Option Investor

Daily Newsletter, Thursday, 10/16/2008

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Table of Contents

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

Market Wrap

Predictable Wave of Human Emotions

Market Wrap

It was just another day for an 800-point swing for the DOW. Nothing exciting. I was watching futures action before the market opened this morning and just smiled at the thought of how we're getting used to (if that's possible) these violent swings. Just before 9:00 AM to the low at 9:30 AM the DOW futures dropped about 240 points, then rallied 140 points in the next 20 minutes and then proceeded to shed more than 500 points in the next 90 minutes, gained back those 500 points in the next 90 minutes and we hadn't even made it through lunch yet. Then the DOW gave up 276 of those points into the early afternoon before tacking on 580 points into the afternoon high.

And what's amazing is that the "little" pullback of 276 points in the middle of the day looked like just a small correction. Do you remember when (just last year?) a move of 100 DOW points was a big day? Trading 40 points on the DOW futures was good for a $200/contract trade and you could make some good money. Now you'll be lucky to survive with a 40-point stop. Welcome to the land of volatility (which pulled back from another new high (81.17) this morning). This kind of volatility also plays hell with spread traders. One day you're panicking about getting run over and the next day you've got a 100-point cushion on your SPX spread. The next day you're panicking again. It could be like this for a little longer before the market starts to quiet down again (but not like it was in 2007).

As you know, I track the stock movements by counting to 5 and saying my ABCs as part of EW (Elliott Wave) analysis. An impulsive move is a 5-wave move and a correction is a 3-wave move (or some variation thereof). As I've been counting the move down from last October, and then the May high and then the August high and then the September high, I've been expecting a large drop (we got it) to be followed by stair-stepping lower. This will be done in order to complete the wave count and several degrees of 4th and 5th waves to the downside have yet to finish. In a nutshell what this means is that the market is about to become more difficult to trade since this stair-stepping lower is going to be full of chop and whipsaw price action. Throw in the high volatility and we're going to see many more days like today. Get used to it, or at least understand that the risk of getting whipsawed out of your trades is now going to increase.

One of the reasons I like EW analysis is because of the repetitive patterns, or fractals, on different time frames. When reviewing stock market patterns it becomes clear that many similar patterns repeat. You'll see repetitive patterns in the same time frame and you'll see them in different time frames. They behave the same and it's what gives us the ability to trade the charts technically without a care about news, fundamentals, full moons, etc. Some common patterns (fractals) that we've heard about are head and shoulder patterns, bull and bear flags, cup and handles and pennants and other triangle patterns. I use EW analysis to identify the wave count that shows up as these patterns.

The point of this is that we human beings react very predictably to stimuli. For us traders the stimulus shows up in the price action. The swings in our emotions cause us to feel fearful or greedy. Depending on how we feel we are either bullish or bearish and as a group we collectively show these swings of emotion in the stock charts. As much as we might believe we're contrarians it's actually very hard to accomplish. We instinctively react with crowds and herd behavior is what's reflected in the stock market movements. We're simply hard-wired to react the way we do because our lives literally depended on it back in the days when our very survival depended on reacting and moving in concert with our group. If a saber-tooth tiger was about to attack the group it was not a good time to be a contrarian and start thinking of ways to be different than your cohorts who were running for their lives. The gene pool of those contrarian thinkers ended up in the belly of the tiger. In our evolution the stock market is very new for us and our brains are not wired properly to discern what's going on and how to react to it. Herd mentality may have given us the survival skills to get here but they hurt us in the stock market. The common patterns we see on the charts reflect the herd's emotional swings and provide us a way to do something different.

The stock market crash during the past month was really quite predictable if you study past patterns leading up to where we were and what was likely to happen. Parabolic rallies follow a predictable pattern and stock market crashes do as well.

Take a look at the pattern of the 1929 crash:

DJIA, the stock market crash of 1929

Once the uptrend line was broken prices experienced a waterfall decline into the end of October, had a strong 2-day rally and then 7 more days of hard selling. After experiencing a waterfall decline into the low last Friday we had a strong 2-day rally into Tuesday's high. This morning marked the 2nd day of selling following that 2-day rally. Does that mean we have 5 more days of selling ahead of us that will take us to new lows? This chart should have you going hmm...

Not all patterns repeat of course. It's not a fool-proof way to trade. If it was we'd be fabulously wealthy and not sitting in front of a computer screen all day. Well, some might anyway. But since patterns often repeat, this chart should have us paying attention to the possibility that we'll see some hard selling continue into next Wednesday, October 22nd. I'll show that potential on tonight's charts.

