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Daily Newsletter, Tuesday, 06/24/2008

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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

Harsh Words From the Fed

Traders are bracing themselves for some harsh words from the Fed when they announce their rate decision on Wednesday. The markets shook off a triple digit drop at the open for a +175 point rebound on the Dow. Fear of the Fed erased most of that bounce before the close with all the indexes back in the red. The Dow is on track to have the worst month since 2002.

Chart of Wilshire 5000 Broad Market Index

The morning opened with an extremely bearish Consumer Confidence report. The headline number fell from 58.1 and a 15-year low to 50.4 and the 4th lowest ever reading since the survey began back in 1969. The present conditions component fell from 74.2 to 64.5 and the expectations component slipped from 47.3 to 41.0. These are extremely bearish numbers and the market was shocked into a major drop at the open. The share of consumers finding jobs plentiful fell to 14.1% and the lowest reading since December 2003. Those consumers finding jobs hard to get rose to 30.5% and the highest since Dec-2003. Those expecting available jobs to increase fell to 8% and the lowest level since 1980. Those planning to buy a home fell to their lowest level since 1982 at 2.2%. Consumer expectations for higher inflation remained at the highest level on record since 1987. All the same factors still apply. Higher utility costs, fuel costs, food costs and general inflation in every item were high on the list along with falling home equities and the inability to borrow on that equity or sell their homes. I would expect the same kind of trend to continue in the Consumer Sentiment report on Friday.

Consumer Confidence

The S&P/Case-Shiller monthly home price index showed a continued decline in home prices in both the 10-city and 20-city composite models. The 10-city survey fell -1.6% and the 20-city composite fell another 1.4%. On a year over year basis the 10-city composite is down -16.4% and the 20-city survey fell -15.3%. Prices fell in 12 of the 20 metro areas surveyed. The largest metro area declines were Miami -4.1%, Phoenix -3.4%, San Diego -2.6% and San Francisco -2.2%. Prices rose in Boston, Chicago, Charlotte, Cleveland, Dallas, Denver, Portland and Seattle. Despite the negativity this report was actually seen as a positive change in the trend. Prices fell overall but there were more cities showing gains and the overall declines were smaller. Credit Suisse went so far as to initiate ratings on the homebuilder sector with an overweight (buy) rating on six. CS said inventory levels should peak in spring 2009 and then begin to decline. This decline would be the first step in the final recovery process. CS put an outperform rating on CTX, DHI, KBH, PHM, RYL and TOL. Not all builders were as fortunate. HOV, MTH were rated under perform and LEN, MDC and NVR as neutral.

Case Shiller Chart

The Richmond Fed Manufacturing Survey fell to -12 for June from the -3 posted in May. This is the lowest reading since September 2003 and is consistent with the other regional Fed surveys showing an accelerating contraction in the manufacturing survey. The shipments component fell 10 points to -11, the new orders component fell 9 points to -13 and unfilled orders fell 16 points to -21. The employment component also fell sharply losing 8 points to -12. The Richmond Fed survey is very volatile month to month but the trend is clear. The most troubling data was not in a component but in the survey responses. Manufacturers said they expected prices to rise by 5.57% over the next six months and they planned to pass these increases on to their customers because they had already absorbed all they could afford over the prior months. They planned to do this even if it meant losing market share. That is a key indicator that inflation is going to increase in our future.

The remaining reports of interest are the New Home sales on Wednesday, GDP and Kansas Fed Survey on Thursday and Personal Income, Consumer Sentiment on Friday.

The most important economic event for the week will be the Fed announcement at 2:15 on Wednesday. Traders expect some harsh words from the Fed on inflation but no rate hike. Actually after some of the recent economics and revelations from the financial sector they probably wish they could cut rates again but the rising inflation has put an end to that cycle. The Fed is in trouble and it will be interesting to see if they can pull a rabbit out of their hat with some new kind of stimulus that does not involve rate cuts. The Fed Funds Futures are showing a full 50-point rate hike by October and a 3.25% Fed rate by next May. There could be a long series of rate hikes in our future but when they will start is the key question. Since nobody expects the Fed to hike this week it would be a real shock to the system. However, once the Fed embarks on their rate hike cycle it will boost the dollar and slow the climb in oil prices. A substantial hike along with harsh comments would give the dollar a huge boost and depress the price of oil. That would not be a bad scenario. Since everyone knows they are going to hike rates before October why not do it now and aggressively to really send a message to the markets? There are three more meetings between now and the elections. Aug-5th, Sept-16th and Oct-28th. We know they are not going to raise rates at the October meeting for political reasons. That leaves August and September and I would bet on hikes at both meetings. If they know they are going to hike then why wait? Why let inflation run another couple months before taking action? This is of course contrary to what the market is expecting so it would be a major shock if it happened.

