The 'fiscal cliff' budget negotiation hangs over the market like a dark cloud. Right now emotion is driving daily trading sentiment as whenever financial news reporters interpret the day's comments from Washington as indicating a budget agreement is near, stocks move toward highs of the near term trading range. However, when the daily news hints at a budget stalemate prices retrench. We have discussed in the past how the current extremely tight trading range is like a coiled spring that tightens every day that a budget resolution is delayed. If this fiscal cliff episode is not resolved in a few weeks expect a steep equity sell-off. But if the White House and congress can agree to some semblance of a long term budget solution the coiled spring should 'pop' and thrust the major equity indexes back toward the recent highs from October. As long as the coil remains tight there is significant risk for both the bulls and bears. One reason equity indexes are in a tight trading range is because while the media talking heads continue to promulgate a perception of an impending cliff that is going to decimate investment markets, the reality is that investors are taking a more tempered, wait-and-see approach.
Another factor that is contributing to the lack of either bullish or bearish conviction is anticipation of next weeks FMOC meeting. Everyone expects the Fed to announce further stimulus action to replace Operation Twist which is winding down as the Fed has exhausted its stash of short-term securities they have been exchanging for longer term bonds. Also, several market analysts are suggesting that Fed Chairman Ben Bernanke is probably not impressed by last week's non-farm payroll report. Along with other headwinds facing the economy and the uncertain prospect of fiscal cliff negotiations, a lot of fed watchers expect the Fed to err on the side of accommodation, and convert Operation Twist into full-bore QE4. If the government's big daddy Ben Bernanke and the other members of his gang do what many people expect and come to the rescue once again next week, this might prop up the market into year end.
Expect trading volume and volatility to accelerate in the upcoming weeks as investors and money managers go through year-end window dressing and continue the tax related selling that began right after the presidential election. Investors are cashing in stock gains to avoid the inevitable higher taxes next year and companies may continue to announce special and accelerated dividend payments before year end. If there is a market rally over the next few weeks expect some of these funds to chase prices even higher, plus money managers will take advantage of the opportunity to reposition their portfolios.
The December 2nd Couch Potato said "... As confirmed in the daily S&P 500 index Heikin-Ashi chart below the current trend may have bottomed out in mid-November and began the current short term uptrend... until stocks make a confirmed break above near term resistance, the longer term trend is still bearish... The chart below is signaling the recent S&P 500 index bullish move may be converting to range-bound trend..." The updated chart below confirms the analysis above is still valid as most of the major equity indexes are hovering at their 50-day SMA's. However, note in the Russell 2000 Small Cap index chart below that the small cap indexes such as the S&P Midcap 400 and Russell 2000 are trading above their 50-day SMA's which suggest 'risk-on' trading action. The Treasury Bond Fund and Gold Trust Shares charts down below appear to confirm that traders are developing an appetite for risk as they are selling these safe-haven investments in favor of riskier assets.
SPY Position Update -------------------------------------------------------------
SPY closed at $142.41 on Friday â€“ the December position is approx. $300 in the black
The November 29th Couch Potato published a December expiration SPY bear call spread
The call spread is approx. $300 in the black (see tables below)
$145 strike price short call delta is .1938 (81% probability this position will be profitable)
SPY Risk Analysis
We have not had a chance to open a put spread, therefore the only risk is stock prices confirming a new uptrend and threatening our SPY $145 strike price short call.
TLT Position Update -------------------------------------------------------------
TLT closed at $124.43 on Friday â€“ the December position is approx. $1,100 in the black
The November 13th Couch Potato published a December expiration TLT call spread
The call spread is approx. $1,100 in the black (see tables below)
$130 strike price short call delta is .0536 (95% probability this position will be profitable)
TLT Risk Analysis
We have not had the opportunity to execute a put spread, therefore the only risk is treasury bonds trending higher and threatening our December $130 strike price TLT short call.
GLD Position Update -----------------------------------------------------------
GLD closed at $165.16 on Friday â€“ the December position is approx. $1,500 in the black
The November 13th Couch Potato published a December expiration GLD call spread
The call spread is approx. $900 in the black (see tables below)
$174 strike price short call delta is .0477 (95% probability this position will be profitable)
The November 13th Couch Potato published a December expiration GLD put spread
The put spread is approx. $600 in the black (see tables below)
$161 strike price short put delta is -.1617 (84% probability this position will be profitable)
GLD Risk Analysis
The most probable risk is a continued downward price pressure on gold will encroach on our December GLD $161 strike price short put.
Anytime the market maker is willing to accept a limit price of less than .11 on one of our short strikes, buy back all the short contracts and sell the long positions on the same spread. However, if it is a few days prior to the expiration date, we may be able to hold out for a .05 bid.
If one of our short strikes is penetrated (closing price above a short call or below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.