Options Trader: Wednesday Outlook

Wednesdays have been wild lately.

Last Wednesday was flattish but July 16th was a 477-point move top to bottom with a big 278-point gain.  July 9th took us from 11,115 to 11,505 (390) as we finished down 234 on that day.  July 2nd gave us a 330-point swing from 11,504 down to 11,215 as we closed down 167 points while June was generally calmer, with "just" 200 point swings on your average Wednesday.  So we start today at 11,397, kind of in the middle of the range for the month and in some real need of a move that takes us well over 11,600 and puts us on the road back to 13,000.

We have our housing bill, we have oil struggling to hold $120, we have the SEC restricting the short-selling of 19 major financial stocks (woo-hoo for our financial plays!), we have not too disastrous financial earnings, we have a dollar finally breaking over 73 and about to test the 50 dma at 74.35 (which can send gold tumbling below $900 along with copper and other metals), we have a Fed that may finally fight inflation rather than fuel it next week and we’re finally cracking down on political corruption - if we can’t get a boost off of this, then I can’t imagine what’s going to work.

On David Fry’s chart (shown above; click to enlarge) we can see that, last time we broke up through this range on the S&P, we were on our way to a 30% run-up that took us to our all-time highs.  Back in mid-2006 we had oil falling from $79.86 in July to $51.03 in January, a 36% decrease that was a huge stimulus for the economy.  35% off our $145 high would take us to $95 and most of oil’s 2006 drop came by September at $60, down 25% - which would be just under my $110 target price so let’s hope we stay this course! 

Looking back at my articles of the time I see the same concerns over the value of the dollar, the deficit, housing, inflation, Iran/Korea nukes, the price of oil - even the problems brewing at the banks.  That was the famous "wall of worry" we climbed in 2006-2007.  Well, we are plenty worried now and S&P 1,300 looks like quite a wall ahead - I think climbing that is going to make the bears plenty worried indeed but, like 2006, we must get a break in commodity prices that quietly redeposit dollars back into the hands of consumers.

Last year I pointed out that investors had their head in the sand as we ran the market up to record levels and ignored the MASSIVE problems that were brewing all around us and this time I believe we have swung the other way and are now over-reacting to the very same problems we ignored in the last cycle.  So Goldilocks - to recap:  S&P 1,500 is too hot, S&P 1,200 is too cold but S&P 1,400 should be just right and we’ve got a long way to go before we get there. 

To that end, we’re starting to play with the SSO’s, the S&P ultra-longs that have been knocked down 35% from their highs last year.  We want to work into a butterfly but our first move is to buy the long leg of the Dec $59s, last trading at $6.90 and, if you have margin for it, you can sell the short put leg of the butterfly, the Aug $60 puts at $2.40 before we cover as the upside momentum slows by selling Aug $59 calls and buying Dec $60 puts.  This play needs to be managed (rolled) if the S&P really takes off but if we get a good entry on our first two legs we can have a very favorable spread.

Another butterfly play we looked at was the UYG’s, the ultra-long finanicals but those are going to open up $1 from yesterday’s close so I think we’ll just take some of the long calls we planned (Dec $20s at $4.90) to offset any over-coverage we have from callers we sold on our financial holdings.   The extension of the short-selling restrictions should give that whole sector an added boost.

Asia got a boost of around 2% following our upbeat market yesterday.   Financials led the way in Tokyo and Nintendo (NTDOY.PK) jumped 34%, which is no surprise to anyone walking into my kids’ playroom.  Strong US sales indicate a not-quite-dead consumer, much like AAPL, when people really want something, they still buy it.  NTT DoCoMo (DCM) bucked the bad telco trend with huge earnings, another good sign for the global economy.  Europe is also up over a point in early trading despite a poll showing very weak economic sentiment.  That’s a strong indication that the US markets are back in charge so it’s all up to us to pull this one out!

It’s oil, oil, oil today with the inventory report at 10:35 today and I’m already hearing notes from GS digging their heels in and telling their people to hold that $120 line.  I doubt there is much hope of that if we get another net build as the traders have already shorted as many barrels as they can for delivery and, with the markets picking up, it’s hard to drive new money into the very tired looking energy sector.  They’ve tried Iran, hurricanes and Rent-A-Rebel already this week, now GS is telling people demand is stronger than we think and even that is not getting oil back in the green pre-market.

I said last night we need gains here, not consolidation - let’s hope we get it!

Comments

[David Lentz:]

Phil, much as I appreciate your longing and expectation for a run back up to the highs ... can you honestly see this happening with housing continuing to head lower, with the financial industry completely and utterly dependent upon handouts from the Fed (and ultimately you and me)?

And where was the fear-drenched sell-off? Have the circuit breakers in the markets tripped even once?

Seems like the (so far) quite mild decline can only be a step lower, as continued housing declines, a year's inventory of unsold homes weighing on the markets, and a likely doubling of the national debt (with the attendant dollar destruction) are going to act as pretty weight albatrosses hanging around our necks.

If we look back at historical declines, the dot-com collapse was far more severe, despite the premise for it being far milder than our current straits.

