Sunday, June 24, 2007

HOTS Weekly Options Commentary

HOTS Weekly Options CommentarySocialTwist Tell-a-Friend
Peter Stolcers

I’ll start by saying that I am bullish over the next six-month period. Earnings are strong, valuations are in-line, interest rates are relatively low, employment is high, inflation is in check and global economic growth is robust. On a short-term basis I'm starting to see some warning signs. The market has run up and we have not seen a decent correction in a very long time.

In the chart you will notice a few developments. The volatility has increased greatly and it is depicted by the long red-bodied candlesticks. Two recent events tell me that the resistance level at the all-time high is growing. The first event happened two weeks ago when we had the gap down after the all-time high was established. That was followed by a very bearish down day. After the market had one of its typical snap back rallies, it was not able to challenge the previous high before it was slapped down. That move came this Wednesday. The market had a positive opened and it looked like it might make a run at the high. Instead, it made a key reversal and by the close the S&P 500 futures had lost 20 points. Thursday’s rally was a half-hearted and once the market was unable to add to Wednesday's decline, the buyers came in to shakeout the short sellers. Today the market is off to a weak start and I’m writing my comments an hour after the open.

Concerns over the Bear Stearns hedge fund bailout (exposed to sub-prime lending) are putting pressure on the market. Overnight, the Shanghai Index fell 3% as traders believe that a rate hike there is eminent. In the U.S., interest rates have been creeping higher and next week the FOMC convenes. I believe their comments will dictate stock prices for the next month. The Fed has already stated its bias favors an increase. Earlier in the year, traders were wondering when the Fed might ease, now they are wondering how long the Fed will hold off on a rate hike. This realization will be bearish for the market as traders adjust their models. Short-term, I am starting to think that the SPY 146 level will be tested soon. That will ultimately set-up a great buying opportunity. The market needs to get accustom to higher interest rates. Once it does so, all of the other pieces are in place for a continued rally.

The economic releases from this week were balanced. Slower housing starts were offset by an increase in building permits. A robust Philly Fed number showed the highest level of manufacturing in two years, however, manufacturer’s sentiment for the next six months fell to its lowest level this year. Next week will be filled with economic releases (Consumer Confidence, Durable Goods, PCE price index, Chicago PMI) but they will all take a back seat to the FOMC comments.

Two earnings releases are of particular interest next week (WAG, LEN, NKE, CAG, BBBY, MU, PAYX, RHAT, MON, RIMM). RIMM and MON have run up and we will see if they are able to meet raised expectations.

Given my longer-term bullishness, it will be difficult for me to short this market. The snap back rallies have been extreme and I don't want to get caught in any of them. I will adjust by reducing my long positions and by selling call credit spreads on stocks that I feel are weak. The retail and restaurant groups are strained and they will experience selling pressure for the next quarter. The key is to identify the underperformers in each group.

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