Option Investor
Index Wrap


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The major market indexes have had a fairly classic 'bull trap' reversal, with the move to new highs followed soon thereafter by a downside reversal and subsequent fall.

The S&P and Dow indices pierced key support/up trendlines this past week, whereas the Nasdaq indexes may just be headed toward the low end of their uptrend channels. The Russell 2000 (RUT) had had only a modest pullback to date, as has the Philly Semiconductor (SOX) sector index. The extent of the decline in the major indexes looks also related to unwinding activity related to Friday's expiration, the market is now oversold on a short-term basis and due for a rebound. However, on an intermediate term week-over-week basis, there's downward momentum and likely intermediate support levels lie still lower.

What started as a modest pullback turned into a rout by week's end. I warned of the implications of the heavy call volume going into, and including, last week as the play might well be against the overly optimistic and complacent bulls.

I myself couldn't see how earnings were going to match recent enthusiasm for stocks. And, if high energy (remember oil prices?) costs were of concern (they should be) to slowing consumer spending on other goods and services, the crude oil chart gave me no sense of huge bullish optimism:

The key to the further technical breakdown that ensued was that the Nasdaq Composite (COMP) and the S&P 500 (SPX), the indexes that had been leading the market higher, fell back below their prior (December) tops. If the last run up had been a new up 'leg' this wouldn't have happened. This is not to say that the major trend has reversed lower, but does suggest that it's not going to be an easy ride higher, contrary to the bulls rosy optimism.

The major uptrend looks to be at risk if SPX has a weekly close below 1245, but only reverses (to down) on a weekly close under 1175; the Nasdaq Composite major uptrend is at risk on a weekly close under 2195, but the trend only reverses lower on a close (weekly) below 2064. So there is some ways to go, especially in tech happy COMP before there's a major trend reversal.

It is a good trading market for index options, but the reversal points have not always been easy to find lately, especially the reversal of the beginning of this month, which seemed to come out of nowhere; at least to my viewpoint as a technical trader. In fact I found the ensuing rally somewhat 'suspect' just on the basis of that strong rally not developing from areas of 'natural' support; or with bearish sentiment; or from an oversold, etc.

It (the early-January rally) seemed to have had most to do with short-covering Fed-following and the burst of money that can come into the market in the new calendar year. However, Q1 earnings hadn't been seen yet and there was still this problem of high pump and heating oil prices. More money there has got to mean less consumer spending otherwise.

My best take of LAST WEEK on why I was taking profits on calls was that ..."some technical objectives, as far as minimum (upside) targets have been met, and mostly, it's getting too 'crowded' in the bulls camp; and me not liking crowds anymore!"

An adjunct companion piece to my weekend Index Trader, where I typically update my market view based on the market/price action into midweek, in conjunction with a fuller explanation of technical analysis patterns and principles relevant to the current market. My Trader's Corner this past week was on accessing support areas on corrections; and, where a pullback might become a (trend) reversal.

One major technical axiom relates to how prior support, once pierced, becomes resistance later on and vice-versa (with resistance becoming support). This applies to prior support/up trendlines as well. A recent case in point in OEX:

My past week's Trader's Corner article can be seen by going back to your Wednesday 1/18 e-mailed Option Investor Newsletter (OIN) or online at the OIN web site by clicking here.

Closing index prices, a recap of market influences like company news and government releases, are covered in the e-mailed and online Option Investor Newsletter, in the 'Market Wrap' section.



As suggested last week, once the 'line' of prior highs around 1275 in the S&P 500 (SPX) was pierced, it was goodbye bullish chart. Besides support implied by the top end of the prior trading range, piercing the 21-day average at 1273 was the next SPX support to go in quick order as selling snowballed on expiration Friday. The close on the low and under the key up trendline was the finale to a very bearish week.

I've marked the first area of SPX resistance now as 1268, back at the up trendline pierced at week's end. There has been a minor down trendline that's forming from the top and its current intersection at 1283 implies next technical resistance.

1245-1246 is a pivotal/key support, suggested both by the area of prior recent lows but also by the high end of the July-Sept trading range (not shown). A daily close under this level not reversed the next day suggests that the intermediate trend is turning down. 1236 begins the area of deep 'oversold', pricewise.

I anticipate a rally attempt soon, perhaps early in the week and carrying into Tuesday then some more weakness after that. If instead weakness continues into Tuesday, look for a short-term low then.

This recent top came right after the 13-day RSI got above the overbought line and this RSI peak more or less coincided with the top. We can wish it was that easy all the time but then too many index traders would make too much money and trading the option indexes wouldn't keep us on our toes anymore!

