Option Investor
Index Wrap

Index Trader Wrap

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THE BOTTOM LINE -
The market is quite mixed at this point with a number of crosscurrents and differing trends or strength of trends in the indices, making index options trading a trickier proposition. 

The S&P is leading the market, but so far only following its resistance trendline up toward the December top - looking at the lackluster recent performance of bellwether GE and the definite drag of most of the tech sector, I don't see how this current rally is going to lead to a new up leg. The S&P 500 might not reach or re-test its 1218 prior high although, as is often the case, it seems drawn there.

The S&P 100 (OEX) has already hit its previous peak at 579. With the possibility of running stops and short-covering OEX could go over 580, say to 583-585, then fall back. Or, it may have made a double top - I think by the second trading day, Tuesday, the pattern may be clear.

If SPX goes to its old high and not beyond it, it's a double top and a signal to exit calls and buy puts in both the S&P indices unless OEX can hold above 580 and gain some traction - right now, I'm not anticipating this but will let the market tell me what's next as its approaching a moment of truth so to speak.

What's keeping Nasdaq afloat is an upside technical breakout in Intel (INTC) and the Semiconductor (SOX) index.  But Microsoft (MSFT) and of course Cisco (CSCO) are still real laggards. 

Mid-cap stocks as represented in the Russell 2000 (RUT), are a bright spot.  Not so, the new high in the Oil Index (OIX) and the strong late-week rebound in the Gold and Silver Index (XAU). Technically, the Nasdaq looks like it will be a put play shortly. 

Fundamentally, sustained high-energy prices look like they will be enough of a drag on the economy to keep a cap on the big cap stocks represented in the S&P 500.  As with any Index that may be at the top of its trading range, I am looking for a rally failure or double top in order to play puts.  Not yet, as a top has not formed yet, it just looks like it's waiting to happen in Nasdaq. I suggest not entering any more Index calls and being watchful for downside reversals.

FRIDAY'S MARKET - 
Friday's closing index prices, a recap of market action, specific company influences and government releases are covered in the Option Investor Market Wrap.

MY INDEX OUTLOOKS -

NOTE: Writing a weekly piece like this, I can only call the markets as I see them as of the end of the week.  The reason I spend some time on trading principles and try to "set up" the trend parameters is so that you will be able to assess new trend directions and conditions as they occur.

S&P 500 Index (SPX) - Daily chart:   
I've been noting how the highs in the S&P 500 (SPX) have been following the previously broken up trendline higher, per the red (down) arrows on the chart below -  

Just as trendlines are or act as resistance or support, they later can also take on an opposite role. However, this does not tell you if there is going to be a tradable top, but it tends to show that the rally is not overly strong.  It's another thing when a major Index like SPX reaches an old high - 1218 in this case - if reached, this area will offer a key test of the staying power of this rally and whether the Index can go into a next up leg.  A second segment to the rally that begin back in the summer and fall.

Near resistance I suggested as being around 1205 held for a bit, then go exceeded on Friday's strong rebound. It looks like SPX is being drawn to its old high.  There is a tendency for bullish investors and traders to keep buying up to this area and then see what selling shows up.

We have the possibility of the formation of a double top and this would be the "easiest" signal to buy puts.  A decisive upside penetration of this area, would be bullish. But at that point, I think call holders may still have achieved the most of the profit that they will see. It depends at that point as to whether the old high sets up a support on a pullback or not.  This type action - where a prior peak becomes new support IS the kind of pattern of/for a new up "leg". However, a move to a new high, followed by an immediate downside reversal is a bull-trap reversal.  Stay loose.  

Near support is in the 1180 area, with key technical support implied at the prior (down) swing bottom around 1164. Major support is implied at the August - October up trendline, which intersects currently around 1148-1150.


 

A fairly neutral Relative Strength Index (RSI) SPX reading currently, but the Index will climb to an overbought reading if there are a few more up days.  

S&P 100 Index (OEX) - Daily chart:
I suggested last time that if the S&P 100 (OEX) pushed through 576 if would test its 579 prior peak. No doubt there was significant short covering once the Index went through 575-576, especially ahead of the weekend.  579-580 is the key price area, which makes for a fairly simple trade set up to exit calls/buy puts if OEX can't advance to above this area.  If the Index dows clear this area however, I'd like to see a couple of days running where the Index closed at or above 579-580. If it does this and assuming it doesn't just keep running, a next target would then be to around 590.

A key test on the downside is whether OEX finds support on pullbacks to its 21-day moving average, currently at 567.  556 is the key technical support below that as far as the trend, at the prior downswing low.


 

My Sentiment indicator hit a recent extreme - in the theory of contrary opinion, certain levels of bullishness tend to mark tops or it more accurate to say, PRECEDE tops. Time will tell on this.  The immediate pullback in the level of my call to put ratio as the market fell back does suggest that the bulls are convinced of the further upside potential of this market ONLY up to point.  

This indicator, like all of them, has its limitations.  There are times that it hits extremes at tops multiple times.  With bottoms, it tends to be more clear-cut as readings in the 1 to 1.2 range very often precede a bottom within a day to a few days. Monday-Tuesday seems that it ought tell the story on whether this most recent rebound has staying power.  Now watch while the market just goes sideways for the coming week! Stay tuned.

S&P 100 (OEX) Hourly chart:
The hourly chart breaks down the recent market action in more detail.  As I note on the chart below, the S&P 100 here is in a key area, at the top of the trading range that goes back more than 2 months.  I've been of the view that the market will remain in a price range and offer another opportunity to enter puts. A nice situation to be in as an Index option trader is to have a highly liquid index approach the top or bottom of a likely trading range.

