Option Investor
Market Wrap

Are we there yet?

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        WE 5-03          WE 4-26          WE 4-19          WE 4-12
DOW    10006.60 + 95.88  9910.72 -346.39 10257.11 + 66.29  - 80.82
Nasdaq  1613.00 - 50.89  1663.89 -132.94  1796.83 + 40.64  - 80.82
S&P-100  530.52 -  1.85   532.37 - 27.42   559.79 +  6.05  - 10.28
S&P-500 1073.43 -  2.89  1076.32 - 48.85  1125.17 + 14.16  - 11.72
W5000  10202.04 -  5.42 10208.26 -426.79 10635.05 +129.08  - 45.46
RUT      512.32 + 10.82   501.50 - 15.90   517.40 +  1.94  + 17.70
TRAN    2743.56 + 20.93  2722.63 - 74.24  2796.87 - 78.16  + 17.70
VIX       23.23 -  1.41    24.64 +  4.34    20.30 -  1.79  +   .96
VXN       46.26 +  4.02    42.24 +  2.89    39.35 -  3.46  +  1.96
TRIN       1.71             1.82             1.18             1.03
TICK       +910             +367             -492             +460
Put/Call    .91              .87              .79              .99   

Are we there yet?

Technology stocks took it on the chin for the second straight week as the "more than tech-heavy" NASDAQ-100 (NDX.X) fell 2.82% on Friday and -4.8% on the week. With the NASDAQ-100 showing losses 7 out of the last 8 weeks, traders and investors are wondering a near-term bottom is in site?

I think the answer is that big technology is a lot closer to finding a near-term bottom now than in December and March. "How can you possibly think that?" says the tech bear with a belly full of gains since the beginning of the year!

It's never easy, but "risk" is what will eventually have the NASDAQ-100 and many technology stocks rebounding. Once again, I'll try and illustrate with my favorite indicator, the NASDAQ- 100 Bullish % ($BPNDX) from Stockcharts.com.

NASDAQ-100 Bullish % Chart - 2% box

In December, it was unthinkable for bulls that the NASDAQ-100 and the bulk of technology stocks were "overbought" as depicted by the NASDAQ-100 bullish % showing that 78% of the stocks in this market were showing a buy signal on their point and figure charts. Nonetheless, we issued a word of caution to be locking in gains on call options that had the bull holding some nice gains or at least snugging up some tight stops to help try and assure profitability. In mid-March (after red 3) we did the same after a rather "quick" and sharp move higher from a low reading in February (red 2) of 28% to a torrid 70% just 5-weeks later.

Today, I'll take the opportunity to tell bears to snug down your stops and implement account management practices to start getting the account less bearish. Why? Because this is most likely what the NASDAQ market makers are doing in their stock inventories.

Why would you or I give a darned what the market maker is doing with their inventories? Because these are the guys and gals that know what the order flows are looking like (I don't), but the history of the NASDAQ-100 as marked by the beginning of each months above tells us, when levels of lower bullish % like we're at right now take place, the risk for a market maker holding an overly short positions in their inventories has that market maker's account at risk.

Imagine if you will, that you are the head of trading for Hewey, Dewey Suckfinger and Associates. You've got 10 market makers under your watch and each of those 10 market makers are assigned the task of managing the firms inventories and trading revenues for the firm. Each of those 10 traders are responsible for making a market in 10 different stocks for the NASDAQ-100.

Now, for simplicity sake, lets imagine that back in December, mid-March, you came into work and noticed that the NASDAQ-100 Bullish % reached a level of 70% and alerted you (head of trading) that the risk levels for bullish inventory was high. What did you do?

You strolled onto the trading floor and slapped each of your 10- traders on the back and said, "Slap those retracement to the highs and the lows and manage your risk. If you're not getting the order flow on the buy side, you'd better be short. The spouse has informed me we're 5-kids on a world tour this summer and it's going to cost me a fortune and I can't afford to lose my job!"

You then sauntered back into your office, pulled up a chart of the NASDAQ-100 yourself, slapped on the retracement from the September lows to the December highs, perhaps added a regression channel to signify trend and have monitored it until now.

Based on the NASDAQ-100 bullish %, what kind of conversation are you going to have with your 10-traders Monday morning? I'm thinking "Stick with those retracement brackets gang and manage your risk. If you're not getting the order flow from the SELL side, you'd better get back to neutral. The spouse has informed me that the neighbors kids are coming along on the summer vacation and it's costing me a fortune and I can't afford to lose my job!"

