By the end of the day one might know that the US markets opened higher on strength resulting from reports that $250 billion of the $700 billion will go to purchase equity stakes in banks with a total of $125 billion going to 9 major companies which include the following banks: Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC). In addition, the FDIC will provide insurance for interbank lending and remove the $250,000 insurance limit on non interest bearing accounts. S&P 500 Futures were up nearly 40 points at the open while Naz futures had declined to only plus 25. Prior to the open Fed chief Ben Bernanke and FDIC Chairman Blair said that the overwhelming majority of banks in the US are strong and well-capitalized. The statement continued to confirm what I wrote about last night that the recent moves were to increase the perception of stability.
Johnson & Johnson (JNJ) posted a 10% year-over-year increase in earnings per share to $1.17. The earnings beat the average analyst estimate by $0.06. The company, which has benefited from strong international sales, also raised its full year earnings outlook, expecting to earn at least $0.04 more than the average analyst estimate next quarter. The stock closed up $1.32 at $64.00.
PepsiCo (PEP) posted a 7% year-over-year increase in earnings per share to $1.06. Excluding nonrecurring items the results missed estimates by $0.02. Profit margins were pressured due to increases in commodity and administrative costs. The company gave downside guidance for the full year that fell below the average estimate and will cut 3,300 jobs, or 1.8% of its workforce. Pepsi cited the economic situation and a strengthening dollar. Pepsi declined $7.37 to $54.40.
After the bell, Intel Corp. (INTC) posted third quarter results of $0.35 and beat earnings estimates by $0.01 with revenues in line with estimates. INTC also guided fourth quarter revenues and gross margins in line. Revenues rose 1.3% year/year to $10.22 billion versus the $10.26 billion consensus. The company stated the following: "As we look to Q4, it is hard to know what impact the financial crisis will have on end customer demand. We are confident that our product portfolio, strong cash flow, commitment to deploying new technology and market momentum will allow us to outpace peer companies at a time when business levels are difficult to predict. INTC is trading at $16.60 after hours or down $0.39 on the day.
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US Market Internals
The list above shows most of the stocks scheduled to report earnings tomorrow. As we get more into the month of October, the lists should grow larger. Tomorrow there are some widely followed stocks that can affect the overall direction of the market. For instance, Coca-Cola (KO) reports premarket. Wells Fargo and JP Morgan also report in the morning. It should be interesting if either company takes this opportunity to disclose their less than stable assets or is they keep to the current financial mantra of not telling the whole truth until it cant be hidden any longer. I distinctly remember recommending LEH for the OptionWriter because the company had just reported earnings and the health of their balance sheet as well as that the company didnt have significant exposure to the MBS markets that were affecting Merrill Lynch and Bear Sterns. As I recall, the stock was at about $52 and we had a stop at about $47 48. The position was stopped out a few weeks later and continued its decline to zero. I predict that some of the CEOs of the banks in question will receive Wells notices informing them of an SEC inquiry or a suit from the state of New York for publicly announcing their companies health when they were not. Other interesting reports will come from Novelus (NVLS) and EBAY. Abbott Laboratories, which just announced a $5 billion share repurchase program, reports tomorrow morning as well.
The above screen shot is from my trading platform. I apologize if some of the numbers are difficult to read, but the green Profit/Loss curve doesnt show up that well on the other color background choices. Normally I put these EPS trade on right before the report in order to get the peak in Implied Volatility (IV). But I will go through the hypothetical position for EBAY even though their earnings are due until tomorrow night. What you cant see is that the November IV is 72% while the farther out months are at an IV 52.4 -53.7%. The October IV is at 157% but there isnt enough premium even at these extreme volatility levels to risk the margin. Especially since this trade is meant to last overnight and be closed out within the first 5 to 30 minutes on Thursday. If we sell the 6 of the November 15 puts at $0.63 and 5 of the November 21 Calls for $0.54, the total initial Delta is slightly positive. Basically, it is as neutral as I could get it. Sometimes we can make a directional speculation and lean the positions bias positive (Bullish) or negative (Bearish). However, I try to think of the EPS trade as a Vega/Theta trade. That is I make the money from IV declining (Vega) and time decay (Theta). So if the stock stays relatively flat and IV drops my assumed 20% to about 52%, on Thursdays open the current position could profit about $375. The break even points are 15 and 21. The position could still be profitable on a 10% move up or down. At a 10% advance the position theoretically profits about $275 while the 10% downside move only profits $200. But the return on the initial margin requirement of $1060 is pretty good for a couple of days. The important point on these trades is that they dont all work. Thats why the return is so high. If you lost 10% on 40% of the trades and made an average of 20% on the rest, what would be your total return? 80%. If you arent comfortable with the strategy idea yet, watch how this example works out and then I will cover another stock next week.
There are a lot of economic reports due out tomorrow. Core PPI and PPI should identify the extent of the weakness in businesses. Furthermore, Business Inventories will give more insight into whether companies are able to reduce stockpiles rather than hold onto depreciating or disposable inventories. Retail sales will show the extent of the economic slowdown affect on the consumers willingness to shop. I know my wife hasnt been affected. In fact she went out this weekend for some retail therapy. Whats that all about? So my family is doing its best to support the US economy. What are you doing to help? I just got back from a meeting at a restaurant and commented that the slowing economy might be an illusion since the place was packed. Perhaps I live in an anomaly, but I doubt it.
