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Daily Newsletter, Wednesday, 09/21/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Natural disaster waiting to happen? SPX turns "bear alert!"

Stocks sold off for a second-straight session as investors braced the arrival of Hurricane Rita, which the National Hurricane Center raised to a Category 4 storm (Category 5 is highest on Saffir Simpson scale) earlier this morning.

Volumes at both the NYSE and NASDAQ were heavy and at today's closing values, both the NYSE's and NASDAQ's more intermediate 10-day NH/NL ratios fell into a column of "O" as both shorter-
term (5-day NH/NL ratio) and intermediate-term bullish leadership turns defensive. In essence, market participants are much less willing to push a stock to new highs with buying, instead more willing to sell their losers, as well as their resent winners.

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Traders appeared more watchful of higher energy prices and Rita's track as it moved across the Gulf of Mexico, than a positive earnings release from Federal Express (FDX) $83.15 +7.98%, where despite a 51% increase in fuel prices versus a year ago, the air/ground shipper said demand remained strong, even after Hurricane Katrina's recent carnage to portions of Louisiana and Mississippi. The company reported Q1 profits of $339 million, or $1.10 per share, which was up from $330 million, or $1.08 per share in the year-ago quarter. Excluding a one-time charge from changing its lease accounting, earnings would have been $1.25, which was comparable to consensus estimates of $1.17 per share. Q1 revenue (ending Aug. 31) came in at $7.71 billion, up 10% from the $6.98 billion last year. Consensus was for $7.58 billion. The company noted that operating expenses jumped 11% to $7.12 billion, with fuel costs surging 51% to $728 million from $428 million a year ago.

A day after the FOMC raised its target on fed funds by 25 basis points to 3.75%, a defensive trade in Treasuries was found. Despite the FOMC's actions yesterday, a strong bid had the shorter-dated 5-year yield ($FVX.X) dropping 4.3 basis points to close at 3.993%, just 25 basis points above the current fed funds rate!

The S&P Banks Index (BIX.X) 339.13 -1.63% traded a 52-week low as a tightening fed combined with a bid for the longer-dated 30-year bond had its yield ($TYX.X) down 4.9 basis points to 4.458%. If looking to "pick a low" in the banks, today was not the day to try and do it.

Did the market "expect" the Fed to not raise rates on Wednesday, as reported by the Wall Street Journal? Fed fund futures contracts, as well as the banking sectors certainly didn't show any type of "expectation" for the FOMC to not raise 25 basis points.

Did Mr. Greenspan raise rates to avoid any type of "future blame?" Or was Mr. Greenspan and company (excluding Mr. Olson who voted against the 25 bp rate hike) trying to show some fiscal responsibility?

In Saturday's Market Monitor at OptionInvestor.com, I made some comments regarding fiscal policy where last week, President Bush outlined his plan for taxpayer's dollars to help fund some rebuilding of areas stricken by Hurricane Katrina.

My commentary wasn't to be considered "politician bashing," but perhaps lay some groundwork to what now faces President Bush, U.S. taxpayers, and yes.... the FOMC.

In brief, though President Bush draws on the entrepreneurial spirit of this great nation, to let the world know that New Orleans will rebuild, it will be the taxpayer that helps provide incentive to entrepreneurs. My point of contention with President Bush was that entrepreneurs usually don't need any type of incentive, if future risk/reward is favorable.

I will try and support my thoughts of how the MARKET might have taken President Bush's comments as a "negative."

For those that don't have access to my little "tirade" on Saturday, I disclosed that I have donated money to causes that should help human/animal relief efforts in Louisiana/Mississippi. I also voted for President Bush in the last two elections.

But from a "free market" perspective, should an incentive to business (tax breaks, outright funding) be given to rebuild business. If so, then precedence has been set.

Now market participants await the approach of Hurricane Rita as it tracks toward Houston, TX, where experts currently predict the storm to reach landfall Saturday morning.

U.S. Market Watch - 09/21/05 Close

Last week I profiled a bullish "option expiration manipulation" trade for Bank of America (BAC) $42.26 -1.72%, which was profitable and exceeded even my bullish expectations for the trade. The stock closes at a new 52-week low today, giving me some confirmation that Friday's gains were highly expiration manipulated, and not necessarily a market run with thought that the Fed would leave rates unchanged on Wednesday.

We haven't seen Friday's highs since early Monday morning. My analysis would be that the market wasn't front-running a pausing Fed yesterday, but was simply manipulated by the quarterly expiration.

