Well, the old market is at resistance again. It made a nice run up after bouncing off the 50-day average. However, it hit the upper trend line on Thursday of last week and has been inching up the trend line hand-over-hand ever since. When this happens, it has tended to signal another down-leg in the trend. Here’s a daily chart from about 1:40p ET today:

The market could break higher, but the 10,000 mark is a choke point, and I expect another run down to test the bottom of the trend line.

Interestingly, the tech indices - Nasdaq 100 and Nasdaq Composite - are showing even less strength, after having shown more strength than the INDU and SPX since March.

Yes, the market could be making a head-fake preparatory to a fresh advance. But these crux points are not a good point to buy stock.

Covered Calls

This is not a time to be putting on covered call positions. The market has to break higher before justifying a long stock position. Advances and declines since March of this year have tended to be of short duration, just a few weeks. My approach this year has been to trade with the market, getting in at support points and writing OTM calls. Please don’t ever feel as though you just have to find a trade at any point in time. Like a sniper, pick your shots.

If the market does pull back, then wait until it finds SUPPORT at the lower trend line or 50-day average before putting on any more positions. Higher-than-normal volume on the INDU (and your stock) at the lower trend line will be a signal for a new advance.

If you have open positions, be prepared to close them if the market starts pulling back and get back into the stock when SUPPORT is found - let the market do the lifting.

We just had a CallWriter members’ trading lab conference last night and I talked (among other things) about how the market needs to break conclusively above 10,000 in order to keep the 2009 uptrend intact. Well, the DOW’s close at 10,015 today was a good start, because the even-thousand numbers are very important, whether the index is northbound or southbound.

In fact, the DOW closed just 10 points south of the day’s high today. Very nice, but we need to see more of this action. One close above resistance doth not a continuation make. The daily chart below indicates how the index stuttered at the 9,830 resistance level yesterday and Monday, then made a strong upmove for a close above resistance today.

The weekly chart below shows the strong 2009 trend since early March. It took about 3.5 months to get the June/July correction. At some point we can expect another correction of equal or greater magnitude, though the recent pullback should have bled off some steam. Notice also how the upper and lower trend lines are converging toward each other,

The same thing is of course happening with the SPX and NDX.

I intend to give the market a day or two - at least - of time to consolidate before writing any calls, since I like to write with the market. We may see some irrational exuberance now, but many don’t believe the DOW can stick above resistance. There may be a little more stuttering before the market moves up, assuming it can live in the above-10,000 stratosphere.

My plan upon confirmation of the break in resistance will be to pick strong stocks off CallWriter’s Global Select list that are following the market (or even stronger) and write OTM calls. This allows a very profitable close early - if the stock moves up as expected - due to the OTM call’s low delta.

There certainly is no shortage of opinion about whither the market! I have CNBC on all day in the background, which is mostly useless - it’s for news. I certainly wouldn’t make any judgment calls about the market from any of the commentary featured.

It is interesting how some of the biggest email-based promoters differ. For example, one commentator is breathless about China. Another also breathlessly extols China and points out how they are buying up raw materials, and then in the bottom part of the same email says China is an ecological nightmare (true) and has stopped buying raw materials. So which is it?

This last pundit, whose name rhymes with Dick Young, also says the dollar is a dead duck and warns of an impending crisis of such immense proportions we will be nostalgic for the Great Depression - but don’t worry, his time-tested stock picking strategies will save us. Well, the dollar is in deep doo for a number of reasons, probably unfixable. But it’s the only dollar we have. Who else’s currency would you rather have? Brazil’s? The Euro?

He makes the coming crisis sound like the Zombie apocalypse so beloved by Hollywood. But, if this crisis is imminently upon us, should we be buying stocks? Maybe items like guns, ammo, water, non-perishable food would be more practical. I don’t have anything against fear-based marketing, but come on. If American ever turns into the dog-eat-dog apocalypse world of the old movie Escape from New York, I’m guessing stocks will be the last thing on our mind. (Honey, there are armed and hungry men outside, I think they want our stocks…)

Jon Markman, on the other hand, points to some more upbeat facts. Domestically, housing sales are up 7.2% and new housing sales even higher, unemployment has peaked at 9.8% just missing the magic 10, corporate profits are up 24% in the first six months of this year and durable goods orders are up 4.9% month over month. Internationally, industrial production and manufacturing numbers are up in Singapore, the Philipines, Spain, Germany, Japan the UK and in many other countries.

