Option Investor

Daily Newsletter, Monday, 2/21/2011

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Not Shaping Up to Be A Good Morning

by Jim Brown

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The U.S. markets were closed on Monday for President's Day but markets around the world were moving lower as the events in Libya spiral out of control. Because Libya exports 1.1 million barrels of oil per day the price of oil has rocketed higher on reports of shutdowns in their oil production. The U.S. WTI rallied to $94.49 and Brent hit $108.70 and a two-year high.

All of this hysteria over Libya is just an excuse to take profits because the impact of Libya on the world economy is negligible. The oil spike is also a knee jerk reaction because OPEC claims to have more than four million barrels per day of excess capacity. If Libya did lose production to either strikes or sabotage it would only take a couple days for OPEC to increase production. It would take longer than that for it to actually hit the market but a statement by OPEC they were going to pump more would calm prices.

The developed nations have 1.6 BILLION barrels of oil in backup inventory for situations like this. That is in addition to the existing supplies used in everyday commerce. If this were Saudi Arabia coming apart at the seams we would have a problem. Libya going down in flames is just a news blip.

Brent Crude Chart

U.S. WTI Crude Chart

The question is what to do in the equity markets on Tuesday. They are obviously going to open significantly lower and we are due for some profit taking. "IF" the S&P futures hold at -16 overnight and IF that translates to a -16 point drop in the S&P that would put us back to support at 1325. I have to believe that is a buyable event because of the number of investors hoping for a decent decline so they can enter the market.

S&P Futures

S&P-500 Cash Index

Remember, Libya is NOT important to the world economy. The real risk here is the possible contagion to Saudi Arabia and Kuwait. So far there has not been any serious demonstrations in either country. Libya was ruled by Gaddafi in a dictatorship he seized in a military coup 42 years ago. He is hated by many, considered an tyrant and a buffoon by most. After turning the military lose on the demonstrators and ordering the air force to bomb the demonstrations he is even more hated today. Even his own supporters are turning against him. Most analysts expect him to be dethroned shortly unless he can hold on to enough military support to murder thousands more. Even that would only be a temporary solution. Once a leader shows that kind of disdain for their people their fate has been sealed. The country is becoming increasingly fractured.

I believe investors will see the future for Libya and realize it really has nothing to do with the U.S. market. After a brief period of decline I suspect the dip will be bought.

The qualification here is the retail trader. If they get knocked out of their existing positions at the open they may pull the rip cord on everything else in a reactionary move. This is exactly the wrong thing to do.

Baron Rothschild, an 18th century nobleman and investor made famous the saying, "The time to buy is when there's blood in the streets." I know it sounds callous but we can't do anything about Libya. A week from now when the market is back in rally mode you can either be glad you were flat in support of Libya or you can be banking some decent profits on your "panic in the street" buys. The choice is yours.

We don't normally have a newsletter on a market holiday but I felt a need to comment on the potential opportunity rather than fixate on the gloom and doom in the news.

Jim Brown

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New Option Plays

Forecasting Stormy Weather

by James Brown

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Tomorrow morning could be a volatile one for stocks! I know in our commentary section there has been some discussion that it would take an unexpected or unforeseen event that would finally spark a real correction in the stock market (-10%). I'm sure no one was expecting Muammar Qaddafi, the leader of Libya, to actually bomb his own people to quell the protests for change.

Over the weekend Qaddafi's son warned protestors that they need to engage in talks or face a civil war. Looks like they didn't want to talk or Qaddafi has decided to take the hard-line approach. On Monday there were several reports that Libyan warplanes and helicopters had started bombing the city of Tripoli. Hundreds are being reported as dead. There was one report that two pilots refused their orders to bomb their own people and took their planes to another country to defect. There are also reports that Muammar decided to travel to Venezuela during or after the attack. A lot of this news has yet to be confirmed.

Investors have been concerned that the protests in Egypt would spread and in recent days there have been some clashes between protestors and the army in Bahrain. Plus, the violence seems to be spreading into Yemen and Iran. What would really, really concern the global markets is if these protests and violence flared up in Saudi Arabia, since they are the crucial supplier to the world's oil market.

Meanwhile China is dealing with its own protestors. Citizens seeking change in China were trying to schedule protests across a dozen major cities calling it the "Jasmine Revolution". Yet the Chinese government was intercepting and blocking text messages, websites, blog posts, and Internet searches for anything related to protests or the situation going on in Libya, at least that's the story according to sources at Bloomberg.

At the moment we're not seeing much of a reaction in Asian markets. The Chinese Shanghai index is up +1.1%, the Hong Kong Hang Seng down -0.4%, and the Japanese NIKKEI index produced minor gains +0.1%. It was a different story in Europe on Monday. Markets were down across the board. Germany and France's major market indices were both down -1.4% while Britain's FTSE was only off -1.1%. I do think we should keep this in perspective. A -1.4% drop in Europe isn't that big of a deal. Germany actually had some positive news with the Ifo institute's business climate survey hitting a new all-time high.

We can not know how the U.S. markets will react on Tuesday morning. At the moment odds are good that stocks will open down. Maybe we see a -1% or -2% move or maybe this starts the long awaited correction bulls and bears have been hoping for. I strongly suspect that the buy-the-dip mentality is still very much alive and well. I would take a cautious approach on Tuesday but I would be watching the markets for another opportunity to buy stocks that dip to or bounce near support levels. Of course given the market's up trend we may be looking at very short-term support levels. Even if we saw a -3% decline that would only be a drop to the 1300 level on the S&P 500, which would definitely be an entry point in my book!

Big picture the news of violence and death in Libya is very sad but I am not expecting it to have a lasting impact on the U.S. stock market.

If you are trading any resource or commodity names I would definitely expect some volatility. The U.S. dollar is likely to rise as a safe-haven trade and a rising dollar would normally put downward pressure on commodities. The exceptions might be gold and oil. Gold is also seen as a safe haven play and rallied to $1,400 an ounce on Monday. Meanwhile Libya and most of the countries that are seeing protests are oil producers. Brent Sea crude oil contracts spiked higher with a +3% gain to a new two-year high of $105 a barrel.

- James

In Play Updates and Reviews

Looking ahead to Tuesday...

by James Brown

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Stocks will likely open lower on Tuesday morning but I am still expecting traders to buy any dip. Readers may want to take a step back and stay cautious on initiating new plays but I would be watching any weakness as a potential opportunity. Tonight would be a good time to double check your stop loss placement so you're comfortable with the amount of risk you're talking on your positions.