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Markets to Watch
Look for Opportunities in S&P E-MINI
Given the sharp run-up in stock prices over the last month, it would appear that the equity markets are well on their way to factoring in the prospect of an economic recovery. But we also see signs that could lead to investor disappointment in the weeks and months just ahead, and that raises the risk for a significant correction in stock prices into the fall. With the September S&P rallying nearly 52% from the March low and more than 15% in the past month, it would also seem like the market is minimizing a large measure of risk and uncertainty that remains in the economic outlook. While a portion of the recovery action in the stock market is probably justified by the mere avoidance of an all-out economic disaster, seeing another extension of the July rally in equities would seem to raise the recovery bar on the economy to an extreme level.
With the S&P managing its big increase in such a short period of time, it is clear the investment community has taken a “glass half full” view on the economy. Part of the bullishness is based on indications that economic conditions are starting to contract at a slower rate, which seems to be raising speculation that the economy is starting to stabilize. This outlook lifted the S&P back towards 950, a level where valuation concerns began to surface ahead of the second quarter earnings reports that caused an 87 point break into the July low. Seeing better than expected corporate results has now turned economic optimism into a euphoria that doesn't seem likely to hold.
First of all, the majority of good corporate earnings this past quarter have largely been due to cost-cutting measures, including a reduced work force, and not the result of increased sales or revenues. We think this raises the odds for disappointing third quarter results. With widespread agreement that the unemployment rate will continue to rise in the months ahead, it is hard to imagine that a strong consumer-based recovery is imminent. Therefore, we expect that it will become increasingly difficult to justify equity values at the current levels unless companies start to see “organic” growth.
Economic optimism stemming from the Cash for Clunkers program may also begin to lose some of its luster, as it seems to be just pulling demand forward by incentivizing these big purchases now rather than later.
Now that the earnings cycle is past, the July employment report may act as a reality check for investors. With the S&P climbing over the 1,000 mark last week, it seems as if the market is starting to price in a “V” shaped recovery with ideas that economic conditions will start to improve at a quicker rate. But considering the rising trend in unemployment and higher tax rates on the horizon and with the bulk of the stimulus package not set to hit until late next year, a robust recovery will be a tall order to fulfill. Therefore, the 1,000 point level in the September S&P is looking more like an over valuation point.
But the pace of the economic recovery may not be the only stumbling block for the bull camp. In addition to the potentially overvalued condition in US equity prices, it would seem like the H1N1 swine flu virus has hung around a little longer than might have been hoped. The World Health Organization declared the H1N1 swine flu virus a global pandemic on June 11th, and this could bring about a quick resurgence of economic concerns and anxieties if cases begin to escalate during the flu season that officially begins in November.
Going forward, it will likely become increasingly difficult to impress the stock market, especially with a variety of short-term technical indicators that also show the S&P has reached an overbought extreme. With the September S&P becoming fundamentally overvalued last week, we think the odds for a significant setback are climbing, as we doubt that enough bullish headlines on both the corporate and economic news front will be seen to keep the market supported at these high valuation levels. Therefore, we feel the timing is right for traders to consider a short leveraged position in the S&P e-mini put options, especially since bullish sentiment has aggressively deflated values of longer dated put options.
We call this strategy a swine flu play. We’re using short premium in the near to expiration August S&P puts to finance a leveraged further out of the money November put position. If the market extends the summer rally, traders can take profits on the short August put position. If the stock market starts to top out quicker than we expect, then traders might able to successively lift one long put and in turn reduce the amount of premium exposure. Given recent deltas, traders with this position will initially have a net spec short position of 12.5% of an E-Mini futures position. In the end, this strategy offers traders an opportunity to position for a autumn correction in stock prices.
If you’d like to receive daily information on the S&P E-mini market, click here.
Suggested Trading Strategy:
- Buy 4 November S&P E-mini 825 puts for 12.75 points or better. Once they are filled on the long November puts, traders should look to sell 1 August S&P E-mini 985 put for 15.00 points or better. Risk the entire position to a net loss of $1,200. Use an objective on the short August put of 2.00 points and an eventual objective of 34.00 on the long puts. Traders should not exit more than 1 long put without first exiting the short August put position!
If you’d like to further discuss this strategy or determine the best way to execute it, contact us.
