Option Investor

Daily Newsletter, Saturday, 10/04/2008

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Table of Contents

  1. Market Wrap
  2. Trader's Corner
  3. Index Trader
  4. New Option Plays
  5. In Play Updates and Reviews

Market Wrap

No Place To Hide

Market Wrap

As you can see in the table above, the past week was brutal for everyone. Each of the indices in the table was down for the week and I highlighted those that were down greater than -10% (with several others very close to -10%. It was a bad week to be in anything other than cash and short positions. In the first table you can see how truly lopsided the new 52-week lows continue to be against new highs. This clearly reflects the selling is hitting all sectors. It's also significant to note that commodities, housing and transports took the brunt of the selling. As I'll show later with the chart of the Transports, this index made a significant closing low this week.

In Thursday's newsletter I closed by saying I expected a small bounce on Friday and then a new low to set up a rally into next week. It's amazing what a day can do to your expectations. We did get the bounce but the small bounce turned into a 300-point rally in the DOW. That's a rally, not a bounce (although in this market lately it does border on a bounce). And then we got the new low but I did not expect a 450-point decline on the DOW from its high. Amazing volatility.

So now the question is what the heck was that? As always I've got a couple of ideas about what is setting up--one is scary (if you're long the market) and the other essentially sticks with the idea I proposed on Thursday that we'll see a rally this coming week (maybe right away on Monday or after another relatively minor new low by the end of the day Monday. Even though Friday's reversal from the pre-House vote high looks rather bearish, and potentially is significantly bearish, I like to look for what-ifs and that's what we'll review in this weekend's charts.

The day started off with a sharp reaction to the negative jobs number report. A loss of 159K jobs was worse than had been expected. The following chart shows the trend in job losses does not look good:

Nonfarm Payrolls, June 2007 - September 2008

There's no denying it's an ugly trend and this kind of loss of employment has always coincided with a recession. It's just a matter of officially recognizing it to be so. The initial reaction in pre-market futures was a quick drop lower but then they magically got spiked back up to a high for the pre-market session. The cash market then opened with a big gap up that was then followed by a strong rally for the rest of the morning to a high near 1:00 PM, just before the announcement of the House vote on the Big Bank bailout bill.

Following the House passing the pork-laden bailout bill the market sold off hard. This prompts the obvious question "what else does the market want?" When is enough enough? For big money of course the answer is enough is never enough. And to those politicians who scared Americans into supporting a yes vote by telling them the stock market crash on Monday was a result of the House not passing the bill, what do you have to say for yourselves now? You've been duped into the biggest robbery of the American taxpayer and it won't make a bit of a difference in the credit contraction but it will make a few powerful people incredibly wealthy. Way to go Mr. Representative (who clearly does not represent the people). You will surely not get my vote next time. I only hope Americans, once they realize they've truly been lied to, stay angry enough to get the bums out of office. Our political system is broken and I hope we're at the cusp of making some significant changes. Pain results in doing something different and that will be the only good thing that will come out of the pain we're about to experience as a country (actually globally).


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Linda has done a great job at covering the TED spread in previous newsletters and a Traders Corner article. I've shown charts recently to show how the spread continues to widen. This reflects bankers (un)willingness to lend money. They want a higher return for it because they feel they need a higher compensation for the risk they're taking. Think of it as another measure of fear. For about the past 20 years and up through the middle of 2007 (before the first crack in mortgage-backed assets), the TED spread was consistently running at or well below 1.0 and below 0.5 for most of the 2000s. So bankers were only looking for 0.5% above the 3-month T-bill rate. This spread was running at a historically low rate which indicated unusually high levels of complacency (which usually leads to a "dislocation event" to shock people back to their senses that there really are risks out there). But notice what happened when problems started to arise in August 2007:

TED Spread, 2004-2008

After the initial spike up in August 2007, to a high near 2.4 points, it mostly bounced between 1.0 and 2.0 as the market tried to settle down, thinking the Fed was going to save us. But then the market began to realize that the problems are bigger than the Fed. Even after the bailout bill was passed the TED spread closed Friday at its highest level ever recorded. This is a clear indication that fear is mounting and bankers are becoming more and more reluctant to lend their money. No amount of taxpayer money will change this (it will only end up in the hands of powerful bankers).

To put this spike up in the TED spread into perspective, look at it relative to the past 24 years:

TED Spread, 1984-2008, courtesy Elliott Wave International

The crises during the previous bull market, including the 1987 stock market crash, did not cause the kind of fear we're starting to see in this market. It's another sign of the bear. It's an indication of a major shift in public mood (reflected in bankers' unwillingness to lend money) and is all part of the credit contraction cycle. The Senate and House of Representatives have been duped by big money to spend taxpayer money to bail out the bankers and it will have no effect on the credit crunch. As happened with the S&L bailout in the 1980s, the only ones to make out will be those who get bailed out. It has been engineered and crafted by Hank Paulson, ex-CEO of Goldman Sachs and who is hiring a Goldman Sachs cohort to help him figure out how to dole out the $700B (and mark my words, they'll be back for more).

The other chart I've shown recently is how the stock market sooner or later follows the credit spreads. As fear of risk intensifies, reflected in higher spreads, the stock market soon reflects the same fear by selling off. The following chart is not a pretty one for bulls:

Credit Spreads vs. S&P 500, courtesy Elliott Wave International

The credit spread is shown inversely so the wider the spread the lower the curve. With the continued sharp decline in the credit spread curve (widening of the spreads) the more ominous it is for the stock market. It doesn't mean the stock market won't bounce back up along the way but as long as credit spreads keep widening the lower the stock market is headed. In other words it's far too early to be thinking about picking a bottom in stocks.

I'll cover the four main indices that I regularly cover but if there were no major changes on the charts for the other sectors from Thursday's updates I'll skip those charts (since I've got a lot I'm showing as it is).

