Option Investor
Market Wrap

Market Wrap

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The S&P 500 ($SPX) closed off its high but higher than the intraday low of 1298. The markets advanced from crude oils decline and gave the gains back when oil bounced. Today was a slow news day. But there was some positive news about Freddie Mac and Fannie Mae today regarding their S&P ratings. S&P affirmed its AAA/Stable/A-1+ senior unsecured debt rating on Freddie Mac and Fannie Mae. However, the ratings on their subordinated debt and preferred stock ratings were lowered to A- from AA-. In addition, the risk-to-the government rating decreased to A from AA- on Freddie Mac and A- from AA- on Fannie Mae. This affirmation reflects the strong implied U.S. government support these securities hold in the marketplace. FRE declined 0.29 to $5.60 while FNM declined 0.44 to $8.40. Even though NY Attorney General Cuomo announced that he is expanding the probe in the Auction Rate securities, the financial sector (XLF) was up 1.41% on Wells Fargo, Citigroup, Bank of America and Washington Mutual.

Boeing fell today on news that the company may not bid on the $35 billion Air force refueling tanker contract. BA was down $1.24 at $66.62.

The New York Stock Exchange (NYSE) closed up 34.93 at 8492.94 on 1,647 million shares in todays session. This is well below the 50 day moving average of 1,720 million shares but higher than Fridays volume. There were 1960 advancing issues versus 1208 declining issues. Finally, there were 71 new highs and 46 new lows. Overall the internals were positive. The market is basically chugging along here and not yet indicating exhaustion. A day with three to one advancers and a $TRIN reading less than 0.50 would show that most of the buying had occurred. Therefore, internally there is still room for the markets to go up.

On the NASDAQ Composite ($COMP) there were 2001 advancing issues versus 889 decliners. The $COMP internals appear healthier than the NYSEs. For instance there were 103 new highs and 67 new lows. The $COMP advanced 25.85 points to 2439.95 on 2,292 million shares or just above the 50 day moving average of 2,238 million shares.


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The S&P 500 opened lower this morning and fell about 5 points before finding support and launching up to a gain of 16 points before declining to close at 1305. The advance was most likely spurred on by continued buying in the financial sector. But with crude oil declining further intraday the consumer staples and discretionary sectors found buying interest. I wasnt certain that the down oil scenario would spur buying in consumer related stocks. I am still not sure people are actually spending their extra 10 20 cents a gallon on clothes and diamonds yet. Maybe the combination on lower food costs and energy expense will actually convert into increased consumer spending.

The SPX finally broke above the 1291 resistance barrier on Friday and then continued to advance higher. I was talking to a friend in the business today about how much higher the market could go. It gave me a chance to talk coincidence indicators. Please refer to the above chart for reference. The heavy blue horizontal line represents the next price resistance level. This level coincidentally lines up with the 89 day simple moving average (SMA) at 1336 (the grey line). I think that if the SPX can break above the 127.2% Fibonacci price extension level at 1315 that the next high level would be around 1335. Notice that todays high was just below the previously mentioned Fibonacci level. The SPX closed above the 50 day exponential moving average and the SMA today. Continued closes above the 50 day may help to provide institutional support in the index. A break below would be a quick short signal that there isnt continued support here. However, should the index consolidate it could make a run up to the 200 day SMA currently at 1373. The negative points of the moving average chart are that both 50 and 200 day SMAs are declining. That confirms the downtrend in the SPX. Also showing weakness is the 14 bar Money Flow indicator; which peaked near 60 and has declined near 48. We want to see uptrending Money Flow along with the SPXs price.

