Thankgiving Holiday - Weekly Wrap

Market Beating Foresight

Next week will be a busy week for economic reports with releases on jobless claims, unemployment, manufacturing, car and truck sales, and service sector activity. The big news will likely center on retail sales data from Black Friday and the holiday weekend. The prospects for consumer spending and employment will also be primary market drivers. However, the government has been the wildcard, as intervention into the private sector to stimulate the economy has been bold and frequent. The hearings will resume for a bailout package for automakers and that result could also drive the market. Volume which has been light with the holiday, but will return in full force next week, and may represent an excellent barometer for where the market may head for the remainder of the year. If the market can hold last week gains in high volume and lower volatility, that would be a strong bias towards a year end rally. Of course, we could also get a pullback from recent gains, or even worse, hit new lows. While volatility decreased significantly last week, we still think volatility will remain at high levels over the near term. We were very encouraged with the market gains last week, but do expect a pullback given the extreme 21% gain over the past five trading days. This is still a very good market for short term trading as market swings are very wide in both directions.

We mentioned in prior posts how to make money writing options as the risk premiums remain quite high given recent market turbulence and extreme volatility. The spread position we entered against the market index is now back in positive territory given the strong market advance last week. However, we do expect a market pullback this week which may put this position back in the red, but the options expire soon in December, and we still think the market will close above 875 prior to expiration. We still think there are option plays that can be very profitable given the volatility and price swings that are occurring regularly in this market. One play is to look for an opportunity to buy both a call and a put on the market index with the same exercise price. If the market is trading in the range between 875 and 900, and premiums are reasonable, our plan would be to hold the put – call position only a few days, hoping to take advantage of a 5% market swing eventually in both directions. Granted, it may take a few days to get the second swing, but if trading patterns continue, the current volatility and average price swings we have been experiencing will give us a very good chance. We also may look for spread positions for writing options, but will only consider those with exercise prices more than 10% from current market prices, along with very short durations. With market moves of 6%on average daily, we caution that writing options is risky and investors need to limit their risk of loss.