Option Investor
Market Wrap

The Gist of It

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The day started out on a sour note with Corning (GLW) issuing downside guidance for the third quarter. GLW has had lower than expected shipments of LCD glass. LG, the manufacturer of LCD computer and HD TVs said that they are only at 90% capacity due to reduced demand. The technology sector declined about 1.7%. Semiconductor stocks fell 4.2% on GLWs news.

Financials advanced 1.4% today on Ambac Financial (ABK) confirming that it has received regulatory approval from Wisconsins Commissioner of Insurance to capitalize and restart Connie Lee Insurance, which will provide insurance for the Municipal bond market. Hope was the note at Lehman Brothers (LEH) with further speculation that the company will be taken over or receive a capital infusion soon.

Perhaps the slightly strengthening dollar is turning the table on foreign companies ability to purchase U.S. stocks. For instance, Coca-Cola (KO) is buying a Chinese juice company worth roughly $2.4 billion. ConAgra (CAG) fell 8.6% after reporting that earnings due would under perform in its consumer business.

On todays Fed Watch, the Beige book was released at 2:00 PM EST. The economic reports on a collection of economic reports from the 12 Federal Reserve districts. Todays report showed a slowdown in most districts. Most districts continued to report price pressures from elevated costs of food, energy and other commodities. Wage pricing pressures have remained subdues, though, as the slowing economic conditions have allowed businesses to curtail their salary increases. On the positive side, factory orders increased for the fifth straight month. July orders rose 1.3% versus the 1% consensus. June orders were revised to upward 2.1% from 1.7%. July orders declined from June.


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The Internals

At the NYSE, there were 1610 advancing issues versus 1483 declining issues. 36 new highs were overshadowed by the 121 new 52 week lows. The NYSE declined 27.72 points today on 1,208 million shares. With the $TRIN at 1.11, there is no trade.

The NASDAQ Composite had 1486 advancers versus 1312 decliners. There were 71 new 52 week highs versus 117 new 52 week lows. The COMP declined 15.51 on 2,115 million shares today.

What to Watch Tomorrow

Tomorrow morning we get the August ADP report. This report has garnered more attention since its data is provided by a private company versus the government. The market is expecting for a decline in employment. Usually a decline in employment equates to lower employment costs. However, people without jobs dont spend as much. It is a double edged sword. Following the ADP report, the government gets to take a stab at the employment number. I dont think that the 2nd quarter productivity revision will be market moving since we are almost in the fourth quarter. ISM Services will be closely watched at 10:00 AM. Finally, the Crude Inventories for last week may give some insight into the Gustav affects on the LOOP and Gulf oil patch. Crude oil doesnt seem to want to move above $110 per barrel until there is some fundamental reason to push it higher. Obviously, $4 per gallon caused the demand structure to collapse and people finally made efforts to reduce expenditures. A stronger dollar is also supporting the decline in commodities. The Eurodollar has moved from $1.59 per euro to $1.44 per euro in two months.

The media is waiting for some fireworks from the Homebuilders to see if the bottom is near. Toll Brothers (TOL) reports tomorrow before the open. TOL builds higher end homes primarily in the south east. Quicksilver (ZQK) and Jos A Bank (JOSB) are some clothing companies reporting tomorrow. Take Two Interactive and the Cooper Companies, Inc. might provide some volatility to trade. Actually, the volatility usually ramps up ahead of earnings. Option traders can sell the increased volatility and buy to close after the event. Sell high and buy low. The main risk is when the price moves farther than your break even points. That equates to a loss.

For instance, Take Two (TTWO) reports after the bell tomorrow. The percentages at the right of each months row identify the Implied Volatility for those options. Notice that the Implied Volatility for September is 111.32% versus Januarys 55.13%. Normally we would look at the historical volatility and stack it up to the implied volatility to determine the direction of the volatility bias, but this is for a quick trade. I can usually look at an option string and determine the probabilities. Now I have fancy tools like the one above to help speed up the analysis. Basically, if Implied Volatility declines to Januarys levels, the trade has the potential of profiting $578 from the decline in volatility and another $13.22 for one day of time decay (Look under THETA). The initial margin requirement for this trade is about $1,249.06 ($662.77 + $578.43). According to the price slices, TTWO can move up or down 10% and remain profitable. If you do this trade, it is best to close the position our within the first 15 minutes of the trading session. If it loses at the open, dont try to be smarter than the strategy. Some of these lose. The goal is to profit on 70% or more of them and lose no more than the average gain on the other 30%.

