Headlines Are The Great Equalizer In Options This Week
Scoreboard: Having two options expirations in one week proved too much for the bulls as markets closed last Friday close to the high open interest point of SPX 2050.
The Friday pre-open gains were quickly shed to close a red week for all indices. A new trend has been in place since two Fridays ago: Markets are closing weak. Although the bears are not yet in control, the bulls seem unable to close strong.
Nothing fundamentally has changed; markets are still moving in waves with sentiment. There has been a tug of war between the benefits of crashing oil prices.
On the one hand investors want to celebrate the resulting benefit of falling gas prices. On the other hand there is panic over the fact that demand for fossil fuels could be weak signaling failing economies. Interest rates are still unable to catch a bid raising fears of deflation while the bonds are threatening another break out.
This duo is not conducive to markets running to new highs without a new game changer.
Enter the ECB. For two years Draghi has been promising a QE for Europe (EQE) and markets so far have given him the benefit of the doubt.
There will come a point when they will cease doing so and sell off if offered yet another dose of words and no action.
January 22 could be that time. Markets for the most part are expecting action from the ECB this January and there is a good chance that they won't get it. A sell off may ensue. There are complicating political factors mainly Germany's opposing stance to it.
The situation in Greece is also a newly rekindled potential hiccup in the EQE process. The economic data that is coming next week could add validity to Draghi's argument but there are too many logistical complications standing in the way.
How to trade: Given that the next two weeks are likely to volatile given the binary ECB event, traders should stay light and nimble. Meaning traders should trim back the size or new positions and ensure that existing positions are well hedged.
The options markets offer an array of ways for doing so. There are a few names that can be taken long but there is no rush to pile into anything especially that markets are so close to all time highs. Furthermore, complacency is high which adds to the potential speed of corrections and their snap backs. Cash is a trade and there is nothing wrong with delaying trading for two weeks.
Even if we know the outcome of the ECB decision, we cannot forecast the way markets will react to the decision. This is too much uncertainty. For the past few months and with all the volatility, markets have been surprisingly range-bound for stretches of time. We may have one for the next week or so.
Headlines have been the break points of these range-bound periods so being hedged is the only way to be relatively safe while still participating. Selling Iron condors has worked best for indices and a few major tickers. Market pops that occur without a change in fundamentals are to be shorted and sell offs without reason can be cautiously bought.
Beware of headlines: Headlines are the great equalizer. Homework and research is often rendered useless in the face of headlines. So when traders make assumptions they better make room for the assumptions going wrong and leave room for error.
Just a few weeks ago the experts were all over the media singing the same tune that nothing can go wrong into year end and here we are fighting for SPX 2050 again. Traders should carry only one sacred assumption: 'anything can happen at any time.'
All other assumptions are smaller pieces of the puzzle.
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