Monday, August 1, 2011
If we assume that our political leaders will come to an agreement to raise the debt ceiling, we may see a "relief" rally in the equity markets, especially given the recent sell-off. With the VIX having risen to over 25 on Friday, option premiums may be relatively attractive to traders looking for option selling strategies. For example, with the September E-mini S&P trading at 1288.50 as of this writing, the August 1210 puts could be sold for about 10.00, or $500, not including commissions. The premium received would be the maximum potential gain on the trade which would be realized at option expiration on August 19th should the September E-mini be trading above 1210.00.
With the August 2nd debt ceiling deadline fast approaching, it appears that our political leaders in Washington, much like a high school student with a term paper coming due, are finally getting serious about coming up with a plan to raise the debt ceiling, as well as finding areas to cut spending to help control our widening national debt. The current talk is of nearly 3 trillion in cuts divided over two stages, with the first stage cutting 1 trillion dollars and the second stage calling for 1.8 trillion dollars in cuts that will be recommended by a special committee of Congress. Should this proposal finally pass both houses of Congress and be signed by the President, the markets can finally breathe a sigh of relief as the US does not do the unthinkable and default on its sovereign debt. It is likely that most traders never really considered that the US would not come to some agreement on raising the debt ceiling, and there is some evidence that played out, as US Treasury securities rallied sharply on Friday. Not the reaction most people would expect if the market believed the US would actually default on its debt payments! What may be a bigger concern for the market is the potential downgrade of the triple-A credit rating by at least one of the major credit agencies. This could occur even with an agreement on raising the debt ceiling if one or more of the ratings agencies believed that not enough has been proposed to actually deal with the rising account deficit. Here is where possible market scenarios become hazy. One guess is that interest rates on the US Government debt would rise to mirror the lower debt rating. However, what major alternative is there to US Treasuries given the enormous size of the debt market? Euro bonds certainly could be considered, but the EU certainly has its hands full with its own debt issues. Japan's economy has a myriad of issues including a Debt to GDP ratio more than double that of the US! If we look at what occurred in the past when the credit ratings were cut to other western nations' debt, such as Canada and Australia, we see that this was actually a wake-up call for these countries' political leaders and actions were finally taken to address their nations' finances. Though it did take some time, both countries finally did receive their triple-A ratings once again, and both countries' finances are now on a much more solid footing. Should the same scenario happen to the US credit rating, we can only hope for a similar outcome!
Looking at the daily continuation chart for the E-mini S&P futures, we notice prices testing the 200-day moving average but not closing below this key indicator. The 14-day RSI has turned weak, with a current reading of 41.10. Looking longer-term, it appears that the S&P may be in the midst of a consolidation phase, with 1240.00 on the downside and 1375.00 on the upside. The next support point is seen at 1257.00, with resistance found at 1347.75
Mike Zarembski, Senior Commodity Analyst