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Daily Newsletter, Saturday, 11/01/2008

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Table of Contents

  1. Market Wrap
  2. Index Wrap
  3. The Contrarian
  4. New Option Plays
  5. In Play Updates and Reviews

Market Wrap

Worst October Since 1987

Window dressing by funds with an October 31st year-end overcame the late day selling and powered markets to the best weekly gain in years. However, even the strong weekly gain could not erase the worst monthly loss for the S&P since 1987.

Market Statistics
[Image 1]

The Dow ended October with a -1525 point loss despite the +946 gain for the week. It was the first time since Sept-26th that the Dow and S&P posted gains on two consecutive days. It was the best weekly gain for the Dow since 1974. The Nasdaq closed positive for the fourth consecutive day and that is the first four-day gain since May 30th. I would love to ramble on about the new bull market but I believe everyone reading this commentary understands this was just a window dressing event from severely oversold conditions. We may continue higher but I doubt it will be without some rocky sessions. We have had some record setting economic reports recently and I believe there are some more records to be made before conditions begin to improve.

On Friday there was a new multi-year low on the Chicago Purchasing Manager Index (PMI) with a drop to 37.8. That was the lowest level since the 2001 recession. This was a drop of 18.9 points from September's 56.7 level. The business conditions coming into October were very restrictive to business with credit lines cut off leading to layoffs, cancelled orders and limited production. The new orders component fell to 32.5 from 53.9 and order backlogs fell to 39.0 from 54.9. The production index fell to 30.9 from 71.4 for a whopping 40-point drop. This is the lowest production level since 1980 and the largest monthly decline in the 62-year history of the index. With orders and order backlogs dropping this sharply it suggests that production and employment are going to suffer even more in November. The recent numbers on the various manufacturing surveys suggest that Monday's national ISM report is going to be very ugly. Analysts are lowering their expectations for the economy and the GDP. Moody's is now projecting a decline in GDP through Q1-2009 and no real economic rebound until 2010. Even worse they are projecting a global recession to be unavoidable.

Chicago PMI Chart
[Image 2]

The National Association of Purchasing Managers (NAPM) report for New York posted the fifth consecutive month of contraction and ninth drop in ten months with a drop to 396.8. The downturn in the financial sector is especially hard on New York and the index reflects this pressure. However, the six-month outlook component jumped sharply to 51.6 from 39.3 as evidence of government programs beginning to work lifted spirits. Tens of thousands of layoffs in the sector have increased unemployment significantly and most are facing limited job opportunities in the area. With hundreds of people applying for any meaningful job in the sector it is going to be a cold winter for many.

Personal income rose +0.2% in September but it was primarily due to hurricane adjustments, additional unemployment insurance benefits and stimulus payments. Real income did not go up, only the government's way of calculating it.

The most surprising report for the day was the Consumer Sentiment survey. Sentiment fell sharply in the initial data two weeks ago to 57.6 from 70.3 but the final revision for the month only showed a minimal 0.1 change. When Consumer Confidence fell over 20 points to 38.0 only a couple days earlier most analysts expected confidence to decline as well.

Consumer Sentiment Chart
[Image 3]

I don't normally report on the ECRI Weekly Leading Index but the index is at a serious inflection point. The index has gone into a steep decline over just the last several weeks and is threatening to break lows set back in 2001 during the last recession. The smoothed, annualized growth rate number derived from this index has fallen to a -21.9% and suggests there is serious trouble ahead. In theory this is a "leading index" and it projecting a serious economic decline in our future. This index contains things like unemployment, manufacturing, stock markets, interest rates, etc. This index, although normally meaningless in the weekly reporting cycles, has suddenly turned into a dire forecast for the U.S. economy.

ECRI Weekly Leading Index Chart
[Image 4]

The economic calendar for next week is peppered with some high profile reports. The ISM fell to 43.5 in September after clinging to the breakeven expansion/contraction level at 50 for several months. With the various regional economic reports all showing sharp drops in October the outlook for the October ISM is grim.

ISM Chart
[Image 5]

On Tuesday the Factory Orders report will show us if the monster -4% drop in August was an anomaly or a preview of coming attractions. With credit lines cancelled and orders/backlogs/production all plummeting the outlook for factory order output is not looking good.

The ISM services on Wednesday should not be as grim as the ISM manufacturing on Monday. The service sector is easing but nowhere near the decline in manufacturing.

The next biggest report for the week is the non-Farm payrolls on Friday. The report is expected to show a loss of 175,000 jobs but whisper numbers are running as high as 350,000. Obviously everybody should understand that the economy is tanking and jobs are being lost but it always takes an actual announcement of a specific number to galvanize people into action. A loss of more than 300,000 jobs would be a normal monthly loss during a recession and so far we have been lucky. However, with the economic decline rapidly gaining speed over the last six weeks this could be the month where our luck runs out.

