Choppy, Low Probability Trading – Sell OTM Call Spreads.

June 2, 2008

This morning, the week got off to a rocky start. In general, the news is been pretty good and it’s hard to justify the decline. It does bring last week’s light volume rally into question.

Factory orders rose to 49.6, up from 48.6 the previous month. A manufacturing number above 50 indicates expansion and we are very close to that level. Construction spending was down by .4% and that was also higher than expected. Global semi-conductor sales were up 5.9% year-over-year. The industry expects computer sales to rise by 10% this year and they expect handset sales to increase by 12%. This is a bullish forecast. Oil was trading lower right on the open and that did not lend support to the market.

In today’s chart I have highlighted two big down days that have come off of relative highs. At minimum, it signals a short-term resistance level. Worst-case, it warns that the market might be poised to resume its intermediate-term downtrend. I have been advising you to keep their size small in this choppy, directionless market. This is not a high probability trading environment.

As I look ahead, there will be many economic releases this week. The ADP employment index, ISM services, crude inventories and initial jobless claims will be important pieces of information. I expect them to be positives for the market. The jobless claims have been coming in as expected and that could bode well for Friday’s Unemployment Report.

There are negative forces at work as well. Inflation is on the rise and the Fed will not be able to keep interest rates at this artificially low level for much longer. Mortgage resets in June and July will cause another round of foreclosures and financial stocks have been drifting down to the lows established in March. Seasonally, investors are mindful of the “sell in May and go away” adage.

I believe the numbers this week will be generally good and there will be ample opportunities to sell out of the money call credit spreads. That is still my strategy of choice.

Last week, the market was able to bounce off of horizontal support at SPY 138. Given today’s decline, that level will be tested again much sooner than the bulls would have liked. If we break below SPT 138, I believe the market will drift down to 133 before it finds support. Ideally, energy stocks will take the biggest hit. I say that because the fundamentals are still intact and they will present an excellent buying opportunity at lower levels.

Downside momentum has been established today. Overseas markets were mixed with Europe trading lower and Asian trading higher. I don’t see any reason for a major decline today and the market is close to a support level. Consequently, I feel that SPY 138 will hold today and there might be a small rally from the lows of the day if the bears can’t make a new intraday low this afternoon.
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