Option Investor

Daily Newsletter, Friday, 10/10/2008

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Table of Contents

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

Market Wrap

Global Crisis Crushes Oil Prices

Global Crisis Crushes Oil Prices

The worsening global financial crisis caused oil prices to fall to $82 as fears of slowing demand suggested a surplus in production. OPEC was quick to warn that an emergency production cut would be coming in November but prices failed to respond.

The global market crisis worsened on Thursday with the Dow dropping another 678 points. On Friday morning Asia collapsed with the Japan Nikkei losing more than 10%. The drop was accelerated when Yamato Life Insurance filed for bankruptcy in Japan. Hong Kong's Hang Seng index fell more than 7% with Singapore's Straits Times index off more than 6%. The Australian ASX200 fell -8.34% and it's biggest one day percentage loss ever. The Indonesian markets were frozen indefinitely on Friday to "avoid deeper panic" stemming from the financial crisis.

The forced liquidation of mutual funds and hedge funds continued with heavy selling into the close. Declining volume was 13:1 over advancing volume. Nearly 14 billion shares were traded across all U.S. markets. Analysts are saying Friday could be really ugly ahead of the bank holiday on Monday. With banks only lending overnight the potential for a 3-day weekend could cause them to tighten cash flow even further. After the close ratings agencies warned they might cut the rating on Morgan Stanley and that came after 25% drop in the stock on Thursday.

On Friday there will be a $400 billion auction to determine a price in Lehman credit default swaps. With Lehman bonds trading in at 12-13 cents on the dollar the holders of Lehman bonds are going to be wiped out. If they bought insurance in the form of a CDS they can recover the lost principle from whoever sold the insurance assuming they still exist. This will be the largest CDS auction ever and the prospect of a complete disaster is weighing on the global credit markets.

Add in a downgrade on GM on Thursday that caused more than a 30% drop in the stock and the red ink continues to flow. The price of GM stock and the price of GM credit default swaps is apparently pointing to a GM bankruptcy. The rest of the auto sector is doing no better with auto loans almost impossible to get in today's market. If high gasoline prices were not bad enough the dealers can't even sell a car to a willing buyer if that buyer needs financing.

The price of energy stocks continues to fall along with the price of oil. It is not specifically because of the oil price drop because $85 oil is still a windfall for most energy companies. Chevron said on Friday morning that earnings in Q3 would be better than expected despite the drop in oil prices. Chevron (CVX) lost $9.10 to $64 on Thursday. Obviously there is no fundamental reason for the drop. Exxon (XOM) lost $9 or 12% to close at $68. Exxon has $38 billion in cash and short-term receivables and earns $11 billion a quarter. They will continue to earn over $10 billion even with crude at $85. There is no fundamental reason for the sell off in these companies.

The sell off in energy continues only because that is the only stocks with value that funds can sell to raise cash. Nearly every other sector is at 52-week or multi-year lows and the weakest sectors have been sold out. There is nothing left but energy and big tech to sell to raise cash.

Funds need to raise large quantities of cash right now. TrimTabs said funds saw withdrawals of $72 billion in September. That was a record for withdrawals. However, in the first week of October they saw another $50 billion in outflows. $43 billion in equity funds and $7 billion from bond funds. They have to raise cash by selling anything they still own that has a value. The losers were sold long ago. The mediocre stocks were sold next and now they are dumping anything left in hopes of remaining liquid through year-end. The various market reporters are blaming the drop in oil prices on potential demand destruction from the global crisis. I agree there will be some decline but the majority of the worlds mobile population will continue to drive to work, drive for business and drive for shopping. If they were doing it two weeks ago they will still be doing it two months from now. Losing a million barrels per day of consumption or even 1.5 mbpd is not the end of the energy society. It just means that gasoline will be cheaper and we all know that cheaper gasoline boosts consumption. This is just a cycle and once the equity markets find a bottom the cycle will reverse with energy stocks and commodity stocks becoming favorites again.

I would be a buyer of energy stocks at this level. I would buy the drillers and service companies that are not specifically linked to the price of oil.

Jim Brown OptionInvestor.com

New Plays

New Option Plays

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

Play Editor's note: I was extremely tempted to add new bullish positions today. A lot of stocks have been crushed back to long-term support levels or significant bottoms. However, if a coordinated, six-country rate cut can't sustain a market rebound then what will? Stocks don't go down in a straight line for too long and will eventually see a sustained rebound. Valuations will eventually get cheap enough that people will choose to step in. Unfortunately for the last couple of weeks everyone has been waiting for someone else to be the first person to step in and buy the dip. I'm going to list a few more stocks to watch or stocks that are near significant support levels. Aggressive traders might want to study these in more depth.

POT: Several stocks in the fertilizer and related chemicals industry saw some very big bounces today. POT produced a huge bullish engulfing (reversal) candlestick pattern. I was tempted to buy it but the stock had a +20% trading range today. Where do you put your stop loss? What makes these moves even more attractive is that they build on Monday's intraday rebound.

SPW: This stock has been eviscerated in the last five weeks with a drop from $120 to $41.60 this morning. Volume today was almost five times the norm. The low today was very close to the 2005 lows. Do you buy the bounce?

IBM: This stock was on my watch list yesterday. Shares went ahead and gave up another 5% to test support at the $90.00 level. Do you buy the pull back to support with a tight stop loss?

BNI: I'm still watching this railroad stock for a dip near the $75.00-74.00 zone.

NRP: Readers might want to keep an eye on this coal stock. The stock rebounded with volume almost seven times the norm.

SSO: If you think we are nearing a bottom you'll definitely want to keep an eye on this one. The SSO is the ultra-long etf on the S&P 500. It will move twice the daily performance of the S&P 500 index.

