Table of Contents
Night and Day
The difference between Thursday and Friday was as clear as night from day. Thursday's mediocre session was caused by losses in Internets and chips. Friday's blazing rebound was led by chips as they broke out over resistance and finally confirmed the index scenario I laid out this week. Internets were down again but were ignored as money poured into the market and into techs and shorts were forced to cover.
Friday morning started off with a bang after the Jobs report came in weaker than expected but still showing modest growth. Bad news turned into good news for the bulls as the report confirmed continued growth but not at a pace fast enough to incur speed brakes by the Fed. This was a case of the porridge being not too hot and not too cold but just right for investors. The headline number showed +146,000 new jobs were created in January and that stretches to seventeen the string of months with positive jobs growth. The last three months have averaged +137,000 jobs and the pace appears to be picking up slightly. The current recovery period has been the longest since the great depression and January's employment finally exceeded the prior cycle high from February 2001. The bond market celebrated the news that the Fed may continue to remain in a measured pace mode and yields fell to two month lows.
The inflation monster is far from dead with the ECRI Future Inflation Gauge jumping +1.1% for January. Over the last four months the index is up nearly +3% at 120.0 and spiking to levels not seen since Sept-2003. Were it not for the drop in commodity prices led by oil in December it would have been much higher. The annualized growth is currently +4.5% on a trailing 12-month basis but we jumped +3% in just the last four months. If this rate of growth continues we could easily be in the high single digits by the end of 2005. This index contradicts the current thought process that inflation is under control and will remain tame. The bond market and investors ignored this report again. It is not normally a market mover because it moves in such small increments. A couple more months of these strong gains and it will get a lot of attention.
The Michigan Consumer Sentiment Survey final for January came in at 95.5 and nearly unchanged from the first reading of 95.8. This was actually a positive surprise after the four weeks of market weakness. The future conditions component did fall from 90.9 to 85.7 but the present conditions spiked from 106.7 to 110.0. This seems contrary to me, as I would have expected the present conditions to deteriorate given the market and the uncertainty about the Iraq elections. The lack of a drop in sentiment and the neutral jobs report appeared to be the right recipe for investor comfort. Sentiment remains at its recent highs, the economy appears to be growing and jobs are being created. Add in a strong rebound in the markets this week and investors/consumers should be seeing clear skies ahead.
We have weathered a strong event risk calendar over the last four months without any material negative events. Almost everything went as planned and the future calendar is relatively clear of any potential problems. Finally we can get back to investing without an eye on potential terrorist events or political uncertainties. The administration is saying things like tax cuts, spending cuts, fixing social security and growing the economy. It is the same motherhood and apple pie promises normally made by administrations but it actually appears we could see some movement this time around. Consumer sentiment should continue to improve and with interest rates still at low levels we could see another round of buying in homes and cars. Oil prices should also continue to decline as we move into spring and seasonal demand weakens. With the market rebound the future suddenly appears rosy.
Even Greenspan made positive comments about the deficit on Friday. I don't think anything has changed since his tirade on the deficit a couple months ago but suddenly his view is also moderating. Greenspan said the decline of the dollar should be reaching a point where imports could slow and the deficits begin to shrink. He said the lower dollar had improved the competitiveness of U.S. exports and is basically leveling the playing field. The market celebrated his comments as a softening of stance that could continue on into future Fed policy. Keeping rates low helps keep the dollar low and improves our trade balance. Of course we should not forget that the administration favors a strong dollar. Talk about saying one thing and hoping for another. Greenspan also pushed the use/abuse of the English language to a new high. He referred to budget cuts as "reducing federal government dissaving" instead of reducing federal spending.
When the tide turns it is not always obvious in the first few minutes but once the inflow begins it floats all boats. The same is true in cash flows into the market. For the first time this year we had strong inflows into equity funds. According to AMG Data there was a sudden injection of liquidity this week with $4.3 billion flowing into stock funds. TrimTabs said the last six days saw +$4.7 billion. This was the strongest week since early December and you saw what happened to the markets. According to TrimTabs over $50 billion went into money markets and savings accounts in the month of January. This compares to only $10B in January 2004 when $40B went into stocks. There was clearly a unanimous move by retail investors to wait for the Iraqi election and the inauguration events to pass before risking those retirement funds in the markets. Once the Iraqi all clear was given last Sunday the cash began flowing and according to those fund trackers the pace is suddenly accelerating.
Is it just me or has the Goldilocks economy finally returned? We are seeing nice sustainable growth, low rates, lack of material event risk, a rising market and for the immediate future reasonable inflation. Profits are coming in much higher than expected at +23% growth for Q4 compared to First Call estimates of only +16%. Over 75% of the S&P companies have reported and 68% of those companies have beaten estimates. Buybacks are exploding with numerous companies announcing a billion dollar per month program. TrimTabs said nearly $20B in buybacks would occur in Q1. That is a huge number and should continue to provide s floor under the market. Mergers and acquisitions are also accelerating and that also puts cash back into the market.
The only real negative on the horizon is the threat of conflict in other Mid East countries. Condoleeza Rice said in Germany that an invasion of Iran was not on the agenda "at this time". Syria may be another matter. There has been an increasing fear that the U.S. could take action against Iran to halt their nuclear weapons program. The thought would be if we don't do it Israel will and that would be very negative for the region. It is widely reported that the U.S. has covert agents in Iran scouting targets and trying to determine if the Iran program is real or imaginary. Bush took shots at all the terrorist countries in the State of the Union speech and his verbal warnings appear to be strengthening. Several knowledgeable sources have said Syria is the next target based on satellite reconnaissance over the last two years showing training camps, stockpiles and ex-filtration routes into Iraq and other countries. The current consensus is that Bush will use Syria as an example of his continued attack on terrorism and punishment of terrorist supporting nations. He is expected to ramp up the verbal warnings even further in hopes of getting other countries to lean on Syria. Expecting no cooperation he will mount a massive surgical strike on these camps as a further warning that we are ready to carry the fight anywhere. It would be another warning that the U.S. is in the region and we plan on being the bully on the block until everyone cleans up their act. The good news is that most Americans are oblivious to this developing scenario and until the saber rattling begins to take on a harsher tone the markets should ignore it. Most sources put any move up to a year away. Other than this the global event horizon is clear for 2005.
Energy prices should continue to fall into spring as the demand for heating oil slows. This will reduce gas prices and the general public will assume the high energy prices of 2004 are history. That is far from the truth and a new development this week continues to highlight the moves underway on the global energy chessboard. Venezuela President Chavez is rumored to be in talks to sell Venezuelan oil to China instead of the U.S. Venezuela is the 10th largest producer and 5th largest oil exporter in the world and 60% of its oil is sold in the U.S. Chavez is a strong critic of the U.S. and wants to reduce its dependency on us. They ship 1.5mbpd to the U.S. and the majority is sold through Citgo, a major retailer on the east coast. Citgo owns 14,000 service stations in the U.S. and eight refineries. Citgo is part of the Venezuelan state oil company PDVSA. Citgo supplies PDVSA with nearly $25 billion in revenue per year. Chavez signed several oil deals with China last weekend and is rumored to be working on a much bigger agreement. There is growing risk to Conoco Phillips and BP assets in Venezuela and both are restricting further investment. This will further reduce expected future production from that area.
Should Venezuela terminate oil sales to the U.S. it would not change the global supply/demand equation as other nations would simply shift their sales to compensate for the new direction. Unfortunately it would force the U.S. to rely even more heavily on Saudi Arabia and the other mid east suppliers and the very unstable political climate currently brewing. This could be part of a larger game plan by those nations to shift our dependency to supplies that could be cut off in an instant. Another reason I don't expect the U.S. to leave Iraq for several years. Venezuela is an OPEC nation and one that is not under Arab control. If OPEC has suggested behind closed doors to Chavez that this would be a way to get back at the U.S. and further their gains they could be working on this as a joint effort. I fully believe that OPEC wants the U.S. to be fully dependent on them so they can continue to raise the prices and threaten us in retaliation for our involvement in Iraq. Our attempt to destabilize the political climate in that area and instill democracy is a direct attack on the ruling families who helped fund the 9/11 attack and numerous other terrorist events.
