Option Investor

Daily Newsletter, Thursday, 08/28/2008

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Table of Contents

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

Market Wrap

"The check is in the mail"

Market Wrap

This morning's pre-market release of a rather important and closely watched July durables good report found a mixed reaction at the open, but once traders and investors looked inside the numbers and started placing some of the pieces of the puzzle together, stocks began recouping some of this week's earlier losses in a still rather light volume trade.

Landlords that may have one, two, or maybe a few tenants that are habitually late with the rent payment each month will probably relate to my market wrap title.

Sometimes the rent never shows. Other times we're supposed to think the postal carrier delivered the rent check by Pony Express.

For a second-straight month, durable goods orders came in well above economists' forecast, suggesting some type of strong underlying fundamental economic trend exists that traders, investors and ECONOMISTS just aren't willing to embrace fully.

I can't quite figure out just how these types of numbers keep getting printed. Not only July's figures, but June's upside surprise was revised higher still.

Meanwhile, stocks just seem "stuck."

OK, OK, the small caps of the Russell 2000 Index (RUT.X) 732.95 +1.30% or its tracker the iShares Russell 2000 (IWM) $73.03 +1.19% have shown the ability to challenge their 12/31/07 closes a couple of times this year, but buyers (bulls, or short-covering bears) just don't seem to have the conviction to actually "deliver the mail" for a significant and sustainable move.

Large-cap NASDAQ, depicted by the NASDAQ-100 Index (NDX.X) 1,900.30 +0.74%, or its tracker the QQQQ $46.73 +0.64% have had their moments, but a prolonged move higher has been hard to come by.

I might also add, that despite the pummeling the financials and housing sector has witnessed the past couple of years, there's got to be some head-scratching going on in a few bear dens too.

If you're like me, you were probably scratching your head this morning and some early indications like the NASDAQ Short Term Trade (TRINQ) had it looking like four and five-lettered stock symbols at the NASDAQ were going to get crammed significantly lower, as the TRINQ's opening tick jumped to 3.06!

For those not familiar with TRINQ, or TRIN (see intra-day internal measures above), each day, a measure of 1.00 is considered to be "equilibrium" or a measure where buy-side and sell-side volume are equally matched. The higher the reading, the greater mount of sell-side volume, while the lower the reading (0.00 is lowest) would suggest greater amount of buy-side volume than sell-side.

A reading of 3.0 at any point during a session is equivalent to driving a car over a cliff, where the driver is gripping the steering wheel for all their worth, but expecting a very hard landing at the bottom of the ravine.

Prior to the open, the Commerce Department said U.S. durable goods orders in July rose well above expectations due to strength in aircraft, machinery and autos.

New orders for durable goods rose 1.3% in July, the same gain recorded in June and the largest gain since December. Excluding transportation, orders were up 0.7%.

Economists had expected a much smaller 0.1% increase for total orders and a 0.3% increase for orders excluding transportation.

The Commerce Department upwardly revised June's total durable goods orders to 1.3% and durable goods excluding transportation to 2.4%.

Non-defense aircraft and parts orders increased 28% following a 21.3% decline in the previous month. Boeing's (NYSE:BA) $64.52 +1.67% orders in July had increased to 70 from 62. Also contributing to total durable goods orders were gains in transportation equipment and motor vehicles and parts. The machinery sector saw a 4.6% increase in July.

The only order declines were seen for computers, electrical equipment and defense capital goods. The latter category declined by 25.7% following a 15.0% gain in the previous month.

The decline in orders for computers and electrical equipment could well have been a number traders were keying on this morning (see TRINQ).

Excluding defense, durable goods rose 2.8%, the largest gain since July of last year.

Durable orders excluding defense and aircraft, a category used as a proxy for overall manufacturing conditions, rose 2.6% in July.

