Option Investor

Daily Newsletter, Wednesday, 07/19/2006

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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

An Old Pattern Revisited . . . or Revised?

[Image 1]

For many months, the SPX established a pattern with other indices often following along. A strong gain was followed by three or four days of sideways-to-sideways-up consolidation. Then the SPX would dip to or toward the 10-sma, spring up and begin again.

During the pre-market and early cash sessions this morning, futures and early equity action indicated that the SPX and other indices were prepped for that next strong gain. By noon, indices had hit the tops of recent consolidation zones and paused. Was the recent pattern about to be revisited or revised?


The pattern repeated with but only on some indices. The SPX revised its pattern to create a gain but not a solid breakout. Breadth indications were positive, other than the fact that volume proved somewhat lighter than it had been recently. Other than some minor breakouts, such as that seen on the tech-heavy Nasdaq and the almost obligatory Dow close above 14,000, the new breakouts failed to appear. That Dow close was only 0.41 above 14,000, so bulls achieved the psychological target but only barely.

The mood was right during the pre-market and early cash sessions, with the enthusiasm for equities prompted by upbeat earnings reports from IBM, CAL and Juniper Networks, among others. However, as soon as FOMC Chairman Ben Bernanke's second day or testimony before Congress began today, senators addressed a steady stream of questions to the chairman, changing that mood. Their questions focused on the impacts of the housing slump, the sub-prime problem and a negative savings rate.

In addition, although Japan experienced an earthquake, it was China that sent out shock waves last night. The tremors might have been subtly felt by equity traders, too, like the rumbling of a heavy truck on a distant highway. During the overnight session, China's government announced that its GDP for the quarter that ended in June expanded 11.9 percent, far more than the predicted, already hot 10.8 percent and last quarter's 11.5 percent. Headline writers immediately speculated about when and how the Chinese government might choose to tighten money supply, either by raising interest rates or reserve requirements. In our current global-economies climate, fears about rate hikes can be quickly transported from one country to another.

Any tremors were dampened by the distance, however. Bond yields did not break out of their recent congestion zone. Ten-year yields closed the day at 5.04 percent, just above yesterday's close at 5.01 percent.

Add in crude futures above $75.00, a disappointing Philly Fed report, concerns about inflation expressed in the FOMC minutes and the usual opex pin-them-to-the-numbers action that begins about mid-morning on opex Thursday, and the day was set up for a revision of the SPX's typical pattern.


Last Thursday, I asked those subscribers who were long call options to make a plan that night for how they would react if the indices began a sideways-to-sideways-up consolidation the next day, as I expected them to do. That typical pattern, if revisited, would have meant consolidation for a number of days, I warned, days that would eat away at extrinsic option premium for July options.

That's exactly what happened. Although we did see some higher numbers early in the week, the SPX essentially consolidated sideways to sideways up and then dipped to its 10-sma yesterday. I tracked an ATM option's price for a Trader's Corner article I was writing into that expected dip, and the result of all that consolidation and subsequent dip on the option's premium wasn't pretty.

Today should have been a follow-through day after yesterday's spring from support. Let's see what happened with the SPX.

Annotated Daily Chart of the SPX:
[Image 2]

Daily nested Keltner charts (not shown) peg next resistance at 1559 on daily closes and then at about 1565 and then about 1570-1571 on daily closes. If the SPX can break above this week's resistance zone, those levels should be watched for next resistance. I'm not at all sure that breakout will occur, however, and neither were the investors participating in today's gains. They weren't willing to buy above certain levels.

Annotated Daily Chart of the Dow:
[Image 3]

The Dow, unlike the SPX, is in breakout mode on the daily nested Keltner chart, but it ended the day at potential resistance. As long as it's producing closes above a Keltner line currently at 13,817 but still rising, it's remaining in breakout mode, but it's beginning to be overdue a trip down to retest that breakout level and possibly even to a channel line now at about 13,641 but still rising.

Annotated Daily Chart of the Nasdaq:
[Image 4]

Like the Dow, the Nasdaq is in breakout mode on its daily Keltner chart, but perhaps due to retest the breakout level, at about 2697 as of the close, but still rising. A trip down to a channel line at about 2660 might be due, too, but can't be predicted yet.

