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Daily Newsletter, Saturday, 10/25/2008

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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

Not Over Till Its Over

It does not make any difference how tired traders are from watching value bleed out of the markets on a daily basis. Despite numerous bottom calls from various analysts and celebrities the pain continues. Asian markets were down over 10% on Friday and European markets were off 4-7%. U.S. futures were lock limit down Friday morning. This is not the sign of an easing financial crisis but worsening global recession.

Dow Chart - 60 min

There was some good news on the economic front on Friday as long as you were not looking overseas. The Existing Home Sales for September rose to 5.18 million units and at the fastest pace since August 2007. It was the fastest one-month gain since Mid-2003. Inventory levels have also improved with only 9.9 months of homes available for sale. This is the first time inventory levels have been under 10 months since January with the peak at 11.2 months in April. The rise in foreclosure sales helped produce buyer interest. Foreclosures were up +71% in Q3 from Q2-2007. Over 765,000 U.S. properties received a default notice, warned of a pending auction or were foreclosed on in the quarter. This was the most since records have been kept. In September one in every 475 U.S. homes received a foreclosure filing.

This report was very positive because it showed that those distressed properties pushing prices lower are being snapped up like Halloween candy and that will support higher prices. On the downside the country is clearly heading into a recession and that will constrain demand somewhat until Q2-2009. Current government programs and those being discussed could also keep prices from declining any further. It will be interesting to see if new home sales also rose in September. Those numbers will be out on Monday.

Existing Home Sales Chart

The economic calendar was relatively light last week but the next two weeks will see the intensity increase. This week the two big announcements will be the FOMC rate announcement on Wednesday and the first look at the Q3-GDP on Thursday. The Fed is expected to cut rates by at least 25-points and many expect a full 50-point cut as a message to the markets. The ECB is also expected to cut rates any day now. This will be a critical FOMC meeting that could have a strong impact on the markets. Most claim the 50-point rate cut is already priced in and a failure to cut rates could be a disaster.

The Q3-GDP is expected to show the economy shrank by 0.5% in Q3 compared to a gain of +2.83% in Q2. We know there was a very sharp turndown in the economic indicators over the last two months so the -0.5% number could easily be wrong by a wide margin. If there is a sharp downward surprise it could definitely impact the markets.

This will be our first look at the Richmond Fed Mfg Survey and the Chicago PMI since the other indicators imploded over the last three weeks. I would expect those to also show sharp declines. The Durable Goods report in September posted the largest monthly drop in nearly six years. Analysts are expecting the decline to continue but hopefully at a slower rate.

Economic Calendar

The Q3 earnings cycle is nearly behind us despite only about 41% of companies reported. The reason I say it is almost over is that nearly all the large and important companies have already reported. There are still hundreds of companies reporting next week but I had a hard time finding 80 companies you would recognize to put in the table below. With the top 200 companies already reported and their average earnings down -21% the potential for any improvement is slim. Typically the quality of earnings declines as the size of the reporting companies decreases. Based on the estimates for the remaining companies earnings would rise to only a -20% decline but the problem with that type of speculation is the major earnings misses we have been seeing. I could see actual earnings decline to -25% before it is over. On January 1st the earnings for Q3 were expected to show a gain of +22%. Even at today's reported average of -20% that is a drop in earnings of more than -40% and that corresponds to the market's -40% drop.

Earnings Calendar

In the energy sector traders spit in the face of OPEC's 1.5 mbpd announced production cut. Crude fell another -3.24 to close at $64.60 after hitting a new low at $62.65. The OPEC agreement was reached quickly and the statement included a rare comment about member commitments. "The Conference has decided to decrease the current OPEC-11 production ceiling of 28.808 million barrels a day by 1.5 mbpd, effective 1 November 2008, with Member Countries strongly emphasizing their firm commitment to ensuring that the volumes they supply to the market are reduced by the individually agreed amounts." It appears there was some harsh language behind closed doors about cheating. The following table shows the new quotas for the 11 member nations that have quotas. Contrast the first table with the second table and the implied cut in production they would have to make to actually hit those quotas. Some countries would actually cut a lot more and Angola could actually raise production. To hit the actual quota OPEC would have to actually cut production by 1.822 mbpd.

Official OPEC Quotas

OPEC Production vs New Quota

Oil prices were crushed after the announcement because nobody expects the cuts to actually take place. There may be some token cuts but most analysts expect them to have trouble cutting even a million barrels much less 1.82 million. To put all this in perspective U.S. demand over the last four weeks was -1.7 mbpd lower than the same period in 2007 and a level not seen in the last eight years. Almost the entire 1.8 mbpd production cut would only offset the drop in U.S. demand. Globally demand is only off about one million barrels per day because India and China are still growing. There are fears that the global recession is accelerating and demand could fall another 1.0 mbpd and that would require OPEC to take another million barrels off the market to compensate.

That all sounds drastic in terms of demand destruction and global oversupply but there is a key factor missing. In the U.S. the average price of gasoline has fallen to $2.78 per gallon but in some areas it is already selling as low as $2.15 per gallon. Nothing rebuilds demand as quick as low prices and some analysts believe we could eventually see gasoline under $2 in some U.S. states. You can imagine how fast $1.95 gasoline would spur demand after seeing it at $4.29 just a few months ago. The concept of peak oil has been completely forgotten even though this temporary glut has nothing to do with the real problem. This is just an anomaly and demand will quickly return. The amount of bearishness in the oil market is unprecedented. There is currently a 30:1 imbalance in open interest in crude options. There are 128,000 put contracts and only 4,000 call contracts. This type of imbalance is extremely dangerous for the bears. If we did see something that triggered a reversal it could be explosive and spike back to $100 in mere minutes. Bubbles don't always occur on the upside. The price spike to $147 was event driven and extremely overdone. The drop to $62 is the bubble in reverse. The selling is way overdone and the pendulum always swings in both directions.

