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Daily Newsletter, Wednesday, 11/09/2005

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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

How the Cookie Crumbles

The ultimate chocoholic disaster happened. Kraft foods raised the price of Oreos, blaming higher energy costs. The company sent retailers a memo last week detailing the cookies, crackers, lunch meats and other products that will see higher prices.

As that Oreo cookie crumbles, so crumble other products in an economy that some still don't believe to be inflationary. In a climate in which consumers are being hit below the belt, literally, by the rising price of Oreos and other foodstuffs, the Oil Pricing and Profits hearing began today in Washington. Senators raucously claimed that energy companies were hitting beneath the belt, too, gouging consumers. Last night, Jim Brown discussed the importance of the hearing, so the implications don't need to be repeated.

The windfall profits by energy companies and the resultant hearing have prompted a debate as to whether market forces in a cyclical and low-profit-margin market should be allowed to govern energy companies' profits or whether government policies have a part. CNBC televised much of the hearing, with the energy companies' representatives led off by Lee R. Raymond, chairman and chief executive officer of Exxon Mobil Corp.

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The questions posed by that Senate hearing were unlikely to be resolved by one hearing, and might legitimately occupy many a lecture period in an economics class. Markets spent another morning with their next near-term direction unresolved, too.

Traders bored into near catatonia were stunned midday, however, by a spike that appeared out of nowhere. Market watchers attributed it variously to a SOX move above a key level, a statement by Raymond that suggested that crude prices had peaked and, conversely, a jump in crude prices that brought energy majors higher. With crude climbing over $60.00 just prior to the spike in the equities, the "crude" explanation wins my vote. A study of charts shows that XOM and other energy companies being responsible for much of the gain during that spike.

Ultimately, many indices could not hold those gains and fell back into the formations in which they'd traded before the spike. A series of explosions in Jordan may have contributed to the failure to hold those highs, but the crazy zigzagging action, zooming past carefully drawn trendlines and Fib levels and any other known technical analysis tool rattled traders and scrambled the charts.

Annotated Daily Chart of the SPX:

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

The opening of the Senate hearing and the release of wholesale inventories roughly coincided. September's build in inventories was much higher than expected, at 0.6 percent against the expected 0.3 percent. However, markets bounced after it was apparent that the build was pegged on increases in drugs and petroleum, with the important inventory-to-sales figure revealing a tightening in inventories. The nondurable inventory-to-sales figure was a record low. Economists, usually the only people paying attention to this number, suggest that the numbers hint at the need to ramp up production, perhaps even of those more expensive Oreos.

Against that backdrop, the Department of Energy released crude inventories numbers, with an upside surprise in the inventories number spiking equities higher. The build in crude and gasoline inventories proved more than twice what was expected. Distillates fell against an expected build, however. If the inventories number drove crude prices, it was difficult to discern which direction. After the release, crude prices dropped, soared above $60.00 and then dropped again.

Other market developments produced no predictable results in market action. Perhaps it was no surprise that insurance Company American International Group (AIG) will restate financial results again, delaying its 10-Q filing. The company had previously restated earnings and was investigated by regulators earlier in the year. The company noted that the errors resulted in third-quarter results being understated by $500 million. AIG was to zigzag its way 0.78 percent higher by the close.

Some retailers had good news. Retailer Federated (FD) beat expectations, climbing 7.72 percent by the end of the day, and Limited (LTD) was upgraded, posting a 3.39 percent gain by the close.

After yesterday's unwelcome surprise to the housing industry, delivered by Toll Brothers (TOL), some might have been relieved that the headline of the Mortgage Bankers Association's Weekly Mortgage Applications Survey for the week ending November 4 noted an increase in applications over the previous week. However, four-week moving averages continued their decline, and home purchase applications fell 3.6 percent below their year-ago level. The DJUSHB, the Dow Jones U.S. Home Construction Index, closed lower by 0.87 percent.

TOL's announcement yesterday hit other homebuilders and also other companies in their food chain. That included companies such as Home Deport (HD). This morning, Piper Jaffray lent its help by raising HD's rating to an outperform one. The firm sees margin improvement for the company. Linens 'N Things (LIN) also received an upgrade. HD gained 0.24 percent, and LIN, 0.15 percent.

