Option Investor
Newsletter

Daily Newsletter, Wednesday, 09/19/2007

HAVING TROUBLE PRINTING?
Printer friendly version

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Hear That Crunching Sound?

Introduction

A faint crunching sound could be heard from across the pond today. Something strange was happening in the credit crunch realm in the U.K., something that was barely noticed on our shores. Not paying attention to that development might be a mistake, but I'll discuss that later in the Wrap.

Of more concern to many market participants were the afternoon technical problems in the CBOT that shut down electronic trading on that exchange for a time and the halting of shares of Nasdaq (NDAQ) pending news. The news was that the Bourse of Dubai will take the Nasdaq's stake in the London Stock Exchange (LSE), leaving open the possibility that the Nasdaq can then move forward with plans to acquire a stake in the OMX.

Today we saw the typical type of day that follows a large-range day. Morning follow-through was followed by afternoon pullbacks, leaving long upper shadows. Volume was okay, but not spectacular, but advancers and up volume soundly beat decliners and down volume. Bears will study charts and discover potential reversal signals: bulls, just a pause to digest gains.

Charts

Annotated Daily Chart of the SPX:

Annotated Daily Chart of the Dow:

The upper shadow on the DOW's chart wasn't as pronounced as on the SPX's, so my conclusion about resistance mostly holding is a bit dicey. Still, that's how it looks to me, particularly as it's entirely possible to draw that upper trendline so that it's a little higher.

The Nasdaq's chart proved to be the most technically interesting of all the charts. It has a classic doji sitting at the top of a climb, at long-term resistance, with a gap between yesterday's close and today's open. That's a setup for a three-candle reversal signal. If the Nasdaq should gap lower tomorrow, anywhere near yesterday's close, the setup continues. We've all seen potential reversal signals fail to produce reversals. It happens all the time, so we can't count on any reversal being a given, even if the Nasdaq does gap lower tomorrow. A gap lower tomorrow is just something that bulls don't want to see.

Annotated Daily Chart of the Nasdaq:

Unlike some other indices, the Nasdaq has not yet touched the top of its rising channel. Such a touch can't be ruled out, but do be careful about any gap down tomorrow morning or any morning high that's quickly sold.

Annotated Daily Chart of the SOX:

Yesterday's SOX failure to break out of congestion with other indices was followed by today's doji that was produced by its fall back from its 50-sma test. The SOX has been so difficult to pinpoint lately that I'm not posting it here to predict where the SOX will go, but rather using it as an indicator of whether moves in the Nasdaq are corroborated.

Annotated Daily Chart of the RUT:

Although the TRAN gained strongly yesterday along with many other indices, it is not keeping up relative to some key benchmarks. The chart shows what I mean.

Annotated Daily Chart of the TRAN:

Today's Developments

At 7:00, the Mortgage Bankers Association released its weekly mortgage application volume survey for the week ending September 14. The Market Composite Index, an index that measures the volume of mortgage loan applications, rose 2.4 percent on a seasonally adjusted basis from the holiday-shortened previous week. Seasonally adjusted refinance, purchase, conventional and government indices rose 4.6, 0.9, 2.4 and 2.4 percent, respectively.

The four-week moving averages also rose as did the refinance share of mortgage activity. The average contract interest rate for a 30-year fixed-rate mortgage rose to 6.29 percent and points increased slightly, too. The average interest rate for a one-year ARM rose to 6.39 percent with points increasing slightly there, too. Although a gain in weekly figures was great to see, other numbers released today resulted in a different outlook on the housing situation.

The August Consumer Price Index and New Residential Construction (housing starts and permits) numbers both appeared at 8:30, with the New Residential Construction number giving us another needed picture of the residential industry. That picture wasn't a cheery one. Housing starts and permits fell to a 12-year low, a Marketwatch.com headline noted. The Commerce Department reported that starts of new homes declined 2.6 percent in August to a seasonally adjusted annual rate of 1.331 million. Authorized building permits fell even harder, by 5.9 percent to a seasonally adjusted annual rate of 1.307 million. Both were the lowest produced since June 1995. Economists that predicted that both starts and permits would fall near 1.35 million, so both were slightly below expectations and well below the recent trend of about 1.42-1.45 million.

