Table of Contents
I am getting seasick on all these market waves. Dropping 200 one day and rising 300 the next reminds me of suffering through 12 hours of 12-15 foot waves on a fishing trip I once took. Traders are getting whipsawed left and right with stops being crushed on both sides of the market. Bears are getting hammered one day and bulls the next. Fortunately Friday's breakout suggests a new trend is taking shape.
Wilshire-5000 Composite Index Chart - Daily
Friday was a lackluster day for economic reports. The Productivity and Costs report for Q2 was worse than expected on productivity but better than expected on costs. Nonfarm productivity rose +2.2% compared to expectations for a 2.8% gain. Unit labor costs rose only 1.3% compared to expectations for a 2.7% gain. These numbers are lagging indicators but do suggest that inflation pressures are easing and that will be good news for the Fed. Wholesale trade numbers for June showed inventory levels rose 1.1% and sales +2.8%. This compared to expectations of 0.8% and 2.2% respectively. This is also a seriously lagging report nearly 45 days after the period surveyed. The markets rarely pay any attention to these numbers as anything other than just another brick in the economic foundation. Most of the price increases were attributed to the rise in crude prices so it is hard to get excited about the gains.
The economic calendar for next week is mostly filler. The only moderately interesting reports will be the Consumer Price Index on Thursday and Consumer Sentiment on Friday. There is just nothing on the calendar that will interest the markets.
The markets on Friday were influenced by three things. The Citi/UBS settlement on auction rate securities, the continued implosion in oil prices and the strengthening dollar. UBS, Switzerland's largest bank, agreed to buy back $18.6 billion of auction rate debt securities whose value collapsed during the global credit crunch. This followed news on Thursday that Citi and Merrill would buy back almost $20 billion in auction rate debt. The auction rate securities were rated as liquid as cash when they were sold by the major firms. The auction rate market was valued at $330 billion before it collapsed in February. Owners had been unable to access their money since February. Several other banks are said to be under investigation by regulators over this issue. The banks are agreeing to pay substantial fines but the buybacks are not going to be immediate. For instance UBS will buy back $8.3 billion beginning on Oct-31st and the remaining $10.3 billion beginning in June 2010. UBS was under attack by the state of Massachusetts, New York and the SEC. The settlement with these agencies and $150 million fine will cover 80,000 investors. Unfortunately just knowing you will get your money back by 2010 is not the answer. Since these securities were marketed as cash instruments many institutions parked operating funds there because they could get it out with 72 hours notice. If I put my next six months of operating cash in an auction rate security and planned on withdrawing as needed over the next six months and suddenly I could not get access to the funds until 2010 I would be hysterical. This is the problem these investors faced.
The auction rate system broke down in February when several banks who made a market in the daily auction system withdrew their support. Suddenly there were no bidders and 100% sellers. The market was frozen without any market makers and nobody had the cash or the credit lines to step up to the auction window. That is the problem with the settlements and the two-year window for buying back the debt. The major banks simply don't have the cash to buy them back today. Everyone in this debt wants out immediately making it a true run on the banks. The concept behind the auction rate market was a liquid pool of capital paying market rates as decided by a daily auction. It was like a big money market where some companies could sell bonds into the market and others could invest in the bonds on a short-term basis. They could always get their investment back at any time by selling the bonds back into the market in the daily auction. When the buyers disappeared the rates offered by sellers rocket by several hundred percent and companies that needed to finance their operations could no longer afford to sell their bonds into the market. A typical seller would be a city government or university building project trying to capitalize on the low interest rates rather than do a permanent bond offering. Some estimates claim there are more than 500,000 players in this $330 billion market. When it froze it caused a monster capital drain on those players. This settlement is only a portion of the outstanding debt but a big step in the right direction. Banks hope that once the market starts trading again it will loosen up and return to its prior cash-liquidity status. Unfortunately it will not happen until the major banks are able to again make a market in these securities. Without cash and credit lines it will be nearly impossible for quite sometime.
The market took these settlements as evidence the credit crunch is beginning to ease. Granted it is a small step but one problem that had been hanging like a guillotine over the sector. With these major banks initiating the settlement process the smaller players will probably see the light and do the same. That gave the market hope that one more credit cloud was dissipating.
Oil prices fell -$4.87 to close at $115 and well under prior support. Traders are now convinced we will see $110 tested next week. This drop came despite a major pipeline bombing that took nearly one million barrels per day offline for up to five weeks and an escalation in the war between Russia and Georgia. Russia is the second largest oil producer and there are fears the escalation could pressure supplies from the region. Elsewhere the U.N. group working on the Iran problem said it could be October before a new vote on sanctions could be brought to the U.N. Security Council. That effectively put the Iran problem on the back burner and out of the headlines. The result was a breakdown in support for oil over fears U.S. declines in miles driven will lessen the long-term demand for oil. The EIA said demand in July fell -2.3% over the same period in 2007. Americans are not driving and are altering their consumption habits. However, as we have seen countless times in the past the return of cheap gasoline always increases demand to prior levels. It is only a matter of time. Until that happens the price of oil could continue to weaken with $110 the next major support level. This is exactly what the Fed was hoping for since oil prices were a major contributor to the rising inflation over the last six months. Falling oil prices will slow inflation, reduce costs for businesses and reenergize the global economy.