S&P 500, SPX, Weekly chart

SPX dropped slightly below the bottom of its parallel down-channel from October and certainly looks like it could at least tag the 62% retracement of the 2002-2007 rally at 1077 and the Fib projection at 1073 (two equal legs down from May). On a weekly perspective that's certainly potential support but I think only for a possible bounce before continuing lower. As I've mentioned before about these parallel channels, a break out the top of an up-channel or out the bottom of a down-channel usually leads to an acceleration of the trend (down in this case).

There have been rumors of the Fed stepping in to help prop up the market with a surprise .5% rate cut. I'm not sure at this time how the market would react to that. The initial reaction would likely be positive (maybe) but then fear of the Fed's fear could spark even more vicious selling. Certainly a Fed-induced rally would be an outstanding short play setup. But as always we have to remain vigilant about the volatility around more government intervention in our not-so-free markets, especially if you're trading this market up and down.

S&P 500, SPX, Daily chart

As I had pointed out on Thursday night, when I thought we could get a minor new low followed by a bounce into next week, it is still a possibility as I look at this daily chart (shown in pink). A little lower is the bottom of a parallel down-channel for price action since May and it coincides with the Fib levels at 1073 and 1077. So certainly watch for that possibility as we could see a bounce back up to the 1160-1180 area over the next week before heading lower again. A break below 1066, which stays below, could see a fast move down to the 1000 area.

Key Levels for SPX:
- cautiously bullish above 1220 and bullish above 1265
- bearish below 1220

S&P 500, SPX, 60-min chart

I actually turned more short-term bearish on Friday (and remaining longer-term bearish). Obviously the reaction to the House vote looks bearish but also the EW (Elliott Wave) pattern has turned potentially much more bearish than I had been considering it before Friday's failed rally. The potential here is for a gap down on Monday and some very strong selling. As mentioned at the end of the day on the live Market Monitor, it's potentially the most bearish setup I've seen since the market started its decline last October. Black Monday comes to mind when I look at the bearish wave count on this chart. That's why the 1066 level is important--if that gets broken and not recovered very quickly, we could see a very bad day on Monday.

Dow Industrials, INDU, Weekly chart

The DOW has now closed below potential Fib and price level support in the 10400-10600 area, as well as below its parallel down-channel from October. The next Fib, price channel and longer-term uptrend support area is near 9500.

Key Levels for DOW:
- cautiously bullish above 11400 and bullish above 12000
- bearish below 10700

Nasdaq-100, NDX, Weekly chart

NDX is still at potential support at the bottom of its parallel down-channel from October. The 1470 area is where I thought we could get a bounce and that's where it closed on Friday. By this measure we could see an immediate reversal of Friday's decline and get a rally started on Monday. It might only be good for about a week of bouncing around before heading lower again (pink) but the risk for anyone holding long put options is that we could see it hold up into opex so beware of that when considering holding any October puts if we get a rally on Monday.

Nasdaq-100, NDX, Daily chart

Support at the bottoms of the parallel down-channels can more easily be seen on the daily chart. Based on Friday's price action I'm thinking we could see an immediate breakdown from here but again, any bounce up on Monday should see a correction for at least for a week before proceeding lower again.

Key Levels for NDX:
- cautiously bullish above 1700
- bearish below 1600

Nasdaq-100, NDX, 60-min chart

A closer view of this week's price action is what has me leaning more bearishly after Friday's rally. The overlap between Friday's high and Wednesday's low means the leg down from Tuesday's high cannot be a completed 5-wave move (can't have overlap between the 2nd and 4th waves). That's a bunch of Elliottician gobbledygook to many but I mention it only because it had me relabeling the wave count. The best way to meet some EW parameters and rules calls for a very bearish wave count and that's why I warned of a possible gap down on Monday and strong selling to follow. But a rally on Monday would negate the immediately bearish wave count and would tell me the bottom could be in for at least a week so I'll know after Monday's price action what to expect for the rest of the week.

Russell-2000, RUT, Daily chart

The RUT's weekly candle is clearly bearish. It convincingly broke the longer-term uptrend line from 2002 through the March low. It could get a little bounce before pressing lower or just press lower from here. I think we'll see the RUT down to or below 550 sooner rather than later.

Key Levels for RUT:
- cautiously bullish above 768
- bearish below 678

NYSE, NYA, Daily chart

I've been keeping an eye on the NYSE because of the greater number of stocks and I think a better gauge of what's happening in the stock market (as compared to more heavily manipulated DOW and SPX). The daily chart supports the idea that it too is at support and ready for a bounce back up (pink) before turning lower again. But Friday's price action leaves me with the same problem as discussed for the NDX 60-min chart. Again, a breakdown on Monday could be very serious otherwise watch for a bounce that lasts about a week.

Banking index, BIX, Daily chart

Friday's big rally in the banks was given up by the close and left a bearish shooting star candlestick with a close just below its broken uptrend line from July. If the market manages a bounce over the next week I see the possibility for a rally up to its 200-dma again, currently near 223. Otherwise look out below.

For a different and potentially bullish perspective on the banks, look at the old down-channel from last year:

Banking index, BIX, Weekly chart

After breaking out of the down-channel in September the BIX has come back down for a retest and so far is holding. By this measure the banks look potentially bullish. At some point the banks will bottom before the broader market so I continually look for some evidence of that happening. Interesting chart here. But if they do turn lower notice MACD (I'm using a fast setting) just starting to curl over at the zero line. When MACD comes back up to the zero line after a bounce off a decline, or comes down after a pullback from a rally, and then reverses back in its original direction it makes for a very strong signal that the trend will continue. So in this case if MACD rolls back over at the zero line it would be a strong sell signal.

U.S. Home Construction Index, DJUSHB, Daily chart

The home builders index closed below its uptrend line from July. It's obviously a minor break at this time and the price level at the 2002 lows has not broken. So a bounce back up is entirely possible (leaving a head fake break and bear trap in its wake). But considering the choppy bear flag pattern here I'd be looking for a breakdown rather than a rally.