To those who say we've got much more interference from the government and that this time it's different, I'd say you're right. But as Secretary Paulson said today, we have several more difficult months ahead of us and that it is difficult to force banks to lend. This is the first time I've heard a government official recognize that turning a fire house onto the banks and refilling their coffers with cash is not necessarily going to get them to lend it out. They continue to be fearful of not getting it back (thus the high interbank lending rates) and they're hoarding the cash instead. It's a natural reaction and simply part of the pendulum swinging back from excessive (irrational) exuberance. This too shall pass but not without some time to heal. And unfortunately that means some more pain ahead but we're certainly closer to a bottom than we were a month ago (astute statement on my part you must admit).


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So even government interference, while causing short-term aberrations in the charts, can't stop the herd's reaction to danger. Giving the banks hundreds of billions of dollars in cash does not wipe away the fear that bankers have about lending that money out or that borrowers have in borrowing it. The banks don't want to lose those precious dollars just given to them and they'll hoard it. Borrowers know they're too deep in debt and are starting to actually pay down their credit cards (finally!). The persistently high credit spreads, such as the LIBOR (London Interbank Offered Rate) and TED spread (spread between the 3-month Treasury and 3-month LIBOR) reflects this fear of lending among bankers. The good news about the TED spread is that it has dropped back down some, closing at 4.07 today (after reaching a closing high of 4.64 last Friday). It's a small sign that some fear is starting to dissipate. How long it will last is the $64K question.

The fact that commercial paper continues to dry up says lending is certainly not increasing. For the fifth straight week the commercial paper market has declined, dropping by $40.3B (-2.6%) in the past week. The good news, for now, is that the rate of decline has slowed. The bad news is that the interest rates for these loans remain very high (unsecured, lower-rated 30-day paper costing 6.05%). Financial firms (the ones getting all the taxpayer money) issued $36.4B less in the past week which is a -5.6% decline. So between a high interbank rate and shrinking commercial paper market, the credit market remains in dire straits.

The governments around the world are doing whatever they can to get the lending institutions some cash through investments and by buying their toxic assets such as mortgage-backed securities. And what of these securities that the government is getting in return for the handing out of so much money? Good cartoon says it all:

Collateral offered for taxpayer dollars, courtesy slate.com

And with that let's move on to tonight's charts, starting with the weekly SPX:

S&P 500, SPX, Weekly chart

First thing I want to point out is a Fibonacci time window of 55 weeks from the October 2007 high which falls on the last week of this month. There are some other shorter-term Fibonacci time windows that call for a possible turn next week. Therefore we should remain alert for a possible market turn next week or the week after. Considering the market is declining into this window we should assume it will be a bottom (for how long can't be known).

SPX has been bouncing around the broken uptrend line from 1990 and the price level near the 2001 low and 2002 highs (about 950) but hasn't quite made it down to the 2002 low near 768. If the market consolidates for a week or so I strongly suspect we'll hit the October 2002 low before the end of this month. That would be quite the anniversary of that low. But then, as depicted, we would not be finished with the decline from October. After another bounce/consolidation we should get another low that breaks the 2002 low and eventually see SPX work its way down to the 1996 low near 606.

S&P 500, SPX, Daily chart

I'm showing one idea for a consolidation pattern that runs into next week--a large sideways triangle (shown in dark red and labeled wave (iv) at the end of it). This is a very common pattern for 4th wave corrections which is where we are in the EW pattern (one of a few 4th waves of larger degrees that need to play out). The other possibility is for a sharper a-b-c rally, shown in pink, which calls for a stronger rally into next week before tipping back over again. When asked what could spark such a big rally (SPX 1070-1080 potential) my only though is another Fed rate cut.

Not shown on the daily chart but is shown on the 60-min chart below is another possibility for an immediate decline following today's rally.

Key Levels for SPX:
- cautiously bullish above 1000 and bullish above 1200
- bearish below 865

S&P 500, SPX, 60-min chart

Instead of a larger bounce up from Friday's low, as part of either the large sideways triangle or sharper rally shown on the daily chart, we might have completed only the 1st wave down in what will be a 5-wave move lower from Tuesday's high. Today's rally is only a 3-wave bounce and therefore a good setup for the short side for a continuation lower on Friday (shown in dark red). This scenario would look best with an immediate decline on Friday. It could tolerate a little higher but anything back above 1000 would be a strong indication that we'll see a move up to the 1070 area.

