Wait For Support – Buy the Dip. Scale Into May Call Positions Into Earnings Season

March 21, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

This week, the S&P 500 backed off from its five-year high. It is gathering strength so that it can breakout to a new all-time high. The news this week has been constructive and all of the puzzle pieces are still in place.

Cyprus is grabbing headlines this week, but it will not even register as a blip on the chart a few weeks from now. This tiny €10 billion bailout will be settled quickly. European credit concerns remain low and Spain held a successful bond auction overnight. As long as PIIGS yields are stable, this dark cloud will not form.

Europe’s flash PMI’s were dismal this morning. Manufacturing and services came in at 46.5. Federal Express released earnings yesterday and their guidance for Europe was discouraging. Fortunately, the expectations for the EU are very low and this won’t spoil our rally.

China’s flash PMI came in at 51.7. That was a nice improvement from last month and this was a more import number. China is still the growth engine for the world and recent tightening by the PBOC could have resulted in a soft patch. This release keeps the macro picture intact and stocks will rally into earnings season.

Domestic economic releases have been positive. Housing starts are improving and job growth is on the rise. Initial jobless claims increased by 2,000 this week and they remain relatively low. Yesterday, the FOMC maintained their economic forecast for 2013. They also said that quantitative easing will continue and they plan to carry a large balance sheet well into the future.

Mutual funds are underperforming the market and managers will buy stocks before the quarter ends (window dressing). Many have been waiting for a 5% pullback and they haven’t gotten one. With each passing day, the bid will grow stronger. Earnings season is right around the corner (April 8th).

Global credit concerns remain low, central banks are printing money like mad, China and the US have stable economic growth, interest rates are at historic lows, corporate balance sheets are strong as ever and stock valuations are attractive at a forward P/E of 14. I still believe the market has gas in the tank and the S&P 500 make a new all-time high in April.

Stocks will work off some jitters the next two days. Cyprus, the Eurozone flash PMI and earnings misses this week (ORCL, FDX) will spark a little profit taking. This consolidation will give us an opportunity to buy calls.

We have patiently been waiting for this consolidation cycle to run its course and we won’t jump the gun now. When support is established, buy May calls. Those options will hold their value better than April options. They are not as exposed to time decay and or a decline in IV because they span earnings.

I doubt we will get is low as SPY $153, but I would love to buy at that major support level.
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