Snapshot Notes - June 20, 2008

This morning we went over some stats related to option expiration, and how down gaps tend to not get filled during the day, more so than non-expiration days. We're seeing that again today, as the major indices have been unable to mount any kind of rally and breadth is absolutely horrid.

A subscriber had asked about market performance going forward when the week of triple witch option expiration was negative. "Triple witch" refers to the expiration of equity options, index options and index futures and occurs in March, June, September and December.

Since 1990, the week following a negative triple witch week was pretty negative itself. Out of 24 such weeks, the next week in the S&P 500 was up only 5 times (a 21% win rate), showed an average return of -0.6%, and an average maximum reward (+1.2%) that was only one-half the average maximum risk (-2.4%).

Most of that negativity was concentrated in the first two days of the next week. Buying the next Tuesday's close and holding for the rest of the week actually showed 58% winners and a +0.1% average return - not great, but certainly better than holding through the first couple of days of the week.

If expiration day itself was down more than 1%, like it looks like will happen today, then the next couple of days still had a negative bias, up only 2 out of 7 times. After those first couple of days were out of the way, then the next few were up 4 times. Again, not great, but no more negative bias.

The price drop has gotten to a point that longer-term positions are beginning to look interesting again. I'm basing that mainly on the Dumb Money Confidence that we discussed this morning, as it has dropped down to 29% and may fall even further after today's ugly session.

Even the shorter-term is starting to look more interesting. Whenever the Dumb Money dropped to 29% since 1995, then the S&P sold off 1.5% or more the next day, buying that close and holding for three days resulted in 91% winning trades (21 out of 23) for an average of an impressive +2.3%. The last 14 trades, dating back to September 2001, were all winners.

If we look at the Nasdaq 100 and a loss of 2%, then the three-day return was positive 81% of the time (21 out of 26) and averaged +2.0%. The short-term results were very volatile in terms of risk/reward, but that's to be expected in times of flux like this.

With a day like today, I suspect we're going to see another attempt to push us lower early next week, but much depends of course on weekend developments, particularly the concern with Israel. With the DJIA about to test its March and January lows, however, and how the market has reacted in the past after Dumb Money readings like we're seeing now, I'm going to consider weakness early next week to by an opportunity to leg into some long exposure, at least for a trade and potentially for a more intermediate-term investment. This is still within the context of a bear market as we've been discussing this week, but as we saw in January and March, we can still have good rallies in bad markets.

Good Friday morning...We begin the day with some selling pressure in the pre-market futures as weak foreign markets, a rebound in commodities and another wave of bad news in the banking sector makes an impact.

Yesterday I mentioned the Dumb Money Confidence, and how the recent market action had taken such a hit to sentiment that that measure had dropped to 33%. As of yesterday's close, it fell even further, to 29%, and is within a hair's breadth of dropping to 25%.

Let's reprise the table from yesterday of S&P 500 forward performance, but updated with a Dumb Money reading of 29% or below.

S&P 500 Performance When Dumb Money Confidence Equals 29% Or Less
	5 Days	10 Days	1 Month	3 Months
	Later	Later	Later	Later
Avg Return	+1.2%	+2.0%	+4.7%	+12.3%
% Positive	70%	74%	86%	100%
Avg Max Gain	+3.0%	+4.4%	+7.0%	+14.8%
Avg Max Loss	-2.3%	-3.1%	-3.8%	-4.2%

The numbers are close to what we saw yesterday, but the average return, percentage of time positive and average maximum gain have all increased, while the average maximum loss has either stayed the same or dropped a bit.

That three-month figure is the one that catches my attention, as the S&P was positive after all 163 days that showed a Dumb Money reading of 29% or below. Even though the study is only from 1995 forward, it includes 74 days - nearly half the sample - from the current and former bear market.

That average three-month performance translates into an annual return of nearly 50%, but more impressive to me is that the average reward is more than three times greater than the average risk. With that kind of skew, such a high average return, and the great consistency of positive future performance, this is hard to ignore. From a trading standpoint, this measure is getting to a point where I am becoming interested again in buying into short-term oversold conditions.

Today we have option expiration, and despite their reputation, they tend to not be quite as volatile as a non-expiration day. We typically see very high volume, but intraday ranges that are a little less than normal. Directionally, the days are a toss-up.

Coming into today, however, we do have a fairly large gap down. I checked for any other time the S&P 500 tracking fund, SPY, gapped down 0.5% or more on an option expiration day, and found that buying the open and holding until the close resulted in 15 winning trades out of 30 attempts, with an overall average of -0.2%. Nothing too solid there, and even holding through Monday's close didn't change the results much at all.

One thing I did notice, however, was that the gap tends to get closed (i.e. trade back above the prior day's close) less often on expiration days. On any day when SPY gaps down 0.5% or more, then it closes that gap the same day 52% of the time. But on option expiration days, the gap gets filled only 32% of the time. So in the past when we've seen weakness right off the bat on these days, it has tended to persist, or at least not recover enough to make it above Thursday's close.

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