Option Investor
Index Wrap

Intel overshadowed by trade figures

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A final hour spat of buying had the major indices finishing with gains as the Dow Industrials (INDU) 10,617.78 +0.58% posted its largest single-day gain for 2005.

While a 61.5-point gain may not seem like much, it was a welcome reprieve for bulls after a shaky start to 2005.

And you can bet there are some economists burning the midnight oil as they try and figure out just how the U.S. trade deficit swelled to a record $60.3 billion in November, after the dollar's recent weakness.

The rising deficit, despite dollar weakness dampened overnight enthusiasm that had been set by Intel (NASDAQ:INTC) $23.16 +2.75%, where the company's mentioning that it would increase its capital expenditures breathed new life into chip equipment makers, with Applied Materials (NASDAQ:AMAT) $16.53 +2.35%, KLA- Tencor (NASDAQ:KLAC) $44.45 +4.78% and Novellus Systems (NSADAQ:NVLS) $26.79 +3.79% giving boost to the Semiconductor Index (SOX.X) 401.83 +1.42%.

Meanwhile, healthcare looks to be one of 2005's leading sectors for bullish gains with the Morgan Stanley Health Provider Index (RXH.X) 402.12 +3.37% lurching its way to an all-time high as worries regarding provisions for doubtful accounts eased.

Transports were today's lone percentage loser in our U.S. Market Watch, with UPS (NYSE:UPS) $77.18 -7.34% leading today's weakness after the company had warned that an unexpected decline in shipping activity after the holiday would negatively impact results. Chief rival FedEx (NYSE:FDX) $94.47 -0.98% slid 94 cents by the close, but assured investors that its business trends remained strong.

U.S. Market Watch - 01/12/05 Close

While stocks did see some volatility today, it was a sharp, and rather sudden decline in the dollar that will ripple through the Treasury bond market.

Take some notes today where just after the trade gap figure were released, the dollar sold off sharply, but so did Treasuries in the easy going.

Think of this from a simple perspective of supply/demand. Dollar weakness gives the impression of capital leaving the U.S., where jumping Treasury yields (selling of Treasuries) gives an added impression that even the "perceived safety" of U.S. debt suddenly becomes "risky."

This action had stock futures pulling back from their overnight highs and then starting to find some acceleration to the downside as the cash markets opened at 09:30 AM EST.

Market Snapshot / Internals - 01/12/05

We can see some real steepening in the yield curve earlier this morning. The shorter-dated 5-year yield slid 0.6 basis points, but the longer-dated maturities found selling. Hey... give an equity bull a stable dollar trade and that type of steepening in the curve and they'll probably buy stocks till the nose-ring makes their nose bleed.

I'm not making any excuse for the major averages to have fallen lower toward 11:00, but the MARKETS don't like sudden and sharp moves in currencies, let alone Treasuries.

By lunchtime, things had calmed down a bit, as if an equilibrium had been found. It wasn't until the bond market closed at 03:00 PM EST that equity buyers put together a little rally, something that we hadn't really witness in the New Year.

I'm sure everyone would like to know why stocks were able to make a little push higher. I'll provide my trader's reply, but that doesn't mean you'll like it.

Answer: Option Expiration

Pivot Matrix -

Three levels in PINK. Today's low. Pretty darned close to where January "Max Pain" theory had been when the SPX was rising in December. Today's low also very close to December's Low of 1,173.76. I'll discuss level number two, and both the DIA and SPX WEEKLY Pivots, as well as a suspicious option trade I just happened to notice in the DIA today. I would also tie in the possibility of some "Max Pain" theory with the SPX, as to my mentioning later in December, as the SPX had risen further, that January "Max Pain" had moved higher to 1,200.

Tonight, I'll note that fellow analyst Mark Davis, when commenting on an intra-day pattern he had evidently discussed earlier this morning in the e-mini S&P futures, pointed to a POTENTIAL bullish target of 1,194.

And level three, that would be MONTHLY S1. As noted in December when updated the changing "Max Pain" theories, the increments were unusually more refined in 5-point increments for January. It is only tonight that if I were to split a range between 1,175 and 1,200 that my eye is drawn to our MONTHLY S1 for the SPX.

You can read some of Mark Davis' comments regarding the S&P 500 e-min futures to get his perspective on things.