Even with Thursdays decline the SPXs 8 day exponential moving average (EMA) still managed to close above the 21 day EMA. Fridays bounce off the uptrend line broke above the 1291 resistance and managed to close at 1296. Today the SPX continued to bounce upward near the upper Bollinger band at 1318.75. Your Bollinger bands may appear different than mine since I use the 21 day EMA as the based to generate the upper and lower bands from. Applying the formula of 2 standard deviations to the more agile exponential moving average produces more responsive Bollinger band movements. But that is my opinion. I used to use the default 20 day simple moving average. In addition, I have embedded the 8 day EMA into the indicator. Notice that I tend to look at the same indicator settings that the majority of institutions, financial advisors and novice investors watch. I do this because I want a broad perspective of the majority. Then I watch the Fibonacci levels, the simple price support and resistance levels and the uptrend and downtrend levels for coincidence indications of support and resistance. Todays high established a recent high to set a new recent high resistance level as well as a high to post the uptrend line from July 9th. As the chart above shows the SPX is forming a narrowing upward moving channel. The RSI is almost overbought at 67 while the Slow Stochastics has turned lower from Friday. The blue Stochastics line has closed below the red Stochastics line (the 3 bar moving average of the blue line) which indicates that the market may be nearing a short term high. It is hard to call the next move here. The positives are that there is still room for the SPX to run until resistance at 1315 and again 1315. The other positive is that RSI still isnt overbought and the 8 day EMA is above the 21 day EMA. Negative indications are from the Stochastics as well as the SPX running up to the 127.2% Fibonacci level and closing noticeably lower.

I have downloaded the September open interest into the graphs above and below to show where cumulative option investors are placing bets on support and resistance. Support is from peaks in put open interest while resistance is from peaks in call open interest. The SPX closed today at 1305. There is a lot of open interest at 1300 and 1400. 1350 has the next peak level at 81694 contracts. The actual peak is at 1250 with 201,571 contracts. As for the support levels, the 1250 level appears to be providing support as well.

The NASDAQ 100 (NDX)

The NDX is showing a lot more promise than the SPX in that the NDX has broken above the 50 and 200 day moving averages while Money Flow has also continued to advance. Today the NDX moved up to 1962 or up 32 but closed at 1941 up 15. Last Wednesday the NDX moved up to the 50 day and closed just above it. Thursday the NDX rested followed by Fridays breakout. The gap down resistance at 1910 was also filled in from this advance. However, the gap up from March at 1752 still needs to be filled, eventually. There is resistance again at 1993 which correlated to an open interest resistance level that I will cover in a little bit. New support is the 200 day moving average and then the 50 day moving average.

The above chart of the NDX is similar to the SPX in that the 8 day EMA is above the 21 day EMA. The NDX still isnt out of the woods yet. The Slow Stochastics is overbought at 87 and is also below the 3 day moving average which confirms the price action is over extended. Also overbought is the RSI. A tick down below 70 would confirm that the NDX is headed back down to test support. The uptrend line is somewhat flat and not at all suggestive of the recent thrust upward. Support may be found at the 8 day EMA (1888).

The NDX closed at 1940. There is peak open interest on the calls at the 2100 strike price with 11780 contracts open. Support is at 1850 with 11928 contracts.


It should be noted that I was wrong two weeks ago in assuming that oil could move up to the then 50% retracement at 133 and 50 day SMA. Last week I noted that there was more supply and that the price appeared to be headed toward $110 112. Todays low of 112.72 almost makes me right. Much of todays afternoon volatility was attributed to crudes dip down and then back up to even just prior to the NYMEX market close. After the close, the SPX and NDX, to name a few, sold off sharply from their highs and never regained their ground.

I am really looking at the 110 112 level to be touched for confirmation that crude is ready to bounce. Both the RSI and Stochastics are oversold. A bounce higher in the commodity may cause the indicators to re-emerge out of oversold territory and confirm a bounce. Also necessary is for the price to break and close above the 8 day EMA (currently at $118.12).

The above chart of the NYMEX crude oil contract (Root symbol CL) shows that there is support near 113 from the 127.2% Fibonacci price extension line along with the support from the 200 day EMA (at 112.34). The 200 day SMA is at $110.16 which also correlates to the May 1st $110.30 low. Money Flow is oversold at 28. However, it could go lower if the 162.8% Fibonacci price extension comes into play. It should be noted that $110 isnt the absolute support. I believe that a test of these levels will be followed by a move higher. We might have seen the short term low in todays capitulation like action. So watch for a confirmation from the price closing above the 8 day EMA to go long. If you are short, that level could also be your stop level.

