Pondering the Uncertain Markets: What it Means for Options Traders

During these first three months of the year, the markets have been dealing with uncertainty. This has translated into selloffs from much higher levels, but these selloffs have not been your normal, garden variety pullbacks. You know those, right? They occur when a drop frightens everyone into submission and dip buyers jump in to pick up the pieces and ride the markets higher. We had plenty of those in 2013.

On top of last year’s pullback pattern, we’ve had the Fed blowing wind at our backs, helping us feel emboldened and drawn to buy stocks. They want us in risk assets – until they don’t. And therein lies part of the issue with this current market. Some analysts have said that the playbook for 2014 will be different than 2013, and that certainly could be the case. As technical options traders, we need to keep our eyes open, because it’s in our nature to follow patterns that our brains are trained to identify and play them over and over, until at some point they stop working. Then we need to look for new patterns and retrain ourselves. And the cycle continues.

But there is something else affecting this market, which hasn’t challenged the boldness of the bulls to step up to the plate. For one thing, we have the situation in Russia, which may be critical, but it may not. The market has dealt with geopolitical concerns before and managed to brush them off, but this has not happened lately – and that’s a notable change. If there is one thing the market hates, it is uncertainty. When uncertainty is hovering in the background, you can bet many traders will scramble towards protection quickly. (Don’t believe me? Check the spiked peaks in the VIX over the last 15 months.)

And then there is the Fed, which is probably closer to the end of easing up on interest rates than we all care to realize. Their bond buying will likely conclude by October, and if there is some inflation in the system, then we can bet rate hikes will be coming in 2015. The recent comments by some Fed governors harken back to last spring when Bernanke and others sent out “test balloons” around cutting bond buying. They wanted to gauge a response, and, if you recall the big dip that occurred, well, suffice it to say that the market was not happy about their plans.

I have to wonder, though, if the Fed is prepping the markets for a disengagement of stimulus because they believe the economy has reached “escape velocity” and is no longer in need of Fed assistance. At some point it will happen, and it will happen sooner rather than later. The bond market is really not giving us the clues, either.

So with that, uncertainty reigns over the economy, inflation, and unemployment. The forecasts the Fed gave us last week were certainly on the dovish side (higher GDP, lower inflation, lower unemployment), but it’s becoming a challenge to read all the tea leaves. 2013 was a rather easy glide, but this year the potential for stepping in a pothole has increased.  BL.