Option Investor

Daily Newsletter, Monday, 08/29/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Alan and Katrina Make Waves

The equity and treasury markets traded smoothly and quietly against a backdrop of Hurricane Katrina and ominous words from Chairman Greenspan. As refugees huddled inside the Superdome beneath its failing roof, the Nymex issued a force majeure declaration and suspended deliveries of natural gas. This was later reversed, and Katrina was eventually downgraded to Category-1, though not before prompting the evacuation of New Orleans and other locales, as well as 711 rigs and platforms.

Volume breadth started almost as deeply negative as it finished positive, with the closing values showing 2.2 advancing NYSE shares for each declining, and nearly 3.3 advancing Nasdaq shares for each declining. Overall volume was surprisingly light, with under 2.5 billion shares traded on the combined exchanges. The impressive strength of equities in the face of strongly rallying energy futures, including crude oil, natural gas and unleaded gasoline, was evidently hard for participants to believe. On its own, the price action was very bullish- key outside reversal/bullish engulfing prints. The light volume was one of the few potential cracks in the foundation.

Daily Dow Chart

The Dow rocketed off its 10349 low to a high of 10487. That's not quite accurate: the Dow actually gapped down to its low at the open, then spent the day advancing in fits and starts, the strongest upside move at the beginning and each subsequent leg up flatter than the last. There was no tradeable weakness, however, and despite the light volume, the bears were dealt a harsh blow. All of Friday and Thursday's losses were reversed, as well as nearly half of Wednesday's decline. Had the volume been higher, it would have looked like a picture-perfect doji hammer- a reversal pattern. If the bears don't get busy in a hurry tomorrow, the volume won't matter. Support is at Friday's low above 10380, while 10490-500 is immediate and heavy resistance. If the bulls can generate a close above 10500, there will be an excellent likelihood that we saw the daily cycle low today.

Daily S&P 500 Chart

The SPX did likewise, gapping down to a low of 1201.53 and then recovering for the remainder of the session, reaching as high as 1214.28. The engulfing move also broke last week's lows and then took out 2 days' worth of highs, but Wednesday's overhang at 1218 continues to loom large. A close below 1204 or above 1218 should be enough to provide direction, either in the form of a bearish downside trending move or a new daily cycle upphase.


Candlestick chart of the NASDAQ QQQQ

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Daily Nasdaq Chart

The Nasdaq bounced from an opening low of 2112 and failed at 2139, right at key resistance but within last week's range. This is a more bullish setup than for either of the Dow or SPX, and the 10-day stochastic also left off on a bullish kiss, ticking higher. If the bears fail to reverse today's gains tomorrow, this chart should be the first of its peers to go bullish. Above 2140, the next significant confluence is at 2155.

Daily TNX Chart

The Fed greased the skids in two increments this morning as the hurricane approached New Orleans, still rated a Category 5 storm. Faced with a $8.25 billion weekend repo expiring, the Open Market Desk first announced a 4-day $6.5 billion repo, and then followed it up 15 minutes later with a $6.25 billion overnight repo. The equity markets responded to each announcement with an upward lurch.

The Treasury did its part, announcing a 4-week bill auction in the amount of $15 billion, which was a net wash with no additional borrowing against the $15 billion in 4-week bills maturing. Equities again lurched higher later in the day as the Treasury released the results of its 13-week and 26-week bill auctions. The 13 week bills generated a high-rate of 3.495%, with a bid-to-cover of 2.23, while the 26-week auction had a high-rate of 3.705% and a bid-to-cover of 2.39. Most importantly, foreign central banks were there to take up the slack, purchasing $8.4 billion of the $28 billion total auctioned.

Ten year note yields (TNX) declined from the open but held only minimal losses. I suspect that what would have been an upside breakout in the TNX resulting from Greenspan's weekend comments was mitigated by the flight-to-safety bid deriving from Katrina, which combined to hold the TNX in a narrow range doji within the apex of a bull wedge. Above 4.17%-4.18% resistance, the bull wedge will be broken, and the overdue daily cycle upphase should target the 4.4%-4.44% resistance area at the top of the wedge. For the day, ten year note yields finished lower by 1.6 bps at 4.173%.

The Fed's open market operations this morning were obviously loose and supportive, and flew in the face of Greenspan's weekend speech. As it always does, the Fed provided liquidity to the banking system and, by association, the markets when faced with an exogenous crisis.

Greenspan's comments about housing on Friday had been followed up on Saturday with his closing remarks at the Kansas City Fed's symposium. His brief speech again referenced housing, and in particular, "Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures."

