Japanese Yen

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Sally Limantour

After a break in the overnight market the yen is now holding firm above 86.00 level in the futures market. There was a piece about the yen in Market News. Apparently State Street developed an indicator called the, “Japanese Yen Foreign Exchange Flow Indicator, or FXFI that makes a point that over the last six months the average short yen position established was 119.70. They assess the majority of yen shorts were probably put on above 118.00 (86.00 level in the yen futures) and,

“Thus institutional investors are significantly underwater, even when one takes into account positive carry. We believe that these accounts will use any rallies in dollar-yen to reduce their short yen exposure and limit further losses.”

It is interesting that State Street only goes back six months. The carry trade has been something that has been going on for years and most likely the level is closer to levels from Jan 2005 at the 105 level (98.00 level in futures) as Barbara Rockefeller discusses in the March issue of Currency Trader Magazine, The Yen: Canary in the Currency Coalmine (www.currencytradermag.com). I also suggest an article published yesterday in the Economist magazine called, The Yen also Rises (www.economist.com).

Assuming this is true, we are not close to breakeven levels and we would most likely see massive liquidation prior to that. Keep that on your radar.

Long yen positions are held with the next target level coming in at 88.43 (Upper Bollinger Band on JY H7 Weekly Chart).

HOTS Mid-Week Options Commentary

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Peter Stolcers

The market bounced from an oversold condition yesterday and the retail public was reassured that all is well. SPY 140.50 represents horizontal resistance and SPY 141 is the 100-day MA, both should provide a temporary "lid". If the bulls can't add to yesterday's gains and make a new intraday high after noon CDT, I feel the bears will try to push the market lower into the close. Higher oil prices and the Beige Book (11:00 am PST release) could provide headwinds.

Editor's note:
This note was emailed to our HOTS Subscribers at 8:00 pst.

Some Stats on Last Week's Market Free Fall

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From our Virtual Trading Room Transcript

08:18:50 PST> Brad_Sullivan: Here is a few things I ran through this morning on the move and its magnitude:

From the summer lows, the Russell 2k rallied 20%ish and retraced that rally by 50% with the recent drop;

The SPX rallied +19% and retraced 37% of the move;

The DJIA rallied nearly +19% and retraced 25.5%;

The Midcap rallied +19.5% and retraced 43%;

Finally the NDX rallied 27% and retraced 35% of its move.

In a nutshell what took roughly 7 months to build crumbled in one week we may rally from here and hold serve above 1400 SPX for a stretch, but sooner or later, leg #2 is coming and my guess is that it will be as vicious.

Equity Index Update

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Brad Sullivan

The index markets are called to open sharply higher after reassuring comments from Treasury Secretary Paulson and a move lower in the Yen/Dollar carry trade. The bid began in earnest last night after a horrid final 30 minutes of trading across the index complex. Once again, each index settled below their respective cash instruments and fair value…however, strong bids began to enter the market moments after Paulson’s comments and the SPH moved rather quickly from 1373 to 1386 the European open. Since that time, the indices have treaded water between 1389 and 1382.50.

Today’s action should be defined by this gap open and whether or not there is any push towards filling it. If the indices are unable to hold higher levels we should see increased selling as the session wears on, particularly in the final 45 minutes…a stretch of time that has produced heavy one way street selling the last 2 sessions. If the indices are able to hold their opening bid, I would look for a sharp move higher that would carry the market above their respective highs from yesterday and test the breakdown level from Friday afternoon. In the SPH7 this would equate to roughly 1394 to 1396.

One aspect of the trade that I would put forward is this…we have moved DRAMATICALLY lower in 5 trading sessions. At some point we will get a bounce that sustains – normally that happens after a sharp down morning as the market reverses course in the afternoon. Given today’s gap higher, I have a hard time believing that this will be day we rally +2%...but you never do know.

One Week Wonder?

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Sally Limantour

After the brutal reversal yesterday and closing near the lows we are coming into calmer asset classes this morning. The dollar is reversing across the board and every single currency has moved contrary to yesterday’s wild action which has a “turn around Tuesday” kind of feel to it. Some are trying to say the carry trade unwind is over and all was accomplished in one week.
I am not so sure about that as at 20 year lows on a trade weighted basis the yen seems undervalued while, on the other hand, the Australian and New Zealand dollar seem over valued and their growth expectations are moderating. More on this later.