MON: Is another fertilizer stock that experienced a huge rebound. It's worth watching.

CF: This stock is another fertilizer-related equity. I would be tempted to buy another dip near $48.50-47.00 with a very tight stop or a new rally over $61.55. If your entry point is over $60 stop loss placement will be a challenge.

AGU: Here's another chemical-fertilizer stock that is seeing massive volume as it tries to find a bottom.

New Calls

Freeport McMoran - FCX - close: 42.60 chg: +3.91 stop: 36.85

Company Description:
FCX is a leading international mining company with headquarters in Phoenix, Arizona. FCX operates large, long-lived, geographically diverse assets with significant proven and probable reserves of copper, gold and molybdenum. FCX has a dynamic portfolio of operating, expansion and growth projects in the copper industry and is the worlds largest producer of molybdenum. (source: company press release or website)

Why We Like It:
I am totally going out on a limb here with FCX. Shares of FCX have been chewed up and spit out with a drop from over $120 back in June. The commodity trade died. Hedge funds were liquidating and now investors worry over a deep global recession. I've been watching it for days, cussing myself for not buying puts on the breakdown under $80.00 or $60.00. Now it looks like shares are close to putting in a bottom. Volume has accelerated but investors have been buying the dips in the $40-37 zone. I'd rather buy a dip in the $40-37 zone but we may not get the chance. We have two targets. Our first target is $49.90. Our second target is $59.00.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 45.00 FCX-KI open interest= 999 current ask $6.35
BUY CALL NOV 50.00 FCX-KJ open interest=5412 current ask $4.65
BUY CALL NOV 55.00 FCX-KK open interest=4464 current ask $3.30

Picked on October 08 at $ 42.60
Change since picked: + 0.00
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume = 16.5 million

New Puts

None today.

New Strangles

None today.

Play Updates

Updates On Latest Picks

Call Updates


Put Updates

ITT Educational Servc - ESI - cls: 72.35 chg: +3.62 stop: 75.05

The rate cut news inflated some hope that money might start flowing again. This should help students get loans to pay for ESI's tuition. However, the market was extremely volatile today and ESI failed to breakout over the $75.00 level or its 200-dma. We are not suggesting new positions at this time. The market is so oversold it is rife for a relief rally. ESI has already hit our target at $67.50. Our secondary target is $61.00 but that might be overly aggressive on a short-term time frame.

Picked on October 06 at $ 73.30 *triggered/gap down
Change since picked: - 1.00 /1st target hit 67.50
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 957 thousand


Hasbro Inc. - HAS - close: 31.80 change: +1.29 stop: 33.85

An early morning analyst upgrade to a "buy" with a $43 target helped HAS out perform on Wednesday. Shares rallied to their simple 10-dma near $33.50 before trimming its gains. Volume was pretty strong on the bounce but the failed rally pattern remains a negative. We warned readers to expect a bounce from the $30.00 level, which is what we got today. Our target is the $27.65 mark. 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: - 0.45
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 2.1 million


Volatility Index - VIX - cls: 57.53 chg: + 3.85 stop: n/a

So what should we do about the VIX? I know it looks like I've been completely wrong on this play. No one could have foreseen the magnitude of the move lower in stocks or at least how fast the move has occurred. In our original play description on September 16th about the VIX I warned readers that these were crazy times in the market and that the VIX could spike to new highs before reversing. Well now the VIX is at new highs. Investor fears over a global recession, even a depression, and a collapse of the financial system have sent demand for "protection" through the option markets through the roof. Average volume in the options market is about 14 million trades a day. On Monday there were 25 million options traded. On Tuesday 17 million traded.

The great thing about our play here with the VIX is that this is not a stock. It can't keep climbing. On a stock the sky is the limit. The VIX caps out at 100%. Readings over 50% are extremely rare. In a normal market people start thinking short-term bottom when the VIX hits 30. If you forced me to make a trade today I would be buying the November or December puts on the VIX. This is an instrument that always reverts to its "normal" range of trading. I'll offer one caveat that I've mentioned before. The elevated readings in the VIX could be influenced by this short-ban on several hundred financial stocks. Being unable to short certain stocks could push up demand for put options on those stocks instead and therefore we have an artificial level of demand. That short ban is due to expire tonight at midnight.

Unfortunately, we do have sort of a catch 22 with options on the VIX. As the VIX moves higher option premiums expand. Right now options on the VIX are very inflated. When the VIX reverses the option premiums will see some deflation as the air in the fear balloon escapes. The November 35 puts (VIX-WI) are trading at $4.50. The December 35 puts (VIX-XI) are trading at 6.80. I would have two targets. Take some money off the table at 40.00 and then again at 35.00.

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: +27.23
Picked again Sept. 29 at = 46.72 second position
Changed since picked: +10.81
Picked again Octo. 08 at = 57.53 third position
Changed since picked: - 0.00
Earnings Date 00/00/00
Average Daily Volume = --- million

Strangle Updates


Dropped Calls


Dropped Puts

Sears Holding - SHLD - cls: 76.23 chg: -2.56 stop: 89.05

Target exceeded. Retail stocks continued to under perform. SHLD dipped to $75.00 late in the day after failing at $80 early in the session. Our secondary target was the $76.00 level. More aggressive traders may want to aim for the July lows but keep in mind we're concerned the market is nearing a short-term bottom and could see a widespread relief rally soon.

Picked on October 01 at $ 89.04 /1st target hit 81.00
Change since picked: -12.81 /2nd target hit 76.00
Earnings Date 11/28/08 (unconfirmed)
Average Daily Volume = 3.1 million

Dropped Strangles


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


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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