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Market Wrap

Market Summary

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The broader markets moved decidedly higher today on the follow through from the international markets. For instance, the Nikkei moved up 311.70 points to 9,005.59 and the Hang Seng moved up 769.80 to 15,323.01 or 5.3%. In Europe, the FTSE increased 190 to 42.53, the DAX increased 53.1 to 4,834.4 and the CAC moved up 3.6% to 3,448.5. Some of the strength in the pre-market was being partially attributed to companies like Eaton (ETN), Halliburton (HAL) and Hasbro (HAS) beating their earnings. Other news that supposedly gave support to the pre-market strength was about NRG Energy (NRG) receiving an unsolicited buyout offer by Excelon (XEC). The deal stipulates that NRG share holders will receive 0.485 for each EXC shares. Other positives came from South Korea saying that it will inject $30 billion into the system and guarantee up to $100 billion of the foreign debt held by its banks. The Netherlands are injecting about $13 billion into ING, a fairly large insurance and annuity company, in order to improve some of its tier 1 debt.

By the open the S&P Futures were up about 10 points where they traded flat for a few minutes before running up to 10:00 am or just prior to Federal Reserve Chairmans testimony before the House Budget Committee. In his testimony, the chairman said he feels the governments recent actions will help restore the financial system. However, he cautioned that the stabilization of the financial system will take time to eliminate many of the economic challenges we are experiencing. He then added that there is likelihood for a weak economy for several quarters to come. It is his belief that the Congress should consider a second stimulus package that would be targeted to increase overall spending and economic activity.

Even though the broader markets advanced upward nicely today, it was done so on lower volume. The S&P 500, NASDAQ, Dow Jones Industrial Average, and Russell 2000 all advanced today and were up 4.77%, 3.13%, 4.67% and 3.88%, respectively. For instance, while the NYSE advanced 5.7% today, the volume on the exchange was only 1.66 billion shares versus the 50 day moving average of 1.83 billion shares. There were 2,909 advancing issues versus 572 declining issues today. Basically, 84% of the issues advanced. Since we are in an apparent bottoming or bouncing phase, whichever you prefer, there werent that many stocks making new highs. For instance, there were 8 new 52 Week Highs and 105 new 52 Week Lows. The NASDAQ Composite wasnt as strong as the big board, as it was only up 3.43% versus the NYSEs 5.7%. 2,164 stocks advanced today and 753 declined on 2,053 million shares. The 50 day average volume is 2,359 million shares.

Treasury Note

The CBOE 10 Year Treasury yield or the TNX declined 0.52 or 5.2 basis points. When the TNX declines in price, the notes are being accumulated and the price is therefore advancing. Normally, when the dollar strengthens and the TNX declines it usually indicates that foreign money is accumulating US debt instruments.

As the chart shows, the TNX is finding support at the 89 day SMA (purple line). If the 89 day SMA doesnt hold, the 200 day SMA at 3.79% (the pink line) will be the next support level. One would think that all of the Feds injections of dollars would translate into a weaker dollar. But the US economy, as weak as it is, appears to be a better place for foreign investments. As option traders, we want to find a way to profit from a move in almost everything. The TNX is optionable. However, there isnt that much volume or open interest. The iShares Lehman 20 Year Treasury (TLT) has options that are more liquid. The price of the TLT has hit peaks around 99 when the TNX dips to 34 or lower. The recent low in the TLT is at 93. Note that the TLT and TNX arent exactly inversely correlated. The Proshares have just released the Ultra short 20 Year Treasury (TBT) which is twice the inverse of the TLT. But there arent options on the TBT yet.

Upcoming Events

This is a slow week in economic reports. Thursdays Initial Claims will only give traders a little glimpse into the most recent employment trends. The Federal Reserve meets next week. At 10am on Friday, the Existing Home Sales will continue to confirm that very few people are selling homes.

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There are a lot of earnings due out tomorrow. There are well over 250 companies reporting their earnings tomorrow. Many refer to tomorrow as Super Tuesday. In the morning, we can expect big name companies such as 3M (MMM), Caterpillar (CAT), Schering-Plough (SGP), and Pfizer (PFE). Apple and Yahoo will be closely watched right after the bell tomorrow afternoon. Panera (PNRA) is another company I watch which will be releasing their earnings tomorrow afternoon. E Trade and OptionsXpress report tomorrow as well. For those of you interested in a market neutral position to trade the APPL or YHOO EPS release, look at the trade setup below. However, as I pointed out with EBAY it is best to place the trade in the last half hour of the trading day because the price of the stock can move all over the place and the Implied Volatility (IV) reaches its max just prior to the EPS release. Since this strategy is based upon shorting Vega, we want the total Vega to be negative when viewing the price slices. If we were long (positive) Vega, we want IV to increase. Since IV usually peaks just ahead of a major corporate event, we want to sell the premium at its peak. There are substantial risks to this trade. One risk is that you are subjected to the after hours stock trading possibly affecting your profitability while you are stuck until the open to exit your options. Another risk is that the open of the stock gaps open out of your profit loss range that you determined from the assumed decline in the amount of IV.

