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.

Equity Index Update

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Brad Sullivan

The index markets gapped open strongly for the second session this week on the heels of a large scale reversal in the Yen vs. all its major counterparts. The reason behind the latest Yen move seems to be the rate hike in New Zealand to 7.25% will allow some of the favored carry countries to continue participating in the infamous lever trade. In response to this move in the Yen, the index markets rallied sharply overnight and continued their gains throughout much of a rather quiet session ahead of today’s February Employment Report released by BLS.

The report this morning came in right around consensus expectations on all levels…and that produced a sharp pre-opening bid in the marketplace. Currently the SPM7 contract is trading at 1424.50, which would equate to roughly 1410 in SP500 Cash index. Using the cash market, 1410 to 1415 should provide significant resistance in today’s session.


The real key behind today’s action will be whether or not the indices can hold their opening rounds of buying. Typically on Employment sessions, the move is fast and violent in the first hour, followed by a counter chop oriented trade. I suspect that will play out today, with one exception and that will be the final hour of trading. I expect to see selling across the index complex during that time frame…remember – since last Tuesday’s debacle, the final hour produced only 1 higher close. And that was a total of 0.30 points in the SPX market.

However we settle out today’s session, next week should provide fireworks as we enter the week of “witching.” There are lots of nervous positions on the books of hedge funds right now…and the fact that these bounces have occurred during overnight hours shows how much “supporting of positions” there continues to be in the marketplace. Next week should provide all the answers needed…if there is a forced liquidation trade during expiration week it will be very ugly. Keep in mind that last year we witnessed consecutive massive legs lower in May and June during their expiration weeks.

The Mysteries of Up & Down Volume

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Jason Goepfert

Over the past week, we’ve seen a laundry list of extremes across a variety of shorter-term sentiment- and breadth-related indicators.

One of the more remarkable is that of the relationship between “up” volume and “down” volume on the NYSE. Up volume is simply the number of shares traded in stocks that closed higher than the previous close, and vice-versa for down volume.

Last Tuesday, that ratio was skewed 100-to-1 in favor of the downside, the worst since the crash of 1987. A week later, however, buyers returned in force and the skew was 15-to-1 in favor of upside volume. Historically, it’s rare to see two such opposite extremes within a week of each other, and it might be instructive to take a look at them.

Each of the four instances in the past 50 years was consistent in their pattern:

1. At least a 15-to-1 skew of down volume to up volume.
2. At least a 15-to-1 skew of up volume to down volume less than one week later.
3. A retest of the recent low within 30 days.
4. A rally off a successful test of that low.

The four charts below highlight each of the occurrences, and it provides a general outline of what we may see this time around if the pattern holds somewhat true. This time we’re seeing the volume reversal soon after a market high, whereas the others occurred after a major downtrend, so that’s one caveat here. And if the recent low breaks, it will invalidate this pattern and I would not be looking for higher prices based on this extreme volume reversal any longer.


October 23, 1957:

June 30, 1965:

May 27, 1970:

October 21, 1987:

NYSE, NASDAQ and Gold

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Tim Ord

NYSE Market:

Below is the McClellan Oscillator for the NYSE.

When the McClellan Oscillator gets below -200 a bounce is likely to materialize for the short term. The Summation index touched the -300 level on the current decline. We have labeled in the past where readings below -300 have produced rallies. Resistance lies near the 9300 which equates to the 1442 range on the SPX and may be the area where the next top forms. Next week is option expiration week which usually has a bullish bias and the SPX could rally into late next week. The bigger trend is down and we are expecting an intermediate term decline to take the SPX down to near the 1140 range. Also notice on the chart above as the NYSE made higher highs the Summation Index made lower highs and this negative divergence help pick out the top of March 2005 top, September 2005 top, May 2006 top and the February 2007 top. We are short the SPX at 1381.95.

Nasdaq 100 Market:

Below is the daily Nasdaq 100, ($NDX) chart.

The NDX McClellan Oscillator has hit into an area where short term lows have occurred in the past (check the NDX chart above). Therefore there is a good possibility the NDX may bounce during option expiration week which is next week. Resistance lies at the gap level that formed near the 1810 range last week. Gaps are like magnets, drawing the market to them. Therefore a possible bounce to the gap level during option expiration week is possible. If the gap at the 1810 range on the NDX is tested on lighter volume then that will create a bearish signal. If a bearish signal is triggered at the 1810 level on the NDX then that would be a good place to add to short positions. We hold an average short position on the Nasdaq at 2378.59. Our downside target on the Nasdaq is near the 1900 level.

