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Daily Newsletter, Monday, 08/18/2008

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Market Wrap

Market Wrap

Today began with the futures up in pre-market trading. The upside sentiment followed positive earnings from Lowes Companies Inc. (LOW). LOW posted 2nd quarter earnings per share of $0.64 and beat their estimates by $0.08. LOW also beat the revenue estimates with a total of $14.51 and a year over year increase of 2.4%. However, they guided their 3rd quarter down and affirmed the previous 2009 guidance of $1.48 1.56 versus the $1.50 consensus. Also reported in pre-market was that Brinker International (EAT) is selling its Romanos Macaroni Grill franchise. BHP Billiton (BHP) reported its sixth straight full-year profit and offered an upbeat outlook.

Except for the attention the Barrons news article about Freddie and Fannie Mae garnered, all in all it was a slow news day. The article suggested that the flailing government agencies, Fannie Mae (FNM) and Freddie Mac (FRE), are becoming increasingly likely that the Treasury will have to recapitalize them in the months ahead (read: at taxpayer's expense). The Treasury is taking advantage of powers it has been granted under the new housing bill signed into law last month. If the Treasury makes the move to recapitalize FRE and FNM that almost would certainly wipe out existing holders of the common stock. In addition, holders of the preferred stock and even holders of the two entities' $19 billion of subordinated debt may also suffer losses. An insider in the Bush administration tells Barron's Fannie and Freddie are being informally persuaded by the Treasury and their new regulator, the Federal Housing Finance Agency, to raise more equity.

The Internals

The S&P 500 (SPX) closed down 19.60 at 1278.6 and the New York Stock Exchange (NYSE) closed down 100.77 to 8281.86. Total volume on the NYSE was low at 1,230 million. The 50 day average is at 1,703 million shares. With lower volume than Friday and lower than the 50 day moving average todays decline isnt considered as a distribution day. There were 943 advancing issues versus 2213 declining issues. The NYSE had 30 New 52-Week Highs and 77 New 52-Week Lows. The ARMs Index or $TRIN ran up to 2.26. Peaks above 1.50 at the close present a short term trader with an opportunity go long the market. Since by the time you read this the only market that is open is the futures market you could buy the S&P E-Mini contract at 1282 1283. Lets assume we buy this at 1283 and set an 8 point profit target with a 4 point stop. Another trade exit method is to close out the position at the open tomorrow.

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The NASDAQ Composite (COMPQ) declined 35.54 to 2416.98 on 1,656 million shares. Todays volume was less than the 50 day moving average of 2,211 million shares. The daily volume has been below the 50 day moving average for five days and has been lower each day. There were 923 advancing issues versus 1952 declining issues and 28 New 52-Week Highs versus 49 New 52-Week Lows. The internals of both indices suggest that todays decline was not a distribution day.

The S&P 500 (SPX)

I am trying a new charting package tonight and hope that it is clear and easy to read. Basically I am trying to consolidate trading platforms. The chart below is of the S&P 500 Index. As of the close, the SPX ended the session at 1278.60 which was just below the 21 day exponential moving average (Magenta Line) at 1280. The 8 day EMA declined from Fridays close from todays decline. The SPX was showing some promise technically last week when it broke above the 100% Fibonacci retracement and up to the 127.2% Fibonacci level before selling off on Tuesday and Wednesday. The SPX did violate the 21 day exponential moving average (EMA) intraday on both of those days but managed to bounce back and close above. The 5 bar RSI began to roll over last week and continued to head down below 50. While the market may be consolidating and absorbing the daily dose of negative news from the financials the RSI is indicating that the market isnt at a high probability long entry price. I prefer to see a stock or commodities price dip below 30 and then re-emerge and close above that level prior to entry. I may miss the bottom but I can get the middle. The Slow Stochastics is also suggesting that the SPX is in decline. Last Wednesday the Stochastics line closed below its 3 bar moving average thus signaling a new potential distribution phase. In the future if the market bounces back up on lower volume and cant muster enough momentum to close above the previous days high (See Thursdays high) and get the Stochastics back above its 3 bar MA the market is probably going to sell off and retest a recent support level.

Onto the chart below that shows the 50, 89 and 200 day Simple Moving Averages (SMA) in blue, yellow and magenta, respectively. The SPX closed today just below the 50 day SMA of 1286. The recent uptrend line from the July 15th low of 1200.44 was broken through and closed under. Both downward violations place the SPX in a negative note. A short position could be traded on a test up to the 50 day moving average. The next price support level is drawn below (yellow horizontal line) at 1262.

