Snapshot Notes - May 14, 2008


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WEDNESDAY, MAY 14, 2008

Gap Morphs Into Trend Day

05/14/08 2:00 PM EST

As of:

SPX 1375

HELP ARCHIVE

When the indices held the morning gap and went on to make higher intraday highs, they had a good chance to morph this into a trend day, and so far that is playing out in a classic fashion.

As we go over often, when we reach into the late morning with the indices hitting higher intraday highs after a gap up open, with breadth solidly positive, and with buying interest coming in every time the NYSE TICK approaches zero, then the probability of a mid-day downside reversal later in the day becomes very low.

Since the October high, we've seen this pattern, this late into the day, on 11 days and 10 of them closed higher than the mid-morning price, so the probability seems strong that we'll close at or near the day's high.

Given what we went over this morning (related to a run into the middle of option expiration week) and the other negatives from yesterday, I didn't feel this morning's gap would hold up, but that looks to be wrong as the trend day unfolds. Additionally, we're seeing the Nasdaq 100 break over 2000 and and Russell 2000 over 740, both of which were levels I had my eye on as potential resistance.

The S&P 500 is flirting with its recovery highs as I type at 1420, so that's the area that many traders are watching at the moment. Our most sensitive indicators are fully overbought at this point, and when we combine that with the other things we discussed earlier, I have no desire to chase this move as I think there's a good chance the gains will be forfeited. In fact, I sold short a modest amount in the S&P at the open, which obviously isn't looking so hot at the moment, and I think the odds are good now that it will get even worse heading into the close. I'm willing to stick with it for a bit, though, based on the overbought short-term guides and other factors we've outlined. A breakout and hold over 1420 would make me anxious, though, especially if it holds past tomorrow.

Rally Into Expiration Mid-Week

05/14/08 9:15 AM EST

As of:

SPX 1375

HELP ARCHIVE

Good Wednesday morning...We begin the day with a modest bump up in the pre-market futures, based on a surprisingly tame CPI report. Not only was it below economists' estimates, it was surprising to a lot of folks who buy stuff everyday.

Earlier this week, I mentioned that option expiration weeks have had a decidedly positive bias over the past couple of years. All of the gains were accounted for by Wednesdays, which were by far the most consistently positive day of the expiration weeks.

That's a questionable kind of study, and I certainly don't place a lot of weight on it. But I took a look to see if there were any other times when the S&P 500 was up at least 1% over the couple of days heading into Wednesday of an option expiration week, then gapped up at least +0.25% on Wednesday morning.

Buying that open and holding until Friday's close resulted in only 4 winners out of 16 attempts since 1993, using the S&P 500 tracking fund (SPY). The average return was a rather hefty -1.1%, with an average maximum risk (-2.2%) that was more than four times as large as the average maximum reward (+0.5%).

The larger the opening gap, the worse the S&P did going forward. If we would happen to gap up 0.5% this morning, then the two-day forward return averaged -1.6% with only 2 positive occurrences out of 12 attempts.

I don't place trades based on seasonality-types of studies, but they do help me flesh out a trading plan if other pieces are in place. We have gone over a few other negatives lately, such as the historically low volume we've been seeing, and the rapid descent of implied volatility.

We also now have 79% of the Rydex sector funds with assets above their 50-day moving averages, the highest amount since last October as you can see from the chart on the site. That's high enough to be considered overbought, and has coincided with the flattening out of past rally attempts, where stocks may have continued higher in a choppy fashion, but ultimately gave back the gains in quick corrections.

I've been mentioning for the past three weeks that while I haven't seen a strong edge either way in the short- or intermediate-term, we've happened across enough negatives that the probability of a sustained upside push seemed unlikely. We've made a bit of upside progress since then, but not much and it's been difficult to trade. I still have the same basic outlook, and prefer to bet against further rally attempts rather than chase them higher, which will become increasingly the case if we rally into the close today.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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