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Daily Newsletter, Thursday, 03/20/2008

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Table of Contents

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

Market Wrap

Sunday, March 23, 2008

Time to Rotate


1.0 Commodities Drop While Financials Rise

1.1 Markets at a Glance--Stock Market Finishes On Upbeat Note for Week
1.2 Commodities Turn
1.3 Economy

2.0 Equities

2.1 S&P 500 Index (SPX)
2.2 Dow Jones Industrial Average (DOW)
2.3 Nasdaq-100 Index (NDX)
2.4 Semiconductor Holder (SMH)
2.5 Russell 2000 Index (RUT)

3.0 Featured Industry Groups

3.1 Banking Index (BIX)
3.2 U.S. Home Construction Index (DJUSHB)
3.3 Transportation Index chart (TRAN)

4.0 Currencies

4.1 U.S. Dollar (DXY)

5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)
5.2 Gold Fund (GLD)
5.3 Silver contract (SI)

6.0 Bonds
6.1 10-year Yield (TNX)

7.0 Summary and Review of Credit Situation


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1.0 Overview

Thursday's Numbers

Weekly Numbers

1.1 Markets at a Glance--Market Finishes On Upbeat Note for Week

This weekend's newsletter will be longer than usual because of all the charts. If you like to print out the report for reading you can highlight the parts that are of interest to you (to save some ink and a few trees). I wanted to take a look at a few charts that I don't normally cover, including some longer term views in an effort to keep things in perspective about where we've been and where we could be going. To those of you really pressed for time I apologize for the length of this report. Consider a quarterly review which is what I had in mind when preparing it.

In my last report (Wednesday, March 12) I had shown charts of the Commodity Related Equity index (CRX.X) and pointed out the parabolic climb in price. It had tagged the trend line along the highs since 2003 along with some negative divergences at the new highs so it looked ripe for a pullback at a minimum (after an expected push higher which we got). I mentioned it could be good for some money rotation back into stocks and this week we saw a little of that.

While money many be rotating back into stocks it's certainly not a smooth flow. This week's stock market, like last week, was one of the more volatile with daily intraday swings of a couple hundred points on the DOW, never mind the swings day to day. And while commodities pulled back sharper than I thought they would this week (I was looking for a smaller pullback and then a push higher into April), freeing up a lot of cash, that cash didn't all rotate into the stock market. Some money continues to run to the safety of Treasuries which pushed yields a little lower (which looks ready for a reversal).

There continues to be a huge disagreement by big players as to whether we've seen the worst of the credit mess or instead there's another shoe about to drop. Each day brings either new revelations of another financial firm in serious trouble or relief from others as they say they've seen the worst. Since January the stock market has gone nowhere but we've seen the DOW move +/- 700-1000 points a few times. The bulls will say we're hammering in a bottom and the bears will say we're consolidating before the next leg down. Neither has the conviction to hold their positions and short-covering rallies and longs liquidating positions are causing some significant volatility.

After Monday's save by the Fed (orchestrating the buyout of Bear Stearns by JP Morgan) and then another big rate cut on Tuesday we got a big rally into Wednesday morning. Following the Thursday "dip" and Friday's rally back up near Wednesday's high ended up giving us a good week for the stock market. The gains reflected in the week's numbers in the table above reflects the strong gains, especially in the beaten down sectors such as the banks and housing stocks. On the opposite end was anything commodity related.

The selling of commodities and taking profits has been brought about by deleveraging in the credit markets and the resulting drop in value of assets that benefitted from easy credit. This means large investors are selling even profitable positions to help shore up other accounts. "People are cashing in profits in the only markets that have been going up in order to pay for losses in other markets," said Stephen Briggs, a metals analyst at Societe Generale in London.

1.2 Commodities Turn

For the past few weeks I've been warning about the next bubble to pop--commodities. With the strong spike up in prices, especially since last summer when the stock market was peaking, it was clear the rally would end in tears for those who held their long positions too long. But you can't argue with the strength in commodities since 2000. The following chart shows the commodity index (CRB) as compared to the S&P 500 for the past eight years:

The S&P 500 shows the big decline after the 2000 high, back up to that high in 2007 and is now down about 10% from 2000 (in nominal terms but in fact much lower in terms of inflated dollars). Buy and holders in the stock market have been rewarded with a 10% decline in nominal terms (not inflation adjusted) for the past eight years. In the meantime the CRB rallied a little over 100% in the same time period (it's up roughly +90% after this week's pullback). Notice the spike up since mid 2007--that was the blow-off top. If you want to get an idea how the stock market really fared when measured in gold, the chart after the next one will be an eye opener.

A closer look at the daily chart shows the how the rally from January 2007 went parabolic:

When you see a rally get steeper and steeper, draw uptrend lines and when you get to the 4th one you will often find a break of it signals the end of the rally and the break down is likely to be sharp. That's what happened this week. It's hard to see on this chart but this week's decline found support on the 3rd uptrend line (from August 2007). The daily candle is a bullish hammer (actually an even stronger dragonfly doji) but this candlestick pattern is typically more bullish at the end of a longer decline. A 4-day decline doesn't exactly qualify.

So while commodities could get a bounce (and might even be able to make a minor new high as a retest), commodity bulls have now had their warning shot across the bow. Proceed at your own risk of getting blown out of the water. If you're long anything commodity (including the metals) I would look to lighten up on your position if we see a bounce next week. I'll review some charts of oil, gold and silver later to show some potential moves.