I have zoomed the daily chart to show the Fibonacci levels so we can see some target price zones. The 38% level is at 1270 and the 50% retracement level is at 1256. Therefore a break below todays low may spur an additional selling spree into 1255 -1260.

Technical analysis is an art and science. It takes science to create the charts and indicators and art appreciation to interpret them. My guess for tomorrow is that the SPX and SPX E-Mini Futures will gap up and sell off to fill in the gap (another short term trade method we can go over later).

The NASDAQ 100 (NDX)

On the chart below the NDX looks to be in much better shape than the SPX above. While the NDX is off about 120 points the chart is in a long term consolidation. Today the NDX closed above the 8 day EMA of 1930.13. The NDXs 8 day EMA has been above the 21 day EMA since August 5th. Last Friday the NDX closed up but the RSI declined down. That is a bearish divergence. As of today the RSI is at 54.43. While it stays above 50 the NDX remains in a positive bias. Last Thursday the Slow Stochastics dipped below its 3 bar moving average and remains below it as of todays close. The 21 day EMA is at 1896 and is also advancing. The NDX is on watch for a Neutral bias and will be changed to one if the NDX closes below the 8 day EMA.

The lower NDX chart shows that the price dipped to the converging 89 and 200 day moving averages at 1914. Even though the low today was at 1920.99 both moving averages served and will serve as major near term support. A violation of these moving averages would put the NDX in a bearish note. The upside resistance resides at June 17ths high of 1993. The uptrend line from July 15th is at about 1840 and the 50 day SMA is at 1881. The Money Flow Index peaked 79.70 on Friday. When the Money Flow Index reaches to 80 the security is overbought while levels at or near 20 the security is oversold. Therefore, with the combination of Money Flow peaking along with RSI and Stochastics on the decline the NDX may drop below the 200 day SMA to 1880. The technology sector isnt directly influenced by Oil or financials. But the consequences surrounding a slowing economy make consumers decrease technology expenditures.

Open Interest

The SPX September options range further than the 200 points on the chart I constructed from downloaded data. However, the totals at the bottom represent the total open interest. There are currently 1.47 puts open for each call open. Levels near 2.0 are very bullish while levels near 1 are bearish. The peak call open interest is at 1250 with 205,849 contracts open. However, the next peak open interest level above the current price is at 1300 with 190,443 contracts open. If you assume that the open interest represents sells to open, then logic suggests that those option traders that can open 100,000 or more options have substantial capital and can therefore keep the market from going through those prices. Peak put open interest is at 1250 with 280,709 but the support nearest to the price is at the 1275 strike level.

The NDXs peak open interest on the calls is at 1950 with 14,260 contracts open. There isnt any open interest higher than the average near the technical high of 1993 this month. The next resistance level is at the 2100 call strike with 13,977 contracts open. As for support the peak open interest is at 1850 which correlates nicely with the 50 day SMA mentioned earlier. The most interesting piece of information above is the Put/Call ratio is at 1.23 which suggests that there is an increasing amount of complacency in institutional investors. I probably forgot to mention that commercial traders and institutions trade the NDX and SPX while retail traders use the QQQQ or MNX options as an NDX alternative and the OEX or SPY as a SPX alternative. Institutions are subject to herd mentality too. They just use a different game trail than the rest of use. I should also mention that Open Interest Put/Call ratios are more static than Volume and dont usually ebb and flow to the same extremes. Therefore, buy and sell triggers are fewer and subject to more false readings (because of expiration). Support is at 1850 and resistance is all the way up to 2100. One should overlay these levels on top of a normal price chart to see where there are consistencies. Then sell the call just above and the put just below where the institutions are selling. You dont have to compete with their orders that way if the position goes against you. If it is going against you it is REALLY going against them! Besides you dont need to make the returns Goldman Sachs and Hedge Funds need. Your costs should be much lower.

Economics and Earnings 101

The big earnings plays tomorrow are Hewlett-Packard (I am surprised my DELL let me type that word) and Home Depot. See the chart below for other big names that have yet to report. Because the Healthcare industry has been on a tear I thought MDT would be of interest. In the technology sector, Analog Devices and Novatel report. Retail names like Saks Incorporated and Target report tomorrow and should provide some better insight into the consumer.

There should be excitement Tomorrow morning before the bell even rings. July CPI and PPI are scheduled to report along side some housing data. The market expects so little from the housing sector that it may just be surprised.