Back in November/December of last year both the DOW and the Transportation index made new lows thus giving us a DOW Theory sell signal. Then in May 2008 the Transports made a new all-time high and many were exclaiming that it was a signal of a new bull market. There was one problem--the DOW needed to confirm the new high since the last signal was a confirmed sell signal. The DOW of course did not make a new all-time high thus leaving a bearish divergence. The past week has now confirmed the DOW Theory sell signal, as shown on its weekly chart:

Transportation Index, TRAN, Weekly chart

Friday's close gave us a weekly close below January's closing lows and that confirms the DOW's lower annual close (in July and again in October). This is receiving very little notice by the financial media but is a potentially significant signal that the next leg down in the bear market is upon us.

I've often discussed the idea that we're going to see selling across the board in the next bear market, that very few areas will be spared. When commodities, including gold and oil, were racing for the moon we heard many people talking about limited supplies, excessive demand, etc. as reasons for continuing to invest in commodities. A funny thing happens when people become afraid and start to sell--funnymentals go out the window. In the past I got caught too many times holding on during rough times because the fundamentals were so strong (or that the company itself was so strong, had lots of cash, low P/E, etc.) and sat there dumbfounded that the market didn't agree with my assessment.

When a bear market takes over, which is a sign of fear by market participants, the baby can get thrown out with the bath water. Commodities may be a good long-term investment but even they will get hurt as people start to sell everything in order to raise cash levels. And if we're entering a deflationary period, as I believe we are, everything but cash will lose value. The monthly chart of the commodities index shows what's happening:

Commodity Related Equities Index, CRX, Monthly chart

The increasing steepness of the uptrend lines since 2003 told us the rally was going parabolic and usually the 4th uptrend line (the shortest one starting at the beginning of 2008) will be the last one. Once the steepest line is broken it usually means the run is over and it broke in July. The oldest uptrend line was broken last week so the run up is officially over and there's very likely more pain ahead for commodities holders. But right now there's hope (dare I use that word?) as the index has dropped to both the 50-month moving average and a 50% retracement of the 2002-2008 rally.

As part of eSignal's efforts to frustrate QCharts users I am not able to pull up the data on the US dollar since September 30. They're dropping the feeds on certain symbols for version 5.1 users and forcing people onto version 6.0 which is not as capable and they want more money for it. I haven't decided yet whether I'll switch to the new version or switch to a new package altogether. I'm not at all happy with eSignal and while I love QCharts I'm undecided whether I'll continue with it.

So without an updated chart I'll just say the US dollar has rallied to a new high above its September high of 80.375 and closed at 80.403 on Friday. The new high completes a 5-wave move up from March and that's significant because it tells us the trend has reversed and the dollar should become even stronger as we head into 2009. Fear will drive people into the perceived safety of the US dollar (probably into Treasuries). But for now the 5th wave up from the September pullback is leaving a bearish divergence against the September high and we should see a more significant pullback over the next couple of months before the rally resumes next year. That might help put a floor under the current decline in commodities. I emphasize might put a floor under commodities because we could be entering a period where we'll see a disconnect in the direct relationship between the US dollar and commodity prices (where both could decline together next).

Economic reports, summary and Key Trading Levels

Next week will be a quiet one as far as economic reports go. There are no major reports on Monday. Tuesday might be affected by the FOMC minutes but I don't think the market is worried about any surprises. The rest of the week's reports are likely not market movers.

Summarizing the week's charts, and especially after Friday's price action, I'm left with the sense that the market is on the verge of collapse. I think it's possible that in the next trading day or two we could see a market crash and I don't use that word lightly. First of all, it's almost always a very bad bet to bet on a market crash. It's a very rare event. The market has been held up through intervention and interference by the government and the Fed but each time they try something it seems to last for less and less time. The bailout bill didn't even last a nanosecond. People are getting scared and scared people do not make for a bullish stock market. So the sense of despair following blatant government efforts to prop the market up actually leaves the market more vulnerable to panic selling. Letting the market decline when it needs to decline, sometimes in a big way, is actually much healthier so that corrections can be finished and people can once again become more hopeful.

In addition to the sense of fear and foreboding that's creeping into the market I get a sense from the EW count that we're either at the edge or only a couple of steps away from the edge of a cliff. In EW analysis a strong move in the direction of the trend is called an impulsive move and consists of 5 waves. The 1st, 3rd and 5th waves are in the direction of the impulsive move and are themselves impulsive waves (so each of them is made up of 5 smaller waves). The 3rd wave is usually the strongest of the 5. As the 3rd wave develops, down in this case, it has a smaller 3rd wave and that 3rd wave has a smaller 3rd wave. Pretty soon you reach a point where the EW count is ready to "unwind" these multiple 3rd waves and that's where we are now. The unwinding process is usually marked by gaps in the direction of the trend. You get your breakaway gap, your continuation gap (or two or three) and then finally the exhaustion gap. The move is usually powerful and seemingly never ending. So needless to say I don't think it would be prudent to be in any long positions right now (look at the second table at the top of this report and see how many survived this week's carnage) and don't be looking for a bottom if the selling kicks off this week.

Having said all that, it's still possible we're going to see a rally this week and into early next week. I believe it will be relatively short-lived but again, October put holders may not want to let a correction play out in time since it will eat up your time premium. If you're looking to play the short side with puts and want to hang on through another bounce you should be in November or December puts.

If you're a spread trader I think selling bull put spreads is asking for trouble. The relatively small credit you take in for the spread is, I think, completely dwarfed by the risk involved in that play at the moment. Even bear call spreads are risky since we know how quickly and violently strong rallies can completely overrun your spreads (but at least tend to be relatively short-lived). Credit spreads are good for non-trending markets and right now we're in a strong downtrend that I believe is about to get stronger. Be very careful with spreads in this environment.

