Don’t Shoot the Salinger! (DIA, USO)

The tests are about to begin.

You’ll have to forgive us, but it looks like we could be in for a little southbound surprise in the coming weeks – a break in the market that will weaken sentiment significantly even as it slices off a goodly number of percentage points from the indexes.

dontshoot

We hate to be the bearers of bad news – even if it’s only temporarily bad. Because the truth is, we don’t see the pullback turning into a rout – at least not yet.

All the same, we’re obliged to point out that the very thin intraday action of the last three weeks is, in our view, indicative of a market that’s running out of buyers, and unless we see someone step into the fray in a meaningful way and fast, the market will likely roll over.

Who the hell’s gonna step in?

 

Well, we can’t say for certain that anyone will. But perhaps there’s a central bank or two – or a collection of banks and brokerages that might be stiff-armed (by a central bank or two) into seeing that it’s in their interest to do a little more buying.

“What?!” you say. “Ludicrous! A central bank dictating to a private financial enterprise what to do with its money? Without shareholder approval?! The very thought of it!”

And we say – calm down, friends. Calm down. It’s all been done before on at least two widely publicized occasions under the stewardship of the turtle-like Alan Greenspan, Federal Reserve Chair for nearly 20 years through 2006. And it could have happened at other times on the Q.T., too.

But that’s not to say it will happen again.

And if it doesn’t… well, look here –

djia121
This is a chart of the Dow for the last six-months. On the far right you’ll see a meaningful contraction in the size of intraday trade (black box, enlarged), a phenomenon that regularly coincides with decreased volatility, and shortly thereafter, a steep drop in price.

RSI readings are also looking complacent (in blue). Any time you see a flat lining like we have here, you have to be prepared for the defibrillator.

hurts

Clear!

 

Our read of what’s happening is as follows –

First, the indexes are plateauing due to a lack of interested buyers at this stage. And we stress ‘at this stage’. Because there will always be those who are willing to buy in ‘once the Dow hits 18,000’ or ‘once we get a genuine pullback’ or ‘once the tension over the current election has passed’ or ‘if we get through the holiday season without a war’ or whatever.

And those who speak this way will, in fact, enter the market – probably somewhere between Dow 19,000 and 24,000, after most of the gains have been booked, and we’re already closing in on a market top.

Latecomers accepted!

 

And that’s fine. Everyone according to his fears.

But in the meantime they’re not willing to hop aboard, and we’ve a hunch that’s going to lead to some genuine fear – and fast.

We’re estimating a roughly 1000 point retreat on the Dow is around the corner – similar to what we saw in late August/early September when the pattern last appeared and the market sold off. We could well get a steeper drop than that, but the first stop, as we see it, is just below Dow 17,000.

That’s at the 137-day moving average.

We’ll reassess once we get there.

Trade Assessments

 

We’ll come back to the upcoming pullback momentarily. In the meantime, let’s take a moment to review a few trades.

We start with our Cooper Tire and Rubber (NYSE:CTB) covered CALL trade that we’ve parlayed into significant gains over the last half-year.

The trade was initiated at the end of June in a letter called The S&P Indy 500, when we bought the shares and sold Calls and PUTs against them. Once those expired, we sold another round on August 18th. That letter was called Options Selling Frenzy Reaps Cross-Eyed Profit Bonanza and with those sales we reduced our adjusted cost base for the shares to just $27.32.

And that’s where it ended. Our shares were called away on expiry when CTB traded above their long CALL strike of 32 at the end of November.

Our profit on the trade was a very sweet $4.68, or 17% in just five-months.

We still have open short CALLs on CTB that we’ll be watching for you.

Whip it good!

 

Let’s look now at a trade we opened on October 13th in a letter called The Oil Dipstick Indicator, wherein we urged you to purchase a CALL spread on the Select Sector SPDR Energy ETF (NYSE:XLE), a corner of the market that’s taken a lashing of a late.

pogues

We certainly didn’t expect the dive that ensued in the crude pits, and the trade resulted in a slight loss.

Total debt on the trade was $1.22, but we closed out our long CALL on November 17th in Insurance Trade for $1.11. The short CALL expired worthless leaving us with a loss of just eleven cents on the trade or 9%.

So it sometimes goes…

If a buyer catch a market falling from its heights…

 

We’re going to attempt the impossible here and make a stab at calling an interim market top. It stems from our analysis of the latest action on the indexes, as outlined at the opening of this letter.

The way it looks to us, there’s going to be some panic in the air regarding oil and what many will view as a deflationary trend in the making (it’s not, but more on that later). The price of oil has crashed in the last six months and it’s making a lot of people nervous.

Look here –

discount

After a 40% haircut, we believe analysts will use oil’s loss as the trigger to begin selling contracts on the indexes.

And so we’re going to attempt to front-run them.

We’re selling a credit CALL spread on the SPDR Dow Jones Industrial Average ETF (NYSE:ETF) and using the funds to purchase PUTs.

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Wall Street Elite recommends you consider selling the DIA January 181 CALL for $1.17 and buying the January 185 CALL for $0.42, for a net credit of $0.75, then using those funds to purchase the DIA March 160 PUT for $1.45. Total debit on the trade is $0.70.

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Wall Street Elite recommends you consider selling the DIA January 181 CALL for $1.17 and buying the January 185 CALL for $0.42, for a net credit of $0.75, then using those funds to purchase the DIA March 160 PUT for $1.45. Total debit on the trade is $0.70.

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With kind regards,

Hugh L. O’Haynew, Senior Analyst, Normandy Research

See what people are saying...

  1. James Ord

    You use the Dow as a Market metric? Please spare me your twisted logic. The Dow is not representative of anything stock market wise. Perhaps you should try the S&P500? Or, better, the MSCI World?

    At the least, start studying something that at least represents the calamity you are predicting./jimo

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