Global Panic - Exit Bearish Positions - Gradually Sell OTM Puts!

Posted by Pete Stolcers on October 10

There is good news on the horizon. If the market keeps up its current pace, it will stop going down in two weeks. Unfortunately, it will be at zero. I have to keep a sense of humor throughout all of this or I will lose my sanity.

As a subscriber, you know that I have been bearish. However, I did not expect a crash of this magnitude. Overnight, global markets were down from 7-10%. Many exchanges suspended trading.

You can run, but you can’t hide. There aren’t any safe havens and all stocks are being sold hard. Brokerage firms have raised margin requirements and that is forcing hedge fund liquidation. This means that there are many bargains to be had.

The key is to identify growth companies that have strong balance sheets and good cash flow. It’s also important to find companies where customers do not require financing to purchase products. Believe it or not, I’ve been able to find a handful of solid opportunities and I am selling out of the money puts. These stocks have been resilient during this bloodbath and I’m sell puts that are below a well-defined support level. If support is breached I will buy them in.

Option implied volatilities are at an all-time high and premium sellers are handsomely rewarded for taking risk.

The situation is dire and I am not going to “candy-coat” this as a fantastic buying opportunity. For months, you’ve heard that from Asset Managers on CNBC. Risk and reward always go hand in hand. The risk is high now and if you keep your wits, you can make some great money while everyone else is running for the exits.

I believe the market will oscillate throughout the day, but it will sell into the bell as it has this week. There is too much damage at this stage and no one will want to hold positions going into the weekend. I am out of all of my short positions and I suggest that you do the same. The risk of a snap back rally increases every day and you don’t want to exit short positions once that reversal materializes. Short-sellers will be grabbing at every offer in sight and put premiums will collapse. Your best bet at this stage is to start lining up long positions and sell out of the money put premium on stocks that you would like to buy.

In a matter of a week or two, I expect to see credit markets improve. That change will start to show itself in subtle ways and once the market identifies it, we will rally hard off of these lows.

Yesterday’s Decline - Lack of Buying Late - Short-Term Lows Are Near!

Posted by Pete Stolcers on October 9

Our financial system has been flooded with so much cash that banks are trying to drink water from a fire hydrant. The situation is dire, but I sense that the tide is turning.

This week, central banks around the world coordinated a global interest rate cut. This has never been accomplished before and it reinforces two realities; the credit crisis is severe and the financial system is global. The decoupling theory that suggested the US would suffer an economic decline while the rest of the world prospered was flawed.

Banks are still hoarding money and the Fed is now purchasing commercial paper to give businesses the liquidity they need for day-to-day operations. The bailout has been approved, but the implementation will take time. The price discovery process for ill liquid assets will be arduous.

The Fed has done all it can. Freddie Mac, Fannie Mae and AIG were bailed out. They progressively lowered rates and they opened up the discount window to investment banks. Recently, investment banks have come under the TARP plan and they can unload some of their ill liquid assets. The Fed has accepted most forms of collateral (including equities and mortgages) in exchange for cash. The Fed has been instrumental in takeovers (Bear Stearns, Wachovia, Merrill Lynch…). The SEC imposed a short selling ban on financial stocks and the government provided stimulus through its tax rebate.

I can’t reinforce this concept enough. We all own lots of great assets that we think they are worth a lot of money. Unfortunately, we’ve borrowed money to purchase them. Now that we’ve all mortgaged our future, there is no one left to buy our assets. Those who need to sell some of their things are doing so at greatly reduced prices. These assets, whether they are stocks, houses or cars are worth less than we expected and our financial condition and is not what we thought it was. Banks have helped us finance our “things” and now they are stuck with depreciating assets. As employment conditions slow, this problem will spread until it runs its course.

The government has taken on a huge burden with the bailout program. They could make money off of it or they could lose money. No one knows because the assets have not been priced in the open market and economic conditions are a moving target. One thing that I am certain of is opportunity cost. Our government was forced to commit $700 billion to this crisis and it means that that money will not be available for other uses. I believe Japan serves as a good example and they are still working their way out of a 20-year hole.

The market has more than priced in a slow economy because the chance of a financial collapse still looms. Stocks will either be a great buy at this level or they will fall dramatically.

All of the monetary policies will take time to work their way into the financial system. The market is inpatient and it wants immediate results. Once we have a sign that liquidity is improving, the market will rebound quickly because confidence will be restored. There is plenty of cash on the sideline waiting for this opportunity.

Next week, earnings season will be in full force. Banks will be the focal point. I don’t believe they will decline because they are back-stopped by the Fed. The write-downs might continue, but at least capitalization is not a primary concern. Companies from other sectors will provide cautious guidance due to a lack of financing, but worst-case earnings scenarios are already factored in. Consequently, I believe there’s a chance for a relief rally.

The market has retraced 37% from its all-time high a year ago and we are headed into the most bullish period of the year. Sentiment indicators (bearish sentiment, put/call ratios, VIX) are all at extreme levels. Corporations have very strong balance sheets and they will aggressively buy back shares as their stock price plummets. If the valuations get too low, we will also see a round of takeovers.

On a long-term basis, I am still bearish. On a short-term basis, I believe we could see a massive bear market rally. The shorts are very confident and they are selling into every rally. I don’t believe that the reversal will come from a news event. It will likely start with the first signs that credit spreads are starting to narrow.

The market seems to be finding some support and I suspect that bears are taking profits. In the last hour of trading, buying dries up and the market declines. The same will probably unfold today. I really like tech and agriculture and i am scaling in, knowing that I am early. Place stops below well-defined support levels. If you have shorts, take profits during the last hour of trading and scale out.

Global Interest Rate Cut - If The Market Is Up After 3:00 ET - Get Long!

Posted by Pete Stolcers on October 8

In the last week the market has shed 17% of its value. Any rally has immediately been met by selling. This is an extreme credit squeeze.

As much as hedge funds want to hold positions, they have to liquidate. Investors are pulling out as fast as possible. Quant models balance longs and shorts and they are not working. Regulators banned the shorting of financial stocks and hedge funds were forced to cover. They were over exposed to commodity stocks because they traded at low P/Es and had high growth rates. Commodity stocks rolled-over and the bottom of that sector fell out as everyone hit the exit at the same time.

Widespread leverage is haunting the market because there is a lack of liquidity. Banks are struggling to improve their balance sheets and they don’t want to lend the money. In essence, they are hoarding cash.

Yesterday, the market staged a nasty decline and traders were hoping for a coordinated interest-rate cut. For the first time ever, the ECU, Switzerland, Canada, Sweden, England, the United States and others dropped interest rates in unison. International monetary officials recognize that this is a global crisis and they are doing what they can to prevent a financial collapse.

Pre-open, the market staged a rally on the news. That move quickly reversed and before the opening bell, the S&P futures were down over 30 points. As you can see in today’s chart, there has been volatile, two-sided action. That actually comes as a relief. During the last week, no one has dared to place a buy order. Now at least there is a tug-of-war.

I would like to see a major drop and a snap back rally into positive territory today. The long-term problems won’t go away anytime soon, but this decline is way overdone. At this stage, the market has more than priced in weak economic conditions.

If the market pokes into positive territory after 2:00 PM central time, get long. This is setting up for a very tradable bear market rally. I particularly like technology and agricultural stocks.

On A Short-Term Basis - Support Is Near - Place Stops On Bearish Positions!

Posted by Pete Stolcers on October 7

European markets tanked Sunday night and they set a negative tone for our markets yesterday morning. European banks met today and the likelihood of a multination European bailout is minimal. During today’s conference, Germany didn’t even attend. It appears that each country will resolve its issues independently on a “one-off” basis. We’ve already witnessed the difficulty in getting a bailout approved for our country, imagine the dissension over there. The ECU structure could be in trouble.

The market is continually looking for the next life raft and it currently wants a rate cut. Specifically, it wants a coordinated interest-rate cut between major industrial nations. The market has priced in a rate cut for this month’s FOMC. I don’t believe that lower rates will solve the current problem, but I guess it can’t hurt.

Today, the Fed announced that they would be purchasing secured and unsecured commercial paper. They are doing everything they can to pump cash into the system. Credit spreads have stopped going up today and that is an encouraging sign.

The market staged a nice intraday reversal off of the low yesterday, but it did not have the impetus I would like to see. Ideally, it will reverse from a deep decline today and actually finish in positive territory. Tomorrow, I would like to see early momentum will carry it to a higher close. This type of price action could come very quickly and it would mark a short-term bottom. I might be a week early, but I feel we are close.

SPY 100 is a psychological support level and we almost touched it yesterday. That represents a 33% decline from the peak and it is statistically significant. The head and shoulders formation on a six-year chart reveals the neck line is equidistant from the peak and today’s market level. That is another measure that tells me we are close to a support level.

Sentiment indicators (bearish sentiment, VIX, put/call ratios) also favor a short-term support level.

Fundamentally, stocks represent a good value. Unfortunately, cash is the biggest concern and all of the other metrics don’t really matter until the liquidity crisis has been resolved.

I am scaling into stocks that have been destroyed. I want to see an established support level and I’m looking at companies that are not dependent on financing (strong balance sheet) or strong economic conditions. Agricultural stocks and technology stocks are two examples.

In the Live Update table, I have taken the restriction off of bullish stocks. They do not have to show a cumulative positive net change for the last three days to make it on the list. All of our bullish stocks are listed in descending order with the largest dollar gainer at the top. I’ve done this so that you can easily spot the strongest stocks on our list if a reversal materializes.

On a short-term basis, I think the bears are getting tired and the deeply oversold condition will keep prices above yesterday’s low. After testing the downside, I expect to see a rally near the bell.

Market Crashes - Prepare For A Capitulation Low - Be Patient!

Posted by Pete Stolcers on October 6

We are in full-fledged panic mode. You can run but you can’t hide. Even the strongest stocks are coming under fire.

Now that the bailout plan has been approved, investors are wondering how it will be implemented and how long it will take. It addresses long-term liquidity issues, but it does not address the here and now. The Fed is pumping money into banks as fast as it can and it has doubled the size of its auctions. It is also considering the purchase of commercial paper. Companies need cash now.

Europe was down more than 5% overnight. The hawkish chairman of the ECB is going to take serious heat as economic conditions deteriorate. He has kept interest rates high and the credit crisis could be worse in Europe than it is here. With so many different nations, a solution for the ECU will be complicated.

Investors are playing it safe and they are pulling all of their money out of the market. This is a bear market and these conditions could last for years. Along the way, there will be sharp, violent rallies.