I used to trade options exclusively until about 2004 when I switched to futures trading. The slippage and relatively small movements in the markets was making it a real challenge to trade options. I've switched back to primarily options as I find I don't have the stomach to tolerate wide stops and large swings against my futures position. If I have confidence in where the market is going I'm playing it directionally with options and I let the intraday noise try to not to spook me out of my position. I tend to go a couple of months out at a minimum. Sometimes I'm right on direction but completely wrong on timing and going out a few months keeps the time-decaying monster at bay.

Bottom line, this continues to be a wickedly difficult market to trade and make money consistently. Profits are returned on a daily basis. Losses wipe out profits every other week and many are feeling frustrated just breaking even after working so hard at their trades. Others of course have been forced over to the sidelines after busting their accounts. The huge number of hedge fund failures should tell you something. If you're not an experienced trader (meaning a few years to experience ups and downs) then take it easy in this market--trade very lightly and do lots of paper trading. Many brokerages enable you to open a simulated trading account that gives you an opportunity to trade for real but not with your money. I highly recommend it but remember it's not like trading your own money. Throw your own money into a trade and suddenly emotions take over instead of rational thinking. And mostly remember that flat is a position.

I'll close with a link to an interesting video that many will think is pure conspiracy theorist crap. I'll let you be the judge but based on what I've learned about the markets and the big banking industry over the years, and watching how our political system has been manipulated by big money I must admit I'm becoming a believer. Even last week's news about Citigroup suing Wells Fargo and Wachovia to prevent their joining after Citigroup's failed attempt at picking up Wachovia for a song starts to make sense after watching the video.

As part of a coming social revolution in the next generation (part of the long historical swings as studied in socioeconomic theory) combined with the age of the internet, we could start to see a swelling of public anger at what's happening within our government and banking system. The people will want to take their country back. Plus you know I don't like the Federal Reserve and what they do. Ron Paul is looking better and better (wink). Anyway, enjoy (or not), and be sure to watch the three parts.

Another video (42 minutes long) is also a great educational piece about the Federal Reserve and the fact that it's really a non-government bank that's essentially a cartel. At the 6:30-minute mark it specifically states the purpose of this cartel is to pass along the losses of the banks to the taxpayers (which should sound familiar about now).

Good luck this coming week and I'll be back with you on Tuesday and Thursday. It could be an active week so I'll have an opportunity to review the action with you along the way.

Key Levels for SPX:
- cautiously bullish above 1220 and bullish above 1265
- bearish below 1220

Key Levels for DOW:
- cautiously bullish above 11400 and bullish above 12000
- bearish below 10700

Key Levels for NDX:
- cautiously bullish above 1700
- bearish below 1600

Key Levels for RUT:
- cautiously bullish above 768
- bearish below 678

Keene H. Little, CMT
Chartered Market Technician

Trader's Corner


I was amazed. Many of you know that along with reading about trading, I'm also a devotee of the CBOE's and CBOT's free webinars. What better way to learn about new options products, look over the shoulder of someone else trading the same strategies you are or learn about ways to control emotions when trading?

I was amazed when I listened in on a CBOE webinar first aired in September, however. The presenter ran an options-trading site issuing trading signals. Before he could even complete his explanation of the parameters of his trades, their success rates or his experience, attendees were sending in questions to the moderator about how they might contact the presenter and sign up for his service. This was literally two minutes into the webinar. Some wanted to know if they could sign up for automatic trades to be executed whenever a signal was issued. Two minutes these people waited before being ready to hand over their money to someone else to trade!

I tend to be a little more independent than that, and I hope most of you are, too. I want to be taught, but then I want to control my own trades. But even if you don't trust yourself to make trading decisions and want a professional money manager or want to follow the signals of more seasoned traders, you need more information than those people had after hearing a guy present for a total of about two minutes.

That's a phenomenon we sometimes run into on our site, too. I'll tell you a little story about one of my experiences.

I make more money trading these days than I do otherwise working, so I'm at least moderately successful at it. I was originally hired to represent the self-taught trader learning along the way, and that's a role I still take seriously. I'm still self-taught and I'm still learning.

Teaching is one mission of our site, so in my role as the self-taught trader, I confess to subscribers when I've made mistakes. Even if the purpose were only to warn subscribers against making similar mistakes, that should be helpful, but the mission goes beyond that. My goal is to let subscribers know what strategies work and what I've discovered about controlling risk or setting up trades.

I'll never forget a time several years ago when I'd tried an unfamiliar strategy and lost a hefty chunk of money in the effort. I talked about the mistake on the live portion of our site and also mentioned it in Trader's Corner articles.

I also mentioned it at a dinner party. I had no sooner confessed the mistake I'd made at that dinner party when I received a request from one of the other guests to trade his entire portfolio! A more than million-dollar portfolio. Literally within minutes of confessing the hefty mistake I'd made.

Of course, I turned down the offer, as I'm not a broker or a money manager and I'm not inclined to trade anyone's money but my own. But what's up with that? Moreover, the same experience had occurred when I had confessed the same mistake on the live portion of our mistake. The same day, someone wrote and asked if I could manage that person's portfolio. I could understand that if I'd just announced that I'd made a ton of money, but I'd just confessed to trying a mistaken strategy that ending up costing me.

Taking responsibility for decisions about our money--in choosing an advisor, a trading guru or finding our own signals--can be scary sometimes, but we still have the responsibility to make well-thought-out decisions and be wise stewards of the money we've earned. As a nation, we're getting that same lesson and we need to inculcate it in our personal trading decisions, too.

It's okay if you just want signals. Not everyone has to be an independent thinker. For those of you who just want signals, however, I have some advice. Follow the signals someone offers for a period of time before you act on them. Trade them on a simulator, either on your trading platform or on the simulator available through CBOE. Some surprises that can occur along the way, even when you're trading a strategy that you were told has no risk other than the debit you paid for it. For example, you might find out that the call you sold as part of a combination strategy has been exercised just in time for you to owe dividends to someone out there. Surprise!

