Another -172 point drop in the Dow took it back to just over 10,800 and only a 100-points away from the closing low on August 10th. Is this just a retest or the beginning of a new decline?

There are several things that would point to a retest instead of a rush to a new low. Volume is not as heavy and the internals are not as bad as the prior crash. Volume on Friday was 9.7 billion shares with 7.8 billion declining and 1.8 billion advancing. That is still negative with a 4:1 imbalance but there were extenuating circumstances.

Friday was the first option expiration since the first August crash. Everyone who used options to launch positions in the first crash and the rebound that followed had to bail on those positions on Friday. The vast majority of options let over from the crash were probably call options from the rebound. I am sure there were some puts acquired when the rebound stalled but I would expect those to be future months not August. Very few traders will buy options with only a couple days left before expiration.

I believe the expiration pressures were market negative. Of course it did not hurt to have some seriously negative economics and a major earnings warning and negative news from Dow component Hewlett Packard.

If you step back from the cliff edge for a minute and survey the landscape a little farther out you will notice corporate earnings are still strong. Estimates for the next two quarters are for 17% earnings growth with only a minor decline to 14% in Q1. Those are not recession numbers. Granted there have been some companies lowering guidance but the vast majority are still predicting growth. Even the ones lowering guidance are still projecting growth. Cutting earnings expectations from 35-cents to 30-cents when the year ago quarter was 20-cents is still growth.

The financial sector has led the market decline. Worries over mortgages and Europe are weighing on the banks but they are still predicting earnings growth even with Dodd Frank looming over the horizon. This is not 2008 all over again.

This is a normal August. The market normally declines in August as companies firm up guidance for the rest of the year. A weak August normally leads into a weaker September, which is the weakest month of the year historically.

The Philly Fed Survey is a survey based on manager sentiment. It is not an actual tally of orders for thousands of companies. It is a "how do you feel" survey. The debt debacle and the ratings downgrade and the millions of lines of newsprint on those topics destroyed sentiment about our economic future. The president's approval rating has fallen to 39% overall with 71% disapproving his handling of the economy. This is a reflection of how businesses and individuals view the economy and our prospects. This will change now that the downgrade news is out of the headlines.

Next Friday Ben Bernanke will repeat his appearance at the Federal Reserve conference in Jackson Hole. Last August he suggested the Fed was about to launch QE2 and the markets took off for a six month rally. Nobody expects him to announce QE3 on Friday but they do believe he will outline future Fed policy actions designed to prevent a new recession. He said last year the Fed "will do anything to prevent a new recession." I am sure that has not changed. Investors are waiting to see what "anything" is going to be this time around.

The worst disaster we are likely to face this week would be a sell the news event if Bernanke's speech disappoints without any specific policy actions to prop up the economy and the market.

The crisis in Libya is almost over. Oil prices are already down significantly but they should fall further once Gadhafi is out of power. It will take a long time for their production to return but at least the future will be known. Lower oil prices will benefit the global economy and U.S. consumers. I paid $3.25 for gasoline today in Denver and I know there are some stations selling as low as $3.15. Gasoline should drop under $3 in the center of the country and under $3.50 on the coasts. This will be bullish for holiday shopping.

The point I am trying to make is the expectation for this current market decline to end soon. I don't see it as the beginning of a new leg down. I expect Monday and Tuesday to be volatile but we could see a rebound before the end of the week.

Futures are down -10 points early Sunday evening so Monday will start off negative if this trend holds until morning. I do have a play to capitalize on that volatility. Once the declines end we should be able to launch some new bullish positions for at least a temporary rebound.

Jim Brown



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$VIX - Volatility Index 43.05 (short call)

The Volatility Index should spike higher at the open on Monday. It closed Friday at 43.05. I am recommending we sell the September $45 call, currently $2.15 but probably higher at Monday's open.

The VIX rarely touches these levels over 40. When it does the hang time is very brief. The only exception in recent memory was the 2008 crash where failing banks and billion dollar bailouts kept it over $50 for several months. This was a one-time event and short of another Great Recession over the next couple weeks the VIX should begin to decline soon.

If you don't have the capability to sell naked index calls you can buy a long call 10 points over the call you are selling and turn it into a spread. Hypothetically you would buy a 55 call, currently $1 and sell the 45 call, currently $2.15.

The risk in this trade is that the market implodes and the VIX remains over 45 through the September expiration. While technically possible I view it as extremely improbable.

Sell Short VIX SEPT $45 CALL, currently $2.15, no stop, no target.

VIX Chart - Daily

VIX Chart - Monthly


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)