Option Investor
Newsletter

Daily Newsletter, Thursday, 01/24/2008

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

Decoupling, "No Rally Like a Bear-Market Rally," Stimulus Plan, and Fraud: Thursday's Bullet Points

Introduction

If this week's action has proven anything, it has proven that the so-called decoupling of the world's economies was a fallacy.

Here's how the week unfolded. By Tuesday morning, Asian and European equities had been cascading lower for two days. Overseas, market pundits blamed the declines on the reviews of the credit ratings of Ambac (ABK) and MBIA, Inc. (MBI), the two largest bond insurers in the U.S.

The response was a global one, with some global bourses seeing percentage losses in the 5-8 percent range in single days on Monday and Tuesday. U.S. market participants wanted our Fed to step in with a rate decrease, but, more than that, they wanted a global response to what was clearly a global situation.

As U.S. equity indices turned down to fresh new lows about midday yesterday, some pundits blamed the hawkish talk from other central banks. The European Central Bank's members had spent the previous twenty-four hours emphasizing that they were more concerned about inflation than they were about recession. Hope that the ECB's Trichet could be persuaded to lower rates died as a result. Some pundits bandied about reports that Chairman Bernanke had pleaded with the ECB's Trichet to lower rates, to no avail. The night before, Japan had held rates steady, too.

Overnight, the stronger-than-anticipated IFO Index in Germany showed an economy was that more robust than expected, perhaps justifying the ECB's hesitation to join the FOMC in lowering rates. Some still believe that the ECB may be behind the curve, as the Bank of England was perceived to be a few months ago. There was going to be more to the story, as it turned out. By this morning, some FOMC watchers were questioning whether the ECB's Trichet was behind the curve or whether our Fed Chairman was perhaps a bit gullible.

To find out why, go back to yesterday when the equity indices were turning to fresh new lows. In addition to blaming the ECB's Trichet, some chatter was surfacing that something was seriously wrong with a bank in Europe. Those rumors were proven to be true.

Overnight, Societe Generale's shares were suspended from trading after the bank, France's second-largest listed bank, announced that one of its traders had engaged in fraud. The bank would take a 4.9-billion-euro or approximately $7.16 billion loss, with the rogue trader's damage amounting to the largest trading loss in a European bank's history. In addition, the bank would take additional charges related to the subprime mess.

The story proved fascinating or horrifying, depending on one's outlook. I heard one prognosticator expressing his doubt that a single trader could be responsible for such big losses. He proposed that the bank could be bundling other losses in with the losses from the rogue trader.

Whether that's true or not, it appears that the bank discovered the rogue trades late last week. To reduce risk, the bank was liquidating equity index futures positions on Monday. It was closing those positions into highly illiquid futures markets since the U.S. markets were closed for the holiday. Some commentators this morning wondered aloud whether our central bank had been fooled into taking action Tuesday morning, not knowing what was going on in Societe Generale. I didn't hear any postulate the idea that perhaps the ECB did not also move because that central bank was aware of what was happening.

Other European banks such as BNP Paribas hastened to assure markets that they would not be warning. Still, the stellar performance of banks and insurers in Europe as we were waking this morning might have been somewhat surprising, given the Societe Generale news. Short covering, reassurances from other banks, and the impression that the worst might be known might have contributed to those gains.

However, a major boost came from the hope that a rescue plan might be in the works for U.S. bond insurers. That reaction questions that theory that our Fed might have been duped. Markets appeared to be driven as much or more by news related to the bond insurers both late last week and the last few days than by the Societe Generale news. Overseas, markets had dropped and risen on worries and reassurances about the U.S. bond insurers. Some might argue that Societe Generale's losses were deepened because it had to liquidate into a market that was already weakened by those worries.

