Bad News = Rally Time?

Plus: “Rolling” SRS into June

PLAY: Sell your SRS May 32 Calls (SAK EZ) at market and buy the SRS June 25 Calls (SAK FE) at market, good for the day. Do not place a protective stop limit at this time. I’ll follow up in a later alert with risk management details.

Dear Bottarelli Research Member,

So here’s the dilemma. Ever since hitting a low in mid-March, the Dow has gained 26.92%. This move falls at the high-end of a typical bear-market bounce.

During this time, the market has not only been brushing off every piece of bad news, but it’s been rallying off this bad news in a rather consistent manner. Dips have been bought, early morning gap-downs have quickly recovered, and severely reduced earnings estimates have barely been beaten. But through it all, we’re still in the middle of one of the most troubling financial crises in history. I simply cannot believe that the worst is behind us.

From a technical perspective, it would be reasonable to see a pullback at any time. Even if the upside momentum continues, the Dow could rally up to 8,400 (another 200 points) and then it could fall. So, from my perspective, we have an upside possibility of another 200 points combined with a downside possibility of 500 to 1,000 points. Another look at the daily Dow versus the weekly Dow chart shows this relationship.

Dow Daily:

Dow Weekly:

In times like this, where market moves defy logic or rationality, I prefer not to over-trade. In other words, let’s not chase moves that we all know are susceptible of quickly reversing. Rather, I’d like to stick to our guns — with one slight wrinkle. And that is, I’d like to give ourselves more time to witness the moves that we all anticipate.

Since our ABX June 30 Calls (ABX FF) and our FAZ June 8 Calls (FAY FH) both carry June expiration dates, I’m comfortable holding both of these plays. And despite the recent market strength, the Semiconductor HOLDRs (SMH) isn’t showing any signs of a pending breakout, so I’d like to maintain our SMH May 22 Puts (SMH QJ) as well. But when it comes to our SRS May 32 Calls (SAK EZ), this is where things get tricky.

After all, we’ve averaged down on our position by making two buy prices. And today, our SRS May 32 Calls (SAK EZ) might have triggered a stop loss when they hit $1.20. Now, if you’re still in this position, my upside bias remains in tact. We just need more time. Therefore, let’s grant ourselves the time to witness the coming upside move by “rolling” this play into June. A roll play entails selling our May calls, and using a portion of the proceeds to re-purchase June calls. Specifically, the SRS June 25 Calls (SAK FE) are currently trading between $4.30 and $4.50 per contract. In my view, selling off the May contracts now and adding the June contacts is our best chance of turning this play into a winner. Therefore, let’s “roll” the SRS play into June now.

PLAY: Sell your SRS May 32 Calls (SAK EZ) at market and buy the SRS June 25 Calls (SAK FE) at market, good for the day. Do not place a protective stop limit at this time. I’ll follow up in a later alert with risk management details.

We’re also seeing price premiums dramatically come out of the options string on Dendreon (DNDN – NASDAQ).First off, please note the new symbol on our DNDN May 30 Calls (UQB EF).Why they changed the symbol is beyond me. But either way, that’s the new symbol. Secondly, it would appear very odd that DNDN traded higher than it did yesterday, yet the May 30 calls lost over $1.30 in premium. This is a direct result of an “unknown” event turning into a “known” event.

You see, leading up to an announcement such as this, nobody knew what would happen to DNDN. Maybe it would soar to $45.00? Or maybe it would precipitously drop to $5.00? In fact, we witnessed this dramatic price indecision with yesterday’s odd price tick. As a result, floor traders juiced the entire DNDN options string full of premium — just to cover both sides of the scenario.

Then, once DNDN reported strong news and the stock jumped back up, the pricing was set. As a result, the options string was recalibrated without the price premium of the “unknown” factor, and that’s why you’re seeing prices trade at their current levels. Now remember, just because we lost these premiums on the remaining half of our position doesn’t mean we’re dead in the water. Remember, DNDN received strong results. The FDA should approve Provenge. Therefore, if DNDN moves above our 30 strike price, we’ll be back in the money. Therefore, let’s continue to hold for more gains.

As always, I’ll continue to update you on any new developments throughout the trading session. But until then…

Lock and load!

Sincerely,