Ah, what a day! As my post of yesterday foreshadowed, the market is selling off. The Dow Jones Industrials (INDU) lost 299+ points to close at 6,763.29 points, while the S&P 500 (SPX) lost 34.27 points, finishing at 700.82. Well, we’re off, as they say. But to where?

DOW:
The DOW took out the 6,933 low from October 1997, but good. The next “support” level is 6,315, reached in Q1 and Q2 of 1997 - just another 450 points to go. After that, the next support level would be at approximately 6,000, seen in October and November of 1966. Below that - let’s talk about that another time, if it comes into play.

SPX:
It’s not holding up quite so well. Today’s 700.92 close is below the lows of both April (733) and January (729) of 1997. The next stop would be a support level of approximately 600, from late 1996.

Some seem to be assuming that those lower levels - 6,000 and 600 - will be THE bottom. Maybe. But I’m not assuming that. There is very little interest in the market, and it’s human nature that most people would rather jump on an officially pundit-sanctioned market rally than buy on the way down, even though one might pay more on the way up. So, buying has not kicked in yet.

Also, the murderous ultrashort funds (which don’t actually have to sell stocks short, using equity swaps instead) are pounding the market relentlessly. They are a force that we didn’t have to contend with before.

Blame Bush, blame Obama, blame AIG. Whatever. The point is that the bottom will form only upon a consensus that stocks have become bargains. We’re not there yet.

Covered Calls

Obviously, don’t put on any covered call trade when the market is selling off. If you have open covered call trades, consider ITM writes that you will CLOSE as the stock pulls back further. In this environment, I like to write ITM calls and then close them opportunistically when the stock loses enough value to yield a reasonable profit. If you are writing at a call strike below your cost basis in the position, be wary of being caught if the market snaps back.

The S&P 500 was, as of Friday, down over 18%, year to date. This is the index’s worst JAN & FEB decline on record. The question on the minds of everyone who follows the market is when will capitulation occur and result in a market bottom? Capitulation is the point at which everyone throws in the towel and the market sells off to the level where buyers come rushing off the sidelines. More on this below, but this question can only be asked in the context of news known to be on the way.

On Monday, May 2nd, the ISM index will be released. This index is based on the Institute of Supply Management’s survey of purchasing executives at manufacturing firms. It may be the best single indicator of whether a recession has bottomed, reflecting as it does new orders by manufacturing firms. December’s number was 32.9%, a number only achieved in major recessions, but in January the number had rebounded to 35.9%. An improvement in Monday’s number would be good news, since a pullback to 34% is widely expected; even a slight drop would be good news - of a sort.

Tuesday - we’ll see data on February auto sales and pending home sales for January. The Fed’s Beige Book report will follow on Wednesday.

On Friday, May 6th, the jobless number for February (employment and nonfarm payrolls) will be released. The consensus number expected is a loss of about 630,000 jobs (January’s number was 597,000), though some estimates put losses as high as 800,000.

And the bad news will continue for awhile. The most optimistic forecasters don’t see a recovery beginning until late 2009, and many don’t see it until well into 2010. Some don’t see a real recovery until the housing market stabilizes and starts moving again, widely expected to occur in 2011.

MarketWatch quotes S&P analyst Alec Young, who wonders if the March data might be the catalyst for real market capitulation, if even “the most bullish people” give up. He considers those buying on dips to be bullish, though many of us are doing that, simply trading stocks with market pulses.

Note that the long-term average P/E (price to earnings per share) ratio for the S&P 500 is approximately 18 through good times and bad. It now stands at approximately 12, so much starch already has been taken out of the market’s shorts. But like many, I don’t think the market has bottomed. Why would it have? The news keeps deteriorating, corporate earnings in particular.

More to the point, we need true capitulation in order for a consensus to arise. We should not be dreading that but rather looking forward to it. Upon the expected market swoon, those sitting on impaired stocks should not be panicked into unloading them. The good ones will recover, and capitulation will provide the biggest buying opportunity in more than a generation.

Covered Calls

For now, consider using my SuperPut (protected covered call) strategy and sticking to the best companies with the least impairment to earnings, which are far less affected by market pullbacks. Despite the market’s continued weakness, the stocks I have mentioned (on our monthly online trading labs for members) as covered call trades worthy of CallWriter member consideration have done quite well. Making money with covered calls in this market can be and is being done.