Support Has Been Breached and Buyers Are Pulling Their Bids!

July 8, 2009
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market started off on a weak note and it never recovered. It convincingly broke below the neckline of the head and shoulders pattern. That also represents the 200-day moving average. From a technical standpoint, the market is very weak. After an initial rally this morning, the market quickly reversed and it is testing the downside. Today, a 10-year bond auction is scheduled and we will have the results around 1 PM Eastern time. If interest rates continue to rise, the market will sell off. There is already a great deal of nervousness priced into the market and it is possible that a decent auction will stop the bleeding today. So far, the auctions have gone well. Traders are also bracing for tomorrow's initial jobless claims number. It has not improved as expected and bulls are starting to lose faith. The government is ready to announce its PPIP program where it teams up with private investment to buy toxic assets from banks. This program has taken more than five months to unfold and it will not have much of an impact. Originally, it was expected to buy up to $1 trillion worth of assets. Now, analysts feel that it might only absorb $125 billion. Banks don't want to sell their toxic assets and the government subsidy is still far below what banks want to fetch. These assets are clogging up the banking system and they will continue to be a drag on lending. Next week, banks will release earnings and they should be decent. They can hang on to toxic assets because of FASB rule changes and the write-downs might not be that bad. I don't believe this sector will rally, but it should not tank either. Banks have issued a lot of stock and that will keep a lid on share prices. Analysts also know the extent of the toxic assets that have yet to be reckoned with. It will take many years of good profits to offset those losses. I expect this sector to flat line for many months The technical damage has been done and you can short any stalled rally. Next week's option expiration is likely to have a negative bias since we are near the low end of the one-month range. As bad as things feel, I am not looking for a cliff dive. A financial collapse has been averted and banks have deleveraged. It will take years for them to recover their losses, but they will. Hedge funds and investors have also deleveraged and we will not see the panic we saw last fall. Any decline below SPY 83 will represent a buying opportunity. For now, the best strategy is to sell out of the money call spreads. You can buy puts selectively, but scale in and don't take large positions in this light volume environment. For today, bears will flex their muscle and decliners outnumber advancers by 3 to 1. They want to see how low they can push the market now that support has been breached. Buyers will step back and we could see another air pocket today as we saw yesterday. In the event that we get a decline down to SPY 86 today, I would take profits on shorts ahead of the jobless claims number tomorrow. Any improvement in employment will spark a big rally. image

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