By watching from the sidelines we probably saved some money last week. The expectations were for another down week and that is exactly what we got.

The Dow and S&P have now posted losses for six consecutive weeks. That is the longest string of losses since 2002 when the Dow declined -15%. The down trend may not be over despite the current oversold conditions. The indexes broke below critical support on Friday with the Dow closing under 12,000 and the S&P under 1280. Both have broken into an area that lacks further support without another drop.

The S&P closed at 1271 and the next material support level is 1250 with the 200-day average at 1253. The Dow is worse with no material support until the March lows at 11,600. The 200-day average at 11,687 could provide a pause point but the Dow does not seem to respect averages as well as the S&P due to its thin 30 stock composition. A single stock can push the Dow 10 points in either direction with just a mediocre move.

Dow Chart

S&P-500 Chart

The Nasdaq has declined -7% since June 1st to close at 2644 on Friday. The Nasdaq will reach its March support lows at 2615. Unfortunately the Nasdaq is suffering from a bad case of big cap flu. The major big cap stocks are very weak with Google closing at an 8-month low on Friday and Apple a 6-month low. Until these major Nasdaq components find a bottom the index will continue bleeding points.

Nasdaq Chart

The Russell 2000 is going to be our coalmine canary next week. The Russell closed at 779 and just a heartbeat above the Jan/Mar support lows at 770-775. The 200-day average is right at 770 making that five-point range crucial for support. The Russell is the sentiment indicator for fund managers. If they are going to buy the market dip this is where the buyers should appear. If the selling continues, -1.7% on Friday, this support will fail and that could setup a major sell signal with a break of the 200-day average. Normally the 200-day average on the Russell and S&P are strong mutual fund buy/sell signals.

Russell Chart

There is also the possibility of a major rebound due to the oversold conditions. However, the +133 Dow short squeeze on Thursday was cut in half by day's end and then obliterated by the -172 point decline on Friday. We may be oversold but the odds of become even more oversold are still good.

The economics for May were very weak and that put fear back into investors anticipating a double dip recession. Analysts believe the economic weakness was the result of the broken Japanese supply chain that slowed U.S. auto production dramatically and forced thousands of layoffs. The thousands of companies that manufacture parts for autos in the U.S. were forced to layoff people as well until auto production restarted and erased the sudden backlog of U.S. parts. We also saw gasoline reach $4 a gallon again in May and that forced consumers to leave the malls and stay home rather than pour hard earned money into their gas tanks.

Gasoline prices have declined to $3.70 but would need to drop another 50-cents to reflate consumer sentiment. Japan is nearly back to full production as are U.S. automakers. How much this will improve the June economic reports is unknown. It may take another month before the recovery is reflected in things like the ISM reports.

I hate to not recommend any plays for a second week but writing puts is a bullish strategy for bullish markets. Writing calls when the market is this oversold could also be disastrous. Sometimes the right play is no play at all. If conditions change I will add some plays during the week but after Thursday's squeeze/reversal it will take more than one positive day to convince me it is safe to go back into the market. There is always another trading day ahead as long as you have ready capital to trade with. Forcing plays when conditions are not right is a good way to lose that capital.

Jim Brown

Current Portfolio

Current positions

Current Position Changes

6/6/11: MCP - MolyCorp (Stopped)

Molycorp declined sharply at the open on Monday to hit our stop at $61.50 and give us a -$1.49 loss on the position after deducting the $1.50 gain on the depreciated call.

6/6/11: NVDA - Nvidia (Stopped)

Nvidia also hit our stop at $18.35 on Monday to close the option at $.37 and a gain of 82-cents but it was offset by the -1.53 decline in the stock to give us a net loss of -71 cents on the position.

New Recommendations

None until a positive market trend returns

New Long Term Recommendations

None until a positive market trend returns

New Aggressive Recommendations

None until a positive market trend returns

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)

Prices Quoted in Newsletter

At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.