Option Investor

Daily Newsletter, Wednesday, 11/02/2005

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Table of Contents

  1. Market Wrap
  2. Trader's Corner

Market Wrap


Equity markets have been in need of a focus lately, with markets swinging first one direction and then another. The Wednesday-morning market open was going to provide that focus in the form of an early TRAN rise to test the March record intraday high.

Annotated Weekly Chart of the TRAN:

All gazes remained riveted on the TRAN, already approaching the March 8 intraday and record high of 3889.97 before the inventories release. After that inventories number, the TRAN drove past that March intraday high and eventually past 3900.

The EIA reported that crude inventories increased 2.73 million barrels, higher than the expected 2.5 million barrels, and gasoline rose 1.03 million barrels, higher than the expected 700,000 barrels. Distillates fell 159,000 barrels, but even in that number, the news was better than expected. Analysts had anticipated a 1.0 million barrel decline.

By midday the TRAN had posted an almost two percent gain, on its way to an eventual 2.29 percent gain, as it charged above its March high and 3900. The XAL, the Airline Index, was posting a strong gain, too, on its way to its eventual 3.42 percent gain. Bear Stearns upgraded that industry group, with shared components of the TRAN and the XAL including AMR, CAL, JBLU and LUV. AMR was one of the specific companies highlighted by Bear Stearns, and AMR was to rise by $0.87 or 6.53 percent.

Other indices charged up to test resistance, too.

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the SPX:

Annotated Daily Chart of the Nasdaq:

Annotated Daily chart of the SOX:

Pre-market focus on political issues seemed to wane as the markets opened and equities displayed such strength. Political issues earn comment on these pages only when they might impact market movements. Jim Brown commented last night on some of the proposed tax code changes that could affect markets, including the housing industry. This morning, two other reports, one an economic report and another an earnings report, refocused attention at least momentarily away from the TRAN and XAL and onto the industry that has been so important in sustaining our economy.


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For the second week in a row, the Mortgage Bankers Association reported a drop in home purchase applications, this for the week ending October 28. The report indicated that the anticipated fourth-quarter softening in the new home sales from their record levels is occurring. The Market Composite Index, the component that measures mortgage loan application volume, fell 4.8 percent from the previous week's number on a seasonally adjusted basis. The Purchase Index dropped 6.2 percent; the Refinance Index, 2.8 percent; the Conventional Index, 4.9 percent and the Government Index, 4.1 percent. The four-week moving average for the seasonally adjusted Market Index dropped 2.4 percent; the Purchase Index, 1.9 percent and the Refinance Index, 3.0 percent. The refinance share of mortgage activity did rise to 43.6 percent, however. The average contract interest rate for a 30-year fixed-rate mortgage rose to 6.21 percent from the previous week's 6.06 percent. Points increased.

If the Mortgage Bankers Association anticipated a softening in new home sales for the last quarter of the year, Beazer Homes' (BZH) earnings report attempted to refocus investors on the record year that some homebuilders had experienced. When reporting fiscal fourth-quarter earnings, the company beat expectations of $3.11 a share, reporting $3.61 a share, up from the $1.82 a share from the year-ago quarter. Revenue of $1.81 billion also beat forecasts of $1.56 billion. For the next fiscal year, BZH raised earnings expectations to $10.50 a share from the previous $10.44 a share.

Annotated Daily Chart of the DJUSHB:

Annotated Daily Chart of the TNX:

If consumers are going to have difficulty due to higher rates, that difficulty certainly didn't show up in the sector performance today. Much of the day, the consumer discretionary stocks led gains. Techs, telecoms, materials and financials numbered among other industry leaders.

Political developments other than proposed tax code changes gained attention in the early morning period. The early morning's political debates, including those on CNBC, centered on whether Democrats had pulled a "stunt," as some deemed their closed-door session yesterday, or a coup that refocused attention on reportedly faulty intelligence leading up to the war with Iraq. That refocusing threatened to create the kind of uncertain environment that makes market participants uneasy.

