Operation 1100

The following is the morning research note from a  major trading desk in NY


During options expiration week, the dealer community’s desire to “pin” the market to certain key levels renders all other thoughtful analysis moot. Options traders, like all traders, seek liquidity, and liquidity is in the big round number strikes – SPX 1100 for example. (Why buy SPX 1095 calls – or SPY 109’s – when any kind of size is going to move that market adversely?) Dealers typically have a hedged book but if they do have exposure it’s at the big round numbers. Pinning the market at those levels (which is a collective act, and doesn’t necessarily imply untoward activity) is a profitable enterprise for them, with investors taking the losses.

During expiration week it makes sense to step back from the news flow and remind ourselves that the stock market is not just a marketplace in which buyers and sellers meet to exchange interests in businesses. It is a den of speculation and the goal is profit – the shorter term the better. Of course, it isn’t only the stock market in which these games are played. How else could one explain Goldman Sachs’ $6 billion in revenues last quarter from Fixed Income, Currency, and Commodity (FICC) trading alone? As a final thought, keep in mind that SPX 1100 lines up almost perfectly with the downward sloping trend line formed by the October 2007 and May 2008 weekly closing highs. (source: Bloomberg)


I won’t pretend to have gone through all the earnings this week with a fine-tooth comb, but my friend Scott Frew at Rockingham Capital pointed out that investor reaction to the heavyweight reports has been pretty underwhelming. The S&P 500 has risen 3.7% since Alcoa reported earnings, but look at how the heavyweights have fared following their results so far: Alcoa is up 1.1% since reporting; Intel is up 0.9%; Johnson & Johnson is down -2.5%; JPMorgan is higher by 3.3%; Goldman Sachs is down -1.9%, and, Citigroup is lower by -5%. There have been bright spots away from the really big boys (CSX Corp; Abbott Labs), and JPMorgan’s results were by all accounts stellar. There is a temporal inconsistency in comparing one or two days of trading results for, say, Citi and Goldman, to six days of performance for the S&P 500. Nonetheless, it’s a dynamic that bears watching (let’s see how Google and IBM and AMD perform today).

I noted a few weeks ago that the market’s perception of “how earnings season went” would likely dictate trading sentiment into the holiday period. Some were saying that this earnings season would be judged not by the bottom line (the margin story is a Q2 story), but by top line growth. At the moment, despite the broad market’s embrace of a bullish narrative, I have not seen many impressive top line beats outside of the TBTF banks. I look ahead to next week’s regional bank-dominated earnings (if you don’t think there’s going to be some hair on those puppies, you haven’t been paying attention) with some trepidation. (source: Bloomberg)

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