As has been discussed on these pages many times previously, a rally or decline is often attributed to some development when those who study the charts already saw the potential for the movement that eventually occurred. The "reason" was just the precipitant, not the cause. Markets were weakened and jittery, and a major global bank selling index equity futures on an illiquid day exacerbated that weakness. The propensity for markets to decline sharply was already there, in my opinion. If you look back at last Thursday's Wrap, you'll find that I was warning that vulnerabilities to certain levels must be factored into trading decisions. The levels seemed extreme at the time, but they were met and even exceeded in many cases. The charts were showing the possibilities.

Whatever else has happened this week, the whole decoupling theory has been trashed. Anyone comparing the performances of the U.S. dollar and euro against the yen to the performances of equities in the U.S. and Eurozone would have doubted that theory anyway. If we're trading in the U.S., we still must be aware of what's happening around the globe. Those who were already thinking globally also learned that they couldn't count on their diversification into other countries' equities as a buffer against downturns in U.S. equities.

The U.S. economy needs a stimulus, some have decided, and U.S. Congressional and Bush administration officials have been rushing to provide it. This morning, Congressional aides alerted media that an announcement of a possible plan could be made as early as today. It was. As hammered out and revealed by House Speaker Nancy Pelosi (D-Calif), House Republican Leader John Boehner (R-Ohio) and Treasury Secretary Henry Paulson, the stimulus is structured so that the money is most likely to be spent and invested.

Key elements currently include tax rebates of $300 to $600 for individuals and up to $1,200 per American family for low and middle-income workers. Some who paid no income tax but did pay payroll taxes would be. The rebates would be capped at families making more than $187,000.

Other elements include tax breaks to businesses. Some businesses could obtain a 50 percent write-off for investments made on capital equipment. The intention is to boost employment.

The promise of federal support for mortgages through Fannie Mae, Freddie Mac and the Federal Housing Administration drew the most interest, at least from those in the housing and financial communities. The conforming mortgage limit would be lifted in the plan's current composition, suggesting that it may again be easier to obtain loans for those whose mortgages were above the previous limit. Jumbo mortgages have been difficult to obtain.

In its current incarnation, the plan does not include extra money for food stamps or the extension of unemployment insurance. That disappointed Democrats, but Republicans were disappointed, too. The plan does not extend the 2001 and 2003 tax cuts beyond 2001, when they will expire.

Naysayers soon debated the merits or deficits of the plans, and they'll go on debating them. It remains to be seen what the final form will take. House Speaker Pelosi promised to get the plan before the House as soon as possible. The Senate would then receive the plan, at which time they could change it.

Market participants worked hard to digest yesterday's gains and all the news, but indices stalled at resistance as they did so. Two events may have contributed to the afternoon stall: waiting for the details of the stimulus plan as well as a statement from the New York State Superintendent Eric Dinallo. Dinallo said that the bond insurer's bailout plan may take longer than some had hoped. However, markets stalled at the natural place they might be expected to stall on a day after a big gain.

Under normal conditions, the expectation would be that we'd perhaps see another day or two of consolidation before a punch up to test the next level of resistance, but these aren't normal conditions. The possibility that this stalling at resistance could presage reversals must be faced. Let's look at charts to see what we see.

Charts

Annotated Daily Chart of the SPX:

Do the signs of accumulation that I've pointed out mean that the SPX can't roll over again? No way. As I've mentioned before on these pages, institutions can and often must begin accumulation on the way down. They can be wrong. What would be ideal is a low-volume test of the same area with the support again holding.

The SPX's daily Keltner chart shows potentially strong resistance on daily closes at 1355-1362. That chart suggests that until and unless the SPX can produce daily closes above that zone, it's vulnerable to further downturns toward Keltner support, currently near 1305.50 on daily closes. I haven't room to include all Keltner charts, too, but traders should know that on both Tuesday and Wednesday, this daily Keltner support did hold on daily closes. Candle shadows pierced those lines but the bodies of the candles were above or at the lines.