You might find, too, that a particular type of trade doesn't fit your personality, although you expected it to be perfect for your situation. Someone in a trading group I attend can't trade condors because the moment he opens them in his account, the profit/loss page shows a loss. They're entered between the bid and ask but the P/L page isn't getting between the bid and ask when making its calculations. A trade that appears to be losing money from the moment it's entered proved too harrowing to this trader, even though he understands the probability that the trade will be profitable at expiration. These trades proved impossible for him to tolerate.

While trading on a simulator can't replicate all the emotions of real-life trading, they can do so more than you might expect. I once found myself complaining that currency traders kept picking off my stops right before the currency pair reversed. Only after I'd voiced the complaint did I remember that I was trading on a simulator. No one was seeing my stops!

Employing these strategies allows you to determine if you trust the person or service providing the signals. If you just want the signals, you can find that on our site or on our sister sites, but I urge you to take advantage of the teaching that's offered, too, before you jump into those trades. Independent thinker that I am, I believe that to be the great strength of the information you'll receive from our writers.

But don't believe me just because you've spent two minutes reading this Trader's Corner. Do your own research.

Index Wrap


The title of my column last week was "will they or won't they" and the question of this week is will they or won't they heed any positives implied by passage of the economic rescue plan (let's lay to rest the "wall street 'bailout'" misnomer!) and will this help stop the fall? Hard to say, as it's going to be some time before we can see if sales and earnings are going to slow, stop falling and then start rebounding.

Technical analysis in a panic free fall situation is not going to be as much help as it can be in 9 out of 10 market cycles. Fundamental analysis is not going to help much either as to suggesting where the bottom will come. Panics are too irrational for such analysis as fear, just like greed, isn't at all rational.

In terms of charts and indicators, there are some things that we should look at and there are some things that I would anticipate as to how and where a next bottom might form:

1.) Almost certainly, trader sentiment is going to get MORE bearish than it is now in terms of call to put readings; i.e., as a ratio of total daily equities call volume in relation to total daily put volume.
2.) We're now looking at '04 and '05 lows as possible next 'support'.
3.) I would guess that the shorter-term daily oversold indicators like RSI are going to get 'fully' oversold, just like the weekly ones are now, before there's a bottom worth trading, either to sell index puts or buy calls for an intermediate (e.g., 2-3 week) rebound.
4.) Analysis of long-term weekly charts has become more important (and I'll be showing several today).

Those holding index puts are also going to want to assess where a next significant bottom might lie although they for will be able to anticipate that rallies are going to be short-lived in this full-blown bear market. The panic phase is not quite the end of major bear markets. After panic comes a sort of surrender or disinterested phase where investors just don't want to hear about stocks, don't want to look at them; don't want to open their 401k statements. We're seeing some of this now.

I wrote my Thursday "Trader's Corner" (10/2) article on how the short selling restrictions might impact call to put ratios, as those wanting to short financial stocks might go into puts and distort call to put ratios. It didn't fit with my analysis that purchases of individual stock puts was picking up significantly due to the short sale restriction.

However, this take on it will be a moot point by mid-week. I didn't mention in my Trader's Corner article that the short-sale restriction was due to be lifted on October 18th OR 3 days after the bail-out bill was passed; i.e., the ban should lift Wednesday. I'm assuming here that the relevant SEC language relates to 3 BUSINESS days, but I'm unsure on this point. Anyway, short selling of stocks will be allowed again shortly.

You might recall me discussing how the sharp run up in transportation stocks in the spring, was such that an arc drawn under its rise went nearly vertical at the end of it, which was when the Dow Transport Average (TRAN) made a double top. What I noted about such parabolic type arcs was that such 'straight up' moves tended to end up coming straight down later on, winding up often where the rally began. It's such a good example of this concept that I'll lead with the TRAN daily chart.

Another trend bites the dust in that the multiyear (2003-2008) up trendline in the CBOE Oil Index (OIX) has finally been decisively penetrated given the recent fall in crude oil prices. OIX, which closed the week at 658, could retreat to 631 if it were to retrace 50% of the aforementioned 5-year advance. It only has taken 4 months for a retracement that is not far away from being one-half of that entire run up, proving again how they 'slide faster than they glide'! So much for 'locking away' oil stocks in your portfolio!!

Please e-mail me with any questions or comments at Click here to email Leigh Stevens support@optioninvestor.com and put "Leigh Stevens" in the subject line.

Other index and sector closes, recaps of market influences like earnings, company news, related market events, government reports and activities, etc. are found in the Option Investor 'Market Wrap' section.


The S&P 500 (SPX) index continues to be bearish in its pattern as rally highs fall short of prior upswings and new lows for this move keep getting made.

I noted in my initial (bottom line) comments above how the 13-day RSI has not yet gotten fully oversold. It's unusual to see this at or near any kind of major bottom, so I assume we're not there yet. Moreover, SPX hasn't yet tested some prior lows such as in the 1060 area. I've highlighted potential support in the 1080 to 1060 zone. It's a best guess of course based on a prior 2004 low as well as what would be a common 62% retracement as shown on the weekly SPX chart that follows.

Near resistance is in the 1155 to 1167 area, then at 1200, resistance implied by the 21-day moving average as of the close on Friday. This average is falling rapidly, so it should be plotted on a daily basis.

Besides the prior low at 1060, a stopping point to the current decline could come at the 62 percent fibonacci retracement level at 1080, or at the 2/3rds-66% retracement around 1050. Other than these type technical measurements there's not a lot of ways to suggest where potential support/buying interest might come in.


520, where we've seen recent support in the S&P 100 (OEX) is also the closing weekly low seen in 2004 but it remains to be seen if this area will see strong buying interest again. OEX has already retraced a bit more than a fibonacci 62% of its entire advance from 2002 into October of last year as measured from closing low to closing high.

512, at the low end of the downtrend channel I've highlighted on the daily chart below, also represents a 66% retracement of the 2002-2007 run up. Next support below 520 and 512, if those levels give way, should come in at 500. Below 500, next support based on long-term weekly chart (not shown) considerations comes in at 483.