Commodities continued their liquidation yesterday. Gold was off its recent highs of over $50 oz while silver had tumbled from a high of 14585 to a low of 12470. The base metals fell hard lead by nickel. However, after the close in the stock market my shortest term model went to a buy and as mentioned yesterday I expected a rally early in the week. Sensing a shift or possibly just worn out from going down, long positions were established in gold, silver, the mini S&P and mini Russell index. The market(s) are oversold on a short term basis as we had the 10 day moving average put to call ratio at a extremely high level. I still anticipate a sell off later, but for now I am testing the long side with break even stops. No hero here!

In the mini S&P today the 1379.00 is a pivot with 1389.50 my 1st resistance, then, 1392. A “point of control” which signifies the area where the most amount of activity occurred the prior day, is 1384.25. Support now is 1381.25, then, should we take out yesterday’s low, 1364.50 is the next support.

I continue to stay long the volatility plays established in mid February as I do not think the roller coaster is over.

Equity Index Update

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Brad Sullivan

The index markets continued to suffer on Friday as buyers failed to materialize at levels around unchanged for the second consecutive session. Sellers took control through the lunch trade and became aggressive in the final 30 minutes of trading. It struck me that most of the selling done during that period was of “forced” nature. Whether it be risk managers or margin clerks, the bosses did not want the weekend risk and pushed out longs. Given our lower open today, that seems like a rather prudent trade.

This morning, the indices are called lower, -800 in the SPH7 at 1377.75, but off its overnight trading lows of 1371. The real volatility this morning seems to be lurking in the currency market which is absolutely up for grabs depending upon which cross you are trading. The Dollar is markedly higher against nearly all its counterparts, save the YEN…the YEN/Dollar continues to sink, the change being about +1% in favor of the YEN this morning. On the flip side, the Dollar is up over +1% vs. the Pound and nearly +1% vs. the Euro…the one thing each currency has in common is that they are all SHARPLY lower vs. the YEN. To put this in perspective, 5 sessions ago, the Euro/Yen cross hit an all-time high. Currently, we are trading -5.3% lower from that mark. Certainly, any levered product moving so quickly has the potential to inflict serious damage across the markets. We have seen the response in our index markets as funds are forced to exit long strategies on equities and short yen positions…an ugly mix.


The question now becomes…where do we go from here? How much more damage is left in the system? Is there systematic risk in the marketplace and if so is that risk not being accounted for (in implied volatility) properly? These questions are the larger ones and whichever trading theme one takes in response will yield either a tremendous bout of profitability or a painful loss…of course that is the point for choosing this business.

One aspect of the trade that I try and remind myself of during this volatility is ANTICIPATION. I am reminded of the axiom that Bobby Knight used for his players…C.A.R.R.E. Concentrate Anticipate Recognize React Execute. Pretty simple stuff…but it works. In these markets many of the larger moves are actually quite orderly (Tuesday afternoon being an obvious exception). However, if you examine Friday’s action in the SPH7…we traded up to UNCHG at 1405 and eventually settled at 1385.75. Most of that action was steady selling with some spike program action involved…however, if you were selling low prints on the way down the market clearly tested your position, bouncing higher quite easily. The key with trading in this environment is to wait…wait until you see the “whites of their eyes” as one of my friends used to say.

Correlation or Contagion?

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Sally Limantour

The selling continues this morning as the Chinese government this morning has rekindled global slowing concerns. We have taken out last weeks lows and now are focused on China’s promise of increased regulation of banking and real estate as well as the possibility of additional interest rate hikes. We still have our usual suspects lurking in the background – carry trade unwinds, sub-prime home blues, and recession fears. With stocks, commodities and currencies falling across the board a question is circulating across the globe – is this a typical “healthy correction” where contagion kicks in as investors/traders liquidate positions across the board in all asset classes? Or does this have a different premise where the global macro backdrop of different asset classes is so highly correlated that a new paradigm is evolving which will threaten our beloved Goldilocks scenario?

