Two directional trades we’re looking at today that are both consistent with the story that this week’s positive action is just a brief pause in a longer bear market.

Gold

Thesis: Gold has been almost unbuyable for months as it kept hitting new highs - if you weren’t in already, it was pretty tough to get in so late in the game. This week may be your opportunity, as the Fed decision caused the biggest single-day plunge in gold since June 2006:

Gold futures for April delivery fell $58.30, or 5.8 percent, to $946 an ounce at 12:49 p.m. on the Comex division of the New York Mercantile Exchange. A close at that price would mark the biggest percentage drop for a most-active contract since June 13, 2006. The metal climbed in the previous six sessions, gaining 3.3 percent.
[...] “There is some measurable support for gold in the low $900s,” Hanlon said. “There isn’t heavy support until $800. It may sound like a dramatic decline, but it’s a correction in a bull market.” Before today, gold climbed 20 percent in 2008 after gaining for seven straight years. [Bloomberg]

We’re seeing pretty strong follow-through on yesterday’s decline, so this looks like a nice opportunity for a contrarian play.

Trade: GLD, the ETF loved by so many, hasn’t listed options yet, so we have to get a little more creative to make this play. Two mining companies stand out:

• Barrick Gold (ABX) has pretty great volume in both the options and the stock, so we like the short 40/35 April put vertical for a $0.50 credit (selling the April 40 puts and buying the April 35 puts), or if you’re not into credit spreads, the April 50 calls are currently about $1.30.
• Compania de Minas Buenaventura (BVN) is another way to play this sector. The liquidity in these options isn’t as strong as in ABX, so you would want to trade small, but the stock has behaved better of late and tracks GLD more closely than does ABX. A nice credit spread here would be the short 65/60 April put vertical for $1.20 (short the 65 puts, long the 60 puts), or you could buy the April 80 calls for $2.00. BVN traded above $85/share as recently as last week.

A word of caution: the volume in these names has been strong, and there’s no guarantee that gold will bounce back promptly, especially since so many investors may have profits to take out first. So it’s worth the trouble to ease into any positions here, and you may need to be prepared to roll these positions forward if the reversal takes longer than expected.

Fannie Mae

Thesis: This story is even simpler: federal regulators provided $200bn to the mortgage-backed securities market by easing capital requirements on Fannie Mae and Freddie Mac.

Regulators for the two companies cut their surplus capital requirement to 20 percent from 30 percent to help expand their combined $1.5 trillion in mortgage investments and revive the home-loan market. The change is expected to provide $200 billion in funds to the mortgage-backed securities market, the Office of Federal Housing Enterprise Oversight said in a news release. [Bloomberg]

The thesis here is just that eased restrictions don’t mean Fannie Mae is out of the woods. Effectively, regulators are just allowing them to increase their leverage, and injecting more capital into the mortgage market won’t help FNM if foreclosures continue to pile up. This seems like just another cash infusion by short-sighted regulators who are more interested in immediate stability than they are in long-term financial solvency.

Trade: The implied volatility in the April options has spiked up to 114% (historically, the IV in FNM options is usually closer to 60), so you’ll have to pay if you just want long puts: the FNM April 29 puts are about $2.25. Alternatively, you could sell the April 35/40 call spread for $1.05 (short the 35 calls, long the 40 calls).

As always, these bonus trades are provided purely for educational and entertainment purposes; though if you find random options trades entertaining, you should probably get out more.

Just a quick note tonight. While the rally today was certainly fun for any long deltas you have lying around, it wasn’t necessarily impressive. There is significant resistance overhead, we didn’t take out any major resistance levels today, and there isn’t much to look forward to on the horizon:

• LEH bought itself a reprieve, and may survive this economic cycle. But that doesn’t mean disappointing news from financial institutions is over.
• The economy stinks, and just about everyone now (except President “we’re going to be just fine” Bush) admits it, and as we’ve been saying recently, there are probably enough unknown unknowns still to be discovered that it’s tough to believe that all the bad news is somehow “priced in.”
• On a more technical note, today had some classic signs of a short-covering dead cat bounce. Bespoke: “today’s best performing stocks in the S&P 500 were also the ones with the highest short interest as a percentage of float.”
• Cutting rates does not - by itself - create jobs, automate liquidity, or spur economic growth. These rate cuts are designed to be a stimulus, and that’s all they are: a shot in the arm, not a substitute for genuine nutrition. This market is a strung-out junkie, but there aren’t any more hits soon forthcoming, and within a few days it will again be waiting for the man.

