December's Option Max-Pain Targets

have been floating around 50.5 to 50.96, very close to last Friday's QQQQ closing price. The stability of the target price over the course of the month has been a little surprising to me, but it's good to know.

Real QQQQ prices has been fluctuating +/- 2.0 around the target price last month. For November when the target was around 52.5, the fluctuation was between +2.5 and -3.5.

Today's target price for January 18 QQQQ price is 49.6. Does this mean the market will bounce between 49.6 +/- 2.0 over the next 4 weeks?

I guess we'll find out.

When does the market go down?

When the bears have ran out of ammo. This month the volume of put contracts has really gone down. The outstanding puts are down 30% compared to last month and down even more compared to August.

Last two day's retracement

to the neighborhood of the 50-day SMA offers another opportunity to enter on the short side, for those who missed the chance on late October.

Most markets should make a move to the short side in the near future.

Let's record today's numbers for the following short candidates:

QQQQ: 51.31
DIA: 134.16
SPY: 148.66
EEM: 154.4
IWS: 143.7
IWM: 76.58

GOOG: 693

Mutual Fund Investors

are beginning to flee RMV (small cap value) and RUT (small cap).

EEM (emerging markets) set to do the next big fall.

Nasdaq

tried very hard to stay above 50 today. In the end the bulk of the put contracts with strike at 50 are disposed off and turned worthless. But the option sellers would have to pay a little bit of money to the puts at 51 or higher.

The incremental returns for pushing the market to 51 or higher is not great for option sellers, given that they need to start paying for calls as well. Given the market condition, it may cost too much to try push the market that high. The effort at the last 20 minutes was just to make sure they didn't lose the 50 strikes.

Tomorrow

is option expiration date, and the QQQQ target price has drifted to 52.4. We'll see if the option sellers will get their price.

QQQQ Target Price, Again

QQQQ Target Price is currently 52.5. This is the option seller's "best wish" price for this Friday, when all the options expired. This is also called the "maximum pain" price from the view point of the option buyers.

The target price is the equilibrium point between the bulls (call buyers) and bears (put buyers). Right now, most of the calls have a strike price around 54 and most of the puts have strike prices around 50. If QQQQ goes to 52.5 by EOD Friday, most of the calls and puts will be out of money and expire worthless.

On the other hand, at today's closing price of 48.73, the option sellers owe an obligation of around $429 million to the put buyers.

Usually, the options sellers get their way -- the options usually expire at maximum pain to the buyers. But this week the market seems to have a mind of its own. Will the option sellers again get their way? We shall see.

Where will the money go?

Realestate and finance has some time to go.

Emerging markets are crumbling.

Oil & gas are over-extended.

The high fliers on Nasdaq are getting tired.

Where will all that money go?

There are some clues: long languished old techs like Microsoft has recently come back to life. Even Nortel is showing some signs of life.

Sector Rotation

Out of: Finance, China, Real-estate.

Into: Agriculture, Metal Mining, Gold, Technology, Semiconductor, Biotechnology.

QQQQ's move toward to 53 area has scared away a bunch (about 40% of what was there as of yesterday) of call contracts congregated on 53. This opens up the path for it to move higher. On the way down, a huge amount of put contracts has congested the 50-52 area, preventing Nasdaq 100 from going down to that area any time soon.

China's decision to close up the pipe to Hong Kong was our loss, but China's gain. Otherwise, all the money in Chinese savers accounts will flow to Hong Kong then on to Wall Street bankers wallets.

QQQQ Target Price

52.9

China Oil

Perfect pendant formation in PTR.

Related play: SNP, CEO, SHI.

Relative Strengs, II

Another weak sector - small cap value funds.

The trend is to rotate from small to big, from value to growth. That's why QQQQ is stronger than Nasdaq, which is stronger than Russell 2000, which is stronger than Russell Small Cap Value.

Chinese ADRs are Crazy

The Chinese ADRs are on fire. Never have seen anything like it.

Comparing to A-shares, the ADRs are mostly cheaper by 30-50%. But this is just discounting for the fact that the Chinese market is in a bubble.