I'd like to make one more point for the buy and holders who argue the stock market will always go up over time. I mentioned the S&P 500 rallying back up to the 2000 high in 2007 in nominal terms. The DOW rallied about 2,450 points above its 2000 high and people (in the U.S.) were elated. But if you measure the performance of the stock market in anything else, such as gold or euros, you'd find the stock market has been one lousy place to invest (chart courtesy Elliott Wave International):

This is not a picture of the tech stocks. This is a picture of the DOW and the "rally" since the 2000 high. Do you see a rally? I don't see a rally. I see my holdings (had I held) getting decimated over the past eight years. It's true that gold has rallied strong and that makes this chart look worse. But part of the reason for the strong gold rally is because the US dollar has been pummeled during the same period. The DOW measured in euros is still well below its 2000 high.

1.3 Economy

Before reviewing Thursday's reports, the following table shows next week's economic reports:

Existing and new home sales on Monday and Tuesday could move the market if there's some surprisingly good news, which is not expected. Bad news has been priced in to a large extent, at least for now. A large drop in Consumer Confidence, reported on Monday, could depress the market. Same for the Durable Goods number on Tuesday--the market is expecting an improvement from last month so another negative number here could spell trouble. Conversely, any unexpected improvement to any of these numbers could spark more short covering and give the bulls a more confident feeling that the market is finding some kind of bottom.

The GDP number on Thursday is expected to be marginally positive and the market would not be happy with a negative growth number. Lastly, on Friday the Core PCE Inflation number is watched closely by the Fed who has already been expressing greater concern about inflation so a higher than expected number here could depress the market out of fear the Fed's hands will be tied and not be able to lower rates any further.

Thursday's reports included the jobless claims, Leading Indicators and the Philly Fed index.

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Initial Claims
Jobless claims continue to rise which signals a continuing deterioration in the job market. First-time claims rose 22K to 378K and the 4-week average rose 6K to 365K. Continuing claims rose 32K to 2.87M and the 4-week average rose almost 20K to 2.83M, the highest it's been since September 2004. The rising unemployment number is one of the indicators that depressed the Leading Indicators.

Leading Indicators
The U.S. economy may be "grinding to a halt," according to the Conference Board that reports the results of the Leading Indicators which fell -0.3% in February making for five straight months of decline. The coincident indicator, which gives the best overview of the current economy, has been flat for three straight months. The index "has sunk to levels that are generally seen only during recessions or the period immediately preceding one," wrote Tim Quinlan, an economist for Wachovia.

In addition to the jobless claims number there were four other leading indicators, out of the 10 total, that fell--building permits, delivery times, consumer expectations and stock prices. Four indicators rose: real money supply (no surprise there), interest rate spreads (I'll come back to this one), orders for capital goods and orders for consumer goods. The factory workweek was unchanged.

The following chart shows the deterioration of the leading and coincident indicators and how the leading indicator has dropped into negative territory this year:

Philly Fed Index
The Philly Fed index rose slightly to -17.4 from -24.0 in February. There was a sigh of relief that it wasn't worse especially after the deep plunge in January. This came after Monday's disappointing number out of the NY region--the Empire State Manufacturing index fell to -22, down from -11.7 in February, a record-low level. Cost pressures ticked higher while employment worsened so we're seeing slowing with higher costs and that's not a good combination.

The NY and Philly indexes are seen as precursors to what we can expect to see from the ISM (Institute for Supply Management) factory index which will be reported on Tuesday, April 1st for March. February's number was 48.3 and any number under 50 signifies contraction. The fact that the NY and Philly numbers are still negative means we'll likely see the ISM come in under 50 again, which would be further confirmation that we've entered a recession.

The following chart shows how the Philly Fed index has been declining since its high in 2004:

Notice how prices paid are spiking higher at the same time activity has dropped sharply lower. Any stock market rally from here would be in anticipation of the end of the recession before it even officially begins (similar to the 2001 recession). But with much more significant problems facing us (housing market decline, credit collapse, etc.), an expectation of a short and shallow recession is probably wishful thinking. The last time activity slowed down this quickly was in 2001 but notice how prices paid came down with it. We've clearly got a different problem this time around and the Fed has less flexibility in fighting a slowing economy as compared to 2001.

Credit Crunch update
I mentioned interest rate spreads earlier. Even though the Fed has been lowering interest rates in an effort to help the credit crisis, the problem has been one of insolvency more than a lack of liquidity. Trust is virtually non-existent and banks have become more fearful about lending money. To compensate for what they perceive to be higher risks the banks are tightening lending standards and demanding a higher return on their money. This has caused a widening in the interest rate spreads between the Fed funds rate and other bond indices. This chart, courtesy Elliott Wave International, shows the widening spread as of this week:

This spread (which is shown inverted so as to match up with the S&P 500) has been a good indicator of stock market direction. The fact that the Fed has been unable to reduce this spread with more money and lowered interest rates is very telling. The spread between the 3-month Eurodollar and the 3-month T-bill (the Ted Spread) has also been widening since the January low and is further proof of the market's reluctance to take on risk. Credit default swaps, used to protect corporate bonds from default, have widened as traders bet the credit-market losses will continue to increase. It says the market has lost its faith in the credit market and as long as that remains true there will likely be more trouble ahead for the stock market, although the market could get a relatively brief respite from the selling.

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2.0 Equities

With the extra length to this weekend's report I'll limit my discussion of each chart and show what I consider the key points. The broader averages look very similar and therefore additional commentary on them is not really necessary.

