Tuesday Tear-Down

Well that was certainly interesting!

The video on the left is a fantastic illustration of the current investing climate.  I especially like the way that Homer is repeatedly smacked in the head on the way up (rescued by Helicopter Ben?) and the end is just perfect!

We had a pretty rough ride right out of the gate so thank goodness I set levels in the morning or I don’t think the markets would have known where to stop.  I called for the markets to hold half their gains off our recent lows:

• Dow 13,100 – finished at 13,041
  • If we don’t retake it in the morning, we’re going down!
• S&P 1,440 – finished at 1,432
  • Ditto
• Nasdaq 2,500 – finished at 2,500
  • Yes, I am pretty amazing aren’t I?
• NYSE 9,350 – finished at 9,289
  • That’s a big miss!
• Russell 775  – finished at 767
  • As I keep saying, I find this one most disturbing
• SOX 486 – finished 476
  • This was, as I predicted, the first to break down but made NO sign of recovering.

Is it then, time to hit THE button?  It was Homer who said "Once harm has been done, even a fool understands it" in "The Iliad" (and anyone who is thinking "Did Homer Simpson write the Iliad?" must leave this blog immediately!).  But today I will be guided by Homer’s later work, The Odyssey, in which he said: "It is tedious to tell again tales already plainly told," which is my take on the Fed minutes – what did they say that we didn’t already know?

I took the Fed minutes as being about as encouraging as they could be for the bulls, they were written way back on August 7th when the Dow was at 13,500, on its way to 13,695 the next day – despite a Fed statement that clearly stated "Although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected."

The market, like Homer (no, the other one!) fell off a cliff on the 8th and dropped a full thousand points by the 17th, and all this came LONG after Jim Cramer’s August 4th meltdown when the Dow gave up its first 800 points.  Now the minutes reveal the Fed was not asleep.  At their one-day meeting they actually said: "A further deterioration in financial conditions could not be ruled out."  Such a development "might require a policy response."  To me this signals a willingness to take action – what else could the bulls have expected them to say in the minutes that PRECEDED a neutral statement that happened 700 points ago?

Since then the Fed HAS lowered Cramer’s discount window and there certainly HAS been a deterioration in financial conditions.  Additionally, the ECB indicated yesterday that they may NOT be raising rates on the 6th, well ahead of the Fed’s scheduled decision on the 18th.  The ECB, the Fed and the BOJ (and other CBs) have all been pumping money into the markets, something I already consider an overreaction to what is simply a normal pullback to the 200 dma – the same one that has happened in Nov ’04, Apr ’05, Oct ’05, June ’06, Feb ’07 and now Aug ’07.

So I’m not quite ready to hit the button yet but I am disturbed that only the Nasdaq held it’s level, and that could be attributed to the "round number syndrome" that causes market pauses at various psychological barriers.  We will take some kind of bounce tomorrow as a given, especially with the energy patch likely to rally off recent lows ahead of the inventory report but let’s see if we RETAKE the levels I set this morning before we get all excited. 

After moving through a complicated day and losing our levels, despite my bullish impression of the Fed minutes, I was forced to roll down our DIA calls and puts to keep a tight strangle on the Dow but we ended the day almost 2:1 bearish on the index options and I’m hoping we don’t regret that in the morning. 

I have been agonizing over the logic that made me hesitate to cover with more calls yesterday as my initial 12:12 take was:

• "Huge gain in STP thank goodness, small loss in LTP but VIX is flying back to 25 again and topping out there so BEWARE! Last time the VIX was at 25 was the 21st, when the Dow was at 13,090 so this action is interesting as it’s already at 25 after gapping up 2 days in a row. Before that, the VIX was at 25 on the beginning of the 17th, when the Dow was at 12,848, which was a 300 point up day.
• "Does the overreaction of the VIX indicate a HUGE snap coming at 2:15?? We won’t have time to play the mo so the most logical thing to do is bite the bullet and press our strangle by rolling the remaining DIA calls down to the $133s and evening out the coverage.
• "I view the VIX as a rubber band which stretches (increases in volatility) when the market is going the “wrong” way. That means that this last 250-point drop in the Dow has made the VIX “tighten up” like it was a 500 point drop, which means we could get a very fast snap back up, similar to what happened on the 17th (although on that day, the Dow was bouncing off the 200 dma so it’s not quite the same). Still, a catalyst like the Fed could be used for a rally, even if it’s a fake one back to 13,300 rather than a breakout back to 13,400. Don’t forget though, as with my picture on top last night, rubber bands sometimes break!"

When we didn’t get a bounce back off what I considered to be good Fed news, I didn’t cover as much as I should to the upside as the market just looked SO pathetic but we’ll have to wait and see how tomorrow plays out.  Meanwhile, we sensibly took another block of cash off the table, dumping all the AAPL covers as our big upside gamble for tomorrow: