Option Investor
Market Wrap

Five up days almost all gone in One!

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Today was one of those days where very little worked. The S&P 500(SPX), Dow Jones Industrials(INDU), NASDAQ 100(NDX) and Russell 2000(RUT) fell 71.47 (8.05%), 679.95(7.7%), 94.59(7.98%), and 51.2(10.93%), respectively. At 1.6 Billion shares traded on the NYSE, the drop was less than the 50 day moving average of 1.8 Billion. There were a total of 5 new 52-Week Highs and 78 new 52-Week Lows today. The NYSE had 368 Advancing Issues and 2,827 Declining Issues. Therefore, today's decline was huge in distance but didn't represent a revisit to capitulation high volumes. On the NASDAQ Composite, the number of Advancing Issues was a total of 469 while there were 2,445 Declining Issues on 1.95 Billion shares. The 50 day average number shares traded on the NASDAQ Composite is 2.4 Billion shares.

As far as the Far East goes, the Nikkei dropped a 115.1 to 8397.22 while the Hang Seng rallied up 220.6 to 14,108.84 or up +1.60%. The European exchanges were more affected by the US markets since they close at 11:00 AM EST. The FTSE 242 to 4045.9 -242.1, the German DAX fell 298 to 4370.9 -298.5 and the French CAC closed down 190.7 to 3072.0.

My hat goes off to you if you have been long the 10 and 30 year bond lately. I have been watching the 10 Year Treasury Yield ($TNX) bounce off of the 3.3% yield throughout the year. Over the past couple of weeks, the $TNX has broken its short term up trend line and fallen to a low of 2.65%. One way to play the 10 and 30 Year Bonds is to use the iShares 20+ Year Fund or TLT. The TLT is also optionable so one can trade the underlying and create a hedge or just create a synthetic long or short position. It should be known that the options aren't very liquid when referring to open interest and volume. ProShares has been kind enough to create the Ultra Short Lehman 7-10 Year and 20+ Year Funds for those of you that think that yields are oversold. The symbols are PST and TBT, respectively.

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So why did the market fall today? I could point a finger to Big Ben Bernanke or that the markets were grossly overextended after 5 up days in a row that equated to a 20+% advance from the lows, or fears brought up by Oppenheimer analyst Meredith Whitney that credit card companies may reduce credit lines by up to $2.2 Trillion or 45% over the next 18 months. For those of you that don't know, Meredith Whitney was the first to cut Citigroups earnings and price forecast stating that with such exposure to toxic assets, the company will either need to cut its dividend or run out of cash. Back in October of 2007 when she released her forecast, the market responded by selling off over 600 points. Is it one or all three? I believe all three and probably more reasons are to blame for the drop today. I am neither a bull or a bear. Just a person recording history each week and trying to figure out where we go from hear. This market is all about risk assessment and management.

Federal Reserve Chairman Ben Bernanke spoke live today to reveal yet another layer of the US Economic onion. I think it is an onion rather than a fruit because it stinks and makes many of us cry. Anyway, the summary of the chairman's remarks suggest that the efforts of the Federal Reserve and other policymakers, the U.S. economy remains under considerable stress. Just one or two quarters after there was continued inflationary risk due to the costs of energy and agriculture, he now states that economic activity was weakening even before this fall's financial crisis intensified. According to the latest estimates, real gross domestic product declined at an annual rate of 0.5% in Q3, with personal consumption falling at an annual rate of 3.7%. Economic activity has slowed a bit from the deterioration in financial conditions in September. Employment losses had been averaging about 100k per month for much of the year. However, employment losses increased to more than 250k per month, on average, in September and October. In addition the unemployment rate jumped to 6.5% in October.

Bernanke states that Housing markets remain weak because low demand and the increased number of distressed properties on the market has contributed to further declines in house prices. On the positive side, the declines in the prices for crude oil and other commodities have helped to reverse what had been a significant drag on household purchasing power through much of the year. Although the near-term outlook for the economy is weak, a number of factors are likely over time to promote the return of solid gains in economic activity and employment in the context of low and stable inflation. Among those factors are the stimulus provided by monetary policy and possible fiscal actions, the eventual stabilization in housing markets, and the underlying strengths and recuperative powers of our economy. The pace of Economic recovery will depend greatly on the speed financial and credit markets can return to normal functioning. Chairman Bernanke concluded his remarks by discussing the policy options of the Federal Reserve: interest rate policy, liquidity policy, and policies to stabilize the financial system. Reductions from the current federal funds rate target of 1% are certainly feasible. However, the scope of how effective this conventional tool is limited.

In other economic news, Construction Spending declined 1.2% from the prior flat reading while the ISM Index came in at 36.2, 2.7 lower than the previous reading. The graphic below shows the upcoming list of events for the remainder of the week. The only thing to look out for tomorrow is the Auto and Truck sales and the testimony of the automakers plan of action. ADP Employment, due Wednesday morning, has gained more credibility from its timely and accurate account of employment trends. Later in the week, we get the Fed's Beige book, which shouldn't be much different from today's speech, ISM Services and November employment data.

