Fed holds key for stocks to break range

Federal Reserve Board Chairman Ben Bernanke makes his way through the Dirkson building hallway after a Financial Crisis Inquiry Commission hearing on ''Too Big to Fail: Expectations and Impact of Extraordinary Government Intervention and the role of Systemic Risk in the Financial Crisis,'' on Capitol Hill in Washington September 2, 2010.

NEW YORK (Reuters) - If the Federal Reserve's view of the economy brightens by just a glimmer this week, it could push the stock market above its four-month trading range.

The S&P 500 closed the week at the higher end of that range, just below 1,130. Some chartists see a break above it as presaging a test of the year's highs.

But options trading suggests some see 1,130 as the market's ceiling and are protecting their portfolios against a decline.

Other investors see the Federal Open Market Committee policy meeting on Tuesday as the turning point that stocks have been searching for to break out of the range with conviction.

"Going up to the close on Tuesday, we could see a little bit of enthusiasm, and perhaps it could be the catalyst that could push us above 1,130 on the S&P," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.

In late August, Fed Chairman Ben Bernanke said he would need to see a significant deterioration in economic conditions before easing monetary conditions further. Recent data, including a stronger-than-expected reading on private-sector jobs growth, could prevent further action from the Fed.

If the Fed does move, people "wouldn't interpret it as a bad sign (for the economy) but as the Fed being vigilant in trying to keep this recovery going," Jacobsen said.

Most analysts do not see the Fed moving in that direction immediately, but Jacobsen said any signal will be welcome.

"It could be the impetus that's needed to push people out of bonds and into stocks, finally," he said.

ALL EYES ON TECHNICALS

Even with stocks losing a bit of momentum as some technical indicators suggest, the S&P 500 seems poised to move above 1,130. Some chartists see breaking that level as a harbinger of future gains, with overhead resistance not seen until 1,173 and then at the year's high near 1,220.

Having pierced 1,130 three times in the last three months, the level is garnering attention even from investors who are more focused on fundamentals than technical analysis.

"Whenever economic uncertainty bubbles up, that's when technicals take over in terms of what market participants look for," said Wasif Latif, vice president of equity investments at USAA in San Antonio, Texas.

"A lot of people have been looking at 1,130 and we look at it as a component because other people are acting on it."

For the week, the Dow Jones industrial average .DJI gained 1.4 percent, while the Standard & Poor's 500 Index .SPX advanced 1.5 percent and the Nasdaq Composite Index .IXIC jumped 3.3 percent.

OPTION TRADERS HEDGING BETS

The CBOE Volatility index, or VIX VIX.N, continued to show high volume as investors were bracing for volatility.

"After VIX September options expired on Wednesday, I expected that index options activity to drop," said Randy Frederick, director of trading and derivatives at the Schwab Center for Financial Research in Austin, Texas.

"But on the day, there was actually a big volume on puts and calls, suggesting that as soon as September contracts expired, they replaced the VIX contracts again for protection."

A large put spread was made on the S&P 500 index .SPX that suggested a substantial move lower in the short term, according to Chris McKhann, an analyst at optionMonster.com.

HOUSING DATA ALL WEEK LONG

In terms of economic data, this week's schedule has nearly a daily dose of housing indicators. From the housing market index on Monday to housing starts on Tuesday, followed by existing home sales on Thursday and new home sales on Friday, investors will get a clearer picture of a key sector that must improve before the economic recovery can really kick in.

"It's been so terrible lately that it doesn't have to be strength -- just a sign of life in the housing market could be support for financial markets overall," Jacobsen said.

(Reporting by Rodrigo Campos; Additional reporting by Angela Moon; Editing by Jan Paschal)