But the trend does not care about pundit predictions. The thing we must remember is that trends remain intact until they end. And until it clearly ends, you play the trend.

The major indices recently rebounded beginning on October 5th. My philosophy is to write covered calls with the market. When the market is pulling back, I tend to close open positions - so I can repurchase the stock lower and ride the rip. I don’t usually write calls on market pullbacks.

However, the market has to reach higher highs to keep the trend intact. For example, the DOW recently hit an intraday high of 9,917.99. We have to move above this high to keep the uptrend intact. The DOW closed at 9,786 today. Breaking through this might not be pretty, but if it does, this trend may last a while.

A lot of American retirement savings are in 401(k) retirement plans. These plans are provided by employers, but more often by third party administrators - always the case for smaller employers. These employers have little leverage with administrators, and account holders are often charged high administration fees - sometimes, unconscionable fees.

An article in USA Today online lays out the issue, along with a way to check on your own plan and its fees. The median fee seems to be about 1.5%. The article points out that if you put $20,000 in a 401(k) and earned 7% annually but paid a 0.50% annual fee it would grow to $70,000 in 20 years. Increase that fee to 1.5%, however, and the same funds would grow to only $58,000.

A 3% admin fee will take close to half the non-contributed growth in your 401(k).

Visit Brightscope.com to check out the rating and fees of your employer’s plan. Publication of ratings and fees can help employers to negotiate for lower fees. BrightScope ratings are based on the public Form 5500 data that plan sponsors must by law provide to the Department of Labor. Although it is the most accurate information that is available, the most recent data are from 2007. But that will change, because starting next year, the Labor Department’s data will be electronic and more easily accessible.

You may feel an uncontrollable desire to speak with your employer after visiting Brightscope.

After hitting a high of 9,437.71 very recently, the DOW has had two sell-off days, closing yesterday at 9,135.34, closing near the low of the day - not good. So far today the DOW’s low is the open, a good sign.

Is this where the market goes over the falls?

Hopefully not, but no one really knows. I think we all can agree that with 10% unemployment (which does not even include people who have stopped looking for work), the prospects for a bull market are not good. Nil, in fact. If this advance off the March bottom is not a new bull market, it is a bear rally and must fall back to earth. Of course, the market could just be looking for its 50-day average, but that is 8,773 on the DOW. Since March, the market has shown some strength, pulling back to the 20-day average repeatedly, which it did today.

Instead of worrying about whether this is the dropoff, the first thing is to close our short calls, which adds slightly to the trade debit. But only do this if the call value has fallen 50% or more - it must be economically worth the repurchase cost. If the market snaps back in the next week or so, we can sell more calls. Imagine that you write a call for $4 in premium, repurchase it for $1.85 on a stock pullback, then write it again for about $4. Now you have more than $6 in net premium, but the person who didn’t repurchase the calls on the pullback only got the original $4 in premium. That is a BIG difference in return. As I write this on Tuesday morning, it still is possible to advantageously repurchase calls on many stocks.

If it does not snap back, our decks are cleared for selling the stock. I am not a big believer in holding onto the falling stock. And rolling down when the market has pulled back to the 20-day average is just a guess as to what it might do next. With the market poised at the 20-day average, it is on a knife edge. If tomorrow is another down day, I would consider selling s stock falling with the market, looking for a chance to repurchase it lower.

My SuperPut protected covered call (calendar collar) strategy really shines in times like this. If the market doesn’t go off the cliff, we remain protected and continue selling calls profitably. If it does continue down, we can sell the stock and hold the puts, which will gain in value.

