TJ's Take » A Global and Urban Flaneur

Tell me something new FEDS, continue to tell me that the economy is doing better (it’s not), continue to tell me that unemployment is improving (it’s not, we are just adding 71k jobs a month, not even enough to keep up with NEWBORNS – 300k the past month), continue to tell me that we are not facing inflation (we are, have you seen the price of milk, gas, wheat & corn products…thanks for nothing Russia), tell me that ISM is improving (it’s not), tell me weekly claims will get better (they’re not, continuously above 450k).

Ok, enough of the ‘gut check’. This market is a Neutral-to-FADE market for the most part that’s actually overbought slightly on the Oscillators. Each morning move is faded pretty much like clockwork. The Algo’s/Machines/Atari 1000 (lol) take over with typically an upward bias.

Anyway, let’s get to the good stuff. As anyone following my twitter stream as of late knows I’ve been selling credit spreads OTM (out of the money) calls or puts. Typically 3-4 strike prices away. It’s been easier to sell OTM call spreads on the SPY because we have been overbought on the RSI (Relative Strength Indicator) & with a slower summer market with deteriorating economy data each week the rally is basically a bunch of BS. However, as we learned with ‘manipulated’ markets (e.g. LAST YEAR….April-Nov 2009); it’s not AS EASY TO SIMPLY BUY PUTS OR SHORT COMMON STOCK.

Just wait for your pitch, if you’re selling SPY call spreads 3-4 strikes out of the money (e.g. if we’re at SPY 111-112 then sell the 114′s or 115′s for less risk. Buy the 116′s and 117′s to create the spread). With time decay increasing on front month options (the 3rd Friday of the month), when you get your pullbacks/selloffs that’s when you buy back the 114′s and 115′s at a much lower price than you sold them (or let them expire and keep all the credit). That’s your profit. Sometimes keep the ones you bought so you can ‘re-leg’ back into the spread. Continue to do this UNTIL RESISTANCE IS BROKEN ON THE UPSIDE. I have seen this work 3-7 times before you lose $ based on resistance being broken to the upside. It typically takes bulls several attempts to break through certain levels so in that time frame you’re winning on that TYPE of shorting the market trade much more than losing once.

So TODAY 8/10/2010, before the FED announcement was made I covered the SPY 115 AUGUST call options for significantly cheaper (.34) than I sold them for (.82). Then when the FED announcement was made, and the market did what I figured it would do ‘throw a pump fake’…’steal people’s money’. I waited this buying frenzy to run its course, then when the BIG GREEN BUYING CANDLES SLOWED UP… I hammered away. I aggressively sold the SPY 114′s AUG calls again (the spy went from 111′s to 112.60′s so I wanted to SELL PREMIUM), …I call that selling HOPE…this time around .76. At the end of the day that upward move was FADED (recall what I said at the earlier part of this post) and the market sold off a bit at the end. At the end of the day that 114 call is now at .71, The THETA is .06 (theta is a Greek term for how much the option loses in TIME DECAY each/next day), the DELTA is .33 (how much the option gains/loses per $1/1 point movement in the price of the equity. I even sprinkled a few SPY puts at the end of the day in case the selling continued overnight(hehe)

NOT TO MY SURPRISE, FUTURES ARE RED, the S&P closed at 1121 but futures have it at 1113. That’s bout a .75-.95 cent move downward in the SPY… so do the math.

Sold the option for .75
The option was .71 on a close on the day
- .06 THETA
-.30 DELTA (not a full 1 point move yet)
= .35
THAT’S MORE THAN A 50% RETURN OVERNIGHT folks if I (you if you followed me on twitter) and we get the chance to buy back these options at .35 (on market open) or perhaps lower.

Stay thirsty my friends……………………….

-TJ

Yesterday I was in two deep conversations via Twitter pertaining to (1) Head & Shoulders pattern (BEARISH) vs. Inverse Head & Shoulders pattern (BULLISH) and (2) When the S&P (spy) gets hard to borrow via the spiders or via the common on the S&P itself that indicates to expect a hard down day soon or downward pressure over a period of days. Let’s discuss the first point in this post and I’ll post a 2nd post pertaining to the S&P being hard to borrow at times and what that typically indicates.

DennisM put out a post intraday on an Inverse H&S pattern that he spotted. Where there is a left shoulder level in the S&P, then a lower level (let’s call that the INVERSE head) and then a right shoulder that is pretty close to the level of the left shoulder. The neckline is a line that can be drawn from shoulder to shoulder and is back tested. Typically when a Right Shoulder is completed (be it inverse or regular) it should continue in the direction. He saw this pattern and said we back-tested the neckline on Friday, that upward pressure fits this pattern and we are home free to go sky high. The period of time for his pattern recognition is roughly early June till now. However; I caught this (he is a Twitter friend of mine) and I told him there was a longer intermediate term H&S pattern that will be complete when the S&P reached 1150. If you go back to January 15th, the S&P topped out during that period at 1150 (MY LEFT SHOULDER), then it corrected almost 10% to 1044′ish. We then ran to 1217′ish by April/May (MY HEAD) and when we get back to 1150 next time it will complete my RIGHT SHOULDER with a neckline around 1100. This next image (I’ll include a link to the video he did in which he mentions throughout it the conversation with me/TJTAKES) shows you how the market can have a near term inverse H&S pattern within a normal longer term H&S pattern.