There was an event today that was more important to the Fed than the Consumer Confidence and it was not even an economic event. The event was the second major price hike in the last 60 days by Dow Chemical (DOW). In May Dow raised prices by up to 20% effective June 1st. They announced today an across the board increase of another 25% effective July 1st. This is a monumental event and unprecedented in its size and scope. Dow has 2500 product families and nearly every product you buy made has something from Dow Chemical in its makeup. They are also putting a fuel surcharge of $300 on every truck shipment and $600 on every rail shipment. Dow uses natural gas and crude oil as feedstocks for its many products. Dow said it cost $8 billion for energy and feedstocks five years ago. That number rose to $13 billion three years ago, $27 billion in 2007 and will exceed $32 billion in 2008. For reference Dow's market cap is only $13 billion. So far in 2008 Dow's costs for these components are up 42% over the same period in 2007.

Dow said it had to pass on costs in order to survive and continue to supply products to tens of thousands of manufacturers around the world. Their chemicals are found in everything from antifreeze, coolants, solvents, cosmetics, pharmaceuticals, detergents, disposable diapers, water treatment, plastic, acrylics, paints, coatings and the list goes on for literally thousands of applications. For every $1 rise in the price of oil it costs the plastics industry $660 million a year. A 45% producer hike in prices over the last 45 days is a monster contribution to inflation. Dow is not going to be the only company passing on rate increases. Their high profile announcement is a green light for every manufacturer to do the same.

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The Fed has to be listening to Dow as just one of the major contributors to higher prices and thinking something needs to be done ASAP. I would not be too surprised to see a rate hike on Wednesday despite what the analysts are expecting. On the flip side an aggressive hike cycle in this weak economy could cause a deflationary recession and do more harm than good. This is seen by some as a bigger risk than inflation at the current level. Consumer prices have risen only 4% year to date and while high that is not the end of the world. One analyst commented today that the U.S. is only one shock away from a financial disaster. In that environment the Fed would probably remain on hold but either way it will be an interesting announcement.

Another signpost for the Fed would be the UPS earnings warning. UPS shares fell -6% on Tuesday after saying that higher fuel costs and lower package volume prevented them from reaching their prior guidance. UPS said it now expects to earn 83-88 cents compared to previous guidance of 97-1.04. UPS already passes on fuel expenses to customers but costs have been rising faster than prices. UPS hit a 5-year low on the news. UPS said, "The anemic U.S. economy is negatively impacting volume in the U.S. and affecting profits from the international segment." You may remember FedEx warned last week that earnings would suffer from the current environment.

If it is Tuesday there must be a Yahoo rumor. Yahoo spiked +9% intraday on rumors they were in secret talks with Microsoft about a new buyout deal. The initial news came from the popular Silicon Valley blog TechCrunch citing multiple sources saying they were in full buyout talks again. The report followed an earlier article by CNet.com that Microsoft had signaled a willingness to sweeten a previous offer for Yahoo's search business and Yahoo's board had signaled a willingness to consider that offer. The report cited a "major investor" who had been in talks with both companies. Microsoft killed the rumors saying they were not in talks on a buyout but would still consider buying the search business according to their last offer. After the Microsoft comments Yahoo declined to close at $22 for only a 3% increase. With the number of shorts piling on Yahoo it does not take much to trigger intraday short covering.

The only guaranteed trend in the market is rising sales of Toyotas in America. Unfortunately that trend just broke. Toyota said the weakness in the U.S. could cause them to miss prior sales targets. Their goal was to grow sales by 1% in the U.S. and missing it would not be earth shaking. What may be bigger news is the potential for Toyota to become the number one automaker in sales in the U.S. in June. GM sales are plunging so sharply that Toyota may actually do the unthinkable and be the top U.S. seller for the first time ever.

Almost as important as the Fed decision on Wednesday will be earnings from Research in Motion (RIMM). Their after hours report could produce some major market moves on Thursday. Expectations are very high and calls are being bought in volume as far out as $170 when the stock closed at $140 today. RIMM guided higher with expectations for 2.2 million new subscribers and a total of 16 million users. RIMM stock has a habit of making big moves after the announcement. Over the last few quarters moves of $8-$10 have not been uncommon. Analysts are worried if the economic weakness is going to make the employee Blackberry an expense that could be cut in an attempt to maintain margins. However analysts point out that with several models under $100 it is a strong consumer price point.