December Crude Oil Chart - Weekly

The equity markets opened on Friday with extreme pessimism. The futures were lock limit down based on bad news overseas and huge market drops in Europe and Asia. The Asian markets were hit the hardest with the Hang Seng losing -1,142 points or -8.3% in one day. It is down -30% for the month of October alone. The close at 12,618 was the lowest level in four-years. Japan's Nikkei Index fell -9.6% and the Kospi fell -10.6%. The drops were on fears of a worsening global recession after many foreign firms posted lower than expected earnings and gave negative outlooks. Currencies were hammered with the dollar gaining intraday against the pound with the largest single day gain in 37 years. By the close the pound had recovered to "only" a six-year low. The damage there came after the UK economy contracted by -0.5% in Q3 and the first negative GDP reading in 16 years. The pound has dropped more than 9% in the last week. News of the UK GDP drop crushed weaker economies on recession fears. The UK was supposed to be the stalwart economy overseas and that suggests other lesser economies may be hurt even more. Bank of England governor Charles Bean said on Friday that Britain's economy was in the early stages of a slowdown that could be the largest financial crisis of its kind in history. Those were pretty strong words for an otherwise reserved British chap.

S&P-500 Futures Chart - 5 min

With the futures lock limit down there were fears the Dow could fall as much as 1100 points at the open. Fortunately it did not happen and we ended up down "only" -312 points. Notice how only a 300-point drop seems almost normal? There was a rumor all over Europe that GMAC was going to collapse over the weekend. Iceland has been a problem for the last two weeks and they finally accepted a $2 billion loan from the IMF as a partial solution to their banking problem. Unfortunately the failure of Iceland has brought into focus the potential failure of a dozen other countries and the repercussions from a domino type drop. Instead of just banking risk and investment bank risk we now have country risk and those could evolve into some really big numbers.

The failure of Iceland's biggest banks has had repercussions around the world. Iceland banks were overly aggressive in seeking out business on a global scale and when they failed it impacted thousands of companies worldwide. Lobster prices in the U.S. are down by 50% because the Canadian packagers who consume much of the lobster in the northeast lost their credit lines. No credit, no lobster. Lobsters now cost the same price as bologna because there was an instant glut and nowhere to sell them. Lobsters probably rank right up there on the scale of discretionary spending so the recession was already a problem for sales. Having the food packagers implode on top of the drop in retail sales was a serious blow. http://www.forbes.com/feeds/ap/2008/10/23/ap5594003.html

Chrysler reported on Friday they were going to cut another 25% of their white-collar work force. GM fell another 13% intraday on worries about sales. Reportedly auto sales have not just slowed but come to a screeching halt with no financing available. Volvo reported it received only 115 heavy truck orders in Q3. That was down from 41,970 orders in the same quarter in 2007. Volvo is the world's second largest maker of heavy trucks and they slashed their outlook and said they were curtailing production. I can't even comprehend the severity of that drop. Volvo said it was cutting 1,400 jobs at the truck division in Europe and another 1,350 in America. Volvo said not only had orders dropped significantly but also prior orders were being cancelled at a record pace. Take this downturn in sales that came primarily from global businesses and you get a picture of how abruptly the decline came. Companies can't plan for this type of sharp decline. I have used this word too much lately but this change in the business environment is truly catastrophic.

Nouriel Roubini is a noted economist and a professor at New York University. He correctly warned in 2006 about the coming financial crisis. He said the U.S. would enter a recession as a result of the crisis. In February of this year he predicted a "catastrophic (his word not mine) financial meltdown that central bankers would be unable to prevent leading to the bankruptcy of large banks exposed to mortgages and a sharp drop in equities." Obviously he was right on the money there as well. Actually he has been exactly right for the last three years and always well in advance of the projected event. After his February proclamation he was nearly banned from stock TV because broadcasters did not want to start a panic. He was too over the top for the mainstream media and despite his on the mark predictions he was viewed as a crackpot when he said the financial system would fail later in the year. Well, Roubini was proven right and now he is predicting again. On Thursday Roubini spoke at the 2008 Hedge Fund Conference and said "hundreds of hedge funds would fail and policy makers may need to shutdown financial markets for a week or more to avoid dumping of assets." He was joined by Emmanuel Roman of GLG Partners who said 30% of existing funds could close.

Roubini said systemic risk was growing and we were seeing only the beginning of a run on hedge funds that would produce massive dumping of assets. Hedge funds had their worst month in over ten years in September and October is not looking any better. Roubini said they used to say, "When the U.S. sneezes the rest of the world catches cold." "Unfortunately this time around it is not just sneezing, it has a severe case of chronic and persistent pneumonia that is crushing emerging markets." "There are a dozen emerging markets in severe financial trouble and there is not enough IMF money to save them." Roubini was a former senior adviser to the Treasury Dept. Earlier this month he said "the U.S. would suffer its worst recession in 40 years and I fear the worst is ahead of us." I find myself probably in the same camp everyone reading these comments are today. It is the same camp I was in when he made all of his prior predictions. I thought they were extremely bearish and I could not conceive they would come true as predicted. Maybe some things would happen but surely it can't be this bad. Months later I look back and cuss myself for not taking him seriously. Will 30% of hedge funds fail? I doubt it but I have been wrong on all of his other predictions as well. I think the continued forced liquidation in the markets is a symptom of a run on the hedge funds. When does it turn into a disaster instead of just a run? Hedge funds typically borrow 5-8 times their deposits in order to juice results. Those loans are being called and like a margin call they require rapid liquidation to prevent the portfolios from being seized by the banks.