I believe we are setting up for a bear market rally. The market is so oversold that we are due for a major bounce. Short-sellers will be eager to lock in big profits and bargain hunters will start to nibble. In today’s chart you can see the head and shoulders formation on a six-year chart. The distance from the neckline to the peak often represents the depth of the decline once the neckline is broken. The low from this morning and the peak are equidistant from the neckline. This move represents a 33% retracement from the peak and in its own right that is significant from a technical perspective.

If we see an intraday reversal off of a deep decline, it will be time to get long. The option implied volatility is extremely high and the way to play this is to buy stocks (not options). Stocks are much more liquid and they will move point for point. Once the bear market rally has stalled, take profits. I have extensive articles that I’ve written on trading How To Trade V Bottoms. This market is a bear market (not a V Bottom), but the same principles apply once a low has been established.

In the event that we do see an intraday reversal, I will open up the Live Update bullish results. Stocks will not need to have a cumulative positive net change for the prior three days to make it on the table. It will simply list stocks and descending order, showing the largest dollar gainer at the top. This will allow you to see which stocks are reversing the most from oversold conditions.

Normally, earnings season would be at the forefront this week. Corporations can’t secure short-term loans to conduct day-to-day business and without it, they might be forced to close their doors. California can’t meet its short-term obligations and the entire state is in peril. Cash is the most important element in today’s trading and until we see some improvement, the market will decline.

Start lining up your long stock positions. Place buy stop orders above resistance. If the market reverses you will get filled on the way up. These orders need to be placed in advance. Once the rally takes place, the move will be so fast that you won’t have time to place all of your trades. If the market continues to go down, you won’t be filled.

I have not seen enough of a bounce today to tell me that this decline will result in a capitulation low. If we don’t see any buying, it is likely to drift lower right into the bell.

The Fed Bailout Should Get Approved - The Market’s Reaction Is Critical!

Posted by Pete Stolcers on October 3

The market is in a holding pattern ahead of the bailout vote. The consensus is that it will get passed. Politicians saw the aftermath of what happened Monday when they voted it down.

Yesterday, the market tanked ahead of the Unemployment Report. Every month this year we have witnessed job losses. Last month, nonfarm payrolls fell by 159,000. Analysts had forecasted a drop of 105,000. As people lose their jobs, the credit crisis will spread far beyond subprime. The ramifications of the current credit squeeze will not be seen until next month.

The CEO of AutoNation described a very dire situation on CNBC this morning. He said that consumers with a prime credit rating normally get approved for auto loans 90% of the time. That figure has fallen to 60% in recent weeks. Subprime borrowers traditionally received loan approval 60% of the time and now only 10% qualify. This week, General Motors announced a 19% drop in auto sales (Sept) and Ford announced a 34% drop in domestic sales (Sept). This is only one industry, but it depicts the state of our economy.

The bailout plan is critical and it will get approved. However, it might not solve the current credit crisis. Banks are avoiding counterparty risk and the LIBOR rate (which measures the willingness of banks to conduct business with each other) is shooting higher. The Fed will still need to raise the capital and deploy it.

This could take months. The Fed will need to engage in price discovery before they can even make a bid for assets. If the market stages little rally after the bailout is approved, we are headed lower. We need to see a substantial rally with follow-through to get the “bid” back. Otherwise, investors will see this as an opportunity to unload shares. Confidence has been destroyed and fear is driving this decline.

I don’t have much faith in the market and I am inclined to fade any stalled rally. If you look at the chart, you can see that every rally has been sold recently. If we get a good reaction, I will stay on the sidelines. I’ll patiently wait for sign of weakness or signs that a temporary low is in.

Political BS Impedes Bailout and Destroys Confidence - I’m Bearish!

Posted by Pete Stolcers on October 2

The message to politicians should be loud and clear, “pass the bailout… or else”. The market tanked Monday after the proposal was rejected. We witnessed the worst one-day decline since October 1987. In good faith, the market rallied Tuesday on the notion that legislators would not let us down.

What started out as a simple three-page proposal now includes vital elements like removing the excise tax on wooden arrows and lowering import taxes on Puerto Rican rum. I would love to know the names of the politicians who put these items ahead of a national crisis. They should be shot.

At a time when confidence is running low, politicians needed to put their differences aside and demonstrate to the world that they can work in unison to resolve a major problem. Instead, we get the same old self-interest crap and fighting across the aisle.

Banks no longer trust each other due to counterparty risk. Credit is tightening quickly and a rising LIBOR rate (a measure of interbank interest rates) reflects this.

GM reported a 19% decline in car sales last month and Ford reported a decrease of 34% domestically. I’ve heard reports that consumers with a 650 credit rating are being turned down for new car loans.

Misery loves company and the rest of the world is fading fast. The “hawkish” ECB Chairman finally admitted that conditions are deteriorating. Until recently, he has supported an interest rate hike. Last weekend, a consortium of European countries bailed out a large insurance company (Fortis). The governments took an equity stake and mandated that they sell their stake in ABN Amro. To date, there are no suitors. On the home front, Citigroup bought Wachovia. The street was not crazy about the deal because Citigroup might have issues of its own. As banks consolidate, they truly become “too large to fail”.

Last night, the Senate approved the bailout. That was largely expected and the market barely reacted. Tomorrow, the House is expected to vote and consensus is that it will pass. Today’s market decline should convince swing votes to approve the plan. If it gets voted down, we will see a meltdown of historic proportions. I expect the plan to be approved, but I am not expecting a huge rally. The circumstances are dire and this will temporarily keep us afloat.

The government still has to raise capital for the bailout and we will gauge the appetite of foreign investors. Analysts are quick to point out that we could make money on this bailout. Those statements are reckless and the banks themselves can’t even price the assets. We don’t know the current extent of the damage. As the economy continues to deteriorate, the problem will worsen. Yesterday, ISM manufacturing came in at a dismal 43.5. By most measures, that is a recession level. This morning, factory orders were down and initial jobless claims rose to a seven-year high. Friday’s Unemployment Report will be frightening. To an extent, the market is already factoring in a bad number. In the last three months we have seen a decline the day before the report is released.

Our country is straddled with a mountain of debt that spans from the government to the people. On a federal level, a slowing economy is a double whammy. Income tax revenues decline and transfer payments (unemployment/welfare) increase. Add a huge bailout and a war to the tab and you have a problem. On a personal level, as the jobless rate climbs, people are not able to make their payments. They have no savings to draw from (60% of baby boomers have less than $100k saved for retirement) and loan defaults will rise. This problem exists with or without a bailout. The difference is that a bailout will give us time to work through this situation. It could take a decade or more for us to get through this problem. We won’t be able to spend our way out of this one. The world is getting tired of financing our lifestyle.

If we do not get a rally after the plan has been approved, look out below. Global markets are rolling over and fear is spreading. As you can tell from the tone of my commentary, I am bearish. Any decent rally can be shorted. The market has broken below support levels and it is in a steep downtrend.

Don’t Buy The Fed Bailout Rally - Wait for A Chance To Go Short!

Posted by Pete Stolcers on October 1

Now that legislators have reconvened, traders are optimistic that a bailout plan will be approved today. Yesterday, we saw a huge relief rally on extremely light volume. I would not give that rally much credence.

Politicians witnessed the largest one-day drop since October 1987 and constituents voiced their concern. Traders are betting that Congress doesn’t want to be responsible for a market collapse and they rallied the market on the premise that a deal would get done today.

On a macro basis, no one wants to bailout a company that made poor business decisions. On a micro basis, Americans don’t want to bail out their neighbor who lived beyond their means. Unfortunately, our financial system will collapse if we let the liquidity problem spread. The government needs to step in quickly.

Although a relief rally will set in, I doubt that it has “legs”. The credit crisis is global and LIBOR rates have jumped. This indicates unwillingness for banks conduct business with each other.
Monday, Fortis received a $16.4 billion government bailout (Belgium, the Netherlands and Luxembourg). The cash injection stopped a run on one of the countries’ largest retail banks. In return, they demanded a 49% stake and ordered Fortis to sell off the operations of ABN Amro it bought for 24 billion euros ($34 billion) a year ago — a humiliating end to a strategic move that brought ruin upon shareholders. To date, no suitors have stepped up.

The US bailout plan will help us avoid a financial collapse, but the problem still exists. Debt levels are extremely high and economic conditions continue to deteriorate. This morning, ISM Manufacturing plunged to 43.5. That level signifies a recession and it is the lowest reading since 2001. Friday’s Unemployment Report will be dismal and I am expecting a selloff heading into the number. This year, we have either seen a sell-off Thursday ahead of the release or the following Monday.

Japan was faced with a similar situation 20 years ago; however, the problem was contained to their economy. They took similar bailout steps to avoid a financial collapse and their government still holds $9 billion worth of assets after two decades. The Nikkei is still at 1/3 of its peak value. We could be looking at a similar situation.

The average baby boomer has less than $100,000 saved for retirement and in 12 years (not including this bailout) our government will dedicate 100% of its national budget to paying interest on the national debt and entitlement programs (Social Security). We will be forced to cut spending, there’s nothing left.

Watch for a relief rally that follows the approval of a bailout plan. We have survived a massive heart attack, but we are far from healthy. Once this rally exhausts itself, a nice shorting opportunity will set up. That could unfold as early as tomorrow. Today’s reaction will set the tone.

If the market can barely generate a rally and it reverses quickly after the news, a very bearish move lies ahead. Wait on the sidelines for a good shorting opportunity and don’t buy into the rally.

No Deal Today - Short Stocks - Take Profits Before The Bell!

Posted by Pete Stolcers on September 30

Yesterday, we saw the market’s reaction to a failed effort by Republicans and Democrats. Our financial system needs a bailout plan. Credit markets are starting to lock up and banks have lost faith in their counterparties.

An enormous insurance company named Fortis was bailed out in Europe yesterday. The credit crisis is spreading around the globe and financial institutions are interdependent. Foreign markets have been hit hard and we are not the only ones feeling pain at this juncture.

Over the weekend, Citigroup bought Wachovia and while that should be viewed as a positive event, it scares me. Big banks are getting even bigger and if Chase, Bank of America or Citigroup falter, a meltdown could be at hand. They have truly become too big to fail.

Legislators have committed to reaching a solution in the next few days. They realize that time is of essence and hopefully they will put their partisan issues aside. O’bama has gained momentum and the market is factoring in a victory. Higher corporate taxes and increased capital gains taxes are not sitting well.

I believe Friday’s Unemployment Report will be weak and if a bailout plan has not been approved, the market will crash heading into the weekend. Traders are impatient and they’ve waited long enough. Legislators either don’t understand the gravity of the situation or they simply can’t get beyond their differences. Neither scenario bodes well for our future.

