Take Profits On Bullish Option Trades – Consider Bearish Stock Options.

May 9, 2008

Yesterday, the market struggled all day to avoid a sell-off. By the close, it was able to inch its way back into positive territory.

A warning shot was fired Wednesday and traders were reminded how quickly the market can fall when buyers step back. There wasn’t any major news to precipitate the decline and that makes it a little more worrisome.

The market is right up on a resistance level and it is struggling to find a catalyst. The Fed won’t convene for another seven weeks and effectively, interest rates have been paused. Quarterly earnings season is coming to a close and retail stocks are the last piece of the puzzle.

Traders have rallied retail stocks on the notion that the rebate checks would be spent in stores. However, surveys have revealed that most people will be paying down credit cards instead. Retail sales came in higher than expected yesterday and most of those stocks pulled back on the news. This is a sign that the sector is tired.

Financial stocks staged a nice rally off of their March lows and they looked tired as well. This week, UBS, Fannie Mae, and Legg Mason all posted dismal results. Financial stocks pulled back on Wednesday and that accelerated the market decline. The write-downs are not over and many analysts speculate that we are at the halfway point. To fortify their balance sheets, financial firms have raised capital and that has diluted ownership. I believe these stocks will do well just to hold their current level.

Oil prices continue to skyrocket. This will weigh on the economy in many different ways. Higher gasoline prices are in essence a tax on consumption. People are cutting back their spending to compensate. It now costs $1000 to fill a semi and transportation costs are escalating. That affects food and finished goods.

Overseas markets were very weak and that will add to the selling pressure today.

The market has reached a resistance level and as we saw Wednesday, buyers have run out of reasons to increase their long positions. There are too many headwinds blowing and there are not enough catalysts to drive the market higher. The bulls tried to rally this market early and failed.

I am going flat and I believe that there is a shorting opportunity today and into next week. I am not turning bearish at this juncture; I simply want to wait for a pullback before I start scaling into long positions.

I believe the market will establish a new low by midday and it will continue to decline right into the close. If you are going to short this market, focused on financial stocks, casinos and consumer durable goods stocks.
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