Option Investor

Daily Newsletter, Thursday, 09/28/2006

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

This Is Just the Beginning of a Brand New Bull Market

Now that I have your attention, let me just say NOT!! I just wanted to sound like every other talking head out there who is declaring the bear market officially dead. As a good trader friend reminded me today, "Remember March 2000? You couldn't find a Bear on the planet (except in Alaska)." Looks like deja vu all over again.

There was a story in MarketWatch that came out at noon today by Mark Hulbert, a popular market analyst. I don't mean to pick on Mark Hulbert but his story was typical enough for me to use as an example and to make my point. After today's climb in the DOW above the January 2000 closing high (11723), the giddiness from this event is more than obvious. Here was the headline part of the story: "An investor who was unlucky enough to have invested a lump sum in the stock market on March 24, 2000, the bull-market high, but who stuck with his investment and reinvested all dividends along the way, was, on Thursday morning, in the black for the first time." This sounds remarkably good and will of course get many to think they'd better buy into this runaway bull market. There's a reason it's a well known fact that the majority of retail investors buy at the top and sell at the bottom. I know, I used to be one of them (still am at times when I lose my head).

This is typical of the many stories in the media--hyping the fact that the bear market is dead. There are several misleading statements in the stories we're hearing and probably the biggest one is the fact that the average investor is back in the black after the DOW makes a new high. First of all only 10 of the 30 stocks are hitting highs that are above their January 2000 highs. The S&P 500 has retraced almost 75% of the 2000-2002 decline. Said another way, it's still down 25% from its March 2000 high. Those who were invested more heavily in techs are still down almost 70% as measured by the COMP. Those who are trying to talk about a bull market would rather point out the fact that the COMP has doubled since the October 2002 low. As we all know, it's easy to get a double on a small number.

Those who were more diversified in their investments in 2000 obviously fared better than the tech investors. Mark Hulbert pointed out that the Wilshire index, if you include dividends, is also higher. The index itself is not higher. Hulbert went on to say, "But one implication is clear, I would think: The new high makes it difficult to maintain that the stock market's rise since 2002 has merely been a bear-market rally in the context of a long-term bear market that began in March 2000."

He described the strength of the 4-year bull market and compared it to the time between 1966 and 1982 (16 years) when it took the DOW that long to convincingly climb above 1000 after first hitting it (almost) in 1966. I'm glad he made reference to that period because I think it's a model of what's ahead of us. This chart shows that period.

DOW chart, 1960-1989

What Hulbert failed to mention is what the stock market did after making a new all-time high in 1973. Coming from a deep plunge into the 1970 low of 662 the new highs in 1973 were greeted with much fanfare and the declaration that the bear market was dead. When the market plunged back down to 577 in 1974-75 (18 months later), a low that was below the one in 1970, it was a convincing statement that the market was mired in a much bigger and longer lasting bear market.

The picture today is very similar to the 1970's, including fears of stagflation. The bull run from the October 2002 low, with today's intraday high for the DOW above the all-time closing high in January 2000, is being declared the bear killer instead of a bear market rally. But I think if it were a bull market we shouldn't be seeing the massive bearish divergences present in most of the charts.

If we follow the example of the 1970's the next big move will be a drop back down that takes out the October 2002 low, and it will happen within the next 18 months (or faster if the derivative mess--discussed below--accelerates any strong decline we get). And that's exactly what I believe will happen. You can call me a bear who is out of touch with reality or you can go with history and what the present charts are telling us. I report, you decide.

The next drop in the stock market could be aggravated by a situation that is far different than your father's market of 1970's. The derivative market has expanded to the point where it is valued at over $300T (yes, that's a T for trillion). The combined value of the bond and stock market is only $65T and therefore the derivative market, which is based on the underlying value of the stocks and bonds, is almost 5 times greater. Things are happening so fast that there are derivative transactions that have not even been registered in the books and in the event of a crisis we may not know who actually owes who.

