Option Investor

Daily Newsletter, Tuesday, 09/23/2008

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Table of Contents

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

Market Wrap

Market Wrap

Market Wrap

The US markets were volatile yet again. I overslept a little bit and awoke to find the S&P and NASDAQ Futures basically flat at 6:30 AM. At about 8:30 AM, the NASDAQ futures were suggested way underperforming the S&P with the NQ futures down over 11 and the S&P down 1.50. The news that rocked the market today was the long drawn out Senate Banking Committee question and answer session and Federal Reserve Chairman Ben Bernanke, SEC Chairman Cox and Treasury Secretary Henry Paulson. By the open the NASDAQ Futures were up about 13.75 points versus the S&P +2 points. The upside was most likely attributed to Paulsons comments that began at 9:00 AM. The Treasury's $700 billion plan saw some contention from the Senate Banking Committee. The plan, as it is currently written, is raising concerns that the size of plan may be limited, or it will take longer to pass then expected. In addition, Senator Dodd stated that the current draft is not acceptable. Last Thursday I pointed out that the Paulson plan is still an idea and not yet ratified. I also pointed out that any advance would be a short term rally until the plan is actually adopted. The short covering from the SEC banning short sales is, in my opinion, socialist and anti-capitalist. People shouldnt be able to pass along false information and drive a company out of business. That is market manipulation. However, investors should be able to short troubled companies. The SEC is putting a band aid on a patient that lost a limb. The troubling thing to me is that the SEC did the cutting. There will be too much regulation added so this type of turmoil cant happen again. Regulators jobs are to protect investors from fraudulent activity and unscrupulous people. Too much regulation prohibits a free market society.

In the Asian markets, the Nikkei was closed for a Holiday while the Hang Seng closed down 759.40 points or 3.9%. The European Markets:
FTSE: closed down 86 (-1.6%) at 5150.3
DAX: closed down 34.1 (-0.6%) at 6073.7
CAC: closed down 69.8 (-1.7%) at 4153.8

Oppenheimer cut earnings estimates on Bank of America (BAC), Citigroup (C), JP Morgan Chase (JPM), Wachovia (WB) and Wells Fargo (WFC). Additional financial sector news came from American International Group (AIG) announcing suspension of common stock dividends. The news from AIG did little to stop the advance of the shares. AIG closed up 0.28 at $5.00. The futures seem to have spiked in the after hours session on news that Warren Buffets Berkshire Hathaway is investing $5 billion in the Goldman Sachs (GS) and is receiving another $5 billion in warrants. GS will be raising an additional $2.5 billion from additional common stock offering. Goldman Sachs is up about $10 from the 4:00 PM close. As I write this commentary, the S&P futures are up 16.00. The amount of overnight volatility is the reason that the VIX is holding above 30.

Lennar (LEN) missed third quarter EPS by $0.04 and beat on revenues. Actual EPS for the third quarter showed a loss of $0.56 per share, which includes $0.53 per share charge related to valuation adjustments and other write-offs. The results were $0.04 worse than the First Call consensus of a $0.52 loss. Revenues fell 52.7% year/year to $1.11 billion versus the $1.07 billion consensus. Revenues from home sales decreased 54% in the third quarter to $995.7 million from $2.2 billion in 2007. Revenues were lower primarily due to a 49% decrease in the number of home deliveries and a 9% decrease in the average sales price of homes delivered in 2008. New home deliveries, excluding unconsolidated entities, decreased to 3,694 homes in the third quarter of 2008 from 7,266 homes last year. The average sales price of homes delivered decreased to $270,000 in Q308 from $296,000 in the same period last year, due to reduced pricing.

Bristol-Myers Squibb (BMY) increased its offer to acquire Imclone (IMCL) to $62 per share, or $4.7 billion, from $60 per share. BMY owns 16.6% of all outstanding shares of IMCL.

