Wednesday was a big session with better than expected manufacturing surging the market 3%. In this article I will do a quick technical take on the current situation for the SP500 and gold as they are both trading at a key resistance level. also its important to know what type of price action we will get in the next 1-2 days so you can have your profit targets or protective stops in place depending on which side of the market you are currently playing.

SPY – SP500 Exchange Traded Fund – 60 Minute Chart

The market is currently in a down trend which means bounces get sold. But if you take a look at the buying volume ratio at the bottom of the chart you will notice that in an uptrend buying surges are the beginning of a rally, and during a downtrend buying surges are the end of a rally. I also want to mention that a lot of volume traded at this current level which you can see on the volume by price bars on the chart. This means there will be a lot of sellers to overcome before breaking to the upside.

The situation the market is at now makes things difficult to tell if this bounce will get sold, or if its just the starting of a rally. There are several arguments for each side but the one which I think has the most influence is the buying volume. It was very strong on this current bounce. It feels more like a rally but we will not know for sure for a couple days…

That being said, if the SP500 moves up Thursday then I would consider the market to be in an uptrend and exiting any short positions is a smart play. But if this bounce is sold and the market drops, then the 3% rally on Wednesday could all be given back and then some.

GLD Gold Exchange Traded Fund – 60 Minute Chart

Gold has continued to grind its way up to the previous top. Problem is the volume has been very light and that tells me there is not much demand for gold at these elevated prices. While we are still long gold it is crucial to have your protective stop in place so we lock in as much profit as possible for when the sharp selling spike happens.

In short, the market feels like its trying to reverse back up but at this time its still in a down trend and trading under a key resistance level. READ MORE

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by Tyler Durden

Summary from the CBO:

The Congressional Budget Office (CBO) estimates that the federal budget deficit for 2010 will exceed $1.3 trillion—$71 billion below last year’s total and $27 billion lower than the amount that CBO projected in March 2010, when it issued its previous estimate. Relative to the size of the economy, this year’s deficit is expected to be the second largest shortfall in the past 65 years: At 9.1 percent of gross domestic product (GDP), it is exceeded only by last year’s deficit of 9.9 percent of GDP. As was the case last year, this year’s deficit is attributable in large part to a combination of weak revenues and elevated spending associated with the economic downturn and the policies implemented in response to it.

And some optimism from the CBO:

The Budget Outlook

Fiscal year 2010 will mark a change in the recent trends that have prevailed for both revenues and outlays. After falling sharply during the recession, revenues are projected to increase (in nominal dollars) for the first time in three years, rising by $38 billion, or about 2 percent. Outlays, which have grown rapidly in recent years because of the recession, the turmoil in financial markets, and policies enacted in response to those events, are expected to decline by about 1 percent. On the basis of tax collections through July 2010, CBO expects federal revenues to total $2.1 trillion this fiscal year, or about 14.6 percent of GDP (see Summary Table 1). Gains in receipts in recent months indicate that federal revenues are beginning to recover from the recession.

In the period from October to December 2009, revenues were about 10 percent lower than in the same quarter a year earlier. But from January to July 2010, revenues were about 6 percent greater than in the comparable period of 2009.

Outlays are expected to total $3.5 trillion this year, or nearly 24 percent of GDP—a level slightly lower than the 25 percent share recorded last year but still much higher than the average level of roughly 21 percent of GDP over the past 40 years (see Summary Figure 1). Spending has dropped sharply this year for certain programs related to the federal government’s response to the turmoil in the housing and financial markets. For activities other than those programs, overall spending will rise by 10 percent in 2010, CBO estimates.

Over the next few years, federal budget deficits would decline markedly as a share of GDP if the current-law assumptions about fiscal policy in CBO’s baseline came to pass. Under those assumptions, the deficit would drop to 7.0 percent of GDP in 2011 and 4.2 percent in 2012 and then would reach a low of 2.5 percent of GDP in 2014. For the rest of the 10-year projection period, deficits would range between 2.6 percent and 3.0 percent of GDP, close to the average of 2.6 percent of GDP experienced over the past 40 years.

What a stunner – optimistic government projections… For exponential revenue hockeystick estimates, look no further than the chart below. Somehow we fail to see the 20% of unemployed (the real number, not the government’s) paying 50% more taxes.

