Option Investor
Market Wrap

Trick, or Treat?

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The major indexes showed some signs of stability after last week's October option expiration, where despite some negative reactions to earnings and continued concern regarding the slowing of the housing sector and "credit crunch," many are left wondering if Friday's sharp sell-off and today's reversal of morning losses was a trick, or a treat for bulls that were looking for a more meaningful pullback than my SPX 1,532, or SPY $153.21 "best entry" level of support from Monday's Market Wrap.

In tonight's Market Wrap, I'll show/discuss some observations made at Friday's close, and then again today, that suggest Friday's action was option-expiration related.

From there, I'll try and show you, or explain to you how I try and get a "read" on what the BIG money institutions may be doing now, but more importantly going forward as it relates to where the open interest was at into Friday's October option expiration, and how the S&P Depository Receipts (AMEX:SPY) $150.54 +0.58% traded, then closed into that expiration.

If I could summarize the bulk of last week's action into a few sentences, it would be that corporate earnings have been somewhat "lackluster" as it relates to the economy here in the U.S., where the upside to top line (revenue) and bottom line (earnings) are coming from overseas markets of U.S. multi-nationals, due in large part to the weaker U.S. dollar, which does make goods and services here in the U.S., more attractive to, or price competitive to overseas consumers.

And that's what surprises me a bit today. The small caps of the Russell 2000 Index ($RUT.X) 810.08 +1.41% atop today's list of major market index gainers?

What's up with that? For the most part, these companies should be more fundamentally sensitive to what is going on here in the U.S.

To say that that small caps don't derive any revenue from overseas would be incorrect, but the BULK of revenues and earnings are derived domestically.

Russell 2000 Index ($RUT) - 4-point box chart

A quick look at the supply (O)/demand (X) chart of the $RUT shows a rather option expiration looking close near 800.00 on Friday. Today, we chart further supply (O) down to 792, but note with "green ?" a rather decent reversal back higher to 812, where I'll note today's close at 810.

With the point and figure charting system, we ONLY chart one day's direction (that's O to 792) and then stop charting.

At tonight's close, I'd view a trade at 788 as BEARISH and further downside risk to bullish support (blue +).

This morning's "dip" to 792 may very well be a "trick" on bears, that turns into a bullish "treat" should the $RUT see further gains (demand X) back to the 856 level, where it has been tough for buyers to show any conviction of higher prices at 860 or higher.

On Friday, we witnessed just 22 stocks achieving a new 52-week high among the small caps of the $RUT, while the number of new 52-week lows grew to 117, the most new lows since August 9th (147) and August 16th (142).

On August 9th, the $RUT closed at 785. On August 16th, the $RUT closed at 769.


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Today's U.S. related economic report was regional with the Chicago Fed Index for September showing economic growth below average for a second month in a row. The Index came in at -0.45 in September, which was better than Augusts' downwardly revised -0.68 reading (revised down from -0.57).

Positive readings indicate above-average growth, while a negative reading point to below-average grwoth.

According to the Chicago Fed, all four categories (production and income; employment, unemployment and hours; personal consumption and housing; and sales, orders and inventories) of indicators contributed negatively to the index in September.

But in a sign of possible stabilization, three of the four categories (production, employment, and sales) rose from August.

The 3-month average, which the Chicago Fed says provides a more consistent picture of national economic growth given volatility in the monthly readings, stood at a -0.31 in September from Augusts -0.20.

Energy prices fell today, and that can be viewed as a near-term positive for the small caps, even the BIG guns of the Dow Industrials (INDU) 13,366.97 +0.33%. Certainly shareholders of Dow component Exxon/Mobil (NYSE:XOM) $90.91 -1.33% might take exception to lower energy prices as being viewed as "bullish."

US Oil Fund (AMEX:USO) - $0.50 box size

NYMEX November Crude Oil's (cl07x) couldn't have come soon enough for some, and the above chart of the U.S. Oil Fund (AMEX:USO) $66.54 -0.89% shows what I, and many believe to have been a MASSIVE short squeeze.

It might have "made sense" that a slowing global economy might have oil prices falling, and that is what likely had short interest building to record levels on the USO.

Ah, but regardless of WHAT you, or I, or industry giants BELIEVE, when you're on the WRONG SIDE of the trade (short, in the case of oil), and it starts moving against you, or I, or industry giants, the move can last longer than a short can remain solvent.

November's NYMEX Crude Oil expiration and news out of the Middle East this morning from Iraq's President saying Turkish Kurd rebel groups operating in the north of the country had agreed to call a unilateral ceasefire this evening, helped ease oils recent rise.

As I view the USO chart, near-term resistance at $68.00 is about as "strong" as resistance at $64.00 was before the trade at $64.50. That very $64.50 level becomes near-term support, where I'd have to think some shorts can't wait to cover, and more formidable support at $60.50.