The Put/Call Indicator
CBOE Equity Volume Put/Call ratio dipped down 0.697 which caused the 10 day moving average to tick downward. As the chart below shows, the 10 day moving average shot straight up from its low near 0.70 established a little over a week ago. I want to take this opportunity to alert the readers that the tick down in the Put/Call ratios 10 day moving average has altered the signal to a Positive bias. One of the reasons the signal is being shifted to Positive rather than Neutral is that the 20 day moving average also ticked downward sharply. The reversal represents the shift in the bearish trend of buying puts to selling puts and buying more calls. That shift in sentiment represents confirmation. As mentioned last week, CBOE Equity Volume Put/Call ratio usually provides short term long and short signals when it breaks above 1.0 and below 0.50, respectively. We could have pointed to the actual Put/Call ratio peaking above 1.0 two days in a row as an indication of mass hysteria and therefore switched to Positive on Fridays close. However, the shift in the trend in sentiment provides confirmation. The 10 day moving average closed down 0.008 to 0.864 while the 20 day moving average ticked down 0.024 to 0.811. Clearly, the 20 day moving average fell more. SIGNAL: POSITIVE BIAS
Volatility Index Indicator
The $VIX or the CBOE Volatility Index peaked last Friday at 76.94. That is higher than any other time that my charts show. As the market continues to decline, the $VIX has continued to move higher. Some traders try to trade the spikes up and down, but the trend has definitely been your friend lately. As of last nights close, the $VIX 10 day moving average ticked down for the first time since the beginning of the uptrend started on 8/29. While you may have missed the absolute bottom of the market, the confirmation of the signals bias kept you short or negatively biased for the last month and a half. The 10 day moving average dipped to 55.56 from 55.72 a day earlier. I had been repeatedly stating that as long as the signal remains negative that traders could short or add negative deltas when the $VIX tests its 10 day moving average. Since the signal switched to Positive the trade the test is no longer valid. However, the intraday test of the 20 day moving average earlier this morning provided a good trading opportunity to reduce ling exposure and/or establish speculative short trades. Therefore, for those of you that are trying to trade the spikes, try looking at trading the tests of the moving average/trend lines.
As stated above the signal is now Neutral and will quickly become Positive once the 10 day moving average remains lower than yesterdays close. A Positive confirmation will occur once the 10 day moving average breaks below the 10 day moving average. If the 10 DMA spikes above 55.72 then the Negative signal is back on. You all can track this signal easily in real time with your charting system. But I will do my best to alert you to any material events that change the bias. Finally, it should be noted that the signal could easily be Positive rather than Neutral. I just dont like the action the $VIX has had so far today. The test of the 20 day moving average showed that there are still plenty of fear volatility premiums. Basically, take your current Negatively biased positions and pair them off with more positive deltas with the goal of being neutral. While the market is down a bit maybe add some positive deltas to make up for the dip. Active traders can really take advantage of the $VIXs action around the moving averages. Longer term investors that may have portfolios that have similar beta weightings as the S&P 500 can sell slightly out of the money calls to hedge portfolios rather than a more aggressive hedge that would include in the money calls. Good trading. SIGNAL: NEUTRAL BIAS
Summary: The overall signal is a Neutral signal. The positive bias of the Put/Call ratio is somewhat offset by the Neutral to Negative bias of the VIX.
Since I covered the SPX in great detail last night, I will only spend a little time on it tonight. As the chart below shows, the market continued to trade in its current volatile state. Todays range was 1044.31 to 972.07 or 72 points (over 7% from top to bottom). There is one troubling thing about todays close. The SPX closed slightly below its 8 day Exponential Moving Average (purple line) for the second day. Maybe I am wrong that the current momentum could negate the downtrend characteristics of this oversold market. The RSI declined a bit today while the Slow Stochastics continued to advance quickly toward overbought territory. Perhaps the SPX will back fill to about a 50% retracement of Fridays low to todays high before it can establish some sturdy legs. The 8 day EMA is again the resistance point to which one could step into short trades while the 21 day EMA provides a better short term sell signal territory. A breach and close above the 21 day EMA and also the 9/29 low would signal to cover the short until the SPX dipped below the 21 day EMA again. Sell into strength in a downtrend until it doesnt work. Just make sure you define the level that doesnt work.
Last night I pointed out that the Naz Futures were already pointing to a gap
higher that would open the NDX above the gap down level. I was surprised to see
the early weakness and mentioned to another trader that the Naz was going to
fill in the gap while the S&P Sectors rallies a bit. By mid day I began
targeting the next gap up to be filled at 1317 from Fridays high (dotted blue
line). The RSI on the NDX ticked sharply lower as did the SPXs. The Slow
Stochastics, at 66.68, continues
to advance higher toward overbought levels.
Once the NDX dips about 47 points lower, we may have a buy the dip scenario on
some NASDAQ stocks with strong balance sheets and high relative strength. Well
thats all for tonight. Please be well this week.