Full budget update:

The Market Guardian

At Active Trading Partners, we take a different approach to trading than most online services in terms of advising our subscribers. Our methodology revolves around behavioral characteristics of the crowd, and taking advantage of the extremes in sentiment, whether bullish or bearish.

In the case of ETF trading, we often work with 3x Bull or Bear ETF’s like BGZ, ERY, ERX, TZA, TNA and so forth. Using a combination of Fibonacci re-tracements and Elliott Wave theory, we look for high probability set-ups and extreme overbought or oversold situations to trigger a trade recommendation. A most recent example with ETF’s was a short position we took against the rising energy stock index, the XLE. This index had become incredibly overbought in just a few weeks, and looking at prior topping indicators and fibonacci trading day cycles, we felt it was a “Low Risk” bet to short the rally. We recommended ERY at $45.40 as the XLE headed over $56 and was becoming overbought. Within 7 days we had a 15% plus gain by going against the crowd. I saw a 13 fibonacci day trading rally at extremes, so we used the XLE chart below, to identify the timing to enter into ERY.

We use the same approach when it comes to trading individual stocks. We look for “Waterfall decline” reversal patterns, which are somewhat proprietary for ATP and our methodology. This method reduces our entry risk because we are buying stocks that have already taken a recent short term multi-day or even multi-week hit as investors have exited the stock. Recent examples include buying DCTH, a former high flier that fell from $16 down to $5.80 when ATP advised purchase. Within days the stock bottomed and ran to as high as $9 within a few weeks for a 50% move. Another example is OREX, who took a hit in concert with VVUS several weeks ago. We felt the sell-off was overdone and recommended the stock at $4.01, after it dropped from $6. The stock ran back to $5.30 within 10 days for a 30% plus gain.

Trading in a volatile market means you need to be patient, discerning, and wait sometimes for an oversold or overbought condition before you act. Sometimes acting early can cause you to get spooked out of positions that end up being profitable, but only after you panic sell out at a loss. At ATP, we use a “tranche buying” methodology which tries to help with the emotional side of entering or exiting a trade. We recommend 1/3 or 1/2 positions at a time, even if we are really confident in our entry point. This way just in case you mis-timed the bottom of your target by one or two days, which often happens, you reserve some powder to add additional capital into the trade to work your way in over several days. We also advise that our partners enter into these tranches over 24 hours of trading time, perhaps buying 3-4 times into our position especially on minor pullbacks. How many times have you bought into a trade entry at say $5.00 a share, and two days later the position bottomed at $4.50, you close it for a loss, and then it runs to $6? Using a tranche buying methodology keeps your emotions in check and you actually look for a bit further dip as a benefit, not a detriment to your trading.

We also adjust our stops as the stock or ETF moves after we have completed our entry. The main goal as a trader or investor is to book profits and limit losses when you are wrong. Since our ego is often our worst enemy, adjusting your stops as the trade moves in your favored direction keeps you from gettting too giddy and letting a profit slip away. In addition, a reasonable stop prevents you from being over-confident and letting a small loss turn into a larger one. Another recent sample at ATP was buying into VITA, which was very oversold at $1.76-$1.80 ranges. We also though advised our partners take profits at $1.92-$1.97, with a nice and tidy 6-10% gain over 7-8 days of hold period. The stock then fell hard just a few days later to $1.64. Not taking profits would have meant wiping out all of your hard work and watching your paper profits turn into a “hoping for a rebound” position.

In volatile markets, don’t get off your game plan and try to keep your ego in check. Enter into your trades no matter how confident you are, slowly and over 24 -48 hours of trade time. Adjust your stops and prevent yourself from getting too greedy or giving away profits. Take your time, wait for set-ups, and also take a break every now and then…nobody needs to trade everyday.

Come check us out at www.ActiveTradingPartner.com and join us and/or sign up for our free weekly reports!

Courtesy of Mish

A new Gallup Poll shows Spending Slumps Even With Back-to-School Underway

Americans’ self-reported spending in stores, restaurants, gas stations, and online averaged $62 per day during the week ending Aug. 8. Early August consumer spending trends trail 2009 and will need to surge to match last year’s anemic back-to-school results.

