How Jim Cramer Might Soon Regret His S&P Oscillator Forecast ~ The Risk Averse Alert

Friday, June 13, 2008

How Jim Cramer Might Soon Regret His S&P Oscillator Forecast

NEWSFLASH! The next seven days could be the most thrilling financial ride of your life.

I continue being amazed by presently unfolding technical developments and price form similarity to the crash of '87. I see absolutely nothing threatening my outlook. Present prospects look good as gold.

Jim Cramer began his Mad Money show Friday evening citing one of the few technical indicators he uses to drive his buying and selling decisions. It was the Standard and Poor's Oscillator. Apparently it's indicating the market is extremely oversold ... registering a reading of -6 (according to Cramer it normally fluctuates between +5 and -5).

Are you freaked out? Don't be! This condition fits perfectly with my outlook.

Let me ask you this. Have you ever heard bull and bear markets tend to extend further than most people think possible?

How about this... Is it true a body in motion tends to stay in motion unless acted upon by an outside force? (Check out the link at this post's conclusion.)

Now, is it reasonable to imagine the Standard and Poor's Oscillator might remain extremely oversold for another 5-8 days? Would this at all be an unrealistic expectation?

Finally, if the stock market crashed, do you suppose a hard bottom might then be at hand ... one from which a base would form and a subsequent market melt-up would soon afterward commence?

Considerations such as these make me not only sanguine, but indeed gleeful Cramer chose to pound the table about what the Standard and Poor's Oscillator is suggesting.

He advised his viewers to close their eyes, plug their noses, step up ... and just buy. He did not, however, mention the possibility viewers might experience an urge to cry should their decision prove premature.

My only wonder right now is whether he will be pounding the table again next Friday when the Standard and Poors Oscillator remains as oversold as it is now (if not even more so). Chances are the crash will not come until after expiration, so I can imagine he might be just as firm in his conviction. Only time will tell.

The open interest situation in the June OEX contract has made a dramatic turn. Unlike just a couple days ago, suddenly the picture reveals there is little upside potential above today's close. At strikes immediately above the market Call open interest is now markedly exceeding Put open interest.

This is a very good sign.

You will recall earlier this week my suggesting the relative balance of Call and Put open interest in the June OEX contract (above the market) was leaving the door open for a bounce in the S&P 100. This door appears to have closed.

At the start of this week's trading the two sides were more or less in balance all the way up to the 650 strike. Then it quickly fell to 630. Now, however, the brick wall is right above the market at 620.

It appears Put buyers have been (and still are) the market's strong hands. At present they have substantially taken profits in the June OEX contract. As such, then, chances of any surprise advance developing during this coming options expiration week have been markedly diminished, because Call open interest markedly exceeds Put open interest at strikes above the market.

Let's not forget this is a market which for months has displayed little fearlessness, much complacency, and yet, scant willingness to apply new money to the trade. I have documented this more or less consistently over the past many weeks. The power the market had in rising off its March 17, 2008 low was much less a function of any pronounced buying interest. Rather, it was largely effected by a notable selling disinterest. This was reflected by diminished volume of shares traded right up to the May 19th top.


This condition plays right into my expectation for how trading likely will develop during the coming expiration week, too ... such that the set up for a crash might assuredly be put in place.

Indeed, I should have supposed selling disinterest leading to the May 19, 2008 peak might have diminished the significance I assigned earlier this week to the June OEX contract's Call and Put open interest below the market.

You will recall the notable disparity I brought to your attention. Put open interest was (and still is) dwarfing Call open interest. I suggested this condition might put a floor under selling, because the writers of these June OEX Put options had a vested interest in assuring these contracts did not move "in the money" before expiration.

Yet, this did not at all materialize as I had expected. Yes, trading Thursday and Friday might partially have been a manifestation of Put options writers protecting their interest. However, this came into play only after selling earlier this week pushed several strikes — previously below the market — "in the money." Subsequently (as I noted above), once these Put strikes were "in the money," their holders either sold, rolled over to the July OEX contract, and/or exercised their right to go short the S&P 100.