For the year, starts have dropped 19.1 percent, and permits, 24.5 percent. If broken down into categories, single family housing was weaker even than the overall number, with starts dropping 7.1 percent and permits 8.1 percent. Yesterday, we had received data that showed that foreclosures were rising.

The numbers were grim and were portrayed by one industry analyst as showing acceleration in the worsening of the housing crisis. It seemed that this report alone would have been enough to trigger some ebbing of the post-FOMC euphoria, but it didn't immediately do so. Perhaps that's because more attention was focused on the CPI, released concurrently, or perhaps it's because many know that these particular housing numbers can be subject to big statistical errors. Most want to see a trend rather than reacting to a single month's number. None, however, want to see a trend in today's direction, unless it's those hoping, on a contrarian basis, that starts and permits drop low enough that the situation can only get better.

A related development involved Freddie Mac (FRE) and Fannie Mae (FNM). The two have long been campaigning to have their portfolio caps raised, and it looks as if they may succeed, at least temporarily. Today, the Office of Federal Housing Enterprise Oversight said that FNM would be allowed an increase of 0.5 percent each quarter, allowing its portfolio growth to increase up to 2 percent a year. FRE's agreement is said to be similar.

FNM's director of communications avowed that the increase was not enough and needed to be at least 10 percent, and at least one Democratic senator agrees. However, the regulating agency claims that the flexibility will allow the two to buy or secure up to $20 billion in mortgages, including some subprime ones.

I heard on CNBC that FOMC Chairman Ben Bernanke agrees with the idea of lifting the cap, but only temporarily. I was not able to confirm this information through any written source.

Advertisement

Earn $2,000 Each Month with a Conservative Options Strategy

We will show you how you can make $2,000 in cash each month using your existing portfolio equity as collateral. This low-risk strategy works no matter which direction the market goes. Best of all, it is easy to implement and no previous experience with options is necessary.

Take a complimentary 30 day test drive. Click Here:

http://www.OptionInvestor.com/newsletters/mcm.aspx?aid=10

In a related development, the Senate Banking Committee approved a bill that will increase the loan limits for Federal Housing Administration insurance eligibility. That could increase the number of those who can avail themselves of FHA loans.

The two developments provided some hope for homebuilders. I checked a number of charts, however, and found that builders such as TOL were pulling back from yesterday's big gains and today's early morning follow-through of those gains.

Lower energy prices in August produced good news in the CPI for that month, at least if you looked only at the headline number. Consumer prices fell 0.1 percent. The core number rose 0.2 percent, however, with both numbers hitting expectations. For the year, the CPI has risen 2 percent, and core prices, 2.1 percent. That's still slightly above the perceived comfort level for the Fed and likely to be higher next month if energy prices hold anywhere near current levels. Food prices rose 0.4 percent, but energy prices had dropped 3.2 percent.

Last night on CNBC Europe, one of the regular commentators noted that he expected that the FOMC would have had access to estimates for the CPI. He couldn't imagine, he said, that the rates would have been lowered as they were yesterday if the CPI had been high. Perhaps that's true, and perhaps not, but with the core number still slightly above the 2.0 percent and the rise in energy prices since August, I can't imagine that this number proved entirely comforting to the Fed. It certainly didn't discomfort market participants too much, though, as futures climbed afterward and prices did, too, after the cash open.

Moody's August's Risk of Recession, as reported on Economy.com, was released at 10:00. That number has risen sharply to 40 percent, its highest level since 2001.

Expectations for crude inventories were not met. When the Energy Department released inventories numbers at 10:30, the decline in crude was sharper than anticipated. Crude supplies dropped 3.8 million barrels with the expectation for a drop of about 1.5 million barrels. Distillates climbed 1.5 million barrels, roughly in line with expectations. Gasoline supplies unexpectedly showed a build, however, of 400,000 barrels. Industry watchers had anticipated that refinery utilization would drop again this week, and it did, to 89.6 percent. That is of some concern, some industry watchers agree, but I'm sure Jim will get us up to date on this in his weekend review in his Leaps column. Last week's Category 1 hurricane disrupted production at several Port Arthur area refineries, shutting them down before they could be safely shut down according to the processes that leach the product from lines and containers first. That makes the process of powering up again slower. That may be all that was behind the lower utilization numbers.

The American Petroleum Institute's numbers differed, of course. The API reported a decline of 1.6 million barrels in crude, a climb of 241,000 barrels in distillates and decline of 2.1 million barrels in gasoline supplies.