Gallup’s weekly spending measure for the first week of August shows no improvement over that of the last week in July or that of the same week a year ago. In turn, this suggests that back-to-school sales are unlikely to substantially exceed last year’s depressed levels. In fact, this week’s comparable of a year ago was a big spending week, making for challenging sales comparables for many retailers this year.

Corporate Spending Slowdown

Bloomberg reports Cisco, IBM Sales May Signal Slowdown in U.S. Corporate Spending

Weaker-than-forecast sales at Cisco Systems Inc. and International Business Machines Corp. may signal a slowdown in the corporate spending that has led the U.S. recovery.

“It’s been business investment, particularly technology, that’s been in the driver’s seat,” said Stuart Hoffman, chief economist at PNC Financial Services in Pittsburgh. Should equipment spending slow significantly, “unless something else picks up the pace, it means the outlook for the economy is going to be that much dimmer.”

Corporate investment is among the few remaining sources of economic growth as the effects of government stimulus measures wane and unemployment remains stuck near a 26-year high. Economists this week cut their forecasts for the second half of the year as the more than 8 million jobs lost during the recession hamstring consumer spending.

San Jose, California-based Cisco yesterday said revenue in the current quarter will be $10.64 billion to $10.83 billion, compared with a $10.95 billion median estimate in a Bloomberg survey. The stock fell as much as 12 percent in intraday Nasdaq trading today

IBM, the world’s biggest computer-services company, last month reported revenue that missed analysts’ estimates, citing a decline in services-contract signings. Signings fell 12 percent to $12.3 billion, the second straight quarterly drop in contracts for services, which make up more than half of IBM’s total revenue.

GDP is increasingly likely to be negative at least one quarter in the second half yet few economists even discuss the possibility.

Mike “Mish” Shedlock

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THANK YOU for the overwhelming positive feedback to the information I posted on Tuesday on our sister site. You can find that post HERE.

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Stock Market Newz

J.W. Jones
As discussed in the first article, “The Hidden Potential of Learning How to Trade SPX and Gold Options” I pointed out that there are several fundamental principles that must be mastered before profits can be attained when trading options. Novice traders typically skip the discussion about “The Greeks” and skim over volatility only to watch their precious trading capital disappear.

As promised, this article and future articles are going to discuss the Greeks as they relate to options trading in a way that hopefully everyone reading this can understand. While there are more than ten Greek symbols that directly relate to option pricing, an option trader must be able to clearly articulate and understand 4 of the ancient Greek symbols and one English invention. (Vega is not a true Greek symbol-Look it up!)

The five core Greek symbols which are critical in order to understand are as follows, in no particular order: Delta, Theta, Vega, Gamma, & Rho. Most veteran option traders have a sound understanding of Delta, Theta, Vega, & Gamma. Rho is not nearly as well known, but anyone who has ever studied econometrics, option pricing models, or has studied applied finance know all too well the importance of Rho. For inquiring minds, Rho measures sensitivity to current interest rates.

Today’s article is going to focus on the Greek symbol Theta. By now many readers may wonder why I continually capitalize the Greek symbols, and the reason is because they are that critical. The technical definition of Theta derived directly from Wikipedia when applied to options is as follows:

THETA – Θ, measures the sensitivity of the value of the derivative to the passage of time: the “time decay.”

Time decay (Theta decay) is of critical importance when an option trader is attempting to quantify and/or mitigate risk. There are two parts factored into the price of an option contract: extrinsic value (a major component of extrinsic value is Theta; the other is implied volatility) and intrinsic value which would be the amount of money a trader would gain if they exercised an option right away. A great many authors who opine about options get caught up using terminology like intrinsic and extrinsic value which only serves to confuse most novice option traders even more. I refuse to use those words in my writing as I find them to be cumbersome and option trading can be made much more difficult than it needs to be.

Theta and time decay are synonyms when discussing options. An easy way to remember their congruence is that the word time starts with a “T” as does Theta. If a trader owns calls or puts outside of any type of spread, they are totally exposed to time decay (Theta) and as an option contract gets closer to expiration, the time value of the contract diminishes. This accompanied with failure to account for implied volatility (to be discussed in the future) are the fundamental reasons why so many people lose money when trading options.

