Option Investor
Market Wrap

Over the Hump

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I dont know if it is coincidence or not but it seems like the market sells off everyday day I write. Stop writing the email asking what my schedule is! For most people working the close of Wednesday says we have two more days left until the Friday night office get together at the local pub and the weekend. For option traders Wednesday signals that there are only two days left until June expiration on Friday, the 20th. The last trading day for many cash-settled index options such as DJX, SPX, NDX and MNX options is Thursday, June 19th, with settlement prices determined by Friday morning's opening prints for the component stocks. Friday, June 20th is the last trading day for the OEX, XEO, ETFs and all equity options. ALERT! ALERT! The threshold for automatic exercise of stock-settled in the money options is has changed from $0.05 to $.01 beginning this expiration. Long equity options in the money by $.01 or more will be automatically exercised. Please monitor all your expiring positions. Be especially careful with the estimated $.15 DIA and $.45 SPY dividend on Friday morning.

The market internals on the NYSE show that 866 issues advanced versus 2268 declining. That is nearly a 3 to 1 ratio. At 1587 million shares traded, volume on the NYSE clocked in 262 million more shares than yesterday. The volume today was also higher than the 50 day moving average of volume on the NYSE. As for the $TRIN it was only slightly bearish at 1.10. Extreme levels above 1.50 and 2.00 can be good short term long entries. Perhaps one of these Wednesdays the $TRIN will read really high and signal that capitulation occurred. If this happens, we will go through a couple of trade ideas. We had one a few weeks ago that ended up working out pretty well.
The internals on the NASDAQ are advancing issues of 799 versus 2089 decliners. The $TRINQ did close above 1.5 at 1.56. The volume was 2,056 million shares and slightly above the 50 day moving average at 1993 million.

Down Reasons

The index futures markets moved down early on negative news from Federal Express (FDX). FDX missed by $0.02 but beats on revenues. The company guided Q1 EPS below consensus and guided FY09 EPS below consensus. FDX reported Q4 (May) earnings of $1.45 per share, excluding non-recurring items, $0.02 worse than the First Call consensus of $1.47; revenues rose 7.8% year/year to $9.87 billion versus the $9.6 billion consensus. FDX also issued downside guidance for Q1. They see EPS of $0.80-1.00 vs. $1.27 consensus. FDX continued to issue more negative news with downside guidance for FY09, sees EPS of $4.75-5.25 vs. $5.92 consensus. This guidance incorporates the current high fuel prices and the related impact on fuel surcharges, which are reducing demand for FedEx services and impacting yield across the company's transportation segments. This outlook is optimistic in that it assumes no additional increases to current fuel prices and no further weakening in the economy. Co said, "The operating environment for fiscal 2009 is expected to be very difficult due to the weak U.S. economy and extremely high fuel prices. However, we will focus on reducing expenses and remaining cash flow positive, and will continue to take positive steps to improve the customer experience across our portfolio of services." FDX closed down 2.03 at 82.60 which were up from the $80.75 open.

Fifth Third Bancorp (symbol: FITB) announced that it is raising $1 billion in capital and cutting its dividend in an effort to shore up its balance sheet. Adding salt to the wound was Moody's placing the long-term deposit and debt ratings of Fifth Third Bancorp and subsidiaries on review for possible downgrade. Today's rating action reflects Moody's view that much of the deterioration in Fifth Third's key credit fundamentals, including risk-adjusted profitability and efficiency, is likely to be permanent. "Most significantly, the bank's risk-adjusted profitability and efficiency are well below Moody's expectations at Fifth Third's current ratings level. Fifth Third's profitability and efficiency are likely to remain below our expectations because, in Moody's opinion, spreads on its loan portfolio will remain tight and provisions for loan losses will grow in the foreseeable future." The stock closed down 3.62 at $9.26.

Moody's is becoming the grim reaper of the financial sector. Today Moodys confirms MF Global's (symbol: MF) Baa1 rating and assigns negative outlook. Moody's confirmed the Baa1 long-term issuer rating of MF Global. The outlook on the rating is negative. The rating review was initially triggered by MF Global's announcement that it incurred $142 million in losses due to unauthorized trading by one of its employees. The review focused on the MF Global's ability to establish a sound long-term capital structure and improve its risk management, while sustaining the companys customer franchise and successfully managing its daily liquidity needs. MF closed down $5.41 at $7.83.

Pfizer will not have generic competition for the world's best selling drug Lipitor for 20 more months after settling a lawsuit with generics manufacturer Ranbaxy Laboratories. The good news is that the stock gapped up at 18.50. The bad news is that the stock only closed up 0.12 at 17.77.