Crude Oil Chart - Daily
Dollar Index Chart - Daily
Lastly the market was helped by the rise in the dollar. The US Dollar Index has exploded over the last two weeks to a six-month high and that makes commodities including oil significantly cheaper in dollar terms. The change in the dollar is coming at the expense of the Euro. The rapidly declining economic conditions in Europe prove once again that when the U.S. economy sneezes the rest of the world catches cold. The Euro also sank against the Japanese Yen and the British Pound. On Thursday the ECB and the Bank of England left their key rates unchanged at 4.25% and 5% respectively. ECB President Jean-Claude Trichet issued a warning on inflation and said economic numbers for Q2/Q3 would be much weaker than expected. He also indicated a rate hike to fight inflation would probably not be coming. This is in sharp contrast to his statements back on June 5/6th that the ECB was planning to raise rates. That comment sent the dollar plunging and the price of oil up $10 over two days. The sharp rise in the dollar is a game changer for commodities and the balance of trade. A stronger dollar helps in many ways but mostly in lowering the cost of commodities and raw materials for U.S. firms.
All of this good news on one day created yet another short squeeze of monumental proportions. All the major indexes broke out to new six-week highs and it would appear on the surface the bear died. Unfortunately that may not be the case. All major market turning points occur on high volume. Friday's volume was barely over 8 billion shares and definitely not a strong day. That is not to say we did not have a change in market sentiment but that did not translate into a change in the internals.
Part of the underlying factors in Friday's market gain was the normal Friday before options expiration trade. For the last couple years the option expiration fireworks have come on the Friday before expiration rather than expiration day itself. This is the funds rolling out of option positions before the premiums collapse completely and before the next months premiums rise as they become the front month. For the oil sector the options on crude futures expire next Thursday. Anybody who was bullish on crude over the last month was dumping those losing positions Friday.
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In stock news Apple caught new coverage at outperform by Credit Suisse after UBS initiated coverage on Tuesday with a buy. Apple gained +5.94 to cap a four day win streak of +$16 to close at $170. That is the highest level it has reached since earnings disappointed on 7/21 and we saw a low of $146 on 7/22. Personally I think Apple is a screaming buy. I went to the mall on Thursday after the market closed to have my glasses fixed. With an hour wait for the repair I decided to walk the mall and checkout the retail activity. Abercrombie & Fitch (ANF) did not have a single customer in the store and I checked twice over 45 minutes. All the high profile stores were ghost towns with salesmen grouped around the registers like vultures waiting to pounce on the next unlucky person to wander into the store. There was one store that was a huge exception to the rule and that was the Apple store. At 2:30 on a Thursday afternoon there were more than 70 people packing the 35x120 foot store. The activity was frenzied and people were carrying out bags in both hands. They were buying iPhones, iPods, notebook computers and accessories by the bag full. I stepped inside and just stood in the corner watching the frenzied activity. The manager noticed me and came over to ask what I was doing. I commented on Apple being the only store in the mall with customers and he laughed. "This is a slow period. Come back on the weekend and we will have a waiting line outside in the mall. We also have a security guard for crowd control." I know Apple was cautious in their earnings outlook but they are making money by the truckload. I would be a strong buyer of Apple on any pullback. $4 gasoline has not hurt their business the way it has everyone else. I would also be a seller of ANF.
Meanwhile I would also be a buyer of Research in Motion (RIMM). I got a kick out of one group of teenagers I saw in the mall. There were six of them and they were having a heated discussion about the various merits of their phones with three holding Blackberries and three holding iPhones. That should tell you something about the impact of these phones that six 15-17 year old high schoolers all had these phones. The BlackBerry is far from dead and as we have seen in past earnings reports the iPhone success has actually helped the BlackBerry rather than hurt it. By raising the average selling price of a fully featured phone it made the BlackBerry more attractive. With multiple models and plans it is actually cheaper than the iPhone in many cases. Did you ever think you would hear the Blackberry called a cheap phone?
If you just looked at the airlines you would think oil prices had fallen back to $15 a barrel rather than $115. The XAL closed at $25.15 and has risen 100% since hitting a low of $12.66 on July 15th. If you were smart and bought airlines when everyone was planning their eulogy you would have a great trade. Some of the individual airlines have gained more than 100%. Take Continental (CAL) for example with a rally off the $5.91 low to close at $16.48 on Friday. AMR $4.00 to $11.26 is another example along with United (UAUA) from $2.80 to $11.13. I hope the rally continues so I can short the heck out of the XAL the next time oil heads towards $150. The pain relief is only temporary and once peak oil arrives we will see permanent new lows across the board. Until then they would be a trading vehicle and a prime example of how quickly consumer sentiment reverses when oil prices fall. Who knows, next week we could have GM telling us they sold out of new SUVs. The Dow Transports were up +5.4% for the week.
XAL Chart - Weekly
Ford joined the anti-lease club on Friday with an announcement they were going to reduce lease volume by making leases more expensive and shifting incentives to favor purchases. They will reduce the residual value assumptions on the leases, which means the user will have to pay more on the monthly payments. This puts the burden back on the consumer and you can bet it will reduce sales simply because leasing was a cheaper alternative in many cases because the user only had to pay for a couple years of use rather than the full price of the vehicle.
CCountrywide Financial Chart - Weekly
It was a year ago this week that Countrywide Financial began the bprime crisis with a note buried in their 10Q warning that unprecedented credit problems had risen sharply and current liquidity "should be enough" to weather the storm. Obviously that statement proved to be wrong and the mortgage meltdown began. Today Fannie and Freddie are about the only mortgage lenders left in the marketplace but there are signs the housing crisis may be easing. Florida actually reported rising home prices in several areas. Sales on the West Coast are increasing and homebuilder losses are slowing. Obviously we are far from out of the woods but conditions are setting up for a rally in the spring of 2009. That of course assumes we avoid a recession this fall.
