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Market Wrap

Between the Lines

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11-11-2002                High    Low     Volume Advance/Decl
DJIA     8358.95 - 178.18 8535.88 8349.53  1310 mln   163/1130
NASDAQ   1319.19 -  40.09 1355.10 1319.07  1260 mln   125/1126
S&P 100   447.63 -   9.76  457.39  446.77   totals    288/2256
S&P 500   876.19 -  18.55  894.74  874.63
RUS 2000  369.14 -   9.86  379.00  369.14
DJ TRANS 2271.47 -  75.41 2353.58  2268.22
VIX        36.11 +   2.55   36.21  35.06
VIXN       55.71 +   3.70   56.93  52.47
Put/Call Ratio .78

Between the Lines
By Steven Price

It's tough to draw any conclusions on a light volume day, when the bond markets were closed for Veterans' Day, but there were several significant developments. We saw previous support/resistance levels fall and it appears we are back into our previous range in the broader indices. Interestingly, we may also be forming another pattern similar to the one we saw earlier this year, but at a lower level.

On Friday, the possibility of war with Iraq helped start the markets rolling down hill. The U.S. proposal on weapons inspections was approved and the Iraqi ambassador responded that it was simply the will of the U.S. and was crafted in such a way as to prevent inspectors from entering the country. That rhetoric continued today, as the Iraqi parliament took up consideration of the U.N. proposal. The opening speaker expressed the opinion that the proposal be rejected, indicating that we may be skipping inspections and heading to war sooner, rather than later.

One interesting non-development the last couple of days has been the price of oil. While there has been quite a bit of saber rattling, oil futures have increased only slightly. They are nowhere near levels from earlier this fall, when war with Iraq seemed even further off. Even then, most pundits predicted we wouldn't be able to enter the country until winter, simply due to the extreme heat. However, now that we are getting closer, with Iraq apparently ready to reject the U.N inspections proposal, oil is hanging down around $26 per barrel. Oil futures traded almost $31 per barrel a month ago, but have dropped as OPEC member countries have overproduced by about 15% over stated quotas for the last few months. This bodes well for our economy, as it is apparent that where there is potential profit, supply will follow. And since an increase in oil prices makes its way to almost every product in the U.S., an increase in fuel cost is the quickest way to put the pinch on our economy. While Iraq certainly produces a significant percentage of the Middle East's oil supply, it is apparent that "quotas" will not restrict supply as much as we have been led to believe, if prices start to rise again. War in the Middle East will certainly lead to some increase in price, as Iraqi production is restricted, and transportation in the region may see interruptions, however it may not be as bad as we thought. A look at the December futures shows a slight increase the last three days, since the U.N. began contemplating the U.S. proposal. While we may not see a huge price increase, it is apparent that oil prices have stopped descent

Chart of Crude Oil Futures

The Dow, S&P 500, and OEX all formed classic head and shoulders formations from July through September. When those patterns concluded themselves with a neckline breakdown in the middle of September, the downside measuring objectives were achieved in less than a month. Once we achieved those levels, we skyrocketed up almost as quickly as we fell. Both moves seemed extreme and certainly the business environment has not changed so dramatically for the worse and then so dramatically for the better in less than three months. However, as illogical as these moves may seem, the patterns have been reliable. We now have begun to form what looks like a possible repeat of the summer- fall head and shoulders. The pattern is only two thirds complete and could certainly turn out to be something completely different, but as we observe the market from this point forward, we should look out for history repeating itself. Since the patterns are similar on all three, I'll post only the Dow chart for illustration.

Chart of the Dow

After the recent rollover, the Dow is also back in familiar territory. The 8200-8550 range has contained the average several times recently, and now that we are right in the middle, my guess is that we will test at least that lower end (8200) before the next move out of the channel. Of course, moving almost 200 points at a crack, that advice may not be good past Tuesday. Which brings me to another point. Picking levels in the current environment does not have the same impact as it did just a couple of years ago. We seem to move in triple digit jumps almost daily. I had to go back to September 20 to find a day in which the Dow did not trade in at least a 100-point range intraday and even then it was 95 points. So we need to be aware of these levels and be very nimble, attempting to trade the top of the range short and then the bottom long. The move may only last a day or two, (or even happen intraday) before reaching the next support/resistance level and reversing itself.

Chart of the Dow Range

We are also seeing a major tech pullback, now that the Nasdaq achieved its August highs. The pattern is not the same as the Dow, but certainly the rejection is similar. It appears that the August high around 1425 in the COMP will be our gauge for whether the tech bear market can break out of its slump. While a break above that level certainly does not indicate we will return to 5000 in the Nasdaq, a repeated failure there may indicate that the downside still has plenty of room. The logical bounce point on the last pullback would have been 1360, after filling the gap from last Monday. However, that held for only a day, on Friday, before today's action took us lower. A re-test of 1300 now appears likely.

Chart of the Nasdaq

One of the groups that helped the Nasdaq to its recent highs, but has now rolled over dramatically, is the chip sector. Led by a downgrade to Taiwan Semiconductor (TSM), the Semiconductor Sector Index (SOX.X) gave up 5.7%, dropping 16.79 to 283.12. After gaining more than 50% in a month, the pullback is beginning to look like more of a major breakdown. AMAT's earnings report on Wednesday should have a pronounced effect on the sector, although it is hard to imagine anything good coming out of the announcement, since the company already announced it was cutting jobs to combat the two year chip slump. In addition, the Semiconductor Industry Association (SIA) said that global chip sales are expected to grow 8-10% in coming years, compared to annual rates of 16% in the past. That 50% reduction, on the low end, was not totally unexpected, but seemed to leave investors wondering why the sector had exploded in value recently. AMD chairman, who also sits on the SIA board, said," We can no longer count on the proverbial rising tide that lifts all boats." The group also cut its global sales forecasts again for 2002, saying it expects growth of only 1.8%; a drop from the 3.1% mid year forecast. SIA also reduced its forecast for 2003 from 23.2% to 19.8% and raised 2004 estimates from 20.9% to 21.7%.

Chart of the SOX

Single stock futures (SSF) began trading on Friday, and although there has not been much volume to this point, they may actually provide more options liquidity. Right now, market makers with short stock positions are held back from filling large in-the- money call orders on the buy side, or large in the money put orders on the sell side, as getting off a short hedge requires an uptick in the stock. A stock that may be pulling back only drops further when a specialist on the NYSE sees a large number of short sellers enter the picture. Therefore, there are option orders that go unfilled, as market makers are not willing to take on the added risk of trying to sell short. However, without a similar rule in the futures, short selling is no longer a problem. If the SSF market can draw enough futures market makers, there may be enough liquidity for options traders to increase the size of their bids and offers, since they will have an easier time hedging their trades.

With the bond markets back open tomorrow, we should see heavier trading and get a better feel for direction. However, now that we are in the center of the current Dow range, there are only 150 points to the downside before testing support. In the Nasdaq, there are only 19 more downside points before the next test. Right now the prevailing trend is down, so until something changes, that is the way I'll play. However, as I said earlier, given the current wide intraday trading ranges, I won't hesitate to close positions and play a bounce as soon as we get one at the above mentioned support levels. That seems to be the best strategy until we cross another line, at which point we have a new range to bounce within. While this makes long term direction tough, we can only trade what the market gives us, and right now trading inside the lines seems to be our best opportunity.

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