Option Investor

Daily Newsletter, Wednesday, 11/21/2007

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Table of Contents

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

Market Wrap

Turkey Market

If this market were a turkey I would kill it and bury it rather than risk food poisoning at the dinner table on Thursday. Ugly does not do justice in describing the various index charts and news releases making the rounds. Bearishness is rampant and by listening to analysts and reporters you would think we were heading into a world war rather than a slowdown in the economy. It must be time to buy because there is plenty of blood in the streets if you believe the news.

Dow Chart - Daily

Nasdaq Chart - Daily

There was a flurry of economic reports on Wednesday led by the second reading on the Consumer Sentiment for November. Sentiment actually rose to 76.1 from the initial November reading of 75.0. This was still down from the 80.9 posted in October and still the second lowest reading since the 1990s. You know the reasons so I don't have to spell them out here.

The Conference Board Leading Indicators, which should be named lagging indicators since it always runs a month behind, fell -0.5% in October. Seven of the ten components subtracted from the reading. The three-month annualized growth rate fell to -4.8% and the lowest level since January-2001. The six-month annualized rate fell to -1.0% clearly showing how quickly the growth has slowed in the last three months.


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Mass Layoffs rose to 1,320 events involving 50-employees or more and totaling 131,780 workers for October. This was the highest level of layoffs events since January. Layoffs are expected to continue rising over the next several months. Year-end changes are routine and getting a holiday check and a pink slip are not uncommon.

The most shocking report for the day was the Risk of Recession Probability, which came in at 47% for October. This was another monster jump from last months 32% probability. This is up from only 15.3% in July. This is the highest level since early 2002. The risks are growing primarily from the rising delinquencies in home mortgages, soaring foreclosures and rising defaults on consumer credit loans. The credit crunch is returning, gasoline prices crushing consumer budgets and retailers are expecting ugly holiday sales. This falling consumer confidence was the major drag on the recession numbers. It is not a pretty picture!

Recession Probability Chart

Traders were not really looking at the economic reports but the global indexes. The major indexes were getting hammered even worse than the U.S. markets. Japan's Nikkei index fell -2.5%. The Hong Kong Hang Seng Index swung more than 1400 points intraday on Tuesday before closing up +341. Then it was slammed for a -1153 point loss on Wednesday of -4.15%. The BSE-30 fell -2.3%, Jakarta -2.3% and the Shanghai was relatively composed with only a -1.5% loss. In Europe it was not any better. The CAC-40 fell -2.8%, DAX -1.5%, Swiss SSMI -2.56% and FTSE-100 -2.5%. They used to say when the U.S. caught a cold the world sneezed. Now we can't tell who is sneezing and who is really sick. The subprime slime has contaminated markets worldwide and the credit crunch is turning into a credit strangle. So many global banks had bought into the U.S. mortgage market using the various mortgage-backed securities that our mortgage virus has now contaminated the global financial system. Banks in Europe were already off from 6% to 10% for the week still falling. The backbone of the American mortgage system, Fannie Mae (FNM) and Freddie Mac (FRE) were still reeling from their multiyear lows hit on Tuesday. With those mortgage banks running at capacity and in financial trouble of their own it cast a new pall over the financial sector. Add in the growing U.S. recession worries and the markets had plenty to worry about ahead of the holiday.

Countrywide Financial (CFC) has to disclaim bankruptcy rumors on almost a daily basis now but nobody believes them. They are currently leveraged 17:1 and 40% of their loans are negative amortizing ARM loans. Treasury Secretary Hank Paulson helped sour the mood saying foreclosures in 2008 would be significantly bigger than the disaster we are already seeing in 2007. AIG dropped another -3 points on worries they have more subprime exposure than originally disclosed. Even GE was tanking on charges related to the subprime slime. Goldman Sachs lost -$8 after saying its Global Alpha hedge fund will end the year with only $4 billion in assets compared to the roughly $10 billion it started with in 2007. This is a quantitative fund that relies on computer models to make big bets. Those quant funds have been killed in 2007 because of the abnormal swings in the credit markets. Goldman also said many investors were asking for their money back.

That could be what is wrong with the broader market. You may remember that last Thursday was the last notice day for investors wanting to withdraw money at year-end from hedge funds. The markets have gone into a steep dive since the 15th and it could be due to a lot of hedge funds selling to meet redemption requests. Bond yields are falling with money pouring into the safety of treasuries. The yield on the ten-year note broke below 4% intraday for the first time since June-2005. The US Dollar Index fell below 75 intraday for the first time in years.