Todays market internals from the NYSE had 872 advancing issues and 2200 declining issues. There were 11 New 52-Week highs and 153 New 52-Week lows on 10 billion shares on and off the exchange. The NYSE index (NYA) declined 133 points to7,785. The NASDAQ Composite (COMP) had 979 advancing issues versus 1,905 decliners. There were 25 New 52-week highs and 135 New 52-week lows on 1,990 million shares. The COMP declined 25 points to 2,153.34.

There are only three main stream companies reporting earnings tomorrow. BBBY and PAYX can be early EPS Short VEGA trades. Basically, we look to sell the increase in the Implied Volatility ahead of the earnings release by creating a positive Theta, negative Volatility market neutral position. If neither position provides sufficient risk/reward, I can look to NKE to trade. In a couple of weeks, I will spend more time reviewing this trade concept when there are more EPS plays to pick from.

Tomorrow has little in the way of market moving data. I think that the Fed is sitting tight on the 25 basis points and wont be swayed by a little economic data. The economy is taking back seat while they are trying to fix the entire financial system. My advice is to start from scratch and create one regulator for banks, brokers and advisors and another for publicly traded companies and the exchanges. Some of the builders have found buying interest (TOL and PHM) as some brokerages are beginning to upgrade them. If you are watching this sector, New Home Sales is out Thursday. Existing home sales are expected to decline from July.


S&P 500

Last Thursday, I wrote about how I saw the 21 day Exponential Moving Average (EMA) would be the near term resistance should the SPX break above the 8 day EMA. But on Thursday, I had no idea how high the market would gap up on Friday morning. By the 9:30 am open, the SPX had already broken through both moving averages and had even traded at a high of 1265.12, higher than the 1255 resistance from 9/12 I cited last week. Normally, the trade is to short the initial test of the 21 day EMA. But the open had gapped above that level. Unless you trade the S&P Futures, there wasnt a short trade until the market began to break down below the 21 day EMA yesterday. The confirmation occurred with the SPX closing below the 8 day EMA. With all of the interaction of the FED, SEC and Treasury it is difficult to stick with conventional methods. Normally, I would guess that the market would continue downward to test the lower Bollinger band at 1161. As of right now, I can cheat and see that the S&P futures are bid up eleven. Another thing to note about the charts appearance is that the RSI is still moving downward. At todays close, the slow Stochastics closed at 49 which was lower than the moving average (green line). Even though the Fed and SEC thwarted a black Monday, for now, the market is still in a confirmed downtrend. Short overbought tests of resistance


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I have to mention that I am not giving trade recommendations but using the existing chart patterns as a lesson format to teach trading methods on. The most important point I can make is to trade in the direction of the over all trend until it doesnt work anymore. But dont let the trade that doesnt work take all your money. The market can be like a casino. Small gains here and there and then, WHAM!! Youve pressed your bet and get am eleven, which is an automatic double down (increase your bet by two), against the dealer showing a ten. You get an Ace for a total of 12 and the dealer only has a seven under that 10. Have stops in place before you start the trade. I realize that seems like putting the cart before the horse but it is important to establish your risk profile and determine your tolerances before beginning to trade. Basically, it is necessary to see how far the stock or index can go against you (how much heat can you take) before your loss eats into your other trading capital. You want to have some diversification of strategies and investment vehicles so dont put all of your trading capital in one idea. Once you are ready to enter the trade, determine the price level that the trade would have to go to in order to negate your reason for the initial investment (a.k.a. stop loss level). Can you determine the total loss including slippage at that price level? If so, will it put you out of business? If yes, then you should reduce the size of trade to a manageable level. It is best to make multiple base hits rather than get struck out while swinging for a home run.