The Dow broke out to a new six week high on Friday on a gain of +302 points and +408 for the week. We have a strong pattern of higher lows and it appears the buying interest is increasing. However, if you look back at the March rally the Dow rose for 69 days after the March 10th low before rolling over into a steep decline. Most analysts are giving cautious comments about assuming a new bull market has appeared. They cite the low volume as evidence of low buyer interest. However, August is a low volume month as traders try to squeeze in the rest of their vacations before Labor Day. I would love to see the rally continue and the breakout appears promising but it did start as a short squeeze at the open. Be bullish but be cautious.
DDow Chart - Daily
Thomas Lee an analyst at JP Morgan claims there have been 31 bear markets in the
last 100 years. Those that dip to the 20% threshold and then quickly rebound are
called cub markets rather than full-grown bears. So far this fits the
description of a cub market exactly. Lee says that in the first six months of a
rebound out of any bear market the average is a 15% gain in the Dow. Over the
first 12 months that stretches to 25%. The key here is determining if the July
15th low is the actual
low and therefore the point where the rally began. With
unemployment claims mounting and retailers whining about less than expected
sales and with another round of bank write-downs still to come there could be
another leg down. An 8-10% rebound in a bear market is a common occurrence and
Friday's gains took this rebound to 8.2%. Also remember that August and
September are the two worst months of the year for the markets. It is not
unusual for the markets to set the lows for the
year over the next 90 days.
Personally I am becoming more bullish each day but remember Thursday saw a drop
of more than 200 points after more than a 400 point gain on Tue/Wed. A market
view can and does change daily with these types of market swings. Who would have
thought at Thursday's close that Friday would see another 300-point gain?br>
Nasdaq Chart - Daily
The Russell dipped back to 711 on Thursday after breaking above 720 on
Wednesday. 710 is uptrend support and it used that level to blast off to a new
high at 733 and a +3% gain for the day. The Russell is approaching its next
serious resistance at 745-750 and a point where we could see further
consolidation. A move over that level is a confirmed bull signal with next
resistance at 800. I believe it is too soon to be talking about numbers over 750
until the bulls prove Friday's rally
has legs. The Russell did break back over
the 200-day average on Friday and that is a fund buy signal. br>
S&P-500 Chart - Daily
The S&P is lagging because the financials were holding back on Friday. There is
still fear of future write-downs and potential bank failures. I checked the news
sources this weekend and did not see any new failures but that does not mean
there are not some in the pipeline. The S&P did close over the 1290 level but
only by +5 points. That level was trouble in July. Current support is 1260. br>
THE BOTTOM LINE:
I wasn't able to update last weekend due to technical problems I was having with my notebook PC while away from home base. I missed my usual Trader's Corner article from a week ago Thursday, but managed to get back in action this past Thursday.
I was predominately bullish on my last Index Trader update from 2 weeks back and even more so on in my Thursday "Trader's Corner". I'll repeat some of that commentary (on 'rectangle bottoms') here. You can go to the full (Trader's Corner) article yourself online also by clicking here.
In the aforementioned article I took note of the 5 technical patterns that Dr. Andrew Lo's research at MIT pointed to as having above average predictive significance in terms of how the trend unfolds after these patterns. Those 5 patterns are the:
1. Rectangle bottom
The bottom pattern in the S&P 500 (SPX) is the more common V-bottom type; this formation was also significant for suggesting a bottom was developing or in place. Heres the SPX daily chart as of the Thursday close:
All that was needed to 'prove' the bottom so to speak was a move above the highlighted 'line' of resistance seen above, but that outcome was fairly well predicted (to me anyway) by the pattern.
So, along comes Friday, a total 'random' event (sure!) and the updated SPX daily chart looks like this of course:
What I ESPECIALLY took notice of was the 'rectangle bottom' that was shaping up in the market-leading Nasdaq 100 (NDX). Not only was this bottom pattern of a higher 'order' of predictive value (per Dr. Lo and my past experience), but the rectangle pattern has a 'measuring' implication for a next upside objective for the move.
Next is the NDX daily chart I showed in my Thursday column so it reflects the index only through Thursday. I noted the following about the NDX chart then:
"There was a breakout above the top end of the implied NDX rectangle yesterday (Wednesday), followed by a pullback to the top end of the box like pattern today (Thursday). If there is a valid breakout that has occurred, what was resistance (the top of the box) ought to now 'become' support. Stay tuned on that!
The measuring implications of a breakout above an apparent rectangle bottom are a 'minimum' one (the conventional interpretation) seen if there's a move ahead equal to distance 'A' and a 'maximum' one, suggested by a move back to retest the 2056 high and equal to distance 'B'."
The next development in the chart is reflected next, where everything (comments, etc) about my graph is the same EXCEPT that NDX reflects Friday's major rally:
A long segue-way intro here saying that I'm STILL BULLISH based on the charts and the market is getting more interesting. Individual stock index commentaries follow below. This coming Friday is expiration of index options, so there may be some volatility related to unwinding.
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FUNDAMENTAL MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) could be bottoming for a move higher, such as back to the 1320 area or even 1350. The dominant or longer-term chart pattern is bearish. I wanted to be long calls since and after the tip of the V-type bottom was made in the 1200 area; on a risk to reward basis the outlook was very favorable at that juncture. I think it's still favorable to be long calls and short puts, just so it's understood that the further upside potential is getting more limited.
