Options Trader: Wednesday Wrapup

by: Philip Davis

Ouch! That was unpleasant…

That was our first down day since March 28th and it seems like a lot of people were simply shocked that such a thing could actually happen. I predicted this morning that the Fed would kill the market as the positive reaction to their last meeting was way off base and the minutes today proved they had not just a hawkish stance but did everything but title the minutes "Stagflation American Style."

Way back on March 15th I said:

It seems to be a little of both because both the Philadelphia and New York Feds reported sharp drops in manufacturing activity in March. The Philly Fed fell to .02 from .06 vs. an expected gain to 4.2 - and that was the good one! The NY Fed reported an activity level of 1.85, down from 24.35 in February and WAYYY below the 17 that was expected. The bank said Thursday in its Empire State Manufacturing Survey that "conditions for New York manufacturers were flat in March. Measures of new orders, shipments, unfilled orders and employment fell, while prices paid and the average employee workweek increased (see also Stagflation).

But the markets did not share my concerns at the time and took off, making me look like Chicken Little.

An illustration of both states, a dead and living cat. According to quantum theory, after an hour the cat is in a quantum superposition of coexisting alive and dead states. Yet when we look in the box we expect to only see one of the states, not a mixture of them.

I couldn’t let it go on the 17th and I went on:


We had an open chat session during the day on Seeking Alpha as our server was down, worth looking at if you’re not a regular member. On Thursday night I warned that the famous "ex-food and energy" reading of the PPI and CPI were ludicrous and that the very foul stench of stagflation was in the air. This weekend the word is starting to pop up a lot in the press and I predict an upcoming "super spike" of the word in the Google trends index. Notice who is most worried about stagflation: New York, San Francisco (Banks and VC’s), Washington (policy makers) and Chicago (traders). My job is just to keep you in the loop on these things…

Whether I caused that spike in the word or whether I was just right is hard to say - a very Schrodinger’s cat sort of problem…


On the 22nd the market went wild over the same Fed statement it just tanked on, at that time I said: "I made the mistake of actually taking the time to READ the Fed statement, which didn’t sound so rosy to me, but obviously, what do I know? The market roared straight up to my 150-point target in less than 30 minutes. The $123 calls finished at $1.80 and the $122 puts held .25 of their value for a net profit of 45% so the lesson for next time is - take the darn spread and stop thinking…

On the 22nd I said:

My mistake (for the whole week actually) was to worry about the actual economy, which the Fed calls "mixed" and the problems in the housing sector, which the Fed calls "ongoing" (and they no longer see "signs of stabilization" like they did in the last report). For some reason the fact that the Fed sees recent readings on core inflation as "somewhat elevated" or that there is a "risk that inflation will fail to moderate" bothers me a lot more when all I should have been focused on was the fact that they replaced the words "additional firming" with "future policy adjustments.

Based on that last three-word change, the bulls ran wild and bought up pretty much everything in sight. As I said this morning, perhaps they were already there, looking to buy on any excuse. The reality check is that the Fed said "Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth." So if investors run right out and buy up the markets (economic growth) and spark a commodity rally (inflation) - doesn’t that pretty much guarantee a rate increase? Not to mention the collapsing U.S. dollar, which promptly dove through 83 on the announcement.

So that was March 22nd - the market dropped 250 points the next week, then rebounded to touch 12,600 before pulling back today. This is quite the round trip! Still, it’s not that bad - yet…













Fib Level


Dow 12,484 -89 12,400 12,450 12,528 12,650
Transports 2,792 -20 2,736 2,817 2,889 2,983
S&P 1,438 -9 1,410 1,426 1,427 1,460
NYSE 9,413 -55 9,250 9,250 9,218 9,465
Nasdaq 2,459 -18 2,400 2,440 2,454 2,500
SOX 471 -5 470 472 477 490
Russell 808 -6 790 798 803 820

US Markets

We had seven red levels this morning, now we have 11. We had 19 green levels, now we have 15. Half our 62% levels are holding so we’ll keep this in the plus column at the moment and don’t forget we pumped these levels up on Monday because we blew through the old ones last week.

So don’t worry, we’ve only pulled back 90 points after an 8-day, 300 point run, until we drop below 12,450 on the Dow it’s not even too much of a pullback. On the other hand, if sentiment is changing from nothing matters to everything matters - well, there’s a lot of stuff out there that can matter a whole lot! I won’t go back into all the problems I laid out on 4/1 but our 20% (of the profit) stops really saved us earlier this week as I said way back then:

Taking our gains with a grain of salt turned out to be a good strategy for the week as it kept us from being greedy and the whipsaw action of the markets turned a lot of gains into losses for people who left it on the table a little too long.

Today we grabbed covers on our LTP as well as some mattress plays, all too numerous to mention and I promise to get caught up on Friday and we’ll do a full LTP review on the weekend. Tomorrow I will be away but back on Friday so watch out for that gas report, which I’m sure ZMan will be on top of and let’s watch our levels very closely but down tomorrow is very, very bad! It’s killing me that I won’t get to see how our Research in Motion Ltd. (RIMM) puts turn out, but I’m pretty confident we’ll make out well in the morning.

The gasoline report killed us on Tesoro (NYSE:TSO) and Valero Energy (NYSE:VLO) but the rest of the oil patch traded down despite a 5.5Mb draw in gasoline. While it’s tempting to throw in the towel, I decided to keep at it, but it’s going to come down to the wire for the April oil puts (which we are mainly out of) as the NYMEX is up to the usual shenanigans. There are still 241M barrels scheduled for May delivery, 234M in June and 100M in July - still a very high barrel count. Also, they still find it necessary to pump up the front-month contract while the longer contracts fall. All I can say is congratulations to the roaches, they sure know how to play this game!

Gold held flat at $681 as the dollar didn’t go down today! No one who read today’s FED minutes thinks they will cut rates now, but the dollar is down for so many good reasons. I don’t think monetary supply is a good enough reason to boost it.


Step one for tomorrow’s outlook is we need Asia and Europe to shake off our little dip today. I’ll be making a brief post in the morning, but I’m going to miss all the fun so keep the markets warm for me!