The chart above is of the daily SPX. It shows the 50, 89, and 200 day simple moving averages (SMA), ADX and the Money Flow Index. The ADX is a common trend indicator while the money flow represents volume of buying or selling. The SPX spent a little time above the 50 SMA on Friday but couldnt close above it. The ADX maintained above 20 (the common trend threshold) with the recent volatility and is still indicating the down trend. The 89 day SMA is far away from being a resistance level to contend with, while at 1292, the 50 day SMA remains the current dynamic resistance level. The Money Flow index had a little blip upward out of oversold territory and is the only positive on the above chart.

The SPX 30 minute chart above provides an internal view of the recent volatility from Thursdays 1133 low to Fridays 1265 high. Easy math has that two day range of 122 points or over 11% from low to high. Todays decline put the SPX below the 50% retracement of last weeks quadruple witching action. Normal markets that didnt have so much information released overnight (cowards!) would make me suggest a move to the 78.6% level of 1161 before any double bottom would be put in place. I actually believe that there are a lot of pessimists out there and that this market is ready to jump. Last Thursday was the capitulation with fear of money market insolvency. But the Fall trend will occur from the double bottom. As the Put/Call indicator in the Contrarian section suggests, the level of Bears peaked last Thursday and caused the indicator to become positively biased.


The NDX chart below represents the daily Bollinger bands. It is similar to the SPX in that it too is on a confirmed downtrend. The NDX, however, didnt break above the 21 day EMA on Friday. It actually closed down from the open after trading lower to the 8 day EMA (blue line). Microsofts buyback announcement couldnt keep the NDX up on todays close, however. The RSI appears to be slowing its momentum downward. The Slow Stochastics closed below its moving average (green line) which confirms the downward tendency of the index. Sell into rallies on a downtrend until it isnt a downtrend. That means to cover a short if the stock or index breaks above resistance and closes there. A higher high changes the perspective for a lot of traders that are looking at various indicators. The various indicators may be confirming or diverging but a breakout is a breakout.

The lower chart is of the NDX moving averages. Last Friday, the NDX ran up to the 89 day SMA and failed to break above it. Even with MSFTs positive news, the NDX couldnt hold onto its gains today. There was a 50 point range for today. A close above the 50 day SMA might put some positive sentiment back in the technology laden index. Money Flow is increasing a little while the index is declining. A strong bounce with a decline in the ADX would help negate the downtrend.

The last chart I want to discuss is of the CBOE Ten Year Yield (TNX). The TNX has bounced from a low of 3.25% to 3.85% in a matter of a week. Last Thursday, I couldnt buy T-Bills with hardly any yield. The reason for the change is that money that was running to safety has begun to run for the boarders as represented in the decline in the dollar. I think there might be a long Treasury play soon just on a fill the gap basis.


Trader's Corner

Trader's Corner

In order to provide more transparency into the contrarian methodology and hopefully give insight into the smart moneys mindset I am going to start sending the newsletter out on Tuesday and Thursday. The Thursday edition will include commentary on the Investors Intelligence polls.

The CBOE Equity Put/Call Ratio

Last Fridays gap up in the markets and close higher provided ample reason for bearish option traders to switch gears and consequently buy calls. The quick shift in sentiment brought the CBOE Equity Volumes Put/Call ratio down to 0.505. This sharp decline caused the 10 and 20 day moving averages to stop their advance upward. Last Thursday, the 10 day moving average peaked at 0.893. As of last night, the 10 DMA closed at 0.861 while the 20 DMA closed at 0.793. As mentioned last week I am going to switch the signal on the initial reversal of the 10 day moving average. Therefore, the signal is now on a Positive bias and will become confirmed once the 10 day moving average crosses below the 20 day moving average. It should be noted that the 20 DMA closed a little higher than Fridays close (0.792). The Negative signal will return if the 10 day moving average ticks upward again. SIGNAL: POSITIVE BIAS

The CBOE Volatility Index ($VIX)