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Industry News
Expectations For Recovery Entrenched
In looking at the recent action in the stock market, it would seem like the expectations for a recovery are becoming entrenched. Given the lingering job loss fears, one could even suggest that the equity market is somewhat comfortable with a “jobless” recovery. While some of the early August euphoria was the result of positive fanfare off the Cash for Clunkers program, there does seem to be a similar improvement taking place in the US housing sector. The US financial sector is also healing nicely off the yield curve gift from the US government. Therefore, it appears that the really big trouble spots in the economy are at least temporarily out of danger.
Certainly worry-mongers continue to express concern for the commercial real estate sector, while others continue to insist that the US consumer lacks the capacity to foster a normal recovery. But with crude oil prices recently reaching almost $13 per barrel above the July lows and as much as $28.80 above the February lows, even the energy markets are sensing some type of sustained recovery ahead. There does seem to be fundamental evidence behind the sharp gains that have been seen across a number of physical commodity markets since the July lows, but the biggest question might now be just how strong the recovery will be and whether it will be consistent. We also think that the stock market in particular will have valuation issues, as investor expectations will periodically get ahead of reality.
One also has to be aware of the potential for a surprise wave of selling in commodities in the event that the CFTC, under pressure from Congress, decides to take aggressive action to stem speculation. Apparently Washington thinks they know the true value of crude oil prices and that the markets are inaccurate. While the recent hearings didn’t seem to give much credence to classic fundamental supply and demand forces, it was painfully evident that the regulators didn’t see anything odd about the unusually low US refinery operating rate that has settled into the energy sector. In other words, it’s easier to blame speculators than it is to acknowledge that a monopoly in the refinery sector is contributing to higher energy prices.
Given the way the wind has been blowing in Washington, one has to anticipate action that discourages open markets. With oil prices recently falling back to levels just above the cost of Canadian tar sands oil and corn prices for 2009 delivery spending most of the month of July below the “cost of production,” we just can’t accept the argument that certain commodity prices are artificially inflated. In the end, a forced liquidation of certain commodities is probably going to reduce supplies for 2010, and a number of physical commodity prices are going to rise sharply, even in the face of the new aggressive anti-speculation measures!
In looking at recent Commitments of Traders report, there are several markets which appear to be technically overbought, and those markets might not tolerate much in the way of macroeconomic adversity in the weeks ahead. Markets with a burdensome net spec long position are gold, RBOB gasoline, heating oil, feeder cattle, palladium, platinum and sugar.
Keep a pulse on the industry and access more industry news.
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Exclusive Article
The Footprint Chart from Market Delta
By professional trader Ramon Barros
The Footprint Chart from Market Delta is one of the truly significant breakthroughs in technical analysis. In this article, I shall review some of the ways that I use this unique software.
But before I do that, it is important that I provide a context to my comments.
Why does a trader use something like the Footprint Chart from Market Delta? The answer is simply that we are looking for a measure of trading success. Unfortunately, in our day, effortless, instant success is promised almost daily. But the fact of the matter is, trading success as a function of:
Winning Psychology x Risk Management x Written Plan
Something like Footprint Chart is useful in the context of a trading plan; but a trading plan without winning psychology and risk management is like a ship without a rudder - ultimately, we will not reach our destination.
To continue reading, please click here.
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| In This Issue |
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| Trading Tip |
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Use technical signals (charts) to maintain discipline.
The vast majority of traders are not emotionally equipped to stay disciplined without some technical tools.
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| Did You Know... |
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One of the significant advantages that floor traders had while most of the trading volume was still conducted there was order flow.
They could visually see which brokers, firms or traders were conducting business and how aggressive the buyers or sellers were at those price levels.
Discover how to bring the secret of floor traders to your screen!
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FREE TRIAL - Visually monitor the buying/selling pressure with the Footprint plug-in for dt Pro
With the Footprint plug-in, you can “see inside the chart” and monitor if the buying/selling pressure is fading or increasing significantly as it approached your price level.
The Footprint chart will show the trades at the bid and the offer, both on a cumulative basis for the day as well as for your chosen time frame.
Your complimentary two-week trial grants you access to the dt Pro platform AND the Footprint plug-in.
This information just might give you the detail needed to move a stop order and remain in the trade. It could also provide the information needed to initiate a new trade if you are not in the marketplace. It could turn a potential negative situation into a positive trade.
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About Daniels Trading
Daniels Trading is a relationship-focused commodity futures brokerage located in the heart of Chicago’s financial district. Founded in 1995, we have a history of providing effective and reliable trade executions to both individual traders and institutional investors around the globe. In addition to our focus on relationship and execution, Daniels Trading is a leader in providing ongoing education opportunities and resources for our customers.
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