Option Investor

Daily Newsletter, Monday, 08/25/2008

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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

The stock markets began the week in a sour tone with the S&P 500 dropping 25 points to 1,266 and the NASDAQ Composite dropping 49 points to 2,365. Volume was very light on the New York Stock Exchange today with only 865 million shares traded. That is far less than the 50 day moving average of 1,328 million shares traded each day. The internals were weak on this late Summer Monday. There were 12 new 52-Week Highs and 101 new 52-Week Lows. Decliners outpaced advancers over 3 to 1 with 2418 versus 700, respectively.

As mentioned in last Mondays commentary, when the $TRIN closes above 2.0 the probability for a morning bounce increases significantly. The best way to trade the TRIN is to be prepared about 5 15 minutes prior to the close and place either a short put spread (bullish) on the S&P 500 (SPX) or S&P 100 (OEX) options or buy long the S&P eMini futures. With the options there is no way to have over night risk management on the options themselves but a trader with a futures trading account could have a stop order set to sell short the appropriate number of contracts that represent the cumulative Delta of the short put spread. For instance, you placed a short put spread on the OEX September 570/560 Put Spread for a net credit of $2.25 per contract and an 11 contracts. The position has a delta of 100.22 which suggests that the position will lose $100.22 per point decline in the OEX. Therefore, we can sell short 2 contracts of the S&P 500 eMini futures (the futures have a delta of 50 or a change in value of $50 per point in the S&P futures) to hedge the position if the futures drop below our overnight risk management level. So either way the TRIN long position can be hedged and have risk management. Our upside target is either closing the position at the open or at an 8 point profit target with a 4 point stop. By the way, last weeks TRIN trade did get stopped out.

Onto the NASDAQ internals, todays advance/decline had almost 4 losers to 1 gainer. The actual numbers are as follows: Advancing Issues = 632, Declining Issues = 2,228. There were 39 new highs versus 104 new lows on a very low volume day. Todays volume clocked in at 1,455 million shares versus the 50 day moving average of 2.08 million shares.

While I am on the internals I am going to cover the Open Interest readings as of today. The SPX closed at 1266.87 or about 17 points above the peak open interest (291,406 contracts open) strike price of 1250 on the September puts. The peak open interest on the calls is at the 1300 strike price with 218,628 open. The peak levels on the calls represent resistance while the peak levels on the puts show support.

As in most downtrends there are significantly more puts open than calls. This is because portfolio managers often purchase S&P 500 puts to hedge their portfolios. They do this according to their overall correlation to the S&P 500. For instance, if your diversified stock portfolio is $1,000,000 with a Beta of 1.30 then you would need to buy enough puts to hedge a $1,300,000 ($1 million X 1.30 Beta) portfolio. Hopefully those of you reading this realize that most option contracts represents 100 shares of stock or 100 times the value of the index. Therefore, the notional value of the S&P 500 at 1266.84 equals $126,684 per contract. A quick lesson in Deltas is necessary to figure the next part out. Delta is a theoretical value assigned to an option that represents the options potential change in price relative to a one point change in the underlying securitys price. For instance, assume we join the crowd and buy the 1250 September Put options for $19 per contract. Each contract has a Delta of negative 0.38 or profits $38 per contract for each point the SPX declines. By dividing the Beta adjusted portfolio value ($1,300,000) by the S&P 500 notional value ($126,684) we get a portfolio multiple of 10.26 or the Beta adjusted portfolios value per S&P 500 contract. To determine the number of contracts to buy to fully hedge the portfolio, we take the portfolios multiple and divide it by the Delta (0.38) to get 27 contracts. Therefore, we would buy 27 contracts of the 1250 puts to fully hedge the portfolio. In more stable markets we might see the S&P Open Interest Put/Call ratio to be skewed toward 1.0 suggesting that there are fewer put buyers protecting their portfolios and more call buyers adding positive deltas to increase their portfolios Alpha.

The NASDAQs open interest shows that there is support at 1850 as provided by the peak open interest of 12,211 contracts open. In addition, the absolute peak open interest is at the 1700 strike level with 17,725 options open. There is resistance at 1950 and again at 2100. But the 1950 strike price has the highest peak open interest with 17.960 opens contracts.

