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Daily Newsletter, Wednesday, 10/19/2005

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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

Fright Night

Foreign bourses created a fright night for U.S. investors, with bourses in Asia and Europe all declining, some more than two percent. The Nikkei 225 had dropped almost 280 points off its previous day's close at one point, although it managed to trim that loss to a mere 222 points by the close. Inflation fears, another hurricane, and hawkish talk by ECB members contributed to the deep declines on bourses that had been soaring and drawing in weak bullish hands.

Investors were also treated to reminders on CNBC that this was the anniversary of the 1987 crash. That increased the panic. However, our futures remained above last week's high, and some chart setups indicated the possibility for a gap lower and then a bounce. That's exactly what happened. The bounce was soon reversed, giving bulls another fright, but it was ultimately the bears who were going to be the most terrorized. Indices printed tall bullish engulfing candles on the daily charts, with the gains accelerating into the close as bears were desperate to cover.

It was a bullish day. However, most of the bounces were from predictable levels, into predictable retests of resistance, with a powerful short-squeeze contributing to those gains. Let's look at the evidence, beginning with the Dow. The Dow continued the predictable bounce that began after it tested the July low.

Annotated Daily Chart of the Dow:

The SPX bounce began from a level that's been identified for weeks, the weekly 72-ema.

Annotated Daily Chart of the SPX:

The SOX bounced from the weekly 200-sma, with that moving average a longtime S/R level for the SOX.

Annotated Daily Chart of the SOX:

Like the SPX, the RUT's bounce began from the weekly 72-ema.

Annotated Daily Chart of the RUT:

The Nasdaq bounced from a best-fit rising trendline off the July low, with that best seen on the weekly chart. The line is not shown in the chart below, but is at about 2027.

Annotated Daily Chart of the Nasdaq:

The fright-night effect was heightened by the opening of Saddam Hussein's trial on charges of murder and torture. As was widely expected, the one-day event resulted in a postponement, with most speculating that the postponement would be of at least a month and with the actual postponement until November 28. The trial's opening featured the one-time dictator demanding to know the identity and right of the presiding judge to do just that--preside over his trial. He talked over the judge and said he did not "recognize the body that has designated and authorized you, nor the aggression because all that has been built on false basis is false." After pleading not guilty, he scuffled with and yelled at guards who attempted to escort him out of the room. The trial, when it begins in earnest, may cause geopolitical upheavals, but it did appear to attract much notice or impact markets today.

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A Friedman Billings downgrade of Phelps Dodge (PD) to a market-perform rating from its previous outperform one added to the fright, sending PD sharply lower shortly after markets opened and adding to the slide in materials-related stocks. The API, the American Petroleum Institute, also delivered a fright to those hoping for the oil majors to help support the markets. September's deliveries dropped 4 percent, with the subsequent year-to-year decline the largest in more than a decade, one article noted. Crude output declined 22 percent from the year-ago level. Refinery capacity utilization dropped to its lowest September level in 20 years, at 82.7 percent, with that drop blamed on Katrina and Rita's impact. Later, the Department of Energy was to announce that U.S. crude inventories rose 5.6 million barrels, gasoline inventories rose 2.9 million barrels and distillates declined 1.9 million barrels. The results saw crude and gasoline inventories building more than expected, and distillates dropping less than expected.

The resulting dip in crude prices was enough to prompt an equity bounce, but bulls got another fright when indices rolled over again, perhaps when the impact of the API's statement was more fully absorbed. While the environmental impact of slower demand in petroleum products can be deemed a good one, the economic impact of American consumers parceling out their automobile usage so carefully might not be.

Ultimately, crude was to decline and markets were to rise.