Speaking of funds, 25% of mutual funds have their year end on Oct-31st. It does not sound that bad at only 25%. However those 25% control more than 75% of all mutual fund investments. We know that October is always the most volatile month because funds are trying to shuffle their portfolios to put the best spin on their results and portfolios for the year-end statements. These are the statements that convince people to either stay in the fund or move to a different one. In the fund business it is a life or death event and has a direct impact on year-end bonuses. TrimTabs said in their weekly update that withdrawals from mutual funds had slowed to only $6.47 billion for the week ended Wednesday. That was down from $14 billion the prior week and an estimate of $50 billion for the entire month of October. Mutual funds saw withdrawals of $43 billion in September. So what will funds do to settle the books by Oct-31st? Surely they have already dumped their losers but then what stock is not a loser? They always try to sell some winners to offset their losers and present the best results possible. They try to load the portfolio with the best stocks in the market at the time so investors will be bullish about their fund outlook for the coming year. A lot of them may be holding large amounts of cash so they can claim we are well positioned to pick up bargains when the market turns. A blind monkey throwing darts would have a better chance of picking the option that best describes fund moves over the next week. About the only positive point is that the selling should be over. Why wait until the last minute to sell stock you don't want at month end? If I were going to bet I would think they are biding their time to gauge redemptions and cash flow until the last minute. They are probably hoping to splurge in the last couple days of the month to window dress their portfolios.

Remember the Fed meets next week and the country is in a recession, declared or not. Bernanke knows the only way out of this scenario is to inflate his way out of it. They call him helicopter Ben after he referred to a Milton Friedman statement about a "helicopter drop of money to stimulate the economy" in a 2002 speech. If the Fed makes money so cheap that my blind monkey could run a business and turn a profit then the country will quickly rebound out of almost any economic scenario. At least under normal conditions it would reflate the markets. We still have the election cloud over the markets and despite the difference in the polls there is still a lot of indecision hanging over the markets. If capital gains are going to double then the time to sell things at the lower tax rate is running out. I suspect Ben is aware of how the election may complicate his job and has plans to work around it.

The easiest way to get out of the housing crisis is for the Fed to create inflation. Rising home prices would be very beneficial to the economy and consumers. Freddie Mac (FRE) said mortgage delinquencies on their portfolio had risen to an all time record high. That is another one of those news headlines that should be ignored. Freddie currently has $736.9 billion in mortgages on the books and ONLY 1.22% are delinquent. That is still $8.99 billion in delinquent loans but only a drop in the $736 billion bucket. If inflation returned and prices began to rise it would stimulate buyers to return quickly before the bargains disappeared. Inflation would heal a lot of problems.

After a quick glance at the market internals and I was actually pleasantly surprised. Down volume is winning the battle but it was not as lopsided as I would have thought. Volume is rising after the calm reversal on Monday/Tuesday but still not capitulation levels. It is almost as though we are seeing a calm decline. The VIX hitting 89 on Friday would be contrary to that calm appearance but that was on the gap down open. Other than the severe volume imbalance on Wednesday the real point that stands out is the new 52-week lows. However, Friday's 2227 new lows were dwarfed by the 5007 we saw back on Oct-10th. Volume on the 10th was 19.5 billion shares. Even though the market is slowly slipping back to those Oct-10th levels the internals are actually not that bad. Of course bad is relative these days.

Market Internals Table

When I started this commentary I was bearish. When the markets collapsed at Friday's open on global economic news after rebounding from Thursday's lows I started reconsidering my outlook. The Nasdaq is positively ugly. It traded under 1500 on Friday and although it rebounded from its lows still close down -52 points. Every day last week was a lower low, lower high. The Dow appeared to want to rebound but every move higher was met with heavy selling. They hammered the close again with a -200 point drop in the closing minutes. It is not pretty.

Nasdaq Chart - Daily

S&P-500 Chart - Monthly

The S&P actually respected the 860 low from Thursday and managed to recover significantly from the opening drop. Still more and more technicians are talking about 840 as real support they are expecting to see tested. After listening to all the bears talk and scanning a hundred articles I was about to throw in the towel.

However, there are some material events coming our way. The Fed meeting should provide a little uptick in sentiment as long as Ben does not turn into a raging bear in the statement and cuts 50 basis points. Friday is month end and year-end for those funds I mentioned. I can't help but think they should be done selling and looking for window dressing material. The drop in oil prices on the OPEC announcement was a classic sell the news event by the bears. Eventually that 30:1 imbalance in puts to calls is going to reverse. We got some positive news Friday evening that PNC Financial Services was buying National City Corp for $5.6 billion. That would not otherwise be news except that PNC sold $7.7 billion in preferred shares to the U.S. Treasury under the new TARP program, (Troubled Assets Relief Program), making it the first bank to participate in the program. This should encourage others to start thinking out of the box and join in the fun. It should also provide some positive sentiment to the banking sector.

My outlook for the week is mixed. I do believe we are at or near a bottom. However that depends on the forced liquidation by funds. All the positive fundamentals in the world can't fight a hedge fund implosion. That is the real unknown, unless of course you are Roubini. Baring selling from further hedge fund liquidations I expect mutual funds to be dressing up their books and actively buying the market. I expect the Fed to cut rates and I think the bad news bulls are itching to get back in the fight. We may not have seen the lows yet but I think we are very close. However, projecting market directions and distance in a 100-year event is a fool's errand. I want to think November 1st will see us higher than we are today but that may only be wishful thinking. I stepped up to some long 2009 calls on the Russell Proshares ETF last week and I plan to hold them through whatever happens next week. I am not going to speculate on the various indexes today and leave that up to Leigh in his Index Trader commentary in this newsletter. I am already well over my commentary size limits. I heard Carter Worth and Jeffery Weiss, both excellent technical analysts expressing bullish opinions on Friday and I respect them both. Bill Gross of Pimco also said a bull market was imminent. In his context he was not referring to next week but "soon." That puts me in good company and hopefully they are right.

