Market Rally Eases Some Tension

Last week's rally was probably the most impressive market performance seen since January. The holiday-shortened week helped to produce a four-day wining streak for the NASDAQ Composite Index (COMPQ), thus leading to gains for the NASDAQ-100 Index (NDX) and the S&P 500 Index (SPX), just to name a few. The Dow Jones Industrial Average (DJIA) was also strong, registering gains for 3 out of 4 sessions.

Selling pressure from security sales to meet tax obligations is now over, and investors will focus on the release of first-quarter results and the economic climate for the U.S. and its trading partners. Several companies reported their results last week, with mixed reviews. Analysts and investors will not only be reviewing the quarterly results to see how they place against expectations but will also be listening to the comments concerning future results, which will paint a picture of corporate expectations for the economy in general.

Another positive factor helping the markets last week was the release of 24 Navy personnel from the "spy plane" that made an emergency landing on a Chinese island. Political tensions have begun to ease from that incident, which has led to calls for economic punishment against China, including the revocation of "Most Favored Nation" status.

VOLATILITY LEVELS DECLINE
As some of the fears of investors and traders waned, so have the premiums paid for put and call contracts. Thus, implied volatility levels for many securities and indices turned the corner last week after reaching highs the previous two-week period. Table I below shows the implied volatility readings for some of the benchmark indices that we monitor.

Table I - Market benchmarks with performance and implied volatility data for the week ended April 13, 2001.

Traders' concerns about market performance have also waned. This is evident by the declining put/call ratios for OEX, SPX, NDX, and the Mini-NASDAQ 100 Index (MNX). Speculation that the market has seen the bottom and that the worst has passed is leading to higher confidence. This leads us to suggest that caution should be urged as these speculators are generally incorrect and their focus is very short-term oriented.

EXPIRATION APPROACHES
This coming Friday will mark the monthly expiration of options contracts, falling in the heart of earnings reporting season. This could raise volatility levels, especially if comments from corporate America are negative. It is anticipated that professional traders will either roll most of their positions early in the week, or offset some short-term risk in order to maintain relatively neutral short-term positions going into expiration. As expiration nears, volatility levels may rise. This may be accelerated by the release of earnings reports.

Long-term investors may see price declines as opportunities to purchase shares. If prices retrace some of their gains from last week, volatility levels and option premiums should increase, thus making option-writing strategies more attractive.

REMINDER
Coming soon our online presentation on the use of volatility models and strategy formation.