After the close, CSCO reported earnings of $0.25 a share, beating by a penny. In his prepared statement, Chambers noted "increasing momentum in both the U.S. and Asia Pacific." The company planned capital expenditures in India, hiring as many as 4,000. Some looked to its higher gross margins, at 68.5 percent, against expectations for something in the realm of 67 percent, for CSCO's rise in after-hours trading. At the time of this report, CSCO was trading at $18.15, up from the close at $17.75. The conference call had not yet begun.

That conference call could help determine the direction for tomorrow. As of the close, charts had been scrambled, with short-term charts even more so than the longer-term ones. If Chambers says nothing to spook markets and CSCO opens above and maintains values above the 72-ema at $17.86, the company's stock may make a rush toward its 200-sma at $18.26, dragging other indices with it. Note, however, that call open interest and volume were stronger than put OI and volume for CSCO in both the $17.50 and $20.00, perhaps limiting upside gains for that company, and perhaps also limiting its contribution to broader market gains. If CSCO opens below those key levels and rolls down, it could help bring markets lower.

Markets so far remain choppy and difficult to trade, with old relationships broken apart. Midday, a rise in crude saw energy majors soar, too, bringing the SPX, OEX and Dow higher, and when crude costs dropped back, so did the energy majors and those indices. The old "crude higher/equities lower" paradigm clearly did not work, and the TRAN ignored it all, doing its own thing. Movements to the upside are often reversed in the SPX, OEX and Dow, while stellar setups on bearish plays produce no follow-through, either. As soon as a formation sets up on a chart and traders are enticed into the trade, the whole setup crumbles, trapping both bulls and bears and cheating as many as possible out of as many funds as possible.

I see no strong evidence of next direction, and would advise caution to all traders. Play the upside breakouts if bullishly inclined, but maintain close stops, keeping the SPX's reversal this afternoon in mind. This afternoon, selling rollovers from the SPX's and Dow's spikes, to 1226.59 and 10,601.92, respectively, would have been the more profitable plays. That kind of action warns of sellers lurking overhead, and those bearishly inclined might take that sell-the-bounce tactic, but be prepared to take quick profits, if any are offered. The TRAN is taking no bearish survivors, zooming ever higher in a climb that still looks unsustainable and begs for a pullback. Volume in TRAN components is dropping in many cases as the stocks rise, a dangerous sign but not a good market-timing one. The TRAN often helps lead the Dow and to some degree, the SPX and OEX, and so the TRAN's direction should be watched, too.

The best bet appears to be to wait for more clarity, and that's this writer's advice. While we used to see volatility and unpredictable behavior on opex week, we're often now seeing it the Thursday and Friday before opex week, so tomorrow could be even more difficult to manage.

Dell reports tomorrow after the close, but has already warned. Many might have already positioned themselves ahead of that report. Tomorrow morning's releases include the September trade gap, October import/export price indices and weekly jobless claims, all at 8:30, and November's preliminary Michigan consumer sentiment, at 9:47. Natural gas inventories will be released shortly afterward, and the last release of the day will be October's treasury budget, released at 2:00.
 


New Plays

New Option Plays

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

New Calls

None today.
 

New Puts

None today.
 

New Strangles

Lowes Cos. - LOW - close: 60.33 chg: -0.17 stop: n/a

Company Description:
With fiscal year 2004 sales of $36.5 billion, Lowe's Companies, Inc. is a FORTUNE 50 company that serves approximately 11 million customers a week at more than 1,150 home improvement stores in 49 states. Based in Mooresville, N.C., the 59-year old company is the second-largest home improvement retailer in the world. (source: company press release or website)

Why We Like It:
Investors will be curious to see what LOW has to say with its earnings report next week. One might normally assume that the recent TOL homebuilder warning might be bad news for LOW. Yet rival HomeDepot (HD) just got upgraded today. LOW is expected to report earnings on Monday, November 14th before the market's opening bell. That gives us two days to launch a strangle position and try to catch any earnings-inspired volatility. We are going to suggest a $60.50-59.50 entry window.