Economic Calendar
[Image 6]

Bernanke was on TV again Friday speaking on housing finance reform. He started off the talk saying the mortgage market was frozen. The process of securitizing mortgages had for all practical purposes stopped. Unfortunately the securitization process is how banks and mortgage companies sell their mortgages to recover capital so they can make more loans. The banks are basically mortgage originators, which are packaged as securities and sold to investors. The process died when investors found the AAA mortgages they were buying were actually subprime slime and over a trillion dollars has been lost in the market blowup. Investors are rightfully wary and today they only want to buy mortgages from Fannie and Freddie with the government as the backstop. That leaves the retail banks and mortgage companies with a limited amount of capital and they are being very picky whom they take on as a mortgage client because they might have to keep the loan for several years. Bernanke said the government might have to backstop mortgage backed bonds as a method of freeing up the market. If the government were going to guarantee the debt then investors would rush to the table to load up.

Bernanke mentioned covered bonds as a way to free up mortgage capital. This is done in Europe in place of the Fannie/Freddie entities. Over $3 trillion in covered bonds are outstanding in Europe. A bank would write X dollars in mortgages. Let's say $100 million. They sell debt in the market secured by the mortgages and by the bank. The amount of debt on the bonds must always be less than the value of the mortgages, say $90 million. The bank retains the mortgages on their books and handles all the servicing. If a mortgage fails they are required to replace it with another one so bond investors are always covered by performing loans. They are considered to be overcapitalized investments. If the bank fails the investors have a priority lien on the mortgage assets. If the assets are insufficient to pay off the bondholders they become unsecured creditors of the bank with claims against the banks other assets. In anticipation of this vehicle being used the Treasury and FDIC have already issued guidelines to promote their use and make sure the banks don't go overboard and assume too much risk. The FDIC regulations require that covered bonds make up no more than 4% of a banks debt. The Treasury requires they are all fully documented loans with a maximum loan to value of 80%. The downside to the program is the transfer of risk from the private investors to other creditors, the FDIC and ultimately the taxpayers if the bank blows up. The investors have a priority security interest in the bank so the FDIC has fewer assets to sell if the bank goes under. That leaves the government holding the bag and backing the debt to the bondholders. Of course you are also going to have to find investors who want to loan billions to banks where financial health may still be an issue. So far only WaMu and BAC have issued covered bonds in the U.S. but JPM, WFC and Citi have said they are going to issue them.

Intel blunted the Nasdaq rally on Friday when it warned that the credit crisis could hurt demand for its chips and lead to the insolvency of key suppliers that would result in product delays. Intel gave no forecasts but shocked the street with their economic warning. Intel said, "Current uncertainty in global economic conditions poses a risk to the overall economy as consumers and businesses may defer purchases in response to tighter credit and negative financial news, which could negatively affect product demand and other related matters." This warning was hidden in a 10-Q filing with the SEC. It was not in the last filing and that suggests Intel is already seeing these factors come into play and that was their heads up for when the details are made public. Numerous manufacturers, not just in the chip sector, have already warned that customers were canceling large orders because the banks were canceling their credit lines and letters of credit. Intel dropped sharply at the open taking the Nasdaq with it. Fortunately the Nasdaq recovered and Intel closed only fractionally lower. UBS said on Friday that PC sales for Q4 were expected to drop by -2.4%. Given the apparent severity of the recession I would be surprised if it is only 2.4%.

SunMicro (JAVA) was knocked for a 13% drop on Friday after an analyst at BMO Capital Markets warned on the outlook for Sun's products. He believed that Sun was stuck with negative product mix issues and a weak economic environment, neither of which is expected to change over the coming quarters. Sun reported a quarterly loss of $1.68 billion or $2.24 per share on Thursday. Gross margins dropped -8.3% for the quarter. Sun refused to give a forecast for the rest of the year.

The commodity sector rallied with the broader market over the last three days but still suffered the largest monthly drop since 1956. The combination of volatility in the dollar, decreasing expectations for global demand and forced liquidations by hedge funds was a perfect storm for commodities. Eventually the volatility in the markets will ease and hard commodities will return to favor but we are not seeing those signs yet. The commodity sector is valued at $1.9 trillion and hedge funds normally control about 45% of that market or $954 billion. Needless to say they were killed over the last three months. It may take a while for their confidence to return.

Morgan Stanley Commodity Index
[Image 7]

You already know October was the worst month on record for the S&P since 1987 and TrimTabs confirmed why on Friday. TrimTabs said investors pulled $70.7 billion from mutual funds during the month of October. The previous high was $56 billion in withdrawals in September. Together it was an outflow of funds that was unprecedented in history. After the 1987 crash it took four years for trading to return to pre-crash levels. The S&P fell -18% in October and the MSCI World Index fell 20% and the most in its 38-year history. Morningstar said the average U.S. stock fund declined -23% in value through Oct-30th. That is a horrible month in anybody's book. In October the $157 billion Growth Fund of America fell -19% and the $62.8 billion Fidelity Contrafund lost 17%. Both are down 35% for the year.

