Welcome to the House of Pain

I’m not going to sugar coat it for my steel rats – this week is going to be ugly. If you thought last week was bad, better prepare yourself for market makers and institutional traders equipped with 20 foot long cattle prods, ruthlessly inflicting maximum pain on us huddled masses of hapless option traders.

Here is a rough visualization of what awaits us:

You have two choices for the looming week of misery: Either embrace the pain or run for cover in the form of cold hard cash. For there is no shame in hiding, as we are furry but intelligent creatures who know that munching on a piece of cheese from the comforts of a cushy front row seat sure beats getting body slammed by some blood hungry market maker bent on inflicting his quota of flesh wounds on option trading mail order chumps like you. But for the intrepid super rats among you, those equipped with grapefruit size chrome plated cohones, there just might be hope, as Evil Speculator will be your shining light, your unrelenting compass guiding you through the inhospitable terrains of expiration week. Maybe you come out bruised but alive – but please make sure to leave a proper note for your loved ones and best equip yourself with a some dog tags so that the NYSE will be able to identify your charred remains.

Anyway, enough with the pep talk, let’s go on with business:

Boy, this chart is getting messy. But right now we are bit in limbo, as there are various scenarios on the table that should be given similar probabilities, as a consolation some are less painful then others. I will talk about the really fun one, marked in green, a bit later – but let’s start with orange, which basically assumes that the old triangle actually concluded last week with a whimper of an {e} wave (triggered by the Chinese bailout announcement) and then proceeded to trace out a {i} of minor 5 down. Then we painted the notorious Thursday u-turn which was the beginning of an a,b,c correction that is expected to conclude around the 950 area this week. After that we should quickly push to the downside and complete minor 5 of intermediate (3) – the target area is difficult to project as of right now but it should be in the lower 700s.

The blue scenario is very interesting and I have added the alternate wave count in blue labels on the charts above and below. The thought here is that we traced out a large flat, which will be followed by what is referred to as a running flat by Elliotticians.

I’ve taken the liberty to draw some example wave patterns, so all this makes sense to you leeches. The first image shows a flat, which is a fancy term for a zigzag corrective wave that received a lot of trend resistance. The next image shows a variation of the theme, an expanded flat, which contains a price extreme beyond that of the preceding impulse wave. In expanded flats, wave B of the 3-3-5 pattern terminates beyond the starting level of wave A, and wave C ends more substantially beyond the ending level of wave A, shown for bear markets in the second image.

What we ware finding ourselves in (no matter which of the wave counts above you buy into) is called a sideways combination of at least two corrective patterns, which is also called a double three. This can be a zigzag followed by a triangle, a zigzag followed by a flat, or a flat followed by an expanded flat. The latter is what the blue scenario is based on and is simulated as a simplified wave count in the third drawing above. Let’s hope this makes it a bit more clear as I will be testing you leeches later this week. Anyone who fails will be thrown into the dungeon of doom, and remember that there is no butter in hell (look that up under Cold Comfort Farm).

Now on to the green scenario – which is the most fun as it would hurt the most bulltards out there. This assumes that we have painted a more vertical double three starting Thursday afternoon and ending Friday right before the drop. Looking at this slightly zoomed in chart, it’s clear how a move like this can be easily mistaken for a regular motive 5 wave correction followed by small retracement. The reason why we are considering this crazy scenario is that the assumed third wave of the long push up is a bit short. Let’s zoom in a bit more:

Aaaah, that’s better. Now, as you can see it’s easy to count this wave as a 1-2-3-4-5 motive wave which ended on Thursday at the closing bell. But if you look carefully it becomes clear that the third wave is actually the shortest of them all, and that violates Elliott Wave rules. The 3rd can never be shortest – it can be shorter than either 1 or 5, but it needs to be longer than one of them. So, the conclusion is that something else is going on here, which leads us to the green scenario. Now, that you understand what a double three is, you may realize why it is possible (but not assured in any fashion) that wave {ii} of minor 5 may have concluded on Friday afternoon. Of course the mouth breathers out there see only a small correction and expect the rally to continue pushing upwards. Maybe they’re right, which would confirm the blue scenario but if we keep dropping on Monday then you’ll know what’s up.

The in between scenario is marked as orange, as it assumes we’re going up a bit more and then plunge. And in case you wonder, at this time there is no evidence to support the notion that we have finalized wave (3) and are already inside intermediate wave (4). There simply has been no capitulation on the parts of the bulls – despite harrowing negative breadth on Wednesday and early Thursday, bullish sentiment has been steady.

Need proof? Let’s take a look at the McClellan (a medium term sentiment indicator), which is currently at -20. Call me ueber-bearish, but this simply does not look like a capitulation to me. Quite frankly, we haven’t seen enough blood letting on the part of the bulls just yet.

Also, the spread between the Moody’s BAA and TYX yields is still stuck around the 5 point mark – this is not exactly what I would expect to see at the onset of intermediate (4), which – to make that clear – will be a major multi-month corrective wave to the upside (or at least sideways).

The Baltic Dry Index is still flat as a flounder – this is bad, ladies and rats. Nothing is getting shipped and to get an idea of the grave implications of basic materials rotting in harbors here’s a great write up on the situation by Yves Smith. By the way, one of my favorite sites – the kid is extremely bright and works day and night to roll over the rocks under which the gnomes are hiding from sunlight. In any case, what you as traders should care about is that credit remains frozen.

Still not convinced? Tough crowd! Well, take a look at our old friend, the TED spread (difference between 3-month LIBOR and 3-month treasury yield). It’s pointing to the upside again and the permabulls better sacrifice a goat to make sure that this thing doesn’t continue on its current trajectory.

Some of you might remember the Nova/Ursa ratio I mentioned last week. We are still in distinct bullish territory – the thick line is the ratio and the thin one is the OEX.

A final piece of evidence in terms of bullish sentiment is a weekly chart of the CBOE Options Put/Call Ratio Index. Right now we’re hovering around the 1.0 level which is basically neutral. Again, I don’t see any fear here, which again is a strong indication that wave (3) has not concluded just yet.

I will touch on Gold once I see a clearer pattern – right now it’s a bit all over the place and it seems it simply follows the market. Keep an eye on crude as we hit 56 on Friday. OPEC has already started the proverbial ‘production cut’ saber rattling – many of those cats must be selling the black gold at production cost right now. I would expect a floor in crude prices fairly soon, so be careful with anything in the energy sector. I saw some of you guys posting about refineries – you don’t want to be long those guys when crude starts pushing upwards again.

I actually wanted to post a DXY (Dollar index) chart but Prophet is not cooperating – I really hope those constant occasional (ahem) data problems will be fixed at some point. In any case – the buck is going up, bank on it – minimum target is around 90, maybe even higher.

Alright, I think I have done enough damage for today – enjoy your evening and don’t be shy with the comments. If you have nothing better to do check out Denninger’s new vid – he really cracks me up – reminds me of a cat that just caught a mouse:

Cheers!