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Daily Newsletter, Saturday, 10/18/2008

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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

Volatility Still Increasing

Market Wrap

The CBOE Volatility Index or VIX hit a new historic high of 81.17 on Thursday with the 800-point market swing. Friday's 563-point range deflated that number only slightly to close at just over 70. The Dow traded down -259 and then went positive by +304 before closing with a -127 point loss. It was just another normal day in the current market environment.

Wilshire 5000 Chart

The market opened up to another record drop in an economic report. The Consumer Sentiment report for October showed sentiment fell -12.8 points to 57.5 and the second lowest reading in the last 28 years. The -12.8 point drop was the largest monthly decline on record. The present conditions component fell from 75.0 to 58.9 and that is the lowest level on record. Expectations fell 10.5 points to 56.7. Inflation expectations were mixed despite the drop in gasoline prices. These massive declines should be no surprise given the almost daily crisis in the global financial sector. With the markets off -40% and newspapers full of great depression comparisons I would not be surprised to see consumers spending their last dollar to put bars on their windows and stock up on food and ammunition. Consumer credit has dried up and home values continue to decline. IRA/401K accounts have been cut in half and the damage does not appear to be over. The Dow has only closed positive twice in the month of October. It is not a pretty picture but at least most analysts don't expect it to get worse.

Consumer Sentiment Chart

On the positive side new residential construction permits fell by -8.3% in September and housing starts fell by -6.3%. Permits are down by 38.4% over Sept-2007 and starts are down by -31.1%. One analyst said we have not seen conditions this bad since the 1950s. On the positive side this means there will be far fewer new homes to compete with used homes for available buyers in the spring. With mortgage loans almost impossible to get the current home owner will need all the help they can find in selling their homes in the spring.

Philly Fed Manufacturing Survey Chart
 

It has been a rocky week for economics with the Philly Fed survey falling to a two decade low of -37.5 from +3.8. Industrial production fell -2.8% in September after a sharp -1.0% decline in August. The NY Empire State Manufacturing Survey fell to -24.6 from -7.4 and the sharpest drop in history. Retail sales fell -1.2% in September and their biggest drop in over three years. The NAHB Housing Market Index fell to 14 and its lowest level since the early 1980s. All these reports are at multi-year or even multi-decade lows and some the lowest on record. The economic drop has accelerated at warp speed over the last 60 days. There appears to be no doubt that we are headed for a sharp recession and moving very quickly in that direction.

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Moody's said credit card charge-offs rose 48% in August, according to the latest data on $435 billion in credit card debt securities that Moody's tracks. That number is misleading as a news headline. The actual charge-off rate jumped from 4.61% to 6.82% or a +48% increase. The headline crossing the wires at 48% sounded like the second great depression had arrived. However, some firms are going to struggle as those rates continue to rise. Friedman Billings Ramsey said charge-offs would continue to rise through 2009 and expected charge-offs at Capital One to jump +25% by year-end and 30% at American Express. Capital One responded saying they expect total charge-off rates to be "only" 7% in Q1-2009. FBR said American Express was experiencing the worst spike in defaults of the entire group. AXP will report earnings on Monday.

The economic calendar for next week is less than exciting. There is only one report that could be called important and that is the Chicago Fed National Activity Index on Tuesday. Everything else is either a routine weekly event or old news.

Economic Calendar

The focal point for traders will be Q3 earnings with numerous companies reporting. So far for Q3 we have seen 82 S&P-500 companies report and the average has been a drop of -33.7% in actual earnings. 59% of companies beat the lowered guidance and 27% missed their lowered estimates. Even the major companies like INTC, IBM and EBAY were sold off after their earnings failed to impress traders. Only Google saw a major bounce after beating the street. This was more of a short squeeze than positive buyer interest. Google is always heavily shorted ahead of their earnings. GOOG closed up +19 on Friday. Thursday is the biggest day of the cycle with more than 325 companies reporting.

Earnings Calendar

Warren Buffett called a bottom on Friday. He did not actually say we were at a bottom but did say he was buying stocks for his personal account this week. He said in an editorial, "Be fearful when others are greedy and be greedy when others are fearful." He said, "Fear is widespread and gripping even seasoned investors." Buffett explained he did not have the faintest idea which stocks would be higher or lower years from now but "what is likely, however, is that the market as a whole will move higher well before either sentiment or the economy turns up." Buffett's opinion piece in the New York Times was repeated about every 30 minutes on stock TV and the news channels. I think the reporters wanted everyone to rush into the market and emulate Buffett. Unfortunately he has deeper pockets than anyone hearing the news and can weather further declines better than most. We will see if his advice was timely when we look back a couple months from now. In the past he has made similar statements and they were not always at market bottoms but generally pretty close.

Meanwhile Carl Icahn put his 177-foot yacht up for sale for $37.5 million. Considering the current financial market and drop in prices for high dollar luxury goods it would suggest Carl needs to raise some money to refill the coffers rather than just deciding to sell. He has taken some sizeable hits on his recent investments. His Yahoo stake is worth about half what he paid for it and the outlook for a quick recovery does not look good.