Wall Street loves derivatives since they're far more lucrative than trading the underlying. The massive profits made by the mega banks is testimony to this fact. The value of derivatives has tripled just in the past 5 years. Hedge funds are huge participants and they continue to blow off requests by regulators for information on their holdings.
Retail investors are getting pulled more and more into this game whether they realize it or not (through mutual funds, pension funds or directly). Many aren't aware how risky it has become, which takes us back to the fact that the market in general has sought higher and higher risks due to the perceived increased stability of the market, thus setting us up for a more painful "dislocation".

This could be the grain of sand that brings down the whole mountain as a dislocation could result in a powerful domino effect that takes down many investment houses. The Securities Investor Protection Corporation (SIPC), which insures brokerage accounts, recently announced that its reserves account is a little more than $1.2T. Compared with $300T at risk that's not much protection. Just as the S&L crisis in the 1980's was bailed out by the tax payer, and more recently failed pension funds, guess who will foot the bill when brokerage accounts fail? Ah the web we weave...


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But in the meantime the bulls are having a blast, a beer blast that is. And the hangover will not be fun. Romp with the bulls but watch the edges of the fields carefully for signs of danger. Remember, you don't want to be tail end Charley when the herd is trying to run away from the marauding bears.

Looking at today's economic reports, it was a relatively quiet day. The unemployment claims showed a drop of 6K to 316K in initial claims. But that was from the upwardly revised number of 322K from 318K for the previous week. In reality it was a 2K drop. The 4-week average fell by 500 to 315,500. Continuing jobless claims fell by 8K to 2.44M.

The Help Wanted Index dropped to 31 from 32 last month. This number has been slowly dropping the past several months and is a sign of lower help wanted advertisements.

The final Chain Deflator number remained unchanged at 3.3%. The final GDP number was lowered from 2.9% to 2.6% and this was unexpected. Slower growth is a reason to rally. Hey, I've never said it makes sense to watch the market's reaction to news. But looking at the reaction of the stock market then I'd have to say a slowing economy is good for stocks (wink). Considering economic growth has averaged 3.6% over the past year, and that it grew 5.6% in the 1st quarter, one would have to say we're seeing a real slowdown in our economy. It won't take long for the stock market to register this if the trend continues. Besides, we first need to get past EOM/EOQ shenanigans where the funds need to show how brilliant they are in their stock selections for their books. Get ready for a disgorging party.

The lower revision to GDP was due to lower inventory builds (businesses are being smart and tightly controlling their inventory--more just-in-time inventory control, and that's a good thing). Worsening trade imbalance also lowered the GDP. As has been the case, consumer spending was the main reason for GDP growth, rising at a 2.6% annual pace. But even that's down from the +4.8% pace in the 1st quarter. With the wallet closing (home equity tapped out, higher interest rates on adjustable-rate loans/credit cards) the mighty consumer will be forced to spend within their means.

Spending on software and equipment dropped the most since Q4 2002, down -1.4%. Residential investment, due to the drop in the housing sector, dropped -11.1% which is the largest decline in 11 years.

Core inflation rate was revised slightly lower to 2.2% from the previous estimate of 2.3%. This is still higher than the Fed's target of 1% to 2%.

As we all know, this week was end of month and end of quarter and as such we expected to see some window dressing as fund managers scrambled to add winning stocks to their portfolio to show how brilliant they are at managing your money. Next week many investors will wonder why such strong companies are selling off. At least that's the pattern. Add in the fact that the DOW is so close to making new all-time highs and it's an added incentive for Big Money to drive the market higher. The combination certainly gave us a bullish week so let's see what the charts are saying now.

DOW chart, Daily

For those who follow EW counts you may wonder at my count showing wave-(b), which is the rally from the June low, as still a valid count considering the fact that it is above the May high now (which was the start of wave-(a) down). The odd thing about corrective wave counts is that that can happen and it often convinces traders that a new bull market run is upon us. This should be just a head fake break to a new high and wave-(c) down should be next. That's the leg that will take us relatively quickly back below the June low. It will convince many longer term investors that they've been had and that they bought the high, again.

