Securities Research Services

Wednesday, July 18, 2007

We need to be careful not to read too much into this week's trading. Options expire on Friday, so there are a number of reasons why the charts are more reflective of gaming than they are of true supply and demand. Likewise, earnings season is just getting started and the market is still trying price in the data as it gets fed in day by day. Once the data is in, it takes time to process. As such, making big predictions about price trends seems dubious to us.

That disclaimer out of the way, let's take a look at the S&P 500 as represented by the SPY exchange traded fund (ETF). The SPY is showing some weakness here and we are likely to see a hard sell day soon; perhaps today.

Note the topping tails over the past three days, which represent the fact that the price tried to move higher, but was turned back to the day's lows three days in a row. This shows us that sellers are using the rallies to open short positions and/or to take profit.

The same thing occurred in late May, as seen to the right of the chart, and it culminated into a large sell day.

While a sell day is indeed possible, it is unlikely that sellers will gain any real momentum here. We've been tracking the daily options readings and for months now the short position on the S&P 500 has been running at extremely overly bearish readings.

Before we go further we need to remind everyone of a market truism that has proven itself time and again; the majority of options traders lose money and the majority of the time, options the majority of options traders are wrong. As such, watching the options markets offers a reliable contrarian reading on market sentiment.

So, what we have here then is the S&P struggling with its highs and projecting a downturn. At the same time, we see an overly bearish put to call ratio in the S&P options market. The SPX saw 2.5 puts trade to every 1 call yesterday. 2-1 is widely considered overly bearish. The SPY saw 2 puts trade to every call. And yesterday, as we said, was not an anomaly. This has been going on for months now. And just look how much downside momentum the bears have realized over the past few months.

The bottom line: We would look for a weak day sometime this week, probably today. At the same time, we will be looking for dip buyers to step in and frustrate the put buyers who have been making big downside bets.

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