Near resistance is at 545 and above this resistance implied by the 21-day moving average is at 555 currently.

Bullish sentiment as measured and seen by the 'CPRATIO' indicator graph above still is not at the very low extremes that would suggest that the major market indexes are due for a sustained turnaround, although another short-term (e.g., 2-3 days) rally could come at any time. On a short-term basis at least the Nasdaq is oversold, although the S&P is not quite there yet.


Once again the Dow 30 Average (INDU) fell from the area of its 21-day moving average, this time by a lot, with the Dow (this past Monday) having its biggest point loss ever. Not that this is so significant since the only meaningful way to measure these things is on a percentage basis, but the media talking heads were putting this out as the big story. It was more or less sideways in a trading range after Monday, with the Dow having a bearish close below this range and with the average ending up near its weekly lows.

Support implied by the low end of the price channel outlined below suggests potential support in the 10200 area. Lower support perhaps then lies around 10150, then at 10000, as noted in the weekly chart.

Again, I'm struck by the fact that due to the zig-zag nature of this decline, the RSI has not fallen to an oversold extreme on a daily chart basis.

As I noted above, the 2005 weekly chart lows suggest potential support in the 10150 area, then at 10000. 10000 is of major significance in terms of this being a prior important low and even more so of its psychological importance; 10000 is the demarcation line between the Dow being a 5-digit number versus a 4-digit one. 10000, if reached, will be a big deal. Holding this level will be major and breaking it of likely great importance in terms of how it could affect more bearishness and attention by the public.


On a weekly chart basis above, INDU has fallen to the high end of an oversold zone between 30 and 25 in the 13-week RSI; 13 reflects a quarter of year (52/4=13) and the 25 area is what I consider to be a 'fully' oversold extreme. To put the current reading of 28.5 in perspective, the 2001 and 2002 lows (not shown) saw the 13-week RSI reach levels just under 25, at 22 and 23 respectively.


The Nasdaq Composite Index (COMP) is bearish like the other major index charts and looks like it may reach 1900 next. Last week I didn't think there would be "a big further decline". Opps, WRONG! Once COMP broke support at 2100 it was downhill from there.

Major chart support could be found again at 1900-1890, at the 2005 lows. The 1750 area is significantly lower potential support implied by the 2004 bottom. We keep reaching further and further back for possible stopping points. COMP is not yet quite fully oversold in terms of the 13-day RSI, in contrast to the weekly oversold condition as will be seen on the weekly chart coming up after the daily.

Resistance is at 2100, then at 2160, at the 21-day average. A close over 2100, not reversed the next day, followed by a close above the moving average for a couple of days running would be bullish in suggesting shifting momentum.

As discussed already, use of the weekly chart is the only way to gain an historical perspective on where COMP stocks might start finding some buying interest; in the 1900 area and then at 1750.

The Composite is now quite oversold on a 13-week basis and neither of those two prior lows (2004 and 2005) seen above saw an oversold condition quite the equal of this one. Not surprising no doubt if this financial crisis is the worst in decades. Still, if the bailout starts to see even a glimmer of results, the degree of this oversold condition suggests potential for a significant rebound at some point.


The Nasdaq 100, by its Friday close at 1470, again reached the low end of the currently projected downtrend channel highlighted on the daily chart below. My thought indicated last week on buying NDX calls if the 1600 area was reached fell apart when the extent of the Monday plunge was seen this past week. NDX is now getting near support implied by the prior 2006 low at 1457 (will be seen on the weekly chart). 1400 is another support suggested by the 2005 lows.

Near resistance is at 1600-1605, then at the 21-day average, which is at 1665 currently and is falling rapidly. A close above 1650 would be bullish and appears as a key 'line' of resistance on the hourly chart.


As noted already, the prior 1457 low seen next on the weekly chart is a next possible near support if the early part of the coming week doesn't bring some stabilization to prices; 1400 is perhaps an even stronger technical support. 1300 is support suggested by the 2004 low.

On another note, a decline to 1345 would represent a fibonacci 62 percent retracement of the 2002-2007 rally and suggest a possible stopping area to this current plunge; NDX has now fallen below its 50% retracement at 1515, but isn't very far below this level so far.

NDX is the most oversold of all the major indexes at this point. Even going back to the 2002 and 2002 lows didn't bring a more oversold condition than this current one in the Nas 100.


There may be some support at 36 in the Nasdaq 100 tracking stock (QQQQ). The weekly chart points we could also be looking at for potential support are the 2006 low at 35.5, the 2005 bottom at 34.3 and the 32.3 low seen in 2004. Take your pick! There can of course be a turn anywhere in between, but those are the levels to focus in given a further decline by working back on the longer-term weekly chart (not shown here).

I've noted near resistance at 38-38.2 in QQQQ with resistance implied by the 21-day average currently intersecting at 41, with this moving average falling like a stone along with the current price trend.


The Russell 2000 (RUT) finally broke with the rest of the market and I've noted some of the prior lows that require an look back to 2005 and have been noted on the RUT daily chart below as potential support areas; i.e., first at 615, then at 570.

Time for me to stop predicting possible support like I did last week in suggesting that I'd be a buyer of RUT calls on another decline to the 650 area. Fortunately I got scared to the sidelines and held on to some puts. I don't know where this thing is going and I'm just along for any further ride to the downside.

I highlighted resistance in the 690 area but should also note 660 as near resistance. The 720 level is resistance implied by the moving average I use with RUT at a 55-day 'length' setting. I also make use of a longer length setting at 21 for the RSI indicator, which is showing falling momentum of course but at 37 is not yet at the fully oversold reading that has typically occurred at 30 and below.


1. Technical support/areas of likely buying interest are highlighted with green up arrows.
2. Resistance/areas of likely selling interest: red down arrows.
[Gray up/down arrows: support/resistance levels that got pierced]
3. Index price areas where I have a bullish bias or interest in buying index calls (or selling puts or other bullish strategies).
4. Price levels where I suggest buying index puts (or, adopting other bearish option strategies).

