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S&P 500: Time for a Trading Range?


Near-term upside may be limited, though worst news is probably already priced in.


Last week, the rally ran out of steam right at the S&P 500's 50-day moving average. This week, the question seems to be whether that 800 level still prove to be sigificant resistance.

This morning, the market has rallied sharply on hopes that the plan to clean up toxic assets will work. Of course, past bailout plans have also been greeted by relief rallies, but all
quickly faded when details -- not to say fundamental improvement in the health of the financial system -- failed to materialize.

Today, we've already seen both sides of that pattern. Stocks quickly came off their pre-market highs when the new plan was first released but then got a second wind. The marker is now making session highs after Geithner clarified that there will be no attachment to compensation packages. It also hasn't hurt that existing home sales came in better than expected.

But there are still big questions about pricing the assets, and just who will participate in the plan won't be known until early May. So while stocks may have moved some solid distance to lay down a decent technical base, the fundemental problems -- weak balance sheets, weaker lending, scarce capital, and shell-shocked investors -- should limit near-term upside. This could send the S&P 500 into a bit of a trading range, albeit a wide one, between 740 and 840, over the next few weeks.

But the feeling that the pieces of the fractured financial system are slowly being put back together -- and that the worst news is already priced in -- should bring some stability to the market.

The VIX has dipped some 7% to 42 so far today. If this rally can hold -- and given the very positive breadth, it appears it will -- the option gauge might close below 40 for the first time since late January. This could signal a further contraction in volatility, since it exploded through 40 last September, when Lehman failed and the wheels came off the market.

With the above in mind, I established a condor in the Spyder Trust (SPY) for the OptionSmith portfolio. The credit or premium collected was equal to the width between strikes, meaning the risk is equal to the reward. The position will benefit from both time decay and a decline in implied volatility - if the Spyder stays with 7% of current price levels, or a 14% range.
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Position in SPY

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