Jim Brown
 


Trader's Corner

Stop Orders in a Fast-Moving Market

It happened again. The OEX was moving against my position. I had placed OCO (one cancels other) orders to take me out of my long call position if the OEX dropped too far or else met my profit goal, so I hadn't been too worried. I didn't like the fact that I was about to be stopped, but traders must expect that some trades would be losing ones.

I just didn't expect the losses to be as big as they turned out to be. The quoted price of the option blew right through that stop without the stop order being filled. Finally, when the calculated value of the call was $2.00 below the order's stop price, I cancelled the OCO orders and placed a limit order to take me out of the position.

Trading in a fast market requires adjustments to your trading plans. Those plans should include extra vigilance even when a stop is set. To understand what happened, it's important to understand how those stop orders are filled. With my broker, a stop order is activated when the option trades at or below the price at which the stop is set. For example, if I had set a stop order for an OEX call at $11.50 and that call trades at $11.40, my stop order will become an active order and will be filled at market.

In regular times, that system works quite well. The OEX drops. Its options are usually liquid, frequently traded. That call trades at a price that triggers the stop, and the OEX doesn't jump around too much in the time it takes that stop order to be active and for the order to fill at market price. Traders expect some slippage, but usually in a liquid options market like the OEX's, the slippage isn't too bad.

No so in a fast market. When the OEX suddenly drops five points in a ten-second interval, it may be that not many call buyers step up to the plate during that ten-second interval. Bid and ask prices for the options drop quickly and much value is lost before someone buys the call at the lower price, the stop is triggered, and the call is sold at market, perhaps at an even lower price if the OEX has continued dropping during the interval.

So, what do you do? Trading without stops is not the right choice. Even experienced traders can fall into the deer-in-the-headlights reaction when a sudden move catches them unaware. Some traders set just-in-case stops to protect them against such deer-in-the-headlights reactions but plan to be vigilant and negotiate their own exit ahead of the stop and between the bid and the ask. It's of course important to cancel your existing stop order before negotiating your own exit.

Another alternative is to talk to your broker about the merits of a contingency stop order based on the price of the underlying versus the price of the option. Some brokerages offer another possibility. At least one broker, Think or Swim, offers several alternatives to the standard stop order. Think or Swim customers can choose to have their stop orders activated or triggered three different ways: when the asset--a call option in this case--trades at the stop price, when the bid falls to the stop price or when the ask falls to the stop price. If my broker had offered that possibility, I could have set the stop to be triggered when the bid hit a certain number.

If I'd been able to set my stop order based on the bid or ask rather than an actual trading price, I suspect my orders might have been triggered sooner, but I still would have experienced slippage. Couple the wide bid/ask spreads that the increased volatility have brought about with the slippage that should be expected when a stop is triggered, trading options becomes less advantageous than at some other times in the past. Add in the erratic nature of the markets these days, and option traders are put at another disadvantage.

In the words of an options market maker a few weeks ago, these conditions require that options traders be "more right" than they've ever been before. There's no room for error here. Re-familiarize yourself with the types of stops your broker offers, if you haven't done so previously. If you find that your broker handles stops as mine does, be aware that slippage might greatly impact the drawdown you experience when a trade goes wrong. Do set stops, but this isn't a time to go off and do something else while the trade unfolds. Forego the trade if you can't watch. Consider your stop a "just in case" stop to take you out if your attention was misdirected for a few minutes or you just did your deer-in-the-headlights imitation, but plan to pull that stop and negotiate your own exit if you can trust yourself to do that. If you can't, then slippage is better than letting the option run to zero.
 


Index Wrap

Will They or Won't They

THE BOTTOM LINE:
Are the major indexes going to hold their recent lows or NOT is the question that inquiring minds want to know! The related risk taker's question is what are the odds for a new down 'leg'?

I've been thinking, without enough conviction to commit much money on this opinion, that the major indexes are in a bottoming process and that they won't see a new down 'leg' near-term. A leg being MORE than a dip; this is the difference between the S&P 500 (SPX) falling to 850 again, versus dropping 50-75 points back to 800-775 where SPX bottomed in 2002-2003. If our, and the world, economy is going into a more severe recession than seen after 9/11, it seems logical we'll re-test (at least) 2002 lows.

From a trading standpoint, my thought has been that we'd get a bounce before any such retest. That pattern occurred in the bottoming process of 2002-2003 when SPX rebounded 150 points on the first dips to its bear market lows. But, again using SPX as an example, such rebounds (2) were from 775-800. If the recession we're galloping into looks worst than then, it seems hard to believe that we won't at least re-test our 2002 lows.

The major market indices were not as oversold THEN, according to oversold/overbought indicators like the Relative Strength Index (RSI) and sentiment didn't get as bearish as it has recently. But, such indicators are only rough measures of the POTENTIAL to rally. Is this all by way of saying, "who the heck knows!"

If recent lows do hold (and the Nas 100/NDX has gone to a slight new low for this move and the major indexes went to NEW WEEKLY closing lows this past week), upside potential is probably for a week rebound only. A typical weak bear market rally would not usually retrace more than 38, or at most, 50 percent of the last downswing. I've noted the 38, 50 and for comparison, the 62 percent retracement levels below to illustrate upside potential.