It is THIS measure, which takes out the more "volatile" month-to-month and VERY LARGE TICKET ITEMS (defense and aircraft) that had selling "drying up,"

Another "grabber" of attention was that shipments for July rose 2.5%, the largest monthly gain since July of last year while unfilled orders and inventories both rose 0.8% in the month.

We'll remember, that on 07/24/08, just before the June durable good report was to be released, economists were looking for durable goods orders to either be unchanged, or to have fallen 0.3%.

Global Economic Calendar - Wednesday

An additional piece of economic data that I feel traders and investors were monitoring today (released at 10:20 AM EDT), even though from overseas, was Germany's preliminary Consumer Price Index (CPI), which did ease as we would have expected as depicted by the CRB Index (CRY in U.S. Market Watch) 401.02 +0.72% on the day, but off its early July highs of 473.97.

I think traders/investors that are short/put, or long/call any US-based company, that derives a meaningful (say 40% or more) of their revenue/earnings from overseas, needs to be monitoring economic trends and markets if they can.

Germany's DAX ($DAX) 6,321.03 -0.31% fell 19.49 points.


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Again, the dollar has shown some marked strength versus the euro the last couple of weeks and SHARP moves UP/DOWN even from very HIGH, or LOW levels tends to create trader/investor jitters.

A very NEGATIVE reaction in European, or UK markets as their currencies "ease" against the dollar, would be to see INFLATION pressures persist in those regions.

Let's take another weekly look at our major global equity indexes, currencies, oil and gold as well as a couple equity-based sectors we might be tracking.

Major Global Indexes, Currencies, Oil, Gold, HUI, OIX and XLF

Sit back for a minute, and take in some of the "bigger picture." These aren't charts, but their are some percentage changes that might begin to noted.

I look for things that "stick out" as somewhat unusual, or don't look like we might thing they should look.

For example, the British pound (FXB/pound) is not NOTABLY weaker than a "closer" counterpart the euro (FXE/euro) versus the US$.

Now look up at the "equity" side of things. In YELLOW, I note the FTSE-100 down 14.37% on the year, but "closer" counterparts perhaps have Germany's DAX -20.90% and France's CAC-40 down 22.11% since 12/31/07.

Could it be that the WEAKER pound versus the dollar is telling us the Bank of England will soon be cutting rates to stimulate the economy there? On a quarter-to-date (2008 Q3) a 7.9% decline in the pound vs. the US$ a bit weaker than the euro's 6.5% decline, yet back above to the equity indexes, FTSE-100 (not part of the EU) seems to "track" during that time comparison with EU members DAX and CAC-40.

Then we start looking at the US equity indexes.

It is somewhat of a "the check is in the mail" type of observation isn't it?

Will "the dollar's strength/weakness will be an accurate depiction of the world's view of the U.S. economy" actually come to fruition as Treasury Secretary Paulson and Fed Chairman Ben Bernanke said?

I hear you! I'll believe when I see it!

If I fully believed it, I'd be pounding my fist on the desktop telling you to "go all in."

"The check is in the mail."

Again, the US$, or the US Dollar Index (DXY) is very complex, and how the dollar trades (strong/weak) really can have different effects on things, or tell us different things about a domestic economy, or foreign economy, or impact on commodity prices (depending on where the commodities are being produced).

Some have "blamed" the dollar's weakness against the euro (or the euro's strength against the dollar) as exacerbating the RISE in commodity prices the last couple of years.

You're preaching to the choir if you're shouting "but many of Chinese consumers are just now migrating from bicycles to motor scooter, or even cars!" Thus some strong overseas demand that many believe is equivalent to when the U.S. consumer first migrated from the horse and buggy to a Model-T.

Yet some have "attributed" a weak dollar versus other currencies as helping BOOST sales/earnings of US-based exporters as the weaker dollar has US-manufactured goods and services being more price competitive (FXE $155, or e1.55 bought more US goods and services than it does today at $147.64, or e1.476).

Now look again at the above table we're tracking. Year-to-date, quarter-to-quarter.

