Options Market Recap, March 6, 2009

Fourth Week of Declines!

Ouch! Another very tough week as the broad market lost 7% in a fourth week of declines. Year to Date the S&P has declined 24% in just over two months and those declines come on the heels of nearly 40% losses last year. We reported our concern last week that volatility and fear was rising, and sure enough the market turned sharply down. We wish we could say the stock market is at bottom, but there is just too much fear and uncertainty to make that call. We continue to be concerned with the downside risk, as there are just not a lot of positives right now to drive the market sharply higher. In our view, the economy is a long way from recovery, and will likely continue to deteriorate in 2009 and perhaps into 2010. As reported last week, even if the market has hit bottom, the upside may be limited over the short term, whereas the downside risk remains high. In that light, we do not like the risk reward tradeoff for the long side of the market. Investors with long time horizons (5-10 years) could consider buying now, but even then we would suggest only slowly entering the market with incremental stock allocations over the next six months. In other words, if you want to resume investment in this market, invest 10% to 20% of your available cash into stocks each month. Investors do not need to hit the market bottom, to be successful over a long time horizon.

Economic Conditions Deteriorate!

The financials were the biggest loser last week as the sector dropped 19% as fears over financial health and nationalization continue to grow. Citigroup stock stoked nationalization fears as their stock price dropped below $1. Mortgage delinquency rates continue to rise sharply as the numbers mount on consumers unable to pay bills. The unemployment rate hit a 25 year high, rising to 8.1% as job losses grow across all industries. Economic data on Housing remains bleak and continues to deteriorate. The auto industry is a disaster as General Motors reported February sales sank nearly 53% with Ford sales dropping 48%. The losses at General Motors are huge, and bankruptcy concerns loom large. Retailers are also showing declines in monthly sales as consumers continue to tighten the purse strings. With all the bad news, it is tough to see the glass as half full. There needs to be more clarity from regulators on how toxic assets will be dealt with and how those remaining assets will be valued in the financial system. Asset valuation is a tall order for the Fed and Treasury to resolve, but may be critical to any meaningful and lasting recovery.

Option Tips For Investors!

Do we have option tips for investors? We expect the market to swing between a trading range of 650 and 825 over the near term. We also expect volatility (VIX) to trade between 35 and 55 over the next month. With that in mind, we may look to write a call on the VIX at 55 and write a VIX put at 35 if we can get in at good prices. This strategy allows us to pick up income as long as the index trades within this range, the most likely scenario. We consider the downside risk high, and if the market does move down further, it could be a sharp and severe move. Investors could consider buying puts for protection, but we would shy away from writing naked puts given the downside risk in the market right now. Investors could be more aggressive writing naked calls on the market index, as the current market is far more bearish than bullish right now. However, extremely low premiums may not warrant that risk. This is still a short term traders market, and can be quite rewarding for option investors that can handle the risk. We are 80% cash, but will continue to look for short term trading opportunities.