He went on to note that while inflation pressures were building, the Fed would remain vigilant to control that inflation: "However, I assume that these imbalances will be resolved before stark choices again confront us and that, if they are not, the Fed would resist any temptation to monetize future fiscal deficits. We had too much experience with the dangers of inflation in the 1970s to tolerate going through another bout of dispiriting stagflation."

For years, the inflation-deflation debate has been focused by monetarists on the Fed's likely response to what many see as an inevitable contraction caused by the aging population, dwindling oil, and other geopolitical trends. The decades-long bull markets in stocks, bonds and real estate (and money supply) are what's at issue.

Greenspan's clear comments indicate that the Fed won't simply buy up (monetize) assets (principally, stocks and bonds) that sellers might seek to liquidate, which suggests a deflationary resolution to these pressures. In other words, if forced to choose between the currency and the equity/treasury/real estate rallies, Greenspan would choose to defend the currency. His successor may feel differently, but that was what he said on Saturday morning.

Those would have been a deeply bearish comments on their own- his similar, weaker comments on Friday didn't do any favors for the HGX, TOL, BZH or the other homebuilders. Those comments and their attendant issues were swept aside, however, as the President declared states of emergency in Mississippi, Louisiana and, later on Sunday, Florida as Katrina drove for the Gulf coast and the Fed went into to damage-control mode.

Daily Chart of Crude oil

Katrina's approach over the weekend had reduced crude oil output in the Gulf of Mexico by more than 30% as of Saturday. The Gulf produces roughly 25% of US domestic oil and natural gas, with an estimated 1.5 million bpd of crude and 12.3 bcf of natural gas capacity. Shell Oil evacuated all of its 1000+ offshore workers, shutting down 420,000 bpd of oil production and 1.345 bcf of natural gas. By the end of the day, the Mines Management Service was reporting that roughly 92% of oil production (1.38 million bpd) and 83% of natural gas production (8.3 bcf) had been shut in. A total of 711 rigs and platforms had been evacuated.

Natural gas futures spiked and held 15%-20% gains from the Sunday night open, and crude oil set a new high of 70.75. Equities dove, with the NQ falling to old confluence at 1544 before bouncing below 1560. The ES futures lost 1200 support overnight.

Refineries were even harder hit, with Chalmette Refining and Murphy Oil's Meraux refinery directly in the storm's path. Together, these two installations account for 310,000 bpd. As of this morning, seven refineries accounting for 8.5% of total US refining capacity (or 1.449 million bpd) had shut down. Gulf of Mexico refineries produce roughly 45% of US gasoline. Closures were announced throughout the session, including MUR, RIG, WMB, SKE, APA, PXD and CF.

Damage estimates were many, particularly as Katrina was upgraded to a Category 5 hurricane and then back down to Category 3 this morning and eventually to Cat-1 this afternoon. The $12-$30 billion range seemed to generate a consensus of sorts on the expected payout from insurers. Reuters quoted Risk Management Solutions of California in assessing the total estimated damages to New Orleans and its 7 surrounding parishes at more than $110 billion. Later in the day, Eqecat reduced its estimate to the $9-$16 billion range.

HD and LOW both benefited from anticipated relief and rebuilding efforts, both gapping up at the open and holding their gains. September lumber futures opened limit up at 287.50, +10. HD closed +1.68% at 40.48, while LOW gained 2.33% to close at 64.65.

Later in the day, as Katrina was downgraded to Category 2, Fitch Ratings announced that it expects the storm to be the largest insured loss since 9/11, and the largest US hurricane loss since Andrew in 1992. More particularly, it expects the losses from Katrina to be material to both primary US insurers as well as to the reinsurance industry. The S&P Insurance Index (IUX) finished the day higher by .01% at 327.25, while reinsurer PRE lost 1.05% to close at 61.22.

Crude oil and natural gas edged back as the hurricane was downgraded, even as the first levee was breached near Buras, LA with 3-8 feet of water entering the city's 9th ward. As New Orleans' mayor ordered the evacuation of the entire city, those who were unable to leave sought shelter in the Superdome. High winds damaged the 'dome's roof, but thankfully the damage was judged to be superficial and the refugees not seriously threatened. The President was considering releasing oil from the Strategic Petroleum Reserve, but the White House later said that it was too early to determine whether such would be necessary.

