Trade of the Day: Yahoo (YHOO)

We don't know how the market will react to the sequester, so use puts and calls to hedge

   

Our indicators are giving bullish readings, as they have for all of 2013 so far. Following a mini-sell off on Monday, the indexes rebounded nicely over the next two days. The sell-off somewhat eased the market’s overbought condition, but that was short-lived. The rebound returned the indicator back near to its recent high levels. The time to “buy low” apparently was immediately following the Monday decline.

In fact, the recovery propelled the Dow through short-term resistance at 14,020, putting a new all-time high well within reach. But for that to happen, traders might need to see the S&P 500 lend some support by surpassing the same resistance the Dow has just broken through. The S&P needs to get above 1530 for that to happen. The Dow making a run alone most likely would not be a move that had staying power.

It would also be beneficial for the Dow if our internal indicators were lining up with its recent move higher. But so far they have been more in line with the S&P than the Dow. In other words, they are lagging the Dow’s move. In fact, our key 200-day Moving Averages indicator, while still bullish, is very close to falling below its 50-day moving average, even after the rallies seen on Tuesday and Wednesday. The Advance/Decline Index and Cumulative Volume Index are also bullish, but like the S&P 500 have not yet returned to the levels they enjoyed prior to Monday’s sell-off.

There is no doubt as to what is causing the divergence: Washington and continued government budget inaction. But more important than the newest episode of political wrangling, the past week left no doubt that the Federal Reserve and other central banks will continue flooding the globe with new money. And that is all that has mattered for stocks over the past few years. Stocks have moved higher even though economic growth has been anemic. Liquidity is what matters, not growth.

The political uncertainty still plaguing the markets is also reflected in the safe haven assets U.S. Treasury bonds and the U.S. dollar. The iShares Barclays 20+ Year Treasury Bond ETF’s (NYSE:TLT)has rallied off support at $116 and is now bumping up against resistance in the $119 area. The PowerShares DB US Dollar Index Bullish Fund (NYSE:UUP) is continuing the strong bullish move it began earlier this month. With the Dow poised for a run at new highs, but internal indicators lagging and safe haven assets rallying, options buyers should play both sides by buying both calls and puts in equal amounts.

Here’s an inexpensive call trade to get you started in Yahoo (NASDAQ:YHOO).

Recommendation: Buy YHOO May 22 call options at 82 cents or lower, when the stock price is at $21.30. After entry, take profits if the stock price hits $22.80 or the option price reaches $1.60. Exit if the stock price closes below $20.50 or the option price falls to 50 cents.

 

InvestorPlace advisor Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.  Try Maximum Options today for 2 months for only $99.


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