Stocks and bonds gapped up at the open and corrected lower, followed by a slow drift to the highs in the afternoon. It was a surreal, slow day on light volume, with small sudden moves reversing in what proved to be a net sideways-upward drift. Even the most devout bull would be hard-pressed to find a breakout move in it, but the absence of weakness and persistence at Friday's highs was anything but bearish.
The indecision was reflected in volume breadth, with advancing volume swapping leads with declining volume throughout the session. The stronger readings were to the upside, however, as was the indecision in the price action. With price holding unfilled upside gaps, there was the feeling of an impending bearish engulfing to bury the sideways range, such as we've often seen in the past. But with the price trend clearly up and no extreme overbought moves (except at the open), it was very difficult to be a seller. The resulting deadlock scared off the volume and caused a flat tape, but again, bulls held the benefit of the doubt.
Daily Dow Chart
The Dow made a new high for the move at 10593, retested but not touched in the final minutes of the session. The morning bounce took off from a low of 10520, right on steeply rising bear wedge support. The daily chart is cluttered with trendlines at the apex of this wedge, but the bottom line is that 10600 is key trendline, confluence and Bollinger resistance. If the bulls can power above that level tomorrow, I believe that they'll convert a lot of bears in the process. On a cycle basis, the 10 day stochastic continues its doubtful drift higher toward overbought territory. Despite the sharpness of the current price move, the action in the oscillator suggests that a sell signal could be as little as a single down day away. For the day, the Dow gained 55 to close at 10586.
Daily S&P 500 Chart
The SPX added 2.67 to close at 1222.81, bouncing from its 1217.29 low and failing again below the 1225 level, the high 1224.18. The 10-day stochastic left off on a bearish kiss, not the first of this cycle. As with the Dow, the move is growing extended in a steep bear wedge, and in this timeframe, resistance looks strong at 1225 and at 1232. Today's light volume shed no light on the picture, but a break above 1232 or 1218 on a spike in volume could do it.
Daily Nasdaq Chart
A nominal new high for the Nasdaq at 2182 was printed as the price scaled the upper rising resistance line on either a conventional bearish or expanding wedge. Neither pattern is bullish, and nor is the 10-day stochastic which stalled for the second time in this upphase, only this time in overbought territory. A break below the 2165 low should be enough for a new sell signal, while bulls need a close above 2185 to set up a retest of the year high at 2220.
Daily TNX Chart
The Fed announced a coupon pass on Friday, resulting in the delivery of $800 million in new cash to the Fed's dealers today. This morning, that addition was supplemented by a generous $6 billion via overnight repo, and with no expirations this morning, the Fed's dealers were treated to a total of $6.8 billion in new cash. Treasuries were firm from Friday's bounce, and the ten year note yield held a 3 basis point decline for most of the morning.
The financial press reported that Treasuries were strong because the higher yield (resulting from bonds falling to a one year low) was expected to attract heavier participation at the afternoon's and tomorrow's Treasury bill auctions. In other words, Treasuries were strong because they have been weak. Foreign central banks have been pulling back from Treasury auctions recently, and that headline, in addition to being circular, appeared dubious ahead of the 13- and 26-week T-bill auctions.
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Central banks purchased $9.2 billion of that $36 billion auctioned this afternoon, a respectable showing. The $19 billion of 13-week bills sold for 3.87% yielding 3.963%, with 2.3 bids tendered for each accepted. The $17 billion in 26-week bills set a high-rate of 4.155% yielding 4.303%, with a 2.01 bid to cover ratio.
Tomorrow's 4-week Treasury bill auction will refund $10 billion in maturing 4-week bills and raise an additional $12 billion in a large $22 billion auction. An additional $18 billion in 3 year notes will be auctioned as well, but net new borrowing of this longer-dated debt will be a minor $5.277 billion when combined with the 5- and 10 year note auctions later this week. Nevertheless, the Treasury will be a big net borrower this week, which could weigh on the treasury and equity markets as that liquidity is diverted.
