Option Investor

Daily Newsletter, Monday, 10/06/2008

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Table of Contents

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

Market Wrap

Market Recap

Market Wrap

At one point today, about 2:45 PM, the Dow Jones Industrials ($DJI) was down 800.06 points. The S&P 500 (SPX) was down 91.26 while the NASDAQ 100 (NDX) was down 131.67 at the low. As the market summary above shows, the indices closed down just above the 50% todays retracement. At 3:59 PM the $DJI looked at though it was going to close above 10,000. But end of day sell in balances came in and brought the senior index to close down at 9,955.50. The rally off the deep lows came on the mention France proposing the G8 nations getting together to discuss the financial crisis. The US markets were initially down on the global financial crisis. If this news hadnt come out when it did, the markets were looking at establishing a new record.

European Markets: The FTSE closed down -391.1 at 4589.2 (-7.9%) while the DAX closed down 410 points to 5387.0 (-7.1%) and the French CAC closed down -368.8 at 3712.0 -368.8 (-9.0%).
Asian Markets: The Nikkei and the Hang Seng both closed down 4.3% today. The Nikkei closed at 10473.09 or down -465.10 while the Hang Seng closed down -878.60 at 16803.76.

There is continued speculation of the Federal Reserve lowering the rates before the next scheduled meeting. Prior to the open, the Fed announced that it is planning to double the outstanding Term Auction Facilities (TAF) balances to $900 billion in attempt to improve liquidity by allowing depository institutions to borrow from the Fed using the same collateral that is accepted at the discount window. The Fed will also start paying interest on depository institutions' required and excess reserve balances. After the close, the Fed announced that they are thinking about offering financing for unsecured debt. The Fed Funds Futures now suggest that the target rate will be cut a least 50 basis points. The Futures also suggest a 52% chance that the rate will be cut by 75 basis points.

In other financial related news, Hartford Financial Services (HIG) is getting $2.5 in capital from German insurer giant Allianz. Hartford, which has more than $300 billion in assets, said it will post a loss in the third quarter and cut its quarterly dividend by 40%. HIG tumbled 52% last week on concerns regarding its capital position. HIG closed up $3.50 at $30.90.

Also hitting the wires today was the confirmation that Citigroup (C) has delivered confirms it has filed a complaint against Wachovia Corporation (WB), Wells Fargo & Co (WFC), and the directors of both companies. The complaint was brought on Saturday Oct 4 and filed with the Supreme Court of the State of New York today. In the complaint C is seeking more than $20 billion in compensatory damages and more than $40 billion in punitive damages from WFC for tortuous interference with C's contract with WB. C is seeking relief from Wachovia for its bad faith breach of that contract. Just last Monday, there was news that the FDIC had brokered a deal for C to buy Wachovias assets for $2.2 billion and initially assume up to $12 billion of bad debt and $12 billion more over the next four years. On Friday, WFC announced that they would buy WB in a stock swap deal. Under the terms, WB share holders would receive 0.1996 shares of WFC. WFC closed down 0.92 at 33.64 which values WB shares at approximately $6.72 per share. However, since there is added uncertainty with the litigation, WB closed down $0.43 at $5.78. C closed down $0.94 at $17.41. The Fed may force both companies to buy the company in a joint purchase agreement.


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Bank of America (BAC) reported its 3rd quarter results below consensus estimates, announced a 50% dividend cut and $10 billion common stock offering. The earnings came in at $0.15 per share which is $0.51 worse than the First Call consensus. Revenues rose 20.8% year/year to $19.9 billion versus the $20.67 consensus. Lower earnings in the third quarter compared with a year earlier were driven by a significant increase in provision expense, as credit costs continued to rise, partially offset by advances in various income categories largely as a result of the acquisition of Countrywide Financial Corporation on July 1, 2008 and LaSalle Bank. Chief executive officer Kenneth D. Lewis said our goal is to resume dividend increases from the new level as soon as our earnings performance warrants.... Increased loss and delinquency trends first experienced in the home equity and homebuilder portfolios have now spread into the first mortgage, unsecured consumer lending and credit card portfolios. Deterioration has been more pronounced in California and Florida, which have been hit harder by home price depreciation and rising unemployment than in other markets.