Suggested Options:
We are going to suggest December options for this strangle although traders could certainly use Januarys if they're willing to pay more. As a strangle traders need to buy an out of the money call and an out of the money put. At current prices this strangle should cost about $1.20. Try and keep your cost under $1.35. We are going to aim for a rise to $2.40 or higher.

BUY CALL DEC 65 LOW-LM open interest=2372 current ask $0.65
-and-
BUY PUT DEC 55 LOW-XK open interest=3496 current ask $0.55

Picked on November 09 at $ 60.33
Change since picked: + 0.00
Earnings Date 11/14/05 (confirmed)
Average Daily Volume = 4.3 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Intel Corp. - INTC - close: 24.80 chg: +0.25 stop: 22.75

INTC continued to climb on Wednesday marking its sixth gain in a row. The stock is nearing resistance at the $25.00 level and its simple 200-dma currently at 24.92. We do expect shares to pull back after testing overhead resistance. Traders looking for a new entry point can wait for the pull back. The $24.00 level or its simple 50-dma (24.16) should offer short-term support and a good spot to look for an entry point. Our year-end target is the $26.00-26.50 range.

Picked on November 06 at $ 23.99
Change since picked: + 0.81
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 51.6 million

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Legg Mason - LM - cls: 113.96 change: +2.33 stop: 106.95

The broker-dealer stocks continued to climb and LM hit a new three-month high with today's 2% gain. We see no changes from our previous updates. The $110 level should act as support. Our seven-week target is the $119-120 range.

Picked on November 02 at $111.69
Change since picked: + 2.27
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 904 thousand

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Rockwell Autom. - ROK - cls: 56.20 chg: +0.57 stop: 53.49

ROK tested previous resistance, now new support, at the $55.00 level again today. The stock dipped to the $55 region this morning but bulls were waiting to buy the dip. We remain bullish on the stock with shares over $55 and today's bounce does look like a new entry point. However, if you think the major indices are due for another pull back you might want to wait a day or two before initiating new positions in ROK. Our seven-week target is the $61.00-62.00 range.

Picked on November 03 at $ 55.90
Change since picked: + 0.30
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand

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Sears Holding - SHLD - cls: 118.53 chg: -0.89 stop: 121.99

SHLD is under performing both the broader markets and the retail sector. Shares have broken under the $120 level today and the afternoon bounce failed to push back over the $120 mark. We're starting to think SHLD might just break down from this trading range instead of breakout. If we see a close under $115.00 we'll re-evaluate our strategy. Currently our suggested trigger to buy calls is at $128.51.

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 12/07/05 (unconfirmed)
Average Daily Volume = 3.2 million
 

Put Updates

Bard C.R.- BCR - close: 62.99 change: +0.14 stop: 63.55

Honestly, we do not know what's going on with shares of BCR. The stock has been trading in a very narrow range for the last five days. If you know of some future event that investors might be waiting on that could affect shares of BCR please email us (support@optioninvestor.com). There could be some sort of upcoming FDA decision on a product for BCR but we can't find anything to suggest this. Volume has been significantly under the daily average. If we didn't know better it looks like trading has stalled as investors wait for the company's earnings report. Yet the company reported earnings back on Oct. 18th. This sort of consolidation makes us nervous. Normally we'd look for the prevailing (bearish) trend to resume. However more conservative traders might just want to bail out now and escape the suspense. We are not suggesting new plays and if we don't see a move soon we'll exit ourselves.

Picked on October 26 at $ 61.70
Change since picked: + 1.29
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 745 thousand

---

Career Educ. - CECO - cls: 34.91 chg: -0.21 stop: 35.01

Rival APOL had a strong session today but it failed to rub off on shares of CECO. We remain bearish on CECO and the recent spike could just be a new failed rally under the simple 50 and 200-dma's. However, we are going to stick to our game plan and that is to wait for 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
Change since picked: + 0.00
Earnings Date 11/02/05 (confirmed)
Average Daily Volume = 1.3 million
 

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.)