Key near resistance is at 1320, representing a fibonacci 50% retracement of the last downswing. Next SPX resistance comes in the 1350 area and that's about the best upside I see for this current move. Longer-term, I don't know. Fortunately I don't have to think 'long-term' as in a portfolio situation. In the S&P I like the major oil stocks again however, as the CBOE Oil Index (OIX) is back down to support implied by its long-term (multiyear) up trendline.
Pivotal near support is at 1260, with next technical support in the 1235 area.
S&P 100 (OEX) INDEX; DAILY CHART:
The S&P 100 (OEX) Index has been trending higher ever since the one bullish call to put volume reading highlighted on my 'sentiment' indicator below, at the green UP arrow. How good is this indicator or what! I don't put much stock in moving averages/moving average crossovers of this ratio in terms of timing entry or exit on trades; the 5-day moving average I display is to give a bit broader take on the trend in the actions of options players.
While it looks like it still ok to hold calls, and buying on the pullback to the low end of the broad downtrend channel offered a fantastic opportunity on a risk to reward basis, I don't want to lose sight of fact that the major trend is still down and bearish. Keeping this in mind makes for a still cautious attitude; as you know there has been a lot of volatility in recent weeks with all the many cross currents.
I can see potential back up the 610 area and possibly OEX will make a run to the low-620 area. Fairly tough resistance begins around 640.
Very near support is at 596, at the line of prior recent resistance. 580-581 is the pivotal technical support. 'Pivotal' implies that a close below the key 21-day moving average, not reversed (back to the upside) the following day, would reverse the short-term trend to down. A 'confirmation' of a renewed downtrend would look conclusive on a two consecutive day close below 570. 550 is major support.
DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 (INDU) remains the weak sister (brother?) of the major market indexes. INDU has rallied recently of course, pulled up by the broader market, but the INDU advance has to be seen as being within a dominant downtrend.
I can envision a continuation of the recent advance to the 12000 area but not much more than that currently. A weekly close over 12000 would be bullish, suggesting potential for a move to still higher levels, perhaps to the 12300 area, maybe even to near 12500 which is major technical resistance currently.
Near support is anticipated around 11400, below this in the low-11200 area, extending down to 11125, at the late-July downswing low. Major support begins at 11000 and extends to the 10800 area.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
If there's a place to be it's in the tech stocks and the Nasdaq Composite (COMP) Index had a powerful surge this past week. After a decisive upside penetration of near resistance in the 2350-2352 area, there was one pullback to this area which was had 'become' technical support, giving a further opportunity to pick up some calls in your favorite tech stock mover or in the awesome Nas 100.
COMP probably will begin to encounter near-term resistance in the 2420 area, with stronger technical resistance around 2480. Major resistance lies at the prior double top at 2550.
Near support is in the 2300 area, then at 2280-2270. Major support is at 2200.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 (NDX) Index projects to 1950-1957 and could get back to at or near 2000, which was the prior 'breakdown' point. The overall chart remains somewhat mixed but the long-term weekly NDX chart uptrend remains intact. Most importantly to index option traders, NDX has had substantial price swings and directional trends BOTH up and down for weeks, not days, unlike say the Dow 30. Once NDX broke out above its well-defined multiweek 1785-1870 price range, it wasn't rocket science to predict that the index was going to run to the upside.
'Rectangle' bottoms tend to have a good record of predicting a good-sized move in the direction of the breakout as the shorts scramble to cover when the index shoots above resistance that's been in place for awhile and the bulls come in less fearful and in a buying mood. In the new global economy, tech has been one of the brighter spots in earnings trends. My recent 'technical' troubles in my trading software were just solved by a new Dell Notebook PC and I'm impressed with how much power and performance it has. Technology is one of THE markets for the future as demonstrated by the powerful aforementioned long-term uptrend in the tech biggies.
Near NDX support is at 1870, with pivotal technical support at 1840, and major support beginning in the low-1800 area.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
It's been a relatively low volume rally in the Nasdaq 100 tracking stock (QQQQ), but I have a new theory on volume as it relates to this key tracking stock. Less volume means less conviction and like low bullish 'sentiment' offers a contrary indicator; i.e., tends to be bullish.
I wrote last two weeks ago that I was projecting a move in the Q's to the 47 area. It now looks like QQQQ could move still higher, but I don't see huge upside before stronger selling interest comes into play, especially if the stock gets back up to 49.
Near resistance is at 48, with tougher resistance likely in the 49 area, which was a prior breakdown point. Near support is at 45.25, with next support coming in at 44.25-44.0. Major support is at 43.
RUSSELL 2000 (RUT) DAILY CHART:
The Russell 2000 Index (RUT) is mixed in its pattern and best resembles a broad trading range market. Buying at the low end of the range on the last dip under 660 was a winning trade and it looks like there is more upside ahead, perhaps back to the 760 area, or the top end of RUT's broad range.
The fibonacci 55-day moving average continues to be a good trading guide as to the trend. The average initially acted as resistance (note the red arrow) and when RUT finally managed more than at 1-day close above this key average, it defined a key area of technical support.
Near resistance is in the 740 area, then at 760-763, the area of the prior top. Pivotal near support is in the 712 area then in the 702 to 694 zone.
GOOD TRADING SUCCESS!
NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.
Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.
I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM) strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as well as projected profitable index price targets, are based on my technical analysis of the indexes.
I knew better.
A year or two ago, I wrote an article detailing how traders can be right about direction but still lose money if they chose the wrong option. The point of that article was to choose an option with a delta high enough to benefit from any price movement. Before putting on a recent option trade, I should have reread my own article.