The retail sales numbers I quoted above paint an ugly picture of the coming holiday season. However, a couple major chains won't live to see those holiday shoppers. Linens and Things was bought by a private equity group a year ago for $1.3 billion. For a year they have been trying to find a way to save the chain of 371 stores. Last month the bankruptcy court said the chain would be sold at auction to benefit creditors. Because there was no financing available in the market there was only one bidder. A consortium of private equity firms bid $470 million. The entire inventory of more than $1 billion in merchandise was put on sale on Friday in a highly publicized event. When that fire sale ends all 10,000 associates will be out of a job. The 371 stores will then be auctioned in December.

Mervyns, also in bankruptcy, said on Friday they were calling it quits and would also have a liquidation sale at its 149 stores before abandoning its remaining real estate. A private equity firm bought Mervyns from Target for $1.2 billion in 2005. Mervyns is suing the private equity firm claiming they forced the firm into bankruptcy by stripping out all their owned real estate and then leasing it back to them at significantly higher prices they could not afford. Sharper Image also filed for bankruptcy and liquidated all its stores. It has not been a good year for retailers and the coming holiday season is not going to help since stores could not buy inventory without financing. Where retailers are normally adding salespeople this time of year many are now trimming staff to offset weaker expected sales.

All day Friday there were sound bites in the news about a potential thawing in corporate debt. Several firms were said to have actually floated loans over the last week. I would urge caution in thinking the credit crisis is suddenly over. Member banks borrowed a record average of $487 billion PER DAY from the Fed discount window last week. That was up from a record of $420 billion the prior week and a record $387 billion the week prior to that. Notice the trend? If the credit markets were thawing I suspect the Fed borrowing would have lessened rather than risen. The Fed and Treasury actually have some programs in the works that will help once they begin operation. One of them will allow companies to go directly to the Fed for corporate loans. That is a scary thought. Reportedly there is about $1.5 trillion in outstanding corporate paper that qualifies for a Fed buy. If you add up the bailout dollars authorized and offered over the last several weeks it is a frightening number. Just in the U.S. it could total more than $3 trillion. While that sounds like a lot that Fed discount window borrowing for last Week was nearly $2.5 trillion. That also sounds like a lot but the majority is refundings from prior borrowings. If the recession is really deep and lasting the Fed/Treasury could end up owning the business sector in the first ever voluntary nationalism program. Obviously I am being dramatic but we are headed into uncharted territory and there are some very big numbers on the horizon. Be very wary if they start offering money to hedge funds to invest in the market.

Hedge funds could use some assistance. TrimTabs said they saw outflows of $43 billion in September. That was seven times the prior record and TrimTabs believes October could be worse. Total capital in hedge funds fell -11% in September to $1.72 trillion. It was also the worst month ever for performance with an average loss of -6.2%. Mutual funds also saw the biggest redemptions in history and October is expected to be worse. TrimTabs said mutual funds were seeing redemptions of $5 billion per day. All funds were hit hard on performance in September with emerging market funds down -15%, equity long funds -11.7% and sector specific funds -7.3%.

Energy funds were down as much as -25% due to the implosion in oil prices. That price hit $68.57 on Thursday and rebounded to $74.30 on Friday. Part of that rebound was due to OPEC moving their emergency production meeting from November 18th to next Friday, Oct 24th. OPEC is expected to cut production and probably sharply by as much as one million barrels. The problem will be policing the quota cut. With cash received for crude off 50% over the last three months many of the OPEC exporters are reeling from the slide. That money received during the spike was easy come and easy go. It was spent almost before it was earned. Now those spending programs are running on empty and the only way to ease the pain is to produce additional oil over quota. OPEC will have a major problem on their hands.

Additional volatility came from crude options, which expired on Thursday, and crude futures expiring next Tuesday.

Crude Oil Chart - Daily

Hugo Chavez has an even bigger problem on his hands. With light sweet crude trading around $70 the price he gets for his oil is closer to $60 because of the poor quality. Venezuela pumps just over 2.36 million bpd and Chavez gives away about half to other Latin American nations to keep them sucking up to him and to subsidize prices inside Venezuela. Venezuela has some of the cheapest gasoline on the planet. That costs Chavez some big bucks to maintain the program. Chavez also announced he was going to implement a six hour workday and enforce severe penalties to employers who violated these policies. This is part of his social programs to stay in office. Many employers said the change from 8 hr to 6 hr plus the mandatory employee benefit programs would drive them out of business. Late Friday we learned that RBS cancelled a $5 billion credit line to PDVSA, the Venezuela oil company. Just over the past couple weeks the interest rate on Venezuelan bonds has jumped from 7% to 15-16% on default fears. The U.S. said on Friday there are indications Venezuela is starting to show signs of financial stress suggesting the country was about to fail. Couldn't happen to a more deserving politician.

The market volatility has prompted several brokers to lower their year-end targets. JPM lowered their year-end target for the S&P to 1125 on Friday from 1375. The last six weeks have forced analysts to rethink the typical year-end rally.

When I sat down to write on Friday I was bearish. I looked at hundreds of charts with many going from just plain ugly to catastrophic. I had already compiled the various economic statistics I reported above and they were not just ugly but simply unbelievable. Then I started to reflect on the various bailout programs heading our way and I could actually see a fundamental reason for hope. Unfortunately fundamentals are sometimes ignored by the markets when in the grip of irrational pessimism.

By the time I got to this point in the commentary several hours of research had passed. While I don't have a magic bullet to use on the markets we are in a repeating cycle that normally prevails. As I reported in prior commentaries the period around expiration week in October is historically a bear killer. More bear markets end between October 10th-22nd than any other period. This is due to mutual fund year-ends, earnings trends, politics and economic cycles. They all seem to converge around expiration week in October.