The last bit of new I will mention tonight is that NYSE Euronext (NYX) reports that it experienced record trading activity on its U.S. cash equities exchanges and all of its derivatives operations for the month of September 2008. In addition, NYX's markets added 60 new corporate listings and 75 Exchange Traded Products. NYX's four European cash equities exchanges traded an average daily volume of 1.8 million transactions in Sep 2008, up 44.4% compared to Sep 2007. September was the second-busiest month ever for trading in Euronext's cash equity markets. NYXs U.S. cash equities exchanges, NYSE and NYSE ARCA, reported average daily volume of 4.4 billion shares handled during September which was an increase of 71.5% versus the same period last year. NYX's U.S. cash equities exchanges experienced their most active month, week and days in history. Finally, NYX's derivatives trading operations on Liffe traded average daily volume of 4.8 million contracts in September. NYX closed down $2.20 to $31.71. CME Group (CME) closed up $41.55 to $403.85.

NYSE Internals. There were 180 advancing issues today versus 2,655 decliners on 3,243 million shares. Today was another 90% down day. The NYA closed down 334.17 to 6754.77 today. NYSE had only two new 52 week highs and 1,662 new 52 week lows.

NASDAQ Internals. On the NASDAQ Composite there were a few more advancing issues than the NYSE. The Comp had 475 advancing issues versus 2,575 decliners. The Comp declined 84.43 to 1,862.96 on 3,326 million shares traded. There were only 8 new 52 week highs and 1,140 new 52 week lows.

The Markets

When referring to the markets today, I plan on covering the Dow Jones Industrial ($DJI), the S&P 500 (SPX), the Oil Futures Contract (CL), the Gold Futures Contract (ZG) and the 10 Year Treasury (TNX). As mentioned at the beginning, this has been a crazy last few months; definitely one that will go down in history. While the broader markets made a slight recovery today, it doesnt mean that the pain is over. There were a few names that I watch that performed countertrend or at least werent completely devastated. For one CME Group gapped higher at the open and then dipped down to $353.63 before shooting up to close near its high of $405. Another countertrend play was AAPL. Even though the stock spent most of the day in the red, it managed to eke a slight gain. I also like US Bank (USB - $34.80 -0.26) because it has maintained a relative strength similar to Well Fargo but without the drama. Even though it was down $13 points at the lows, Goldman Sachs continues to top my lists ($124 -4.00). Finally, Amedisys Inc. (AMED) managed to pair its losses and close up $1.35 to $48.69.

The $DJI has been in along for the ride on the current downtrend. I normally dont track the $DJI because I dont think of it as the market as do many investors. The reason is that it only has 30 stocks to make up its universe. While at times, the SPX can be too affected by the larger sector allocations, at least the SPX has nine definitive sectors. The $DJI wasnt as affected by the decline in oil or the decline in stocks like AAPL, RIMM and GOOG since the only technology names are Intel and Microsoft. Since many of you like the $DJI, perhaps for the reasons I mentioned in the later, I will do a quick analysis of the charts to see where we are and where we might go.

The chart above shows a daily chart of the $DJI over the last 6 months or so. The peak of 13,136 was 27.5% higher than todays low of 9,525. The high in May was about a thousand points off the all time high of 14,189.10 established on October 12th, 2007. The decline from the peak established almost a year ago measures at 32.87%. Currently, the $DJI ADX readings of 25.05 suggest that the current direction is trend like and will continue to do so until the $DJI either consolidates are bounces aggressively. Money Flow Index readings are somewhat obscure. For instance, todays move showed an uptick in money flow while it apparently bottomed on 9/17. The 50 day moving average, as indicated by the light blue line, has been the resistance for the $DJI. The moving average, currently at 11,252, is a dynamic resistance level. October 1st high of 10,882 is the daily resistance level while the intraday low is the current support level. We have a long way to go fundamentally and technically before discussing the 89 and 200 day moving average resistance levels as well as the down trend line (red dotted lines).