However, the steep declines have turned that support lower, so it's now possible for the SPX to slide lower along that descending channel line and still ostensibly hold onto its support. To decrease the vulnerability to a rollover and further sliding down that channel's descending support, the SPX needs to first maintain daily closes above about 1362, and then it needs to climb steadily enough to turn the daily 10-sma (or 9-ema, which I use on my Keltner charts) higher again. Fibonacci levels have seemed to have been well established as support on the way down, and so now might be considered potential resistance on the way up.

Relief or technical rallies can be sharp, as that "No rally like a bear-market rally" quote from this morning suggests. They can blast through resistance as easily as the decline blasted through support. I've been expecting a sharp relief rally, perhaps one that carries on for days or even up to a couple of weeks. We've had the days now: two of them. In my opinion, anything can happen now.

I still believe it's a time to look for rollovers as potential new bearish entries, but do watch for confirmation before you attempt bearish entries in a sharp relief rally because they can endure so long that market participants are sure the worst is over.

While I have been watching for a bounce and was watching particularly for signs of institutional involvement, I don't think we've hit the bottom yet. Perhaps "a" bottom has been reached, but factor in vulnerability to sharp downturns into any trading decisions now. That means that you should not carry home too much risk, especially to the downside. You've seen this week what can happen in a single day.

Annotated Daily Chart of the Dow:

Like the SPX, the Dow closed Tuesday above the Keltner support now at 11890 on daily closes. Until and unless the Dow closes above the 10-sma, immediate vulnerability to a retest of that level remains. Eventually, support should be retested, but that retest may not occur until after days or weeks of a relief rally that must run its course. Watch for rollover potential at the levels indicated on the chart, as I believe that once that relief rally does run its course, we're still in a sell-the-rallies mode.

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

Annotated Weekly Chart of the RUT:

Annotated Daily Chart of the TRAN:

Today's Developments

The economic calendar has been light most of the week. Today was no exception, but the day did include a few releases that have gained in importance. The weekly initial and continuing claims have drawn more attention in recent weeks.

Initial claims fell 1,000 from a revised higher 302,000 last week. The four-week moving average declined 14,000 to 314,750. These numbers were lower than predicted and remained well beneath the 350,000 or so that benchmarks the level at which labor-market weakness might harm the economy. Continuing claims dropped, too, by 75,000 to 2.67 million.

December's Existing Home Sales fell to a nine-year low, the National Association of Realtors reported. For December, resales dropped 2.2 percent to a seasonally adjusted annual rate of 4.89 million. If broken down into categories, sales of single-family homes dropped 2 percent to 4.31 million, a ten-year low.

Year-over-year figures showed resales falling 22 percent. The median single-family home price declined 1.8 percent for 2007, the first time there's been a year-over-year decline in the 40 years the association has collected the data. The numbers were weaker than anticipated, but that didn't stop the DJUSHB, the Dow Jones U.S. Home Construction Index, from gaining. Last week, I mentioned that the housing starts figures were approaching levels that Keene Little had suggested months ago as the levels that must be reached before we could even begin to look for a bottoming in the housing market. This week, the DJUSHB did not decline along with other indices.

In a separate release, Freddie Mac's chief economist noted that 30-year fixed-rate mortgages averaged 5.48 percent for the week that ended today. The week before, they averaged 5.69 percent. Those rates haven't been this low in almost four years.

Other housing-industry news concerned home builder Lennar's (LEN) earnings report. Including a $7.50 a share charge, LEN reported a fourth-quarter loss of $7.92 a share. Revenue was $2.18 billion, driven lower by declining numbers of home deliveries and average sales prices. Analysts had expected revenue of only $2.06 billion, however, and investors awarded it with higher stock prices although the trading tended to be a bit volatile. The company does not anticipate improving market conditions this year, it said.

The Bureau of Labor Statistics reported December's and 2007's Mass Layoff's this morning. A seasonally adjusted 1,433 mass layoffs were reported for December. The bureau termed this the highest number of mass layoffs since December 2005, during the time when Hurricane Katrina hit, and the highest for December since 2002.

