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SPX 1040 – IRS 1040 I don’t like either of them…

It was an interesting week for the markets. Earnings, though light, continued to impress and the US economic numbers were still mostly reflective of a recovering economy.

Form 1040
Image by theblog via Flickr

China scared the markets early in the week and then reassured the markets early Thursday morning which sparked a big rally. Europe was oddly lacking as a conversation piece. If you were to look at a weekly chart you might say, gee, seems like a quiet week. The daily chart would suggest otherwise. So, the biggest question is where are we headed from here?

Talking heads are speaking of excellent valuations (this is just a couple of weeks after the same talking heads were speaking of the market being overvalued…), buying opportunities. Eric Hale (coach extraordinary at OptionsAnimal), accurately predicted that we would close at least once at the “flash” Thursday low. So, now that we have tested that point and moved higher, the question becomes an even louder WHERE ARE WE GOING FROM HERE???

It seems like every answer has to be qualified with “it depends”… but it’s true. Lately, it has been the surfacing of unforeseen events that have caused the markets to truly move. So, IF Europe stays quiet over the long weekend, and IF China doesn’t threaten to see off Euro debt and IF….. I think that there’s a better than 60% chance that we’ve put in a short-term bottom and that the overall direction for at least the next couple of weeks is higher.

(chart courtesy of Trade Monster Brokerage www.trademonster.com )

Many had called for the rally that we saw on Thursday because so many technical signals were in dilating an oversold condition. Had there been a clear follow through on Friday, I think that many would be calling for a short to mid-term bullish trend. However, the downgrading of Spain’s debt by Fitch from AAA to AA+ was treated by the market as something new and ominous which in fact it isn’t. I think that the real reason that the market sold off in the final 10 minutes of trading on Friday was the concern of being long over a long 3 day holiday weekend. If your only options were to be in or be out, which would you choose? Out, of course! Too much uncertainty. Fortunately for us here at OptionsAnimal, we know how to hedge our positions so that we don’t have that worry.

Looking at the chart of the SPX, it seems that a base is forming and that the 200 day SMA is about to be broken. Look for Tuesday to be the day where that happens. Of course, the usual disclaimer applies – IT DEPENDS. If we have no major issues over the weekend (like a crazy dictator self-named the “Dear Leader” ) attacking one of their neighbors, or a major Euro bank failing, or some unexpected country indicating financial troubles, then we are likely to see Mutual Fund Monday (now a Tuesday because of the holiday) bring a lot of buyers into the market. If we do break the 200 day SMA, then I think that we are likely to move up to about 1130 in the near term. From there – we’ll see.

Another reason for this forecast is what has happened to the VIX over the past few weeks and the historical pattern when the VIX reaches these levels. Please look at the following 10 year chart of the VIX (compliments of Trade Monster www.trademonster.com )

With the exception of 2008 when the world WAS in fact coming to an end… when the VIX has spiked above 40, it tends to revert back towards its prior range. You can see the pattern several times in the past 10 years. So, will the pattern repeat this time? I think it likely, though by now you know what the disclaimer is!

So, I expect that we do in fact have a bottom, short-term, in place. Due to the uncertain times that we are in, now is not the time to take a decisive stand in either direction, but rather to stay hedged. As Greg Jensen (President of OptionsAnimal LLC) said this past Saturday; this is a great time to be into collar trades, married puts and in the money covered calls, but not unhedged positions. Unfamiliar with any of those? Contact us. An educated investor is a smart investor. Which would you rather be? Educated or not? Though so….

All the best and stay hedged – at least for now!

Jeff McAllister
OptionsANIMAL Instructor

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