Option Investor

Daily Newsletter, Monday, 08/13/2007

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Table of Contents

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

Market Wrap

Majors Finish Unchanged After Friday's Injection

The major U.S. equity indices, be it big and narrow, or broad and small started the week out mostly lower as traders and investors digested Friday's dose of central bank injections.

In a sign that U.S. money markets had calmed, the New York Fed carried out a small overnight repurchase agreement at its normal time of 9:30 a.m., accepting just $2 billion in overnight repos, out of a hefty $52 billion submitted.

Economic data released during today's trade showed retail sales rising 0.3% in July, with fractional broad-based gains overcoming falling demand for autos. The 0.3% increase was slightly better than economists' forecast for a 0.2% rise.

Separately, June business inventories rose 0.4%, which was in line with expectations.

Small caps as depicted by the Russell 2000 Index (RUT.X) 779.81
-1.13% were notably weaker on Monday, but not overly so when considering this rather broad index of small caps stocks, which were beaten lower since mid-July, traded strong from a relative low of 744 last Monday.

This index really begins to "mirror" the tightening credit markets as I began discussing on a more frequent basis a couple of weeks ago.


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Pacholder High Yield (AMEX:PHF) $8.94 0.44% released its net asset value over the weekend. At Thursday's (08/09/07) close, the net asset value of securities held by this closed-end "junk bond" fund had edged up to $9.58 after 7/31/07 and 08/02/07 net asset values of $9.50.

I've been posting the Pacholder High Yield (AMEX:PHF) as a representitive security for "junk bonds" in the U.S. Market Watch.

As you can see from the intra-day snapshot above, stocks started out on bullish footing, but as the session progressed, buyers didn't appear to be overly aggressive.

A rather strong advance/decline line at both the NYSE and NASDAQ faded to the close, but not one of those "suck'em in and spit'em out" type of moves that a bull would be overly concerned with.

The bulk of the session's new highs at both the big board and the NASDAQ came early, then leveled off, here too a sign that buyers simply weren't willing to get aggressive and "chase" stocks that had little overhead supply of stock to hold them back.

While new lows did build toward the close, the 221 at the big board is well off the 630 found on Monday, the 524 found on Tuesday, 443 on Wednesday, 329 on Thursday, and Friday's 459.

At today's close, the NASDAQ's 5-day NH/NL ratio does reverse back up into a column of X, following the NYSE's 5-day NH/NL ratio reversal from Wednesday. Here too we're seeing some stability at the new lows after last Monday's inflection low of 535 new lows. Tuesday thru Friday saw respective new lows of 439, 386, 274 and 276.

The modest hint that bullish leadership might be returning to the NASDAQ came on Wednesday when 212 stocks traded new 52-week highs! I give those 212 stocks an exclamation mark as it was the most new highs since July 16th's 235.

U.S. Market Watch - 08/13/07 Close

Homebuilders and banks/brokers paced declines, while telecom, cyclicals and health insurers were among some of today's sector winners.

Goldman Sachs (NYSE:GS) $177.50 -3.00% did its part to keep traders and investors on the edge of their seats after the investment bank said one of its hedge funds got a $3 billion cash injection from a group a group of investors including Maurice "Hank" Greenberg and Eli Broad after losing about 28% of its value last week.

The investment bank said its Global Equity Opportunities fund, one of its largest hedge funds, "suffered significantly" as global markets sold off on worries about debt and credit, dragging its value down to $3.6 billion, from about $5 billion last month.

Goldman Sachs said it was investing $2 billion, while other investors were contributing about $1 billion to the fund, whose COMPUTER-driven "QUANTITATIVE" investment strategies were disrupted by triple-digit swings in the financial markets.

Now, I (Jeff Bailey) will want to bring your attention to the COMPUTER and QUANTITATIVE part of Goldman's news.

COMPUTERs don't "think." They do what they are programmed, or told to do, based on QUANTITATIVE data received.