For December, the 15,493 mass-layoff events were higher than 2006's 13,998. Initial claims were higher, too, with layoffs in the insurance and finance industry contributing to those higher layoffs. However, the industry with the largest number of initial claims was street, highway and bridge construction. Manufacturing comprised 32 percent of all mass-layoff events. When looking at regions, the Midwest suffered the most with the South coming in second. One state that recorded the higher number of initial claims in December due to mass-layoff events was in neither region, however. That was California.

The market holiday on Monday delayed the Department of Energy's release of crude inventories by a day. Crude inventories rose 2.3 million barrels. Gasoline inventories climbed 5 million barrels, but distillates declined 1.3 million barrels. Refinery operating capacity was reported at 86.5 percent.

Our FOMC also released its weekly figures on outstanding commercial paper. Outstanding commercial paper fell a seasonally adjusted $1.6 billion, with the decline appearing to be mostly attributed to a drop in domestic financial paper. This was the first decline in at least five weeks on the seasonally adjusted number, although the unadjusted figure has seen declines up until two weeks ago.

Some watch this number closely as a gauge of how easily firms and corporations are able to place short-term promissory notes in order to raise cash. It can measure how tight credit is. Typically lately, big declines in outstanding commercial paper have troubled markets, but this either didn't appear too big or else the markets reasoned that the FOMC's actions would ease the credit crunch for corporations and firms.

Today included many earnings announcements or changed guidance. Lockheed Martin Corp. (LMT) reported earnings of $1.89 a share, higher than the expected $1.69 a share. In addition, the company raised revenue guidance and its 2008 earnings outlook. LMT gained.

Reporting companies today also included Nokia (NOK). The company reported a better-than-expect 0.47 euros a share. Thomson Financial had pegged expectations at 0.44 euros a share. The company's year-ago EPS was 0.32 euros a share. Operating margin and market share both improved. NOK climbed today.

F reportedly missed earnings by a penny, but the company said that it expected 2008's net loss to be narrower than 2007's. F originally gained, but then dropped off its high of the day to close slightly lower than it had yesterday. AT&T (T) reaffirmed its 2008 forecast for strong growth when reporting earnings that rose almost 62 percent. The company said it had added a record 2.7 million net mobile customers. That's a record for the industry, not just for the company, but something in the report disturbed investors. T dropped right back through to yesterday's opening level and a little below, reversing all of yesterday's gains.

After the market close, AMGN, JNPR and MSFT reported, but their reports were just coming out as this report was prepared. I caution traders not to jump to conclusions based on first top-line reports or first reactions in after-hours trading.

AMGN reported declining revenue, but revenue that still beat expectations. Although one news source said that AMGN also beat on its EPS, another report said that, excluding various items, the company would have earned $0.90 a share, and I see expectations listed at $0.97 a share. Some confusion obviously exists.

JNPR earned $0.22 a share. Excluding certain charges, the company would have earned $0.27 a share on revenue of $809.2 million. Thomson Financial had reported expectations of $0.24 a share on revenue of $785.9 million.

MSFT reported earnings of $0.50 a share on revenue of $16.37 billion, against expectations of $0.46 a share on net revenue of $15.95 billion. The company attributed the 81-percent gain in Q2 profit to strong sales of Windows software. All three companies were showing strong gains in after-hours trading, but that trading was occurring shortly after the releases. The reactions can change after the reports are analyzed and the company spokespersons give more updates.

Tomorrow's Economic and Earnings Releases

Before discussing tomorrow's developments in the U.S., I thought I might mention what's happening overnight. Japan's December CPI and Bank of Japan Minutes were scheduled to be released at 6:30 and 6:50 pm ET, respectively.

Tomorrow's economic calendar for the U.S. is light. Only the ECRI Weekly Leading Index is scheduled to be announced.

