I want to begin by introducing myself. I currently write the Option Writer newsletter and provide the weekly contrarian information each Wednesday. I first began writing for OptionInvestor.com in 1998 about strategy money and risk management. It is my pleasure to contribute to the newsletter again after taking about five years off to manage the portfolio of a Multi-Strategy Hedge Fund. As you will learn, I prefer to sell premium versus buying. Over time I hope to teach and inform why selling is a preferable strategy.
The week turned out to be full of disappointments if you are a bull. Monday tricked a lot of us with a strong open and run above and beyond the S&P 500 ($SPX) 200 day simple moving average (SMA). The end result was that the $SPX ended slightly up on Monday but just shy of its 200 day SMA. The same test and failure occurred on the Dow Jones Industrials ($INDU). The $INDU ran up to 13130 +/- for the second time in two weeks (5/2/2008) only to fail to breakout again.
The NASDAQ 100 ($NDX) was a different story. The Index was already well above its 200 day SMA at the start of this week. The only resistance to note was from a gap down that occurred on January 3rd of this year. Price Gaps are often target support and resistance zones that represent price demand or supply, respectively. On Monday, the market decidedly moved up above the 2040 resistance and filled in the gap. Then news came out from Sandisk (SNDK) that the company was experiencing slower US April sales. The markets were looking for a reason, any reason at that, to sell off and take profits from the two month run off the March lows.
The advance decline line showed heavy distribution of equities. The NYSE had only 825 Advancing issues versus 2021 declining. The same was true on the NASDAQ Composite with 876 advancers and 1913 decliners. The TRIN (or ARMs index) closed at a high 2.28 while the TRINQ closed at 1.11. Long trade signals can be taken when the TRIN closes above 1.50. I like this trade on the S&P Futures contract. Normally, I set a profit target on part of the position with an equal stop loss for a one to one ratio. Then the remainder of the trade is closed at the open, assuming it wasnt stopped out first. This trade can be compared to trying to catch a falling knife. Using options I would sell premium on the SPY or SSO puts for an overnight trade to gap up. The risk is that you grab the knife by the blade and have to close the puts out for a substantial loss.
The CBOE 10 Year Treasury Yield ($TNX) dropped 0.90 or 9 basis points to a 3.831% yield. The 10 year has been consolidating for a few weeks and has substantial resistance at 4%.
Master them with Hotstix QQQ Trader. We'll show you exactly when to buy and sell the QQQQ and turn you into a master trader who knows how to cut your losses, nail short term gains and rack up some incredible profits.
30-Day FREE Trial:
The big story all week has been the uptrend in commodity prices. Throughout the week the main commodity highlighted was Crude and Heating Oil. There is no doubt that the increases in food and energy have affected the cost of living (read the real CPI). Goldman Sachs pinned a very specific $141 crude oil target by this summer while Boone Pickens of BP Capital spoke out on CNBC and gave oil a $150 target. The result was that the speculators came in along with the commodity linked funds and ETFs to buy therefore pushing crude above $135 per barrel. However, at the time that crude oil was running toward new highs the DJ Oil Service Index began to decline. The headline on CNBC was Americas Oil Crisis on Thursday and Friday. As a contrarian, I took that as a signal similar to that of the Business Week headlines seen in 2000 regarding the new economy. DUG is the Ultra Short (2X) Oil and Gas ETF that tracks the inverse of the DJ Oil & Gas Index. That means that a 2% move down in the DJ Oil & Gas Index would result in an approximate 4% advance in DUG. For those of you that dont subscribe to Option Writer we sold the June 24 Puts on DUG. Selling Puts is bullish. I chose the 24s just in case Boone Pickens was right and oil went to 145 150 therefore pushing DUG to new lows. The value of the puts increases on DUG as the price of the ETF approaches the strike price. The opposite is true in that the value of the puts decrease as the price of the underlying increases. As Crude Oil futures and the high flying oil service stocks like RIG, HAL, CVX, APC, and SLB declined, DUG moved up to 28.47 from a low of 25.41. Oil closed the day at $131.60, up $0.79 on the day. We have the option to close the position early or wait for the puts to (hopefully) expire worthless. DUG has resistance at $28.75 from a gap that was established earlier this week.
The other commodity story this week was Gold. As the re-emergence of inflationary pressures became more evident Gold was this weeks inflation hedge of choice. After basing near the 860 865 area Gold Futures rallied to a high of 935.5 before settling at $925.80. This has been a very volatile commodity. The chart below shows a variety of moving averages. The most relevant being the 50 (Blue) and 89 (Gray) day SMAs show that the price has broken and closed above the two moving averages for three days in a row. A little consolidation is due and a retest to the 50 day SMA at 914.49 would be healthy. There are a few options for option traders to play Gold. GLD doesnt trade options. The Power Shares DB Precious Metals Fund (DBP) trades options and represents about an 80/20 Gold and Silver split, respectively. The only problem is that the options have very little volume. The Gold Bugs Index ($HUI) trades options too but like the DBP has little volume and open interest. Then there is the CBOE Gold Index ($GOX). The $GOX is a decent index to write options on because it is priced at $194.88 versus the $HUIs $441.20. That means it costs half the margin to write options on the $GOX.