There's been a major effort by Big Money to push the major indices to new highs so as to convince the majority that the bear market is dead and it's time to buy. How else can they have willing buyers to whom they can unload their inventory. It's why the crowd buys the top and sells the bottom. If this keeps heading higher it will catch me flat-footed and it wouldn't be the first time. But all the signals I'm getting from this chart tell me the top is very close and that it's ready for a hard reversal back down.

SPX chart, Daily

It's the same pattern and story for the SPX. The big caps are getting the attention lately and that's of course a defensive move--they're much easier to park your money in (other than cash) and sell if the market starts dropping fast. This week we're getting another throw-over above the top of the wedge so we're waiting to see if it drops back inside for a sell signal. The manipulation this month has prevented the normal ebb and flow of buying and selling and it's one reason why we're seeing this relentless buying here.

Nasdaq chart, Daily

The leg up from August has become too much too fast and is due at least a rest. A rest (pullback) would be a break of the bottom of its ascending wedge and that could spell trouble for the whole bounce from July. The COMP has quite a ways to go to match the new highs being made in the DOW and SPX. The same is true for the small caps which have not even retraced 62% of their May-June decline.

SMH index, Daily chart

Whereas the COMP has retraced a little more than 62% of its April-July decline and the small caps (RUT) has retraced a little less than 62%, the semis have been able to retrace only 50% of their January-July decline. Also they've formed lower highs on the bounces since the January high. This shows the relative weakness of the semis and that's not what bulls want to see. When bulls feel very confident in a bull market they go for the higher-beta stocks like the semis. The lackluster performance of this group tells me my bearish interpretation for the broader market is probably the right one.

BIX banking index, Daily chart

The banks are leading the way to new highs above May's highs and this is what bulls want to see. Banks and brokers should be leading the way. So we've got some mixed signals when I look at what the banks are doing but then wonder why the semis are lagging. And then I look at the bearish divergences at the new highs and I side with the message from the semis. Trade it higher but leave yourself a quick exit. With price back up to a parallel line to its uptrend from October 2005 it's a time for caution. With MACD up against its downtrend line it's a time for caution. With the false propping of the market this week it's a time for caution. Have I mentioned you should be cautious at these highs?

Securities broker index, Daily chart

The broken uptrend line from May 2005 is still being tested--price has been walking up underneath it for the past week. A rollover from here would be a very bearish sign as it would indicate failure to recapture its uptrend line. And why aren't the brokers making new highs above May's high? With the huge sums of money the brokers are making one would think they'd be at the top of the heap. Not being there makes this a time to be cautious.

The new home sales number for August that came out yesterday showed sales rose and everyone jumped for joy that the worst is probably over. Silly people. Sales figures for July were revised lower so the sales number for August sounded better than reality. It's expected that the August numbers will also be revised lower. Gamesmanship with the housing numbers this close to elections? Nah, that wouldn't be honest reporting by our government.

Actually, the reason for the lower revisions has to do with counting sales when contracts are signed and not when they're closed. They don't take into consideration cancellations which the home builders have been reporting are on the rise. This then results in lower revisions for the sales numbers (making the subsequent month look good until its numbers are also revised lower).

Many are saying these bad numbers have already been baked into the cake for the home builders and that we've put in a bottom. I don't think so.

U.S. Home Construction Index chart, DJUSHB, Daily

The home builders index has made it up and over to its downtrend line from January. At the same time, the test of that downtrend line left a bearish divergence at the new price high in the bounce. It looks like a perfect setup for lower prices. I expect to see another leg down to new lows.

Oil chart, November contract, Daily

Using a parallel down-channel off the downtrend line from early August we can see that that's where price found support. The reason these channels work is because of "measured moves". People respond to certain patterns whether they consciously see them or not. Now we'll get to see if we'll get a sideways consolidation (which is the way I'm leaning) and then a continuation lower or if oil bulls can drive this back above its downtrend line, currently near $65.70. If instead it consolidates sideways over to its downtrend line then there will be little doubt in my mind that we'll see lower prices. We'll need to let price point the way.

