Option Investor
Index Wrap

Hammer Time!

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        9-19-2001          High      Low     Volume Advance/Decline
DJIA     8759.13 -144.27  8945.47  8480.21 1.67 bln   1228/1926	
NASDAQ   1527.80 - 27.28  1568.22  1451.31 1.83 bln   1440/2300
S&P 100   518.85 -  7.95   529.92   500.87   Totals   2668/4226
S&P 500  1016.10 - 16.64  1038.91   984.62             
RUS 2000  503.20 -  8.46   413.44   391.38
DJ TRANS 2165.86 - 51.21  2247.68  2104.63
VIX        43.22 +  0.72    47.62    40.80 
VXN        76.93 +  2.19    78.28    72.84
TRIN        0.88 
Put/Call    0.67

Hammer Time!
Austin Passamonte

What a difference forty minutes make. At 3:00pm EST the markets looked to be headed higher as shorts covered from the downdraft in the Dow that plunged beyond -400 index points. Then news broke that U.S. warplanes were ordered to the Middle East and more selling ensued from there.

However, that didn't last long and the Dow quickly bounced +300 index points higher into the close. We saw open interest shrink on the S&P 500 Dec futures (SP01Z) contracts, which indicates shorts are covering. Sure enough, CNBC announced that some pension funds went long a large number of S&P futures contracts in the last hour. That will get shorts covering for their lives in a hurry, rest assured.

(Daily Charts: Six Index Watch)

Here's a squeezed down version of my main Qcharts page. I watch the big six indexes on changing timeframes to monitor overall action. All daily charts posted clear bullish reversal hammers and such is not to be taken lightly. These are very accurate in calling near-term reversals, especially at very extreme moves like we've just seen.

This does not mean that the ultimate bottom is in and it's now full-bull ahead. However, it does seem likely that upside pressure will continue to release in Thursday's session barring any disastrous news release before then. Secondly, we will not remain so grossly oversold very much longer. A massive short-squeeze rally is indeed right around the corner, the only question we ask is when.

(60/30 Minute Charts: Dow)

The old index had quite an interesting day. It began with an attempt at upside strength off the bell and turned to selling soon after. Boy, did it ever! At one point the Dow was -465 index points from peak to trough. That final hour rally drove price action +279 points higher from the low to end another volatile session. But look what happened with near-term stochastic values: they barely began their trip back up from oversold extreme towards overbought.

There is plenty of upside room to continue on Thursday and I would look for first clear resistance at the middle Bollinger band 20- hour moving average near 8870 or +100 index points higher from tonight. Then the biggie would be 9,000 area which served as an important pivot point not long ago.

(60/30 Minute Charts: SPX)

Same stochastic readings as the Dow. Both posted very clear bull flag patterns today and predict higher prices tomorrow. Look for resistance at 1130 and heavier if/when 1140 get tested in the time ahead.

(60/30 Minute Charts: QQQ)

Similar stochastic values to the leadership indexes in the QQQs and looking for higher levels tomorrow as well.

(60/30 Minute Charts: OEX)

We see a clear pattern developing here: bullish stochastic values with plenty of room to run higher. Same bull flag patterns (not shown) and overhead resistance levels denoted as well. One thing I've seen over and over and over in my brief career is this: when all 60/30 minute chart stochastic signals are aligned and moving in unison so clearly as this, the odds of continuation are greater than 90% probable.

No question I've seen nine out of ten setups like this result in continuation moves. The last crystal-clear entry like this came back on September 4th when the Dow shed -200 index points in the final hour of trading. We've not seen this ideal a setup since, and I'm loaded to the gills with OEX calls because of it.

(Weekly/Daily: VIX)

The VIX spiked back up to Monday highs above 47.00 and relaxed from there. Put/call ratios have held extremely high and both now signal a bullish reversal of considerable force is building steam that will blow off soon.