NASDAQ-100 Index Chart - Daily Interval

With retracement to define a range from the September lows to the December highs (correlates with the bullish % too) the NASDAQ-100 trader now has a way to define the NASDAQ-100, not only as it pertains to risk (from the bullish %) but in a numerical trading value for the NASDAQ-100. With a regression trend overlaid, we see some technical significance that ties in directly with historical trading dating back to February.

Earlier I said "the NASDAQ-100 is at the same level of RISK as it was in early September (red 9) as defined by the bullish %. On the far left of the chart, I marked September 4th, which was just about the time the bullish percent reading of 18% (red 9) would have been charted. Notice how the NDX.X was sitting right on/near the 1,335 level several session later, September 10th? One could almost argue that the NASDAQ-100 had "sought out" that level as potential support. The collapse lower came the next trading session, September 17th, just after the terrorist attacks.

That argument could be further supported as the NASDAQ-100 attempted to hold that 1,335 in October, February and April. Note the more "powerful" rally from February and check it against the bullish % reading of 28%. Do you see, or at least "get the observation" of how market action can reflect levels of bullish %?

If a bear is looking or anticipating such a collapse as experienced in late September from current levels, I think he/she must then be looking for a similar type of catastrophe experienced on September 11th. While I'm a believer that the MARKET is all knowing, I do NOT believe the MARKET knows anything about events like those that took place on September 11th.

So if a bear has the bulk of risk right now, is there a way a bull can perhaps look to capitalize on a market rally in the NASDAQ-100 and still not get crushed should the rally not take place?

The answer is yes. A trader still holding some put/short positions is perhaps in the best situation as any offsetting bullish positions in the NASDAQ-100 Trust (AMEX:QQQ) $29.74 (depending on dollar amount weighting) creates a "synthetic hedge."

Let's imagine you've got some puts on individual stocks in the QQQ that still have some room to their bearish vertical counts and their relative strength is weak and they trade below their bearish resistance trends. These are the stocks you and I perhaps feel should "outperform" to the downside if the QQQ is going to accomplish its bearish vertical count of $38.

Say what! BEARISH vertical count of $25, what are you talking about going long or getting neutral for? Let's look at a risk/reward trade setup, but lets use the p/f chart where we can then "tie in" with the bullish percent chart better.

NASDAQ-100 Trust (QQQ) - $1 box

Market makers aren't concerned about market direction. They're only concerned with account/inventory risk management. If most trading desks at the major institutions listened to what their analysts said about the markets there wouldn't be any market makers or institutional trading desks around. They'd all be out of business or posting losses of biblical proportions if they didn't manage their inventory risk.

Same can be said for most traders if they disregard risk and how the bullish % can help them manage and trade it.

Let's once again look back and imagine you're a market maker and you wanted to make the "most" money from past trading in the QQQ. Let's benchmark back again to early September (red 9). It's as god as any since the bullish % readings are now at similar levels.

We don't know what might have happened in the QQQ if the September 11th terrorist attacks didn't happen, but the QQQ did achieve its bearish vertical count, just 2 days prior to the attacks. With that said, did a market maker get crushed if he/she got their inventory to 20% long and 80% short in the QQQ at that point? Heavens no. They came out smelling like a rose. Heck, just two months later, that 20% they bought was actually profitable.

Will a bull in the QQQ get crushed form current levels? He/she might if they don't implement some trade/account management practices. Right now, I'm still assessing longer-term downside to $25 from the bearish vertical count. Isn't it funny though (maybe not) how we were alerting bulls to be careful in the NASDAQ-100 or QQQ in December (red C) at the $40-$43 range?

You can't believe the amount of e-mail I got from the bulls saying we were too bearish!

Guess what the e-mail may be reading in the next day or so? Too bullish is my guess.

Let's talk about getting 25% of a market maker's inventory back on the bullish side of things in the QQQ. This doesn't necessarily have to translate to an individual trader like you and I placing 25% of our $10K options trading account into a QQQ call.

In September (red 9) at $35. Imagine that you put 25% of what you'd normally put in an options trade in a QQQ call. How long did you have to "wait" for that call to show a gain? By November (red B) the call was probably slightly positive or at least break-even (considering time erosion.)

Here we'll talk about risk once again. I'll argue that current month options are inherently "more risky" that an option that is dated for expiration a couple of months out. We can perhaps use the past to help trade the future. Therefore, if I'm going to risk 1/4 or even 1/2 of my stated trade discipline amount on a QQQ call, I want to at least go out to July. I'd much prefer August as that would give me 3-months and tie in nicely with the "peak" in the QQQ of December (red 3).