It is a historical fact that Nov-1st through April 30th are the best six months of the year for investors. In the last 54 years those six months saw a combined gain of 10,599 Dow points while the other six months of the year saw a combined loss of -588 points. $10,000 invested in 1950 for just the six months of the year starting on Nov-1st would have returned $482,000 though 2003. The same $10,000 invested in the opposite six months would have lost $318. This fact is not lost on fund managers and they do game this cycle to some extent. Granted there are other factors and some years there are losses but those losses were minor and occurred in only 12 of the last 54 years. November, December and January are the three strongest months of the year. Fund managers plan their investment buys for October to take advantage of these months. Given the horrible market over the last several months they will need to act aggressively to capture any future rebound and rebuild profits. Many fund managers report being heavily invested in cash as a protection against redemptions and to have ammunition for the eventual rally.

Obviously nobody can call a bottom, not even Warren Buffett. However, this is the first weekend in recent memory where we did not have some crisis that had to be resolved by Monday's open. This was also the first week in recent memory where some corporate paper actually traded. Baring some new revelation on Monday we could be nearing a period of calm in the financial markets. We still have to hold our nose and cover our ears when the banks report earnings over the next few weeks but there is really nobody big left to fail. All the usual suspects have either already been convicted or proven innocent. As each day passes we move closer to those bailout programs actually being implemented and some semblance of normal returning to the credit markets. I could stand some normal days without 500 point swings to take out my stops on both the upside and downside.

As we were strategizing Friday evening the general consensus was for a possible retest of the lows on Monday/Tuesday as the last round of redemptions were removed from the market. Any retest of the lows should be met with some buying as long as a new crisis does not erupt. I would be a buyer of the next dip. I believe we could see 8000 on the Dow, 850 on the S&P and 1600 on the Nasdaq. Since early Q3 earnings have not been a disaster there are actually some fundamentals worth buying.

The wild card here is the election. I am going to try and touch on it gently so as not to anger either side. Most market analysts feel an Obama win would be market negative because of the massive new taxes and large spending programs possible with the democrats in full control of the house and senate. Raising taxes on businesses and redistributing the wealth is not a market friendly policy. It is entirely possible some of the market "adjustments" of late were also influenced by shifting of investments in expectation of an Obama win. For the two weeks after Labor Day when the candidates were running almost even the markets were calm. Once Obama began to stretch his lead again the markets extended their declines. To be fair most of the declines were on financial worries but the chances for an Obama win could have also been a worry. McCain is also not without risk. He is seen as a reformer that could shake up the status quo by use of the veto pen. He is strongly anti-pork and has promised to veto anything that crossed his desk. Those promises rarely mean much because of the way lawmakers structure their bills. The president has to sign bills he does not like in order to get things he does want. His pledge to cut taxes on businesses and capital gains is always market friendly. It is historic fact that cutting capital gains taxes and taxes on business always produces more revenue rather than less. Many politicians have a hard time with this concept but the market always warms to it. The point to this paragraph is that the next three weeks will see the election weigh on the markets in ways we can't quantify and that could easily push them lower. Indecision is a crippling disease and until the election is behind us investors don't really know which way to turn.

The Dow gained +401 for the week but lost -127 on Friday to close at 8852 and under the key 9000 level. The intraday highs on Tuesday and again on Friday were just a continuation of lower highs over the last month. The chart clearly looks like we should expect another retest of 8000 if not something lower. This was option expiration week and we really can't apply much logic to the markets moves ahead of expiration. Next week is when the real market should reappear.

Dow Chart - 30 min

S&P-500 Chart - 30 Min

The S&P-500 is showing the same pattern with initial support at 850. Very long-term support is 800 and while that does not appear likely as a target today it is still a potential bulls-eye on any future sell off. I would be perfectly happy with a touch of 800 by the S&P and 8000 by the Dow with a lasting rebound to follow.

The Nasdaq has initial support at 1550 followed by 1450. With Friday's close at 1711 it is well above those levels. Google has already reported earnings but Apple will report on Tuesday. That will produce a direction for techs. As Apple goes, so goes the Nasdaq.

Nasdaq Chart - Monthly

Russell-2000 Chart - Monthly

The Russell-2000 is floating through the twilight zone at 526. There is minimal support at 500 and decent resistance at 585. Fund managers have abandoned the small caps and until they return to favor any rally is just smoke and mirrors. A move over 600 would be confirmation buyers have returned in volume.

For next week I would key on those support levels above and those earnings reports I highlighted in the table above. We are just a little over a week from another FOMC meeting and odds are good there will be another 50-point rate cut as insurance. Inflation has evaporated along with oil prices so the Fed can continue to act aggressively. The bears should head for hibernation soon so be prepared for a rebound that has legs.

Jim Brown
 


Trader's Corner

Putting the Advance/Decline Line in Perspective

As the open approached on October 7, 2008, futures stayed above fair values. Even before the open, I had worried about a pop-and-drop type day, as noted in my 9:27 am post on the Market Monitor, the live portion of the Option Investor site. When the advance/decline (A/D) line made its first prints, however, I had even more reason to be worried. "The A/D line went into breakout mode first thing," I wrote in my 9:40 post, "which is always a bit iffy of a setup."