Futures are up big pre-market, though there’s no guarantee those gains will stick. Lehman and Goldman seem to have dodged the bullet for another quarter, and both are up significantly premarket.

We’re looking for positive trading most of today, with some selling possible after the Fed announcement at 2:15. We’re selling small into strength today, and adding to directional positions as more selling likely unfolds through the remainder of the week.

But if all that sounds uncomfortably close to a weather report, that’s because we have about as much confidence in any directional predictions this week as most weatherpersons should have in their forecasts. The fundamentals of this market are horrible and the trend is down, but as we said on Sunday the ever-present possibility of government intervention makes strong opinions dangerous.

Look for resistance around 1320-1330 on the S&P, and at 44 on the Qs.

Some volatility-related items of note, ranging from the obvious to the esoteric, in that order.

1. On Friday, the VIX closed at 31.16, its highest level since April 2003. Today, it spiked up to 35.60, which does not exceed the highs from January 22, 2008 or August 16, 2007 - but remember that the VIX is just an index calculated from SPX options prices, it’s not a tradable entity in its own right, and it’s really being asked to bear too much of a predictive burden these days. Sure, this spike may be short-term tradable, but by itself VIX 35 may or may not mean much of anything: remember that this index spent most of 2002 in the 30-50 range.

2. Bill Luby has some fascinating notes on the relationship between panic, the VIX, and 3-month and 10-year Treasury yields. In short: buy when the VIX spikes relative to T-bill yields.

3. At right is the print from the VIX:VXV ratio this morning. By the end of the day, that candle fell all the way below the 1.10 threshold. So today looks like another data point confirming that when the ratio between one-month and three-month volatility gets really stretched, you may have a tradable bounce on your hands. But VXV is still wet behind the ears, so this is all just speculative.

Today, the Dow had a trading range of 319 points, which by itself isn’t that amazing (the range last Tuesday was 419 points), but keep in mind that futures were down 200+ points last night and this morning, and the Dow managed to close in the green by 21 points. Of course, all of the other major indexes didn’t fare as well, with the RUT down 1.87% and NDX down 1.55%. SPX was off by 0.90%, but managed to close at 1276, just above that important 1270 level from the intraday January 22 low, though nobody believes that 1270 is actually going to be firm support at this point.

Bear Stearns, shown here, was acquired for $2/share by JP Morgan. One of the more interesting conversations around the office and around the internet today was why BSC traded up to $5 today, closing at $4.81. Theories ranged from last-ditch bids from other players, to Joe Lewis-related shenanigans to force a higher price from JPM. People could not seem to shut up about the fact that Bear’s building is worth $1.2 billion.

This is a particularly eventful, if weird, week - the Fed is cutting rates on Tuesday, Lehman and Goldman report earnings on Tuesday, Visa is scheduled to start trading on Wednesday (we are bullish), and Thursday is March options expiration, though trading should be relatively lighter ahead of the long weekend. In light of all that, and given all the bouncing around we’ve seen intraday over the past few weeks, it’s not a bad time to step away from your trading platform if you’re a casual position trader.

One of our readers, Larry, sent in the following note, which captures our mood exactly:

SOH: A Legitimate Strategy
In these times of extreme volatility, a trader needs to constantly be reminded that we trade to make money, not to have activity. It is also important to remember that Cash is a position and that SOH (Sitting on Hands) is a legitimate strategy. Repeat it to yourself three times – I do not have to place a trade today! It is a freeing concept and helps preserve the one thing that keeps us in the game – our capital.

During the last week giving yourself permission to employ the SOH strategy would have been a wise choice for many traders. One market commentator made an interesting observation: “We’re not even gonna bother trying to explain what’s going on in the broad market because basically there is no explanation….As far as the S&P is concerned the constant barrage of news is creating charts that have no respect for technicals.”

This is an astute observation which reinforces that in a week which includes the FOMC, surprise Fed announcements, the demise of Bear Stearns and option expirations the best strategy for all but the most astute scalpers or those who are taking advantage of selling high volatility with well defined trading plans is to SOH.

So yeah, those really seem to be the only three rational strategies right now:

1. Sit on Hands
2. Scalp movement intraday, or
3. Short these volatility spikes with risk-defined positions, like the ones we trade.