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Market Updates

Stock futures reverse after inventory data

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Stock futures have turned fractional losses into fractional gains after this morning's economic data showed that June inventories at businesses rose 0.2%, which was slightly higher than economists' forecast for a 0.1% rise and compares to May inventories rose an unrevised 0.2%, while May sales fell 0.3%. Sales for June rose 0.3%.

Manufacturing inventories fell 0.1% in June, while stocks at retailers grew 0.5% and inventories at merchant wholesalers fell 0.3%.

The overall inventory-to-sales ratio stood at 1.36 in June, unchanged from May. Many economists feel the still low levels in the inventory-to-sales ratio bodes well for industrial production in the months ahead.

While there wasn't really any "eye popping" news in this morning's inventory data, S&P futures (sp02u) 886 (+0.70) reversed earlier losses and now hints at a flat open for stocks. NASDAQ futures (nd02u) are higher by 3 points at 914 and Dow futures (dj02u) are up 25 points at 8,505.

Fair value for the S&P 500 today is $0.50. That price will not change during the session. HL Camp & Company has their computers set for program buying at $2.02 and set for program selling at $-1.72. Fair value for the NASDAQ-100 today is $2.00.

Cautious bear with an eye on the SPY

A "favorite" broader market average for many traders to trade (bullish or bearish) is the S&P 500 Index. A security that represents a basket of these 500 stocks that traders will trade is the S&P Depository Receipts (AMEX:SPY) affectionately called "the Spyders."

From my vantage point, one of "the best" risk reward trades that may exist currently from the bearish trader's perspective is a short in the SPY.

Let's walk through some things and first take a look at the point and figure chart of the SPY. I'm going to first look at the supply/demand picture of the SPY to understand what supply (O's) and demand (X's) have perhaps "said" about the SPY in the past to set up a bearish perspective in the SPY at current levels and try and explain why I think a bearish trade in the SPY currently presents a good risk/reward trade to the downside.

S&P Dep. Receipt (SPY) Chart - $2 and $1 box scale

Since giving a "sell signal" at $108 back in September of 2001 (the day before the terrorist attacks of Sept. 11th) the SPY has not been able to achieve a point and figure "buy signal" (depicted by a column of X, demand, exceeding a prior column of X). Once that "sell signal" was generated (column of O, supply, exceeding a prior column of O) the resulting column of O had turned the vertical count back to bearish to $44.

Now this does NOT in any way tell us that the SPY will trade $44 eventually, it does give traders/investors a longer-term level of risk assessment until a "buy signal" is generated. Currently it would take a trade at $92 to do so.

Therefore, a bear's current risk/reward WITH A STOP PLACED AT $92, would be; risking $3.03 to potentially make reward=$44.97 (based on last night's close of $88.97).

Now let's not get carried away right now and target the $44 level. Personally, I don't think the SPY will trade $44, so lets work from other levels of support from the point and figure chart at $84 and then lower at $78 as they will certainly be hurdles that a bear would need to clear if he/she is ever to see the $44 level from the bearish vertical count.

Risk/reward from $88.97 could quickly be assessed to the $84 level with a stop at $92 as; risk=$3.03 and reward=$4.97. As you can see, suddenly risk/reward is not necessarily attractive for initiating a full short position at current levels is it? But a partial position may be attractive should the $84 level be violated and $78 then come into play.

Another "reason" for only looking short 1/4 or 1/2 position is that the internals as depicted by the S&P 500 Bullish % ($BPSPX) from www.stockcharts.com continues to show some internal repair taking place.

With yesterday's FOMC meeting not producing a rate cut, I still think a bear needs to be cognizant of the FACT that the Fed didn't cut interest rates, and therefore still feels that there is some underlying strength in the economy and that further stimulus at this point was NOT warranted.

Perhaps that "thinking" may hold some merit and allow some respect from even the bearish of bears as the S&P 500 Bullish % ($BPSPX) continues to show a net gain of stocks that are generating "buy signals" on their point and figure charts. One has to at least wonder where the DEMAND is coming from that has stocks generating buy signals. While I've been thinking that it has been short-covering into yesterday's FOMC meeting as Treasuries have been seeing buying, I don't want to risk much more than a trade above $92 to perhaps "find out" at $102 why the bullish % and internals were improving.