The unexpected draw in the Energy Department's calculation, the action in the currency markets (lower dollar equals more dollars required to buy this dollar-denominated commodity), and volatility surrounding the expiration of the front-month crude contract all combined to punch crude prices above $82.00 today, again into new highs. As this report is prepared, crude was at $81.93, pulling well back from its $82.50 high on the expiring contract, but certainly not comforting those who were short the contract.

Other economic developments questioned whether we can consider the credit crunch kaput, its impact contained as our Fed and other central banks take care of any problems that might arise, dusting their hands off after yesterday's action. Not all the information is reassuring. Today, the American Institute of Architects reported that nonresidential, commercial construction is being affected. The AIA's chief economist was quoted as saying that the subprime mess is causing difficulties in securing credit for nonresidential construction projects.

The problem is being discussed--and dealt with--in other countries, too. One difficulty showing up is that the BBA LIBOR, the benchmark three-month rate established daily by the British Bankers' Association and used in many countries, has been gapping further above the Bank of England's benchmark rate than it typically does. This causes all kind of problems, problems that I'll cover in my Trader's Corner this weekend. The BBA LIBOR is supposedly the rate at which banks lend to each other, but it hasn't been working that way lately.

What this gap did today was prompt the Bank of England to pump more money into the system to try to bring the rates back in line. Last week, the Bank of England head Mervyn King had asserted that making such moves would amount to risky behavior that he deemed excessive. Mr. King has been late to the party, with other central banks making numerous cash injections during the worst of the crisis. One article said that both Mr. King and our Fed had lost credibility this week.

The BOE's move was intended to bring the BBA LIBOR more in line with the central bank's targeted benchmark rate. The Bank of England's rate is 5.75 percent and Monday, the LIBOR jumped to 6.5 percent. After pulling back yesterday, today it jumped to 6.55125 percent, according to an article in THE LONDON TIMES. Typically, the LIBOR is only about 0.41-0.45 percentage points above the BOE's rate, and this jump was considered extreme. Today's gap was prompted at least in part by problems with Northern Rock, and that bank was in the news again today. As many will remember, last week Northern Rock was forced to go to the Bank of England, the Financial Services Authority (FSA) and the Treasury for a bailout. Last night, the head of the FSA asserted that other banks would get similar bailouts only if there existed "the danger of contagion" to the rest of the financial system, according to an article in THE LONDON TIMES, similar to what had happened with Northern Rock. Only the Treasury's guarantee stopped a run on the bank's branches by customers pulling out their life savings. I was traveling to a funeral last Friday, listening to a BBC station on the radio as I did, listening to interviews with people standing in line to pull their money out of Northern Rock. They wanted to do everything from spread their money out among several institutions so that no account topped insured limits to just hide it in their houses. My grandmother, a young married woman in Depression-era times, literally kept her money under her mattress. It isn't a laughing matter to hear customers express such sentiments again.

Today, the bank's shares dropped when news that a potential rescuer would be offering a heavily discounted bid for the bank. None of this, including the implication that the Northern Rock's troubles could have spread contagion across the financials, appears reassuring.

There's some fear and some evidence, too, that all these actions by central banks are not providing more liquidity, but rather more cash for banks to hoard. An article in The LONDON TIMES today mentioned this as a possibility. Keene Little has mentioned this in his writing. The Trader's Corner article for this weekend will touch on this trend, too.

One of the worries is that the difference between the rates that central banks set as their target rates and the rates at which banks are actually willing to lend to one another are far different, and banks' profits will suffer as a result. Today, Wall Street investment bank and broker Morgan Stanley reported earnings. Third-quarter net income fell 17 percent with the firm characterized as missing expectations. Some industry watchers hadn't expected MS to take such a hit. Articles repeated the expectation that this was a one-time thing for this quarter, and said that the easing of the credit crunch would ameliorate such damage in future quarters.

Investors in Bear Stearns (BSC), which reports tomorrow, weren't so sure. Neither are some industry specialists. Without the economic background to evaluate their concerns effectively, I can only report that not all the globe's economists are yet convinced that central banks can effectively bring lending rates down close enough to their own benchmark rates to encourage banks to quit hoarding cash and loan it out. One industry analyst said that financials' 2008 earnings could take a hit of at least 10 percent if central banks are not successful in lowering the gaps between BBA LIBOR and their targets for their benchmark rates.

