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Monitoring many to build an opinion

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Often times I talk about how important it is for traders to monitor the broader markets then the sector and finally the stock they're trading to help guide them in their decision making. While we're doing this, we're looking for pattern of similarity and divergence. When we see divergence we take note and perhaps take action. A stock that is diverging from the broader market or related sector is often times a very important alert that something is up. I'm going to a moment and discuss what is taking place in the Forest/Paper Products Index (FPP.X) and also give traders an account management tip if they're thinking of trading the Forest/Paper Products Index (FPP.X) or any other index/stock for that matter. Check out a chart of International Paper (NYSE:IP) and compare it to the FPP.X. Then pull up an option montage for both and you should realize how trading a stock that closely resembles the index might allow traders to limit their capital exposure. Hopefully this will also get every subscriber to begin focusing on the SECTOR/STOCK relationship to make sound judgements in future trades/investments. At the same time we can "test" one of our scenarios as it relates to the potential of a strong economy as indicated by a cyclical group.

International Paper (IP) Chart - last six months.

If we want to compare apples to apples, we might want to take a quick look at the APR$37 calls (assuming we're bullish on IP). The symbol is IPDU and bid/ask for this contract was $2.55-$2.85. Traders that wanted exposure to this group might be able to do so for an investment as little as $285, plus commission.

Forest/Paper Products Index (FPP.X) Chart - last six months.

Exposure to the group through an index option in the FPP.X through April expiration might compare the APR$310 call option (assuming we are bullish). The symbol for this call is FPPDB and bid/ask was $18.10-$20.10. It would take a $2,010 plus commission investment to get exposure here.

IMPORTANT POINT!

The above is an example of how to limit capital exposure to the markets, but still have the potential reward of a stock move or group move (if you believe that 80% of a stocks price movement is attributed to the group that it is in). However, most traders know that there is "higher" potential risk/reward in an individual security (IP as an individual security) than there is in a basket of stocks (FPP.X as a basket of stocks). Traders that are trading smaller accounts may not want to expose one- fifth of a $10,000 account in an index option, but might use the similarities between IP and the FPP.X to just expose 3% of their account and perhaps get the exposure (call or put) to the group.

How it relates to our "strong/weak economy" scenario.

Back in October, I profiled a LEAPS play in shares of IP on the belief that the stock was in an "oversold" group based on supply/demand analysis and felt the group would be an "outperformer" in the months ahead. As time progressed I posed the scenario of how a deep cyclical group like the FPP.X might be an index that led us out of an economic slowdown. My thinking based on past observations was that deep cyclicals often times appreciated in value ahead of an economic strengthening cycle. From the above charts, traders can see that we are at a fairly important observation level that should be monitored as it relates to our economic scenario. If we were to have an upside alert above the 50-period MA's for both IP and the FPP.X, that might serve as an upside alert to what the MARKET is thinking not only as it pertains to the group, but perhaps the economy. At the same time, we can set alerts at upward trends and retracement support levels to alert us to potential weakness.

Jeff Bailey
Staff Analyst
www.indexskybox.com
www.OptionInvestor.com

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