Annotated Weekly Chart of Crude for December Delivery:

In general, early morning economic and earnings releases should have consoled those frightened investors, slowing their desperation to get out. Two early economic releases related to the much-watched housing market. The Mortgage Bankers Association released mortgage applications for the week ending October 14 at 7:00 EST. Applications rose. The Market Composite Index rose 6.1 percent, with this release measuring mortgage loan application volume. This number was adjusted due to the Columbus Day holiday. The Purchase Index rose 7.3 percent; the Refinance Index, 4.5 percent; the Conventional Index, 6.0 percent and the Government Index, 7.8 percent. This still keeps the four-week moving average for the Market Index down 1.2 percent; for the Purchase Index, up 0.2 percent and for the Refinance Index, down 3.0 percent. Refi share fell to 42.8 percent of all applications. The average interest rate for a 30-year fixed-rate mortgage increased to 6.09 percent from the previous week's 5.98 percent.

Ninety minutes later, September's housing starts were released, with those increasing 3.4 percent, bringing the seasonally adjusted annualized rate up to 2.108 million. Expectations had been for an increase to 1.970 million on the annualized figure, but housing starts increased more than they had since February. Building starts increased, too, by 2.4 percent, to a seasonally adjusted annualized rate of 2.189 million. A Marketwatch.com article tagged this as the highest increase in 32 years. Single-family building permits rose 4.4 percent, hitting a record number, and starts of single-family homes climbed 2.6 percent. Looking specifically to the South, the hurricanes couldn't stop a 6.9 percent increase in housing starts.

Like many other indices, the DJUSHB, the Dow Jones U.S. Home Construction Index, ultimately saw strong gains for the day, but not before it dipped down to test the weekly 72-ema. It engulfed the previous day's candle, but, unlike many other indices, it could not bounce above Monday's high. Any further bounce would just bring it into stronger resistance, at the converging 200-sma and -ema's, at 911.62 and 897.84, with further resistance above that. It looks likely to roll over in the 900-950 range, if not earlier, although perhaps not until it engages in some typical right-shoulder-building choppiness. The DJUHSB closed the day at 869.05. A climb above the 50-sma, now at 950, would question that scenario, however.

The general tenor of earnings reports appeared soothing, too, at least those reporting before the bell. Earnings releases continue to be mostly solid, and about two-thirds of reporting companies are beating estimates. Reporting companies today, both before and after the bell, included ABT, MO, AMGN, BAC, GD, ETC, EK, EBAY, EFII, EMC, HON, ITW, JPM, JNPR, KRB, ODP, NTRS, QLGC, VRSN and WM.

Before the bell, BAC reported income rising 10 percent, helped by credit-card results. EK reported a loss. EMC beat expectations by a cent but matched revenue expectations. Defense contractor GD beat expectations by posting $1.84 a share compared with predictions of $1.76 a share. Revenue was higher than expected, too. HON appeared to beat expectations by a couple of cents per share, but guided revenue lower for the full year. ITW reported earnings of $1.43 per share against expectations of $1.36 a share in the fourth quarter and $5.12-5.18 for the full year, against expectations of $1.39 and $5.09 respectively. Trading revenue and investment-banking fees helped JPM's net income. The company appointed a successor to its CEO, due to retire at the end of the year. Jamie Dimon, now serving as president and COO, will take the reins about six months earlier than had previously been planned. MO appeared to beat expectations of Q3 earnings of $1.33 a share, reporting $1.38 a share. The company narrowed expectations for the full year from continuing operations, forecasting $5.05 to $5.10 a share, from the previous $5.00 to $5.10 a share, narrowing it to the top half of previous expectations. One of the reasons for that narrowing included repatriation of $6 billion in foreign earnings that would account for a $0.10 a share benefit. NTRS beat expectations by two cents. ODP reported a loss of 15 cents a share due to charges it had already announced. Outside of those charges, it beat expectations by a penny but sales were still shy of expectations. TER was characterized as beating expectations.

Before the bell, ETR raised guidance for Q3 earnings, to $1.64 per share from its previous $1.22 per share and above broker estimates of $1.58 a share. The company also increased its estimate of restoration costs associated with the two hurricanes hitting the Gulf region. The company kept open the possibility that the bankruptcy of its New Orleans unit and the hurricane-associated developments could materially change reported earnings and accounting disclosures.

