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Insurance Index bounces back, but time for covered calls

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The S&P Insurance Index (IUX.X) has bounced back the past two trading sessions and this gives investors that were holding some stocks in this group the opportunity to assess their holdings and perhaps be writing some covered calls to generate cash for their accounts. A weekly interval chart of the IUX.X gives hint that bullish traders were lurking at the 600 level and bearish traders may now be found between the 700 and 650 levels. Now may be a good time to sell some out of the money or in the money covered calls for those that have a longer-term view for their investments.

S&P Insurance Index (IUX.X) - weekly interval chart

There have been some striking correlations that have occurred at levels near the retracement bracket on the above chart of the IUX.X and this should help subscribers begin to ascertain just how to trade things from current levels. Yesterday's session high was 649.05 and there were probably some traders selling the strength at the 50% retracement level. Today's move above that retracement gives some guidance that a further move to the 700 area would be most welcome, but somewhat unlikely. Look for some rather defensive trading in the group near-term as this sector has some nice gains in the past two sessions, but insurance claims still yet to hit the books may be coming. A break back below the 648 level could see a retest of the recent lows and a longer-term investor that is selling some covered calls might be able to work down their cost basis in their insurance stocks and be able to raise some cash. This is an important strategy for those investors that perhaps came very close to getting margin calls late last week.

Property/Casualty Insurance Stocks - Sorted by volume

Here's a list of Property/Casualty insurance stocks that we had covered early last week. As we look through the list very quickly, subscribers will note that shares of American Intl. Group (NYSE:AIG) are now trading above their 9/17 high of $71.07, yet shares of ACE Ltd. (NYSE:ACE) are still trading below their 09/17 high of $29.60. I find this interesting as it relates to past commentary regarding ACE. Several weeks ago, I had mentioned in the "hot list" on OptionInvestor.com and wrote about this stock in our commentary that it looked like money was rotating out of shares of ACE (before terrorist attacks). Perhaps current trading gives some confirmation that shares of ACE are losing sponsorship and are a laggard in the Insurance sector.

ACE Limited (ACD) - $1 and $0.50 box

Shares of ACE have rallied back nearly 35% from recent lows, but I'd expect some firm resistance at the $26-$28 level in coming weeks. Somebody stepped up to the plate in the $18.50-$20 range and may now be looking to take some profits or at least sell some covered calls to generate a nice little dividend. Share of ACE do trade options, but not a lot of activity. The October 25 calls (ACEJE) show 55 contracts have traded today, with open interest of 625 (largest open interest on Call side for October). The put side has little activity right now, with open interest on the October 25 puts (ACEVE) at 308 (largest open interest on put side). I'd expect shares of ACE to remain rather range-bound to lower the rest of the month, with a trade presenting itself to the downside should the insurance group see profit taking. Look for institutions to implement some damage control in this group and perhaps par back on some bullish positions on this rally.

Relative Strength becomes important

In a declining market like we witnessed the past month, relative strength is still very important for traders and investors to be monitoring. One sector I still feel the NASDAQ needs to show some leadership for the NASDAQ Composite (COMPX) to actually show some type of sustained strength is the biotechs. This is perhaps one of the technology groups that isn't as dependent on a strong economy as other parts of technology. Until this group gets moving to the upside, I'd remain very cautious for prolonged technology investing as the biotechs can give hint of how aggressive many market participants are going to be on the buy side of things. If the market is going to get aggressive on the buy side, then the biotechs are a group that has yet to make their upward move and a group that traders and investors should be monitoring closely.

The Biotechnology Index (BTK.X) is one group that really hasn't "rebounded" from their recent sell off, but its relative strength point and figure chart is still on a buy signal, but in a column of O's. Traders that may have been fortunate to have "bought a bottom" in some other areas of the market may be reloading and raising some cash and perhaps getting ready to play some stocks in the Biotechnology sector.

Relative Strength of BTK.X vs. S&P 500 Index

Relative strength is easy to calculate and can actually help a trader make some risk/reward types of decisions. It can also help the trader set stops and bullish targets. For example, relative strength for the BTK.X vs. SPX is 42. This value can be charted on a point/figure chart using the 3-box reversal system of charting. We calculate the 42 value by simply dividing the value of the BTK.X (422) by the SPX 1,004. This gives us a decimal value of .4203. We can then simply multiply that value by 100 to get a more "chartable" value of 42. Then, every day at the close of trading, we could calculate just how the relative strength is holding up or deteriorating. Using math basics, we can also determine at what level RELATIVE to the SPX at 1,004 this index would reverse back into a column of X's or give us the sell signal. Traders that are using their retracement brackets on other technical indicators that monitor price, will be better able to make some buy sell decisions regarding the group and perhaps stocks that then reside in the group or have a biotech flavor.

What a trader might surmise at current levels of trading is that the Biotechs are at a relative level of strength where they've seen reversals higher in the past. For the bullish trader that is identifying potential bullish candidates that have pulled back to longer-term support levels, this gives them some confidence that a bullish trade with a tight stop is a good risk/reward trade. Yesterday's high for the BTK.X was 431 and today's session high was 428. This gives hint that a break above the 432 level is most likely a bullish move and a trader that is monitoring the NASDAQ Composite gets even more bullish if the NASDAQ is moving in the same direction. Current observation is that the NASDAQ may have problems mounting further gains without the help of the biotechs.

Jeffrey Canavan
Assistant Analyst
Premier Investor

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