Even more preferable perhaps would be the September $30 (QAVID) $2.65.

What does your stated trade discipline say with regards to how much you place in a trade? Don't talk to me about "number of contracts." 10 contracts of a $5 option is twice as "risky" as 10 contracts of a $2.50 option. I want to know what your trade discipline says about how much you are allowed to risk in any one trade on a full position.

You'll blow yourself up as a trader (stock or option) if you're trades shares/contracts and not dollar amounts.

I (Jeff Bailey) have said before, I don't use stops losses with my option trading. I assign myself to the potential loss before the trade takes place, as this assures myself I've properly assessed the risk/reward.

On the previous chart, I "imagined" potential near-term trading in the QQQ. As we pull in some observations from the bar chart, we can see how the downward regression trend could serve as similar support as found in the Feb-March timeframe. A "simple" rally on the point/figure chart would have a level near $34 achieved. That would have a September $30 call most likely trading a minimum bid of $4.00.

Should the QQQ decline to the September 2001 lows of $27 this week, I would then "round to full" in the exact same Sep. $30 call. I do NOT consider averaging down in a 1/4 or 1/2 position as a violation of what we teach about "never averaging down." Again, a trader using some trade/account management with a partial position has already started to reduce his/her risk in a bullish trade. Besides, with the NASDAQ-100 bullish percent down at 20%, it's the bears that currently carry the bulk of the risk.

New market terminology comes of age

The term "Blue Chip" is an age-old term used by investors to describe stocks that represent large, well-established companies that usually pay dividends. Subscribers are beginning to use the term "Red Chip" to describe the bulk of technology stock that continue to have a habit of dishing out disappointment to the bulls as the weekly statistics continue to show red numbers on a more regular basis.

This also has some thinking/believing we're in a "bear market." Well, I guess that depends on where you've been that last several months. One might even say it depends where you were this week.

For the week, the Russell 2000 Index (RUT.X) gave bulls a stellar gain of 2.2%. That's right! A gain. The "Blue Chip" Dow Industrials managed to shrug off some of the previous weeks losses and rebounded with a 1% gain of its own. Heck, even the NYSE Composite (NYA.X), what some old-timer considered the "real market" edged higher with a 0.5% gain.

I'm getting a little tired of some media channels and anchors talking about the beating bulls took this week. The S&P 500 Index (SPX.X) didn't show a gain this week, it slipped lower by 0.3%, but it hardly suffered the shellacking the NASDAQ Composite (COMPX) and narrower NASDAQ-100 (NDX.X) took this week as they fell 3% and 4.8% respectively.

Bear market? Yes, for most of technology. What we saw this week was a good old-fashioned "belch" from technology bulls. I get the feeling that the last little bit of last year's four-course meal of losses has now created the feeling of indigestion. If you've ever seen a sick dog, then you know what I'm talking about. A sick dog usually starts salivating, then its stomach starts retching, just before it lays a rather unpleasant surprise right on the new dining room carpet.

No, it's not a pretty sight and just about enough to make one gag.

Plop, plop, fizz, fizz....

We talked about the NASDAQ-100 Bullish % ($BPNDX), which showed a reading of 25%, but Friday's action found a net-loss of 5 stocks to sell signals on their point and figure charts as the gut retching picked up.

It's rather interesting to me that we seeing such a nice round of selling in technology, when for the first time in over nine months, the economy actually added jobs! That's right, sell them technology stocks just when the economy actually adds some jobs.

So why all this selling? Because the technology bulls can't take the pain anymore, that's the most probable reason. Yes, the 8- year high unemployment rate of 6% is enough to make a bull's stomach queasy, but once again, there's been areas of relief and even select stocks with a technology theme that have done well.

Weekly market averages/sector performance

Forest/Paper Products (FPP.X) were this weeks winners with a 4.3% gain. It's nice to see a deep cyclical group like the paper stocks bounce back strong and help boost the Morgan Stanley Cyclical Index (CYC.X) back after a four-week losing streak.

It's interesting that just as the economy begins to add some jobs, some of the more economically sensitive sectors that should benefit most from an early recovery actually show yearly gains! This is something we've been talking about in the last 12 months and it continues to show up.

Also worth noting is that the 10-year Treasury YIELD ($TNX.X) stayed rather steady this week and actually edged higher. Lots of subscriber's have been asking just where the money is going since it isn't going back into the bond market at an alarming rate.

