Table of Contents
The Dow only gained +44 points on Friday but it traded in a triple digit range every day last week. In fact you have to go back to June 23rd to find a day where the Dow did not trade in a triple digit range. The volatility has been extreme but for the last week there was no direction. The only real trend in the markets is the strength in the Russell and Nasdaq. I highlighted them in the graphic above as the only major indexes with four consecutive weeks of gains.
Wilshire 5000 Composite Chart - Daily
Friday had a heavy calendar of economic reports but they were all the equivalent of a mailbox full of junk mail. None had any real importance for the market. The NY Empire State Manufacturing moved back into positive territory for the first time in four weeks. The headline number was an anemic +2.8 but still the highest reading since January. That is a good sign regardless of size of the gain. The prior month was -4.9 making that a +7.7 point gain. However, shipments turned fractionally negative at -0.9 from +13.5 in July. New orders also turned negative at -2.2 from +8.3 in July. There was still plenty of weakness in the internals so I would not expect the headline trend to improve much.
July Industrial Production rose a better than expected +0.2%. Capacity utilization rose to 79.9% and the highest level in four months. Manufacturing production rose +0.4% and mining +0.9% but utilities fell -1.9% dragging the headline number lower. The cooler weather in many parts of the country was responsible for the utility decline. Business equipment production rose +0.8% and the fastest rate of growth since September. Computer and peripheral equipment rose +0.6% and just slightly slower than the +0.7% in June. Despite the gains overall production is still running at recessionary levels.
Friday's Economic Reports Table
August Consumer Sentiment rose for the second month to 61.7 but remains very weak. The current conditions component fell from 73.1 to 69.3 and only 2 points above the June low. The six-month expectations rose to 56.8 from 53.5. Lower gasoline prices provided a burst of improved spirits but the trend quickly faded. This suggests the back to school shopping season is going to continue to be dreary for retailers. Remember, the June low of 56.4 was the lowest level since 1980 and clearly indicates a recession mindset for consumers.
Consumer Sentiment Chart
Internet E-Commerce Sales rose to $34.6 billion in Q2 and the highest level ever. After Q1 sales went nearly dormant at $33.6 this was a solid improvement. E-tailers report that fear of identity theft is growing and concerns over the safety of online shopping are slowing sales. We have seen some very good phishing emails lately that were nearly indistinguishable from real E-tailer advertising complete with authentic looking websites. This makes it even more important that you don't open any unsolicited emails even if they claim to be from major sites like Ebay or Amazon. If you do open them NEVER click on any link. Go to the website by typing the name of the store in your browser. Consider using PayPal as your online payment plan. Retailers never get your credit card info from PayPal and PayPal will not fund scammers. PayPal also has a feature where they can assign a single use MasterCard number to an online purchase for merchants that don't take PayPal directly. I use my Bank America Visa account the same way with single use numbers available on the BAC website.
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On a side note CNN was the victim of a clever phishing program over the last two weeks. Unsolicited mails started appearing with random news headlines. The emails claimed to be from your CNN alert settings. To change your settings or unsubscribe from future alerts click the link below. Of course everyone was hostile at the new spam source and immediately clicked on the link to unsubscribe. The link took you to a page where you had to re-register to access your settings if you could not remember your password. Since it was a bogus site there was no password to remember and everyone had to reregister to obtain their forgotten password. A person filling in their email, name, address and info to get a new password to gain access to their settings just gave the phishers everything they needed to impersonate your identity. The website was very convincing and proved the scammers are getting smarter every day. Within a week a copycat phishing scheme appeared for MSNBC.com. Remember, NEVER click on an unsolicited email link.
CNN Phishing Email
Next week's economic calendar is almost as bland as last week with only the PPI and Philly Fed Survey as highlights. The PPI is expected to show a decline in prices/inflation due mostly to the decline in energy prices. The higher dollar has also pushed commodity prices lower so producer costs over the next 90 days should decline. This week's report may be too early in the cycle for a major dip in prices but it is coming.
The Philly Fed Survey is expected to continue in negative territory but the last three months have seen a minor gain to -16.3 from April's low of -24.9. The improvement is expected to continue but only slightly.
The US Dollar continued its monster run to close at 77.18 on the dollar index. The rebound in the U.S. GDP and the perception that the worst is over for the U.S. has been responsible for the move. Oil and commodities in general have been crushed by the dollar rebound. There is also a growing perception that Europe and Asia are accelerating into the economic weakness while the U.S. is slowly recovering. That makes the dollar the investment vehicle of choice rather than the Euro. Over the last two weeks the dollar got another boost from the Russian attack in Georgia. Every time a conflict erupts overseas investors flee those currencies to the safety of the dollar. To the extent that U.S. inflation is slowing that also helps the dollar. The key is going to be that strong resistance at 77.75 on the dollar index. Many analysts expect that to be the end of the current rally followed by weeks of consolidation if not outright decline. That would resurrect the commodity sectors for a brief rebound while the dollar rested prior to its next move.