Today in Review

I believe that the market started off in a sour note this morning partly due to American International Group (AIG) having their third quarter earnings estimate cut to a loss of $0.86 per share by Credit Suisse. Fitch Ratings placed the insurance companys credit ratings on a negative watch. AIG dropped to its lowest level in thirteen years today and closed down $1.09 to $18.78.

The Financial Sector dropped about 3% today on the AIG news as well as news that South Korean regulators told the Korean Development Bank to be cautious about taking over any overseas banks. The Korean Development Bank expressed interest in Lehman Bros (LEH) last week. Shares of LEH dropped $0.96 to $13.45.


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The only three companies that posted a gain in the financial sector were Freddie Mac (FRE), Fannie Mae (FNM) and MBIA (MBI). The $2 billion debt offering by Freddie Mac was well received by investors. Fannie and MBIA apparently rose in sympathy as there was no news surrounding the stock.
The only economic news released today was from the National Association of Realtors existing home sales report for July. The report was mixed, but signals that a bottoming process in housing industry is taking shape. The number of home sales rose by a larger-than-expected amount, while home prices declined. In addition, the amount of unsold inventory rose to the highest level since at least 1999. July existing home sales rose 3.1% month-over-month to a seasonally adjusted 5.00 million annual rate; which is above the median economist estimate that called for 1.1% growth to 4.91 million.
Existing home sales are down 13.2% year-over-year. Existing home inventory supply is 11.2 months, compared to the 2007 average inventory supply of 8.9 months. The inventory of single family homes improved to a 10.6 months supply from 11.0. The decreased inventory time indicates that falling prices are helping to stimulate demand. Finally, the median sales price fell 1.3% from the previous month to $212,400 which is down 7.1% compared to last year. Not that it feels good but a 7.1% decline relative to the S&P 500s 14% decline isnt that bad.

Tomorrows Reasons for Moving

Tomorrow morning the August consumer confidence reports will be released at 10:00 AM. It is expected to be 53 versus last months 51.9. Also at 10:00 AM the New Home Sales report will be released which should provide some additional insight into whether housing remains weak overall. The August 5th FOMC minutes will be released. Usually, the equity markets are fairly quite ahead of the release. However, currency, credit and equity markets become volatile following the report.

Most of the stocks reporting earnings tomorrow are international stocks that I dont trade. Frankly, I dont many of the stocks reporting tomorrow. I used to trade Chicos FAS (CHS), Corinthian Colleges (COCO) and LTX Corporation (LTXX) many moons ago. There are a few consumer discretionary stocks reporting tomorrow including AEO, BIG, BGO, CHS and JCG. Consumer Staple stocks include SFD and SAFM.

The S&P 500 (SPX)

Today the SPX closed down more than 25 points at 1266.84 on light volume. The lighter trade suggests that the day was not a distribution day. Another reason for the light volume was that many traders are taking their vacation the week before Labor Day.

In this weeks newsletter, I am using a different background color and layout for the charts. The chart shows three moving averages, the 50, 89 and 200 day Simple Moving Averages (SMA). The longer term moving averages aid in determining the overall trend of the underlying security. The SPX is obviously in a long term downtrend as indicated by all three moving average intervals. As the chart above shows the market appears to have peaked short term at 1313.15 on August 11th. I have drawn a Fibonacci retracement from the July low to the peak. The SPX has been maintaining just above the 50% retracement level as it tries to break above the 50 day SMA, currently at 1278.82 (green line). If the SPX breaks below Last Wednesdays low of 1261 then the 50% retracement is the target line. But we need to see a breach of that level (currently at 1256) and a hold of the 61.8% Fibonacci level before taking a long position. A breach of the 50% level could be traded with a partial position with the 61.8% level, less a couple ticks, the stop loss. There are a number of ways to trade the SPX which include SPX options, futures, the S&P SPDR (SPY) and the Ultra Long Proshares (SSO). The next price level support after 1261 is at 1247 which is the August 4th low. Money Flow remains steady in the 50s but took a dip lower on todays decline in the market. The Money Flow Index shows that if the market begins to decline that there is still a lot of room for the indicator to fall before suggesting a selling stampede.

