Quiet Pre-Holiday Trading Favors Bullish Option Trades.

May 19, 2008
Author: Peter Stolcers, Founder of OneOption

Last week the market posted impressive gains. It was able to overcome weakness from two weeks ago and we can now look back at that decline as a shallow pullback that retested the SPY 138 breakout. Of particular surprise was the recovery last Friday. By mid-morning, the S&P 500 futures were down 10 points. By the end of the day, the market had recovered all of those losses. There was not news related up gap this morning and that legitimizes today's rally. Steady buying has pushed the market right up to a major resistance level. As you can see in today's chart, there are converging technical indicators that make this a very important price level. I expected to see a lot more selling as we approached this level. Two months ago, the market was driven by fear and today it feels like greed is driving it higher. After the Bear Stearns debacle, investors thought a full-blown financial crisis was possible. Today, Asset Managers fear that they may have missed an excellent buying opportunity and they don't want to be left behind. This morning, the LEI came in as expected. Foreign markets were marginally higher and Microsoft might still pursue a Yahoo takeover. Those were all mild positives for the market. The path of least resistance is higher and during this pre-holiday week, trading is likely to favor the bulls. I am skeptical of the rally and I still see many areas of concern. Economic data continues to weaken and inflation is hot. The Fed has thrown the kitchen sink at the financial crisis and they will be forced to raise rates in the near future. I have been short out of the money calls spreads on financials and retail stocks and although I am taking a little heat, those stocks are barely participating in this rally. If the market closes above SPY 145, I will reel them in. I have to respect this rally and a close above this critical level would be very bullish. As the week wears on, volume will decline. Tomorrow's PPI number will be a "fly in the ointment". With oil, steel, iron, corn and many other commodities at all-time highs, I can't imagine how this number could possibly miss to the downside. However, a "hot number" doesn't mean the market will decline. To date, the market has been able to shrug off the consequences of inflation. That mentality is likely to exist as long as interest rates stay low. The Fed will not convene for another six weeks and traders have a free pass until then. I am also not expecting any new wrinkles when the FOMC minutes are released Wednesday since they have been very vocal. I suspect that any pullback tomorrow will set up a buying opportunity the rest of the week. Shorts are covering their positions and that is supporting this rally. I doubt that the bears will have what it takes to keep a lid on this market during a quiet week. The economic news is fairly light this week and the earnings are dominated by retailers. If you get long, trade small size. I am going to stay liquid until next week. I would prefer to buy a dip, but the last one was very shallow. If we break out above SPY 145, get long and use SPY 144 as a stop. I do not believe the market will be able to break through today. The highs are probably in and it will trade in a fairly tight range. The fact that it has been able to run up and hold this level is impressive. image

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