Ten year notes held their gains for the duration of the session within Friday's range, the ten year note yield (TNX) never breaking 4.65%. For the day, TNX closed lower by 1.8 bps at 4.639%, above 4.6% support and the unfilled gap from last month above 4.52%. The daily cycle is very extended and trending within the uptrend from the September low, but remains bullish above 4.6% confluence.
Daily Chart of Crude oil
The International Energy Agency released its 2005 World Energy Outlook, in which it estimated that world energy demand will increase 50% by 2030, and that prices will rise if capacity remains at current levels. The IEA cited new demand from growing economies such as China and India, and predicted that carbon dioxide emissions will increase 52%. They expect that there are sufficient reserves to meet this demand, but that additional capacity is needed to bring it to market. The IEA sees these projected as being unsustainable both environmentally and security-wise: "We must change these outcomes and get the planet onto a sustainable energy path."
Crude oil lost 1.125 to close at 59.45, off a low of 58.60, while natural gas gained +.455 to close at 11.87, off a low of 10.965. Crude's close was the lowest since July. On the daily chart, crude oil's move today gapped it down to back below 60, while the low held last week's low. While support has been stabilizing above the 58 level, the failure at last week's high sets up a possible bearish triangle above that support. This is shaping up to be a key week, and a break below horizontal support would target the 56 level at confluence and linear regression support.
It was a quiet news day as earnings continued to wind down. The lone economic report was Consumer Credit, announced at 3PM. Tomorrow, there will be none, followed by Wednesday's release of the weekly Mortgage Bankers report, the EIA petroleum report and Wholesale Inventories, followed on Thursday by Export Prices ex-ag. and Import prices ex-oil, the Trade Balance, Initial Claims, Michigan Sentiment and the Treasury Budget.
A situation that most in North America have successfully ignored continues to worsen in France, as the wire services reported that 36 police officers were injured and 1400 vehicles burned in Grigny as the French riots continued for an 11th night. Rioters fired on police with pellet guns, with the police union referring to the altercation as a "civil war" between the government and the youth, many of Arab or African descent. The conflict is being depicted as race riots, with the rioters mostly disenfranchised youth in poor neighbourhoods complaining of racial discrimination, touched off by the electrocution of two youths by police. The police union stated that the violence is unprecedented "since the Second World War." The first fatality, a 61 year old man who was beaten when he went outside to put out a fire in a garbage can, died of his wounds today.
The euro was weak again against this backdrop, setting a new 18 month low against the dollar at $1.1786 in Germany. The ECB's failure to raise rates at the last meeting and the Fed's ongoing rate hike campaign are no doubt contributing as well to the move in EUR:USD.
In corporate news, El Paso (EP) reported a Q3 loss that worsened from -$214 million or -33 cents to -$321 million or -50 cents per share, due principally to failed gas and oil hedges. Revenues fell 43% from the year-ago quarter to $810 million. Estimates were for earnings of +15 cents on $1.07 billion revenue. CEO Doug Foshee said, "While a sharp rise in natural gas and oil prices created non-cash losses during the quarter, we have significant earnings and cash flow upside as the percentage of our hedged production declines going forward. As we approach next year, our core pipeline and production businesses are performing well, and we are confident that 2006 will be a breakout year for the company." EP closed lower by 5.83% at 11.31.
Guidant (GDT) reported Q3 sales that declined 14% to $795 million, with earnings of 20 cents or $65 million, down from $161 million or 50 cents. GDT also announced that it is suing JNJ to require the latter to complete its acquisition of GDT pursuant to their $25.4 billion merger agreement. JNJ has stated that it may no longer wish to complete the takeover, following GDT's withdrawal of some defibrillators from the market. Later in the morning, JNJ said that it would "vigorously" context the lawsuit based on the fact that GDT's recalls provided it an out under the terms of the merger agreement, as do the various inquiries to which GDT is currently subject. GDT closed -2.38% at 57.52, while JNJ added .55 to close at 61.43.
