Option Investor
Index Trader

Not so Fast

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THE BOTTOM LINE:
Whew, what a week!! Trader sentiment went from extremely bearish at the beginning of the week to very bullish by the end of it; it's highly unusual to see trader sentiment shift this quickly. And how the mighty have fallen: on Monday, American International Group (AIG) will be replaced by Kraft Foods in the Dow 30 Average (INDU). This is the second change this year in the makeup of the Dow (in February, Bank of America and Chevron replaced Altria Group and Honeywell International).

It's been a peculiar bottom in some other technical respects, since the volatility and whippy nature of this recent period have led to 'oversold' measures like the Relative Strength Index (RSI) showing a less oversold condition then occurred at the July bottom. On a long-term weekly chart basis (not shown) Nasdaq was also less oversold than the July '06 and March '08 bottoms. Only on a daily chart basis did the Nasdaq RSI get equally oversold as occurred in March and July.

These two factors suggests a cautionary stance as to whether its off to the races or a further bottom building process. The question is how much further upside there is before the major indexes start backing and filling and drifting lower from Friday's close. The sharp pick up call volume on Friday suggests too optimistic of an outlook, like the economy is 'saved' all of a sudden. What I understand about this bailout plan is that it's going to be hugely complicated and may only slow the march to a deeper recession. In terms of my sentiment indicator, the shift suggested from an extreme bearish outlook to a highly bullish one doesn't appear realistic and the truth should lie somewhere in between.

There were upside price 'gaps' between the Thursday high and Friday low in both the S&P and Nasdaq charts. Pullbacks ahead that at least 'fill in' those gaps would not be surprising.

Buying index calls on Thursday morning was a good trade for those who took the shot. I didn't find it easy to find potential technical support but could point to potential for upside reversals at the low end of downtrend channels in the S&P 500 (SPX) weekly chart, the S&P 100 (OEX) and Nasdaq 100 (NDX) daily charts. I got some participation based on analysis of these charts but exited on the Friday close. I usually like to stay in an emerging trend or perhaps get out at a preset objective that's shy of major resistance.

However, when I looked at the intraday CBOE volume figures on Friday afternoon and saw that equities call volume was approaching double that of put volume, I felt that the sentiment shift was too quick and too extreme. I prefer being in index calls when there's still a fair amount of bearish sentiment and the reverse when I'm in index puts and there's still significant bullishness.

As to picking a potential bottom, I can't say that I saw such an extreme low coming but when the S&P 500 (SPX) broke down below 1200, a quick review of the longer-term weekly chart suggested a possible bottom at the low end of a broad weekly chart downtrend channel dating from tops seen in July and October last year. The NDX chart will be seen further on in my regular commentaries. Support implied by NDX's lower (daily chart) downtrend channel boundary was even better 'defined' than the SPX weekly lower channel trendline.

I've highlighted a weekly downtrend channel in SPX below. The conventional way of drawing any trendline would be to extend a line from the end point of at least 2 lows or highs. In such a conventional or 'external' trendline (dark magenta line), the lower support trendline of the channel would intersect around 1120. I also allowed for an 'internal' trendline that cuts slightly through a prior low; i.e., blue trend- line and estimated 1150 to 1120 as a zone of support and a corresponding area to buy October 1200 calls.

If I can project potential support at a trendline, I can set a risk point to just under it. If I can't project a relatively close by exit (risk) point that makes sense in terms of the charts, I won't go into a trade. Hey, I learned to be 'scared' from highly successful traders!

On balance, after this rapid first rebound and the 'relief' short-covering rally, I'm taking a wait and see attitude. Although the charts formed significant upside reversal patterns, especially in the Nasdaq Composite (COMP) and all have favorable bull 'flag' type hourly consolidation type patterns suggesting further upside potential in the near-term, although all major indexes are also at overbought short-term extremes. My current preference is to look at calls again after seeing where and how a first correction plays out and get positioned for a second up leg.

QUESTIONS/COMMENTS:
Please e-mail me with any questions or comments at Click here to email Leigh Stevens support@optioninvestor.com and put "Leigh Stevens" in the subject line.

MARKET NEWS and INFLUENCES:
Other index and sector closes, recaps of market influences like earnings, company news, related market events, government reports and activities, etc. are found in the Option Investor 'Market Wrap' section.

** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **

S&P 500 (SPX); DAILY CHART:

Quite a ride to the downside! The S&P 500 (SPX) has seen a major rebound from the 1150 area and in two days rallied over 100 points and managed a strong close above its 21-day average currently at 1250. Further upside potential is to the 1300 area, perhaps to 1340. This may be the continued high end of a range however.

Downside support I've pegged first at 1250, then in the low-1200 area and next around 1180.

Based on a hunch, which is I believe is mostly past experience talking, I think that SPX will get to an oversold RSI extreme again. There may not be a lower low, but a sideways to lower drift once the current excitement quiets down could result in an oversold indicator extreme such as seen at the March and July bottoms. Stay tuned on that! Relief about avoidance of a financial meltdown can boost stocks in a big initial surge, but it won't keep bringing in continued buying necessarily, as investors and traders watch to see how these measures pan out.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) chart is bearish in its predominate downtrend as seen in the downtrend channel highlighted on the chart. However, the OEX offered a solid trade in calls if you assumed that OEX could find solid technical support when it reached the low end of its downtrend channel. Who could envision such a major rebound, but even a more modest rally would have offered a good risk to reward, assuming risk was held to a point not far under lower channel line; e.g., an exiting stop at 520.