One area of bullishness that may be "hidden" a bit is the slight DIVERGENCE between the Airline Index (XAL.X) and the Dow Transportation Average (TRAN). The XAL.X got hit for a 7.2% loss this week, but look at the broader Transportation Average (TRAN) showing a marginal gain of 0.8%.

As I flip through the charts of the Dow Transport components, one stock I'll monitor closely at the beginning of this week are shares of Fedex Corp. (NYSE:FDX) $51.49 -0.29%. I want a few observation days, but I like the way the stock found support right at the $50 level. premierinvestor.net had profiled the stock as bullish in the past and if not for a tight stop and a brief 1-session decline, the stock performed quite well.

Fedex Corp. Chart - Daily Interval

Unfortunately our play list at PI didn't get the "full potential" from a previous bullish trade in FDX as a one-day decline triggered our stop just before the stock really got going. Here we are about 3-months later and FDX is right back where it started from in January. I'd like to see the stock hold above the $48 level as a trade there would have a sell signal on the point and figure chart canceling out the current bullish vertical count of $83, which has been in place since October of last year.

Roadway Corporation (NASDAQ:ROAD) $34.01 +7.35% was today's transport winner. While I consider it a "trucking/ground" stock and Fedex (FDX) an "air/ground" transport, it's the similar patterns and today's bullish move from ROAD that has my attention.

Roadway Corporation Chart - Daily Interval

After a week of consolidation right at it's 50% retracement bracket, shares of Roadway (ROAD) made a nice move this week and today broke back above its 200-day moving average on strong volume. Roadway's earning's warning of March 21st that it would post a loss of $0.08-$0.12 a share for its 1st quarter had all the truckers seeing some losses that day (YELL, JBHT, KNGT, SWFT), but for some reason (we'll eventually find out) the stock continues to trade rather strong.

Here's the Dow Transport components and how they traded today. Notice the commercial aircraft stocks like LUV, NWAC, AMR, UAL and DAL trading down today, but transport stocks that carry packages and cargo traded stronger.

Dow Transport Components - Sorted by % gain

When sorted by % gain on today's session, we see that the "truckers" were really the stocks that outperformed. I think one reason that CNF Inc. (NYSE:CNF) 31.98 -2.94% didn't participate today was that the stock had traded strong in the previous two trading sessions. CNF has also found good support in recent months at its 50% retracement level of $30.31, but stays range- bound with resistance at $34.

The trade in the transports has been to buy weakness at support, then sell strength at resistance. I haven't see monstrous gains of more than 10%, but those have been very hard to come by in bullish trades in recent weeks.

However. As the group continues to consolidate, it looks as if weaker hands are passing stock off to stronger and more longer- term committed hands. As this stock "turns over" it can then create a supply/demand setup where the bulk of the stock is owned at a rather tight level and should a bullish catalyst present itself and sellers become few, a strong move can take place.

My goodness! There's a four-lettered technology stock in our play list at PI and it's in the "bullish" section. What's up with that!

I had to go back to early March to find a 4-lettered technology stock in the PI bullish play list. That was a play in Research in Motion (NASDAQ:RIMM) $16.40 -5.36% from the $27.32 level. We actually held that silly bugger until March 20th, when the play was stopped at $26.49. With the stock now at $16.40, it's another lesson on how important a stop loss can be when investing/trading. I guess you could say the dog was salivating when we got stopped out, and now suffers from "motion sickness."

I have to say, I am somewhat impressed with how Applied Materials (NASDAQ:AMAT) $22.17 -3.06% traded Friday. The Semiconductor Index (SOX.X) fell 4.72%, so there was a little bit of relative strength in AMAT. As mentioned in the intra day commentary on OI Friday, AMAT has pulled right into its bullish support trend. With the NASDAQ-100 Bullish % down at 20% a lot of "risk" has been reduced for the bulls and AMAT is still 1 of the 20 stocks in the NASDAQ-100 still showing a "buy signal" on its point/figure chart. From the institutional/point figure perspective, AMAT has had a nice little pullback.

One thing we should note today is that AMAT and "like" semiconductor equipment stocks Novellus (NASDAQ:NVLS) $43.50 -4.66% and KLA Tencor (NASDAQ:KLAC) $52.78 -4.40 tested, or came very close to testing their 200-day moving averages today. There's been quite a bit of "risk" taken out of the stocks in the past two-weeks as AMAT has lost about 21%, KLAC has fallen approximately 24% and NVLS has dropped 19% from their recent highs.

When enough is enough!

