Option Investor
Index Wrap

Thinking about a 4-day weekend

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After a whipsaw session that found the major indices being jerked around and finishing relative unchanged, I'm thinking about a 4- day weekend.

Markets will be closed on Monday in observance of Martin Luther King Jr. Day, and with equity option expiration on the plate for tomorrow, those traders that didn't get enough rest during their Christmas to New Years holiday break, might think about taking tomorrow off.

After two unsuccessful attempts to Toll Bros. (NYSE:TOL) $39.50 +1.07% bullish and getting stopped out just after the open, and later in the day shorting the QQQ at $38.25 to get stopped out minutes later at $38.36, I'm thinking a visit to the chiropractor tomorrow to check out a case of whiplash is a good idea.

Economic data released today, though mostly ignored due to what I truly feel was index option expiration, had various economic indicators showing positive signs.

December consumer prices rose a tepid 0.2%, which was in line with economists' forecast, but up from November's -0.2% decline. The core rate, which factors out the more volatile food and energy components edged up 0.1%, also matching economists' forecast, and offsetting November's 0.1% decline.

The continued lack of any meaningful inflationary, or deflationary indicators at the producer and consumer levels, combined with a bounce in the dollar had gold and gold stocks under strong selling pressure again today. The AMEX Gold Bugs Index ($HUI.X) 97.34 -4.03% closed at a 2-month low. The U.S. Dollar Index (dx00y) 86.55 +0.6%, hardly a picture of technical strength, now approaches its trending lower 21-day SMA (01/14/04).

Gold did see some late session firming after the December U.S. Treasury Budget showed a -$16.2 billion deficit, which was wider than economists' forecast of $13.0 billion. The budget deficit is currently $21 billion larger than a year ago.

Treasuries caught a slight bid on the news, with the benchmark 10-year Treasury YIELD ($TNX.X) finishing down 1.5 basis points to close at 3.971%.

The regional New York Empire State Index improved for the ninth month in a row, rising to 39.2 (consensus 35.0) from December's upwardly revised 37.4 (prior 36.2). The Federal Reserve Bank of New York said respondents reported improved business conditions and continued optimism, with nearly all those surveyed expecting conditions to be the same or better six months from now. The new orders index rose to 36.13 in January from 35.19 in December, while shipments climbed to 41.73 from 36.66.

Total retail sales for December rose 0.5%, which was below economists' forecast of +0.8% and November's downwardly revised +0.9% (prior +1.2%). Excluding autos, December sales rose a fractional 0.1%, also below economists' forecast for a 0.4% gain. Some comments I read regarding December's lackluster ex-autos data was that gift cards were very popular during the holiday shopping season, and retailers can not book the sales of gift card purchases until credits are redeemed by consumers.

Without success, I did try to look for any forecasts for January retail sales, which might have economists factoring in gift card redemptions, but I could not find a current economic forecast.

The S&P Retail Index (RLX.X) 377.79 +0.58% closed back above its rounding lower 50-day SMA, but just above the mid-point of its November high and December relative low. Retailing Dow components Wal-Mart (NYSE:WMT) $53.49 +0.65% edged up $0.35 per share, while Home Depot (NYSE:HD) $35.43 -0.11% slipped lower by $0.04 per share.

I received a very good question from a trader/investor the other day regarding the recent buying in Treasuries, which has YIELD falling, and the relationship with a sharply lower gold trade. Is this a sign of coming negativity toward broader equities, and perhaps the economy.

It might be, and I would only use these observations as a reason to be disciplined with bullish trading in broader equities at this time. Not that we shouldn't be with the bullish % indicators still at very high, but still very strong levels of bullishness.

It has become somewhat obvious to this analyst (Jeff Bailey) that the Fed isn't going to move on interest rates, until one of two things happens. The first and foremost is that it sees some type of inflation, with the second observation being that the labor market shows steady improvement.