It was also revealed this week that China helped finance the phony Yukos asset sale in Russia. Remember also that China is trying to lockup production in Canada. Are you starting to see the global picture forming? Lock up supplies well in advance of the coming peak in global production and you control your own fate for the decades to come. China has seen the future and is acting on it while the rest of the world is still napping. The bottom line here is buy oil stocks on the dips. The long-term oil outlook is growing more bearish on supply and bullish on prices.
The stock markets not only retraced a strong percentage of their January losses but in several cases actually broke the overhead resistance. The tsunami of cash pushed the indexes to the point where shorts were forced to cover at resistance breaks and those waiting for confirmation of the move were forced to chase prices higher. It was a great day and a great week for the bulls.
I am not going into great depth on the index analysis today because Leigh Stevens does that very well in his weekend Index Trader Wrap. However, I believe it is critical to note that the index scenario I have laid out all week was given a huge boost by the Prudential chip upgrades. The SOX was the index holding the rest of the markets back on Wed/Thr and Friday's explosion of +17 points, +4.35% was a major relief valve. Prudential changed its rating from unfavorable to favorable on the sector saying the fundamentals should bottom in the first half of 2005 and begin to grow again by Q3. Ironically the upgrade was not sector wide with XLNX, ALTR and LLTC drawing downgrades BUT increased price targets. The SOX roared past the 410 resistance to close at 418 and well over the January resistance. The next material resistance is 430-435 and a move to 440 would produce a bullish cup and handle formation.
The breakout in the SOX released the Russell and it tacked on another +8 points to 637 and it is also above all the January resistance. Small caps came back into favor with the resumption of retirement cash flows and fund managers breathed a sigh of relief. The SPX paused briefly at the strong 1195 resistance and for a few minutes it appeared it might hold. The soaring SOX released its weight on the S&P and when the break over 1195 came it triggered some strong short covering. The S&P closed just under 1203 and well above its January resistance.
The Nasdaq was supposed to be the next index to breakout but news in the tobacco sector sent Altria much higher with a +3.26 gain. An appeals court said the tobacco industry did not have to pay $280 billion in penalties wanted by the Justice Dept. All the major tobacco companies posted huge gains late in the day when the ruling was announced. This provided a very strong late day surge to the Dow and by association all the stocks in the Dow. According to TrimTabs much of the cash flowing into the market is going into ETFs. When an investor buys an ETF the manager of that ETF has to buy all the stocks represented. A strong surge by a company like MO sends other Dow stocks higher and causes short covering in the ETFs thereby pushing all 30 Dow stocks even higher. Quite a lot of complex hedging and investment strategies now revolve around the ETFs and that increases the amount of program trading. Sudden moves in single stocks in an ETF produces broader reactions as those ETF programs are triggered.
As a result the Dow surged ahead of the Nasdaq in the index race and resistance levels tumbled like dominoes. 10600, 10650 and even 10700 fell to the short covering and price chasing. The Dow closed up +288 for the week and +344 off its January 25th low. When corrections are overdone the markets tend to react strongly once buying returns. Who would have thought last week we would be talking about 10850 as the next resistance level to conquer?
Unfortunately the Nasdaq is now the weakest link and while the +29 point gain on Friday erased the -17 point drop on Thursday it still finished below the 2100-2110 resistance level we have watched for the last month. I would like to think the race is on because we know from experience cash follows cash. Once a move is confirmed it can run on momentum for several days. The Nasdaq could gap open on Monday and blow right past 2120 but I would not count on it. The Nasdaq has a very nice uptrend from the Jan-25th bottom but it lacks the excitement in the other indexes. The networkers and Internets refuse to join the party and until that selling ends the other indexes may be forced to drag the Nasdaq anchor behind them. Once over 2110 it could turn into a drag race when short covering hits the Nasdaq over that level.
I have to admit I don't see very many negatives going forward and that worries me. When everything appears the most positive is when disaster normally strikes. The VIX hit a new multiyear low on Friday of 10.90. (VXO 10.75) Internals were very strong with new highs at 632 and the highest level since Dec-2nd. Up volume was nearly 4:1 over down volume with advancers better than 2:1 over decliners, 3.5:1 on the NYSE, 4:1 on the S&P. Were it not for the weak Internet and networking sectors on the Nasdaq I believe it would have been much higher. With the SPX over 1195 everyone should be aggressively long and we are back to buying the dips until the trend changes. It is entirely possible this uptrend could last until March earnings but I would sure hate to bet the farm on it. We need to continue to trade the trend the market gives us and right now that trend is up. I do expect some profit taking from this weeks gains but I believe the dips will be bought by those that missed the train. Have a great week!