Gold Market:
On the recent decline that started from the late February high the energy has increased over 30% compared to the previous up leg going into the late February high and shows there is more force to the downside and implies the trend has turned down. For short term a bounce may materialize. On Market Vectors Gold Miners ETF (GDX), Resistance now lies at the gap level near the 41.30 range and our downside target is the 32 range. The anniversary of last years high comes in May. A lot of the time previous important highs and lows in the past mark important turn in the future. Therefore there is a possibility the market may hold down until the May time frame. The next major impulse wave up may start near the 32 on GDX and 115 range on the XAU. We are neutral on the XAU for now.

Japanese Yen

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Sally Limantour

After a break in the overnight market the yen is now holding firm above 86.00 level in the futures market. There was a piece about the yen in Market News. Apparently State Street developed an indicator called the, “Japanese Yen Foreign Exchange Flow Indicator, or FXFI that makes a point that over the last six months the average short yen position established was 119.70. They assess the majority of yen shorts were probably put on above 118.00 (86.00 level in the yen futures) and,

“Thus institutional investors are significantly underwater, even when one takes into account positive carry. We believe that these accounts will use any rallies in dollar-yen to reduce their short yen exposure and limit further losses.”

It is interesting that State Street only goes back six months. The carry trade has been something that has been going on for years and most likely the level is closer to levels from Jan 2005 at the 105 level (98.00 level in futures) as Barbara Rockefeller discusses in the March issue of Currency Trader Magazine, The Yen: Canary in the Currency Coalmine (www.currencytradermag.com). I also suggest an article published yesterday in the Economist magazine called, The Yen also Rises (www.economist.com).

Assuming this is true, we are not close to breakeven levels and we would most likely see massive liquidation prior to that. Keep that on your radar.

Long yen positions are held with the next target level coming in at 88.43 (Upper Bollinger Band on JY H7 Weekly Chart).

HOTS Mid-Week Options Commentary

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Peter Stolcers

The market bounced from an oversold condition yesterday and the retail public was reassured that all is well. SPY 140.50 represents horizontal resistance and SPY 141 is the 100-day MA, both should provide a temporary "lid". If the bulls can't add to yesterday's gains and make a new intraday high after noon CDT, I feel the bears will try to push the market lower into the close. Higher oil prices and the Beige Book (11:00 am PST release) could provide headwinds.

Editor's note:
This note was emailed to our HOTS Subscribers at 8:00 pst.

Some Stats on Last Week's Market Free Fall

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From our Virtual Trading Room Transcript

08:18:50 PST> Brad_Sullivan: Here is a few things I ran through this morning on the move and its magnitude:

From the summer lows, the Russell 2k rallied 20%ish and retraced that rally by 50% with the recent drop;

The SPX rallied +19% and retraced 37% of the move;

The DJIA rallied nearly +19% and retraced 25.5%;

The Midcap rallied +19.5% and retraced 43%;

Finally the NDX rallied 27% and retraced 35% of its move.

In a nutshell what took roughly 7 months to build crumbled in one week we may rally from here and hold serve above 1400 SPX for a stretch, but sooner or later, leg #2 is coming and my guess is that it will be as vicious.

Equity Index Update

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Brad Sullivan

The index markets are called to open sharply higher after reassuring comments from Treasury Secretary Paulson and a move lower in the Yen/Dollar carry trade. The bid began in earnest last night after a horrid final 30 minutes of trading across the index complex. Once again, each index settled below their respective cash instruments and fair value…however, strong bids began to enter the market moments after Paulson’s comments and the SPH moved rather quickly from 1373 to 1386 the European open. Since that time, the indices have treaded water between 1389 and 1382.50.

Today’s action should be defined by this gap open and whether or not there is any push towards filling it. If the indices are unable to hold higher levels we should see increased selling as the session wears on, particularly in the final 45 minutes…a stretch of time that has produced heavy one way street selling the last 2 sessions. If the indices are able to hold their opening bid, I would look for a sharp move higher that would carry the market above their respective highs from yesterday and test the breakdown level from Friday afternoon. In the SPH7 this would equate to roughly 1394 to 1396.