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM) strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as well as projected profitable index price targets, are based on my technical analysis of the indexes.

New Plays

Most Recent Plays

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New Option Plays
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Strangle Options Plays
C ESI None

Play Editor's Note: Friday's sell-the-news reaction to the bailout bill's approval is not a good sign for stocks. It would appear that investors are still trying to sell on any strength. There has been some talk that the Federal Reserve might surprise the market with an inter-meeting rate cut next week. A rate cut is a potential risk for us since it could spark a short-covering rally. I wouldn't expect any rally to last too long but it could hit a lot of stop losses. Furthermore I need to point out that the VIX, while extremely elevated, can go higher. More importantly, the VIX is not usually this high for very long and these types of spikes in the VIX tend to mark bottoms in the stock market. Don't get married to your bearish positions.

FYI: A few more stocks that look like bearish candidates or I'm watching for potential entry points are: FRO, HD, NILE, TTC.

New Calls

Citigroup - C - close: 18.35 change: -4.15 stop: 17.45

Company Description:
Citi is today's pre-eminent financial services company and was built to create a highly diversified financial services company that could act as one to deliver solutions to clients throughout the world. With the most diverse array of products and the greatest distribution capacity of any financial firm in the world, our 350,000 employees manage 200 million customer accounts across six continents in more than 100 countries. (source: company press release or website)

Why We Like It:
Citigroup was hammered for an 18% loss on Friday when it looked like Wells Fargo had outfoxed C from scooping up ailing rival Wachovia (WB). Shares of C bounced near short-term support around the $18.00 region. After such a one-day, news-driven move this might be a new bullish entry point to buy calls. Citigroup is going to be one of the few large banks that comes out of this credit crisis with room to grow. We're suggesting a stop loss at $17.45. More conservative traders might want to use a stop just under Friday's low (17.70). Our short-term target is $22.25. More aggressive traders may want to aim higher but keep in mind that we would not want to hold over the earnings report coming up soon.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 17.50 C-KR open interest=1664 current ask $3.35
BUY CALL NOV 20.00 C-KD open interest=8568 current ask $2.08
BUY CALL NOV 22.50 C-KA open interest=11074 current ask $1.23

Picked on October 05 at $ 18.35
Change since picked: + 0.00
Earnings Date 10/16/08 (confirmed)
Average Daily Volume = 109 million

New Puts

ITT Educational Servc - ESI - cls: 76.08 chg: -2.03 stop: varies

Company Description:
Carmel, Ind.-based ITT Educational Services, Inc. owns and operates more than 100 ITT Technical Institutes in 36 states across the country. ITT Technical Institutes offer career-focused, technology-oriented programs of study that reflect U.S. employment trends and employer needs. Approximately 54,000 students are currently enrolled in the ITT Technical Institutes. (source: company press release or website)

Why We Like It:
ITT could be in trouble as the credit crisis is having a huge impact on student loans. The student loan market is evaporating. Meanwhile shares of ESI appear to have produced a bearish double-top like pattern. Friday's move had ESI flirting with a breakdown under its 200-dma. We have two different entry points to buy puts on ESI. Entry point number one is a continuation lower with an entry at $74.35. If triggered at $74.35 we'll use a stop loss at $80.51. We know that's a wide stop but shares were very volatile on Friday. Trigger point number two is $82.75. Should ESI unexpectedly rally higher we'd expect it to fail under the $83.00 region. If triggered at $82.75 we'll use a stop loss at $85.05. We have two targets. Our first target is $67.50. Our second target is $61.00. The P&F chart points to a $65 target.

Suggested Options:
We are suggesting the November puts. See the play entry above on entry points.

BUY PUT NOV 80.00 ESI-WP open interest=604 current ask $11.10
BUY PUT NOV 75.00 ESI-WO open interest=158 current ask $ 8.40
BUY PUT NOV 70.00 ESI-WN open interest= 32 current ask $ 6.10

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 957 thousand


Hasbro Inc. - HAS - close: 32.84 change: -0.01 stop: 34.15

Company Description:
Hasbro, Inc. is a worldwide leader in children's and family leisure time products and services with a rich portfolio of brands and entertainment properties that provides some of the highest quality and most recognizable play and recreational experiences in the world. (source: company press release or website)

Why We Like It:
HAS could be facing a tough fourth quarter. Not only is consumer spending slowing down but not many retailers who buy from HAS may not be able to get credit to purchase inventory for the holidays. The stock of HAS has produced a big bearish head-and-shoulders pattern. HAS has already broken the neckline but has found support at its 200-dma. We're suggesting a trigger to buy puts at $32.25. If triggered our target is the $27.65 mark. Don't be surprised to see a temporary bounce near $30.00. More aggressive traders may want to aim lower but we don't want to hold over the late October earnings report. FYI: The P&F chart is bearish with a $24 target.

Suggested Options:
We are suggesting the November puts. At this time we do not see any Nov. 27.50 puts.

BUY PUT NOV 32.50 HAS-WZ open interest=1767 current ask $2.95
BUY PUT NOV 30.00 HAS-WF open interest=1071 current ask $1.95

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 2.1 million

New Strangles

None today.

Play Updates

Updates On Latest Picks

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Call Updates

JPMorgan Chase - JPM - close: 45.90 change: -3.95 stop: 44.45

JPM was holding up pretty well and trading above round-number resistance at $50.00. That was until the post-vote sell-off began. JPM fell off a cliff and ended the day down 7.9%. Technically the move looks like a bearish engulfing candlestick pattern, which can be interpreted as a bearish reversal pattern. We still think that JPM will out perform the rest of the financials but where the sector goes from here is a good question. The short-selling ban on financials, which was extended last week, will be removed around midnight on Wednesday, October 8th. Some traders could be exiting ahead of what they see as potential selling pressure. A bounce from the $45.00 level can be used as another bullish entry point to buy calls but you may want to tighten your stop loss even further. Our first target is $53.00 and suggest readers exit 50% to 75% of their position at $53. Our secondary target is $57.50.