Hartford Financial Srvs. - HIG - cls: 71.17 chg: +1.86 stop: 66.95
Why We Like It:
BUY CALL MAR 65 HIG-CM OI=1711 current ask $6.60
Picked on February 06 at $ 71.17
Aetna Inc - AET - close: 130.45 change: -0.40 stop: 125.00
The IUX insurance index enjoyed a strong day on Friday with the broad market rally but the IUX remains under resistance at the 325 level. A breakout here would be good news for insurance bulls. Meanwhile AET failed to participate in the rally and that concerns us a bit. The stock has spent the last three days consolidating between $130 and $132. We are encouraged to see the $130 level holding as support but we're running out of time. AET is due to report earnings on Thursday morning. That means we need to plan an exit on Wednesday afternoon to avoid the event. Currently the bottom edge of our target range is $135 and we will exit there on any spike higher or we'll be forced to close the play at Wednesday's close.
Picked on January 13 at $127.61
Amerada Hess - AHC - close: 91.30 change: +0.13 stop: 84.99
Oil stocks continued to climb this week in spite of a pull back for crude oil prices. The OIX oil index has broken out to new all-time highs again. The OSX oil services index has done the same. AHC turned in a very strong week and the breakout over the $89 and $90 levels is very bullish only now AHC looks short-term overbought. We suggested that short-term traders actually consider taking some profits here but our target remains the $94 level. We would not be surprised to see AHC dip after last week's gains and we would use the dip as a new entry point. Look for the $89 level to act as support.
BUY CALL MAR 90 AHC-CR OI=732 current ask $3.70
BUY CALL MAY 90 AHC-ER OI=614 current ask $5.90
Picked on January 31 at $ 86.65
Cooper Industries - CBE - close: 70.40 chg: +0.39 stop: 67.49
CBE is a new call play from Thursday's newsletter. The relative strength and breakout through the top of its trading range is a bullish entry point. The P&F chart shows an ascending triple-top breakout buy signal with a $74 target. We're targeting a move to the $74-75 range. Friday's rally put CBE above its all-time high of $70.37 dating back to May 1998. If shares surprise us with a dip we would look to the $69 level for support and a bounce from there as a new entry point.
BUY CALL APR 65 CBE-DM OI= 719 current ask $6.10
Picked on February 03 at $ 70.01
Goldman Sachs - GS - close: 110.02 chg: +1.28 stop: 105.00 *new*
Another big week of merger and acquisition news continues to fuel the favor for the investment banks that help facilitate these deals. GS has soared from the breakout of its trading range a week ago and already tagged the $110 level. We suggested that short-term traders consider exiting at this level given the potential resistance from December's high. Some of our suggested options have doubled in value and that's a tempting reward to pass up, especially with GS now looking short-term overbought. We remain bullish on the stock and the group but right now we'd look for a dip, probably back to the $108 range, before considering new positions. Our ultimate target is the $115 region but if you check out the weekly chart it looks like GS is producing a potential cup-and-handle formation and patient traders might consider targeting the $120 level.
BUY CALL MAR 100 GS-CT OI= 150 current ask $10.70
BUY CALL APR 105 GS-DA OI=16727 current ask $6.90
Picked on January 30 at $106.12
Invitrogen - IVGN - close: 70.20 chg: +1.12 stop: 67.00 *new*
We have come pretty close to giving up on IVGN as a bullish candidate merely because the stock refused to participate in this past week's market rally. Now after several days of consolidating under resistance at the $70.00 level IVGN is on the move again. This close over $70 looks like a new bullish entry point for a run toward the $75 region and the top of its rising channel. The risk now is that we'll run out of time before IVGN's February 17th earnings report that we do not plan to hold over. More conservative traders can still wait for IVGN to trade over the $70.50 level before initiating long positions. We are going to raise our stop loss to $67.00.
