Equity Index Update

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Brad Sullivan

BEWARE THE IDES OF MARCH…so warned Mr. Shakespeare long, long ago. Maybe he should have written beware selling new lows for the move in the index markets the day before the ides of March. The tide turned awfully fast across the board for those trading indices yesterday in the late morning. After undercutting the previous lows made from our downdraft in the last two weeks buyers came rushing in and fresh shorts were forced to pay up in order to cover. When the dust settled it was a fabulous show of strength from the Hedgies ahead of this critical expiration…and to that end I say touché.

This morning the index markets, which had been trading higher earlier, are called to open lower on the heels of our PPI reading this morning. The reading came in at +1.3 on the headline and +0.4 on the core…well above expectations on both counts. However, this reading is notoriously volatile and fickle – my assumption is that the markets will wait until we get tomorrow’s CPI before making any rush to judgment about inflation. Accordingly, I would take this open with a grain of salt and assume that the path of least resistance will be towards the upside.

March Madness begins today, I would anticipate a lightening of the volume by mid-morning ahead of this annual gambling extravaganza. Beware…

Wednesday of Options X -- The Low we put in Today, was that the Bottom you were looking for?

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Fari Hamzei

Not exactly !!

I was asked that question a number of times earlier today, both by professional and institutional traders.

IMHO, the market is following the Script we put out two Sundays ago on this blog (see http://hamzeianalytics.blogspot.com/2007/03/market-timing.html).

Our Script calls for a volalitity retest in the +4 to +5 sigma region. That should translate to a test of our last May 2006 high (~1326 on SPX), now acting as a critical Support. If that support level does not hold, the next logical stop is 1280 on SPX (July 2006 highs).

Here are two Volatility Indices that we follow very closely. (I am in the Prof. Robert Whaely's camp (the orginal VIX inventor), now called VXO -- and yes, I don't like the new VIX, as it has to do with its construct).


During this vol retest, we should see the VXO between the high 20s to low 30s, and

We should see VXN in the mid 30s before the dust settles. As far as its timing, with this week's quad-witching March Expiry as a backdrop, market should sell thru Friday and Monday ahead of Tuesday which happens to be Vernal Equinox (First Day of the Spring or "Norouz" in Persian).

Equity Index Update

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Brad Sullivan

Was it the other shoe…or did we just untie it? That is the question, and the only question that really matters facing the domestic and global index markets over the next several weeks. Yesterday’s severe decline was the 2nd such implosion over the last 11 sessions and laid to rest the silly notion that the massive selling from two weeks ago was due to a computer glitch revolving around the DJIA pricing. Given the complete lack of volume on any of the higher sessions during this bounce phase, yesterday’s action does not come as a total surprise. Sooner or later something would trigger another round of selling and the fact that it happened during expiration only exaggerates the move. More importantly, this downdraft may continue to spiral lower due to the expiration of options and futures this week. I have continued to point out that the favorite fund game on the board over the last 3 trading years has been to sell naked puts…when the jig is up on expiration week the moves, potentially speaking, can become quite severe. Yesterday morning I commented that this market had about 5% of downside risk by Friday. After yesterday, we are only 3% away. While I felt the odds of such a trade were remote, they have increased dramatically after yesterday’s action and those that are speculatively short --- particularly those that have watched out of the money puts become in the money --- are faced with the decision as to take in some of the position, all of the position or none of the position. Personally I took in enough yesterday to give me a free roll + profits no matter what plays out from here.

Subprime...I am wondering if it will become a verb in the next few years, like “Homer” in the classic Simpson’s episode where Homer’s constant idiocy becomes a cult classic of “ oop’s I did a Homer” when making a mistake. Only time will tell. But, there is no question that this fiasco lit the fuse yesterday. Accredited Home Lenders (LEND) got the ball rolling saying it was in financial trouble and in need of waivers on outstanding debt. New Century (NEW) was delisted from the NYSE and closed at .85 on the pink sheets. Bear Stearns is the supposed target of subpoena’s on bullish research in this zone. Essentially, we are watching a implosion of a financial product that created affordable homes and thousands of jobs – Savings and Loan scandal anyone? This will end when there is no longer a purely subprime lender left in the building, and at the rate of descent, that may happen sooner than one can imagine. The only question that matters within this arena is will this meltdown trickle through the broader economy? If it does, as many of the bears are forecasting, the result will be recessionary in nature. After a choppy overnight session, the indices have caught a bid from their respective lows and are called to open around UNCH. The Yen/Dollar is trading around UNCH as well after having been well bid earlier in the evening session. Keep a close eye on all product classes today as yesterday’s equity market action drove prices lower in grains, gold, crude and higher in treasuries. Funds are forced to push out positions in one market as their other positions lose value…sell beans, sell SPM7 for example. I don’t expect that to change anytime soon.