GDT also announced that the SEC has launched a probe into its product safety disclosures and the trading of its shares, with which the company is cooperating. This follows last week's suit by New York A-G Eliot Spitzer, who accused the company of failing to inform doctors of a design flaw in one of its defibrillators. Moody's placed the cherry on the sundae, adding that they're considering a downgrade for GDT in view of the failed merger.
In other news, the Fed reported that 5 out of 57 commercial banks surveyed eased lending standards and terms "somewhat" during the past quarter, for loans to small and medium-sized enterprises. 15% of domestic banks reported increased demand during the quarter for commercial and industrial loans, down from a 40% gain in the prior quarter.
At 3PM, the Fed reported that Consumer Credit, the amount of outstanding debt owed by consumers, was unchanged in September compared with expectations of a $5.3 billion increase. The weakness was attributed to slowing auto sales as revolving credit (ie credit card debt) rose 4.7% to a $3.1 billion rate, while nonrevolving credit (ie car loans) fell 2.8% or a $3.2 billion rate. August's $4.9 billion reading was revised up to $7.9 billion.
After the bell, NetEase (NTES) announced Q3 revenues that increased 11% from the year-ago quarter to $57.2 million (RMB 462.2 million). The company earned $45.8 million or 89 cents per diluted share, a 13.5% quarter-on-quarter gain but missing expectations by 2 cents. The stock traded -15.13% at 69 as of this writing.
For tomorrow, there will be no major economic reports, and the markets will be left to consider today's decisionless range. This has been the third consecutive session above Thursday's unfilled gap, either a true breakaway or an island top in the making. Because of the rising wedge formations on the daily chart, there remains downside risk in the absence of a decisive high volume breakout. But in the meantime, it's still a rising market, and still bullish. Bulls can help address the risk by following their stops behind rising support, while bears need to exercise patience and wait for entries either at the top trendline, or just below rising support. In either case, we should see a resolution either way, soon as the wedge continues to tighten.
Building Mat. - BMHC - cls: 90.72 chg: +2.66 stop: 84.49 *new*
Monday was a strong session for BMHC. The stock added just over three percent to breakout over the $90 level again. We do not see much change from our previous updates. Our five-week target on the stock is the $98-99 range. We are going to raise the stop loss to $84.49. We hesitate to raise the stop much higher since BMHC has been a bit volatile lately.
Picked on November 02 at $ 87.55
Peabody Energy - BTU - close: 79.98 chg: -1.38 stop: 76.99
Oil stocks took a hit today as investors reacted to news of dropping gasoline prices and warm weather in the northeast. BTU is not an oil stock but a coal stock but shares fell in sympathy with the rest of the energy sector. The intraday bounce from the $79 level on Monday could have been another bullish entry point as BTU effectively filled the minor gap higher from last week. However, we would wait for a move back over $80.50 to confirm upward direction before initiating new call positions. The next level of support, if BTU falls under the $79 mark, is the 50-dma near $77.65. Our seven-week target is the $89.50-90.00 range.
Picked on November 06 at $ 81.36
Intel Corp. - INTC - close: 24.50 chg: +0.51 stop: 22.75
INTC displayed some relative strength today and was part of the tech sector's leadership with a 2.1% gain. Today's gain in INTC is also a bullish breakout over the $24 level and its simple 50-dma. If you are the patient type you might want to wait for a pull back before initiating new call positions in INTC. Broken resistance at $24 should now act as new support. A dip to $24 would be an attractive entry point. We do expect some resistance at the 200-dma overhead near the $25 level. Our year-end target is the $26.00-26.50 range.
Picked on November 06 at $ 23.99
Legg Mason - LM - cls: 112.07 change: -1.50 stop: 106.95
Before the opening bell LM received a downgrade on valuation concerns. The stock gapped lower and dipped to its simple 10-dma near $107.80 before rebounding back above the top of its previous trading range (and what should be support) at the $110 level. We would use the bounce today as a new bullish entry point. Our seven-week target is the $119-120 range.