Ten-Year Yield Chart

US Dollar Index Chart

The only sector still treading water is energy with crude oil setting a new historic high at $99.29 on Wednesday. Crude inventories were mixed in today's report. The EIA report showed crude stocks fell -1.1 million barrels but the API report showed stocks rose by 1.4 million barrels. This confused traders and the much-awaited $100 tick never happened. The key factoid was a monster drop in distillates by -2.4MB in the EIA report and -3.6MB in the API report. Distillates are things like jet fuel and heating oil. Home heating oil hit a new record high on the news at $2.72. With the cold front blanketing the U.S. we could easily see $3 heating oil soon as demand increases.

January Crude Oil Chart - Daily

Heating Oil Chart - Daily

A new factor is entering into the oil trade. Since oil is a shrinking resource with a high daily demand, institutions are using it as an inflation play instead of the traditional bonds and gold. Buying oil as we approach the peak of global production is almost a guaranteed trade. It also compensates for the falling dollar and it is inflation proof. This movement into the futures contracts is skewing the normal supply demand volatility cycles. This is only going to get worse as demand, even our current weaker demand growth, continues to grow. Production has stagnated but not yet peaked but that event is rapidly approaching. Long-term oil investments are going to be worth more than gold.

Today's market action was no exception to the recent trend. Mid afternoon rallies were sold and we closed at new post August lows across the board. The Dow closed at 12799 and under the August closing low of 12,845.78. A close below this level as we had today is a Dow Theory sell signal. The general outline of a Dow Theory sell signal has these three conditions. 1. Both the Dow and the Dow Transports undergo a significant correction from joint new highs. This happened back in August. 2. In a rebound rally from that correction both averages fail to rise above their prior highs. 3. To trigger the sell signal both averages have to close below their respective correction lows, which happened today. Why is a Dow Theory sell signal important? According to Mark Hulbert, founder of the Hulbert Financial Digest, a 70-year study from 1930 to 1997 found that Dow Theory signals averaged 4.4% per year better than regular buy and hold investing. That is enough to make many institutional investors sit up and take notice.

Not everyone believes this will happen in 2007. Abby Joseph Cohen, Jason Trennert and David Bianco are still holding to their year-end forecasts of 1600 on the S&P by year-end. Abby is strategy head at Goldman Sachs, Joseph at Strategas Research partners and David at UBS. They expect the markets to rebound with the steepest year-end rally since 1971. Abby also does not believe the U.S. will see a recession. Looks like these strategists are going to be severely tested over the next five weeks.

The Dow declined to 12840 on Tuesday but rebounded out of danger before the close. With the global indexes down hard overnight the Dow opened lower to 12820 and under the signal point but rebounded by late afternoon on positive news from GM. That was not enough to scare away the bears and the closing sell cycle we have seen so often over the last three-weeks slammed the indexes pushing the Dow to close under 12,800 to trigger the sell signal. Regardless of the Dow Theory a close under the August lows is a definite sell signal on just a technical basis. This suggests the next Dow target will be 12500 and not 15000 as those analysts expect. At today's close the Dow has declined -1399 points or -9.9% from its intraday high of 14198. On a closing basis that is a drop of -1365 points or -9.6%. If today is any indication of what Friday is going to look like the Dow will meet the -10% correction criteria.

The Nasdaq finally cracked the support of the 200-day average to close at 2562 and while still off its August lows by 100 points or so the Nasdaq has fallen -297 points on a closing basis and a -10.4% drop. This puts the Nasdaq Composite in full correction mode with a potential target of 2500 as initial support. The Nasdaq 100 or NDX has actually performed rather well over the last two weeks. The NDX was the hardest hit when the correction began and fell -245 points in only four days. It found support at 2000 and has held over that support for seven trading days. Even though it has been holding at this level today's close gives it a -10.4% correction loss as well. Based on the NDX relative strength I would be a strong buyer of big cap techs when this correction is over.

The S&P-500 closed at 1416 or -9.5% from its closing highs but today's close was a new 3-month low. There is minor support at 1407 but the real backstop is down at 1375. The S&P is far more important to fund managers and that close under uptrend support at 1425 is likely to make it dinner table conversation on Thursday.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

Nasdaq-100 (NDX) Chart - Daily

The Russell-2000 has been the weakest link since the middle of October. Today's close at 740 is a new 52-WEEK LOW for the small caps. This is extremely bearish and represents an 11.4% correction from its October 11th high. I do not think the worst is over for the small caps even though 740 is support from April 2006. If fund managers obey the Dow Theory sell signal then small caps are going on sale when the market reopens.