Other pre-market news included the announcement that Thomas Weisel had filed for an IPO and that CSFB had upgraded auto-parts supplier DANA Corp. to a neutral rating after Tuesday's restatement. Before any of that--the general tenor of earnings, a company raising guidance, and other positives--could be digested and impact the markets, investors had to recover from their fright.

They were already doing so before the Beige Book release, with markets climbing into the release. The gains accelerated after that 2:00 release. Fed members have been warning lately of increased signs of inflation, and the Beige Book reiterated those concerns, with higher wages in a number of industries contributing to those pressures. All regions saw higher costs for energy, petroleum-based products, building materials and shipping. The FOMC members had prepared investors well to hear that news, however, with increasingly hawkish statements of late.

The Beige Book went on to console investors, saying that although the Atlanta and Dallas regions were impacted substantially by Katrina and Rita, most of the U.S.'s economic activity hadn't been significantly impacted. Mining, financial services, manufacturing and commercial real estate were performing well in most regions. Only Atlanta and St. Louis failed to see an increase in manufacturing activity, for example. Although auto sales were weaker in all regions, most reported a moderate increase in retail sales. Housing was mixed, with four regions reporting strong or growing housing markets while six reported weakening markets.

The bulls were through being frightened and it was time for the bears to experience their own version of fright night. Indices surged, with financials leading the way as they had attempted to do in the first aborted bounce. By the end of the day, reporting financial companies BAC, JMP and NTRS had gained 1.07, 0.99 and 1.53 percent, respectively. The energy sector provided help, with the OIX gaining 2.05 percent and the OSX gaining 2.72 percent. MO received a reward for its earnings report, gaining 1.37 percent. EBay, due to report after the bell, posted a 3.93 percent gain.

However, eBay was not to hold those gains after hours, when the company's report that full-year profit would be less than expected sent it as much as six percent lower in after-hours trading. Its acquisition of Skype Technologies would send its full-year sales above estimates. Earnings for the quarter were 18 cents a share on revenue of $1.11 billion, against expectations of 20 cents on revenue of $1.1 billion.

Amgen (AMGN) suffered a similar fate in after-hours trading, also dropping as much as 6 percent as of the preparation of this report. The company's earnings for the third quarter were 77 cents a share, or 85 cents on an adjusted basis, on revenue of $3.15 billion against expectations of 83 cents a share and revenue of $3.26 million.

While not dropping as deeply as EBAY and AMGN, QLogic (QLGC) also fell in after-hours trading, more than 3 percent at one point, after earnings from continuing operations appeared to come up shy by a cent. Netflix Inc. (NFLX) fell almost 5 percent at one point after an item related to the settlement of a lawsuit resulted in earnings of 11 cents a share on revenue of $174.3 million against expectations of 15 cents on revenue of $175 million.

Not all companies reporting after the bell declined. Other reporting companies included JNPR, rising after reporting revenue that beat expectations, but earnings per share that appeared to miss, if the reports I found were correct. Expectations had been for earnings of 18 cents a share on revenue of $531 million, but were 14 cents on revenue of $546.4 million if those reports were correct. VeriSign Inc. rose after meeting eps estimates on higher-than-expected revenue and reporting that profits grew 11 percent over the year-ago period.

It all starts again tomorrow. Tomorrow's earnings include ACS, BRCM, COF, CLS, CY, LLY, F, FDRY, GNSS, GOOG, MCD, NOK, PFE, DGX, SNDK, TQNT, UPS, XLNX and XTO. Thursday's economic releases begin with the usual 8:30 release of jobless claims, but also include September's Leading Indicators at 10:00 and the October Philly Fed report at noon. Previous numbers include 389,000 jobless claims, with the predictions mostly between 364-368,000 but ranging up to 395,000. Leading indicators were down 0.2 percent in August, with most predictions for a further decline of 0.3-0.5 percent for September. The Philly Fed is expected to push higher in October, with predictions ranging all over the place, mostly from 9.4-10.4, but as low as 7.5.