“US demand has come in weaker than expected. Maybe the China story and the sub prime story are linked. The weakness in housing is going to cause real problems in the supply chain to the US consumer and that could be US small caps, or it could be in Asia. The saying these days is that the only thing that goes up when the market goes down is correlation.” --from FT.com article, Feb 28, titled: ‘Correlation rather than contagion’

People are now focused on concerns and until that changes, markets will stay under pressure. Now the hard questions are being asked concerning China and their murky accounting practices, their still stringent capital controls which defacto prevent an exit and the true rights and claims of so called Chinese shareholders (350 out of 500 of the largest listed Chinese stocks are still government owned). In addition questions regarding the private equity market (which is for the most part unregulated and unreported) and its size and risk to the overall banking and financial system are being asked. Not to mention the size of the carry trade unwind and derivative positions. I am not one to get to negative, but as I said last Wednesday we are trying to assess where real liquidity begins and leverage ends. It is a tangled web.

In the short term I expect a short covering rally perhaps early in the week and then further weakness in the equity markets. My shortest term model is getting close to a buy signal and we have the put to call ratio now at a high level. Intraday ranges should continue to be wider than what we became accustomed to and volatility will continue to move higher.

I watched Master and Commander (for the 3rd time) over the weekend and there is a classic scene when the ship is under attack and a small boy is crouching with fear. The Captain pulls him up and says, “stand tall in the quarterdeck,” meaning, be present and responsible. Heading into the week listen carefully to what the market has to say, respect the charts, preserve your capital and trade only with good risk/reward scenarios.

Market Timing

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Fari Hamzei

Given the high readings we have empirically observed in our Volatility Indices during the last week, for market timing purposes, go to CASH for a minimum of two weeks -- past the March Quad-Witching Options Expiration (Friday, March 16th) and the Vernal Equinox (March 21st, 00:07 GMT).

Market participants should expect massive vol expansion at or near the March Expiry, while historically speaking, both Vernal & Autumnal Equinoxes, plus or minus 1 to 2 days, have often been a time for key reversal days in the equity markets.

First, let's review our 'new & improved' Timer Chart.

While a -222 reading on McClellan Oscillator for NYSE and a -196 reading for NASDAQ's sounds like a good buying opportunity, we are mindful of recent outlier events for VIX (see my Feb 28 post titled, "Volatility -- My Two Cents").


Part of the reasoning here is for us to wait and observe the strong vol retest we expect both in magnitude and Sigma Channel position. That event should complete before the month end. This is also in line with the talk Sherman McClellan gave at our last meeting of LA Chapter of MTA, which met on January 30th in Seal Beach, CA.

Here is VIX sigma chart as of Friday Close. Notice on Friday, VIX fell below +3 Sigma. Ideally, VIX, as part of our anticipated vol retest, should visit +4 to +5 sigma levels before the dust settles.

HOTS Weekly Options Commentary

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Peter Stoclers

Earnings are good, the economy is strong, employment is full, the P/E ratios are in-line… The stocks that looked good a week ago still look good and they are cheaper. What could possibly cause the market to go down? In a word – fear.

When traders are over-extended, they can’t take the heat when the market starts to fall. That is a classic shakeout. Most people think… well I’m in it for the long haul and I’ll just ride it out. That mentality works for the first 10% move. By the next 10%, they are nervous and they are out. A big decline with a “V” bottom becomes a mere blip on the radar screen of a 10-year chart. However, seasoned traders look at those blips and remember the blood that was spilled.

Such was the case in 1998. I had grown one of the largest option order desks in the country and I had thousands of option traders using our services. The economy was strong, the earnings were good, interest rates were in line and the internet was creating a buzz. Out of nowhere, we had a big rally to new highs and a sharp reversal. Sound familiar? Everyone looked at the fundamentals and took comfort knowing that everything was still intact. It seemed that a hedge fund had lost some money. Initially, everyone thought… so what, it’s one hedge fund. The stock I liked yesterday is the same today, except it is 5% cheaper. Two brilliant men created the hedge fund in question and it was called Long-Term Capital Management. They were both founders of the modern day Black-Scholes option-pricing model (Robert Merton and Myron Scholes). They had a very “conservative” arbitrage model and brokerage firms felt very comfortable letting them leverage the positions. In 1998 one of the wheels came off when Russia defaulted on their debt and the whole house of cards came crashing down. The ensuing sell off in 1998 was huge and the SPY fell 25% in two months.

Prior to the hedge fund collapse the market had been on a steady four-year climb. You could throw anything at it and it wouldn’t go down. Mind you, the SPY was still 25% below the 2000 high and it had a long way to go.