Annotated Daily Chart of the SOX:
[Image 5]

The SOX's triangle forms at the breakout level on its daily Keltner chart. This outer channel boundary line often serves as resistance, but when prices close consistently above the channel line, momentum has been proven to be strong. So far, the SOX is not closing consistently above that channel line but rather is forming candles right along it. Resistance is tentatively holding. I took a look at On-Balance Volume for the SMH, not a perfect proxy for the SOX, but one that allows me to look at volume patterns. OBV has been rising as SMH price rises, so there's no divergence in that pattern as yet, although OBV isn't as high now as it was in April and May.

Annotated Daily Chart of the RUT:
[Image 6]

The Russell 2000's Keltner outlook is similar to the one seen on a traditional chart. The RUT chops around as various channels line up one inside each other rather than converging, showing where resistance or support may lie. No strong preference is shown to resistance or support on the Keltner chart, so that it's difficult to predict whether the RUT might be more likely to move up or down.

Today's Developments

Today unveiled several important economic releases or events, but the first releases of the day--weekly jobless claims and the Conference Board's Leading Indicators--aren't often market moving. Economists had predicted that initial jobless claims for the week ending July 14 would rise to 315,000 from the previous 308,000, but instead they dipped to 301,000, a two-month low. That was a decline of 8,000 in initial claims. The four-week moving average also fell, declining 6,250 to 312,000.

The 301,000 number of initial claims approaches a key level of 300,000. Initial claims below that number suggest a labor market that might be tightening enough to add wage pressures to other inflation pressures.

However, continuing claims rose 20,000 to their highest level in three months. The four-week moving average of continuing claims rose to its highest level in four months. Once a job is lost, applicants are finding it difficult to obtain a new one, these numbers suggest.

The Conference Board June's Leading Indicators decreased 0.3 percent. This marks the fourth month out of the last six that the index has declined, with housing permits pushing the index lower in June. Only three out of ten indicators climbed, with average weekly manufacturing hours, stock prices and new orders for non-defense capital goods comprising those three.

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The lagging index increased 0.5 percent and the coincident one, 0.2 percent. The Conference Board noted that the strengths in the coincident index have been broad even if the rate of growth of this index has slowed. Four indicators comprise the coincident index: industrial production, personal income (less transfer payments), non-farm employees and manufacturing and trade sales. The Conference Board noted that the order in which these were listed was also their ranking as to which contributed the most to that positive coincident index.

Weekly natural gas inventories were released next. Those inventories rose by 65 billion cubic feet.

FOMC Chairman Ben Bernanke of course continued his two-day testimony today. Much attention focused again today on the sub-prime problem, with many questions addressed to Chairman Bernanke about the committee's responsibility to regulate banks' mortgage practices and their packaging of loans. Chairman Bernanke repeated a statement that has been addressed by other OptionInvestor writers: the committee's responsibility is to see that banks remain safe and sound. He did not add "not necessarily to protect the consumer," but that might be one subtext, although he did say that regulations better protecting consumers should be produced soon. He pointed out that the FOMC has no jurisdiction over the companies that rate the securities such as those that produced the problem with the two Bear Stearns' hedge funds this week.

Although Chairman Bernanke reiterated a belief shared by others, that the impact of foreclosures and delinquencies could continue to worsen before improvement, he also reassured senators that the sub-prime mortgage problem hasn't produced a system-wide credit crunch. He estimated the losses at $50 billion to $100 billion. Ouch.

In last night's Wrap, Keene mentioned that rising food prices were impacted by the government's focus on ethanol as a proposed solution to a potential energy crisis. One senator honed in on this topic during Chairman Bernanke's testimony. He repeated the lament that real people drive cars and eat food, and that rising energy and food costs did constitute inflation for the consumer even if core rates don't show the pressures to the same extent.

Chairman Bernanke's testimony was followed by the two most important releases or events of the day. At noon, the Philadelphia Federal District released the Philly Fed Survey, an indication of manufacturing strength or weakness in that district. The Philly Fed for July disappointed, the headline number coming in at 9.2 versus the expected 15.0.

A number above zero still indicates expansion, but July's number had tumbled from 18.0 in June. The prices-paid component eased but not enough to indicate that inflation pressures have been erased. The expectations index, the component that measures how businesses feel about the future, also rose, from 30.4 to 16.7. Shipments rose to 20.3 from 5.0 but the new orders index declined to 11.3 from 18.3.

At 2:00, the minutes from the June FOMC meeting were released. Those minutes revealed that some FOMC members do not share Chairman Bernanke's purported belief that inflation pressures are contained. Those members pointed to elevated headline inflation numbers and Treasury inflation-indexed securities that had moved higher.