High 40s are extreme and we've seen those levels and more in the past, but each time marked a powerful, sustained rally from a time when all the world had little hope that the markets would do anything but continue to plunge. Will history repeat itself this time? Doesn't it always?

Expectantly Impatient
Today's action has been anticipated for days. The Dow has shed an amazing 1,500 index points in the past six live trading sessions. Six trading days ago saw a session high just above 10,000 and today a break to 8,480 lows. Can anyone expect a market to dive straight down like this without coiling up for a massive short squeeze event?

It appears that insurance companies have been selling bonds and equities this week to raise needed capital as we noted last week in predicting this week's action. DS, one of IS long-time readers wrote me last week to say he works in the NYC-area insurance field. He told me that insurance companies will make good on most if not all claims for favorable public opinion and would be forced to sell bonds and equities to raise cash.

Plenty of good companies with solid fundamentals got dumped in the street out of necessity. Why else would GE and others get ravaged on huge volume? We can be sure that hedge funds began shorting the markets soon after they opened and rode them down for significant gains. When I hear that pension funds (commercial traders) are in the SP01Z going long oodles of index futures contracts it tells me that the big shorts are starting to cover.

Why would they? Everyone knows that buyers will boycott these equity markets for weeks and months on end. Sentiment couldn't possibly be worse! Which is precisely when the market giants step in and begin to buy good companies sold bad.

Out Of The Depths
Just when things couldn't possibly look worse for a market is exactly when most significant rallies begin. Make no mistake: we are coiled for a sustained event that will see more than one monster session where the Dow rallies 300+ index points higher as well. That will be when weak-hand shorts cover like mad as bargain hunters turn on their buy programs.

Did it start today? We'll let you know tomorrow . Seriously, this market is still very vulnerable to pending news that could cause it to plunge again. It appears that market action intends to move higher unless otherwise thwarted by further adverse news to such a move.

Today was a fantastic session for the experienced day trader. I saw some SPX and OEX OTM puts gain +600% to +800% from low sale this morning to high sale at the end. Do you mind paying $200 for an option only to sell it five hours later for $1,700 to exit? How about just a small chunk of that?

I turned over some SPX 1025 puts for +200% and watched them roar off far higher than that afterwards. Then I tried some OEX 630 calls on the first solid bounce and lost -50% on that play. They actually closed up +25% above my entry but when the stop was hit I'm out, no questions asked! When in doubt, give me my capital back and let's hit the next entry better.

In the last hour I bought some OEX 620 calls, set a sell-limit for +100% above cost and filled those too. Then I scrambled to buy some OEX 630 calls after the bell and fought a bunch of you guys to get filled. I took all of today's profit and rolled it into those 630 calls with a 2.00 cost basis and will happily sell them for more (or less) tomorrow if given the chance. I expect to make three to five trips each of the next two sessions if they are half as good as this one was.

Phew! Just another typical day in the last three sessions of expiration week for me. Hindsight tells me I should have sat on the puts longer, but seeing large amounts of potential gain sitting there in my account with all charts buried in oversold extreme is very unnerving. I've given back too many solid unrealized gains in my life to be greedy any longer. Give us our pre-determined chunks and let's get ready to do it again.

Buy & Hold
That's the approach for short-term traders right now. We are currently playing around a huge inflection point within markets seemingly about to make a turn. Traders with longer-term outlooks should strongly consider bull-call debit spreads, long shares or OTM calls (in that order) busing October or November contracts on further strength ahead. Both option tactics will help reduce (but not eliminate) high extrinsic values right now. A significant move over the next few weeks would offset high valuations and offer solid rewards in the process. The key is to use small amounts of capital we can afford to lose and just let time and market direction take over.

My opinion is we are approaching a key reversal in the market and may have witnessed the start of it today. April 2000 saw several sessions similar to this before the bubble burst. This March lows were retested in April before the upside explosion from then. I wouldn't fall in love with either direction just yet, but adverse risk most clearly lies to the downside for nervous shorts at this time.

Best Trading Wishes,

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