Other than the futures contract how can you trade oil? I have mentioned the Proshares Ultra Short Oil & Gas ETF (DUG) in previous newsletters. DUG has been my preference due to the lower underlying cost. If I sell options on the Ultra Long Oil and Gas ETF (DIG) the margin is based upon the $79 current price. The $38.24 current price of DUG requires less margin per contract. Lets assume I want to go long Oil here. The main consideration is whether I can sell half number of put contracts of DIG for more premium than selling twice the number of DUG calls. It also depends upon where the support level is on each contract.

Trade Example

Sell 2 of the September 44 Calls (there is resistance there) for $1.65 per contract
Gross premium of $330
Margin Requirement = $765.89 (approximately)

Sell 1 of the September 70 Puts (there is support there at 73 and 66) for $3.40 per contract
Gross premium of $340
Margin Requirement = $700.02 (approximately)

Obviously the 70 put costs less and provides more return ($10). But is there easily measured support and resistance? DUG clearly has resistance at $44 and support at the 200 SMA. DIG is well below its moving averages now. So there isnt much there to help determine risk management. I still like DUG for now.

The Sector Report

I am currently working on a sector rotation strategy to provide a more tactical investment approach for the advisors I manage money for. You might have heard or read about the Core and Explore investment methodology. For instance, everyone tries to beat the S&P 500 or the Dow Jones averages. The basic strategy is to go long the S&P 500 SPDR (SPY) and either buy the assumed strong sectors and/or short the weak sectors. For instance a good hind sight trade would be short the S&P Energy SPDR (XLE) and long the S&P Consumer Staple SPRD (XLP).

If you can only go long in your account (i.e. most IRA accounts) then you might just buy the stronger sectors to overweight them. For instance, the S&P Consumer Discretionary SPDR (XLY) sector sold off quite a bit earlier this year but has bounced nicely. However, in todays action the ETF ran up to its 200 day SMA (red line) and closed lower. Additional weakness would give reason to either sell the position or hedge the ETF heavily at the 32 or 33 levels with calls. Another trade is to short the ETF altogether. The main problem with the SPDRs is that the options have very little option premium.

The S&P Healthcare SPDR (XLV) has also shown some relative strength this year. As the chart below represent the Healthcare sector has been in an uptrend since mid June. However, it is reaching over bought territory and the sector rotation may begin soon.

The new sectors that may be of interest to buy include the S&P Energy SPDR (XLE). The chart below as well as above shows how deeply the sector has been sold off. The stocks have declined further than the commodity they produce.

A break and close above the 8 day EMA (pink line) would confirm the long bias. Another sector of interest is the S&P Materials SPDR (XLB). It too has been thrashed and beaten down to oblivion. Since the options have little premium to sell the alternative is to buy the long term options as a stock replacement strategy. For instance, buy the SPY or the SPY March 129 Calls and sell the September 137 Calls for a net debit of $8.86 per contract. The trade is a positive THETA trade which means it will not lose money from time decay for a while. Then buy calls on the sector ETFs that you want to overweight and buy puts to underweight. There are a couple of brokerages that allow long and short options within IRAs.

I also think the XLB or S&P Basic Materials SPDR ETF is the next sector rotation. My indicators show that Healthcare, Financials and Consumer Discretionary may sell off or consolidate and Consumer Staples may just consolidate; while Energy and Basic Materials may bounce. If the market and economy is going to advance even energy stocks need to move up, eventually.

Tomorrow is light on the economic report front. However, Wednesdays retail sales should provide some insight into whether or not the consumer is beginning to spend their gas savings at the mall. CPI and initial claims will be interesting for those that follow inflation. The market expects an increase of 0.4% on the July CPI versus Junes 1.1% increase. I guess the lower July is supposed to reflect the consumers lack of demand and is therefore providing an averaging effect to Junes huge increase. Good trading to all.

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