Earnings reports picked up this week. So many important companies reported today before and after the bell that any discussion of earnings must remain brief. Upbeat reports from early reporters and those reporting last night, such as IBM, CAL and JNPR, were credited with creating a positive tenor this morning. As many of you will already know, IBM raised its full-year profit outlook last night with its quarterly performance termed its strongest in five years. JNPR also raised its full-year forecasts, producing a profitable quarter.

BAC also beat expectations, but equity investors didn't know what to think about financials with the sub-prime problem looming. They sent BAC's price up and down, doing nothing but churning price within a recent congestion zone. The day's candle was more negative than neutral, but did not break either recent $48.50 support or the July low.

In this weekend's edition of the newsletter, Jim Brown mentioned the importance of one company's earnings report today: MGIC (MTG). As Jim noted, this company insures most sub-prime loans. Jim thought this company could help pinpoint the impact or extent of the sub-prime problem.

MTG failed to meet expectations. The company reported that its Q2 earnings were almost halved. Net income was $76.7 million or $0.93 a share, down significantly from $149.8 million or $1.74 per share a year ago. The miss of expectations was significant, too, with analysts projecting $1.38 per share for this quarter.

Losses climbed from $235.2 million in the year-ago period to $146.5 million. California, Florida and the Midwest produced the biggest insurance losses, with those areas also the hardest hit by the housing slump.

Reporting companies today included AMD, GOOG, MSFT, BRCM, HON and MOT, among others. HON's quarterly profits beat expectations, rising 24 percent. Like many other companies today, HON raised full-year guidance.

A new financial security debuted today. MF Global listed at $30 a share, below the expected $36-39 range.

Crude futures pushed higher today, closing above $75.00 although the day's trading produced a candlestick formation that sometimes indicates that a pullback is near. Production at a key platform in Angola was cut down significantly due to an electrical problem, CNBC announced this morning, with a commentator there speculating that was the reason for the new recent highs produced today.

MSFT reported after the close. Revenue rose slightly more than anticipated, with the company calling the acceptance of its products, including Vista, "solid." Due to an already anticipated $1 billion chart from its Xbox video game business, fourth-quarter profit was only a few cents above its year-ago level, at $0.31 a share compared to $0.28 a year ago. If those charges had been excluded, earnings would have been $0.39 a share, right in line with expectations. Revenue, however, was only slightly above the expected $13.27 billion, at $13.37 billion. As I typed, MSFT was trading at $31.00 after closing at $31.51.

AMD results were just crossing the wire, too. The company reported a net loss of $600 million or $1.09 a share, down from its profit of $0.18 a share a year ago. Sales of $1.37 billion beat expectations, however, helped by a 38-percent increase in microprocessor shipments. AMD's share of global microprocessor shares increased from 10.9 percent to 11.4 percent, iSuppli said, as quoted in a Marketwatch.com article. As might have been anticipated, AMD wrote off older microprocessor parts and lowered prices for desktop chips, reporting margin pressure. AMD moved higher in after-hours trading.

Tomorrow's Economic and Earnings Releases

Tomorrow's economic releases will be mid-morning ones. June's Mass Layoffs, released at 10:00, will be followed by the ECRI Weekly Leading Index at 10:30.

Companies reporting tomorrow include C, CAT and SLB.

What about Tomorrow?

Indices sometimes clamp down in a pin-them-to-the-numbers action beginning about midmorning on opex Thursday and continuing through to Friday's close. That pattern certainly asserted itself today, working against the other pattern--that of a strong gain following the last week's type of action.

Such pin-them-to-the-numbers action renders my beloved Keltner channels less useful on an intraday basis than is typical, but let's look at what they show. We'll be looking specifically for evidence that the pin-them-to-the-numbers action could continue tomorrow morning. Remember that important earnings announcements after the bell this afternoon could change the outlook seen on these intraday charts.

Annotated 15-Minute Chart of the SPX:
[Image 7]

I didn't show lower indicators to make the upper chart clearer, but including indicators such as RSI wouldn't have proven much anyway. RSI flattened.