2.1 S&P 500 Index (SPX)

SPX chart, Weekly

Since the February 1st high it appears as though we might have seen the completion of the 5th wave down for the decline from October 2007. This week's candle is a very bullish looking engulfing candle. So we could see a larger bounce into April/May (pink). An alternative is for another new low (dark red) before starting a larger correction of the decline. The H&S price objective is 1230 which would have price finding support near the June/July 2006 lows. The more bearish possibility (thin dark red line) is for a strong decline that takes the S%P 500 below 1100 within the next month. That possibility is shown a little more clearly on the daily chart:

SPX chart, Daily

The more bearish possibility from here (dark red) shows us to be on the verge of a strong breakdown in the market and from an EW (Elliott Wave) perspective I have to respect this possibility. You'll definitely want your long positions protected (or get out) if this scenario plays out. Otherwise, a drop to about 1225-1230 to meet some Fib, H&S and price level support (light green) could be the next move. The bulls need the rally to continue on Monday--a rally above Wednesday's 1342 high would be a higher high and a break of the downtrend line from December, both bullish. So the key levels are:

Key Levels for SPX:
- Short term bullish above 1342
- Longer term bullish above 1420
- Short term bearish below 1260
- Longer term bearish below 1215

The 60-min chart merely shows a little closer detail the important trend lines and price levels for traders:

SPX chart, 60-min

2.2 Dow Jones Industrial Average (DOW)

DOW chart, Daily

Same price pattern for the DOW as that shown for SPX. It's interesting how price has been oscillating about the longer uptrend lines from October 2002 and March 2003. I'm showing both trend lines because you can see how price is reacting around both of them.

Key Levels for DOW:
- Short term bullish above 12460
- Longer term bullish above 13200
- Short term bearish below 11760
- Longer term bearish below 11350

No additional comments necessary on the 60-min chart:

DOW chart, 60-min

2.3 Nasdaq-100 Index (NDX)

Nasdaq-100 (NDX) chart, Daily

The price pattern for the techs is a little different from the DOW and SPX. The downward sloping consolidation of price since the January low is either an ending pattern and will lead to an immediate rally (pink) or else it's a sideways/down correction of the decline from October (indicating a relatively weak sector) and is getting ready to let go to the downside (dark red). Bulls have some work to do to negate the bearish price pattern--they need to get this above 1865. One reason why I'm favoring the downside on this one is because of what I'm seeing in the semiconductors (shown after the NDX 60-min chart below).

Key Levels for NDX:
- bullish above 1865 (target 1950 by mid April)
- bearish below 1668 (target 1513 by mid April)

As shown on the 60-min chart, the key levels for at least a heads up for which way the market could be headed next are last Wednesday's and Thursday's high (1772) and low (1713):

Nasdaq-100 (NDX) chart, 60-min

The semiconductor stocks are typically a good proxy for where the tech stocks will be headed (which in turn is often a good proxy for the broader market):

Semiconductor Holder (SMH) chart, Daily

The tight price consolidation in a contracting triangle pattern is typically a continuation pattern and in this case that means to the downside. Notice how it has consolidated over to the top of the parallel down-channel and this is often a good setup for a short play and in this case it's for a downside objective of 23.38. I've got it labeled as a 4th wave correction and that would mean another leg down to complete the decline from July to then set up a larger rally into May/June. Not shown but a break above the February 1st 30.24 high would negate the triangle pattern and would be at least short term bullish.

2.4 Russell 2000 Index (RUT)

Russell-2000 (RUT) chart, Daily

The RUT has a very similar setup as the DOW and SPX.

Key Levels for RUT:
- short term bullish above 724
- longer term bullish above 750
- bearish below 643

Russell-2000 (RUT) chart, 60-min

A break above Wednesday's 689.36 high would be bullish but especially if it breaks above 693 to get above the 62% retracement and its downtrend line from December.

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3.0 Featured Industry Groups

Banks and brokers got a strong shot in the arm this past week. Many are calling for a bottom here and putting money where their mouths are. It's certainly possible we've put in some kind of bottom and I've been pointing out the past several weeks that short is not the place to be in either the banks or home builders as I saw by the price patterns and price objectives that the downside could be very limited. Short covering could wipe out months of gains for bears who hold on too long. The question now is whether we made the all-important low.

3.1 Banking Index (BIX), Daily chart

Thursday's rally had the banks poking their heads above the top of the parallel down-channel for price action since last year's high. From a price pattern perspective the important high to take out is the 274 high on February 27th. That would likely lead to a rally at least up to its 200-dma near 322. Otherwise a turn back down next week would probably mean a trip down to 200 or lower.

3.2 U.S. Home Construction Index (DJUSHB), Daily chart

The home builders have been mirroring the banking index and it's close to giving us a buy signal like the banks if it too can climb above its February 27th high near 400. There are a few possibilities playing out to the downside if it tips back over here but I'll continue to caution those who want to short either the banks or home builders--there may not be that much more downside even if it does head for new lows.

3.3 Transportation Index (TRAN), Daily chart

The Trannies need to rally above the February 26th high near 4827 to confirm we'll probably see a rally at least up to the Fib target at 5145 (and back up to its broken uptrend line from March 2003). Otherwise the choppy price action continues to support the bearish view that this will tip back over.

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4.0 Currencies

The Fed's actions this past week had many leaning the wrong way on commodities and currencies. Many thought a rate cut and more liquidity pumped into the market would both be inflationary and therefore hurt the US dollar and help commodities. With most commodities seeing in excess of 90% bulls and the dollar with only about 7% bulls it didn't take much to tip the boat over. Now the question is whether this past week's moves will hold or if it was instead just a knee-jerk reaction.