BUY CALL MAR 65 IUV-CM OI= 30 current ask $6.50
Picked on January 27 at $ 70.05
RD Donnelley - RHD - close: 61.44 change: +0.68 stop: 57.95
RHD is a new play from the Thursday night newsletter. The stock has been a relative strength leader for months as it channels higher. The recent breakout over round-number resistance at $60.00 is a bullish entry point and we're seeing some follow through with Friday's gain. We're targeting a move to the top of the channel near $64-65. Readers can consider new positions at current levels or hope for a pull back toward $60, which should now act as support.
BUY CALL MAY 55 RHD-EK OI= 338 current ask $8.70
Picked on February 03 at $ 60.76
Texas Industries - TXI - close: 64.91 change: +0.63 stop: 59.95
When we originally added TXI to the play list our short-term target was the $64.50-65.00 region. TXI has hit this level multiple times now giving short-term traders a chance to exit for a profit. We have since adjusted our target toward the $69-70 range given TXI's longer-term up trend. Now that the market is finally in rally mode TXI can finally get started on its next leg higher. We're encouraged by the Friday morning dip to $64.00 and the quickness that traders bought that dip. The P&F chart currently points to $74 but if TXI can trade over the $66 mark it will produce a new spread triple-top breakout buy signal.
BUY CALL APR 60 TXI-DL OI= 78 current ask $6.80
Picked on January 09 at $ 60.18
Apollo Group - APOL - close: 78.66 chg: +0.49 stop: 80.11 *new*
When the market is in rally mode and almost ever sector is rebounding the best we can hope for from our put plays is under performance. Fortunately, APOL has done just that. The stock continues to struggle under round-number resistance at the $80 level. We remain bearish on the stock but look for another down day to confirm direction. We're going to lower our stop loss to $80.11 to reduce our risk. If the broader indices continue to climb we would hesitate to launch new put positions on anything.
Picked on January 23 at $ 77.61
Nike Inc - NKE - close: 87.04 chg: +0.44 stop: 87.01
We are still in wait mode with NKE. The stock has under performed the market this past week by churning sideways instead of participating in the rally. NKE is currently trading under its six-week trend of lower highs. A move up through its 50-dma would break that trendline and probably spark some short covering. We are currently sitting on the sidelines waiting for NKE to breakdown under the $85 level and its 100-dma to hit our trigger at $84.65.
Picked on January xx at $ xx.xx <-- see TRIGGER
KB Home - KBH - close: 116.22 change: +4.22 stop: 105.00
Target achieved. The lackluster jobs report helped push long-term interest rates lower again and that's good news for homebuilders who thrive on low mortgage rates. The DJUSHB index soared for a five-percent gain. KBH added 3.76 percent on big volume to burst into our target range of $115-120. We're closing the play at $116.22.
Picked on January 13 at $106.00
Pixar - PIXR - close: 87.62 change: +0.54 stop: 85.75
We are throwing in the towel on PIXR. The stock continues to consolidate sideways in a coiling pattern. The formation of higher lows and lower highs is actually neutral and PIXR could breakout either direction. We're choosing to exit early because PIXR has failed to participate in the market rally.
Picked on January 18 at $ 88.24
Eli Lilly - LLY - close: 55.03 change: +0.16 stop: 56.01
We remain bearish on LLY but the market rebound is starting to tug at the DRG drug index. Looking more closely at the DRG index we see signs of a short-term bottom and if the sector rallies next week then odds are LLY will spike higher and hit our stop loss. We would rather exit now for a small loss and keep LLY on our watch list for another bearish entry point.
Picked on January 30 at $ 53.58
Ask The Analyst
Billing out a block trade. Take note!
What exactly does : "1.2 m share block of QQQQ billed out" mean? Is this a long position while the Q's were falling in extended trading?
Somewhat revised reply given on Thursday evening, 02/03/06
While we don't have an archive of Market Monitor postings I made back in December, there were a couple of VERY LARGE blocks trades made in a couple of extended sessions.
They may have been an alert to the decline in January, but it is difficult to say.
These block trades are usually "billed out" positions that had been accumulated during the REGULAR session of trade. Perhaps 12 separate 100,000 share trades during the day, being put together by a trader for an institutional client.
When I see these trades (I don't sit and look for them each night, but will alert traders to them if I see them) I want to make note of them, and at what PRICE they were billed out at.