Last but not least: there's not a lot technically that can suggest if prior major lows WILL get re-tested. I've noted major prior lows on the daily charts. They are not all that far away. There IS the old charting adage that retracements that are greater than 2/3rds or 3/4th's of a prior move will often complete at least a 100% retracement back to major prior lows. If prior lows do get re-tested, I'll be looking at some new trades; e.g., selling puts and buying some more distant calls, especially if sentiment continues to be super bearish.

In this type market, I also find myself drawn to possible trades in individual stock options, rather than just in index options, since at major market bottoms there are stocks that bottom first and outperform on the upside. I'm spending more time that usual looking at a broad array of weekly stock charts.

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) chart is bearish, but prices haven't yet broken down below the low end of the recent price range, so some upside potential can be assumed to exist (hope springs eternal!), especially given how oversold this market remains. Support has been seen in the 850 area and just a bit under. Major support begins at 800 and extends to 775.

Near resistance is at 985, extending to 1005, at the 21-day moving average. If a rally got going and last week's low was not exceeded, resistance implied by a 38 percent (fibonacci) retracement is at 1020 currently. A close above 1000, a key psychological level, with a subsequent ability to hold this area, should turn traders bullish and lead to follow through buying in the S&P stocks.

S&P 100 (OEX) INDEX; DAILY CHART

The chart pattern suggests that a bottom could be forming, but a close under 400 would make that interpretation look iffy in the big cap S&P 100 (OEX). Besides a continued sideways move with its potential to suggest at least an interim bottom, the most bullish indicator aspect is seen with my 'sentiment' indicator, which has had its THIRD bullish ('oversold') daily extreme since October began.

October tends to be a bearish period also on a seasonal basis, with lots of cross currents. This October is proving true to its pre-Halloween form. This is not to say that there's just some seasonal 'cycle' at play, but there have been many October bottoms made.

Support is noted at 400, then at 385. Near resistance is at 475-480, and then comes in next around 495-505.

SENTIMENT:
The repeated dips in my call to put sentiment indicator suggests that traders have finally gotten predominately bearish and are more inclined to sell rallies than to buy dips. I've long thought that a sustained rally wouldn't set up until a cluster of such readings in the "oversold-extreme bearishness" zone. This doesn't mean that a rally 'has' to happen anytime soon, but does give me pause in being heavily short this market, even in the face of mostly bearish economic news.

DOW 30 (INDU) AVERAGE; DAILY CHART

The Dow 30 Average (INDU) has support in the 8000 area, then at 7500, with key resistance at 9000, then in 9500 area. Where to from here? The chart can be read either as potential bottoming action or a consolidation prior to another downswing that carries to lower lows.

I've been thinking that a rally is due/overdue, but will be watching price action if there is another retreat to the Dow 8000 area. There is a lot of distressed liquidation going with hedge funds and we could still go over another cliff but don't see what near-term news will come that is more bearish than what is already built into the market. I'm talking about economic news of course, not an unexpected political meltdown somewhere or the like.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite Index (COMP) chart remains bearish, especially given the decline to a new closing low. I've measured the key retracements based on the low to date, which provides an idea of upside potential for a more sustained rally.

Initial COMP chart resistance is noted at 1700, then at 1770, at the 'line' of recent highs and finally around 1890, as implied by a fibonacci 38 percent retracement. Upside retracement possibilities, especially for a 'minimal' 38 percent rally, will need re-drawing if COMP sinks to a lower low ahead.

I've noted initial support at 1500, down from 1600 last week, but the 1500 level hasn't been tested much yet. Stay tuned on where COMP will finally see buyers rush in, if only for the purposes of short-covering.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart is bearish and the index could be heading lower again as suggested by technical signs of renewed downside momentum. The RSI is also a 'momentum' type indicator. The dip under 1200 and new low close show a still bearish chart.

The 1200 area is hanging in as potential support but just by a thread. I owned some NDX calls, with a break-even exit point at 1200, but I was gone after a third successive top formed just over 1350. Three strikes and you're out applies!

1352 is noted as a first resistance per the red down arrow below with next resistance noted at the prior 1470 rally high, which also corresponds to resistance implied by a 38 percent retracement; as measured from Friday's low up to the August high. Current retracements assume that this most recent low is not exceeded and measures from that low. Retracement calculations give an ongoing estimate of rebound potential.

Key chart/technical support now looks to be in the 1100 area. If 1100 is pierced, major next support implied by the early-2003 lows (not shown), is in the 960 area. 1000 seems like a 'natural' support but if NDX gets there, traders may try to press it under.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

Showing up my fruitless attempt to pick a possible low this past week, the Nas 100 tracking stock (QQQQ) fell below 30. If we go back now to the Q's early-2003 low, potential buying interest lies significantly lower still, in the 23.5 area.

I discussed last week that any long positions should have been jettisoned, at the lowest on a sell stop at 30 even. I thought there might be a rally attempt this past week, such as back up to 36 even, but the 2nd and 3rd days'(Monday and Tuesday) rally attempts that formed intraday highs at 33.5 was the tip off to the still bearish chart pattern for QQQQ.

I've noted first resistance at 33.5. If 28 should turn out to the low for a while and the stock can pierce 33.5 this time, 36 becomes resistance implied by a fibonacci 38 percent retracement.

The 24-23.5 area may be a downside target if a new down leg develops on a decisive downside penetration of 28.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) is back down to the low end of its recent range; actually, RUT penetrated its prior 468 low slightly, but overall, buying interest has been coming in at 469-470. I've noted major support in the 400 area.

Resistance begins around 550, and then is noted on the chart at 570. Assuming the recent low is it for a while and that remains to be seen, 576 is resistance implied by a 38 percent retracement from Friday's low relative to the mid-August price peak.

GOOD TRADING SUCCESS!

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

Railroads, Miners, and biotechs.

