The witch is dead and futures are down. Time for the real market to appear.

I was out of town for the Thr/Fri on a family emergency in Texas and did not get a chance to watch the markets. It is always interesting to open up my charts after a couple days away and try to reconstruct what happened without the benefit of market commentary.

This weekend I see the markets set new highs on Thursday and although they finished Friday with a gain it was a lower high. It was also triple witching expiration and that always plays havoc with trends. To try and construct a material case for market direction next week on just the charts for Friday would be a daunting task.

One factor that does make me concerned is the volume. The last four days have all been over 10 billion shares each with Wed/Thr over 11 billion shares. Tue/Wed were positive days with advancing volume well over declining volume. Thr/Friday were skewed in the opposite direction with declining issues getting the nod. Ordinarily that would be a serious cause for concern but this was a triple witching and that spoils the volume for accurate analysis.

My first view of the markets this weekend suggested they were poised for a decline. We have been living on borrowed time for quite a while and that time may be about to run out. However, there is still one major factor at work with about 10 days left to play. That is the end of quarter window dressing. That is actually a stronger factor than the triple witching.

Fund managers will want to own the leaders when the quarter ends ten days from today and they will want those leaders to still be leading. This should keep the trend in tact as long as nothing rocks the boat. Unfortunately there is a potential tsunami on Wednesday when the Fed releases the results of the September FOMC meeting.

Bernanke said last week the "recession was very likely over." If that is the official outlook for the Fed then they should begin changing their statement towards a neutral bias on rates. Nobody expects any rate changes until mid 2010 so ANY change in the statement could have a negative impact on the market. The inclusion of the "extended period" comment from recent Fed statements will be required to keep traders from changing their short term outlook.

While nobody actually expects the Fed to make any changes to their bias this will continue to be a stumbling block whenever there is a meeting on the calendar.

Based on the lower highs, higher volume, declining over advancing volume, the end of the upward bias from triple witching and the Tue/Wed Fed meeting I would expect the markets to move lower and consolidate their gains. The positive factor of end of quarter window dressing may not appear until Thursday.

I looked at a couple hundred charts and nearly all were projecting potential weakness. For the combination of these reasons I am not going to add any plays this weekend. If we get a material pullback before the Wednesday announcement I will follow it with some new plays on Wed/Thr.

I want to thank the readers who emailed me with their fills on the FSYS stop last week. It appears those with automatic stops were filled at 9.32 and those who manually entered the trades were filled at 9.40. That is a far cry from the $7.77 opening print and more inline with what I thought the exit should have been. I updated the history table with the automatic 9.32 number.

Jim Brown



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Methodology

We do not sell out of the money puts for a few cents and then hope the market does not correct and cost us a fortune to exit. I don't like to risk a dollar to make a quarter.

The concept for Option Writer is to find solid momentum plays with enough volatility to inflate the option premiums. We will sell in the money naked puts ahead of the stock price and let the stock rally to our strike.

Selling in the money puts allows us to capture nearly dollar for dollar the movement in the stock price.

Because we are selling in the money that same dollar for dollar move can go against us as well. For this reason we establish tight stops to take us out of the play for a loss of a few cents rather than let the losers grow and "hope" they rally again. In a typical month we could get stopped out of twice as many plays as we close for a profit but those stops will be minimal and the winners worth the trouble.

If you do not have the ability to sell options you can turn the plays into spreads by buying a lower strike put. This will decrease your margin requirements but it will also decrease your profits.


Margin Requirements:

There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.

Here is the most common margin calculation for naked puts.

100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))

For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)


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