I Can’t Embrace This Bad News Rally – Cover Shorts – Cautiously Sell OTM Puts!

December 3, 2008
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market staged a nice rebound after one of its biggest one-day declines ever. That bounce was rather impressive given the weak news around the globe. Even more impressive is the reversal this morning. Horrible employment statistics and a weaker than expected ISM services number weighed on the market this morning. After an hour of trading, the S&P 500s futures rallied over 30 points from their lows. Challenger Gray & Christmas announced that November job cuts totaled 182,000, up 61% from October. That represents a 148% climb year-over-year. ADP estimated the November job cuts at 250,000, much higher than the 205,000 analysts had expected. ISM services came in at 37.3 when the consensus was 42. Any number below 50 indicates economic contraction. This afternoon, the Fed will release its Beige Book. It will show economic activity across the nation and the statistics will move the market. At this juncture, the market has shown resilience. It has been able to shrug off bad news and a bid has returned. SPY 85 is a solid horizontal support level and given today's price action, it might hold ahead of the Unemployment Report. Typically, the market has sold off ahead of the number and I expected Wednesday and Thursday to be weak. Many analysts are calling for a year-end rally and it could materialize. Bearish sentiment is extremely high and even a small amount of buying could force shorts to cover. Once that momentum starts, it could continue as high as SPY 110. That would fill in the gap from September. I am long-term bearish, but I respect bear market rallies. They can be greater in magnitude than you would ever expect and you can't let them wipe you out. The tactic at this juncture has to be to scale in to short positions as the market rallies and to scale out as it declines. There are many negative developments that will take years to resolve and I am confident that the path of least resistance is down. From an option trading standpoint, selling out of the money puts on stocks that have formed solid support is the way to go. I am finding many bargains and the implied volatilities are sky high. For today, I would cover short positions. The reversal makes me doubt that sellers will aggressively short ahead of Friday's number as they have done every month this year. Seasonal year-end strength could be keeping the bears at bay. Given yesterday's late day rally and this morning's strength, I believe the market will finish in positive territory and it might even grind higher into the close. In today's chart you can see that we have reached a critical juncture. The market will either break the down trend line and rally or it will breach support and retest the lows. image

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