So, at least we see visual evidence of the resistance the SPX dealt with today, pinpointing breakout or rollover levels for tomorrow. Be careful of upside breakouts that are soon reversed, especially if occurring on the first 15-minute candle tomorrow. Those sometimes prove unreliable. If you're thinking about going long and use an upside breakout as an entry, be ready to bail quickly if markets reverse against you. That goes doubly if you intend to enter a bearish play on a supposed rollover. That tangle of lines below the SPX's current position indicates visually how tough it might be to get much lower during early trading at least if there's not a strong impetus.

The formation seen on this chart could be described as an inverse head-and-shoulders formation, but I distrust continuation-form inverse or reverse H&S's. Still, they're useful to watch if less useful for predictive purposes than they once were.

A break of mid-channel support, currently near 1546, on 15-minute closes, sets a potential downside target of 1538-1539.

The Dow's intraday chart proves similar.

Annotated 15-Minute Chart of the Dow:
[Image 8]

Annotated 15-Minute Chart of the Nasdaq:
[Image 9]

Annotated 15-Minute Chart of the RUT:
[Image 10]

All in all, these intraday charts suggest that the pin-them-to-the-numbers action could continue without offering convincing proof that it will. I just don't see and so don't have a strong conviction either way. Even when I get drawn back by the siren of daytrading, I don't trade opex Friday's much, and these kinds of setups are why. Even though the SPX and Dow setups seem to show perfect points from which to enter a long position on an upside breakout, for example, opex Friday's often feature upside breakouts or downside breakdowns that then go nowhere. Which is the real move and which will fizzle? That's hard to know on an opex Friday. Spend lottery money only on new plays tomorrow.

New Option Plays

New Option Plays

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

New Calls

PetroChina - PTR - close: 110.60 chg: +3.00 stop: 107.49

Company Description:
PetroChina Company Limited (PetroChina) was established as a joint stock company with limited liabilities under the Company Law of the People's Republic of China (the PRC) on November 5, 1999 as part of the restructuring of China National Petroleum Corporation (CNPC). In the restructuring, CNPC injected into PetroChina most of the assets and liabilities of CNPC relating to its exploration and production, refining and marketing, chemicals and natural gas businesses. (source: company press release or website)

Why We Like It:
In spite of a sharp three-day pull back in the price of crude oil shares of PTR have remained inside its three-week trading range. Yet now that the U.S. markets are bouncing shares of PTR could be on the verge of a breakout. If the markets do see some follow through higher on today's gains then we want to be ready to catch the breakout in PTR. Thus we're suggesting a trigger to buy calls at $111.55. If triggered our immediate target will be the $119.50-120.00 range. The Point & Figure chart is pretty bullish with a quadruple-top breakout buy signal with a $139 target. We do not want to hold over the mid August earnings report.

Suggested Options:
We are suggesting the August calls. You need to choose which strike(s) is best suited for your trading style.

BUY CALL AUG 110.00 PTR-HB open interest=288 current ask $5.00
BUY CALL AUG 115.00 PTR-HC open interest=243 current ask $2.70

Picked on July xx at $xxx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/16/06 (unconfirmed)
Average Daily Volume = 708 thousand

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Dominion - D - close: 76.50 change: +1.48 stop: 74.49

The market's strength on Wednesday helped push shares of D back above resistance at the $76.00 level. The stock closed at a new five-month high. This looks like a new entry point to buy calls. Our target is the $81.00-82.00 range although more conservative types may want to exit near $80.00. Please note that we do not want to hold over D's early August earnings report.

Picked on July 17 at $ 76.05
Change since picked: + 0.45
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 1.5 million


EOG Resources - EOG - close: 67.99 change: +1.11 stop: 69.90

Oil stocks rallied higher with the market today in spite of a third day of losses for crude oil futures. Shares of EOG added 1.6% but remains under the short-term trend of lower highs. We are still sitting on the sidelines. Our trigger to buy calls is at $72.55. Nimble and aggressive traders might consider buying a bounce from current levels but EOG needs to breakout from its short-term trend of lower highs.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 3.5 million


Fortune Brands - FO - close: 72.10 change: +1.36 stop: 69.74

Wednesday was a bullish day for FO. The stock added 1.9% and looks poised to move higher. We hesitate to suggest new positions right here because FO has short-term resistance near $73.00 and its descending 50-dma near 72.92. We did note that FO is now expected to report earnings on August 1st so that gives us more time. We're going to adjust our target to the $74.75-75.00 range.