Delta is one of the Greeks of option pricing. It measures how much an option's price can be expected to change for each one-point move in the underlying. For example, if I had a call contract on the XEO with a delta of 0.70, each time the XEO climbed a point, my call option would, in theory, gain 0.70. Of course, other factors influence options pricing and it's rarely that clear-cut, but looking at delta can give traders an idea of how an option's price will be impacted by price movement.
Obviously, if the XEO dropped a point, my call option would be expected to lose about 0.70 in price. It works the opposite way with puts, of course, with a put's price decreasing if the price of the underlying climbs and increasing if it drops. For that reason, a put's delta is negative. That reflects the result when a 1-point rise in the underlying results in a loss of 0.70 for a put with a delta of -0.70. A call's delta is positive.
My choice for day trading was an option with a delta above 0.70. Depending on the nomenclature used, some would consider that a delta of 70, multiplying the 0.7 for one contract by the 100 multiplier for most options. In fact, McMillan in OPTIONS AS A STRATEGIC INVESTMENT advises that you eschew options entirely if you're day trading. Trade the underlying, he advises, where your delta is 1.00. I don't go that far, but the idea is that the shorter term your trade is, the higher the delta should be for most traders and most trades. As with any advice, caveats to that exist, but for most cases, that's the way it works.
Delta can provide a rough estimate of how likely an option is to be in the money at expiration. An option with a delta of 0.70 is considered to have a 70 percent probability of being in the money at expiration. Options that are at the money when purchased typically have deltas near 0.50 or -0.50, depending on whether they're calls or puts. This reflects the 50/50 chance that they'll be in the money at expiration. An out-of-the-money option with a delta of 0.15 has about a 15 percent chance of being in the money at expiration.
That's the background. Here's the story. The VIX was hitting what I thought might be support, which to me meant that options were cheaper than they were going to be in the near future. I'm making concerted efforts this year to vary my delta and vega risks. Since my credit spreads are heavily negative on the vega side, I thought looking for some long option trades might balance those portfolio risks. Most times, a climb in the VIX brings equities lower, so a trader who expected the VIX to climb and wanted a long options trade to take advantage of the plumping up of options' values would be looking for long put trades. I was, but there are some exceptions. My search led me to one the evening of July 8. That evening, while researching, I noticed something on the chart for PFE.
Annotated Monthly Chart of PFE:
Confirmation that big money had been doing some buying would come if the next month's candle was a green one, and by July 8, PFE was climbing well off the June low of $17.12. I know from my limited understanding of volume/price-spread analysis that the best time to buy is actually when there's a retest on low volume, but I was looking for a short-term trade of a week or two, with little money put at risk, since PFE was due to report soon. What I really wanted was a test of my theory that options were cheap, that a long trade would moderate my vega risks and that the volume/price-spread analysis, as I understood it, was still working. This volume/price-spread analysis is usually the basis upon which I place my rare directional options trades, and I like to test it every once in a while. This was intended to be a speculative trade for the speculative part of my portfolio.
So what did I do? Something stupid. My further chart analysis told me that before August expiration was up, PFE was likely to hit $19.50. So, with PFE at $18.12 on 7/09, I bought 10 contracts of an OTM AUG 20 call for $0.17 each, for a total of $185.00 with commissions. My thought process was that if PFE bumped up to $19.50 within a week or two of opex, the OTM call would plump up enough that I would gain, especially if it did so rather quickly. However, I was worried about that possibility of PFE rolling over to retest again, and I didn't want to put more than $200 at risk. I was also managing a lot of trades at the time and knew I'd be juggling more if indices rolled down again, and I wanted something I could just let run.
I didn't write down the delta in my trade records for this speculative trade, but an option pricer calculates that the delta of that trade was probably about 0.15. Although in my own defense, I thought that volatility would also increase heading into earnings, also helping to plump up the costs of the option, how did I think I was going to profit on that?
I was right about direction and somewhat right about timing, too. On August 5, well before option expiration, PFE hit $19.50.
Annotated Daily Chart of PFE:
At 3:44:38 on 8/05/2008, with PFE at $19.70, I sold those 10 PFE AUG 20 calls for $0.14 and was lucky to get that. With commissions, I collected $124.99 and lost $60.01 on the trade. In effect, I paid $60.01 to learn that my guess about PFE's target and the before-opex timing was right, but I was all wrong when I made my choice of the option to trade.
I've written articles about traders who wonder why their options' prices aren't changing when the underlying moves in the direction of their trade. That's almost always because the option had a low delta. I set up a trade that had almost no chance of profiting.
Well, actually it had a chance. A 15 percent chance, according to the delta at the time I entered the trade.
I knew better. Now I hope you do, too.
Play Editor's Note: I don't trust this rally. My bias is that we're still in a bear market and this is just a big bounce. However, I can't trade what I think is happening - only what the market is showing us. I'm adding a couple of bullish positions but traders need to be cautious!