As noted previously, on 10/08/07 as the USO did trade $60.50 in what now looks to be a "shake out" pattern, I profiled a trade in the PetroChina PTR Nov. $160 Put (PTR-WL) for $4.10/contract when the stock of PTR $249.29 +7.00% traded $181.42! At the time my downside target was $160 in the stock. I've moved that target UP to $216.

A "shake out" pattern is when you see a point and figure chart give a reversing lower sell signal, but then suddenly, demand (X) outstrips supply (O) and a reversing higher buy signal is given as found on 10/11/07.

In this evening's U.S. Market Watch (above), I've "rolled" the various NYMEX Crude Oil futures (cl07z) to December. It's recent floor-trade high was $88.13 on 10/18/07, but did trade as high as $88.49 later that evening. Today, December Crude Oil (cl07z) settled down $0.93, or -1.07% at $86.02.

Bottom line on crude oil for now is that it would take some type of settlement below $77.50 for me to begin to think oil prices are anywhere close to easing.

Now I want to move onto the S&P 500 Index ($SPX) 1,506.33 +0.37%, and its tracker the S&P Depository Receipts (AMEX:SPY) $150.54 +0.58%, where on Wednesday, I did think traders in the OptionInvestor.com Market Monitor should be looking to buy one (1) of the SPY Nov. $153 Calls (SYH-KW) for $3.70 (they closed bid/ask $2.05/$2.11 today) when the SPY itself was trading $153.41 (roughly SPX 1,534). I did not establish a stop for the option (maximum risk is $370 for 1 option), and my target is/was $160.00 (roughly SPX 1,600) on, or before November expiration of 11/16/07.

S&P 500 Index (SPX) - Daily Intervals

Before I show you a couple of OCTOBER SPX option montages, that show where option interest was at just one day BEFORE Friday's option expiration, and then at the conclusion, we'll want to look at the SPX with its MONTHLY Pivot retracement (prior monthly are PINK, October is DARK PURPLE).

Now, we KNOW that the VERY BROAD $RUT went out Friday right around a 800.00, and the BROAD $SPX went out very near 1,500.
How humans can get things that close I have no clue. How computers can do it, that's a little easier to imagine.

See the "cursor box" where I've lined up my chart crosshairs on the 10/17/07 date? That's the day (Wednesday) I thought would be a "best entry" (see last Monday's Market Wrap) for a bullish call play (buying an SPY call).

Things looked "OK" for about 24-hours, then came Friday's sharp decline.

Friday's decline also had the institutionally follow S&P 500 Bullish (BPSPX) from Dorsey/Wright and Associates reversing back LOWER to "bull correction" status from "bull confirmed" status. At a MINIMUM, this indicator suggests a more CAUTIOUS stance among BULLS. For now, the "bull market" takes a rest, but should resume shortly. This indicator of internal strength/weakness achieved "bull confirmed" status on 09/19/07 when the SPX/SPY closed 1,529/$153.36 at 60.77% bullish (of the 500 stocks, roughly 304 were showing "buy signal" association with their charts).

At tonight's close, the BPSPX has fallen to 58.55%, down 2.62% today.

Subscribers can view a FREE S&P 500 Bullish % ($BPSPX) at Stockcharts.com. The conventional box size should be 2.

I would also suggest viewing a chart of the S&P 500 ($SPX) on its conventional 10-point box size. The recent pullback to 1,500 comes right at its most recent double top "buy signal" of 1,500.

We can think earnings announcements/guidance, or economic reports, or any Middle East tensions may have had a NEGATIVE impact on things as the $SPX pulls back from the recent highs of 1,570. All are worthy of consideration.

But what about Friday's option expiration?

Now, we've witness some very BULLISH trade action headed into an option expiration, where I have viewed it has NAKED call sellers (those that sold call options against no underlying position) having gotten caught up in what amounts to a "short squeeze."

But going into Friday's expiration, that could have also taken place, as the BULK of call option open interest was still IN-the-money. That is ... IF option market makers (the BIG institutional traders) were NAKED call, then the bias should have been to the UP side.

However, price FELL.

Here is what I was looking at Friday evening. The Open Interest was as of Thursday's close (10/18/07) as open interest is only known AFTER each days trade.

You see, each day, thousands of options are traded on any particular options, and it is impossible to know during a day how many call options were "bought to open" a contract, or "bought to close" a contract, or "sold to open" a contract, or "sold to close" a contract.

Remember! An option contract is a LEGAL and BINDING contract.

SPY Option Montage - Open Int. As of 10/18/07 Close

What I viewed as somewhat BEARISH was the FACT that the SPY itself closed BELOW the $150.00 strike.

The MAIN reason for this analysis is the heavy PUT open interest at the $150 strike of 102,369 contracts.

What do the BULK of institutions, or institutional traders do with options?

The SELL options, in order to try and RAKE IN the premiums.

Now, see how that SYH-VT traded 105,081 contracts on Friday?

See, IF option market makers were EAGER to take possession of the SPY at $150 (when you SELL NAKED a Put option, you are OBLIGATED to BUY the SPY at $150, minus any premium you may have received. That what MOST institutional option traders do. They SELL premiums).

