Option Trading Stategy For Next Week’s FOMC.

April 25, 2008
Author: Peter Stolcers, Founder of OneOption

All told, it's been a good week for the market. Earnings have been meeting expectations for the most part and we were able to hold the gains from the prior week. There weren't many economic releases to drive the market. Durable goods orders fell by .3% when a flat number was expected. That was a vast improvement from February's 1.7% decline. Initial jobless claims dropped by 33,000 and that was much better than expected. In fact, the average initial jobless claims for the prior three weeks came in around 370,000. This news prompted some traders to believe that the Fed would not lower interest rates by .25% next week. There is currently a 70% probability of a .25% rate cut factored into bond prices. Next week will be filled with economic releases. From the top, we will get consumer confidence, ADP employment index, GDP, PCE deflator, initial jobless claims, Chicago PMI, auto sales, ISM manufacturing, factory orders and the Unemployment Report. Here's how I see things playing out. The Fed is likely to stop lowering interest rates. If they do lower by .25%, they will let the market know that this is the end. The rate cuts have been relatively ineffective, financial institutions have been able to raise capital, the dollar is showing signs of strength and inflation is a concern. The market won't like the news initially. That pullback could gain momentum since the market is right up on a resistance level. This decline will set up an excellent short-term buying opportunity. I believe the unemployment number will come in at a bullish level. The initial jobless claims have come down since the last report. This is the most important piece of economic data released each month. If people lose their jobs, the credit crisis will worsen and we will see another round of foreclosures. I have heard talk that some traders think the Fed could quickly change direction and start raising rates. I don't see that happening until September if the credit crisis has been averted. In June and July, we have another round of mortgage resets. The Fed will want to see how that plays out. They will also want to see a reduction in write-downs by major financial institutions. In the last few months, they have thrown "the kitchen sink" at the subprime crisis and they are not going to reverse direction until they are certain the storm has passed. That scenario sets us up with a great opportunity. I have been tracking earnings reports and many companies that have beaten estimates have declined after the number. These stocks are not over-bought, they are in long-term up trends, they trade at low P/E ratios, and they do most of their business overseas. This is where I'm looking to place my money on the next dip. The market has been very resilient and I believe it will breakout above SPY 140 on its next run. Hundreds of companies will be releasing earnings next week. Strangely, stocks that have been in a severe downtrend are rallying on poor results while stocks that are beating expectations and have been in an up trend are being sold off. The momentum players have pushed these stocks to the extreme and at is why these unexpected reactions are happening. There are not any mega cap stocks that are announcing next week. Here is a sampling of some stocks that I follow: HUM, SOHU, VZ, FLS, MTW, ADM, CRS, ENR, MA, MHS, X, VLO, ESRX, PNRA, SWIR, BHP, CMI, GRMN, GM, IR, IP, K, KFT, SI, SLAB, AKAM, OII, APA, CI, DRQ, MRO, AMX, CHK, MET, WYNN, AGU and BWA. If my scenario does not play out, I will buy the breakout but I will trade smaller size and I will take profits as the market nears the SPY 144 level. If the market does pullback, I will be a much more aggressive buyer once support has been established. image

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