Important companies reporting earnings tomorrow include CAT, FO, HOG and HON. Some other reporting companies include CCUR, GWW, WFT, IDXX, FED, DLA and CBH.

What about Tomorrow?

Annotated 15-Minute Chart of the SPX:

If the SPX falls beneath that 120-ema on 15-minute closes and maintains levels below it, a downside target would be set at the lower black channel line, where first support might lie.

Annotated 15-Minute Chart of the Dow:

Annotated 15-Minute Chart of the Nasdaq:

Annotated 15-Minute Chart of the RUT:

Can indices hit those upside targets? The TRAN not only hit its upside target, but in fact exceeded it. So did the BIX and RLX, other indices that sometimes lead the SPX, OEX and Dow, although the RLX has pulled back. Those performances don't promise that these other indices will hit theirs, but they do suggest that it's possible.

In each of those cases, however, the index has flattened after doing so, so be wary of that possibility. Keltner targets are sometimes exceeded, but they also can serve as potential resistance on closes of the period being charted. Therefore, I'd spend some time tonight looking at those levels, deciding how to manage trades if there's a push up toward those potential targets and then either a flattening or a pullback into a doji-type day. Will you hold bullish positions over the weekend if doji or other potential reversal signals are produced at resistance? Whether you'll do so depends on your risk tolerance as well as your overall belief about the market's next action.

If these were normal times, that push up to the target and possible stalling might be exactly the kind of action that I'd peg as the best-guess scenario for tomorrow. As we all know by now, these are not normal markets. We could wake up tomorrow morning with SPX futures up 20 points or down 20 points and deem it a normal day these days. There's no way I can predict which can happen tonight. I can only tell you what my best-guess scenario would have been in normal times and show you the levels to watch.

Good luck. Remember that in times like these, your most important task is first to decide that you'll enter quality trades only and that you won't take on more risk than you can afford when you do enter a trade. Then, it's to do absolutely everything to make sure that trade is profitable, not letting profits evaporate once you have them. Then, it's to keep losses small.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
USM None None
USO    

New Calls

United States Cellular - USM - cls: 72.74 change: +2.57 stop: 67.89

Company Description:
U.S. Cellular is the nation's sixth-largest wireless service carrier, providing wireless service to six million customers in 26 states. (source: company press release or website)

Why We Like It:
The January sell-off in USM pulled the stock back to very long-term and what should be very tough support (see chart). Shares bounced and readers could probably buy positions now. However, we would much rather jump in on a dip. Our suggested entry point will be a dip into the $71.00-70.00 zone. We'll put the stop loss under the recent low. Our target is the November low in the $74.50-75.00 range. More aggressive traders could easily aim for the $77.50-80.00 zone.

Suggested Options:
We are suggesting the February calls although March options would work just as well. Our suggested entry point is $71.00.

BUY CALL FEB 65.00 USM-BM open interest= 0 current ask $9.20
BUY CALL FEB 70.00 USM-BN open interest= 0 current ask $5.80
BUY CALL FEB 75.00 USM-BO open interest=31 current ask $3.10

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/26/08 (unconfirmed)
Average Daily Volume = 153 thousand

---

United States Oil Fund - USO - cls: 70.93 chg: +1.43 stop: 68.59

Company Description:
The USO or United States Oil Fund is an exchanged traded fund (ETF) that seeks to mimic the performance of the spot price for West Texas Intermediate (WTI) light, sweet crude oil.

Why We Like It:
It looks like crude oil has found support at its rising 100-dma. This ETF has broken its two-week trendline of lower highs. We're suggesting calls at current levels. Our short-term target is the $74.50-75.00 range. More aggressive traders could easily aim for the $77.50-79.00 region.

Suggested Options:
We are suggesting the February calls. Strikes are available at every dolllar.