It certainly sounds to me that Goldman's Global Equity Opportunities fund was/is using a black-box system that needed some type of an adjustment. The adjustment needed some type of HUMAN intervention, didn't get it, and now needs a $3 billion dollar program adjustment.

I've often taught/spoke about how a good/great trader continues to repeat their successes, until the repetition eventually provides a loss, or a couple of losses. The repeating of success is usually the easiest part, but it is the STOP DOING what ISN'T WORKING that some find to be most difficult.

When past SUCCESSES begin to produce DISSAPOINTMENT/LOSSES, its time to STOP doing what we're doing, step back, and try to figure out what's changed!

I can only imagine that Goldman's QUANTITATIVE system for the Global Equity Opportunities fund was based on some type of valuation model (price/earnings, return on equity, cash flow, etc), where despite FALLING PRICES, stocks/securities just kept getting cheaper and cheaper, more and more attractive, and the computer just kept buying and buying. The computer probably kept doing so, and once CASH balance was depleted, kept buying on MARGIN.

I suppose Goldman's QUANTITATIVE system could have also gotten into some "trouble" if it was SELLING SHORT stocks/securities that kept RISING and RISING, even though "valuations" got more and more expensive.

Ring! Ring!


Hi! Is Margin there?

Margin? Margin who?

Margin Call!!!!!

Global Equity Benchmarks / Currencies

When I look at the week-to-week major equity benchmarks from around the globe, it is tough to find a "margin call" other than being short China's Shanghai Composite ($SSEC). Maybe an overly bullish program for France's CAC-40?

It is notable, and has drawn some questions from traders as to "why" the small cap Russell 2000 ($RUT.X) has been "outperforming to the upside" relative to the BIG and NARROW Dow Industrials ($INDU) the past week.

One can never be certain with an answer as to "who" is buying small caps, and "who" is selling BIG and NARROW, but it really doesn't matter.

A likely answer to "who is buying the small caps" would be a PROFITABLE bear. A likely answer to "who is selling BIG and NARROW" Dow Industrials is a ONCE very profitable bull (relative to his/her small cap holdings), where after seeing the Russell 2000 holdings fall 9.93% from 7/16 to 8/06 decides to cut back on the BIG and NARROW after a more modest 3.44% decline during the same period.

However, as we may have witnessed today, the RUT.X -1.13% does "outperform to the downside" relative to the INDU -0.02% today.

But this type of "longer-term" observation (7/16 to 8/06) compared to today's action is an observation I really want traders and investors to focus on!

BIG and NARROW is still the STRONGER in my opinion, and as we get "broader" to the S&P 500 we get a little weaker, and small and VERY BROAD to the Russell 2000, weaker still.

The IMPORTANT observation is this!

Past WEAKNESS is trying to STRENGTHEN, if not at least firm.

WEAKNESS is trying to "dig in" as buyers try to stand their ground against sellers.

Russell 2000 Index (RUT.X) - Daily Intervals

I think it would be WAY TOO EARLY to even begin to think that the small caps of the RUT.X have suddenly become the "leader of strength" for the major indexes.

I should confess that I have profiled a BEARISH trade in the iShares Russell 2000 (AMEX:IWM) $77.64 -0.53% in the OptionInvestor.com Market Monitor from 8/09/07 at the $78.37 level. I thought traders should utilize OPTIONS and selected an IWM Sep $78 Put (IQQ-UZ) for $3.25. Right now, our STOP on this type of trade is a CLOSE just above the recent high.

One TEST (bull or bear) I will utilize with fibonacci retracement is what I call a "two level rule." Once a stock, or index closes BELOW a level, it should NOT close two levels BACK above the lowest close.

For the RUT.X, it CLOSED (see this CLOSE?) below the 760.06 level. The "bounce" came right back to 796.62 (say 797), but notice how SELLERS seemed to show just enough conviction (more than BUYERS anyway) at that 797 level.

For me, and perhaps many market participants, that become a "key level."