Looking at the monthly chart of the US dollar I'm showing how it dropped to the bottom of a parallel down-channel for price action since its 2005 high:

4.1 U.S. Dollar (DXY), Monthly chart

Many of you may have heard that the dollar could sink down to $68 before finding a meaningful bottom. I show a Fib projection at $67.88 where the 2nd leg down in its decline from 2002 would equal 62% of the 1st leg down so there's a reason for that speculation. That remains a good downside target if the dollar only manages a bounce, even if it's a bounce that lasts for a couple of months.

The small red down-channel is shown with the lighter blue lines on the daily chart:

4.1 U.S. Dollar (DXY), Daily chart

The dollar actually dropped marginally below its longer term down-channel and the bounce is currently back up to the bottom of the channel (often times resistance once price has broken below the bottom of a channel). The mid line of the shorter term down-channel from January 2007 is also where the bounce in the dollar stopped. Dollar bulls need to keep the buying going. If price consolidates instead (dark red) it would be bearish for another leg down.

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5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)

As mentioned at the beginning of the report, commodities of all kinds dropped hard last week. This included oil:

Oil Fund (USO), Daily chart

The bullish price pattern requires USO stay above 79 otherwise the next support level will be the 50-dma at 76.77, 100-dma at 75.15 and then its uptrend line from August near 73 (about 92 for oil, May contract).

Oil Index (OIX), Daily chart

For the bears this price pattern leaves a lot to be desired as it appears to be a choppy pullback. That suggests another rally leg is coming. A rally above 865 would confirm it. Otherwise it could be set up for some strong selling that will take the index well below the January low.

5.2 Gold Fund (GLD

On Wednesday gold experienced its largest one-day decline in 28 years (which was after the parabolic rally up to its 1980 high). After hitting a high of 1033.90 Sunday night it had dropped as low as 904.70 by early Thursday morning (-12.5%) before closing at 920, down -8% from Friday, March 14.

Daily chart

GLD almost dropped down to the bottom of its parallel up-channel for price action since August 2007 and did drop back below the top of its longer term up-channel from 2005. A break below 88.63 (900.60 for gold, May contract) would confirm a top is in for gold. Then it will be a matter of figuring out how far it will drop down. For starters it would likely drop down near 80 (810 for gold, April contract), the apex of the previous triangle pattern (notice that it found support at the apex of its last triangle into February).

The monthly chart of the gold contract shows how price nearly tagged the trend line along the highs since 2001 and a Fib target at 1043.90:

Monthly chart

Just as I showed the possibility for the US dollar to make it a little lower I see the possibility for gold (and other commodities) to push a little higher but ideally gold will not drop any further next week (or the dollar rally) in order for that short term bullish possibility to have much of a chance. As the monthly chart shows, the bearish price pattern shows gold should be putting in a major top and it will have a long way back down to correct the 7-year rally (BTW, 7 is an important number in the market). To all who poopoo a selloff in gold, read my commentary on commodities and the credit market--all asset classes will suffer.

5.3 Silver contract (SI)

While gold had a big drop this past week, silver did an even bigger number on its bulls. Its Sunday night high was 21.44 and Thursday's low was 16.72 for a -22% haircut. It closed at 16.85, down -18% from Friday, March 14. When these metals break down from a parabolic rally they do it with gusto.

Monthly chart

Silver tagged the trend line along the highs since 2004 and immediately retreated, hard. The week's candle is a bearish engulfing candlestick at resistance so it looks like a strong reversal signal here. It's close to finding possible support at its uptrend line from August 2007, shown more clearly on its daily chart:

Daily chart

After jumping above the top of its parallel up-channel at the end of February, the pullback found support at the top of the channel (very common) but then the new high on Monday was met with bearish divergence and the double top was confirmed when price broke below the valley between the two peaks (19.28 on March 10th). The bulls still have a chance to drive this back up for one more new high (shown in green) but only if they can hold it above the November high at 16.27. A break below that would also be a break of its uptrend line from August 2007. Like gold, if the metals bounce watch for a retest of the broken uptrend line from December.

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6.0 Bonds

10-year Yield (TNX), Daily chart

The 10-year yield has been chopping its way lower (look at all the overlapping red and white candles since the beginning of March). This is typically indicative of an ending pattern so I continue to believe yields are getting ready to bounce. Rising yields means selling in bonds and that money could find its way into stocks. That's why the key levels on the stock charts are important--break those and we could see a good sized rally, especially if the bond market is selling off. Inflation fears may become greater and profit taking in the bond market could be the result.

7.0 Summary and Review of Credit Situation

The Fed did what they had to do on Monday and save Bear Stearns. While it's a bailout with public money (raising all kinds of moral hazard questions), having Bear declare bankruptcy on Monday, and thereby locking up the entire credit market, was simply not an option. They're clearly in the category "too big to fail". The Fed did the right thing here.

What the Fed is trying to do is control the deflation of assets now. They know the economy was leveraged up to its eyeballs the past decade and that it's now crashing down. They're trying to let the air out of the balloon slowly. That will be a very difficult task--when bubbles are pricked they don't squeak air out, they pop. The Fed is attempting to slow down a rapid deflation of the credit market which would be painful for all of us. The economy could end in a tailspin as the vicious circle of deflating assets starts more margin calls to cover loans which then causes more selling (including anything with value) which causes more deflation and then more ratings downgrades, more selling and more margin calls. A collapse of Bear Stearns could have accelerated that process to the nth degree. It was a stick save by the Fed. But how many more stick saves can they do? The offensive players are lining up and taking shots at the goal in rapid succession now.