DXY +0.42% on year, let's call it "unchanged," and FXE/euro a near-match, as it might be as the euro is the most heavily weighted currency in the DXY basket. Yet the U.S. Oil Fund (USO) $95.55 +1.87% today, still up 26.27% during same time observation. Q3-to-date, a much different story.

This is where I, and I think others, are having such a hard time getting our arms around things.

Speaking of oil, we got the EIA inventory data at 10:35 AM EDT, and there wasn't too much of a surprise, or at least, what few market participants are around this week, sure didn't show that great of a reaction.

The EIA reported a 177,000 barrel draw in crude oil stockpiles to 305.76 million barrels, while total gasoline stockpiles fell by 1.18 million barrels to 195.44 million barrels. Total distillate stockpiles rose by 57,000 barrels to 132.12 million barrels.

Versus a year ago, crude oil stockpiles are down 8.35%, total gasoline stockpiles are up 1.49% and total distillate stockpiles are up 1.70%.

On the demand side of things, US refineries increased their daily crude oil inputs by 300,000 barrels per day to 15.37 million barrels/day, and brought into production some idle capacity by utilizing 87.28% of their 17.6 million barrel/day operable capacity. In the prior week, refineries were utilizing 85.7% of total operable capacity.

As hurricane season looks to be getting into full swing, the number of days of crude oil supply remained unchanged at 20.5.

The more things change, the more they seem to stay the same. In late August of 2005, just before the Gulf of Mexico was slammed by Rita and Katrina, the number of days of crude oil supply stood at 20.3.

I would encourage subscribers to go back and look at the ARCHIVE pages (last August to mid-September'05) and read/observe all that was going on.

It was an exciting and historic event for me, as I hadn't experienced such an event. What worked? What didn't?

You might be VERY surprised what oil, unleaded, natural gas prices did.

Understand EXACTLY what the effects of the hurricanes were. Where they hit the coast at. Then if the Gulf of Mexico is once again hit by a hurricane, and refiners are flooded, with no power, and tankers pile up off the tip of Florida, why things traded as they did.

Bottom line here is traders had better EXPECT volatility in the energy pits, and if you have NO CLUE, or some type of historical reference (that's what the archives are for) as to how things traded and why the outcome was as it was, then hold on for the ride of your life, cause here comes Gustav.

Tropical Storm Gustav

Just recently you saw "Fickle Fay" wander around Florida. We'll see if Gustav can chart a steady course.

Yes, yes. "Female drivers." Hey, it's us guys that never stop to ask for direction when were lost.

"The mail's supposed to arrive" late Monday. Yes, Gustav was supposed to hit landfall late Sunday.

Yes, yes, yes! "The check is in the mail."

You got it.

U.S. Market Watch - 08/27/08 Close

As you could already see from the "Major Global Equity Index" table earlier, there's not a lot to write about this week.

Volume at the big board and the NASDAQ picked up a bit, but gosh they're light.

For example, the average volume on the big board the last 21-sessions has been 4.49 billion shares, and we've been running about 3.6 billion the last 5-days. NASDAQ was running just over 2.0 billion shares per day over the last 21-days, but that's been drawn lower with average daily volume of just 1.72 billion since our last visit.

I point out today's TRINQ high. Pretty good range you can see the intra-morning reversal.

I also point to the 5-year, 10-year and 30-year Treasury YIELDS. They too had a rather "wild" session.

YIELDS (they move INVERSE of PRICE) JUMPED higher on the durable goods data. That would be something that "makes sense" when you get a STRONGER than expected economic report, that might then think "Fed bias towards tightening."

However, by the close, PRICE LOSSES, turned into PRICE GAINS and YIELDS finished lower.

I will note, that juuuust about the time the major STOCK averages were hitting their HIGHS of the session, that about the time YIELDS turned red.

I could certainly argue some "defensive" buying of Treasuries into a long weekend, where Gustav might be knocking on some doors.

