Option Investor
Market Wrap

A Busy Company News Day Provides Volatility

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The markets gapped higher on news that China would provide a fiscal stimulus package worth $586 billion or 18% of their GDP and that AIG’s government bailout being restructured. However, stocks fell today as concerns regarding the automakers and financial companies overshadowed the positives from China. There is a two year term to the Chinese fiscal package that will target various industries including housing, infrastructure and health care. The new government deal for AIG is that the aid will expand to $150 billion from $123 billion and better loan terms. The changes are meant to give AIG more time to sell assets after losing $24.5 billion in the third quarter. In addition, the revised deal stands to reassure investors that the insurance giant will be able to satisfy its counter party obligations. AIG closed up $0.17 to 2.28.

Another positive story came from McDonalds (MCD) gaining ground from their relatively low price food offerings. MCD said October same store sales increased by 5.4% and global same store sales rose by 8.2%. The US counted for 35% of McDonald’s 2007 revenue. MCD closed up $1.01 to $56.48.

While it wasn’t exactly positive, UPS and FedEx (FDX) gained on news that they will have less competition in the U.S. from DHL U.S. Express starting early next year. DHL said it will discontinue domestic-only air and ground services to only focus on international offerings. DHL is owned by Germany-based Deutsche Post World Net and will cut 9,500 more U.S. jobs, on top of the 5,400 jobs it has already eliminated.

On the negative side, which seems to get a lot more attention, was that Merrill Lynch decided to close its stand alone proprietary trading business. Merrill Lynch dropped 1.24 to $15.51. Goldman Sach’s (GS) had its fourth quarter earnings estimates cut to a loss of $2.50/share from a profit of $2.71/share by Barclays on concerns from dramatic equity market declines. GS dropped $6.57 to 71.21.

General Motors (GM) tumbled to its lowest level in six decades after Deutshe Bank downgraded it to Sell from Hold. In addition, Deutche Bank cut GM’s price target to $0 from $4 stating that GM may not be able to fund its U.S. operations beyond December without government intervention. Ford (F) dropped $0.09 to $1.93.

Internals

The NYSE declined 69.93 points to 5,802 on 4.663 billion total shares today. There were 1,155 advances (32%) and 2,372 decliners (66%) as well as 4 new 52-Week Highs and 192 new 52-Week Lows. The NASDAQ Composite (COMP) fell 30.66 to 1,616.74 on 1.7 billion shares. There were 8 new 52-Week Highs and 219 new 52-Week Lows. The COMP had 857 Advancers (29%) and 1,985 Decliners (67%).

Economics

There were no economic reports released today and there won’t be any tomorrow due to the Veterans Day. There was talk that the bond market might close tomorrow but the stock markets will be open. This week is a slow economics week because there isn’t anything released until Thursday. The markets are watching the employment reports very carefully for any sign of stabilization. If things go as they have been, the Fed may have to reduce another quarter point. The Michigan Sentiment is expected to decline a little from the last report. However, last week’s Consumer Sentiment numbers came in well below the expectations at 37.

[Image 2] The Index Report

As always, we will begin the review with the S&P 500 (SPX). I prefer to analyze the charts on a daily time frame to see the broader picture and then focus in by using the 2 minute charts. Last week I wrote that the SPX had failed to break and close above the 21 day Exponential Moving Average (EMA). However, the SPX trusted upward Tuesday following the Fed’s latest move to improve the countries situation. There is a trade scenario that I have to try that says to fade the reaction move of the markets following a Fed decision. In this case, sell the market at the close. Had it dropped the trade would be to buy the market. As a trader, you should have a number of trade setups in your arsenal to take advantage of consistent market tendencies. But don’t have too many strategies that your funds and attention are diluted and you can’t keep track of what is what. My advice here is to list the strategies and create a menu of sorts. At the beginning of each day, go through your menu to determine what strategy might be available that day and visit the existing strategies to review profit targets and risk management. [Image 3]