Picked on November 02 at $111.69
Rockwell Autom. - ROK - cls: 56.36 chg: +0.62 stop: 53.49
ROK bounced again from its early dip toward the $55.00 level. Broken resistance at the $55 level should act as new support. We see no changes from our weekend update on the stock. If you'd rather not chase the stock here there will probably be another dip to the $55 level again. Our seven-week target is the $61.00-62.00 range.
Picked on November 03 at $ 55.90
Sears Holding - SHLD - cls: 124.02 chg: +0.02 stop: 121.99
There is little change in the price of SHLD and no change from our weekend update on the stock. Our goal is to catch a breakout from its current trading range. Our trigger to buy calls is at $128.51. If triggered we'll target a move into the $139.50-140.00 range. We would consider this a higher-risk, aggressive play since the stock can be pretty volatile. We do not plan on holding past the December 7th earnings report.
Picked on November xx at $ xx.xx <-- see TRIGGER
Bard C.R.- BCR - close: 63.00 change: +0.03 stop: 63.55
The tug-of-war between the bulls and the bears is now in its third-day of a stalemate. The stock is coiling tightly in a sideways pattern that will eventually see a breakout. We'd like to think the prevailing bearish trend will come out the winner but there is no guarantee and we're not suggesting new positions. If BCR continues lower our target is the $58 level.
Picked on October 26 at $ 61.70
Career Educ. - CECO - cls: 34.79 chg: +0.99 stop: 35.01
CECO turned in a pretty strong bounce today adding almost three percent. The rally did stall under the bottom of last week's gap down. It's common for the upper or lower edge of a gap down or window to act as support or resistance. We are still on the sidelines. Our strategy is to catch a breakdown under support at the $33.00 level. Our trigger to buy puts is at $32.95. If triggered our target is the $30-29 range.
Picked on November xx at $ xx.xx <-- see TRIGGER
(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: 76.59 chg: +0.09 stop: n/a
We see no changes from our weekend update on ABC. There are only two weeks left before November options expire. That means more conservative traders may want to adjust their target on the November strangle from $3.50 to $2.10(breakeven). The options in the November strangle were the November $80 calls (ABC-KP) and the November $70 puts (ABC-WN). We also suggested a December strangle and the options for the December strangle are the December $80 calls (ABC-LP) and the December $70 puts (ABC-XN). We are leaving our target at $5.00 for the December position. We are not suggesting new plays.
Picked on October 16 at $ 74.81
Genentech - DNA - close: 93.11 chg: -0.84 stop: n/a
DNA spent the day consolidating some of its recent gains. We see no changes from our weekend update. We still have seven weeks left before the December options expire. Our target was for a rise to $4.50-5.00 in the strangle and the December $95 calls (DWN-LS) look like they'll be the winning side.
Picked on October 20 at $ 84.83
eBay Inc. - EBAY - close: 41.87 chg: +0.29 stop: n/a
EBAY is still trying to breakout over resistance at the $42 level. If it is going to breakout we hope it happens soon. Over the weekend we adjusted our target to breakeven at $1.05. The options in our strangle were the November $45 calls (XBA-KI) and the November $35 puts (XBA-WG).
Picked on October 18 at $ 40.42
General Dynamics - GD - cls: 116.50 chg: +0.12 stop: n/a
There is little change in shares of GD today and no change from our weekend update on the play. We need to see GD pick a direction and move pretty soon. There are only two weeks left before November options expire. Therefore we are adjusting our target for the strangle from $4.00 to breakeven at $2.00. The options in our strangle were the November $115 puts (GD-WC) and the November $125 calls (GD-KE).
Picked on October 09 at $119.59
Harman Intl - HAR - cls: 104.55 chg: +3.73 stop: n/a
Yeah! HAR is finally showing some signs of life again. If we have any hope for this strangle play HAR needs to make a real effort to breakout over resistance at the $110 mark. Over the weekend we adjusted our target to $2.75, which is actually a loss compared to our cost of $3.80 but we're trying to recover some of our capital. The options in our strangle were the November $110 calls (HAR-KB) and the November $90 puts (HAR-WR).