Here's a screen capture of Wednesday evening's Market Monitor. It can be helpful to understand various "events" that take place too.
Market Monitor - Wednesday evening (02/02/05)
I just happened to see the block trade of 1.25 million shares time stamped at 05:54:44. Usually this large of a block is a trade that is simply being time stamped (made official) and is an accumulation of various trades during the day, which is then "billed out" to the trader's institutional client at the marked to market price.
Then, in coming sessions, that PRICE may become an important point of influence. Maybe a buy or sell program is found at, or very close to that price.
Perhaps we can NOW assume, build an observation, that on Wednesday, somebody had some knowledge of Amazon.com's earnings and negative reaction, perhaps had shorted the QQQQ during the day (assume smart money knew, shorted during the session into the report). We should also think the other side of the trade, and think like a bull that was betting on a big UPSIDE surprise from AMZN.
These are trader's notes I will make, just as I will make notes about some unusual option activity.
A trader can then make some ASSUMPTIONS, build a bullish and bearish scenario for what the large trade was thinking.
If you are a pivot matrix trader, or have determined/identified a key level of support/resistance for that day, a trader like you and I can often times then use some of the notes made previously (hmmmm.. There was a large block trade at $xx.xx and the QQQQ is moving lower/higher from a key level of support/resistance. Maybe I should take action too!
We could now set a PRICE alert on the QQQQ at $37.57 as being a possible level of influence. What's Friday's DAILY R2? Answer: $35.60. Now we're ready and perhaps have a little more information than the next trader.
Here's how the QQQQ traded since the large block observation. I missed a decent day trade short opportunity on Thursday, but not on Friday!
NASDAQ-100 Trust (QQQQ) - 10-min intervals (daily pivot levels)
I must give some credit to a trade I profiled to John. It wasn't until I saw his question, and made a tie with Friday's DAILY R2 of $37.60 that it dawned on me that a positive response to Friday's nonfarm payroll data might have the QQQQ recovering from Thursday's declines. ASSUMING that a "smart money" hedge fund had shorted 1.2 million shares on Wednesday, a positive response to nonfarm on Friday might at least have the QQQQ gravitating back to $37.57. ASSUMING "dumb money" had bought on Wednesday, then the QQQQ was "cheaper" on Friday and a bullish response to nonfarm payroll might also have upside to $37.57 before some meaningful selling was found.
Imagine that you're reviewing "Chapter 37: How Volatility Affects Popular Strategies" in McMillan's OPTIONS AS A STRATEGIC INVESTMENT or reading it for the first time. You come across the section discussing bull call spreads. For those unfamiliar with these combination plays, you would be long a lower strike call and short a higher cost one. As the name suggests, it's a strategy for times when you expect the underlying to rise.
McMillan comments that a rise in implied volatility harms the bull spread. Huh? Try as hard as you can and despite McMillan's helpful graphs, you can't wrap your mind around that concept. You need to put pencil to paper, or fingers to keyboard, and crunch the numbers. The CBOE website provides you with the tools needed to do that.
After its modest beginning April 26, 1973, trading 911 contracts on sixteen listed stocks, the Chicago Board Options Exchange had by 2000 traded 200 million contracts in a year. By then, the CBOE had added puts, not available until four years after that first day of trade. Along the way, the CBOE also adopted the Black-Scholes model for pricing options and introduced LEAPS, the VIX, the VXN and the CBOE-100 Index, since renamed the OEX, among other additions. It also created The Options Institute, dedicated to teaching investors about trading options, and developed a website. Your search for understanding McMillan's comment starts at the website (www.cboe.com) at the "Volatility Optimizer" tab under "Trading Tools."
You find a free service titled "IV Index." Clicking that link connects you to a tool supplied jointly by the CBOE and IVolatility. You decide to use the OEX for your number crunching. Plugging in the OEX's symbol, you locate tables on historical and implied volatility, volatility graphs, and the following chart, with only the call portion copied here. According to information on the site, the chart was at the close of the day February 2. It's updated daily.
OEX Call Options:
You note that the implied volatility does appear low, so it's at least easy to imagine that volatility might increase. That gives you extra impetus to discover what would have happened if you had instituted a bull call spread about February 2. The same page provides you with the information that just a week earlier, implied volatility for call options had been 10.37 percent and a month ago, it had been 13.27 percent. You decide that for the purposes of your calculations, you'll imagine that volatility has risen to 11 percent in a week's time.
