Morning Commentary for Monday, November 1, 2010

by Steven Chanin on November 1, 2010

Good Morning SOM traders…Let me start by apologizing in advance for this morning’s rather lengthy commentary. For those of you who already heard me describe in webexes last week this unusual market situation I ask a little forbearance…

We have been in a news driven market for almost 2 years with events over shadowing traditional market moving factors such as earnings, PE ratios, fundamentals, economics and technicals. This week we have 3 major news events coming our way: the election results, the FOMC statement and the Monthly Employment (jobs) report. Each requires a short commentary (below). Unlike most market moving news that blindsides traders forcing them to react rather than anticipate, traders have known these events were coming for weeks so collectively these events have created an “earnings event” for the overall market with the market steadily moving higher in anticipation. The “main event” is on Wednesday with the combined election results and FOMC statement. Will the markets make a big move Wednesday? No one knows BUT these events are an additional risk factor to be considered when evaluating your positions or before initiating any new trades other than spec.! It’s up to each trader to decide what, if any, protective action to take on existing positions before Wednesday.

What happens in a typical earnings event? Why do we do VIPES and stay out of corporate earnings unless making a spec. play? Because our income strategies do not make money in the week(s) leading up to the event. Neither front month strategies (Butterflies, Condors) nor time spreads (Calendars, Diagonals)! In an earnings event all of the action is in the front month so the front month volatility goes up (bad for short Vega front month strategies). You would expect positive Vega time spread strategies to do well BUT they also suffer because the back month volatility does not move as much as the front so the skews deteriorate. The shorts in the front month lose and the longs in the back month stay flat or lose due to their negative Theta and the lack of comparably increased volatility. Prices tend to stagnate or drift higher waiting for the event and most of the expected gain from Theta is offset by rising volatility. If prices do move up, volatility moves up along with them. So we are not being rewarded for the risk we are taking. Last week the NDX made a small move up but the VXN moved up with it and while the other indexes were flat their vols. went up as well. Is there a play? Buy the rumor, sell the news? A bit late to the game for that. Sell the high front month and buy the relatively cheap back month expecting to cash in when the vols. revert? The vols. WILL come out by the end of the week and the skews will normalize but remember that price movement always trumps volatility. What’s left are spec. plays.

On to the events (in order of occurrence): The election results (announced Tuesday night with market impact Wednesday, BOM): The pundits and polls show the Dems. losing the House and possibly the Senate. Gridlocked Washington is good for business/the market so the market has “factored that in” and moved higher. The risk is an unexpected result where the Dems. keep control of both houses. Next the FOMC statement (also on Wednesday, at 2:15 EDT during market hours): Why is this FOMC announcement different than those in the past where the focus was on setting rates and the inflation outlook? The Fed (Uncle Ben) announced in the last meeting that the Fed still has ammo to boost the economy and create jobs. They also want to increase inflation to avoid deflation. The ammo? Monetize debt (Quantitative Easing) for a second round, now called QE2. This anticipated flood of liquidity, a potential put on the market, is what has really fueled the run-up since the last meeting. Conspiracy? What about creating a rising market into the elections to off-set the bad economy and help the Dems., with the actual statement coming after the elections? The big question – What will the details in FOMC statement contain? What will be the scope and duration of QE2? The anticipated ½ $Trillion over 6 months? More (some predict as much as $2T)? Less? Will there be a knee-jerk reaction in the market, one more lasting, or no reaction at all? Finally, we get another Monthly Employment Report (Friday at 8:30am EDT, BMO) which, after the Wednesday “event”, is a little end-of-week kicker that can move the markets yet again. While we’re at it there are also Personal Income (BMO) & ISI Manufacturing (10:00 EST) on Monday and Durable Goods on Wednesday (BMO) so really 6 events in all but with a “Big 3”. It should be a very interesting week!!!

Overnight the Asian markets were sharply higher, up over 2% and at the time of this writing Europe is mixed and the US index futures are higher indicating a higher opening today.

Technicals…While technicals take a back seat to news this week it will be interesting to see where any potential move due to news places us with regards to the technicals. Last week the SPX, DJI and RUT were flat and the NDX made a small move higher. There was some intra-day movement but dips were bought and moves higher sold so the candle bodies were tiny with long tails and the markets traded in a tight range all week waiting for this Wednesday. Here is what I see for technical support/resistance:
DJI: support $11,035 (20 EMA) resistance $11,207 (prior swing high)
SPX: support: $1,171 (20 EMA) resistance $1,210-$1,220 (prior swing high)
NDX: support $2,074 (prior swing low), resistance $2,234 (pre 2008 swing high)
RUT: support $695 (20 EMA), resistance $720 (prior swing high)

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{ 1 comment… read it below or add one }

Robert Kafarski November 1, 2010 at 8:24 am

Thanks for that analysis Steven.

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