New Option Plays
Call Options Plays
Put Options Plays
Strangle Options Plays
BNI BNI None
FCX CHTT  
     
     
     

Play Editor's Note: So who do you believe? Do you believe the crowd who is calling this a bottom? Are they the same crowd who has been calling a bottom for the last 2,000 points on the DJIA? Or do you believe those calling for another 20% decline? You've heard it before but this is one of the toughest markets in history if you're trying to trade it.

I was listening to some on the street interviews recently and most people responded with some sort of "I'm just trying not to think of the market or what it's doing to my portfolio" or another version of sticking their head in the sand. Long-term they are right to stick with it if they have a 30, 40 or 50-year time horizon. If you continue with that train of thought then this massive sell-off is probably a great long-term entry point to buy stocks. Of course one has to wonder if next month will be a better long-term entry point to buy stocks another 10%, 15% or 20% lower.

If you're reading this then you're obviously a more independent-minded investor who believes that actively trading the market can out perform just a "buy-and-hold" philosophy. It's certainly been done. People have made fortunes trading the market. They've also lost fortunes. If the market happens to be going your direction then things look pretty good as the huge intraday swings can produce big returns on your computer screen. If the market isn't going your way then just wait. Tomorrow it probably will.

Traditionally if we look at the size of the sell-off, the pessimism in the market, and the extreme readings on the volatility index then there is a good amount of evidence that we're near "a bottom" but maybe not "the bottom". Stocks have been unable to build on any sort of rebound attempt. Rallies are sold hard as another chance to unload. Plus, you have plenty of pundits suggesting we're far from a bottom because everyone is too quick to try and call a bottom.

This week will probably see more volatility as fund redemptions and forced selling fight with end of year window dressing for those funds with an October 31st year-end. Now throw in an FOMC rate cut that may or may not be already priced in and add to it some serious bearish breakdowns in the last couple of days and it is almost impossible to pick a direction.

At this point I'm adding both bullish and bearish plays but generally we're going to stick with the trend, which is down. Traditionally the newsletter publishes directional put and call plays where we are buying calls or puts. Yet right now, with the volatility so high, options are incredibly expensive.

A smarter trade would be to use a strategy that sells option premium. Covered calls, selling puts on stocks you want to own, or some sort of credit spread seems like the better strategies in this environment. As I wrap up keep in mind that this month has taught us that volatility can always get higher and stocks can go lower than you or I expect. There is nothing to suggest that trend of surprises will change.

-------------------------------

NEW DIRECTIONAL CALL PLAYS

Burlington Northern - BNI - cls: 80.00 chg: -1.58 stop: 73.85

Why We Like It:
Railroad giant BNI has been consistently bouncing from support in the $75-74 zone for months even during this volatile time in the market. We want to buy calls on another dip near support. Our suggested entry zone is the $75.50-74.00 region with a stop loss at $73.85. If triggered our first target is the $79.95 mark. We unload most of our position there. We are listing a secondary, more aggressive target at $84.00. Note: BNI is also a short-term put play as we try to catch the drop to $75.

Suggested Options:
Our suggested entry point is $75.50. We're suggesting the November calls. These calls will be cheaper when we're triggered.

BUY CALL NOV 75.00 BNI-KO open interest= 549 current ask $8.10
BUY CALL NOV 80.00 BNI-KP open interest=1593 current ask $4.80

Annotated Chart:
Burlington Northern Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/23/08 (confirmed)
Average Daily Volume = 5.1 million

---

Freeport McMoran - FCX - close: 24.86 change: -1.42 stop: 18.45

Why We Like It:
Shares of copper and gold producer FCX have just been crushed as investors liquidate stocks or sell them on fears of the global slowdown. Eventually this stock is going to get so cheap that people will pile in. Currently the stock's P/E is nearing 3 so I'm not sure how much cheaper it can get. Here's the plan. FCX seems to have some heavy support in the $20 region. We're suggesting readers buy calls on a dip into the $21.00-20.00 zone. We'll use a stop loss at $18.45. Our first target is $29.00. Our secondary target is $37.50.

Suggested Options:
We are suggesting the December options. They're a little more expensive but we get more time. Remember, they'll be cheaper when FCX hits our entry point at $21.00.

BUY CALL DEC 25.00 FCX-LE open interest= 485 current ask $4.90
BUY CALL DEC 30.00 FCX-LF open interest=1817 current ask $3.00
BUY CALL DEC 35.00 FCX-LG open interest=1743 current ask $1.76

Annotated Chart:
Freeport-McMoran

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/21/08 (confirmed)
Average Daily Volume = 20 million

NEW DIRECTIONAL PUT PLAYS

Burlington Northern - BNI - cls: 80.00 chg: -1.58 stop: 82.35

Why We Like It:
While BNI has continued to bounce from support near $75-74 the stock seems destined to retest that level again. We want to try and catch the drop with a quick put play. We'll use a stop above Friday's high. Our target to exit will be $75.50. This is where we would switch directions and buy calls.

Suggested Options:
We're suggesting the November puts.

BUY PUT NOV 80.00 BNI-WP open interest=9621 current ask $4.70
BUY PUT NOV 75.00 BNI-WO open interest=10018 current ask $2.85

Annotated Chart:
Burlington Northern

Picked on October 26 at $ 80.00
Change since picked: + 0.00
Earnings Date 10/23/08 (confirmed)
Average Daily Volume = 5.1 million

---

Chattem Inc. - CHTT - close: 67.73 chg: +0.32 stop: 70.75

Why We Like It:
CHTT has been pretty consistent with reaffirming its earnings guidance but in this environment investors really don't care. The stock's recent rally attempts have failed. Shares are breaking down from a very common two-week consolidation phase. We're suggesting readers buy puts with a stop loss above Friday's high. We're setting two targets. Our first target is $61.50 near the October 2008 lows. Our secondary, more aggressive target is the 58.00 level near its summer 2008 lows. FYI: I would consider this a more aggressive play because CHTT doesn't have a lot of volume and the option spreads are a little wide!