U.S. Dollar Index Chart
While I am on the topic of a potential halt to the dollar's rise I am going to diverge into gold for a paragraph. I heard two interviews this week on the potential for a rebound in gold. I always listen to the gold bugs with a partially deaf ear because they tend to always believe another $100 move is just around the corner. Both of these guys sounded reasonable and credible. The talking points were potential profit taking in the dollar, a continued growth in global demand, growing economic weakness overseas, the seasonal fall buying cycle and gold at strong support levels. I will be the first to tell you I am not a fan of trading gold. The moves never seem to pan out as the "experts" predict and they always have a hundred reasons why it did not happen. Now that I have painted myself into a corner I will tell you I tended to believe them this week. I must be getting soft in my old age. They actually made a reasonable case for getting long so I am going to test that next week. I would also warn that Goldman recommended selling gold this week as the end of the inflation trade. If inflation is going to decline then there is a good chance gold will as well. Fortunately the chart gives us a clear entry and exit setup. Long over $76 and short a break under $75. That gives us a trade regardless of direction. We don't really care which way it goes just as long as it picks a direction and sticks with it.
Chart of GLD - Weekly
The tech sector and the small caps continue to lead the markets higher. One of the reasons for the tech rally is the growing demand for chips. International Data Corp announced on Friday that worldwide chip shipments grew +3.1% in the second quarter from the first quarter and +16 increase from Q2-07. Analysts credited the strong demand for notebooks and a very aggressive push by Intel in PC chips. Analyst Shane Rau said Intel's processor shipments drove the growth with a 4.3% growth in processors for the quarter and 20.8% year over year. He also said aggressive pricing by Intel in the middle to lower end of the market led market revenue to decline -4.5% sequentially. Intel accounted for more than 80% of the processor market.
The two companies going counter to the trend are Texas Instruments (TXN) and SanDisk (SNDK). TXN has seen its market share erode as Nokia started using multiple vendors for their chips rather than just TXN. SanDisk is tanking because of an extreme glut of flash memory chips. When you can buy 8GB USB flash drives for under $10 you know there is a glut on the market. Hopefully the new flash memory replacement drives for laptops will divert some of that manufacturing capacity away from things like storage cards for cameras and USB flash drives. The low or even negative margin in some of those markets is already doing a job on the marginal producers.
The SOX is butting its head on the 200-day and as you can see by this chart the 200-day rules the SOX. This is a picture perfect example of respect for the 200.
Retail sales for July declined by -0.1% despite the tax rebates, $4 gasoline and $180 billion in aircraft orders. This has led to a list of earnings misses by several big name retailers. Abercrombie and Fitch said profits and sales fell in Q2 and warned that sales would be below analyst estimates for the rest of the year. Where stores like American Eagle and Aeropostale have been focusing on sales to boost revenue and reduce inventories ANF said on Friday the company is taking a longer term view. CEO Mike Jefferies said, "We do not compete on price or promotion regardless of macroeconomic conditions. We will not sacrifice our inventory investment and growth plan for short term results." I guess that is why there were no shoppers in my local ANF store last week. I was at the mall again on Friday and walked by to see if conditions had changed. The mall was packed but there were only two shoppers in ANF. Abercrombie expects same store sales to drop -7% in the fall quarter. I guess if they want to remain stuck on themselves while the rest of the retailers fight for their market share that is their prerogative. That is probably why their stock has fallen from $86 to $50.
Abercrombie Chart - Daily
SunPower (SPWR) shares spiked +14 on Friday after announcing a purchase by PG&E of 800 megawatts of Sunpower and OptiSolar. The company said that was enough energy to power 239,000 homes each year. SunPower also said it was equivalent to a years production by SunPower. The two plants when completed will generate more energy than all the PV solar-electric systems panels installed in the U.S. in 2007. That was 473 megawatts. Privately held OptiSolar will complete their 550-megawatt Topaz Solar Farm project in 2011 and SunPower will deliver their 250-megawatt project to PG&E in 2010. Both are contingent on the renewal of the expiring tax credit by congress.
Wachovia Bank (WB) joined the crowd and announced a settlement on the auction rate security issue. They agreed to buy back $8.5 billion in ARS and pay $50 million in fines. Wachovia is the 5th bank to agree to settle. The others were Citi, UBS, MS and JPM. Merrill is under fire and NY AG Andrew Cuomo said he sent a letter to Merrill notifying them he will sue Merrill next week if they don't settle. Merrill expressed surprise that it received a letter saying they thought talks were continuing. Evidently Merrill was not reading the AG as well as they thought. Late Friday the AG office said they were broadening the probe to include Fidelity and Schwab as sellers of the debt and 25 other companies. I feel a Spitzer clone maturing here.
