Support At SPY $134 Should Hold. Watch For A Small Earnings Rally. Sell OTM Puts – Keep It Small

July 9, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

The news over the weekend was relatively light. Last week, the market rallied ahead of the holiday and it gave back those gains Thursday and Friday. The jobs report was 20,000 short of expectations. It was weak, but not disastrous.

China’s CPI fell to 2.2%. That is the lowest rate in years. Inflation will not stand in the way of future easing.

In a surprise move, China lowered interest rates by .25% last week. This was the second cut in the last month and it appears preemptive. Over the weekend, Finance Minister Wen cited weak economic conditions. On Thursday they will release industrial production, new loans, retail sales and GDP.

The weakness in Asia is not unique to China. Korea, Japan, Taiwan and India are also reporting soft conditions. The recession in Europe is having a global impact.

European Finance Ministers are meeting to discuss Greece and Spain. Tax receipts in Greece are plummeting and officials are discussing future bailouts. The ESM/ESFS will directly provide aid to Spanish banks, but the details are still being hammered out. It appears that sovereigns will be responsible for any bank loans until a centralized Euro banking authority is in place (late 2013).

Interest rates in Spain are above 7%. Many analysts believe that Spanish banks are “tapped out” and they won’t be able to purchase debt in future sovereign auctions. This could wreak havoc during their bond auctions in coming months. Spain’s provinces are also in dire straits. Valencia said that it will default without government aid.

Last week the BOE and ECB lowered interest rates. England also launched a $50 billion round of QE. The ECB did not mention LTRO3, but European banks have borrowed $1 trillion this year. That liquidity will help temporarily. The IMF recently doubled its coffers and it now has more than $1 trillion. These backstops will prevent a major decline during the first few weeks of earnings season.

After the close today, Alcoa will report. The stock is near the low end of its quarterly range and bad news is priced in. Commodity stocks have been hammered and any shred of good news will attract bargain hunters. Later in the week, Citigroup, J.P. Morgan and Wells Fargo will release.

Earnings season is “front end loaded” and the strongest companies announce early in the cycle. I believe Intel, Apple and IBM will spark a nice rally and the SPY will break through resistance at $136. Interest rates are at historic lows and stocks are attractively valued. As long as European credit concerns are pacified, the market will grind higher.

Unfortunately, this move will stall in the next two weeks. Pre-announcement warnings are considerably higher than they were in Q1. Analysts have not adequately lowered estimates and the market is set up for a nasty decline. The consensus earnings have only been revised downward by .8% for the S&P 500. Corporations are very cautious and we can expect dismal guidance. Transparency will also be an issue since corporations are faced with uncertainty.

Eurocrats will go on vacation and credit concerns will escalate. To date, every solution has been a Band-Aid. Money printing and bailouts won’t solve structural deficits. Finland is threatening to leave the EU. It doesn’t want to pay for the reckless habits of other members. The entire union is divided and the cracks are growing.

US elections also loom. Employment conditions are deteriorating and the race will tighten. Furthermore, the fiscal cliff draws closer. In January, massive spending cuts are scheduled because politicians couldn’t balance the budget a year ago. This “can” has been kicked down the road and the day of reckoning is months away.

I am looking for put credit spreading opportunities in July. I still believe we have a couple of weeks of decent price action. This strategy will allow me to distance myself from the action and to take advantage of time/volatility decay.

The only good thing this market has going for it is earnings season. Corporate balance sheets are strong and valuations are attractive. Asset Managers will nibble and this will help the market tread water.

I will keep these bullish put spreads small. If the SPY breaks below $130, I will reel in my short puts and I will hang on to the long side of the trade. I will buy more puts if that happens.

The next big move is down, but I do not want to jump the gun.

Stocks will probe for support today and they should find it at $134. China’s economic releases should be a bit soft later in the week, but they won’t be devastating. Once we get past those releases, solid earnings reports will attract buyers.

Try to keep your powder dry as long as possible. Stocks have a tendency to rally into earnings and it is too early to load up on puts. My put credit spreads will give me something to watch and they will keep me from doing something stupid. If my forecast is correct, I will make a little money while I wait and I will not be taking on much risk.
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