Option Investor
Market Wrap

Stepping Outside Of The Range

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      10-17-2001          High     Low     Volume Advance/Decline
DJIA     9232.97 -151.26  9489.33  9226.95 1.44 bln   1143/1964	
NASDAQ   1646.34 - 75.73  1754.01  1646.34 2.26 bln   1415/2215
S&P 100   554.67 -  9.47   569.15   554.26   Totals   2558/4179
S&P 500  1077.09 - 20.45  1107.12  1076.57             
RUS 2000  424.49 - 10.04   437.23   424.48
DJ TRANS 2228.50 - 69.22  2302.24  2228.50
VIX        37.12 +  1.90    37.23    34.23 
VXN        67.11 +  3.10    67.11    63.48
TRIN        1.48 
Put/Call    0.63

Stepping Outside Of The Range

Wednesday's reversal across the major market averages was one of the biggest in recent history. The question then becomes: Did Wednesday's reversal mark a change in trend? The recent buyers of dips didn't prop the market up Wednesday afternoon. Instead, increased levels of fear caused canceled bids.

Reports of anthrax discoveries was the primary catalyst that increased the level of fear among market participants. Both the CBOE Market Volatility Index (VIX.X) and Nasdaq-100 Volatility Index (VXN.X) popped higher following the release of the news. The VIX and VXN closed on their day highs, gaining 5.39 and 4.84 percent, respectively. While some of Wednesday's weakness may have been a product of profit taking following the Intel (NASDAQ:INTC) and IBM (NYSE:IBM) earnings pops, the price action across the major market averages felt as if buyers were simply stepping to the sidelines.

The lack of demand for stocks left the averages with little in the way of intraday support Wednesday. In fact, the Dow Jones Industrial Average ($INDU) and S&P 500 (SPX.X) closed just off of their session lows, while the Nasdaq-100 (NDX.X) closed right on its low for the day. Recall that on Monday I wrote about the tightening trading ranges across the major market averages. Well, Wednesday's trading was in stark contrast to how the averages behaved Monday.

All three averages "stepped" well outside of their respective ranges. The INDU almost printed 9500 Wednesday morning, but fell back below the 9300 level, which had acted as an apex of sorts for its recent consolidation. While the INDU has two relative lows that might be referenced as potential support, I think that the 9150 level is of more importance as far as support levels go. A breakdown below 9150 could push the INDU back below the 9000 level over the short-term.

While the 151 point drop in the INDU may have seemed large, consider the fact that the index is still up by 1170 points since its low on September 21. And the same perspective should be used when viewing the SPX's 20 point drop. After accounting for Wednesday's pullback, the SPX is up by 133 points since finding its bottom on September 21.

For its part, the SPX could find some very short-term support around its relative low at 1072. The SPX will have a better chance of rebounding from Wednesday's pullback if the Bank Sector Index (BKX.X) continues trading well. The BKX.X only dipped by 0.55 percent Wednesday, which earned it a spot on the day's top performing sectors list. Part of the BKX.X's strength came from J.P. Morgan (NYSE:JPM). The company reported numbers that edged past consensus estimates by a penny, but didn't offer much in the way of positive guidance. J.P. Morgan's CFO said, "...I don't have the basis for expecting the fourth-quarter to be better than the third-quarter." Yet, shares of J.P. Morgan finished 66 cents higher on the day.

If the BKX.X continues trading well, then it could help to prop up the SPX.X. But, the SPX.X also contains a lot of technology, so further weakness among Nasdaq issues could drive the SPX.X lower. If the 1072 level doesn't hold, which is a questionable support level to begin with, then the SPX.X could make its way back down towards the 1050 level over the next few trading sessions.

The NDX's reversal Wednesday was the most severe of the three major market averages. The index came close to the upside target I set forth in Monday's Market Wrap with its opening high at 1440. But its sharp reversal brought the index all the way back down to the lower-end of its gap at the 1310 area. If 1310 doesn't hold, then the NDX will probably travel towards 1270 in short order.

Despite the bullish combo of Intel and IBM, the NDX shed more than 6 percent Wednesday, which was mostly due to the aforementioned increase in fear. But earnings jitters from other tech heavyweights may have exacerbated the tech sector's weakness. Data storage giant EMC (NYSE:EMC) reported its first loss from operations since late 1989. Not only did the company lose money during the quarter, but it lost more than its officials and analysts had previously expected. The company reported a 12 cent per share loss after a one-time restructuring charge, while consensus estimates had called for a loss of 5 cents. Shares of EMC shed more than 16 percent.

The after-the-bell earnings reports were tech-heavy, and are likely to sway the NDX Thursday. Apple Computer (NASDAQ:AAPL) reported 19 cents per share in profits, which included a $1 million investment gain. Shares edged higher in the after hours.

Texas Instruments (NYSE:TXN) reported a narrower-than-expected loss for the third-quarter, but guided expectations lower for the fourth-quarter. But, the company reported that orders declined at a slower pace during the third-quarter. TI's chief, Tom Engibous, opined, "As things stand now, it appears that the third-quarter will mark the bottom for orders, and the floor for revenue should be set in the fourth-quarter." Despite the encouraging words, shares of TI shed almost $2 in the after hours.

Another chip maker, Advanced Micro (NYSE:AMD), reported a loss that met estimates, but fell a bit short on revenues. Officials said that they expected fourth-quarter revenue to flat to slightly higher over the third-quarter. But that guidance was of little consolation as the stock finished slightly lower in the evening session on thin trading.

The recent advance of the major market averages from their September 21 lows was an awesome rally -- one for the history books. The NDX rallied more than 30 percent from its lows to Wednesday's high. And 30 percent in 19 trading days is no small rally! Therefore, Wednesday's sell-off wasn't all that excessive when taking into account from where the averages have come. Backing and filling is part of the natural process.

But, Wednesday's reversal does bring up a few interesting questions. For instance, was the recent advance across the averages merely another bear market rally, such as the rally earlier this year? Will the NDX ultimately take out its low set on September 21? Will the SPX retest its low at 944.75? Or, will the INDU resume its trend and rally into the end of the year? It's too early to answer any of the aforementioned questions -- such is the market. But I think they are valid questions nonetheless.

I've been writing about the short-term overbought nature of the markets by way of daily Stochastics readings. And Wednesday's decline helped to work off some of that particular situation. But the averages are still relatively overbought on the daily timeframe. In addition, the NDX and INDU are still on strong buy signals according to Bullish Percent data even after Wednesday's reversal. And, although trading activity up-ticked, volume was still far below what it was during the post-attack weakness.

At least from where I sit, the signals are mixed. Wednesday's decline could've been the turning point at which the market heads back down towards its September 21 lows. Then again, it could've been no more than the beginning of a consolidation phase. It's difficult for me to adopt an aggressively bearish bias with the INDU and NDX Bullish Percent charts on strong buy signals. Yet, if the support levels I set forth in the averages fail to hold in the coming days, then I think the bearish argument grows stronger.

For my part, I'm going to be trying a balanced approach over the next few days, buying stronger stocks (calls) near support levels with ultra tight stops and shorting weaker stocks (buying puts) on breakdowns. And with my signals mixed, I'll be operating with half-positions.

Hey, who said this game was easy? I'd like to have a chat with that person.

Eric Utley
Option Investor

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