As mentioned earlier the $SPX attempted to close above the coveted 200 day SMA on Monday but was unable to hold onto the morning gains. The market traded flat on Tuesday until the Federal Reserve minutes were released. The easy explanation of the minutes is that a couple of the governors had dissenting votes which indicated that the inflationary pressures may potentially create the need to increase interest rates sooner rather than later. Wednesday the market broke the two month uptrend line and continued to close just above the 50 day SMA. With the recent decline, the 89 day (Grey line) may be the next line of support (at 1358.65).
The above chart is a depiction of the daily $SPX chart with exponential Bollinger bands and RSI. The close is near the lower Bollinger band. However, the lower Bollinger band is declining. This suggests that the amount of volatility is increasing and thus the downside potential is also increasing. The midline or the 21 day Exponential Moving Average is represented by the Dark Green line. I began using the Exponential Bollinger band study about four years ago when I discovered the Bollinger band lines were much more responsive to price and the range of price. Bollinger Bands can be a good indicator of the price range but can also provide an early indication of the stocks tendencies. For instance, the $SPX charts upper Bollinger band is flatter than the lower Bollinger band. The lower band is curling sharply lower too almost as if the indicator was taking a cue of the fast moving averages decline (8 day EMA in Magenta)
The above grid represents the $SPX June Open Interest at each strike price. The put open interest represents possible peak support at the 1350 price level. The Call Open Interest shows resistance at the 1400 level. There is a little more Call open interest than the Put open interest which is interesting in that the total Put Open Interest is greater for these strikes than the Call strikes.
The Nasdaq 100 ($NDX) began the week above the 200 day SMA and about down 3.27% Year to Date. By the end of the week the $NDX was down 6.42% YTD. As mentioned earlier the index filled in an important gap at 2040 on Monday and declined precipitously to end the week down 72 points at 1958.
The $NDX chart shows the gap (in yellow) from January being filled on Monday. Another important point with this chart is that the $NDX broke the 200 day SMA (red line) but managed to close above it by the end of the day. The technology weighted index managed to close down 5.96 or 15 points above the intraday lows (1943.85) while the $SPX closed near its lows on Friday. If the $NDX cant hold above the 200 day SMA, there is a gap that could need to filled at 1846. 1846 is just above the 89 day SMA but below the 50 day SMA. The support for the $NDX is that the Slow Stochastic is oversold.
However, the Bollinger Band chart doesnt convey the same story of support. The price resembles a cliff hanger holding of for dear life at the 21 day EMA (Green Line). In addition, the RSI isnt at extreme lows either. The Lower Bollinger Band is still advancing. This shows that the lower band is still providing support. The problem with the lower band being support is that it is 60 points lower. The Open Interest grid (see below) shows a similar fate. Peak Put Open Interest doesnt exist until 1900. Peak Call Open Interest is close at 1975. That shows that option investors are placing a lot of resistance at 1975.
The CBOE Volatility Index ($VIX)
The VIX reached a short term peak low on Monday and trudged higher all week. The weekly low of 15.89 broke the prior October low of 16.08. Had the VIX closed below 16.08, the sentiment indicator would have continued to signal a bullish signal. Since it bounced on Monday, the trade signal was to neutralize long positions and/or begin positioning into bearish trades. When writing The Contrarian I look for the signal to be confirmed by the slower to react 10 day SMA of the $VIX (shown below).
As you can see the Moving average has only flattened out its decent and not confirmed a bearish trade signal. A good example of the confirmation was the moving average crossover on 3/27/08 which signaled the bullish trade signal that is just now being removed. There were multiple short term signals provided from the sentiment indicator but the patient trader waits for the confirmation and positions their portfolios with an overall bias. When running a Multi-Strategy portfolio one can weigh the portfolio according to the signals bias and then take opportunistic positions on the short term signals we get from the actual $VIX. In summary, there isnt a new bearish signal yet.
CBOE Put/Call Ratio Update
Normally, the Put Call ratio signal updates are on Wednesdays. But I wanted to take this opportunity to cover the recent signal change. We got a sharp bounce up in the CBOE Equity Put/Call ratios 10 day SMA this week which created a neutral signal. However, the 10 day SMA wasnt able to break above the 20 day SMA to signal a confirmation of a bearish signal.
Since we are an option trading website I want to discuss options and strategies that utilize options. With the popularity of ETFs there have been many new concepts delivered to the market place. The Ultra Shares have begun to trade options thus providing a leveraged product on a leveraged ETF. Disclaimer: This isnt for the faint hearted. However, lets assume it is 3:50 PM and that we think that the market will bounce at the beginning of trading on Tuesday. Furthermore, our assumption is based upon historical high probability signals including technical analysis and sentiment indicators. Thus we take a position on the Ultra S&P 500 Proshare (SSO). SSO closed at $71.39 on Friday. The most aggressive option writer can sell and in the money put at the June 73 Strike for $3.70 per contract. For this example, we feel the best coarse is to sell the June 71 Put for $2.65 per contract. Selling 10 contracts there is an approximate $14,000 margin requirement. Therefore, one contract requires $1,400. Since we are receiving $2.60 per contract, we have to have at least $11,400 in the account to initiate this trade ($14,000 less $2,600 initial premium). I will be doing the Wednesday Market Wrap and reviewing how the trade resulted. Have a nice long weekend.
Robert J. Ogilvie