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Sitting on the Market's Spike


Veteran traders understand that if there is one thing Hoofy can't do it is sit on a spike, the last few months notwithstanding.

Cause all you women is low down gamblers,
Cheatin' like I don't know how,
But, baby, baby there's a fever in the funk house now,
This low down bitchin got my poor feet a itchin,
You know you know the duece is still wild

Tumbling Dice (The Rolling Stones)

"Behind every great fortune there is a cirme"
Honore de Balzac

After Wednesday's large fourteen point stab down in the S&P, some well known option players proclaimed how wildly bullish it was that there were six times as many puts as calls on the session.

It's not a new phenomena: some proprietary put/call indicators have been jumping whenever the market falls; there's nervousness at the first sign of serious selling because veteran traders understand that if there is one thing Hoofy can't do it is sit on a spike, the last few months notwithstanding.

In any event, despite the table banging of these aforementioned well-regarded option players, in their face, the S&P doubled down, extending Wednesday's losses by retreating twenty eight points on Thursday. As they say, timing is everything.

We remember that, as Aaron Levenstein says, " Statistics are like a bikini. What they reveal is suggestive, but what they conceal is vital." In my experience, when it comes to the market, statistics are like a Brazilian thong on Quazimoto.

Is it possible that the relentlessly persistent market advance since the Feburary/March mini-crash on top a four year run in search of a ten percent correction, has made market participants more nervous than usual, feeling that any tug on the trend line could be the one that pulls the plug on the whole shebang?

In other words, the abundance of put buying versus calls doesn't necessarily reflect extreme outright bearish conviction or bearish bets on the market for that matter. Rather, the plethora of puts purchased as the market stabbed down may be seen in a somewhat different light---- a desire to protect substantial unrealized gains, ie. fire insurance. To be sure, fire insurance in a brush area after a muted rainy season. The dry timber of speculation is all the more vulnerable due to the lack of rains of retrenchment. In the vernacular, the harder they come the bigger they fall is a notion well tucked into the folds of seasoned traders' minds. The degree of fire insurance, the large numbers of puts being bought last week, may be better viewed as a function of exactly how loaded for bulls the Street really is.

The abundance of put buying may be viewed as a function of the reluctance to actually sell long positions in stocks. Instead, puts are purchased to protect against the downside and futures are sold. If the market stabilized, the leg is lifted on the short futures position and the market shoots right back up. I submit that the bulls don't really want to consider selling their stock positions--especially right in front of quarter end- loading up on protection instead--- and this actually speaks to the high degree of bullishness.

The bottom line is if you thought the table pounding by the big option dogs on the heels of the spike in put buying on Wednesday was an invitation to bid, then Thursday's 90% down day obliterated bidders.

After Wednesday's selloff I fully expected the Weekly Swing Chart to turn down on Thursday, but I was surprised to see the 1500 S&P level fold.

A) Last spring yields breaking out preceded by a stock sell-off into July

Perhaps the capitulation of Bond King, Bill Gross, aggravated Thursday's decline.
Be that as it may, the market was in a precarious position at Thursday's close with the S&P perched at its 50 day moving average and the possibility that the abundant puts at the 150 Spyder strike (and below) written to collect premium, could blow up in the arbs faces.

This is one of the reasons that I posted on the Buzz and Banter that if the market followed through on Friday, something was very very wrong. With thirty billion dollars of IPO's in the pipeline due in the next few weeks, quarter end approaching and the large number of 150 Spyder puts outstanding there was every reason to think the S&P would make a stand at 1500---with a little help from its friends.

Consequently, I wrote on Friday that I suspected if the market made a first hour low and stabilized, the S&P would recapture 1500 for the important weekly Friday close. If there was ever a time for the Presidents Working Group to step up to the plate, it was on Friday. Why? A big down Wednesday and a bigger down Thursday and another large decline on Friday going into an options expiration and breaking a key moving average (the 50 day moving average) with interest rates spiking on the heels of a blow off in stocks, is an all too familiar operetta from twenty years ago. If there was ever a day for THEM to squelch the Fat Lady warbling in the wings and earn their keep, it was Friday.

On Friday, the S&P made a first hour low, stabilized, and broke out late in the session, recapturing 1500.

In fact, the S&P did make a first hour low, stabilized and began to edge higher before exploding as rumors that a German company was interested in taking out U.S. Steel (X). How do you say "Working Group" in German? Just askin'. Hey, maybe it's for real---after all, X was up nine points. Or, maybe it's just a sign of the times. It will be interesting to see how the hype plays out.

Additionally, I suspected the S&P would recapture 1500 because the Thursday the week before options expiration is often times a misdirection day as to the true bias for option expiration.

The big, hot money is more attracted to making 1000% on options than a 20% move in a stock.

With the S&P index making a new multi-year closing high just last Monday at 1541, the 1500 puts were "cheap." By Thursday's close, 1500 calls were "cheap." Let's just say that during the week lots of premium was drained from both ends of the spectrum. After all, there is no rule against bluffing in high stakes poker. And let's face it, the history of the Street is paved with scroundrels, not choir boys.

It is curious that last week before the selling got rolling, Goldman Sachs capitulated on its call for three rate cuts before the end of the year. Morgan Stanley issued a "Full House" sell signal and Citibank issued a "triple momentum divergence" sell signal. Is that like double probation from animal house? These three little piggies rattled the market.

Last June ('06) 10 year yields peaked (A) as the S&P bottomed. However one year later it's a stark contrast as yields are spiking convincingly above (B). This is occurring with the S&P 300 points higher. Moreover, the breakout in yields are occurring from a 3rd higher low which often signals a powerful move. (C) Note how the breakout in yields in the spring of 2006 preceded the May high in stocks and retreated into July.

In any event the week went like Bluto after one to many Buds in Texas Holdem'. After a straight line up in May, a flush beat a full house.

I don't ever recall when Wall Street firms advertised and nailed a top. So, despite the trendline break last week, the S&P's convincing recapture of 1500 puts it back in a strong position. If the index can convert initial resistance at 1510 and then recapture its twenty day moving average at 1518, there is a better than average likelihood that the market will be up every day this week into Friday's quadruple expiration.

One thing is certain, the increasing volatility since May 23rd is just the appetizer to what promises to be a smorgasbord of volatility in the second half.

Lady Volatility is the Market's Mistress. Hey Na Ne Na, the girlfriend's back.
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