Thursday’s Stock Option Trading Strategy!

January 10, 2008

The is staging an oversold bounce. I am looking for short term bullish opportunities and long term bearish opportunities.

Yesterday, the market tested the lows made last March and August on an intraday basis. The selling pressure did not have much conviction and by late afternoon, a nice reversal was underway. Do not rush in to buy this market on the notion that this was some type of capitulation.

We have seen weakness in some of the market leaders and that is one of the first signs that we are reaching an oversold condition. I am expecting a short covering bounce; however that bounce should only be traded. There are too many unresolved issues for us to see a “V Bottom”. Any market rally is likely to lose its steam in a matter of days. That doesn’t mean that we can’t see a substantial snap back.

In today’s chart I have drawn the down trend line. I believe that will ultimately provide the strongest resistance level. If we do get a short-term bounce, I have also identified the most likely resistance level. The market has a tendency to fill in the gaps and that would rally the SPY to the 145 level. We are below the five-year up trend line, below the 200 day moving average and below significant horizontal support at 146. All of these are very negative factors.

In February 2007 the notion of a housing bubble seemed plausible, but losses had not spread outside of the home builders. Consequently, the market was able to rally. In August, there were “dead bodies”, but there was also the promise of lower interest rates. Currently, there are massive write-downs, lower employment, rising inflation and a quarter point interest rate cut is already factored in. Today, December retail sales were released. They were the worst results in 5 years.

Next week we will get earnings from the financial sector. Those results could weigh on the market; however, bad news has already been factored in. There will also be many economic releases.

I am expecting this market to bounce soon. Things deteriorated a little too quickly. That is why I am buying put diagonals spreads. My long term options have not lost much of their value and the January options assault against them are vaporizing with only a week left until expiration. The Fed Chairman speaks today and the market is rallying in advance with expectations that “big brother” will be there to pick up the pieces.

As I mentioned yesterday, I believe there will be some good earnings plays coming up on stocks that have been producing great results. Look for companies with low P/E ratios where more than 50% of their revenues generated overseas. If they have pulled back to a long term support level due to market weakness, take a long position and use a stop. I also suggest you to look for stocks that had a positive reaction to the last earnings announcement. Buy short-term calls on these stocks and get out after the initial move. Most of these companies announce in two weeks. You don’t need to take positions until next week.

This market has long-term issues that need to be resolved and I am looking for short-term bullish trades and longer-term bearish trades.
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January 9, 2008

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