BUY CALL FEB 70.00 UNA-BR open interest=1797 current ask $2.75
BUY CALL FEB 72.00 UNA-BT open interest=1084 current ask $1.80
BUY CALL FEB 74.00 UNA-BV open interest= 454 current ask $1.10

Picked on January 24 at $ 70.93
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 3.2 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Blackstone - BX - close: 20.97 chg: +0.40 stop: 17.24

BX ended the session with a 2% Gain but the rally continues to struggle with its 50-dma overhead. The stock continues to look bullish, even more so now given the double-bottom pattern formed this month. Another dip to $20.00 could be used as a bullish entry point. Remember, this is a high-risk, speculative play. We do not want to hold over the February earnings report. Our target is the $24.00-25.00 range for now.

Picked on January 10 at $19.84
Change since picked: + 1.13
Earnings Date 02/11/08 (unconfirmed)
Average Daily Volume: 2.7 million

---

Flowserve - FLS - close: 83.54 change: +1.19 stop: 75.49

Bulls ran into their first hurdle with FLS. The stock traded near $85.00 and the convergence of its 10 and 100-dma. This is resistance but if market continues to bounce we're expecting FLS to push through it. Short-term the stock could see another dip to $80.00. We would use any bounce near $80 as a new entry point for calls. More conservative traders might want to consider a tighter stop loss. Our short-term target is the $87.50-90.00 range. Unfortunately, due to the stock's volatility we have a very wide stop loss.

Picked on January 23 at $ 82.35
Change since picked: + 1.19
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 736 thousand

---

Google Inc. - GOOG - cls: 574.49 chg: +25.87 stop: 514.00

GOOG continues to receive negative comments. Another analyst worried about a slow down and the company's upcoming earnings report downgraded the stock today. The midday swoon in GOOG had me a little bit worried but the stock recovered and closed up 4.7%. We wouldn't chase the move now and the options are still richly priced. Most of the options we listed yesterday are up about 37%. Our short-term target is the $595.00-600.00 range. We do not want to hold over earnings.

Picked on January 23 at $548.62
Change since picked: +25.87
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 5.3 million
 

Put Updates

None
 

Strangle Updates

None
 

Dropped Calls

Henry Schein - HSIC - cls: 59.89 chg: -1.07 stop: 59.65 *new stop

Our strategy to buy the bounce from support on HSIC did not pan out. Shares under performed the market today and closed under support near $60.00, its 50-dma and its trendline. Our stop loss was hit at $59.65.

Picked on January 23 at $ 60.96 *stopped at $59.65
Change since picked: - 1.07
Earnings Date 02/21/08 (unconfirmed)
Average Daily Volume = 623 thousand
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Finding Support; and 'Key Reversals'

NOTE: Today's column was mostly written yesterday (Wednesday). A funny thing happened to this article on its way to you via the Wed 1/23 Option Investor Daily as my column got misplaced by the folks that put the OI Daily together, due to a technical snafu. Its necessary for me to mention this because my price charts further on reflect yesterday's (1/23) close. Since these charts are illustrating points about this recent bottom, it was not necessary for me to redo them just because they don't reflect TODAY'S close. I have redone my comments regarding days/dates.

First, just to pick up on what I wrote about last week in this space about the STAGES of a bear market, where stage #1 is 'distribution', as more savvy insiders start selling stock to the 'trend following' fund managers and the public and stage #2 is 'panic selling'. Well it appears that stage #2 ended yesterday. Yet to come, and stage #3 doesn't always follow, just usually, is the 'discouragement' stage #3; i.e., a longer phase of discouraged liquidation as time goes on without much encouraging news and where rallies don't carry that far or for that long.

I also just would pick up on the point made on the 'December Low' indicator. This is where the Dow falls below its December closing low of 13167 in Jan-March (Q1). The average further decline in 26 of the last 27 occurrences of violation of the December closing low (this is #28) averaged a further 10.1 percent decline before a bottom was made. Such a further 10.1% decline would equal an INDU close of 11838.