The approval for Fannie Mae (FNM) and Freddie Mac (FRE) to free up capital was another effort to help the dying mortgage market. By allowing them to drop their reserve requirements they are allowed to leverage up their remaining capital to make more money available to the market. To me this is a desperate act. These companies are already leveraged 28 and 18 times, respectively, and we know this is exactly what has caused massive failures in hedge funds (including Bear Stearns) as the mortgage paper drops in value. Their capital base will simply not be enough to absorb the losses. This is probably where the public money will be "invested" next as the government is forced to bail out both FNM and FRE. And we're not talking chump change here.

Or next for the Fed's stick save attempt could be CIT Group, a company that provides capital for business loans. This is a 100-year old company (owned by Tyco for a short period in 2001) that offers financing to companies and now may need some rescuing itself. It has suffered greatly from the freeze-up in the credit markets. They have been unable to borrow money to pay off its commercial paper coming due this year. They tapped their entire $7.3B line of credit this week and if the credit markets remain frozen they will simply run out of cash and become insolvent, joining the growing list of firms in the same predicament. Their stock price reflects what has been happening:

This chart is all too familiar by now when looking at so many banks and lending institutions. Have we seen a bottom to this carnage? Grab for those falling knives with great care.

So how do we protect ourselves during this difficult time? Going to cash is of course an option (one I've been strongly recommending for a while now). If assets truly start depreciating then cash will do better. Inflationary problems may soon switch over to deflationary problems (which the Fed is clearly more worried about at the moment). But if you prefer to always be invested and not worry about market timing there are other ways to protect your portfolio. Options traders have several tactics they can employ. Here's one example from a reader (thanks John):

John says, "You know what totally baffles me? Even if you are a bull (and who doesnt want to look on the bright side -- I do) why wouldn't someone who has a portfolio of long positions take steps to protect those positions in case they are wrong? Putting on a "collar" is an easy and almost cost free way to do it. Let's say you bought AAPL at $100 and you were one of those lucky folks that rode it up to $200. Now you are a little nervous -- youve doubled your money and you don't want to give it all back. Heres what you do: one, buy front month 190 Puts. They will probably cost you about $3.00; two, since you are a little perturbed about having to spend $3.00 for "insurance" you decide to go out three months and sell the 230 Call. Chances are good that you will collect more than $3.00 for the Calls. Now your "insurance" is free (with maybe some left over).

"Take a look at what happens: Scenario #1, AAPL continues to climb to 225. No harm, no foul. Your stock has gained 25 points. Once you have passed 230 you are now into a "covered call" situation (so whats wrong with that, unless you are greedy and want all the gain with no risk). Scenario #2, AAPL rolls over and heads straight for the earth and drops to $120. Your long front-month puts are now worth $70 (you paid $3 for them). Your 230 short calls are almost worthless so you get to keep that too. You have lost $80 (-40%) of your stock value but your collar put $70 back in your pocket for a net loss of $10 (-5%) for what was a no-cost play."

Some food for thought. As for what we can expect next week, continue to be wary of the roller coaster market. The price pattern makes it very difficult to evaluate possible directional plays. This is a market for gunslingers who can trade intraday quickly. I continue to prefer trading with the trend (down) until we get a trend change but trading with the down trend hasn't exactly been easy the past two months. Stick with the key levels for now as far as identifying the next potential market direction for at least the next couple of weeks. Good luck and I'll be back with you next Wednesday. Live commentary is offered on the Market Monitor so join us there if you're trying to make sense of the wild daily swings.

Key Levels for SPX:
- Short term bullish above 1342
- Longer term bullish above 1420
- Short term bearish below 1260
- Longer term bearish below 1215

Key Levels for DOW:
- Short term bullish above 12460
- Longer term bullish above 13200
- Short term bearish below 11760
- Longer term bearish below 11350

Key Levels for NDX:
- bullish above 1865 (target 1950 by mid April)
- bearish below 1668 (target 1513 by mid April)

Key Levels for RUT:
- short term bullish above 724
- longer term bullish above 750
- bearish below 643
 


New Plays

New Option Plays

Call Options Plays
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AAPL None None
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Play Editor's Note: I don't want to overstate the obvious but the major indices are still in a bear market and the trend is still lower. The DJIA and the S&P 500 have still not broken through their four-month trendline of resistance. However, it does look like the major indices have produced a significant market bottom. At this particular moment I would be more inclined to search for short-term bullish trades but in the back of my mind this is just a bear-market rally that may have potential for more, maybe not. The recent actions by the Federal Reserve have thrown a new spin on things that has yet to be completely digested by market forces.


New Calls

Apple Inc. - AAPL - close: 133.27 chg: +3.60 stop: 121.90

Company Description:
Apple ignited the personal computer revolution in the 1970s with the Apple II and reinvented the personal computer in the 1980s with the Macintosh. Today, Apple continues to lead the industry in innovation with its award-winning computers, OS X operating system and iLife and professional applications. Apple is also spearheading the digital media revolution with its iPod portable music and video players and iTunes online store, and has entered the mobile phone market with its revolutionary iPhone. (source: company press release or website)

Why We Like It:
It's taken about eight weeks but it looks like AAPL has finally built a base big enough for shares to launch higher. With the NASDAQ poised to rally, leaders like AAPL could really out perform the pack. Given the market's recent volatility, stop loss placement is one of the biggest challenges. We're suggesting a stop at $121.90 but more conservative traders could definitely try something tighter near $125 or even $129.00 if you really want to try and limit your risk. We are suggesting bullish positions right here. However, another dip in the $129-130 zone or a breakout above its 50-dma around $134.35 could be used as alternative entry points. The bottom of the gap down from January near $140.00 should be expected to act as resistance. However, we are setting our target in the $148.00-150.00 zone. More aggressive traders could aim higher, maybe $160ish. The Point & Figure chart is bullish with a $166 target.