Later in the session, the New York Mercantile exchange issued a declaration of force majeure, suspending contractual obligation arising from and deliveries of August natural gas indefinitely. The Henry hub in Louisiana, which is the pricing point for Nymex gas, was shut down. Marketwatch quoted A. Ameko, a partner at First Enercast Financial, as saying, "A shutdown to Henry Hub is a crisis situation for the markets. ...As futures expire, there will be no facility for gas delivery. This is an unprecedented situation that has never happened in the history of the NYMEX futures contracts." Henry Hub was reopened later in the day, and the suspension lifted. While crude oil declined as Katrina was downgraded to Cat-2, briefly going negative, natural gas held its 10% gains. The one-year daily chart of October natural gas is a bullish sight to behold.

Daily Chart of Natural gas

As with crude oil, there was a great deal of bearish speculation at the end of last week, from energy bulls as well as bears, given the fast, sharp run of recent weeks. If today's action was a terminal blowoff on a number of uptrending cycles, then we should have seen the highs of the move today. A break back into the mid-to-lower end of last week's range for crude oil and natural gas would result in a gravestone doji for this week, a potential reversal pattern. With 4 days' left to go, energy bears will have their work cut out for them.

For the day, crude oil finished +1 or 1.51% at 67.125, while natural gas gained 1.375 or 14.02% to close at 11.18. September unleaded gasoline futures finished +13.4 cents or 6.9% at 2.06. The CBOE Oil Index (OIX) gained .88% to close at 527.25, while the Oil Service HOLDRs (OIH) rose .39% to close at 113.30. The PHLX Oil Service Index (OSX) gained .79% to close at 162.71. The Commodity Index (CRB) closed up 6.13 at 323.23, led by natural gas and heating oil futures.

For tomorrow, traders will have their screens full. What will prove to be a heavy week for economic data kicks off with Consumer Confidence and Factory Orders at 10AM, followed by the 2PM release of the August 9th FOMC minutes. These are the first of 15 reports to be released over the next 4 days, including preliminary Q2 GDP, and the monthly nonfarm payrolls report.

As so often happens with exogenous disasters, the opening panic may well have marked a significant low for equities (as it may have a high for energies). If so, then today's engulfing prints for equities should not be retraced to the downside, and either a base or a rally from here should follow. I remain suspicious of any show of strength from equities and treasuries while energy futures remain so high - it was surreal to watch the Dow, SPX and Nasdaq engulf Friday's range as natural gas "tanked" from a 17% gain to a 10% gain intraday. However, we have the luxury of following each chart individually. Regardless of what we think the prices should do, the charts tell us what they are doing. Believe what they say: if equities and treasuries want to rally alongside natural gas, oil and gasoline, so be it. Today, that's exactly what occurred.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None Today.

New Puts

None Today.

Play Updates

In Play Updates and Reviews

Call Updates

Kerr Mcgee - KMG - close: 85.49 chg: -0.53 stop: 81.99

Crude oil and oil stocks closed well off their highs for the session. As one reporter put it, Hurricane Katrina's bark was a lot worse than its bite, at least given the initial reports. Looking more closely at shares of KMG we see that the stock failed yet again at resistance near $88.00. The more KMG fails at the $88 level the bigger the breakout will be if KMG does breakout to the upside. Right now we're growing a bit cautious here. We're not suggesting new plays. More conservative traders may want to move their stop loss toward the $84 level, which is short-term support.

Picked on August 21 at $ 85.99
Change since picked: - 0.50
Earnings Date 07/27/05 (confirmed)
Average Daily Volume = 2.4 million

Put Updates

AutoZone - AZO - close: 95.37 change: -0.08 stop: 97.75

AZO did manage to hit a new relative low near the opening bell but glancing at the intraday chart you'll notice that the stock has produced a quick double-bottom near the $94 level. We suspect there will be some follow through tomorrow and AZO could rally back towards the simple 50-dma, which is resistance near $97. For more information see our previous update in the weekend newsletter.

Picked on August 28 at $ 95.45
Change since picked: - 0.08
Earnings Date 09/20/05 (unconfirmed)
Average Daily Volume = 732 thousand


Carnival Corp - CCL - close: 50.01 chg: +0.36 stop: 52.01

Uh-oh! Put traders need to double-check their stop losses. The action in CCL today might suggest a potential new bottom. The stock traded lower at the open but buyers appeared near $49.00 right at the August 17th low. This is starting to look like a double-bottom pattern. We're not suggesting new plays and more conservative traders might want to ratchet down their stop loss to either 51.51 or 51.26.

