Monday’s Stock Option Trading Strategy!

December 3, 2007
Author: Peter Stolcers, Founder of OneOption

After a large snap back rally last week, the market is taking a breather today. Those gains represented the best five-day stretch that we've seen in over a year. As you know from my commentary, I am viewing this rally as an opportunity to sell out of the money call credit spreads. An interest rate reduction during next week's FOMC meeting and seasonal bullishness are the only things keeping this market afloat. Treasury Secretary Paulson is trying to design a plan that will "freeze" adjustable rate mortgages for a year. I'm not sure how they will decide who is "deserving" of this consideration. The government’s actions indicate just how grave the credit issues have become. Last week’s economic releases were very weak and I am not in the "bad news is good news" camp. I don't believe that lower interest rates are going to keep us out of a recession. The Fed has lowered its GDP growth estimates for 2008 and they are forecasting higher unemployment. This morning, the CEO of Countrywide Financial said that the mortgage issues are spreading into the prime loan segment. If the unemployment number rises this week, the market will have a negative reaction. A .25% interest rate reduction is already priced into the market and I doubt that the market will rally on a rise in unemployment with the notion that a .5% rate cut is in the works. Remember, inflation has been creeping higher and based on last month's comments, the Fed is reluctant to lower rates. They are also aware of the dollar’s precipitous decline. They also don't want to fire all their bullets at one time. Another half-point cut would mean that they've lowered interest rates by 1.25% in just three months. Given this rationale, I believe that we might see some selling pressure into the unemployment number. The SPY has hit resistance at 149. Now that last week's snap back rally has stalled, sellers will be a little more progressive in exiting their long positions. Many of the shorts have covered and the market will not have that bullish catalyst. We are also past end-of-month/beginning-of-month fund buying. During the last month of the year, I expect the market to trade within a range of SPY 142 - 150. As the market approaches either end of that range, sell out of the money credit spreads with the idea that the market will return to the middle of its range. If we get a breakout from that range, buy in your spreads and wait to see if there is any follow through. Today, I am expecting the market to drift lower. It seems like that is the path of least resistance is down given the early price action. I am also expecting the SPY 149 resistance level to hold. Restaurant, retail and financials are good call credit spread candidates. image

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