Suggested Options:
We are suggesting the April calls. We do not want to hold over the late April earnings report.

BUY CALL APR 130 APV-DF open interest=36663 current ask $ 7.90
BUY CALL APR 135 APV-DG open interest=24947 current ask $ 5.25
BUY CALL APR 140 APV-DH open interest=25432 current ask $ 3.35
BUY CALL APR 145 APV-DI open interest=14245 current ask $ 2.00

Picked on March 23 at $133.27
Change since picked: + 0.00
Earnings Date 04/23/08 (unconfirmed)
Average Daily Volume = 48.5 million

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DIAMONDS - DIA - close: 123.11 change: +1.97 stop: 120.75

Company Description:
The DIAMONDS trust, series 1, is an exchange-traded fund that corresponds to the price and performance of the Dow Jones Industrial Average.

Why We Like It:
If this market rally has any legs then we want to capture part of it with a bullish play on the DIA as a proxy for the Dow Jones Industrial Average. You could also use the DJX index. Please note that this is an aggressive entry point with the DJIA and the DIA still under its four-month trendline of resistance (see chart). An alternative entry point would be to wait for a breakout over $125.00 (12,500 on the DJIA). Our target is the $128.00-130.00 zone. We are going to try and play with a relatively tight stop. Odds are probably pretty good that if the market does not see any follow through higher on Monday that we will be stopped out.

Suggested Options:
We are suggesting the April calls. Strikes are available at $1.00 increments. As with all of our suggested candidates it is up to the individual trader to decide which month and which strike price best suits your trading style and risk.

BUY CALL APR 120 DAW-DP open interest= 7344 current ask $5.60
BUY CALL APR 123 DAW-DS open interest=13167 current ask $3.55
BUY CALL APR 126 DAW-DV open interest= 3838 current ask $2.05
BUY CALL APR 130 DAW-DZ open interest= 3093 current ask $0.63

Picked on March 23 at $123.11
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 19.1 million

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Essex Prop. Trust - ESS - cls: 113.00 chg: +0.13 stop: 109.90

Company Description:
Essex Property Trust, Inc., located in Palo Alto, California and traded on the New York Stock Exchange (ESS), is a fully integrated real estate investment trust (REIT) that acquires, develops, redevelops, and manages multifamily residential properties in selected West Coast communities. (source: company press release or website)

Why We Like It:
We strongly considered bullish positions in ESS right here at $113. Last week's breakout over resistance near $110 and its 200-dma is bullish and ESS performed this reversal higher on above average volume. However, we are suggesting readers use a trigger to buy calls at $115.50 for a reason. The long-term weekly chart shows a trendline of resistance near the $115 level. Aggressive traders could jump in now. We are suggesting readers wait for confirmation. ESS and the REIT stocks tend to be a volatile group. That can be great if we catch one of the trends but it is very painful if the stock doesn't cooperate. If triggered at $115.50 Our target is the $124.50-125.00 range. Traders should expect some resistance near $120 but it will probably be temporary. The Point & Figure chart is bullish with a triple-top breakout buy signal and a $132 target. FYI: Aggressive traders could also try buying calls on another dip near $111-110.

FYI: Another REIT stock we would consider a potential candidate is SPG. Readers could buy Thursday's bounce or look for a dip.

Suggested Options:
We are suggesting the April calls or May calls. Trigger is at $115.50.

BUY CALL APR 110 ESS-DB open interest=548 current ask $6.50
BUY CALL APR 115 ESS-DC open interest= 10 current ask $3.80
BUY CALL APR 120 ESS-DD open interest= 20 current ask $2.40

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/05/08 (unconfirmed)
Average Daily Volume = 408 thousand

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Intuitive Surgical - ISRG - cls: 300.69 chg: +9.03 stop: 278.00

Company Description:
Intuitive Surgical is the global leader in the rapidly emerging field of robotic-assisted minimally invasive surgery. (source: company press release or website)

Why We Like It:
We tend to shy away from playing ISRG because the options always look so expensive and the stock sees really big intraday swings. Last Thursday ISRG had a $13 range. Given these factors and the volatile market environment we have to label this an aggressive, higher-risk play. Looking at ISRG's chart the stock looks poised to rally. Traders bought the dip on Thursday near $290 (actually 288) and ISRG closed the session above round-number resistance at $300 and above technical resistance at the 100-dma. Furthermore ISRG has broken through its multi-week trendline of lower highs. Our only complaint would be the lack of volume behind the current rally. We're suggesting calls at current levels but readers could probably pick their spot anywhere in the $295-305 zone. There is likely to be some congestion in the $310-312 area and a dip back to $300 would not be a surprise. Our target is the $339.00-340.00 zone. The P&F chart is bullish with a $360 target.

Suggested Options:
We are suggesting the April calls. We do not want to hold over the April earnings report around April 17th.

