Weekly Options Recap, January 30, 2009

Worst January Ever!

A fourth straight losing week as the S&P declined -.7% last week. The weekly decline was not horrible, but the loss ensured that this month would be the worst January performance on record. The S&P lost a whopping -8.6% for the month. What might that performance signal for the rest of the year? Statistics from Stock Traders Almanac suggest that 90% of the time the market will end the year with an overall loss if January has negative performance. Should we move completely to cash? These kinds of statistics are always interesting, but in reality have little relevance or predictive power. However, the significant market decline in January clearly communicates the state of the markets and the economy. There are recessionary factors that we may very well have to live with through the rest of the year if not longer. The weight of those factors has more credibility than the Stock Traders almanac. But how bad is it? For perspective, January was bad, but the market is still above lows hit in November. However, we could test those November lows if government credibility and resolve towards solving the economic challenges comes into question. Given all of the challenges currently in play, we expect the market to remain very rocky over the near term.

Dismal Corporate & Economic Data!

Many companies reported fourth quarter earnings last week that reflected the poor economic environment. But the other disconcerting news was the uncertainty and lack of clarity most companies had giving further guidance. Many companies would not or could not provide guidance for the remainder of the year. That showcases the concerns and impact the global meltdown is causing. Consumer confidence hit a record low just as jobless claims hit another high. Housing brought mixed results as December existing home sales rose 6.5%, yet new home sales fell to their lowest annualized rate since 1963. Gross Domestic Product (GDP) dropped -3.8%, a significant drop, but that was not as sharp a decline as expected. The roller coaster ride in the financial sector continued as the sector was up strong through Wednesday before giving back gains by the end of the week. Each week, companies from nearly all industries announce more and more layoffs. No doubt there is considerable uncertainty over what this year will bring in terms of economic activity, and that just adds to investor fear.

Market Beating Foresight

Fourth quarter earnings reports continue, but there is little doubt most companies are struggling as evidenced by the reports last week. The Obama spending plan passed the House and the Senate will take up review this week. It is worth noting that the House version had no republican support. Changes in the Senate are likely and failure to make progress on the plan could swing the market severely. Another item that could sway the market is the government plan for the financial sector. Last week discussions centered on a possible plan to create a “Good Bank” “Bad Bank” structure by segmenting all bad assets into the “Bad Bank”. Early discussions propelled the market higher on Wednesday despite the lack of details and clarity around the proposal. However, by the end of the week the market and financial sector came back to earth after succumbing to the uncertainty and the lack of details over the proposal. The market is clearly looking for a plan, something to hold onto for hope. Greater definition and agreement on a plan of action will help restore investor confidence at least for the short term. Next week, additional reports will again be released on the economy, but they will likely provide more evidence of the decline in housing, jobs, and economic growth. The market will remain rocky over the next several months as the economy finds better footing and searches for bottoms in housing and jobs. Volatility has increased, although it remains well below the extremes from October and November. In addition, the massive selling and flight to cash from stocks and mutual funds that we saw late last year has subsided. We think this means investors are just adjusting to the realization of a longer lasting recession. As investors resign themselves to a difficult market, bad news just doesn’t carry the shock value that it did late last year. But for stocks, we remain concerned over the next three months as the market will remain rocky as the full weight of poor earnings, bankruptcies, and bailouts reach critical mass. Consumer spending is extremely weak and we do not see consumer confidence returning any time soon.

Option Tips For Investors?

We expect the market (SPX) to swing between a trading range of 800 and 925 over the near term. We also expect volatility (VIX) to trade between 40 and 55 over the next month. With that in mind, we may look to write a February call on the VIX at 55 and write a February VIX put at 40 if we can get in a good prices. This strategy would allow us to pick up income as long as the index trades within this range. We may also look to write options on the market index. Writing puts are always more risky in volatile markets, so we would look for a put around an exercise price of 775, but only if the price is right. For a market index call, we would look for one to write in the 925 or 950 range. This is still a short term traders market, and can be quite rewarding for investors that can handle the risk. The financial sector remains very volatile right now, and that may present some short term trading opportunities. We may look to buy a call on BAC stock if we can get in at a good price prior to release of a government plan for the financial sector. We are now 90% cash, but will continue to look for short term trading opportunities.

Remember, our complete list of options is Available Online At: http://www.marketbeatingstocks.com