What made the setup "iffy"? The A/D line's first print was +856. Within the first few minutes after the cash markets opened, the A/D line had reached +1218. That means that there were 1218 more advancing stocks than declining ones on the NYSE. What's iffy about that? Sounds good, doesn't it?

Not necessarily.

In forming my own market outlook, I find it's important to put the A/D line in perspective. I've mentioned the way I use the A/D line in previous Trader's Corner articles, but I find that perspective even more important in the current market environment. We need all the help we can get these days.

Here's what I was seeing the morning of October 7:

Unfortunately, those annotations needed editing, but my charts carry back only 10 days, so I can't edit the last sentence. It should have read, "This one was, as was the similar breakout on Thursday, 10/9."

I have several reasons for my preference in using Keltner channels or bands to gain that perspective on the A/D line. I'll explain those reasons, but then show what you can do if you're not interested in Keltner channels or bands, don't understand them, or can't set them up on your charting platform.

I can base several different Keltner channels or bands on different moving averages. The settings I use are the same that I use for equities. On a 15-minute chart, I base one channel on a 9-ema, with the bands having an offset (called "multiplier" on Q-Charts) of 1.4; one channel on a 45-ema with an offset of 3 and one on a 120-ema with an offset of 7.2. It's the outer channel that gives me the most information about strongest support or resistance or breakout moves with the A/D line, but I use all the lines.

When the channel lines or midlines converge, I can make judgments about the strength of support versus resistance and set possible targets. For example, when the A/D line was at +957 on the morning of 10/9, I wrote in a 9:39 Market Monitor post that the A/D line was vulnerable to "the possibility of a strong pullback, perhaps to +400 historical [support] or to -128 to -245 potential Keltner support." That Keltner support was the then-current level of the black-channel support, the channel or band based on the 45-ema. I thought it possible that the A/D line could drop rather quickly to that level.

It was to drop further, and I was to update at 10:58 that the A/D line was "vulnerable to a drop to near -1250." I added that "I would, however, watch for a potential steadying anywhere from its current -996 level down to about -1250."

That steadying did occur until late afternoon. The support then caved, something that was as visible on the A/D line as it was on equities. These and other reasons result in my preference for these layered Keltner channels, but I've heard from plenty of subscribers who can't employ these channels. They, too, can find perspective.

Fifteen-Minute Chart of the A/D Line with Bollinger Bands:

I'm not as accustomed to watching the A/D line on Bollinger bands, so I can't verify that the BB's work as well as the Keltner channels to identify breakouts. Nor can I tell you that this setting is the optimum one. The purpose of the article is to suggest that you refer to your own preference for determining overdone status and learn the ins and outs of how your preferred indicator works in relationship to the A/D line.

What you're trying to do is get some perspective on the A/D line. My Keltner channels might tell me one day that a -1000 A/D line is actually a rather neutral reading, while a week later, a -1000 might be overdone to the downside.

As with any indicator, this shouldn't be used as a trade setup but rather as a warning to update your profit-protecting plans if you've been trading in the direction of the A/D line's breakout. Such breakouts, particularly first thing in the morning and last thing in the evening, particularly when verified by an RSI at extreme levels, can alert traders of the possibility of a reversal.

They do not prove a reversal will occur. They're indicative of strong momentum and sometimes that strong momentum carries through all day with the breakout maintained all day, at least on Keltner channels. Wouldn't it have been worth some money, however, to have been alerted the mornings of 10/7 and 10/9 to be careful with bullish trades and to prepare what-if plans in case of a reversal? I think it was worth some effort to get some perspective on the A/D line. Maybe you will, too, by whatever method you use to obtain that perspective.
 

Index Wrap

BOTTOMING OUT FOR NOW

THE BOTTOM LINE:
It looks like the market has reached an area of equilibrium if not 'support' as a lot of bad news is out and stock prices appear to have built in an expectation of a steep drop in earnings. We can't yet project how bad earnings trends may get but for now, a sizable drop is built in. With Ford (F) having traded down to 2 bucks, I would say that Warren Buffet is right in that many if not most stocks and the underlying assets they represent are cheap.

As to the technical aspects of a bottom, besides being extremely oversold now on a long-term basis, trader sentiment is quite bearish. Ah, traders have a genius for finally getting bearish when most of a decline is usually over with!

Options traders have a different problem from stock jocks in that the short-term swings are still capable of being volatile and in a leveraged situation price entry is more critical, and tricky. Hey, we could have given some better advice to those bankers! If we could be sure that the market would continue to have large price swings however, select straddles could be a play. But the fireworks may be over for now.

Index calls seem attractive if bought around recent lows, but how much upside is there; e.g., low-1400 area on a buy of NDX around 1200 as I answered in my Thursday "Trader's Corner" article. Also, bull spreads as attractive? If prices continue falling, what about bear spreads? All kinds of questions on how to make a buck or two in this current market.

It looks to me like prices will stabilize, although I can't carry a high degree of certitude on this. A stable sideways movement would be favorable for selling puts.

A lot of questions and you are more in need of answers! I am sitting on the sidelines mostly and that's MY answer and there is a place for that. It's called preserving trading capital in a period of uncertainty. I did buy some November NDX calls when the index got down to 1200 and formed a second low in that area. What the heck, if tech isn't a wreck, Nasdaq should rebound some.

