Option Investor
Market Wrap

Trade Your Plan

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The markets played out pretty much as expected last week and the game plan I laid out last Sunday produced gains for those who followed it. The major hiccup in the middle was the court news for Altria (MO), which produced a significant Dow/SPX spike on Thursday's open and shocked the other indexes into paralysis. The decline from Wednesday's high was interrupted but only temporarily. The indexes closed at the lows on Friday just as we expected.

Dow Chart - Daily

Nasdaq Chart - 30 min

SPX Chart - 60 min

NYSE Composits Chart - 60 min

Friday lacked any market moving economic reports and the indexes were left to digest the combination of a triple witching expiration, Nasdaq reconstitution and S&P rebalancing. For most of the day the markets remained in neutral with the Dow in the green, Nasdaq red and the S&P walking the flat line. As the close approached and rebalance volume increased the Dow gave up its gains and all the indexes finished in the red but the losses were minimal. All in all this was a bullish week for the markets despite the mixed results listed above.

The game plan I left you with last Sunday was to remain long into Wednesday morning and then short a Wednesday bounce and hold it into Friday's close. That would have been a textbook plan except for the court news on Altria at Thursday's open. Dow component MO spiked nearly $5 at the open on Thursday, which equates to roughly +40 Dow points. This interrupted the Dow's decline from Wednesday's high but the decline reappeared before days end. Option expiration sent the Dow and S&P back to the highs at Friday's open but the rebalancing activity again weighed on the indexes knocking the S&P and NDX back to close at the post Wednesday lows.

Using my recommendations for the last ten days you would have waited to enter long positions until the Friday after the Intel update around SPX 1255. I suggested exiting those longs on any post Fed spike on Wednesday, which came at 1275. The plan was to hold that short into the close on Friday, which we now know, was 1267. The MO spike on Thursday interrupted that plan but otherwise it worked as expected. I was personally stopped out on the Friday morning spike but was able to reenter and hold into the close.

SPX Game Plan Chart - 20 min

Expiration and rebalancing activity was especially harsh for the energy sector. Despite strong draws from storage the gas stocks and big cap oils were hammered severely. The combination of all the expirations and rebalancing was too much for the sector to bear. The big cap oils were hit with a double whammy by falling oil prices and by the S&P changes. Big cap oils have been buying back billions of dollars of shares and that lowers their market cap. The S&P rebalancing forces funds to lighten up on those stocks whose market cap has shrunk and add to positions of those who have grown. Exxon, Conoco and Chevron all lost about -$1.50 on Friday to end a week of an oil related slide. Oil prices fell to $58 and a two week low despite a record cold snap and more cold weather on the way. The three day expiration related slide in oil prices saw it fall from the $61.95 high on Tuesday to $58 on Friday. This -6% drop should be temporary but I would not look for any new highs this month. I told you on Tuesday night I expected a sell the news event when the gas storage levels were announced and that is exactly what we got. There was a -202 bcf drop in storage and much higher than the official estimates. It was simply profit taking related to expiration and the approaching year end.

Crude Oil Futures Chart - Daily

Natural Gas Futures Chart - Daily

To highlight the impact of options expiration we only need to look at gold prices. Gold hit a high on the December contract at $538.50 on Monday and then the bottom fell out to settle at $503.50 on Friday. It was a great run as the contract matured and profits needed to be taken.

December Gold Chart - Daily

Volume on Friday was huge at 5.352 billion shares and a full billion over Thursday's levels. It was weighted slightly 3:2 to the downside but that was a function of expiration/rebalancing pressures. The A/D line was nearly flat with decliners edging out advancers only slightly at 38:33. Given all the negative undercurrents I consider this a bullish day.

I believe the market strength we saw this week in the face of heavy selling pressure suggests next week will be bullish. The Dow and SPX are very close to their recent highs with better internals than we have seen in the last two weeks. The Nasdaq is dormant at 2260 but should wake up next week once the NDX rebalance pressures fade.

Next week is a full week of trading and while there are some major economic reports I believe they will be ignored as long as there are no surprises. The markets are closed for the Christmas/Chanukah holiday on Monday 12/26. Volume will be anemic ahead of the holidays with many institutions running only a skeleton staff for the rest of the year. This bodes well for the indexes since program trades will be scarce after Monday. This is the two weeks of the year where retail traders thrive and push the markets higher. Those year end bonuses will be put to work and the odds are very good we will see new highs on the Dow and SPX.


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Late on Friday Time Warner announced that Google was in talks to buy 5% of AOL for $1 billion. Time Warner said Microsoft was no longer a contender and a deal with Google on AOL and an increased advertising presence was near completion. This helped to power Google to a new intraday high at $432.50. Google was also added to the Nasdaq-100 this week and buying for that index produced a +$13 gain over the last two days. I would be cautious on Google next week as arbitragers dump any excess stock they could not sell to funds as Friday closed. Offsetting any dumping could be late buying by those funds that refused to buy at the new high on Friday. Typically the index funds have three days to complete index adjustments but most are either early or done at the close on rebalance days.