The advdec parameters I watch show a potential for a pullback tomorrow morning, but don't preclude a gap higher first and don't give an indication as to whether it will be a minor pullback or a deep downdraft. Any early move higher is likely to bring the SPX up to approach its 200-sma and the Nasdaq to test 2097-2103 resistance. Until otherwise proven, today's gains, as strong as they were, are just part of predictable bounces up to test predictable resistance levels. You can expect them, but when they occur, they certainly feel different and more bullish than you'd expected them to feel, and that may be happening now. This argues against charting evidence that my own favored index, the OEX has approached downside targets, so I'm cautious about these conclusions.

Because of the setup for at least a pullback in early trading, be aware of the possibility of a rollover beneath those levels noted in the charts and in the previous paragraph if in bullish positions or if looking for bearish ones. This would be especially true if the advdec line opened at or above 1800-2300 (QCharts symbol and value), perhaps climbed a little, and then reversed sharply in the second or third 15-minute period of the day. If the rollover begins but is soon reversed and some of these known resistance levels are breached, it's time to revise the scenarios.

Until then, remain suspicious of bounces from predictable support to predictable resistance, especially on a day when there was every reason for market forces to combine to prevent a steep downdraft on the anniversary of a market crash.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Biosite Inc. - BSTE - close: 67.10 chg: +0.45 stop: 61.49

Hmm... given the magnitude of today's market rally we're disappointed that BSTE didn't participate more. The stock is already short-term overbought and today's action would suggest that the stock does need to consolidate a bit before turning higher again. Watch for a dip into the $64-65 range. Our secondary target is the $69.50-70.00 range.

Picked on October 13 at $ 63.39
Change since picked: + 3.71
Earnings Date 10/25/05 (unconfirmed)
Average Daily Volume = 261 thousand

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Cardinal Health - CAH - close: 63.94 chg: +1.02 stop: 61.95

A strong day for healthcare (HMO.X +2.4%) and drugs (DRG.X +1.4%) helped push CAH to a new closing higher near $64.00. We are not suggesting new plays at this time and plan to exit ahead of next week's earnings report. Our short-term target is the $66-67 range.

Picked on September 25 at $ 61.95
Change since picked: + 1.99
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 2.0 million

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Pre Paid Legal - PPD - close: 41.11 chg: +0.45 stop: 39.75 *new*

Shares of PPD dipped to support near $40.00 and its 50-dma this morning but the stock rebounded higher once the market rally got underway. We are running out of time on this play. PPD is expected to report earnings on Monday, October 24th after the market's closing bell. We do not want to hold over the report. At the moment we're considering an exit on Friday afternoon at the close or on Monday afternoon at the close. We are going to raise the stop loss to $39.75 under today's low.

Picked on October 10 at $ 40.10
Change since picked: + 1.01
Earnings Date 10/24/05 (unconfirmed)
Average Daily Volume = 72 thousand

---

SurModics - SRDX - close: 41.48 chg: +0.53 stop: 39.49

SRDX offered another bullish entry point this morning. Shares dipped back toward broken resistance now new support near $40.00 and its 100-dma. We see no changes from Tuesday's play description. Our target is the $44.50-45.00 range. We plan to exit ahead of SRDX's October 26th earnings report.

Picked on October 18 at $ 40.95
Change since picked: + 0.53
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 249 thousand

---

Target Corp - TGT - close: 56.00 change: +2.78 stop: 51.49

It was a very big day for retailers. The RLX retail index surged higher with a 2.8% gain. Shares of TGT were leading the way with a big breakout (+5.2%) over resistance at its 50-dma and the $54.00 level. Volume came in about double the daily average! Our trigger to buy calls was at $54.01. Our mid-November (before earnings) target is the $59-60 range. Keep an eye on the RLX index. The RLX did breakout over its short-term trend of lower highs but is still under resistance near 440 and its simple and exponential 200-dma's.

