The Eye of the Derivative Meltdown
From 1990 to 1997, Kevin Haggerty served as Senior Vice President for Equity Trading at Fidelity Capital Markets, Boston, a division of Fidelity Investments. He was responsible for all U.S. institutional Listed, OTC and Option trading in addition to all major Exchange Floor Executions. For a free trial to Kevin’s Daily Trading Report, please click here.
The SPX finished last week on 3 straight plus days to 1251.70, but the Derivative Meltdown took over on the weekend. Lehman Brothers
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PowerRating) was expected to make a deal, and was in talks with Barclay, and Bank of America
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PowerRating), but both of them walked away, so LEH declared bankruptcy. However, the big surprise was BAC taking out Merrill Lynch
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PowerRating), which was obviously much worse off than Thain said they were. Both Thain, and Dick Fuld misled the public from day one, and there were a lot of investors that got burned by it.
The American International Group
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PowerRating) situation also deteriorated quickly over the weekend, and they are scrambling for capital, as it got downgraded by the ratings agencies at the worst possible time, kind of like the perfect storm. AIG closed yesterday down 60.8% to 4.76 No one seems to know for sure the extent of the counter party risk of LEH, and AIG, but it is probably extensive, so the net result can`t be good for the market, especially if some accounts sell equity to cover the counter party losses. The FED said no to LEH, and has drawn a hard line with AIG, that they will probably have to soften to avoid a much bigger, and more complicated problem for the different institutions involved in the AIG derivatives world wide.
The SPX declined to 1212.70 on the 9:40 AM bar yesterday on the fear, and then reversed the -2.0 VB zone and traded up to 1235.43 on the 10:55AM bar. The SPX then went sideways as it set up a bearish contracted volatility triangle, and traders jumped on the B/O below 1225, and the SPX declined to an 1192.70 low, which took out the 1200.44 7/15/06 low. Before it did that, it bounced off the -3.0 VB 1202.74, after the 1201.56 low, and and hit 1211.81 on the 3:25PM bar. The SPX declined -17.5 points in the market-on-close (MOC) session to close at 1192.70.
NYSE volume expanded to 1.9 billion shares with 1.7 billion down and breadth any -2885. The financials got crushed as you would expect with the XBD -9.0 and BKX -8.4, as did the energy and commodity stocks with crude oil closing at 94.75 (WTIC) or -6.4%. The OIH finished at -7.3 and the XLE -7.7 There was a rush to to the TLT which was +3.2%.
The NYA Composite broad market index had already taken out its 7/15/08 low on 9/4/08 so that didn`t bode well for the SPX, and INDU. Yesterday, the INDU made a new bear market low close to 10917, versus the 7/15/08 low close of 10963, but did not take out the 10828 actual intraday low, which will happen this morning as the SPX futures are -25 points as I complete this at 9:00 AM.
The key zone in this bear market all along, as you know from many of the previous commentaries is 1172-1077 The 1172 level is the .50RT to the 10/10/02 769 bear market low, and is a -25.6% decline, while 1077 is the .618RT from 1576, and is a -31.6% decline, so it it a very high probability reversal zone for this bear market, especially for those investors that are mostly in cash, and can institute a scale in strategy to increase their equity exposure. If you are one of those party-line Buy and Holders, and are fully invested, and did nothing since the 1576 top, you can just say a few prayers and hope it turns around.
Crude oil is trading below $93 this morning having taken out that major $100 support level yesterday, and the $US Dollar is up as the $DXY is trading at 78.69 +0.3. Under normal conditions, that would boost stocks, but the fate of AIG controls the near term market action, not to mention that this is also a Triple Witch option expiration week, and we have the FOMC today, so fellow traders- there will be trades to play the next few days because of the volatility.
Have a good trading day!
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