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As an options trader, I love to trade around corporate events. I remember when I used to avoid stocks that were scheduled to report earnings before option expiration. Then I learned to sell the volatility. A list of stocks reporting earnings tomorrow is below. Normally, SHLD and SPLS offer good risk reward to trade. For instance, SHLD is at $31.84 while the December 20 Puts are at a mid of $1.30/contract and the December 40 Calls are at a mid price of $1.50/contract. December Implied Volatility is at 209% while June 09 IV is at 158%. If the IV drops 50%, the potential profit is about $180 per contract on a trade with an initial margin of $305. OVTI reports EPS after the close tomorrow. But like a lot of high fliers, the stock is too low to offer a good array of option strike choices. For Wednesday, ARO and AVAV look interesting to trade volatility ahead of earnings.

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As mentioned earlier, the S&P 500 (SPX) dropped 80 points today. The interesting thing came on Friday when the index ran up above the 50% Fibonacci retracement I drew in last week's commentary. To refresh your memory, I drew a retracement line from the 11/4 high to the 11/21 low. The 50% retracement level was at 874 while the 61.8% was at 905. The high on Friday was at 895 or 10 points shy of the 61.8% retracement. My point last week was that the market looked as though it could make a run up to above the 50% retracement and then fail from exhaustion. This is along the lines of the ongoing theme of trading the direction of the trend.

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We can trade oversold bounces in a downtrend but it is important when to cut counter trend trades loose whether they are winners or losers. Losers are easy. Sell the long if the bounce fails and the price of the security declines below the recent low. Profitable trades are harder to close out because the allure of the long term trend ride is similar to catching the perfect wave. Just like the sea, the markets are often turbulent and the bottom can rip you to shreds. I believe in setting profit targets on all trades. For instance, trading the bounce would require the Slow Stochastics and RSI to both re-emerge from oversold territory. Once that occurred, the profit target is set to the 8 day EMA on one third, the 21 day EMA on the last and then let the last on go with the stop raised to a close below the 21 day EMA. However, a short entry was screaming at the 50% Fibonacci level and a long trade would be net offset by the new short trade. Besides the trade I have been covering for the last four months is to sell at the 8/21 day EMA and cover once the index breaks above a previous high to establish a daily higher high. There are a lot of additional opportunities to trade the mini bull runs and bear traps on the intraday cycles. However, that would require the entire newsletter content to cover one index. Actually, we have that service with the Index Wrap. As the chart below shows, the 50 day SMA has declined below 1000 to 963. At some point, the moving averages will catch up to the markets and become additional dynamic support/resistance levels, stop loss and profit target prices. The ADX is still declining which confirms that the downtrend has subsided. The MoneyFlowIndex is just above 50 after the SPX ran up over 20% from its lows. That tells me that there wasn't a slew of institutional buying interest and that some important institutions want the market lower in order to catch the next train.

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The normal safe haven investment, GOLD, has been one of the most volatile commodities to trade. Volatility provides opportunity. Gold fell $49 to close the day at $768.5 per ounce. As the chart below shows, the high was $989.70 in July. The low of $681.50 was achieved just three months later while the markets were in turmoil. Obviously, buying gold as a hedge against market volatility isn't the reason to buy. Traditionally, investors bought gold to hedge against inflation. As the Fed began to cut rates to shore up the affects of the ongoing credit crisis, the market adjusted its value of the inflation hedge. Therefore, I might be a little early on my inflationary play as evidenced by today's action in gold. For those of you that aren't able to trade gold futures, you might want to look at GLD and its options. If you primarily trade within your IRA, you should be able to buy and write options within your IRA account. I know a couple of the online brokers offer this service.

I continue to believe that the dollar will weaken once again. The strength is coming from international money piling into US Government debt while we increasingly auction off our county. At some point, we have to pay off the debt with dollars. When a company issues more stock, it increases the float of shares and decreases the value each share. As with the stock, adding more dollars decreases the value of each dollar which spurs inflation. Therefore, I am looking at international plays and inflation protected investments like gold and TIPS (Treasury Inflation Protection Securities). I am also interested in buying dividend paying corporate stocks by selling puts and then hedging the heavy dollar weighted portfolio with Long Yen, Euro, Swiss Franc and Short Dollar currency pairs. I want to get paid to wait if I am long the market. The chart below is of the E-Mini Euro FX Futures contract. As you can see, my seemingly paranoia was quickly rewarded early last week. A bounce from these levels would establish a higher low and provide confirmation to the establishment of a longer term uptrend. As with the SPX or any trade, scale out to reduce the risk of losing all of your gains.

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