As the picture above shows, the Theta is 212 or equivalent to a theoretical profit of $210 per day from time decay. That means that by Wednesday morning, the above position should have profited a total of $210. The Vega at the current price is minus 168. If the IV declines by 10 points while the price stays the same (it wont), the position will profit approximately $1,600. Since the position has a negative Delta, it will profit from a decline in the underlying stocks price. The cost to place a position like this is about $980 per contract. The margin requirement has already taken the proceeds from the two sold options into consideration.

In the above picture, the P/L increases to $1,948 on Wednesday. The vertical red lines depict the breakeven points on Wednesday. Mind you that all of these numbers are theoretical until realized. AAPL can gap up or down 10% before the positions becomes a loser. At this positions max, it could profit about 19%. We could sell call and put spreads to reduce the margin but that would also reduce the amount of profit potential. I will do my best to add this trade to tomorrows Market Wrap as it should look. For those of you that are also Option Writer subscribers, expect an alert tomorrow afternoon with this trade setup.

The Index Review

As mentioned above, the S&P 500 (SPX) was much stronger than the technology heavy NASDAQ 100 and Composite. After a disappointing close lower on Friday, the SPX showed relative strength in todays session. As the chart below shows, the SPX has thus far established a higher low from the one at 839.80 on 10/13. The 8 day exponential moving average (EMA), which closed today at 971.14, was well below the SPXs close of 985.40 today. Last Wednesdays high at 1044 is still the next barrier to break above. But the 21 day EMA at 1036 will stand in the SPXs way before the recent high comes into play. The RSI closed above last weeks high which is showing relative strength. However, the Slow Stochastics has yet to break above the congestion high established at 69.33 last week. The lower Bollinger band has curled upward as of todays close. One could buy the SPX here with a stop set at todays low. A short entry could come at the initial test of the 21 day EMA. Remember, short tests of resistance while on a downtrend until it no longer works. With the election so near, the market may make a move back to the late September lows around 1106 just to celebrate that the depression has been avoided for now.

The next chart is also a daily chart of the SPX but it shows the 50, 89 and 200 day simple moving averages. I have also drawn the Fibonacci retracement lines from the August high to the recent low. The 38.2% retracement level is at 1020 and the 50% retracement level is at 1077. For those of you bulls, I wouldnt expect a quick run up back to the 50 day SMA at 1176 (green line). I expect the SPX and other indices to consolidate and make higher lows. Because of the volatility normally associated with earnings, there will be a couple of failures to advance over the remainder of October. One thing to note is that the ADX has begun to decline from its highs while the market is moving upward. This indicates that the downtrend is beginning to subside. Therefore, the probability of successful shorts at resistance is decreasing. I might suggest going long here with a target set at somewhere between the 50% and 61.8% retracement levels. The 50 day SMA will most likely be around the same level and therefore provide a lot of resistance.

The NDX has retested the previous lows and bounced to close above the 8 day EMA at 1340.78. The lower Bollinger band is beginning to move upward while the upper line is declining quickly in order to catch up with the advancing index. The upper Bollinger band usually provides the upside range for a market or stock. Therefore, the NDXs Bollinger bands need to come down really fast to catch up. An increasing lower band with a declining upper band depicts a reduction in volatility. All of the price gaps have been filled. Thus the market can move upward without having to fill in any holes. RSI isnt confirming the momentum is here to stay until it breaks above last weeks high. The same isnt true with the Slow Stochastics. At 67.57, it is a tick higher than last weeks high of 66.67. The next resistance level is at the 21 day EMA or 1434.21.

The NDX is very far from testing the 50 day SMA (green line). Basically, until the moving averages come into play, we need to monitor the fast moving averages like mentioned before, the price support and resistance levels and Fibonacci levels. The next resistance level is at about 1400. Then there isnt any resistance until last Wednesdays open high at 1470. Then the 50% and 61.8% retracement levels at 1525 and 1628, respectively, come into play as resistance. All of the indices have had a great deal of technical damage done. There is a lot of work and consolidation that must occur in order to bring the moving averages down and put the indices at prices that can begin to resemble a confirmed uptrend. Just as with the SPX, short at resistance levels until it no longer works. I have to believe that the consistency of the short at resistance and/or breakdown will decrease the closer we get to the end of the year. There is a lot of cash on the sidelines. I have been dripping into a few stocks and indices on the down days and raising the stops on the big up days.

With oil breaking below 70 last week, the concern for energy related inflation is fast subsiding. We all freaked out when oil broke above 100 and ran up to 140 plus. How long has the price of gas been above $3.00 per gallon this year? I saved $30 at the pump this weekend when I filled up the Yukon XL! I like stocks in the energy and agricultural related sectors since they were beaten down the worst. When looking to where to most pain was coming from, most fund managers were likely over allocated in the only sector that worked most of this year. Then they sold the winners to offset the financial losers. The winners quickly became losers for many. So here we are with some high quality oil producers at deep discounts.

I will send out The Contrarian tomorrow. The 10 day moving average of the VIX did not decline today. But the VIX declined 17.36 points to close at 52.97; which is just above the 20 day moving average. VIX traders can short the SPX when the VIX tests the 20 day SMA as long as the negative bias remains. Tests of support on the VIX are usually ideal times to add negative deltas or reduce positive deltas. When the VIX tested the support this August, it was the first sell the market signal. Remember that when the VIX is low its time to go. Just because the VIX is higher than it has ever been, it is low relative to last weeks 81.17 all time high. Have a nice night and good luck with the rest of the weeks earnings related volatility.
 

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