Option Investor
Index Wrap

History Repeated And In The Making

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       9-17-2001           High     Low     Volume Advance/Decline
DJIA     8920.70 -684.81  9580.32  8883.40  2.6 bln    471/2820
NASDAQ   1579.55 -115.75  1629.10  1579.28  2.3 bln    795/3174
S&P 100   529.10 - 29.48   558.58   527.83   Totals   1266/5994
S&P 500  1038.77 - 53.77  1092.54  1037.46
RUS 2000  417.67 - 23.06   440.73   417.67
DJ TRANS 2271.68 -404.81  2675.47  2267.01
VIX        44.77 + 10.17    47.70    39.76
VXN        73.26 +  9.42    99.32    70.96
TRIN        0.98 
Put/Call Ratio      1.14

From Friday's Wrap: "So I expect extreme volatility on Monday. The Dow could drop -400 to -800 points minutes from the open. Don't be surprised to see an opening plunge, substantial bounce soon after and subsequent selloff again.

Keep in mind that volume is likely to be huge and many foreign players in equities and futures arena will gleefully trade fundamentals if U.S. patriots play emotions. Too much money is at stake otherwise, and plenty of players will readily accept us "throwing the game" if we choose to buy or refuse to sell the wrong stocks next week."

Whereupon Monday's action played out precisely as we guessed. How did this happen? History lessons.

We've traded our way through several extreme sessions like this in the past albeit few to the degree witnessed today. That being said, highest odds in foresight was selling pressure would swamp buying attempts. I received numerous emails forwarded thru dozens of recipients imploring us all to buy 100 shares of any stock in support of America today. Such suggestion made me wince. This was obviously begun by non-market players who don't realize how many institutions would be dumping shares in 100K and 1 million-share blocks to thwart such well-intended but hapless efforts.

Hedge funds swore they wouldn't sell and other large funds swore they would buy in addition to many large corporations in support of market action. How many of them kept their word remains to be seen, but none of this activity or rhetoric was able to prevent the inevitable: massive liquidations and readjustment of market value. In the end, U.S. markets are a compilation of global players. I'm not saying that patriots balked at buying falling swords in a big way but any emotional boost to the markets obviously had zero effect at best.

What can we expect for the balance of this Triple-Witch week? Our charts have barely begun a return to predictive behavior and we'll take their forecast with cautious grains of salt. Here goes:

(Weekly/Daily Charts: SPX)

This chart reflects the Dow, SPX and OEX alike. All look very similar right now so we'll use the SPX as a proxy example.

The big picture shows that long-term charts remain buried in oversold extreme with no upside strength apparent at this time. The next bottom may be in place soon but isn't clearly in place tonight.

(Weekly/Daily Charts: QQQ)

Similar story for the tech sector, but this one might have far less downside risk than the Dow and S&Ps. At a 75% loss of historic high value, the NDX has shed far more value than the big indexes and might stabilize first. Upside potential remains to be seen, but my guess is techs fall very little from here relative to other issues.

(60/30 Minute Charts: Dow)

We really don't have much to work with on a technical basis quite yet. The Dow did make some semblance of descending consolidation patterns which are bullish and all stochastic values remain buried in oversold extreme. The 30-minute charts flashed a few false buy signals today but price action never pierced intrasession resistance and no call plays were taken.

The question is not whether these signals will soon pop up from oversold extreme: without doubt they shall. The question is whether sustained upside strength can prevail or if it's just the next high-odds put play entry as shorts return with a vengeance.

(60/30 Minute Charts: SPX)

We hit session lows three times today in the S&Ps as a bottom tried to form. Stochastic values are buried in oversold extreme but do not indicate upside strength until slow bars (red lines) turn up and emerge above 20% oversold line.

Meanwhile, we do have bearish descending triangles with lower highs but flat base. This tells us downside pressure is growing stronger and these patterns usually break to the flat side nearly 70% of the time. But an upside break would confirm bearish failure and is bullish by contrarian nature. We'll see which direction prevails tomorrow.

(60/30 Minute Charts: QQQ)

We're grasping some straws here, but descending wedges are actually bullish. An upside break in harmony with bullish reversal in stochastic values could signal the next relief rally has begun.