September Crude Futures Chart - Daily
Oil prices fell to $111.34 intraday on expiration pressures. September crude options expired this week and crude futures expire next Wednesday. Short covering at the close pushed prices back to $113.77. Late Friday tropical storm Fay formed in the Caribbean and is tracking South of Cuba with an expected turn north to move up the western coast of Florida. As long as this track holds it will poise no danger to the gulf oil patch. However, not all forecasters are in agreement with this prediction. Several were posting diverging opinions that Fay could continue westward after passing Cuba and turn north right through the middle of the oil patch and possibly hit New Orleans again. It is not surprising some traders decided to close short positions over the weekend.
Track of Tropical Storm Fay
August option expiration went off without any surprises with most high profile stocks pinned to their critical strikes just like the market makers wanted. This kept the Nasdaq pinned to 2450 and the markets in check for the last two days. Volume on Friday was the lightest since the day before July 4th at 6.7 billion shares. The markets ended the week mixed but with the uptrend still intact.
The Dow moved over the resistance lows from Jan/Mar but then fell back to support on Wednesday. Position squaring into expiration put the Dow right back at prior resistance at 11650. Just based on the Dow chart I would be borderline bearish given its reactivity to the financials. However, with the recent flurry of ARS settlements there are quite a few analysts thinking we are suddenly closer to a bottom in the financials than previously thought. If the financials could break out of their current doldrums the Dow and S&P would have a chance. Since the Dow is not the leader of this rebound we need to concentrate more on the techs for market direction rather than the Dow.
Dow Chart - 120 min
XLF Chart - Daily
S&P-500 Chart - 120 Min
The Nasdaq remains comfortably over support at 2350 by +100 points. Now that August options have expired there will not be any artificial support or resistance by the market makers trying to pin prices at specific strikes. The next major stepping stone for tech stocks will be Hewlett-Packard's earnings on Tuesday. HPQ may not be a Nasdaq stock but their earnings guidance will definitely provide direction for techs. The Nasdaq has risen to long-term downtrend resistance at 2450 but the shorter-term chart looks much more bullish. The Nasdaq has rebounded +13% from the July lows with most of the acceleration in the prior week. I believe it was consolidation from those gains and the OpEx that held it a 2450 last week. Note on the 30-min chart how the Nasdaq used prior resistance as support on Friday.
Nasdaq Chart - Daily
Nasdaq Chart - 30 min
The Russell is the hero of the group with a +6% gain for August. The Russell touched June's resistance high on Friday before sliding back on OpEx congestion. The Russell has been rallying on the strength of tech and the strong dollar. I know that sounds crazy but historically the small caps do well when the dollar is rising. The Russell needs to move over that June high at 763 to attract new buyers. The next hurdle will be 800 and the December resistance high. Initial support has risen to 740.
Russell 2000 Chart - Daily
For next week the support levels to watch would be Nasdaq 2400 as light support and 2350 as solid support. I would be surprised to see 2400 break unless HPQ severely disappoints. The support levels on the Russell would be 740 followed by 720. I would look to buy dips to 2350/720 but hope support at 2400/740 holds. The corresponding levels on the Dow and S&P are much more vague and I recommend ignoring those indexes to focus on the Nasdaq/Russell as the leaders for market direction. We are approaching a critical period for the market as we head towards September. So far there has been no indications of a normal third quarter dip but in reality the market hardly ever telegraphs its plan to crash. With the auction rate security problem being addressed you would think the market would see that as a positive. However, you never know when a major landmine is going to be touched. I doubt it is with Merrill but they are on the hot seat for next week. Hopefully they will announce a settlement on Monday and get it behind them. That would leave the market to focus on the Hewlett-Packard earnings on Tuesday. I am still cautiously bullish as long as those lower support levels are not broken. I am not ready to back up the truck but I feel the urge beginning to grow. I would rather buy a Q3 dip but until one presents itself we have to trade what the market gives us and a continued rally would not be a bad gift to trade.
THE BOTTOM LINE:
The advance slowed this past week but continues in both markets. There's quite a divergence of course between the two markets, the NYSE and the NASDAQ and it's hard to make generalities anymore about 'the' market. I remain bullish on the Nasdaq and Russell 2000 and mildly bullish on the S&P. The major trends are well illustrated by the S&P versus Nasdaq long-term weekly charts.
The S&P has managed to hold the major bottom of June-July 2006, per the S&P 500 (SPX) chart below. SPX would have to manage an upside penetration above 1360 in the coming week to start to break out to the upside on this chart. The major trend is still down, but a possible long-term double bottom is in place. SPX is no longer oversold and is approaching a neutral 8-week RSI reading.
The Nasdaq Composite (COMP) and the Nas 100 (NDX) present quite different chart pictures. Per the weekly NDX chart below, it's apparent that this index remains within its major uptrend channel; which is also true of COMP (weekly chart not shown). However, NDX is also at a key near-term juncture in that it's come up to a down trendline and needs to close above 1960 to achieve a chart/momentum breakout.