As the above chart shows, the SPX dropped below the 21 day EMA on Wednesday and then the 8 day EMA on Thursday. Both the RSI and Slow Stochastics were near overbought territory as of Tuesday’s close. While the RSI hasn’t dip down to oversold territory yet, the Stochastics closed below 20 on Friday and closed up at 24 today. RSI dipping downward while the Stochastics is bouncing upward shows some divergence in the oscillators. The Bollinger bands have narrowed quite a bit from just a few weeks ago. The current spread on my 21 day EMA Bollinger Bands is at 154 points and narrowing. Once the narrowing stops and begins to increase, there is another strategy that suggests trading in the direction of the momentum. With the 8 day still below the 21 day EMA, the trend is still down. The trend signal was close to reversing last Tuesday, but the quick reversal stopped that technical signal from occurring. Our first level of resistance is at 936 (8 day EMA), followed by 952 (today’s high) and then at 958 (21 day EMA). Support is from Thursday’s low at 899.73. There is a low grade uptrend line from the 10/10 low to the 10/28 low that is currently around 880. With so much anticipation for a bounce into the end of the year, I suspect that the smart money may stop that from happening. We’ll have to see.

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The ADX in the above chart is suggesting that the previous trend has all but subsided. If the indicator begins to advance, a new trend may be emerging. Also suggesting the decline is over, for now, is the MoneyFlowIndex. A break above 60 would help confirm this assessment. Finally, there is some resistance just above 1000 and then the rapidly dropping 50 day moving average (currently at 1070). As the chart shows, the 68.2% Fibonacci has provided the recent support for today’s bounce from the lows. The SPX had a volatile day again traveling from a high of 951.95 to a low of 907.47 and finally ending the day at 919.21. That is a 44 point range. While pretty wide, it is actually less than the Implied Volatility or $VIX has priced in; which closed up 3.88 today at 59.98.

The NASDAQ 100 or NDX showed some relative weakness today. For instance, the NDX dropped 20.62 points to 1251. The NDX chart below is very reminiscent of the SPX daily chart. Both indices 8 and 21 day EMAs are in a decline. The slope isn’t very steep which signals that the momentum downward is slowing. The near term support on the NDX is at 1235 while the resistance is at the 8 day EMA (1284) and the 21 day EMA (1314). One difference from the NDX and the SPX is that the Slow Stochastics failed to break above or re-emerge from oversold territory. This may end up indicating that there is still more weakness to come for the technology sector. The Bollinger bands are pinching together as each day’s range subsides closer to normality. I believe it will be a while until Volatility is back to normal. So we have to get used to trading within these extremes. Where a $VXN (NASDAQ 100’s CBOE Volatility Index) would have peaked around 40 – 45, that is now the bottom range of volatility in which to sell the market. As with most trades, this may work until the break down. Be careful to not over think the trade. Set stops and stick to them. If you short the NDX on the $VXN’s next test of its low, make sure a stop is in place in case the $VXN dips and closes below support.

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The Russell 2000 (RUT) chart is shown below. The main difference in the daily pattern is that the RUT closed lower than Thursday’s low. The RUT opened strong today and moved higher intraday above the 8 day EMA (508). However, the weakness in the smallcap sector over concern for these companies inability to raise operating capital or even revisit previously established credit lines. In my opinion, the broader markets need to see support from the small caps before any sustained move upward can exist. While the Slow Stochastics ticked up a little, it failed to break out of oversold territory (20). The current view of the market is that it may sell off again before Thanksgiving and then run up into the end of the year as all of the money sidelined comes back in to play. However, anything can happen overnight to cause the current picture to change.

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Crude oil has been quite volatile over the last few trading sessions. However, for once the charts of the commodity as well as the United States Oil Fund (Symbol: USO) have been showing some signs of support. I mention the USO because it is tradable as a long/short stock play as well as an option play that most accounts should be able to trade. It tracks the commodity closer than the Proshare Ultra Long and Short ETFs, DIG and DUG, respectively. For instance, if you believe that oil will move higher from the low 60’s, then you may want to buy the USO, Buy USO calls or Sell USO puts. With 11 days until expiration, the USO November 45 puts are trading at $1.00 to $1.10. That is some interesting premium. You could be bold and sell the 51 strike for about $3.20/contract. Selling puts, by the way, is an option contract that obligates the seller to purchase the shares of the underlying security at the strike price on or before expiration.

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