Fannie Mae (NYSE:FNM) $6.48 +15.30%, now off its 8/21/08 low of $3.53 may have once again had something to do with the bond market's gyration after it auctioned another $2 billion in short-term debt. The company sold $1 billion of 3-month bills 99.348 with a yield of 2.597% and $1 billion of 6-month bills at 98.549 to yield 2.912%.

Only note here is that today's auction found modestly HIGHER yield, which tells me that bond traders want a little more for the "modestly" HIGHER RISK they think they have over the next 3-to-6 months.

Fannie also shook up it management team, which some EQUITY traders viewed as a positive.

The Biotechnology Index (BTK.X) 823.40 -1.79% is red.

Shares of Amylin Pharmaceuticals (NASDAQ:AMLN) $20.46 -24.88% plunged after it and Eli Lilly (NYSE:LLY) $46.87 -0.31% said that four (4) more patients taking their Byetta diabetes medication have died.

Cell Genesys (NASDAQ:CEGE) $0.79 -71.78% fell sharply after the company halted an advanced prostate cancer drug trial.

I didn't highlight the Dow Jones Home Construction Index (DJUSHB) 297.50 +5.30%, but perhaps I should have. The 300.00 level has been some horizontal resistance since 06/06/08.

Today's Mortgage Banker's Association (MBA) weekly application survey showed what I would consider to be "stability."

That in itself could create some jitters among bears.

The MBA said its seasonally adjusted purchases index inched up 0.6% to 315.9, which is the sub-index I tend to tie with the DJUSHB. My 4-week SMA of the purchases index did rise to 315.1 from last week's 4-week SMA measure of 313.5, while my 12-week SMA (about 1 quarter time period) fell to 330.7 from last week's 12-week SMA measure of 335.10.

Undoubtedly the DJUSHB will "make the move higher" before the data from the MBA does, but some "stability" from the data may have some bears still on their toes.

Not much change in the average contracted interest rate for a 30-year fixed-rate mortgage, which edged down to 6.44% from the prior week's national average of 6.47%. A one-year ARM rose to 7.17% from the prior week's 7.07%, where some of Freddie's recent auctions sure isn't going to help things for those with ARMs.

Tonight, I'm going to leave you with one chart, and one chart only. We looked at this chart a couple of weeks ago and if the "check is in the mail," then with the Democratic National Convention drawing to and end, Tropical Storm Gustav moving into the Gulf of Mexico, and the Republican National Convention starting next week, this isn't just the chart of the week, but if the majors are going to begin to make a sustainable move higher to the end of the year, then this will likely be THE index to tell us.

The postman delivered two consecutive upside "surprised" in the form of durable goods orders for June and July.

S&P 500 Index (SPX) - 5-point box

There's been little change for the SPX in weeks, but by adding some "noise" with a less-conventional 5-point box, we can see some type of action.

Internals a/d lines over the past 5, 10, 21, and 50 days are what I would depict as "neutral" with many measures at 50%.

The larger picture, or the more institutionally followed BULLISH % indicators have "slipped" a bit for the BPSPX (take all 500 point and figure charts of the S&P 500 components and place "buy signal" in one stack, and "sell signal" in the other) and there's still 47.09%, or 235 in the "buy signal" stack and 265 in the "sell signal" stack.

It sure looks like there's been selling into the recent bounced, but buyers have been stubborn at the "apex" of the bullish triangle.

Something's got to give pretty soon.

My bias, based on various observations is the resolution will come to the upside. I'm leaning probably 60% bullish and 40% bearish on these observations.

Tomorrow (Thursday) is historically a BEARISH day for equities where August's next to last day has had the S&P 500 up only once the last 11 years.

