Weekly Options: Desperate Times Call for Desperate Measures ~ The Risk Averse Alert

Friday, July 09, 2010

Weekly Options: Desperate Times Call for Desperate Measures

You must be hearing it, too: a growing number in the bear camp are giving this week's bounce very little due. Their sense is the market could turn over at any moment and take out last week's low.

Of course, being a huge bear myself I agree this week's rally is better thought a fake. Yet let's not underestimate potential follow-through here, particularly since wave (c) of (2) very well might be unfolding off last Tuesday's low (6/29/2010).

A "c" wave being an Elliott third wave is likely to demonstrate considerable dynamism. Indeed, we certainly saw a good measure of this dynamism over the course of this week's advance.

Truth is there are plenty of reasons to expect this very quality to continue being demonstrated over the period ahead, possibly even resulting in some technical measures producing their best readings of 2010 (believe it or not). In other words, the market might rise considerably further before wave (c) of (2) has run its course.

You might say the bear camp's relatively sanguine stance toward this week's rally is inciting consideration of a view as might press this side of the trade to the wall...


Let's begin with volume. Quite simply, as long as there is no rush to the exits — complacency holding those long equity firmly to their positions — there exists proven, effective, well-oiled capacity to goose a higher bid. This simple reality has been plainly evident since March '09 bottom.

The mechanics are options- and futures-driven, and the aim is increasing capacity for distributing equity into weak hands.

First, covered calls (written by strong hands) are fed to rightly cautious portfolio managers. Next, the CME is used to excite a bid likely to precipitate massive short covering, lifting to in-the-money out-of-the-money call option positions. Then, portfolio managers, looking savvy, exercise their options, and as a result a distribution (to PMs) is achieved.

Come to think of it ... could there be any better reason for weekly options? Might not these things largely exist for perpetuating a scam venturing to cheaply increase distribution capacity at this very late hour in the life of a global, wildcat financial system gone bust? All I know is you might, in fact, be brain dead if after these past 10-15 years (the past three in particular), you do not perceive a fixed object on the financial landscape that is a protected fraud racket fleecing its larger captive audience. But I digress...

Now, this background requires I right a wrong put forward in analysis on Wednesday commenting on RSI's moon shot. Rather than [wrongly] citing its similarity to the period just prior to the market's collapse in 2008, one might better look [rightly] to the launch off March '09 bottom, and then again in July '09.

Suddenly, RSI's [fundamentally unhealthy] imbalance makes a great deal more sense. We are seeing the same technical symptoms as before during the formation of an Elliott "c" wave. Previously was wave C of (B) (five waves up) from March '09 low. Now is wave (c) of (2) of (C).

Supporting this view are two matters of technical circumstance.

First is improving momentum (MACD) — indeed, positively diverging in early-June, and then again on June 29th.

(Per momentum presently languishing on the negative side of its balance, this could be seen substantiating the likelihood that, trouble looms once wave (c) of (2) is complete.)

The second technical element supporting probability wave (c) of (2) is in the early stages of its formation is that recent demonstration of profound complacency witnessed via RSI going into April's peak (ending wave C of (B) up from March '09 bottom). Complacency's well-proven existence reveals the foundation on which a dynamic move higher might be easily manufactured at this most frightfully vulnerable moment in history.

So, forget about yesterday's "moment of truth." Last week's low is unlikely to be imminently tested. One and the same are the writers of that elevated July put contract open interest at strikes below last week's low, and those manufacturing this week's surge higher in an effort to facilitate a more favorable climate for continuing distribution.

The objective for wave (c) of (2) indicated above is in the vicinity where ended the fourth wave of wave (1) down from late-April peak. In light of this prospective objective one thing we should be alert to is possibility that, wave (c) of (2) might reach its end rapidly. This possibility is in keeping with a view toward wave (2) detailed one week ago, wherein its component waves are seen developing in a complex-to-simple manner. With wave (b) of (2) being notably simpler than wave (a) of (2), wave (c) of (2) might scarcely miss a beat.

Something to keep an eye on. (As is this ... in light of a still very bearish big picture.)

Fast Money
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