The market is deeply oversold and a bear market rally could materialize at any time. All of the sentiment indicators (put/call ratios, implied volatility, A/D, bearish sentiment) are at extreme levels. The bailout will help to calm nerves, but I doubt that it will spark a sustained rally. Troubles still loom and the effectiveness of the plan won’t be known for quite some time.

Nothing will get done today and I believe this rally will come under pressure by afternoon. I am shorting here with stops and I am day trading this market because the overnight risk is too great. The bailout (or lack thereof) and the Unemployment Report will provide plenty of fireworks this week.

The TARP Bailout Will Get Passed - There Is Too Much At Stake!

Posted by Pete Stolcers on September 26

Congress needs to approve the bailout now and hammer out the details while it raises capital. The funding is so large that it will have to be done in stages. Credit markets are locking up and the situation is dire. Fundamentally sound companies are having difficulty raising credit to fund basic day-to-day operations.

President Bush felt compelled to reassure the markets and in his two-minute speech today, he said a deal will get done. Warren Buffett staked $5 billion on the likelihood that it will be passed. He said that he would not have invested in Goldman Sachs if he did not believe a finalize plan was imminent. The Fed Chairman and the Treasury Secretary made a plea before Congress. They left no doubt that this situation is urgent and it needs to be resolved immediately.

The markets rallied prematurely on rumors that a bailout had been finalized. If politicians had tempered their excitement and waited for the ink to dry, this market whipsaw could have been avoided. The timeline has always been to get something done this weekend and there was no need to raise false hopes of an overnight approval. Now, traders and the financial world are wondering if this has become a partisan issue.

Time is of essence and any delay will raise fear. The world is watching. If both parties can’t come together on an issue of this magnitude, it will not bode well for the future.

The market has shouldered the delay and we caught a small glimpse of what will happen if we can’t get TARP approved over the weekend. Given the urgency, I believe there is a 90% chance that this will be approved over the weekend. Traders are expecting an approved bailout plan and the market has rallied off of its lows.

RIMM missed its number and the stock is getting pounded. It is dragging the rest of the tech sector lower and it is weighing on the market.

We are likely to see a relief rally Monday once the bailout is finalized. End-of-month fund buying will also lend support to the market. Once that is rally runs its course, a nice shorting opportunity will present itself. The Unemployment Report will stifle any rally and the downtrend will resume.

Don’t get too cute with the rally. The better trade will come on the downside. The market will survive this heart attack, but it is far from healthy.

Fed Bailout Rally Will Set-up A Short!

Posted by Pete Stolcers on September 25

There’s an old saying on Wall Street, “buy the rumor – sell the news.” I believe “buy the rumor” is what we are seeing today and we are setting up for “sell the news” next week.

Traders believe that a bailout will be approved over the weekend and they don’t want to get caught short. This rally will exhaust itself and it will set up a great shorting opportunity.

We are not going to experience a financial crash, but that’s hardly great news. Let’s not forget that financial institutions are in dire straits. The unemployment rate is rising and consumers are up to their eyeballs in debt. The sub-prime crisis is spreading and someone still has to pay for poor lending decisions.

The Fed doesn’t know what it will find once it opens the books. The fact that more firms want to come under the TARP is a little concerning and it makes me think that the problem is worse than expected. Capital is very difficult to secure and as demonstrated by Warren Buffet’s $5B stake in Goldman Sachs, it comes a stiff price. When Bank of America cuts off loans to McDonald’s franchisees, you know its getting tough. Lending practices will tighten until the Fed can get its arms around the problem.

Today, durable goods came in much lighter than expected and continuing jobless claims increased. The most significant piece of economic data will be released next Friday. If unemployment continues to climb, the market will take a hit.

I am in a trading mode. Prices will climb higher right into the closing bell Friday. Once this rally stalls, it will set up a nice shorting opportunity. SPY 128 represents resistance and I will start shorting from that level. Be nimble.

Fed Bailout Probable - Buy Calls On Strong Stocks Heading Into The Weekend!

Posted by Pete Stolcers on September 24

The Fed Chairman is usually very balanced in his statements and the market tries to read between the lines every time the FOMC statement is released. In the last few days, he has not minced words. He has let Congress know that we were on the verge of a financial collapse last week.

Legislators are well aware that the circumstances are dire. They do not want to write a blank check and they do not want to grant Treasury Secretary Paulson unbridled power. As is typical of these congressional hearings, some are using this opportunity to get on their political soapbox. In the end, I believe a bailout plan will be passed.

The longer this process takes, the more impatient the market will grow. We will see a continual decline in stock prices and that will pressure legislators.

Overnight, Goldman Sachs secured $5 billion in capital from Warren Buffett. They are the best Investment Banker on the street and as a result, they have access to capital. Other financial institutions are not as fortunate. During his interview, Warren Buffett said that he would not have made the investment if he did not believe that a bailout plan was imminent. Goldman Sachs paid a hefty premium to attract this capital.

If the government under-bids for ill-liquid assets (and it should) it will be the last resort for financial institutions that need cash. Consequently, banks may wait until the final hour before they come under the “TARP”. If this happens, shareholder equity will already be in jeopardy.

The Fed’s priority is to stop a run on the banks. When needed, they should assume the obligations of the company and wipe out shareholder equity. This will stop the systemic risk from spreading. They are taking risk in doing so and we should all benefit if there are rewards. This is no different then JP Morgan’s involvement in the Bear Stearns bailout (except that the Fed backstopped that deal). If taxpayers have to bear risk, they should be rewarded.

Chairman Bernanke seems reluctant to go this way because he feels that financial institutions will not embrace the terms. I disagree. Many firms are already teetering on disaster and new capital is not coming into the market. CEOs know that there aren’t any alternatives. They can try to salvage some shareholder equity or they can risk it all, putting our entire financial system in peril. When Goldman Sachs secured capital, they diluted shareholder equity, this is no different.

Legislators are angry and they have little pity for financial corporations. Equity will be the sticky point for getting the deal done.

Stay short until Friday and use stops. If a deal gets done, the market will gap higher.

Traders will speculate that a plan will get signed over the weekend and I would close short positions Thursday and Friday. I am playing this by scaling into stocks that have held support well and looked poised to rally. If the plan does not get passed, the market will tank. Being in the right stocks will help mitigate the damage if this unfolds. If the bailout is finalized, these stocks will jump.

Fed Bailout Prevents Crash - Shareholders of Financial Stocks Beware!

Posted by Pete Stolcers on September 23

According to Ben Bernanke, we are close to a financial collapse. Immediate action is needed and the details of the bailout plan are being hammered out. Both parties know what is at stake and I don’t believe it will become a partisan battlefield.

Until the plan has been finalized, the market will drift lower. The reversal last Thursday and the short covering rally last Friday were over-extended. Yesterday, the market took back some of those gains as uncertainty looms.

Fed officials witnessed the aftermath of their decision to let Lehman fail. Bear Stearns, Fannie Mae, Freddie Mac and AIG lost shareholder equity, but their bond holders and obligations were preserved. Systemic risk quickly spread to other financial institutions and Goldman Sachs, Merrill Lynch and Morgan Stanley were on the brink of failure.

The Fed bought time for the issues to be resolved in an orderly manner, however, that doesn’t mean the outcome will be favorable for shareholders. The government has already shown its willingness to throw shareholders under the bus. Treasury Secretary Paulson is a shrewd businessman and he will underpay for assets that have no bid. Financial institutions will be forced to take a big hit and taxpayers want them to pay for their mistakes. In the process, it is possible that the government might actually come out “whole”. That would make policymakers look good.

In the meantime, financial stocks continue to drift lower. They may not fail, but tough times lie ahead. Regulation and oversight will reduce profit margins. The economy is slowing and this is no longer limited to sub-prime loans. Investors are getting out during the short-selling ban. They know this condition is temporary and they are taking advantage of the short covering rally.

Risk capital is essential to growth and it comes at a high premium. Today, Bank of America announced that it is not extending credit to McDonald’s franchisees. This is one example of how a solid business is finding it difficult to finance operations.

It will take years for us to work our way out of this mess. Bad decisions have been made by individuals and financial institutions. In the end, someone has to pay. If the government pays too much for assets, the taxpayer will suffer and the national debt will rise. If the government under-bids, financial institutions and individuals will suffer loses. In either case, the end result leads to an economic slow down.

In today’s chart, you can see a defined downward sloping channel. The trend is lower and you need to stay bearish. There will be violent bear market rallies and you need to take profits as the market plunges. Conversely, sell the rallies. I believe the market will settle in to an orderly decline where we rally on the open and sell into the bell. Once a deal gets hammered out, look for a sharp rally at stalls around SPY 130.

Massive Bank Bailout Prevents Crash - Problems Continue - Stay Short!

Posted by Pete Stolcers on September 22

Last week, the market suffered a heart attack that could have been fatal. At the last minute, the Fed resuscitated financial stocks with a $700 billion bailout plan. The timing could not have been worse for short-sellers as they scrambled to covered positions hours before option expiration.

This crisis came dangerously close to a meltdown. It was poorly handled by the Fed. First of all, the Fed made it clear that it was not going to bail out Lehman. The systemic risk from that decision was taking affect just as AIG was about to go under. The Fed was willing to let that happen, but a series of evaluations forced them to reconsider. They were able to gauge the effects of the Lehman collapse and it was much greater than expected – AIG posed a much greater threat. They stepped up with capital and stripped shareholders of most of the equity. AIG was solvent; it simply needed time to generate cash. The Fed’s action created panic and many financial stocks were down 30% overnight. They finally made an announcement Thursday afternoon.

If the Fed had simply let the market know that a bailout was possible, the market would not have plunged like it did. Short sellers would have been passive and financial stocks would have rallied on the news. Instead, the market assumed that they would allow others to fail and shareholders in AIG and LEH were wiped out.

Huge market declines destroy confidence and even though market rebounded, investors will be slow to return. Sovereign funds have been a huge source of capital and they are reluctant to invest. The perception is that the Fed is either reckless, or they don’t have a clue – neither is good. This bailout could require upwards of $1.8 trillion and foreign investors are diversifying away from the US. They still have huge exposure here, but they are not interested in adding to it.

In 12 years (2020), 100% of our national budget will be spent on interest (national debt) and entitlement programs (social security). Think of it, there is nothing left over for all of the other necessities! That projection was before this massive bailout and we are less than 12 years away. As a nation, we are headed for trouble and the world no longer wants to finance our gluttonous ways.