Last week I mentioned that new money shouldnt buy into the Negative delta (short) bias until the $VIX falls to touch the 10 day moving average, assuming that the signal will still be negative. The 10 day moving average is at 26.80 while the 20 day moving average is at 23.59. As the chart shows, on Friday the $VIX dipped to the 10 day moving average on the initial pop in the SPX. That would have been an excellent time to put new negative Delta money to work. Then you would have been properly exposed to Mondays decline. Since the 10 and 20 day moving averages continue to rise, the Signal remains on a Negative bias. In addition, the current trading high/low range of the $VIX is 26 36 with the 20 day moving average is the low end of the range. Once the $VIX closes below the 200 day Upper Bollinger band, the low range will become the 200 day moving average. Volatility is high which usually presents occasional buy signals. However, a patient trader might reduce negative deltas once the $VIX closes below the 20 DMA and add negative Deltas on a test and bounce off the 20 DMA. The 10 day moving average is at 30.48 which is almost as high as the July spike in the $VIX. SIGNAL: NEGATIVE BIAS

Robert J. Ogilvie

New Plays

Most Recent Plays

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

Play Editor's Note: The play list is looking pretty light these days. The markets remain very volatile and if you're actually trying to trade these markets it's like playing tag on a multi-lane freeway. Sooner or later you're going to get crushed by a passing truck. We should be taking our cues from market veterans who have been trading the market for decades. Right now the pros are cutting back. They are trading less often, they're trading smaller positions, and the best advice has been to just sit out this market until we see something that resembles normalcy.

If you forced me to pick a short-term direction for this market I'd pick down. The Friday bounce followed by Monday's drop is a classic bearish reversal pattern. Nothing is likely to happen on the government's bailout plan until next week. That means that financials could lead the market lower until next week. After the bell it was announced that Capital One Financial (COF) was going to sell another large chunk of stock to raise capital. Individual traders can't short COF but the company can dilute their own stock price. This could start a huge run by other financial companies trying to raise capital by selling more stock while their shares can't be shorted. Currently the short-sale ban is set to end in early October unless the SEC extends it.

I was about to add bearish plays in the financials but then news crossed the wire that Warren Buffett's Berkshire was investing $5 billion into Goldman Sachs and shares of GS and the financial sector in general were spiking higher after hours. I decided against new plays tonight.

FYI: Potential trading ideas...

XLF: Look for the morning bounce on Wednesday to fade and then open bearish positions.

IYF: Same idea as the XLF just with a higher-price equity. Watch your option spreads! Another idea would be to consider some sort of straddle or strangle if the IFY trades near $70.00 again. However, this is a rough time to consider straddle or strangle plays with option premiums so expensive.

AAPL: Keep an eye on AAPL. I would consider buying calls on a dip near $120 or $118, which should be support. The challenge is where do you place your stop loss. Do you place it under $117.00 or $115.00?

RIMM: This stock might rebound if it trades near $90.00 again. The September 18th low was near $88.

Some of the ultra-longs and ultra-short ETFs and ProShares might be trades. Unfortunately, many of them don't have a lot of option volume and the option spreads are terrible. We remain in a bear market and the path of least resistance is down at least until next week when we might get another bounce when further news and details on the government's bailout plan comes available. Of course we're going to be subject to headline risk everyday as some sound byte could spark another short-covering rally. Remember, the best trade may be no trade at all at this time.

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

Updates On Latest Picks

Click here to email James

Call Updates

Allergan - AGN - close: 57.36 change: -0.60 stop: 54.95

The market drops again as investors question the probability of the government passing anything significant to "save" the market in the next few days. Biotechs were not exempt and AGN produced another failed "rally" between $59.50 and $60.00. I am reiterating my comments from Monday that AGN looks poised to retest the $57.00-56.00 zone. Wait for signs of a bounce from the $56 region before considering new bullish positions. If you look at the VIX and how it is creeping higher it suggests the market could see another swoosh lower. Traders will want to avoid bullish positions until after that occurs. Don't forget we're still in a bear market. AGN is a bullish candidate thanks to some relative strength. More conservative traders may want to use a stop closer to $56.00 instead. Our target is the $64.00-65.00 range. The Point & Figure chart is bullish with a $75 target.