All the support levels I discussed last time in the S&P 100 (OEX) gave way ... bing bing bing! First and foremost, OEX pierced its prior double top around 584, then its 21-day average at 580 and finally the Oct-Dec up trendline at 577.5

OEX would need to get back above 580 now to get back on a bullish track technically and I peg this as pivotal resistance currently. There is another sort of down-sloping trendline that might mark support around 566.

At 563 OEX would be at the beginning of an oversold extreme price wise. An index can be at an extreme in terms of the typical price range it traverses as measured by the (percentage) moving average envelopes and it can be oversold in terms of momentum oscillators like the Relative Strength Index (RSI) that I'm always showing on my charts. OEX isn't there yet (oversold) in terms of the RSI.

The top was seen, as it turns out by the move back up to the previously broken up trendline (see the gray dashed line & gray down arrow), and this pattern was seen even more clearly on the hourly chart, which I showed early on (in my 'bottom line' commentary) as an example of prior support 'becoming' resistance later on. But lets face it, this was a difficult top to find. I myself didn't do much with puts, just exited calls.

I anticipate further weakness in the coming week, but after another rally attempt, expected since OEX has reached a minor oversold reading according to the 21-hour RSI (shown in the second chart in this article but there's no oversold yet seen on the on the daily chart indicator.

Just as the peak came right around the time that the 13-day RSI got to its 'typical' overbought reading (at 65), my CPRATIO indicator of market 'sentiment' read the top perfectly. That is to say within ITS lagging timeframe, as tops tend to come within 1-5 trading days AFTER extreme readings registering at the upper end of the indicator at the red upper (horizontal) line.

In this case the top on 1/11 came 4 days after the first 1-day reading in the upper extreme range and the second extreme in the sentiment indicator was 2 days before the top. As I often say, it's a 'ready, get set' type indicator; the 'go' comes from price action which must be watched closely especially on hourly charts.

Also, help in finding this top, using the 'CPRATIO'(CallPutRatio) indicator above, was that rare situation when the 5-day average of this ratio also touched an extreme at 2.0 (average call volume on a 5-day basis for CBOE equities was double that of puts).

The pattern seen below on the OEX weekly chart is a so-called 'horizontal' triangle of the type that is 'ascending', with a flat top. Most often the resolution of this formation is an eventual breakout above the upper horizontal line; i.e., a breakout in the same direction as the ascending trend (rising prices with its series of higher relative lows). Not so however if there was a weekly close under 557-560, as it would suggest risk of a bearish major trend reversal in the OEX.

Not surprisingly, a similar triangular pattern as shown in the OEX weekly chart above is seen in the Dow (not shown).

As anticipated the Dow 30 Industrials (INDU) struggled to keep above 11000. This level has been the kiss of death to the Dow. INDU bellwether GE took a major plunge on Friday, but in a forewarning the stock had closed under its key long-term 200-day average by the beginning of the week.

The other key level, on a closing basis, was the double top at 10940. INDU pierced this level at the beginning of this past week and was a bearish forewarning. If you still held major index calls after that it was only a matter of time, not IF, prices were going to go against you. As with the OEX, inability to hold above a double top like this, especially when the first peak goes back nearly 11 months (March '05), shows continued technical weakness or at least an inability to achieve a second up leg.

My best take on the Dow Index LAST WEEK: "Given expiration week ahead and the level of buying calls, it seems doubtful as to DJX closing the week over 110 (Dow 11,000)." Nice if I had had the one-word insert about being 'HIGHLY' doubtful having the DJX close over 110:- (And, how about 'look for a Close under 107!')

Support now can only be guessed at, but I estimate buying interest surfacing again around 10600 if not before. Look for an early week rally attempt on so-called 'bargain hunting' buying.

Resistance is easier to guess at. Look for near resistance at 10800-10820, with even more pivotal resistance at the approximate high end of the prior trading range, in the 10940-10950 area.

Downward momentum is of course still showing on the 21-day (slow) Stochastic indicator, but no oversold extreme.

The Nasdaq Composite (COMP) has been forming a minor down trendline, and first key resistance at this trendline is at 2300. The 'line' of prior highs around 2275 is also anticipated resistance: let's call pivotal resistance as 2275-2300.

Support implied by the low end of my projected uptrend channel is around 2226 currently. In terms of defining the trend, even more pivotal is the prior COMP low at 2190 and the prior Closing low (coming the day before the lowest intraday low) at 2205.

All in all, 2200 is a key area in the Composite and, in the event it's reached, look for substantial buying interest there. A close under 2200 not reversed the next day would shift the intermediate trend to down; so, 2200 continues to be must-hold support for the bulls. Conversely, a close over 2300 suggests renewed bullish potential and a possible challenge to the 2333 high.