You'll set up a paper-trade bull call spread using the February 565 as your long position and the February 570 as the sold position. You'll use the option value provided in the table shown above rather than searching for bid/ask quotes, available on another part of the site. This would not exactly mimic the costs of a spread you actually traded, of course, but simplifies your calculations and serves the purpose of testing McMillan's statement.
The chart provides you with a $7.60 cost to buy the Feb 05 565 call and a $4.30 credit to sell the February 570. On paper, you've established the bull call spread for a total debit of $3.30. Now you want to see what would happen if volatility expanded to 11 percent one week later. Imagine that the OEX had remained at that February 2 closing price of $570.28, ensuring that you're measuring how volatility affects the spread and not how a change in price does.
Also under "Free Services" on the "Volatility Optimizer," you'll find "Options Calculator." You input the new values, including the strike, 11 percent volatility, $570.28 price, and the new number of days (10) until expiration.
Clicking the "Calculate" button returns the following numbers.
The long 565 strike now shows a value of $7.57. Following the same procedure for the short 570 call returns a value of $4.49. As McMillan predicted, the spread has suffered. Your long 565 call is now under water by $0.03, and the sold 570 is now worth $0.19 more than you collected. You plug in a few more numbers and now have a hands-on feel for what McMillan meant, all courtesy of the CBOE website.
This information could have been obtained by visiting IVolatility's site, but the CBOE's offers more. Perhaps you've never traded index options. As you're making these calculations, you wonder what would happen if both options are in the money at expiration. Are you going to have to deliver somewhere upwards of $57,000 worth of S&P 100 stocks to a $570.00 call buyer?
You can always ask someone on the OptionInvestor staff. (Hint to new options traders: No, you wouldn't be delivering those stocks.) If it's midnight, you're less likely to find someone at OptionInvestor to answer your email, but the CBOE site has that answer for you, too. Under the "Learning Center" tab on the home page, you'll find "Ask the Institute." Your question has already been answered in the archived questions. If you hadn't located the needed answer there, you could have submitted your own question. The Institute chooses questions at random to be answered in the "This week's question" section.
The archived answer refers to index options as being cash settled. What does that mean? The "Options Dictionary," found under the same "Learning Center" tab, provides the answer. Perhaps all this research prods you into learning more about option expirations, settlement and assignment. You've come to the right source. In the same "Learning Center" section, you'll find a pull-down menu under "The Options Institute."
Under the "Online Tutorials" section, shown here in orange, you find a 15-minute course titled "Options, Expiration and Settlement." It's free. Under "Educational Webcasts," you can register for a twenty-minute course in the basics of trading index options. If you've advanced beyond those basics, perhaps advanced strategies are right for you. They're available, too. Somewhere in those courses, you'll find information that you wouldn't have wanted to create this imagined bull call spread in real-life unless you thought the OEX was headed higher. Due to your research, you would know that you perhaps wouldn't want to consider one in a low-volatility setting.
For-fee seminars and events are also available. By this time, you're deciding that the CBOE site has much to offer, but the surface hasn't been tapped yet. Click under "Products" and you'll find a tab that directs you to index sites. Want to know the components of the OEX since you're imagining that you created a spread on the OEX? Click through to the OEX's site.
You notice that MedImmune (MEDI) is an OEX component and you remember that it reported February 3. What was MEDI's outlook? Want to listen in on a recording of the earnings conference call? Back on the CBOE's home page, you'll find a tab for the Equity Research Center, and there's an easy link there to the conference call. You'll also find links for conference presentations. For example, if you wanted to listen to MedImmune's November 8, 2004 presentation at the CIBC World Markets 15th Annual Healthcare Conference, you'd find it in that same section.
This article was not meant to offer a comprehensive overview of the information and tools available at the CBOE site, but rather to encourage both new and experienced options traders to spend some time clicking through the various offerings. Some day when markets refuse to move and there's no trade to be taken, give yourself a self-directed tour.
Today's Newsletter Notes: Market Wrap by Jim Brown, Ask the Analyst by Jeff Bailey, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.
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