Option Investor
Market Wrap

Crude Reality

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I know I didnt come up with that title. I am not that creative. But the fact is that crude is on an uptrend as indicated by the daily chart shown below. It looked like we had a nice reversal and that oil may be on its way down to the 50 day moving average. But it ran down to its 21 day exponential moving average at about 126.

Then at about 9:00 AM EST crude began to run up to close positive on the day at $131 per barrel. I am sure everyone is tired of the coverage of this commodity. But it is affecting the economy and therefore the stock markets. Stochastic on the daily chart show that oil may still have room to move down. But the fact is it bounced hard off of the 21 day EMA.

Those of us with huge vehicles can only hope that the price comes down. The reality is that we should look for long opportunities on the commodity or related stocks. The Proshares DIG and DUG provide a leveraged ETF that allows investors/traders to go long the DJ Oil and Service index with two times leverage. On Saturday, I wrote about the DUG trade we put on in the Option Writer section of the newsletter. To review we sold the DUG June 24 Puts for $0.55 per contract. The current mid price is $0.225 with a bid/offer of $0.15 to $0.30. I didnt look at the price of the position at the open of the market. Unless it reaches $0.05 I probably wont close out the position. Why you may ask? Because I mostly intend to let the option expire worthless unless crude breaks above the previous high of $135 a barrel.

Todays summary is that futures were signaling a gap up open of $4 points on the S&P 500. The main reason is that Durable Orders were only down 0.5%. That was actually better than expected and caused the S&P Futures to open higher. The pre open on crude futures were also down which was giving a sense of false comfort. The market is very reactive to the commodity right now and basically declined while crude advanced. The market hovered around the break even line most of the day only to run up into the close. On the 15 minute time frame chart the $SPX looks to be breaking out with the 8 bar exponential moving average chasing the price of the stock up and also nicely above the 21 bar exponential moving average. The close was also above the 21 bar exponential Upper Bollinger Band. The can be a sign of continued strength and momentum. RSI or Relative Strength is trying to break above the 3:30 PM close. But it all starts over tomorrow.

The SPX

The bigger picture or daily chart below shows that the S&P 500 bounced off its 50 day moving average. On Saturday I was concerned that the indexs downward momentum was going to pull it to the 89 day moving average at 1360. The end result was that the market pulled off an up day after being down as much as a seven points. Frankly, the market may have some follow through unless some of the economic reports surprise us.

The Open Interest for the June SPX options can sometimes give us a different perspective of support and resistance. I have highlighted the peak open interest levels on the Puts and Calls in pink. The Puts show peak open interest at 1400. However, 1375 is next in line with 122,927 Puts open. On the call side 1400 is the peak open interest level at 209,583. That suggests to me that there is pretty good resistance at the 1400 level. You may be asking Why is out of the money call open interest resistance. One popular concept is to only think of the open interest as short options that institutions and hedge fund bets place. In addition, I think this way since it is one of the trades I made when running the fund. Furthermore, we assume these traders are more astute traders and considered the smart money that has more capital and market influence than us. What that basically means is that the smart money may be able to make the index close between these numbers. Another view is that a huge majority of retail option traders are buying out of the money puts and calls at these strike prices. If you are in the contrarian camp as I am you can view these levels are support and resistance since average (non-optioninvestor.com readers) investors are generally wrong the majority of the time.

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Not to forget the Dow Jones Industrials, but it was up 45.68 points today. The S&P 100 ($OEX) closed the day up 1.33 at 634.38 today. The NYSE was up 50.2 at 9364.34. Except for the last 30 to 45 minutes today was just a really boring day. The TRIN was at 0.80 at the end of the session. On the NYSE, there were 1700 Advancers versus 1400 decliners on 1,442,627,000 shares traded. That was higher than yesterday but less than the 50 day moving average (1,510 million). In summary, net advancers on higher volume counts as an accumulation day. The final internal report is that there were 48 New Highs and 92 New Lows.

The NDX

Today on the tech heavy NASDAQ 100 (NDX) we saw slightly higher volume (1812 million shares) on a slight advance of 4.63 points. However, the advancers fell to 1434 from 1894 yesterday and the decliners increased 423 to 1441. That means there were more declining issues than advancing ones. Therefore I cant call this as an accumulation day.

As did the S&P 500 the NASDAQ 100 opened higher and dropped in the first hour of trading. The open was at 2002 and fell 17 points to 1985 by 10:30 AM. By the end of the day the market almost made it up to the open print. That is somewhat negative to me. Perhaps the strength of the SPX will bring the NDX some help tomorrow. In addition the 5 bar RSI is still showing there is some room for the index to advance. But this stops at 4 PM while the futures trade all night. As I write this the futures are down 3 points.