I'm not writing this to scare anyone or to claim that financial markets are going to crash. I'm merely reporting what I read and don't claim to have the economic background to evaluate the worries that others are expressing. I do have the common sense to be cautious about automatically believing anything either too bullish or too bearish while doing all I can to protect my money. That doesn't require me to be frightened, and it doesn't require that you be, either, but do be aware of the possible forces out there and make appropriate just-in-case plans.

Other news impacted GM, Ford and Chrysler. Industry news hit the automakers as they bargain with the UAW over new labor contracts.

Tomorrow's Economic and Earnings Releases

Today Art Cashin said on CNBC that Fed Chairman Ben Bernanke will be testifying tomorrow before Congress at 10:00. I can't find any information about that on the FOMC's website. If it's true, you can bet his testimony could move markets and might be a primary market-mover. In addition, earnings from BSC and GS may upstage most economic releases, with the possible exception being the Philly Fed at noon. Other companies reporting earnings include FDX and ORCL.

Other economic releases include the 8:30 weekly initial and continuing claims, the 10:00 Conference Board Leading Indicators, and the 10:30 weekly natural gas inventories.

What about Tomorrow?

Yesterday, if the day had been normal, I would have predicted exactly the kind of day we got today. We can usually predict some sort of digest-the-games candle on daily charts after such a big-range day.

I started the day out warning short-term bulls to set up plans for how they would deal with a day that produced a doji or a digesting-the-gains type candle. The trouble was that times aren't normal. The Fed doesn't usually do what it did yesterday. The Bank of England doesn't normally have to rescue a bank seeing customers stand in long lines outside its branches to withdraw their life savings.

It's not normal, but today we got the normal reaction anyway at the normal places where you would expect such reactions. We just got to those levels a little quicker than might be anticipated earlier in the week! The normal reaction to expect now is either a pullback or else sideways-to-sideways up reaction while support catches up.

Remember that if Fed head Bernanke really is speaking tomorrow or if BSC lands a stink bomb of an earnings report tomorrow morning, these intraday charts are going to be worthless. Let's look at what a few of the charts show anyway.

Annotated 30-Minute Chart of the SPX:

The TRAN's daily chart is signaling that something isn't quite right with the SPX, OEX and Dow gains, so use it as a barometer tomorrow.

Annotated 30-Minute Chart of the TRAN:

The RUT is a good index to watch for short-term guidance, too, as it tends to be another momentum index that leads.

Annotated 30-Minute Chart of the RUT:

Once again, the Nasdaq's chart may prove the most interesting of them all.

Annotated 30-Minute Chart of the Nasdaq:

 


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

Apple Inc. - AAPL - cls: 140.77 change: -0.15 stop: 133.69

The action in AAPL today should make you cautious. The stock under performed the rally yesterday and shares under performed again today. There was a minor gap higher at the open but after trading sideways all day AAPL spiked lower late in the session before bouncing from the $139.40 region. This is not the sort of bullish follow through we should be seeing on top of yesterday's breakout past $140. The trend is still bullish but momentum indicators are starting to suggest problems ahead. More conservative readers may still want to consider a tighter stop loss. We have two targets. Our first, more conservative target is the $144.75-145.00 range. Our second, more aggressive target is the $149.00-150.00 range. We do have a very wide (aggressive) stop loss because the markets and AAPL have been so volatile. The P&F chart is still bullish with a $180 target. We do not want to hold over the mid October earnings report.

Picked on September 17 at $140.25
Change since picked: + 0.52
Earnings Date 10/18/07 (unconfirmed)
Average Daily Volume = 39.9 million

---

Broadcom - BRCM - cls: 36.09 change: -0.22 stop: 33.95

BRCM also under performed the market today. Shares traded toward resistance near $37.00 and then reversed lower. We warned readers that the $37 level would probably be resistance and more conservative traders may want to wait for BRCM to trade over $37.00 before considering new bullish positions. A bounce from here near $36.00 or a rebound on a test of the $35.00 level could be used as alternative entry points. Our target is the $39.85-40.00 range. The Point & Figure chart is bullish with a $49 target.

