We’ve had a good couple of days in the markets, and with immediate-term risk assets being quite oversold, the bounce we are seeing may have further to go.
Soon the question will become whether this bounce leads to performance-chasing (and hence a rally) in risk assets by fund managers, or whether the global growth slowdown and European debt issue will weigh even more heavily in the markets.
Right now, with volatility elevated, my trade idea involves selling options. In that case, I would like to sell far out-of-the-money calls, or call spreads, on the Semiconductor HOLDRS ETF (AMEX:SMH).
The semiconductor stocks often act as a leading indicator to global equities. And the SMH’s recent sell-off along with the market started at the resistance point at its 200-day simple moving average.
If global growth is to slow, then semiconductor investing should also cool somewhat … and charts like copper and the inverted yield curves all over the world are also confirming slowing growth. On a weekly chart, the SMH — along with the PHLX Semiconductor Index (NASDAQ:SOX) — is developing a major two-year-long head-and-shoulders pattern which, if it works out, would have a final price target near the 2008 lows.
So, in order to enter the trade, we need to see the SMH up somewhere between $30 or $31 (it’s at $29 and change, as of this writing), and we would then want to sell calls at least two months out (February or May) and about 5%-10% out-of-the-money.
When selling options, your broker will require you to have a margin account, so be sure to check with him or her before making this or any option-selling trade.
Alternatively, and especially if the SMH gets to between $31 and $33, we would also be happy to buy puts, as volatility would have come down. We would then buy May at-the-money puts.