Europe and Asia Feed the Crisis but Market Dead Cat Bounces

The weekend financial crisis in Europe and Asia is carrying back over to the U.S. markets this morning as the cycle feeds its own frenzy.

Watch out for a short term oversold gap and pop, it's going to be pretty tough to buy puts right out of the gate. I am looking for a little bit of a short term oversold condition this morning. I'm not bullish on the markets, but we could pop a little out of the gap.

8:15 am MT: The next support down for the Dow is the 9,750 - 9,900 area.

9:00 am MT: The market is continuing to fade off the gap and the VIX is getting too hot for this to sustain much longer. I think we will get a short-term oversold climax today. I’m looking to pick up calls on the DIA and SPY on a Dead Cat Bounce strategy, which is countertrend, but suited for days like today.

9:30 am MT: I started cherry picking calls on DIA and SPY.

9:45 am MT: I added a little more to the DIA and SPY calls.

10:00 am MT: I added a little more to the DIA and SPY calls.

12:45 pm MT: I added the last of the calls I wanted on the DIA and SPY calls.

1:40 pm – 1:55 pm MT: I scaled out of all the calls. For the SPY trade I made .85 cents or 13% return intra-day. For the DIA trade I made .43 cents or 7% intra-day. I was pretty confident with the probable dead cat bounce so I took bigger positions. I ended up adding a total of $2,560 to the “paper” money account today, so it was a nice day of trading.

3:30 pm MT: Market Wrap: Here’s the easy version of this…..the global financial crisis pushed back and forth across several continents today. That pretty much sums up the day. I was watching for a Dead Cat Bounce all day, and I traded it profitably. The Naz was the only index that actually turned (dead-catted) at a key support area, which was exactly on the 61.8% Retracement (Fibonacci Retracement) of the Bull Market. The SPX was the next closest to bouncing off a key support area as it bounced off a bottom of 1,007, which is very close to the round number of 1000. The Dow kind of bounced in space, although it did reach near a semi-round number of 9,500 before jumping back intra-day. I speculate that the Naz 61.8% retracement and the SPX 1000 were more important numbers to traders today. Any way you slice it, we were dramatically oversold short-term and the VIX was screaming at the market with a reading of 58.

I warned that we could have a 2-3 month topping out process on the VIX, so this is volley shot number one. I expect that we will get a short-term oversold bounce with a volatility compression tomorrow or the next day, but I’m still not doing anything other than what I did today – play it intra-day. I don’t want to get caught in a volatility collapse by holding a long position overnight.

There is a lot of chatter amongst traders that the Fed will cut rates dramatically at the October 29 FOMC meeting. Now think about that for a moment…..I’ve shown you the irrelevance of a rate cut because the real short term interest rate number as represented by the LIBOR and the Credit Swap Spread is totally ignoring the Fed Target Rate. Benny knows a rate cut is pointless. I’ve taught you that. Now, also think about this, the Dow dropped over 1,200 points from the end of Friday to the middle of today, or in about 9 trading hours. In addition, the world is on fire as European and Asian markets dump the big dump over the financial crisis (what planet were those traders on the past 10 months?). So if Benny was going to cut, he would have cut RIGHT NOW. Look what happened in January with the emergency 75bp inter-meeting cut. Why not now? What’s he waiting for? That’s exactly why I warned you last week that the Fed has nowhere to go with rate cuts on the short end of the yield curve. That’s exactly why I showed you those LIBOR and Credit Swap Spread charts. In fact, the Fed did exactly what it could do today - what really had a chance to affect the market. They attempted to improve liquidity by doubling the outstanding Term Auction Facilities balances to $900b. The TAF’s targets liquidity by allowing depository institutions to borrow from the Fed using the same collateral that is accepted at the discount window. So the Fed is trying to provide financial institutions with CASH, which is far more important right now than a short term rate cut.

The two bits of good news from today were that the market bounced sharply off the lows and that oil dropped down into the $87 area. The market may even bounce a little more off the short term oversold condition as I wrote above. However, don’t lose sight of the fact that the macro, global financial picture is still squishy, and that we are still in Earnings Warning Season, then we get Earnings Season, then we get the Fed, then we get the Elections, and we get various Economic Reports throughout all that period of time. We may bounce short term, but I haven’t seen the huge, blow-off climax followed by the huge, even bigger bounce yet. In other words, I haven’t seen the signal that this is done yet. I keep warning about this, but don’t lose sight of the fact that we probably won’t get a one and done on the VIX. I still speculate it will be a 2-3 month process, even if we find a market bottom in October…..which means I’m in short swing mode for the foreseeable future. It’s plenty profitable, as I demonstrated today, it just means understanding what to do in these type of market conditions.

Here is a chart of the Naz showing the Dead Cat Bounce off the 61.8% Fibonacci Retracement today:
(click on image to enlarge)

Here is an intra-day 5m chart of the DIA showing the entry points for one of the "paper" trades I did today. The entry points are in green highlight circles and the exit area is in the blue rectangle. You can check the time stamps on the "paper" trades in my Papermoney account on the Wednesday VC for a more precise look:
(click on image to enlarge)


Here is the same DIA chart on a 15m time frame so you can see the swing a little better:
(click on image to enlarge)

I showed the DIA chart above because I wanted to demonstrate visually the type of trade I mean when I say intra-day swing. It's the only kind of directional trade I am willing to go heavier with right now. Everything else is nibbling.