Option Investor
Market Wrap

Wimpy, wimpy, wimpy!

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        WE 5-5            WE 4-28          WE 4-20          WE 4-14
 DOW    10577.86 -156.05 10733.91 -110.14 10844.05 +538.28 - 805.71
 Nasdaq  3816.82 - 43.84  3860.66 +216.78  3643.88 +322.59 -1125.16
 S&P-100  769.79 - 11.63   781.42 +  4.30   777.12 + 45.18 -  89.58
 S&P-500 1432.63 - 19.80  1452.43 + 17.89  1434.54 + 77.23 - 159.04
 RUT      512.84 +  6.59   506.25 + 24.41   481.84 + 28.12 -  89.27
 TRAN    2876.11 + 26.10  2850.01 + 16.76  2833.25 +106.21 - 100.68
 VIX       30.42 +  1.64    28.78 +   .37    28.41 - 10.92 +  12.39
 Put/Call    .53              .51              .75              .94


Wimpy, wimpy, wimpy!

Don't look now but that rally on Friday really did not happen. Well, almost. Would it count if one team only used their third string players while their superstars were lounging in the stands sipping brews and laughing at their efforts? If you have ever played team sports then you know the victory would be real but it would not count in your mind. If you could not play the first string even a win against the bench team would be hollow. This was a hollow win on Friday. The volume on both the NYSE and the Nasdaq was the lowest of the year. Many traders never showed and of those there many left early. The NYSE only managed a wimpy 800 mln shares. No home runs, no doubles, no triples. The Nasdaq closed out the lightest day this year with only 1.19 bln shares. The Nasdaq closing total of +96.58 was very deceptive. If you take away the first hour and last hour the Nasdaq traded in a very narrow 30 point range all day. Don't get me wrong, I would much rather start next week with a close over 3800 at our backs but the numbers clearly don't illustrate the action today.

The much dreaded non-farm payrolls report came out Friday morning stronger than expected but NOT as strong as some feared. With new jobs clocking in at +340,000, 30K over official estimates of 310,000, there was almost a sigh of relief. The unemployment rate finally broke the 4% barrier clocking in at 3.9% and a 30 year low. But the main component of the report that is most watched was the increase in the average hourly wage. That number showed a +0.4% gain and was in line with estimates. Kind of a good news, bad news report. The markets opened down on the headline news but quickly recovered and in the case of the Nasdaq soared +120 points in the next 45 min only to hit a ceiling after the initial relief buying passed. The gains were broad but not spectacular. Of the 100 stocks I watch only five had double digit gains and very few had gains over +3.00. Most of the big gains came in the last 30 min of trading as traders speculated on the direction for next week.

The bad news for the day continues to be the Fed. Just like a recurring bad dream that will not go away and one you will have to live with for at least six more market commentaries prior to the event, the strong jobs data almost guarantees aggressive action. The Fed Funds Futures which have been right 30 of the last 31 meetings has now escalated from a 66% chance on Thursday to an 80% chance the Fed will raise +.50%. The good news is the market has already discounted this hike and is now just waiting to exhale.

Fund managers, fresh from a week of net redemptions, are waiting patiently before moving back into the market. Even though the Fed move is crystal clear to most there is always the fear of the unexpected. Could the Fed see something we can't? Will the PPI on Friday show blowout inflation? Will the CPI on FOMC Tuesday show inflation rampant in the consumer sector? Everybody expects some inflation creep but is it worth possible multi million dollar losses if they are wrong? What if the Fed does the unthinkable and raises +.75% or even +1.00% to shock the market and take control of the future? While nobody expects this, stranger things have happened. So the funds sit and wait. This is historically a weak period anyway and with no buyers in sight there is a good chance of a better entry point next week. The earnings cycle is over. The last few majors to announce are CSCO and Dell next week. Then all eyes will start focusing on the next cycle in July. But until then we have to first get out of this cycle alive.

CSCO is expected to beat estimates but many analysts are now expressing concern about Dell. With the PC sector soft for the first quarter some feel Dell may only post in line with estimates but some are expressing quietly that Dell may miss and telegraph another round of sector weakness. With earnings over the final group of earnings traders will sit back and plan their strategy for the next cycle which could include cooling off on the sidelines until after the Fed meeting.

So what should we as the elite of the investing public do next week? It is all a matter of time frame. If you are day trading then you are likely to have a very tough week. If you are investing then get ready to rumble. What am I talking about? This is simple in my book. If you expect the markets to rally after the Fed meeting and at least trend upward into the July earnings cycle then next week will provide a great entry point for that run. It makes no difference if the Nasdaq is up 200 points or down 200 points before the meeting, it is still lower than we expect it to be by July 1st. In order to capitalize on this cycle you only need to buy longer term options like July/Aug/Sept and wait for the storm to pass. Is this heresy? Buy and hold from Jim? It depends on your outlook. If you are a trader then trade away but be prepared to roll with the punches until after the Fed meeting. For those who cannot remain tied to a PC during the trading day, the week ahead will provide you with that perfect entry point (we hope) for the next earnings run. The week before every Fed meeting in recent history was flat to down with a relief rally following the meeting even when they raised rates. Can you say "buying opportunity"?

