Stock Option Trading Stragtegy – Trade next week’s move using stocks with realtive strength/weakness

This is the calm before the storm. This week the market rallied on expectations that the Fed will lower rates. The probability of a .25% rate cut is 70% and the probability of a .50% rate cut is 30%. Last week’s Unemployment Report solidified this notion. The dollar hit new 30-year lows against the Canadian dollar and the Euro this week. We have a huge trade imbalance and a weak dollar forces us to pay more for the goods we import. Translation: a weak dollar is inflationary. Oil has just hit an all-time high. Last week, TSN said that profit margins are being hurt by higher food costs. I've even heard that Italians are boycotting pasta because it has gone up 25%. I spare you the other countless examples of inflation (tuition, health care, local taxes). I believe the Fed will reluctantly lower interest rates by .25% next week. They will lace their rhetoric with inflationary comments to curb future rate cut expectations. The market will have an initial negative reaction. The earnings releases by LEH, GS and BSC will be much more important. To a degree, the Fed’s actions are priced in. However, no one really knows the earnings impact from the sub-prime/credit crunch debacle. Historically, LEH has made a 2% move after releasing its earnings. This time around, the option implied volatilities are pricing in an 8% move in either direction. Goldman Sachs and Bear Stearns will be releasing earnings after the Fed's decision. Earnings, not interest rates, will determine the market's direction next week. Quadruple witching will throw gasoline on the fire, accelerating the move. All you can do in these situations is to have your stocks lined up. Trade relative strength and weakness. If you are wrong on the direction, the right stock will give you some cushion. Also use the breakout/breakdown lines in the chart to support your decision.

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