Picked on September 12 at $ 35.85
Change since picked: + 0.24
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 11.0 million

---

Citigroup - C - clos: 48.27 change: -0.10 stop: 44.49

Shares of C experienced some minor profit taking after yesterday's big gain. The stock hit the $49.00 level this morning and then turned south. Yet traders bought the dip near its 50-dma around $47.75. Our initial target is the $49.85-50.00 range but we might decide later to add a more aggressive target at the 200-dma.

Picked on September 16 at $ 46.64
Change since picked: + 1.63
Earnings Date 10/19/07 (confirmed)
Average Daily Volume = 40.7 million

---

Intl. Bus. Mach.- IBM - cls: 116.67 chg: +0.04 stop: 113.90

IBM did not see much follow through higher today but the overall trend still looks bullish. We would only suggest new positions here if you believe the market rally will continue and that IBM can push past resistance near $119-120. The stock has already hit our $118-120 target range. Our second, more-aggressive target is the $124.00-125.00 zone. FYI: The Point & Figure is very bullish with a $177 target.

Picked on August 26 at $113.24
Change since picked: + 3.43
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

---

Stryker - SYK - cls: 68.68 change: +0.50 stop: 65.90

SYK is still rebounding. We don't see any changes from our Tuesday comments. More aggressive traders might want to consider new positions on SYK right here. We are going to stick to our plan and wait for a new relative high. We're suggesting readers use a trigger to buy calls at $70.65. If triggered at $70.65 our target is the $74.90-75.00 range. Given the length of SYK's consolidation we would actually aim higher, maybe the $77.50-80.00 range, but we don't have much time and plan to exit ahead of the mid October earnings report. The P&F chart is bullish with an $83 target.

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/17/07 (confirmed)
Average Daily Volume = 1.4 million

---

Thornburg Mtg - TMA - cls: 13.50 chg: +0.04 stop: 10.90

The mortgage lenders are still under performing. TMA displayed some strength this morning but it quickly faded. This may turn out to be a more aggressive play and readers will want to consider a tighter stop loss. We have two targets for TMA. Our first target is the $16.25-16.50 zone. Our second target is the $17.50-19.00 range. The P&F chart has reversed into a new buy signal with a $19.50 target. We do not want to hold over the mid October earnings report.

Picked on September 16 at $ 13.63
Change since picked: - 0.13
Earnings Date 10/15/07 (unconfirmed)
Average Daily Volume = 5.4 million
 

Put Updates

None
 

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.)

---

AutoZone - AZO - cls: 114.54 change: +1.42 stop: n/a

Shares of AZO were upgraded to a "strong buy" this morning. The news pushed shares higher at the open and the stock hit an intraday high of $117.09. We're quickly running out of time with the September strikes and readers may want to exit early to try and salvage some capital. We are adjusting our targets to breakeven. We listed two strangles. The first strangle was with the September $115 calls (AZO-IC) and the September $105 puts (AZO-UA) with an estimated cost of $2.50. We want to sell if either option hits $2.50 or higher. Our second combo suggested the September $120 calls (AZO-ID) and the September $100 puts (AZO-UT) with an estimated cost of $0.95. We would sell if either option hits $0.95.

Picked on September 16 at $109.90
Change since picked: + 4.64
Earnings Date 09/18/07 (confirmed)
Average Daily Volume = 812 thousand

---

Bear Stearns - BSC - cls: 115.64 chg: -3.56 stop: n/a

A negative earnings report from Morgan Stanley (MS) prompted some profit taking in BSC. The stock lost almost 3% today but not before hitting a new relative high at $122 this morning. Tomorrow is the big day for BSC. Earnings for BSC are due out on September 20th before the market open. Wall Street expects a profit of $1.98 a share. We're not suggesting new positions at this time. Currently our strangle involves the October $115 call (BSC-JC) and the October $95 put (BVD-VS). Our estimated cost was $9.50 and we want to sell if either option hits $14.00 or more. The company is expected to report earnings on September 20th. This should be considered a more aggressive play.

FYI: Good news! Last week we switched our strangle from September strikes to October strikes due to a move in BSC's earnings report date. The call side of our September strangle actually hit our target this morning. The options we suggested were the Sep. $115 calls and Sep. $95 puts. Our estimated cost was $4.40. We wanted to sell if either option hit $7.85. The September $115 calls hit an intraday high of $8.00 today.