Bears should have looked to book some gains today in some stocks on Friday. One of PI's bearish plays is perhaps indicative of how a market maker may also be reducing some bearish inventory risk. I think the action in SERENA Software (NASDAQ:SRNA) $13.10 +3.47%, while not indicative of the entire technology area right now, hints that there are definitely some bears locking in gains on broader tech weakness.

As profiled in the SERENA (SRNA) trade, our bearish target of $12.51 was achieved. While the stock did trade as low as $12.45 and below our target, evidently we weren't the only ones watching current levels closely.

SERENA Software Chart - Daily Interval

It's always nice to lock in a gain ahead of the weekend and build a little cash in the account. The bearish side of the play list is off to a nice start this month, as it should be, considering tech weakness.

Also closed out today on the bearish side was semiconductor stock DuPont Photomask (NASDAQ:DPMI) $32.32 -4.05% at the profiled target of $35.50. There may be some downside left in this one to the bearish vertical count of $29 (tie it in with the bearish count in the QQQ of $25 perhaps), but the stock has fallen for about 5-straight sessions. A trader that may have played AMAT long could have held the stock short, but a nice gain was at hand and that's what a trader is looking for. Gains.

Dow Industrials just didn't have it

As mentioned earlier, the Dow Industrials did manage to edge out a gain this week and didn't get hit to the downside too bad today, loosing just 85 points on the session. Last night we felt a break above the 10,120 level might spark a rally, but the MARKET was too fixated on this morning's 6% jobless rate.

Dow Components Intel (NASDAQ:INTC) $26.60 -4.55%, SBC Communication (NYSE:SBC) $31.14 -3.97% and Microsoft (NASDAQ:MSFT) weighed on the index, while gains in Eastman Kodak (NYSE:EK) $33.65 +4.5%, McDonalds (NYSE:MCD) $29.29 +2.77% and Hewlett Packard (NYSE:HWP) $17.44 +2.04 helped keep the Dow above the 10,000 level on a closing basis.

Dow Industrials Chart - Daily Interval Chart

If any of the major market averages shows any technical strength or ability to stage a rally, then it's the Dow Industrials. General Motors (NYSE:GM), 3M (NYSE:MMM), Procter & Gamble (NYSE:PG) and Wal-Mart (NYSE:WMT) are now showing the biggest gains since the terrorist attacks, while SBC Communications (NYSE:SBC), Eastman Kodak (NYSE:EK), AT&T (NYSE:T) and General Electric (NYSE:GE) are now at the bottom.

Hypothetical Dow Portfolio - $1000 in each on Sept. 10th

The good old Dow "hypothetical portfolio" we started on September 10th, the day before the terrorist attacks, is holding up rather well on a total basis with a 2.92% gain. There's a large disparity between the upper 15 and lower 15.

Quick generalizations continue to have telecom in SBC $31.14 - 3.97% and T $13.86 +1.38% at the bottom. Eastman Kodak (EK) $33.65 +4.50 rallied right back to its 200-day moving average today and may be a stock to watch for a move off the bottom. Conglomerate General Electric (GE) $31.70 +0.31% managed a small gain today and I'd like to think the weaker U.S. $ would help, but the MARKET just doesn't seem interested in the stock.

General Motors (GM) $65.68 -0.84% "shocked" the market earlier in the week reporting strong car sales and saying it would ramp up production. Look for a bullish play in "like stock" Daimler Chrysler (DCX) $47.33 +0.55% next week in our bullish play list. For a "prep," traders and investors may want to go back and review Wednesday's market wrap and comparisons between the big 3 automakers and their point and figure charts.

All eyes on Cisco

You can bet that technology bulls will have their eyes and ears open next week when networking giant Cisco Systems (NASDAQ:CSCO) $13.14 -3.66% is scheduled to report earnings on Tuesday, after the close of trading. Analysts polled by Multex are looking for CSCO to report earnings of $0.09 a share. I'm not expecting an earnings "surprise" from CSCO, but what most likely influence technology trading is what CSCO says about visibility.

Suffice it to say, if CSCO gives negative or "lack of visibility" type guidance Tuesday evening, then expect a now salivating dog to finally cough up what's been stuck in its throat since the December highs. Conversely, any bullish outlook on the future will most likely see a large short-covering rally as gains have been plentiful.

Have a great weekend!

Jeff Bailey

Editors Note: We are having a spring cleaning sale at OIN. We have rounded up the last remaining videos sets of the last seminar consisting of 10 four hour VHS cassettes and workbooks. I think we have eleven of them. click here

Also we have a couple dozen of the year end special CD/Workbooks available. Watch the website this week for our special offers. Act fast because there are no more. When they are gone they are GONE! click here

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