Oil Index chart, Daily

Like oil itself I'm expecting to see this index consolidate before heading lower again. Today's shooting star doji is potentially bearish, especially if it's followed by a red candle tomorrow.

Transportation Index chart, TRAN, Daily

A retest of the May high for DOW and SPX is not being accompanied by a test of the high for the TRAN. That's bearish non-confirmation. The bounce since the August low looks very corrective--overlapping and choppy and this is usually a good sign that it's just a correction of the dominant trend--down in this case.

U.S. Dollar chart, Daily

As I had mentioned last week, I'm beginning to get a more bearish sense about the US dollar based on the larger sideways triangle pattern that's been developing since the May low. This should be a continuation pattern meaning the move down should continue. Looking at two equal legs down from last November's high gives us a downside target near $77. If we're looking at that kind of drop in the dollar, which should be relatively quick, that should be bullish for gold. I've been leaning bearish on gold but the dollar chart has me wondering.

Gold chart, December contract, Daily

The pattern in gold has been leading me to believe we're going to see it drop down to a Fib target at $506.50, perhaps even as low as $400 eventually. That's still a distinct possibility when I look at just this chart and ignore all fundamental reasons why gold should rally, or the dollar chart which is beginning to look more bearish to me (since gold and the dollar tend to have an inverse relationship).

For the bearish picture to hold, the current bounce can not get higher than 616.50 otherwise it will overlap a the previous low and cancel the bearish EW count. So the current bounce can't go much further. For the bullish picture, which I do not have drawn in, we could be forming a sideways triangle since the May high. This would be a bullish continuation pattern. So we'll keep an eye on the current bounce and subsequent drop to help answer this question. A drop from here below $575 would strengthen the bearish case.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's reports have the potential to move the market. Funds that have been buying this week are not obligated to hold onto their inventory tomorrow since any selling they do will not be reflected on their books until after the month/quarter closes. Therefore if there's anything scary in these reports we could get a flight response. The Chicago PMI number needs to come in close to the expected number.

As can be seen in the table at the beginning of this report, volume was light today and has been a little lighter than usual this week. While the market has been pushed higher it hasn't been with the participation of many. Selling has been especially light and the rise in the market could have been as much from that as anything else. But there was nothing in the market breadth numbers that stands out in contrast to what the prices tell us.

With the continuation higher in the market, the weekly chart now looks like price could make a stab at the top of its long term ascending wedge. For SPX that's near 1357. Give it a throw-over and we could easily see a blow-off top take it to 1375. That's not a prediction but a warning to bears. These ending moves can take on a life of their own.

SPX chart, Weekly, More Immediately Bearish

The hard part in joining the bulls here is that the reversal back down could be very sudden and very swift. If you can't watch the market intraday I consider the long side to be very risky right now (and have felt that way for a while which admittedly has cost me in lost opportunity which I'm perfectly fine with). Looking at this chart, until I see those long term bearish divergences negated, then I believe the current leg up will fail like the other ones. This time the failure should lead to a break of the bottom of the wedge but proof of that will be the price action. It will take a break below about 1260, so a 100-point drop (1000 points for the DOW) before we can declare the bull run as finished.

This of course means you shouldn't get married to your positions. Bulls have been able to hold onto their long positions for the past 4 years but even that is a long stretch for a bull run. Bears have nothing but a guess here that the bull run is over. That's my guess based on several technical indicators and the EW count but it's still just a guess.

Tomorrow could see a final effort to drive the DOW to a new closing all-time high. Gotta get that in the weekend paper. But just as likely in my mind is an effort to start selling off inventory that fund managers don't really want and don't want the risk of holding it over the weekend. In other words it could be a tricky day to trade. Waiting for the dust to settle next week is not a bad idea. Good luck and I'll see you next Thursday or tomorrow on the Market Monitor.

