Take Profits On Put Positions and Wait For Clarity. Light Volume and Big News = Volatility
Yesterday, the market staged a nice little recovery. The news out of Europe has been bearish and officials are tempering expectations. Eurocrats claim that issues will take months to resolve and investors should not expect landmark decisions. This rhetoric should have sparked selling, but it did not.
This morning, stocks are pushing higher. The volume is very light and the action already has a pre-holiday feel. I took profits on short positions this morning. Eurocrats are likely to “whisper sweet nothings” into the market’s ear and big promises will be made.
The Supreme Court will render a decision on healthcare tomorrow. If any of the components are deemed unconstitutional, the market will rally.
We are also on the doorstep of a major holiday and that is bullish.
Earnings season will begin July 10th. Preannouncement warnings are up relative to Q1 and guidance will be cautious. I believe stocks will rally during the first two weeks of earnings season and then they will rollover.
We have three weeks to sell out of the money put credit spreads. This strategy will allow us to keep our distance. We will take advantage of time decay and a decline in implied volatility.
Spanish banks were audited and the results were sketchy. Actions speak louder than words and Spain requested a bailout yesterday. It did not want to go down this road because it will lose control of its fiscal spending. That leads me to believe that the situation is worse than expected.
Eurocrats will be pushing for a centralized banking system. Sovereigns will have to relinquish control over national banks and battle lines will be drawn. This is the least “invasive” solution and it would take a year to implement. Germany won’t jeopardize its own credit rating unless fiscal spending policies are added to the EU treaty. Most of the members are already “underwater” and these policies will never be passed.
After the summit, Eurocrats will go on vacation. Credit concerns were faster and the market will lose confidence. Money printing and bailouts won’t solve their problems and the EU has not come up with a single long-term solution.
Stocks are attractively valued. The S&P 500 is trading at a forward P/E of 13. With 10-year bond yields at 1.6%, Asset Managers will rotate into equities. That buying will temporarily offset a very negative backdrop. No one feels as if they will miss the next big rally and investors won’t chase. Resistance at SPY $136 is likely to hold.
Over the last 25 years, I’ve learned not to short quiet markets. These light volume rallies can be very painful and they tend to last longer than expected.
I have my put credit spreading candidates lined up, but I will wait for the news tomorrow. There is no need to rush into new positions. I am focusing on stocks that have very little exposure to Europe. In fact, I am favoring companies that do almost all of their business in the US. China’s economic activity is also waning.
Put credit spreads will allow me to generate a little income while I wait for the next wave of selling.
Now that I have a clean slate, I can objectively evaluate the price action. Huge economic releases next week could wreak havoc during the short week. I am ready to trade in either direction, but I believe support at SPY $130 will hold into earnings season.
The price action today has been positive. However, we have fallen into a tight range and I’m not expecting a big move ahead of huge events tomorrow.
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