August Crude Oil Chart - Daily

Crude oil was flat at $137 for the second day after the Saudi meeting. There was plenty of news in the market but nothing that was a market mover. The weekend Saudi meeting was structured to push prices lower by exposing the supposed glut of oil and the impact of speculators that are pushing prices higher. Today the OPEC president negated all of that publicity with his announcement that OPEC would not be raising production. "All you have to do is look at the data to be convinced that the market is well supplied in oil and that we have enough spare capacity and that we have enough stocks in the market," Chakib Khelil, OPEC President. Last but not least, Libya's Oil Minister Shokri Ghanem announced over the weekend it may "cut" production to prevent market oversupply. Despite Saudi's energy conference on supply and prices we believe there is plenty of supply in the global market. Good try Saudi but your own cartel members are working against you. Weekly crude inventories will be released tomorrow and crude is expected to show a drop of -1.7 million barrels. It would be the sixth consecutive weekly drop.

The markets were confusing today with the early morning drop on the Consumer Confidence shock. The Dow dropped -120 points at the open to touch 11725 and test the March closing lows. Buyers rushed into the dip and the Dow rebounded +179 points to 11904. While the bulls were congratulating themselves for excellent analysis and buying at what should be strong support at the March lows the market rolled over again and erased the majority of their gains. The 11725 level on the Dow should be strong support but the rest of the indexes are not confirming. The Dow is ahead of the pack and the S&P, Nasdaq and Russell are lagging but appear to be breaking down.

Dow Chart - Daily

Nasdaq Chart - Daily

The problem for me is the Dow as the leader to the downside. I speculated on Sunday that the March lows would be a rally point ahead of end of quarter window dressing. So far that theory is holding but the window dressing has failed to show up. Actually we saw selling in winners today rather than buying. Agricultural stocks like MOS -7.69, POT -8.90 and MON -6.26 should have been moving higher as funds try to show how smart they were by stacking the deck with winners. Losers like the financials rebounded today. This is completely contrary to normal window dressing. Will it reverse as the week progresses? Who knows?

SS&P-500 Chart - Daily

Russell 2000 Chart - Daily

A big concern for me today was the Russell. When the other indexes had turned positive for the day the Russell was still down -7 points and that is a huge measure of negative sentiment for me. The Russell ended with a close at a new two-month low and a clear breakdown. As a fund manager sentiment indicator this is very bearish.

I was also especially disturbed about the sudden increase in the negativity of the market internals. In the table below look at how strongly the new 52-week lows have surged over just the past week. Volume has also increased with the majority on the downside. Note that the decliners are increasing as well. If the window dressing is going to appear it better hurry.

Market Internals

The line up for the rest of the week is going to be a battle between the Dow/Wilshire at strong support and the sdaq, Russell and S&P breaking down. The S&P closed at 1314 and has risk to 1275 and the March lows. The Nasdaq also closed at a two month low at 2369 and has risk to 2260. The Russell closed at 708 and has risk to 685. Once that 720 level broke the chart turned ugly and it will take a major change in sentiment to repair it.

EExpect volatility at 2:15 Wednesday afternoon when the Fed announcement hits the wires. Remember the initial market move is rarely the correct direction and the reversal is normally the trend that continues. RIMM earnings after the close if you want to play with fire. If you would rather play oil the inventory announcement is 10:30 with expectations for a continued decline in inventory levels. A sudden unexpected build could really create a slide in prices. I still expect window dressing to appear but it may get run over by the bears if the Fed statement is harsher than expected. After the Fed announcement volatility the volume the rest of the week is going to drop like a spent holiday rocket as traders leave for a long July 4th holiday. With the 4th on a Friday that makes the coming week the holiday week rather than the following week. I know it is still a week away but it is summer and it is a dull market. That is a perfect recipe for an extended holiday.

Jim Brown
 


New Plays

New Option Plays

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

Play Editor's Note: I was expecting to find more short-term bullish candidates following the DJIA's bounce from its March lows today. Unfortunately, nothing looked good enough to add to the newsletter and tomorrow is the end of the two-day FOMC meeting, which almost always brings added volatility. Keep an eye on the fertilizer stocks and the coal stocks. Both sectors look like they might be topping out. The fertilizer names could be volatile following MON's earnings tomorrow.


New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Bucyrus - BUCY - close: 75.99 change: -1.71 stop: 72.45

Volatility continues in BUCY. The stock reversed and gave up more than 2% today. The general trend remains a positive one but you could argue that the daily technical indicators don't look that healthy. We have two targets. Our first target is $79.85. Our second target is $83.50. The Point & Figure chart is bullish with a $92 target.