Now, here is the Russell 2000 Index (RUT.X), but with MONTHLY Pivot retracement. Institutional COMPUTERS will utilize these types of LEVELS in order to manage inventory of stocks.

Russell 2000 Index (RUT.X) - Daily Intervals

If it is true that "weakness tends to lead weakness," then I'm focusing a bit more on the RUT.X tonight. MONTHLY Pivot Levels are simply derived from mathematical formula using the prior month's high, low and close.

For months, the RUT.X showed a pattern of "buy S1" with some pretty good bullish success. But in July, "something changed" and MONTHLY S1 (816.84) didn't hold has there was more sellers than buyers. Then July's MONTHLY S2 gave way at 799.97 as buyers continued to outnumber buyers at that level.

But now we see a nice bullish bounce from MONTHLY S1, but note where the bounce stopped. Right at August's MONTHLY Pivot.

Think of a Pivot, as being the MID-POINT of an institutions "average cost" of holdings from the previous month.

If YOUR computer bought 817 and 800 in July and again at 745.65 on Monday of last week, what might YOU have programmed your computer to do if you got a BOUNCE back to 801?

I also utilize WEEKLY Pivot levels, where its PIVOT is simply derived from last week's high, low and close.

At tonight's close for the RUT.X, it closed JUST ABOVE its WEEKLY Pivot of 778.56!

Major Indexes - WEEKLY and MONTHLY Pivot Levels

Monday is the first day of the trading WEEK, and upper 1/2 of picture above is the WEEKLY Pivot Levels from S2 (support 2) to R2 (resistance 2). What the Pivot levels tend to do is put the securities, or indexes into a RANGE that is RELATIVE to a prior period of time. Here, all we're doing, which institutional computers will do, is begin calculating "levels" based on last WEEK's, or last MONTH's (lower 1/2) high, low and close.

So far in July, both the BIX.X and RUT.X have seen trade at their MONTHLY S1, as well as their MONTHLY Pivot.

See the technical "weakness" in the BIX.X and RUT.X relative to the equity-based indexes in the MONTHLY Pivot Levels? INDU/DIA, SPX/SPY, OEX, NDX/QQQQ and SMH have NOT traded their MONTHLY S1.

The Semiconductor HOLDRs (SMH) have NOT traded EITHER of its MONTHLY S1, or MONTHLY Pivot. So far this MONTH (August) we could begin to think the SMH isn't as STRONG as others as it hasn't been able to trade its MONTHLY Pivot.

Now look at the WEEKLY's. Notice anything that "shouldn't be" happening?

Again, only one day has passed this week, but the WEAKEST RUT.X is the ONLY equity-based index that has NOT traded its WEEKLY Pivot.

Tuesday's are usually a "big day" for pivot traders. If the WEAKER RUT.X does NOT trade its WEEKLY Pivot, or CLOSES above, then a trader becomes VERY ALERT that WEAKNESS is finding strength.

When that happens, it is not unusual for LONGER-TERM STRENGTH to really catch a bid, as BEARS that have shorted strength start to cover, and BULLS that have been treated RELATIVELY better in the STRONGER stocks/indexes return and start buying their favorites that have treated them better.

One of the general RULES for pivot trading is this.

The "Pivot" is considered a mid-point of a range. It is a point of EQUILIBRIUM.

BEARISH BELOW a PIVOT, with TARGETS of S1, S2 maximum.

BULLISH ABOVE a Pivot, with TARGETS of R1, R2 maximum.

Now "test" the index YOU are interested in. Start with a "longer-term" MONTHLY. Once completed, go to the WEEKLY.

Right now, the RUT.X is kind of 50/50 as it is STILL ABOVE its WEEKLY Pivot.

Now, what has been the #2 weakest major index the last few weeks?

My analysis and writings have been saying the S&P 500 Index (SPX.X). These are BIG caps, but the index is rather broad with 500 stocks.

Now I need to bring you up to date on the internals that I've been mentioning in prior market wraps.