Dow Industrials, INDU, Weekly chart

The DOW has made an attempt to get back above its broken uptrend lines from 1982 and 1990 but so far no luck sticking above them (about 9150 and 9475). The pattern to the downside looks incomplete at this point and I expect to see it head lower to potential support surrounding its October 2002 and March 2003 lows (7197 and 7416, resp.). I show a stronger bounce up into the end of year and early 2009 after the new low but I could be a bit early in making that kind of projection. The daily chart shows those support levels will probably break before get a bigger rally.

Dow Industrials, INDU, Daily chart

The wave count is the same as SPX in calling for at least one more down-up-down sequence before we see a longer-lasting bottom in November. Some folks whose analysis I trust, Jeff Cooper being one, are using Gann tools to call a bottom around mid November and the pattern depiction on the DOW agrees with that.

Key Levels for DOW:
- cautiously bullish above 9794 and bullish above 11450
- bearish below 9794

Nasdaq-100, NDX, Weekly chart

NDX made its high in October 2007 a few weeks after the DOW and SPX. It was part of the bearish divergence that set up at the time and gave us a heads up that something was wrong with the rally. Measuring a Fibonacci 55 weeks from its top gives us a potential turn window in mid November, which agrees with the Gann folks calling for a turn around the same time.

The EW count I've got on this chart does not call for a significant turning point in mid November but only a bounce before it continues lower into the new year. Assuming the market will stair-step lower into November I will be attempting to "square up" the different indices to see which one is giving me the better picture. For now it's immaterial since they all are calling for lower lows into either the end of this month or into November at a minimum.

Nasdaq-100, NDX, Daily chart

Sticking with a relatively wide down-channel for NDX shows it needs to rally quite a bit just to break out of its down-channel. I try to identify potentially important lows long before that happens so as to capture as much of the move as possible. I see a strong possibility for the decline to simply continue from here (dark red) and see NDX approach its 1998 and March 2003 lows (about 940) before the end of the month. It could find support higher--watch the trend line along the lows from July and last week.

Key Levels for NDX:
- cautiously bullish above 1600
- bearish below 1471

Nasdaq-100, NDX, 60-min chart

I've kept the trend lines from August 19th (along the August and September lows) and September 19th because, along with the broken downtrend line from October 1st, to show how price action is reacting around them. Today's close stopped at the August 19th trend line and counts complete as a 3-wave bounce off this morning's low. It doesn't mean it will reverse here and head for new lows (dark red) but it's a setup for it. Therefore any turn back down on Friday morning is a sell signal. A rally above today's close would set it up for a rally at least up to the 1400 area.

Russell-2000, RUT, Daily chart

The RUT was in a world of its own back in August and September, holding up better than the others. I therefore have a different wave count on it but it's essentially the same picture--it either found a tradable bottom last Friday (pink) or else it's got some more downside work to do (dark red). The key levels are 100 points apart so not exactly helpful here. In between those levels we could see lots of chop if price is going to consolidate sideways before heading lower again.

Key Levels for RUT:
- cautiously bullish above 585
- bearish below 485

Banking index, BIX, Daily chart

BIX bounced back up to the top of its primary down-channel from October 2007 (it has stayed inside this down-channel except for its brief excursion into the unknown in September before returning to the safety of its channel). If it manages to push a little higher it's got its 50-dma near 182 to deal with. Its pattern is not yet complete to the downside.

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

I'm showing a longer-term scrunched weekly chart of the home builders to keep in perspective where it was and where it is. It's got two parallel down-channels I'm watching, the shorter-term one for this year's price action and of course the one from the 2005 high. As I've been stating for a while now, I believe the home builders index is close to a bottom. It might have another up-down sequence to go and I foresee a slightly break below its 2001 low at this time but it's not an index (or stock) I'd be interested in playing--it's dead money for a while.

Transportation Index, TRAN, Weekly chart

The Transports were also doing their own thing this year and even made a new high out of their efforts. I remember wondering at the time what these traders were smoking. Whatever it was it apparently made them sick since they quickly disgorged themselves (trying to be nice here) of the transportation stocks they were so in love with only a month ago. As depicted, the wave pattern needs a bit of consolidation in a 4th wave correction and then a 5th wave low before its decline should be complete. A Fib projection down to 3243 means a slight break of the 2005 lows near 3380.