Picked on June 15 at $ 75.41
Change since picked: + 0.58
Earnings Date 07/31/08 (unconfirmed)
Average Daily Volume = 2.4 million

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Cephalon - CEPH - close: 70.56 change: -0.36 stop: 67.95

Yesterday CEPH had its price target raised to $86. This morning a different firm downgrades the stock. Shares react by gapping open lower at $69.71 and dipping to $69.38 before bouncing back. Our suggested entry point to buy calls was a pull back into the $69.50-69.00 zone so the play is now open. The test now is whether or not CEPH merely fills the gap from this morning or does it continue higher. Our target is the $74.00-75.00 range. CEPH could see more volatility tomorrow as it and several other companies present at a healthcare conference. We do not want to hold over the late July earnings report. FYI: The P&F chart is bullish with an $83 target. The most recent data listed short interest at 18.6% of the 66.2 million-share float. That is a relatively high amount of short interest and raises the risk of a short squeeze, which would obviously be good for the bulls.

Picked on June 24 at $ 69.50 *triggered
Change since picked: + 1.06
Earnings Date 07/29/08 (unconfirmed)
Average Daily Volume = 1.4 million

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DIAMONDS - DIA - close: 117.94 chg: -0.39 stop: 116.99

The Dow Jones Industrial Average pulled back toward its March lows as we expected. The intraday low in the DIA was $117.16. Our suggested entry point was the $117.75-117.45 zone. The play is now open. If you missed today's entry consider waiting for a bounce tomorrow, maybe over $118.75, before opening new positions. Our target is the $121.50-122.00 zone.

Picked on June 24 at $117.75 *triggered
Change since picked: + 0.19
Earnings Date 00/00/00
Average Daily Volume: 13.1 million

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SPDRs - SPY - close: 131.19 chg: -0.26 stop: 129.19

The market's pull back this morning also drug the SPY toward the $130 level. The intraday low was $130.19. Our suggested entry point to buy calls was the $130.50-130.00 zone. If you missed today's entry point then consider waiting for another bounce near $130.00 before initiating positions. Our target is the $134.00-134.50 zone.

Picked on June 24 at $130.50 *triggered
Change since picked: + 0.69
Earnings Date 00/00/00
Average Daily Volume: 200 million
 

Put Updates

Apple Inc. - AAPL - close: 173.25 chg: +0.09 stop: 182.55

AAPL managed to eke out a very minor gain. Yet I would give a victory to the bears. AAPL produced another failed rally under $176.00 for the second day in a row. If you are looking for a new entry point then consider new positions on another failed rally near $176.00 or a failed rally under $180.00. This remains a very aggressive, speculative play. We're aiming for $166.00. More aggressive traders could aim for the 200-dma near $162.00. If AAPL were to test $160 we'd expect a bounce and consider buying calls for a short-term rebound.

Picked on June 22 at $175.27
Change since picked: - 2.02
Earnings Date 07/27/08 (unconfirmed)
Average Daily Volume = 34.2 million

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Caterpillar - CAT - close: 76.64 change: -3.36 stop: 80.25 *new*

Shares of CAT plunged more than 4% on news it was buying a Brazilian company that makes train parts. CAT stalled midday at its 100-dma but eventually fell through it. The next stop should be our target at $75.25 just above what is probably support near $75.00 and its 200-dma. We're not suggesting new positions at this time. Our new stop loss is $80.25.

Picked on June 11 at $ 79.45 *triggered
Change since picked: - 2.81
Earnings Date 07/18/08 (unconfirmed)
Average Daily Volume = 6.2 million

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Deere & Co. - DE - close: 75.34 change: -2.14 stop: 81.05 *new*

DE sank to another new relative low today. We would not suggest new positions since the DJIA looks like it could bounce from its March lows. We are adjusting our stop loss to $81.05. Our target is the $70.50 mark. The Point & Figure chart is forecasting a $72 target.

Picked on June 12 at $ 78.49 *triggered
Change since picked: - 3.15
Earnings Date 08/13/08 (unconfirmed)
Average Daily Volume = 5.4 million

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Electronic Arts - ERTS - close: 46.14 chg: +0.10 stop: 48.55

ERTS bounced from short-term support near $45.50 this morning but the rebound was rolling over later this afternoon. The trend is still bearish but we're not suggesting new positions at this time. The stock looks poised to make a run at its 2008 lows. Our target is the February lows near $44.50-44.00. FYI: Don't forget that trading in ERTS is at risk for headlines regarding its attempted acquisition of TTWO. Depending on the news the stock could go either way.