Lucky and 500% Richer
Last Monday 9/10 IS Swing Trade entered OEX & SPX put plays and elected to hold over into the following session. I personally had some SPX 1025 puts with a 5.00 cost basis. That day the markets closed rather bullish and next morning looked to open stronger. We were prepared to exit those put plays for a slight loss on Tuesday's open before the horrid events began. Cessation of trading left us stuck holding those contracts for the past week until today. Some e-mini traders had short-sale triggers tripped near 1190 area as pre-market price action reversed before trading was halted.

After suffering one week's worth of premium decay and only four sessions left to trade, my deep OTM puts stuck open were not looking good. I bought them using 100% risk capital instead of stops so was prepared to take a total loss without worry should markets have rallied. Markets plunged as expected and no option trades or quotes went off for over fifteen agonizing minutes. I would have been happy to exit at any price and long before decided to hit the first bid on a sell-limit order when posted.

Why? Because most of the time I've traded similar extreme sessions I've seen the best prices post at the open. Wild volatility spikes make for insane option values. Imagine my surprise when the first quotes printed 25.00 bid / 35.00 ask! I couldn't type the sell- limit order at 25.00 fast enough to suit me and filled to exit moments later.

This trade had zero to do with skill or ability and everything to do with fate. Terrible fate for humanity, favorable fate for those stuck short in a plunging market. Now I find myself with an unexpected windfall of working capital and will do my best to pyramid it aggressively the next four sessions. The Red Cross will get a lion's share in a check at Friday's close of trading as my direct contribution to the tragedy that provided such gains.

Considering I fainted cold the last time some nurse shoved a needle in my arm, maybe cash is the better gift I can provide. If you see Wendy at the fall OI seminar or elsewhere, please do not ask her to recite that sordid event for my sake. She'll gleefully give you every embarrassing detail in drawn-out fashion at my agonizing expense.

Big Dilemma
So the Red Cross and I are flush with cash to work with. Now what?

Well, a VIX in the 40s does not give us much room to work. Option premiums are wildly inflated with worthless, extrinsic value. A strong rally could easily plunge the VIX from 45 to 35 range in a single session. Let me assure you of one thing: any calls bought when the VIX is near 45 will appreciate very little if at all should volatility plunge. No matter how high indexes rally, a big drop in the VIX will suck huge extrinsic value out of calls and puts alike.

OTM and ATM ption prices traded nearly flat today once the noon hour arrived and into the close. Yes, indexes rolled up and down but it made little difference to our accounts: market makers merely rolled bid prices up or ask prices down as direction dictated in favor of them and against outside buyers & sellers. That game will continue tomorrow as well.

ITM contracts have higher deltas, more intrinsic or actual value and are affected less by volatility skews. They are subject to wide bid/ask spreads and will also collapse in value if the market moves against us. Therefore, they yield nicely when we're right but terribly when we're wrong... especially holding puts in a rising market. That would sag intrinsic AND extrinsic values for put players holding fast in a rising market.

Soooooo...
I will personally lay a bit low on Tuesday. First, chances are good that it will be a small-range day that chops along to digest Monday's monster move. Secondly, the VIX should continue to settle down in a flat or rising market. Third, Wednesday and/or Thursday are usually the most active sessions during expiration week. This is especially true during Triple Witch when September SPX, DJX options and futures cease trading on Thursday.

Therefore, Tuesday may be a good day of rest. I plan on risking small amounts of capital if any and then ratchet up my bets for the final three trading sessions this week.

My best guess is that retail traders get spooked tonight over the day's events and decide to pre-stage sell orders at the open. I expect further selling tomorrow but we could see a sustained relief rally bounce at any time from here. Indexes are grossly oversold and very near key levels of support. Shorts will be back trying to drive price action down, but expect plenty of funds to salivate over current price levels at hand.

This is a great time to test the upside with sector shares, debit spreads or position trades each using October call contracts in a rising market. Swing Trades using September options have their work cut out for them, and Tuesday may be the worst of our next four sessions ahead. Check out the other Gameplans, consider buying some time for yourself and wait for the inevitable bounce to occur.

Best Trading Wishes,

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