I bought some Ford, stock and options, given the decline to around $2! I don't usually buy into devastated stocks but the big 2 ought to survive and our political leaders will prop them up while they re-tool. If F doesn't survive then I haven't lost much or much sleep over such a cheap stock. Maybe it's my Michigan roots, but I like some of the cute newer (and smaller) Chevy products and the Volt is a sexy concept.

Time to shop for bargains. Also in the words of the Oracle of Omaha, be fearful when everyone is greedy and greedy when everyone is fearful. Fits MY contrarian philosophy!

QUESTIONS/COMMENTS:
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.

MARKET NEWS and INFLUENCES:
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.

** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) remains bearish in its overall pattern, but selling has begun to dry up and with some buying coming in around recent lows, especially on the dips below 900. Initial support is at 875-890, with highlighted support at 850 on the chart, then at 800 and a longer term support.

I thought that a bottom would be seen when the 13-day RSI also finally got 'fully' oversold and guess what, it finally did, as RSI dipped below 25. I noted last time that: "In a market of 'extremes', EVERYTHING (all indicators) will get extreme. I can't point to an exact principle at work here, just something that experience suggests to me." Hey, you learn something as you get older, but I'm no Warren Buffet either.

Key overhead resistance is at 1000, extending up to around 1040 with other key resistances at the 21-day moving average (1073 currently) and then at the recent 'breakdown' point at 1100.

S&P 100 (OEX) INDEX; DAILY CHART

I wrote in my Thursday Trader's Corner article not to look for "V" type bottoms in this kind of market, but the S&P 100 (OEX) initially at least could be forming one. How OEX fares on rally attempts above 470-480 will better tell the story if this recent bottom could be a V-type pattern or if there will be a sideways trend and a 'rolling' type bottom.

Major tops are usually of the rolling variety and bear market bottoms as well. It seems we have a long way to go before the economy rebounds and doubtful stocks are going to get ahead of economics for a while. But we're talking HERE of potential in OEX to climb (claw?) back up to 500-520, based on this first bottom in OEX.

Support has been seen in the 420 to 440 areas recently, with major support at 400. Near resistance is at 480, then in the low-500 area and with probably tough resistance beginning around 520.

A bullish technical aspect is provided by the recent bearish extremes in my sentiment indicator seen above, with my 'CPRATIO' dipping below 1.1 to 1. The low 5-day CPRATIO reading shows a substantial increase in total put volume in equities relative to calls.

DOW 30 (INDU) AVERAGE; DAILY CHART

It helped some when Dow Jones took AIG out of the Dow 30 Average (INDU) as replacement Kraft Foods (KFT) held relatively steady, more or less holding its support in the $28 area. INDU in turn held 8000, then next developed support around 8200 and rebounded a 1000 points from there. Not a bad move for those who bought the DJX calls on the retreat to 80 and/or collected most of the premium by selling the Nov 82 puts.

Of course when the Dow got to 8000, it wasn't hard to imagine it going to 7500; but, there's where the extreme oversold RSI extreme helps in keeping things in perspective.

Near INDU support comes in around 8500, then can be expected at 8200, next at 8000, with major support beginning at 7500. Near resistance is at 9500, then at 9800 and with probable tough resistance at 10000. I doubt that INDU can break out above 10000 or will break below 8000; outside possibility: a 10500 to 7500 price range.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite Index (COMP) chart remains bearish. The question is whether we have seen a temporary bottom, one that will be re-tested later, or even exceeded substantially later on.

A 66% or 2/3rds retracement, the importance of which I emphasize a lot, is 1690; i.e., as a retracement of the October 2002 to November 2007 multiyear advance. We end this past week with COMP above this key retracement level and it speaks to the possibility that this recent sell off, although very steep of course, is not going to retrace all the back to the 2002 lows or anything close to it. Stay tuned on this!

I've noted support on the chart at 1600, with next support around 1550-1545, then major support at 1500.

Near resistance is at 1800, then around 1845 and with what may prove to be tough resistance starting at 1900 and extending to 1945.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) remains bearish in its pattern, but also very oversold, especially on a long-term weekly chart basis (not shown). NDX is the only major index where I can still project a downtrend channel, giving some further ideas of potential 'support' and 'resistance'. 1200 is a definite support that developed recently. Next likely support is in the 1140 area, down to 1100 even.

Near resistance is at 1425, then at the top end of the downside price gap at 1470 as highlighted on the daily NDX chart below. Major resistance begins at 1600.

I bought some NDX calls on the successful re-test of 1200 based on the idea that an exit at 1180 made it a low risk trade in 'normal' market circumstances. At entry, I assumed that the index could rebound again back up into the gap area or to around 1500 even. That trade still looks ok. I'd be interested in buying puts if the 1600 area was reached. Buying calls or puts at what could or should be 'extremes' is my sole favored trade entry on an outright basis.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

The pattern and trade strategy for the Nas 100 tracking stock (QQQQ) is the same as outlined for the underlying NDX index.

Buying the second low in the 31 area looked like a place to cover shorts and exit puts, and to buy the stock for the adventurous. Risk at on the last dip below 31.0 was in my mind to 30 even and that's where I suggested sell stop protection; my suggested exiting sell stop is still at 30 even. I think the upside potential for the Q's is back to 36-36.5 or a bit higher, such as to resistance at 37; my most bullish target currently is to 39.5-40.0.