Picked on September 21 at $ 58.68
Change since picked: - 1.32
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 2.4 million


Tidewater Inc. - TDW - cls: 60.68 chg: -1.99 stop: 57.90

Some profit taking in crude oil and the widespread market weakness was enough to pull TDW to an intraday low of $59.83. Our suggested entry point to buy calls on TDW was the $60.25-60.00 zone. Our play is now open. The dip in TDW may not be over yet. I would not be surprised to see TDW dip toward its 10-dma around $58.90 or the 200-dma closer to $58.00. My comments in the AGN update about the VIX and the bear market also apply here with TDW. Now that our call play is open we have two targets. Our first target is $64.90. Our second target is $68.00.

Picked on September 23 at $ 60.25 *triggered 9/23
Change since picked: + 0.43
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 1.4 million


Washington Mutual - WM - close: 3.20 change: -0.13 stop: n/a

Financial stocks led the market lower on Tuesday as investors doubted the government's success to actually crank out a plan to save the financial system. WM is also sliding as rumors slip out that the company is getting pressure by the Office of Thrift Supervision to sell itself soon before the government decides to step in and facilitate a break up of the company's assets. Currently there are about six different banks considering an acquisition of WM but there was talk yesterday that WM may want to wait it out and see what the Treasury's actual plan will be before allowing itself to be sold. At any rate it looks like WM's fate could be sealed by the end of the month. The government could step in or it could be sold. This is a very speculative, high-risk bet that WM will be bought and bought for a premium. The recent decline is just a "better" entry point to buy calls.

We're not listing a stop loss because the stock is so volatile. We listed the October or January calls as suggested strikes to buy.

Picked on September 21 at $ 4.25
Change since picked: - 1.05
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume = 113 million


SPDR S&P Oil - XOP - cls: 49.72 chg: -1.11 stop: 47.45 *new*

It should be no surprise that the XOP continued lower today. The next stop should be the 10-dma near $48.50 or the $48.00 level. Wait and watch for a bounce near $48.00 before considering new bullish positions. Readers may want to consider a stop loss closer to $48.00. We are moving our stop to $47.45. Nimble traders should also consider taking some money off the table if the XOP nears technical resistance at its 50-dma again. The XOP hit our first target on Sept. 19th. We're currently aiming for the $53.50 mark.

Picked on September 16 at $ 46.70 /1st target hit 9/19/08
Change since picked: + 3.02
Earnings Date 00/00/00
Average Daily Volume = 2.0 million

Put Updates

Volatility Index - VIX - cls: 35.72 chg: +1.87 stop: n/a

The VIX is still bouncing higher and represents a high-level of fear in the market by investors. The lack of confidence in the government's latest plan seems to be setting us up for another big plunge lower in stocks and another spike higher in the VIX. At this time I would wait for another blow-off top type of move like we saw on September 18th in the VIX before opening up new bearish put positions. We're setting our first target at 25.50. Our second target is 21.00.

Picked on September 16 at = 30.30
Change since picked: + 5.42
Earnings Date 00/00/00
Average Daily Volume = --- million

Strangle Updates


Dropped Calls

Toll Brothers - TOL - close: 23.52 change: -1.10 stop: 23.95

A negative earnings report from rival homebuilder Lennar (LEN) and the broad-based market weakness helped push TOL to another decline. The stock broke down under its 10-dma and broke down under the $24.00 level hitting our stop loss at $23.95. The next stop for TOL could be the 50-dma near $22.0 or the 200-dma near $21.00.

Picked on September 22 at $ 26.00 *triggered 9/22, stopped 9/23
Change since picked: - 2.48
Earnings Date 12/04/08 (unconfirmed)
Average Daily Volume = 5.1 million

Dropped Puts


Dropped Strangles


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


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