I point to the 5 and 30-year yields. You can see from the % change that the curve has narrowed. On a pure net change basis the 5-year yield is up 4.9 basis points in the last 5-days, while the 30-year yield has risen a more modest 1.7 basis points. This is curve flattening and finds the S&P Banks Index (BIX.X) down another 2.23% in 5-days.

If there were ANY sign that the Fed is nearing the end of its rate hikes, it may well be the continued weakness in the Eaton Vance Ltd. Duration (AMEX:EVV) $17.56 -0.67%. Yes, its current SEC yield ($0.1261/share/month = $1.5132/share/year) looks attractive (SEC Yield based on $17.56 close = 8.617%), but this shorter-date maturity closed-end bond fund continues to decline (capital depreciation) as investors look to be discounting an end to the Fed's tightening policy versus the appearance of a nice dividend. What is happening here is what I warned traders/investors about this summer. A flattening yield curve, at what "should be" nearing the latter stages of Fed tightening brings greater risk to an investment vehicle like the EVV that offers a "high dividend yield" that is not in par with shorter-dated maturities. Either the dividend from EVV gets cut (we've seen some of that), or the price has to fall to equate to something equivalent to the 5-year Treasury yield.

As we look at the 5-day Net % changes, I'm going to draw your attention to the Defense Index (DFX.X) 271.00 -2.05% as action here may well be a market response to future budget cuts, if the government is to help fund the rebuilding of Katrina-stricken areas. Since President Bush's speech last week, this sector is down 3.17%. That's a decent decline for a sector whose components are somewhat reliant on federal dollars.

With speculation rising that some Federal budgets will come under the knife, in order to fund a projected $200 billion federal aid package toward Katrina, traders and investors might want to review investments that might be subject to some budget cuts.

Defense Index (DFX.X) / Lockheed Martin (LMT) montage

The DFX.X doesn't get a lot of attention from traders/investors, should budgets get cut at the federal level to fund the rebuilding of businesses that are adversely impacted by natural disasters, the DFX.X action may hint that some market participants are also factoring in some of the government's recently stated policy to give financial incentives to business. What the government gives to one area, it may have to cut in another.

Yes! National defense would most likely be one of the last places the government would look to cut budgets, but market psychology can become "when in doubt, get out!"

Lockheed Martin (LMT) was just a "top of mind" defense contractor, and it was only tonight that I note its violation of a rising 200-day SMA.

Friday's volume spike and downward price action does come at quarterly expiration. Could it be that some other market participants view federal funding for rebuilding a negative policy move from the White House? It may be a negative coincidence, but the President's actions are more "socialist" than that of "entrepreneurial."

Perhaps Mr. Greenspan and company were sending a message to Washington on Wednesday. You can borrow to fund what should be a market driven rebuilding, but it is going to cost you (and U.S. taxpayers) to fund it.

The Dollar Index (dx00y) was weak today, while gold, as depicted by the StreetTracks Gold Trust (GLD) $47.06 +1.79% ($47.06 roughly $470.60/ounce) rose sharply. It is notable that the night before Katrina hit, the GLD closed at $43.01. The GLD closed at a new 52-week high today.

My analysis here is that it might not be "FOMC policy" being critiqued by the markets, but policy out of Washington.

Let's take a quick look at some PnF charts. Let's start with a BIX.X chart on its conventional 5-point box scale. Just remember that Xs are up (demand outstripping supply) and Os are down (supply outstripping demand). For a column of O to be reversed into X, a meaningful 3-box reversal (in this case, 15-points) would be needed.

S&P Banks Index (BIX.X) - 5-point box size

Today's trade at 340 generates a second-consecutive "sell signal" as a column of O falls below a prior column of O. In my opinion, it isn't so much what the FOMC is doing, but what longer-dated maturities are doing (yields still relatively low) and the flattening of the yield curve. Banker's margins continue to get squeezed.

When the FOMC says it still doesn't see great risks to inflation, that keeps a bid in the longer-dated 30-year. Meanwhile, the tightening of the Fed has shorter-dated maturities "inching higher." Not good for banks.

The above chart is from www.dorseywright.com. Stockcharts.com's $BIX.X chart is funky as it doesn't reflect the adjustments made to this index back in June of 2002.

Here's the S&P 500 Index point and figure chart on its conventional 10-point box.

S&P 500 Index (SPX.X) - 10-point box

Today's action combined with recent selling from 1,240 does have the SPX seeing enough meaningful selling to reverse 3 boxes lower. It would take a trade at 1,200 for this index to generate a "sell signal." In early July, the SPX also gave a double bottom sell signal at 1,160, fell 1.7%, then reversed sharply higher. Trader's and investors might be able to use a 1.7% decline from 1,200 as a minimum assessment of downside risk.