New Plays

Most Recent Plays

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New Calls

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New Strangles

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Play Updates

Updates On Latest Picks

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Call Updates

Arch Coal - ACI - close: 55.40 chg: -0.02 stop: 52.37

Commodity stocks under performed the market's rally on Thursday. Shares of ACI dipped to $53.74 before bouncing back. We are still expecting a rally to its 50-dma near $58.25. Our target is the $58.00-60.00 zone but readers may want to exit at the 50-dma if it falls under $58.00. The P&F chart is bullish with a $68 target.

Picked on August 20 at $ 52.37
Change since picked: + 3.03
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 6.4 million


Chesapeake Energy - CHK - cls: 49.24 chg: -1.36 stop: 46.90

Oil and natural gas stocks reversed lower today. At first the oncoming hurricane Gustav led prices higher this morning but oil reversed when the Department of Energy announced it was willing to tap the Strategic Petroleum Reserves if necessary. This sent crude oil prices falling. Natural gas also weakened under rising inventory levels from the latest report. The three-week trend in CHK is still bullish but today's session was a tough one to swallow and looks bearish with the close back under $50.00. Fortunately, traders bought the dip near its trendline of higher lows and the 10-dma and 200-dma. More conservative traders might want to raise their stops toward $48. We have two targets. Our first target is $52.00. Our second target is $54.85. More conservative traders may want to inch up their stop closer to the 10-dma (near 47.50).

Picked on August 20 at $ 48.05 *triggered
Change since picked: + 1.19
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 20.2 million


Itron Inc. - ITRI - close: 105.53 change: +2.08 stop: 99.90

The market's rally lifted ITRI to a new relative high near $106. The intraday high was $105.89. Our first target was $105.75. ITRI appears to have some resistance near $106 as seen around the April 2008 highs. Our second target is $109.90.

Picked on August 14 at $ 101.50 /1st target hit 105.75 (08/28)
Change since picked: + 4.03
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 616 thousand


United States Oil - USO - cls: 93.39 chg: -2.27 stop: 89.79

Ouch! Today's drop in oil was unexpected. Oil spiked higher this morning as hurricane Gustav inches closer to the Gulf. Yet the rally in oil reversed after the Department of Energy said they would be willing to tap the SPR if need be. Plus, a larger inventory report on natural gas influenced the trading in the energy group. Technically, today's move in the USO is a bearish engulfing candlestick and a potential bearish reversal. More conservative traders are going to want to consider an early exit right here to cut their losses. We're going to wait and see what happens on Friday before making any decisions on the USO but we're not suggesting new positions at this time. If you don't feel like exiting but you want to be more defensive you could adjust your stop loss toward the $92 region. Our short-term target is $99.50.

Picked on August 27 at $ 95.12 *triggered 1 hour after report
Change since picked: - 1.73
Earnings Date 00/00/00
Average Daily Volume = 13.9 million


CBOE Volatility Index - VIX - close: 19.43 chg: -0.33 stop: n/a

A rising stock market is dragging the VIX lower. I'm starting to think it may be two or three weeks before the market finally falls and the VIX reverses higher. Of course Murphy's law states that as soon as I give in everything will reverse. We are not suggesting new positions at this time. I might be tempted to buy calls on a dip in the VIX near 17.50 or lows around 16.25. Otherwise, I would stick to the sidelines and wait for a break above its trendline of resistance. This play is essentially a bet that the market will see another sharp sell-off and investor fear will rise enough to push the VIX toward 30.00 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: - 3.14
Earnings Date 00/00/00
Average Daily Volume = x million


Whiting Petrol. - WLL - cls: 94.57 chg: -2.36 stop: 89.95

Crude oil and a good number of the oil stocks all produced bearish engulfing candlestick patterns. These are normally seen as potential bearish reversals. WLL managed a bounce near $92.70 and its 50-dma but the rebound was rather feeble. Traders need to be defensive here. More conservative traders will want to seriously consider an early exit right now to cut their losses. You can always jump in again later. We are not suggesting new bullish positions at this time. We are setting two targets. Our first target is $103.50. Our second target is $107.00. FYI: More conservative traders may want to play with a stop loss at $91.45, under the recent low. Meanwhile the Point & Figure chart is bullish with a $132 target.