The longer term daily chart provides more insight by presenting us with a view of the index bouncing off the 200 day moving average (Red Line). By the way, todays bar is red because it opened higher than it closed. The Stochastic indicator is based upon five bars and is showing that the NDX still has room to advance before reaching over bought status. Resistance is at 2050 from last Mondays intraday high while support (1943) is from Fridays low.

The open interest on the NDX is viewed the same way as the SPX. With a close at 2000, the peak open interest is at the money (2000) on both the Puts and Calls. However, we are looking where there might be resistance and support. The next level of peak open interest on the calls is at 2050 while the peak on the puts is at 1950. The strong point here is that the price resistance is at 2050, as mentioned earlier, from Monday. And the peak put open interest correlates to the price support from Fridays low at 1950.

The TNX

The TNX or CBOE 10 Year Treasury Yield has been slowing gaining strength over the last two months. The above chart is a daily view of the yield and is showing that there is heavy resistance at 4%. The high broke above the 200 day moving average (40.23) intraday and posted a high of 40.28. However, the yield closed at 4.01% just below the big red line. A close above the 200 SMA may put the yields back in bonds. If you trade bonds or bond derivatives, it has been frustrating to create a desirable bond ladder. Why do I watch bonds and trade them? Bonds can be applied as a cash collateral alternative to sell options against. Money markets (1 2%) arent paying very high and a properly allocated bond portfolio can be much better (5 8% corporate; 4 5.5% municipal).

I would normally cover the VIX and the Put/Call ratio here but that is way down at the bottom. Please read that section for my contrarian views. The $VIX declined 0.57 to 19.07 and the $VXO declined 0.32 to 19.67. I didnt spend much time on Gold today but it was more volatile than crude oil. Gold gapped way down to 891 and was down as much as 19 points before closing down about 8 points. On a daily basis, Gold Futures are looking weak and have near term support at todays low and then again at 861 (the 200 daily exponential moving average).

Important Earnings and Economic news due tomorrow are:

Other news today that moved the market include Chicos FAS (CHS) and American Eagle Outfitters (AEO) reported earnings today that surprised the markets. CHS beat by a penny while revenues fell 9.6% on year over year. Co said, "We continue to expect negative comparable store sales for the first half of 2008, and expect to have lower earnings than the first half of 2007. Our current expectations are to gradually improve and return to positive comparable store sales increases sometime in the second half of 2008 if we can expect some level of improvement in the economic environment resulting in overall earnings growth during this time frame." AEO beat by 2 pennies and revenues rose 4.6% on the year. The company issued in line guidance for the second quarter.

In transportation news, the Tranny or Dow Jones Transportation Index ($TRAN) increased about 1% on some news that UPS was going to step in and help DHL with its routes. The agreement, when finalized, would be expected to extend for 10 years and produce up to $1 billion in additional annual revenue for UPS. The company said it would begin phasing in a limited amount of volume in 2008 with ramp up in 2009. The agreement would not involve the pick-up or delivery of DHL packages to their customers, only the transport of packages, primarily between airports, in North America. As such, the work will be similar to that currently performed by UPS for the U.S. Postal Service.

Strategy Discussion

I truly enjoy educating option traders. So I want to continue that and review the SSO trade from last weekend that was based upon writing a short put trade on the June 71 strike. Dont forget, the SSO move 2 times the S&P 500. This is a turbo option. In our assumption, we sold 10 contracts at $2.65 for a total initial credit of $2,650 and an initial margin of $14,000. So if we wait until expiration, there is a chance of a max return of over 18% on the initial margin or over 20% on the cash needed.

The closing mid price is $1.75 which provides a potential profit of $900 on ten contracts. It is always nice to show how a trade works and also have it be profitable. I am sure I will pick one that will lose money so we can discuss money management and risk management techniques. My favorite topics to write on include discussing money and risk management and helping option traders understand why to use proper and consistent methods. The next view shows the Profit/Loss line of the position as of today as well as a very faint green line that shows profit points of the short put on expiration.

The max gain (Green Line) is the initial premium of $2,650 less transaction fees. Not that we covered the aggressive setup much but the June 73 puts that were in the money could have been sold for $3.70 per contract and are now marked at $2.60. Lets compare the trades.

Out of the Money: Current Profit of $900.
In the Money: Current Profit of $1,100.

The initial margin on the 73 Put is greater than the 71 Put. The 73 strikes compensation isnt enough to take risk of selling the 73 strike versus the 71. If we decide to hold the position to expiration then the 73 strike could provide enough added return for the added risks. As for now, we will keep this position and possibly cover it more next time. If the S&P 500 becomes extended on the upside, we should close out the position.
 

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