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October 26th, 2010

Investors still buying dips along with POMO

If you are an avid reader of the "Stock Trader's Almanac" you are likely aware of the fact that we have officially entered what is known as the "Best Six Months" of the year.  You might also know that historical stats suggest the best time to be long stocks within the presidency cycle is the fourth quarter of the midterm year and the first quarter of the pre-election year.  In addition, history suggests the markets have out-performed when there is a Democrat in the White House and a Republican controlled Congress. 

What does all of this mean?  Investors maintaining a buy on dips mentality will likely face better odds of success than one that is fighting the statistics in the coming months. 

With all this in mind, chasing markets higher can be (more often than not) a recipe for disaster.  With the U.S. dollar ripe for a rather large short covering rally, it might be possible for equities to suffer from corrective trade at some point in the near-future.  This move has been a long time coming...we haven't given up on it, but warn those that have gotten complacent in the currency markets (and thus commodities) there could be some ruffled feathers when the somewhat inevitable technical trade takes hold. 

Excerpt from yesterday's newsletter for those of you that missed it:

The near-term direction seems to be solely based on trade in the currency markets.  Without a Dollar rebound, it might continue to be difficult for the stock market bears.  Similarly, the continued drip lower in the Dollar index has the ability to propel stock gains regardless of underlying fundamentals.  However, I doubt many could argue the fundamentals backing the Euro today are dramatically better than what was seen this spring while the Euro was believed to be going to par with the Dollar. 

Many analysts believe that while commodities and other dollar-based assets have benefited greatly from a weak dollar, the Fed and the marketplace might be reaching a point of diminishing returns.  Art Hogan, of Jeffries, said in a CNBC interview, "It's certainly not something that's sustainable...You get to an inflection point where its beneficial for our exports and multinationals, and then you lose that."

George Feiger, CEO of Contango Capital Advisors in San Francisco, says "What you're seeing is simply a momentum wave against the dollar which doesn't have a lot of economic substance attached to it at all."  He added, "We are in this period of excess enthusiasm to sell dollars."

If you want to be a seller, you are going to want to do so on an upswing.  If the dollar rally fizzles tomorrow, stocks could make moderately new highs on this move.  Resistance lies at 1195 and then 1204ish in the December S&P futures, 716ish in the Russell future and NASDAQ futures at 2130 and then again at 2205.

The first level of support in the S&P will be the 1160 area, but if the Dollar manages a swift recovery (short squeeze), S&P futures could see as low as 1130ish. 

**Seasonality is already factored into current prices, any references to such does not indicate future market action.

Please note: An e-mini S&P and e-mini NASDAQ chart are used because they better for charting purposes, but trade recommendations can be applied to either the full-sized S&P or the mini.  Unless otherwise noted, profit and loss will be based on the mini version.

Futures and Options Trading Recommendations

**There is unlimited risk in naked option selling and futures trading

Position Trade -

October 6 - Clients were advised to sell the November S&P 1215 calls for about $8, fills ranged from $7.50 to $8.00. 

Ideas from previous newsletters:

October 14 - We still like the idea of buying lottery ticket puts in November options with strikes near 1100 (about $7).  The market seems a bit complacent in the short-term, and this opens the door for a good correction.  On the other hand, being overly bearish could be dangerous...so if you are a bear, give yourself room for error and be quick to take winners off the table.

October 18 - The NASDAQ has been a runaway freight-train but good things rarely last forever.  We like the idea of trying to play this market from the downside by selling a December futures contract and hedging with a November Bull call spread.  For example, the 2100/2160 call spread is going for about $540 and intrinsically insures the short futures position from 2100 through 2160...but leaves it naked (with unlimited risk above 2160) at which point you would want to apply another hedge.  The risk to 2160 is limited to the cost of the hedge and the profit potential on the downside is unlimited.  For another $400 in risk, you could buy the 2100 outright to eliminate the concern of needing insurance beyond 2160. 

*Due to the volatile nature of the futures markets some information and charts in this report may not be timely.

There is substantial risk of loss in trading futures and options.

Past performance is not indicative of future results.  The information and data in this report were obtained from sources considered reliable.  Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities.  Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.