Now that we are finally out of October is the bear market over? I would not be the one to make that claim. Despite the massive declines of the last couple of months the recession is still not priced into the market. The minor 0.3% decline in the Q3 GDP was like a mosquito bite in recession terms. The velocity of the current economic decline suggests it could be revised down sharply and the Q4 GDP could be really ugly and in the range of -3% or even lower. The labor market has seen job losses for the last nine months but the average has been only about 75,000 jobs per month. Again, that is akin to another pesky mosquito interrupting your barbeque. When the economic reports start flying in late November that intensity could escalate to the level of yellow jacket stings and that should really capture the attention of picnickers. It may be a really nice sunny day with perfect weather but knock over a yellow jacket nest in the middle of the party and the picnic is over.

I really want to think the lows are behind us given the forced liquidations by hedge funds and the $127 billion extracted from stock funds. This has been the ugliest and most persistent decline I can remember. I would also agree that most investors have bought into the coming recession story but we can't tell if they really believe it or not. On the flipside we know that the stock market normally rebounds 6-9 months before the recession is over. If economists are projecting Q2/Q3 of 2009 as the start of a lasting recovery then the markets should be getting ready for a rally. That is a long-term view not a view for next week. There are probably some serious news events in our future including the presidential election.

The short-term view is cautious. The broader markets rallied an average of 11% last week. Many years we don't move 11% in an entire year. I believe the rally was generated by the Oct-31st fund year-end. I told you last week that year-end fund selling was likely over and I expected window dressing as the week closed. That was exactly what happened with volume decent but lackluster on Thr/Fri. When the market opens on Monday with an 11% gain under its belt those funds will be free to take profits and return to cash at the slightest hint of negativity. Even with the window dressing we still saw strong sell programs late in the afternoon each day last week. Selling into the window dressing means some funds are still raising cash. That suggests to me that we could see a resumption of some selling next week.

I would still be in buy the dip mode if that selling appears. The key for me was the Russell 2000. The index gained nearly 100 points from its Tuesday low of 441 to its Friday high of 540. That is nearly a 23% rebound from trough to peak in only four days. Odds of profit taking are very strong. However, I view the return of fund managers to the small cap market as a strong signal the bottom may be behind us. I doubt the right side of that chart will look like the left but I do believe we will regain some of that ground over the next couple months. If the Russell moves over 550 it would be very bullish.

Russell 2000 Chart
[Image 8]

The Dow rallied +11% for the week but reached only to 9350 before running out of steam. There is a line of reasonable resistance at 9500 and that is the line in the sand keeping the gains from being just a bear market rally. If the Dow can find traction and break over 9500 on strong volume then the bottom behind us. if the Dow falls back below 9000 we will see the bears loading up again and the bulls heading for the sidelines. This will be a critical week for market direction and the strength of any early week profit taking will be critical.

Dow Chart
[Image 9]

The Nasdaq rebounded right to the top of its downtrend channel and closed Friday at exactly where it should fail if the window dressing rally fades. The warning by Intel, the UBS warning on PC sales and the warnings with earnings by several chipmakers over the last couple weeks suggests the Nasdaq is going to need some help to survive next week's expected profit taking. However, the bad news bulls were alive and well last week so anything is possible.

Nasdaq Chart
[Image 10]

The S&P-500 came to a dead stop right under 985 on Friday and a resistance level analysts feel is the key to any future rally. I also believe 1010 is going to be crucial but we have to cross 985 first. The clear stop at that level on Friday suggests sellers are waiting patiently for the window dressing to be over. The banks have been improving slightly along with the energy sector. Those are the two biggest sectors on the S&P representing nearly 38% of the index. Either one can hold the S&P back and both would need to be in rally mode to more the S&P over 985.

S&P-500 Chart
[Image 11]

Friday marked the end of the year for mutual funds, the end of the worst month since 1987 and the end of the "sell in May and go away" strategy. Monday marks the first day of the "best six months of the year" strategy and historically there are a lot of investors that subscribe to that theory. Whether or not they have any money left to invest is an entirely different question. I would love to see Nov-3rd blast off over resistance but I seriously doubt it will happen. I think it will be a fight until the election is over and we get the non-Farm payrolls next Friday. Investors will be watching to see if the end of day sellers are still with us or they packed up and left town. Another date to watch is Nov-15th. That is the last notice day for investors wanting to take money out of hedge funds on Dec-31st. Most analysts think the redemptions have run their course and I hope they are right. Also just receiving a notice on Nov-15th means the funds need to plan to have the cash on Dec-31st. It does not mean they are going to sell on Nov-15th. Either way the fund activity after that date should give us a clue as to which way hedge fund investors voted. Nov-15th is also the Washington meeting of the G20 and a global response to the credit crisis could mean sweeping currency changes. This could be a serious market mover or a complete dud. Large meetings of heads of state rarely produce much real agreement but this one could be different given the current crisis.

