The dollar has bottomed and is beginning to trend higher for the first time in several years. Dropping crude oil prices are pushing gas prices lower at the pump and the dollar is strengthening. That's a combo that should make most consumers feel wealthier in time. Europe's economic woes as well as weakness in other parts of the world is putting pressure on foreign currencies. With the Federal Reserve here in the U.S. on hold - at least for now - the dollar is strengthening on a relative basis to its foreign counterparts. What's good for the greenback is not-so-good for commodities. The commodity run appears to be over. I'd be a seller into strength. The technicals have quickly deteriorated to levels not seen in the last few years. The strength in the dollar will make it difficult for commodities to regain their earlier form. Take a look at Chart 1 below to see how the technicals on the dollar are beginning to change for the better.
For the first time in over two years, the dollar has moved above the 50 week SMA. While the dollar could encounter some short-term resistance near 78, the long-term resistance area will be in the 80.00-80.50 range. Should the dollar push through that resistance, I believe we'll challenge the 92.50 level possibly by the end of 2009 or early 2010. A stronger dollar will push all commodities lower, but will especially hit gold hard. Until conditions suggest otherwise, you should consider trading the trend at hand.
In the July 19th issue, I discussed the effect of max pain and how the market gravitated higher to lessen the impact of net in-the-money put options. The same thing just occurred for August options expiration, only in reverse. Financials and consumer discretionary stocks had led a sizeable market rally into the beginning of this week. I calculated on Monday evening that the XLF (ETF tracking financials) had $118 million in net in-the-money call option premium. I'm only talking about one ETF here, so you can imagine what the total value of net in-the-money calls were at Monday's close across all index, stock and ETF options. Tuesday's decline in the XLF erased $67 million of this net call premium and Wednesday's 61 cent drop finished off the rest. JP Morgan Chase (JPM) had one of its worst days ever on Tuesday, wiping out millions of in-the-money call premium. Stock prices tend to gravitate towards the area of max pain, which is the price point where in-the-money call premium equals in-the-money put premium. While this gravitational pull doesn't work with every stock or sector at every expiration date, I'd caution any trader from trading stocks during options expiration week without first checking the underlying open interest. A quick glimpse at the open interest and in-the-money call and put options could save your portfolio dearly.
If you're not familiar with the concept of max pain or are interested in seeing how it might help your trading, follow the link below to an audio/video presentation that was done on Tuesday for our members. The presentation was shortened to highlight the discussion of max pain as it pertained to several stocks - mostly commodity stocks. I think you'll find it interesting at the very least. Go to www.investedcentral.com/maxpain.html for more details.
Happy trading!