The S&P 500 (SPX)

The SPX has been quite boring lately. Yesterday, however, was a lot more interesting. I like to gap up and then the nice decline intraday. Strangely, the CBOE Volatility Index ($VIX) barely moved. At one point today, the SPX was down about 11.50 points but managed to close down only 2.60. I have drawn the Fibonacci retracement on the chart above to show that the SPX has maintained relatively close to the 38.2% level. In addition, the spikes lower have done so without piercing to lower lows. However, the advances keep getting slammed down at resistance that was first at 1315 and then at 1305. Declining highs and increasing lows form a triangle pattern. We are waiting for the breakout in either direction. An early indication could come from a break of the 14 day Average True Range. One would then take the direction at the time of the break to determine whether to go long or short. Neither the RSI nor Slow Stochastics are giving us an accurate gauge to determine the SPXs future directional tendency. The upper and lower Bollinger bands are squeezing together thus indicating that the volatility of the SPX is decreasing. In reality, the SPX is fairly volatile within this relative range. Support is at 1250 from the lower Bollinger band and the 50% retracement level. A break of the 50% level would greatly alter the shape of the chart and give room for the price to retest Julys lows. Yesterday the price tested the upper Bollinger band. The SPX is like a caged tiger testing the integrity of its new home. So far the ceiling is secure. While it is hard to determine the 8 day Exponential Moving Average (EMA) is slightly above the 21 day EMA.

The SPX has been hanging on for dear life above the 50 day SMA (green line). As the chart above shows, the SPX dropped below intraday but found some late day buying to help get back above. The Dow Jones closed positively today on the fact that it isnt as exposed to the energy and materials sectors as the SPX. While the SPX has remained in consolidation the Money Flow index hasnt moved up or down. If you are bullish, this is a good sign because the money flow hasnt peaked therefore providing ample room for buying to come in before reaching overbought territory. The peak in the ADX histogram correlates exactly with the low in the SPX. Once the ADX begins to advance upward above 15 20 the direction of the SPX is confirmed. Choppy trade occurs when the ADX is less than 20. Resistance is at 1320 from the 89 day SMA. The moving averages point the overall picture of the SPX; down trend. A close below the 50 day SMA will be a short opportunity since it is now the new dynamic support level. My guess is that the SPX would run down to 1240 on the weakness. However, the SPX might make a run upward to the 89 day SMA. September is usually very volatile since the go away in May traders arent supposed to back until October and it is the last month of the third quarter.

The Russell 2000 (RUT)

RUT is my new favorite technology sector. The NDXs chart isnt as pretty so RUT is my new best friend. The RUT is very volatile and keeps me on my toes. While the SPX set a lower low in July, the RUT squeezed out a slightly higher high in July versus March (see chart below).

ADX is moving up along with the RUTs price which confirms the uptrend. Interestingly the RUT has moving up while the Money Flow index has declined from above 70 on 7/29/08. Last Thursday, the 89 day SMA crossed above the 200 day SMA. If we just used the 200 day SMA, we would think that the RUT is on a downtrend. But looking at the 50 and 89 day SMAs the RUT appears to be on a newly established uptrend rather than just a bounce. Up trends are usually traded differently than bounce opportunities. For instance, professional traders buy the oversold conditions during an uptrend and scale out of part of the position at resistance levels and overbought levels. Oversold conditions in downtrends are riskier since there arent many other indicators providing confirmed long signals. Support is at the 89 and 200 day SMAs currently at 720. Dont forget that moving averages provide dynamic support and resistance.

Referring to the chart above of the RUT, the upper Bollinger band is fairly flat while the lower band is moving up fast in order to catch up and provide support if needed. The 8 day EMA remains above the 21 day EMA. The 21 day EMA provided support for the RUT yesterday. There is a little bit of convergence between the RSI and the Slow Stochastics. The RSI is showing upside momentum while the Slow Stochastics has crossed below the confirmation line. Generally, the Slow Stochastics crossing the moving average (green line) is a confirmation in the direction of the Stochastics line. We will have to see which one is right. The negative part of technical analysis is that there is always a line that can be drawn to make your opinion seem correct.

Sector Inspector

The Healthcare Sector (shown above) has remained relatively strong compared to the other 8 S&P sectors. However, the XLV has begun to weaken as traders are obviously swapping shares of this with other sectors just beginning to gain strength. For instance, the Financial Sector (XLF) has received some attention from investors and institutions. The XLF options were traded aggressively last week as the sector began to gain ground. The 8 day EMA broke above the 21 day EMA which confirms the long bias in the battered sector. However, RSI is overbought and Slow Stochastics is fast approaching overbought territory. Traders should be patient for the price to test the 21 day EMA before buying the XLF. There is existing momentum that could allow for a partial position to be placed. The benefit of partial positions is that you have powder dry for adding to a profitable position or reducing the cost basis.

The Consumer Discretionary sector (XLY) is shown below. The chart remains on a positive trend while the Consumer Staples sector is beginning to falter. There is still room for upside momentum as indicated by the RSI. The Slow Stochastics crossed just below its moving average at the close today. One way to trade the uptrend is buying one third at these levels and then wait for a test of the 8 day EMA for another third and the 21 day EMA for the remaining position.

Money seems to be exiting the Materials, Energy and the Technology sectors and moving into the Healthcare, Consumer and Financial sectors. The Industrial Sector is maintaining its stability. If the XLV declines below its 21 day EMA which would probably cause the 8 day EMA to fall below the 21 day EMA, the position should rotate to the XLI. Good trading to all!

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