Weekly Options Recap, March 27, 2009

Bull Market or Consolidation?

Another strong week as the broad market advanced 6.2% last week. That makes the third straight week that the market has advanced reducing the Year to Date loss to 9.7%. Most of the weekly gain came on Monday, but the fact that the stock market held those gains through the rest of the week was an excellent sign of resistance. Investor confidence appears to be returning and with that will come the more cash to push stocks higher. In our view, the stock market has been consolidating in the 800 range (S&P 500) for nearly six months now, since November of last year. Yes, there have been large swings above and below that level as we have seen over the prior two months, first losing more than 24%, before recovering 22% over the last three weeks. These percentage movements have made for a very rocky market over the last six months. However, when those market movements are smoothed out over a longer period, we see a market that has been consolidating in that 800 range. Many consider a bull market to have begun once the stock market moves more than 20%. The market has now moved up more than 20% from its March lows! However, our view is more cautious as we believe it is still too early to call for the start of the bull market. Frankly, we see the recent move as more of a consolidation back to that 800 level. Although not ready to jump on the Bull stampede, we are growing more optimistic that the worst may be over for the stock market. We sense that investor confidence is building and eventually that will bring the necessary demand to drive stock prices higher.

Economic Data Fuels Optimism!

Last week the economic news was pretty good. Existing home sales and new home sales both rose substantially more than expected. Estimates called for month over month declines, but instead both new and existing reports increased in the 5% range! Granted these increases need to be validated over a longer trending period, but nonetheless are encouraging signs. Reaching a bottom in housing will certainly help the economy regain its footing. Another positive was durable goods orders which rose 3.4% for the first increase in six months. Retail sales also showed strength with results that exceeded expectations. Consumer spending appears to be showing signs of life and that is critical for an improving economy. Last week long term mortgage rates moved lower as a result of recently introduced FED programs to buy up long term treasury securities. Those programs will help drive mortgage rates down for consumers, and lower rates will encourage refinancing and in turn put more money in consumer pockets. Consumer spending will pick up as the cash available to consumers grows. Mortgage refinancing is not the only factor driving up cash levels. Tax refund checks have begun to arrive and government relief programs are now taking hold which result in additional cash to taxpayers and consumers. We do believe having additional cash will help build consumer confidence pushing spending levels higher and driving the economy forward. However, we have not yet seen the jobs situation improve and unemployment may continue to rise over the next few months. The concerns over job loss and employment will certainly temper any growth in consumer spending that we do have.

Option Tips For Investors

We expect the market (S&P) to swing between a trading range of 725 and 875 over the near term in choppy trading. We also expect volatility (VIX) to trade between 35 and 50 over the next month, mostly in the low 40 range. With that in mind, we may look to write an April call on the VIX at 50 and write a VIX put at 35. The sales prices will not be great given the short duration, but we also think the risk is low for falling out of this range. This strategy allows us to pick up income as long as the volatility stays within this range, the most likely scenario. We may also consider writing an April call option on the market index in the 875 range if we can get in at a good price. We still believe writing call options are less risky than writing naked puts given the downside risk in the market. However, we consider the likelihood of the market exceeding 875 by April 18 as small, so picking up income on writing the call may be worthwhile. As we have mentioned before, we are more protected writing call options since most of our other portfolio positions are long stock positions which will tend to move in opposite directions to the call position. In short, if we guess wrong on writing the call that will mean the market has risen sharply which will benefit our other long stock positions and mitigate the loss on the call. We still consider the market downside risk high, but are encouraged that the market has held the large gains from the prior three weeks. We are also prepared to buy calls and puts on the market index if there are large swings that show signs of a market overreaction. We have also recently added a number of stocks to our Momentum and Value buy list. All of these stocks also trade options and we may buy a medium term call option on one or more of these stocks if we can get in at a good price.

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