If you are reading this letter in your email this weekend then we were successful in our weekend website conversion. We have been working on returning the look and feel of the old Option Investor website for several months. You will be able to find any newsletter, Traders Corner or Option 101 dating back to 1997. I encourage you to visit the new site and the wealth of knowledge you will find there. I am sure there will be some bugs we have not found yet so be the first to venture in those undiscovered pages and let us know what you find. Starting the following week we are going to bring back the intraday updates on the website and by email. Watch for a notice about the free sign up. I hope you enjoy the website as much as I do when I look back in the archives at all the wonderful articles written over the years. I have tasked all the writers to produce some more Options 101 and Traders Corners and on the new system they will show up in your email the instant the writer posts them to the website. They will no longer be in the nightly newsletter but sent to you as stand alone content. We have also put a new system in place to get the newsletters to you earlier every evening. It may take a couple weeks to get it functioning perfectly but the goal is faster and better. If you have any comments, questions or complaints just click on the "Email Jim" link at the top of this commentary and I promise you will get an answer.

Jim Brown


Index Wrap

THE DOW WINS THE FIRST HEAT

THE BOTTOM LINE:

As discussed last week, I'm focused on whether the current recovery rally hits the 'fibonacci' 38, 50 or 62 (or 66) percent retracement levels in the major indexes. My expectations were that the S&P and Dow indexes especially would at least retrace a 'minimal' 38 percent of the August-October decline.

Looking for at least a 38% retracement potential was suggested by the deeply oversold condition according to the RSI indicators AND the extreme bearish sentiment that built up from 10/9 to 10/24.

The extremely oversold Dow 30 (INDU) is now the first and sole (to date) major index to recover at least 38% of its August-October downswing as measured from intraday top to intraday low. By way of comparison, the Nasdaq Composite (COMP) has so far retraced 25% of its Aug to October decline.

You know how in news reports of serious crimes there might be a report that someone is a "person of interest"? That in a way is how I feel about 'fibonacci' percentage retracements. Whether prices make it TO, or BEYOND the 'minimal' 38% retracement, the 'common/normal' 50% retracement or the more extreme 62-66% retracement levels, is a matter of definite trading interest. This, in terms of providing a sense of how weak, average or strong is a counter-trend retracement move.

In a pronounced bear market trend, the major market indexes or a particular stock will often see only a weak recovery type move, and that rebound often doesn't carry beyond a third to around 38 percent of the prior major downswing. If a rebound doesn't exceed 38 percent, the dominant trend remains quite bearish.

If a retracement move equals or comes close to a one-half 50% retracement, such a move is showing a bit more relative strength. It may also suggest that the index or stock got VERY oversold and the larger snap back rally is what it takes to 'throw off' the oversold extreme before the bear trend resumes. A recovery move equal to half of the prior decline, puts me on alert to exit calls and look again at the potential in puts.

A recovery rally equal to 62 to 66 percent of the prior decline can suggests not only that the recovery move is regaining some equilibrium after a decline that was way overdone so to speak AND to be on alert for a resumption of the prior decline, BUT ALSO to be aware of the possibility and potential for a round-trip 100% retracement back to a prior top. This might be the prior all-time high or only the top of the last down 'leg'.

I've again this week noted the common fib retracement levels as 'resistance'. They are not however potential resistance levels in the more precise way that a prior prominent high or a 'line' or cluster of prior highs may prove to be. Retracement levels, if they act as a form of resistance, are more approximate. A retracement in an index or stock of approximately half of its previous decline is getting into an area where selling interest may naturally tend to pick up; and buying interest starts to wane as bargain hunting tends to slack off.

If (instead) buying interest picks up after an index has retraced 38 percent of its prior decline, it provides an implied next upside objective equal to a price approximating one-half of the prior decline. If the recovery rally goes beyond the 50% retracement level, I take as a next potential target a move equal to a fibonacci 61.8 (rounded to 62) percent or a 'little bit more', which often works out to a 66% retracement.

Following this progression, a retracement of MORE THAN 2/3rds of a prior decline suggests the real possibility that the recovery move is going to re-test the area of its prior highs or a 100 percent retracement. This is how double tops come about.

These guidelines don't of course always work out precisely or even close to it, but they do often enough to have made fib retracements a useful guideline in my trading considerations.



MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) chart has had a decent trading bounce off its recent lows and has closed above its 21-day moving average, which is a minor bullish positive. SPX has also now throw off its oversold condition seen when a bullish price/RSI divergence set up.

The key near-term question is whether SPX stalls at resistance at 985 as noted on the daily chart below. If the index can churn 985, next resistance is not too far overhead, at 1000-1020. Next resistance is then assumed for 1044, the top of a 3-day rally high into mid-October.

Initial support is in the 925 area, then around 850.

I'll be evaluating buying puts should SPX make it into the 1050 to 1075 price zone. Currently, I'd be surprised if the index could get back to its 'breakdown' point at 1100.

[Image 1]



S&P 100 (OEX) INDEX; DAILY CHART:

The chart pattern for the S&P 100 (OEX) is similar to that of the 500, with the key question as to whether OEX may stall around Friday's high. If the rally continues and nothing raises hopes like interest rate cuts, next resistance is at 480, then at 495, extending to the 500-505 area.

