Option Traders – Fade The Fed Rally.

August 4, 2008
Author: Peter Stolcers, Founder of OneOption

Friday, the market was able to tread water after a dismal Unemployment Report. Job losses continue to mount and the unemployment rate reached a four-year high. End-of-month fund buying helped to support the market. In the absence of that influence, the market is testing the downside today. Better than expected factory orders were not enough to overpower concerns in the financial arena. Loan defaults are spreading to new areas and the credit crisis continues to grow. The Fed has proposed a bail out or Fannie Mae and Freddie Mac. However, many other banks are teetering on bankruptcy. Housing prices continue to fall and some analysts believe they could slip another 33%. Two weeks ago, Chrysler halted their leasing program because they are not in a financial position to shoulder that risk. Car leases accounted for 30% of Chrysler's revenues. All of the major auto manufacturers reported earnings last week. The results were horrible across-the-board and most saw revenues fall by 20%. General Motors posted a $15.5 billion loss for the quarter and there future is in jeopardy. General Motors bond prices slipped to under $.50 on the dollar as another government bailout candidate surfaces. American consumption is falling quickly and that is the driving force behind our economy. Higher unemployment, extreme debt levels and escalating food/energy prices are to blame. The tax rebate checks have run their course and more than 60% of the people polled use that money to pay bills or to pay down debt. The market has spent a few weeks consolidating after a nasty decline. This oversold condition should have been able to spark a nice rally once it tested the double bottom low from March. Falling energy prices did not generate a short covering rally and that is very bearish. I suspect that we are preparing for another leg down. Tomorrow, the FOMC will release its statements. I believe they will be bullish for the market. Last month, they reiterated their commitment to the economy and financial stability. Lower energy prices will help them to temporarily stave off inflationary concerns. By the end of the week, we will hear from the ECB and the Bank of England. They might soften their hawkish stance in light of lower oil prices and deteriorating economic conditions in Europe. This relief rally will set up a shorting opportunity. I am going to trade the rally in very small size (quarter position) since I am on the "wrong side of the market". I am going to trade the SPY on the rally. It will be a short lived trade and I want to stay in a liquid instrument. I also need to make sure the underlying moves. A stock with relative strength might not participate on a short-term basis. Earnings this quarter are down 20% for the S&P 500 compared to the same quarter a year ago. International companies are reporting a slowdown around the world and global expansion won't pull us out of this mess anytime soon. The path of least resistance is down and I continue to favor a "sell the rally" strategy. I believe we will get an opportunity to enter short positions at a good price by the end of the week. Once the rally stalls, I will be scaling into short positions. I don't believe the SPY will be able to make it back to 133, however, I hope it does. The bigger the market bounce, the better the bearish trade. Any company that depends on the American consumer is worth a shorting. image

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