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Why We Like It:
BUY CALL SEP 130.00 IBM-IF open interest=6210 current ask $3.30
Picked on August xx at $ xx.xx <-- see TRIGGER
Illumina - ILMN - cls: 89.36 chg: +1.34 stop: 86.45
Why We Like It:
BUY CALL SEP 90.00 IQA-IR open interest=629 current ask $4.60
Picked on August xx at $ xx.xx <-- see TRIGGER
Focus Media - FMCN - cls: 25.00 chg: -1.62 stop: 28.75
Why We Like It:
BUY PUT SEP 25.00 QOH-UE open interest= 918 current ask $2.80
Picked on August 10 at $ 25.00
Adobe Systems - ADBE - close: 45.15 chg: +1.93 stop: 41.50*new*
ADBE displayed some impressive relative strength on Friday with a strong rally out of the gate. The stock added more than 4.4% and closed above potential resistance at the $45.00 mark. Volume was above average on the move, which is a good sign. Broken resistance near $42.00 should be new support so we're inching up our stop loss to $41.50. Our target is the $47.50-50.00 zone. If the NASDAQ can keep its rally alive then ADBE should be in good shape. If not then ADBE will be a target for profit taking. The Point & Figure chart is positive with a $71 target.
Picked on August 05 at $ 43.34
Research In Motion - RIMM - cls: 133.75 chg: +6.50 stop: 122.50*new*
Target exceeded! RIMM out performed the market with a strong 5% gain on Friday. Volume was just barely above the norm. The rise above resistance in the $129-130 zone is a big positive. Shares hit $133.89 intraday. Our first target was $129.00. We suggest readers take some money off the table. We're adjusting the stop loss to $122.50. More conservative traders may want to move their stop closer to $125, which should be short-term support that is underpinned by the rising 100-dma. We are not suggesting new positions at this time but a dip or bounce near $127-125 might be another entry point. Our secondary target is $137.00.
Picked on July 31 at $120.50 /1st target exceeded
CBOE Volatility Index - VIX - close: 20.66 chg: -0.49 stop: n/a
The VIX is struggling and you'd be tempted to think that with a 300+ move on the DJIA and a 2.4% rise in the S&P on Friday that the VIX would breakdown under the 20 level. It did not break 20, not even on an intraday basis. The short-term trend is still lower. If you recall our original play description outlined our thinking on the VIX. We're moving into the two worst months of the year. The short covering in the financials was running out of steam. Banks were borrowing from the Fed at record levels because they won't lend to each other. Most everyone believes we are approaching the half-way point in the credit crisis. The housing market is still struggling. Experts are predicting that the U.S. government will have to take over FNM and FRE before they go under. The U.S. consumer is still struggling. The country is losing jobs, although not yet at a recession level pace. By buying September calls on the VIX we were betting that the stock market would have another plunge lower and the VIX would spike to 30 and beyond. The stock market is still in a bear market and it's common to see a 10% bounce in a bear market. The current bounce in stocks has not yet hit 10%.
At this point I would look for two things. Wait to buy calls on the VIX until we see the S&P 500 back under the 1260 level. Or wait for a very clear, can't be denied, sort of failed rally/bearish reversal pattern in the major indices. If you are looking for new positions I'd buy October calls instead of Septembers. Our exit target is 29.75 on the VIX.
Picked on August 03 at $ 22.57
Bank of Amer. - BAC - cls: 32.25 change: +0.73 stop: 34.15
We added BAC on Thursday night after what appeared to be a failure in BAC's oversold bounce. The stock had been struggling at significant resistance. Friday's big bounce in the market definitely throws a stumbling block in our progress. Yet the financials did not rally to a new relative high like other sectors in the market. The bounce in banking stocks was impressive but they still look vulnerable. We're still tempted to buy puts here at current levels or, considering the market's big rally on Friday, you can wait for a new decline under $32.00 or $31.50 to initiate positions. We have two targets. Our first target is $28.00. Our second target is $25.50.
BUY PUT SEP 32.50 BAC-UZ open interest=21770 current ask $2.87
Picked on August 07 at $ 31.52
Freddie Mac - FRE - close: 5.90 change: +0.01 stop: n/a
A disappointing earnings report sent FRE's sister company FNM down 9% on Friday. Shares of FRE did not react much and closed almost unchanged after a spike to $5.43. The trend is still lower and investors remain worried that the U.S. government may have to step in and save FRE and in the process wipe out the stock holders. Negative comments from industry experts that they don't see FRE and FNM surviving certainly don't help. We are not suggesting new put positions at this time but if you think FRE is going to fall toward $2.50 or lower then you may want to consider a speculative position. We still consider this a very high-risk play. The stock has been extremely volatile and we're not using a stop loss. More conservative traders may want to take some money off the table now. We consider this a lottery-ticket style of play. The put option is our ticket. If we win, we should win big. If we lose, we lose it all. Our short-term target would be a move back to $5.00. More aggressive traders may want to aim lower.
Picked on July 20 at $ 9.18
Legg Mason - LM - close: 42.29 chng: +3.04 stop: 43.51
The 300-point rally on Friday was unexpected. The broker-dealers out performed the market with a 4% gain in the XBD index. Shares of LM out did its peers with a 7.7 gain, which almost completely erased Thursday's losses. We added LM as a put play on Thursday night because Thursday's drop appeared to be a breakdown from a bear wedge pattern. The short covering on Friday lifted LM right back to its recent highs. More conservative traders may want to abandon the position now or tighten their stops toward $43.00. This was an aggressive play and we're to stick to our wide stop at $43.51. Consider waiting for a new decline under $41.00 or $40.00 before buying puts again. We have two targets. Our first target is $35.75. Our second target is $32.50.
Picked on August 07 at $ 39.25
(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.)