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AmerisourceBergen - ABC - cls: 76.87 chg: -0.07 stop: n/a

We see no changes from our weekend update on ABC. There are less than 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
Change since picked: + 2.06
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

---

Genentech - DNA - close: 93.38 chg: -0.52 stop: n/a

DNA continues to consolidate under resistance at the $94.00 level. 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
Change since picked: + 8.55
Earnings Date 10/10/05 (confirmed)
Average Daily Volume = 3.9 million

---

eBay Inc. - EBAY - close: 42.08 chg: -0.22 stop: n/a

We are quickly running out of time before the November options expire. The game plan here is to try and recover capital. 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
Change since picked: + 1.66
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 18.3 million

---

Four Seasons - FS - close: 56.67 chg: +1.30 stop: n/a

Wow! FS did not trade in our suggested entry window (55.50-54.50) very long but we did have an opportunity early this morning. The stock quickly shot higher and closed the session near its simple 50-dma. Tomorrow the company is expected to report earnings before the opening bell. Estimates are at 37 cents a share. We are not suggesting new strangle positions at this time. The options in our suggested strangle were the January $60 calls (FS-AL) and the January $50 puts (FS-MJ). Our estimated cost was around $2.60. We are targeting a rise to $5.00 or more.

Picked on November 08 at $ 55.37
Change since picked: + 1.30
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

---

General Dynamics - GD - cls: 117.20 chg: -0.06 stop: n/a

GD acts like it is trying to breakout to the upside from its recent trading range. Unfortunately for shareholders the stock has resistance at its 50-dma (117.46) and the $118 level. A move higher would also be bad news for us unless the move was significant. We're running out of time on the November options. We recently adjusted 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
Change since picked: - 2.39
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

---

Harman Intl - HAR - cls: 102.44 chg: -0.61 stop: n/a

We see no changes from our previous updates on HAR. 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
Change since picked: + 1.65
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 739 thousand

---

Hutchinson Tech. - HTCH - cls: 25.56 chg: +0.09 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
Change since picked: + 0.67
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 666 thousand

---

Inamed Corp. - IMDC - close: 74.43 change: -0.94 stop: n/a

IMDC is still seeing profit taking from its early November rally. It looks like the stock will retest the 50-dma near 73.50 and potentially the $72 level. 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.

Picked on October 30 at $ 70.63
Change since picked: + 3.74
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 533 thousand

---

Kos Pharma - KOSP - close: 56.97 chg: -0.47 stop: n/a

KOSP continued to decline and dipped to technical support at the 200-dma near 55.60 before rebounding. We are not surprised that shares bounced from this level of technical support. The question is where will the bounce fail? The $60.00 level should act as overhead resistance. 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
Change since picked: - 2.83
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 460 thousand

---

Lear Corp - LEA - close: 28.56 chg: -1.28 stop: n/a

Carmakers suffered a bearish day on Wednesday and shares of LEA lost more than 4.2% on strong volume. Today's move pushed LEA outside our suggested entry window so we're no longer suggesting new strangles. The options in our strangle are the January $35 calls (LEA-AG) and the January $25 puts (LEA-ME). We are targeting a rise to $3.20 or more.

Picked on November 06 at $ 30.24
Change since picked: - 1.68
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 1.8 million

---

Loews - LTR - close: 95.47 change: -0.04 close: n/a

LTR hit a new high today but after the bombing news hit the wires this afternoon shares of LTR pared their gains. 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
Change since picked: + 5.53
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

---

Microsoft - MSFT - close: 26.96 change: -0.09 stop: n/a

MSFT was way overdue for some profit taking and we're surprised that the stock didn't pull back more deeply today. Look for shares to retrace some of their steps before resuming its bullish trend. 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.

Picked on October 25 at $ 25.03
Change since picked: + 1.93
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 64 million

---

O'Reilly Auto. - ORLY - close: 30.50 chg: +0.14 stop: n/a

ORLY pulled back to $29.82 this morning but traders bought the dip again. 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. The call side of our November strangle is the November $30 call (OQR-KF). Currently these calls are trading at $0.65bid/$0.85ask.