Picked on June 06 at $ 47.75 *triggered
Change since picked: - 1.61
Earnings Date 07/31/08 (unconfirmed)
Average Daily Volume = 3.7 million

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E*Trade - ETFC - close: 3.44 change: -0.07 stop: 3.81 *new*

Target achieved! ETFC plunged to $3.25 this morning before paring its losses. We have two targets. Our first target is $3.25. Our second target is $3.05. We have to warn readers that today's rebound looks like a short-term bullish reversal. At a minimum we would expect a bounce back to its 10-dma near $3.62. We're adjusting the stop loss to $3.81. We are not suggesting new positions.

Picked on June 17 at $ 3.68
Change since picked: - 0.24
Earnings Date 07/23/08 (unconfirmed)
Average Daily Volume = 20.8 million

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3M Co. - MMM - close: 72.43 chg: -0.53 stop: 76.26

MMM declines again and produced another failed rebound near $73.50. The stock might bounce near its 2008 lows around $72.00 so readers may want to exit early near $72. We have two targets. Our first target is the $70.25-70.00 zone. Our secondary target is the $67.00-65.00 range. The P&F chart is bearish with a $69 target.

Picked on June 06 at $ 74.95 *triggered
Change since picked: - 2.52
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 4.0 million

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PowerShares QQQ - QQQQ - close: 46.81 chg: -0.24 stop: 49.05*new*

The intraday low in the Qs as $46.41. Our target is $46.10. Our concern is that some of the major indices like the DJIA and Wilshire 5000 have bounced from their March lows. If these indices bounce then the QQQQ will probably follow. It is worth noting that many of the major indices, including the NDX-100 which the Qs are based on, has produced a bearish head-and-shoulders pattern with a sloping neckline. We're not suggesting new positions. Our new stop loss is $49.05.

Picked on June 17 at $ 48.54
Change since picked: - 1.73
Earnings Date 00/00/00
Average Daily Volume = 133 million
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

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Amgen Inc. - AMGN - close: 46.36 chg: +0.47 stop: n/a

AMGN has continued to rally and it looks like the call side of the July strangle will be the winning side. The July $45 calls hit $2.14 intraday. We have less than four weeks left with the July options. We are not suggesting new positions at this time. The options in the July strangle are the July $45 calls (AMQ-GI) and the July $40 puts (AMQ-SH). Our estimated cost for the July strangle was $1.65. We want to sell if either option hits $3.50.

Picked on May 22 at $ 42.77
Change since picked: + 3.59
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 6.7 million

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Alpha Nat. Res. - ANR - close: 92.65 chg: -3.42 stop: n/a

It continues to look like the coal stocks have produced a short-term top but it remains a risky bet to just buy directional put positions. That's why we suggested this strangle. We're not suggesting new positions at this time. This is a higher-risk strangle play with the options so expensive. The options we suggested were the July $105 calls (ANR-GA) and the July $85 puts (ANR-SQ). Our estimated cost was $9.40. We want to sell if either option hits $14.50.

Picked on June 15 at $ 94.25
Change since picked: - 1.60
Earnings Date 08/05/08 (unconfirmed)
Average Daily Volume = 3.7 million

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Fording Cand. Coal - FDG - close: 93.40 chg: -0.35 stop: n/a

FDG shrugged off the general weakness in the market and the more-specific weakness in coal stocks today. Shares remain poised to hit new highs. We're not suggesting new strangle positions at this time. The options we suggested were the July $90 calls (FDG-GR) and the July $75 puts (FDG-SO). Our estimated cost was $5.45. We want to sell if either option hits $ 8.00 or higher.

Picked on June 15 at $ 82.91
Change since picked: +10.49
Earnings Date 07/21/08 (unconfirmed)
Average Daily Volume = 1.7 million

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Garmin Ltd. - GRMN - close: 43.19 chg: +0.57 stop: n/a

GRMN bounced from its lows near $41.40 but the rebound seemed to struggle near its trend of lower highs. We're not suggesting new positions at this time. The options we listed were the July $50 calls (GQR-GJ) and the July $40 puts (GQR-SH). Our estimated cost was $2.55. We want to sell if either option hits $ 4.75 or higher.

Picked on June 15 at $ 44.91
Change since picked: - 1.72
Earnings Date 07/30/08 (unconfirmed)
Average Daily Volume = 4.1 million

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Holly Corp. - HOC - close: 39.18 chg: -0.35 stop: n/a

HOC plunged to $37.65 intraday. The afternoon bounce made it back to the $40 level before rolling over again. This looks bearish. HOC gave us another entry point with the bounce back toward $40.00 but we're not suggesting new entry points at this time. The options we listed were the July $45 calls (HOC-GI) and the July $35 puts (HOC-SG). Our estimated cost was $2.00. We want to sell if either option hits $ 3.00 or higher.