Suggested Options:
We're not suggesting new positions at this time but if JPM offers another entry point we'd use the November calls. October calls work too but they expire in two weeks.

Picked on September 30 at $ 46.70
Change since picked: - 0.80
Earnings Date 10/15/08 (unconfirmed)
Average Daily Volume = 50.6 million


Wells Fargo - WFC - close: 34.56 change: -0.60 stop: 32.95

WFC was at the center of a dramatic merger story on Friday. The company announced a deal to buy all of rival Wachovia Bank (WB) in an all-stock deal that values WB at $15.1 billion. The move was a shock since WB had already been pledged to Citigroup (C) in a FDIC broker-deal last Monday. WFC was higher on the session following the news before eventually turning lower in the post-bailout vote sell-off. The stock has closed under $35.00 but found short-term support at its 20-dma. We already cautioned readers that technicals on WFC had been deteriorating and Friday's move is a bearish engulfing candlestick pattern. We were not playing WFC for its technical picture but on the expectation that after the bailout plan was passed those banks that are poised to take advantage of the new financial landscape would surge higher. Stocks in general saw a sell-the-news move, which doesn't bode well for the banks. More conservative traders will want to consider an early exit now or raising their stop loss toward $34.00. We are not suggesting new bullish positions at this time. We have been using a very wide stop loss because the financials are so volatile. Our first target was the $42.50 mark and suggest readers sell 50% to 75% of their position there. Our secondary target was $47.50.

Suggested Options:
We are not suggesting new positions at this time.

Picked on September 30 at $ 37.53
Change since picked: - 2.97
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 54.5 million

Put Updates

Sears Holding - SHLD - cls: 87.32 chg: -0.29 stop: 95.15

Several of the big retail stocks turned sharply lower on Friday. SHLD was not one of them. The stock bounced sideways between technical support at its 100-dma and short-term resistance at the $90.00 level. We see Friday's failed rally under $90.00 as another entry point to buy puts. The fourth quarter is not looking very good. Unemployment is rising. Consumer spending is falling. A lot of retailers are having trouble getting credit to buy inventory for the holiday season. As one of the larger retailers we don't see SHLD at risk for not getting credit but it might cost them more and they should suffer from the economic slow down. SHLD has showed some support at $85.00 in the past so don't be surprised to see an oversold bounce. We have two targets. Our first target is $81.00. Our second target is $76.00. The Point & Figure chart is bearish with a $77 target.

Suggested Options:
We are suggesting the November puts.

Picked on October 01 at $ 89.04
Change since picked: - 1.72
Earnings Date 11/28/08 (unconfirmed)
Average Daily Volume = 3.1 million


Volatility Index - VIX - cls: 45.14 chg: - 0.12 stop: n/a

The sell-the-news reaction to the bailout vote in Washington caught many market participants by surprise and fear began to rise again. The VIX remains at very elevated levels. We would still consider buying November puts in the 45-50 zone. Very short-term and nimble traders might consider buying some short-term calls with a target in the 49-50 region. Our September 16th put position (suggested entry at 30.30) has a 25.50 target. The September 29th position (suggested entry at 46.72) has two targets at 36.00 and 31.00.

Suggested Options:
Look for another failed rally type of move before buying November puts.

Picked on September 16 at = 30.30 first position
Change since picked: +14.84
Picked again Sept. 29 at = 46.72 second position
Changed since picked: -1.58
Earnings Date 00/00/00
Average Daily Volume = --- million


Whirlpool - WHR - close: 71.13 change: -5.25 stop: 80.01 *new*

Target achieved. As investors look ahead to the slowing economic outlook stocks were hammered lower on Friday. WHR lost another 6.8% and broke through potential support at the 100-dma and the $72.50 region. Our first target was $75.25. WHR is very close to our second target at $70.25. We're adjusting our stop loss to $80.01. We're not suggesting new positions at this time but another failed rally in the $78-80 zone could be another entry point for puts again.

Suggested Options:
We are not suggesting new positions in WHR at this time.

Picked on October 01 at $ 83.00 *triggered 10/01
Change since picked: -11.87
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 1.6 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.)


Financial Sector SPDR - XLF - cls: 18.78 chg: -0.86 stop: n/a

XLF traded on both sides of our suggested entry range (19.50-20.50) so we had multiple opportunities to open up a strangle position. We're not suggesting new positions at this time unless the XLF sees another bounce back toward the 20.00 zone. This is a two-week bet that financials see some big movement following the approval of the bailout bill. We suggested the October $22.00 call (XLF-JV) and the October $18.00 put (XLF-VR). Our estimated cost was $1.54. We want to sell if either option hits $2.25.

Suggested Options:
We are not suggesting new positions at this time.

Picked on October 02 at $ 19.64
Change since picked: - 0.86
Earnings Date 00/00/00
Average Daily Volume = 222 million

Dropped Calls

Apple Inc. - AAPL - close: 100.10 chg: - 9.02 stop: 97.45

We were off to a good start on Friday morning. AAPL gapped open higher at $104.00 and traded over $106 before suddenly plunging under $95 a share. Investors reacted sharply to a "news" item by a CNN iReport that Steve Jobs had been rushed to the hospital following a heart attack. The story was false and odds are good that the SEC will be investigating the news and timing for potential fraud. Of course that doesn't help us. We were stopped out at $97.45. Even after it was revealed that the story was fake shares of AAPL eventually faded from its afternoon bounce and closed under $97.00.

Picked on October 02 at $102.50 /stopped out 97.45
Change since picked: - 2.40
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume = 28.5 million

Dropped Puts


Dropped Strangles


Today's Newsletter Notes: Market Wrap by Keene H. Little, Trader's Corner by Linda Piazza, Index Trader by Leigh Stevens, and all other plays and content by the Option Investor staff.


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