Picked on October 09 at $ 28.23
Change since picked: + 2.31
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 513 thousand

---

Verifone Holdings - PAY - cls: 24.35 chg: -0.46 stop: n/a

There are no surprises here. We've been telling readers that PAY was overbought and due for some consolidation. The $23.00 level might act as short-term support or the 10-dma near $23.70. We see no changes from our previous updates. The January $22.50 calls (PAY-AX) appear to be the winning side of our January strangle but our target is for a rise to $4.50.

Picked on October 12 at $ 19.98
Change since picked: + 4.37
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand

---

Protein Design Labs - PDLI - cls: 25.61 chg: -0.13 stop: n/a

PDLI is inching closer to a breakdown under technical support at its simple 100-dma. 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
Change since picked: - 2.09
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million

---

Spectrum Brands - SPC - close: 20.28 change: -0.35 stop: n/a

Tomorrow could be a big day for SPC. The company is expected to report earnings before the opening bell. Wall Street is looking for earnings of $0.13 a share. We are no longer suggesting new strangle positions. The options in our suggested strangle are the December $22.50 calls (SPC-LX) and the December $17.50 puts (SPC-XW). We are aiming for a rise to $2.50 or more.

Picked on November 08 at $ 20.63
Change since picked: - 0.35
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 576 thousand
 

Dropped Calls

Peabody Energy - BTU - close: 77.70 chg: -3.28 stop: 76.99

It's time to go! BTU displayed relative weakness today with a breakdown under the $80.00 level and its simple 50-dma (78.07). Technicals have turned sour and its MACD indicator is nearing a new sell signal. We are going to exit now before BTU hits our stop loss.

Picked on November 06 at $ 81.36
Change since picked: - 3.66
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 2.6 million
 

Dropped Puts

None
 

Dropped Strangles

Legg Mason - LM - cls: 113.96 chg: +2.33 stop: n/a

Target achieved! It took a lot longer than we expected but our strangle finally hit our target price of $5.00. LM's two-percent gain today helped push the November $110 calls (LM-KB) to a high today of $5.55. A move to $5.00 represents a 108% rise in value from when we launched the play back in October.

Picked on October 12 at $102.59
Change since picked: +11.37
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 966 thousand

---

Oshkosh Truck - OSK - close: 43.00 chg: -0.00 stop: n/a

On a day that automakers turned lower shares of OSK failed to move at all. Therein lies the problem. Lack of movement is the deathknell for a strangle so we're going to try and exit early to salvage our capital. More aggressive players might want to think about keeping the play open. We launched the play in late October with an estimated cost of $1.75. If we could exit now the options should sell for around $1.10. The options in our suggested strangle are the December $45 call (OSK-LI) and the December $40 put (OSK-XH).

Picked on October 30 at $ 42.82
Change since picked: + 0.18
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 405 million
 


Trader's Corner

Use of the OBV Indicator; Computing My Call/Put 'Sentiment' Indicator

NOTE ON MY TRADER'S CORNER ARTICLES:
My weekly (Wednesday) 'Trader's Corner' article is an extension of my Sat/Sun Index Trader column in that I explain the whys, wherefores and uses of the technical (analysis) principles, chart patterns, and indicators that I use in my Index Trader weekly column. Moreover, in providing explanations and how to use these principles and tools, I can update as needed my outlook and opinions on some of the major Stock Index charts [e.g., S&P 100 (OEX) and Nasdaq 100 (NDX)] and my view on them midweek.

The Index Trader is a section on the Option Investor.com web site and is NOT seen in the OI Newsletter (OIN) that is e-mailed on the weekend (Sat/Sun). There is however a 'link' to this article at the TOP of the weekend e-mailed Newsletter that will take you to my weekend Index Trader article on the OI Website.

This past Saturday, I wrote on my market outlook (still bullish, but turning cautious), the specific major Index support and resistance levels that I appear to be important technically, and an explanation of how I calculate my call to put bullish/bearish 'sentiment' indicator, which I'll also repeat below; my 11/5 Index Trader can be seen by clicking here.

OIN SUBSCRIBER QUESTION:
Can you explain how daily trade volume relates to how the trend in the Nas 100 (tracking) stock QQQQ looks or in any other stock for that matter?

