My post from February 17th opined that the market had gone into a retracement (of the July through January market rise), beginning with the selloff on January 20th. I won’t repeat those posts, but on February 5th the retracement hit what appears to have been its bottom and has risen strongly since.

Until this week.

Tuesday was a blow-off day, Wednesday regained the ground lost on Tuesday, and today the market sold off early on jobless data, but has recovered most of that by day’s end. However, trading volumes have been declining after February 12th, which means that the down days this week have occurred on falling volume - a bullish divergence.

My guess is that this week’s price action is just chart chattering.

Yo, covered call writers: when your covered call positions pull back with the market, be sure to buy back the calls. I do this if I can buy the calls back for 50% or less of their selling price. If the premium was large ($5 or more) I will pay even more to close, maybe 60% of the selling price; but no more. This percentage is based on the calls’ STO price, not the current market price!

Then I write the calls again when the stock snaps back. This is known as trading the short calls. The market has natural rhythms, like any living thing - all traders and investors are living, and thus the markets they create are living, also. For the market to chatter after a strong rise, like it did this week, is natural. Take advantage of it.

Have you closed your calls today?

Market Action

I won’t retrace my recent posts on the market retracement. But it would seem the correction is over. I would have preferred a little more of a correction, personally, but it is what it is. Even in these flaky economic times, the market tends to follow the rules. Today’s action was not spectacular. The INDU gained 43.4, the SPX 3.5 and the NDX 8.8 points. The Russell 2000 outperformed them all, a good bullish sign in my view.

Well, now what?

Now is a good time to write OTM calls or puts on great stocks, like those on CallWriter’s Global Select lists, providing they also are recovering along with the market. Why OTM? Well why not? The only justification for an OTM buy-write covered call is that you are short-term bullish. After all, you are getting less premium and less downside protection. Ah, but if the stock moves up you can close the trade early for a profit or let the trade be assigned at a nice profit.

This works just as well for naked puts, although the low delta means the put is slow to lose value and give you an early close unless the stock really moves. If really emboldened, consider a put very near the money. Though probably posing more of a risk - at least statistically - of assignment than OTM puts, they are more profitable.

In both cases, CallWriter members should use the Industry Rank link in our Research Page to look at the stock’s industry to make sure peer stocks are recovering along with your stock.

There isn’t much February premium out there, so look at March and beware of earnings reports.

Head Fake?

Wait a minute… what if this is all a head fake and the market starts selling off again? It’s not impossible. Just look at the last week of June 2009 for an example. If that appears to be happening, close the covered call position with the intention of getting into the stock lower. If short a put, close or turn the position into a put spread.

If you wait for all the technical confirmation even your Grandma would want, you’ve missed an awful lot of it.

Members’ Trading Lab

The evening of Thursday, Feb. 23rd there will be a Members’ Trading Lab for CallWriter members, 9:00 pm ET. The signup link appears on the members’ home page. It will be fun and very useful, so don’t miss it.

Everyone is aware that on January 20th, the market generally went into a swoon. This is no big deal from my perspective, and here’s why. Markets have to retrace periodically. After a period of uncorrected up (down) movement, the market periodically retraces some of the gain (decline) from the last correction bottom (top). The market shot up after the March 9. 2009 low and then corrected in June and early July.

Since that correction, the market had a solid advance without a serious correction. Note that movement within a trading range does not constitute a retracement. Real retracements (extensions, in the case of a downtrend) tend to give back 38, 50 or 62% of the uncorrected rise. On February 5th, the S&P came within 1 point of a 38% retracement, but the Dow didn’t come nearly so close.

So the question is, do traders believe the correction is over? In late January and early February the market advanced, only to sell of again. That brief advance clearly was a bear flag.

What about the latest advance off the February 5th bottom? It looks much like another bear flag, with lots of hammer candlesticks indicating sell-offs during the day and a close close to the day’s high. Today’s price action (1:45pm ET) as I write this is a large white candle on a daily chart peeking above (but just barely) the 20-day and 100-day everages.

On a weekly chart, the INDU and SPX both appear to be bouncing off the 100-week average on rising volume.

Today’s action seems to have moved higher than we would expect from a bear flag, so we may have seen the end of the retracement. I’m not putting on any trades today, because I view the market as being on a knife’s edge. I want to see a couple of solid closes above the 100-day average.