On the Bright Side
Good news came from a couple of companied today. Early in the morning, probably when all the bagels and bread were baking, Panera Bread (symbol: PNRA) raised Q2008 PES guidance. The company issued upside guidance for Q2 (Jun), sees EPS of $0.48-0.50 vs. $0.42 First Call consensus. The increase is driven by projected co-owned comparable bakery-cafe sales growth of 6.1% to 6.4% (versus its previously targeted range of 5% to 6%), and better than expected margin improvement on higher growth in gross profit per transaction. Panera also announced that with the continuing rise in gasoline prices, they expect an incremental $(0.02) to $(0.03) per diluted share of negative impact on the previously announced EPS target range for 2H08. PNRA gapped up at 49.42 but closed down from the open at 48.11 but up $2.39 on the day.

Monsanto (symbol: MON) announced its Board declared an increase in the quarterly dividend on its common shares from 17.5 cents/share to 24 cents/share, an increase of 37%. The stock closed down $0.54 at $141.50 but is basically rubbing their prosperity in all of our faces.

Morgan Stanley (symbol: MS), a financial company, beat First Call Estimates by $0.03 but missed on revenues. MS reported Q2 (May) earnings of $0.95 per share, $0.03 better than the First Call consensus of $0.92. Revenues fell 38.0% year/year to $6.51 billion versus the $7.05 billion consensus. The annualized return on average common equity from continuing operations was 12.3% in the current quarter, compared with 29.4% in the prior year. The company reduced the leverage and adjusted leverage ratios to 25.1x and 14.1x, respectively. The stock closed up $0.22 at $40.69 per share as many other financials were distributed.

Boeing was informed today that the Government Accountability Office (GAO) found in Boeing's favor on a number of issues related to its protest of the U.S. Air Force's award of a $35 billion contract to supply the service with its next-generation aerial refueling aircraft, or KC-X tankers which are slated to replace the current fleet of KC-135 tankers. Boeing released the following statement from Mark McGraw, vice president, Tanker Programs: "We welcome and support today's ruling by the GAO fully supporting the grounds of our protest. We appreciate the professionalism and diligence the GAO showed in its review of the KC-X acquisition process. We look forward to working with the Air Force on next steps in this critical procurement for our war fighters." This news basically means the Dow Jones component can present another bid to replace the tankers originally thought to be built by Northrop Grumman (NOC). This news helped the markets from collapsing further.

The CBOE S&P 500 Volatility Index (VIX)

The $VIX advanced 1.11 to 22.24 today. As the chart shows the index came down to touch the uptrend line. The 200 day SMA at 22.83 provided some resistance for the index that measures Implied Volatility of the $SPX. As the $SPX declines the $VIX usually moves up. This inverse relationship is believed to occur from the declining market prompting speculators to buy put option at a rapid rate. The increased rate represents the willingness of the speculators and portfolio managers buying protection to pay higher prices as the supply evaporates. Supply evaporates at cheap volatilities because the increasing volume of put buying indicates to the store owner (the market makers) that there is a lot of demand at the current prices. The store increases the price and therefore causes inflationary pressures on the options price. Higher prices represent higher implied volatilities.

If the $VIX can break above the moving average cluster just above the close 24.47 will be the next target high to test. A test of this high without a breakout and close above it can be a decent short term long entry. I cover the current signal the 10 and 20 day moving averages are signaling in The Contrarian part of the newsletter. The Slow Stochastic (blue line = 29.76) has crossed above the 3 bar moving average (red line = 27.45). A cross and re emergence close above 20 normally signals a long. The index is currently on an uptrend. An uptrend in the $VIX represents increasing fear as measured by option premium and therefore confirms the downtrend in the underlying security ($SPX).

The S&P 500

The last few days have been trying for the bulls. The 89 day moving average served as significant resistance on Friday, Monday and Tuesday. The $SPX closed down a little of 13 points at 1337.84 after hitting an intra day low of 1333.40. As mentioned before, the volume on the broader market NYSE was higher than average and also classifies today as a distribution day. The next line of support is the 1324.25 low from April 15th. As the chart below shows the Slow Stochastic has also curled over. The $SPX may or may not bottom out at the next support because the Stochastic (51.85) has a lot of room until it is oversold.

A break below the 1324 support could put the index in jeopardy to breakdown completely and run down to around 1270. The uptrend line is currently inline with the 89 day moving average which should provide even more resistance once the market bounces.

