I expect the US markets to open lower tomorrow, with the S&P 500 dropping 0.5% to 1.0% fairly quickly. There are a lot of people still understandably nervous about the stock market after the last two years, and I suspect the speed of this correction has surprised them. People forget that any real drop-off in the market tends to happen at 2X the speed of the climb. After missing most of the action last week and worrying about the market over the weekend many people will just want out.
I didn’t see any news that warrants a different view of the economic environment. Google and Intel reported good numbers, and overall the financial section reports didn’t justify a rush to the sidelines. Of course, if congress really does what Obama is asking, and restructure the worst offenders of the “too big to fail, but now giving outrageous bonuses bunch” , they will get hurt, but this is hardly going to be a quick thing. Congress can’t even move quickly with a (former) super majority in the Senate.
In my opinion this was just a long overdue correction. After a early sell-off Monday, I expect things to stabilize, and recover to close around even for the day. The market rarely does strong “V” type recoveries, so I doubt the market will start making significant positive progress for a couple of days–of course if we go into a bear phase, things will be much different. If things do stabilize I expect that the market will recover at least half of the general losses by the end of the week.
Most of the time I don’t trust my own predictions enough to try to day trade off these short term prognostications–but I think it is a useful exercise to take a position and try to defend it.
I’m about 90% cash right now, so I avoided the pain of this particular blow-off, but I’ve found that avoiding the bear is just one step–you have to jump back in to get the gains.
Short term I looking at a bear spread on VIX options, selling deep in the money calls, and buying calls in the 27.5 to 30 range as disaster insurance. The drop-off on the VIX once the fear subsides tends to be pretty rapid. Of course, VIX options don’t get you the full action of the VIX index, but percentage wise it is still pretty dramatic.
I also plan to do covered calls on USO, it is nearing its support levels at $36.
The increased volatility is making SPY covered calls more attractive, but I will be cautious because of the risk that I will be wrong about this being just a moderate correction.
