Is the Correction Over?

Yesterday, the equity markets started where they left Monday, continuing the sell-off which started after Meredith Whitney’s bearish interview. Unlike Monday, the selling was across the board with no divergence between exchanges or between the market breadth and advance/decline statistics. The decline was led by the riskiest classes, the small cap Russell 2000 index and the growth stocks as represented by large cap tech. Bonds got a bid and yields continued to creep down.

The bearish momentum gathered steam as the S&P500 cash index broke the 900 mark, a crucial psychological level. However, this was just a set-up for a bear-hunt. The sell-off had been orderly and the equity markets formed a nice rounded bottom, before blasting off after 1:00PM. The S&P500 wiped out most of its losses, while the Nasdaq and the Russell 2000 finished well off their intra-day lows.

Is the Correction Over?

On an intra-day basis, the S&P500 has declined 3.6% from the high reached last Friday (930.17). Similar declines for the Russell2000, the Nasdaq Composite and the Nasdaq100 stand at 4.73%, 4.36% and 5.15% respectively. These numbers are right in line with the earlier pullbacks seen in this rally; and with the nice round bottom put in today, it is likely this correction is over.

Another key factor to observe is that the VIX closed down Monday, showing growing risk appetite. Even when the SPX went below 900, the VIX did not see any big spike, indicating that investors are increasingly confident that a major price collapse is unlikely.

Opex Week: The 200 Day Moving Average

The 200 Day Moving Average is a very important market indicator used to determine long term trends. A market trading above an upward sloping 200 Day Moving average is considered Bullish; one trading below a downward sloping it considered bearish. During bear markets, this average often represents a line in the sand, where rally often reverse; in a bull market it is often the last line of defense where a pull-back stops and reverses.

The 200DMA for the SPX is at 951.12 (4.7% away); for the Russell2000 it is at 523.56 (5.7% away). The Nasdaq Composite and the Nasdaq100 have already reached this mark and have been straddling it for the past week. Since this is the week of Options Expiration, which is typically bullish, we are likely to see the S&P500 and the Russell2000 make an assault towards their respective levels.

It is very likely that this level is going to form a formidable resistance for the equity markets and perhaps set the stage for a stronger pull-back.

My Portfolio: The Capital One Price Action

The price action in Capital One (COF) is a great example of how Big Money is helping support the market to allow banks to raise additional capital. I have been using puts and puts spread to trade COF on the bearish side with some success.

Last week the price of COF moved up 80% as a result of a massive short squeeze following the news that the stress test results for COF were positive. There were murmurs on chat boards that both Goldman Sachs (GS) and Merrill-Lynch (Bank of America (BAC)) were supporting the stock. This is typically a sign of an upcoming secondary offering.

Over the weekend, COF filed for a secondary offering with Barclays as the sole underwriter. The secondary was sold on Monday at a price of $27.75. This seems to have triggered a sell-off on Monday with a gap down-open. However throughout the day the stock traded in a very narrow channel with $27.75 as the line in the sand. In the last five minutes there were a few trades below that level. On Tuesday the stock sold off right at the open, presumably after Barclays withdraw their support at the conclusion of the offering, spending most of the day around $25.

I have closed out most of my puts on COF but do feel sorry for some of the investors who would have bought this stock above $30, not realizing how the system works.

My Portfolio: Stays in Cash but Preparing For Options

In spite of my belief that we are ready to run to the 200 Day Simple Moving Average, I did not initiated any new long positions today. I sold some out of the money May calls on my TLT holdings, and day-traded Apple (AAPL) on the long side, and the Russell2000 derived instruments (IWM Options, TF Futures) on the short side. I did not go short under SPX 900, and escaped the bear-hunt; but I was too chicken to go long.

I will be day-trading options rest of the week. During the options expiry week, the time premium associated with the options declines rapidly, allowing you to build up a larger amount of leverage for the same amount of cash commitment. Due to the rapid time-decay of option this strategy is useful only for quick day-trading moves, and not for overnight positioning. However the positive gamma of options allows you to make large profits if you can catch a big move while keeping your total capital at risk, low.

Comments

[TonyNasir:]

Technical indicators like MACD and Nasdaq Advance Decline Index ($NAAD)'s 19-Day EMA crossing over 39-Day EMA are generating bearish signals for the market leader Nasdaq. Hard to be bullish in this kind of backdrop!

May 13 07:03 AM

[ain't no fo...:]

"Another key factor to observe is that the VIX closed down Monday, showing growing risk appetite. Even when the SPX went below 900, the VIX did not see any big spike, indicating that investors are increasingly confident that a major price collapse is unlikely."

Or it could be a sign of complacency - markets down hard across the board and the VIX is UP 1.45 minutes after the open. So much for the correction being over.

May 13 09:36 AM

[chleoku:]

Yes, market is definitely consolidating before another rally. Looks like we are expecting another drop in May:

www.wealthalchemist.co.../

May 13 09:42 AM

[Techtrader10:]

You might be someone I want to follow as I day trade Apple usually on the short side. How do you find the time to follow all the various indicators you mentioned? And do you really find all the index information of any real value?

May 13 09:56 AM

[Vikram Saxena:]

You can follow my intra-day tweets for setups on stocks I trade:
twitter.com/aviat72

Use tweetdeck to filter out relevant tickers.


On May 13 09:56 AM Techtrader10 wrote:

> You might be someone I want to follow as I day trade Apple usually
> on the short side. How do you find the time to follow all the various
> indicators you mentioned? And do you really find all the index information
> of any real value?

May 13 12:43 PM

[TonyNasir:]

SPX has tested and held its 21-day moving avg. (for now) currently around 880. POT is showing excellent strength - I think its a good trade in the short-term.

May 13 01:54 PM

[Erick Tippett:]

Maybe Cetin Hakimoglu needs to make another mug-shot for
release to this website. The old one seems to be a little, how
shall I say, tweeked!

EDT
Chicago, Illinois

May 13 11:07 PM