Picked on October 19 at $ 54.01
Change since picked: + 1.99
Earnings Date 11/10/05 (unconfirmed)
Average Daily Volume = 3.8 million
 

Put Updates

Teleflex Inc. - TFX - close: 65.85 chg: +0.21 stop: 69.01

TFX dipped toward round-number support at the $65 level this morning. More importantly the afternoon rebound in shares of TFX significantly under performed the rest of the market. That's good news for the bears although we would still expect an oversold bounce from here toward the simple 10-dma near $67.50. Our target is the $62.50-62.00 range but we plan to exit ahead of next week's earnings report. We are not suggesting new positions.

Picked on October 13 at $ 66.49
Change since picked: - 0.64
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 174 thousand
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

---

AmerisourceBergen - ABC - cls: 76.16 chg: -0.01 stop: n/a

There is nothing new to report on for ABC. We are now in a wait-and-see mode. We are not suggesting new positions.

Picked on October 16 at $ 74.81
Change since picked: + 1.35
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

---

eBay Inc. - EBAY - close: 42.01 chg: +1.59 stop: n/a

Wednesday was a strong day for EBAY. The stock started off strong and continued to rise through most of the day as investors turned optimistic ahead of the company's earnings report. After the closing bell EBAY reported earnings of 18 cents a share, which missed estimates of 20 cents a share. The company blamed its recent Skype acquisition and issued a mixed view going forward. After hours saw EBAY trading lower near $39.00. We're going to make an adjustment to this play. Previously we suggested that readers needed to launch their positions before the earnings report. However, if EBAY opens up near $40.00 or trades back toward the $40 region (39.50-40.50) tomorrow readers might want to consider a new strangle with the same November $45 call and November $35 put options. We'd like to keep our total investment in the $1.00-1.15 range if possible. Our goal is to double our money so we'll plan on selling if either option trades in the $2.00-2.30 range.

Picked on October 18 at $ 40.42
Change since picked: + 1.59
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 18.3 million

---

E*trade Financial - ET - close: 17.05 chg: +0.55 stop: n/a

Shares of ET joined the rest of the market and surged higher in the last 90 minutes of trading. The close put ET back above technical resistance at its 10 and 50-dma's. After the closing bell ET reported earnings of 28 cents a share, which was one-cent above analysts' estimates. Profits rose 35% for the quarter and revenues soared to a record $422.8 million. After hours the stock was trading slightly higher above the $17.00 level. We are not suggesting new plays. We plan to exit if either option trades in the $1.60-2.00 range. Our time frame is before the November expiration.

Picked on October 16 at $ 16.28
Change since picked: + 0.77
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 3.4 million

---

General Dynamics - GD - cls: 121.06 chg: +1.14 stop: n/a

Shares of GD produced a lot of volatility today. The company reported earnings this morning and beat Wall Street's estimates by eight cents. The company then followed up by raising its earnings guidance. Traders seemed confused. Shares of GD gapped higher and traded to $121.68 before quickly falling to its lows of the day and outside its recent trading range to $117.78. Then just as quickly GD began to rebound. The real question now is that once Wall Street has digested the earnings news what direction will the push the stock price? We are no longer suggesting new strangle positions in the stock. Remember, our goal was to double our money. If either option in our strangle trades at $4.00 or more we'll exit.

Picked on October 09 at $119.59
Change since picked: + 1.47
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

---

Google Inc. - GOOG - close: 308.70 chg: +5.42 stop: n/a

Tomorrow is the big day for GOOG. The company is expected to report earnings after the closing bell. Analysts are looking for earnings of $1.36 a share. Meanwhile in the news GOOG is being sued by a publishing group over its plans to digitize a significant number of books. Plus, the company is still fighting over its Gmail name in the United Kingdom. Right now we are not suggesting new strangle positions but if GOOG were to dip back toward the $300 level tomorrow before the close traders might want to consider launching a strangle. Please see the October 16th update for details.

