It’s A Traders Market, So Embrace the Volatility

by Dan August 30, 2011 9:14 am • Commentary

As I write at 9am, the S&P500 futures are down 70bps, the DAX is down ~80bps near the lows of the session, following a strong showing by Asia overnight up in sympathy with our strength yesterday…..Gold has had a big overnight reversal up almost 2%, and now only down ~4.5% from the all time highs made Aug 22nd.

Which brings us to the curious case of the Euro……many market participants that I speak to are left scratching their heads as to why the Euro holds up so well relative to the dollar, especially given the extent of their debt issues, Germany’s increasing unease with the bailout, the potential for the whole central currency to dissolve and that the ECB is more likely than not lowering rates as opposed to their previous tightening stance.  A popular trade in the last few months has been to short the Euro at about 1.45 to the dollar and cover at 1.40 (which i have done myself through FXE, and am considering again).  Technically this looks like a decent spot to step in especially in front of a couple catalysts that could be disruptive to European markets in Sept, namely the September 7th constitutional court decision on the legality of the EMU bailout packages and the September 29 vote in the Bundestag on the latest version of the EFSF.  Chart below shows the previously mentioned channel.

1 Yr Euro vs Dollar Chart from Bloomberg


The quick 6.5% rally from Friday’s lows immediately following Bernanke’s speech is indicative that volatility is likely to stick with us for a bit and that we are probably not out of the woods yet….Since Friday morning I put on a couple of long positions in the banks……and as of yesterday’s close I took and used the profits in the common stock to switch into call spreads to define my risk (read here).  I did this while also adding a long Sept call position in CSCO for risk management purposes…..while I have no sense of certainty that Friday was the near-term bottom, I wanted to play for a close above 1200 (which we got yesterday) and test of the important 1250 resistance level.  The easy money was made off of the bottom in common stock positions, and now I have defined my risk to see if my inclination is correct……

As I stated yesterday in my morning commentary, I will look to re-short the market at about 1250 as I think this will be a very difficult level for the  market to get through in the near term.  I will also look to portfolio hedges like last weeks SPY put spread in an effort to hang onto some longs……

If the market can regain its footing today and again close above 1200 in the SPX, I would expect a retest of 1250 in the coming week…..At this point, when our markets are basically unchanged on the year, I would expect this out-performance to Europe, with the DAX still down 18.50% ytd to get quite a bit of attention.  I am not going to get stubborn on any longs here, and trust me, I have my finger on the trigger…..the volatility that is being afforded to traders provides ample opportunities to make money long and short…..I am not of the mindset that this recent downdraft is the buying opportunity that most dumb mutual fund managers who go on tv will tell you, but I will certainly “rent” longs, especially when you can capture 10% gains in a day or 2 like I have done in names like Sprint, E-trade and BAC.