Picked on July 06 at $ 71.30
Change since picked: + 0.80
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 674 thousand


Reynolds American - RAI - close: 120.32 chg: -0.05 stop: 117.45

With the market in rally mode investors forgot about relative-strength winner RAI. Highlighting just how much investors ignored RAI for other, more beaten down equities, the company's positive news this afternoon failed to inspire any buying interest. Late in the session RAI announced it was raising its cash dividend by 20% and had approved a 2-for-1 stock split payable on August 14th, 2006. We don't see any other changes from our previous updates. Our short-term target is the $124.50-125.00 range. We have a limited amount of time for this play to work since we plan to exit ahead of the late July earnings report.

Picked on July 17 at $120.20
Change since picked: + 0.12
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 636 thousand

Put Updates

Alcon Inc. - ACL - close: 93.24 chg: -0.59 stop: 100.05

We knew ACL looked bearish but we're still surprised that the stock failed to participate in today's widespread market bounce. Today's relative weakness is a good sign for the future but that doesn't mean we should be ready for a bounce. The $97.50-98.00 region should offer some overhead resistance if ACL does rebound. We're suggesting two targets. Our conservative target is the $90.50 mark. Our aggressive target is the $87.00-85.00 range. We do not want to hold over the July 24th earnings report so we don't have a lot of time.

Picked on July 13 at $ 95.61
Change since picked: - 2.37
Earnings Date 07/24/06 (confirmed)
Average Daily Volume = 805 thousand


Air Products Chem. - APD - close: 63.47 chg: +1.57 stop: 65.01

APD responded with the market's bullish tone with a 2.5% gain in the stock price today. Shares did move over short-term resistance near $62 and its 200-dma but the rally stalled near the 50-dma and the $64.00 level. We can't say if the market rally today is a one-day pop or the start of something more. At this time we're not suggesting new positions. More conservative traders may want to tighten their stops toward the $64.00 level or just exit early to reduce any losses. Our target is the $59.00-58.00 range.

Picked on July 09 at $ 62.95
Change since picked: + 0.52
Earnings Date 07/26/06 (confirmed)
Average Daily Volume = 1.2 million


Apollo Group - APOL - close: 49.31 chg: +0.82 stop: 51.01

APOL did add 1.69% today but the stock remains under broken support and what should be new resistance at the $50.00 mark. APOL is also still trading under its trend of lower highs. We are not suggesting new bearish plays at this time. More conservative traders may want to consider a tighter stop loss. Our target is the $45.50-45.00 range. The P&F chart points to a $40.00 target.

Picked on July 09 at $ 49.92
Change since picked: - 0.61
Earnings Date 09/19/06 (unconfirmed)
Average Daily Volume = 1.4 million


Caterpillar - CAT - close: 71.12 chg: +1.65 stop: 72.31

A 200-point rally in the DJIA helped fuel a 2.3% gain in shares of CAT on Wednesday. So far the stock remains under its short-term trend of lower highs and minor resistance at the $72.00 level. There is no way to know if today's market rally is a one-day fluke or something more. We're not suggesting new positions and more conservative traders may want to tighten their stops or just exit early. Our target is the $67.50-66.50 range, which is just above the rising, simple 200-dma.

Picked on July 12 at $ 71.31
Change since picked: - 0.19
Earnings Date 07/21/06 (confirmed)
Average Daily Volume = 5.1 million


IDEXX Labs - IDXX - close: 74.91 chg: +1.30 stop: 76.05*new*

We warned readers yesterday that IDXX would probably rebound if the market responded well toward Bernanke's comments. We're actually a little surprised that shares closed under resistance at the $75.00 level and its simple 200-dma. We're not suggesting new plays and we're repeating our suggestion to exit early. Please note that our new stop loss is at $76.05. Our conservative target at $75.25 has already been hit and we're aiming for the $72.00 level.

Picked on June 12 at $ 77.95
Change since picked: - 3.04
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 144 thousand


Jacobs Engineering - JEC - cls: 74.46 chg: +1.47 stop: 76.55*new*

The market rally fueled a 2% rebound in JEC but the stock's momentum stalled near the $75.00 level and its 200-dma. We don't know if the market will see any follow through tomorrow so we're not suggesting new bearish positions at this time. Please note that our stop loss has been adjusted to $76.55, this is below JEC's three-month trendline of resistance (around $77.50) so more aggressive traders may want to leave a wide stop. Our target is the $69.00 level near the June lows. More conservative traders may want to exit at $70 while aggressive traders may want to aim lower. Bear in mind that we do not want to hold over the July 25th earnings report so we only have a few trading days.