And talk about disgorging, one look at the monthly chart of commodity stocks says it all:

Commodity Related index, CRX, Monthly chart

Anyone who has studied parabolic rallies and their eventual demise is not surprised by this chart. Next potential support is the 78.6% retracement near 379. A break of that level would mean a likely retracement of the entire 2002-2008 rally. I keep expecting a big corrective rally before heading lower again but so far no signs of it.

Gold Fund, GLD, Weekly chart

Gold's rally from 2005 is being threatened again. After bouncing off its uptrend line in September, and looking quite bullish there for a while, the drop back down towards the trend line does not look bullish. A break of the trend line would likely mean GLD is headed for the 60 area ($600 gold) but there's still hope for gold bulls as long as the September low of 72.51 holds.

Oil Fund, USO, Daily chart

USO dropped back down into its down-channel from July and made it to the bottom of the channel where it could find support. Whether that support leads to a rally up and out of the channel or just a bounce before continuing lower is the big question here. Based on the wave count I don't think we've come close to finding a low for oil. Good news for cash-strapped consumers and the consumer price index but it's bad news for showing signs of economic malaise leading to lowered demand for oil. I believe it's another sign that we'll soon be hearing more about deflation than inflation (and another reason why I think gold will also break down).

Economic reports, summary and Key Trading Levels

The housing numbers tomorrow should not be market moving. Even if it does move the market in the morning it should only cause a 200-point ripple in the DOW (wink). This market is worried about a lot bigger things than economic reports right now. Even earnings announcements cause some ripples but those are quickly pushed aside as the bulls and bears duke it out at these lows.

I'm still in the bear camp as I believe the market has some more bad news to deal with. I don't think it's fully priced in the severity of the recession we're facing, nor the problem with deflation that I believe is coming. But I prefer to stick with the charts and right now the wave pattern is very clear in its need for more work to the downside. We have entered the period where we'll see bounces/consolidations get bigger and take longer. It will be accompanied by multiple bottom calls (like last Friday's, and the bottom before it and the before it and...).

When calls for the bottom stop, along with confidence about where we are in the wave pattern I hope to be one of the first to start recommending longer term long plays. I'm tired of being called a permabear (although sticks and stone can break my bones...) and I look forward to joining the bull camp where I suspect I'll feel lonely again. Frankly it's starting to get a little crowded in this bear camp.

But I think we're still perhaps a month away before I'll even consider a multi-week long play (other than speculative plays that I'll call out on the live Market Monitor where I know people are watching the market during the day). Surprises will still be to the downside so stay very cautious if you're attempting to time the bottom. I've reduced my exposure to the short side of this market but it's too early to start thinking long. I'd rather be out early from my short position and sitting on the sidelines than be in early on the long side.

Summarizing what I see in tonight's charts, first thing is a setup for the short side heading into Friday. But this setup requires, preferably, an immediate start back down in the morning. Today's rally off the low achieved two equal legs up at the close so that's why it should start right back down if today's rally was simply a correction of the decline from Tuesday.

If the rally continues then I see the possibility for a push back up near Tuesday's highs before turning back down within a large sideways triangle pattern. We might get a pullback first thing tomorrow and then a continuation of the rally so any pullback followed by a break of today's highs would be at least short term bullish.

The other bullish possibility is for a stronger rally leg above Tuesday's high. Look for SPX 1070-1080 and DOW 10K in that case. DOW 10K is only a 1000-point run and I think this market can handle that now.

Downside potential if we start selling off again is for a quick break of last Friday's lows, small bounce and then continuation lower into early next week.

Good luck and stay careful in this wild market. I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1000 and bullish above 1200
- bearish below 865

Key Levels for DOW:
- cautiously bullish above 9794 and bullish above 11450
- bearish below 9794

Key Levels for NDX:
- cautiously bullish above 1600
- bearish below 1471

Key Levels for RUT:
- cautiously bullish above 585
- bearish below 485

Keene H. Little, CMT
Chartered Market Technician

Trader's Corner

Bottoming Out

"Are you still thinking that we could have reached a bottom for now? I bot NDX calls when the index got down to 1200 again today. you wrote this weekend about support in this area. It was nerve racking when the market looked like it was going to break down again and I usually dont go in like that, but some of the other averages were holding above there lows I saw and figured I'd get out if it fell much under 1200. What do you think from here?"