Another big technical milestone would be achieved IF the index managed a weekly close above 2030, or to above its May price peaks on a weekly closing basis.
FUNDAMENTAL MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) is maintaining it's well defined up trendline, thereby keeping the large V type bottom intact. The chart is bullish on a short-term basis, but mixed still on an intermediate-term time frame.
A close above 1350 is needed to suggest that SPX might be on track to challenge a key high at 1400 and then of course the prior May price peak. A long climb is ahead to suggest that a bullish trend was resuming.
Key near-term resistance is at 1320, representing a fibonacci 50% retracement of the May-July decline. It seems doubtful that this level will be exceeded without some corrective action setting in, given an approaching overbought condition suggested by the 13-day RSI. Next key resistance as mentioned is 1350.
Near support comes in around 1275, with next support in the 1250 area.
S&P 100 (OEX) INDEX; DAILY CHART:
The S&P 100 (OEX) Index has a resistance overhang or 'supply' beginning around 610. A close over 610 and not reversed in the following 1-2 trading days would suggest that OEX could challenge key resistance in the 620-621 area. Major resistance begins around 640.
The current uptrend begins to 'break down' with a close below the 21-day moving average at 588.6, if for more than a day. Next technical support is at 580.
The OEX has had a nice run off its bottom and I don't think there's a lot of upside left on this first leg up, assuming there is a second (up) 'leg' coming.
DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 (INDU) also appears to be struggling to get above, on a closing basis, its prior 'breakdown' point at 11730-11750. The next key technical resistance is at 12000 and represents a one-half retracement of the prior major downswing (May-July). A close above 12000 would be bullish and seems unlikely currently, as the Dow stocks as a group are struggling and most prone to lackluster to poor earnings in coming months.
Near support at the 21-day moving average, is at 11500. The next key lower support is at 11230, extending to 11125. The recent advance in the Dow appears due to the rising tide lifts all boats concept. There is nothing much compelling going on overall with the 30 stocks themselves. I favor buying DJX puts for a trade on a further advance in the Average to the 12000 area.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
The Nasdaq Composite (COMP) presents a bullish chart pattern and looks like it can re-test its prior highs in the 2550 area. The index is also getting close to an overbought extreme also and is moving higher along the 5% upper envelope resistance line, which is not to say that COMP won't just climb higher hugging this line for a while. 2500 is a next resistance in my estimation.
Near support is at 2400, then at 2350, at the pivotal 21-day moving average. I see nothing in the current chart pattern that would suggest that the index, now this close to its prior top, can't or won't challenge its double top of mid-May/early-June.
I thought last week that COMP probably would hit "stronger technical resistance around 2480". The index did start running into selling in the 2260-2262 area and may start selling off some from there. However, the low-2400 area right now looks like it could provide a support floor to any sell offs.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 (NDX) chart remains bullish in its pattern, but a key test is ahead if the index climbs back to the 1993 area again. NDX traced out a 'rectangle' type bottom; such a sideways 'base' could 'support' a move to retest the prior top in the 2050 area. The 'minimum' upside objective suggested by the rectangle bottom has been met however; i.e., at 1957.
A next higher objective, as highlighted on the chart below, is more subjective, but which I take to be 2050. More 'subjective' as it's based on my rule of thumb that the 'width' of the sideways move suggests a price swing equal to that distance on the UPSIDE. It's subjective in that this is 'Gann' type technique but without the use of a specialized Gann chart. A less esoteric charting concept is simply that a retracement of the amount already seen in NDX, greater than 2/3rds of the prior decline, suggests that the index is likely to go on to re-test it's prior high.
Near NDX support is now up to 1920, with next key lower support around 1870. Buying calls on a pullback to this area, if that much of a decline develops, probably still offers a favorable risk to reward. 'Risk' at that point should be held to 10-15 points in terms of an exiting stop.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
The Nasdaq 100 tracking stock (QQQQ) has the same potential to test its prior high and mirrors the underlying NDX chart pattern of course. Pivotal near resistance is at 49, then at the prior closing high at 50.55.
Near support is at 47.0, then in the 46 area.
QQQQ continues to see relatively low volume for such a strong move. I've begun taking this volume pattern as reflecting low expectations and, in a contrarian sense, probably bodes well for a continued move higher.
RUSSELL 2000 (RUT) DAILY CHART:
Hey, how about that Russell 2000 Index (RUT)! Back challenging its prior high at 763 no less.
RUT looks like it can next move to a new high although caution is indicated if the index tops at this prior high for some period of time; e.g., 1-2 weeks or more. I've projected possible next, and probably major, resistance at the 'kiss of death' trendline, currently intersecting in the 805 area.
Near support begins at 740, then at 725 and next at 714, at the pivotal (for RUT) 55-day moving average.
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.
Are you feeling restless and on the lookout for new play candidates? Or, are you, like me, driving yourself to vary the types of trades that you employ in the ever-present search to diversify risks?