Suggested Options:
We are suggesting the November puts. More conservative traders may want more time so consider the December puts.

BUY PUT NOV 70.00 HQT-WN open interest= 56 current ask $6.80
BUY PUT NOV 65.00 HQT-WM open interest= 35 current ask $4.10
BUY PUT NOV 60.00 HQT-WL open interest=302 current ask $2.35

Annotated Chart:
Chattem

Picked on October 26 at $ 67.73
Change since picked: + 0.00
Earnings Date 09/25/08 (confirmed)
Average Daily Volume = 400 thousand

---


In Play Updates and Reviews

Friday's market gap down had a big impact.

---------------------- CALL Play Updates ----------------------

CSX Corp. - CSX - close: 42.38 chg: -1.36 stop: 38.90*new*

If we had only been more patient and waited until Friday then CSX would have hit our original entry point in the $40.50-40.00 zone. Instead we jumped the gun on Thursday night suggesting new positions above $43. Actually, fortune smiled on us anyway as CSX gapped open lower on Friday at $40.41, which would have been our first opportunity to open new positions. The stock rebounded but eventually pared its gains. So here we are with a bullish call play on CSX and the trend is bearish. Essentially we're betting that long-term support near $40.00 will hold as it has done several times in the past. Given our $40.41 entry point we're going to widen our stop loss to $38.90. More conservative traders will want to consider keeping their stop right where it is, about five cents under Friday's low. Our target on CSX is $49.90. At the moment odds look pretty good that CSX will retest the $41.50-40.00 zone on Monday so if you're looking for new positions I'd wait for another dip.

Suggested Options:
We are suggesting the November calls.

Annotated chart:
CSX

Picked on October 23 at $ 40.41 /gap down entry
Change since picked: + 1.97 /originally listed at $43.74
Earnings Date 10/14/08 (confirmed)
Average Daily Volume = 6.5 million

---

Hansen Natural - HANS - close: 21.12 change: -1.76 stop: 19.95

As fate would have it we were given a lower entry point with HANS as well. Our original plan was to buy calls on a dip in the $20.65-20.00 zone. Thursday night we decided to jump in at $22.88. Well Friday morning rolled around and HANS gapped open lower at $20.60 - at least that is what most quote services are going to tell you. If you look at an intraday chart HANS never traded under $21.00. It appears that HANS actually opened on Friday morning at $21.47, which is where we're setting the official entry price. The short-term trend is obviously down. If you are looking for a new position we would wait for a dip into the $20.50-20.00 zone. Now that the play is open we have two targets. Our first target is $26.85. Our secondary target is $30.00.

Note: If HANS breaks down under $20.00 it would be very bearish. We're suggesting readers buy November puts on HANS if the stock trades under $19.50 and target the $15.50-15.00 zone.

Suggested Options:
Currently we are suggesting the November calls.

Annotated chart:
HANS

Picked on October 23 at $ 21.47 /gap down entry
Change since picked: - 0.35 /originally listed at 22.88
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 10.6 million

---

MasterCard - MA - close: 130.62 chg: - 5.38 stop: 118.99

These days it pays to wait for your entry point. We could have bought MA closer to $120 instead of $130. We had been suggesting readers buy calls on MA on a dip into the $131-120 zone. Shares hit our trigger on Thursday at $131.00. Friday's morning scare sent MA plummeting lower and the stock actually traded around $118.50 in pre-market hours. When the market finally opened MA began trading at $122.28 (not the $120.02 your quote service my tell you) and within 15 minutes MA was back above $130. The trend is very negative here. Readers might feel more comfortable waiting for a bounce back above $140.00 before initiating bullish positions. At the moment, if you're looking for a new bullish entry point, I would be watching for another dip into the $125-120 zone. We have two targets. Our first target is $158.00. Our second target is $169.50.

Remember, MA doesn't have any consumer credit exposure. The company only processes transactions. This massive sell-off is way overdone and is probably just investors (and funds) liquidating anything of value to raise cash. If we get stopped out at $118.99 I would be looking for another bullish entry point near the $100 zone.

Suggested Options:
We are suggesting the November calls. However, keep in mind that we do not want to hold over the early November earnings report. That only gives us one week.

Annotated chart:
MA

Picked on October 23 at $131.00 *triggered 10/23
Change since picked: - 0.38
Earnings Date 11/03/08 (confirmed)
Average Daily Volume = 3.8 million

---

Energy SPDR - XLE - close: 43.65 chg: -2.90 stop: 37.45

We continue to wait for the XLE to pull back and retest its October lows. Nimble traders could try and scalp a couple of points on the way down. We're going to wait for our bullish entry point. Right now our suggested entry to buy calls is the $40.50-39.00 zone. If triggered we're setting two targets. Our first target is $45.00. Our second target is $49.75.

Suggested Options:
If triggered we are suggesting the November calls.

Annotated chart:
XLE

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume = 47.7 million

---

---------------------- PUT Play Updates ----------------------

Volatility Index - VIX - cls: 79.13 chg: +11.83 stop: n/a

Hmm... let's review our check list. Did we see incredible volatility in the stock market? Check. Did the volatility index see a double-digit percentage move? Check. Did the volatility index hit new obscene, record highs? Check. Did the VIX close near these new obscene, record highs? Check. Well it looks like just another "normal" day in the markets. The volatility we are seeing is just incredible. If you subscribe to the idea that we are experiencing a once-in-a-century event for the financial markets then we are probably seeing lifetime highs in the VIX. Years from now people will point back to these wild swings in the VIX with amazement. At least that's the hope. We certainly don't want this to become the new "normal".

