Boo! The Ghost of Lehman Still Haunts the Market

Dear SlingShot Trader Subscriber,

On Sept. 15, 2008, Lehman Brothers filed the largest bankruptcy in U.S. history. For us traders, the anniversary of the bankruptcy isn’t as important as equity prices at the time, which is why we’re thinking about that event this week. The S&P 500 (SPX) closed at 1,192 that day, quickly lost support and fell to 667 by March 2009. Since that time, a narrow range around the 1,200 level has been an inflection point where consolidations occur and (with one exception) has held as resistance.

You can see how this price level has acted like an anchor for traders in the chart below of the S&P 500 index. These technical levels are important for short- and long-term traders because they represent an area of heightened risk and volatility. We know that the market will be more volatile and prone to reversals here than at other technical levels. That means that when the S&P 500 gets to 1,180 to 1,210, stocks are very likely to reverse.

 

Chart courtesy of MetaStock: S&P 500 Weekly chart

All of this may sound like it’s mostly important for trend traders, but it also matters to news traders like all of us here at Slingshot Trader. We know that surprises tend to be more dramatic when they’re in favor of the prevailing short-term trend. If traders are bearish, then we look for puts on weak stocks before a news event — and vice versa in a bull trend.

In a tight channel, this kind of analysis can be challenging because we have less time to evaluate the prevailing trend, and we usually have to maintain some level of balance between anticipating bullish and bearish surprises. In the Closed section of our portfolio on the Slingshot Trader website, you can see how we’ve done that since the beginning of the current channel following the August collapse.

 

Short-Selling Hits Highs

When traders get nervous about a convergence between negative technicals (the current “Lehman level”) and fundamentals (European debt crisis), they look for a hedge. Sometimes that means they’ll diversify into fixed income, precious metals and other safe-haven investments, many of which have hit all-time highs this year.

They also might take outright bearish positions on stocks through short-selling, which means that traders are borrowing stock from their broker or bank to sell in the market today hoping to buy it back later at a cheaper price. Short-sellers live by the adage of “sell high, buy low” to be profitable in the market.

We can track short-selling to a certain extent, and it’s currently getting to extremes. For example, some stocks included in the S&P 500 index — such as Gamestop (GME), AK Steel (AKS), First Solar (FSLR) and JC Penney (JCP) — have short interest ratios above 20% and up to 32%. A short interest ratio is the percentage of the outstanding stock that’s being “held” by short traders. In the case of First Solar, it means that 32% of its outstanding shares are controlled by traders who think the stock is going to fall in the near future.

In the chart below, you can get some historical perspective about how high short interest is currently compared with the last five years. Point A was when the yield curve became inverted in 2007 (a rare, but very bearish, signal), and Point B is the date of the Lehman bankruptcy. Short interest is approaching these past levels again, and that indicates a lack of confidence.

 

Source: New York Stock Exchange Mid-Month Short Interest – Bloomberg

Why Do We Care About Short Interest or Fear?

We don’t short stocks, but we are interested in puts when conditions are right. When traders are nervous, they hedge and open short positions — and that nervousness quickly can turn into fear. Fear leads to fast selling, which is a good thing for us if we’re holding put options on weak stocks.

In a bear market, negative surprises tend to result in very dramatic declines. We aren’t predicting some kind of market crash in October, but we do think resistance is likely to hold — and the timing for that resistance bounce couldn’t be better. Third-quarter earnings season starts to heat up next week, so there’s a lot of news that can be traded. If the market gets a little bearish, that’s all the better for us.

 

This Week’s Events

With earnings season starting this week, the schedule will get a lot busier. The list below covers most of what we’re watching as potential game-changers. We’ll discuss some of these in tonight’s webinar live at 6 p.m. ET.

  • 10/13 – U.S. and Chinese trade balance reports
  • 10/13 – Google (GOOG) quarterly earnings, before market open
  • 10/13 – JPMorgan Chase (JPM) quarterly earnings, before market open
  • 10/13 – JB Hunt (JBHT) quarterly earnings, after market close
  • 10/14 – U.S. core retail sales
  • 10/14 – U.S. consumer sentiment report
  • 10/17 – Wells Fargo (WFC) and Citigroup (C) quarterly earnings, before market open
  • 10/18 – U.S. TIC long-term purchases
  • 10/18 – Apple (AAPL) quarterly earnings, after market close

 

The Bottom Line for Next Week

We’re bearish for the short term, but the reality is that the market is channel-bound. Until that situation changes, we’ll still want to have a little balance in our trades. We may emphasize bearish positions, but looking for calls on some of the best stocks before a big news event — like our recent profitable trade on Infosys (INFY) — is still appropriate. At this point, we don’t see anything fundamental that will break the channel or change our strategy in the short term.

One big caveat that we must apply to the statement above is earnings season. Corporate profits aren’t expected to be great, but expectations also are very low, which could lead to a surprise. Right now, we don’t have enough data to be able to say how important this season will be, but by next week’s update, we should be able to start seeing a trend and make a better forecast. For now, we need to work with the channel, remain flexible, and be prepared for changes.

 

TRADE REVIEW

When it’s time to open or close a trade, we’ll send you alerts via email. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here and view our portfolio here. You also can be directed to trade-specific details by clicking on the company names below.

 

Positions Opened

These are the SlingShot Trader positions we opened during the past week of trading and are currently open.

Fastenal (FAST) On Oct. 11, we recommended you to “buy to open” the Nov 32.50 Puts for $1.15 or less. We entered the trade at $1.05. This trade is currently priced near $1.05, and we still like it for new entries.

 

Positions Closed

These are the SlingShot Trader positions we closed during the past week of trading.

Infosys (INFY) Earlier today, we recommended you to “sell to close” the Nov 55 Calls at market. We closed this trade at $3.80, for nearly 100% gains.

CurrencyShares Euro Trust (FXE) On Oct. 10, we recommended you to “sell to close” the Nov 130 Puts at market. We closed the trade at 95 cents.

 

Top Trades Now

These are the current SlingShot Trader positions that we still recommend getting into now, assuming you haven’t already bought a full position.

Fastenal (FAST) See Positions Opened above.

 

Webinar Preview: Join Us Tonight at 6 p.m. ET

Every Wednesday at 6 p.m. ET, we host our live webinar, in which we’ll review this weekly newsletter, discuss coming events in more detail and walk through our Top Trades. We also encourage you to submit your questions live during the session. We want to do everything we can to help you become a successful options trader, which is why you’ll have live access to us for an hour every week.

And if you have any questions or comments you would like to send us in advance of the live session — or anytime during the week — you can write to us at johnandwade@slingshot-trader.com.

If you can’t attend the session live, you can watch the archived version on our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.

 

 

John Jagerson and Wade Hansen
Editors
SlingShot Trader