We survived a heart attack, but we are far from healthy. The U.S. Treasury will be purchasing mortgages from troubled financial institutions. One out of every 10 homeowners has negative equity and that condition will take years to reverse. The unemployment rate continues to climb and tight credit conditions will slow domestic and global growth. Banks will be highly scrutinized and profits will decline as tight lending practices are introduced. Morgan Stanley and Goldman Sachs are now under the “bailout umbrella”. Their profit margins will decline, but they have survived.

I hate that US taxpayers have to pay for poor regulatory supervision and negligent lending practices. However, a financial collapse would have been unbearable. I don’t think that any of us can truly imagine the hardship that would have followed.

Last week’s rally was largely due to short covering. Once the dust settles, I believe an orderly decline was set in. Financial institutions have mountains of crap on their balance sheets and now that the government is involved, we will eventually determine how bad the problem really is.

The SPY is below 126 – stay short.

Fed Bailout Sparks Huge Short Covering Rally!

Posted by Pete Stolcers on September 19

The Fed pulled another rabbit out of his hat. Legislators are drafting a plan to bail out troubled financial firms. They are pumping massive amounts of money into the financial system and they have prohibited the short selling of financial stocks. All of this comes on the eve of option expiration and this is the third time in the last year that material events have been timed this way. I’m sure the Fed feels that it is un-American to short and they don’t mind screwing traders who bet against the market. If it sounds like sour grapes, it’s not. I did not get caught short in this market.

If the Fed would have simply disclosed the possibility for such a bailout last week, billions of dollars in shareholder equity could have been saved. Market volatility does little to instill confidence and we would not have seen a dramatic plunge or rally this week. There is a chance that they weren’t prepared to do this. They reluctantly bailed out AIG and after Lehman’s demise they signaled that the bailouts were over. It’s possible they are flying by the seat of their pants. In either case, this has been handled very poorly.

The Fed had to step in and we were on the brink of a financial meltdown. When money markets (a cash equivalent) start failing, you have an enormous problem and a possible run on banks. I don’t like the fact that taxpayers will once again pay for the mistakes of large corporations, but a financial collapse would have been unbearable.

It angers me to hear that traders are being blamed for the problem. Regulators have not enforced naked short selling by institutions and that’s wrong – the rest of us have to locate the stock before we can short. If they want to reinstate the up-tick rule, fine. This won’t keep stocks from declining; it will just make the drop a little more orderly.

I heard Cramer use the term “financial terrorism” yesterday as if there were some Muslim plot to destroy our financial system. Give me a %^&* break. The Arab nations are growing their economies and they are very dependent on our well-being. They hold tremendous assets in the United States and they have been a huge source of capital for financial institutions. The people with enough money to wreak havoc have a vested interest in seeing us succeed. They also have their money in major banks around the world and all of them would have collapsed if this continued. Foreign central banks know this and they also flooded the market with money!

Can we please stop blaming everyone else for our desire to live beyond our means?

I don’t suppose that the financial institutions themselves could be to blame. They have constructed complex derivative products that can’t be priced, they have overleveraged themselves and they have made horrible lending decisions. They can’t even evaluate their own situations so they are reluctant to trade with other firms that might have similar exposure.

The key to the solution is fiscal responsibility. The government needs to raise taxes to pay down its mountain of debt and individuals need to stay employed and save. This will take many years to resolve if we start now and it will be painful. I feel Japan serves as an example and after 20 years, their market is still a third of where it was in 1989.

We are “fat” and there is not a magic pill that will make us thin. If we eat right and break a sweat, we’ll be ok. We’ve just survived a hear attack. I hope we learn from it and change our ways.

The problems that existed yesterday are still present and today’s rally had more to do with short covering than anything else. Once this move runs its course (and that could end today), this will be a shorting opportunity. I am shorting stock in small size right now. The Market Makers widened the option bid/ask spread and you could drive a truck through them. I was fighting a $.40 bid ask spread on SPY options on the open this morning and they are typically $.10 wide. In stocks, I was seeing markets that were $2-$3 wide. Keep your trading small and wait for some of this volatility to ease.

STAY SHORT HEADING INTO OPTION EXPIRATION!

Posted by Pete Stolcers on September 18

On the trading floor, your word is your bond. Once your integrity is questioned, you’re finished. This week, financial institutions that have been trading with each other for decades have stopped – the trust is gone. Financial behemoths like Bear Stearns, Lehman and AIG have been carried off in body bags. Merrill Lynch wisely struck a deal with Bank of America as the noose was tightening. After posting decent numbers, Goldman Sachs and Morgan Stanley have been pounded. How can you trust the other side when you can’t even reconcile your own books?

The issue at hand is transparency. Financial institutions are laden with complex derivative products that can’t be priced. Credit spreads in the inter-bank market have widened dramatically as firms stop trading with each other and they could freeze up. Central banks around the world are flooding the market with money in hopes of avoiding that.

The smart money is sitting this out and capital is very tough to attract. Rumor has it that China is looking to take a 50% stake in Morgan Stanley. That might help to temporarily restore confidence. Mergers like the Bank of America/Merrill Lynch deal are also a possibility. Large deposits held by banks could ease leverage concerns and stop the massacre in the investment banking group. This is not a long-term solution. Banks themselves are in a tough spot. Unemployment is on the rise and so are mortgage defaults. One out of every ten homeowners has no equity in their property and many are “underwater”. Two weak companies rarely evolve into a strong one.

The economic data today was positive, but it has been ignored. Durable goods and GDP will be released next week, but in the grand scheme of things they are insignificant. Confidence in our financial system is of paramount importance.

Emerging markets have not been spared. Hyper-growth spawns loose lending practices and those investments could also be in danger. One thing is certain, new capital will be hard to come by and growth in developing countries will slow dramatically. Russia was considered to have tremendous potential and this week it closed its market after an 11% plunge. That does little to instill confidence.

Stocks represent a great value at this level, but value doesn’t mean anything during a liquidity squeeze. Those who need to generate cash sell everything. In an unprecedented move, the Fed decided to accept equities as a form of collateral. Conceptually, it will keep financial institutions from dumping stocks. Unfortunately, it’s not working. Financial institutions are selling stocks with the notion that they can buy them cheaper in the future. They also don’t want any “favors” from a Fed that has wiped out shareholder equity. Individuals are pulling money out of the market as well. The nightly news has focused on bank failures and dramatic declines in the market. As I search for sector rotation, I don’t see any. All of the money that has come out of commodity/tech stocks has not rotated into other sectors.

The VIX has spiked to 36 and many analysts are calling for a capitulation low. We have convincingly taken out the SPY 120 level and I believe we are beginning the next down leg. I have seen the VIX stay elevated for months while issues like this are resolved. There will be snap back rallies, but clearly the trend is down.

The kitchen sink has been thrown at the financial crisis and I can’t imagine a quick solution to a problem that has accumulated over decades. I am hearing analysts talk about Japan and how they solved their problem. When I started working on the trading floor in 1989, the Nikkei was at 40,000. Look at where it is 20 years later.

Option expiration favors the bears. Sell programs and a reluctance to go home long over the weekend will push the market lower. We are also heading into the weakest seasonal pattern of the year. I have not been this bearish in 20 years.

Look Out Below - Support Has Been Breached and Panic Is Setting In!!

Posted by Pete Stolcers on September 17

The Fed has done all it can to avoid a financial calamity. These problems have formed over decades and as a country, we are overleveraged. Investment banks and mortgage companies created complex derivative products and now they are paying the price. Unfortunately, these obligations are “off balance sheet” and the transparency is nonexistent. No one knows how to value these companies and they don’t know how much capital will be needed to fix the problem.

AIG needed support and the Fed did the right thing in this case. My understanding is that the company is solvent, it is just not liquid. Given time, it can sell assets at a reasonable price and generate cash. When credit agencies lower debt ratings, the reserve requirements skyrocket and that is why this problem seemed to come out of nowhere. If the Fed had walked away, the market would be much lower than it is today.

I’ll pat myself on the back with yesterday’s suggested trade. If you would have bought 1000 shares of AIG and bought puts on the SPY, you are making a ton of money today. The stock is down $1 from the time I published the report and the SPY is down more than $5.

The market isn’t down because it hates the Fed’s action. Over 100,000 jobs have been saved and the systemic risk has been reduced. Other financial firms rely on AIG’s credit worthiness and they have interdependencies. The market is selling off because it does not know where the next problem will come from.

The Fed immediately put new management in place and they took and 80% stake in the company when they arranged the $85 billion loan. Shareholders will be left holding the bag. However, if the Fed did not intervene, they would have lost everything on the investment anyway. The message is clear. The Fed does not want to bail out other firms. If it feels compelled to, the equity in the firm will vaporize.

Any financial institution that has leverage is being taken behind the shed. Morgan Stanley and Goldman Sachs are plunging. Emerging markets around the world are also tanking. Russia was down 11% yesterday before they halted trading and they were not able to re-open their stock market today. Capital for new projects/investments will be tough to come by.

For those of you who are familiar with the money multiplier effect, everything is fine until the need for cash arises. Deposits are loaned out many times over and the Fed only requires a fraction of the original deposit to be held in reserve. Lending practices have been loose for decades and Americans are up to their eyeballs in debt. The financial institutions that have extended all of this credit now need to raise cash. Unfortunately, no one is depositing more capital (cash) and their need for liquidity is increasing on a daily basis.

This crisis is far from being resolved. Forced liquidation feeds on itself and today’s bargains will be cheaper tomorrow. Get short and stay short!

Gaps - My Favorite Trading Set-up

Posted by Pete Stolcers on September 16

In today’s option trading blog I will discuss gaps. If you believe in efficient market theory than everything is priced in to a stock every moment and a move is a random, unpredictable event. As the theory goes, you should just put your money in an index fund and a bond fund because you can’t outperform the market. In the era of full disclosure, that is more the case now than ever. Information flows freely and there are fewer “secret handshakes” than ever. I don’t believe in the theory and I am able to find opportunities on a daily basis. However, let’s say that I did believe. What happens when the unexpected ocurrs – a gap.

The market scrambles to assess the news and to weight the importance of the event. All of a sudden, imbalance and chaos exist. This is the environment I seek. The market hates uncertainty and the reaction can be very telling. Down gaps are my favorite because they can lead to big drops. Here’s my angle.

I define a bearish gap as a stock where the high today is below the low from the prior day – it is a true gap. If the low price for a stock yesterday was $42 and the high today was $41, it qualifies. The move was so pronounced that the stock could not even rally to $42 intraday. This tells me that there’s a crack in the dam and the stock is weak.