RESPONSE:
It is said technically about stock volume, that for the trend to look strong technically, volume should move in the SAME direction as the trend. This is more true in individual stocks than it is in the QQQQ tracking stock for some reason. (In periods of a sideways trend, volume will tend to tend neither to increase or decrease much from day to day.)

In an up or bullish trend, daily trading volume will tend to increase (expand) on upswings and contract (fall off) during down days or periods. IF it does this, volume is 'confirming' the price trend.

In a down or bearish trend, daily trading activity tends to 'confirm' the trend direction (down) when volume tends to increase on down days and contracts or diminishes on up days.

I would add something about the price and volume relationship and make the statement above read ".. for the trend to look strong technically, 'On Balance Volume (OBV)' should move in the SAME direction as the trend.

ON BALANCE VOLUME:
On Balance Volume or OBV is an indicator that constructs a running total of volume that ADDS all the day's volume number when the close is higher than the day before and deducts all the day's volume when the close is lower than the prior trading session.

With the OBV indicator, we are not concerned about whether volume is greater than or less than another day, and are looking at the direction of the LINE; i.e., it the OBV line trending higher with an up trend or lower with a down trend (volume is 'confirming' the price trend)?

Conversely is the OBV line trending down while prices continue higher; or, lower while prices trend higher; i.e., volume is 'diverging' from the price trend and suggests that the trend may be technically weak.

I'll show some chart examples of some of these concepts.

In Google's (GOOG) chart below, you can see the parallel tendency for daily volume numbers to expand/increase when prices are going up. When prices are going sideways to lower, daily volume for GOOG tends to taper off during that period; if this stock was headed into a downtrend, volume would tend to increase.

Note that this most recent spurt higher in GOOG above was NOT accompanied by any substantial volume surge and, not surprisingly, the stock looks like it might have started a downside correction today (11/9). Note the major jump in volume on the big upside price gap of October.

In the daily chart of ExxonMobil (XON) below, periods of rising prices are followed by nothing worse than a sideways trend on balance when the stock was declining in March-May. This pattern suggests that the stock was being 'accumulated' or bought on weakness.

The period of price weakness in XOM over the past few weeks, except for the big jump in volume on the one-day, has been accompanied by volume holding steady. If the October decline was the start of any prolonged bearish trend or period, it's likely that more liquidation of the stock would have occurred which would have been suggested by RISING volume, which hasn't happened.

Use of the On Balance Volume indicator can make the volume situation more clear as to whether the volume trend is moving in tandem with the price trend or diverging from the price trend. It helps that OBV is a single line and that it is easy to see its DIRECTION (up, down or sideways) direction:

Looking at Google again, the volume trend as mostly matched the direction of the (price) trend. Sometimes, OBV tips us off to an upcoming trend reversal, even if minor. While GOOG went up strongly in Aug-Sept, OBV trended sideways to lower. A 2-week downside correction followed.

OBV stabilized and started turning up AHEAD of the last big price surge in GOOG (above). A nice tip off, as the calls were still cheap; not so after the sharp upside move that resulted in a major upside price gap.

There are times that OBV turns up, or down, ahead of the trend. In early-March the OBV line in ExxonMobil (XOM) turned down just ahead of the sharp price break. Then this indicator went basically sideways while the stock continued lower in April. This was suggesting that the stock was being bought on balance on the decline.

The best OBV 'signal' occurred during the period circled in yellow above, when OBV started trending higher in August while prices were still going sideways on balance. This allowed a period when it was advantageous to accumulated XOM calls.

BEST USE of the OBV Indicator: use WITH the daily volume BARS
I suggest applying the OBV indicator on TOP of the daily volume bars if your charting application will allow you to do that (per the QQQQ chart below). If your own charting application or one on a web site allows OBV use as a separate study, put it above or below the volume indicator.

Going back to QQQQ, which was part of the Subscriber question, use of the On Balance Volume OBV Indicator proved to be quite useful on occasion to alert us to a trend reversal at some key points. In early-July, OBV turned up ahead of the upside reversal in the Q's. Beside the approximate double top of early-Sept., a tip off on the correction that followed was the fact that the OBV line turned down just ahead of the downturn.

