Options Trader: Wednesday Morning Ideas

by: Philip Davis

Don’t blame China - they’re flat this morning.

Blame the ECB, who are expected to hike rates this morning, which will force the Fed to do the same or we will literally be burning dollars to keep warm this winter as it will be cheaper than buying fuel.

But you can’t blame the ECB for having a responsible fiscal policy aimed at curbing inflation. Not our pretend "core" inflation, but the real inflation that is killing the real people in their Union. We used to have a Union - in fact the entire point of the Constitution was "in order to form a more perfect union." Lincoln fought a civil war to save the union and we elected George Bush because he was "a uniter, not a divider," but I’ve never seen a bigger division between our interests and the world’s interests in my lifetime!

Speaking of the Constitution, not to get into it here but Section 8 says that Congress (not the President) has the power to:

• To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water;
• To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years;
• To make Rules for the Government and Regulation of the land and naval Forces

In Article 2, Section 2 it simply states: "The President shall be Commander in Chief of the Army and Navy of the United States, and of the Militia of the several States, when called into the actual Service of the United States." While the President requires the approval of Congress to end a war, there is no such restriction that runs the other way.

Anyway, I’m here to talk about the war on inflation, not the military actions we have going in on in Afghanastan, Eritrea, Ethiopia, Djibouti, Georgia, Iraq, Kenya, Lebanon, Pakistan, Somalia or Yemen. The war on inflation is turning into a losing battle as those pesky "non-core" energy prices start to spill over (unlike the collapse of sub-prime lending, according to Uncle Ben) into the broader economies of those nations who choose to count such things.

According to the WSJ: Signs are now multiplying that global growth is fueling inflation rather than restraining it, says Richard Fisher, president of the Federal Reserve Bank of Dallas and a nonvoting member of the Fed’s policy committee. "More and more, I hear people complain about the rising costs of [hiring] Indian M.B.A.s or the wages paid to Chinese workers," he says. As an inflation-damper, he adds, global capacity has gone from "tailwind to a headwind."

Bruce Kasman, chief economist at J.P. Morgan Chase, warns investors world-wide have been underestimating central banks’ willingness to raise rates to avoid a repeat of the spiraling inflation of the 1970s, the last time the world economy grew as strongly as today. It won’t require much higher rates, he says, to "cause significant damage in the markets."

Real Disposable Income

Even if we pretend $65 oil doesn’t matter, US import prices EXCLUDING oil rose 2.9% in the past 12 months while, not at all coincidentally, Chinese export prices rose 5.3% in March, significantly up from last year’s 2.9% rise. Monthly disposable income fell off a cliff in April and that does not bode well for Q2 consumer spending so we’ll have to keep a very close eye on consumer debt for signs of BIG TROUBLE.

Cleveland Fed Governor Pianalto said:

The reality of rising oil and commodity prices is evident, and my Federal Reserve colleagues and I have been clear about our belief that the impact of these influences will dissipate over time. But until our beliefs are validated by the data, there is a risk that the public’s trust could erode and inflation expectations could move higher.

Indicating that the Fed is starting to think that excluding a 70% rise in energy prices and a 50% rise in agricultural prices over the past two years may not have been the smartest policy move.

Europe is selling off sharply this morning with the much expected 1/4-point hike now (8am) a reality, Germany is down 1.5% and London is off a point and our futures are not looking particularly bright. but let’s see if we can hold our levels for the day:



Index

Current

Day's Move

Must Hold

Comfort Zone

Break Out

Next Goal

Dow

13,595

-80

12,468

12,600

13,000

13,500

Transports

2,914

-28

2,825

2,900

3,000

3,250

S&P

1,530

-8

1,430

1,460

1,500

1,550

NYSE

10,001

-62

9,218

9,465

9,600

10,000

Nasdaq

2,611

-7

2,454

2,500

2,600

2,750

SOX

487

-3

477

490

500

560

Russell

848

-6

803

820

850

900

Hang Seng 20,818 -23 20,200 20,600 21,000 22,000
Nikkei 18,040 -23 17,400 17,500 18,300 18,500
BSE (India) 14,255 -279 13,200 14,000 14,725 15,000
DAX 7,810 -109 6,900 7,000 7,400 8,000
CAC 40 6,041 -36 5,650 5,800 6,000 7,000
FTSE 6,576

-56

6,325 6,450 6,600 7,000
Click to enlarge

US Markets

We are NOT comfortable about the SOX. Even if the Dow and the NYSE can hold their levels, it will only be a matter of time before the SOX drag the Nasdaq down into what will become our DIScomfort zone as those boxes start turning red on us. Hopefully this will only be the " venting " that Happy and I have been looking for but the SOX, which are not oil dependent, are a very good canary in the coal mine of international growth.

US productivity numbers were so-so (up 1%) but it cost 1.8% more to get there, and that’s not good! This will be a real good test of our levels today as we can’t get hit with much worse news all in one day... Oops, I was wrong - Morgan Stanley says SELLSELLSELL the whole market! I’m not kidding: "Morgan Stanley has advised clients to slash exposure to the stock market after its three key warning indicators began flashing a "Full House" sell signal for the first time since the dotcom bust." I guess they don’t see this as just a little venting…

Criminal Narrators Boosting Crude continue to pump that cyclone story for all it’s worth, but Zman and I are on to that scam. We will be appearing live on Market News First at 10:25 for a play-by-play of the oil inventory report, which had better have a drawdown to live up to the hype of Memorial day fuel demand. Last week on our first radio broadcast, I had a big winner with our Valero Energy Corporation (NYSE:VLO) momentum puts (the $75 puts I recommended picked up up 50% in 2 hours on Thursday), but ZMan came in with quality long positions on Chesapeake Energy Corporation (NYSE:CHK) (+5%), Quicksilver Resources Inc. (NYSE:KWK) (+7%), Contango Oil & Gas Company (NYSEMKT:MCF) (+3%) and Southwestern Energy Company (NYSE:SWN) (+3%).

A build in gasoline of over 1.5Mb will give us another crack at those same VLO $75 puts, now .85 and hopefully cheaper on a pre-inventory run-up as they continue to overstate what is actually going to be a tropical storm by the time it hits the Strat of Hormuz late tomorrow. Take a look at this chart, and keep it in mind as you hear the BS spouted by our TV energy "experts." I’m not too keen on puts in general, but will play them on momentum later. ZMan, however, has an excellent find in Endeavour International Corporation (NYSE:END), now $2.15 that he features in today’s write-up.

Imports fell by 600,000 barrels per day last week as US oil thieves firms hid parked 19Mb of crude off the gulf in order to jack up prices alleviate the glut of storage insure a steady supply for US suckers consumers.

Only a steep drop in oil prices is likely to save our markets in the short run, but that drop will itself exert downward pressure on the markets. So let’s make sure we have our mattress plays ready - it may finally be time to go to level two on our Diamonds Trust, Series 1 (NYSEARCA:DIA) puts!

Oil and Dollar