On the downside, there's certainly potential for a slide back to the 30.5 area or perhaps to 30. Given how oversold NDX is, I don't see big potential however for a new down 'leg' below 30.

RUSSELL 2000 (RUT) DAILY CHART:

Support did end up holding in the Russell 2000 (RUT) in the 470 area again this past week and I've highlighted support at 470-485 in RUT. Resistance is seen at 570 and then very strong resistance I think at the prior 'line' of support in the 650 area.

I think there's potential for a further rebound in the Russell to the 570 area and higher, such as to 600 or a bit higher. Support begins in the 500-505 area and extends to 470 as mentioned and then to 450; major support is at 400 currently.

GOOD TRADING SUCCESS! and...BE CAREFUL OUT THERE!!

NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
CHART MARKINGS:
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]
I WRITE ABOUT:
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

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
CSX ACI None
IWM MON  
  PTR  

Play Editor's Note: Credit markets are just barely beginning to thaw and no one seems to have a good argument to buy stocks except that Warren Buffet said so. Yes, it's possible we're near the bottom. It's also very probable that we'll retest that bottom and from the looks of it sooner rather than later.

This remains one of the toughest markets in history to trade. Multi-hundred point swings in the DJIA are daily occurrences now. Volatility is at all-time record levels. If you consider the high volatility, which inflates option premiums, it is not a very good time to be buying options.

A better strategy would be to sell options (selling volatility). Covered calls are an excellent strategy these days if you can stomach the movement in the underlying equity. If you're looking to buy stocks then I would be selling puts to collect premiums on stocks you are interested in buying. It's like getting paid to buy the stocks you want!

We're stepping into the heart of earnings season. Normally we'd be looking to add strangles to hold over some earnings reports. These days the price of the options are too expensive to buy strangles or straddles.

Speaking of earnings, AAPL is due to report earnings on Tuesday night. I would not be surprised to see a $20 post-earnings move in the stock. The question is what direction will it move? I would still be tempted to buy calls on a dip near $85.00 but only after earnings. Short-term it looks like AAPL is headed lower ahead of its earnings report.


New Calls

CSX Corp. - CSX - close: 43.33 chg: -0.89 stop: 37.99

Why We Like It:
Railroad company CSX reported earnings last week that sparked a rally over $50.00 in the stock. Unfortunately for the bulls investors sold that rally pretty hard. Shares now look poised to retest support near $40.00. Buying a dip near $40.00 looks like a decent bet since the level has been significant support for months. We're suggesting readers buy calls on CSX when the stock dips into the $40.50-40.00 zone. We'll use a stop loss at $37.99 to start. More conservative traders may want to use a tighter stop! We're listing two targets. Our first target is $45.00. Our second target is $48.00. Traders need to be aware that two of CSX's rivals, BNI and UNP both report earnings on October 23rd this week. Their earnings news and guidance could have a big impact on CSX's performance.

Suggested Options:
Our suggested entry point is $40.50. We would use the November calls.

BUY CALL NOV 40.00 CSX-KH open interest= 437 current ask $6.00
BUY CALL NOV 45.00 CSX-KI open interest=2465 current ask $3.30

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/14/08 (confirmed)
Average Daily Volume = 6.5 million

---

iShares Russ.2000 - IWM - cls: 52.45 chg: -1.26 stop: 44.90

Why We Like It:
Sooner or later when fund managers feel confident enough to put money back into the market the small cap stocks could see some big gains. Right now we're willing to bet on a bounce if the Russell 2000 retests the October lows. We'll play the RUT through the IWM iShares. The IWM is an exchange traded fund that mimics the Russell 2000 small cap index. The IWM traded to $48.29 last Thursday. We are suggesting that readers buy calls on a dip into the $48.50-45.00 zone. Optimistically last week's lows will hold. If not we want to give the IWM some room to maneuver. We're suggesting a stop loss at $44.90. If triggered at $48.50 we're listing two targets. Our first target is $54.50, which could be hit in just a few days. Our second target is $58.00, which might take a few weeks.

Suggested Options:
Our suggested entry point is $48.50. We're suggesting the November calls. Strikes are available at $1.00 increments.

BUY CALL NOV 50.00 IWM-KX open interest=8838 current ask $5.55
BUY CALL NOV 54.00 IWM-KB open interest=12901 current ask $3.30

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 123 million
 

New Puts

Arch Coal - ACI - close: 24.15 change: +1.24 stop: 25.90

Why We Like It:
Long-term fundamentals for the coal industry are very strong. The world's energy needs will constantly be growing and clean or not coal will always be in demand. The sell-off in ACI and the coal industry has been a sector rotation out of anything related to commodities thanks to concerns over a global recession and part of the hedge-fund liquidation. Short-term we suspect that ACI will continue lower - at least to its October lows. We're suggesting put positions now with a stop over Friday's high. Our target is $20.25. More aggressive traders could aim lower. If ACI breaks $20.00 the next stop is probably $15.00. If we see the $20 level hold again we'll consider buying calls to catch the next bounce! We do not want to hold over the late October earnings report.

Suggested Options:
We're suggesting the November puts.