Heavier selling interest may come in on a climb above 500, particularly starting around 520-525. My expectation is that OEX could get back to the 500 area, but not close above it for more than a day. I stand corrected if the index not only makes that climb but keeps going.

[Image 2]

SENTIMENT:

The recent strong rebound in bullish sentiment as noted on the chart above, looks like too much too soon and makes me think that the recent rally is not going to be a sustained one, at least not above 500. Stay tuned on that.



DOW 30 (INDU) AVERAGE; DAILY CHART:

An oversold Dow 30 Average (INDU) has managed to climb back to the first fibonacci retracement level at 38 percent noted below at 9375. INDU's recent rebound has throw off its oversold condition at least on a daily chart basis; not yet on a longer term weekly chart basis.

The key or pivotal area or resistance next lies in the 9795 to 9875 area. 10000 if approached or reached, is going to offer intense media interest; I doubt that INDU will climb above 10000.

Initial support is noted below 9000, which had been resistance. I didn't mark 8500 support, but that's a key level; 8135 should offer solid technical support and is noted per the lowermost green up arrow.

I'd rather sell an extension of this rally than buy into it now. I liked calls when the Dow bottomed around 8200 as was apparent on the hourly chart (not shown) but when INDU reached the 9400 area and a fibonacci 38 percent retracement it also hit my profit objective.

[Image 3]



NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite Index (COMP) has had a more anemic rally than the S&P, but it also had resisted selling off as hope sprang eternal for the tech sectors. Initial resistance is 1770. Next is resistance implied by the 38% retracement at 1867; call it resistance at 1867-1900 as 1900 is the beginning of the downside price gap and the 'breakdown' point.

Initial COMP support is in the 1650 area, then probably pretty solid chart support at recent 1500 low. I talked about support at 1500 last week and how it looked like the next area to be tested. At this recent low, like the other major indexes, a bullish price/RSI divergence is noted on the respective charts.

[Image 4]



NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart has rebounded to its first technical resistance in the 1350 area. It may churn through this area and hold support at 1300. If NDX works higher, look for pivotal resistance in the 1470 area. I'm interested in put purchases if there's a move into the 1470-1500 price zone.

Initial chart or technical support is in the 1300 area. Next support isn't readily apparent before the 1170 area. Major support in NDX begins around 1000 if we go back to the 2003 lows. (The 2002 bottom came at 780.)

[Image 5]



RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) rebounded from the 450 area and caught fire on Friday. Its 38 percent retracement, which has been my technical target de jour, lies at 566 and is noted as possible 'resistance' on the RUT daily chart below. The next, even more pivotal resistance for the index is in the 600 area.

Initial support lies at 500, then around 450.

As far as trading thoughts, I'd favor puts if 600 is seen again. If in calls from the dip to the 450 area, a 200 profit objective is what I'd be hoping for and happy to get.

[Image 6]



GOOD TRADING SUCCESS!


The Contrarian

Overall Neutral with positive bias

The Put/Call Indicator

The Put/Call Indicator references the CBOE Equity Volume Put/Call (PC) ratio’s tendencies to identify relative market lows and highs by obtaining a glance into the sentiment of option traders. Since most retail option traders use equity options, the best real time sampling of investor/trader sentiment is achieved through viewing Equity Option Volume of Calls and Puts. The identification of peaks in the market is done so by determining when traders have stopped buying calls as a stock replacement strategy and begun to buy protective puts. Market peaks are usually identified by the Put/Call ratio dipping below 0.60 and then bouncing. The 10 day moving average of the PC ratio is somewhat lagging as compared to the Put/Call ratio but provides a smoothing of the data and confirmation.

[Image 1]

With the current volatility in the market’s there have been some short term opportunities to trade the PC ratio peaks above 1.0 and lows below 0.60 or the confirmed peaks in the 10 day moving average (DMA). As of yesterday’s close, the CBOE Equity Volume Put/Call ratio closed lower at 0.796 after reaching its high of 0.898 on 10/17. The 10 DMA (0.836) dropped below the 20 DMA on (0.844) on 10/23 which should have signaled the switch to a Positive bias. However, the 20 DMA was still moving upward and creating a negative divergence. Now that the 20 DMA is lower as of today’s close and the 10 DMA is less than 0.80, the signal is now a confirmed Positive bias. For those of you keeping track, the 10 DMA closed at 0.796, down from 0.826. The 20 day moving average ticked down to 0.84 from 0.849. SIGNAL: POSITIVE BIAS