Picked on October 16 at $296.14
Change since picked: +12.56
Earnings Date 10/20/05 (confirmed)
Average Daily Volume = 8.1 million

---

Harman Intl - HAR - cls: 103.10 chg: +2.30 stop: n/a

HAR almost gapped open too high and came close to aborting our play before it began. Yet after its bullish open at $101.40 the stock dipped to $98.80 before the market's afternoon rally. After the closing bell the company reported earnings that were 12 cents above Wall Street's estimates. Plus, management raised its 2006 earnings guidance. The stock was trading in the $108-109 range in the after hours session. We are aiming for a 50% profit on the play so we plan to exit if either option rises to $6.00 or more! Our suggested strangle is with the November $110 calls and the November $90 puts.

Picked on October 18 at $100.80
Change since picked: + 2.30
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 739 thousand

---

Legg Mason - LM - cls: 104.67 chg: +3.07 stop: n/a

Broker-dealer stocks turned in a very strong day. The XBD index added more than three percent and shares of LM paced the move with its own three-percent gain. LM was also upgraded to a "neutral" today by Banc of America. We are not suggesting new positions at this time. If LM were to trade back toward the $100 level traders might consider a new strangle.

Picked on October 12 at $102.59
Change since picked: + 2.08
Earnings Date 10/24/05 (unconfirmed)
Average Daily Volume = 966 thousand

---

O'Reilly Auto. - ORLY - close: 26.87 chg: +0.76 stop: n/a

The action in ORLY looked bullish today. The stock rallied from short-term support near $26 and pushed against resistance near $27 and its simple and exponential 200-dma's. The net effect was a bullish engulfing candlestick pattern. We are not suggesting new positions at this time.

Picked on October 09 at $ 28.23
Change since picked: - 1.36
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = million

---

Verifone Holdings - PAY - cls: 20.71 chg: +0.52 stop: n/a

The rally today has pushed PAY outside our window to consider launching new strangle positions. If shares pull back again to the $20.00 level then readers can consider new plays. (see our weekend play for more details).

Picked on October 12 at $ 19.98
Change since picked: + 0.73
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Concepts of Trend & Constructing Trendlines

Before I get into the subject of the basic concepts of 'trend' and trendlines, especially as it relates to technical analysis, I respond to another Subscriber question of interest. In order to make an occasional explanation of my method of making trading suggestions and guidelines in my weekly INDEX TRADER, a response to the following Subscriber query is my initial topic.

SUBSCRIBER QUESTION:
" I signed up for your option investor this evening an want to know if you provide option set ups for the index's. Upon review of the Index trader, I notice you mention area's on the index's that might be attractive to place a trade but I did not notice any suggested trades."

RESPONSE:
[NOTE: My INDEX TRADER column is up on the weekend, typically Saturday, but is seen on the web site ONLY. From your Sat/Sun. Option Investor e-mailed Newsletter, there is a link near the top of the Newsletter where you can CLICK to my column, but you will be going on the web site at that point.]

I do make specific 'trades' or trading suggestions in terms of the major stock Indexes in terms of a price or area for entry into calls or puts (with a suggested exit point basis the option PRICE levels; but not a specific call/put strike price and month.
WHY?
# 1 - There are too many different preferences as to how our Subscribers like to trade, from very aggressive to more conservative in terms of close by expirations or calls or puts that have some weeks yet to expiration.

# 2 It's too much of an administrative nightmare to keep track of several specific trader recommendations involving price of the option, an exit point for that option if I want to suggest a 'stop' or exit point, an objective, relative to the option, and so on.

I'll give an example of the S&P 100 (OEX) calls and puts from yesterday's (10/18) CBOE most actives: The OCT. 555 Puts closed at 4.50, +2.35. The OCT 555 Calls closed at 1.35 2.75.

Playing options this 'close' by, with so FEW days to expiration is not my particular trading style. I like the idea of trading In The Money (ITM), but would be out in November.

I have been bullish on the OEX calls and, for those that can trade actively and watch the market, what price swings these are! Not my game, as I tend to look for moves that I think will develop over 2-3 weeks, not 2-3 days.

You can tell that I tend to be a BUYER of options. I basically have been 'timing' the stock indexes (first for all UBS brokers), taking directional trades, since when stock index futures first started. Later I switched to options when I wanted to 'slow down' a bit; I noticed anyway that my biggest 'following' was with the option brokers. Anyway, they were interested in buy or sell (direction) and in what areas (price).