The reasons for seeking new trades or types of plays vary. So do the methods that traders employ to find those trades. I don't like varying my trades. I like to be familiar with the underlying and the specific options strategy, so familiar that I can trade it under any kind of conditions, such as when my granddaughter has been rushed to the hospital again or when I'm experiencing spring fever and really can't be bothered to concentrate. However, one type of underlying with one type of options strategy creates a portfolio with risk setups that aren't balanced, and that's not good in some environments. So, this year, I'm forcing myself away from my comfort zone.
I'm inviting you to look over my shoulder as I search for specific types of play candidates in my year-long trading goal of diversifying risks away from a trading account full of condors.
As some of you may know, condors tend to suffer in when volatility rises. If you didn't know it before, many have had reason to learn that lesson this summer. Among the Greeks of option pricing, vega measures volatility risks, and condors have negative vegas. That means spot profit/loss values in an account full of condors drop as volatilities rise and rise as volatilities decrease.
Straddles show a much different profile. The straddle involves the purchase of a call and a put with the same strike and expiration date. If those calls and puts are at-the-money ones, the delta of the total position is near zero and the vega is positive. This means that, until the price moves far enough away from the position, price action doesn't tend to help the total position, so traders want a big price move. In addition, the positive vega means that the position benefits if the volatility rises, because the position's value is moving with the vega.
Delta stays neutral only while prices sit still, however. The trade can be profitable if price moves far enough that one of the options gains far more than the other loses. The position can also benefit from a rise in volatility. The risk in the position is only and totally the debit paid to enter it. One shouldn't ignore an in-the-money options position at expiration, of course, unless one wants to buy or put the underlying, so plan to close out the position the day of if not before option expiration.
Condors, of course, have a terrible risk/reward profile.
There's a catch with straddles, however. Theta is negative for straddles. That means that the position will lose value each day without movement or a rise in volatility. As option expiration approaches, that theta will rise for ATM positions, and the theta-related decay will accelerate. The closer an option is to expiration, the faster price and volatility have to change to offset that theta-related decay.
For me, there's another catch. Although I tend to be a patient trader, I'm not when I'm trading straddles. I don't know why, but I keep trying to micro-manage the position and trade in and out of one leg or the other. For that reason, I abandoned straddles some time ago for my personal trades, but they're a trade I needed to add back to my repertoire if I am going to vary my risks appropriately.
Where to start? Since this trade benefits from a move in price or a rise in volatility, I decided to start my search by looking for a security with implied volatilities below historical volatilities. My thought was that, since implied volatilities tend to revert sooner or later to their historical volatilities, this might set up the possibility of a rise in volatility, if not promising it. On my brokerage page, this search is done by screening for stocks with low IV/HV ratios.
In addition, I wanted other parameters met. I wanted a stock with an average daily volume of above 1,000,000 and with a price above $50.00. I wanted options with decent open interest, too. The object of these parameters was to insure that there was enough liquidity to easily enter and exit positions. As will be shown, my search for enough liquidity didn't exactly turn out to be realized in actuality.
The search, accomplished on August 3, 2008, turned up several candidates, but I zeroed in on Barr Pharmaceuticals (BRL). BRL's three-month average daily volume was 3,323,430, according to Yahoo's finance pages. However, with BRL at 66.44 as of the close on Friday, August 1, BRL's SEP 65 call and put, the nearest to ATM strikes, had open interest of only 14 and 189, respectively. I prefer to get far enough from option expiration that theta-related decay isn't accelerating so fast, but that OI showed me that I wasn't going to find much liquidity in the September options. I probably wouldn't be able to get between the bid and the ask on the combined position.
The August versions had open interest of 5,683 and 299, respectively. Bid x ask for the SEP straddle would be 3.15 x 4.90, and for the AUG, 2.45 x 3.00. SEP option expiration was 47 days away; August's, 12. Looking at volatilities for the SEP and AUG 65 calls showed about a three-point skew, with the volatility for the AUG about three points above that for SEP.
That skew in volatility told me something was expected to happen in August. Since it was earnings season, I thought I knew what that "something" might be: earnings. In fact, a search of Yahoo's finance pages turned up the information that BRL would report on August 7.
That threw a wrinkle into the theory that volatilities might rise, because they tend to do the opposite after earnings. BRL's AUG options would stop trading six trading sessions after the day it reports earnings. What about price? What has typically happened with BRL after earnings, I wondered. Does it tend to move big enough to offset any decline in volatility after earnings?
Action near earnings reports:
05/08/08: On 5/07/08, the day before earnings, BRL closed at $49.65, and, by 5/08/08, the day of earnings, had closed at $38.10, a 23 percent decline.
02/28/08: BRL closed at $48.35, and, by 3/03/08, 2 trading days later, had closed at $45.67, a 5.5 percent decline
11/08/07: BRL closed at $56.68 and, by 11/12/08, 3 trading days later, closed at $51.76, an 8.6 percent decline.
