Since ETFs are made up of a basket of stocks, owning an ETF entitles you to receive any dividends paid by members companies in the ETF. For some strange reason, many ETFs have decided the best time to pay those dividends is on the exact same Friday that monthly options expire.
For example, the S&P 500 tracking stock (SPY, often called Spyders) declares a dividend (usually in the $.50 -$.60 range) on the third Friday of December, March, June, and September). The financial ETF called XLF follows the same policy.
If you are short an in-the-money call on one of these expiration Fridays, there is an excellent chance that the holder of the option will exercise the call (the deeper the call is in the money, the greater the chance of exercise). If an exercise takes place, people who are short these calls are selected randomly for assignment. On the morning of the third Friday of the month, you may find that you are short shares of the company stock in your account. You will have to buy those shares back with the cash that was put in your account by the person who exercised the call.
However, in addition to the cost of buying the shares, you are responsible for paying the dividend that was due to owners of the ETF on that day. Your account will be charged the dividend amount about 30 days later.
To avoid this dividend charge, it is important to close out (i.e., buy back) in-the-money call options on popular ETFs such as SPY, DIA, and QQQQ no later than the Thursday preceding one of those expiration Fridays.
This action is called for more frequently in the Dow Jones Industrial tracking stock (DIA, better known as Diamonds) which declares a dividend (usually in the $.15 -$.30 range) on the Friday expiration every month.
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Terry
The market continued its wild vacillation this past week. The recent advance continued early in the week with most of the gains coming on a large opening gap on Tuesday after Alcoa kicked off the earnings season with a better than expected report. However, the gap seemed to be the short-term exhaustion point for the S&P 500 (SPY) as it was unable to sustain a push through strong overhead resistance at the $110 area.
The market entered the week in an extreme short-term overbought state. Couple that with a gap into the already overbought levels followed by the inability to push through strong overhead resistance for the next three trading days and it is no surprise to see why the market tumbled on Friday.
Yes, the consumer sentiment report was less than stellar as it pulled back from a 2 ½ year high on concerns about income and jobs. The University of Michigan's consumer sentiment report actually plummeted to 66.5 from 76.0 in June. It was well below analysts' expectations of 74.5. So, most of the decline Friday was attributed to weak decline Friday, but there had been numerous reports throughout the week that stated the economy was still struggling. There is no doubt in my mind that Friday's decline was technical.
The recent advance, much like the last one was on the backs of very low volume. Conviction was not truly present. Yes, the talking heads were touting the new bull run, but the technical set-up was pointing towards a short-term decline.
I have already mentioned a few reasons why the bears came out Friday, but there were several more indicators that I watch closely that had hit technical extremes. On Thursday, the SPY had managed to close above its open for six straight days, which is a feat that has not occurred since May 22, 2001. That particular date, if any of you can remember that far back, marked the end of that rally. The next day, the S&P was only able to close above its open 2 out of 9 times when it was below the 200 moving-average.
Moreover, the Rydex Bull/Bear RSI Spread had hit an extreme reading which signals a short-term pause is near. Couple that reading with the Rydex Beta Chase Index in an extreme state and the probability of a move to the downside increased that much more.
In fact, over the past ten years there had only been 19 occasions when both Rydex indicators hit this type of extreme at the same time and out of the 19 there had been only 3 occasions when the S&P displayed a positive return three days later. However, even the 3 occurrences were eventually met with bearish fate over the next week. So, as you can see the probability of a short-term move lower was quite high on a technical basis.
So where do go from here? The market has once again moved back into a neutral state (albeit close to an oversold state) which seems like an uncommon place over the past month or so. The day after options expiration is typically lower, so I would not be surprised to see a continuation of the move from Friday on Monday. However, I do think a bounce will occur once a few of the shorter-term technical signals hit an oversold extreme. That could potentially be during the intraday Monday or on Tuesday. Either way the probability of that type of move increased after Friday's plunge. After that, well, we shall see when the time comes. The charts are displaying that we are still in a downtrend. Just look at the one year charts on all of the major indices and it is easy to see with the lower-highs, etc. Furthermore, the major benchmarks are still below the 200-day moving average which also indicates that a downtrend is still in place.
Andy
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