MY OPTION CRITERIA -
#1 - the contract should be actively traded, so am looking for a month and strike price that will allow me to buy 5-10 puts or calls and not have the price move much.

#2 I like to have 2-3 weeks left to expiration, but don't tend to trade options that go out beyond 4-6 weeks. You may be paying a greater time premium than is necessary assuming your TIMING is good timing is, as they say, everything!

I want to go out beyond the lead month options if there is only 1-2 weeks left to expiration. I prefer to have more time left in order to stay with a developing trend. I could roll into a higher/lower strike and go out further, but tend not too.

#3 - I try to buy an Index at what I think is a significant high or low point, at their infrequent extremes when the index or market is either quite 'oversold' or 'overbought'.

#4 because of #3, I trade LESS, not more, frequently. I'm NOT your broker urging you to jump in, jump out and making commissions each time you do so. (Hey, I was one once!) I only care that I end up the year at a substantial profit. To do this, in my estimation anyway, most traders should pick their (occasional) spots only.

#5 - If I think we're at a bottom, I tend to buy At The Money (ATM) or slightly Out of The Money (OTM) calls. If I think the market is at a top, it becomes a bit trickier.

Bottoms are "easier" in a sense as there tends to be these 'spike' lows or 'V-bottoms' because selling tends to be more of a once or twice decision among the sellers.

Whereas there is multiple and piecemeal buying of stocks on the way up, selling tends to be more emotional and investors/traders exit frequently all at once - sell everything, get me out of the market kind of thing. This dynamic creates a bottom that is often a one-time spike low - of course, sometimes you get a retest of the low and get a double bottom or a slightly lower low, then it rallies.

Tops typically take longer to form and in an advancing trend a rally can keep going for some time or index prices will tend to "hang" around resistance(s). This makes timing of put purchases a bit different. I am more inclined to buy half the number of puts I want to end up with and have room to buy more, perhaps to price average. I am more inclined to buy ATM or In The Money (ITM) puts, with a month or so before expiration.

EXAMPLE - FROM MY 10/8 INDEX TRADER COMMENTARY:
" ... I'd buy (OEX) calls on dips, but am also waiting for any 1-day confirming extreme in my Call-Put 'sentiment' indicator. But assuming a call buy around 545, risk to 542 is 3 pts, versus upside back up to 559-560. (the 'risk to reward') Ratio is good."

The above comments are made after the close of trading on 10/7. This trade is only now just working out in my estimation. I preferred than, when OEX dipped to the 545 area, to go into the November 545 calls. I don't want to 'overtrade' relative to how much I have in my account and buying the more distant strikes is an 'encouragement' so to speak, for me to buy twice or three times as many calls.

Just because calls are limited RISK doesn't mean we should not be careful not to overbuy relative to our trading capital. Buying more of a cheaper call or put is not necessarily a smart trading STRATEGY. I plan on being wrong a certain amount of the time and I want above all to preserve trading capital and take small losses. I learned this stock index trading futures, which is what I did first for a few years.

THE OEX CHART THEN (when I wrote my 10/8 commentary) -

THE OEX CHART TODAY (as of 10/19)

Buying the OEX November 545 Index calls when the S&P 100 Index got down to 545 on two occasions now, even using a very 'tight' stop or exit point at 542, looks like its turning out to offer an outstanding risk to 'reward' potential. Stay tuned on that!

Today's OEX price action is what I would call a KEY upside reversal; i.e., a new low for the recent move, followed by a close that is above the previous day's HIGH. The fact that today marked a new 5-day high, even more so.

For more on why a LESS bullish/more bearish 'sentiment' level suggests this recent bottom will lead to more sustainable rally, I refer you to my most recent Index Trader Commentary (10/15), and the section on the S&P 100 (OEX), which you can see in the INDEX TRADER section on the OIN home page or go to directly by clicking here

That my call to put indicator was more 'bullish' today should be very encouraging to the bulls

For a bit more in-depth discussion of trader 'sentiment' as an INDICATOR for future market behavior, you can look at one of my Wednesday Trader's Corner articles from August by clicking here.