Trading the extremes of a range usually offers relatively low risk and high reward potential. For example, if OEX is trading around 580, it's only necessary to set an exit (a stop-out) point at 585 as a move to this area suggests the index is breaking out. Relative to a loss of 5 points in the underlying index, downside potential is easily to 565, making for a risk to reward potential of 1 to 3.  Only taking trades with ratios like this greatly increase potential to have a very profitable year trading the indexes.     


 

There is something worth noting about the price trend on the hourly chart relative to what the RSI is doing.  I preface this with the fact that HOURLY price/oscillator divergences are not as reliable in forewarning of a top as is the same divergence on a daily chart.  That said, the new high in OEX at week's end, was accompanied by a lower low in the RSI. 

I would further note that this divergence was seen when the last top formed in the OEX when prices got up above 575.  As to whether this is a telling warning of ANOTHER top is impossible to know - it should make holders of calls very watchful as to whether this rally continues.  If there is a dip, it would be important for the Index to hold 572, its last hourly low.   

Dow 30 Average (INDU) - Daily chart:  
The Dow 30 (INDU) broke out above its minor down trendline, which is bullish, but the key test is ahead.  The Dow is approaching or within striking distance of its 10868 high which, if reached, also puts INDU at the upper trading envelope line - at 2.5 to 3% over its 21-day moving average, the Dow has been over-extended in the past.  At a minimum, this kind of extension above this key trading average suggests that the rally will slow down.  Sometimes, as at the last top, this is as high as the average will go before falling back again.

If the old high is pierced, there is further upside potential to around 10950-11000.

The 10600 area is support - a close under here is bearish for the near-term direction.  Significant next support is then likely found at 10370-10400.


 

As mentioned before, the 21-day slow stochastic, when at the high or low extremes, tends to highlight the areas where tops and  bottoms show up.  This indicator suggests we could be near a top but there is also a tendency for this indicator to hang up in the 85-90 area for a time. 

Sometimes, only a minor pullback in the stochastic (same with the RSI indicator) leads to another advance of a couple of hundred points.  The value of this indicator is that it gives an alert as to the potential for a shakeout. What you can say about an oversold or overbought market is that bullish or bearish "news" can tend toward a bigger reaction than is otherwise the case.

Nasdaq Composite (COMP) Index - Daily chart:
The Nasdaq Composite (COMP) rebound at the end of the past week retraced some of the ground that it lost earlier in the week - but, unlike the S&P, COMP stopped shy of going to a new high, closing or otherwise.  In fact, the high formed another point at a down trendline dating from the December top. 

A move above 2083 is need to pierce the bearish down trendline.  If COMP manages this, key resistance then is at the prior rally high at 2105 - this is also an area of possible resistance implied by its 50-day moving average.  Right now, I would judge the chart still bearish in its pattern.  This will be the case until and unless the Composite can close above 2105 and stay above this level on subsequent pullbacks. 

The 2070 area, previous resistance implied by the downside price gap was overcome in the past week. Not so in the Nasdaq 100 which, in a switch, acts weaker than the Composite.  As the Nas 100 (NDX) usually leads and, trades pretty "technically" (i.e., often trades according to the what the technical pattern(s) would suggest), this suggests that the broader market itself may not be able to reverse it's still bearish chart picture.    


 

Overbought/oversold measures are in mid-range, so are neutral. 

Nasdaq 100 (NDX) Index  - Daily:
The aforementioned "gap" area showing up with the Nasdaq 100 (NDX) has, so far unlike the Composite (COMP), been an area where enough selling is coming in to stop rallies.  This is not uncommon in the area where prices previously "gapped" down - buying is common in the reverse situation, where prices gap higher.

1545 is key resistance.  If NDX closes, and stays, above the 1245-1250 area, a test of (rally to) the prior 1576 high is a next potential move. Absent that, my expectation is for a fall back to the 1500-1475 area.  I lean to buying the at or slightly in the money March NDX puts with the Index trading in the 1535-1545 area, as I'm anticipating another top is forming.

Any reservation about a put trade is wanting to see what upside follow through there is in the indexes, especially the S&P, early in the coming week.  Nasdaq appears to be just following the S&P at this point. Only a close above 1550 in NDX would suggest that Nasdaq was possibly gaining some independent strength.  
       

 


Nasdaq 100 tracking Stock (QQQ) Daily chart:
Key resistance is still quite apparent at 38 - this was the low end of the trading range before QQQQ fell sharply three weeks ago and has appeared to cap recent rallies. Friday's rebound was a strong one one-day move, so a test of the bulls ability to push the stock above 38 may be next. 

On the most recent rally, volume jumped with the gains, which suggests somewhat more bullish potential with the recent rally.
If there is a close above 38, I would give it another day to see if there is upside follow through, especially if the close is just barely over 38.00.  If there's another day above 38, this action suggests upside potential to 39-39.15 and those long the stock or its calls, would want to stay with your trade. 

As with the NDX, I favor a bearish play if the key resistance is not exceeded, or can only manage a day above it.  With the Q's I favor shorting the stock, setting a (buy) stop at 38.50.  I think that downside potential is to 36.50, perhaps to a lower low to the 36-35.50 zone.
 

 


Please send any technical and Index-related questions to me at Contact Support with 'Leigh Stevens' in the subject line, for possible use and answer in my next Trader's Corner article on Wednesday.  

Good Trading Success!

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