Sector Bets

Of course I use bets loosely because we dont bet on stocks as many option naysayers claim. I like following the SPDR Select Sector ETFs to see where the money is going to and from. For instance, the Healthcare ETF (XLV) has maintained its relative strength throughout most of the year. However, as the chart below shows the early trade this year was to short the sector. The sector appears to becoming overbought here as many traders had missed the healthcare kick and loaded on at the last minute. A good entry on this sector, in my opinion, is at a test near the 21 day EMA. (Long Alert)

I still think that the energy sector was oversold and is poised for a bounce back to retrace a few steps. With that said (written) the Energy Select Sector SPDR ETF (XLE) may still have room to go down until a true bottom is set. The problem with bottoms is that you dont know it was the bottom until after the fact. China has shut down a lot of industry in Beijing during the Olympics to reduce smog. Defined: China will start using more energy resources in a week which may increase global demand. I believe that the high in oil was hit and that oil will trade between 100 and 130 for some time. Heating oil should be the next seasonal runner. We should listen closely to this winters forecasts to determine which way to go. I still like the energy long here. Another way to trade it though is buy the Proshares Ultra Long Oil & Gas ETF (DIG) that I write about so often. It is a way to leverage the move once it begins. Since IRAs cant be margined like cash accounts, it is also a way to leverage within an IRA. However, some firms have found ways to establish restricted margin accounts that allow option traders to establish most option strategies within an IRA.

The Sector to be long going into a recession is mostly cash except for the negative return from inflation. But if you want pick a Select Sector, the Consumer Staples SPDR (XLP) seems to move counter trend to the market. The ETF was down slightly today while the overall markets were in a slight freefall. Except for Utilities, there wasnt one Select Sector SPDR that closed positively today. So when the market is declining and you can only go long, buy the one that doesnt go down as much. The XLP appears to be advancing so a buy the dip with a partial position would be an initial entry into this sector. Another entry that I like is a retest of the 21 day EMA. That way a close lower than the 21 day EMA would provide quick risk management and may be a stop and reverse scenario.

Good trading to all. I have to get ready for Fay that is headed our way.
 

New Plays

Most Recent Plays

Click here to email James
New Option Plays
Call Options Plays
Put Options Plays
Strangle Options Plays
None RKH None

New Calls

None today.
 

New Puts

Regonal Bank HOLDRs - RKH - cls: 99.80 chg: -3.74 stop: 105.75


Company Description:
The Regional Bank HOLDRs (Symbol: RKH) is an Exchange Traded Fund (ETF) that represents major stocks in the regional banking industry. There are about 19 companies in the RKH.

Why We Like It:
Banks look poised for another leg lower and a good way to play that might be the RKH. The recent bounce has failed near its 10-dma and today saw the RKH close under the $100 mark. Technicals have already turned negative. We're suggesting traders buy puts now with two targets. Our first target is $91.00. Plan to exit all or most of your position there. We'll set an aggressive, secondary target at $86.00. FYI: The top three holdings in the RKH are JPM (19%), WFC (13.6%) and WB (10%).

You may want to consider bearish put plays on JPM or even the XLF in addition to or instead of the RKH.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 100.0 RKH-UT open interest= 131 current ask $6.20
BUY PUT SEP 95.00 RKH-US open interest= 129 current ask $4.10
BUY PUT SEP 90.00 RKH-UR open interest=1548 current ask $2.65

Picked on August 18 at $ 99.80
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 3.1 million
 

New Strangles

None today.
 

Play Updates

Updates On Latest Picks

Click here to email James

Call Updates

Adobe Systems - ADBE - close: 44.10 chg: -1.01 stop: 41.50

The broad-based market weakness hit the tech-heavy NASDAQ for a 1.4% loss. Shares of ADBE under performed the market after being downgraded this morning before the bell. Shares ended the day off 2.2%. Today's decline has exceeded a 38.2% retracement of ADBE's August climb and shares closed under the rising 10-dma, which might be considered short-term bearish. We are not suggesting new bullish positions at this time. More conservative traders may want to raise their stop loss. Our target is the $47.50-50.00 zone. The Point & Figure chart is bullish with a $71 target.

