Bears On The Prowl…

The market can turn on a dime and as an option trader you have to be prepared for it.  We have been following the market closely and over the last few weeks we have been telling you that it has been searching for direction.  We have seen the Dow run from a low of 6,440 on March 6th to a high of 10,157 on October 20th/ 21st.  Before we got to the March lows, we were calling for a bear market once the Dow fell below 10,000 in October 2008.

Basically, a year later, we are right back where we started.  We use a lot of clues to help us determine market direction and we are still uncertain of the next MAJOR leg up or down but we have been telling you that the bulls have been running out of steam.  That doesn’t mean the bull run we have had is over it just means as option traders we have to be a little more careful.

Our trading philosophies are pretty simple and when we are in this transition phase you can still play both call and put options.  Last Wednesday we had this to say:

“We mentioned the Dow trying to hold the 10,000 level and more recently the 9,900 level.  We also had a short-term target of 10,300-10,400.  Remember, we have been calling this market rally since March and in July when the Dow was under 9,000 we were calling for Dow 10,000 before anyone even had a clue.  In August, we said September and October might not be that bad.  It is still hard to believe we have almost made it through the month of October without some kind of correction though as it is notorious for some of the greatest market corrections of all time.” (END)

Well, on Friday, the Dow ended October with its biggest loss of the month as it tumbled 250 points to finish at 9,712.  The low was 9,664.  Was that an omen?

It was an ugly day but it was a GREAT week for our subscribers as we took advantage of our own “writing on the wall” and recommended buying put options on stocks that could be caught in the back draft.

We banged out some incredible returns as an Abercrombie & Fitch (ANF, $32.82, down $1.41) put option trade we profiled hit a 111% return.  A First Solar (FSLR, $121.93, down $0.45) put option recommendation was stopped out at 100% return but many of you made upwards of 200%-250%!

One of the trades we wanted to review was a Radioshack (RSH, $16.89, down $0.40) play on earnings.  We recommended the November 15 calls (RSHKC, $2.10, down $0.02) on Friday, October 23rd and that Monday we told subscribers to sell into strength.

That’s it.  trade over.  Those same put options were at $1.20 and we closed the trade at $3.10.  They are still up 75% but they were closed for over a 150% return.  Can you see how they are slowly deteriorating?  New option traders may be holding onto these calls hoping Radioshack was going to make a run to $20 but given the market conditions and the fact these options expire in less than three weeks it appears the stock is headed towards $15 rather than $20…

The point we want to make is that given the current environment we are leaning towards profiling more put options rather than call options but that doesn’t mean we have given up on the bulls.  However, the Dow recently broke through its 20-day moving average and is on the verge of breaking its 50-day MA.

Now that the bears have momentum on their side it appears the Dow could test 9,500 this week.  If that fails, we could see 9,200-9,300 quickly.

As for the S&P 500, we were watching the 1,100 level and that has proven to be a brick wall for the bulls.  They made a push prior to last week as the index reached a high of 1,101 on October 21st but they could not break through in convincing fashion.  Friday, the S&P fell 30 points, or 2.8%, to close at 1,036 and the picture doesn’t look any better than the Dow’s.  If we break below 1,000 watch for 980 to hold but if that is penetrated the we could see the 900 level come into play.

The Nasdaq fell over 50 points and finished Friday at 2,045.  As you might expect, the bears are trying to push the index back below 2,000 and 1,925 could easily come into play.

We had back-to-back days of the Dow trading up or down 200 points which shows you the volatility is picking up.  Wall Street already has the bulk of earnings under its belt and is looking ahead to 4Q earnings and 2010.  There are still plenty of earnings due out and we have some big ones this week.  However, we also have some economic news that will play an important part on which direction we take from here.  If we do get a bounce then our near-term target would still be Dow 10,300 but that looks like a long shot.

We will be back in the morning with the current trade updates that will be available in the Members Area and the companies reporting earnings.  If you are not a current subscriber you can catch tomorrow’s updates by subscribing now.  With the market searching for direction we are poised to capture some big returns.  If you don’t believe you can make triple-digit returns in this type of market just take a look at what we accomplished last week….