There's further upside potential to the 600 area, perhaps to 615. Near support is in the 555-550 zone, with major support around 530.

TRADER SENTIMENT
My trader sentiment indicator is calculated by dividing total daily CBOE call volume BY daily put volume, not the reverse in the usual way this indicator is calculated. However, figures, options volume activity has seen a startling rebound, from an 'oversold-extreme bearishness' extreme of heavy put activity, to a high bullish reading implied by heavy call volumes.

This extreme reversal or flip-flop in my "CPRATIO" suggests to me that this rally will cool down in the coming week. It's too hot not to cool down! Wasn't that a movie line? But also true of this current market craziness.

DOW 30 (INDU) AVERAGE; DAILY CHART

The Dow 30 Average (INDU) remains within an overall downtrend, but bottoming action is again evident, although this recent reversal came from a lower level than seen at the early-July low. It's been a long time since I've seen tops occurring at 3 percent above the centered 21-day moving average and bottoms forming at 6 percent under the average. It's characteristic for more volatility on the downside, but this recent action is unprecedented. Where do we go from here, after Thursday's upside reversal and the strong Friday follow through?

AIG doesn't look like it will help keep the INDU rally going, but as of Monday it gets the gets the hook. We'll see what replacement Kraft can do to help out. Oil stocks Chevron and ExxonMobil should be strong contributors to a further Dow rally as they are rebounding strongly from support. INDU ought to at least make it back to the top end of its recent price range and get back to the 11800 area. A close above 11782 for a couple of days running would be bullish and the first rebound in some months to exceed a prior rally closing high. Given how oversold so many of the 30 stocks are, there's also potential to 12000-12100.

Very near support at the 21-day average is at 11330, with pivotal support in the 11000 area.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite Index (COMP) saw a bullish turnaround this past week in a convincing fashion technically. A key upside reversal pattern developed with the move to a new low below 2100, followed by a rebound so strong that the Close was above the prior day's HIGH. Friday's close back below its 21-day average wasn't a super strong close, but the big upside price gap of Friday was impressive and continues to show how buyers have come in after successful retests of major technical support in the 2200 to 2150 area or below, even though this recent panic sell off blew through 2150 briefly.

Upside potential is the key unknown as each rally to date after the mid-May/early-July double top has so far led to rally successively lower rally peaks, keeping the overall chart bearish in its pattern. If COMP falls back to the 2200 area and thereby 'fills in' the chart gap, another tradable rally may follow, such as back to the 2350 area.

Near resistance looks like 2290-2300, next at 2350, then at the prior line of resistance at 2410, which also would put COMP at my upper moving average envelope line. The upper moving average envelope line is not an area of resistance in the way that may come in at a prior high, but tends to be a good gauge of where a rally is getting 'extended' and vulnerable to either slowing of upside momentum or a reversal.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 chart pattern is that of a bullish rebound from a fully oversold condition (note the 13-day RSI) and support implied by the low end of its downtrend channel. Since NDX remains in a downtrend, the chart remains bearish on an intermediate-term basis. A move to above 1873, resistance implied by the upper channel line, is needed to suggest a bullish breakout. 2-3 or more points will establish a trendline and then a parallel touching just ONE extreme (high or low) will establish the other trend channel boundary.

The lower trendline of the downtrend channel did a superb job of pointing to where this last shot down to the low-1600 area, would find support and establish the potential for an upside reversal. The upside price gap established with the higher Friday opening, didn't see strong follow through as the close was around mid-point in Friday's range, suggesting that prices may drop back to 'fill in' that gap by a pullback to at least 1700 where I've noted support.

Key resistance is at 1800, at the 21-day average. I wouldn't get too bullish without the ability for the index to close above this key moving average and then go on to challenge the upper down trendline, currently intersecting around 1873 as I noted above.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
Darn, I've been commenting for some time that support and a buying opportunity would come in on a decline back to the 41 area. I was off on that score as the bears managed to run stops and push the stock to just under 40, before the rumors of a massive government bailout of our mortgage mess turned things on a dime.

I've highlighted near support at 42, then at 41. I anticipate that 42 will be tested as an area of support. If QQQQ does not pull back to the 42 area and Q's can climb above 44, this development would show continued upside momentum follow through. If 44 was then established as an area of support on subsequent pullbacks, a move up to next resistance in the 46 area could be next.

The spikes in daily trading volume in QQQQ have continued to come on the declines, suggesting continued liquidation and which keeps the volume pattern concurring with bearish price action. A sizable volume surge on a further big upside move would be encouraging for the bulls and suggest new buyers coming in, not just buying by those short the stock.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) had a key 2-day upside reversal as it made a new low for the move (not by much, but a new low all the same) followed by a close that was above the prior two days' highs. The next important bullish technical test will be on any decisive upside penetration of the prior line or resistance at 763. A close above this level, not reversed (back to the downside) in the following 1-2 days after such a move, would be bullish and set up a possible test of what should be tough resistance around 800.

I've noted near support at the low end of the upside price gap, just over 720. Next lower support is at 714, then back down in the 680 area.

GOOD TRADING SUCCESS!

NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
CHART MARKINGS:
1. Technical support/areas of likely buying interest are highlighted with green up arrows.
2. Resistance/areas of likely selling interest: red down arrows.
[Gray up/down arrows: support/resistance levels that got pierced]
I WRITE ABOUT:
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.
 

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