Apple Inc. - AAPL - close: 169.55 chg: +5.98 stop: n/a
It was an incredible week for AAPL. The stock traded under $153 on Monday and by Friday's closing bell shares had rallied 10%. AAPL has rebounded back through resistance near $164-165 and through technical resistance at its 200-dma. The next hurdle for the bulls is the two-month trendline of lower highs. We are down to our last five days before August options expire. Due to our dwindling time frame we are adjusting our exit target to $4.50-5.00 in an attempt to recoup some of our capital. Unfortunately, stocks start to hover around major psychological support &resistance as we near options expiration so we're not expecting any big moves this week, which does not bode well for our strangle. We are not suggesting new strangle positions. The options we suggested were the August $180 calls (APV-HP) and the August $150 puts (APV-TJ). Our estimated cost is $8.90.
Picked on July 20 at $165.15
Popular Inc. - BPOP - close: 7.48 change: +0.36 stop: n/a
BPOP has rallied right to resistance near $7.50 and its descending 50-dma. This could be a really tough level for the bulls to crack. We are adjusting our suggested exit target to $0.95-1.00, down from $1.45. We need to be more conservative with just five trading days left for August options. If stocks continue to rally then BPOP has a good chance of rising to a new relative high. Once over $7.50 the call will start building intrinsic value. More conservative traders may want to adjust their target to $0.50-0.65 in an attempt to recoup their capital. Just about any significant decline from here will slash our chances of exiting. We are not suggesting new strangle plays on BPOP. The options we listed were the August $7.50 calls (BQW-HU) and the August $5.00 puts (BQW-TA). Our estimated cost was $0.65.
Picked on July 16 at $ 5.82
DIAMONDS - DIA - close: 116.95 chg: +2.36 stop: n/a
The Dow Jones Industrial Average's rally on Friday pushed the DIA to a new six-week high and above technical resistance at its 50-dma. Volume was strong for the DIA. Unfortunately we're down to our last five trading days for August options. More aggressive traders may want to keep their targets where they are at. The August $115 call did hit $2.95 on Friday. We are lowering our exit target to $4.00-4.35 in an attempt to recoup our capital. We're not suggesting new strangle positions at this time. The options we suggested were the August $115 calls (DIA-HK) and the August $109 puts (DIA-TE). Our estimated cost is $4.35.
Picked on July 07 at $112.21
iShares Brazil - EWZ - cls: 74.61 chg: -1.30 stop: n/a
The Brazilian Bovespa index continues to decline and the EWZ sank to a new relative low on Friday. The August $75 puts are technically in the money but not by much. A sudden rally from here would slash our chances of success. We only have a few days left before August options expire so we're lowering our exit just under breakeven. Our new suggested exit is $3.50-4.00. We're not suggesting new positions at this time. The options we suggested back in early July were the August $90 calls (EWZ-HR) and the August $75 puts (EWZ-TO). Our estimated cost is $3.95.
Picked on July 03 at $ 83.06
FosterWheeler - FWLT - close: 51.96 chg: -2.83 stop: n/a
The post-earnings bounce in FWLT has already failed. The stock plunged 5% on Friday and looks poised to retest the $50 zone soon. We have five days left for August options. We're adjusting our exit to $2.50, just under breakeven, in an attempt to recoup our cost. We are not suggesting new strangle positions in FWLT at this time. The options we suggested were the August $70 calls (UFB-HN) and the August $50 puts (UFB-TJ). Our estimated cost was $2.60.
Picked on July 15 at $ 61.24
Corning Inc. - GLW - close: 20.68 chg: +0.87 stop: n/a
The back and forth in shares of GLW will make you seasick. The stock hasn't gone anywhere for about five weeks. Now that we're nearing options expiration we definitely don't expect GLW to break out of its trading range. If by some slim chance that GLW does rally or plunge enough to push our options in the money we would exit. Our new targets to exit are $0.40 in an attempt to recoup some capital. We are not suggesting new strangle positions. The options we suggested were the August $22.50 calls (GLW-HX) and the August $17.50 puts (GLW-TW). Our estimated cost is $0.75.
Picked on July 10 at $ 20.16
Google Inc. - GOOG - close: 495.01 chg: +15.89 stop: n/a
When GOOG reported earnings last month the results disappointed investor expectations and the stock plunged to one of its biggest one-day losses in history. Yet the drop was not enough to hit our profit target. The play did turn profitable a few times (July 22nd, Aug. 1st, and Aug. 4th) but we were looking for a bigger reward. Now after last week's big bounce we are looking at a potential loss. GOOG has rallied back toward resistance near $500. With only five days left on August options odds are not good for our strangle's success. We are lowering our exit target to $10 in an attempt to recoup some of our capital. We're not suggesting new strangle positions in GOOG at this time. The options we listed were the August $590 calls (GOO-HR) and the August $480 puts (GOP-TI). Our estimated cost was $19.10.
Picked on July 16 at $535.60
Internet Holders - HHH - cls: 51.28 change: +1.50 stop: n/a
The market's rally on Friday lifted the HHH to a 3% gain but our strangle remains terminally ill. We are not suggesting new positions at this time. The options we suggested were the August $55 calls (HHH-HK) and the August $45 puts (HHH-TI). Our estimated cost is $1.65. Note: We're adjusting our exit target to $0.75-0.80.
Picked on July 03 at $ 50.50
Lehman Brothers - LEH - close: 18.62 chg: +0.95 stop: n/a
LEH's short-term bullish trend of higher lows is being tested again. A breakdown from here could herald a new leg lower. We have six weeks left before September options expire and need to see LEH significantly above $24.00 or under $10.00. We're not suggesting new positions at this time. The options we suggested were the September $24.00 calls (LYH-IR) and the September $10.00 puts (LYH-UB). Our estimated cost is $2.15. We want to sell if either option hits $3.50 or higher.
