Option Traders – Prepare For a Retest of SPY 125.

March 7, 2008
Author: Peter Stolcers, Founder of OneOption

This has been a tough week for the market. Monday, the Ambac deal hit snags and that elevated risk in the financial sector. Eventually, the company did secure the required capital to maintain its AAA credit rating. Once the details were revealed, the market was less enthusiastic and the stock sold off. Financial institutions are at the epicenter of the credit crisis and they took a beating this week. Thornburg Mortgage missed a payment and the stock lost 50% of its value overnight. Rumors circulated that Citigroup was going to take a larger write-down and that additional capital was required. We also learned that a Swiss hedge fund failed when it was forced to liquidate its holdings. Thursday, statistics showed that mortgage delinquency rates rose to 6% for all outstanding loans in the last quarter, a level not seen since 1985. That compares to a 5.6% rate in the prior quarter and a 4.95% rate a year ago. Mortgage foreclosures hit another record high. The percentage of loans in the foreclosure process was 2.04% of all outstanding loans. That is up from 1.69% in the previous quarter and 1.19% a year ago. Jobless claims have been on the rise and the ADP employment index that was released Thursday came in much weaker than expected. Friday morning, before the release of the Unemployment Report, the Fed took new steps to boost banking liquidity. In the first measure, it increased the size of the Term Auction Facility to $100 billion. Then, it said it would initiate a series of term repurchase transactions that are expected to cumulate to $100 billion. This liquidity will help financial institutions. Due to its “timely” release, the news telegraphed that a weak Unemployment Report was on deck. As traders braced themselves, the Unemployment Report was released minutes later. It showed 63,000 job losses when economists were expecting a gain of 20,000. In addition to the dismal number, December and January were revised down by 46,000. Manufacturing, construction, retail and financial services were the hardest hit. The weak results added to the probability of a .75% rate cut this month. In the early going, the market was able to ward off selling pressure and it actually made it into positive territory much to everyone's surprise. The Fed’s actions prevented an opening bloodbath, but by midmorning, prices reversed. Traders don’t want to own stocks ahead of the weekend. Foreclosures are on the rise and they will accelerate as people lose their jobs. Investors are nervous and they are pulling money out of the market. Trim Tabs reported an unprecedented outflow from equities that averaged $2B per day in February. Next week, the economic and earnings releases are very light. That will allow this week’s bad news to fester. Support at SPY 132 has been breached and there is a good chance that the market will try to test the intraday capitulation low of SPY 125 made in January. If we don’t see strong buying at the SPY 125 level, prepare for another down leg. . image

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