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Oh Dear! What A Mess

Author: Ravi Prakash (info)
Website: http://www.optionstradinglessons.com/
Posted: January 7th, 2008 at 11:14 am EST
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The key is employment. The latest data showed unemployment climbing up to 5% and new employment slowed down to a trickle. That is not very good news. To add insult to injury US manufacturing is contracting instead of expanding. Unemployment at 5% is historically still on the low side. Economists in the 70’s used to believe that “normal unemployment is around 6%.” For all purposes this may seem to many as a horrible indication of what is to come in 2008. It does take about 6 months or so to see the real affects of changes in the economy and I believe that this data was due after this economic mess started around the middle of 2007. All the steps taken by the Feds since then will also take some time to show up in the economy.

Now Wall Street is expecting the Feds to drop interest rates by 0.50% and maybe a portion of that before the FOMC meeting near the end of this month. The most obvious outcomes are 1) the US Dollar losing more value and 2) higher inflation in the economy. But the Feds do not have much choice. They are going to drop interest rates. My next thought was ’somebody has to be benefiting from all this cheap money’. Financial institutions for one. Also large corporations that need capital to grow and have access to this cheap cash. So we may see employment improve and financial stocks get a boost from all of this cheap money. However, us regular folks will still have to pay LIBOR and then some for any money we borrow. It is that large spread between LIBOR and Fed funds that will benefit the banks and various other loan sharks.

My crystal ball ‘got busted’ in 2000. If that hadn’t happened I would be already in retirement and probably traveling instead of writing this newsletter. Never the less, I do have a few opinions about the Market in 2008:

- I think we will see the DOW make new highs before the end of this year.
- The economy will accommodate and learn to live with $100+ oil a barrel.
- Tech firms will do well after the 2nd quarter.
- The Feds may start raising interest rates by the end of this year.
- Home builder and real estate may stop its slide by the end of this year

In my last newsletter I showed you a 17 year chart of the DOW and in that I pointed out that the DOW could revisit the 12,000 level and still remain bullish going forward. So as long as the DOW remains above that level I think my predictions have good odds. A drop to that level may indicate capitulation on the Street and could signal a reversal to the upside. The Feds and Wall Street are afraid of a recession. They are also afraid of a big bank and/or real estate firm going belly up. I personally do not agree. Instead I think that allowing one or two big institutions to go under although painful, would be an essential part of the financial healing process. We in the US need to get tougher and deal with some pain now, otherwise we are going to feel a lot of pain in a decade or so.

As an options trader I want to emphasize the importance of choosing the right option series to trade. I cover this point several time in my lessons. It is not good enough to pick the right stock and the right direction. You can do all of that and still end up selling your options for a loss. The key factor is time; it is your enemy when you buy an option and your friend when selling it. Things are going to be volatile for the coming months. It is very important to choose options that do not expire for a good 4-6 months. If you have a decent chunk of money and permission to sell options do so carefully and you could do very well. My final suggestion is to stay away from using margin to trade equities. I learned my lessons many years ago and although it reduces your leverage, it also keeps you from having to sell positions prematurely. In a volatile environment like this one, margin calls are just a day away for many. By trading options instead of stocks you have already achieved a reasonable amount of leverage.

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