Yesterday, the stock market and almost all commodities got smashed along with a rise in the US dollar following confusion about whether Ireland would or would not accept some form of bailout from the EU.

It’s a replay in many important ways of the situation in Greece which was only ameliorated (I won’t say solved because we don’t know for sure that it’s really over) after an EU bailout which cost German Chancellor Angela Merkel her majority in that nation’s legislature.

Ireland is part of a group of 5 countries called, appropriately enough, the PIIGS.  They are Portugal, Ireland, Italy, Greece, and Spain, and they, or rather their sovereign debt, represent 5 big dominoes with reasonable likelihood of falling.

This turmoil is extremely bad for Europe, extremely bad for consumer confidence there (and, to a lesser extent, here).  As the Euro weakens along with that drop in confidence, Europeans will buy less from the US and elsewhere and perhaps cause, if not a worldwide economic “double-dip", then at least a leveling off of what for the last several months has been a fairly decent recovery except for in the employment statistics.

It should also be noted that some part of Tuesday’s sell-off was due to investors raising cash to buy into the GM IPO which should price Wednesday evening after underwriters increased both the size and the price of the offering.  Even after raising the price from around $27 to around $32 and increasing the size by over 30%, the offering is massively over-subscribed with reportedly 7 shares wanted for every share available.  Also, it appears that “retail", which means individual public customers, will have a hard time getting any shares.  Instead, all the shares will go to the biggest hedge funds and other clients of the biggest investment banks.  Many of those funds and clients will simply sell the stock if it spikes 10%-20% on its first day of trading, as expected.  I find it rather reprehensible to use taxpayer money to bail out GM and then hand “free money” to the investment banks and hedge funds rather than insist that most of the IPO actually go to retail customers, i.e. taxpayers.

For traders, this is both an exciting and difficult time.  It’s very hard to guess what’s going to happen next.  And in the world of derivatives, it’s very hard to guess whether this level of volatility is a temporary spike or the first ominous clouds before a really big storm hits.

Combined with the uncertainty about QE2 and whether the Fed might be making a mistake of historical proportions, I think we’ve seen (about a week ago) the low that we’re going to see in market volatility for at least a couple of months.

I don’t expect a market crash, though if a major bank fails in Ireland because the government refuses to take the admittedly bitter medicine of EU-imposed budget restrictions and the ego-trouncing loss of economic self-direction, stocks could certainly drop 10% from here.  That said, if the Congress extends tax breaks for all brackets by a few years, then US stocks would probably be a bargain if they fell 10% from here.

In the meantime, this is a market for the nimble and the non-risk-averse.  Personally, I’m selling far out-of-the-money S&P 500 puts, betting that the market won’t fall more than 10% this week.  If I lose money on these, I can hardly imagine the turmoil that will be going on all around us.  I’m also selling some out-of-the-money calls, betting that the market won’t go up by more than about 6% this week.  It’s because the market is so frightening and volatile right now that customers are buying such options.  Usually, nobody would be buying protection against or betting on a 12% drop with just 2 full trading days plus one market opening to go until options expiration.  It’s a somewhat dangerous strategy but the only time people want the earthquake insurance is right after a tremor, so if your income comes from selling insurance, that’s not a bad time to do it.  The key is to not sell so much that if there is an earthquake the losses put you out of business.  Again, this is a strategy for an experienced and risk-tolerant trader.

I wish you all a relatively calm financial second half of the week.