It looks to me like the major indexes are bottoming for now and that's a process. In a market like this I would expect to see a kind of rolling bottom and not a "V" type bottom more characteristic of trading range markets or markets that are either in a predominately bullish trend or having a wide-swinging range without being clearly in bear market like this.

Definitely in this type market you have to pick your spots, such as what you (me too) did in buying in a prior area of support that looked like it was going to hold. Then if you're right, you have to set some reasonable target on the trade and not overstay. It's best to just look at the charts in this kind of situation. I know if I start following the financial media in this kind of market where, as soon, as we see a bottom re-test or another break, there's immediately a lot of bearish chatter again.

On buying what I think may be a short or other-term bottom, I LIKE to see bearish sentiment and go against that if I'm also in a situation where:
-the market is very oversold on the RSI indicator on both daily AND weekly charts
-I have a prior low that looks it can or will hold, giving me an exit point not far under that low

Seeing this 'set up' on my charts, including following the call to put options ratio confirming still heavy put activity in stocks, is one thing. But LISTENING to this on CNBC like I used to is too much for me, as I tend to lose my conviction and a more pure 'technical' approach I get too influenced by others. It's hard enough to see that we're down 500 points and think that a bottom is forming nevertheless.

I emphasize the psychological and 'sentiment' aspect because I know how much that goes against my making outstanding trades and because of some great traders I've known who traded off the floor and took positions other than day-trading and who just didn't watch all that stuff. Before CNBC and that media it was watching the tape, listening to rumors, following the news ticker, etc.

This thing of not wanting to be influenced by the 'mob' so to speak (the herd?) and being pushed back and forth in your option of the market by one's own very changeable INTERNAL thoughts, opinions and feelings about where prices are headed is one reason why there are a sizable number of 'systems' traders, who try to take the emotional aspect out of trading decisions and go with the buy and sell indications of a mechanical trading system or one run by computer or computer algorithms. I don't rely on this approach either.

Anyway, I'm speaking to the point you make about it being "nerve racking" to buy into a decline like today. This approach can work very well in a decline IF the conditions I mention above about price (test of a prior low), a a very oversold market and bearish sentiment COUPLED with strict adherence to an exit point that is not far below a double bottom or prior important low. You can even 'ASSUME' a double bottom will develop and have an idea where the calls I want to buy should get to at the prior low. Assume moreover that you won't get the best price. I'm willing to buy a little higher on a limit order than my estimate of a possible low for a particular call based on where I think the underlying index will get to.

I find that in fast moving and volatile conditions if I'm watching the market trade, especially in an oversold condition and down near a prior low that's shown itself as an area of buying interest, I do less well in going in on market orders once I see a turnaround develop and buying come in. With market orders in some situations I feel like I'm offering a 'license to steal' or an opportunity to get whatever inflated price I'm given.

Let me get to a couple of charts and where I think we could from here after another fairly dramatic turnaround today.

Looking at the Nasdaq 100 Index (NDX) daily chart, it's obvious that today's low formed a minor double bottom relative to this past Friday, which is why I say 'minor' double bottom. Assume that NDX rallied from its recent 1200 low and didn't work back to that level for 1-3 months, but it rallied again strongly from that area after several weeks/months of trading; this pattern would make for a more significant double bottom in terms of its chart. Nevertheless, given the second low at the same level makes for successful re-test of this low for now and a worthwhile trade potentially.

We still see a quite oversold condition in terms of the RSI. In terms of an objective, a 'safe' bet might be a trade objective back to the low-1400 area. Resistance was already seen technically as soon as NDX 'filled in' its recent downside price 'gap'. The 1550-1600 area should offer a strong zone of resistance. Meanwhile, adhere to an exit on NDX calls if NDX breaks more than 15-20 point under 1200.

Speaking of NOT looking for a "V" type bottom in such a market as this, as the economy heads into a likely deep recession, is the action of the S&P 100 (OEX) per my next chart, looking initially like a V-bottom formation. Well, for now anyway, as highlighted on the OEX chart below. Giving me some added confidence in holding index calls, especially bought around today's lows, is 'sentiment' considerations.


As also highlighted above is the most bullish of the indicators I rely in going against the flow so to speak, which is to look at how much trading in equities put options resumed in the past two days. The LOW reading today, given the strong rebound off intraday lows, suggests to me a bit of comfort in playing the upside in this market for now. Stay tuned for the next few days bring, as we're still in a very fluid and volatile situation!


Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

New Plays

New Option Plays

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New Puts

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New Strangles

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Play Updates

Updates On Latest Picks

Call Updates

Apple Inc. - AAPL - close: 101.89 change: +3.94 stop: 91.45

So we didn't get a retest of AAPL's lows near $85. It is still a possibility. Yet today's 800-point bounce off the DJIA's lows today was pretty amazing. More conservative traders will want to wait for that retest of the October lows and stick with the entry point in the 85.50-85.00 zone. I'm going to suggest more aggressive traders go ahead and buy some November calls on AAPL right now. We'll use a stop loss under today's low (91.74) and we'll target the 119.50 mark since the $120 level could be short-term resistance.

Here are some alternatives:

Alternative #1) Covered Call on AAPL. You could buy AAPL stock here around $102. Sell the January $100 call for $17.90. That puts your cost basis in AAPL in the $85-84 zone. Granted you'll probably get called out but you have a lot of room to see AAPL move. You could use a stop loss under $84.00 to buy back the call much cheaper and then get out of the stock if things go against you.

Alternative #2) Sell an out-of-the-money covered call. This means buying AAPL now at $102 and selling something like the January 120 calls, which are about $9.50. This puts your cost basis in AAPL down around $93 and if AAPL goes over $120 and you get called out then you captured almost 20 points in the stock on top of collecting the covered call premium. Again, you'll need to play with stops and be ready to buy back the call if you want to get out.

Alternative #3) If you are willing to own AAPL stock then sell the November $90 puts for around $7.25. You collect the money now and if AAPL goes under $90 again you will probably get put the stock but your cost basis will be around $82.75. If you want to collect even more premium then sell the January $90 puts for almost $11.

Today's aggressive play is to buy out of the money November calls. I'd use the November $115s around $7 or the November $120s around $5.50.

Picked on October 16 at $101.89
Change since picked: + 0.00
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume = 10.6 million


DIAMONDS - DIA - close: 89.87 change: +5.00 stop: 74.40

We were expecting a retest of the lows near $80.00 and our suggested entry point to buy calls was $80.25. The DIA only hit $82.08. If you were nimble enough to catch the bounce then congratulations. After an 800-point bounce I don't feel like chasing it here. The optimistic investor in me wants to believe that today's "higher low" is another sign the bottom is in but there is still a good chance that the DJIA will eventually retest its lows. I could easily see this bounce carry toward the $95 region (9,500 for the DJIA) before it begins to run low on steam). We're going to stick to our $80.25 entry point for now.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 30 million


Hansen Natural - HANS - close: 23.00 change: -1.16 stop: 19.45

HANS came relatively close to hitting its lows. We were aiming for a dip toward $20.50ish and HANS slipped to $21.47 before bouncing. More aggressive traders might want to buy this dip with a tight stop under today's low. The stock closed lower today so it didn't fully participate in the rebound. We're going to stick to our plan and wait for an entry point in the $20.65-20.00 zone. If triggered at $20.65 our first target is $24.50. Our second target is $27.50. If triggered we're suggesting the November calls.

If you like the covered call alternative then consider buying HANS stock and selling the March 2009 $25.00 calls, which are trading around $5.00-6.00. That gives you a lot of room for HANS to move around and effectively puts your cost basis in the stock around $18.00. If HANS trades over $25 and you get called out then you collected the $5.00 premium and the $2.00 appreciation in the stock.

Another alternative strategy would be wait for the drop toward $21-20 and then sell the November $20 puts as long as you don't mind owning HANS at $20.00. If HANS dips toward $20 the November $20 puts could spike to $4.50-5.00ish. That offers a lot of room to protect yourself. See my Play Editor's note on 10/14/08 for more details.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 10.6 million


MasterCard - MA - close: 156.68 chg: + 3.13 stop: 118.99

Shares of MA dipped under $144 before bouncing back this afternoon. Moves like this suggest the $140 zone might be stronger support than previously thought. I'm not 100% convinced that the market won't go lower but more aggressive traders may want to consider some alternatives. Currently the plan is to buy calls on MA on a dip into the $130-120 zone. If triggered our first target is $149.50. Our second target is $167.50. This is a very volatile stock and options are extremely expensive. This play is not for everyone due to volatility and the price of options.