However, the political impact was upstaged by those previously mentioned market developments and perhaps by encouraging news from the Challenger report. Few market participants cared what Republicans or Democrats were doing as bulls celebrated and shorts trembled. That Challenger report said that layoffs had fallen 20.2 percent year over year in October, but were up 13.2 percent over September's announcements. Year-to-date, layoff announcements still run 4.7 percent higher than the previous year, lower than September's 8.2 percent year-to-date figure. Hiring announcements increased by 45 percent. Some articles and CNBC commentators deemed the report encouraging while others noted that the developments were expected after some recovery from hurricanes Katrina and Rita. From an anecdotal perspective only, I can note that here in the Dallas area, local news channels focus on the dilemma faced by evacuees relocated here, as many have been unable to find work, have not received FEMA reimbursements and may soon be kicked out of the apartment complexes that had offered them free rent for a short period of time. The Challenger report may indicate a recovery from Katrina and Rita, but evacuees might not have the same perspective.

Another sector battled for attention in the pre-market session: the media industry. Time Warner Inc. (TWX) announced that it was increasing its stock buyback plan by $7.5 billion, Deutsche Bank upgraded publisher Knight-Ridder (KRI) after KRI's largest shareholder, Private Capital Management, pressured the company to sell the group, and Cablevision Systems (CVS) approved a special $3 billion dividend.

Time Warner rates as the world's largest media company, according to one source. The company announced the stock buyback plan as part of its third-quarter earnings report, including $0.19 a share earnings, above the expected $0.17. Shareholders have been campaigning for the company to do something about the decline in the stock's price, and the stock buyback plan appeared to be the company's answer.

In addition, the Wall Street Journal reported that a consortium composed of large cable operators would announce a plan to sell cell phone service that would run over Spring Nextel's (S) wireless network. That announcement did come. In early trading, S, TWX and sector stock Comcast (CMCSA) all rose, with both TWX and CMCSA reportedly included in that consortium. At the end of the day, S had gained 3.68 percent; TWX, 1.87 and CMCSA, 2.49. Other members of the consortium are Cox Communications and Advance/Newhouse Communications.

Techs performed well, certainly garnering their share of the attention and perhaps surprising some who had focused on recent Dell and Symantec disappointments. Certainly during the pre-market session and the early trading period, some attention focused on Symantec's (SYMC) disappointment as well as other earnings reports. SYMC beat expectations but received seven downgrades this morning after its provided downside guidance for the full year. Pre-market reports from Sun Microsystems (SUNW), ATP Oil & Gas (ATPG) and Dean Foods (DF) were deemed disappointing, while Cigna (CI), EDS (EDS), Duke Energy (DUK) and Electronics Arts (ERTS) joined TWX in producing better-than-expected results. In early trading, ERTS' leap higher was to be balanced by SYMC's plummet. ERTS was to close higher by $4.44 or 7.95 percent, and SYMC, lower by $4.63 or 19.29 percent.

Utilities and the healthcare sectors, both sometimes seen as good defensive bets during times of equity weakness but sometimes abandoned on equity strength, were among early decliners, but the UTY, the Utility Sector Index, was to close higher by 0.62 percent. The HMO, the Morgan Stanley Healthcare Index, was to closer lower by 0.67 percent. The healthcare sector also suffered from developments that focused negative attention on the sector. A jury began another day of deliberation on the second Vioxx liability suit against Merck (MRK), and the stock slipped lower in early trading. MRK closed lower by $0.11 or 0.38 percent. In addition, the Federal Trade Commission cleared Johnson & Johnson's (JNJ) acquisition of Guidant (GDT), but the troubled medical device maker's stock dropped after news circulated that JNJ might not follow through with the acquisition. JNJ posted a $0.60 or 0.96 percent loss for the day, and GDT, a $1.99 or 3.15 percent loss. By the end of the day, Standard & Poors Ratings Services and Fitch Ratings said that GDT had been put on a "developing" and "evolving" rating watch, respectively, with the uncertainty over JNJ's acquisition leading to those changes.