Just as theta can be an option trader’s worst enemy, it can also be used as a profit engine. If an option trader sells an option contract to open the position, that option trader is using theta as a method to profit or as a way to reduce the cost of a spread. While this article will not spend a ton of time discussing various option spread techniques, in the future we will discuss them in detail. At this point, we are only attempting to understand that Theta represents the time decay priced into an option.

It is also critical to understand that Theta (time decay) is not linear in the time course of the life of an option and accelerates rapidly the final two weeks before an option expires. The rapid time decay the final two weeks before expiration presents a multitude of ways to drive profitability, but it also can represent unparalleled risk. While this article is just an introduction to Theta, the next article later this week will continue the time decay discussion.

Since we are discussing Theta, I thought it would make sense to discuss a trade I took last week which utilized Theta as the profit engine. Recently a variety of underlying indices, stocks, and ETF’s have options that expire weekly. Weekly expiration expedites Theta and gives option traders additional vehicles to produce profits.

While most equity or futures traders might shy away from a chart like this, an option trader has the unique ability to place a high probability trade. I believed that the market would stall around the SPX 1130 area so I looked for a trade which would utilize the SPX weekly options. The SPX weeklies expire based on the Friday SPX open. With the SPX trading around 1124, I put on a call credit spread which used time decay as the primary profit engine.

The setup I used involved selling an 1150 SPX call and buying an 1175 SPX call, which is also known as a vertical credit spread. I received $100 (1.00) for the 1150 SPX call and purchased the 1175 call for $20 (0.20). The $80 dollar profit represents the maximum gain per contract sold. As an example, if I placed this trade utilizing five contracts per side I would have a maximum gain of $400 dollars. The probability of success at the time when I placed this trade was around 78% based on a log normal distribution of the price of the underlying.

Immediately after placing the trade I utilized a contingent stop order that would close my trade entirely if the SPX reached the 1135.17 area. Essentially, my maximum loss not including commissions was limited to around $60 dollars per contract with a maximum gain of around $80 per contract assuming we did not get a big gap open.

Essentially, if the SPX stayed below 1135.17 for two days and opened on Friday below the 1150 level my trade would reach maximum profitability. This is a trade I actually placed on Tuesday afternoon, however I exited the position before the close on Thursday due to the impending jobs report which was set to come out Friday morning. I was able to collect over 60% of the premium sold per contract ($80) which came to about $45-50 per side. At $1,000 dollars risked based on my stop level, the trade would have produced a net gain of around $750 dollars in less than 3 days.

Hopefully this basic example illustrates the potential profits options can produce if they are traded appropriately with risk clearly defined while having hard stops in place. This trade produced a nice profit, however it was susceptible to a gap open, thus I maintained a relatively small position to mitigate my overall risk profile. As always, a trader must see potential risks from all angles and utilize proper money management principles when determining how much capital to risk. In closing, I will leave you with the insightful muse of famed trader Jesse Livermore, “A loss never troubles me after I take it.”

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J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized.

by Tyler Durden

In advance of today’s FOMC statement which the entire market is waiting for with bated breath, specifically focusing on just what form any incremental quantitative easing will take (if any), Barclays’ Joseph Abate once again steps back to observe the forest in avoidance of the trees, and asks the critical question: just what is the objective of this round of QE: is it to force down short- or long-term interest rates. And since the economic benefit of the former is minuscule, the Fed will arguable be focused on the latter, thus forcing Abate to ask how this can be best accomplished “without causing the disruptions that cropped up in the first round of asset purchases.” The Barclays strategist also wonders if the purpose of a possible MBS monthly purchases on a periodic basis, rather than en masse, is merely to prevent a problem that has recently become prevalent: namely the surge in MBS trade fails, a phenomenon that has received surprisingly little attention lately, yet which as the chart below from Mortgage News Daily shows is become quite a major problem, and one which the Fed is certainly concerned about (and if it isn’t it should be). In other words, most pundits openly ignore the very likely distortions that will arise from a wholesale attempt at pushing LT rates lower. Read on for Abate’s open ended question, as well as his logic as to why possible QE forms, at least as presented by the general media, are likely to be woefully insufficient.