I'm just seeing that tonight's S&P 500 Bullish % ($BPSPX) from wwww.stockcharts.com has fallen an additional 1.8% to 67.20% and has now reversed BACK DOWN to "bear alert status!" This is a DEFENSIVE signal from this broader market breadth indicator.

This should have BULLS taking a more defensive posture, and these internals do suggest the SPX will generate a "sell signal" at 1,200 as supply looks to be outstripping demand.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

Play Editor's note:

It is nice to see stock's trading lower as we expected they would during the second half of September. If/when the market bottoms in October it could offer a nice set-up for bullish positions into the fourth quarter. We wanted to add new plays to the list tonight but could not find anything we really liked that wasn't already looking oversold. A few were in the retail sector but the RLX index is already down seven days in a row. We will certainly try again tomorrow!

New Calls

None today.
 

New Puts

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Apache - APA - close: 77.26 change: +1.66 stop: 72.49 *new*

Energy stocks continue to set new highs. Wall Street is worried that hurricane Rita may cause additional refinery shutdowns and damage to oil platforms in the gulf of Mexico. This sentiment pushed shares of APA to a 2.19% gain and another new all-time high. Our target is the $79.00-80.00 range. We are raising our stop loss to $72.49.

Picked on September 18 at $ 73.42
Change since picked: + 3.84
Earnings Date 10/27/05 (unconfirmed)
Average Daily Volume = 2.6 million

---

Cameco Corp - CCJ - close: 54.24 chg: +1.34 stop: 49.49

The higher crude oil climbs the more CCJ looks attractive as an alternative. We see no changes from our previous update. The 51.50-52.00 range should act as short-term support. Our target is the $58-60 range.

Picked on September 18 at $ 53.30
Change since picked: + 0.94
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 862 thousand

---

Altria Group - MO - close: 71.63 change: -1.23 stop: 69.90

Three days of heavy losses on the DJIA are finally taking its toll on this Dow component. Shares of MO lost 1.68% and looks poised to trade lower. Readers can watch for the stock to find its next level of support at $71.00 or the $70.00 level. We are not suggesting new plays at this time. We'll watch for a bounce from support first.

Picked on September 18 at $ 73.14
Change since picked: - 1.51
Earnings Date 10/19/05 (unconfirmed)
Average Daily Volume = 6.7 million

---

Noble Energy - NBL - close: 46.59 chg: +1.17 stop: 43.24

Another day, another new high for NBL. We are raising our stop loss to $43.24. Our target is the $49.00-50.00 range.

Picked on September 11 at $ 44.90 *post-split price
Change since picked: + 1.69
Earnings Date 11/02/05 (unconfirmed)
Average Daily Volume = 796 thousand

---

Noble Corp - NE - close: 70.99 change: -0.17 stop: 67.85

Oddly enough shares of NE are not participating in the energy-sector rally. Investors might be worried about the company's exposure to hurricane Rita, which just became a dangerous category five storm. While we're not going to exit the play just yet we would not suggest new bullish positions until we see a new relative high in the $72.50-72.75 region. Our target is the $78-80 range.

Picked on August 31 at $ 71.30
Change since picked: - 0.31
Earnings Date 10/17/05 (unconfirmed)
Average Daily Volume = 1.8 million
 

Put Updates

Adobe Sys. - ADBE - close: 27.87 chg: +0.13 stop: n/a

We see no change from our previous update. This is a strangle play on ADBE's recent earnings report and we're in wait mode to see how far the post-earnings reaction will run. We are not suggesting new entries.

Picked on September 13 at $ 26.82
Change since picked: + 1.05
Earnings Date 09/15/05 (confirmed)
Average Daily Volume = 6.2 million

---

Black & Decker - BDK - close: 80.62 chg: -1.69 stop: 85.05

BDK is performing on cue. We warned readers to watch for a bounce from the $80.00 level. That's what the stock did today. Wait for the failed rally under the $84 level before considering new bearish positions. Our target is the $78-77 range.

Picked on September 14 at $ 83.31
Change since picked: - 2.69
Earnings Date 10/25/05 (unconfirmed)
Average Daily Volume = 636 thousand

---

Hovnanian - HOV - close: 50.38 chg: -0.81 stop: 55.01*new*

Homebuilders continue to look weak and shares of HOV lost another 1.58% today. The stock came within five cents of our target 50.25-50.00 range. We are not suggesting new plays. Instead we're suggesting that our readers exit at will. There's no need to wait for that extra five cents and we would expect an oversold bounce from round-number support at the $50.00 mark. We are lowering the stop loss to $55.01.