Picked on June 15 at $ 41.25
Change since picked: - 2.07
Earnings Date 08/07/08 (unconfirmed)
Average Daily Volume = 1.1 million

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KLA-Tencor - KLAC - close: 40.90 chg: +1.10 stop:

KLAC out performed the markets today with a 2.7% gain. The stock gave us another chance at an entry around $40.00. We would open positions in the $40.50-39.50 zone. The closer to $40.00 the better. We listed two different strangles on KLAC.

KLAC Strangle #1) The options we listed were the July $42.50 calls (KCQ-GV) and the July $37.50 puts (KCQ-SU). Our estimated cost is $1.65 We want to sell if either option hits $3.00.

KLAC Strangle #2) The options we listed were the July $45.00 calls (KCQ-GI) and the July $35.00 puts (KCQ-SG). Our estimated cost is $0.70. We want to sell if either option hits $1.50.

Picked on June 22 at $ 40.07
Change since picked: + 0.83
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 3.7 million

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Tyco Intl. - TYC - close: 42.44 change: -0.46 stop: n/a

TYC is slipping lower and fell to its 200-dma today. We are not suggesting new strangle positions at this time. The options we suggested were the July $47.50 calls (TYC-GW) and the July $42.50 puts (TYC-SV). Our estimated cost was $1.30. We want to sell if either option hits $1.95 (50% gain). FYI: The $42.50 puts hit $1.35 today.

Picked on June 03 at $ 44.89
Change since picked: - 2.45
Earnings Date 08/05/08 (unconfirmed)
Average Daily Volume = 2.9 million

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United States Oil - USO - cls: 110.95 chg: +0.03 stop: n/a

The USO continues to coil sideways around the $110 level. We got another entry point near $110 more than once today. We would still consider new strangles in the $111.00-109.00 zone. We suggested two different strangles. The strangle with the wider strikes costs less but has higher risk.

FYI: If you opened new positions now the USO strangle #1 would cost about $5.85. The USO strangle #2 would cost about $3.10.

USO Strangle #1) The options we listed were the July $115 calls (IYS-GK) and the July $105 puts (IYS-SA). Our estimated cost is $7.10 We want to sell if either option hits $9.75.

USO Strangle #2) The options we listed were the July $120 calls (QSO-GP) and the July $100 puts (IYS-SV). Our estimated cost is $4.10. We want to sell if either option hits $6.50.

Picked on June 22 at $109.14
Change since picked: + 1.81
Earnings Date 00/00/00
Average Daily Volume = 12.5 million

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Valero - VLO - close: 43.16 change: -0.28 stop: n/a

VLO is still bouncing sideways. At this time we're not suggesting new positions. However, if you are looking for a new entry point then consider option positions in the $44.75-45.25 zone. The options we suggested were the July $50 calls (VLO-GJ) and the July $40 puts (VLO-SH). Our estimated cost is $1.89. We want to sell if either option hits $2.75 or higher.

Picked on June 15 at $ 44.84
Change since picked: - 1.68
Earnings Date 07/29/08 (unconfirmed)
Average Daily Volume = 10.8 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Another Tradable Bottom at Hand?

TRADING AT EXTREMES AND OTHER TA FACETS

I usually write this column on Thursday and did so last week, but a production glitch occurred that kept me out of the OI Daily Newsletter that day and I'm back with that article, but revised to today.

"TA" could stand for Teacher's Assistant, an element in the periodic table, Thermal Analysis, or the name of an investment group. TA is also an acronym for 'Technical Analysis'. As I sit here looking out over the beautiful blue Pacific Ocean, I am in my usual deep think about what I'm going to write about. As usual I will write about what technical analysis could be telling us about the current trend, along with notes on risk protection. When I don't hear from OI Subscribers suggesting their topics of interest, I rummage around in my own mind as to topics useful in trading options, what and why I got into past trades or, why not; e.g., why I stayed on the sidelines based on chart and indicator patterns. Also, very important, what mistakes I made (plenty) and what they taught me.

I can also report that I'm not IN a trade all that much, as I tend to wait for certain 'extremes' in the market. Extremes in price (e.g., waiting for a prior low or high to be re-tested);'oscillator' extremes (e.g., the RSI at 65-70 on the upside or 30-35 on the downside); extremes in 'sentiment' (i.e., traders get very bullish or bearish); some chart (price) 'patterns' you don't see all that much also reflect a type of extreme so to speak (e.g., a Head & Shoulder's Top/Bottom, a major double bottom or top, a 'rounding' bottom).