Economist and money manager Barry Ritholtz recently pointed out that about 65 percent of the banks in the U.S. are triple-A rated (and ratings agencies should know, right?), mostly small commercial and regional banks – on the whole, well run and profitable. But… about two-thirds of the assets in the country are held by the four or five largest banks.

Bank of America (BAC): one of the worst-ever acquisition track records. Countrywide and Merrill Lynch badly stretched BAC’s capital account. Years ago it acquired Continental Illinois, nationalized in 1984 and 1991. The bank-bank core of the company is solid, and seems to be well run. The problem is bad acquisitions, subprime loans and mortgage and credit defaults. The normal loan loss rate of 3% is now 8%, which is sailing pretty close to the wind. BAC has the least tangible (hurts if you drop it on your foot) assets of all the major banks.

Money manager Martin Sosnoff, who considers BAC stock a spicy piece of paper, lays out a fascinating lady-or-the-tiger scenario. In the bullish case, BAC could earn $20 billion annually, though note the problems above. The tiger scenario is that $30 billion of preferred stock and $51 billion in subordinated debt is converted into equity due to nationalization (um, restructuring) to pump up equity, and in a conversion the debt could be valued at 60 cents on the dollar. This dilution poses too much risk for buy-and-hold, and probably too much for covered writing.

JP Morgan Chase (JPM) is by far the strongest of the major banks, but we have to wonder if there aren’t black holes awaiting. Major bank balance sheets are seen through a glass, darkly; and that may be optimistic.

Covered calls on banks should be limited to the healthy regionals and perhaps JP Morgan, but be aware that sector rotation in banks, or financials generally, can take the wind out a bank stock’s sails pretty quickly, even if it happens to be doing well. If you’re bullish on a bank stock, use a variation of the protected covered call (add a 6-8 month put with low time value). BAC is just too risky, and Citigroup (C) is too cheap – just buy the stock if you want a thrill.

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.

UPDATE: I misspoke in the original post. The stock market is OPEN on Monday, October 13th.

Ye gods, what a couple of weeks! Starting on October 2nd, the market has been driven by sheer panic. The retracement has been over 40% from the October 2007 market high. If you recently put on covered call positions - using good stocks - without using the SuperPut structure, I sincerely hope you have not taken needless panic losses. Pretty much all the individuals in panic mode have sold, and we are starting to see a climax in institutional (hedge funds, etc.) selling.

This has indeed been a panic-driven selloff. The situation was never quite as dire as the administration painted it, but panic is self-sustaining. Pros sell at the top, buy at the bottom; amateurs do the opposite. So why have institutions - which have driven the panic - been selling out? Money managers will not be put in the position of explaining why everyone else got out and they didn’t. Many institutions saw the writing on the wall and got out, intending to get back in at a bottom. Indeed, many automated programs will start buying at about the 8,000 level on the INDU.

Unless you have lost all faith in the American economy and think it’s headed for the trash heap, it has all along been a matter of where the market ultimately finds support and rebounds. For this to happen, the selling must climax, which is likely, though not certain, to occur at a historical support level. Thus the bottom is unknown, as is the strength and momentum of a rebound. But we can look at some obvious support levels for the Dow Jones Industrials (INDU):

10,700 (2006) - blown
9.800 (2004) - blown
9,000 (2002) - blown
8,000 (2003) - being tested
7,500 (2003) - not in play yet
7,197 (2002) - not in play yet

The market is testing the 200-month moving average as the chart below shows:

As you can see, volume is headed towards a climax and capitulation point. This does not mean a bounce is right around the corner, since the market could easily look for the lower support levels. Much will depend on how much automated buying kicks in, and when. A decisive break below the 200-month moving average would indicate that the we’re going to test lower levels yet.

