Options Trader: Friday Wrapup

by: Philip Davis

Well I don't know if that was a top but I sure am glad I cashed out! Just 20% in at this point and barely a call in the bunch!

If I'm being overly cautious and we're going to 15,000 then we have a long time to play (unless the Dow adds 1,000 points a day next week). If I'm right, there will be lots of things to play on the way down...

Appropriately, the markets were simply frightening today with a sharp drop at 1:15 that seemed to be some sort of programmed selling kicking in that hit the Nasdaq very hard but spared almost no one.

On the whole we are still up about 1% for the week, nothing to complain about, but it's the first late day drop we've had in a long time so I was in no mood to ride it out.

There was lots of good news in the GDP report today:

  • The Price index (1.8%) was much lower than expected (2.8%)
  • The Core PCE (Bernanke's favorite indicator) was 2.3% vs. 2.5% expected.
  • Consumer spending was up 3.1% and, since it wasn't being spent on gas and homes, it went into useful parts of the economy!

One thing I like that companies don't is that wages were up 4% over the past 12 months; with corporate profits at 17% it is the very least they can do!

So why did that suddenly matter?

Because it was only 1.6%!!! That's a low number!!! Very low. Home prices are down 10% and the only reason residential prices aren't down 10% is that people aren't as realistic as builders about the price of their homes -- that's why they're not selling!

The AutoNation action has snowballed because they effectively pointed out that the Big 3 auto makers have been making cars that nobody wants for the past quarter. Take out the surge in automobile manufacturing and you are looking at 0.9% GDP!

Treasury Secretary Paulson's pals at Goldman Sachs decided today was a good day to give us a Halloween scare by telling us that chip makers are manufacturing motherboards that nobody wants either. [cue very scary music]

Mr. Jones finished the week at 12,090, 90 points above Monday's open, and still in magic 12,000 land, but there's trouble in paradise and we'll see what the pundits decide over the weekend.

I didn't realize when I wrote this morning that Tom had said virtually the same thing about the NYSE that I said about the Dow this morning. Tom said "Oh my! Am I the only one who sees that NYSE is doing a parabolic run? I hate those patterns since they are a sign of an unsustainable run and they often end up very badly."

Now I hadn't read that as I was at a party last night, but in a definitive case of great minds thinking alike, this morning I said, "You don't often get a parabolic weekly chart but the Dow has clearly fought off gravity and "looks" ready to achieve escape velocity. As we all well know, there is a critical juncture, right before you leave the earth behind, when a loss of fuel can lead to a critical failure -- so let's make sure we have the right stuff today!"

As I've often said, when Tom and I agree on something, its a powerful signal!

Tom and I also agree that there is a strong possibility that this is our long-awaited healthy correction, and I have to say that a 73 point drop with a 1.6% GDP, a Goldman Sachs Group Inc. (NYSE:GS) downgrade on tech, and a sector scare in autos during an oil sector sell-off is nothing, They Got Nothing!!

I'm going to call 12,151 the serious resistance point we need to watch. 12,075 is the 5% rule above 11,500, where the Dow first rested after it's 9/11 breakout. That means we can get a 50% retracement all the way to 11,787 without even calling it a serious downturn!

Got Gravity?

It's a funny thing about gravity -- it works much better on the way down...

Going back to the morning's rocket example, you need money to fuel a rally. The bigger the rally the more money you need to feed it. When ExxonMobil Corp. (NYSE:XOM) costs $40 a share, it needs $8B worth of buyers to sustain the average daily volume of 20M traded shares. When that stock goes to $70, $14B worth of buyers need to show up every day just to keep them afloat!

As you can see, it gets harder and harder to fuel our little stock rockets as they reach new heights, and resistance levels are like little pockets of gravity that need a little extra oomph to get past. Think about the vast daily inflows of capital that are required to take the entire market higher and you can see where we might run into difficulty on a "parabolic" run.

So when we get a pause that refreshes, it is no reason to panic unless something happens (like a horrendous GDP report) that may interrupt the continuing inflows of capital we need to sustain a rally.

Since it is the season, I will leave you with one last scare. Since 5% off the top is a bigger number than 5% on the way down, the downside 5% rule is 11,543 -- 600 points away! Happy Halloween...

We'll take a holiday pass on worrying about a 1% drop in our indices -- consider it a good scare, lot's of fun as long as no one gets obnoxious about it. The SOX held their 50 DMA despite the GS bogeyman trying to ruin Christmas, and the transports barely budged off the 2,600 line they had fought so hard to achieve.

Testers were successful 20 out of 22 times they tried to get guns and bombs past screeners at Newark, my local airport -- Way to go boys!

I don't even know why the terrorists would bother; according to the stewardess on my last flight, all it takes to bring down a plane is for me to listen to my iPod during takeoff!

I'll wrap up positions over the weekend; just thought I'd drop this note with a little friendly advice -- Don't Panic! Plenty of time for that on Monday...

Read all of Phil Davis's articles on Seeking Alpha.