Are we going up or down from here? Great Option trades see COTW

Fellow Friends and Traders,

If you can remember as far back as March this year the U.S. stock market was coming from a structurally oversold level and an almost apocalyptic level of fear. We were staring into the abyss. In the course of the next five months with have discounted the "Depression", a Recession and we are on the road to discounting a full-blown economic recovery. How far we have come.

The news is now full of stories of 2-1/2%-3% 3rd quarter growth and were headed back to 1200, the pre-Lehman levels. Wow! All this is less than 1 year. Maybe? Meanwhile let the good times roll. I turned bullish on a dime. Once we cleared 950 there was really was nothing in the way to 1050-1100.

I have seen more than my share of bull markets over the last 48 trading years. That's a lot of wisdom my friends. This one will not correct hard without a serious outside event. So far, all declines are nothing more than an intraday event. Looking ahead from here, we are capable of maybe a 2-day drift down say of 30 or so points. Sep/Oct maybe back to the breakout area of 960. Right now all news is good but the rate of climb is rather steep and we could use some backing and filling before resuming the rally.

Barron's has a great interview with Michael Hartnett, Merrill Lynch's Chief global-equity strategist (now owned by BofA). He co-wrote a piece last month called ”The Recession is Over”. I’ll briefly cover a few of his more interesting thoughts. Remember I wrote or said in the Chat Room earlier that Chinese leaders put a figurative gun (perhaps even real) to the heads of their bankers with a message – in essence, lend until you drop. Hartnett writes and I'll summarize, “China's credit growth this year exceeds all the credit growth in the rest of the world combined.”  You should take notice of this massive stimulus.

Since China has no bond or debt markets as we know. This lended money landed mostly in real estate and equity markets. The equity markets just exploded and are up over 100% for the year. Hartnett fears that you can get a much earlier and a much more Draconian tightening of the Chinese monetary policy than is currently factored in. I recently noted that the Chinese market dropped 5% in one day last week on just those rumors.

He sees a still bigger risk that the recovery proceeds in a much more normal way than most investors are positioned. The usual look ahead says higher costs, taxes and whatever else facing the consumer. None of the will help next year. Remember I just want to know what can go wrong. Right now looks rather good given the current momentum.

My favorite financial columnist Doug Kass laments his negative stance of the last month or so and writes Friday, "After covering my trading shorts, I am going to contemplate the market dynamic over the weekend with the recognition that I have been wrong…and I don't want to continue to be wrong". He "alone" nailed the March low in print and on TV. I can't wait to read his thoughts on Monday.

For NET traders, we got lucky a few times this week. There was a put trade Thursday morning with 30-minute leading divergence, weak A/Ds and Tick readings. Puts went from $1.90 to $5.10 in a few hours. An overnight call trade goes from $1.40 to over $4.50. We had a rather good put setup into the jobs # rally Friday morning and scaling up or even re-entering into the 2:00 TOD trade down. Puts traded earlier as low as $0.75 into major sell resistance. There were some very profitable long hedges as well. A re-entry put trade hit $0.35 near 2:00 EDT and closed at $1.95. See attached "C" chart. The featured re-entry call trade is also featured on the attached chart.

I'm not aggressively recommending stocks at the moment but I do still like HUN long if under $5.50 or so and BAC under $15 using leap options. For now, I will focus on shorter term trades using ETFs (BGU and BGZ), OEX options and E-minis until there is a more favorable equity re entry.

As always keep those cards and letters coming.