Rut ro, Relroy.

So, as it stands, today's rally — which from the get-go was readily apparent the bear market kind (much as yesterday's proved to be) — is not likely to lead to any alteration in my present outlook. Everything continues appearing much as it did going into options expiration week, October 1987.

One other thing I would like to note about the layout of June OEX open interest...

If you've read "Reminiscences of a Stock Operator," you have some better sense of how strong hands in the stock market work to shake weak hands of their shares. So with this in mind, let's again consider the June OEX open interest situation below the market.

As I already indicated Put open interest continues to dwarf Call open interest. Yet, as we saw this past week the capacity of Put option writers to defend their positions was weak at best. Now, maybe I should have expected this ... given the run up to the May 19, 2008 peak. But that's neither here nor there right now.

Surely, there are many different circumstantial interests associated with Put open interest presently below the market in the June OEX contract. I could not possibly attempt to detail all these. Indeed, many possible scenarios might play out should the S&P 100 substantially fall going into Friday's expiration (as I expect) ... resulting in a significant preponderance of presently "out of the money" June Put strikes moving "in the money."

However, there is one thing we might assume with a relative degree of certainty, were several June OEX strikes to gain intrinsic value prior to Friday's expiration. Volatility would likely increase markedly thereafter (i.e. following expiration). This, because June Put option writers (who were quite possibly weakened considerably this week already) would need to sell the underlying to come up with the necessary capital to honor their financial obligations. Thus, the likelihood of a stock selling avalanche would be raised.

This is precisely what happened following options expiration October 1987.

This also is what unfolded following January '08 options expiration.


As per the likelihood of this coming to pass again ... well, given how this past week's trading unfolded ... and given the market's tenor from the March 17, 2008 bottom to the May 19, 2008 top ... there's just thing I might succinctly conclude:

The trend is your friend...

Probably the most important comment I made Friday on my Mr. Market Twitter was, "It's ... occurring to me I should stop ... trying to play a bounce..." I made this remark just before the market opened.

Indeed, this is why I laid half my account into a couple June OEX Put positions right near this morning's peak. I did this, too, without the luxury of certainty afforded by June OEX open interest analysis provided above. The extremely sharp advance off Thursday's (6.12.08) low — one clearly possessing all the character of a bear market rally likely to be reversed — was cause enough to take on these new positions.

However, the day's trading did not proceed as I expected. What's more, I might have known better, too. Nevertheless, I am not at all worried. Chances are I can just hold these positions and they will be "in the money" before Friday's (6.20.08) expiration.

With hindsight, though, I might better have plowed half my account into the July contract rather than June.

Now, I will not claim I also should have waited until today's close to do this, despite just saying I might have known better Friday's trading would unfold differently than Thursday's (contrary to my expectation when I purchased my two June OEX Put positions this morning).

However, I probably did screw up trading the June contract rather than July.

This confession aside, though ... had I anticipated today's trading would likely develop differently than yesterday's ... and had I bought July OEX Puts this morning, rather than June ... I probably would have plowed the other half of my account into the June OEX contract going into today's close ... at the 610 strike instead of 600.

So, here is my plan right now...

Depending on how much selling we see on Monday, I will be looking to sell one (or both) of my June OEX Put positions. I may use the proceeds to continue playing the June contract, anticipating any quick hit trade as circumstances might afford.

Per the remainder of my risk capital, I will be looking for a suitable occasion sometime during options expiration week to purchase deep, out of the money, July OEX Put positions in anticipation of the post-expiration crash.

If the present similarity to October 1987 continues, positions in the July OEX contract will best be established no later than Tuesday...

(Is Lehman ready to blow?)

* * * * *

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adan said...

couldn't find where to find to comment on your twitter blog, but wanted to say really fun seeing your comments through out the day; nice going :-)

ps - appreciate your honesty too, when things don't go as hoped/planned

nice work tom

Trader said...