There are many keys to trading gaps, here are two. First of all, where is the stock in relation to the 52-Week range? I’m much more interested in a down gap on a stock in the upper quadrant of the 52-week range than a stock that has been in a free fall. Why? Because everyone is long and panic and profit taking can easily set in. For that same reason, I’m more interested in stocks with high P/E ratios and “lots of promise”. If the resistance level is defined (long term horizontal) I can be pretty sure those highs will not be tested soon. Option traders… do you see the implications?

The second key is to watch the reaction the second/third day. If it was a big gap and it filled in easily, the news may not have been material. If the stock tries to bounce and “fill” but it fails and makes a new low on a steady drift lower, it has more room to fall. You should always read the news and determine the reason for the gap. An analyst downgrade means nothing, those gaps will fill. A material change in earnings guidance… now that move could have legs.

I can make a living just trading gaps. I have a scan that shows me gaps that are up to 4 days old. Sometimes the older the better. If you are a OneOption subscriber, click on the Scanner and try it out. You will get a one day pass. If not, Register and try all of the research free (including 5 reports). The Scanner will show you at least 300 new stocks each day and the charts are integrated.

What’s your favorite set-up? Tell me and I’ll share my thoughts.

Posted in, Analysis - Technical, Fundamental, Market

This Is Going To Be Reolved This Week - Buy AIG and Buy SPY Puts!

Posted by Pete Stolcers on September 16

This weekend, the government decided NOT to bail out an ailing financial institution. Lehman could not find a buyer and risk capital is very expensive (if not impossible) to come by. AIG is currently trying to secure $75 billion to maintain its credit rating. The Fed has asked Goldman Sachs and Morgan Stanley to help. It’s unlikely that they will provide the capital, but they might be able to spark interest. This company has $1T in assets.

This situation will be resolved one way or the other in the next day or two. Either AIG will be a great bargain or it will go bust. This insurance company employs 116,000 people worldwide and if it goes down, the market will tank.

Two weeks ago, Bill Gross of PIMCO (world’s largest bondholder) said he was buying up Freddie Mac and Fannie Mae bonds. The government already committed to bailing them out, they just hadn’t formailized it. This was a sure bet for him and he was getting in at a nice price. Traders misinterpreted the good auctions as a sign that capital was ready to return to the market. Now that the Fed has stopped back-stopping financial firms, no one wants to take the risk.

Over the weekend, Bank of America bought Merrill Lynch. Although the two companies denied it, “the street” suspects that the deal was forced to by the Fed. They did not want another huge investment banker to fail and the noose was already around their neck last Friday.

In an unprecedented move, the Fed is allowing financial institutions to pledge equities as collateral. In essence, our government has become a shareholder. In the last year they have lowered the Fed Funds rate, opened up the discount window, accepted mortgages for collateralized loans, provided a backstop for Bear Stearns, lowered reserve requirements for GSE’s, provided a tax rebate, given investment banks access to liquidity and bailed out Fannie Mae and Freddie Mac. The FOMC meets today and they know they are out of bullets. They can reduce interest rates, but it won’t do much good.

This financial crisis is going to finally play itself out. Cash is king and no one wants to take risk if this house of cards is ready to fall. Every month it seemed like the Fed would pull another rabbit out of its hat – they’re done.

As financial institutions fail, there is a cascading affect. They are all inter-dependent and they have OTC hedges, insurance and investments in each other. Right now, value means nothing. They need to sell what they can to raise cash.

I have been looking for asset rotation the last two months and there isn’t any. Normally, as one sector declines, the money flows into another. Energy stocks have been pounded and there is not one sector that has attracted the capital. That means that money is leaving the market. The same is true of global markets. The money is flowing out everywhere.

I am currently buying shares of AIG and I am buying SPY puts. One of these two trades is going to make a lot of money.

Pivotal Day - Go to Cash - Short If SPY 120 Breached.

Posted by Pete Stolcers on September 15

Today will prove to be pivotal and it all boils down to confidence.

Over the weekend, Lehman was not able to find a suitor and the Fed made it clear that it is done with bailouts. AIG is scrambling to find capital and it is on the verge of a credit downgrade. UBS announced another $5 billion write-down and it could be trying to attract additional capital as well. Months ago, the Fed warned financial institutions to secure capital and Lehman waited too long.

Bank of America purchased Merrill Lynch at a premium to Friday’s closing price. “The street” believes that this deal was forced by the Fed. However, management denies that and they are speaking of synergies.

In a bold move, the Fed has agreed to accept equities as collateral. In essence, they are supporting the market. Financial institutions do not need to liquidate their holdings in order to generate cash.

A consortium of international financial institutions has established a $70 billion liquidity fund. They collectively want to avoid a run on the financial system.

China has lowered its interest rates by a quarter of a point. It has been in a tightening mode for the last 14 months and this is a significant event.

We are clearly at a crossroads. If investors get spooked, panic selling could set in. On the other hand, if calmer minds prevail, this could present an excellent buying opportunity.

From my perspective, cash is king. I suggest staying on the sidelines. I would rather forego the first 10% of the market rally so that I can sleep well at night. If the market recovers and is able to move above horizontal resistance levels, I will put money back to work.

At this juncture, the risk is not justify the reward and I hate to use the word crash, but it is possible.

Unlike 1987, the stock market represents a good value. The balance sheets and P/E ratios are very reasonable. However, the leverage and debt levels are much greater now. A liquidity squeeze throws value out the window. If mutual funds, banks and individuals need to sell stocks to generate cash, valuation means nothing.

I have noticed that there is not much rotation and that simply means that money is being pulled out of the market. As commodity stocks sold off, that money was not reinvested in other sectors. In fact, technology and healthcare have also started moving lower and I don’t see signs of strength anywhere.

This situation reminds me of an old saying, “Water, water everywhere, not a drop to drink.” Capital is hard to come by yet there is plenty of cash on the sidelines. No one wants to engage risk until they see how all of this plays out in the coming months.

If the SPY closes below 120, get short.

Commodity Stocks Look Good - We Need Follow Through!

Posted by Pete Stolcers on September 12

Yesterday, the market staged an unexpected reversal. Volatility in continues to dominate the market and we have been to hell and back since last Thursday.

The initial jobless claims showed a loss of 6,000 jobs and that was in line with expectations. Continuing claims climbed to 3.53 million and that was a bit concerning. As people stay unemployed, the credit risk rises. Import prices fell in August and that set the table for a tame PPI today.

The PPI was expected to decline by .5% and it actually dropped .9%. Unfortunately, that number was overshadowed by weak retail sales. Economists had been expecting a rise of .3% and sales dropped by .3%. This result casts serious doubt on the theory that lower gasoline prices will spark consumption this fall.

Next week, the FOMC will meet. Lower inflation and global interest-rate cuts will help them maintain their current policy. Interest rates are not expected to change and some analysts believe they could fall by year-end. In any case, I don’t believe the FOMC comments will have much of an affect.

Earnings from Goldman Sachs and Morgan Stanley are likely to drive trading. The financials have been struggling to maintain gains over the last few weeks. Yesterday, Goldman Sachs broke below key support and traders would are choosing to error on the side of caution. This is one company that continually exceeds expectations and I believe the market could have a positive reaction.

The market is right in the middle of its one-month range and I don’t expect a huge option expiration bias next week.

The intermediate-term trend is down and we are in a seasonally weak period. Consequently, I am trying to temper my excitement over yesterday’s reversal. The fact that the market found major support well above the SPY 120 level is very encouraging.

As I mentioned, commodity stocks were putting in a capitulation low. If you took my lead and got long fertilizers stocks, you made a ton of money. I still like commodity stocks and I believe they are deeply oversold.

The market continues to chop around and it has been all over the board this week. Traders are expecting some news on the Lehman front and will see what happens over the weekend. I expect directionless trading. If the market stages a small late day rally, it will add credence to yesterday’s reversal.

Capitulation Low In Commodity Stocks - Get Long - Use Stops!

Posted by Pete Stolcers on September 11

Nothing has really changed since yesterday. Lehman announced that it is seeking a buyer for the whole firm. The “street” should have suspected this when they could not get what they wanted for Neuberger Berman. Initial jobless claims fell by 6000 last week, but continuing claims shot up 122,000 to 3.53 million. August import prices fell for the first time this year and they declined by 3.7% in August. All told, the news was not market moving.

This morning, the market tested the downside first. The S&P 500 futures were down 18 points right out of the gate. Overseas weakness spooked investors and Asia was down 3% overnight. Europe was down almost 1%. We have another hurricane approaching, we are in a seasonally weak period and memories of 9/11 all cast a dark cloud over the market.

Fortunately, prices have recovered and it appears that support was found above the SPY 120 level. That is a positive development. Commodities stocks have been crushed and I believe that liquidation was the cause. We may have seen the final stages of the yen-carry trade. Hedge funds would borrow the yen (short it) and use the proceeds to buy commodities. The strengthening yen has put enormous pressure on this position and hedge funds are bailing out. That has forced a massive sell-off in commodities stocks as the trade is unwound.

The fundamentals are still intact and these stocks have gone from over-valued to under-valued in three months. I feel confident that we will hear of hedge fund failures in the next few weeks. These liquidations set up excellent buying opportunities and we are near a capitulation low. I do not believe that commodity stocks will return to their old high, but they could retrace half of that distance. In order for commodity stocks to get back to their old highs, global economies need to show growth. We could be a year away from that (or more). In the short term, value investors are getting back and that could spark a short covering rally.

China reported that its inflation rate dropped to 4.9%, a 14-month low. Tomorrow, our PPI will be released and analysts expect a decline of .5%. I believe this number could generate a rally. The market has been searching for good news and lower inflation will give the Fed some breathing room. New Zealand lowered its interest rates by .5% (more than expected) and global interest rates are heading lower. That’s good news for the dollar.

I still feel that danger looms in this market, but the big drops have come off of rallies. Goldman Sachs has finally broken a major support level and the market has prepared itself for a worst-case scenario when it releases earnings next week. That sets up for a rally. I don’t want to get long GS, but this is one company I would not bet against. I also feel that GS has been heading down because traders think they will buy LEH.

From the early lows this morning, the market has staged a nice reversal. I believe the rest of the day it could find support. Tomorrow, the PPI should provide a positive bias and I expect a contained rally. If the PPI comes out “hot”, it will be discounted by traders because they know commodity prices have fallen. I like getting long coal and fertilizer stocks in here.

No More Silver Bullets - Option Traders - Favor The Downside!

Posted by Pete Stolcers on September 10

Yesterday, I got a little long-winded so I’ll keep this brief. The market had been expecting the government’s bail out of Fannie Mae and Freddie Mac. Without it, a financial collapse was possible as investors would have lost faith in our system. This move bought us time to work through this mess, but it did not solve the problem.