Picked on August 10 at $ 51.79
Change since picked: - 1.69
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = 2.5 million


CDW Corp - CDWC - close: 60.15 chg: +0.71 stop: 62.01

CDWC got a bounce back above round-number resistance at the $60.00 mark and technical resistance at its 50-dma (59.96) and its 200-dma (60.02). This is potentially bad news for the bears but right now we're still sitting on the sidelines. Our strategy is to buy puts only if CDWC trades at or below our trigger at $58.99.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/19/05 (confirmed)
Average Daily Volume = 867 thousand


Federated Dept. Stores - FD - cls: 70.66 chg: +0.16 stop: 75.01

We have been predicting a bounce from the $70 level and/or its simple 100-dma so today's action is not a surprise. What's encouraging is that the trend of lower highs remains intact. The bounce may not be over yet. Look for resistance in the $72.00-72.50 region. Our target is the $67-65 range.

Picked on August 22 at $ 71.99
Change since picked: - 1.33
Earnings Date 08/10/05 (confirmed)
Average Daily Volume = 2.2 million


Fedex Corp - FDX - close: 82.20 chg: +0.52 stop: 86.01

Transport stocks got a bit of a boost today as crude oil was unable to hold on to its highs. This helped FDX to a minor bounce. We remain bearish and a failed rally under $83.00 could be used as a new entry point to buy puts.

Picked on August 23 at $ 82.99
Change since picked: - 0.79
Earnings Date 09/22/05 (unconfirmed)
Average Daily Volume = 2.0 million


Google - GOOG - close: 288.45 chg: +4.87 stop: 290.51

It's time to go to red alert if you own puts on GOOG. The stock displayed a lot of strength today adding 1.7% and appearing to breakout above its five-week trend of lower highs. There is still round-number resistance at $290 and technical resistance at the 50-dma near $292. Yet somehow we suspect that if the market is at all bullish tomorrow that GOOG will push through the $290 level and stop us out at $290.51. It's probably time to exit bearish positions at your earlier convenience.

Picked on August 11 at $284.50
Change since picked: + 3.95
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 13.6 million


Ingersoll Rand - IR - close: 77.64 chg: +0.31 stop: 80.01

IR remains under its simple 200-dma. If shares trade above the $79.00 level then we'll start to worry. Remember, we plan on exiting this play on Thursday, September 1st near the closing bell to avoid holding over the 2-for-1 stock split.

Picked on August 24 at $ 77.49
Change since picked: + 0.15
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.1 million


Illinois Tool Works - ITW - cls: 84.41 chg: +0.62 stop: 87.35

ITW produced an oversold bounce today. We would watch for a failed rally in the $85.00-85.50 range as a new bearish entry point. Our target is the $80.25-80.00 range.

Picked on August 23 at $ 85.05
Change since picked: - 0.64
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.2 million


KOS Pharma - KOSP - close: 67.98 chg: -0.86 stop: 72.51

Biotech stocks turned in a strong performance lead by biotech titans like DNA and AMGN. Shares of KOSP did not participate in the market or sector's bounce today. That's good news for put holders. Our target is the $63-62 range but we'll adjust this as needed based on the 100-dma.

Picked on August 22 at $ 68.25
Change since picked: - 0.27
Earnings Date 08/04/05 (confirmed)
Average Daily Volume = 642 thousand


3M Co. - MMM - close: 71.08 change: +0.09 stop: 73.01

MMM did not participate in the bounce today and that bodes well for bears. Our target is the $70.00 level although more conservative traders might want to exit in the $70.50-70.00 range. The low today was $70.41.

Picked on July 19 at $ 74.29
Change since picked: - 3.21
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million


Simon Prpty Grp - SPG - close: 74.33 chg: -0.29 stop: 77.01

SPG hit new two-week lows today but managed to bounce from its worst levels of the session. Readers can watch for a failed rally under the $75.00 mark as a new bearish entry point. Our target is the $71.50-70.50 range near its 100-dma.

Picked on August 18 at $ 75.24
Change since picked: - 0.91
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 946 thousand


United Parcel Svc - UPS - cls: 71.20 chg: -0.13 stop: 74.21

UPS, like its rival FDX, sank at the open but unlike FDX, shares of UPS failed to return to positive territory. The stock remains under its simple 50-dma. The P&F chart currently points to a $56 target but we are targeting the $68-67 range.

Picked on August 17 at $ 71.99
Change since picked: - 0.79
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 2.6 million


Wynn Resorts - WYNN - close: 48.15 chg: +0.14 stop: 52.01

There is no change from our weekend update on WYNN. A failed rally near its 10-dma could be used as a new entry point. Our target is the $45.25-45.00 range.

Picked on August 19 at $ 49.95
Change since picked: - 1.70
Earnings Date 08/01/05 (confirmed)
Average Daily Volume = 2.0 million

Dropped Calls

None Today.

Dropped Puts

None Today.


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