The Effectiveness of Short Selling Bans (sarcasm)

With Italy now requiring disclosure of short positions and debating an actual short selling ban I thought the following news headlines and accompanying charts would be reassuring to observe.

SEC bans short-selling

Agency puts temporary halt to trading practice that 'threatens investors and capital markets' for 799 financial companies.

·

By David Goldman, CNNMoney.com staff writer

Last Updated: September 19, 2008: 7:41 AM EDT

"This will absolutely make a difference," said Peter Cardillo, chief market economists at Avalon Partners. "Short sellers are going to have to cover their positions very heavily."

http://money.cnn.com/2008/09/19/news/economy/sec_short_selling/

Schaueble plans to ban short-selling –sources

BERLIN | Tue May 18, 2010 12:16pm EDT

BERLIN May 18 (Reuters) - German Finance Minister Wolfgang Schaeuble plans to ban short-selling from midnight, coalition sources told Reuters on Tuesday.

http://www.reuters.com/article/2010/05/18/germany-schaeuble-shortselling-idUSBAT00546220100518

2007 Top and Current Price Action

The following charts represent a study I have been analyzing the last few days which concerns the topping pattern seen in mid-2007 before the financial crisis, and the chart pattern that has been observed in the last few months in the S&P 500. Granted the charts do not line up perfectly, it is obvious that the chart of the last few months is happening at a faster, more compressed rate than that of the price action in 2007. Nonetheless similarities are abound even MACD, stochastic, and rsi indicators are all lining up with eerie resonance. In addition to the technical side of the pattern, I think too we can examine what’s going on globally and concur that the problems facing the European Union right now are similar in potential systemic affect as those that caused the financial crisis. Quite simply when Lehman collapsed it created a domino effect in the credit and derivative markets. With an Italian default in question a similar domino effect could be observed, not to mention that many more of the European Union members are in poor position to even service the debt they have now, much less be able to deal with an imploding credit market. Many individuals are speculating that a default by one of these nations would be more systemic and more destructive then the financial crisis of 2008. I’m not too sure to what degree I agree with that statement however, a situation as illustrated would create significant downside in the markets.

Reviewing Yesterday and Todays Strategy

We had a nice rally in the market yesterday; we broke the prior day’s highs and ran strongly through several minor resistance levels as well as a major s/r around the 1295 handle. I took profits on the SPY calls and VXX puts, I felt the risk reward into the Greece vote of confidence was too far weighted to the risk side. It became evident after the vote that the event had been priced in and we had a shallow sell the news pull back in equities and the euro. Overall today though we are pushing higher, we have some more serious resistance at the 1300 handle which I feel is a psychological pivot point in the market. From here it really depends on how the market digests the Fed statement at 1230 there seems to be a slight expectation of some more easing, maybe in some different form, but definitely a continuation of SOME accommodation. I stress that because an all-out QE3 would be a surprise to this market and we would see a pretty aggressive rally. Obviously any hint of tightening will lead to a steep sell off. So what’s the strategy into the meeting?

Strategy 1

·         Fed does QE3/Keeps Interest Rates Low

·         Unlikely/Market Surprise

·         Strong Rally

·         Buy 4 GLD July 150 Calls

Strategy 2

·         Fed Keeps Interest Rates Low/Provides Additional Alternative Accommodation

·         Market Should Have This Priced In

·         Sideways/MixedàEuro/Greece Headline News Focus

·         Hold current GLD position and see mkt reaction

Strategy 3

·         Fed Tightens

·         Surprise

·         BIG sell off

·         Sell Current GLD position/Buy 4 SPY August 129 Puts

Technical Take

The S&P currently looks ready to go on the daily if we get a break of Friday and today’s highs. We’ve bounced nicely off the 200sma and closed above the 200 ema since testing these levels last Thursday. On the daily chart a run to the top of the megaphone pattern looks likely to occur but will likely take some positive news flow to get the market motivated. From a contrarian perspective there are plenty of reasons to be bullish but we must remain conscious to the reality of the systemic properties of Greece and if the issues are not resolved serious impact to liquidity in the credit markets will be observed and will quickly spill over into all other risk classes. Now, do I honestly believe Greece will default? There is a possibility but I think there is too much “big money” at stake for the leaders of the ECB and Eurozone nations to allow such a reality to develop. In essence what I am saying is just as in the US, large players have large leverage on government decisions and it tends to fall in their favor. So i am still bullish on the S&P, now regarding my Friday post on my “risk/reward” trade my mental stop was the lower trend line of the channel. When Moody’s came out with their potential downgrade of Italian debt the market rolled over hard and broke that trend line. Honestly the news in my opinion should have already been priced in and Moody’s credibility is nonexistent in my mind as well so I waited for a retracement and took one contract off at a small profit. Anyway we will see what tomorrow brings looking for more upside but this market can roll very quickly, the 200 SMA remains critical support we break there 1250 will come into view quickly.

Where do we go from here?

There are some interesting developments that will be playing out in the market this week. While there is a multitude of economic data coming out only two things are in main focus for this week. Numero uno is the Greek vote of confidence scheduled on Tuesday at 5:00pm est. A vote of confidence will support the euro and equities as this should lead to the necessary austerity cuts demanded for a bailout of Greece. Thus a failure on the vote of confidence will likely have the euro falling and equities breaking major support. Numero dos  is the FOMC meeting on Wednesday at 2:30 pm est all eyes will be on Bernanke on whether there will be a QE3 and/or extended low interest rate language in the statement. In my common sense based approach I like to assemble various scenarios regarding possible outcomes.

Scenario 1

·         Greek Vote of Confidence Passes/ QE3 Launches

·         Probability is low

·         Extremely Bullish market reaction

·         Long risk

Scenario 2

·         Greek Vote of Confidence Passes/Fed keeps interest rates low and Balance Sheet stable

·         Probability High

·         Believe market has priced in this possibility, market reaction would be sideways to upward depending on headline news out of Europe and economic data

Scenario 3

·         No Vote of Confidence/ Fed keep’s interest rates low and Balance Sheet stable

·         Moderate Likelihood

·         Market will bleed lower with respect to headline news from the Eurozone.

·         Close long, risk based position. Take short term downside bets and prepare for reversal when/if Eurozone crisis is resolved.

Scenario 4

·         No vote of confidence/Fed “tightens”

·         Low Probability

·         Market takes a big dump

·         Close risk based trades buy LOTS of puts.

Conclusion

Overall my pick is scenario 2 of course I would love Scenario 1 to occur because it presents the most brainlessly simple trade just go long any risk based asset and you will make money, do it with leverage and you can turn that lots of money reference into fortunes. However I would be surprised if the fed flat out surprises and does a QE3, it’s not Bernanke’s style and it’s more likely to be put in place towards the summers end in the august meeting.

Risk/Reward

Added yet another SPY contract here off the lower trend line (1). Pretty good risk reward here bought just a few ticks above the trend line-which is rising –plan to exit on a break to the downside of this trend line if that occurs. In terms of upside I really do not want to hold this much risk over the weekend so plan to exit between the midline of the channel (2) and upper channel trend line (3).