Picked on September 09 at $105.37
Change since picked: +10.27
Earnings Date 09/20/07 (confirmed)
Average Daily Volume = 8.7 million

---

Diamonds - DIA - cls: 138.16 chg: +0.81 stop: n/a

The market continues to rally but time is running away from us with these September options. Traders might want to consider an early exit and salvage some capital here. We're not suggesting new plays at this time. Our DIA strangle play suggested using the September $137 call (DAZ-IG) and the September $127 put (DAW-UW) with an estimated cost of $2.05. We want to sell if either option rises to $3.10 or more. We have two trading days left before September options expire. FYI: The September $137 calls traded to an intraday high of $1.95 today.

Picked on August 30 at $132.57
Change since picked: + 5.59
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 20.8 million

---

Dow Jones Industrial Avg. - DJX - cls: 138.16 chg: +0.77 stop: n/a

The DJIA and DJX continue to march higher. The 1/100th version of the DJIA is the DJX. We're not suggesting new positions after the Fed meeting tomorrow. We listed two separate strategies. Our September strangle suggested the September $137 calls (DJY-IG) and the September $132 puts (DJW-UB) with an estimated cost of $1.25. We want to sell if either option hits $2.00. Our October strangle suggested the October $137 calls (DJY-JG) and the October $132 puts (DJW-VB) with an estimated cost of $4.75. We want to sell if either option hits $6.75. FYI: The September $137 calls hit an intraday high of $1.70.

Picked on September 16 at $134.43
Change since picked: + 3.73
Earnings Date 00/00/00
Average Daily Volume = million

---

Lehman Brothers - LEH - cls: 64.11 chg: -0.38 stop: n/a

After yesterday's 10% gain LEH experienced some profit taking but not before spiking to an intraday high of $66.98. The September $65 call spiked to an intraday high of $2.10 but we were aiming for $2.50. Considering our time left we're adjusting our target to $1.95. More conservative traders might want to get out around breakeven. We're not suggesting new positions at this time. This is an aggressive play since the September options expire in three days. We suggested the September $65 calls (LES-IM) and the September $55 puts (LES-UK). Our estimated cost was $1.55.

Picked on September 16 at $ 59.50
Change since picked: + 4.61
Earnings Date 09/18/07 (confirmed)
Average Daily Volume = 15.4 million

---

S&P 100 Index - OEX - cls: 713.53 chg: + 3.45 stop: n/a

We only have two days left on the September options so readers might want to get conservative with their targets. We've been aiming for $19.50 but the September 700 calls (OEX-IT) hit a high of $18.30 today. We're not suggesting new positions at this time. Our strangle strategy suggested using the September 700 call (OEZ-IT) and the September 660 put (OEY-UL) with an estimated cost of $14.30. We are adjusting our target to sell if either option hits $19.50 or more.

Picked on August 30 at $680.46
Change since picked: +33.07
Earnings Date 00/00/00
Average Daily Volume = 1306 thousand

---

Financial SPDR - XLF - cls: 35.15 chg: +0.22 stop: n/a

Financial stocks continued to rally and the XLF hit an intraday high at $35.67 before running into resistance at its 100-dma. We only have two days left so readers might want to adjust their targets to breakeven. We're not suggesting new positions at this time. We were aggressive and suggested the September options, which expire in two days. Our suggested strangle used the September $35 calls (XLF-II) and the September $33 puts (XLF-UG) with an estimated cost of $0.65. We want to sell if either option hits $0.95 or higher. FYI: The $35 calls hit $0.70 intraday.

Picked on September 16 at $ 33.98
Change since picked: + 1.17
Earnings Date 00/00/00
Average Daily Volume = 69.1 million
 

Dropped Calls

Manitowoc - MTW - cls: 44.09 change: +2.24 stop: 37.48

Target achieved. The rally in MTW continued. Shares spiked higher this morning and hit an intraday high of $44.96. Our target was the $44.00-45.00 range. The action in the stock looks like there was news but we can't find anything in the news that might account for today's 5.3% gain.

Picked on September 05 at $ 40.13 *split adjusted
Change since picked: + 3.96
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 1.0 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Near-Term Technical and Far-Term Fundamental Market Analysis

Chart patterns (support/resistance, gaps, bull flag), inflation, employment and the yield curve

CHART GAPS
Last week in my Trader's Corner column, I wrote about the concept of rising and declining chart 'gaps' that are created by sharply lower or higher openings relative to the previous day and caused by big order imbalances. Big buying interest means that stocks have to be marked up to lure sellers and big selling interest means that stocks have to be marked down to attract buyers.

