Overhead Resistance Is Strong – Option Traders – Sell OTM Call Spreads Into Rallies

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

Yesterday, the market opened with a bang and then it settled back, closing lower for the day. I mentioned that the good news from Goldman Sachs was already factored in and the stock and it retreated after the earnings release. I also felt that the PPI number was bearish since inflation came in above expectations. Resistance at SPY 138 seems to be strong and the last rally was very shallow. This morning, Morgan Stanley posted a relatively weak number. It’s revenues were down 38% and profit was down by 50%. FITB announced that it will need to raise $2 billion and it cut its dividend by 66%. Regional banks are getting pounded today and I have been encouraging you to sell OTM calls spreads on this sector for over a month. More trouble lies ahead and mortgage resets in June and July will spark another round of foreclosures. RBS told investors to go to cash ahead of a steep market sell off. Inflation is spiking interest rates around the world (Sweden raised by .25% today) and they believe the S&P 500 will tank by more than 300 points in the next two months. Mortgage applications were down 8.7% and 30 year mortgage rates rose by 33 basis points during the last week. The Fed has lowered interest rates, but that has not translated into lower interest rates for home buyers. Banks have priced in a risk premium to account for deteriorating economic conditions. Yesterday, we learned that housing starts slid 33% in May to their lowest level in more than 17 years. We are getting used to the bad news in the housing sector, but danger lies ahead. From 2001 to 2005, 50% of our employment growth came from the housing market. This is an all-inclusive number and mortgage lenders, home builders, equipment manufacturers, realtors… are all considered in that estimate. Housing employment tends to linger well after the peak because projects still need to a completed and companies don't want to prematurely layoff workers. We are now feeling the affects. Perhaps the biggest news this morning was the guidance from FedEx. They lowered their earnings forecast for next quarter and the entire year. Fuel surcharges have taken a toll on shipping demand and week economic activity persists. The company now expects full-year earnings of $5 per share when analysts had expected $5.98 per share. FedEx is widely considered to be a gauge of economic activity and this news is concerning. Next week, the FOMC will meet. I am not expecting an interest rate hike, but I the rhetoric should prepare traders for that event in coming months. This morning's oil inventory number came in as expected. President Bush is urging Congress to approve offshore drilling to help contain oil prices. Currently, 85 million barrels of oil are produced each day on a global basis. The United States consumes 21 million barrels a day and it only produces 7 million barrels. Total global demand for oil has reached 86.4 million barrels per day. As long as demand outstrips supply, the price will continue to move higher. I continue to have a bearish bias and I still like selling OTM call credit spreads on regional banks, restaurants and retail. Retail has held up surprisingly well and there are many opportunities in this sector. The final rebate checks are being spent and this sector is ready to rollover. I will consider buying puts in the next few weeks. For today, the news is fairly negative and the downward momentum has been established. The A/D is a negative 1:3 and if the bears can establish a new intraday low late by mid-afternoon, prices could slide right into the closing bell. SPY 134 is the closing low from last week and it is close to today's low. I believe it will hold today. Unemployment is on the rise and last week's initial jobless claims were higher than expected. There is a chance that tomorrow's number will also be greater than expected and that will weigh on the market. image

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