The only bright spot besides the Nasdaq NDX is the NYSE composite at 9405. It is still declining but has yet to reach its August lows by 300 points. The NYSE has only fallen -8.7% but I am afraid its strength is about to be tested. At this point I would focus on the NDX as the major standout but with the NYSE and Russell picking up speed I think it is a mute point.

45 of the last 55 years the day before and after Thanksgiving combined produced a positive result. With the Dow off -211 and the sell signal triggered I think the odds of a repeat of those 45 years is nearly impossible. Black Friday is normally positive but it is going to have a tough task ahead to continue that trend. Friday is not normally a fund day in the markets due to low volume with most funds not coming back to the market until Monday. If we start out with a negative bias on Friday that could change quickly. If funds do jump into the market on a low volume holiday Friday it could get really ugly. We are reaching textbook oversold extremes but there is nothing on the horizon that we can expect to stop the slide. If you look at the internals on the market stats graphic at the beginning of this commentary you will see only 61 new 52-week highs and 901 new 52-week lows. That is actually a smaller number of new lows than Monday or Tuesday with Tuesday hitting 1035 new lows. The trend has been accelerating and there are no signs of change. As long as the global markets are still tanking on financial worries it will be hard for the U.S. markets to lead us higher. I have nothing positive to say except Friday is only a half-day of trading. At least the pain will be over quickly. Eat a lot of turkey and maybe you will be able to sleep through it.

Happy Thanksgiving!

New Plays

New Option Plays

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

Play Editor's Note: The major indices are in bearish trends dating back to their October peaks just a few weeks ago. While our short-term bias is bearish the indices are looking oversold and due for a bounce. Oversold bounces in a bearish trend are usually sharp but they also tend to be over quickly. While Friday is a shortened trading session we will be adding new plays to the newsletter this weekend.

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Constellation Energy - CEG - cls: 99.05 chg: -1.51 stop: 94.45

One day after hitting new highs CEG pulled back thanks to a very widespread market sell-off. Readers can use the decline as a new bullish entry point. However, we would suggest waiting for the dip to hit short-term support near $98.00 before jumping in. If you're feeling conservative then readers might want to raise their stop loss toward $96.00. The trend remains bullish. Our target is the $107.50-110.00 range.

Picked on November 20 at $100.56
Change since picked: - 1.51
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 1.3 million


Express Scripts - ESRX - close: 64.36 chg: -1.34 stop: 61.14

Trading in ESRX took on a bearish tone this Wednesday. The stock hit profit taking this morning and the afternoon bounce failed pretty quickly. Shares closed near their lows for the session. We would expect a dip near $63.50 or the $62.00 level should the markets continue lower. Wait for signs of a bounce before considering new bullish call positions. Readers may want to use a tighter stop loss. The P&F chart is bullish with a $97 target. Our short-term target is the $69.50-70.00 range.

Picked on November 13 at $ 64.67
Change since picked: - 0.31
Earnings Date 02/07/08 (unconfirmed)
Average Daily Volume = 2.4 million


Gilead Sciences - GILD - cls: 43.06 change: -0.69 stop: 41.74

Investors will want to turn defensive on biotech stocks. The BTK biotech index just broke down to new two-month lows and closed under technical support at its 200-dma. GILD has been out performing its peers but the intraday action is starting to grow more bearish. More conservative traders will want to consider higher stops or an early exit. AT this time we would expect a decline in GILD toward the 50-dma around $42.70 or a dip back toward $42.00. Wait for signs of a bounce before considering new bullish positions but overall we would hesitate to open new call positions at this time. Our target is the $47.00-48.00 range. There might be some resistance its 10-dma near $45.00.

Picked on November 13 at $ 43.11
Change since picked: - 0.05
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 7.6 million


ExxonMobil - XOM - close: 87.02 chg: -0.80 stop: 82.99

Crude oil futures traded over $99 a barrel last night in after hours markets but the commodity traded lower, down 74 cents, to $97.29 a barrel during the regular session. Meanwhile the oil stocks failed to be any sort of safe haven during the market weakness. Shares of XOM did not see any follow through on yesterday's impressive rebound. At this time we would expect further declines in XOM. The question is where will traders buy the dip? Look for potential entries on a bounce at $86, 85, and 84. More conservative traders might want to adjust their stops toward $84.00. Our target is the $92.50-95.00 range. More conservative traders may want to lock in some gains near $90.00.