Monday’s rally was merely a knee-jerk reaction to the first shred of good news. Yesterday, the bears jumped on a golden opportunity and they pounded the market. The Fed has fired its last silver bullet and now we will wait to see if it hit its mark.

That’s really what this all comes down to. This recession will have to run its own course and there aren’t any white knights to come to the rescue. Global economies are slowing and our unemployment rate is climbing. Years of loose credit led to extreme debt levels and this credit crisis could take years to run its course.

Of course, we could just print more money. I can’t believe the Democrats are lobbying for another stimulus package. Our government is already up to its eyeballs in debt and the last one wasn’t that effective anyway.

The market is vulnerable and we are seeing big down days. Yesterday, the VIX spiked and fear is creeping back into the market. This is a seasonally bearish period and it is likely that we will retest SPY 120. I believe the next round of weakness will come from consumer stocks.

On the positive side, the panic selling in commodities is setting up a capitulation low. I believe these stocks represent a great long-term buying opportunity and I am starting to eye them up. I want to see another decline and a sharp intraday reversal in commodities stocks.

The rest of the week is light on news. Friday’s PPI might generate a rally. Next week, we will hear in from the FOMC and I’m not expecting any surprises. The biggest news will come from the investment bankers as Goldman Sachs and Morgan Stanley release earnings.

For today, I expect the market to chop around. During the first two trading days of the week, it has been all over the board. If it heads into negative territory with an hour left, we are likely to sell off into the bell. During yesterday’s steep decline, we did not see an afternoon bounce and that tells me that we have not seen a temporary bottom yet. Although a rally is possible, I would not trust it.

Bailout Buys Time - Problem Still Looms - Favor the Downside.

Posted by Pete Stolcers on September 9

Last week, the market sold off dramatically ahead of the Unemployment Report. As expected, the results were concerning. The jobless rate rose to 6.1%, up from 5.7% the previous month. Unemployment also increased by more than 50,000 jobs in June and July. Friday’s market reaction was rather subdued given the huge decline on Thursday.

The last three Unemployment Reports have generated selling on Monday. I expected the market to decline in the early part of this week. The government threw a curveball when they bailed out Fannie Mae and Freddie Mac. The market gapped up a huge and shorts scrambled to cover.

This was a widely expected move and the government was forced to play its last trump card. Financial markets were getting nervous and investors were perplexed over the delay. The nationalization of mortgages helped to stabilize credit markets. The government has assumed the risk and they have deep pockets to weather the storm. Like an emergency room doctor, the government has demonstrated that they will do everything they can to save the patient.

The bottom line is that people own more home than they can afford. If lenders force them into foreclosure, a domino effect could take hold and home prices would plunge. This could jeopardize the entire financial system as the assets devalue. The government has access to capital and over the next few years, this bailout will force them to issue new debt.

One out of every ten homeowners has no equity and many are “underwater”. The government hopes to keep people in their homes long enough to reverse this situation. Once the asset increases in value, people will be able to sell their homes and make good on their loans. In a worst-case scenario, they would have walked away from their mortgages, straining the financial system. That would normally be fine, except that this time the problem was too widespread (the two largest GSE’s accounted for half of all mortgages).

Taxpayers will shoulder the burden for poor lending decisions. In the short term, our national debt will increase and the dollar will suffer. In the long-term, this problem should resolve itself. Once again, the US has “mortgaged the future”. As a nation, we spend more than we make and that has to stop.

People keep asking, “How did we get here?” This problem has been brewing for decades and it is reaching a critical point. Unfortunately, no presidential candidate will ever get elected if they stress saving money – that would send us into a deep recession. The alternative is to maintain our gluttonous ways until the entire house of cards comes crumbling down.

In another 12 years, 100% of our national budget will be spent on interest on our national debt and on entitlement programs (Social Security, Medicare…). Think of the implications! There’s nothing left for education, defense, infrastructure or dozens of other necessities. How can this country maintain its global status if it has no money?

Baby boomers are starting to retire and 60% of them have less than $100,000 saved. A major roadblock stands in our way and if we act now, we can avoid a financial disaster. That does not mean that we won’t struggle along the way.

I do not envy either presidential candidate and I believe they are faced with an impossible situation. Everyone wants to point fingers and no one wants to take responsibility for their own personal decisions.

Enough gloom and doom.

The market had a muted response to yesterday’s news. A financial meltdown has been postponed and perhaps avoided. The government has fired its last bullet and they did not get the desired reaction. Stocks rallied on the initial news, but today they are trading down. The crux of the problem still exists.

As a nation, the economy is slowing and our debt levels are at all-time highs. Last week’s Unemployment Report will weigh heavily the rest of the week. This Friday, the PPI could spark a rally and we might start seeing some signs of relief as commodity prices continue to fall. However, that is largely expected by the market and the rally will be short-lived.

During this quiet week, I need to look to ahead for a driving force. The FOMC will meet and it is unlikely that that event will drive the market. Bond prices imply that interest rates will not be going up for the remainder of the year and the Fed is likely to cite weak economic conditions and moderate inflation. Perhaps the bigger release next week will come from investment bankers such as Goldman Sachs, Morgan Stanley and Lehman when they announce earnings. This morning, Lehman is down substantially and it appears that the Korean Development Bank takeover is not going to happen. I will also be watching earnings from FedEx. Their earnings should improve due to lower fuel costs; however, it’s their shipping outlook that will be of greatest importance. Their guidance is often considered a barometer of economic activity.

The VIX stayed elevated even after yesterday’s news and uncertainty continues to plague the market. We are in a seasonally bearish period and we have breached horizontal support at SPY 126. Consequently, I still favor the downside.

Without A Bailout The Market Would Have Tanked - Don’t Look For A Big Rally!

Posted by Pete Stolcers on September 8

This weekend, the government finally committed to a Fannie Mae/Freddie Mac bail out. That move was largely expected, but global investors were relieved once it was finalized. An ensuing rally generated short covering and the market gapped up on the news.

In the grand scheme of things, nothing has really changed. Financial institutions can breathe a little easier knowing that these particular bond holdings are secure. Investors can also take comfort in our government’s effort to stabilize credit markets.

The burden for bad loan decisions will fall on the shoulders of the taxpayer. The government will have to issue many new bonds and the appetite for US treasuries could be limited. Many of the loans held by these GSE’s are “negative equity” and it will take more than a decade for them to rebound. One out of ten homeowners has no equity or is “upside down”.

I don’t like the bail out, but there weren’t any alternatives. If the government would have let these two agencies fail, our entire financial system could have fallen. The crux of the problem is that we continue to spend more than we make on a federal, state, municipal and personal basis.

This bailout will not make it easier for new homeowners to buy homes, but it should help current homeowners through this rough period. The homeowner who “bought the top” will cut back consumption because their home is a ball and chain. They won’t feel good about spending money until their biggest asset has a positive value.

Last week’s unemployment report was dismal. The unemployment rate climbed from 5.7% to 6.1% in August. The numbers for June and July were also worse than expected. As economic conditions continue to deteriorate, the cycle worsens. People spent less money and companies contract.

Global economies are also starting to show signs of strain. International companies that have been prospering from a weak dollar and robust emerging markets are now cutting back forecasts. Global growth will not pull us out of this recession as many analysts predicted a year ago.

The market has already given back most of its early morning gains. From my perspective, this is a good shorting opportunity. Nothing has changed from last week and the Unemployment Report should continue to weigh on this market. We are now below horizontal support at SPY 126 and the uptrend line from July’s lows has been broken.

Get short consumer stocks. I believe the market could reverse and if we make a new low after 1:30 p.m. central time, we could finish down for the day.

Contained Selling Today and Follow Through Next Week.

Posted by Pete Stolcers on September 5

This has been a nasty week for the market. Since Monday’s reversal, we have been in a steady decline. Yesterday, the market dropped sharply ahead of the Unemployment Report and we broke horizontal support at SPY 126.

It looked like most of the bad news had already been factored in as the market braced itself for rising unemployment. The report showed that we lost 84,000 jobs last month and the numbers for June and July were revised lower by 58,000 jobs. The unemployment rate jumped from 5.7% to 6.1%, the highest level since 2003. The market has been looking for a catalyst and now it has one.

As more people lose their jobs, the credit crisis will worsen. Loan defaults will spread beyond sub-prime and another round of write-downs should be expected in coming months. This morning, we also learned that US home foreclosures rose to record highs in the second quarter. The percentage of loans in foreclosure at the end of the second quarter was 2.75% compared to 1.4% in the second quarter of 2007. The US mortgage delinquency rate rose to 6.41%, the highest level since 1979.

Global economies are showing signs of strain and they will not pull us out of this recession. Emerging markets might be particularly vulnerable. Hyper-growth usually spawns aggressive lending practices and we might see write downs in those assets. New capital will be hard to find as credit tightens. Overseas markets reacted to our sell off yesterday and the backdrop was weak before the Unemployment Report was released.

In today’s chart, you can see the breakdown below horizontal support at SPY 126. That was the double bottom that was formed in January and March. The bearish momentum this week will likely result in a retest of the July lows. We are in a seasonally bearish period and the SPY 120 level will likely be tested next week.

Interest rates will remain stable and I don’t believe the FOMC meeting will have much of an impact on the market. Bond prices imply that interest rates will be stable the remainder of the year. The Fed has thrown the kitchen sink at the financial crisis and I do not believe they have anymore bullets to fire.

Earnings for the S&P 500 were down 20% compared to last year. The guidance for this quarter has been very conservative and corporations are in a defensive mode.

Today’s unemployment report will weigh on the market for many weeks to come. Jobs influence economic growth more than any other factor.

Given yesterday’s huge decline, I believe the selling will be rather contained the rest of the day. Next week, I expect to see more selling. In July and August, the market declined ahead of the Unemployment Report. The market had a negative reaction to the release in both instances, but Friday’s declines were rather subdued. However, selling continued the following Monday. I believe that same scenario could unfold as we test SPY 120 Monday or Tuesday.

Financial stocks have been holding up well given today’s news. These stocks have recently bounced from an oversold condition and I believe once today’s news runs its course, the second shoe will drop. Retail has defied gravity and I believe that sector is also vulnerable. Focus on the short side and look for companies that are dependent on consumption.

Employment Fear Sparks Breakdown - Look For Continuation!

Posted by Pete Stolcers on September 4

The market has a distinctly negative tone to it this week as traders return from holiday. Monday, the market spiked higher after hurricane Gustav produced less damage than expected. After an initial rally, the market reversed the rest of the day and ended on a weak note.

