Option Investor
Index Wrap

Think fast, act slowly, and prepare for VOLATILITY!!!

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In my opinion, if I wasn't at least alert to some type of option expiration-related activity heading into next week's option expiration, today's final close would have left me scratching my head, as there were a couple of things that took place in today's trade that simply don't make sense.

I agree with those traders that thought today's Market Volatility Index (VIX.X) 15.39 +2.53% rise was modest considering some of today's action. Even more suspicious is the NASDAQ 100 Volatility Index (VXN.X) 22.35 +0.4% fractional rise, especially when we consider the Semiconductor Index (SOX.X) 473.53 -3.24% was smacked for a 16-point decline, as it falls to the June "Max Pain" theory value of 475 well ahead of next week's Triple Witch expiration.

Before we start looking at some of today's charting action, lets quickly cover some of the internals, where today's trade does have one of out shorter-term breadth indicators suggesting some lack of near-term bullish leadership.

Market Snapshot / Internals - 06/09/04 Close

Four points as it relates to PRICE action. By the close, the SOX.X did slip below its WEEKLY Pivot and June "Max Pain" of 475. By the close the Dow Industrials (INDU) 10,368.44 -0.61% eventually gave up their DAILY S1 (10,379.63 from last night Index Wrap) by just more than 10-points (I like to give the INDU 10-point either side due to its larger index value). Now comes the confusing part.... Two comments were made on the higher 10- year yield ($TNX.X) trade today. One was that some Treasury bond traders sold bonds in disgust, when it was announced that the Producer Price Index (PPI) report for May was going to be delayed until June 15 or later. A second comment was that the selling was a "fear" response from the bond market toward inflation.

I would tend to think today's Treasury selling was a disgust among traders as the Commodity Index ($CRB : cr00y) is back lower at 270.00, where the decline in oil and commodities in general would not be adding much confirmation to the "inflation" trade today.

Moving on... while we wouldn't expect a great expansion of new highs with a 1.18% decline at the NYSE and a 1.63% decline at the NASDAQ, the 10-day NH/NL breadth advance is notably smaller than what we have been seeing.

This has me making some notes/observation, with a focus on the NASDAQ NH/NL 5-day and 10-day readings.

NYSE and NASDAQ NH/NL Breadth - 05/04/04-06/09/04

I've flagged today's trade with "Expiration Trick" where I think we got some of the option expiration-related trade we discussed in last night's wrap. Two things I'm noting today. Today's trade would have the NASDAQ's shorter-term NH/NL 5-day Average ratio (column AI) edging below its 10-day NH/NL Average ratio (column AJ). I'm also noting that on June 2 (row 349 and BLACK underlined) the 5-day NH/NL average ratio looks to have made a near-term inflection point high. See how yesterday's NSDQ NH/NL 5-day Average ratio came juuuuuust shy at 74.6%, and now moves below its 10-day? Notable considering today's reversal.

I also find it observable that when Barton Biggs did a pretty good job of finding an inflection point low with his "Market is most oversold I've seen in 20 years!" (05/12/04 Index Trader Wrap) it was 5-days later when the NSDQ 5-day NH/NL ratio moved above its 10-day NH/NL ratio after the NASDAQ 5-day ratios achieved that 19.9% inflection point low.

NYSE NH/NL indications still in bull mode for now with 5-day above 10-day, and no apparent inflection points, unless yesterday's NYSE NH/NL 5-day Avg. (column AE) of 83.2% becomes the short-term inflection points.

U.S. Market Watch - 06/09/04 Close

Not an equity sector in the green by the close. In BLUE I mark the "it doesn't make sense trade" between YIELD and the CRB Index. If there is ANY sign that today's trade was NOT option expiration manipulated, I'd have to say it was the NASDAQ 100 Volatility Index (VIX.X) 22.35 +0.4%, and I'll discuss the "why this may be," as it serves as a VERY GOOD reason to actually EXPECT VOLATILITY!!!!!!

Here's a quick look at the Pivot Matrix, and if there's ever a time when a trader may need to be disciplined, then the week heading into a Triple Witch is the time. Remember, these option market makers can be a tricky bunch.