Volatility Indices
The CBOE volatility indices, which function as sentiment indicators and move inversely to the market (they’re high when the market is low) have all hit all-time highs; in fact, they keep reaching new highs:

$VIX - hit 74.46 today (previous high 49.53 - 1998)
$VXO (OEX volatility) - hit 99.65 today (previous high 72.13 - 1997)
$VXN (Nasdaq volatility) - hit 80.37 today (previous high 71.72 - 2001)

I’ve had to revise those highs skyward - twice - since I began writing this post. Those are 7, 10 and 11-year highs, at least based on the “official” indices. Note that the current VIX (tied to the S&P 500) was newly created in 2003. The “original” VIX was launched in 1993 (tied to the S&P 100), but was re-christened the VXO in 2003. Because it is older and S&P 100-based, and perhaps because VXO options are American-style, many market commentators prefer the VXO (old VIX).

NOTE: VXO (old VIX) data actually goes back to 1986, before launch. Using those numbers, the VXO would have hit a high of 152.48 on October 19, 1987 (Black Monday) and a high of 172.79 the following day. Source: VixandMore

Wrap-Up
The market will in all likelihood soon find a bottom and begin to recover. However, it may well be an intermediate bottom, with lower lows to come. In other words, are we going straight to THE bottom now, with a stronger recovery, or will we see only an intermediate bottom, with the market continuing the falling-range behaviour we saw from October 2007 through September 2008?

If the market does bottom soon, don’t assume the market gyrations and volatility are “over.” They likely won’t be. At the very least we will continue to see a lot of choppiness and volatility.

How strongly will the market snapback? Unknown, but programmatic buying will move the market smartly once the selling climaxes.

Covered call writers:
Use the SuperPut structure when you start writing again. Those long puts have a life of 6-8 months, and the likelihood of the market coming back down in that time frame is, um, reasonable. So don’t think you are throwing away the put cost.

On stocks that are down, do not write below your cost basis, or you will be forced to close those calls at a loss on a market snapback - and the magnitude of the snapback could be ferocious.

UPDATE - 10:50 am - Thankfully, the historic selloff predicted this morning by NYSE floor traders has not materialized, though the day isn’t over. I think President Bush’s address at 9:35 am helped, and the market seems to believe the bailout will happen over the oppostion of the House Republican Leadership and Main Street itself, which clearly does not understand either the magnitude of the problem or the bailout provisions.
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Treasury Secretary Paulsen hammered together a pretty good bailout plan in which Main Street will buy the bad mortgages - and benefit by the ones that pay. Warren Buffett says that 75% of the subprimes and Alt-A mortgages will pay. Not a bad deal.

Last night the House Republican leadership announced they will not support the bailout, demanding that the bailout be recast as a plan to insure the mortgages. How stupid. You don’t insure something after it goes toes up. Besides, Paulsen’s plan has an upside; taxpayers could conceivably come out not badly at all. The House Republican plan would mean 1) vastly greater cost to Main Street, and 2) mortgagees and mortgage lenders would have no incentive to minimize losses, since the insurance would provide a net. Maybe Congressmen should have to pass an economics test before being seated.

So - stock index futures are down today. The market, expecting a bailout, rallied a bit this week. Well, that’s about to change. Expect a horrible day today in the neighborhood. The selloff could continue into next week. NYSE floor traders were in tears this morning. They believe we will see history made today.

Forget technicals - this is bigger than technicals.

If the market tanks as expected, close the short calls. Beware of rolling the calls down, however, since some kind of bailout will occur soon - who knows what it will look like, or when it passes? You could become trapped in a strike below your basis. Only roll down IF the roll will result in a profitable trade if called. Our trade management calculator will calculate this for you automatically.

If really concerned about another Black Monday-type selloff, close the position.

Other alternatives:

1) Ideally, we would sell the stock and buy back the calls after the stock falls, but this would leave the short calls naked. Consider buying a higher-strike call (this turns the short call into a bear call spread), which will free the stock to be sold - IF you have spread-writing approval.

2) Create an OTM bear call spread (separate from the open covered call position), and close it profitably if the stock tanks.

3) Buy a long-term put and turn the CC position into a SuperPut. Puts might be, ahem, expensive today - even the long-term puts.

Stay frosty, and don’t panic. This, too, shall pass.