Comparing to H-shares, the ADRs are actually 5-10% more expensive! Don't know what to make of that one.

The Chinese regulations on QDII sounded like a good design: half the money has to support China related shares. Allowing money out of China reduces pressure on the Chinese bubble as well as the Chinese currency to appreciate. Reserving money for China related shares supports Chinese companies overseas while avoid buying to much oversea assets that are too expensive already.

I still think the Chinese Government's sovereign fund is a bad, bad idea. Bad idea, bad timing in terms of western market valuations. Sovereigns just should not play the stock market. Maybe it's okay for tiny countries like Singapore. Imagine the Federal Reserve getting into the stock market, it's just not done.

QDII good. Sovereign fund bad.

Relative Strengths

Relative Strengths:

Stronger: Oil, Nasdaq

Weak: Financial, RealEstate

In uncertain markets, long the strong ones and short the weak ones, may be a way to play.

Short Squeeze Appears to be Over

Short squeeze appears to be over for now. The bulls are losing it again.

Notice the recent run back to the top by DJIA was not confirmed by DJTA, as required by the Dow theory.

The Case For Short Squeeze

There was excessive bearishness for the month of October. However, the bears appear to have lost the propaganda war. The bulls have been able to spin everything as good news: bad news becomes reason for another rate cut, while good news is simply good news. As a result, the 401k'ers are not bolting.

The bears need the 401k's to head to the exits to harvest their fruits. Not only that is not happening, but the 401k'ers will be putting in another batch of money into the market every month. The bears will lose their patiences and buy back to cover, which will drive the market even higher.

There's also the smell of fresh money in the air. Chinese investors, who have lately gone crazy in the mainland market, are now allowed to put their money into the global market through QDII. Not only that, the Chinese government has also formed its own investment company, with 200 billion US$ to play with, and perhaps another trillion to follow. The sharks in Wall Street are smelling blood.

Here's how things might work out: the Chinese Government, which seems to have too much money than it knows what to do with, hires some Wall Street firms to 'manage' its money. Wall Street sells buble-level U.S. assets to C.G., then engineer a market crash, then buy the same assets back from C.G. at much lower prices. C.G. ends up with less money, Wall Street ends up with more, and everyone is happy.

As a result, even though our stops have not been triggered, we are closing our short positions until all the Chinese money has its chance to play. The Chinese bull market will probably last until next spring, and the global market may well last at least that long.

October Could Be Another Bear Trap

Bears historically have loved October, and many bears are expecting the market to crash again this month. The problem is, there are too many of them -- the bears have again bought 1.5 million put options on QQQQ so far. By expiration time that number will surely surpass last month's figure.

All that big money betting the market to go down is making it very difficult to go down. That's why the big guys are now spinning all bad news as good news. The bears need the 401k'ers to head to the exits to harvest their catches. The option writers meanwhile are trying to sooth the herd: stay calm, no problem at all, bad is good, good is also good.

We'll continue to hold our short positions, but will stay away from options. Meanwhile we need to watch our stop strategies in case this short squeeze gets serious.

The Party Has Begun

The first bank failure this season! And dear little NTBK too! I remember buying it at $95 one Friday and selling it at $160 the next Monday. On Tuesday it went to $240! Talk about opportunity cost! LOL.

This afternoon, NTBK closed at 6 pennies. Next Monday, 1 penny? Anyone?

The party begins on October the first. Don't be late.

Eager Bears Eaten Alive [model portfolio opens]

Tomorrow's option expiration day. Over-eager bears have bought 2.2 million put contracts on QQQQ, representing a short equivalent of 200 million shares worth 10 billion dollars. At least half a billion dollars must have been spent during the last month buying these contracts. By closing bell tomorrow, 95% of these contracts will expired worthless.

Internet rumors said that some trader(s?) have spent 1 billion dollars buying put contracts betting major European indexes will fall by a third to a half by closing time tomorrow. Yet right.

Heed me on this one: don't buy options, neither puts nor calls. At least not when everyone else is buying. I don't care if you have a billion dollars to burn. The guys who dare to sell you those contracts have much deeper pockets than you. And they have Ben Benanke working for them.