At this point with the VIX this high we don't want to buy VIX options. We'd rather sell VIX options. More aggressive traders might want to just sell some at-the-money or out-of-the money VIX calls for November. If you really wanted to get crazy you could sell some in-the-money VIX calls (maybe the 65s or 60s). In spite of the jaw-dropping moves in the VIX odds are still better that the VIX will see a major contraction before November options expire on November 19th. If the VIX is under your call's strike price at expiration they'll expire at zero ($0.00) and you keep all the premium you sold it for.

Note: The VIX options, which are European style options, have a unique expiration date. 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: http://www.cboe.com/Products/indexopts/vixoptions_spec.aspx

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 put positions at this time.

Annotated chart:
VIX

Picked on September 16 at = 30.30 first position
Change since picked: +48.83
Picked again Sept. 29 at = 46.72 second position
Changed since picked: +32.41
Picked again Octo. 08 at = 57.53 third position
Changed since picked: +21.60
Earnings Date 00/00/00
Average Daily Volume = --- million

---

---------------------- Strangle & Spread Play Updates ----------------------

CBOE Volatility Index - VIX - cls: 79.13 chg: +11.33 stop: n/a

It was another record-breaking day on Friday for the VIX. The moves to these high extremes provide investors who are selling options more opportunities to increase their odds of success. You can tell by looking at the prices for November options versus Decembers that the market is expecting a big drop in volatility over the next several weeks. Our question is how far will volatility contract in the next three weeks? We would still consider new positions but if you're launching new spreads now consider adjusting your strike prices higher than the ones we have listed.

Summary:

Please see the CBOE website or our Sunday, October 12th play description for details on margin requirements for selling VIX options. Link: http://www.cboe.com/Products/indexopts/vixoptions_spec.aspx

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

VIX spread #1 has been completed.

VIX spread #2 with November options (date Oct. 12th):

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:

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
Update 10/20/08 open 16.30, high 17.20, closed 15.00bid
Update 10/21/08 open -----, high 15.50, closed 14.40bid
Update 10/22/08 open 16.40, high 19.20, closed 18.10bid
Update 10/23/08 open 17.50, high 21.40, closed 20.30bid
Update 10/24/08 open 25.00, high 26.50, closed 25.80bid

-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
Update 10/20/08 open 3.90, high 5.30, closed 4.40ask
Update 10/21/08 open ----, high 4.70, closed 3.80ask
Update 10/22/08 open 4.30, high 6.60, closed 6.40ask
Update 10/23/08 open 5.70, high 7.70, closed 7.30ask
Update 10/24/08 open 10.10, high 11.00, closed 11.00ask

Picked on October 12 at $ 69.95
Change since picked: + 9.18

-

VIX spread #3 with November options (published 10/22/08):

We wanted to SELL the November 35 calls (10/23/08 opening price was $ 14.00) and BUY the November 60 (10/23/08 opening price was $3.00) as a hedge against the VIX remaining elevated. We'll fill in the prices Thursday morning. Our account will be credited with the amount for selling the November 35 calls, while it the price paid for the 60 calls will be deducted.

In a different format the play is:

SELL CALL NOV 35.00 VIX-KI
Wednesday 10/22/08 closed at 14.00 bid
Update 10/23/08 open 14.00, high 17.00, closed 15.30bid
Update 10/24/08 open 19.40, high 21.50, closed 20.60bid

-and- BUY CALL NOV 60.00 VIX-KN
Wednesday 10/22/08 closed at 3.70 ask
Update 10/23/08 open 3.00, high 4.50, closed 4.10ask
Update 10/24/08 open 7.00, high 7.00, closed 6.90ask

Picked on October 12 at $ 69.65
Change since picked: + 9.48

Annotated chart:
VIX

---

---------------------- CLOSED PLAYS ----------------------

-- Closed Call Plays --

iShares Russ.2000 - IWM - cls: 47.17 chg: -1.82 stop: 46.45

It was a painful morning for stocks on Friday. We had just been triggered in the IWM on Thursday's dip past $48.50. Friday morning saw the IWM gap open lower at $44.95, well under our stop loss, before the small cap ETF bounced back.

chart:
IWM

Picked on October 23 at $ 48.50 *triggered 10/23
Change since picked: - 1.33 /stopped out 44.95 gap down
Earnings Date 00/00/00
Average Daily Volume = 123 million

---

SPX Corp - SPW - close: 41.37 change: -2.07 stop: 39.95

It was an awful morning for stocks and the opening was so bad that our play on SPW never opened. The stock gapped open lower at $38.61, which was under our stop loss at $39.95. The stock did rebound back above $40.00 but we're yanking our plans to buy calls given the market's move.

chart:
SPW

Picked on October 23 at $ xx.xx <--never opened
Change since picked: + 0.00 /originally listed at $43.44
Earnings Date 10/29/08 (unconfirmed)
Average Daily Volume = 1.2 million

---

U.S. Oil Fund - USO - close: 53.00 chg: -3.60 stop: 54.45

Our attempt to buy calls on the USO was also aborted before we got the chance to play it. The morning weakness on Friday was so bad that the USO gapped open lower at $51.37. This was well below our stop loss at $54.45 so the play would have never opened. At this point, given Friday's big decline, the USO doesn't appear to have any support until the $47.50 region.

chart:
SPW

Picked on October 23 at $ xx.xx <-- never opened/gap under stop
Change since picked: + 0.00 /originally listed at $56.60
Earnings Date 00/00/00
Average Daily Volume = 13.1 million

---

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.

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