Buy Puts – Possible Air Pocket. This Decline Will Catch Bullish Speculators By Surprise.

June 11, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

I mentioned yesterday that the recent decline was much more organized than the dips we’ve seen over the last eight months. Trading volumes were elevated and there was profit taking. Today’s decline will surprise bullish speculators and we could hit an air pocket.

Previously, the declines have been marked by a single “bad day”. The market would bounce and we would retest support a couple of days later. Sellers could never get organized and these dips were resolved within a week. Asset Managers would step in and stocks would slingshot to a new relative high.

This pattern has been very pronounced and I am certain that bullish speculators piled back into long positions last week. Today’s selloff will come as a surprise and they will bail out of positions. Asset Managers will take notice and they will pull bids.

We are stuck in a no-win situation. Global economic growth is slowing and money printing has not stimulated activity. Europe has had 6 consecutive quarters of negative GDP. Analysts keep calling for a bottom, but there are no signs of life. China’s growth is slipping and government officials do not have stimulus plans. Many analysts feel that they will not take action unless GDP falls to 7%.

Domestic conditions are stable, but fiscal spending cuts will start to take their toll. This will take a couple of months to work through.

Should economic growth rebound, central banks will tighten. Traders also don’t want to have the punch bowl removed. Hence, we are in a no-win situation.

This market rally has been focused on two things; central bank intervention and stock valuations. Money printing has pushed interest rates to historic lows and it has reduced credit concerns. Stocks are attractive relative to bonds and we have been in “risk on” mode. Corporate revenue growth has been flat, but cash flows/balance sheets are strong.

The focus will shift to economic activity. Central banks have fired all of their bullets and their actions are not resulting in growth. Stocks can tread water under these conditions, but they won’t move higher.

Asset Managers will wait for signs of global growth. Higher interest rates will not be welcomed initially, but the market will eventually embrace the move as long as it’s accompanied by increased activity.

The market has rallied 25% in the last year and it needs to take a breather. If economic conditions improve over the next few months, we will make new highs this fall. If conditions deteriorate, the market will pullback.

We are entering the summer doldrums. I am expecting choppy trading in a range between SPY $159 and $168.

For today, I suggest buying puts. This is a nice entry point and I believe we will test the 50-day moving average before the FOMC meeting next week. I plan to take profits on my put positions at that level.

SPY $159 is a major support level and I am expecting it to hold. If it fails, we will see a swift round of heavy selling. That was the prior all-time high and many traders got long at that level. If it fails, they will sell.
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