Option Investor
Market Updates

When the "wheels come off"

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At the bottom of this update, I'm going to discuss what traders might want to do when the "wheels come off" in a trade. For now, lets get a quick update of the markets, then try to learn something late.

10-year Treasury Bond YIELD Chart - 60-minute interval.

Subscribers that have been with us for awhile now understand how they can use bond YIELDS to help decide if they should be looking long or short in their trading strategies. The above chart shows how yields have dropped in the 10-year Note (TNX.X) since it reached a high on January 25th. Now the YIELD on the 10-year has fallen to 5.016% and a lot of money went into bonds since January 25th. That's money that could have gone into stocks, but chose to do otherwise. If we start seeing YIELD rise, that gives hint of selling in bonds and that money might be slated for stocks. It's our job to try and figure out where that money is going.

Automotive Stocks

One area I think institutional money is flowing is into the automotive group. Last week, I thought General Motors (NYSE:GM) looked to be attractive for bullish traders if it pulled back to our upward trend near $54. On Friday, the stock pulled back to $54.16 and looks strong this morning.

General Motors Corporation Chart - 60-minute interval.

Shares of GM look to be attracting capital as the stock recently broke above a downward trend on our 60-minute chart and there seems to be buyers at our upward trend. The upward trend now looks to be the overriding trend and I like the stock here with a stop just below at $53.75. If we looked at a DAILY interval chart of GM, we'd see the 200-DAY MA is currently at $62.73 and I'd be targeting the $61 level over the next two weeks.

Disk Drive Index Chart - 60-minute interval.

One group in technology that I like on a risk/reward basis remains the Disk Drive Index (DDX.X). This index trades options on the AMEX and offers the option investor a way to get broader exposure to the group. Index Components are (HTCH), (IOM), (MXTR), (DSS), (HDD), (RDRT), (SNDK), (STK) and (WDC).

When the "wheels come off."

If you trade long enough, eventually you're going to get some disappointments. In some cases, they're going to be "big disappointments." On Friday, I highlighted a bullish trade based off a point and figure chart in shares of Emulex (NASDAQ:EMLX). This morning, the company warned that earnings were going to be "less than spectacular" and the stock got drilled to the downside. Option traders that may have bought a call option can do very little when a stock gaps down from a close of $77.75 to $52.25 and trades lower. However, a bullish trader in the stock must immediately take defensive action by using a put option to hedge their position. Let's say we bought 100 shares of EMLX on Friday near $75, representing a $7,500 risk of capital. With the stock currently trading at $41, what would we do now? On paper, we're currently at a loss of $3,400 and we don't want that to get any worse. What I need to assess right now is at what point I'm going to "cut this stock" and take my loss. I don't want it to get any worse than it is. Now that the MARKET has the news, it will act accordingly. I could look at a covered call, say the March $50's (UMQCJ) and sell that call, thus receiving $412.50 in premium. I could do this and put a stop under today's low on the stock. I could also just buy a put contract to hedge my position, then sell the stock if it were to drop below today's low and hold to put if it looked like there was further downside. We'll discuss this strategy later today, but we're running out of time here. The key point is to hedge your position and look to get rid of the stock!

Jeff Bailey
Staff Analyst

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