Picked on July 16 at $ 73.75
Change since picked: + 0.71
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 583 thousand


Panera Bread - PNRA - close: 60.01 chg: +0.60 stop: 62.01

PNRA produced an initial bounce this morning but it failed and the stock spent the session consolidating in a tight range near the $60.00 mark. While this looks like relative weakness we're not suggesting new put positions at this time. We do not want to hold over the July 25th earnings report.

Picked on July 18 at $ 59.49
Change since picked: + 0.52
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 494 thousand

Strangle Updates


Dropped Calls


Dropped Puts

Cardinal Health - CAH - cls: 65.84 chg: +2.34 stop: 65.25

Healthcare stocks turned in a very big rally today. The HMO index added 2.75%. Shares of CAH out performed its peers with a 3.6% gain on above average volume to breakout over resistance near $65.00 and its 50-dma. Our plan was to buy puts if CAH traded at $62.25 or lower. We were never triggered so we're dropping CAH as a bearish put candidate.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 1.6 million


Express Scripts - ESRX - cls: 72.90 chg: +2.80 stop: 71.51

We've been stopped out of ESRX at $71.51. The stock responded strongly to the market's rally today and shares of ESRX added almost 4% although it may be worth noting that the rally stalled under resistance in the $73.50 region.

Picked on July 17 at $ 69.30
Change since picked: + 3.60
Earnings Date 07/26/06 (confirmed)
Average Daily Volume = 2.0 million


Lazard Ltd. - LAZ - close: 36.55 chg: +2.15 stop: 36.75

We have been stopped out of LAZ at $36.75. The XBD broker-dealer index was one of the best performing sectors in the market today with a 4.1% gain. The strength of the rally probably produced some panic short covering and LAZ responded with a 6.2% gain and a move back above resistance at $35.00, $36.00 and its 200-dma.

Picked on July 18 at $ 34.49
Change since picked: + 2.06
Earnings Date 08/08/06 (unconfirmed)
Average Daily Volume = 504 thousand

Dropped Strangles


Trader's Corner

Signs of a Bottom in the Indexes

When I wrote my last Saturday 7/15 Index Trader, ("At Or Near a Bottom" see this article by clicking here)

you could tell from the title that I felt confident that a trade was coming up very soon and that the market was bottoming. Of course 'the' market is a bit misleading because, as we know, there is much greater relative strength in the S&P indices and the Dow currently, so these would be the indexes to focus on as far as what to trade, such as in buying Index calls.

Nevertheless, it's important to look at ALL the major indices to see what technical bullish criteria are being met. Sometimes the 'double bottom' is seen in 1-2 indices, not others; sometimes a 2/3rds or 66% retracement is seen in the S&P but not the Composite. At times, the Composite might be registering an EXTREME oversold condition, not quite realized in the S&P. Chart pictures will be worth a 1000 words on this coming up.

There are 3 technical 'indicators' that, when they line up as bullish or bearish, together make a pretty reliable indication for a bottom and provide a solid reason to get ready to enter a trade in the indexes likely to lead the market higher.

The 3 are:
1. NYSE and Nasdaq daily Up Volume, 10-day average.
2. 'Sentiment', especially certain lows in the daily ratio of CBOE equities call to put volumes.
3. RSI (or Stochastic) indicator extremes. #3 is a 'confirming' or secondary indicator only. Extremes here suggest that bottoming indications for 1 & 2 are being 'confirmed' so to speak.

#1 above, Up Volume this one you can most likely, hopefully, chart yourself in whatever you use for charting.

Why UP Volume? Up volume, or the daily volume of stocks bought on up ticks, tends to be an objective criteria of buying interest. The absence of it reflects the lack of this interest of course. But it always only goes on so long in a typical market cycle before stocks are perceived as in a value area again.

The potential for a double bottom in the Nasdaq Composite Index (COMP) was considerable, when this pattern occurred ALONG WITH the contraction in Nasdaq Up volume back to a 'baseline' area which tends to define bottoms. I am now defining this zone as between 300-500 million shares on a 10-day moving average basis. When the 10-day moving average turned UP below, after reaching this baseline zone, it is one of the better and INFREQUENT (meaning TAKE ADVANTAGE of it!) signals for a reversal.