Energy prices lead a massive sell off in commodities. Prices did not spike ahead of the hurricane and I do not believe that the “near miss” can be blamed for the decline. I have heard comments about demand destruction. This situation would take months to unfold and I do not believe it was the cause for the decline. This commodity plunge feels like panic selling. I suspect that traders and investors were over exposed to this sector and they are bailing out/liquidating. In the next few weeks, we are likely to hear of a hedge fund failure or two. This drop will set up a capitulation low and this sector will present a buying opportunity once it has established support.

The fundamentals for energy are still intact and global demand continues to grow. Supplies are slow to come online and there are many potential disruptions that lie ahead. Two new hurricanes are making their way toward the US and one of them is already a category four. Russia continues to occupy Georgia and they can toy with the oil supply that feeds Europe. Instability in Iran, Venezuela and Nigeria could also disrupt supplies. I am long-term bullish on energy.

In the short term, lower commodity prices will help the Fed maintain its current interest rate policy. Bond prices imply that we will not see a rate hike this year. This week, Australia lowered its interest rates. The BOE and ECB have been more accommodative as well. This has helped to strengthen the dollar and it is another reason that commodity prices have fallen. The FOMC does not meet for two weeks and their rhetoric won’t be a driving market force.

Next week, the economic releases are very light. The most significant number is the PPI and it won’t be released until Friday. As long as commodity prices continue to drift lower, even a “hot” number will be discounted. Retail sales will also be released on Friday and we will see if lower gasoline prices are sparking sales. Today, higher gasoline and food prices were blamed for sluggish back-to-school sales.

The key driver over the next few weeks will likely come tomorrow. The Unemployment Report will tell us which way the economy is heading. Yesterday, Challenger, Gray & Christmas reported a 29% increase in layoffs during the first eight months of 2008 compared to the first eight months of 2007. Initial jobless claims increased by 15,000 last week and the continuing claims rose to a concerning 3.44 million. After the last four Unemployment Reports, the market has declined. Can you tell which way I’m leaning?

If the unemployment rate rises, the credit crisis will spread beyond sub-prime loans. We are in a seasonally weak period and I believe the market will breach support at SPY 126 as it retests the lows from July. We are trading down substantially today and much of the bad news might be factored in by the end of the day.

From a trading standpoint, a breakdown would be a relief. We have been chopping back and forth in a tight trading range for the last six weeks. The movement has been random and we need momentum. Regional banks and retailers have bounced recently and they both present shorting opportunities if the unemployment number rises.

Day Trading Opportunity Today - Follow The Beige Book Reaction!

Posted by Pete Stolcers on September 3

Yesterday, the market rallied when hurricane Gustav produced less damage than expected. Energy stocks crumbled and the magnitude of the decline surprised many traders.

Three new tropical storms are on their way and energy supply disruptions are likely. This should be keeping a bid to energy prices, but it’s not. The Russian/Georgian conflict could also lead to energy disruptions, but the market is focused elsewhere. Demand destruction seems likely as global economic expansion slows.

Overnight, Asian and European markets traded lower. There are signs that economic activity is decreasing in those two continents. At one point, many analysts thought that global expansion would pull the US through this recession. Some even spoke of “decoupling” where the US would falter while the rest of the world prospered. We now know that all economies remain interdependent.

This morning, factory orders in July were slightly better than expected. The rise was due to an increase in transportation orders and that is consistent with last week’s durable goods number. A report from Challenger, Gray & Christmas showed that layoffs continue to rise. During the first eight months of 2008, layoffs were up 29% compared to the first eight months of 2007. Tomorrow morning, the ADP employment index and the initial jobless claims will set the tone for the market. While these numbers are important, all eyes will be fixed on Friday’s Unemployment Report.

Earnings season has ended and interest rates should remain stable. Consequently, I believe the market will seek direction from the Unemployment Report. If the unemployment picture has improved, the market could stage a nice rally and a possible breakout above SPY 130. On the other hand, rising unemployment push the market below support at SPY 126.

In today’s chart you can see the volatile trading that has taken place within that range during the last month. The price action is random and this is a very low probability trading environment.

This afternoon, the Beige Book will be released and it is likely to drive the market the rest of the afternoon. Ahead of the release, find a very strong stock and a very weak stock from the table on the home page. Once the market reacts, use the appropriate stock (no options, the bid/ask is too wide) and try to capitalize on that momentum. My gut feeling is that the market will continue to trade lower. Close out the day trade and do not hold overnight positions.

Day Trade Stock For Short Term Gains - Avoid Overnight Risk!

Posted by Pete Stolcers on September 2

The market continues to chop back and forth on a daily basis. Last Thursday’s big gains were erased Friday as hurricane Gustav set its sights on New Orleans. News of John McCain’s VP selection also surprised the market ahead of the holiday weekend and traders sold into the uncertainty.

This morning, the clouds have parted and the market is rebounding. The hurricane damage was contained and oil rigs/refiners should be back online quickly. Consequently, oil is down almost $7 and commodity stocks are getting pounded. I believe this reaction is a bit overdone. Three new tropical storms are forming in the Atlantic and Russia still has the potential to disrupt energy supplies from Georgia.

On the financial front, it has been confirmed that Korea Development Bank is in talks with Lehman. A takeover would relieve some of the anxiety in the financial sector. Decent Fannie Mae/Freddie Mac auctions also stabilized financial stocks last week.

This morning, ISM manufacturing came in as expected at 49.9. US factory activity fell slightly, but so did inflationary pressures.

Easing oil prices could stimulate the economy as consumers shift their spending. Retail stocks are moving higher as a result.

This Friday’s Unemployment Report will determine the market direction for the next two weeks. As you can see in the chart, an ascending triangle has formed. The market will either breakout above SPY 130, or it will breach the trend line and test support at SPY 126.

If we do not get a big reaction, I fear that we could be setting up for a prolonged trading range. We are two months from the presidential election and at this stage it could swing either way. There is a lack of transparency in the financial sector. We are still in a discovery phase and no one knows if the second shoe is about to drop. The possibilities range from a broad-based financial collapse to the bargain of the century. As each new piece of information is digested, the market will react. Eventually, one side or the other will prevail and we will see a prolonged directional move.

Until then, I would avoid large positions. Day trading has been very successful since the early momentum has continued throughout the day. However, you need to close out positions because the overnight risk is too great. Stocks that were up big the prior day lead the market lower the next. Expect this type of price action the rest of the week as traders return from vacation.

Easy Come - Easy Go. Market Gives Back Gains In Directionless Trading.

Posted by Pete Stolcers on August 29

Yesterday, the market was able to post a nice rally after a better than expected GDP report. Strength from exports and the tax rebate helped to fuel the economy. A decrease in initial jobless claims also helped as did a better than expected durable goods orders report (Wednesday). With many traders taking time off, the market rallied unimpeded.

The SPY closed above 130 which is a minor resistance level. Continuation through this resistance would be bullish and we could see short covering. I am very cautious when trading the long side of this market. The intermediate term trend is down and I don’t want to get suckered in ahead of a seasonally bearish period.

The headwinds are still blowing strong. Unemployment is on the rise, consumers have high debt levels, banks are on the brink of failure, global economies are contracting and global interest rates have been on the rise. These conditions will keep a lid on the market since they will not be resolved anytime soon.

Next week, there will be many economic releases over a four-day period. The biggest by far is Friday’s Unemployment Report. A number is pivotal. A strong report will spark a short covering rally while a rise in unemployment will raise concerns that the credit crisis will spread. This data has the potential to create a breakout or a breakdown from the current trading range.

The Fed does not meet for another two weeks and this number will have the greatest influence until then.

For today, overseas markets finished higher and the last three days have been bullish. The market is bumping up against resistance at SPY 130 and no one will want to place a big bet heading into a three day weekend. This means that we are likely to see a choppy trading. Dust off the golf clubs and enjoy the day.

Have a great holiday!

How I Trade Options - Liquidity and Implied Volatility

Posted by Pete Stolcers on August 29

Today’s option trading blog concludes my series – How I Trade Options. To date, I’ve found the trade and quantified my opinion. Here’s how the liquidity and implied volatility of the options influences my strategy selection.

One of the advantages of being an individual trader is that I don’t have to worry about “size”. Often, 10 contracts is a large enough position and my order won’t “drive” the market. As a newsletter writer or an institutional trader, I need to make sure the liquidity can support hundreds of contracts. I measure size based on the bid/ask spread and the respective size behind each quote. If I see a $.10 wide spread with 300 contracts on each side for a $4.00 option – I consider it to be liquid. Conversely, if the option market is $.30 wide on a $4.00 option and the size is 20 contracts, the liquidity is poor. There are a number of factors that influence liquidity. The average daily volume of the stock, the number of exchanges that list the options, the expiration month and the strike price.

Active stocks that trade well over a million shares a day are active and have tight bid/ask spreads. That interest spills over to the options. Market Makers/Specialists are able to take the other side of your option trade and they know where they can get their hedge “off”. If you are buying calls, they are selling them to you and they will instantly go out and buy stock against the position. If the stock has a three cent wide bid/ask, they know that they will not have to “reach” for an offer. On the other hand, if the stock trades 300k shares a day and it is a volatile little bio-tech with a $.20 wide bid/ask spread, expect wide ill-liquid option markets.

The more option exchanges that list a stock, the more liquid. By nature, the exchanges don’t want to list every option. The overhead for listing an option might exceed the income they can generate from it. Market Makers don’t want to be spread too thin either. Even though auto-quote programs have made Market Making less labor intensive, they still have costs. There are some stocks that might only support one Market Maker. If an option is multi-listed across more than 3 exchanges, it will be a notch up on the liquidity scale. Each Market Maker on each exchange has to compete to get the order and the best market wins the order. Don’t be afraid to “work” an order from one exchange to another. Even on the same exchange I have entered, cancelled and re-entered an order all in the span of minutes. All things constant, it got filled the second time around because they knew the order was not going to be “dead meat” and that the price was fair. They knew that I was managing the order and there was a chance it would get yanked. If the Market Makers know the order is there to stay, they will lean on it.

In general, the deeper the option (in-the-money and higher dollar value) and the farther out in time, the less liquid. Most people like to trade front month at-the-money options and consequently, that’s where the liquidity is.