Picked on August 26 at $ 95.80
Change since picked: - 1.23
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 1.1 million

Put Updates

Chipotle Mex.Grill - CMG - cls: 70.24 chg: +1.00 stop: 73.65

CMG continues to struggle but did manage a 1.4% bounce on Thursday. Look for a clear failed rally under $72.00 or a new drop under $69.00 as a potential entry point. 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: + 0.34
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 888 thousand


Millicom Intl. - MICC - cls: 80.66 chg: +0.85 stop: 80.75

MICC tried to bounce today but shares didn't get very far. We don't see any changes from our previous comments. We are sticking to our plan and suggesting puts with 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

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: 15.87 chg: +1.09 stop: n/a

The rally in financials fueled a 4% gain in the XBD broker-dealer index. Leading the back was short covering in LEH with a 7.3% gain. It sounds like investors are starting to hope the worst is over for LEH as the company tries to cope with its problems before a hostile bidder does it for them. That doesn't mean the problems are gone and the bounce today may not mean much on such light volume. We're not suggesting new strangle positions. We have less than 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: - 1.18
Earnings Date 09/18/08 (unconfirmed)
Average Daily Volume = 63 million

Dropped Calls

Research In Motion - RIMM - cls: 126.65 chg: -1.57 stop: 124.65

There was no reason for RIMM to under perform the market the way it did today. Both AAPL and RIMM were laggards during today's rally. RIMM looks poised to retest support near $125.00 and if the technical indicators are true then the stock is rolling over into a deeper correction. We're abandoning ship early to cut our losses. More aggressive traders may want to let it ride since the $125 level has held as support at least three times in the last month.

Picked on August 21 at $132.30 /early exit
Change since picked: - 5.65
Earnings Date 09/25/08 (unconfirmed)
Average Daily Volume = 19.1 million


UltraShort S&P 500 - SDS - cls: 63.87 chg: -1.57 stop: 64.95

We were expecting more of a sell-off following the market's Tuesday bearish reversal lower. There has been no follow through by the bears and suddenly the stock market is starting to look positive again. Our plan to capture the next leg lower with the SDS did not pan out. This ETF never hit our trigger (68.01) to buy calls so we're dropping it unopened. Keep an eye on the SDS as a trading vehicle should the rally run out of steam. We'll be watching for a potential entry point if stocks reverse.

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

Dropped Puts

Bank of Amer. - BAC - cls: 31.43 change: +1.78 stop: 31.05

We were growing suspicious of the strength in financial stocks yesterday. Thursday saw the rebound turn into a route and the shorts were running panicked today. The banking indices were up more than 4% and BAC soared 6% - right to technical resistance at its 100-dma. The stock hit our stop loss at $31.05 closing the play. BAC had previous hit our first target at $28.00 on August 19th.

Picked on August 07 at $ 31.52 /stopped 31.05/1st target hit
Change since picked: - 0.09
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 90.4 million


iShares Russell 2000 - IWM - cls: 74.51 chg: +1.48 stop: 74.15

A few days ago it looked like the Russell 2000 small cap index was poised to breakdown. We wanted to capture that move with puts on the IWM. We narrowly avoided the IWM hitting our trigger to buy puts at $71.45 on August 26th but it failed to hit our entry point. Today's breakout is short-term bullish so we're dropping this play unopened.

Picked on August xx at $ xx.xx *never opened
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 110 million


Regional Bank HOLDRs - RKH - cls: 104.22 chg: +4.46 stop: 103.05

The short covering in financials on Thursday was enough to lift the RKH through our stop loss at $103.05. We cautioned readers yesterday that the group was starting to look ready for a pop.