Acquisitions in the energy sector continue to make the news with Southern Union (SUG) paying $1.6 billion for Sid Richardson Energy Services. This adds 4600 miles of pipeline to Southern's network bringing their total to over 22,000 miles in 17 states. Because of the high price paid for SR, Southern bought $45 million in gas options to hedge against gas falling below $11. Energy analyst Kenneth Stern of FTI Consulting did not expect the price of gas to crater and said more deals were in the pipeline. Earlier in the week Conoco agreed to pay $35.6 billion for Burlington Resources adding to Conoco's already growing gas reserves. Constellation Energy spiked on Wednesday's news that FPL Group was in talks to acquire them for $11 billion. CEG has 10 power plants and is trying to get permission to build a giant nuclear reactor as a showcase for a new generation of reactors they hope to build around the country. FPL needs more capacity as more than 100,000 new customers move into its Florida power base every year. That will increase substantially as boomers begin to retire.

AMR Chart - Daily

The falling price of oil helped push American Airlines (AMR) and Continental Airlines to new highs. Both charts resemble an Internet chart from 1999 or maybe the flight path of the new 787 Dreamliners from Boeing. The Indian Cabinet announced on Friday that it had approved the purchase of $8.2 billion for 68 Boeing planes. Boeing had a good week also signing a deal with Cathay Pacific for $2.85 billion and Qantas for $15 billion.

Software was in the news as Oracle posted disappointing results and took a sharp dip at Friday's open. Revenues rose +19% but profits fell -2.1%. Adobe jumped +3.89 or +11% after posting stronger than expected results.

The potential economic bumps next week are the PPI and New Home Construction on Tuesday, GDP on Wednesday and CFNAI and Mass Layoffs on Thursday. Friday closes with Durable Goods, Consumer Sentiment and New Home Sales. We are expecting a drop in the PPI of something in the -0.4% range due to falling energy prices. New Residential Construction is also expected to fall slightly to 2.01 million units, down from 2.014 in October. The GDP revision on Wednesday is not expected to change at +4.3%. Consumer Sentiment on Friday should rise slightly to 89.0 from 88.7 due to the improving stock market, falling gas prices and the holiday season. New Home Sales could be the challenge for the week. They are expected to fall to 1.3 million annual units, down from 1.424 in October. This is a material drop and could put the pop back into the housing bubble conversation after weeks of talk about a less damaging slow deflation.

The game plan for next week is simple. Buy any opening dip on Monday and hold it the rest of the week. The week after the December triple witching expiration has been up 10 of the last 13 years with Wednesday and Thursday the strongest days of the week. The first three days of the following week are typically bullish but Friday the 30th has a skull and crossbones on my calendar. The last nine years has seen some serious losses on four of those years. 1996 -101, 1997 -8, 1998 -93, 1999, +44, 2000 -82, 2001 -115, 2002 +9, 2003 +29, 2004 -20. The more recent trend over the last three years has been neutral with an average gain of +6 points. While you can't count on any specific day repeating past performance you can expect long term trends to exert pressure on the present. For this reason I would look to either be flat or have really tight stops should any post Christmas/Chanukah bounce appear tired late in the week.

BTU Chart - 30 min

If you are looking for something to trade next week I would look at healthcare, specifically United Health (UNH). That sector typically outperforms during this period. I would also look at Whole Foods Markets (WFMI), which has a 2:1 split after the close on the 27th. This is a retail trader favorite and there is a strong potential for a pre-split rally. Valero would be another option after splitting 2:1 after the close last Thursday. The $110 high flyer is now affordable at $52 after the two day expiration related decline in oil prices. Peabody Energy (BTU) would also be a potential winner with a steep expiration decline and strong support at $80. I hesitate to recommend any other energy stocks due to the potential for profit taking into year end. If the selling this week was really related to options/futures expiration as I expect then we could see a new uptick begin on Monday. I bought energy on the close on Friday with that expectation. If you see futures rise on Monday then energy stocks would be back in play. Gas plays like Ultra Petroleum were crushed late in the week on the sell the news gas storage numbers and expiration pressures. With gas still hovering just under $14 a new high is not that far away. I would look at UPL as a way to capture a rebound in gas prices. The drillers are less susceptible to oil prices as their revenue is derived from day rates for drilling. Diamond Offshore gave up about -$3 as oil declined but managed to hold the high ground. Diamond (DO) and Nabors (NBR) would be my choices in that sector.

Streettracks Gold Trust Chart - 30 min

One last suggestion would be the gold ETF, GLD. GLD appears to have found support at $50 and nothing has changed in the global picture for gold. Sorry, no options but it would work in retirement accounts where options are not allowed. Optionable gold stocks with a strong trend include Freeport McMoran (FCX). You could also use the $XAU.x Gold/Silver Index with the shorter month strikes. Farther months tend to be expensive. Watch the spreads and use limit orders only.

This is going to be a short commentary this weekend and far less than the nearly 5000 words I penned last Sunday. Sometimes there is a lot to talk about, sometimes very little and there is no reason to add useless market trivia as filler. The trading next week is going to be the same. There is little to motivate the markets other than good old investor sentiment. Volume will decline as the week progresses but it should not inhibit any gains as retail traders leave early for the holidays and find themselves in front of their home PC trying to find a home for that holiday bonus. Plan on capturing the gains from that scenario but being out of those trades before year end.

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