An Eye Toward the Sky ~ The Risk Averse Alert

Wednesday, March 25, 2009

An Eye Toward the Sky

Well, yesterday's Eye Toward Transition has become today's Eye to the Sky...

OEX 5-min

The need to change perspective caught first sight in the opening minutes, when out of nowhere rapidly unfolded a rather unexpected 2% move higher. Where in pre-market futures did this come from? Why, it was hidden from view!

Odd, too, was the market's unusual display of strength coming on the back of the alarming fact that, during Monday's 7% surge there were approximately three times as many new, OEX Call contracts opened versus Put contracts. Normally, you'd expect Put open interest (hedging long equity positions) to swell with a gain like Monday's. Instead the opposite was true.

So, the real question is whether the position of OEX Call buyers is stronger than that of the contract writers. Are the buyers paving the way to maximizing their score prior to driving the market higher over days ahead?

Was today's strong lift out of the gate a warning shot? Likewise, was the final hour a coup de grace?

Well, here is what I know...

Yesterday, the market fell 2%, yet OEX Call open interest did not widen versus Put open interest. What does this reveal? That Monday's bump in Call open interest probably was less to do with short equity hedging than with speculative position building. If it were the former, then Call open interest would have swelled further during yesterday's decline as the market moved in favor of short equity positions.


Nothing alarming on the technical front. There's no sign of weakness at all. Rather, all indications suggest conditions are strengthening.

So, let's move our view into the explosion higher NOW camp. I wrote about this possibility not long ago. The thinking was the market could charge higher so fast that, most players would be left behind, still on the sidelines nursing wounds suffered over the past year ... afraid to pull the trigger on any new long position. Then, only after a huge move up would new money willingly enter. Subsequently, early adopters would have their witting flock to whom they could feed their shares.


I also discussed the possibility daily RSI might ramp rapidly to the vicinity of a buy-side extreme (upward of 80) ... something like weekly RSI back in 1970. Here's why this might be the likely course...

Have you noticed the President and the Treasury Secretary are being very clear about the future of structured finance? Like Elvis it ODed. Like Elvis it is dead. You have to listen a little more carefully to Secretary Geithner. But the message is there.

So, now that lines are drawn with clarity toward a future whose intention is to be less dominated by wildcat finance ... and as soon as possible at that ... there's less hope the riskiest of financial assets — common stocks — and the mountain of debt that has supported their levitation for the past 20 years can be sustained in a fashion harmonious with the heretofore status quo. In other words, the gig is up. (No need to wonder any longer about what has been motivating the "Get Geithner" media drive.)

Let me ask you this, then. Imagine you're Mr. Big and you see the writing on the wall. Would you panic? Or would you scheme to maximize your power to improve your position? You're holding a beefy inventory now that the weakest hedge funds have been bled dry. You'd like to significantly lighten your equity stake, right?

So, wouldn't you be best off somehow driving the market higher as rapidly as possible, then moving to unload your inventory as slowly as possible afterward?

Technically — viewing this two-step dance from the perspective of RSI — you really should take another look at weekly RSI 1970-1973. You'll get a better sense of how things might proceed from here ... first convincingly up ... then holding gains for as long as possible ... and finally down to the neighborhood of Dow 3600.

Fast Money
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