/1,376, NYSE 4,410/4,515 and Russell 362/370.

The Hang Seng jumped 500 points at the open but lost 40% of it by the close, resting right back on the 12,000 mark. The Nikkei (David Fry’s chart right) put on a better show, having their own Free Money Day, pulling just off the 5% line to finish up 4.5%. Australia gained 2% but the Shanghai actually lost a point and India fell 2% so all is not well in Asia (but the Baltic Dry Index rose yet another 1.5%). We can attribute the Shanghai loss to a sharp drop in exports as well as the end of China’s Parliament session coming without a firm commitment of fresh stimulus. Don’t forget the Shanghai is up 25% this year and up 50% since November, so we can forgive them for having trouble breaking the 200 dma at 250.

Europe is mixed ahead of our open with the FTSE bouncing right off its 7.5% line from 3,500 lows, now drifting along the 3,700 line, which is a still healthy 5.7%. Keep in mind that 3,733 was the November low and it would be nice to see them hold that so we can pretend the first 9 days of March never happened. The CAC took a hell of a bounce off the 60% off line at 2,500 but is running the exact same pattern as the FTSE today except holding 2,700 would be an 8% gain so nicely bullish there. The DAX is in lockstep with the other EU indexes as well and they too flew off the 60% line on Monday with 3,870 being their 7.5% line so looking good if they can hold 3,900 through the close. Keep in mind a 20% retrace off a 60% drop is 12% but, since the index is down to 40% of its original value, you need a 30% gain just to make that bounce!

[Cities and States Take Stabs at Reviving Local Economies]While our own Federal government mulls over the possibility of additional stimulus programs, local governments are now getting into the act launching home-grown economic-stimulus plans (click to enlarge graphic) aimed at spurring local spending and keeping small businesses afloat during the recession. Some are taking the traditional route of cutting corporate taxes. Others are trying all sorts of ideas: Paying residents to shop in local stores; giving real-estate brokers bonuses for bringing tenants to empty strip malls; reducing fees on new development; etc. More than 16 states are preparing their own stimulus packages, which are expected to total about $10 billion in spending, according to the National Conference of State Legislatures.

New York City has a $15 million plan — a fraction of its $43 billion budget — to help laid-off investment bankers start new careers as entrepreneurs. This month, the city began offering office space, complete with computers and kitchens, at the low rate of $200 a month per person. San Francisco is tapping a pot of federal funds to offer small businesses $23 million in no-interest loans. The mayor also is pushing to waive local payroll taxes on new hires and to give tax rebates to companies that buy new equipment, such as commercial dishwashers, from local vendors. "It’s a million flowers blooming," says Neil Kleiman, policy director for Living Cities, a community-development nonprofit.

[firepower]Meanwhile, with a Fed meeting coming up next week, we can expect even more money to be pumped into the economy through lending and securities-purchase programs. It already has ramped up lending and asset purchases, but the Fed could decide to push harder by, for instance, purchasing long-term Treasury securities or increasing its purchases of debt issued or guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE). In some respects, the Fed’s existing efforts are having success. For instance, interest rates on high-rated commercial paper have come down since the Fed introduced a program to backstop that market last year. But with broader market strains unrelenting and the recession not showing signs of reversing, the next steps are on the agenda.

The Fed’s total assets grew from about $900 billion to $1.9 trillion as of March 4, an indication of the huge amounts of cash it is pumping into the financial system. That amount has shrunk by more than $300 billion in recent weeks as some of its programs are tapped less aggressively. But it is likely to grow substantially in the months ahead. The TALF program, for instance, could grow to as much as $1 trillion. "We’ve grown our balance sheet by a factor of about two," said Governor Plosser. "It’s going to get bigger before it gets smaller."

This is inflationary and that makes commodity plays a good way to go as either inflation, a dollar drop or an economic recovery can lead us to victory. DBA is a way to play agriculture into harvest season. The ETF is close to 50% off its highs and the Jan $22s are just $3.95 and we can be perfectly happy picking up .50 per month, which is the current price of the Apr $25s but I’d hold naked for a while, hopefully getting .75 or better. DBC is a broader commodity basket that includes oil and metals and it’s hard to imagine going wrong with the 2011 $15 calls at $6.10 ($2 in premium) when you can sell Apr $20 calls for .60 but hopefully $1 on a good run. Since we could have a big commodity rally, it is very important to always use stops on your covers or be ready to add more longs, one of several strategies we practice regularly.

We’ll be watching our levels closely today, wary of a pullback like Europe had this morning, but hopefully we can hold up and put in 7.5% total gains - still not too impressive in the big picture, but anything less will force us to be much more cautious as the weekend draws near. We also have Retail Sales tomorrow along with the usual 650,000 job losses for the week, and Business Inventories will be out at 10 and better show some contraction.

Not likely to be another Free Money Day - we’ll have to work for it!