Option Investor
Market Wrap

Natural Reaction

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      11-07-2001          High     Low     Volume Advance/Decline
DJIA     9554.37 - 36.75  9644.12  9522.41 1.42 bln   1601/1526
NASDAQ   1837.53 +  2.45  1868.31  1820.28 2.04 bln   1669/1921
S&P 100   573.64 -  2.66   579.46   572.03   Totals   3270/3447
S&P 500  1115.80 -  3.06  1126.62  1112.98             
RUS 2000  440.80 -  1.98   444.66   440.64
DJ TRANS 2307.50 + 16.35  2309.64  2275.94
VIX        30.47 +  0.62    31.72    29.67 
VXN        57.20 -  0.11    59.95    48.28
TRIN        1.30 
Put/Call    0.48

Natural Reaction

Wednesday was a routine day of profit taking following the big ramp into the close Tuesday. Surprisingly, big cap tech carried the torch again despite Qualcomm's (NASDAQ:QCOM) slight misstep. The major averages gapped slightly lower after the bell. But keeping stocks down recently has become a lot like holding a balloon underwater. Stocks just don't want to go down. The gap lower Wednesday morning wasn't met with enough supply from longs liquidating. Guess what? The shorts who'd sold into Tuesday's ramp had to cover Wednesday morning.

Qualcomm's behavior Wednesday was picturesque short-covering. Obviously a few too many traders had shorted the stock going into the company's report Tuesday night. By no means did the company knock the cover off the ball with its report. Judging by the reaction in Tuesday's evening session, shorts had a minor victory. But no. Qualcomm rebounded in full force early Wednesday, and exploded as it surpassed Tuesday's highs. The velocity and magnitude of Qualcomm's intraday move revealed one thing: Fear. Fear on the part of shorts who'd bet the wrong way.

The short covering rally Qualcomm displayed Wednesday afternoon has been popping up all over the market. Heck, QCOM staged a more than $5 reversal from Wednesday's lows to highs. Find these situations and exploit them! They're quick and so must you be. If you have the ability to monitor the market on an intraday basis, there's some money to be made in these short covering situations.

My trusted colleague, Jeff Bailey, and I were enjoying a few pieces of sushi for lunch, Hamachi Maki and Unagi Maki to be specific, and discussing the Oil Service Index (OSX.X). Short covering may have been at play in the OSX.X in the last two days. The energy group as a whole was knocked down over the past week but rebounded late Tuesday and followed through Wednesday. Of the 30 sectors I monitor, the OSX.X was the second best performing group of the day with its 3.62 percent gain. (The Internet Index (INX.X) was the best performing sector with its 3.68 percent gain.)

The rebound in crude futures back above the $20 level was the main driver behind the OSX.X's recent advance. The commodity moved higher Wednesday on news of declining gasoline futures and ahead of OPEC's meeting next week. An OPEC member stated that the cartel would cut production by at least 1 million barrels per day if not by 1.5 million barrels.

The OSX.X looks like it could move higher. A breakout above the $80 level would increase my conviction level, so readers tracking the Amerada (NYSE:AHC) put play may want to watch the index closely in Thursday's session. More importantly, I wanted to point out the set-up in the OSX.X that Jeff Bailey alluded to in the Option Investor Market Monitor Tuesday afternoon. I think the set-up the OSX.X delivered Tuesday is going to be a recurring theme going forward.

The OSX.X pulled back to a key retracement level around the 75 level as displayed on the Daily chart. The level also happened to be the site of its 200-PERIOD moving average on the 60-minute chart. The timeframes aren't significant. The bigger picture here is that after the OSX.X staged a big rally up to the 90 level, it pulled back to a key support area, which sits at the 75 level. One-and-a-half days later, the OSX.X is five points higher.

The process of rallying, retracing, and bouncing is something I think we're going to see repeated over the next several months. I could be wrong. The market could go straight higher, or lower from here. But, if the market thinks the economy and corporate profits are on the mend, which is the way it's been acting, then stocks should continue discounting the good news to come in the next six to nine months methodically. Not irrationally.

The process of picking your targets, such as the OSX.X example I highlighted, may be the more rational approach. Yes, there's money to be made in the Qualcomm-type short covering scenario above. But, consider the fact that QCOM closed near the inflection point that induced the short covering. The stock finished about $2 off of its day high. In other words, buying breakouts should be done selectively and only when the market is supporting such a strategy.

Major Market Averages

The Dow Jones Industrial Average ($INDU) worked slightly higher Wednesday, but pulled back later in the day. The INDU closed about 50 points off the 9500 level, which is the first potential support level to monitor. Below 9500, the 9300 retracement area is technically strong.

The INDU has some serious resistance at the 9700 level. That level is the site of a retracement level as well as the bearish resistance line of the point & figure chart. If the INDU breaks above the 9700 level in the coming days, then the index is a lot stronger than most people think right now.

The S&P 500 (SPX.X) also has serious resistance above current levels. The key retracement level to monitor in the SPX is 1130. The SPX's high Wednesday was at 1126. I think a similar situation exists in the S&P in that if it can rally past resistance at 1130, then it's a lot stronger and probably headed much higher over the short-term.

Meanwhile, the Nasdaq-100 (NDX.X) also has some heavy congestion between the 1575 to 1600 area. The 1575 level is the 50% retracement level of the May highs and 1600 was the level that support the NDX through July and August. There're a lot of positions waiting to get back to breakeven around 1600, so it's going to be difficult for the NDX to move through that level. Support for the NDX is located around 1500 over the very short- term. Summary

The major averages are growing overbought on the Daily Stochastics readings and nearing meaningful resistance. A profit taking pullback from current levels makes the most sense to me. But a lot of what the market has been doing lately hasn't made sense to me. Ideally, the markets will routinely pullback to their various support levels, in similar fashion to what the OSX.X recently did, and allow traders new bullish entries. But, they could keep going higher and readers can gauge the strength of any forthcoming rally attempt by the averages' abilities to push through the overhead congestion.

Eric Utley
Option Investor

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