Picked on August 18 at $ 99.80 /stopped out 103.05
Change since picked: + 4.42
Earnings Date 00/00/00
Average Daily Volume = 3.1 million


Uniao de Bancos Brasil - UBB - cls: 121.68 chg: +3.00 stop: 117.75

The rally in U.S. financials is also rubbing off on overseas financials. UBB rose 2.5%. We had been waiting for a breakdown under support. That doesn't seem likely any time soon. We're going to drop UBB as a bearish candidate with the play unopened.

Picked on August xx at $ xx.xx *never opened
Change since picked: + 0.00
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 1.5 million

Dropped Strangles


The Contrarian

The CBOE Equity Put/Call Ratio

Last week the CBOE Equity Volume Put/Call ratios 10 day moving average spiked above the 20 day moving average which signaled the Negative bias. However, in the following days the 10 day moving average dipped back down to around 0.70 and remained there through Mondays close. As of last night the 10 day moving average bounced up to close at 0.706 from 0.699. At 0.710 the 20 day moving average is still higher than the 10 day moving average. The signal is back to Neutral until the 10 day closes back above the 20 day moving average. The best long signals occur when the 10 day moving average dips to 0.65 and then bounce. However, the 10 day peaked higher than normal the last time (near 0.85) and the difference between the peak and trough is roughly 0.15, which is the same as the normal range of 0.65 0.80. Bearish signals occur when a peak in call volume is achieved and confirmed by the 10 day moving average curling upward. The signal will become Negative again when the 10 day moving average crosses the 20 day moving average. SIGNAL: NEUTRAL BIAS

The CBOE Volatility Index ($VIX)

The $VIX is the measure of implied volatility of the S&P 500 options listed on the Chicago Board Options Exchange (CBOE). When the $VIX readings are high relative to the current range, the indication is that option traders are more willing to pay any price for options, whether puts or calls. Generally volatility levels peak at lows in the market and bottom at highs in the market. The SPX and $VIX have a negative correlation. Traders buy calls at high volatility levels more often as a speculative bottom fishing trade. Traders buy puts at high volatility levels as a portfolio protection technique. While one can trade the peaks and troughs of the $VIX, I prefer to use the 10 day moving average of the VIX to generate signals to adjust the bias.

I have inserted a screenshot from my thinkorswim charts of the CBOE $VIX as compared to the $SPX. The chart above represents only three months of price action. But it shows the clear bottoming process in July as the $VIX peaked above 30 intraday. As the $VIX has trended down the SPX has remained range bound. The 10 and 20 day moving averages continue to show the down trend as well. While the $VIX is at its lower range short term long entries can be taken on tests up to the 20 day moving average. However, a break above 22.10 would indicate that the market has more room to decline. The light blue dotted line represents the 200 day moving average and the solid light blue lines represent the upper and lower Bollinger bands. The $VIX usually hugs the 200 day moving average. Therefore, there is a chance that the $VIX will go back up to test the 200 day MA at 23.22. A sharp move up in the 10 DMA toward the declining 20 DMA will make the signal Neutral. However, a break through the Thursday low would confirm the move up in the markets and readjust the moving average range. The current range of the $VIXs 10 DMA has been extended to 17 as a low and 24 as the high. When the VIX is High its time to buy; when the VIX is low its time to go! The 10 day MA closed down at 20.42 while the 20 day MA closed at 20.95. SIGNAL: POSITIVE BIAS

The Investors Intelligence Polls

I look at the Investors Intelligence Polls to view the pooled sentiment of professional newsletter writers. The report that was released today shows that both the percent Bullish and percent Bearish were deadlocked. This week the percent Bullish declined a little to 39.3% from 40.7%. The percent Bearish increased a little to 39.3% from 38.4%. The spread is at zero, which is historically low but not according to recent levels. Normally, I would keep the signal Positive but since the recent lows in the spread I am taking this slight tick down in sentiment as an opportunity to go back to a Neutral bias.


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


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