Since the S&P 500 (SPX), S&P 100 (OEX) and the Dow 30 (INDU) have been going down less on the declines and rallying more on the upside, Up Volume in the NYSE market is key in my trading; more so than the Composite, which was my first chart. But, again, COMP is also 'confirming' what's happening in S&P.

Use of the S&P 500 Index (SPX), as plotted below, correlates well with the NYSE Composite and has also been leading the S&P 100 (OEX):

As far as the chart/technical pattern, there's a support or bullish up trendline above that held in SPX as seen above. A slight intraday dip under that line isn't important.

#2 of my most reliable technical cluster of indicators tending to be indicative of being at or near a bottom (or top) are ONE-DAY readings at the lower (and upper) extremes on my bullish/bearish 'sentiment' indicator, which is the lowermost indicator on the S&P 100 (OEX) chart below.

Chart support at recent OEX lows was apparent at the what had been resistance implied by the down trendline; as noted in the area of the green up arrow below (resistance once broken, tends to 'become' support later on).

A solid tradable (trend) reversal should occur WITHIN 1-5 days after such extremes IF the other conditions are met, especially the upturn in the Up Volume (10-day) average from the lower baseline area talked about in my commentary with the first two charts. The low occurred 4 days after the low reading in my CBOE Equities Call to Put volume ratio seen at the green up arrow immediately above.

Another aspect to look at are retracements of prior big moves. The OEX rebounded before it got to its prior low, which then didn't provide THAT guide to a bottom. But, the Index DID quite precisely (more so than previously), reverse at support implied by its 2/3rds, 66% retracement:

OEX's rebound back above its 50 and 200-day moving averages became a further suggestion that we're seeing an overall bottoming process here.

A note on the #3 suggestion for a bottom or top, being extremes in the RSI overbought/oversold indicator; going back up to the chart before this last one above, you'll note that the RSI on the S&P 100 did not get to a 'fully' oversold reading, as suggested by the lower level line on the RSI indicator.

With overbought/oversold considerations it's useful to look at an 8-week RSI ('length' set to 8) on the Weekly chart as well as a 13-day RSI on the daily chart; both 8 & 13 are part of the 'Fibonacci' number series along with 5 & 21.

Before jumping to the (8-week) RSI indicator seen at bottom of the S&P 500 (SPX) weekly chart below, I would also note that recent lows were occurring at a 2-year up trendline. Again, in technical analysis, we're always looking for 'confirming' or similar patterns that are suggested by price, trendlines, retracements, overbought/oversold, etc.

As to the 'oversold' aspect of the WEEKLY chart above, the 8-week version of the Relative Strength Index in SPX was registering as much of an 'oversold' extreme as was seen in all but one period in 2004.

Since the Dow 30 Average, the Industrials (INDU) has been such a key index, naturally, us option trader types are going to pay attention to INDU closely. I don't find that it's literally necessary to watch the market all day in order to see IF the Dow bottoms in the same area as before.

Because of the aspects suggesting that we were at or near a bottom and given how oversold the major indices were, I use what I call an "ASSUMED 'DOUBLE BOTTOM'".

I calculate that the Dow should either bottom in approximately the same area as BEFORE (that is my 'trendline' so to speak that I rely on) OR will go through it substantially, in which case I want to be out if INDU falls only moderately under its prior low. If I'm right, my upside potential is great relative to my 'risk' point.

It's not too difficult to come up with where the Dow Index calls I'm interested in (August 107's) should trade more or less if the Dow falls again to the 10,700 area. A limit price for the desired DJX Call can be placed along with an sell (exit) order if DJX falls to 106.5.

My trusted broker is the one paid by my commissions who loves nothing better than to watch the market for me and execute my exit (sell) order if prices get to my 'stop'; hey, more business for them. I myself have other projects and businesses that I also attend to. And, there's summer!

Use of the 21-day stochastic (anther Fibonacci number) has worked well over the years to suggest where the INDU is at an oversold or overbought extreme. I would also note above how the Dow bottomed in roughly the same area, while the Stochastic process model turned up from a higher level than before in a mildly bullish divergence.

Coupled with the other factors I've discussed, this divergence added to the overall take I had for an impending bottom, making it time to exit puts and buy calls, especially in S&P and DJX. In trading, the more patterns and indicators that suggest and 'support' the trading decision I've made, the LESS worry I have about having made a correct call on the trend.

Please send any technical and Index-related questions for answer in Trader's Corner articles to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **

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


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