Thursday’s Stock Option Trading Strategy!

I am still not buying into this snap back trally and I believe your option trading should focus on selling out-of-the-money call spreads. Yesterday, the market staged a huge rally and we witnessed the largest two-day gain in the last five years. The Fed hinted that it might ease in December and the market shot higher. A number of influences exacerbated the move. The market has corrected 10% from its October high, end-of-month fund buying supported prices and excessive bearish sentiment fueled a short covering rally. Yesterday's economic news was very weak. I dissected the durable goods number in yesterday's commentary and it looked bleak. The Beige Book confirmed an economic slowdown. Today's GDP number looked robust; however, most of the gains were attributed to a buildup in inventories. Housing sales also looked promising, but last month’s number was revised downward and sales were much lower than originally reported. Sales are still down 23.5% in the past year and the September to October median sales price fell 8.6%. In yesterday’s "Fed speak", we learned that they are expecting an uptick in unemployment. That notion was consistent with today's higher than expected jobless claims number. If the unemployment rate starts to rise, the credit problems could accelerate quickly. Consumer debt levels are high and we recently concluded a 24-month stretch where the personal savings rate was negative (people spent more than they made). If the Fed lowers interest rates it tells me that they are more worried about the economy than they are about inflation. They are painting themselves into a corner and it is just a matter of time until they run out of bullets. The dollar is in a long-term downtrend and it has reached a 30-year low against most major currencies. This is inflationary and lowering interest rates will only add to the problem. Two months ago the market rallied on an aggressive move by the Fed and the economic numbers did not support their action. The economic numbers were still strong and it was hard to tell if the Fed was catering to the financial community or if the concerns were legitimate. I knew those numbers were backwards looking, but I had to go on the information I had. Consequently, I maintained my bullish bias until I had proof. Now that the weakness is starting to show itself, I am concerned that we are headed for trouble. Lower interest rates won't fix what ails us this time around. After 9/11, lower interest rates gave homeowners the opportunity to refinance at lower rates. This was a windfall opportunity and people spent the extra money from this maneuver. Smart homeowners locked into low fixed rates that are way below the current rates and that means that marginally lower interest rates will not release the same amount of cash that we saw five years ago. New homeowners that opted for three and five year ARMS will be helped by lower interest rates, however their fixed-rate will still be much higher than their earlier rates and they will have to cut back their consumption to meet their higher mortgage payments (the one positive to a rate cut is that many homeowners might be able to avoid foreclosure). In conclusion, either way you slice it, consumers will have to tighten their belts. In the chart I have referenced the declines this year. Each one has taken longer to unfold and a longer to recover. I believe that the market will test the recent lows and once this snap back rally runs its course, there will be another shorting opportunity. The double top formation has resulted in heavy resistance at the SPY 156 level. Another resistance level lies at SPY 149 and I believe that is where this rally will stall. Look to sell out of the money call credit spreads on stocks that are in a long-term downtrend and have recently bounced. These stocks include retail, restaurants, durable goods, homebuilding and lending.

Daily Bulletin Continues...