Oil Trumps Housing By Steven Smith Director and Chief Strategist, Options Alerts 5/16/2008 10:13 AM EDT

Stocks put on a very nice tail yesterday afternoon in what looked like combination of technical buying, short-covering and options-related buy programs after the S&P 500 index crossed above the important 1420 resistance level.

One would expect those same forces to carry the day today, as options expiration typically builds on the week's trend, and we've have three consecutive up days. Plus, this morning's housing data, which showed an unexpected increase in home sales, should be providing a nice goose.

But that old demon oil, which looked like it put in key reversal yesterday, is now burning back to record levels and is taking some of the starch out of stock gains. And now those who tried to pile into shorting oil feel like they just smoked an exploding cigar.

Options will be active in the energy sector, as those that loaded up on puts yesterday will now need to reassess when the correction might occur -- if ever. While I don't believe speculation is the driving force in the price of oil, its impact is probably marginal in the short term and negligible in the long term, and the continued increase in volatility can become self-fulfilling.

Professional traders lean toward where the action is, and volume and price swings feed into each other. So for hedge funds or the proprietary trading desks of institutions and investment banks, the notion of a "superspike" in prices -- I'm looking at you, Goldman Sachs (GS) -- is just viewed as a great opportunity with no regard for the economic impact of oil at $130 or $150 a barrel.

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Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

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