BUY CALL APR 290 AXV-DZ open interest= 660 current ask $29.00
BUY CALL APR 300 AXV-DT open interest=1838 current ask $23.70
BUY CALL APR 310 AXV-DA open interest=1002 current ask $19.20
BUY CALL APR 320 AXV-DB open interest=1378 current ask $15.30
BUY CALL APR 330 AXV-DC open interest=1048 current ask $12.20

Picked on March 23 at $300.69
Change since picked: + 0.00
Earnings Date 04/17/08 (confirmed)
Average Daily Volume = 1.1 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Research In Motion - RIMM - cls: 104.94 chg: +3.82 stop: 95.75

Shares of RIMM bounced back (again) on Thursday. The stock dipped to $99.70, which was probably enough to trigger a few stops, and then surged back toward resistance in the $105-106 zone. Thursday's move should qualify as a "higher low" in what appears to be a developing bullish trend. After the closing bell on Thursday rival Palm (PALM) reported earnings that were lower than expected. RIMM and AAPL have been taking market share from PALM and PALM's earnings report might give a lift to RIMM and AAPL on Monday. We are not suggesting new positions at this time. Our target has been the $110.00-112.00 zone. More aggressive traders may want to aim higher in the $120 region.

Suggested Options:
We are not suggesting new positions in RIMM at this time.

Picked on March 11 at $100.74
Change since picked: + 4.20
Earnings Date 04/02/08 (confirmed)
Average Daily Volume = 25 million
 

Put Updates

Ambac Fincl. - ABK - cls: 6.70 change: +0.86 stop: n/a

More action by the Federal Reserve on Thursday helped re-launch the financial rally and ABK managed a 14.7% bounce. We are not suggesting new bearish positions in ABK. This remains a very speculative play. We will definitely hold over the April earnings if we get the chance. Previously we had been suggesting the May out-of-the money puts ($5.00 and $2.50 strikes).

Suggested Options:
We are not suggesting new plays in ABK at this time.

The bounce from $5.00 is struggling.
Picked on January 27 at $ 11.54
Change since picked: - 4.84
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 10.9 million

---

Cytec Ind. - CYT - close: 52.62 chg: +0.12 stop: 56.15 *new*

CYT tagged another new relative low on Thursday. Shares slipped to $51.06 before bouncing back. The trend is still negative but any oversold bounce could easily lift it toward $54.00. We are adjusting the stop loss to $56.15. The $50.00 level looks like nearest support so we are targeting a drop into the $50.25-50.00 zone. More aggressive traders might want to consider aiming lower.

Suggested Options:
We are not suggesting new put positions in CYT at this time.

Annotated chart:

Picked on March 09 at $ 54.72
Change since picked: - 2.10
Earnings Date 04/17/08 (unconfirmed)
Average Daily Volume = 601 million

---

MBIA Inc. - MBI - close: 12.77 change: +0.74 stop: n/a

MBI has rebounded higher for three days in a row after dipping under $10.00 on Monday last week. Short-term the stock looks poised to keep bouncing but MBI is nearing resistance around $13.00 and its 50-dma. We're not suggesting new bearish positions at this time. We had been suggesting the out-of-the-money May puts (7.50, 5.00 and 2.50 strikes). We will definitely hold over the April earnings if we get the chance.

Suggested Options:
We are not suggesting new puts in MBI at this time.

Annotated chart:

Picked on January 27 at $ 14.20
Change since picked: - 1.43
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 15.2 million
 

Strangle Updates

None
 

Dropped Calls

Joy Global - JOYG - close: 62.04 chg: -2.33 stop: 67.45

It turned out to be a very ugly weak for anything related to precious metals. Gold lost about 12% and JOYG fell close to 10% in just the last four days. The stock is arguably short-term oversold and traders did buy the dip near its rising 100-dma. While we did consider how we could play bullish positions here we would only expect a snap back toward $65.00 maybe $66.00 before JOYG ran into congestion again. Long-term the fundamentals behind JOYG should be good but short-term it will probably remain volatile. If JOYG breaks down under $60.00 look for a dip near its 200-dma and probably the $55.00 region.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/29/08 (unconfirmed)
Average Daily Volume = 2.4 million

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Yahoo! Inc. - YHOO - close: 27.66 change: +0.59 stop: n/a

We are throwing in the towel on our speculative YHOO play. We listed this play as a gamble that MSFT would raise its bid to buy YHOO before March expiration. Our "bet" did not pan out. The general idea behind this play still works. The challenge is the time frame. Odds are still good that MSFT will acquire YHOO but we can't say when this deal will finally happen or more importantly when MSFT will raise its offer. It could be next week. It could be a couple of months. It could be longer. You could speculate on April or May calls and try again. Another alternative would be to turn this into a covered call play. You could buy YHOO the stock here with a stop loss under $25.70 and start selling calls. On a purely technical note I found it interesting that last week's low was very close to a 38.2% Fibonacci retracement of its rally from the January lows. However, YHOO shouldn't be trading on technicals due to the potential merger with MSFT.

Picked on February 17 at $ 29.66
Change since picked: - 2.00
Earnings Date 04/17/08 (unconfirmed)
Average Daily Volume = 54 million
 

Dropped Puts

Harley-Davidson - HOG - close: 38.23 chg: +2.47 stop: 38.51

What in the world happened to HOG on Thursday? Shares exploded higher and ended the session up 6.9%. We could not find any news to account for the rally. The stock has broken through resistance near $37.50 and its 50-dma. This is very negative for the bears. Yes, the overall trend is still bearish but short-term we're looking at a bullish breakout and potential bullish reversal. We are suggesting an early exit immediately. We can look at HOG again when it nears the long-term descending trendline. HOG should be a bearish candidate if we are facing a consumer-lead recession.

