Keep Option Trading Light – Dead Till The Fed.

June 23, 2008
Author: Peter Stolcers, Founder of OneOption

Last week, the market dropped below key support at SPY 132. That was the capitulation low from March 2007 and August 2007. It represented significant horizontal support and this breakdown looks poised to gain momentum. In March, we saw two big gap up days from this level and those rallies were sustained. That "bid" seems to have disappeared. The VIX has not moved higher and the option premiums are still relatively cheap. This tells me that traders are not concerned about this pullback and they don't view it as a long-term threat. I view this complacency as bearish. Higher interest rates, inflation, rising unemployment, a slowdown in economic activity and continued write-downs in the financial sector are pushing the market down. The PPI has risen with out a corresponding move in the CPI. This tells me that producers are absorbing higher costs and their profits will be down. I am expecting a fairly weak round of earnings. All eyes are on the Fed and they are meeting after an eight week hiatus. The market is not expecting an increase this month; however a .25% in rate hike is expected in August. Global rates are on the rise and our interest rates are artificially low. The Fed had to throw the kitchen sink at the subprime crisis to prevent a financial collapse. They feel that risk is behind us and they are seeing some signs of economic stability. As many Fed officials have recently stated, their focus has now shifted to inflation. They have been encouraging banks to raise capital (hint: rates are going up). If the Fed tempers its inflation rhetoric, a relief rally could materialize. At this juncture, I am favoring a "sell the rally" strategy. There are too many headwinds and global markets are weakening. Tomorrow, we will get consumer confidence. I don't believe that number will have much of an impact on the market. Wednesday, we will get durable goods and crude oil inventories before the FOMC statement. The durable goods number could be weak as auto and airplane orders could be down. Durable goods orders were down .5% last month. Crude oil prices are likely to maintain their current level. Saudi Arabia's production increase has not had much of an impact and the Jeddah Oil Meeting did not have any impact on energy prices. China's discontinuation of its oil subsidies did not have a long-lasting affect either. There are a few earnings that are of interest this week and Wednesday will be the busiest day. GIS, MON, NKE, RIMM, ORCL, and CAG announce. GIS and CAG could be feeling the pinch of higher commodity costs and they will be reflective of what other companies will be faced with this earnings season. The FOMC decision will drive the market the rest of the week. I am hoping for a rally. I will wait for that move to stall and then I will be looking for shorting opportunities. I currently have many OTM call credit spreads on and if the market declines, I don't believe I will be adding at this juncture. The market is oversold and I believe we are due for a bounce. The opening rally today was the result of merger news. BG is buying CPO and RSG is buying AW. Once that move played itself out, the market pulled back. It has been chopping back and forth and it is currently unchanged. There is not enough news to drive the market today and I am expecting a very tight range. Most traders will square up positions and they will minimize risk ahead of the FOMC. Keep up positions small and be patient. image

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