5/31/2009 4:23:50 PM

Advantage Credit Spreads

Last week I mentioned our sister service - Advantage Credit Spreads. This service involves the use of options on the S&P 500 (SPX).

Essentially Credit Spreads involve the purchase of one option and a sale of another option in the same class and expiration but different strike prices. The sold option is slightly closer to the market than the bought one, which generates a credit that goes straight into your account (the net premium received).

The aim of Advantage Credit Spreads is to have the position expire worthless each month so that you keep the entire premium that was paid to you at the beginning. This is our performance so far this year:

As you can see, we don't shoot for the moon with this strategy, we consider ourselves as the tortoise, slow and steady wins the game. Some consider this style to be boring but if you're looking at the market as a place to get your thrills, you'll likely lose in the long run (much like a player in a casino!).

This strategy is about being the house (continuing with the casino analogy), and we all know the house does very nicely in the long run. This is why it makes sense to place a portion of your portfolio into this strategy. To learn more, please click here.

Note, this service can also be auto-traded (for free) through Think or Swim brokers (to make it even more boring!)

On to the weekly report.

Current Positioning:

SPY: Short 50%
QQQQ: Short 50%

General Commentary:

This past week was somewhat bullish, despite the fact that news was generally negative. The markets are still considered to be in a sideways pattern, although the potential for an upward break seems to be growing.

We'd been looking for a close below 880 on the SPX and 1350 on the NDX to confirm our bearish stand but support has held very well and Friday's close was quite strong. The one proviso to all this is that Friday was end of month and so there's a possibility that the close was just window dressing for the mutual funds to look good.

The week ahead may give us a more definite direction but if that move is higher, a larger retracement will be due at some point down the track.

A side note about non-trending markets and timing services. One of the keys for any timing service is the ability to position itself for intermediate trends. No one knows the exact point of when a new trend begins (except in hindsight), so when the market goes sideways for a while, conflicting messages come through as the bulls and bears jostle to win the day. The result of this jostling is draw downs on your account! As long as the trends are in fact captured, these draw downs can be accommodated for as part of the cost of trading (assuming your position sizing and leveraging are being managed also).

On to the analysis..

SPX Chart - Bigger Picture

Not a great deal has changed in the bigger picture other than we are testing a high point. If we get a close above the resistance points then that will change the picture for the near term.

SPX Chart - Shorter Picture

The shorter picture shows how we've been going sideways since the start of May but Friday's close was the highest level since early May.

For the week ahead, the likelihood is that we touch the 200 DMA around 930 and then continue sideways again. Having said that, the longer we consolidate sideways, the greater the probability that we'll get an upside break.

As a side note, the MACD has the potential to turning positive here, it's not guaranteed to do it of course but if it does turn positive, the bulls will be in full control.

Support on the SPX is now 860 - 875 and resistance 925 - 950.

NDX Chart - Shorter Picture

The Nasdaq broke out of the triangle discussed last week and has now closed at its highest level since early October, it's now testing the high of May 6th.

As unlikely as it seems that the market will continue the great run that started on March 10, the potential is building. We have a MACD that's very close to turning positive, the 50 DMA is close to crossing the 200 DMA, a rising RSI and an up tick in volume. If the rise does in fact continue, it's likely to lift the rest of the market also.

For the week ahead, support on the NDX is 1350 - 1390 and resistance is right here.

The VIX - Bigger Picture

I thought I'd give a broader perspective of the VIX as a possible indicator of where we're heading in the medium term.

The chart is quite interesting as it shows that we've had a weekly close below 30 for the first time since September last year. There's also a large symmetrical triangle, which implies that volatility is going to be contained in the mid term between 25 and 40 (that's still quite a big range).

From the indicators perspective the RSI is approaching one its lowest levels in over 3 years, there's divergence on the MACD histogram but the linear MACD is not indicating a change of direction in the near term. The conclusion to be drawn from this is that the markets will remain resilient here but a retracement can be expected within the next few months.

The VIX Picture

In the shorter term, the VIX is essentially confirming the sideways move of the markets, although the MACD is showing the possibility of a cross lower. This scenario adds to the potential for a break higher in the markets.

As mentioned last week, 34 is the level to watch for a break down in the markets. However until then, the markets bias is sideways to up.

The VIX measures the premiums investors are willing to pay for option contracts and is essentially a measure of fear i.e. the higher the VIX, the higher the fear in the market place.

Quote of the Week:

The quote this week is from Henry David Thoreau, "Things do not change, we change."

Feel free to email me at angelo@stockbarometer.com if you have any questions or comments.

If you are interested in continuing to receive our service after your free trial, please click here.