Weekly Options Recap, April 3, 2009

First Monthly Gain in Eight Months!

Another strong week as the broad market advanced 3.3% last week for its fourth weekly gain in a row! Even better, those four weeks left the broad market index with a monthly gain of 8.5%, the first monthly gain in 8 months. However, despite the large monthly gain, Year to Date performance remains at a loss of 6.7%. All things considered, it does feel like the market is starting to stabilize and investors are gaining more confident. March price movements were indeed rocky, but we find the recent strength very encouraging. We mentioned last week that the market has been trading in a wide range around 800 now for the past six months. Right now the market is on the upper end of that trading range and we think the next few weeks will be very telling with regard to its long term trend. Many stock market pundits now consider the worst to be over. That could be right, but we also don’t think the market can sustain the recent trend and rise 8% each month for the rest of the year. Given the strong advance, do not be surprised if the market pulls back or trades in a much smaller range over the near term. Nonetheless, this appears to be a good time for investors that are sitting on the sidelines to gradually re-enter the market.

Market Advances Despite Weak Economy!

The economic news last week again highlighted the weak economy. The stock market was able to advance for the week despite less than good economic news. Home prices came in with declines worse than expected at 19% year over year. In addition, consumer confidence remains at low levels and was lower than expected as measured by the recent March reading. Manufacturing reports continue to show a contracting economy, although the rate of that contraction is slowing. The jobs situation continues to be the more troublesome indicator, as jobless claims continue to mount. Most economists expect unemployment to trend upward and at 8.5% is already at the highest level since 1983. We would not expect the unemployment rate to crest until later this year or even early next year. The other big news was the pending bankruptcy of GM and Chrysler. The CEO for GM was forced out last week, and news rumblings are rife with bankruptcy talk. It may be very likely that GM does enter some form of bankruptcy protection, although we suspect the government will help soften the impact of such an event on the larger economy. As for Chrysler, the government has been blunt suggesting that they have 30 days for which to consummate an agreement with FIAT. The government message is that Chrysler will not be bailed out if a merger agreement is not reached. The market has been taking the potential for bankruptcy from these automakers in stride as stock prices still advanced through the week despite all the talk. We are more cautious as bankruptcy with one or both of these automakers will have significant downstream impacts on supply chain participants and other industry stakeholders. The market did appear to get a lift from the Financial Accounting Standards Board when it was confirmed that mark-to-market accounting rules would be eased.

Option Tips For Investors?

Do we have option tips for investors? We expect the market (S&P) to swing between a trading range of 750 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. We still consider the market downside risk high, but are encouraged that the market has held the large gains from the prior four weeks. Our primary options strategy is to buy long call options on stocks that hit our Momentum and Value screen. Given the rocky market since November, that strategy has been pretty much on hold. However, we now see encouraging signs such as the market strength shown over the last four weeks, poor but stabilizing economic indicators, and a growing optimism amongst investors. We are now getting closer to putting our strategy of buying long term options back in play. This strategy will not work in periods of a sustained market downturn, so we have to feel comfortable that the worst is over for the stock market. We are not ready to go all in on options, but do plan to increase our allocation on long call options over the near term. 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 expect to have more choices on options to buy now that the number of stocks showing on our Momentum and Value buy list trends upward with the overall market. We are currently 80% cash in this portfolio, but may increase our investments and reduce that cash level over the coming weeks if market conditions remain favorable.

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