Head and Shoulders patterns

The video can be shown here and I suggest you spend 90 seconds to listen to it.

So say Stock Market ramps up to 1150, it will fall back to the neckline and more than likely continue and potentially could retest the lows of the year.

-Trey Jarmond

SPY (S&P 500 spider) 115 is the LINE TO WATCH, if we close below that it will be a freefall, if that is held on the close the Mkt can rally next week. Let’s go deeper.

In the last week, we have witnessed a 1000 point intraday freefall and a 500 point gap higher in the Dow Jones Industrials. Fear of a European credit crisis rattled investors and officials quickly took action to restore confidence.

During the last few months, the EU has been indecisive. They debated on whether or not they should bail out one of its smaller members. This process reminded me of our credit crisis in 2008. Monetary officials wanted free markets to function and they were willing to let financial institutions fail. When Bear Stearns and Lehman went under, they quickly realized that magnitude of the situation and they took action. Last weekend, EU officials drafted a $1 trillion bailout plan for struggling EU members.

The market now knows that the EU stands unified and traders were able to focus on great earnings and low interest rates. A European credit crisis has been the only “fly in the ointment” and once those fears subsided, buyers returned in force. Unfortunately, the rhetoric from the EU is just lip service. Promises are easy to make and tough to keep.

Since the announcement, the Eurodollar has continued to plummet. Traders do not believe that EU members will bail each other out and debt levels have already reached the point of no return. Germany has been kicking and screaming throughout the entire process. It is the largest and strongest EU member and it has been reluctant to provide aid. Prime Minister Merkle has lost support after offering financial support to Greece and polls reflect a drop in popularity. Without Germany’s support, the rest of the EU will fail to exist.

The proposed $1 trillion bailout program has yet to be funded. Contributions will be made on an as needed basis. If the EU were serious, they would ask member nations to fund the program now. They won’t do this because most of the nations don’t have the money. For instance, Portugal and Spain were asked to contribute to Greece’s bailout. Both nations are in dire straits and they will be asking for aid shortly. Traders know that one “panhandler” can’t bail out another.

Austerity programs have been announced this week. The proposed cuts are miniscule and they will do little to balance budgets. In fact, not one nation plans a budget surplus in the next five years. They are simply trying to sink into the abyss at a slower rate. Meaningful cuts to pensions and retirement benefits are not being considered. As the population ages, this drain will escalate. This is similar to what we’re experiencing in the United States.

Social Security and Medicare/Medicaid comprise more than 50% of our annual expenses. Baby boomers are retiring and the government is paying out more in Social Security than they receive from payroll deductions. The CBO (Congressional Budget Office) did not project this to happen until 2016. We are six years ahead of schedule and we are sliding down a very slippery slope. When it came to proposed spending cuts, Obama put a spending freeze on a tiny part of our nation’s budget that accounts for 13% of our expenses. He did not cut spending; he merely promised not to increase a tiny portion of it. This is not going to balance a budget.

The bottom line is that politicians are not able to balance budgets. It doesn’t matter if it is Europe or the United States. Conservatives want to keep taxes low and liberals want to increase social spending. Both sides need to compromise in a big way and neither will. This problem will continue and we have already reached the point of no return. It’s just a matter of time until the market starts to price in default risk. That warning will come in the form of failed bond auctions and increasing interest rates.

When bondholders feel that the risk of getting back their principal has increased, they will demand a higher rate of return. That vicious cycle was starting to take root last week in Europe. Greece had barely received its aid package when interest rates started to climb in Spain and Portugal. The next victims were already being sized up.

The debt can has been kicked down the road for 40 years and it has reached a brick wall. The EU’s comments over the weekend stopped a market freefall, but traders will soon realize that these statements lack substance. The problem is too big and aid won’t solve it. Massive spending reform that starts immediately is the only solution. That will never happen because it will drive the economy into a recession. It is much easier to continue down the road we are on and when everything falls apart, blame it on prior administrations.

In addition to Europe’s problems, keep an eye on China. The economy that is supposed to pull us all out of a recession is slowing down. Construction is dropping off and their market is down 25% from the highs last August.

The snap back rally this week has set us up another shorting opportunity. Wait for the rally to stall and sell out of the money credit spreads on stocks that have been slow to rebound. If the SPY closes below 115, then buy puts. Otherwise, a ‘relief rally’ could happen as soon as next week.