The chart above shows the $DJI price relative to two oscillators, two exponential moving averages and Bollinger bands. The initial curl downward in the Slow Stochastics last Monday was confirmed after Wednesdays failure to break out higher (Doji pattern) followed by Thursdays decline further caused the Stochastics line to fall below its moving average (blue line). As of todays close, the Slow Stochastics dipped below the oversold threshold of 20. A bounce cant be confirmed until the Stochastics re-emerges above 20 while the RSI does the same. At 23.89, the RSI is also below its oversold threshold of 30. The upper Bollinger band continues to drift slightly lower while the lower Bollinger band continues its freefall. The lower band closed at 10060, well above the $DJI close of 9,955.50. A common occurrence following a close below the lower band is that the index bounces the next day. See last Tuesday and 9/18. The trade is to buy the confirmation of the bounce and sell all or part at the test of the 8 day EMA (dashed line). The remaining shares/contracts can be closed at the initial test of the 21 day EMA. The trend is your friend and your friend is down. As I have written before, trade the short side at test of resistance or break downs in support. Do this until it doesnt work anymore or the trend changes to upward. If you short at the initial test of the 21 day EMA, set a stop loss at a breakout point or pivot point. The most important part of any trade is the risk management.

The chart above is the weekly chart of the SPX since 2002. I have drawn a Fibonacci retracement of the cup and handle breakout low to the October 12th peak. The low is at 960 and is the next low before testing the extreme lows of 2001 and 2002. As you can see, the 127.2% extension level of $792 is close to those lows. However, the weekly money flow index is extremely low at 22.13. The SPX broke through the 78.6% retracement level (1,091.82) on todays gap down. By looking at the previous market characteristics the last time the 50 week moving average traded down through the 200 week moving average (September 2001). So there might be additional downside following the potential bounce. The market will bounce, it just depends from where. We may have seen the capitulation today in that the VIX spiked to 58.24, a high not seen on the index since the calculation changed. The VXO or the old VIX calculation hit a high of 69.92, a level not seen since October 1987. As Warren Buffett said dont try to catch a falling knife; wait to grab it by the handle. There are signs of a buy the bounce trade developing. The evidence is from the weekly Money Flow and the VIX spike.

Both the RSI and Slow Stochastics are in oversold territory on a daily time horizon. The trend continues to be downward. A buy the bounce swing trade (a trade over a few days) should be done on a bounce confirmation from the two oscillators re-emerging out of oversold territory. Otherwise, short term intraday scalp trades on the buy and sell side can be done when bottom fishing. But we might be trying to bottom fish on the intercontinental shelf. The 8 day EMA is declining rapidly and most likely wont be at 1128 when the SPX bounces upward. Moving averages provide dynamic support and resistance. The trend should remain downward on the daily chart until the 8 day EMA is above the 21 day EMA and the 21 day EMAs slope is upward.

The gold market has regained some attention over the last two trading sessions as investors place investment dollars in one of the assumed safe havens should the market crash or the recession extends its duration. The gold contract moved up over 23.40 points to close the session at 860.60. It was strange how gold was aggressively declining while the markets declined into Fridays close. As the chart above shows, the assumed safe haven peaked over 932 on 9/29 after the initial bailout vote was declined. Gold saw some initial resistance at the 89 day SMA (yellow line) today. The next level is at the 200 day SMA of 894. The ADX is declining which suggests that the trend is faltering. With so much leverage in the futures contract, using a stop below the recent lows of 825 would be costly. There is also support at the 9/15 gap up at 770.6.

Oil continued to decline today. According to my charts, it dipped to a low of 87.55 per barrel. There seems so be some support at $85 per barrel. My guess is that the decline is due to a decline in global demand and the strengthening of the US Dollar. The Euro costs $1.35 versus the $1.59 summer high. The Pound Sterling is at about $1.70. However, the US Dollar/Yen pair shows the Dollar is weakening versus the Yen. At some point, crude should bounce upward as China turns their economy back on. Wouldnt it be amazing if the current decline in the global economies and demand in commodities could be tied to China almost halting their economy for the Olympics? The fact is that oil at $88.56 is still expensive.