While the Dow closed yesterday at 12270, it reached 11645 at the Tuesday low, and a bit lower yesterday, which puts INDU well under the average decline if viewed on an intraday, rather than on a closing, basis. While the Dow is close to having realized the average decline based on what happened in years past when there was a drop (in Jan-Mch) below the December low, the 10.1% average is made up of declines that were greater than this and less than 10,1%. Still it gives us an idea of the fact that its possible the worst is behind us in terms of a price decline.

Unfortunately, even if the absolute low has been seen (with the possibility of a second low in the same area; i.e., a double bottom), the period ahead may require picking your trades carefully in indexes and stock options especially on the buy side, as we could see a lengthily and frustrating period ahead where the indexes go more sideways then strongly up and without big volatility swings (typical of bear market stage #3), which is not the greatest environment for big trading opportunities. That's OK unless you a broker or floor trader who gets paid on a per transaction basis!

Fortunately, the Fed and Bernanke in particular got a fire lit under them and did that major emergency rate cute Tuesday. Good that the Fed can act so swiftly. Not always true however of Congress and the President, although news came today of an agreement. Its a bit of an eye opener to look at the historical record of when recessions (determined well after the onset usually) ended, relative to when federal government stimulus packages were enacted. I ran across the following table below; the footnotes simply refer to the name of the noble-sounding act that got passed.

You'll notice that often the recession ended either before or right around the time the anti-recession package got passed and went into effect. An interesting record don't you think? And raises the question: what's the point? Well, since psychology plays a big part in these things (and is a major interest of mine), maybe government action helped change the tone and reluctance to go ahead with spending and hiring plans for businesses.

But I digress a bit. So much excitement Tuesday and Wednesday, it's enough to get your head spinning if you were watching the blow by blow this week or even anxiously checking in when you could snatch a moment from other work.

WHEN TRENDLINES DEFINE SUPPORT

The second point of this article is about how some key indexes found technical support in the recent price free-fall. There were two key charts that I highlighted in most recent (Saturday) Index Trader column. This article can be seen by clicking here if interested, but I am also going to show similar charts again.

I have been anticipating possible technical support to develop, if it was going to materialize, at the low ends of major WEEKLY chart uptrend channels in the Dow 30 (INDU) and the Nasdaq 100 (NDX). WHY them? For one thing, as of this past weekend, unlike the other major indexes, INDU and NDX had NOT pierced the low end of their long-term uptrend channels. Besides this and more important really, INDU tends to trade very 'technically'; e.g., the Dow tends more than many of the other indexes to form reliable support and resistance trendlines.

As to the Nas 100, NDX was the strongest index in recent months and had been until Tues-Wednesday resisting the decline more than the S&P and Dow for sure. IF NDX didn't hold long-term support, no other index was likely to maintain any long-term support trendline. Always look at what's been leading a rally and see how it fares on the decline, especially in the 'capitulation' phase of the 'panic selling' stage I talked about above.

I have the Dow long-term weekly chart in two versions: its bar or OHLC (Open, High, Low, Close) chart and (2) a 'line' or close-only chart.

The standard bar chart would suggest of course a major downside penetration of INDU long-term support up trendline yesterday. But, it's important to note where there is an intraday, or in this case, intraweek, penetration of a trendline versus how prices end up at the CLOSE. Japanese traders considered lows or highs below or above the range between the Open and the Close to be of relative un-importance, which is why Candlestick charts consider the true (fat)'body' as the price range from Open to Close and the highs and lows outside of that, shown in a narrow width, the 'shadow'; i.e., lacking true significance. I don't really agree with that in charting but I get their point too.

For trading purposes, yesterday's strong intraday turnaround, after the big spike below INDU's long-term support line, did give some clue that the sell off had run its course--and a lot of stops! Better evidence for a price low, not just based on the price action feel or TONE, was provided by following NDX's action; more on that in a minute.