I'm going back and looking at the AMEX Gold Bugs Index ($HUI.X) here tonight, and noting the recent highs of 258, from which the HUI.X appears to have double-topped at its December 2nd high of 258 and now witnessed a lower low. My economic calendar shows that on January 6th, November factory orders were released, and showed a -1.4% decline, which was slightly below the -1.5% decline economists had forecasted. While it is my belief that a market will accurately forecast, or predict future data, which will either positively or negatively impact trade, I'm simply benchmarking what appears to have been a key point of resistance in the $HUI.X with economic reports released to all market participants.

On January 6th, the benchmark 10-year YIELD ($TNX.X) was trading 4.30%, and while its decline in YIELD, spurred by buying, does suggest a somewhat defensive posture from the bond market, it may well be based on reiteration of Fed policy that the Fed Fund rate is staying at 1.0% for "the foreseeable future."

One of the dynamics I've noted in past comments, is that during the great bull market of the late 1990's gold fell sharply, while Treasury YIELDS rose, matching the rise in equities.

The "killer" signal for equities decline seemed to be the continued pummeling of gold, and renewed buying in Treasuries at much higher YIELDS than found in recent months.

With the brief conversation of gold and bond relationship being somewhat suspicious in that the major equity indices are not showing any real sign of meaningful weakness, we should still observe today's trade with the thought that it may have been highly manipulated due to index option expiration.

I agree with those investors that this week's trade may have been somewhat influenced by index and stock expiration, which should keep traders and investors disciplined with our stops.

I would use the recent sharp decline in gold, along with a lower Treasury YIELD trade as an alert for weakness in the major equity indices, but then be looking for some type of technical confirmation that weakness is actually being observed.

Tonight I'm going to set a downside YIELD alert on my 10-year YIELD ($TNX.X) chart at its inflection point low of 3.912% from October 1, 2003, where if broken lower, may indeed be some type of signal from the bond market that we should be alert to. The reason I'm not overly concerned with some of the renewed interest that Treasuries are finding right now is that on September 30, 2003, the SPX traded a relative low of 990.36 and closed 1,132.05 today.

I'm also monitoring the Pacholder High Yield Fund (PHF) $9.41 +0.10%, which is a closed-end "junk bond" fund, as it battles with $9.50, but 52-week highs. It's current YIELD based on last month's $0.075 per share distribution (pays monthly) is 9.56%.

My thinking by following this security as a general representation of "junk bonds" is that if the market perceives downside risk, it doesn't care about a higher yield, if downside risk is perceived as high. The combined buying of Treasuries, which are backed by the full faith and credit of the U.S. government, with the observation of buying in a much riskier set of bonds (junk bonds) gives the impression that income investors see some type of acceptable risk/reward relative to where it currently seed Fed interest rate policy heading.

Perhaps gold has started to say the same thing in recent weeks.

Market Snapshot / Internals - 01/15/04 Close

The major indices finished just about where they ended Wednesday's session and closing A/D lines were just about even. Volumes were brisk and heavy, which we might expect on an Index expiration. A quick review of my buy/sell premium chart on 5- minute intervals has me counting 5 buy program premium alerts and 6 sell program premium alerts during today's trade. This to me hints of some heavier institutional activity and not a surprise.

Tomorrow it will be stocks' turn for option expiration, along with the QQQ, so I'd plan on some more volatility.

NH/NL breadth remains very bullish, with the NYSE 10-day ratio now at 98.9% and NASDAQ NH/NL ratio at 98.6%.

You can probably pick up on the intra-day volatility in the point change columns by the hour and it is notable how the INDU/SPX/OEX/RUT.X/QQQ all finished positive with an Index expiration, while the very broad NYSE and NASDAQ Composite finished fractionally lower.

I make not of this, only because of some observations we have been making regarding some of the option action in the current month option contracts, combined with the Market Volatility Index (VIX.X) 15.56 -7.1% suggested we might well see index expiration have an impact into today's trade.

This week I concentrated more on the SPX, and while today's close of 1,132.05 may be thought as "random" its close is right between our MONTHLY R1 and WEEKLY R1 and today's DAILY R1 correlation found in last night's wrap.