Besides trading LESS than many if not most, I mostly only BUY premium, although many good analysts and traders ONLY sell premium and think buying puts or calls is a losing strategy. One reason I do is my competitive nature. It's a heck of a challenge and thrill to accurately pick turning points in the market. My Wall Street/Trader mentor, Mark Weinstein (see the "Market Wizards" book), was an absolute master of knowing when the market was about to change direction.

Back to this question of BUYING options, versus selling premium; everything from selling puts, calls, and all the varieties of spreads and straddles, etc. Isn't buying a sucker's game so to speak? Don't most traders lose money that way? It's true many if not most holders of options lose money. However, I say the reason is NOT that, intrinsically, buying calls and puts is a losing proposition, but the reason is a failure of discipline and at least some dedicated work and study. It's a failure of WAITING for the right opportunity. Many great traders will tell you that they made more money waiting for the right conditions to pull the trade trigger than they did by frequency of trading.

People who advise being on only one side of the buying versus selling premium game are saying that they find the buying game a losing proposition for THEM. Is it more profitable to be in the market frequently, making steady perhaps modest money taking advantage of the relentless erosion of premium, or to be in the market only a few times a year, maybe only a couple times a month, for big 'scores' as my mentor used to say? Having been a stock and options broker once, I know for sure that you don't need to trade often (it paid me well!), only to trade well for yourself.

WAITING FOR 'EXTREMES'
Timing is everything in terms of buying options. If you wait only for the relatively few times that the major indexes or key stocks are quite overbought or oversold, raising the probability for a trend reversal or a break out move, you will have more time on your hands to study market conditions. If you can't wait as you're addicted to action, know that this involves a greater degree of gambling. I rarely devoted full-time to trading but often was paid to comment on the market OR run a department; even then I consistently made time daily to update my charts and thinking on the market.

Buying options at extremes tends to also control risk and makes for a more favorable risk to reward. Extremes in the market are points where you can usually exit with a small loss if you are wrong; e.g., when an index or stock is extremely oversold does NOT tend to also be when the market tanks on negative news as all or most bearish influences have already been factored into current price levels. Markets tend to go from extreme to extreme.

You can use 'tight' stops/exit points only at extremes. Your 'reward' potential is greatest at the high potential points for reversals if you've gone against the trend-followers. The tendency for a 'trend-following' strategy and thinking is what makes 'contrary opinion' work. When all are bullish everyone is long and it's often time to exit. I'm going to pull much of the above 'theory' into illustrating some past and current trade 'set ups'.

HOURLY CHART AND INDICATOR EXTREMES
Even in a market with a dominant and prolonged trend, there are nevertheless challenges in knowing where to take profits on an options position, then knowing when to get back in, especially when the trend turns mixed and volatility increases. Especially then I recommend close study of HOURLY charts and especially with the stock indexes, using 90-120 day or more of hourly history, which is why you usually need your own charting application with a good data base, whether history resides 'locally' on your machine or you pull in all price history from your provider's database.

I often say that the Dow 30 (INDU) is one major index that trades quite 'technically' much of the time. For example, INDU trends steadily lower along a well-defined down trendline as seen below. I also suggest use of the Relative Strength Index (RSI) with a 21 'length' setting, a fibonacci number; I use 13, a fib number, on daily charts.

In a downtrend, RSI extremes will be less frequent and won't tend to as high as 70. 30 and 70 are the most common 'default' settings for 'oversold' and 'overbought', but you should evaluate your own 'extremes' for any given market cycle. Readings at 65 and above have defined 'overbought' extremes in recent months on the 21-hour RSI. A clear cut put buying opportunity came in mid-May, when a double top and a 65 RSI extreme lined up, per the first set of red down arrows (left) below.

The oversold extreme in the INDU downtrend has been at the common 'default' setting at 30, as highlighted by the green UP arrows. Should puts have been exited at these points? Yes, as you don't know the strength of a counter-trend rebound. After the rebound at the first such extreme, there was not a second overbought 'extreme'. However, there was another TA pattern that suggested a next put buy.

An important technical concept is that of a chart 'breakdown' point, where prices have a DECISIVE downside penetration of a prior low. Expect a return to this breakdown point be a definite new resistance as seen at the second red down arrow on the hourly chart below. The return to a key breakdown point is also a type of 'extreme' and suggests a good opportunity in puts; with tight stops, it also offers a favorable risk to reward ratio; e.g., 1 to 3 or more.

Based on the MOST RECENT oversold RSI reading occurring TODAY, there is now a compelling reason to get out of puts based on the above hourly chart and indicator patterns. I also see a favorable risk to reward in buying S&P and Dow Index calls.