Equity Index Update

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Brad Sullivan

The index markets are called to open at or near their respective low trading zones over the past 3 trading sessions. A combination of the sub-prime lending blowup, a weak retail sales report and – most importantly – whispers of INFLATION out of the BOJ last night has produced another big leg of unwinding in the YEN carry trade. On the flip side, GS produced blow out numbers on its quarterly earnings report released this morning…keep a close eye on this stock as it has been our proxy over the last several months.

One of the concerns behind yesterday’s small move higher was the complete lack of volume. It seemed as though it was a holiday trade yesterday as players were on the sidelines…this morning it appears players have awoken from their collective slumber and appear ready to monitor their collective portfolio risk. One key aspect of the trade that few have discussed is the expiration week that we are currently 1/5th of the way through.

Since our massive selling 2 weeks ago today, the indices have been able to hold at higher, but rather uninspired levels. There is little question that this move has been propped by large demand amongst the funds as they try and protect their favorite trade of selling options. If there were to be an unwinding this week of the YEN/DOLLAR it would have dramatic ramifications on the index market. Players are holding their breadth that this does not turn out to be the case, but, if they must let their positioning go due to the risk department LOOK OUT. Certainly the odds of such an event are outlier by definition. However, when looking at such events in a historical context there is always a trigger. The index markets are faced with a POTENTIAL trigger of a YEN carry unwinding that forces index positions out of portfolios creating a vacuum of selling. If this scenario plays out – I would suspect the SPX would fall roughly -4% by Friday’s close from current levels. Keep in mind that the probability of such a happening is small – perhaps as little as 5% to 10% so any plays on this theory should be done with ample speculative cash.

Finally, keep a close eye on GS…a reversal below 200 would put the overall market in jeopardy.

HOTS Weekly Options Commentary

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Peter Stolcers

The character of the market has changed in the last two weeks. From September through most of February, we experienced a nice, tight upward trending channel. Option premiums dropped to historically low levels and the public borrowed on margin to buy into the global growth story. Along the way, we heard the words “soft landing” over and over again.

Out of nowhere, we hit an “air pocket” and the bid to the market was gone. After establishing a low Monday, the market rallied the rest of the week and formed a “V” bottom. The initial drop tells me that there was a legitimate concern with the Yen-Carry trade. Most of the large brokerage firms that clear hedge fund trades also engage in proprietary trading and they know the risk exposure. On the retail side of the equation, the public was reassured to stay the course. Paper losses were mitigated last week and now retail traders are hoping for another rally to make them whole. I believe a warning shot has been fired and the market will retest the lows from Monday.

The “air pocket” I spoke of is caused by fear and it suggests that liquidity is drying up. A few weeks ago, China raised its reserve requirements. Two weeks ago, Japan raised interest rates and last week the ECB raised interest rates. Domestically, lenders are tightening credit policies after seeing the defaults in the sub-prime sector.

I see two problems. First, traders are over-leveraged. The run-up in emerging markets, the Yen-Carry trade, the premiums being paid in private equity deals and the debit margin carried by retail traders are examples of excess speculation. Secondly, the market lacks a catalyst. Earnings guidance indicates a single-digit growth rate for next quarter and the Fed is not going to ease. A few weeks ago, the path of least resistance was up and that was all the market needed to move higher.

There are three events that will drive the market this week: quadruple witching, earnings from Goldman Sachs, and the CPI/PPI. SPY 141 is a critical level because a number of technical indicators are converging on that point. Some traders will view it as a pivot point to switch from short to long. Last week’s bounce represented a Fibonacci retracement. The rally brought the SPY right to its 100-day moving average and to a horizontal support/resistance level. A close above SPY 141will put me into the “neutral camp” and a pullback will confirm my short-term bearish bias. At this juncture, we have to take our lead from the price action. In very short order, the market will tell us how to position ourselves.