Wednesday’s Stock Option Trading Strategy!

November 14, 2007
Author: Peter Stolcers, Founder of OneOption

Yesterday's strategy was spot on. implied volatilities (IV) dropped as the market rallied and the short puts quickly lost value as stocks ran higher. You can't start buying calls until the IVs drop some more and the SPY closes above 149. Without question, the market was oversold after last week’s decline. A new round of selling Monday started the week off on a negative note. As I have mentioned, when the market leaders get trashed (as they did Monday) it usually indicates that we are near a capitulation level. Yesterday, the market rallied on retail news from Wal-Mart. On a weekly basis, Goldman Sachs reiterates that it is not going to take any additional subprime write-downs this quarter. Finally, those statements gain some traction. The market was oversold and worst-case scenarios were priced in. This morning, that same theme was revisited when retail sales came in slightly better than expected and the PPI hit expectations. At this juncture, no bad news… is good news. After a monster snap back rally yesterday, the market is struggling to move higher today. It bumped up against a major resistance level at SPY 149. If the market can grind higher there is a chance that we will see option expiration related buy programs. In order for this to happen, the market needs to stage a nice orderly rally. If that unfolds, traders will leg out of hedged positions and that will "goose" the market. This event could also generate some short covering. The market breached many technical support levels and bearish sentiment is high. In March and August we saw violent snap back rallies as traders realize they were caught in a bear trap. I've been mentioning that financial stocks have found a least temporary support. In order for the market to rally that sector needs to participate. Keep an eye on the XLF and use it as your guide. You should've established some long positions in commodity stocks and tech stocks when the market broke above SPY 146. As I outlined yesterday, you should add to your long positions and if the market can close above 149. If the market falls below 146, go to cash. This is a very volatile market and your trading activity should be minimal. The probability of success is lower because you can't predict a directional move with any degree of certainty. I still believe that the market will stage a year-end rally. For today, I expect a pullback early. The market needs to find another support level were buyers will step up to the plate. If it is able to find buyers, it will gradually rally into the close. I am not looking for a big gain today after yesterday's monster move. By the same token, I am not looking for a big sell off. I feel that traders realize a worst-case scenario was priced in and that today's news was decent. image

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