Perhaps you mean that we should expect a spirited rise, possibly approaching the previous highs, but only in preparation to dash investors on the rocks below with even steeper plunges to greater depths.

Is that kinda what you mean to say, with all this happy-talk? Or is this all merely a difference in time horizons, with you, the day-trading options whiz, looking no further ahead than a week at most, and me with a bit longer time horizon?

2008 Jul 30 10:29 AM

[Al Rob:]

David

Remember in March they pumped financials and comsumer names first. Then held financials and consumer discretionary flat for several weeks while they pumped energy, materials, and tech to put the broad idices up higher.

Do what works until it doesn't

2008 Jul 30 02:49 PM

[Philip Davis:]

David - I'm surprised and pleased that we had this rally even after oil jumped up. My bullish premise hinges on oil prices coming down. Housing is old news and I think priced in as are the bank woes (Federal aid and all). I'm not saying we're in great shape, just that we're not in Dow 11,000 shape.

Will you begrudge me 13,000 - while we may have some misfunctioning segments, earnings on the whole are chugging along. I think we did have our "fear drenched" sell off as the Dow just dropped from 13,200 to 10,800. Just because it didn't happen in one day, doesn't mean it didn't happen.

I just wrote up something last week, I think on one of my evening posts that are free over at my site, comparing the current decline to the .com burst and this is actually worse. We just fell from 14,200 to 11,000 (22%) in 9 months while the Dow fell from 11,700 to 9,800 (16%) from Jan - Feb 2000 (about the same as our recent 2,000 point dip) and didn't really make a new leg down until March 2001, which quickly reversed and then 9/11, which is hard to use as a benchmark, cost us about 2,200 points but that was all the way into Oct 2001 - 21 months to lose 4,000 points and we dropped 3,200 in half that time. I consider that panic.

I've been saying since my 12/31 predictions for the year that Q2 earnings would begin the recovery so not so short a timeframe as you may think. I don't try to be a market cheerleader - I was Mr. Doom and Gloom last year when I thought 14,000 was ridiculous but if I get a sense that the members are too bearish, then I do tend to accentuate the positive and vs. vs.

You're right Al, same old, same old but it's fun to play when you catch the right waves...

2008 Jul 30 04:31 PM

[David Lentz:]

Maybe oil prices coming down will boost things, but I tend to think that oil prices are coming down in large part because the demand is crumbling along with the economy. That, and the futures scam is getting a few beams of light thrown at it (it IS an election year), and the perps are probably taking the money and running.

Housing is not "old news", but rather "continuing news", and until we see if the much-ballyhoo'd bailout bill actually does prevent further foreclosures, and until we see some glimmer of a sign that the ginormous overhang of unsold houses is beginning to decline (instead of continuing to rise as it is), housing will continue to eviscerate the financials. I simply don't see any way that the rest of the economy can flourish without a financial industry to fund it.

As for the dot-com chart, when I look at the NASDAQ chart over the past decade, I see it peaking at a snerd above 5000 late in the first quarter 2000, and bottoming out around somewhere around 1200 early in the forth quarter of CY 2002. Yes, there was a rally (dead cat bounce?) in mid-2000, but the overall course of the decline seems pretty clear to me, a 75% fall from the peaks.

Now for sure, the NASDAQ was the worst hit in that situation -- the NASDAQ was all about dot-com back then. The Dow did not get overheated and did not rise nearly so high nor fall nearly so far. But looking at the chart for the DJIA, it also peaked early in 2000, and bottomed late in 2002, at a bit over 7000 (let's say 7300, it's not worth being precise about it). That's about a 4400-point drop from top to bottom, or 37.6%

So far the current market declines look like 22% for the Dow and 22% for the NASDAQ.

While there is quite a bit of difference between 37% and 75%, I submit that these differences are due to the differences with how these indices are aligned to the elements of the economy that drove that particular boom. Our current boom seems much more closely aligned to the Dow (financials) than the NASDAQ, so I would expect to see the Down decline by something closer to 75% than 37% this time around. That's why I think we have a ways to go. I expect that the NASDAQ will ultimately drop at least 30% in the current decline, after this Christmas season when spending dries up for consumer electronics (no money, no credit = less spending).

We have yet to see the debt that was pushed up into credit cards implode, but that's probably coming. And doubtless Uncle Ben will bail out the credit card companies, leaving the credit card holders severely wounded, in a repeat of the housing debacle, a refrain with a different verse.

So who drives a consumption-driven economy when the consumers have had their homes repossessed and credit cards cancelled? And what does it take to make the consumers well again? I doubt that any number of tax refunds will do the trick. It's going to take time to heal these wounds. Years, not months.

The next quarter's earnings will tell the story, resolving these minor quibbles I have about whether the worst is behind us.

I am confident that your strategy of hedged trades will serve you well, whether the bottom lies behind us or ahead of us. Best of luck.

2008 Jul 30 06:27 PM

[David Lentz:]

Al -- "Do what works until it doesn't "

Excellent advice. I submit that when nothing works, the bottom will have been achieved.

2008 Jul 30 06:30 PM