Picked on March 10 at $ 34.69 *triggered
Change since picked: + 3.54
Earnings Date 04/17/08 (unconfirmed)
Average Daily Volume = 3.1 million
 

Dropped Strangles

None
 


Trader's Corner

Spider Webs

Last week, I proposed last week that applying technical analysis tools to a study of the NYSE A/D line helps traders predict where SPX prices might go. The previous article displayed examples of trendline and channel support and resistance. My favorite technical analysis tool, however, is the nested Keltner channels that I employ for stocks and indices, too. Examples of those were included in the last article, too. The moves in the A/D line were correlated with moves in the SPX to show why it's important to know when the A/D line was going to move and how far it was likely to move. If you missed last week's article and want to catch up, you can find it at this link.

The next few Trader's Corner articles will demonstrate how much information nested Keltner channels can show about the A/D line. Knowing something about what's going to happen with the NYSE A/D line enables traders to better predict what's going to happen with SPX prices.

Maybe you're tempted to stop reading because of your unfamiliarity with Keltner channels. Perhaps your charting program doesn't provide them or doesn't allow their parameters to be changed so that you can nest several on the same chart.

Don't stop reading. It's possible that you might be able to employ some of the same tactics by nesting other types of channels, such as Bollinger bands. Although Keltner channels offer some important differences, the process of determining when a move is likely to reverse is similar. Read these articles and experiment with the types of channels or bands with which you're familiar and your charting program provides.

Before delving into the Keltner channels, it's appropriate to discuss what chart interval works best. The A/D line might be strongly negative or strongly positive, but the NYSE version is still going to be bound by the number of issues trading on the NYSE. The A/D line is not going to continue to climb over a year or even a month, as it has those boundaries. That makes a study of a daily or weekly chart less helpful in most cases than an intraday chart.

Annotated Daily Chart of the A/D Line:

Unless this interesting but still anecdotal observation turns out to merit further attention, short-term charts appear more helpful when studying the A/D line, with the 15-minute or 30-minute charts often the chart intervals I choose. I also occasionally watch the 7-minute chart, but for most times, the 15-minute chart is my chart of preference for the A/D line. It's on that chart interval that other characteristics such a trendline support and resistance also can be found.

Annotated 15-Minute Chart of the A/D line:

If we're looking at Keltner charts rather than traditional studies such as trendlines, where would one look for resistance or support?

Let's look at some examples. The first consideration to be discussed is the setup for the Keltner channels. I nest three together. Each is based on a central moving average, an exponential moving average. The first is based on a 9-ema, with a multiple of 1.4 to set the channel lines. The second is based on a 45-ema with a multiple of 3, and the third, at 120-ema with a multiple of 7.2.

These settings aren't magic or set in stone. Experiment. Perhaps you'll decide that for the security you trade most often, a 10-ema, 50-ema and 100-ema work best.

For legibility reasons, you'll have to make some decisions about the colors and line widths you'll use. Otherwise you'll be staring at charts with spider webs cast across them. The most important lines are the 120-ema, the 9-ema, and the outer boundaries of the 45-ema and 120-ema channels. I employ different colors for each channel, but do use the same color for each channel's upper and lower boundaries. I thicken each channel's outer boundary lines. I also thicken the 120-ema. Find what works best for you.

On the chart below, I've included only the lines I routinely thicken.

Annotated 15-Minute Chart of the A/D line:

When the A/D line lost support at the outer channel line, the SPX began its long descent into the 3/10 low of 1272.76. First, however, it dropped through black-channel support and rose to test it, finding resistance at that line on 15-minute closes.

This brings up an important point about Keltner support or resistance. When determining whether support or resistance is holding for the A/D line, wait until the end of the 15-minute period or whatever the period is on the time interval being watched. That support or resistance is sometimes pierced during the chart interval being studied, but often the support or resistance holds on the close of that period.

Price action and A/D action have been more volatile in recent weeks, so the adherence to Keltner or any other support/resistance lines isn't as clean. In addition, the A/D line always tends to overrun support or resistance a bit since the numbers on the line are so large and change so quickly. Still, the climb underneath the black-channel resistance on the afternoon of 3/5 illustrates a period when Keltner resistance was holding even though the A/D values were climbing. Something seemed to be wrong since the resistance kept holding. The next morning, the A/D line was to gap beneath its 120-ema. So were SPX prices.

It should be obvious by now how Keltner support or resistance is found. It's located at the channel lines. It's found at both Keltner outer channel lines and central basis lines. It's determined upon the close of the interval being studied, such as a 15-minute period.

Not all potential Keltner support or resistance is created equally, however. Those most important lines mentioned earlier--the 9-ema, 120-ema, and the outer channel boundaries of the two widest channels--tend to be most important. Each has separate uses and characteristics. The chart below isolates the 9-ema.

Annotated 30-Minute Chart of the A/D Line:

In calmer and less volatile times, the channel based on the 45-ema usually contains most values, but in these times, it's the wider channel based on the 120-ema. On the chart below, I've hidden all channel lines except that widest channel's outer boundaries and central basis line.

Annotated 15-Minute Chart of the A/D Line:

If outer channel boundaries and the 120-ema prove the most important to watch, why include the full component of Keltner channel lines? Why turn a chart into a spider web of lines?

Oh, but that's where it gets interesting. We'll look at some charts showing all the Keltner channel lines I use next week.
 

Today's Newsletter Notes: Market Wrap by Keene H. Little, Trader's Corner by Linda Piazza, 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.

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