After-hours reports included Qualcomm's (QCOM) earnings report, with the company earning $0.32 a share on profit that climbed 37 percent and revenue that rose 40 percent. The stock closed at $40.37 and was last at $41.28 as this report was prepared. Qwest Communications (Q) was unchanged in after hours after reporting that its loss had narrowed to $144 million and that the company had reached a tentative $400 million settlement in lawsuits sought by shareholders after the company was forced to restate revenue due to a reported accounting scandal. Federated (FD) reported that same-store sales dropped 0.7 percent in October, but climbed 0.6 percent in the third quarter when compared to the year-ago period. Priceline (PCLN) produced earnings of $0.47 a share, up from the year ago $0.28 a share. Expectations for the fourth quarter were set at $0.24-0.28 a share on a pro forma basis. PCLN closed the regular session at $19.50 and was last trading at $22.45. Prudential Financial (PRU) reported operating earnings of $1.46 a share against expectations of $1.16 a share, according to one source. PRU reported that third-quarter profit more than doubled. The chief executive affirmed that the company would meet full-year targets. PRU closed the regular session at $71.85, but last traded at $74.49 as this report was prepared. Symbol Technologies (SBL) beat expectations, and the stock of the manufacturer of mobile-computing and barcode-scanning technologies last traded at $8.75, after closing the regular session at $8.15. Univision (UVN) beat expectations on an adjusted-for-one-time-items basis by a cent and beat on revenue. The company also announced an additional $500 million stock buyback program. UVN closed the regular session at $27.46 and last traded at $28.00. Hewlett-Packard announced a change in the way it elects its board of directors.

With many earnings reports and economic and possible political developments, opportunity exists to refocus the markets again tomorrow, especially after strong climbs that ended at resistance. Earnings reports scheduled for tomorrow include those from TDSC, ACCL, ADPT, ABC, CPN, CELG, CLX, CMCSA, CSC, CVS, EE, RDEN, ENB, ENZN, EXPE, FLR, GMST, HIG, ICOS, IDA, IDCC, IPR, LSE.L, NTIQ, PDC, PWAV, GOLD, REV, SLE, SUN, SSYS, TRN, UN, WGRD and WMB, among others.

Thursday's economic releases won't be concluded with the usual 8:30 release of jobless claims. At that same time the third quarter's preliminary productivity number will be released, but that time period's releases will be followed at 10:00 by September's factory orders and October's ISM services. Productivity is expected to rise 2.3-2.7 percent, depending on the source, up from the prior 1.8 percent increase. Factory orders are expected to be flat to down 1.0 percent, also according to the source, with the previous month's orders up 2.5 percent. ISM services for October is widely expected to rise to 57.0 from the previous 53.3.

With indices jammed against important resistance, traders have close-by stops, whatever bias they might hold. The TRAN broke out strongly out of a chart formation that was distinctly bearish, and now appears to be trying to lead the indices upward. Breakouts above the trendlines and important moving-averages in this report would look bullish, rollovers beneath them, perhaps not bearish but at least indicating a possible pullback.

A Nasdaq downturn back below the descending trendline off the summer high, an SPX downturn below the 100-sma and the top of its descending regression channel off the summer high, and a Dow rollover now that it has been unable a second time in a week to close above its 200-sma, and the short-term bias looks negative. However, bears need to be prepared for support just below to produce some churning. Many indices have climbed back into long-term rising regression channels that they had broken below or tested, and bulls have had some encouragement, and will not give up easily if indices pull back to retest that support.

Other than the TRAN's chart, the SPX's chart perhaps looks most bullish, because that chart could be interpreted as an attempt to invalidate a head-and-shoulders formation. I don't think the formation has quite been invalidated, but the attempt to run the SPX up past the most appropriate right-shoulder level has certainly occurred. However, any rollover beneath the 100-sma, even after a piercing of that average if the piercing is brief enough, should urge bulls to exercise caution. The SPX may be beginning a pullback or rollover through the channel. If that happens, support converges at the 200-sm and the rising trendline that formed the support on its rising wedge shape. Another choppy period could begin, as warned in the previous paragraph.

Because so much focus appended to the TRAN today in its often-seen capacity as a market leader, it may be imperative to watch that index tomorrow for guidance. I leave you with a last chart.

Annotated Thirty-Minute Chart of the TRAN:

Watch the TRAN tomorrow to determine if it was the front-running to further gains for other indices or a front-runner in trapping bulls.

Trader's Corner

'Too Much' of a Good Thing: The Theory of Contrary Opinion

The market has had some real whipsaw days after the 10/13 low, but has been working higher on balance. The price/chart patterns are bullish as seen in the pattern of 'stair-stepping' higher lows and higher relative highs on the way up in the 3-week old advance.