I start with this concept of gaps again because we saw the major indexes gap higher today. Moreover, the low end of the gap seemed to where support/buying interest was coming in on the minor pullbacks that occurred today. One thing we often see with chart gaps is that they mark areas of support or resistance, depending on which way the trend is moving.

Gaps are not seen all the time, but are not so infrequent either. To see a fuller explanation than my short synopsis here, you can go back to my last Trader's Corner column (Wed, 9/12 OI Daily) by clicking here.

You have to turn to hourly charts to see S&P chart gaps as the daily index Open substitutes the prior night's closing prices for stocks with order 'imbalances' that don't open immediately. This convention by Standard & Poor's masks' gaps so to speak. Not so in the Nasdaq.

Before I turn to some charts, I would just note that upside chart gaps tend to signal still higher prices, downside gaps still lower prices ahead but this pattern doesn't usually have a measuring implication to suggest a further upside or downside objective. The exception to the forecasting value of chart gaps suggesting still more upside (or downside) ahead, sometimes after a prolonged move (up or down), a gap ends up being a so-called 'exhaustion' gap, marking the END or near the end of a move. I don't think that's what we saw today but stay tuned on that!

I've marked the upside chart gap on the S&P 500 (SPX) hourly chart below with the yellow circle. Prices pulled back a bit 'into' the gap created between the low of today versus the high of yesterday. The top end of an upside gap like this will often be as low as a subsequent pullback will get before another rally sets in. It gives us an idea of possible technical support at 1520. More pivotal technical support should be found in the 1500 area. Another technical rule of thumb is that after a key prior high is pierced, that prior resistance should 'become' a new area of support.

I was a disbeliever that the Fed would cut a full half percent or 50 basis points and that the major indexes probably would not rally all the way back to their July peaks. Of course this hasn't happened yet either but it looks like it can. Just on a technical basis and putting my long-term 'fundamental' concerns aside, the pattern off the lows was one of ever higher pullback lows as highlighted by the blue up arrows below. This pattern suggested that a bullish chart was the best interpretation until and unless prices topped out again around 1500 in SPX.

FLAG PATTERNS
The sharp run up (the 'flagpole'), followed by the backing and filling that that creates a downward sloping formation that looks like a 'flag', is often a consolidation before a next up leg. There is a measuring implication to this pattern in the second leg or height of the flagpole is going to at least equal the distance that the next move will carry; suggesting, in this case, a 'minimum' upside objective to around 1585. We'll see.

OVERBOUGHT/OVERSOLD INDICATORS
Working somewhat contrary to the bullish flag interpretation I note above, there is also a significant tendency for EXTREMES registering in the 21-hour Relative Strength Index (RSI) indicator to mark at least temporary tops or bottoms as noted above with either the red down arrows or the green up arrow above on the RSI graph.

Looks like you have a technical interpretation that could suggest that SPX is only about half way in move that will carry fairly quickly to new highs for this current move higher, or an interpretation that suggests prices would more likely pull back some to adjust or consolidate recent gains. If there were a pullback within a still strong bullish trend, I'd expect good support/buying interest to develop in the 1500 area, before the index was in a position to challenge its July top.

Not surprisingly TECHNICAL analysis can point to different possibilities for the direction of stock prices. It's not surprising because, this is the way of economic or FUNDAMENTAL analysis, which I'm going to also delve into shortly. The different forms of analysis are just different ways of interpreting the same underlying market dynamics.

The NASDAQ Composite (COMP) hourly chart picture and interpretations are the same as the S&P 500 regarding the:
-bullish pattern of higher pullback highs that led into this latest strong surge higher
-strong upside breakout above resistance implied by the prior 2644 high
-bullish upside chart gap, and minor consolidation after that, that looks like a pause (bull flag) only, with still substantial upside potential
-overbought extreme suggested by the RSI indicator that might signal a pullback first.

FED ACTION, EMPLOYMENT AND THE YIELD CURVE:

Many were seeing significant danger signals for a deep economic slowdown, even recession, as signaled by an INVERTED YIELD CURVE. Alan Greenspan rated the chance of a U.S. recession as being somewhat more than a 1 in 3 possibility. I was one of those thinking that the Federal Reserve, especially the Chairman, were going to be too concerned with inflation to take the stronger medicine signaled by the 50 basis point cut that it surprised the market with yesterday.