As I look at record high volatility I would like to suggest a better plan. Consider covered calls on MA. You could buy shares of MA at $157.00 now and sell the November $155 calls for almost $16.40. MA could dip to about $141 before you lose any money. Essentially that's a quick 10% profit in five weeks and MA would have to breakdown to new lows to really lose much. You could always use a mental stop that if MA traded under $140 you buy back the call for much less and sell the stock.

Or you could sell the January 2009 $155 calls for $23.00, which gives you a lower cost basis (about $135) in the stock if the stock went down. Plus, you'd have a really good chance of being called out (while you keep the premium). The question is where will MA be in January 2009. If it's trading over $180 then you're going to wish you hadn't sold those calls. Of course you'd have to endure a lot of volatility over the next three months to find out.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/03/08 (confirmed)
Average Daily Volume = 3.8 million

Put Updates

Volatility Index - VIX - cls: 67.61 chg: - 1.64 stop: n/a

The volatility index spiked to yet another new all-time record high of 81.17 when the market was at its lows this morning. As stocks rebounded the VIX pulled back sharply falling about 16% from its intraday peak. Yesterday in our VIX spread section I suggested readers consider new positions on a move in the VIX near or past its highs. If you were considering new put positions on the VIX this is a good spot but the problem is that VIX options are so expensive and even if the VIX falls the option premiums will deflate.

Note: The VIX options, which are European style options, have a unique expiration date. October VIX options expire on October 22nd, 2008. November VIX options expire on November 19th, 2008. The last day of trading for these options is the Tuesday before expiration. For more information check this link:

Our September 16th put position (suggested entry at 30.30) has a 25.50 target. In all honesty this position may be dead. We still have plenty of time with these next two. The September 29th position (suggested entry at 46.72) has two targets at 36.00 and 31.00. Our October 8th position (entry 57.53) has two targets at 40.00 and 35.00.

Picked on September 16 at = 30.30 first position
Change since picked: +37.31
Picked again Sept. 29 at = 46.72 second position
Changed since picked: +20.89
Picked again Octo. 08 at = 57.53 third position
Changed since picked: +10.08
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.)


CBOE Volatility Index - VIX - cls: 67.61 chg: - 1.64 stop: n/a

This morning's market sell-off and spike to new highs in the VIX was another great opportunity to sell some VIX options. We don't see any changes from our previous comments. I will point out that you can see by the higher-priced October options over Novembers that the market expects volatility to decline into November.

Please see the CBOE website or our Sunday play description for details on margin requires for selling VIX options.

Note: VIX options are European style options that settle for cash at expiration. Furthermore VIX options have unique expiration dates. October options expire on Wednesday, October 22, 2008 and will stop trading on Tuesday, Oct. 21. November options expire on Wednesday, November 19, 2008 and will stop trading on Tuesday, November 18th.

We have listed two different plays. The strategy was to sell an deep in-the-money call to collect the premium while buying a much higher call as a partial hedge should the VIX remain extremely elevated.

VIX spread #1 with October options:

We wanted to SELL the October 40 calls (the opening price Monday morning was $13.00) and BUY the October 60 (open was $2.90) as a hedge against the VIX remaining elevated.

Here is the strategy in another format:
Monday 10/13/08 open 13.00, high 15.16, closed 11.00
Update 10/15/08 open 11.00, high 17.00, closed 17.00 (2nd chance)
Update 10/16/08 .........., high 29.60, closed 23.75

Monday 10/13/08 open 2.90, high 3.70, closed 1.80
Update 10/15/08 open 1.35, high 5.00, closed 4.40 (2nd chance)
Update 10/16/08 open 4.10, high 12.20, closed 7.90

VIX spread #2 with November options:

We wanted to SELL the November 30 calls (opening price was $ 8.60) and BUY the November 50 (opening price was $1.61) as a hedge against the VIX remaining elevated.

In a different format the play is:

Monday 10/13/08 open 8.60, high 9.80, closed 8.40
Update 10/15/08 open 10.00, high 13.00, closed 13.00 (2nd chance)
Update 10/16/08 open 13.70, high 16.20, closed 13.25

Monday 10/13/08 open 1.61, high 2.10, closed 1.50
Update 10/15/08 open 2.00, high 3.60, closed 3.60 (2nd chance)
Update 10/16/08 open 3.70, high 5.50, closed 3.65

Picked on October 12 at $ 69.95
Change since picked: - 2.34
Earnings Date 00/00/00
Average Daily Volume = ---

Dropped Calls


Dropped Puts


Dropped Strangles


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


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