New Plays

New Option Plays

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

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Cymer Inc. - CYMI - close: 44.60 chg: -0.75 stop: 41.95

The SOX semiconductor index added 0.95% led by another (fourth) day of gains in shares of Intel (INTC), its biggest component. Shares of CYMI under performed both the market and its peers with a 1.6% loss. We could not find any specific news to account for the weakness in CYMI and volume came in below average, which doesn't suggest a lot of conviction behind the move. It is worth noting that today's session appears to have produced a bearish engulfing candlestick, which tends to act as a one-day bearish reversal pattern. More conservative traders may want to take some profits early or tighten their stops. We're not suggesting new plays. Our target is the $47.00-48.00 range.

Picked on September 06 at $ 42.55
Change since picked: + 2.02
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 1.0 million


General Dynamics - GD - close: 72.41 change: +0.96 stop: 69.94

GD got some good news today with a $62 million contract from the U.S. Navy to work on some submarines. However, we suspect that the stock's strength was probably more window dressing. Shares hit another new all-time high but pared their gains by the closing bell. The good news for traders is that GD did not see any follow through on yesterday's failed-rally type pattern. We are not suggesting new call plays at this time. Our target is the $74.00-75.00 range. We do not want to hold over the mid October earnings report.

Picked on September 24 at $ 70.61
Change since picked: + 1.80
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 1.3 million


Mettler Toledo - MTD - close: 66.03 chg: +0.44 stop: 63.45

MTD posted another gain and closed at new three-month highs. The breakout over last week's area of congestion/resistance is a good sign. Currently our target is the $68-69 range. We do not want to hold over the late October earnings report.

Picked on September 13 at $ 63.66
Change since picked: + 2.37
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 169 thousand


Omnicom - OMC - close: 93.90 chg: -0.20 stop: 89.89

The rally in OMC stalled on Thursday. However, the profit taking was negligible and the lack of selling could be seen as a sign of strength. More conservative traders may want to take some money off the table right now. We continue to aim for the $96.00-97.00 range.

Picked on September 10 at $ 90.97
Change since picked: + 2.93
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 1.1 million

Put Updates

Caterpillar - CAT - close: 66.59 chg: +0.91 stop: 67.36

Shares of CAT continued to see buying pressure on Thursday. The stock bounced from a dip near $65 and the stock's 1.38% gain certainly helped the DJIA's attempt at a new high. Thus far CAT remains under the bearish pattern of lower highs but we're not suggesting new positions with CAT above $65.00. More conservative traders may want to tighten their stops. Our target is the $60.25-60.00 range but more aggressive traders may want to aim lower. The P&F chart does point to a $48 target.

Picked on September 21 at $ 64.59
Change since picked: + 2.00
Earnings Date 10/20/06 (unconfirmed)
Average Daily Volume = 5.2 million


Chipotle - CMG - close: 49.60 change: -0.20 stop: 52.61

Our new play in CMG is now open. The stock dipped under $49.50 and hit our trigger to buy calls at $49.45. The bounce back is a little discouraging but looking at the intraday chart the rebound appears to stall under the $50 level. Our bias remains bearish but traders may want to wait for further weakness before opening new put positions, especially since the DJIA seems determined to hit a new high in the next day or two. Our target is the $45.50-45.00 range. We do not want to hold over the late October earnings report.

Picked on September 28 at $ 49.45
Change since picked: + 0.15
Earnings Date 10/30/06 (unconfirmed)
Average Daily Volume = 459 thousand


Monster - MNST - close: 36.29 change: +1.01 stop: 37.55

MNST experienced a little bit of a dip this morning but traders bought the dip at $34.81. That means we're still spectators and sitting on the sidelines. Our suggested trigger to buy puts is at $34.65, which is under the June 2006 low. If triggered our target is the $30.50-30.00 range. If you study the weekly chart you'll notice a long-term trendline of support stretching out just above the $30 level. More conservative traders might want to exit earlier near $31.00. We do not want to hold over the late October earnings report.

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 1.6 million


Maxim Integrated - MXIM - close: 28.74 chg: +1.01 stop: 30.05

Recently we have been cautiously bearish on MXIM since the stock was under performing and breaking down under support. Yet today shares bounced strongly and out performed the market and its peers with a 3.6% gain. We suspect this is just bargain hunting since there was not any specific news to account for the move. The SOX did add almost 1% and we've been warning readers that the SOX has not yet broken support at the bottom of its rising channel. We are not suggesting new plays at this time.