As of the close the 8 day Exponential Moving Average (EMA) closed just above the 21 day EMA. A breach of the 21 day EMA by the 8 day EMA would therefore suggests a negative bias. As a trader, when this bias shifts to negative short trades should be placed on the initial breach as well as when the price tests the 8 day EMA. For instance, a short trade on the SPX would be entered at the closing confirmation of the moving average cross over. Then a buy stop would need to be placed at a break of the recent high or some other parameter that meets your risk appetite. The Bollinger bands are squeezing together which is a reflection of the recent bit of lower volatility. The low Bollinger band is providing support at 1249 while the upper Bollinger band has the resistance at 1307. Slow Stochastics ticked down but hasnt confirmed a sell signal. That will occur once the Stochastics line closes below the moving average (green line). RSI is falling fast bust has support at 34. A break below that will suggest further weakness in the SPX.

The Russell 2000 (RUT)

I want to look at a different market this week. The RUT has held up stronger than the Dow Jones Industrial, S&P 500 (SPX) and the NASDAQ (NDX). As the charts below show the RUT did dip down quit a bit in March and July but have had phenomenal relative strength versus the SPX and Dow.

The RUT has posted a higher low and higher high since the July 15th low, barely. Stochastics appear different on the RUT chart when compared to the SPXs. For instance, the RUT is still on a long confirmed because the Stochastics line is above 20 after re-emerging from below 20 and the Stochastics line is also above the moving average. However, RSI isnt confirming the long as of todays close. The Lower Bollinger band is indicating the uptrend and is providing support at 700. There is also support neat 700 from the early August lows. We need to watch the 8 day EMA as it is approaching the 21 day EMA. A cross would suggest weakness in the small caps.

The RUT came down just below the 200 day SMA (719.99) intra day but closed just above it at 720.54. In addition, the 38.2% Fibonacci retracement at $719.88 provided support today. A break of the 200 day SMA and the 38.2% level would suggest the 50% retracement level and coincidentally the 50 day SMA as the next support level. Even though the RUT is showing decent relative strength it remains in a slight downtrend overall.

The Healthcare sector has been the darling of the Select SPDRs so far this year. However, the XLV closed below the 21 day EMA which suggests rotation into another sector may be occurring.

The Consumer Staples SPDR (XLP) is the only sector represented in the Select Spiders that is still above its 50 and 200 day SMA. One could buy the XLP on dips and sell short the weaker Sectors like financials (XLF) and materials (XLB) on spikes. Trade the trends direction. If the trend is down as indicated by the 50 or 200 day SMA sell the sector short on overbought signals. Cover the position at a risk level that you are comfortable with. For instance, if the ETF closes above the 21 day EMA or the 8 day EMA closes above the 21 day EMA. Another method may resemble a Turtle by placing a stop at the break above the 20 day high. Another stop may be relative to volatility of the security. For instance, on a short trade, one could set a stop at a break of 150% of the 20 day ATR on an up bar. Theses are just some examples. Good trading!

New Plays

Most Recent Plays

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New Option Plays
Call Options Plays
Put Options Plays
Strangle Options Plays

Play Editor's Note: Traders looking for bullish candidates might want to check out Joy Global (JOYG). I came really close to adding the stock as a call play today. The intraday bounce from support near $68.00 looks like a potential entry point. Or readers could wait for a new bounce over $70.00 to buy calls. What stopped me was the overhead technical resistance at the 50-dma and the widespread weakness in the major indices. If the market keeps falling even a strong stock tends to go down.

New Calls

UltraShort S&P 500 - SDS - cls: 67.02 chg: +2.50 stop: 64.95

Company Description:
The UltraShort S&P 500 ProShares are an exchange traded fund (ETF) that moves twice the inverse performance of the S&P 500 index.

Why We Like It:
Short-term technical indicators are turning positive on the SDS and the daily chart's MACD is nearing a new buy signal. Today's rally might be a tempting entry point for more aggressive traders. We want to see the SDS clear last week's highs. We're suggesting a trigger to buy calls at 68.01. If triggered our target is the $73.50-75.00 range. We would consider this a slightly more aggressive play since the SDS is going to be twice as volatile as the S&P 500. For every 1% the S&P goes down, the SDS will go up 2%.

Suggested Options:
We are suggesting the October calls although September calls would probably work just as well. September options expire in just under four weeks.