One aspect of the trade that I would put forward is this…we have moved DRAMATICALLY lower in 5 trading sessions. At some point we will get a bounce that sustains – normally that happens after a sharp down morning as the market reverses course in the afternoon. Given today’s gap higher, I have a hard time believing that this will be day we rally +2%...but you never do know.

One Week Wonder?

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Sally Limantour

After the brutal reversal yesterday and closing near the lows we are coming into calmer asset classes this morning. The dollar is reversing across the board and every single currency has moved contrary to yesterday’s wild action which has a “turn around Tuesday” kind of feel to it. Some are trying to say the carry trade unwind is over and all was accomplished in one week.
I am not so sure about that as at 20 year lows on a trade weighted basis the yen seems undervalued while, on the other hand, the Australian and New Zealand dollar seem over valued and their growth expectations are moderating. More on this later.


Commodities continued their liquidation yesterday. Gold was off its recent highs of over $50 oz while silver had tumbled from a high of 14585 to a low of 12470. The base metals fell hard lead by nickel. However, after the close in the stock market my shortest term model went to a buy and as mentioned yesterday I expected a rally early in the week. Sensing a shift or possibly just worn out from going down, long positions were established in gold, silver, the mini S&P and mini Russell index. The market(s) are oversold on a short term basis as we had the 10 day moving average put to call ratio at a extremely high level. I still anticipate a sell off later, but for now I am testing the long side with break even stops. No hero here!

In the mini S&P today the 1379.00 is a pivot with 1389.50 my 1st resistance, then, 1392. A “point of control” which signifies the area where the most amount of activity occurred the prior day, is 1384.25. Support now is 1381.25, then, should we take out yesterday’s low, 1364.50 is the next support.

I continue to stay long the volatility plays established in mid February as I do not think the roller coaster is over.

Equity Index Update

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Brad Sullivan

The index markets continued to suffer on Friday as buyers failed to materialize at levels around unchanged for the second consecutive session. Sellers took control through the lunch trade and became aggressive in the final 30 minutes of trading. It struck me that most of the selling done during that period was of “forced” nature. Whether it be risk managers or margin clerks, the bosses did not want the weekend risk and pushed out longs. Given our lower open today, that seems like a rather prudent trade.

This morning, the indices are called lower, -800 in the SPH7 at 1377.75, but off its overnight trading lows of 1371. The real volatility this morning seems to be lurking in the currency market which is absolutely up for grabs depending upon which cross you are trading. The Dollar is markedly higher against nearly all its counterparts, save the YEN…the YEN/Dollar continues to sink, the change being about +1% in favor of the YEN this morning. On the flip side, the Dollar is up over +1% vs. the Pound and nearly +1% vs. the Euro…the one thing each currency has in common is that they are all SHARPLY lower vs. the YEN. To put this in perspective, 5 sessions ago, the Euro/Yen cross hit an all-time high. Currently, we are trading -5.3% lower from that mark. Certainly, any levered product moving so quickly has the potential to inflict serious damage across the markets. We have seen the response in our index markets as funds are forced to exit long strategies on equities and short yen positions…an ugly mix.


The question now becomes…where do we go from here? How much more damage is left in the system? Is there systematic risk in the marketplace and if so is that risk not being accounted for (in implied volatility) properly? These questions are the larger ones and whichever trading theme one takes in response will yield either a tremendous bout of profitability or a painful loss…of course that is the point for choosing this business.

One aspect of the trade that I try and remind myself of during this volatility is ANTICIPATION. I am reminded of the axiom that Bobby Knight used for his players…C.A.R.R.E. Concentrate Anticipate Recognize React Execute. Pretty simple stuff…but it works. In these markets many of the larger moves are actually quite orderly (Tuesday afternoon being an obvious exception). However, if you examine Friday’s action in the SPH7…we traded up to UNCHG at 1405 and eventually settled at 1385.75. Most of that action was steady selling with some spike program action involved…however, if you were selling low prints on the way down the market clearly tested your position, bouncing higher quite easily. The key with trading in this environment is to wait…wait until you see the “whites of their eyes” as one of my friends used to say.