Options Trader: Thursday Outlook

by: Philip Davis

What a wild ride! Gosh, things looked pretty grim there at 3pm, with the Dow making a new low for the week right about at our 7,750 target but then - MAGIC! A sudden rally into the close on no news whatsoever that took us back to 7,840. Isn’t that incredible (as in NOT credible)? It’s amazing what shenanigans can be played in these low-volume markets. It’s tons of fun if you can keep up but our Mattress Plays, for example, long covers that used to change perhaps once or twice a month, are now being changed two or three times a day for those who like to day trade the swings.

I mentioned in the morning post that we had finished Tuesday accidentally bullish as we held onto our levels and the morning dip didn’t faze us as we came close, but didn’t break the watch levels I posted (still valid today) of Dow is 7,750, S&P 812, Nas1,525, NYSE 5,100 and RUT 428. Those were the levels we gapped up from last Wednesday and this morning we’re going to see if we can hold last week’s breakout levels of Dow 7,900, S&P 833, Nasdaq 1,580, NYSE 5,225 and Russell 444. I know these are the same old boring levels we’ve been watching since the middle of March but that’s what happens when you”re trapped in a range.

My call of the day was to flip entirely bearish at 1:29, just about the day’s high, ahead of a 100-point drop but we had previously taken a speculative bearish play at 1:10, when I said to members: "I like DIA $78 puts at $1.25 as a speculative buy ahead of the Fed, out at $1, looking for $1.75+ on a sell-off." That one worked out to the penny and, other than adjusting our DIAs, was the only short-term play of the day as we mostly sat back and watched the madness, well protected by our hedges.

Because we ended up holding our levels, we finished the day 60% bullish yet again and actually more bullish than we were previously as we had stopped out our more aggressive long puts and we sold the DIA $78 puts for tight covers. The reason for this is we held our gap levels and our next set of levels are only 150 Dow points lower so we’re not too worried about being blown out to the short side and we are wary of repeating last Thursday’s crazy pre-market pump, which we will be thrilled to flip short into as there is no way we are not hedging bearish into the weekend..

Don’t get me wrong, we are not at all on board with this rally but that’s no reason to sit it out… For perspective, look at the 5-day chart of the Dow. We gapped open last Thursday and ran up 300 points to 8,075 by mid-day. The next morning we were back down at 7,900 and were "stick saved" to 7,950 at the close. Monday we gave it all back and fell 150 points into lunch (7,866) but then made a spectacular recovery back to just under 8,000 at the close. That turned out to be a joke the next day as we fell 200 points by 10 am to 7,800, which is what we’ve danced around since but you’d think we were in some kind of mega rally if you listened to the MSM, which looked more like the running of the bulls this week as there was nary a bear to be found. In fact, today the WSJ decided to hunt the ultimate bear as they set their sights on the great and powerful Meredith Whitney with the provocative headline "The Meredith Whitney Myth" in which they dare to say: "But to put it bluntly, Ms. Whitney’s call on Citi wasn’t that great."

[w]Also featured in the Journal this morning is "Retailers Offer A Nice Surprise" on the on-line front page but, if you actually click on the article, you’ll find that the words "in Bargain Bin" are appended to the title, giving us a more realistic assessment of the retail reports. But that spin is nothing compared to today's REALLY BIG NEWS. according to Federal Banking Regulators: "ALL 19 banks undergoing the exams will pass them." See - No one failed the stress test - everything is fine - BUYBUYBUY!" (end extreme sarcasm font). So Meredith Whitney discredited and 100% of US banks tested passed with flying colors - what a day! (OK, still a little sarcastic).

One thing I do love about the Journal (and it’s not the new sports section) is their totally cool interactive graphics. Here’s a very good one of projected Dow earnings and you can flip back historically to see how they’ve changed in the past 6 quarters. One thing I take away from playing with it is the same thing I’ve been saying for quite some time - earnings are not bad enough to justify a 50% market sell-off. In fact, only 2 Dow components are projected to lose money this quarter and Alcoa (NYSE:AA) already reported and we’ll have to see what Citi (NYSE:C) has to say. In fact, if we boot GM from the Dow and remove their $11.07 loss per $2 share from the calculations - this quarter may be above average for the past 2 years. Earnings season will indeed be interesting.

Japan is keeping things interesting by pushing through a $155Bn stimulus package even as machinery orders suddenly turned around and rose 1.4% in February after 4 months of declines. The 15.4 Trillion Yen stimulus announcement sparked a rally in Asia with the Nikkei gaining 3.7% while the Hang Seng rose 3% and Shanghai gained 1.4%. "The [machinery orders] numbers themselves are overwhelmingly better, but in order to begin talking about any economic recovery reflected in the machinery orders, we’re going to have to see improvement in the key manufacturing sectors," said Kyohei Morita, chief Japan economist at Barclays Capital. "Since we can’t expect domestic demand to fill the gap here, it will have to be overseas demand leading any pickup," he added. So everyone is counting on everyone else to start buying things - what could go wrong?

EU markets are up about 1.5% ahead of our open and our futures are looking bright as well, up about the same as good news from Wells Fargo (NYSE:WFC) regarding earnings trumps bad news from Wal-Mart (NYSE:WMT) regarding sales so far. We’ll be watching the 4,000 line on the FTSE with great interest as that’s the mark they need to take out to get back on track - anything less than that is just a weak bounce, as would a failure by us to hold our breakout levels after such a nice boost in the morning. WFC is projecting RECORD $3Bn Q1 earnings, double what was expected (sorry Meredith) which only proves that banks can make money charging interest to others when the government gives WFC $25Bn for free - I think that’s a business plan most of us could manage to stick to…

WMT, on the other hand, saw 1/2 their expected sales growth at 1.4% while Target (NYSE:TGT) fell 6.3% and Costco (NASDAQ:COST) fell 4%. Overall, it looks like Retail Sales will decline 5% for March. It’s not like people are having a great time and moving back to luxury - Abercrombie (NYSE:ANF) sales fell 34% and even The Childrens Place (NASDAQ:PLCE) fell 2%, so not even children are getting a break in this economy. While Wall Street may decide to celebrate WFC's victory, the retail numbers indicate that none of this money is finding its way to Main Street, who lost another 650,000 jobs this morning and is being shrugged off by the markets that are simply bored hearing roughly the same number 10 weeks in a row, although I’m sure the 6.5M people who were laid off aren’t taking it quite so lightly.

As I said, we’ll be shorting into this morning rally because it’s stupid. We’ve been long on financials for ages based on my premise that if you give banks Trillions of Dollars at 0% and they lend it out at 3% or more, they will make a profit. Well, home loans are still higher than 5% and the spread made by the banks has never been higher, even as they tighten lending requirements and no longer even make loans to people who don’t have pristine credit and rock-hard assets. Of course they are making money, but it’s our tax money they are making as we subsidize this scam and this economy will not get back on its feet just because we’re making some bankers rich, so be careful out there - things can turn sour very quickly as the real world reports earnings!

Other than that - have a great holiday weekend!