A 'normal' yield curve is a 'positive' curve. Generally when the yield curve is positive, it indicates that investors are requiring a higher rate of return for taking the added risk of lending money for a longer period of time. The belief and long-time experience with it, is that a steep positive yield curve indicates that investors expect strong future economic growth and higher future inflation and thus, higher interest rates.

A sharply inverted yield curve means investors expect sluggish economic growth and lower inflation and thus lower interest rates. (A flat curve generally indicates that investors are unsure about future economic growth and inflation.)

BBecause the yield curve is so indicative of future interest rates, which are then indicative of an economy's expansion or contraction, yield curves and changes in yield curves convey significant forecasting information. A study done in the 1990s found that inverted yield curves preceded the prior FIVE U.S. recessions. Since stock prices are all about the bullish or bearish expectations for EARNINGS, a sharp slowdown is going to kill a bull market.

YIELD CURVE OUTLOOK COUPLED WITH THE EMPLOYMENT TREND:

Floyd Norris, who writes on the economy and business for the New York Times and is an intelligent read usually, suggested that the two charts below (forgive the poor reproduction!), with one representing a particular way of looking at an inversion in the yield curve AND the downtrend trend going on in the percentage of the U.S. population that are employed, is suggesting some danger of a future recession.

The top chart below shows the spread in yields between the 2-year T-note and Fed funds. The bottom chart shows the 6-month change in the percent of the overall population employed in the U.S. It's the combination of the underlying conditions signaled by the inverted yield curve and weak employment trends that the Fed did appear to recognize fully in their strong action of this week.

In normal times, the Treasury rate is usually higher than the Federal Funds rate, EXCEPT before the 1990 and 2001 recessions. At the widest spread recently, the 2-year Treasury note yield was 3.85 percent, while the fed funds target rate was 5.25 percent. The difference of 1.396 percentage points was the widest since early-January 2001.

Floyd Norris in his reporting noted that "It was also in January 2001 that the Fed surprised the market with a 50 basis point reduction in the target rate for fed funds. That move briefly cheered the stock market, but did not prevent the recession that began in March." The Fed, as I said before can waive its magic wand to lower interest rates but this medicine doesnt always cure the patient.

EMPLOYMENT:
The lower chart seen above shows the 6-month changes in the number of people with jobs, as reported by the Labor Departments household survey. In a growing economy, with the labor age population rising, the number of jobs almost always increases; but, not recently of course.

The August employment figures showed 145,794,000 people with jobs, or 125,000 fewer than in February. When that six-month change rate goes into negative territory, it has been a warning of economic slowdown. As can hopefully be made out in the chart above, the sharp dip in jobs seen July 1990 was also the month in which a recession began. A warning of the 2001 recession arrived in July 2000 in these figures, but few took it seriously.

IIf a recession does arrive there may be criticism that the Fed was too slow to cut interest rates as suggested by the warning of an inverted yield curve, and that it focused on inflation for too long. Stay tuned on that!

INFLATIONARY PRESSURES:
The above is not to say that inflationary pressures are something to be ignored; controlling inflation is also a key Federal Reserve mandate. We've seen the great economic boom in China putting upward pressure on all kinds of industrial commodities prices; e.g., copper. A more basic commodity for all and especially in the energy hungry U.S.A. is OIL.

The closing price of nearby crude futures today in New York was nearly $82 a barrel. We seem to have come to taking such high prices in stride and you often hear the talk about the inflation-adjusted price of oil not yet equaling the all-time (inflation-adjusted) peak of around a $100 a barrel.

SStill, with the weakness in housing and jobs slowing consumer spending already, the added impact of higher gas prices and especially heating oil in the weeks and months ahead, is a cause for concern.

I can only say I GLAD I don't have to perform the Federal Reserve's delicate balancing act. Not unlike the conflicting picture seen sometimes in the technical outlook that makes the right trading decisions a very tough proposition at times!

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for my answer or feedback to Click here to email Leigh Stevens support@optioninvestor.com with my name ('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.

DISCLAIMER

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.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

To ensure you continue to receive email from Option Investor please add "support@optioninvestor.com"

Option Investor Inc
PO Box 630350
Littleton, CO 80163

E-Mail Format Newsletter Archives