Sure there may be more down days and I am not saying that there may not be some nail biters ahead but the market is showing us a bottom in my opinion. If you buy enough time to get you past the rest of the May weakness then you could be rewarded handsomely. The challenge of course is the Fed and the market in general. The correction we saw in the Internet stocks and the biotechs could just as easily return and stocks do not always go back to their previous highs. One only needs to look at MSTR, CMDX/VNTR, ETYS, ACOM to prove this point. As I always tell my seminar students, "buy all the time you want, just don't use it." Buying time will give you that false sense of security and lull you to sleep. If the stock you pick next week for a July earnings run drops below your predetermined stop loss point then by all means close the position. You can always buy it back if it rebounds but sometimes you may never get a second chance to sell those options at the current price. Ask any one who ever had an option expire worthless. They did not plan it that way and they always thought it would come back. One of our recent seminar students has a huge position in the Jan-$125 MSFT leaps. He paid $25 and now they are worth $2. I have not talked to him personally this week but I am sure he is now a strong believer in stop losses. Up until recently he was also a strong believer that MSFT would always come back. After having made millions in MSFT over the last few years he stands to give it all back because times change, stocks change and "past performance is no guarantee of future results." But of course it only happens to the other guy.

Back to the topic, I personally believe the market, that is the Nasdaq, will rally after the Fed meeting. While it will not go straight up it should rally into the July earnings. Normally this rally does not start until late May or early June but after the beating we have taken I don't believe there is much downside. Sure we could still see another retest of the recent lows but with every higher low that possibility diminishes. The low volume that the talking heads on CNBC are so quick to point out as the beginning of the summer doldrums is not in my opinion summer doldrums. It is simply Fed dread and will go away after the meeting. Sure we may not have the 2.8 bln share days from the last real rally but it should be over 2 bln again. Returning volume and a close over 4000 should be your sign to open long call positions. We have had two closes over 3800 and four higher lows. Support is building. I looked at several hundred charts on Nasdaq stocks Friday and better than 80% of them had a two or three level stair step up trend showing progressively higher support. As stocks go, so goes the market. I repeat, this does not mean we can't fall back on bad news. Bad news could rock the market back to 3600 without much effort. Getting below 3600 would require some really bad news and a total buyers strike.

So here is the game plan. You have two choices. One, wait patiently until after the Fed meeting and for a confirming close over 4000 with higher volume. I can hear it now, that may never happen, I could be waiting weeks. DUH! If the Nasdaq does not close over 4000 that means it is either flat or down. Neither are great long call climates. Obviously this is the safer more conservative strategy. We let the market tell us when to play. It may be next week or even next month but I think the idea is to trade only when profitable not just trade to be trading. Choice two, for the more risk averse, wait for intraweek dips in the stocks you like and take a position before the Fed meeting. More risk is involved and there is always the possibility of being stopped out several times between now and 4000. Of course there is also the possibility of being $10-$20 in the money if stocks keep edging up. In reality you already know what you are going to do. You bias was already decided before you started reading this article. This bias is what will decide if you are going to make or lose money next week. With this attitude you have a 50% chance of being right. 50/50, red or green, odd or even, black or white. Sounds like table games in Vegas.

If you watched a shooter throwing dice for several minutes the odds of getting a seven out of the 36 possible combinations of numbers will be 1 in 6. Would you buy call options with a 1 in 6 chance of success? If a voice from heaven told you that when the next seven was rolled it would be followed by a streak of ten sevens in a row. Would you bet on the next roll or wait for the next seven? You would wait, saving your money for the streak. If you lost your money before the streak you would not be able to profit from it when it happened. Would your bet be larger after the first seven, second, third, etc? Once you had confirmation that the promised streak was really happening would you be more profitable? Your risk/reward ratio would be skewed heavily in your favor after you got confirmation.

In order for the Nasdaq to "streak" back to 5000 it has to pass 4000 first. Can it wander around aimlessly under 4000 for the next week or so before the Fed meeting? Sure. Will you make that much more money if you buy now instead of waiting for a close over 4000? I doubt it.

I am not trying to scare you into staying out of the market until after the Fed meeting. I am not saying you should not take part in any rally. All I am trying to say is this. There are two more big economic reports between now and the rate hike. The markets may react negatively to either or both. The talking heads on TV will probably say Fed, rate hike and aggressive in the same sentence next week more times than there were shares traded on the NYSE Friday. Even though I am bullish about the market possibilities after the meeting I am cautious about the market before the meeting. I want to "hedge" my bets and conserve my cash until I have confirmation that the trend is really up. Black and white. I may cheat, just like many of you will cheat, but if I do it will be with the full realization of the risk I am taking. I will do it with only a small portion of my cash and only with stop losses. I suggest you do the same.

I am happy to announce today a new project for OptionInvestor. Our regional seminar series where we bring the education to you. Check out the schedule for the first 13 cities listed below. These are two and three day seminars which focus on making you better traders in both stocks and options. The first day is spent entirely on technical analysis and once we give you a thorough understanding of the subject the second and third days are how to implement this information into winning option plays. Unlike the 600 person Denver Expo we held in March, these seminars are limited to a small class room environment to promote more personal interaction. You will still get the quality education of the big seminars but on a personal level. Option 101 writer and professional educator Chris Verhaegh will be the primary speaker. Chris has taught over 50 option seminars and many of our readers know him well. For more information check out the details in the Sunday newsletter.

Trade smart, don't buy too soon.

Jim Brown
Editor

Disclosure:
My current long positions: NTAP, RAMP

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