Picked on September 18 at $ 54.75
Change since picked: - 4.19
Earnings Date 09/07/05 (confirmed)
Average Daily Volume = 1.2 million

---

Hershey Co. - HSY - close: 55.48 change: -1.60 stop: 58.01*new*

The sell-off in shares of HSY is really picking up speed now that the stock has broken down from its recent trading range. We are lowering the stop loss to $58.01. Our target is the $54.00-53.50 range.

Picked on September 14 at $ 57.90
Change since picked: - 2.42
Earnings Date 10/20/05 (unconfirmed)
Average Daily Volume = 760 thousand

---

MBIA Inc. - MBI - close: 55.75 chg: -1.63 stop: 59.01

The financial sector was hammered lower following yesterday's FOMC decision on interest rates. Shares of MBI gapped lower and closed near their lows of the session. Our target is the $54.25 mark.

Picked on September 13 at $ 57.75
Change since picked: - 1.72
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 1.2 million
 

Dropped Calls

Amer. Intl Group - AIG - cls: 59.40 chg: -1.11 stop: 58.99

Another broad market sell-off and a triple-digit loss in the DJIA sent this Dow component to a 1.8% decline. The breakdown under round-number, psychological support at the $60.00 level and technical support at the simple 200-dma looks like bad news. We are choosing to exit early here. We'll keep an eye on AIG to see if shares rebound from their 100-dma, which is nearing the late August lows.

Picked on September 11 at $ 61.23
Change since picked: - 1.83
Earnings Date 11/08/05 (unconfirmed)
Average Daily Volume = 7.2 million
 

Dropped Puts

None
 


Trader's Corner

Trendlines

I was absent from this space last week, due to an attack of the killer flu bugs. Well, maybe I shouldn't make any kind of joke regarding a 'killer' flu, as there are some much worse ones that may be out there now or in the future, than the one that laid me low for a couple of days.

As I was wondering this morning what illuminating topic I might write about, hopefully to take my mind off why I wasn't short this market!, I was 'saved' (as to a relevant topic for discussion), by an OIN SUBSCRIBER QUESTION that came in:

"What do you see now in the trend and do you consider that the market is now in a down trend? Also, what do the charts show you about oil prices, and gold too which has been really strong lately?"

RESPONSE:
Those who follow my work no that I tend to define trend direction more than anything by the use of TRENDLINES.

And, in those terms and looking first at the S&P 500 (SPX) daily chart, the index has broken down under its multimonth downtrend line; it looks like it might be headed to the 1200 area again.

If SPX reached this area and staged a rebound it would set up a potential double bottom low and could start rallying again. Trendlines don't tell us everything about where the market is going, trendlines can be pierced and the market come back later. It's just more rare.

Other technical aspects are 'trigger' points that relate to trend, and also can show changes in near-term/trading momentum. I especially tend to rely on the 21-day moving average. I noted in my weekend (9/17) 'INDEX TRADER' commentary [see online by clicking here],
** production note: 'click here' URL = http://www.OptionInvestor.com/page/oin/commentary/iwrap/2005/09-17.html>that I would stay with October Index calls bought near recent lows UNLESS the 21-day moving average was pierced; especially on a closing basis. The next day's opening was time to exit calls!
I don't stay in an option unless on the 'right' side of trend.

The most definitive chart aspect for the intermediate trend and used on DAILY charts, are the relevant up or down trendlines:

Today's S&P close under the May Aug uptrend line suggested that its likely the index will fall further. The prior lows become a next possible target or objective.

The SPX rally failure shy of the highs was a warning that the uptrend was losing momentum, but the rally could have gotten going after a minor pullback or consolidation. This possibility becomes much less when a major index falls under its 21-day average.

The trendline break shown in the SPX chart above suggests more than a 'pullback' or minor retracement, rather, another down 'leg' ahead. A down LEG is a move equal to, or greater than, the last downswing; i.e., from 1245 to 1200 or 45 points. It's sometimes the case for a second leg down to be as much as 1.6 times the first; suggesting a target to 1170 for example. By the way, am not predicting this kind of downside unless there is a close under 1200 and not reversed the next day.

HOURLY AND DAILY CHARTS

It's important to look at trendlines on charts in timeframes 'above' and 'below' the daily chart time interval. My favorite intraday time frame that is finer detail than daily, is hourly. Hourly chart trendlines show you shorter-term trend reversals. Weekly chart trendlines, a time frame above daily, shows the long-term or major trend.

Hourly chart trendlines are very useful for the option trader trading trends of shorter duration, over a few days, rather than 2-3 weeks, or longer.