08/08/07: BRL closed at $55.00, and by 8/16, 6 trading days later, closed at $52.59, a 4.4 percent decline.
BRL, then, had a history of moving at least 4.4 percent within six trading days after earnings. Moreover, it had a history of moving down after earnings, which would tend to beef up the volatility rather than decrease it. With BRL at $66.44 as of 08/03, a 4.4 percent move, the minimal move after the last four earnings reports, would be a $2.92 move. With the bid x ask of the AUG 65 straddle at 2.45 x 3.00, as already noted, there's the possibility of a move big enough to bring that straddle into profitability. However, any move would have to be a fast one to overcome the accelerated theta-related decay that close to AUG option expiration.
Did the chart shed any light on the situation? A glance at the point-and-figure chart showed that BRL had a revised bullish price objective of $117.00, but it's long climb up that began in July had yet to see its first three-box reversal, something that may have been long overdue.
The daily chart showed the possibility of a big move after the AUG earnings announcement, too, with some caveats.
Annotated Daily Chart of BRL as of 8/03/08:
The weekly Keltner chart provided possible upside and downside targets as of 8/03/08.
Annotated Weekly Keltner Chart of BRL as of 8/03/08:
The weekly Keltner chart showed the possibility of a post-earnings move big enough to benefit the straddle: down toward $60.24 or up toward $70.00. However, moves on a weekly chart might not unfold quickly enough to turn a straddle profitable within a matter of days.
An FOMC decision was due on Tuesday, August 5, two days before BRL was due to report. If equities moved big in anticipation of that decision, BRL could be carried along. There existed, then, the possibility of a big pre-report or post-report move, especially if the FOMC decision resulted in a strong downdraft that might carry many equities lower, regardless of expectations.
By Tuesday afternoon, just prior to the FOMC decision, premiums had changed slightly. The AUG 65 straddle was priced at 2.45 x 2.8. My brokerage page pulled up the following Profit & Loss Chart with the blue line and P/L calculations showing profit and loss at expiration and the red line showing projected profit and loss on August 8, one day after the earnings reports.
Profit & Loss Chart for BRL AUG 65 Straddle:
The input for this trade was a debit of $2.80, the full ask at the time. I used that input in case it turned out to be difficult to get between the bid and the ask on BRL, which it in fact turned out to be. However, at 2:19 pm on 8/05/08, I was filled for 2 contracts each at $2.70 for a total debit of $480.95 once commissions were added. I use fewer than 6 contracts when I'm testing a strategy that I haven't used recently.
My intention was to seek a mere 10 percent gain on the position since this was a test run only, but I wanted 10 percent after commissions. I set my profit limit at $3.15. For the purposes of this test, I would accept a 25 percent loss.
BRL reported, and all my calculations about typical moves after earnings were for naught. BRL didn't budge. Much.
On the day on which it had reported, BRL had jogged up to a high of $68.15. However, when it did so, it was hitting what I know can be significant Keltner resistance that was then at about $67.90 on 15-minute closes. In addition, the weekend and its deleterious effect on AUG options was quickly approaching. I started looking for an exit.
By the afternoon of Aug 8, the straddle had bids and asks that indicated that I could exit for near my 15 percent profit, at least, by coming between the bid and ask. However, when I tried to exit, I found that I couldn't exit the trade anywhere near the midpoint between them. I began trying to exit at 2:36 pm, asking for a credit of $3.10. I wasn't filled until 3:10 pm, by which time I'd gradually lowered the order to $2.85, only a nickel above the bid, if I'm remembering correctly.
Trade Confirmation to Close:
Although the $2.85 credit was more than the $2.70 debit I paid to enter the position, commissions took a bite out of my takings, and I ended up making a paltry $34.09 or 7.01 percent gain on my original investment.
BRL never again gave me the chance to exit at even that much until option expiration Friday, when it bumped up to a high of $68.16 and then settled in near $68.00 for a few hours. At noon of that day, the bid x ask for the $65 call was 3.00 x 3.20, so I could have exited for $3.00. However, my stop loss likely would have been hit long before that, when BRL traded down to a low of $66.45 on 8/13 before it began soaring again. I made an educated guess the week before opex and attempted to exit at slightly less than my original profit target, before theta-related decay accelerated. By then it had become obvious that BRL wasn't behaving as it usually did after earnings, one of the reasons upon which the trade had been predicated. I ended up having to inch down the credit I was asking until the profit was much less than anticipated, but it was a profit. And, I left the straddle alone until the exit, not micromanaging by trading in and out of each leg.
What did I learn? I learned that, yes, I can abstain from micromanaging the position. I think, given BRL's typical behavior after earnings, its low IV with respect to historical volatilities and its precarious perch far above a gap that just begged to be filled, it was a decent attempt at a trade. However, I should have paid more attention to BRL's tendency to consolidation for long periods when it's not making a big move--a sort of conundrum in its behavior. Also, the difficulty the first day in getting close to the midpoint of the bid and ask and the total inability to get between them when exiting convinced me that I don't want to dabble in BRL options.