BUY PUT NOV 25.00 ACI-WE open interest=1164 current ask $4.10
BUY PUT NOV 22.50 ACI-WS open interest= 742 current ask $2.85
BUY PUT NOV 20.00 ACI-WD open interest=1523 current ask $1.90

Picked on October 19 at $ 24.15
Change since picked: + 0.00
Earnings Date 10/27/08 (confirmed)
Average Daily Volume = 8.7 million

---

Monsanto - MON - close: 80.00 change: +1.75 stop: 85.01

Why We Like It:
MON is part of the fertilizer industry and the group has been hammered pretty hard during the market's sell-off. The oversold bounce from its October lows stalled near its 50% retracement. Furthermore, MON and several stocks in the group have produced bear-flag consolidation patterns, which suggest another leg lower is about to begin. MON has broken out from its flag pattern and Friday's failed rally looks like a new entry point to buy puts. We're suggesting a stop loss at $85.01. We have two targets. Our first target is $70.25. We suggest readers exit the majority of their position here. Our secondary target is the $63.00 mark. Readers need to note that this week is the heart of earnings season. Rival fertilizer companies like POT will be announcing earnings this week and their news could have a big influence on MON's performance. POT reports on October 23rd before the market's opening bell.

Suggested Options:
We are suggesting the November puts.

BUY PUT NOV 75.00 MON-WO open interest=1447 current ask $6.80
BUY PUT NOV 70.00 MON-WN open interest=1278 current ask $5.00

Picked on October 19 at $ 80.00
Change since picked: + 0.00
Earnings Date 10/08/08 (confirmed)
Average Daily Volume = 9.8 million

---

PetroChina - PTR - close: 79.84 change: -2.38 stop: 84.05

Why We Like It:
Energy stocks continue to sell-off as crude oil slides farther and farther from its highs. PTR, an arm of the state-run China National Petroleum Corporation, is no exception. Shares broke through multiple layers of support and where it stops next is anyone's guess. The recent oversold bounces have failed and continue to build the pattern of lower highs. At a minimum we're expecting a retest of the October lows near $70.00. We're suggesting readers buy calls now with a stop above Friday's high. Our target is $70.50. More aggressive traders may want to aim lower. The Point & Figure chart is forecasting a $56 target.

Suggested Options:
We are suggesting the November puts.

BUY PUT NOV 80.00 PTR-WX open interest= 93 current ask $10.30
BUY PUT NOV 75.00 PTR-WO open interest=123 current ask $ 8.00
BUY PUT NOV 70.00 PTR-WN open interest=168 current ask $ 6.00

Picked on October 19 at $ 79.84
Change since picked: + 0.00
Earnings Date 03/06/09 (unconfirmed)
Average Daily Volume = 947 thousand
 

New Strangles

None today.
 

Play Updates

Updates On Latest Picks

Call Updates

DIAMONDS - DIA - close: 87.54 change: -2.17 stop: 74.40

Several of the major market averages not only put in a lower high but the failed rally today ran out of steam around the 61.8% Fib retracement of its Monday-Thursday decline. We are sticking to our plan to buy calls on a dip in the $80.25-79.00 zone. However, we're also adding some short-term puts on the DIA, see the new play section tonight. If the DIA hits our trigger to buy calls at $80.25 our first upside target is $88.50. Our second target is $94.50. More conservative traders may want to use a stop loss much tighter than our stop at 74.40.

Suggested Options:
If triggered we're suggesting the November calls. This should be a relatively quick play once it's opened.

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: 22.62 change: -0.38 stop: 18.95*new*

We feel pretty confident that HANS is going to retest its lows near $20.50 soon. The question is will support hold this time? Right now the plan is to buy calls on a dip into the $20.65-20.00 zone. We're going to widen our stop loss to $18.95. More conservative traders will want to consider a tighter stop (maybe 19.75-19.45ish). If we are triggered at $20.65 then our target to exit the calls is at $24.50 and then $27.50.

However, if HANS continues lower and hits our stop loss at $18.95 we want to immediately switch to puts. Our stop at $18.95 can be used as the entry point to buy puts. If triggered with the puts our first target is $15.05 with a stop loss at $20.65.

On Thursday I mentioned a covered call alternative or a naked put alternative. Those strategies still apply but you have to play with some sort of exit plan!

Suggested Options:
If triggered at $20.65 we are suggesting the November calls. I'd probably use the November 22.50s or 25.00s.

If HANS hits our stop at $18.95 then we suggest buying puts. We'd use the November $17.50s, which are the lowest strikes available at this time.

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: 156.75 chg: + 0.07 stop: 118.99

MA held up relatively well compared to the rest of the market on Friday. However, the intraday action was still bearish. Nimble traders could try and scalp a few points between here and $140, which is where we think MA is headed.

We are going to alter our plan here and split it up into an aggressive trade and a slightly less aggressive trade. I can't call it a conservative trade because MA is so volatile and the options are so pricey.

Trade #1 is to buy calls on MA if the stock trades down into the $141.00-140.00 zone. We'll stick with a wide (a.k.a. aggressive) stop loss at $118.99. Our first target is $164.00. Our second target is $177.50.

Trade #2 (less-aggressive) is to buy calls on MA if the stock trades in the $131.00-120.00 zone with a stop loss at $118.99. Our first target is $158.00. Our second target is $169.50.

On Thursday I suggested a couple of alternative strategies. One was a covered call play. Today I would look for the dip to $140ish and then consider buying the stock and selling some calls. The second alternative was selling the puts. Look for the dip toward $140 and then sell puts to collect the premium but only if you're happy to own the stock. You could sell the November $140s puts for about $15.00 if MA nears $140. The January $140s puts will probably be over $20 if MA nears $140. You still need an exit plan if MA continues to drop!