Volatility Index Indicator

The $VIX indicator has been one of the most reliable contrarian indicators during the recent market decline. It has been noted multiple times in this newsletter that the $VIX is hard to trade the spikes alone. The moving averages have remained in an untrend since late August. While in an uptrend, the Negative bias is confirmed and constant until the 10 day moving average declines. The signal becomes positive once the 10 day moving average declines below the 20 day moving average and remains so until the 10 day moving average reverses upward. At some point, the $VIX should retrace to trend within the Upper and Lower Bollinger bands (shown by the blue lines). If you are new to the $VIX, the concept of how signals are generated are simple. Traditionally, buy signals came from identifying levels where the $VIX is spiking while sell signals came from reaching relative low levels. However, the purpose of this newsletter is not to provide actual buy and sell recommendations but to help translate the current readings into a consistent portfolio bias. This is done so by utilizing the 10 and 20 day moving averages. Moving averages provide a filter for the choppy index. Timing of altering one’s bias from the current Negative to the eventual Positive has been discussed over the last few weeks. For instance, adding Negative Deltas when the $VIX tests the 20 day moving average has proven to be very reliable. However, the signal will most likely shift to a Neutral or Positive bias once the $VIX closes below the 20 day moving average. Therefore, the signal would require any recent Negative additions to be paired off with Positive Deltas. While this adjustment may cause short term losses, one’s portfolio could profit sufficiently, if positioned correctly, to offset the Negative deltas that were just added at the 20 day test, for instance.

[Image 2]

The $VIX’s 10 day moving average closed up today from 67.69 to 67.76 while the 20 day moving average closed at 62.22 from 60.72. The $VIX indicator is still Negative until the 10 day moving average declines. With a market environment like this, we should probably wait for a two day decline before switching the signal to Positive. A close of the $VIX below the 20 DMA would cause me to alter the signal to Neutral. I will send out an alert if the signal on the $VIX indicator changes. SIGNAL: NEGATIVE BIAS

Investors Intelligence

The Investors Intelligence Bullish/Bearish polls are released each Wednesday morning. The polls represent the percentage of investment newsletter writers that are bullish, bearish and calling for a correction. As contrarians, we are looking for the masses to be extremely bearish to define a buying opportunity (long biased). We also look for the masses to be overly optimistic about the markets and/or economy to define a point to raise cash, hedge one’s portfolio (long puts and/or short calls) and/or short the market with index futures.

[Image 3]

This week the percentage of bullish advisors increased a little bit to 23.1% from last weeks 22.2%. As previously mentioned the normal low for this poll is around 35 – 40%. While the historical highs are about 40 – 45% bears, the percentage of advisors that are Bearish has been above 50%. This week had the percentage bearish advisors decrease to 52.7% from 54.4%. The spread between the Bulls and Bears (shown below) ticked up this week. The signal has been adjusted to a Positive bias. Looking back I should have kept this indicator at a Negative bias until this week. That way it would have helped lean the overall signal more bearish. SIGNAL: POSITIVE BIAS

SUMMARY: The $VIX indicator is beginning to flatten and may actually turn into a positive signal today or tomorrow. The Investor’s Intelligence and the Put/Call indicators are both Positively biased. Therefore, the overall signal is Neutral with a positive bias.


New Option Plays

Tech and Defense

New Option Plays
Call Options Plays
Put Options Plays
Strangle Options Plays
AAPL None None
LMT    
     
     
     

Play Editor's Note: The expectation this week is that the market will see some sort of profit taking after a 10% bounce in the market. More and more it looks like the lows are behind us at least for the next few weeks. November begins a traditionally bullish time of year for stocks but these seasonal trends may struggle as we face a global recession. Our short-term plan is to buy the dips. Our challenge will be stop loss placement. We want them to be tight but not too tight. I wouldn't be surprised if the market did nothing Monday and Tuesday as the nation waits to see who is elected President but many market pundits are already discounting an Obama win.

FYI: Some of the stocks I'm watching as bullish candidates that look like a buy on a dip are: FO, HES, AMZN, and SPG and VNO. Don't rush out and buy SPG and VNO. They have earnings early this week. Wait until after earnings.

The only bearish candidate that looked tempting was CMI.

NEW DIRECTIONAL CALL PLAYS

Apple Inc. - AAPL - close: 107.59 change: -3.45 stop: 94.45

Why We Like It:
It appears that AAPL has put in a significant bottom. Traders bought the dip at $85.00 in early October. They then started buying the dips in the $92-90 zone. Now that AAPL has produced a bullish breakout from the consolidation phase we think investors will buy the dip around $100. Our suggested entry point to buy calls is the $101.00-95.00 zone although I don't expect AAPL to trade under $100-99.00. We're starting the play with a stop loss at $94.45. More conservative traders could try a tighter stop but these remain volatile markets. If we are triggered at $101.00 Our first target is $111.00. Our second target is $118.50. The $120.00 level looks like it could be significant resistance.

Suggested Options:
We are suggesting the November calls. Our entry point is $101.00.