Picked on July 27 at $ 17.05
Legg Mason - LM - close: 42.29 chg: +3.04 stop: n/a
Last Thursday LM appeared to breakdown from its consolidation pattern but Friday's rally pushed it right back to its recent highs. We only have five trading days left for August options so we are adjusting our exit price to $2.00 in an attempt to recoup some capital. We are not suggesting new strangles at this time. The options we listed were the August $45 calls (LM-HW) and the August $35 puts (LM-TG). Our estimated cost was $3.15.
Picked on July 23 at $ 40.20
MarketVectors Agribusiness- MOO - close: 51.27 chg: +0.37 stop: n/a
The MOO has fallen to round-number support at $50. A bounce from here will crush our odds of exiting this play with any money. We only have five days left on August options so we're adjusting our exit price to $2.00. More aggressive trades may want to risk it and keep their target higher. We're not suggesting new positions at this time. The options we suggested were the August $62 calls (MYV-HJ) and the August $50 puts (MOO-TX). Our estimated cost is $2.10.
Picked on July 03 at $ 57.25
Netflix - NFLX - close: 31.05 change: +0.59 stop: n/a
NFLX rallied to a new relative high and tagged technical resistance at its 100-dma directly overhead. The short-term trend is up but it looks like NFLX wants to dip and retest $30 again before moving. We don't have much time left so we're adjusting our exit price to $1.00. We're not suggesting new strangles at this time. The options we suggested were the August $32.50 calls (QNQ-HT) and the August $22.50 puts (QNQ-TX). Our estimated cost is $1.20.
Picked on July 23 at $ 27.98
PowerShares QQQ - QQQQ - cls: 47.32 chg: +1.05 stop: n/a
Wow! The NDX delivered a strong weekly performance and the Qs broke through resistance at the top of its trading range, and through resistance at several moving averages including the simple 200-dma. The August $47 calls are just barely in the money and any sort of correction is going to crush our chances to exit with any capital. We are adjusting our exit price to $1.50-1.80. We are not suggesting new strangles and more conservative traders will want to consider closing this play. The options we suggested were the August $47 calls (QQQ-HU) and the August $43 puts (QQQ-TQ). Our estimated cost is $1.80.
Picked on July 07 at $ 44.90
Starbucks - SBUX - close: 15.12 change: +0.60 stop: n/a
Currently the August $14 call is trading around $1.20. More conservative traders will want to consider an early exit right here to minimize their losses. If SBUX can continue to rally then great, we have a chance to score a profit. If SBUX reverses lower that call option is going to crumble to nothing very easily. We are adjusting our exit price to $1.90 instead of $2.10. We are not suggesting new strangles. The options we suggested for the strangle were the August $14.00 calls (SQX-HK) and the August $13.00 puts (SQX-TJ). Our estimated cost was $1.38.
Picked on July 15 at $ 13.58
UBS Ag - UBS - close: 21.15 change: +0.75 stop: n/a
UBS was caught in the Auction Rate Securities (ARS) fiasco. This past week Citigroup and Merrill Lynch announced they would buy back billions in ARS that they had sold to individual investors under the impression they were extremely liquid and almost as good as cash. Unfortunately, when the credit crisis began to worsen the ARS market froze (see tonight's wrap for more details). On Friday UBS announced they would buy back almost $19 billion in ARS and the stock actually rallied on the news. Shares hit $21.51 before struggling with its simple 50-dma. We don't have much time left. August options expire in five days. We're adjusting our exit targets in an attempt to recoup our cost.
UBS Strangle #1) This uses the August $22.50 calls (UBS-HX) and $17.50 puts (UBS-TW). Our estimated cost was $1.90. Our new exit target is $0.95.
UBS Strangle #2) This uses the August $25.00 calls (UBS-HE) and $15.00 puts (UBS-TC). Our estimated cost was $0.90. Our new exit target is $0.40.
Picked on July 13 at $19.49
Valero Energy - VLO - close: 34.72 chg: +1.78 stop: n/a
The oil refiner stock have been cursed. Investors sold them as oil climbed higher and investors refused to buy them as old sold off. VLO has been trying to form a bottom for the last four weeks and still has a bearish trend of lower highs. We had suggested an early exit as soon as VLO failed to see any big post-earnings move. Now we're down to our last five trading days. We're adjusting our suggested exit price to $0.80. We are not suggesting new strangle positions. The options we suggested were the August $37.50 calls (VLO-HU) and the August $27.50 puts (VLO-TS). Our estimated cost is $1.38.
Picked on July 27 at $ 31.88
Washington Mutual - WM - close: 4.58 chg: -0.39 stop: n/a
The trend in WM is down but it looks like we're going to run out of time before the stock challenges the July lows. August options expire soon so we're adjusting our suggested exit price to $0.40 in an attempt to recoup some capital. We are not suggesting new positions at this time. The options we suggested were the August $8.00 calls (WM-HV) and the August $4.00 puts (WM-TH). Our estimated cost is $0.72.
Picked on July 20 at $ 5.92
VISA Inc. - V - close: 72.60 change: +3.10 stop: 72.55
The sharp market rally on Friday fueled some short covering in V and the stock surged more than 4.4%. Shares hit our stop loss at $72.55 closing the play. The overall trend remains negative and we would keep V on your watch list for another bearish entry point until it breaks out over the 50-dma.
Picked on August 07 at $ 69.45 */stopped out 72.55
Today's Newsletter Notes: Market Wrap by Jim Brown, Index Trader by Leigh
Stevens, Trader's Corner by Linda
Piazza, and all other plays and content by the Option Investor staff.
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