BUY CALL OCT 68.00 SDS-JP open interest= 181 current ask $4.00
BUY CALL OCT 70.00 SDS-JR open interest= 628 current ask $3.30
BUY CALL OCT 73.00 SBJ-JZ open interest= 13 current ask $2.45

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 25 million

New Puts

iShares Russell 2000 - IWM - cls: 72.06 chg: -1.62 stop: 74.15

Company Description:
The iShares Russell 2000 Index is an exchange traded fund (ETF) that mimics the price and performance of the Russell 2000 small cap index.

Why We Like It:
The small cap index has produced a failed rally under its simple 10-dma and came to rest right on its simple 200-dma today. Short-term technicals have turned bearish and the daily chart's MACD is three days into a new sell signal. More aggressive traders may want to consider new positions now. We want to see a confirmed break through on the 200-dma. We're suggesting readers use a trigger at $71.45, which is actually under the IWM's 100-dma. More conservative traders could wait for a drop under the 50-dma (near 70.85) or wait for a drop under $70.00. Our target is the $66.50 level.

Suggested Options:
We are suggesting the October puts.

BUY PUT OCT 72.00 IOW-VT open interest=7596 current ask $3.05
BUY PUT OCT 70.00 DIW-VR open interest=18462 current ask $2.19
BUY PUT OCT 67.00 DIW-VO open interest=6148 current ask $1.29

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 110 million

New Strangles

None today.

Play Updates

Updates On Latest Picks

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Call Updates

Arch Coal - ACI - close: 53.88 chg: -1.73 stop: 49.95

Coal stocks were hit hard today as traders sought to lock in gains from last week as the broader market posted a steep decline. ACI slipped to its exponential 200-dma before bouncing. Volume was very light. Today's session also produced a bearish engulfing candlestick pattern. We are not suggesting new bullish positions. Our target is the $58.00-60.00 zone. The P&F chart is bullish with a $68 target.

Picked on August 20 at $ 52.37
Change since picked: + 1.51
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 6.4 million


Adobe Systems - ADBE - close: 43.67 chg: -1.24 stop: 43.34

ADBE was unable to avoid the market-wide sell-off. Shares lost 2.7% and dipped to short-term support near $43.50. Today's move only reinforces what looks like a failed rally near $45.00 and its 10-dma last week. We would seriously consider an early exit right here! However, our stop loss is already at $43.34 (breakeven on the stock) and ADBE did manage to hold the $43.50 mark. Readers should expect ADBE to hit our stop loss if the NASDAQ continues lower tomorrow. We are not suggesting new bullish positions in this stock. 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: + 0.33
Earnings Date 09/16/08 (unconfirmed)
Average Daily Volume = 6.5 million


Chesapeake Energy - CHK - cls: 48.00 chg: +0.35 stop: 46.45

Natural gas stock CHK spent Monday's session churning sideways and actually closed higher. We would wait for a new move over $49.00 before considering new bullish positions. More conservative traders might want to tighten their stops toward today's low (47.11). We have two targets. Our first target is $52.00. Our second target is $54.85. FYI: As expected CHK produced a brand new P&F chart buy signal that now points to a $62 target.

Picked on August 20 at $ 48.05 *triggered
Change since picked: - 0.05
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 20.2 million


Itron Inc. - ITRI - close: 103.24 change: -1.55 stop: 99.90

Readers shouldn't be surprised to see profit taking ITRI. We warned investors over the weekend that the stock had stalled just under resistance. The trend of higher lows is still in place but momentum is waning a bit. We're not suggesting new positions at this time. 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: + 1.74
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 616 thousand


Research In Motion - RIMM - cls: 127.03 chg: -4.42 stop: 124.65

Our bullish play in RIMM is not looking healthy here. Shares were hammered for a 3% loss and the stock fell back toward its 100-dma. Several days ago we had closed our previous RIMM play when it looked like shares were poised to break support near $125.00. Now it looks like RIMM is set to retest the $125 mark. We would consider buying a bounce near $125.00 but keep in mind the short-term technicals are starting to roll over into bearish signals and last week's high could be considered the second peak in a double-top pattern. We have two targets. Our first target is $143.50. Our second target is the $155.00-160.00 zone. However, readers should expect RIMM to encounter some resistance in the $145-150 area.

