Expect A Market Decline Before Friday’s Close. Wait For Support – Then Sell Put Options!

February 4, 2009
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market staged a nice rally and it closed near its high of the day. There weren't any major news items to stand in the way. This morning, the market reacted positively to the ADP Employment Index. It showed that private employment shed 522,000 jobs in January. Economists had expected a drop of 530,000 jobs. In December, ADP had reported 693,000 jobs had been lost and that number was revised downward to 659,000. These figures are somewhat suspect since ADP recently revised its reporting methods. Mortgage applications increased 8.6% after slumping 38% the previous week. The Mortgage Bankers Association includes new mortgage applications and home refinancing loans in the number. Long-term interest rates are ticking higher and the majority of this increase is refinancing as home owners rush to lock in. All other housing data has been extremely weak and there's no reason to believe that people are snapping up homes when the unemployment rate continues to climb. Nevertheless, any positive news goes a long way in this market. ISM services came in at 42.9 when economists had expected 39.0. That is an improvement from December's reading of 40.1. Any number below 50 indicates contraction. This also added to the buying momentum this morning. China's purchasing managers index (PMI) for January rose to 45.3 from 41.2 in December. Asian markets rallied 2.5% on the notion that this might signal the bottom of this economic cycle. Europe is also trading higher by about 2.5%. I wouldn't put too much credence into this rally just yet. The market is rallying from an oversold condition and the news has not been great. Tomorrow, the initial jobless claims number could weigh on the market early on. Weak employment conditions are expected. The market could decline and reverse after the release since it seems able to shoulder bad news. However, I expect nervous trading into tomorrow's close and no one will want to stick their neck out ahead of Friday's number. If we get a mid-day rally, I would be inclined to fade it. The unemployment rate has been accelerating much faster than expected. Factory orders will also be released tomorrow and a decline of 3.5% is expected. That would represent an improvement from December if it materializes. On the earnings front, Cisco, Visa and MasterCard release earnings before tomorrow's open. All three are "street favorites" and they are all trading near their lows and near support. Even a small earnings miss could result in a rally since buyers are eager to scale into these stocks at the slightest sign of improvement. I would not play the earnings announcements, but they should have a positive bias. Many other companies will be releasing earnings before tomorrow's open and all sectors will be represented. In today's chart you can see that the market tried to break out to the upside twice and failed. A nasty decline ensued. After testing the downside twice, the market has rebounded to the middle of its trading range. In the meantime, the VIX has declined. This price action tells me that the range is here to stay for a while. Worst-case scenarios are factored in and that allows the market to shoulder bad news. On the other hand, traders don't feel any urgency to buy stocks and they did not fear that they will miss a huge rally. That allows shorts to sell into rallies. The Unemployment Report is likely to attract sellers this week and the promise of a stimulus plan should support the market next week. Consequently, I see this as a great opportunity to continue selling out of the money puts and put credit spreads. My positions are performing extremely well and I have 75% of my desired risk exposure. I'm not in a hurry to add, but I will if the market declines Friday and it finds support at SPY 80. Yesterday, I mentioned that aggressive traders could short into the rally in small size. I still believe that between now and Friday's close you will have an opportunity to take profits on short positions. Today's rally has stalled and I wouldn't be surprised to see it pulled back going into Friday. image

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