The 10 Year Treasury yield finally filled in the gap up from 9/19. The yield is now at 3.426% and is nearing support. I was telling my 20 month son that 3.4% is really low interest return for 10 year money. Rates are low because bonds are high from the massive inflow of foreign and domestic capital into Treasury bonds looking for the safest return on/of their money. I believe that Treasuries will sink in price and that yields will return. The Fed doesnt need to lower rates because the market has already implied the lower rates. Notice that the markets generally move on what they dont know or expect. The market moved down because it expected the Economic Plan to pass Congressional vote. The market moved down further because it expected the Fed to lower rates too.

Economic and EPS

The most notable companies reporting tomorrow are Yum Brands and Alcoa Inc. Both can move their respective sectors. We have another week until the EPS calendar really fills up and provide us with the EPS trade I love.

I dont think that the Fed will lower rates on the same day the minutes are released. With todays effort by the Fed, they are doing whatever they can to avoid lowering rates. Its almost as if they dont want to fix the problem because they are concerned they will create an environment that got us where we are today. I would like to think that the big banks have learned from their mistakes and wont lend to anyone that can sign. It isnt the same economy as it was in 2002 2006. Without Fannie and Freddie to make the same level of packaged mortgages and their hedged counterparts, banks, brokerages, and insurance companies wont be able to buy them. The banks just need to start banking. By the way, I will send out The Contrarian commentary in tomorrows newsletter. Be patient. Good trading

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

Play Editor's Note: While I have consistently been bearish these last few weeks, trying to time an entry point to open new shorts has been challenging. Bets on those financials expected to out perform have failed - at least in a short-term time frame. This is not the time to commit a lot of money toward new shorts. I consistently hear and read how other professional traders are cutting back on position size and trading frequency. We've been saying for weeks that the best bet was to sit out and not trade this mess. The volatility index (VIX) soared to 10-year highs today. Spikes in the VIX of this magnitude are very rare and usually signal a short-term bottom is near. The question is does "near" mean tomorrow or next week? We remain in a bear market and that means bounces are going to be brief but powerful. Could it be a coincidence that the Dow Jones Industrial Average rallied more than 400 points off its lows of the day in the last hour of trading on the same day that the Plunge Protection Team issues this press release?
The press release doesn't say anything earth shattering but it lets us know that the PPT is here, they're watching, and we can speculate that they could have been very active in the markets today.

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


Put Updates

ITT Educational Servc - ESI - cls: 71.99 chg: -4.09 stop: 80.05

Target achieved. Gap downs were pretty common place today and ESI opened at $73.30. We had been suggesting an entry point to buy puts at $74.35 so we would have been triggered at the open today. ESI plunged to an intraday low of $65.05. Our first target was $67.50. While we didn't get the best entry point ESI still performed for us. Yet now we face what appears to be a very significant bounce back. Shares closed down 5% but formed a "hammer" style candlestick pattern. We are adjusting our stop loss to $80.05. More conservative traders may want to use a stop loss around $78.25 or $75.85 instead. We are not suggesting new positions at this time. Our secondary target is $61.00.

Picked on October 06 at $ 73.30 *triggered/gap down
Change since picked: - 1.31 /1st target hit 67.50
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 957 thousand


Hasbro Inc. - HAS - close: 31.72 change: -1.12 stop: 34.15

Shares of toy maker HAS are not very volatile so the stock didn't move quite as much as the rest of the market. Yet HAS still broke down under support and hit our trigger to buy puts at $32.25. The play is now open. 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.

Picked on October 06 at $ 32.25 *triggered 10/06/08
Change since picked: - 0.53
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 2.1 million


Sears Holding - SHLD - cls: 85.74 chg: -1.58 stop: 95.15

I am very surprised that shares of SHLD did not show more weakness today. The stock only lost 1.8% and failed to close under its 100-dma. At this point I half expect a bounce back toward the $90.00 level. Speaking of which a failed rally near $90.00 would be a new entry point for puts. 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.

