The good news, the month is over, the bad news, the month is over.
Did you survive the month of September? This was a tough one but now you can look back on it and say "I am glad it is over." The bad news, October is now upon us and the outlook is very uncertain. The rally this afternoon was very satisfying and expected. It actually gave me a chance to get some fills on puts that I was target shooting. More on that Sunday. September definitely turned out as a "dump the duds" month but many blue chips were thrown out as well. The rally today was a direct result of last minute window dressing by fund managers who wanted to list more winners in their portfolios than losers on their quarterly statements.
After trading basically flat for the last two days the starting bell rang at 1:30 this afternoon and the Dow gained +140 points to bounce off 10400. The flurry of activity was focused into recent winners and big names. The Dow failed to hold the highs and slid back to close at 10336, only +36 points above the ceiling from the last two days. After the close the downward drift continued with the S&P futures going immediately into negative territory. Tuesday I said for any rally to hold the Dow would have to trade over 10400 and close over 10350. Close but no cigar.
While the rally was nice for the books, it was the biggest gain since Sept 3rd, it has a very good possibility of being a bear trap. The advance/declines was positive for a change but just barely. With Greenspan talking tonight, key economic reports due out tomorrow and the Fed meeting next week there is not a good reason to rush out and buy stocks. Most of the news which drove stocks this week is old news and the key players are all suffering from profit taking. AMZN is old news. AOL is old news. CMGI earnings are old news. Now we have to wait for another week before the October earnings news takes control of the market. Next week will still highlight earnings warnings and set the tone for the real earnings season. The major even next week will be the YHOO earnings and fortunes of the Internet stocks which will be painted by the same brush. Fortunately the 3rd qtr earnings are still expected to be in the +20% range. This is probably what is keeping the market from falling even farther.
While nobody can predict the direction of the markets for October, the collective memory of past October crashes is flashing in the rearview mirror for most traders. This fear factor is one of the reasons we are range bound. Traders are still selling into rallies and attempting to raise cash for any buying opportunity to come in the next few weeks. Bargain hunters that may not have been around for some of the past October crashes are continuing to buy the dips. A classic tug of war between the buyers and sellers. How do you win?
I would suggest that you consider selling some time. There are four things that can happen when you buy an option. 1.) Stock goes up fast. 2.) Stock goes up slow, 3) Stock is flat, 4) Stock goes down. Only ONE of these options will make you money if you are a Call/Put buyer.
When you sell time you win when THREE of those conditions exist. If you buy time you have to be right to win. When you buy time you have to pick the direction, the timing and the movement to win. When you sell time you only have to be close to win. If you are selling calls then you pick a stock that you think will not reach your strike price. That means it can go up slowly, stay flat or go down for you to make a profit. If you sell a $50 call on a $45 stock for $3 then the stock has to close over $53 on expiration day for you to lose. ANY price under $53 and you win. If you bought the call for $3 then the stock would have to move from $45 to over $53 before you can win. (simplified examples)
The same holds true for selling puts. You pick a stock that has a good bullish trend, wait for a down day and sell a put out of the money. If you sell a $40 put on a $45 stock for $3 then the stock must drop to less than $37 before you can lose. Remember you use this on a stock that is moving up. A $45 stock moving up must make a major direction change and a major move to close under $37.
Why the option lesson today? Friday is option selling Friday. That is the Friday two weeks before expiration. Premiums still have some time value but two weeks is too short for a major direction change on most bullish stocks. Tomorrow is the best day of the month to sell puts. Almost anyone with a margin account can sell naked puts and pocket some almost free money over the next two weeks. I would recommend selling puts instead of calls because of the oversold market conditions. Put premiums are inflated because of the recent drop and the odds of the market moving dramatically lower in the next two weeks are slim. I think 10,000 will offer strong resistance if we go in that direction.
Remember that put premiums reflect the expectation that the stock will or will not reach that strike price. The Dell $40 OCT-put DLQ-VH is only $1 because nobody expects Dell to trade under $40. The EGRP $22.50 QGR-VX is only $.88 because $22.50 is strong support and nobody expects it to break the strike. The YHOO $165 put YHV-VM is $4.38 because of the chance YHOO will drop from $175 to $165 in the next two weeks is high. Also the stock price is much higher.
The returns may not be the same as a call on AOL but the risk is much smaller. The margin on the Dell Put is about $16 for a $1 profit but it is a 6% profit for two weeks effort. The EGRP Put produces a profit of about 10%. The YHOO play about 7% profit. You decide if this type of play is right for you. I love it and I use some uninvested cash to sell puts every month on this Friday. Check out the Sunday newsletter every week for some great naked put plays.
Which way next? Barton Bear(Biggs) was on CNBC tonight with his permanent Dow is going to hell speech. I doubt anybody takes him serious anymore. He was only one of dozens of analysts predicting doom over the last week. They could be right but when everybody lines up on one side of the argument the reverse normally comes true. The bearish sentiment is so thick that a rally must be about to break out. I heard one analyst today that said the advance/decline line had been so bearish for so long that nobody must be left holding stock. His point was that there was now an estimated $2 trillion dollars available to buy stock in money markets and uninvested cash in mutual funds. Everybody is waiting for the bottom. Yes, some of this will wait until after Y2K, but there is still a lot of cash on the sidelines. Don't get me wrong, I am not saying that today was the first day of a record rally. It could be days or weeks before it is safe to go back into the markets. It is up to us as personal funds managers to wait for a green light before opening new positions. If you are a risk taker then buy the next dip. If you would rather be safe than sorry then wait until after the Fed meeting to make your next investment. I had a reader ask me today if we could get another pre-Fed spike like we had in August since the +.25% increase is already priced into the market. I think since it is October and this is the retraction of the third and final rate cut from last fall, the chances are slim. However the very oversold condition of the market makes anything possible. The volume on the NYSE was over 1 billion shares today. I have mixed feeling whether this was good or not. Normally a rally on strong volume is a good thing but the mood at the close was negative. Some wondered if the volume was from the rats selling into the rally to flee the sinking ship. Tomorrow will tell. Futures are down -2.70 and a lot of dark before morning. I would like to believe the drop to 10081 on Tuesday was the last leg of a double bottom but then I would have to believe in Santa Claus and the Easter Bunny also.
Sell too soon.