Wednesday’s Stock Option Trading Strategy!

December 5, 2007
Author: Peter Stolcers, Founder of OneOption

should concentrate on day trades and should focus on premium selling strategies. The market is simply biding its time ahead of the Unemployment Report Friday. The economic news was decent, but not robust enough to justify this type of rally. Productivity is up and the ISM number was above 50 (which indicates growth), although it decreased from last month's level. The ADP Employment Index showed better growth than expected. The validity of this number is still questioned by many analysts since it can materially differ from the government’s calculations. Nevertheless, the market reacted positively to the news. Fannie Mae cut its dividend and the stock is rallying on the news. Normally, this would not be well-received. Perhaps, the financial stocks have found a temporary support level (XLF 30). I still feel that this rally is living on borrowed time. Clearly, the economic conditions have changed and the Fed is concerned. Transportation companies are a gauge of economic activity and FedEx, UPS, and all of the truckers have reported a slowdown. Year-end seasonality and loose monetary policy are the only things keeping this market afloat. It is possible that the market will be able to maintain this level into year-end. However, I do not believe that it will breakout to new all-time highs this year. The headwinds are blowing strong. This is a day traders market. Stocks are very liquid and you can get in and out easily with a minimal amount of slippage. Once the early momentum has been established for the day, the market continues in that direction. From an option trading perspective, it is tough to be long premium. From day to day, you don't know which way the market will swing. The option bid/ask spreads are so wide that you can not efficiently get in and out of positions. Consequently, option traders should focus on premium selling strategies. The implied volatilities are high and you need to use that to your advantage. In today's chart you can see that the market is caught in a relatively tight trading range. Friday's number is significant enough to generate a breakout or a breakdown. If it renders a muted reaction, next week's FOMC meeting could result in a meaningful move. I suggest selling out of the money call spreads on very weak stocks that have been in a downtrend and have recently bounced during the market’s snap back rally. Wait until the momentum has slowed. I also suggest selling put credit spreads on the strongest of stocks. Healthcare and tobacco fit this bill nicely. I expect the market to continue to grind up to resistance (SPY 149). The early momentum has been established. A breakout above this level would be bullish, but I'm reluctant to read too much into the rally since the news does not justify the magnitude of the move. image

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