Bear Market Rally – Time Is Running Out – Sell Out-of-the-Money Puts!

October 28, 2008
Author: Peter Stolcers, Founder of OneOption

The market held up well yesterday in spite of major declines around the world. It rallied up to Friday's high and then it failed miserably. In the last 10 minutes of trading, buyers ran for cover and the S&P 500 futures fell 30 points. In doing so, it established a new closing low for the year. This is not the kind of action I expect to see at a support level. Foreign markets exhibited the type of capitulation low I've been looking for. The Hang Seng was down 10% yesterday and today is up 14%. The problem is follow-through. The rallies have been one-day events and until we see consecutive higher closes, we can't get long with confidence. The market has not been able to rally above Friday's high of SPY 90. It has made three attempts and they have all failed. In today's chart, I have drawn a down trend line. We now have horizontal resistance and the downtrend line that meet at the same level. You can't get long until the market breaks out above SPY 90. It’s no surprise that consumer sentiment plunged to an all-time low. Economists were expecting a reading of 52 and the number came in at 38. Yesterday, I heard an analyst argue that retail sales could be decent because gasoline prices have declined. What an idiot! Americans have lost hundreds of thousands of dollars in their portfolios in the last few months and their homes have declined by more than 25%. Unemployment is on the rise and 58% of Americans fear they will lose their job. I just filled up my gas tank and I didn't spot one happy face. Retailers are cutting inventory and staffing ahead of the holiday. Tomorrow, durable goods orders will be released and we can expect the worst. In the afternoon, the FOMC will release its statement. The market has already factored in a .5% rate cut and it is searching for any shred of good news. The impact of the rate cut will be negligible and the reaction will be temporary. I was expecting better price action this week and if we don't lift off soon, it's likely that we will continue to drift lower. A solid rally with follow-through needs to materialize today and tomorrow or a legitimate snap back rally won't come to fruition. We need to see an explosive move higher with lots of volume. That would help traders regain their confidence and they might be able to look beyond next week's Unemployment Report. If we get the typical one-day rally with no follow-through, traders will get spooked and next week's Unemployment Report will be a dark cloud on the horizon. For today, we have rallied out of the gate and fought off a bearish reversal. The market is stabilizing and we have regained yesterday's losses. Watch the closing price action. I absolutely believe that selling out of the money puts on stocks you like is the best strategy you can trade right now. In order for this strategy to get into trouble, the market would have to fall another 10-15% in the next three weeks. I don't see that happening. If it does decline, I believe it will drift lower in orderly manner now that the credit markets are improving. This will give you time to reel in your position. image

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