On the above chart the lower Bollinger Bands has flattened a bit while the upper band is declined at a rapid pace. Last week I wrote how this might happen after the upper band began to go up while the index was breaking down. The 8 day Exponential moving average was the first line of defense or resistance earlier this week. The 8 day EMA is still below the 21 day EMA. A coincidental point here is the lower Bollinger band is about in line with the 61.8% Fibonacci line, giver or take a couple of points. Technical analysis is an art and a science. It takes science to calculate and view and art to interpret each chart. As with most art each spectator has the right to obtain their individual impression of the picture. For instance, I see a bearish pattern on the daily chart. You may put your own lines and indicators on top of the price and derive a completely different opinion from the same innate data. That is your right, and you may be right. One more point that I need to make is that trading the markets is not easy to do if you just pay attention to one stock or sector. It is just as important to understand various macro forces that affect stock prices. For instance, the internal pulse of the markets can be felt through listening to bond and commodity traders. The overall macro view of the market can be affected by something as simple as the exchange rate. My view is that the dollar should begin to strengthen somewhat and cause the crude prices to decline toward $100 by the end of the year. Why do I think the dollar should strengthen? Because as bad as America seems right now, the Euro zone (except for Germany) and Great Britain are about to experience a worse economy than ours. Also, the Fed is probably done flooding the world with greenbacks. Simply supply and demand: more supply lower value of the goods (the goods being the bad dollar). A strong dollar means that multi national stocks and international stocks will be fighting an uphill battle. That helps me come up with the plan to target companies with more exposure to the US. I am really looking at companies with exposure to Brazil, Germany, India and Canada. On to the next market, the NASDAQ!

The NASDAQ 100 (NDX)

I will be brief on this index today. The NDX closed down 21.72 at 1951.1 on higher than average volume. The day was classified as a distribution day and posses the threat to more to come. In addition, the NDX closed below the 200 day MA (1963) indicating additional reason for institutions to stay flat technology holdings. However, the 50 day moving average (1950) served as some short term support today. The Slow Stochastic ticked a little lower today but hasnt really confirmed that the momentum is negative.

The chart below shows the daily view of the NDX with Bollinger bands, the 8 and 21 day exponential moving averages and the 5 bar RSI. The NDX wasnt able to hold above the 21 day EMA for more than one day so far this week. Also the 8 day EMA is still below the 21 day EMA. I might have mentioned last week that the stock or index tends to retest its new found downtrend to the limits by running up to and testing the slow moving average as the NDX certainly did. The markets are like children, always testing their boundaries. The lower and upper Bollinger bands are moving down slightly. The lower Bollinger band (1910.67) is calling out as a target for the NDX to test. And with the RSI only at 40.11, there might be some downside room for the market to move to before reaching really oversold. However, a close above the 21 day EMA may reverse the chart to a bullish pattern. Both the NDX and Russell 2000 (RUT) have been showing astounding resilience while the Dow and S&P have been weak. This is probably due to the financial and consumer discretionary sectors. Here is a quick view of the RUT to show what I mean.


I think we are sick of oil news. However, just so you know, the crude inventories were released today and crude inventories for the week ended June 13 fell 1.24 million barrels, a smaller decline than the expected 1.75 million decrease. The commodity continues to run up with not much resistance. Todays low at 131.75 nearly touched the 21 day EMA and then bounced up to close at around 136.70.

From up above

Picture looking down at the market place, with all of its components and variables, as if you were sitting in the press box at a football game watching from high above. You have to wear two hats up here: one as the offensive coordinator and the other as the defensive coordinator. Each indicator is a player on your team. I like to play a different game by adopting a creative playbook that uses coincidence indicators for confirmation and contrarian indicators to move with the smart money. One of the players I use is the Put/Call Open Interest levels. While I forgot to highlight the strike prices, it is really easy to read how your opponent is lining up with your team. First of all, the out of the money calls show resistance levels and the out of the money puts show support levels.

The next NDX support levels are at 1950 and peak at 1850. The resistance is clearly at 2000 with 18,118 open options.

1325 shows some good open interest at 59,077 contracts. However, the peak out of the money put open interest is at the 1300 strike. Going up, 1350 stands as pretty good resistance with 21,693 contracts open. But the 1400 strike is really the peak level with 143,663 contracts.

Earnings and Economics for Tomorrow

The market will have to deal with the initial claims, leading indicators and Philadelphia Fed economic readings. There are seven companies confirmed to report earnings, including Carnival (CCL) and Circuit City (CC).


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