Picked on November 13 at $ 86.75
Change since picked: + 0.27
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 24.2 million

Put Updates

Canadian Pacific - CP - cls: 61.59 change: -1.27 stop: 66.26

CP continues to slip and the stock hit new six-month lows today. We do not see any changes from our previous comments although more conservative traders might want to tighten their stops. Do not be surprised to see an oversold bounce near $60.00. Our target is the $57.50-57.00 range. The Point & Figure chart is bearish and points to a $51 target

Picked on November 19 at $ 62.85
Change since picked: - 1.26
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 553 thousand


ESSEX Property - ESS - close: 102.29 change: +0.48 stop: 107.31

ESS produced an oversold bounce today after traders bought the dip near $99.00 again. A failed rally under the 10-dma (near $104) or a new decline under $101.50 could be used as a new bearish entry point for puts. Our target is support in the $94.00-93.00 range. The P&F chart is much more bearish with a $78 target.

Picked on November 20 at $101.75
Change since picked: + 0.54
Earnings Date 10/31/07 (confirmed)
Average Daily Volume = 272 thousand


J.B.Hunt - JBHT - close: 24.33 change: -0.67 stop: 27.05

JBHT actually gapped down this morning and opened at $24.41. The stock spent the rest of the day trading sideways and lost 2.68% by the closing bell. Volume was big on the decline, which is normally a bearish sign. Do not be surprised to see an oversold bounce back toward what should be support near $26.00 and its 10-dma. A failed rally under $26 could be used as a new bearish entry point. Our target is the $22.50-22.00 range. Today's move has produced a brand new P&F chart sell signal with a $20 target.

Picked on November 20 at $ 24.95
Change since picked: - 0.62
Earnings Date 01/29/08 (unconfirmed)
Average Daily Volume = 1.8 million


PACCAR - PCAR - close: 47.68 change: +0.23 stop: 50.81

We warned readers to expect an oversold bounce toward the 10-dma and PCAR delivered one today. A new decline under $47.00 could be used as a new bearish entry point of a failed rally under $50.00. Our target is the $42.50-42.00 range. The Point & Figure chart is forecasting at $38 target.

Picked on November 16 at $ 46.99 *triggered
Change since picked: + 0.69
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 2.7 million


Regency Centers - REG - cls: 66.22 chg: +0.83 stop: 72.01

REG hit a new three-month low this morning before bouncing back and closing up on the session. The overall trend remains bearish. Watch for a failed rally near $68.00 as a new bearish entry point. More conservative traders may want to use a tighter stop near $70. Our suggested stop is above resistance near $72.00. Our target is the $62.50-62.00 range near the August 2007 lows.

Picked on November 18 at $ 67.56
Change since picked: - 1.34
Earnings Date 10/27/07 (unconfirmed)
Average Daily Volume = 570 thousand

Strangle Updates


Dropped Calls

Goodrich Corp. - GR - close: 68.48 change: -1.54 stop: 67.90

Today's weakness in GR has changed our mind. It's time to abandon ship. The stock broke down under technical support at its rising 50-dma. Both daily and weekly technical indicators have turned bearish. Shares of GR look poised to fall toward the 100-dma in the $65-66 zone. We'd rather exit now and cut our losses.

Picked on November 05 at $ 71.05
Change since picked: - 2.57
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 1.0 million


Las Vegas Sands - LVS - cls: 110.45 chg: -3.53 stop: 109.90

Investors quickly sold into strength and erased yesterday's bounce from support near the $110 level. Furthermore the early morning weakness in LVS hit an intraday low of $109.16, thus we've been stopped out at $109.90. The reversal of yesterday's bounce is bad news and LVS looks poised to breakdown further. Nimble traders willing to stand the volatility might want to consider bearish positions on a break below today's low. Look for support near $105 and again near $100.

Picked on November 08 at $111.60
Change since picked: - 1.15
Earnings Date 11/02/07 (confirmed)
Average Daily Volume = 4.0 million

Dropped Puts


Dropped Strangles


Today's Newsletter Notes: Market Wrap by Jim Brown 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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