Stock Option Expiration Could Spoil A Rally This Week.

February 11, 2008
Author: Peter Stolcers, Founder of OneOption

Last week, the got off to a horrible start. Monday, were reminded of a weak employment number and dismal GDP growth as they nursed a hangover from the Fed's rate cutting party. Tuesday, a much weaker than expected ISM services number crushed the market along with any hopes of a rally. As the week progressed, horizontal support at the SPY 134 level was tested. Thursday, the Bank of England cut interest rates by a quarter-point in a largely expected move. Their rates are still at 5.25% and there is plenty of room for easing. The ECB did not follow suit and their hawkish inflation-stopper stance remains. One positive note from Europe is that Deutsche Bank did not report any new sub-prime write downs when they released earnings. If the sub-prime write downs start abating, financial stocks can start the healing process. We are not going to see a market rally related to future Fed rate cuts. The rate cuts are artificially supporting the market at this juncture. The government needs to shore up the mortgage insurers. If they do this, it will send the strongest possible message to the market and it will take a lot of the uncertainty out of the picture. If the government took the money that it allocated to the tax rebate program and used it to back the mortgage insurers, the market would be trading much higher. Fear of the unknown is the current catalyst. Investors don't know how aggressive financial institutions have been in writing down their assets. Poor transparency makes investors worry that the problem is bigger than it appears. I believe that the write-downs have been aggressive for one reason. Many of the lenders are under new management and they will over-allocate losses to the old regime so that they can get a fresh start. Earnings have actually been pretty good. That performance has been masked by financial stocks. Last quarter, financial stocks lost $25 billion. That's the same amount that they made in the same quarter a year earlier. In essence, they gave back what they made. When you put it in that light, things don't seem quite so dire. If you strip out financial stocks from the S&P 500, companies have been reporting and 11% earnings growth rate. As I look ahead, this week will be pretty light on the economic data front. Most of the information will come towards the end of the week. Chairman Bernanke will testify before Congress on Thursday and that will be the major market driver. The earnings will also be fairly light and some of the big names are; General Motors, Coca-Cola, John Deere, Bidu, NVIDIA, Ingersoll-Rand and Chipotle Mexican Grill. If you take out the capitulation low that immediately followed January expiration, the market sits at the low end of its one-month range. That tells me that next week's expiration bias is to the downside. If the market starts to decline in an orderly manner, sell programs could fuel the drop. If the market bounces strongly before the capitulation low can be tested, a solid, sustainable rally back to the SPY 144 level is likely. On the other hand, if the selling pressure accelerates and the SPY 125 support level gives way, we are headed for another down leg. Personally, I believe we are near a low. I am seeing some good values. If you compare the two charsts below, you can see that the first rally after the capitulation low did not take in August. Once the relative support level was tested, the market had a sustained rally. I believe we are at that juncture after last week’s retest. Option expiration could be the only fly in the ointment. . . image . . image

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