Scale Out of Call Positions Ahead of the Fed. Any Dip Will Set-up A Great Buying Opportunity

September 13, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

The market has staged an impressive two-week rally after testing the 100-day moving average. We are within striking distance of the all-time high and Asset Managers will not chase stocks ahead of the FOMC decision next week. In fact, they might reduce risk.

Traders are bracing themselves for the first round of tapering. Economic conditions continue to improve and the Fed is likely to reduce bond purchases by $10 billion. If purchases are cut by more than $10 billion the market will decline. This action is a big deal because it marks a change in monetary policy. The market is prepared for the move and the Fed is likely to act.

Stocks should decline on the news. After a few days, the dust will settle and reality will set in. Even though the Fed is tapering, their monetary policy is still accommodative and it won’t hamper this rally. Investors will embrace higher interest rates if they are accompanied by economic growth.

President Obama is likely to announce his selection for Fed Chairman next Thursday or Friday. The consensus is Larry Summers.

The FOMC is one of the last remaining “dark clouds”. Seasonal weakness is winding down and air strikes in Syria have been canceled. The debt ceiling rhetoric will escalate, but Republicans will extend it if Democrats agree to push back Obamacare for a year. The program is extremely complex and Democrats might view this as a reasonable compromise.

Global economic activity is rebounding. Even Europe is seeing growth for the first time in three quarters. Domestic data has been strong and initial jobless claims are at a five-year low.

Corporations are flush with cash and they are buying back shares. Apple and Disney made huge buyback announcements this week. We are also seeing big M&A deals and Twitter is planning its IPO. These are all bullish signs.

Asset Managers want to front run a year-end rally. After the FOMC, they will be looking for an entry point and the bid will strengthen.

Here’s how I plan to play it. I am taking profits on my call positions and I will be out of all of my trades by the close Tuesday. If you are long stocks that still have good momentum, ride them for another day or two. If the momentum has stalled, get out.

I will be day trading from the short side. I want to focus on laggards that have recently bounced and have run out of steam. Basic materials are one example. Growth in China has stabilized, but they are not rebounding to levels seen a few years ago.

Retailers are another example. Back to school purchases were not postpone, consumers simply aren’t spending money on low ticket items. This morning, retail sales came in at .2%. That does not keep pace with inflation.

I don’t want to get too cute with this dip so my shorts will be very short term.

If the Fed does not taper (5% chance), the market will rally. I would not buy into that move. In fact, I would short it once it runs out of steam. If they don’t taper now, they will taper next month.

It is also possible that traders just want to get this news out-of-the-way. Once the taper is announced, they will buy stocks. This scenario is also unlikely (10%). If it unfolds I will not hesitate to buy into strength.

There is some uncertainty next week and that is why I urge you to take profits on long positions. From my standpoint we are likely to selloff, but that dip will be very brief. It will set up a great buying opportunity and I will be ready.

Look for a quiet day today. Take some risk off ahead of the weekend.
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