It is rather unusual that the S&P 500 Bullish % (BPSPX) is as "volatile" or fast moving as the index ($SPX) itself, but buy gosh, that's exactly what we've seen.

Suddenly, the S&P 500 Bullish % (BPSPX), and what it says about RISK, looks EXACTLY like it did in May, June, July of 2006! (see 7/30/07 Market Wrap).

S&P 500 Bullish % (BPSPX) - 2% box chart

Now I continue to observe SIMILARITY to the May (5), June (6) and July (7) 2006 time period. DIVERGENCE to that period that I've been alerting traders and investors to would be a BULLISH % falling to 46%.

On August 8th, 2007 (Wednesday of last week) the BPSPX did reversed up to "bear correction" status. By the close of Friday's action, it had reversed back down to "bear confirmed" status.

It would now take a REVERSAL back higher to 54% to once again turn "bear correction" status, but it would now only take a measure of 56% to achieve "bull confirmed" status.

That type of measure would be SIMILAR to the September 13, 2006 action!

S&P 500 Index (SPX) - 10-point box chart

With RISK as measured by the BPSPX VERY SIMILAR to that found in May, June and July of last year, the SPX itself finds an EQUAL Low of 1,430 holding support after giving a REVERSING HIGHER point and figure buy signal at 1,480 on August 7th (last Tuesday).

BEARS want to see FURTHER weakness to 1,420 and get some DIVERGENCE to the past!

Bulls would love to see SIMILARITY to the past and find the SPX giving another "buy signal" at 1,510 with some "short squeeze" action to a new 52-week high.

I'll be filling in for Jim Brown tomorrow evening and will address the INDU/OEX and NDX, which are the NARROWER and BIG indexes.

I should also confess that I have profiled a Dow Diamonds (AMEX:DIA) $132.18 0.18% December $144 Call (DAZ-LN) in the OptionInvestor.com Market Monitor. That trade was profiled on 08/07/07 when the DIA was trading $135.15.

The STRATEGY between an IWM Sep Put and a DIA Dec Call was to be BEARISH the "weaker" IWM on a near-term basis, but BULLISH the "stronger" DIA on longer-term basis.

Tonight I wanted to focus on the "weaker" indexes. If they gain further strength, start getting BULLISH and monitor those bullish %.

I feel great pressure building in these markets. When it releases, the direction of the release should be powerful.

New Plays

New Option Plays

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

Play Editor's Note: Buckle your seat belt! The market's inability to maintain its gains today is bad news. Last Friday's intraday rebound was impressive but there was no follow through and that suggests there is more weakness ahead. We would not open new bullish positions at this time.

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Cleveland Cliffs - CLF - close: 68.25 chg: 1.08 stop: 61.45

Please see tonight's Play Editor's note. CLF opened stronger this morning with a gap open at $69.45. The initial rally failed at resistance near $70.00 and shares drifted lower midday. After CLF filled the initial gap from this morning the stock began to bounce again and shares closed up 1.6%. We remain bullish on the stock but more conservative traders may want to wait for a new relative high over $70.14 (today's high) before initiating positions. Our target is the $74.50-75.00 range. The 50-dma could be another layer of overhead resistance.

Picked on August 12 at $ 67.30
Change since picked: 1.08
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 1.8 million


Chevron - CVX - cls: 82.45 change: -0.97 stop: 79.35

Hmm... oil stocks failed to hold any strength today. Crude oil ticked higher but oil stocks rolled over early in the session. The OIX and OSX indices both appear to have produced some short-term failed rallies. That's not good news for the oil stocks. The next couple of days could be bearish. At this point we would expect CVX to dip back toward support in the $80.50-80.00 range. Wait and watch for a bounce before initiating positions. Our target is the $89.00-90.00 range. FYI: The P&F chart is still very bearish with a $68 target.