Picked on August 21 at $132.30
Change since picked: - 5.27
Earnings Date 09/25/08 (unconfirmed)
Average Daily Volume = 19.1 million


CBOE Volatility Index - VIX - close: 20.97 chg: +2.16 stop: n/a

Today's sell-off may have really gotten traders attentions - at least those traders still here and not on summer vacation. The VIX rallied more than 11% but the trend of lower highs has not yet been broken. We have been suggesting that readers wait for a new rally over 22.50 to buy calls again. We're betting that the market will see another sharp sell-off and investor fear will rise enough to push the VIX toward 30.00 and all before the October option expiration. 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: - 1.60
Earnings Date 00/00/00
Average Daily Volume = x million

Put Updates

Bank of Amer. - BAC - cls: 28.96 change: -1.25 stop: 31.55

Financials were a real weak spot in the market today. Shares of BAC gave back all of Friday's rally. There is still potential support at the 50-dma but today's move looks like a new entry point for bearish positions. We have two targets. Our first target was $28.00, which has already been achieved. Our second target is $25.50.

Picked on August 07 at $ 31.52 /1st target exceeded
Change since picked: - 2.56
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 90.4 million


Chipotle Mex.Grill - CMG - cls: 70.13 chg: -1.87 stop: 73.65

CMG lost about 2.6% on Monday and almost closed under the $70.00 level. Over the weekend we suggested a move under $71.00 or $69.00 as a new entry point and that still holds true. The MACD on the daily chart is very close to a new sell signal. We have two targets. Our first target is $65.50. Our second target is $61.00.

Picked on August 20 at $ 69.90 *triggered
Change since picked: + 0.23
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 888 thousand


Millicom Intl. - MICC - cls: 79.69 chg: -2.20 stop: 80.75

More aggressive traders will want to consider buying puts on MICC following today's 2.6% drop and close under $80.00. We are going to stick to our original plan and use a trigger at $78.49. If triggered we're listing two targets. Target number one is $75.05. Target number two is $72.50.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 1.0 million


Regional Bank HOLDRs - RKH - cls: 97.70 chg: -3.34 stop: 103.05

The RKH regional bank HOLDRs erased Friday's gain with today's 3.3% reversal. The move today looks like another entry point to buy puts. More conservative traders may want to tighten their stops toward the $102 region. We have 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%).

Picked on August 18 at $ 99.80
Change since picked: - 2.10
Earnings Date 00/00/00
Average Daily Volume = 3.1 million


Uniao de Bancos Brasil - UBB - cls: 115.14 chg: -3.20 stop: 117.75

Weakness in financials was around the world and Brazilian bank UBB lost 2.7%. We are still waiting for a breakdown under support and we're not ready to give up just yet. Our suggested entry point to buy puts is at $112.50. If triggered our target is the $102.50-100.00 zone. FYI: More nimble traders may want to switch to bullish strategies if UBB can bounce above the $123.00 mark.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 1.5 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.)


Lehman Brothers - LEH - close: 13.45 chg: -0.96 stop: n/a

News that the Korean government cautioned Korean banks against making any big acquisitions in "overseas financials" (a.k.a. LEH) sent shares of LEH to a 6.6% loss. We don't see any changes from our previous comments and we're not suggesting new strangle positions. We have four weeks left before September options expire and need to see LEH significantly above $24.00 or under $10.00. 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: - 3.60
Earnings Date 09/18/08 (unconfirmed)
Average Daily Volume = 63 million

Dropped Calls

Illumina - ILMN - cls: 89.97 chg: -1.36 stop: 89.45

Over the weekend we tightened our stop loss on ILMN to $89.45. Midday Monday shares of ILMN had dipped to $89.09 hitting our stop and closing the play. The long-term trend on ILMN Is still bullish. A bounce near $87.00 or a dip (or bounce) near the 100-dma near $83.00 might be a new bullish entry point in ILMN. Buying dips near the 100-dma has been a good entry in the past.

Picked on August 14 at $ 91.55 /stopped out 89.45
Change since picked: - 1.58
Earnings Date 07/27/08 (unconfirmed)
Average Daily Volume = 1.2 million

Dropped Puts


Dropped Strangles


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


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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