Here's what I saw, and what my thoughts are, in regards to today's INDU/DIA trade action. I'm trying to remove some of today's "noise" and news, and figure out just what might be in play.

Dow Industrials (INDU) Chart - 30-minute intervals

I usually don't point out intra-day head and shoulder patterns (top, or inverse), but today's observation of a somewhat large trade in the Dow Diamonds (DIA) Feb. $104 calls (DIA-BZ) at 12:12 PM EST (300 contracts) that came in between the bid/ask at $2.60 got my attention. I was just snooping around, checking option premiums, and keeping an eye on trades I've profiled in the Market Monitor.

I mentioned this trade observation (MM 02:45:14 PM EST) and immediately started trying to figure out what this trader might be thinking. What is he/she doing? Trading a directional play, hedging risk, what? I always like to add and subtract the trade price from the strike price to see if anything "makes sense."

I added and subtracted the $2.60 per contract trade from $104.00, to derive "targets" of $106.60 and 101.40, while looking to see "why $104?"

So.. on the above chart of the INDU, this trade would have taken place after the INDU would have made its now observed "head" and was bouncing up to its MONTHLY 61.8% retracement of 10,583.81.

While I can never be sure, especially when the trade was made between the bid/ask (when you trade size the market maker will usually get you filled in between) I think the trader, maybe a computer, was buying MONTHLY S1/10,500 higher, then hedging the risk with an in-the-money covered call (sell the Feb. $104), maybe, just maybe, factoring in some further weakness into the end of the month and the Iraq elections.

Certainly I must disclose a bias to my recent profile of selling two (2) NAKED DIA February $104 calls for $2.75, stop $3.75 on the option, with a downside objective of $104.00.

Now, look again at the Pivot Matrix. Hmmmm.... it is notable that tomorrow's DAILY R1 would be within a penny of $104 + $2.60 = $106.60. On a "longer-term basis" $106.60 isn't to far from January's MONTHLY Pivot for the DIA at $106.74 either.

For me, and especially my previously profiled NAKED put trade, this becomes a key level where I would expect some selling resistance.

What does some of this sound like? How about "Max Pain" theory for a January expiration?

I made comment in December and January regarding the S&P 500 (SPX.X) "Max Pain" theory value, which into the December highs had moved up from 1,175 to 1,200, in 5-point increments.

It is tonight that I would note today's low of 1,175, and with such small 5-point increments, yet open interest split rather evenly from 1,175-1,200. Split the middle (1,187.50) and it may be no coincidence that MONTHLY S1 might be a point of gravitation into next Friday.

What I would hope some of the above commentary does for a trader/investor, is to not have them "thinking too hard," as to what today's trade gap figures mean.

I would be lying if I didn't say that I was surprised by the widening gap, and even more cautious from the bullish side.

Begin to question why the dollar was rallying earlier in the month. Were currency traders buying the dollar, in an attempt to front-run a narrowing trade gap? Boom! A complete reverse surprise, a widening trade gap, and the best-laid plans come undone?

My INDU observations have me LOOKING for an INDU range of 10,400- 10,700 in the context of today's trade gap figures. That's it.

The FACT that I profiled a NAKED call in the DIA with a strike of $104.00 has me thinking beforehand, that the INDU would be vulnerable to that level.

Why February and $104 you might ask? With the VIX.X at these low levels, there isn't a whole lot of premium to be had, and while I have no inside information that the market's will be jittery into the Iraq elections, some of the NH/NL internals still suggest that there's a tendency for softness, where I can envision some pre-determined pullback into the end of the MONTH.

Let's keep a note of this morning's dollar/bond trade. From a supply/demand basis, one thing I think an EQUITY BULL does NOT want to see is further SHARP DOLLAR DECLINE, and SHARP TREASURY YIELD rising.

For me, this equates to less confidence in the dollar, combined with less confidence in U.S. Government Debt.

We will also note the weakness in the financial sectors today. The BIX.X and BKX.X to be more specific, which would be a pretty good representation of the U.S. banking system.

Personally, I do NOT believe, nor do I see the dynamics for any type of banking system "crisis." If I do, I be sure to change my tune, but the major averages will usually follow these sectors around.

Jeff Bailey

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