From Joseph Abate:

Musings

In thinking about another round of quantitative easing, the Fed would have to work through a few issues. First, it needs to decide what the objective is – is it to drive down short- or long-term interest rates? Second, if the goal is to pull down long-term rates – which would produce the most economic stimulus – how can this be accomplished without causing the disruptions that cropped up in the first round of asset purchases?

Given the current level of short-term interest rates, we think any additional stimulus designed to pull the funds rate, repo or bill yields lower by increasing reserve balances at banks would likely be quite small. First, the relationship between the overnight funds rate and the level of bank reserves has broken down. Not only are banks structurally long cash, but, volumes traded in the funds market have shrunk substantially, with only the GSEs as the biggest players. Thus, there is no need to target a specific level of bank reserves – it matters little to short rates whether the level of bank reserves stays at $1.050trn, goes higher, of falls by $200bn through year-end, as we expect. Second, we think there are more effective ways to pull short rates lower – either by cutting the IOER or by allowing the SFB program to expire. Both could drag short rates down without being tied to a reserve operation of a specific size.

Since short rates and reserve balances have become unmoored, and the stimulative effect of pushing these rates down another 10-15bp would be low, any additional QE from the Fed would mostly likely focus on bringing down long-term interest rates, where it could get more “bang for its buck”.

The Fed would then be resurrecting a key FOMC debate from 2009 – what matters more for long-term interest rates: the size of the Fed’s asset (MBS) holdings or the pace of their acquisition? If the size of the portfolio matters most, then the only reason to purchase MBS securities at a monthly rate rather than in rapid-fire succession might be to prevent the disruption its earlier purchases created by causing fails (or incomplete deliveries) to spike. Alternatively, the Fed could simply buy Treasuries where its purchases would be less likely to cause significant distortions. Regardless, re-engaging QE – even in the light version to keep the Fed’s balance sheet steady – may require a bit more thought than simply flicking a switch.

QE ‘lite’

Markets have begun pricing in a small probability of some kind of Fed action by year-end with 3m OIS slipping 2bp to 17bp in the past month. At the same time, the December FF contract is very slightly inverted to the September contract. Discussions about what the Fed might do to prevent additional softening have focused on a QE ‘lite’ strategy of MBS (or Treasury) purchases to offset the shrinkage in the Fed’s balance sheet caused by prepayment roll offs. Our economists do not believe that growth will become sufficiently soft to justify another round of quantitative easing. Since the start of the year, reserve balances have remained fairly steady at 1.050trn (as of Wednesday, $1.038trn). More significantly, the Fed’s MBS portfolio, which peaked 3 weeks ago, is only $12bn lower.

Looking ahead to year-end, our mortgage strategists believe that at prevailing interest rates the Fed could see an additional $115bn in prepayments ($275bn annualized). Since prepayments shrink the size of the Fed’s portfolio, they permanently reduce the level of reserves in the banking system. Other components of the Fed balance sheet should also lead to a permanent shrinkage in reserves, including maturing Agency debt securities and the secular increase in currency in circulation. Adding in temporary swings in the Treasury and GSE cash deposits at the central bank, we look for aggregate reserve balances to shrink by almost $200bn by December, ending the year at $875bn. Thus, the QE ‘lite’ proposal being discussed in the press would have the Fed in the market buying approximately $23bn in either Treasuries or MBS each month – just to keep the Fed’s MBS portfolio from shrinking.

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by Tyler Durden

A quick look at market volume: in a word – deplorable. It confirms what Gillian Tett said last week, piggybacking on our ongoing fund outflow observations, that there is “a loss of confidence – not merely in the idea that the future will be a brighter place, but also, most crucially, about whether anybody is able to predict that future at all.” She concludes: “it is bad for investors to feel confused about the outlook for government regulation or deflation; but it seems that nobody really understands how the basic mechanics of the equity market work any more, it is hard to trust that the stock markets are a good destination for your money. Little wonder, then, that those US equity mutual fund outflows have accelerated.” Presenting exhibit A of precisely this phenomenon: today’s ES volume is about the worst it has been in, well, ever, at 50% below average!

Another perspective of where volume has been in the past two weeks:

And a result of the ongoing dislocation in stocks, the bond to stock divergence is just plain silly now.

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