Major indexes will fall by a third to a half, or perhaps, to two thirds. But that won't happen in a month's time. It's a process that will take up to 18 months.

And before that can happen, the big guys will need to first finish eating up all the eager bulls, bears and the weaker shorts. They don't want to leave the table until they finish their last meals.

Only then will they awaken the sleeping 401(k) account holders: wake up! sell! The avalanche will then begins. The big guys will set up traps 2/3 of the way down harvesting all the much cheaper shares from the 401kers.

So, we will be patient, anxious, even a little eager, but not overly so. We will take advantage of the Fed-triggered short squeeze to open up a model portfolio before option expiration tomorrow. We'll come back in a month to track their performance.

We'll be shorting the following indexes: Real estate, Nasdaq, S&P500, DJIA, RMV & RUT. Let's say we put $20,000 into each positions at today's closing price as follows:

Short ICF 217 shares at $92.38 each.
Short QQQQ 400 shares at $50.03 each.
Short DIA 145 shares at $137.70 each.
Short SPY 131 shares at $152.28 each.
Short IWS 132 shares at $151.56 each.
Short IWM 248 shares at $80.79 each.

We'll set up 10% sliding soft stops for each position. If stopped out, we'll re-enter at the next high point using the remaining funds allotted for that position. Otherwise, we'll check back in a month.

Elliot wave theory says that the China bubble will top out around Jan 2008 with the Shanghai Index (currently 5446) going to around 8000 points by then. If so, FXI (currently $163) will top out around $235. However, we consider this market too volatile at this point to play on the long side, but instead will wait for a signal to enter on the short side.

Current Market Trends

The real estate sector has been in a down trend since Feb 2007. Since late July ICF has entered into an upward tilted wedge continuation pattern, signaling that the down trend will continue. However, most wedges would have resolved to the downside during the last week or so. This one seems destined to delayed resolution -- it might exit the wedge to the upside in the short term, but since the downtrend since February has not reversed, it should continue on its down trend shortly there after. Eventually ICF should fall to the 50-60 range over the next few months.

Look at the charts of DUX (utility), RMV (mid-cap value), RUT (small cap) -- they are amazing. It seems a group of people have set up their 401(k) accounts for these funds around 2002 and 2003, buying the same amount of stocks from the same group of companies month after month. Moreover, not one of these people has tempered with their accounts since then, nor were there anyone new joined in later. The result is a straight line along the bottom of these charts, with the occasional hot money pulling the charts away from the line to the upside, but only slightly. But watch out, at least in RMV's case, some of these people have begun to pull their money out of their 401(k) accounts during the last month or so.

Nasdaq has been on a long-term down trend since the Spring of 2000. Recently it has completed its primary fibonacci retracement -- that is, it has recovered 38% of its losses between Spring 2000 and the Summer of 2002 (see chart). The fibonacci retracement level around 2700 will pose as strong resistance forcing the index to resume its downtrend.

SPX (S&P 500), on the other hand, has come back to the same level as its Spring 2000 peak, while DOW has proudly surpassed its 2000 level. We are closely watching the actions of these indexes -- it is quite possible that the actions in the market during the last 2 months, particularly the heavy sell-off during mid-August, may have constituted a reversal signal to the downside. If this is true, SPX will have exhibited a perfect double-top in its long chart: an ominous signal for the future of this economy.

Gold: not much to say here, the up trend since 2002 is still intact. Getting a bit too volatile lately, though.

The China bubble is a short one -- it's barely two years old, not the kind of 10-year bubbles that was in Nasdaq or Japan. The Chinese market is showing signs of fatigue, however, as the volume of its most recent 2-month uptrend is significantly less than last two up legs.

The Fed action today produced a bit of a short squeeze. This sort of short-term actions usually has no effect on longer term trends. But will it somehow delay or disrupt the pending reversal in Dow and SPX? We shall watch closely.

Postscript: this is a resumption of a market commentary series I've put out during the Nasdaq bubble/bust years. Selected articles from that series are being reposted to a sister blog.