Picked on September 25 at $ 27.90
Change since picked: + 0.84
Earnings Date 11/03/06 (unconfirmed)
Average Daily Volume = 5.4 million


Nucor - NUE - close: 49.58 change: +0.44 stop: 50.01

NUE is still trying to bounce. The stock dipped to $48.09 this morning but rallied back toward resistance near $50.00 and its 50-dma. We are not suggesting new positions at this time.

Picked on September 25 at $ 45.95
Change since picked: + 3.63
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 4.2 million


FreightCar Amer. - RAIL - close: 52.98 chg: -1.77 stop: 56.32

RAIL continues to under perform and lost more than 3% on Thursday. The recent trading looks like a failed rally under $56 and we see the weakness as a new entry point for puts. We're going to list two targets. We suggest selling half or more of your position at our first target in the $50.25-50.00 range. Sell the rest at our second target in the $46.00-45.00 range.

Picked on September 21 at $ 54.50
Change since picked: - 1.52
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 353 thousand


SanDisk - SNDK - close: 53.02 chg: -1.15 stop: 60.05

SNDK is also showing more relative weakness today. The stock produced a failed rally under $56 yesterday and followed up with a 2.1% decline on Thursday. Please note that we're adjusting the target from $51.50-50.00 to $52.00-51.00 because the 50-dma is rising and could be support just under $52. We do not want to hold over the mid October earnings report so that only gives us about four weeks.

Picked on September 22 at $ 56.69
Change since picked: - 3.67
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 9.9 million


U.S.Steel - X - close: 57.10 chg: -1.08 stop: 60.05

The bounce in X appears to be fading with today's 1.8% decline but we hesitate to suggest new positions at this time. Another drop under the $56.00 level would be a new entry point to buy puts but if you do open new plays we'd suggest a tighter stop loss probably near $58.50.

Picked on September 22 at $ 55.95
Change since picked: + 1.15
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 4.4 million

Strangle Updates


Dropped Calls


Dropped Puts

Express Scripts - ESRX - close: 75.55 chg: -1.26 stop: 82.51

Target achieved. The sell-off in ESRX hit another new relative low with a break under the $76 level. The intraday low was $75.22 and our target was the $75.50-75.00 range. If you failed to exit be careful. The $75 level looks like potential support boosted by its 100-dma.

Picked on September 21 at $ 79.85
Change since picked: - 4.30
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 1.6 million


Joy Global - JOYG - close: 36.96 change: +0.76 stop: 36.55

We have been stopped out of JOYG at $36.55. Thursday saw investors still bargain buying stocks in the construction and agricultural machinery industry. Shares of CAT also ticked higher. We warned readers yesterday that if the markets displayed any strength today we'd be stopped out.

Picked on September 20 at $ 34.95
Change since picked: + 2.01
Earnings Date 11/30/06 (unconfirmed)
Average Daily Volume = 2.6 million


Las Vegas Sands - LVS - close: 68.33 change: +1.76 stop: 70.05

LVS is just not cooperating so we are suggesting an early exit to cut our losses. The bearish breakdown several days ago has reversed and the technical picture is turning more bullish although we would not switch directions and buy calls since the $72 level looks like overhead resistance.

Picked on September 19 at $ 65.99
Change since picked: + 2.34
Earnings Date 11/01/06 (unconfirmed)
Average Daily Volume = 2.2 million


Textron - TXT - close: 86.51 change: +0.43 stop: 84.01

The breakout over resistance in the $85.00-86.00 region for TXT looks pretty bullish although we'd stop short of buying calls with additional overhead resistance with its 200-dma, 100-dma and its multi-month trendline of lower highs. It was our plan to buy puts on a breakdown under support at $80.00 but it hasn't happened yet and doesn't look like it will happen any time soon. We're dropping TXT as a candidate.

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/19/06 (confirmed)
Average Daily Volume = 829 thousand

Dropped Strangles



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