Picked on August 05 at $ 43.34
Change since picked: + 0.76
Earnings Date 09/16/08 (unconfirmed)
Average Daily Volume = 6.5 million

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Illumina - ILMN - cls: 92.68 chg: -1.41 stop: 88.45 *new*

We're not giving up on ILMN. The stock hit $95.00 on Friday and our first target is $95.25. The stock displayed some volatility this morning and eventually pulled back toward the $92 region before bouncing this afternoon. The rebound this afternoon could be a new bullish entry point. Readers should note that we're raising our stop loss to $88.45. Our second target is the $99.50 mark, just below the top of its trendline of its rising channel and below round-number, psychological resistance at $100.00. 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
Change since picked: + 1.13
Earnings Date 07/27/08 (unconfirmed)
Average Daily Volume = 1.2 million

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Itron Inc. - ITRI - close: 102.23 change: -2.80 stop: 98.45

ITRI spiked to a new three-month high at $105.99 this morning although if you look at an intraday chart the move toward $106 looks like a bad tick. I don't see it really trading over $105.25 this morning. Today's session was negative with a 2.5% loss and what appears to be a potential bearish engulfing candlestick pattern. I would look for a dip back toward the $101.00-100.00 zone before considering new bullish positions. We've set two targets. Our first target is $105.75. Our second target is $109.90.

Picked on August 14 at $ 101.50
Change since picked: + 0.73
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 616 thousand

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Research In Motion - RIMM - cls: 127.01 chg: -1.79 stop: 124.45*new*

RIMM pulled back to the $125 level again and found additional support near the 50-dma. The technical momentum indicators are starting to struggle, which should put traders on the defensive. We are adjusting our stop loss to $124.45 and we're adjusting our secondary target to $134.75. RIMM has already exceeded our first target at $129.00. We're not suggesting new positions at this time.

Picked on July 31 at $120.50 /1st target exceeded
Change since picked: + 6.51
Earnings Date 09/25/08 (unconfirmed)
Average Daily Volume = 18.6 million

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CBOE Volatility Index - VIX - close: 20.98 chg: +1.40 stop: n/a

The widespread market weakness produced a little surge in the investor fear gauge and the VIX rallied 7%. This indicator still has a bearish trend of lower highs, which is actually bullish for the market. I still expect another market sell-off that could push the VIX toward 30 and beyond. This is an aggressive bet that the market will drop and the VIX will climb sharply before October option expiration. Readers might want to wait for a new climb over 22.00 or 22.50 before initiating new positions. Our target is $29.75 but readers might want to consider scaling out of positions in the $28-29 region.

Picked on August 03 at $ 22.57
Change since picked: - 1.59
Earnings Date 00/00/00
Average Daily Volume = x million
 

Put Updates

Bank of Amer. - BAC - cls: 29.30 change: -1.40 stop: 34.15

Financial stocks led the market lower on Monday. A Barron's article over the weekend re-emphasized what many on Wall Street are worried about - that if the U.S. government does have to step in to save FNM and FRE that it would wipe out current shareholders. Shares of BAC reacted with a 4.5% decline and the two-day pattern looks like a failed rally and the resumption of a new down trend in BAC. This looks like a new entry point for puts if you're aiming for the $25 region. More conservative traders may want to consider a tighter stop in the $32.50-31.50 zone. We have two targets. Our first target is $28.00. Our second target is $25.50.

Picked on August 07 at $ 31.52
Change since picked: - 2.22
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 90.4 million
 

Strangle Updates

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

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Lehman Brothers - LEH - close: 15.03 chg: -1.14 stop: n/a

Weakness in the financials also hit the broker-dealer stocks. The XBD index lost about 3%. Shares of LEH under performed their peers with a 7% decline. The MACD on the daily chart is very close to a new sell signal. The stock definitely looks poised to move lower. We have five 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
Change since picked: - 2.02
Earnings Date 09/18/08 (unconfirmed)
Average Daily Volume = 63 million
 

Dropped Calls

None
 

Dropped Puts

Freddie Mac - FRE - close: 4.39 change: -1.46 stop: 8.15

Target exceeded. We can attribute a good portion of today's 25% drop in shares of FRE to a Barron's article over the weekend. The stock was already weak and vulnerable and Barron's merely reiterated what has already been said, that if the government has to step in to save FRE current shareholders will probably be wiped out. Our target on FRE was the $5.00 mark. Shares opened at $5.40 and plunged to $4.36 intraday. The July 11th, 2008 low was $3.89, which is where we would expect an oversold bounce.

Picked on July 20 at $ 9.18 *target exceeded
Change since picked: - 4.79
Earnings Date 08/06/08 (confirmed)
Average Daily Volume = 45.5 million
 

Dropped Strangles

None
 

Today's Newsletter Notes: Market Wrap by Robert Ogilvie and all other plays and content by the Option Investor staff.

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Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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