Picked on October 18 at $100.80
Hutchinson Tech. - HTCH - cls: 25.22 chg: -0.28 stop: n/a
We see no change from our weekend update on HTCH. The options in our strangle are the January $30 calls (UTQ-AF) and the January $20 puts (UTQ-MD). Our target is for a rise to $3.00. We are not suggesting new strangles at this time.
Picked on October 26 at $ 24.89
Inamed Corp. - IMDC - close: 76.77 change: +1.90 stop: n/a
Shares of IMDC rallied strongly today added 2.5% making it one of today's best performers. The very strong volume (more than 3 times the norm) is a bullish sign. We are not suggesting new plays at this time. The options in our strangle are the December $75 calls (UZI-LO) and the December $65 puts (UZI-XM)). Our target is for a rise to $5.00 or more. It looks like the calls may be the winning side relatively soon.
Picked on October 30 at $ 70.63
Kos Pharma - KOSP - close: 57.86 chg: -1.48 stop: n/a
KOSP tried to bounce this morning but the rally failed under the $60 level, which apparently is acting as round-number resistance. We are not suggesting new plays. There are only two weeks left before November options expire and conservative traders may want to seriously consider adjusting their targets lower. Our target is for a rise to $5.00 or more. Our hypothetical cost in the play is about $2.90. The options are the November $65 call (KQW-KM) and the November $55 put (KQW-WK).
Picked on October 20 at $ 59.80
Lear Corp - LEA - close: 30.20 chg: -0.04 stop: n/a
Perfect! LEA continued to trade in a very tight range near the $30.00 level on Monday. This provided a great opportunity to launch new strangle positions. We're suggesting an entry window of $30.50-29.50. The options in our strangle are the January $35 calls (LEA-AG) and the January $25 puts (LEA-ME). Try and keep your costs under $1.75. We are targeting a rise to $3.20 or more.
Picked on November 06 at $ 30.24
Legg Mason - LM - cls: 112.07 chg: -1.50 stop: n/a
LM was downgraded this morning before the opening bell. Shares reacted sharply and dipped to $107.82 before rebounding back above the $110 level. We see no changes from our Weekend update. The call side of our strangle is currently the winning side. Watch the November $110 calls (LM-KB). Our target is for a rise to $5.00 or more.
Picked on October 12 at $102.59
Loews - LTR - close: 94.61 change: +0.08 close: n/a
LTR continues to consolidate sideways above the $94 level so we see no change from our weekend update. We're not suggesting new strangle positions in LTR. The options in our strategy are the December $95 calls (LTR-LS) and the December $85 puts (LTR-XQ). We'll plan to exit if either option rises to $5.00 or more.
Picked on October 23 at $ 89.94
Microsoft - MSFT - close: 27.01 change: +0.35 stop: n/a
The rally in MSFT continues. The stock added 1.3% as investors responded positively to news that the company was the lead contender to buy a stake in rival AOL from TimeWarner. The stock does look short-term overbought and due for a pull back. We are not suggesting new strangle positions. Our strangle is based on the December $27.50 call (MSQ-LY) and the December $22.50 put (MSQ-XX). We are aiming for a rise to $0.80-0.90 for either side of the strangle. FYI: the December $27.50 call has already more than doubled in value.
Picked on October 25 at $ 25.03
O'Reilly Auto. - ORLY - close: 30.68 chg: +0.78 stop: n/a
Good news! ORLY has broken out over resistance at the $30.00 mark. Shares added 2.6% and hit new two-month highs. The target on our strangle play was for a rise to $1.20 but recently we've been suggesting that more conservative traders consider exiting around breakeven in the $0.75 region. Well today's rally in the stock price has pushed the November $30 calls (OQR-KF) significantly higher. The high today for the calls was $0.80 and they are currently trading at $0.85bid/$105ask.
Picked on October 09 at $ 28.23
Oshkosh Truck - OSK - close: 43.29 chg: +0.01 stop: n/a
OSK remains range bound in its $41.50-44.00 trading range. If we do not see a breakout one way or the other in the next couple of days we're going to abandon this play early! We are not suggesting new strangles. The options in our suggested strangle are the December $45 call (OSK-LI) and the December $40 put (OSK-XH). We're targeting a rise to $3.00 or more.