II. TREND and TRENDLINES

SUBSCRIBER QUESTION:
"I am new to the technical analysis mindset. I read articles like yours with great interest and with the hope that I can also see the pattern the writer is talking about.

I have one question about the chart and commentary noted in Option Investor Daily, Wednesday 10-05-2005, Hourly charts and "Double Trend line" Resistance, S&P 500 (SPX) Hourly Chart.

You have drawn three trend lines on that chart, T1, T2, and T3. T1 and T2 follow consistent drawing patterns, that is from end Aug's bottom to adjacent bottoms. T3 however, does not follow this pattern.

T3 is drawn from end Aug's bottom to the last adjacent top. Why is this? Is this a particular technical analysis technique? Can you refer me to some sort of reference material that might explain this"?

RESPONSE:
First of all let me engage in shameless self-promotion and refer you to Amazon books and my "Essential Technical Analysis". You can buy used copies. By the way, I don't benefit at all from the sale of this book, as was well paid already by John Wiley & Sons to go off an write it back in 2001. [Which is why I was NOT in my office on the 105th floor on 9/11/01 in the North Tower of the World Trade Center, along with the rest of my (deceased) Cantor Fitzgerald colleagues.]

I think the trendline section in my book is better than the others out there because I go into more depth on the valid variations of constructing trendlines.

THE CHART YOU REFERRED TO:
The first two upward sloping blue dashed trendlines below, reading from left to right and higher slope to lower, are more or less 'conventional' trendlines. I say more or less, because, unlike the most restrictive way of drawing trendlines, they 'cut through' or bisect one or more 'bars' of the chart; i.e., one or more INTRADAY lows.

An 'internal' trendline, pioneered by Jack Schwager, connects the MOST number of highs and lows and generally or 'artfully' shows the PREDOMINANT rate of ascent or descent for a price trend.

The way that the most significant resistance is shown by a down trendline is drawing a straight line connecting 2-3 or more DESCENDING rally peaks; i.e., this is the DOWN trendline. The #1 trendline of what I called 'double' trendline resistance is the red down sloping trendline below. A rally peak made close to this down trendline is seen at the 3rd red down arrow.

The 4th and last down red arrow is at the 3rd upward sloping blue trendline and is another means of showing resistance; this trendline also starts at August lows, but connects 2-3 HIGHS made over the course of the last rally, before its sharp break.

This method of connecting the highs seen in an UPTREND such as we had from mid to late-Sept, is also the way that the top end of an uptrend channel is constructed showing rising minor resistance.

On the way up, prices of stocks and indices tend have both up and down price swings, but within a rising trend. This movement tends to occurs WITHIN two rising trendlines, one drawn through the lows (the up trendline) and other through the highs (the top end of a rising trend channel). The reverse tends to be true in downtrends, although there are more straight-line declines.

MORE TRENDLINE, AND TREND 'CHANNEL', CONCEPTS
The first rising up trendline on the left in the hourly S&P 100 (OEX) chart below is drawn through rally highs and defines resistance within the rising trend; i.e., the upper end of OEX's uptrend 'channel'. This trendline is drawn parallel to the T2 up trendline that connects the various lows on the way up.

Trendline T1 is the initial rising UP trendline connecting the various lows. This up trendline had to be revised once prices pierced the steep angle of T1. The new up trendline became 'T2' and defined potential support on pullbacks. The parallel gray up trendline (to T2) defined the upper end of the rising trend channel, showed areas of periodic resistance or selling interest ('profit taking') on the way up.

An uptrend is a series of rising rally highs and RISING pullback lows. The lows 'define' the uptrend line. When there's break of this trendline, the rising trend angle then becomes less steep OR the trend reverses.

Just as prior support, once broken, tends to 'become' resistance later on, so to with trendlines. Trendline T2 was penetrated. When OEX rebounded back to that line (at the red down arrow), resistance was hit and the trend reversed down.


** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

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

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