Shifting to the daily S&P 500 (SPX) chart and using the 13-day RSI as a trading input, today's second foray into the RSI oversold zone, is more compelling as a possible trading 'signal' because SPX held an important prior low. I would set my exit point on calls bought today to just under today's lows, which constitutes a 'tight' stop. Relative to this amount of risk, I assess upside potential as 3 times my exit point and the trade risk to reward potential I favor.

Trader sentiment as suggested by my 'CPRATIO' indicator seen next with the OEX daily chart, has been coming down steadily and got to the kind of extreme on Friday after which I then anticipate a good-sized rally to follow within 1-5 (trading) days of such a 1-day extreme, at the level green line highlighting an equities call to put reading of 1.1.

All prior extreme 1-day readings seen below at the green up arrows suggested rallies should develop. 'Too many' traders were in puts, short stocks or out for the market NOT to go the other way; i.e., UP! The market is perverse that way, but this dynamic reflects the fact that too many traders follow what others are doing rather than ANTICIPATE where/when the market would be primed to shift direction. The first 'CPRATIO' extreme was a shorter-lived rally, the second was a major rally, the third was a 'continuation' signal and the forth or last one has an unknown outcome.

It seems 'logical' that that when a key stock index such as the S&P 100 (OEX) is coming down to likely support, such as OEX 595-600, that traders might get MORE bullish and pick up their activity in calls, but they have been trading in the proverbial REAR-view mirror and looking at what came before and expecting the current trend to carry on!

For another view of the further downside potential in S&P puts, I'll shift to the hourly SPX chart for a closer up view in the S&P 500 (SPX) to compare to and with the SPX daily chart seen above.

Although there was no hourly RSI overbought extreme (at 65) that was seen, the double top in SPX (with the second top noted at the red down arrow), is the type of chart 'signal' that only comes along occasionally and is a pattern that suggests perhaps going into puts in a bigger way than just a typical trade as long as this is not an over-commitment of total trading money and with a tight overhead exit point/stop. This is where WAITING pays off. It would take a lot of trading to make as much as could have been achieved after the second tip off top.

The recent hourly RSI has finally 'signaled' an oversold condition. In order not to get too mesmerized by just the RSI, the price pattern is of primary importance. Today's rebound from the highlighted down trendline, intersecting around 1304, provides a favorable suggestion of a bottom. I don't think there's much downside left, but on call purchases would risk only to just under today's 1304 low or, at most, to just below 1300 through tomorrow (Wednesday) only.

I've noted a bunch of LETTERS at points on the hourly Nasdaq 100 (NDX) chart below where trade possibilities are suggested and their rationale technically.

Points 'A' and 'B' were both accompanied by RSI (overbought) extremes and buying puts at point A would have resulted in being stopped out if we went on the overbought extreme alone. There WAS a sharp but brief dip that followed. The rebound and climb back ABOVE point A would have been my exit point and the most I would have risked. The second top B constituted a favored trading set up where RSI failed to 'confirm' price action by its own higher high, which suggested that 'internal' relative strength was diminishing.

Point 'C' not only saw an oversold extreme but most importantly was a double bottom low. A major rally followed. Points D and E constituted the same type of trade set up suggested at point A and B. Point 'F' looked like a significant buy in the area of prior low 'C', but the well-defined although short-lived up trendline (after the low at F) got broken and was a clear cut warning to the bulls. When point F was pierced after that, it was time to exit if not done sooner.

The recent NDX top at 'G' formed an approximate double top in the 1987 area, but prices rebounded yet again after declining to 1940. That rally failed again in the same area forming a TRIPLE top. Puts bought in this area were quite profitable into today, with 1900 looking like a good place to exit. Just as important as the 'reward' potential, placement of a tight stop, just over recent highs, offered a low 'risk'. Relative to that exit point or risk, a sell off to the 1900 area (my target) offered good potential relative to the amount risked.

LAST BUT NOT LEAST, point "H" seen above was today's hourly low and along with it came an oversold 21-hour RSI reading, where previous buying opportunities have occurred. My chart analysis has suggested that the 1900 area ought to hold as a low with part of the reason being support implied by the circular arc bottom pattern I've highlighted on the NDX DAILY chart below.

While the NDX daily chart still suggests potential for prices to fall further and 'fill in' the chart gap on a decline to the 1850 area, I also see trade potential in buying NDX calls around 1900, risking only to 1885, knowing that I could end up with a small loss and re-evaluating calls later on, such as on a decline into the gap area.

QUESTIONS/COMMENTS:
Please e-mail Click here to email Leigh Stevens support@optioninvestor.com with any questions or comments, with 'Leigh Stevens' in the Subject line and it will get forwarded to me for a reply.

GOOD TRADING SUCCESS!
 

Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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