DRAWING TRENDLINES:
You need only two highs or lows to tentatively establish a down or up trendline. The first trendline shown on the hourly chart below, began by drawing a straight line between two hourly highs. The next high after that (the 3rd point) came right up to that line and gave what we most desire in trendlines, which is 3 or more points. The following rally high again touched the hourly down trendline. An upside reversal occurred by the thrust up above the down trendline at the (2nd red) down arrow.

Up trendlines were constructed on the next rally, the steepest of which (Trendline 1 or T1), was pierced and suggesting to exit calls. I was trading the active S&P 100 (OEX) options based on the SPX as the broader '500' group was leading the big cap NYSE stocks. I tend to 'trade off from' the leading index in that market segment; so, I wouldn't trade the Nasdaq 100 (NDX) based on the trendline breaks or breakouts related to SPX.

The second trendline (T2) also got pierced. When the prior low as also penetrated, this was a 'final' confirming chart indication that at least the short-term trend had reversed.

DRAWING AND RE-DRAWING TRENDLINES:
There is a necessity to re-draw trendlines. For example, the first low in SPX that held at 1225 and seen in the hourly chart above was the second low used to construct my hourly up trendline. The subsequent pullback around 9/15 fell under that line and I re-drew it using THAT low. The next price break took prices below this trendline and was a second 'confirming' break of upside momentum and any up trendlines.

'INTERNAL' OR 'BEST-FIT' TRENDLINES:
Internal trendlines can cut through a bar as these kind of 'best-fit' trendlines connect the MOST number of highs or lows. The long-term weekly chart up trendline is a case in point. You notice on the lower left, that the trendline begins in an area where it cuts through one weekly bar; i.e., the range between the weekly high and low that particular week.

The weekly up trendline in the chart below, drawn through the cluster of lows made in the early-2003, then connected to the cluster of mid-2005 weekly lows, conveys the dominant trend. A simple way to think of a trendline is that it shows the dominant RATE OF PRICE CHANGE or momentum.

The key point to make about this trendline relating to where we are NOW is major trendline support is suggested in the 1200 area, which was also the area of the last low. 1200 becomes the 'make or break' area so to speak, as far as the trend.

There is another consideration when looking at very long-term (weekly or monthly) charts, where there has been a big run up or run down in prices. Check the trendline using the logarithmic scale, which draws equal PERCENT changes to be an equal distance.

The so-called 'semi-log' or 'log' scale is different than the way we usually see price charts displayed, in the arithmetic scale, where equal PRICE moves have the SAME length.

An internal up trendline connects even more weekly lows by using the semi-log scale on the weekly chart below. It suggests that the long-term chart and trend picture starts to turn bearish if there is much more of a drop from today's low.

EVEN SIMILAR, INDEXES OR MARKETS HAVE DIFFERENT TRENDLINES
The S&P 100 (OEX) daily chart below, while bearish given the sharp two-day break and its closes near or AT the lows. But, its daily up trendline has not yet been pierced. It would take a move below 560 for that to happen. I think a daily close under 560 would suggest that the prior, late-August, lows were not going to become support again. Those lows, around 556 bear watching, but with a close under 560, I will not be holding my breath expecting a double bottom at 556.

There is another aspect to trendlines that the OEX shows that the S&P 500 does not. A down (again, an internal/best fit) trendline that suggested declining or falling momentum. An OEX chart trendline showed this aspect, whereas the SPX chart did not. Once there was a high not exceeded the next day, there were some points to construct an internal trendline.

Notice that the prior highs in the OEX chart that were ABOVE the down trendline in the chart above, did not have a close above this line. These are little things to look for. The big picture thing we're looking at is that there is a PATTERN of DECLINING HIGHS.

BEWARE OF TRENDLINES THAT APPROACH A VERTICAL SLOPE
You asked about gold prices and it looks like the Gold and Silver Index (XAU) could top again in the 112-113 area. The subscriber question was about GOLD. I don't tend to 'trust' these gold rallies that go straight up. They then tend to come STRAIGHT DOWN.

OIL PRICES?

Well, the OIL STOCK (OIX) Index looks like it is going to the moon, but as with the XAU chart above, I think the rate of increase is getting a little 'scary'. If I had to be an option, I'd rather be in puts with this latest acceleration. Especially so, if we go on to look at the crude futures chart.

This chart 'strings' together the nearby futures contacts to get a longer-chart view. And, that view, that pattern, suggests that $70 may be the top of its uptrend channel. Again, the straight up move is seen. Again, this current runaway up trend is probably not sustainable. I'd start to look for prices to come back down on balance.

PLEASE NOTE:
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

Today's Newsletter Notes: Market Wrap by Jeff Bailey, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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