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[dcengr]

U.S. Stock Market Stumble Presaged by S&P 500 Options (Update3) By Jeff Kearns and Michael Tsang Enlarge Image/Details Oct. 8 (Bloomberg) -- Skittishness over the U.S. stock market's record-setting rally is reaching a crescendo among options traders who are preparing for a crash. Investors are paying the most ever to protect against a drop in the Standard & Poor's 500 Index, data compiled by Morgan Stanley show. The gap between the price of so-called put options on the benchmark for U.S. equity and the cost to wager on further gains has averaged about 8 percentage points since August. That's more than the previous high in July 2001, before the index dropped 34 percent and fell to the lowest this decade. The widening spread is a warning for OppenheimerFunds Inc. and Harris Private Bank, which oversee more than $300 billion and say the bearish bets indicate stocks may fall. The S&P 500 rebounded 10 percent since Aug. 15 on speculation the worst is over for banks and homebuilders hurt by the collapse of subprime mortgages. Shares in developed markets outside the U.S. have done even better, climbing 14 percent from their trough. ``Battle-scarred investors are buying some insurance this time around, having the benefit of hindsight,'' said Jack Ablin, who oversees about $50 billion as chief investment officer at Harris Private Bank in Chicago. Ablin said he bought put options for clients during the rally. The seven-week rebound in stocks allowed investors in S&P 500 shares to recoup all the $1 trillion they lost during the biggest plunge in four years. Global indexes fell as defaults on loans to people with poor credit and the worst U.S. housing slump in 16 years caused corporate borrowing costs to increase. All-Time High The S&P 500, which dropped 9.4 percent between July and August, rose 2 percent last week to a record 1,557.59, eclipsing the previous high of 1,553.08 on July 19. The Morgan Stanley Capital International EAFE Index of non-U.S. developed markets gained 1.6 percent to 2,336.47, also ending the week at an all- time high. The S&P 500 today lost 0.3 percent to 1,552.58 in New York as concern grew that third-quarter earnings rose at a rate that won't justify this year's rally. The Dow Jones Stoxx 600 Index of European companies slid 0.3 percent, while the MSCI Asia-Pacific Index fell 0.2 percent. The MSCI EAFE Index declined 0.7 percent, the biggest drop in three weeks. Last week's advance hasn't dispelled concern among traders in U.S. options. They are pricing in the highest risk of an equity-market decline since the technology-stock bubble burst at the start of the decade, according to Carl Mason, head of U.S. equity-derivatives strategy at Morgan Stanley in New York. Implied Volatility Mason says implied volatility, a measure that calculates expected price swings of an underlying asset and is used as a barometer for options prices, shows many investors are betting that stocks may fall. Since Aug. 15, the implied volatility of put options that lock in gains should the S&P 500 drop at least 10 percent in six months has averaged 24.08 percent, according to data from Morgan Stanley, the second-largest U.S. securities firm by market value after New York-based Goldman Sachs Group Inc. The implied volatility on puts is 8.1 percentage points higher than for call options, enabling investors to profit if the index rises at least 10 percent in the same period. The so-called implied volatility skew climbed as high as 8.53 points since mid- August. That's steeper than 99 percent of all readings since the start of the decade, Morgan Stanley said. The median difference is 5.9 percentage points. The gap shows there's ``an awful lot of nervousness,'' said Mason. ``A lot of investors don't want to get caught out.'' Slowing Economy The last time the skew steepened as much was in July 2001, when it touched 8.24 percentage points, according to Morgan Stanley's data. In the following 15 months, the S&P 500 tumbled as the U.S. economy suffered its first recession in a decade. This time around, economic growth is also slowing, increasing the likelihood stocks will fall, according to OppenheimerFunds' Kurt Wolfgruber. The U.S. economy expanded at an annual rate of 2.4 percent in the third quarter compared with 3.8 percent in the previous three months, a Bloomberg survey of economists showed. They expect growth this quarter to slow to 2.2 percent. Analysts have pared their earnings forecasts for S&P 500 companies. They estimated profit growth of 0.7 percent in the third quarter as of Oct. 4, down from 4.6 percent in mid-August. If the projections are correct, it would end a streak of 20 straight quarters of at least 10 percent growth. `Less Sanguine' Citigroup Inc., the biggest U.S. bank, last week said third- quarter profit fell 60 percent, while Merrill Lynch & Co., the world's largest brokerage, reported its first quarterly loss in six years. Both New York-based companies cited losses on asset- backed securities and loans for leveraged buyouts. ``There's a good case to be made that the market is a bit ahead of itself,'' said Wolfgruber, who oversees $265 billion as OppenheimerFunds' chief investment officer in New York. ``Things are less sanguine than they were three months ago.'' Morgan Keegan & Co.'s John Wilson said interest-rate reductions by the Federal Reserve will make equities even more attractive. The central bank lowered its benchmark lending rate on Sept. 18 by a half-percentage point to 4.75 percent, which helped to fuel the stock-market advance. A jobs report last week also showed that U.S. employment increased by 110,000 jobs in September, while revised figures for August showed an unexpected gain of 89,000. The change wiped out what had been the first drop in employment in four years, and lessened concern the six-year expansion will come to an end. Fed Funds Futures ``We're going to keep moving higher,'' said Wilson, co- director of equity strategy at Memphis, Tennessee-based Morgan Keegan, which manages $120 billion. Investors are ``foolishly buying'' protection, he said. Dean Junkans, who oversees $250 billion as chief investment officer at Wells Fargo Private Bank in Minneapolis, says investors are putting too much faith in the Fed keeping the economy from slowing. The chance of policy makers cutting rates twice by December fell to 28 percent last week, fed funds futures showed. Two weeks ago, prices reflected a 74 percent chance of two quarter-point rate reductions by year-end. ``Just because the Fed lowered rates doesn't mean that everything is hunky dory,'' said Junkans. ``We had a quick snapback in the last couple weeks. Is that warranted? I think you have to scratch your head and say `Gosh, it's tough to see that it is,' based on the economic data.'' Former Fed Chairman Alan Greenspan said last week that the chances of a U.S. recession have increased and ``the worst may not be over'' for the credit markets roiled by subprime defaults and borrowing costs that rose to a six-year high in September. David Tice, who runs the $789 million Prudent Bear Fund in Dallas, is more pessimistic. He owns S&P 500 put options because stocks could ``easily'' decline by more than 50 percent in the next 12 months to 24 months. Tice says the latest rebound only delays an inevitable crash, comparing it to when ``somebody falls out of a 95-story building.'' ``They haven't hit the ground yet,'' he said, ``But they're getting closer and closer.'' To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net ; Michael Tsang in New York at mtsang1@bloomberg.net .

[eminimee]

I'm not by any means trying to get "87 crash" talk going again....but with the possibility of a B wave top....a nasty C wave might just seem like a crashette.

Don't shoot me....just posting a chart. Short term possible one more high...still watching spx 1562.52 and oex 731.

http://stockcharts.com/c-sc/sc?s=$SPX&p=M&st=1980-06-01&i=p23527181071&a=60339873&r=5542.png

Edited by Teaparty, 09 October 2007 - 06:58 AM.

[eminimee]

the count the way I have it...would mean this is the final wave of a 1 of ED or B wave. Any new high could do it.

http://stockcharts.com/c-sc/sc?s=$SPX&p=30&yr=0&mn=0&dy=17&i=p51122528271&a=118913201&r=6520.png

[eminimee]

http://stockcharts.com/c-sc/sc?s=$SPX&p=D&yr=8&mn=6&dy=0&i=p40519880007&a=107023022&r=9015.png