Picked on October 01 at $ 89.04
Change since picked: - 3.30
Earnings Date 11/28/08 (unconfirmed)
Average Daily Volume = 3.1 million


Volatility Index - VIX - cls: 52.05 chg: + 6.91 stop: n/a

Wow! The volatility index just exploded higher today. This fear gauge hit 58.24 intraday. That was the highest level since October 1998 (high of 60.63). This is higher than the post-internet-bubble sell-offs where the VIX hit the 40s, higher than the post-9/11 sell-off (VIX hit 57.31). This is an extremely rare event and levels this high should be predicting some sort of bottom soon. If I had to make one bet today it would be a contraction in the VIX back to the 40-35 zone, which are still considered high. Aggressive traders could buy the October or November 40 puts. 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.

Picked on September 16 at = 30.30 first position
Change since picked: +21.75
Picked again Sept. 29 at = 46.72 second position
Changed since picked: + 5.33
Earnings Date 00/00/00
Average Daily Volume = --- 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: 17.80 chg: -0.98 stop: n/a

A meltdown in the foreign markets led to a steep sell-off here in the states. Financial stocks were some of the worst performers. The XLF opened at $18.02 and dipped to $17.23 before bouncing. The October $18 put hit a high of $1.74. We are not suggesting new positions at this time. This is a two-week bet that financials will 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.

Picked on October 02 at $ 19.64
Change since picked: - 1.84
Earnings Date 00/00/00
Average Daily Volume = 222 million

Dropped Calls

Citigroup - C - close: 17.41 change: -0.94 stop: 17.45

Financial stocks were crushed again on Monday as investors ran in fear. Rising concerns about the depth of a global slowdown and a continuously frozen credit market, in spite of the recent bailout legislation, all played a part in the worldwide sell-off. Meanwhile the exploding merger triangle between C, WB, and WFC certainly casts more shadows and uncertainty over C. The stock vaulted right past our stop loss with a gap open lower at $17.23. We would have been stopped out at the open. Pressure from the Federal Reserve has pushed C, WB and WFC to temporarily halt all current litigation as regulators try and broker another deal, possibly carving up WB between its two suitors.

Picked on October 05 at $ 18.35 /stopped 17.23/gap down exit
Change since picked: - 0.94
Earnings Date 10/16/08 (confirmed)
Average Daily Volume = 109 million


JPMorgan Chase - JPM - close: 44.00 change: -1.90 stop: 44.45

Massive one-day drops in Asian and European markets lead to a fearful open in the U.S. on Monday. Shares of JPM gapped open lower at $43.49, which was under our stop loss at $44.45. We would have been stopped out immediately. Traders decided to buy the dip near JPM's 200-dma but it looks like nothing more than an oversold bounce.

Picked on September 30 at $ 46.70 /stopped 43.49/gap down exit
Change since picked: - 2.70
Earnings Date 10/15/08 (unconfirmed)
Average Daily Volume = 50.6 million


Wells Fargo - WFC - close: 33.64 change: -0.92 stop: 32.95

Shares of WFC followed the trend in banks this morning with a gap open lower. The stock rallied back toward $35.00 before sinking through the next five hours. Shares hit our stop loss at $32.95. Putting additional pressure on shares of WFC was uncertainty surrounding the Wachovia deal. A major legal battle was about to erupt between C, WB, and WFC but the Federal Reserve pushed all parties to temporarily halt their legal action until Wednesday while they try to work out a deal.

Picked on September 30 at $ 37.53 /stopped out 32.95
Change since picked: - 3.89
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 54.5 million

Dropped Puts

Whirlpool - WHR - close: 70.10 change: -1.03 stop: 80.01

WHR has exceeded our second target. The stock gapped open lower at $68.81 and fell to $66.15 before bouncing back. Our secondary target was $70.25. We would keep an eye on WHR for the coming oversold bounce to fail.

Picked on October 01 at $ 83.00 *triggered 10/01
Change since picked: -12.90 /1st target hit 10/03
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 1.6 million

Dropped Strangles


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


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