The Market Will Drift Lower Into the Bell – Sell OTM Call Spreads!

May 20, 2008
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market staged an impressive rally and it rose above SPY 144. There wasn't any major news to justify the move. Talks between Yahoo and Microsoft continued to fuel takeover speculation. The LEI came at as expected and a positive tone was set for yesterday's opening. As the afternoon wore on, sellers started to take profits at a major resistance level. SPY 144 represents a 200-day moving average, one-year horizontal support and the five-year up trendline that was breached in January. These technical indicators are converging at the 144 level. I was surprised to see how easily the market was able to rally up to that level. I am not surprised to see it back off today. In fact, I mentioned yesterday that the PPI would be a "fly in the ointment". The headline PPI number came in lower than expected, but the core rate rose by .4% and that spooked traders. This means that food and energy went down on a seasonally adjusted basis. How in the heck can the food and energy component possibly be going down when oil is making a new all-time high? Traders know these calculations are inaccurate and they are nailing the market. Today, Fed Vice Chairman Donald Kohn mentioned that the central bank will pause its aggressive rate cutting campaign. That is consistent with Chairman Bernanke's speech last week where he suggested that banks quickly get their house in order. Retail sales are dominating the earnings scene. Today, Home Depot missed their number and blamed it on housing. Their profit fell 66% and sales were down 3.4%. Yesterday, Lowe's reported an 18% opt in profit and they lowered full year guidance. Target also missed its number and first-quarter profit dropped by 7.5%. In the last two months, the market has gone from an overly pessimistic sentiment to an overly optimistic one. I believe that this market will trade in a range for the next few months. There are many issues that need to be resolved in the financial sector and we need to see signs that the housing crisis is starting to bottom out. As interest rates start to creep higher, the market will have a chance to rally as long as earnings are on the mend. The bid to the market is strong and I am inclined to "buy the dips". However, I am not buying this dip. I am looking for a pullback to SPY 138 (at least) before I start nibbling. For now, I will continue to sell out of the money call spreads on financials and retail. That strategy has been working well and today I have regained plenty of breathing room. If I can get through this week, next week will be quiet during a holiday shortened week and the positions will be much easier to manage. The momentum has been set today and I believe the market will continue to drift lower right into the close. Two weeks ago, we hit an air pocket and I took that as a warning sign. Today, buyers are likely to step back and we could see another air pocket. image

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