Maybe you don’t pay too much attention to Wall Street and the Dow Jones Industrial Average. That’s ok. You might not know that the big question for a while has been “Will the Dow hit 11,000? Will the Dow end 2005 over 11,000?” Many analysts say yes, because the economy is going great and oil prices are coming down. Some of the big brokerage houses are behind this analysis. You can tell when an article supports this theory by the lists and bullet points. Others point out that the Dow hasn’t been at those levels in almost 5 years and there’s a lot of resistance just under 11,000. These folks give the caveat that should the Dow actually get over 11,000, it will continue to rise from there. An article supporting this theory usually has lots of charts with technical indicators and annotations.
At the risk of pointing out the obvious, this is the last week of 2005. The one thing that neither side in this debate is taking into account is the one thing that can change the balance. Options.
There are two basic kinds of options and many strategies for using them. A “put” gives the holder the right to sell something at a given price, regardless of what that something normally sells for. Someone who buys a put is expecting that prices will go down. Some put buyers see it as an insurance policy for their portfolio; if prices drop unexpectedly, they exercise the put and minimize their losses. A “call” gives the holder the right to buy something at a given price, regardless of current value. The call buyer expects prices to go up. A great use of calls is airlines buying options to buy fuel, insulating themselves from spikes in prices.
These options don’t exist in a vacuum. Somebody has to take the other side of the deal. The person who sells options is betting the buyer won’t exercise his options. He is prepared to buy if the put is exercised — meaning he has cash on hand or can have it in short order. He is prepared to sell if a call is exercised — meaning he has the thing or is prepared to get it in short order. If someone sells a call but does not have the thing he is agreeing to sell, that is called a “naked” option. Doing this is like sitting down to play poker with Wil Wheaton and his close friends; you don’t do it unless you are really good or really stupid.
So what the heck does that have to do with what the Dow is doing this week?
Where the Dow goes is going to boil down to what options are written and exercised on the Dow itself and each of its 30 components. Who has exercised puts on GM as it sits near 20 year lows? Who is betting that Wal-Mart had a good Christmas? Who is poised to sell should we near the resistance around 10940? It is possible to know how many options there are out there, but it is impossible to know how many of them will be exercised, let alone when. Keep in mind that actual trading may be light because of people taking the week off — not only is it the week between Christmas and New Years, it’s Hannukah. Light trading means that the people who are actually there can move the markets more easily, whether accidentally or deliberately.
Sit back and enjoy the show. I’m one of the folks that thinks the Dow will not hit 11,000 this year. As for next year, Jim Jubak has some interesting theories.
In closing, two articles about schools trying so hard to bring the lowest performing students up to a level they can fake their way through standardized tests that they are failing to meet the needs of middle class and academically gifted kids; what was that I was saying last week about people not being able to retire; and they make pills for everything else, why not for dieting.
I’d like a rich pill plzzzz.