I came across your posting when looking for information regarding the S&P Oscillator. Did you even watch Cramer's show on Friday? Cramer did not say that you should buy right now and he certainly didn't say to do it blindly. In fact, one of his rules is to not buy, hold and sell stocks blindly. On Friday he said that at +5 he considers the market overbought because it tends to swing between -5 and +5. But he also said that it could of course go up to +9 but on average he considers +5 a good time to start getting out. If you think his message was to simply pull up the S&P Oscillator and start buying and selling at -5 and +5, respectively, then you seriously missed the point of his show. I admit that I also take his recommendations with a grain of salt, but I'm annoyed by people who don't even seem to carefully watch the show but still criticize his suggestions. No one is always right with their market predictions. Maybe it makes you feel better about your own mediocrity to point out the mistakes of someone who clearly has been more successful than yourself (unless you also ran a $500 million hedge fund, are very rich and have your own TV show). The funny part is that you call him a douche bag on your twitter page and say how stupid his recommendations are, yet you seem to tune into his show time and time again. Either you are bored out of your mind or actually learn something from him from time to time after all.

TC said...

Trader: Got your comment on 8/17/09. Did you notice the date on this post? It's 6/13/08. That's over a year ago. Indeed, Cramer's bullish posture last year was maintained right up until just prior to the Lehman collapse. But he did get out of the market before the market came unglued, and indeed, I gave him due credit for this.

My issue with Cramer right now is this: he is a devotee to monetarism. He believes Bernanke has saved the day. However nothing could be further from the truth because, in fact, monetarism is as dead as Elvis. The Fed is bankrupt. The greater underlying element remaining now to sustain the status quo of the past 40 years is best characterized gangster finance. Every contemporary financial affair with which we are regaled reveals this.

So to summarize my sentiment toward Cramer ... his macro view is a terribly mistaken one, making his bullish outlook easily criticized. By the looks of things right now he wouldn't know a short squeeze (which is 89% of what has been behind the market's advance since March '09) from a short stack of pancakes. The counter-trend rally whose volume clearly is diminishing is no more a bullish backdrop now than it was from March 17 - May 19, 2008. In other words ... this rally in all likelihood will end badly.

Having said that, I don't believe Cramer will be wiped out should the market crash as I suspect it will sometime over the next 1-3 years (or days ... whatever). He in all likelihood will be out of stocks during the greater brunt of coming selling. He may be a macro douche bag, but he's no trading idiot. He knows how to butter his bread and I never claimed he didn't. Nor do I say he has nothing to offer. It all depends on what you're looking at and what you're looking for. We all come to this game from different perspectives. And this thought dovetails into one last comment I'll make per my issue with Cramer's macro view of the contemporary investment landscape.

His separation of individual investment motive (i.e. purely greed-motivated, plain and simple) from the larger moral matter whose truth gave life to the American Revolution -- his politics of investing -- is purely British school, and if I might say, it is the echo of the voice of the enemy to the United States of America largely by its being devoid of any substantive principle wherein the American investment world, too, would conform to the profound idea expressed in the simple, one-sentence Preamble to the U.S. Constitution. I, on the other hand, recognize how absolute truth embodied therein (i.e. in the Preamble) is being defied by our present financial landscape, which, in fact, is nothing more than the same face of tyranny as existed 233 years ago. As the American Revolution demonstrated against incredible odds, tyranny cannot stand. Yet try it will. And that is why, right now, the stock market stands doomed. Tyranny's attempt in maintaining its power over the affairs of this nation absolutely requires de-leveraging. And since the entire bull market from 1982 has been premised on a debt bubble -- the very thing facilitating leverage -- equity, therefore, is dead money in the midst of this ongoing financial de-leveraging whose impact, in fact, has only but begun to be felt.

As per my mediocre performance, stay tuned. (And if you want to call my stepping aside from last year's disaster "mediocre," you might wish to broaden your command over the English language. There are better words. Like, say, "not bad.")