Looking next at the Dow (close-only) line chart makes it appear quite accurately that INDU has found, to date anyway, technical support at the low end of its multiyear uptrend channel. Of course, you had little to go on trading wise yesterday in just 'hoping' that INDU was going to have a rebound back up to its weekly support trendline.

You might have also noticed that CBOE equities call volume picked up considerably Tuesday relative to put volume, as compared to last week.
Market timing can't always be perfect of course and traders were guessing or feeling that this sell off was coming close to being at a final 'extreme' or final low for awhile (the capitulation I mentioned) so they started accumulating some calls. I covered most of my puts on Friday. Would I have rather done that yesterday on that major decline? Of course, but I play the averages so to speak, which doesn't take into account the crazy panic extremes that COULD occur.

The really interesting NDX chart picture is next and I wasn't necessarily convinced that the Nasdaq 100 would finally get all the way down to its long-term support up trendline, but when it did and prices started to rebound, I wasn't going to waste any time in buying NDX calls. This is not just to say that I 'trust' trendlines all the time, but for sure buying near the trendline gave me a close by 'risk' point by placing my exiting stop just a bit under the trendline.

Of course the 'trendline' strategy didn't work so well in timing Dow Index call purchases as INDU went so far under its trendline INTRADAY, but: two things here, NDX was the KEY index and it was a HUGE sell off to finally get the index to this potential support area. I had been targeting the 1700 area for some time in NDX and was willing to wait to see if it finally got there. I wasn't completely alone in that! (The reference to 'Today's Low' below refers to the where prices were as of the 1/23 closing date of this chart.)

KEY REVERSALS AND OTHER BOTTOMING INDICATIONS

A daily 'key upside reversal' is where in a decline, prices fall to a new intraday low but Close ABOVE the prior day's High. Some consider it enough if there's a new low followed by a close above the prior day's close. The more stringent pattern I'm suggesting was apparent in the S&P. Not so in the Dow and the Russell 2000 (RUT) as they did not quite fall to a new low. The Nasdaq Composite didn't quite make it back above its high of Tuesday and the Nas 100 didn't quite close above its Tuesday close either. The Nasdaq indexes certainly had sharp 'spike' down lows and came back a long way from those lows yesterday even though they didn't achieve the key reversal definition.

Besides the daily S&P 100 (OEX) chart below showing a KEY UPSIDE REVERSAL (new Low for the move, followed by a Close above the previous day's High), a principal way I measure 'oversold' is how far a major index gets below its 21-day moving average on a percentage basis.

As I've highlighted below, we have to go back to the first major low in 2002 to find an envelope percentage extreme as great as today, when OEX fell to 9.5% below its 21-day average. We need to go back to the second 2002 low forming a double bottom low in OEX, to see where prices touched my second lowest 7.5% 'envelope' line. The important point is that this sell off was really getting extreme and buying that OEX dip under 600 in OEX was relatively low risk in terms of the snap back potential. This was coupled with what I noted about the NDX chart support AND the bearish 'sentiment' extreme seen last week. You can imagine, in a panic especially, that there is NO floor under prices, but there always IS a floor.

The chart notations above reflect price/indicator action as of the Wednesday (1/23) close.

As many if not most of you know, a single reading or multiple readings of the 'CPRATIO' (seen above) below 1.1 suggests that a significant upside reversal is not far off, specifically within 1-5 trading days. In a bear market trend 'CPRATIO' will often have a close cluster of days that register below the 'oversold-extreme bearishness' line; moreover, in a steep decline the 5-day average will ALSO typically reach the oversold line seen above.

The fact that call activity picked up at the beginning of the week (Tuesday) such that this indicator popped back above the oversold level, I took as mildly bullish, since it suggested a movement toward greater call activity; i.e., Tuesday daily equities call volume was 1.3 times put volume. Traders were starting to probe the long side of the market even in the face of a downside panic type market; the strong Fed action helped of course!

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