Trading the Triangle - Day 5
Monday night, I was expecting the market to rally and did indeed make a nice profit playing it from the long side. However, I was looking for a two-day rally rather than the one-day monster that we had on Tuesday. Take a look at how SPY moved from the lower trendline (black) of its ascending-triangle pattern nearly all the way up to the top resistance line (blue). Click the enlarge:
Many analysts are attributing the big rally to the FOMC’s allegedly dovish statement. While I predicted a dovish tilt from the FOMC, I now agree with Tony Crescenzi of RealMoney.com who points out that the Fed devoted an entire paragraph solely to their inflation concerns.
So, the big rally was less about the Fed than it was just another sudden, sharp, short-squeeze rally that are typical of bear markets.
The Fed is going to keep on doing what it has been doing: loaning to deadbeat banks while squeezing the money supply to kill commodities. Evidence for that could be seen on Kudlow last night. Former Fed Head Wayne Angel was on, and the man was practically doing a jig because he was so euphoric over the collapse of commodities. Central bankers across the world are probably just as giddy.
Politically, the Fed cannot raise rates as job losses mount, but that doesn’t mean that they can’t fight commodity prices. So, if you are thinking about playing commodities for a bounce, just keep in mind that you have a very powerful group of people lining up a red laser-dot between your eyes.
Even with all the hoopla, SPY’s volume was barely acceptable. In an ascending-triangle pattern, you want to see heavy volume on the up-days and light volume on the down-days. And as you can see on the chart, Tuesday’s volume was below the recent average.
I think what is happening is that the traders who think that the bottom is in and want to be long are only buying at the black line and pulling their bids as prices run up to the blue line.
Even though I am critical of Tuesday’s rally, the larger ascending-triangle pattern must still be respected. It is a very bullish pattern.
The Q’s, which had lost their up-trend line on Monday, have fought back into their ascending triangle:
While the volume was weak here too, Cisco reported a good quarter after the bell and the NASDAQ-100 futures soared by about 0.5%. That gain is sticking as I write this. Cisco cut back their usual one-year guidance to only six months, and that tells me that they couldn’t think of anything good to say on the prospects for the next four quarters. So, I think the gigantic surge in their stock price in the after-market might be a bit over-done.
Nevertheless, the gains in the futures look like they are going to stick, and the Q’s could gap-up and over their blue line at $46 Wednesday morning. If so, I think the market would be too overbought at that point to try and ride along. Rather, it might be better to wait for the Q’s to come back down and test the breakout at some point in the near future and then perhaps go long at that point.
The IWM had the weakest volume of all, failing to exceed Monday’s down-volume:
Also notice how the black up-trend line is now a resistance line. The IWM’s performance is a concern because it has been leading this rally. Notice also how the pink down-trend line from the October high is getting closer. And finally, the IWM lagged the market all day Tuesday, and only reluctantly caught up during the last half-hour of trading. I think there was a contingent of shorts fighting it who were forced to barf-up before the close. They were probably a bit early in their timing.
So, this up-leg is looking a bit tired, and I am looking for an exhaustion gap led by the Q’s tomorrow morning as a good short-side entry point for another trip back down to SPY’s black up-trend line.
Some Notes From Bespoke
A chart of the plunging Baltic Dry Index.
Consumer-discretionary stocks are now just as bad as Financials profits-wise. Now, when Larry Kudlow shouts that profits are just fine when you ex out financials, he will have to work twice as hard to keep that particular line of BS going!
August 6th, 2008 at 4:42 am
Matt seems to me the rut leads up and down the trends in the market,that is the way it has seemed the last few years that I have been watching the correlation
August 6th, 2008 at 7:43 am
Paul - re the vix calls : best of luck with the trade. I read over your thoughts and am curious to se how the trade works out for sure. A couple things, with 2 weeks left, won’t you lose through option decay about 20 cents per trading day ? I guess that is obvious. What might be less obvious is that say the VIX is at 22.50 later today. Will the bids for your options match the $ in the money ? I’m not even sure of that. That is one thing I’d like to know, if you do ca$h in these today, how you do on your price relative to the level of the VIX.
Should the VIX jump to an unrealistic amount of 50 today or Monday, I’m pretty convinced these options won’t necessarily fetch the full $ 30 value that one might think.
Anyway, lets see how you do and good luck!
August 6th, 2008 at 8:16 am
Matt-
On the daily chart the SPX shows an A-B-C-D-E wave
pattern. On the weekly chart it shows an A-B-C pattern.
The SPX closed at 1284.88 yesterday and is testing the
prior high of 1284.93. The next test comes at 1291.17.
Success is bullish…failure is bearish. One never knows
where the top will be. If wave C equals 0.618 of weekly
wave A, the top will be in the 1290 area…if wave C equals
weekly wave A, the top will be in the 1325 area. I agree
with other comments about the time…8th to 11th of
this month…with a low around the 28th and a rally
into Sep 11th.
August 6th, 2008 at 8:41 am
Thanks everyone especially Matt , Paul and Yerk .
My dog getting sick is distracting me from more
important things like sleep and money .
August 6th, 2008 at 8:43 am
still nervously long etf SKF
August 6th, 2008 at 8:47 am
Baltic Dry -2.85%. Fall is enormous. Down 19 days in a row.
August 6th, 2008 at 9:01 am
“The market rose sharply on Tuesday, but we only had 1027 stocks making fresh 20-day highs against 868 new 20-day lows across the NYSE, NASDAQ, and ASE. That is fewer new highs than we saw during the prior market bounces in July.”
Brett Steenbarger
August 6th, 2008 at 10:38 am
Hi after,
I think I’ll lose close to $.10/day. The VIX itself is so volatile, that this is insignificant. If I’m right about the direction, I’ll do fine. The VIX hasn’t moved much so far.
VIX options trade very strangely when you first see them. This is because of two reasons:
1) VIX is a mean reverting index. So if VIX is much higher than average, the closer expiration months will have more expensive calls and cheaper puts. If ithe VIX is much lower, than closer calls will be cheaper and puts more expensive. This is because it is expected that the VIX will move towards its mean over time. With other options, closer calls and puts are both cheaper.
2) VIX options are european style. This means that they can only be exercised on the day that they expire. So you are purchasing the option based on what the VIX will be on expiration day. So options farther out aren’t as affected by moves in the VIX. You asked about jumps in the VIX. It is true that these jumps don’t get fully priced in the option. This is because when the VIX spikes, it is very likely to level off within a week or so (particularly when a VIX spike means a big financial problem that the government is eager to try to fix to help their fat cat friends).
You are right in thinking that VIX options can actually sell for less than their intrinsic value. If the VIX spiked to 30 today, I would expect the VIX to be in the 25-28 range in two weeks (at expiration), so my option would probably be selling for 5-8. As another example, when the VIX dropped to 16 in May, I think 25 puts were selling for $5: $4 below the the intrinsic value.