Fast forward to 2007.

The Yen-Carry trade borrows cheap money by selling low yield Japanese debt. It then uses the proceeds to buy other assets with higher yields. Last month, Japan raised interest rates. Consequently, the loan is still cheap, but getting more expensive. On the other side of the trade, the higher yielding assets that are denominated in other currencies started to take heat. As the trade unwinds, the first traders to hit the exit sell their higher yielding assets. With every trader that unwinds the trade, those assets get cheaper and the squeeze is on. This trade has been leveraged at a ratio of 15:1 and as the asset prices drop, liquidation is force to cover margins. Currently, there are more hedge funds than ever.

Did you realize that retail margin debits as a percentage of the account balances are at the levels seen in the year 2000? Your fellow trader is leveraged up to his eyeballs and I sense a shakeout. This is a time to be balanced and to keep a portfolio of longs and shorts. If you are over-exposed on the long side, reduce your risk exposure.

After the dust settled in 1998, there was a great buying opportunity and the SPY went from 95 to 140 in less than a year. The take away is that the market was a good buy in 1998 at 125. However, if you were an option trader, you blew through your capital and you never got a chance to participate.

Now let’s talk about us. This was a brutal week. We got into our new options trades on Tuesday and we were stopped out within a day or two. Our existing longs that were making progress also stopped out for losses. In the spirit of the report, this is not supposed to be an in and out service with continual adjustments. I felt that I needed to let the stops and targets work as they were designed to. My biggest error was not being persistent in having a hedged position on at all times. In the four months since inception I have always had at least 2 or 3 short positions on. During the rallies, one by one we were getting picked off and the hedges were costing us money. Even worse, once we were stopped out, we no longer had protection.

This was the largest drop since 9/11 and the Weekly Report did not suffer a big draw down. I hate giving back profits, but these events happen and they can’t be predicted. In the long run, it will set us up with some great trading opportunities on both sides of the market and the profits can come quickly. We are very liquid and we will be trading form a position of strength. Before the market gets better, it will get worse.

In the next week or two, we are going to be looking for longer-term entry points. We are going to distance ourselves from the market and we will keep our powder relatively dry. As the market compresses and the lows are established and tested, I will start layering buy stop orders so that when the market rebounds, our orders will be executed on the way up. I still feel that the earnings are good, interest rates are relatively low, employment is robust and inflation is in check. This is also the third year of a Presidential term and that has historically been very bullish. If I had to pick support levels, I would say SPY 132.50 and then SPY 125. The missing piece of the puzzle is the leverage used by the hedge funds. We don’t know that answer, but the brokerage firms that clear their business do. Come to think of it, those same firms have proprietary trading operations. I’m sure there is a “China Wall” between those divisions and that information is never shared – not. They know the “panic levels” and someone will get hurt. We’ll let the charts be out guide.

Flash Update on SPX & Gold

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Frank Barbera

We are issuing this brief flash update, as we see a great of evidence continuing to mount that both the S&P and the Gold market are near an important short term low. In the case of the S&P 500, prices spiked down violently yesterday morning marginally taking out the prior panic low. Importantly, prices then recovered off the token new low leaving a distinct positive divergence on the 5 minute chart. The subsequent recovery was strong enough to lift prices back up across the range testing some important price resistance at 1410.00. At this point in time, we still cannot altogether rule out a final retest of the 1390 level, however, the prospect of such a retest appears to be fading fast with the market trying to engineer a rally back into positive territory. Even if, on the long shot chance, that prices did retest 1390 again, the odds at this point favor a bottoming sequence and a lead into a powerful recovery rally. In our view, any move above yesterday’s highs by the S&P 500 at 1409.50 should trigger a very large stock market rally, which would complete this corrective bottom. Bottom Line for the stock market: prices have been basing, this is most likely positive action, and a break above 1410 should unleash the bull once again.

Turning to Gold prices, we just witness a similar style waterfall panic in gold this morning, very much along the lines of the sharp stabbing move down that was seen in the S&P yesterday AM. April Gold is presently fully oversold on both the Short Hourly RSI – 9 Hours – at +18.78, and the Long Hourly – 20 Hours, at +30.72 (where +32 is the oversold benchmark. In hour view, while Gold is not yet fully stable, the odds are very high that prices bottom in this $645 to $650 range and begin a rally back up toward $670.