I made two trading "mistakes" today. One at the open in TOL, as the SPX was nudging just above 1,133. I traded long and you can see from the intra-day internals what took place by 11:00 AM EST. Then later in the day, I "wised up" and when the QQQ rallied back to its correlative levels of pivot matrix resistance of $38.25, I shorted with a stop placed tight at the 52-week high, was promptly stopped out, before the QQQ fell back lower.

I've been known to make a few trading mistakes that result in losses, and mistakes I seem to be willing to make time and time again is to initiate trades during option expiration. It won't be the first, it won't be the last, and when I do trade at option expiration, I expect volatility, but will always use a tight stop.

Pivot Analysis Matrix -

Today's e-mini S&P futures (es04h) settlement above my fitted retracement level of 1,113.25 gives a bullish bias into tomorrow's trade, and has me currently looking at a cash (SPX) 1,132.05 +0.13% trade potential to its WEEKLY R2 1,144.19 and correlative DAILY R2 of 1,143.83.

I've noted in pink today's HIGH on the OEX was smack on its WEEKLY R1, and the trigger for upside potential to SPX WEEKLY R2 is an OEX break above that high, where OEX now shows some tentative (dashed green) early support at the MONTHLY R1 and DAILY Pivot.

I marked today's LOW in the SPX and tomorrow's DAILY S1 as a level I think really needs to hold some support. It was this 1,125 level where the bulk of my observations regarding heavy option trading into index expiration was taking place. For me, this becomes a rather important near-term level of support if bullish traders are committing new bullish capital to these markets.

The ONE thing I think traders need to be careful of right now, is that I really do think there has been some scrambling by institutions to "get long" in an attempt to square up on some calls written previously at 1,125 and above, which may create some artificial bullishness. What bulls need to be careful of is that this "artificial" bullishness, if it exists, doesn't unwind itself early next week after expiration.

For bears, they've got the same problem tonight that has been a concern for months. 52-week highs and limited overhead supply of stock.

S&P 500 Index (SPX.X) Chart - Daily Intervals

1,125, 1,125, 1,125 keeps showing up in recent sessions. Even that very short-term downward trend from the January 9th relative high, which was firmly broken to the upside late Wednesday, served support at 1,125 on a pullback test early this morning.

With futures closing above my bullish bias level, I think there's enough upside emphasis to have the SPX trading 1,144-1,145 tomorrow.

S&P 100 Index (OEX.X) Chart - Daily Intervals

Here's a 10-minute interval chart which shows this weeks trade. I wanted to brink in the observation of the downward trend from the recent 52-week high, and when broken, how it serves support this morning.

While the Pivot Levels give us levels to be looking for institutional program buying and selling levels, these basic trends give some insight as to what other market participants have been doing. My best guess is there were some shorts playing trend, maybe thinking of a 550 OEX settlement, but when trend is broken and overhead supply is limited, a bear will turn on a time and look to buy a retest of the trend.

Dow Industrials (INDU) Chart - Daily Intervals

Tomorrow's DAILY R2 at 10,656.82 adds another near-term level for resistance in the INDU. After we looked at a INDU point and figure chart earlier this week and saw a 3-box reversal (finally) it is now that I begin to wonder what is going to take place early next week when option expiration is over.

If we're going to finally see a more meaningful pullback and digestion of gains after the bold move above 9,900, then I'd have to be looking for a spike higher, but a quick reversal back lower type of trade. With MACD fading a bit in a strong upward trend, and Stochastics providing some near-term bullishness, traders should be alert to such a trade.

NASDAQ-100 Tracking Stock (QQQ) - Daily Intervals

QQQ option expiration is tomorrow and despite a lower trade in INTC and YHOO, the Q's held tough on IBM's upbeat earnings and comments. An after-hours upside surprise and upward revisions to prior guidance gives the Q's a lift in after-hours. Aggressive bulls can play for a squeeze, and important support becomes visible at $37.55.

Those bulls not willing to risk downside to $37.55, I saw some "bad ticks" lower at $37.95 today, which hinted to be of a near- term "floor" of support, which a bull could look to leverage from.

Jeff Bailey

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