Sell the Rip. Look for Opportunities To Buy Puts – Scale In. Greek Elections Are the Key.

May 24, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Yesterday, stocks tested the downside early and they staged a massive reversal. By the close, the market was unchanged. Under normal circumstances, this would be bullish. Unfortunately, we are in light volume, pre-holiday trading and the price movements are meaningless.

Stocks tend to rally ahead of major holidays. The last two years, the market has moved higher into Memorial Day even though the trend was negative. After the holiday, stocks continued their decline. I believe we will see the same pattern this year.

Flash PMI’s were negative. Europe was worse than expected and it came in at 45.9 (46.6 expected). Germany was particularly weak. China’s PMI was also worse than expected. It fell to 48.7 from 49.3 in April.

Initial jobless claims fell by 2,000 and that was worse than expected. Applications for unemployment benefits tend to drop off ahead of major holidays and I expected a better number. Initial jobless claims are hovering around 370,000 (four-week moving average) and that will not instill confidence heading into next week’s jobs report.

After the holiday, all eyes will be on Greece. If pro-bailout politicians do not fare better in the polls, the market will decline. There is also unlikely that moderates will form a coalition. The elections will be held on June 17th and Asset Managers will not aggressively bid for stocks until the results are known.

If leftists win the election they will reject austerity agreements and Greece will default. The market will have a very negative reaction. After a few weeks, the dust will settle. I believe the ECB and IMF will be able to prevent contagion. Greece is relatively small and European banks have recently borrowed €1 trillion from the ECB. A deep trough (if it happens) would set up a nice buying opportunity.

If Greece elects pro-bailout candidates, we will continue to muddle around. Catastrophe will be avoided this summer, but eventually they will default.

Economic releases have been soft and corporations will hold off on expansion plans (investment and hiring) until they have more clarity. Dell announced earnings this week and they missed the top line. This morning, NTAP provided weak guidance and now we know that CSCO was not an isolated event. The news is weighing on the tech sector.

The market has been able to hold major technical support at SPY 128.20 this week. I believe that level (200-day moving average) will be tested next week. Major economic releases (ISM manufacturing, ISM services, ADP, initial claims and the Unemployment Report) will be slightly bearish. End-of-month fund buying and light bargain-hunting will help support the market at the 200-day moving average. A small round of short covering could also push stocks off of support.

I believe we will fall into a tight trading range just above major support. Traders will closely monitor the situation in Greece. If it becomes apparent that leftists will win the elections, the market will fall below major support.

I own a handful of puts and I will try to add if we get a decent rally. Otherwise, I will wait for an opportunity next week. I will also buy a few calls on the VIX. Option premiums will expand ahead of Greek elections.

Keep your size small and wait for opportunities to scale into bearish positions. I believe you will still have time to get short next week. I don’t want to load up on puts ahead of a major holiday. Time premium decay is an issue and conditions in Greece could improve over the weekend. Ideally, stocks will rally and an excellent entry point will present itself.

The market looks poised to rally on light volume today. The news was rather bearish and this is short covering ahead of the major holiday.
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