From last week: "An overbought and recently falling RSI indicator is something to take into account in an expiration week as, besides the expiration related influences, an overbought market also suggests potential for increased volatility". I forgot to insert 'DOWNSIDE' volatility! Oh well.

Sometimes it happens, and the recent peak was right at my upper moving average envelope line, set to equal a price 3.5% above the 21-day moving average for the Nasdaq 100 (NDX). Wish that it was an 'automatic' put buy signal; NOT!

Near resistance is anticipated around 1700-1705, or what had been key support, especially on a closing basis. The key trendline intersection now implies overhead intraday resistance at 1730.

NDX, with the close on its low Friday, looked like it was headed next (and soon) to 'test' its up trendline with an intercept at 1662. With expiration past and a weekend for cooler thoughts to prevail (plus some great football?), I anticipate that they'll try to lift stocks first.

The prior intraday low around 1633 and the prior low CLOSE at 1645 are key levels in defining the trend, should NDX sink back to test this 1633-1645 area. A close under the prior low 1045 close not reversed the next day, would shift the intermediate trend lower by technical standards.

I think insertion of the Weekly chart is of interest here, as NDX reversed at resistance implied by the top of its weekly uptrend channel. I hadn't noticed this possible trend channel chart until the top was in place, or might have been suggesting buying NDX puts with both hands and feet at 1750! Just goes to show to NEVER lose sight of the weekly chart picture.

Anyway, as to buying NDX puts with the Index at 1750 or better at the top end of the weekly trend channel outlined on the chart below: the odds of the Index breaking out above this technical resistance, especially given the overbought (13-week, fourth of year) RSI extreme appeared low, ASSUMING risk was held to 1% or a bit less of 1750; e.g., by setting a 15-20 point exiting 'stop'.

Relative to a 15 NDX point risk, there's already seen a retreat of around 75 points from 1750 (not the 1761 high). A risk of 15, relative to the 75 point decline so far, is a 1 to 5 risk to reward ratio on such a trade.

Of course we don't yet know where the Index will end up or where to exit puts, but this is the kind of risk to reward 'calculus' of seeking trades of 1 to 3 or more (risk to reward potential), that can be sought out using technical analysis tools.

Of course, this type trade means getting beyond 'trend following', OK in stocks but not making for as many overall winners in index options. I also recognize the tremendous discipline that it takes to go short an apparent runaway trend; it's why there are so few 'market wizards'! BTW, I'm only an apprentice wannabe wizard:-!!

Key resistance now is down to 42.5 as the Nasdaq 100 (QQQQ) tracking stock took a pounding this past week; 42.2, at the top end of the prior trading range, is overhead resistance just under 42.5. 41.9, at the pivotal 21-day trading average, is an important level for QQQQ to get back above on rally attempts.

Given the short-term oversold condition, I anticipate some buying coming in. The bulls may be sobered but are far from joining those 'traitorous' bears.

40.8 is key trendline support. 40.16 is the prior intraday low and 40.41, the prior closing low, and levels of key importance. Absent a close under 40.8, which would be a break of the up trendline highlighted on the daily chart below, the Q's don't seem to me to be poised for a further full-blown retreat.

Am I a buyer of QQQQ? More market action is needed for me to try anticipating a bottom; I need something to base such a decision on, such as a double bottom low near around 40.15.

A major spike in volume was seen on Friday. Maybe the NDX has made a high-volume low, but given the sharp fall seen on Friday ... well, I'm still thinking about my statement last week that: "if there was a sharp fall into expiration, buying the stock looks attractive." Buying the Friday close will actually probably turn out to be a good short-term trade given the potential for a bounce and maybe more than just a 'bounce'.

Hmm, buying down around 40.75-41 if prices got there; or in the 40-40.15 area. Stay tuned for more market action. I'd also like to see the RSI in that oversold zone again!

Good Trading Success!

Please send any technical and Index-related questions to me at Contact Support with 'Leigh Stevens' in the subject line; not only for answer, but also for possible use in my coming week's Trader's Corner article. Your emails are appreciated and where I learn what's on YOUR mind!

1. Technical support/areas of likely buying interest are typically shown by green up arrows on the charts.
2. Resistance/areas of likely selling interest (red down arrows)
[Gray up/down arrows: support/resistance levels that got pierced]
3. Index price areas where I have a bullish bias or interest in buying index calls (or selling puts or other bullish strategies).
4. Price levels where I suggest buying index puts (or, adopting other bearish option strategies).

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM) strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as well as projected profitable index price targets, are based on my technical analysis of the indexes.

Index Wrap Archives