Light Holiday Trading Setting In – Year-end Rally Unlikely – Sell Puts!

December 18, 2008
Author: Peter Stolcers, Founder of OneOption

The stock market has not budged in the last week. In light of all of the bad news, that's an accomplishment. It has been struggling to get through minor resistance at SPY 91. If a full-blown year-end rally was in the cards, we would have easily run through this resistance level on our way to SPY 100. The table was set and the bulls were not able to take advantage of the opportunity. After Tuesday's FOMC announcement, the market surged higher than it was poised to break out. The SPY was near the high end of the one-month range. Wednesday, we just needed to see a little follow-through late in the afternoon. Unfortunately, bears were unimpressed by the bulls efforts and they pushed the market back down on the close. If the market had marched higher, proprietary trading firms would have legged out of hedged index positions, "goosing" the market higher. That in turn could have sparked short covering. Portfolio managers like to bid up prices heading into year-end and that results in an anomaly called the Santa Claus rally. It officially starts after Christmas. Given the lame effort by the bulls this week, I doubt we will see much of a run up. If a rally fails to materialize, that will set a bearish tone for next year. The Fed has fired its last interest rate bullet (FedFunds 0% - .25%) and now it will resort to printing money. It fears that deflation will choke the economy because consumers postpone purchases with the expectation that prices will drop in the future. That means the savings rate will rise. Our savings rate must increase for this problem to work itself out over time. The Fed wants to alter the natural course of an economic cycle. Our problem is debt and it won't be solved by issuing more debt. The Fed is risking our AAA credit rating. The bailout scene will increase dramatically next year. The subprime crisis will spread to traditional loans and many homeowners will be on the brink of foreclosure as the unemployment rate rises. States will be lining up for bailout money as well. As unemployment rises, state and federal tax revenues decrease. The states are already running deficits and many (NY, FL, MI, IN, OH) can barely cover unemployment insurance through the rest of 2008. From a trading standpoint, 2009 holds many opportunities. The key will be finding relative strength and weakness within the market. Sector rotation will be pronounced and money will flow from one asset class to another. Macro conditions are changing quickly and that favors option trading. For today, the market is settling down. We needed to see a breakout yesterday and is unlikely that prices will change much in the next week. Traders have had more than enough excitement this year and they are not going to stick their necks out ahead of the Christmas holiday. The GDP and durable goods numbers next week will have little impact. They did not drive the market a month ago. Sell out of the money puts on stocks that have strong support levels. image

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