Picked on August 12 at $ 83.42
Change since picked: - 0.97
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 11.3 million


Fluor - FLR - clse: 123.57 change: 2.57 stop: 114.99

FLR displayed some relative strength today. The stock rallied sharply higher from the opening bell. The stock hit an intraday high of $128.00. Our suggested trigger to buy calls was at $123.25. Now that the play is open we have two targets. Our first target is the $129.75-130.00 range. Our secondary target is the $134.00-135.00 range. The move over $123.00 has produced a brand new quadruple top bullish breakout buy signal on the P&F chart which already points to a $169 target. In spite of this seemingly good news the move today actually looks somewhat bearish. Yes, FLR has produced a new bullish breakout over resistance. Yet today's session looks more like a big bearish failed rally pattern. The question is where will it bounce? More conservative traders may want to tighten their stops toward the $120 level. FYI: Today's move was fueled by news that ICA Fluor, a joint venture that FLR is a part of, won a $1.4 billion services contract at the Chicontepec oil field in Mexico.

Picked on August 13 at $123.25
Change since picked: 0.32
Earnings Date 11/06/07 (unconfirmed)
Average Daily Volume = 1.1 million


Penn National Gaming - PENN - cls: 56.80 chg: 0.75 stop: n/a

PENN received an upgrade this morning. This pushed the stock to gap open higher and hit $57.99 before paring its gains. The analyst raised their price target to $67.00, which is the current buyout price for PENN. Currently we're planning to drop this stock with August expiration but if the markets are going to turn positive on this deal actually getting done then readers may want to reconsider their speculative positions. We don't see any significant changes from our previous comments. We are not suggesting new positions at this time.

Picked on June 17 at $ 62.12
Change since picked: - 5.32
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume = 1.0 million


XTO Energy - XTO - cls: 55.81 change: -1.27 stop: 54.45

Warning! XTO has produced a bearish reversal. The stock spiked higher this morning to $59.91 and then quickly reversed course. Shares closed with a 2.2% decline. Not only is this a bearish failed rally under $60.00 but it's also a bearish engulfing candlestick pattern. To make matters worse we were suggesting a trigger to buy calls at $57.61 and XTO gapped open higher at $58.43, giving us a worse starting position. If you did enter positions today you may want to just exit early to cut your losses now or tighten your stops. We're not suggesting new positions at this time. Our target is the $62.00-62.05 range. FYI: We didn't see any specific news to account for the spike this morning.

Picked on August 13 at $ 57.61
Change since picked: - 1.80
Earnings Date 10/24/07 (unconfirmed)
Average Daily Volume = 4.6 million

Put Updates


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.)


Daimler-Benz AG - DAI - cls: 84.71 chg: 0.87 stop: n/a

Shares of DAI managed a 1% bounce on Monday. Overall we don't see any significant changes from our previous comments. We are not suggesting new strangles on DCX at this time. The options in our suggested strangle were the August $95 calls (DAI-HS) and the August $85 puts (DAI-TQ). Our estimated cost was $3.70. Please note that we're running out of time. August options expire in four trading days. Therefore we're adjusting our target to sell the winning side of this strangle to $5.55, which would be a 50% gain.

Picked on July 22 at $ 89.75
Change since picked: - 5.04
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 1.3 million

Dropped Calls

Sears Holding - SHLD - cls: 140.55 chg: 7.45 stop: 127.49

Target achieved and exceeded. The company reaffirmed its Q2 earnings guidance and the numbers were narrowed toward the upper end of guidance. Plus, SHLD announced a $1.5 billion stock buy back program. The news pushed SHLD to gap open higher at $136.00 and hit an intraday high of $141.34. Our target was the $139.50-140.00 range. We have been suggesting that more aggressive traders may want to aim higher. The $145-150 zone looks like a good target for the more adventurous investors out there.

Picked on August 3 at $133.00
Change since picked: 7.55
Earnings Date 08/30/07 (unconfirmed)
Average Daily Volume = 1.7 million

Dropped Puts


Dropped Strangles


Today's Newsletter Notes: Market Wrap by Jeff Bailey and all other plays and content by the Option Investor staff.


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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