Again, because OBV is a directional line, it's easier to see the direction of the volume trend, in order to match it to the price trend. It is not the holy grail of indicators, but On Balance Volume is useful, especially at those times when daily volume jumps around; you need only glance at OBV to confirm the dominant trend in trading activity. It's even more useful when OBV turns up or down ahead of key (price) reversals.

OIN SUBSCRIBER QUESTION:
"Love your column.
Would you share exactly how you obtain the put to call ratio?"

RESPONSE:
Before I note the method of computation for the indicator, the indicator is shown on the bottom of the S&P 100 (OEX) chart below. The recent call/put extreme was suggesting that the OEX might be at or near a top.

The failure of OEX to pierce resistance at the previously broken up trendline has followed since the call/put extreme. However, OEX is also holding support at the prior downtrend line. The jury is still out! OEX above 565 maintains a bullish chart, whereas a fall under 560 suggests a correction is underway.

CALCULATING EXTREMES IN 'SENTIMENT':

EXTREMES IN BULLISHNESS:
I define bullishness as getting 'extreme' when any ONE day's CBOE equity options call volume is 1.9 to 2 times or more the total put volume (this figure excludes INDEX options volumes).

On a day that 1 million equities options traded on the CBOE and 500,000 puts changed hands. Dividing 1,000,000 by 500,000 equals a call to put ratio of 2.0. Call volume is divided by put volume each day. Quite simple.

EXTREMES IN BEARISHNESS:
I define bearishness as being or getting extreme when there is any one day when the daily ratio of CBOE total equities call volume to that day's put volume is 1.2 or less.

For example, a day when daily equities call volume equaled 919,301 and daily equities put volume was 819,150. 919301 divided by 819150 equaled a call/put figure (a ratio) of 1.1. Readings at or below 1.2 tend to precede bottoms, often within 1-5 trading days.

DEFINING EXTREMES:
My rule of thumb is to look for a tradable top OR tradable bottom to be reached within 1-5 trading days AFTER either 'extremes' (1.9-2.0 or more and 1.1 or less) are reached.

AFTER any such extreme, I ALSO then look for a 'confirming' sign of a trend reversal. For example, a key downside price reversal such as a sharp final spurt up followed by a close under the prior day's low, or a double bottom or top, and so on. Also, I look for whether there's an RSI overbought or oversold extreme around the time of, or after, a call/put extreme.

WHAT MARKET 'SENTIMENT' IS ALL ABOUT:
One measure of whether the market is getting overheated or, the reverse ('overdone' on the downside), is by examining the daily volume of option put volume relative to call volume; a "standard" measure of this is the study of put to call option volumes; i.e., a ratio of total put volume to call volume, including both equities and Index options and using the CBOE (Chicago Board Options Exchange) volume figures alone or for all exchanges.

My method is different in that I divide call volume by put volume to get a whole number rather than a fraction in the standard 'put/call' ratio; plus I take OUT Index volume numbers, which includes a lot of hedging, rather than more purely 'speculative' activity.

Why use Option Volume Ratios?
It has been noticed that when put volume gets quite high, such as being equal or more than to call volume, traders are getting pretty bearish. If call volume is twice or more that of put volume the market it typically approaching a bullish extreme in terms of how traders feel about the market. Traders are 'closest' to the market so to speak, day in and day out, which is why options volume is a good indicator about the market in general.

How bullish or bearish option traders are is best shown by where they are putting their money; more into calls or more into puts and what is the trend of that. There is the factor or selling calls and selling puts of course; e.g., selling puts is a bullish play. Nevertheless, the majority of option traders are betting on market direction, so call volume goes up on rally phases and put volume increases substantially in declining markets.

I've talked before about how Charles Dow, back more than a 100 years ago, observed that at significant market tops most market participants are bullish and at market lows many were shorting stocks, or they were out of the market; no options then!

Dow started writing about the idea that if there is especially heavy buying or heavy selling, the market could be nearing a trend reversal and something contrary to the trend was about to happen when everyone was heavily betting on one direction or the other for the market.

The concept of "contrary opinion" more or less started with Dow. That extremes in bullishness are bearish and bearish extremes in trading are bullish, reminds me of 'Alice in Wonderland' for its topsy-turvy ways of seeing things!

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

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

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