"Operation Twist" Begins with a Thud!
Friday, September 23, 2011
Equity futures have sold-off sharply since the Fed announcement of the beginning of "Operation Twist", setting a test of major support near the 1100.00 area. Volatility as measured by the VIX has moved above 40.00 once again, which is the fifth time we have been above this key level since August. The spike in volatility makes option premiums rather rich, which could make short-option strategies attractive to more aggressive traders. Some aggressive traders who believe that the S&P 500 will either rally, stay neutral, or fall moderately in the next month may wish to explore a put ratio spread in out-of-the-money options in the E-mini S&P 500 futures. For example, with the December E-mini S&P trading at 1129.00 as of this writing, the October 1000 puts could be bought and 2 October 950 puts sold for a 3.00 credit, or $150 per spread, not including commissions. This trade is best done for a net credit, as it expands the price levels at which the trade would be profitable at expiration.
Fundamentals
The Federal Reserve has put a new "twist" in its arsenal to try to stimulate the economy by announcing that it would purchase 400 billion of longer-dated Treasuries in an attempt to lower longer-term interest rates. In addition, the Fed will re-invest proceeds from maturing agency debt into mortgage backed securities to help keep mortgage rates low. The Fed's actions were not supported by all voting members, as there were three dissenters to the new efforts. The increase of longer-term maturities will be offset by a decrease in shorter-term maturities in the Fed's portfolio, which will lengthen the average maturity of the Fed's portfolio to eight years by 2012. The effect of the Fed's action should be a flatter yield curve in hopes that lower longer-term rates will spur an increase in borrowing for mortgages, as well as by businesses to meet funding needs. The big losers in this policy could be regional banks, who benefit from a steep yield curve, as they normally borrow short-term and lend long-term, locking-in the interest rate differential. The market's reaction to the Fed's announcement was for longer-term Treasury futures prices to rise sharply, while the short end of the curve saw declines. Equity markets sold-off sharply, and commodity prices -- especially Gold and Oil -- tumbled. What market participants seemed to get out of the Fed's post meeting comments was that there were still very real down-side risks to the economy, and that any action by the Fed may not only take some time, but also may still be ineffective in reviving the economy. That seems to have been the catalyst that sparked the renewed flight to less risky assets occurring since the Fed's announcement.
Technical Notes
Looking at the daily continuation chart for the E-mini S&P 500 futures, we notice that Thursday's steep sell-off seems to have confirmed the "bear flag" formation that has been developing since early August. The pattern began once prices broke downward from the "consolidation pattern that the E-mini's have been in for most of 2011. Notice how volume has declined during the formation of this "flag", which is a hallmark of this pattern. Traders would likely want to see volume increase once the lower "uptrend line" is taken-out, which adds to the validity of the pattern. There is support near the 1100.00 area on the cash S&P chart, and major support for the futures at the "spike" lows of 1077.00. If 1077.00 gives way, there is not any chart support until the 1000.00 level. Upside resistance is found at the 20-day moving average, which is currently near the 1180.00 area. Major chart resistance is found at the lows of the 2011 consolidation near the 1241.00 area.
Mike Zarembski, Senior Commodity Analyst