Will I try straddles again? Certainly, but not on BRL.
Adobe Systems - ADBE - close: 45.11 chg: -0.25 stop: 41.50
Although ADBE was the subject of several news articles this week, including a John C. Dvorak article on MarketWatch about what ADBE needed to do to fight back against MSFT's Silverlight, the end of the week proved to be light on news for ADBE. Volume proved light, too, as ADBE pulled back from its early week high into a retest of its simple 10-day moving average. ADBE's chart and the shape of its daily candles had shown that it was getting stretched to the upside, and it's happily been burning off its slowing momentum through sideways consolidation. That's the way that bulls would prefer that its overbought status be burned off. As suggested midweek, conservative traders may want to take some money off the table, and all readers need to assess the possibility that if that if the channel's midline support is lost on a daily close, ADBE could make a quick trip down to $44.50-$44.66. Our target is the $47.50-50.00 zone, but the more conservative of the traders who elected to stay in the trade with full positions might consider taking at least some of those positions off the table if $47.50 is approached. They might also consider resetting their stops a bit higher if they don't want to risk a downturn through the rising channel, toward our official stop. We'd like to raise that official stop but are waiting for the 30-sma to rise up closer beneath the current price before doing so. The Point & Figure chart is positive with a $71 target.
Picked on August 05 at $ 43.34
Illumina - ILMN - cls: 94.09 chg: +0.34 stop: 86.95
ILMN provided a nice start to a bullish trade, but by Friday, it was ready for a rest. During the week, ILMN announced that it had completed its public offering of 7 million shares. The company raised $342.6 million through that public offering. Now that ILMN has bounced so hard, we're somewhat reluctantly leaving our official stop loss at $86.95. It was only 8/08 that ILMN was last trading at that level. However, as we've been suggesting, conservative readers may want to use a stop loss closer to the $88.00 level, just below the 30-sma from which it often bounces. We have two targets. Our first target is $95.25, a target that ILMN came within $0.25 of hitting on Friday. We advise traders to take partial positions at that target. Our second target is $99.50, just below the top trendline of its rising price channel. FYI: ILMN has a 2-for-1 stock split scheduled for September 23rd. Traders might also want to note that ILMN's short interest is about 19% of the 50 million-share float. That's high enough to spark some short squeezes.
Picked on August 14 at $ 91.55
Itron Inc. - ITRI - close: 105.03 change: +2.38 stop: 98.45
With its earnings behind it, ITRI powered through our trigger this week and nearly hit the first target, too. Earlier, ITRI's bounce had been on light volume, but Friday's gain was on larger-than-normal volume. ITRI presented at a Global Growth Conference earlier this week, but no news that we could find was published as a result of that presentation. Thursday's action had produced a bullish engulfing candle on the daily chart, and Friday's confirmed the bullishness but brought ITRI perilously close to its late April high of $106.25. Potential resistance exists near the April high, but as mentioned Thursday night, some charts suggested that resistance may begin to kick in around $105.10. We've set two targets. Our first target is $105.75, but Thursday night, we advised conservative traders to consider taking at least partial profits as ITRI passed through $105. Our second target is $109.90. We strongly suggest readers take some money off the table at the first target, if you didn't as ITRI passed $105.
Picked on August 14 at $ 101.50
Research In Motion - RIMM - cls: 128.80 chg: -1.93 stop: 122.50
RIMM spent last week pulling back to its 10-sma to test it, bouncing from tests or near tests Wednesday, Thursday and Friday. We continue to believe that conservative traders should raise their stops to just under $125 and would like to raise our official target to that level. However, with RIMM frequently producing daily ranges of the 5-8 points, doing so could stop out readers if RIMM should dip to test its 10-sma again. With the 10-sma now at 127.30, a stop just beneath the 8/13 low of $125.05 does give readers some leeway. RIMM is capable of exceeding that intraday but still bouncing back above that rising trendline off the July low by the close. We're going to leave our stop loss at $122.50 for now but urge readers to give consideration to their own preferences and risk profiles this weekend, thinking over the risks of each stop loss. We further suggested Thursday night that the more conservative of those who have not stepped out of partial profits as the first target was hit consider doing so if RIMM should approach $132.50, ahead of this week's high and near the midpoint of RIMM's almost two-month-long broadening pattern from earlier in the summer. RIMM did approach that level Friday, with a high of $132.41. RIMM has already exceeded our early target at $129. Our secondary target is $137.00.