BUY CALL NOV 100.00 QAA-KT open interest=31939 current ask $11.95
BUY CALL NOV 110.00 QAA-KB open interest=20943 current ask $ 5.95
BUY CALL NOV 120.00 QAA-KD open interest=25099 current ask $ 2.38

Annotated Chart:
AAPL

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/21/08 (confirmed)
Average Daily Volume = 48.3 million

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Lockheed Martin - LMT - close: 85.05 change: +2.87 stop: 77.45

Why We Like It:
Aerospace and defense stock LMT has seen a huge rebound off its lows. The stock has broken its bearish trend of lower highs. We want to buy a dip near what should be support around $80.00. Our suggested entry point is the $81.00-80.00 zone with a stop loss at $77.45. If triggered at $81.00 Our target is the $89.00 mark.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 80.00 LMT-KP open interest= 412 current ask $8.00
BUY CALL NOV 85.00 LMT-KQ open interest=1036 current ask $4.80
BUY CALL NOV 90.00 LMT-KR open interest=1321 current ask $2.55

Annotated Chart:
LMT

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/21/08 (confirmed)
Average Daily Volume = 3.8 million

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In Play Updates and Reviews

Looking for a dip

Play Editor's Note: The expectation this week is that the market will see some sort of profit taking after a 10% bounce in the market. More and more it looks like the lows are behind us at least for the next few weeks. November begins a traditionally bullish time of year for stocks but these seasonal trends may struggle as we face a global recession. Our short-term plan is to buy the dips. Our challenge will be stop loss placement. We want them to be tight but not too tight. I wouldn't be surprised if the market did nothing Monday and Tuesday as the nation waits to see who is elected President but many market pundits are already discounting an Obama win.

______________ CALL Play Updates ______________

Burlington Northern - BNI - cls: 89.06 chg: +2.47 stop: 82.45

The big news for BNI on late Thursday-early Friday was a headline that Warren Buffet of Berkshire fame bought another 825,000 shares of BNI. His company now owns almost 19% of BNI stock. Most would consider that a huge seal of approval from the Oracle of Omaha. Shares of BNI bounced from round-number support near $85.00 on Friday morning, which was where we suggested readers open new bullish positions. We're going to leave our stop loss at $82.45 for now but more conservative traders may want to tighten their stop a little toward $84.00. There is short-term resistance at $90.00 but we're aiming for $94.00. The 100-dma and 200-dma look like big resistance near $95.00.

Suggested Options:
If the market dips this week we would buy the November calls on a BNI dip back into the $86-84 zone.

Annotated chart:
BNI

Picked on October 30 at $ 86.59
Change since picked: + 2.47
Earnings Date 10/23/08 (confirmed)
Average Daily Volume = 5.1 million

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CSX Corp. - CSX - close: 45.72 chg: +0.67 stop: 43.45 *new*

Railroad stock CSX continued to bounce on Friday but shares pared their gains after hitting $47.35 intraday. The stock is up more than 10% from our entry point and we strongly suggest that readers consider taking some profits right here. Tonight we're adjusting our stop loss to $43.45. Our target remains $49.90.

As we look ahead to this week we're going to set up a secondary entry point (position). We want to buy calls on a dip into the $44.25-43.75 zone with a stop loss at $43.45. If triggered our target is $49.90.

FYI: CSX is due to present at a Goldman Sachs Industrials conference on November 5th.

Suggested Options:
Our new entry point is the $44.25-43.75 zone. We're suggesting the November calls.

BUY CALL NOV 45.00 CSX-KI open interest=3583 current ask $3.70
BUY CALL NOV 50.00 CSX-KJ open interest=4961 current ask $1.40

Annotated chart:
CSX

Picked on October 23 at $ 40.41 /gap down entry
Change since picked: + 5.31 /originally listed at $43.74
Earnings Date 10/14/08 (confirmed)
Average Daily Volume = 6.5 million

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Energy SPDR - XLE - close: 51.40 chg: +1.05 stop: 44.75

After our research this weekend we're expecting a dip this week as investors take profits on a 10% bounce in the markets. The way to play that would be to buy a dip in the XLE in the $48.00-47.00 zone. More conservative traders might want to tighten their stops toward the $47 region. We're going to give XLE extra room and leave the stop at $44.75. Our target is the $56.50 mark.

Suggested Options:
We are suggesting the November calls.

Annotated chart:
XLE

Picked on October 30 at $ 50.35
Change since picked: + 1.05
Earnings Date 00/00/00
Average Daily Volume = 47.7 million

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______________ PUT Play Updates ______________

Volatility Index - VIX - cls: 59.89 chg: - 3.01 stop: n/a

The VIX continues to retreat. This past week has done a lot to signal a top in the VIX but just like stocks the VIX rarely moves in a straight line for very long. Don't be surprised to see some spikes higher on the way down. The question now (and always has been) is how low will the VIX be by November's expiration of VIX options. We have two and a half weeks left.

We're still not suggesting readers buy VIX puts. Instead look for a spike toward 65 or 70 as an opportunity to sell November calls.

If the VIX is under your call's strike price at expiration (11/19/08) 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.

