Breakdown Forcing Bullish Speculators Out of Positions. SPY $143 Will Be Tested – $140 Should Hold

September 26, 2012

Yesterday, the market tried to rally and the momentum stopped early in the day. There simply aren’t any catalysts to push stocks higher. Central banks have all of their chips on the table and traders don’t have anything to look forward to. Since the FOMC statement, the market has been drifting lower.

I’ve been looking for a pullback and when I saw the reversal yesterday, I bought puts in a couple of my services. If you have taken my advice, you are out of all of your long positions. Option implied volatilities have dropped to historic lows and we were able to buy SPY $145 puts for $1.65. These options have almost 4 weeks life and they are ridiculously cheap.

You know from my comments the last week, I’m not calling for a market top. I believe this rally is over extended and bullish speculators need to get flushed out. The economic releases next week (official PMI’s, ISM manufacturing/services, jobs reports and retail sales) will remind traders that conditions are fragile.

Spain’s bank stress test results will force them to formally request a bailout from the ECB. Many analysts believed that they would wait until elections in a few weeks, but the pressure is growing. Citizens are rioting over austerity measures and yields are inching higher. The situation in Greece is also tenuous.

All of this can be solved with a printing press. The ECB needs to extend aid and the “can” will get kicked down the road for a few months.

China’s economy is deteriorating and the PBOC is slow to act. They fear that inflation will rise and they have been battling it for years. Diplomatic relations with Japan are heated and the territorial dispute over group of islands could result in economic sanctions.

I am buying puts, but I am using tight stops. I will take profits around SPY $143 on half of my position. If the market holds that level for a few days I will exit the remaining positions. If we blow through that support, I will ride the wave. Eventually, this will set up an excellent call buying opportunity.

Asset Managers that under allocated will get a chance to buy stocks. Valuations are attractive and balance sheets are strong. Earnings warnings have been contained to PCs and transportation. Central banks are backstopping the market and we are still in “risk on” mode. Money will flow out of equities and into stocks.

If you’re nimble, trade this decline and use stops. If you are a swing trader, line up your bullish candidates and wait for support. Q3 window dressing will pressure the market and 75% of the time it results in a temporary market decline.

Look for continued selling throughout the day and watch for support. Bullish sentiment has been extremely high and we could see an air pocket as bullish speculators dump positions. Not to worry, Asset Managers are waiting in the wings and they will snap up stocks in the next week or two. There is support at SPY $140 and major support is at $138. I don’t believe we will get to $138.

It is nice to see some movement.
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September 25, 2012
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