Two of three ways that I most rely on to measure the technical performance of the trend remain bullish: 1.) the unfolding price pattern and 2.) price momentum (i.e., RSI, 'MACD' and Stochastic indicators) models, which are not showing 'overbought' extremes.

Some examples of charts showing these positives follow. After that I'll discuss the topic of the day, which involves the third of my big-3 price/indicator models: that of 'sentiment', which attempts to measure the level of trader bullishness (or bearishness) and involves the 'theory of contrary opinion'.

In an uptrend, it's not enough to make an apparent bottom and begin trending higher, and having successively higher lows. A prior rally high must be exceeded to suggest that an uptrend has developed; that the trend has reversed from down to up.

However, another bullish event, before that higher rally high, is to break out above a down trendline. SPX poked above the down trendline that is seen on the daily chart below ...

Moreover, the RSI 'momentum' indicator has not reached an 'overbought' extreme, although it's heading toward it apparently.

SPX above must still get back above resistance implied by the previously broken UP trendline, at the second down red arrow, currently intersecting around 1227 and then above the prior closing (up) swing high at 1228.8; but that's another story.

What about the most-trader S&P related index option, the S&P 100 (OEX)? OEX is not there yet in terms of bullish upside penetration of its down trendline around 560-561; or the previously broken up trendline ('kiss of death' trendline) at 564. But, so far so good; market trends unfold and moves don't get to their ultimate destination immediately.

OEX is not in overbought territory yet. Not that the market has to get to some extreme and then 'boom' it will reverse lower, etc., but overbought/oversold readings suggest that an index or stock is more VULNERABLE to reversal type news; or, rather I would say, a big run up, or big decline, makes traders more ready to exit and go the other way.

The hourly OEX has this textbook example of a rounding bottom. Usually, when prices move toward the right side of a rounding formation like the below, there is often an acceleration to the upside.

Continuing with the bullish CHART picture and moving on to the Nasdaq 100 (NDX) daily chart below, today's price action saw a decisive upside penetration of IT'S down trendline. Significant overhead resistance and a minor double top, must be pierced next, but NDX appears headed toward this area next, around 1620.

As with the S&P, the Nasdaq indices, like NDX above, are not yet at any overbought extreme, so no vulnerability to a trend reversal is implied by THIS indicator.

The foregoing daily chart analysis is not to imply that there is not some other ways of measuring more immediate potential overhead technical resistance ...

The emerging hourly uptrend channel suggests that another push higher in the next day or two, will put NDX into possible resistance beginning starting around 1607.

You will see a regular commentary related to my CBOE Equities Call to Put daily Volume indicator (seen on the OEX chart below) in my Index Trader weekend article; by the way, this article is NOT included in the Sat/Sunday e-mail OI Newsletter, as it's only on the OI Website. There is a LINK to my weekly Index Trader article at the top of the weekend OI Newsletter however; e.g., the (10/29) Index Trader is 'accessible by clicking here'.

My call to put volume indicator is the chief means by which I measure trader 'sentiment' or the degree to which traders are ACTING bullishly or are presumed to have a bullish outlook on the market. When that outlook, as reflected in my sentiment 'indicator', reaches a level or zone where suggests that traders are very to extremely bullish and optimistic for a continued climb in prices, it gets into the top zone; above at least the lower of the topmost dashed level lines in the "CPRATIO" portion of the chart below:

The spikes up in this indicator recently to at or above '2' (call volume is at least TWICE that of total daily equities put volume) is telling me to be especially alert in the next few trading days for a short to intermediate reversal in this current uptrend.

I AM going to attempt to stay with the trend (i.e., stay in my OEX and NDX calls) as long as it continues, BUT will be very alert to a possible reversal; e.g., an apparent rally failure at one of these key trendlines OR at a prior high, etc. I will tend to NOT give the benefit of the doubt to the trend, rather to the possible REVERSAL. Why?

A plot of this ratio between daily all-equities call volume relative to daily put volume tends to become a 'LEADING' indicator. Extremes in this indicator IF also associated at some point with a bearish (chart) PATTERN or an OVERBOUGHT (indicator) extreme, tend to occur a day to as much as a few days (e.g., 3-5) ahead of significant tops. By 'significant' I mean that such reversals are frequently points where its opportune, for example, to exit calls; maybe, as well, to go into puts for a trade.