Annotated chart:
VIX

Picked on September 16 at = 30.30 first position
Change since picked: +29.59
Picked again Sept. 29 at = 46.72 second position
Changed since picked: +13.17
Picked again Octo. 08 at = 57.53 third position
Changed since picked: + 2.36
Earnings Date 00/00/00
Average Daily Volume = --- million

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___________ Strangle & Spread Play Updates ___________

CBOE Volatility Index - VIX - cls: 59.89 chg: - 3.01 stop: n/a

We have about two-and-a-half weeks left before November options expire. It's going to be an interesting two weeks as we watch the VIX contract. As we near VIX option expiration the lower strike calls will rise in value to more closely match where the VIX is actually trading. Any strikes out of the money will quickly fade toward zero.

While the play has not panned out exactly as planned anyone who sold calls with the VIX was near its highs should be looking good. The suggestion to sell the higher strike calls on Monday appears to have been a good move if you took it.

Readers could use another intraday spike to 65 or 70 as another opportunity to open positions but if you do I would use a pair of higher strikes than the ones we have listed below. How about selling the November 50s and buying the 65s or 70s on a spike?

We'll make that VIX spread #4. If the VIX "trades" over 66.00 we want to sell the November 50 calls and buy the November 70 calls as a hedge. You may want to buy the 65s instead.

We don't see any changes from our prior comments on the VIX spread plays listed below.

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 10/13/08 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
Update 10/27/08 open 26.32, high 26.45, closed 29.30bid<-high
Update 10/28/08 open 29.00, high 29.00, closed 23.70bid
Update 10/29/08 open 25.60, high 25.60, closed 26.20bid
Update 10/30/08 open 24.06, high 27.32, closed 25.20bid
Update 10/31/08 open 25.20, high 25.20, closed 24.30bid

-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
Update 10/27/08 open 11.43, high 13.80, closed 14.20ask<-high
Update 10/28/08 open 11.00, high 13.30, closed 9.40ask
Update 10/29/08 open 9.23, high 10.70, closed 11.00ask
Update 10/30/08 open 8.69, high 10.90, closed 10.00ask
Update 10/31/08 open 10.30, high 10.30, closed 9.00ask

Picked on October 12 at $ 69.95
Change since picked: -10.06

-

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
Update 10/27/08 open 23.00, high 23.00, closed 23.90bid <-high
Update 10/28/08 open 22.93, high 24.70, closed 18.60bid
Update 10/29/08 open 19.59, high 21.13, closed 20.90bid
Update 10/30/08 open 18.50, high 22.00, closed 20.30bid
Update 10/31/08 open 21.10, high 21.10, closed 19.20bid

-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
Update 10/27/08 open 6.91, high 8.80, closed 9.00ask <-high
Update 10/28/08 open 7.60, high 8.60, closed 5.50ask
Update 10/29/08 open 5.40, high 6.30, closed 6.50ask
Update 10/30/08 open 4.90, high 6.20, closed 5.80ask
Update 10/31/08 open 5.90, high 6.10, closed 4.90ask

chart:
VIX


Picked on October 12 at $ 69.65
Change since picked: - 9.76

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______________ CLOSED PLAYS ______________

Freeport McMoran - FCX - close: 29.06 change: -0.96 stop: 27.45

I really think that FCX has a lot of potential. Unfortunately there was no follow through on Thursday's move. We still want to play defensively here so we're suggesting an early exit in FCX. Take a small loss now before it gets worse since we are expecting a market dip this week. Readers may want to keep an alternative entry point in mind to buy calls on a breakout higher at $30.65 or $30.75. At the moment I am watching for a pull back near $26.00 or maybe $25.00 as the next bullish entry point to buy calls on FCX.

chart:
FCX

Picked on October 30 at $ 30.02 /early exit 29.06
Change since picked: - 0.96
Earnings Date 10/21/08 (confirmed)
Average Daily Volume = 20 million

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Hansen Natural - HANS - close: 25.32 change: -0.13 stop: 23.45

On Thursday night we told readers to exit and take profits. It looked like HANS had hit an important level of short-term resistance. The stock confirmed that on Friday with a late-day sell-off and failed-rally pattern. We're closing the play early instead of holding on for a rally to the $28.00 level. Move HANS to your watch list and see if shares find support again in the $23-24 zone.

chart:
HANS

Picked on October 23 at $ 21.47 /gap down entry/1st Exit 25.45
Change since picked: + 3.85 /originally listed at 22.88
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 10.6 million

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MasterCard - MA - close: 147.82 chg: + 7.76 stop: 129.90

Shares of MA look like they are picking up speed on their rebound. The stock added 5.5% on Friday albeit on lackluster volume. At this point I would expect a dip back toward $140 and then a continuation of the bounce. Unfortunately, we're out of time. MA is due to report earnings on Monday after the closing bell. We do not want to hold over the report so we're exiting early. The play turned out all right, especially if you waited and bought the dip in the low $120s.

chart:
MA

Picked on October 23 at $131.00 *triggered 10/23
Change since picked: +16.82 /early exit 147.82
Earnings Date 11/03/08 (confirmed)
Average Daily Volume = 3.8 million

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