Picked on July 31 at $120.50 /1st target exceeded
CBOE Volatility Index - VIX - close: 19.58 chg: -0.76 stop: n/a
After showing signs of life earlier in the week, the VIX dropped sharply Thursday and Friday to test and slightly exceed a rising trendline off its 5/19 high. It continues to find resistance just below 22.50, with both the shape of its daily chart and its inability to scale back above 22.50 proving somewhat problematic for this long trade. However, the good news is that it tests potentially significant support, if slightly exceeding that support by Friday. Odd effects can occur during option expiration week, somewhat discounting the slight dip beneath historical and rising trendline support/resistance in the 20.00. Other nearby support, also slightly violated, is the 6/17 low of 20.02, the 6/25 low of 20.34, the 8/05 low of 20.06, and the 8/11 low of 19.66. This was always an aggressive trade, and, with the VIX's formation on intraday charts looking a bit like a broadening formation, it was suggested Thursday night that aggressive traders who understood what they were risking might want to let the VIX drop slightly below the 8/11 low of 19.66 before they decided that near-term support has been broken. The VIX has done that, producing a potential reversal signal on its weekly chart as it did. Potential reversal signals aren't always followed by reversals, of course, and without a quick rebound or a steadying near 20.00, it's time for readers to assess the possibility that the VIX could drop toward 18.25 or even 16.00 before rebounding. As stated last night, this was an aggressive and speculative bet that with all the troubles this market (and economy) is seeing that there will be another significant sell-off before October options expiration. Normally when the market sees a super sharp sell-off the VIX spikes to the 30.00 level and beyond, and now it's poised to either bounce or fall lower. We continue to suggest that subscribers wait for a new rise over 22.50 before considering new positions. We were suggesting the October calls. Our exit target is 29.75 on the VIX, although the least aggressive of the aggressive traders entering this trade might consider locking in at least partial profits if the VIX moves through and above 28.80.
Picked on August 03 at $ 22.57
Bank of Amer. - BAC - cls: 30.70 change: +0.52 stop: 34.15
Analysts spent all week debating the merits of various banks and their exposure to problems associated with the mortgage market, including BAC. New York State Attorney General Andrew Cuomo held several press conferences either announcing settlements with the likes of MS and JPM, requiring them to pay fines and buy back troubled securities from retail clients, or threatening legal action, as it did with MER. Investors don't know what to do with financials such as BAC, as demonstrated by BAC's charts. While the debates raged, BAC's choppy formation began consolidating into a narrowing triangle with an upper trendline just below our $34.15 stop. Midweek, we warned readers not to be surprised by an oversold bounce from near $28.00 and we speculated Thursday that the bounce might be intended to rise up and test Wednesday's gap lower. It was and it did, with Friday's candle a small-bodied one sitting right in that gap. BAC might attempt to keep testing its simple 10-day moving average from the underside, with that 10-sma now curving lower and hopefully ready to provide resistance on daily closes. MACD dropped below zero this week and has remained negative, even on the late-week bounce attempt. As suggested midweek, conservative traders may want to lower their stops. However, in order to give BAC any room, especially with the triangle's top trendline validating the importance of that level, we're leaving our official stop as it is until BAC has broken below the triangle formation. Whatever optimism buyers felt toward financials midweek, BAC's troubles aren't finished. Those include a rising tide of lawsuits after its acquisition of Countrywide. The midweek update also noted the expiration of the temporary rule to limit short selling in certain stocks. Although the expiration of that rule doesn't appear to have impacted financials this week, it might in the future. Our first target is $28.00. Readers should consider taking partial profits there in case BAC is reaching down intraday to test its triangle's and the 30-sma support, but closes the day back above both. Our second target is $25.50.
Picked on August 07 at $ 31.52
Freddie Mac - FRE - close: 5.85 change: -0.09 stop: 8.15
As happened with many entities likely to be impacted by the mortgage mess, FRE
spent the week consolidating while analysts and official entities debated what
would happen in the future. In addition to the information detailed in the BAC
Picked on July 20 at $ 9.18
(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.)
Lehman Brothers - LEH - close: 16.17 chg: -0.03 stop: n/a
LEH spent the week churning, producing the fifth week in a row of small-bodied weekly candles that went nowhere. The news articles concerning financials have been detailed in other play updates, but specific news about LEH surfaced Friday. According to a Reuters article, LEH wants to sell its $40 billion portfolio of securities and commercial real estate in an attempt to shore up its finances. LEH has told prospective buyers that it will accept the first $5 billion in losses on that portfolio following the sale. As of May 31, the Reuter's article says, the portfolio's real estate assets were valued at $10.4 billion and its mortgages and mortgage-backed securities at $29.4 billion. We wonder what they would be valued at now. A FINANCIAL TIMES article concerning the sale was titled "Lehman faces fight to shed real estate assets," so we're guessing the financial world isn't exactly confident of LEH's ability to clinch that sale. At the close of trading Friday, LEH had fallen back slightly from its near approach to the converging simple 10- and 30-sma's and the trendline that had formerly supported it as it climbed off the July low. LEH needs to drop below last week's $15.14 low, however, to confirm that former support as new resistance. We have several 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
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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