S&P 500 Bullish % Chart - 2% box scale

The S&P 500 Bullish % ($BPSPX) is still at too low a level and continues to show net gains of stocks to "buy signals" and internal repair to be shorting full positions. While the SPY is at very similar levels $88.97 to the $89.77 close of July 29th, when the bullish percent reversed into "bull alert" status, the continued gains in stocks generating "buy signals" is considered bullish divergence and should be respected by bears.

True, it is obvious that the SPY itself jumped higher before the bullish % reversed the needed 3-boxes or 6% to signal "bull alert," but we "knew" beforehand that bears were carrying the bulk of the risk 12%. Only smaller bearish positions and tighter stops may have been the proper trading strategy that saved some bears from some noticeable pain. While the S&P 500 Bullish % is no longer "oversold" it is by no means "overbought." As such, will understand risk and internal strength until a reversal is found.

Now lets look at a bar chart of the SPY. Here we'll use some indicators like MACD and Stochastics that traders will follow as well as volume and our "fitted retracement" techniques to honor levels found in the point and figure charts.

S&P Dep. Receipts (SPY) Chart - Daily Interval

At this point, I'm not looking to fit a retracement bracket to the current bearish count of $44. If $44 is to someday take place, I'll roll down my retracement in the SPY, but for now, attempt to honor "key" levels identified from the point and figure chart.

With retracement anchored at the $118 level (the first high after the sell signal at $108 was generated on the p/f chart) and "fit" to the $92 level, which has been recent resistance, we get a "resulting" 80.9% retracement level at $83.95 (pretty darned close to $84 on p/f chart) which served as support on the last pullback on August 5th (remember the bullish % was reversed up into bull alert at that point). Currently, a bear's first hurdle to clear would be a break of upward trend and first bearish target would be the $83.95/$84 level.

A trader that likes to use stochastics likes the dipping back below the "overbought" level on this indicator and can perhaps envision a stochastics back at the "oversold" level should the SPY test the $83.95/$84 (similar perhaps to the August 5th trading at $84 pullback.

With MACD still trending higher, a bear envision that indicator rolling over below zero, but upward trending MACD still deserves some respect and thinking is 1/4 or 1/2 new bearish positions.

Note: A bear that may have established 1/4 or 1/2 bearish positions back in April/May/June (red 4,5,6) at higher levels of bullish % when SPY was giving sell signals, may leg into further bearish positions, but stops at $92 on all positions and still comes out a winner.

Option Traders

Option traders may take note that index options expire on Thursday. As such, it may be worth noting current month open interest at various S&P 500 Index (SPX.X) 884.21 -2.16% strikes.

Open interest on the call side (right to buy at specified price if the contract was purchased) or (obligation to sell at specified price if sold to open the contract) for August expiration is at 950 (36,781), 1,050 (21,399) and 900 (21,103).

Open interest on the put side (right to sell at specified price if the put contract was purchased) or (obligation to buy at specified price if put was sold to open the contract) is at 900 (17,471), 850 (16,442) and 800 (15,221).

Some "commonality" is found at the 900 strikes so any type of trade near-term at $84 SPY may get reversed back to current levels quickly.

At current SPX levels of 884, one has to be thinking "smart money" sold the covered calls at 1,050 and 950 and perhaps 900. While "smart money" sold the 850's and 800's when volatility was high and time has eroded premiums.

Option traders may want to keep an eye on these different strikes near-term, just in case an institution unwinds a position.

It also interesting to note how heavy the open interest is in the September expiration and strikes there. The "reason" this is that many institutions use options to HEDGE risk on a quarterly basis. September marks the end of the 3rd quarter.

As a benchmark for future use, Sept. Call interest is at 900 (43,388), 950 (27,940), 925 (27,207) and 975 (19,942).

Sept. Put interest is at 800 (49,379), 900 (41,280), 850 (27,252) and 700 (25,335).

For the most part, institutions SELL the premiums of puts and calls, not buy it. A trader that will track open interest on a weekly basis may get a feel for what institutions are doing with their capital and thoughts on market direction.

For instance, an institution that "sold naked" the Sept. 700 puts today (9,407 contracts traded) raked in $380/contract. This type of "bet" would have the trader willing to buy the SPX at $700 less the $3.80, premium received.

Jeff Bailey
Senior Market Technician
Option Investor

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