Weekly Options Recap, March 13, 2009

Market Rallies From Oversold Levels!

Relief! The broad market advanced 10.7% in its best week since November. The market had gotten oversold over the past few weeks as the selling pressure and short interest intensified. It is good to see the market break the downtrend, as it had become far too easy for short sellers to make money. We like the market rebound, but are still very concerned with the downside risk, and consider the recent move more of a bear market rally. We expect the market to be rocky, swinging back and forth between a trading range of 150 points. We would like to think that last week was the beginning of a sustained bull run, but just do not think the economy and financial sector are quite ready to support a prolonged uptrend. 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.

Market Beating Foresight

Next week will bring an onslaught of economic reports on inflation, manufacturing, housing, the labor market. These measures will help us gauge the state of the economy and perhaps offer more clarity on its near term direction. The data is likely to confirm the gloomy view of the economy and its future prospects. It will interesting to see how the stock market responds particularly after the strong market gains last week. We do think the market got oversold over the past month, so part of the strong advance can be attributed to those adjustments. But as we have said before, the market remains very shaky and further downside moves are possible. We continue to believe the market will remain rocky over the next three months as job losses continue to mount and economic conditions deteriorate. The market can move up in this kind of environment as it did last week, but investors need to be prepared for large swings. In our view, the market is not yet poised for a sustained bull market advance. On a positive note, volatility (VIX) did fall significantly last week and that is one of the measures we watch closely. Lower volatility levels will help bring investors back to the market. We are currently 20%invested in our option portfolios.

Option Tips For Investors?

We expect the market to swing between a trading range of 675 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 still consider the downside risk high, even after the strong market advance last week. 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 still far more bearish than bullish right now. However, extremely low premiums may not warrant the call risk. We are going to watch the market carefully over the next few days following the remarkable gains last week. It will be a positive sign if the market can hold recent gains, particularly if the economic data released next week is not good. However, it is just way too early to call a bottom is this rocky market. 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.

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