Picked on October 30 at $ 42.82
Verifone Holdings - PAY - cls: 24.99 chg: +0.67 stop: n/a
Wow! PAY continues to rally and shares added another 2.75% today. The stock is very short-term overbought and due for a dip. Friday's move pushed the November strangle to our target and now the November $22.50 calls are well past our target. The January $22.50 calls are climbing as well. Our target for the January strikes is the $4.50 mark. Our hypothetical cost for the January strike was around $2.60. Currently the January $22.50 calls are trading at $3.20bid/$3.80ask.
Picked on October 12 at $ 19.98
Protein Design Labs - PDLI - cls: 25.89 chg: -0.10 stop: n/a
PDLI continues to look weak but the stock needs to breakdown under its simple 100-dma near 25.45. We are no longer suggesting new strangle positions. The options in our hypothetical strangle are the December $30 calls (PQI-LF) and the December $25 puts (PQI-XE). We'll plan to sell if either side rises to $3.25.
Picked on October 30 at $ 27.70
The BXN Buy-Write Index Nasdaq 100 (NDX)
An index that mirrors the Nasdaq 100 generates extra income for your portfolio, while additionally providing you with downside protection.
The Theory Behind the Practice
The strategy of covered call writing is a term that is generally understood in the option community. It is the strategy of selling call options against the underlying stock in your portfolio. The term buy-write is also synonymous with this strategy. This strategy is used to generate income for an investors portfolio by using his stock assets as collateral. The buyer, in return for a premium paid to the owner of the stock, gains the right to take that stock from the owner at a specified price, within a specific period of time.
The Nasdaq-100 Buy-Write Index (BXN) is a benchmark index that acts like a portfolio of stocks traded on the NASDAQ on which call options are written against those positions. The BXN index is based on the following concept
1. Buying an NDX stock portfolio (NASDAQ 100 portfolio) and
The NASDAQ-100 Buy-Write Index (BXN) is designed to represent a hypothetical buy-write strategy. The BXN Index does not take into account factors such as transaction costs, commission and/or taxes. When you compare performances to stock covered call writing strategies, the performances may more often than not find the BXN index under-performing the individual stock strategies. However the index does make the cloning of the NASDAQ 100 quite a bit simpler than buying all the stocks in the index and selling the corresponding call options against those positions. When you consider that the BXN is an index that mirrors a passive covered call strategy of a basket of stocks, you need to take into consideration that the commission costs will be higher than the commission costs for a similar strategy which just buys and holds those securities in a normal equity portfolio.
The settlement price is determined by the opening quotes of all the NASDAQ 100 stocks on expiration date usually before 11 a.m. EST.
The final settlement price is based on the following:
A. The difference between the determined settlement price and the strike price of the expiring option. OR
The final settlement price is the greater of A or B.
As soon as the option for the month has expired, a new call option is set up based on the price of the NDS (NASDAQ 100). This option will be the lowest strike price that is out of the money, closest to the index price.
FIGURE 1-1: EXAMPLE AS TO HOW THE STRIKE PRICE FOR THE BXN INDEX IS DETERMINED
Once the new strike price is established it is sold at a price determined by the Chicago Board Option Exchange based on the volume-weighted average price and a calculated formula used by the CBOE.
The Bottom Line
The BXN and other buy-write indexes are used most effectively by institutional investors, by pension and profit sharing plans and by Registered Investment Advisors to minimize volatility in those large institutional portfolios. The major drawback to the buy-write index is the same as any covered writing strategy. The drawback is that you limit your upside potential in return for this extra income and downside protection. However, it allows even the smallest investor to synthetically simulate the performance that an institutional investor experiences. It is the closest thing to actually holding the basket of the NASDAQ 100 stocks in an actual portfolio and selling the NDX (NASDAQ 100 index) against those underlying positions.
Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Options 101 by Steven Gail, and all other plays and content by the Option Investor staff.
Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.
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