Or vice-versa: an extremely bearish outlook could occur not far ahead of a significant bottom. The reality of these things happening could be seen as quite CONTRARY to what we would expect. TRUE grasshopper! This cock-eyed view of the universe deals with a theory of market behavior called the 'Theory of Contrary (Market) Opinion'.

'Sentiment' is generally considered to be any statistical way that attempts to measure how bullish or bearish traders and investors are regarding the future prospects of the market.

A measure of market sentiment I use to see if the market is getting overheated or, the reverse on the downside, is by examining the daily volume of daily equities option call volume relative to daily put volume on the CBOE.

The 'standard' measure of this kind of trader 'sentiment' is called the PUT/call reading. This is a ratio of total put volume to call volume, such as on the CBOE (Chicago Board Options Exchange) alone or on ALL options exchanges in total.

Put volume any given day for both (individual) equities AND index options is compared and is (usually) a fractional number - for example, .75, indicating that put volume was 75% of call volume. If the put/call reading was 1.00, put volume equaled call volume that day, which doesn't happen all that often.

Total daily index AND equities options put volume is divided by total daily call volume. You can check this number all over the place, such as on the CBOE web site or in charting programs like Q-Charts; e.g., under symbol "QC:PUTCALL" I think.

It has been noticed for a long time that when put volume gets quite high, such as being equal to call volume, traders are getting pretty bearish - and, trader sentiment may reflect another type of "oversold" situation, where the market may finally be near a tradable bottom.

In the case of call volume being very high relative to puts, trader 'sentiment' may be at or approaching a bullish extreme in terms of how traders feel about the market. Extremes don't last for long, at least in most 'normal' market cycles.

The concept of "contrary opinion" was more or less started with Charles Dow in that he held that extremes in bullishness start suggesting an soon or eventual contrary OUTCOME; e.g., extreme bullishness marks a possible contrary, bearish, situation ahead. As well, extremes in a bearish point of view an early indication that the market may be near a bottom.

Again, why? Because simply that when 'everyone' is bullish, everyone who is going to be in the market is in already. More specifically, most traders that participate in trading/investing has bought the market; e.g., they are long stock, maybe on margin too, long calls, etc. When there is no one left to buy the market, any rough patch like some negative news, will lead to a scramble by some to take profits. This selling is not met by much buying to an absence of new buyers. The old saying is that "bull markets fall of their own 'weight'". This is implying that there are few participants waiting 'under' current price levels to prop it up by buying dips.

The reverse is true at bottoms, where most active traders and investors have sold out and probably lost interest or faith in the upside potential of stocks. Many who are still in the market, are short stock, in puts, etc. A bullish spark can easily set off an initial short-covering rally, which is met by very little selling. Rallies then can go very far, VERY fast.

Something that can make the standard put/call method of doing the math and measuring market extremes tricky is the effect of INDEX calls and index puts in the total option volume figures. There is a lot of hedging by money managers and hedge funds that goes on and this can be related more to that (hedging) than simply how individual traders see the market.

I have found it useful to keep up my own way of measuring option volume numbers. I only look at daily EQUITIES option volume numbers. It's been my experience that this is a more 'pure' measure of bullish/bearish trader sentiment.

This method also makes an indicator that is more like the other overbought/oversold indicators like stochastics and RSI. A LOW number is suggesting a possible "oversold" market and a high reading is indicating an "overbought" market.

Summing up, with my use of the indicator be aware of the ORDER of the words the indicator I use divides CALL volume by put volume and only uses equities volume and excludes Index option volume. I call it my CALL/put indicator. Note the difference from the PUT/call ratio in the wording and which divides all option put volume by call volume, INCLUDING the Stock Index option volume numbers.

My indicator, plotted this way, was part of the OEX chart above. I'm able to create a 'custom' data item in TradeStation software there are other ways of doing it too; e.g., keeping this ratio in Excel. I used to plot it by hand even.

My Call/Put indicator as of the (11/2/05) close today was 2.047, or not quite 2.1. This indicator is pretty self-explanatory. Extremes are seen by how I have the level lines constructed areas where this daily ratio is suggesting an extreme such as currently. Such extremes are similar to saying a market may be 'overbought' or 'oversold'.

Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Contact Support support@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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