Last night the market direction outlook for today was a market sitting at the crossroads. The push away from the 50 period exponential moving average (EMA) yesterday, seemed to mark a reversal for the market direction correction. By 11:30 today the Dow was already up over 200 points and the S&P 500 was up $18.91 or more than 1%. So is this the end of the correction? Just as in April it may appear that the markets have withstood another shallow test and are moving higher. So what’s driving this market direction rally back? The answer in my opinion is the Fed.
Bernanke Put Continues To Hold Market Direction
The Fed Chairman Ben Bernanke advised that the Fed was looking to scale back its bond buying program which would essentially mean a retreat from Quantitative Easing which has been part of the Fed policies since 2008. This announcement caused the recent decline in stocks. The unemployment numbers today were not spectacular but at the same time show anemic growth which is exactly what investors hope will delay any reduction in quantitative easing by the Federal Reserve.
The Fed Chairman has indicated his desire to keep the Fed policies accommodative until unemployment is down around 6.5% or inflation is half a percentage point above 2% two years out. Today’s employment numbers continue to convince investors that with unemployment edging up to 7.6% and no signs of inflation on the radar, the Fed will remain accommodative longer than the summer period and possibly even into the fall or dare investors believe into 2014. In other words, the Bernanke Put remains on the market direction longer.
Market Direction Game Of Chicken
Today’s market direction is like a “game of chicken”. Investors want to stay in the markets as long as possible trying to keep pushing market direction higher and racking up profits but they all hope to get out before an expected market direction tumble when the reduction of quantitative easing starts or its effects are felt by markets. Investors in general seem to believe that the Fed will not allow stocks to collapse at this stage of the recovery.
Market Direction and Put Selling
In this kind of market direction environment volatility will remain with investors allowing Put Selling to continue to bring in substantial gains but I believe a solid strategy must be used. That strategy has to include:
- Staggered selling of fewer put contracts at strikes closer to at the money and more put contracts out of the money to boost the overall month return
- Careful use of margin. Margin should be used only on far out of the money put contracts in the event that the market corrects more significantly than expected. A significant and swift market correction can send stocks lower quickly and assignment of too many contracts can mean margin calls.
- Staying with large cap dividend paying stocks that have a history of recovery from corrections are safer bets
- Limit use of Put Selling against speculative stocks to just a small handful to protect the overall portfolio from losses in the event stocks pull back harder than anticipated
- Closing naked puts early when put premiums fall to mere pennies to remove risk of assignment and lock in profits.
- Following stock fluctuations more carefully to sell puts when a stock pulls back or “dips” and then buying to close these sold puts when the stock recovers. Repeated use of this strategy often makes for significant gains and helps to control risk by limiting the amount of capital that is committed to a position to a shorter period of time.
- Stay with large cap stocks that you would own if assigned shares.
- Consider using in the money covered calls at the first sign of stocks falling significantly (break of 50 day support)
- Have a rescue plan in place before entering a trade.
- Keep more than the usual amount of cash available for rescue strategies should stocks fall and naked puts need to be rescued.
- Consider credit put spreads but close them early rather than keep adjusting them to accommodate stock movements.
- When doing credit put spreads consider increasing the number of contracts done to increase actual income amounts when they are closed early to lock in gains. Again, I would not adjust positions but close them to lock in profits, then reassess.
No Reason To Wait For Correction
In the environment that we are in, I see no reason to sit on the sidelines and wait for a hoped for correction in market direction. It is important to understand that stocks are manipulated all the time. As a retail investor I realize that the market is always stacked against me. Insider trading, stock manipulation, leaked earnings and much more have always been a part of stock markets and will not change. But through using option strategies and staying with big cap stocks I can continue to earn profits and income while protecting myself as much as possible from manipulation. I know that in any market environment, bull or bear, I can continue to profit through carefully studying the stocks I trade.
The 3 keys are:
- watching for revenue changes
- watching for product changes
- continue to monitor stocks through technical indicators that pinpoint events like:
- accumulation or distribution
- oversold and overbought
- unusual volume activity
Overvalued Stocks
Today’s market direction action shows that the majority of investors, institutional and retail are committed to this market until the Fed scales back liquidity.
In my opinion most large cap stocks are now overvalued but that does not mean I have to stop Put Selling or discontinue my stock and option strategies. It simply means that I need to remain aware of the risks of committing capital to this market and follow the tips I have listed above to continue to generate income. It also means that I need to use the Spy Put Options for downturns to keep building up my cash cushion for when a full correction finally comes and to always have a rescue strategy in place before I commence a trade. In other words, I always have an “out” to protect against capital loss.
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