Sharp Short Covering Rally Due During Options Expiration

by: Kunal Vakil

The coming week will be interesting for sure. Freddie Mac (FRE) and Fannie Mae (FNM) were the story stocks of the last week with talk of insolvency sending their stocks tanking to multi-decade lows.

There is talk of the Fed invervening and availing the discount window to the two GSEs to prevent a failure. Freddie will be issuing debt to shore up more capital and this cannot be a good sign. Short term volatility aside, one or both of these entities looks like they may be assumed by the government. Remember, without GSEs like FRE and FNM, the housing market will collapse and the Fed knows this. Worst case is that the stock moves to 0 while the entities remain.

Even with all this news and the massive price declines in these two equities, I am sticking by my belief that the market is poised for a rally, and a stealth rally at that. IndyMac Bank (IMB) failed and was assumed by the federal government and even with this news, the futures are up sharply as I write this piece.

Let's not forget that this week is options expiration week and these put holders will not be allowed to make all this money, which has come with almost no resistance to them. To the upside, I continue to look for Dow 12,000 in the short term.

The McClellan Summation Index has crossed below -2000 and this generally leads to strong rallies in the market. There are some other indicators that I follow which are also calling for a bottom of some substance.

Eventually, this rally will fade and new lows will be made once again. However, there's nothing wrong with making a little money to the upside in between, is there?

Stay safe this week.

Disclosure: Long DDM