Suggested Options:
If MA hits our entry points we're suggesting the November calls.

Trade #1, I'd consider the November 150s, 160s even 170s.

Trade #2, I'd consider the $140s, 150s and 160s.

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: 70.33 chg: + 2.72 stop: n/a

The Volatility index continues to trade near all-time record highs. At this point with the market rolling over on Friday afternoon it looks like the VIX will re-challenge its highs near 80 soon. Buying VIX options with volatility this high doesn't seem like the best play. Selling VIX options is a better way to take advantage of these high option prices. Even though the VIX will be lower in November I'd rather not buy new VIX puts they're just too expensive.

On September 16th we started this play on VIX options and listed either the October or November puts. Those Octobers are going to expire worthless here in a couple of days. The November strike we listed is a long shot at this point and will most likely expire worthless too.

The September 29th and October 8th positions suggested November options and we have a much better chance of success.

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.

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

Picked on September 16 at = 30.30 first position
Change since picked: +40.03
Picked again Sept. 29 at = 46.72 second position
Changed since picked: +23.61
Picked again Octo. 08 at = 57.53 third position
Changed since picked: +12.80
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: 70.33 chg: + 2.72 stop: n/a

Needless to say our VIX spread trade isn't working out as planned, at least not the October trade. We listed this play last weekend after the VIX had just peaked at its (then) record highs. A reversal seemed like a sure bet and the VIX did reverse. It fell from 70 last Friday, Oct. 10th to 46.35 at its Tuesday low. Unfortunately, it quickly reversed and made a new high. October VIX options expire this Wednesday and stop trading at Tuesday's close. Right now we're in the hole with the October spread.

Our October trade was to sell the October 40 calls and buy the October 60s. If the stock market is poised to trade lower Monday morning we want to buy back the October 40s we sold (for a loss) but keep the October 60s, which have risen in value. You could dump both positions but if the VIX is going to keep rising then the October 60s will keep climbing as well (as will the 40 calls, which is why we want to buy them back to cover the short). I would actually sell the October 60s if the VIX nears 80 again (official exit will be 79.50). More aggressive traders could just let it ride. It's possible we might be able to get out of the October trade without a loss - it depends on what happens Monday.

Okay, so what happens if stocks are poised to move higher on Monday morning? Then we would keep the October trade open. If stocks rally then the VIX will tend to contract. The trick will be to decide when and where to close the position. I know there are a lot of "ifs" here in this play. If stocks manage to hold any gains on Monday then keep the play open look to exit completely on any rally on Tuesday. Or you could just let them expire. VIX options are cash settled.

The November trade is still in good shape. If you're looking for a new position I would consider a new trade on Monday, especially if the VIX is climbing near 80 again. Our November trade was to sell the November 30 calls and buy the November 50s. You may want to adjust those strikes depending on your risk tolerance and where the VIX is trading when you open the play.

Summary:

Please see the CBOE website or our Sunday, October 12th 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 a 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:
SELL CALL OCT 40.00 VIX-JH.
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
Update 10/16/08 .........., high 29.60, closed 23.75
Update 10/17/08 open 27.00, high 27.00, closed 23.90ask

-and-
BUY CALL OCT 60.00 VIX-JN.
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
Update 10/16/08 open 4.10, high 12.20, closed 7.90
Update 10/17/08 open 8.40, high 9.50, closed 6.60ask

--

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.

*Sunday, 10/19/08* If I was looking for a new position this looks like a pretty good trade, or you could sell the November 40 calls (currently trading around $10.00) and buy a higher call as a hedge.

In a different format the play is:

SELL CALL NOV 30.00 VIX-KF.
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
Update 10/16/08 open 13.70, high 16.20, closed 13.25
Update 10/17/08 open 15.55, high 17.70, closed 17.50bid

-and-
BUY CALL NOV 50.00 VIX-KJ.
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
Update 10/16/08 open 3.70, high 5.50, closed 3.65
Update 10/17/08 open 4.50, high 5.30, closed 5.50ask

Suggested Options:
See above

Picked on October 12 at $ 69.95
Change since picked: + 0.38
Earnings Date 00/00/00
Average Daily Volume = ---
 

Dropped Calls

Apple Inc. - AAPL - close: 97.40 change: -4.49 stop: 91.45

Yesterday we decided that the sharp bounce from AAPL's lows near $92 looked like a bullish entry point to buy calls. Today's failure to see any follow through on that bounce is a big warning sign, especially in this market. We have to tread lightly in this market so we're suggesting an early exit immediately. Cut our losses now before they get worse. If you decided to make this a covered call play then you have more room for error based on what call and the amount of premium you collected. The same goes for selling puts. Just be sure to use some sort of stop loss plan to limit losses.

FYI: Friday's movement in AAPL looks like a mini-double top, which is bearish. Very quick and nimble traders could buy puts with the expectation that AAPL will fall toward 87-85 again. The challenge is your time frame. Earnings are due out on Tuesday afternoon after the market close. We would not want to hold over the report. See tonight's play editor's comments for more details.

Picked on October 16 at $101.89 /exiting early
Change since picked: - 4.49
Earnings Date 10/21/08 (confirmed)
Average Daily Volume = 10.6 million
 

Dropped Puts

None
 

Dropped Strangles

None
 

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

DISCLAIMER

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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