Quite a Wall Street day, the DOW down 362 points. Worse, it trended down all day and ended very close to the low, which does not augur well for tomorrow. I said on Tuesday of this week that the market might sell off without a 50-point cut in the FedFunds rate. I didn’t really expect a one-day sell-off of this size, but the point of the post on Tuesday was that the market is quite volatile, and ahead of a rate cut - you just never know. And truth be told, it might have sold off no matter what.

Interestingly, there are almost always stocks that are up on days like this. Microsoft was up today; not much, but up. Regarding my “Witch Hat” post from yesterday, I think MSFT is going to stick at the higher price level. If it didn’t come down today…

A lot of covered call writers like to write on these pullback down days, because you can get an artificial pop as the stock snaps back with the market. The key is that the stock is down with the market. If the stock is down on its own, or the stock (like MSFT) isn’t down with the market, then the rationale for a down-day write is not present.

This pop is quite real and we see it on larger time frames, as well. Look at just about any chart over AUG and SEPT this year. From the market bottom, stocks commonly rose with the market although volume didn’t increase for most stocks. That is, the stock pricess rose as volume fell, normally a bearish divergence. But when the market comes roaring back, divergences be damned - they just don’t mean much, because most stocks have then become lighter than air.

Which brings us back to down-day writing: when the market snaps back, good stocks will spring back with it. If you have been buying back short calls with the market’s fall, and you should be spanked if you haven’t, don’t rewrite the stocks just yet. Wait and write at a higher point. The down days are also a great point to get into a stock (some covered call gurus believe you should only write on down days), since you can either 1) write an OTM call and expect an easy assignment, or 2) leg in by purchasing the stock and writing calls at a higher stock price.

Now to the fun part: wait to buy the stock until you see the whites of the market’s eyes. Tomorrow could be another down day, so get a feel for market direction before doing anything, especially since the afternoons tend to be sell-off prone. And tomorrow being Friday, I don’t expect an up day, but it could happen. Better to wait for confirmation that the market volatility is occurring in a more heavenward direction - even this means not getting in at the “bottom.” (The bottom may be yet to come)

Did anyone buy protective puts on Wednesday? If so, I would like to hear from you - please post a comment with the gory details. The anti-gloating rule is suspended for you.

This entry was posted on Thursday, November 1st, 2007 at 7:41 pm and is filed under Covered Calls, Trading Tips. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.