So, let's ASSUME that going into Friday's option expiration, institutional traders were NAKED each call contract, and put contract.

Remember where the SPX/SPY had closed on Wednesday!

On Thursday, the SPX/SPY was relatively little changed.

On Friday, all heck broke lose to the downside.

Let's try to FOCUS on "the trade" that had the HEAVIEST open interest, that saw the "most pain."

That is that Oct. $150 Put (SYH-VT).

Now, here's what I looked at this morning. The SPY October options expired Friday evening, but look at the CHANGES in the open interest.

On Friday, the "spike" UP in the VIX.X was noted by just about every market technician.

The VIX RISES due to more put BUYERS/call Sellers than put SELLERS and call BUYERS.

SPY Final October Open Interest -

I note that the SYH-VT open interest FALLS to 72,749 by Friday's close, from Thursday's 102,369. With the VIX having RISEN sharply on Friday, that probably suggest there were BUYERS of that put. Did a BUYER of that put on Friday make any money? Heck no! So the question is ... "WHY DID ANYONE BUY THAT PUT?"

Open Interest FELL. That means the bulk of orders for the SPY $150 Puts was "buy to close" out NAKED positions. That's similar to saying "I'd rather close out the position, than have to buy X-number of SPY for $150."

Do you see where I might interpret Friday's option expiration CLOSE as somewhat bearish?

Nobody made any money ($+0.01/contract) buying the $150 puts. But it looks like market participants DIDN'T want the RISK

The 151 puts (SYH-VU) also saw open interest FALL to 75,602 from 90,910.

The 153 puts (SYH-VW), which were OUT-the-money at Wednesday's close ($154.25), finished well IN-the-money at Friday's close ($149.67).

Bottom line here, as I see it, is that ANY SPY close back below the MONTHLY Pivot (SPY= $1,501) is going to be FURTHER VULNERABLE to WEEKLY S1 (see upper corner of SPY Chart) and correlative MONTHLY Pivot retracement of 1,478.12.

Again, if you don't think all HUMAN market participants can get the $RUT to close so near 800.00, and the $SPX to close so near 1,500, then you might think that institutional computers are in control of things right now.

If the SPX/SPY is going to trade 1,600/$160 by Halloween, as I have thought capable, then the SPX should be able to get back ABOVE WEEKLY Pivot (1,522) and correlative MONTHLY Pivot retracement (1,525) by Wednesday's CLOSE.

Market Internals -

While today's A/D lines at both the NYSE (columns J/K) and NASDAQ (columns Q/R) ended positive, I would have to think today's action was an "oversold" bounce and 5-day A/D ratios (columns M and T) having neared the 30% level.

The build in new lows (column O and V) have started to build below recent benchmarks of 09/25/07 of the NYSE and 09/10/07 for the NASDAQ.

After I had profiled the BULLISH trade in the SPY on Wednesday (10/17/07), I thought we could EASILY get SPY $160 by Halloween if the NH/NL ratios were to "snap back."

We haven't seen that, but there's always tomorrow.

I do NOT condone the "average down" methodology of trading or investing (bullish, or bearish positions). ONLY average INTO a trade that becomes a WINNER, or is PROVING your (or my) analysis CORRECT.

Some of this evening's earnings ...

Tech darling Apple Computer (NASDAQ:AAPL) $174.36 +2.31% extended today's gains in this evening's extended session after reporting Q4 results that beat analyst views.

For the three months that ended September 30, Apple said it earned $904 million, or $1.01 per share, compared with $542 million, or 62 cents per share, in the year-ago quarter. Revenues for the quarter came in at $6.22 billion, compared with $4.84 billion in the same quarter last year.

Apple easily beat the expectations of analysts polled by Thomson Financial, who predicted earnings per share of $0.86 on sales of $6.07 billion.

Shares of Texas Instruments (NYSE:TXN) $34.27 +1.03% fell in the extended session to $32.88 after the largest maker of chips used in wireless phones said Q3 net income rose to $776 million, or $0.54 per share from $702 million, or $0.46 per share, in the year-ago period. Consensus was for EPS of $0.50 per share.

Revenue fell 3% to $3.66 billion from $3.76 billion a year ago, which matched Wall Street's expectations.

Looking ahead, Texas Instruments issued a Q4 revenue target that is lower than the average analyst estimate. The company expects revenue between $3.40 billion and $3.68 billion in revenue, while Wall Street projected $3.72 billion. The company projects profit of $0.48 to $0.54 per share, compared with Wall Street's average estimate of 50 cents for the quarter.

Dow components American Express (NYSE:AXP) $56.87 -0.42% shows a last tick in tonight's extended session as higher at $58.67. The company said quarterly profit rose to $1.07 billion, or $0.90 per share, from $967 million, or $0.79 per share. Revenue rose 11% to $6.95 billion from $6.27 billion.

Analysts had forecasted earnings of $0.85 per share on revenues of $7.27 billion.

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