Pivot Matrix -

Look at those DAILY R2 and MONTHLY R1 correlations. Consider those to be "in play" for tomorrow. I mean it!

OEX Daily S1 and its WEEKLY S1 is the main correlative support into tomorrows trade. Get that one in your head when looking at the SOX.X DAILY S1. Here's why.....

Semiconductor Index (SOX.X) Chart - 10-minute intervals

OK.... so the SOX.X likes its WEEKLY Pivot and June "Max Pain" of 475. Now... look at where I've marked tomorrow's DAILY S1 (correlates with the WEEKLY 61.8% retracement at 468.58 and is the lower end of a zone of support).

In black text, I explain the possible scenario of how DAILY R2 could easily become in play. On an intra-day basis, we might also try and understand how the SOX.X traded on a sudden gap higher back on June 4th, then went on to test its downward trend into Monday and yesterday's closes.

So.... going into tomorrow's trade, begin to think that SOX.X is still the weakest index in our WEEKLY pivot matrix, and if weakness is going to lead lower, then DAILY S1 for the SOX.X is a support level until broken back lower.

Now... look at these two option chains for the Semiconductor Index (SOX.X) 473.53 -3.24% (closed Tuesday at 489) and the Semiconductor HOLDRs (AMEX:SMH) $37.57 -2.94% (closed Tuesday at $38.71).

SOX.X and SMH Option Chains - 06/09/04 most actives

How can anyone be so fortunate to get nearly a 100% gain in one day's option trade? One way is to be able to manipulate things in your favor, where the predetermined outcome was planned the prior day, then implement that manipulation. I'm thinking the traders that BOUGHT the SMH June $37.50 puts at $0.35 and SOLD the July $37.50 calls at the open of trade, may have had a pretty good idea of where the SOX/SMH was headed today.

Now... what would YOU do with a 100% gain, if you had it at tonight's close?

If you even thought... Close it and take the profits and run! Then you begin to understand the potential for VOLATILITY and the potential for DAILY R2 if what was put on today, comes unraveled tomorrow. Where might a trader have some profit stops on such a wonderful trade from this morning's open? I didn't mark it, but I'm thinking just above DAILY Pivot and/or WEEKLY Pivot as a starting point.

Aren't you at least a LITTLE bit curious/suspicious as to why the NASDAQ-100 Volatility Index (VXN.X) 22.35 +0.4% was little budged today? I am.... so be alert for VALATILITY.

OK... so now we make note of SOX.X support into tomorrow trade.

Here we go with the S&P 100 Index.... If the SOX.X can gravitate toward its June "Max Pain" then the OEX may want to do the same, but to do so, I think the SOX.X would have to still show some weakness.

S&P 100 Index (OEX.X) - 10-minute intervals

Very similar intra-day trade in the OEX as just reviewed in the SOX.X intra-day chart. I've marked two "hot spots" on the OEX that show trade where after the OEX moved above a yellow zone, the dip into the zone got bought faster than you can pull your hand of a hot stove burner. If it happened once, be prepared for it to happen again.

The intra-day chart of the OEX also looks like there are still quite a few "trend traders" around this summer as the OEX got a little pop on the retest of broken downward trend. That's right as the SOX.X traded its WEEKLY Pivot of 475 at 02:00 PM EDT.

NASDAQ-100 Tracker (QQQ) - 10-minute Intervals

Sticking with the 10-minute interval chart, traders can be observing price action against the moving averages too. For the QQQ I do make note of a "volume spike" that came on some strength after the 02:00 PM intra-day low, just after the QQQ can dipped below its WEEKLY R1. Right now, I'd consider that a "sell, or short strength" back in the zone after a violation of WEEKLY R1.

If this is incorrect analysis, then we may well be alert for STRENGTH back above that level. If the VXN.X implodes lower, then MONTHLY R1, here you come, if option expiration trade unravels back the other direction!

Dow Industrials (INDU) Chart - 10-minute intervals

It wasn't until just prior to the close of today's trade that the INDU finally "gave up" its DAILY S1. I can't say the INDU traded overly bearish, and if anything, traded pretty darned tough. I haven't looked at the DIA option chain, but my general feel is that the INDU would be less likely to be "manipulated" into expiration.

Jeff Bailey

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