If an option is liquid, it will not impact my strategy and I don’t have to modify my game plan. If it’s ill-liquid, I need to look at the duration of the move. For short term moves that may only last a week, I will trade the stock. A $.30 wide bid/ask spread in the options is too big of an “edge” to give up. If the duration of the trade is a month or more and I want to buy options, I will scale into a position with 3-4 months of life. The key is to minimize the transactions and the slippage. I like to go farther out in time because I might have a chance to sell near term out-of-the-money premium against the long “leg” and offset some of the entry/exit slippage. Also, if the position is working out, I don’t have to worry about rolling it as expiration approaches. If the implied volatilities are relatively rich and I’m inclined to sell premium, I will look to sell naked options. If I’m right, they’ll expire worthless and I won’t have to exit the trade. I don’t like to credit spread the position because I don’t want to buy the farther out leg and give up another bid/ask spread and commission. If an option is ill-liquid, the trade carries greater risk and it should be smaller in size.

I could write a 400 page book about trading volatility, but that’s already been done. If you don’t plan on being a Market Maker – keep it simple. I remember listening to two friends and respected option experts each share their views on option trading at a conference. Larry McMillan talked about how options with high implied volatilities were the best ones to buy and Ken Trester stressed never buying an “over-priced” option. In their own context – both were right.

There are many people who will bleed you dry teaching you about delta-gamma neutral trading, back-spreads, ratios, skews…. Focus on the direction of the stock and then consider these simple concepts. There are three things to consider: the historical volatility of the stock, the historical implied volatility of the options and the implied volatility of the options.

If the stock traditionally whips back and forth, it has historical volatility and I can expect the options to carry a relatively high premium. Since it is more difficult to predict, it ’s only natural for me to distance myself from the day-to-day noise. In these situations, I consider selling out-of-the-money premium. In doing so, I increase the probability of success and I take advantage of time premium decay. In the case of calls, I almost always sell credit spreads since I don’t like the unlimited upside risk. In the case of puts, I normally sell credit spreads. However, if I really like the stock I will sell naked puts with the idea of trying to buy the stock.

Historical implied volatility and implied volatility can be covered in the same breath. The implied volatility depicts the current expectations for price movement and it is a component of the time premium. Historical implied volatility is where the implied volatility has been in the past. From my standpoint, I want to know that the current implied volatility is within the normal range of where it has been historically. In other words, I want to make sure that there is not an unexplained spike in the premiums. Such an event would tell me that there is uncertainty and that the risk is elevated. If I’m not sure of the reason (earnings, patent, law suit, FDA approval…) the trade should be avoided. If the premium is in range, I should sell it if it is high relative to other stocks and buy it if it’s relatively cheap. optionsXpress has a nice tool that shows all 3 volatilities in a chart format.

The chart below is a current situation. The yellow shows the stock’s price performance, the blue line shows the current and historical implied volatility and the red line shows the historical volatility of the stock. Notice how the implied volatility has spiked to an incredible 200 from it’s normal range of 50! The unassuming novice would run their little implied volatility search program and flag this as a great covered call situation. In two weeks they might be wondering why it went down to $5. This company has been working on a synthetic blood to be used in emergency situations for 15 years. It will release the results of its clinical trials in the next week or two. It could easily go to $0 or $30. Avoid these situations.

In summary, if the options are liquid, sell them if they are relatively expensive and buy them if they are relatively cheap. If they are ill-liquid, try to minimize transactions and go out in time for longer duration trades. For short-term trades, consider trading the stock.

In my next blog, I will try to put it all together in a trade.

Posted in, How I Trade Options!

Ride the Rally - Be Out By the Close Friday.

Posted by Pete Stolcers on August 28

In general, this has been a positive week for the market and we are near last Friday’s close. Monday, the market pulled back when it did not have any resolution to the financial crisis. Traders expected to hear of a Freddie Mac/Fannie Mae bail out and they thought a suitor for Lehman might have surfaced. When they did not get that news, they sold stocks heading into the Fannie Mae/Freddie Mac auctions.

As it turns out, those auctions fared much better than expected and investors still have an appetite for that debt. The market rallied on the news and it has been able to maintain a positive tone during light holiday trading. Durable goods orders came in higher than expected. Transportation and capital expenditures helped to boost the numbers. Today, the GDP came in better than expected and it was revised upward to 3.3% from the 1.9% preliminary number. Exports and the tax rebate helped to stimulate economic activity. This morning, jobless claims decreased by 10,000 and they stand at 425,000. Continuing claims rose to 3.42 million, the highest rate since 2003, and they are a concern.

Next week, we will get many economic releases (ISM manufacturing, ADP employment index, factory orders, the Beige Book, ISM services and the Unemployment Report). Without question, all eyes will be on the Unemployment Report during this holiday-shortened week. Earnings season has ended and the Fed is content with the current interest rate level. The Unemployment Report is the one major piece of economic information that the market can lean on for direction. If employment deteriorates, the financial crisis is likely to worsen. If employment improves, we are likely to get a nice rally as investors regain confidence.

Oil has started to move higher and the Russia/Georgia conflict could have long-lasting political ramifications. The United States has expressed their anger over the continued presence of Russian troops in Georgia. During last night’s Democratic National Convention, Joe Biden served warning to Russia. A new “cold war” would not be good for global economic expansion.

Hurricane Gustav is bearing down on Louisiana and fear is gripping residents on the three-year anniversary of Katrina. My prayers go out to those who have worked so hard to restore a place they love. This storm and the damage from Fay will impact an already battered insurance group.

In the chart, you can see that the market is caught in a tight range. It lacks direction and there is not a catalyst in sight. Prolonged trading ranges produce big breakouts and they favor the intermediate-term trend (bearish). This is a seasonally bearish period and we could be biding our time ahead of the next leg down.

As I mentioned yesterday, there was a chance for an end-of-month rally. That has materialized with help from a round of decent economic numbers. Do not be suckered in by this light volume rally. Trade it, but be quick to take profits.

The A/D is a positive 2:1 and this rally is likely to hold. The market has fallen into a tight range after the initial move this morning and I believe it will simply tread water at this level the remainder of the day. SPY 130 represents minor resistance and I don’t believe there is enough conviction for us to rally through that level today. If we break through this afternoon, buy strong stocks and hold them overnight. There is not any major news due out tomorrow and we could continue to grind higher. Keep your size small.

Day Trade the Momentum - Bullish Bias Likely the Rest of the Week!

Posted by Pete Stolcers on August 27

Yesterday, the market declined after the FOMC minutes were released and there was a nice little shorting opportunity – if you took profits. As I mentioned in yesterdays commentary, this is a day traders market. The moves intraday are somewhat predictable once the moment has been established. On the other hand, overnight moves are random and the risk of carrying positions is greater than the reward.

This morning, durable goods orders rose more than expected. Contrary to my belief, transportation orders boosted the number. Capital expenditures rose and that sheds a glimmer of hope in an otherwise depressing environment.

Oil prices are moving higher. Inventories decreased by 100,000 barrels when an increase of one million barrels was expected. Hurricane Gustav and the Russia/Georgia conflict will keep energy prices elevated throughout the week.

The well-received Fannie Mae and Freddie Mac auctions have calmed anxiety in the financial sector. Traders are waiting for the next shoe to drop and the XLF has not budged over the last 6 trading days.

Tomorrow, we will get the GDP and initial jobless claims. The GDP has been on a steady decline this year, but it still shows growth. As long as the number stays positive, bulls will live with it. The initial jobless claims have decreased the last two weeks and another decline would certainly be bullish as the market prepares for the Unemployment Report next week. I feel both reports could have a slightly positive affect.

It’s possible that we will see a bullish bias to the market over the next few days. In the absence of any major news, end-of-month fund buying could push the market higher. Holiday weekends also tend to be bullish. This is a very light holiday trading environment and no one will stand in the way.

The A/D is a positive 2:1 and the early momentum favors the bulls today. Overseas markets were quiet and they did not provide any impetus. If you choose to get long, I like commodities stocks at this level. Day trade the stocks and exit your positions by the end of the day.

Do not construe my comments as being anything more than a 1-2 day guess. This is a nasty, directionless market and it can not be trusted. It is simply chopping back and forth and you should trade very small size or avoid trading all together!

Trade FOMC Minutes - Follow The Reaction - Get Out Today!

Posted by Pete Stolcers on August 26

Yesterday, the market took a nasty tumble. In reality, it just gave back the big gain from last Friday. The market is searching for direction and it is unlikely to find it during quiet holiday trading.

Monday, I mentioned that interest rates and earnings (two key market drivers) are “known” for the time being. That means the market lacks a catalyst. All of the other tidbits of information are relatively insignificant. Consumer confidence was better than expected and housing data continues to look bleak. Analysts are dissecting the housing numbers 50 different ways to try and find some signs of improvement. Personally, I feel we are at least a year a way from seeing that.

Tomorrow, we will get durable goods orders. Car sales have been horrible and airlines are grounding planes. These two factors will weigh on the number.

Oil inventories have been building, but energy prices are stable. Hurricane Gustav and the Russia/Georgia conflict will keep prices elevated.

This afternoon, the FOMC minutes will be released. The Fed has been vocal and I am not expecting any surprises. Last week, Ben Bernanke said that inflation is waning and signs of economic/financial deterioration loom. The Fed wants to maintain the current rate as long as possible.

The early momentum points higher today. Europe was mixed and Asia was weak. Decent results from yesterday’s Freddie Mac/Fannie Mae auction are supporting today’s rally. Investors have demonstrated a willingness to finance a struggling mortgage industry.

It is likely that the market will continue to grind higher today. The A/D is a positive 2:1. Watch for the market’s reaction to the FOMC minutes at 2:00 pm ET. Have a strong stock and a weak stock selected ahead of time. Once the market reacts, use the appropriate stock and ride the momentum. Which ever way the market moves, it is likely to continue in that direction. Make sure to exit the position today. Nice little short-term trades are one way to make money in this market. The overnight risk is too great to take large positions. The moves are random and you don’t know what piece of information the market might latch onto.

Keep positions small and spend most of your time on research. Better trading conditions are only a couple of weeks away.

Wedge Formation and Seasonality Favor the Downside!

Posted by Pete Stolcers on August 25

The market continues to trade on “noise”, chopping back and forth on every tidbit of information. On a daily basis, I could justify the move and tie it to a news story. The truth of the matter is that there is not a catalyst and traders are taking time off during a quiet market. We just emerged from earnings season and that variable is known. The Fed is content to leave rates unchanged and that variable is known. Earnings and interests rates drive the market and for the time being, they are AWOL.

Earnings for the S&P 500 were dismal. They declined 20% this quarter compared to last year. If you strip out financial stocks, they were up a meager 4%. The market will wait for next quarter to see if we are on the mend or if conditions are on the slide.

Last week, Ben Bernanke suggested that inflation is moderating. However, he also mentioned that economic conditions are deteriorating