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Daily Newsletter, Monday, 11/03/2008

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Table of Contents

  1. Market Wrap
  2. In Play Updates and Reviews

Market Wrap

Volatility is Shrinking

[Image 1]

With less than a 17 point range today, the S&P 500 (SPX) had a much more subdued day today versus the last few months. The 14 day Average True Range (ATR), which measures the average difference between a price bar's High and Low, shrunk to 57 from its October 16th peak of 75. That translates into the average range over the last 14 days has been about 57 points! Coincidentally, the $VIX is roughly the same level.

Today’s market internals showed a little more strength than the closes may have indicated. For instance, the NYSE closed down 9.22 points to 6,054.98 on 1,963 advancing issues versus 1,503 decliners. The volume today pf 1.29 billion, however, was about 500 million less than the 50 day average of 1.93 billion. There were 8 new 52-Week Highs and 65 new 52-Week Lows. The NASDAQ Composite closed up 5.28 at 1,726.33 on 1.79 billion shares. There were 1,600 advancers versus 1,271 decliners. The NASDAQ saw 13 new 52-Week Highs and 68 new 52-Week Lows.

While it was a good day today, in that the markets were flat and they were less crazy, there was still a lot of news that came out throughout the day. The morning was very slow until the ISM or The Institute for Supply Management Manufacturing Index fell to 38.9 for October and at lows not seen since the early 1980s. Even though the report suggests the recession is deeper than many thought, the markets held up fairly well. Construction spending in September reduced 0.3% from the prior month’s 0.3% increase.

[Image 3]

Goldman Sachs (GS) took another hit today when they had their 2008 to 2010 earnings estimates cut by Ladenburg Thalmann. The analyst said the short-term outlook for the company is poor, intermediate outlook is challenging, while the long-term outlook is good. Ladenburg cut its price target on Goldman to $80 from $140 and maintained its sell rating. GS closed down 3.41 to $89.09.

In other corporate related news, Boeing's (BA) machinists union voted in favor of a new contract as expected. Goldman Sachs added BA to the Conviction Sell list today. BA battled the sell indication by closing up 0.43 to $52.85. Wal-Mart (WMT) was upgraded to Overweight from Neutral at JPMorgan. WMT closed up a little to $55.97.

The Telecom sector showed some relative strength from companies like AT&T (T) and Verizon (VZ) leading the way from The Wall Street Journal reporting some FCC commissioners want to put off an Election Day vote to revamp the system of how telephone companies pay each other to transfer calls. T and VZ closed up 1.04 to $27.81 and 1.08 to $30.75, respectively.

[Image 2]

After downloading all of the companies that are slated to report earnings tomorrow and seeing that there were over 200 companies, I decided to chop the list down to a more manageable list. Starting from the top, AMMD, HNT and THC are among the medical services companies reporting. Health care and medical devices have been and should continue to provide some relative strength into the new year. While some other beaten down sectors (energy and financial) may provide the largest potential returns from an oversold bounce, you might find that sprinkling in some best of bread health care sector stocks into your portfolio can add some balance to an otherwise speculative mix. NILE is an online jewelry store that may provide some guidance into the trends of discretionary spending. Compare NILE results to Tiffany's (TIF) to see if the trend is shifting toward staying at home and shopping rather than visiting the brick and mortar store. Watch KCP, a clothing store, for additional insight into the consumer. SAM is the maker of Samuel Adams beer. Usually alcohol and cigarettes sell in bad times. SAM makes more exclusive brews, though. I will be watching UBS, an international wealth manager, for further indications of the financial crisis hitting overseas companies worse than here. Finally, AUY is involved in gold exploration, development, and operation of gold properties. Gold has declined decidedly from its near $1,000 an ounce high.

[Image 4]

The S&P 500 declined only 2.45 points or 0.25% today at 966.30. The chart below shows the 8 and 21 day (EMA) Exponential Moving Averages (pink and green, respectively) as well as the 21 day EMA Bollinger bands, the 5 bar RSI and Slow Stochastics. The 21 day EMA closed at 969.60, which is higher than today’s close. As I have written before, one can short at a test of a major resistance level. Today’s test actually breached above the 21 day EMA but then closed lower. A close higher would have signaled a potential long entry. A short position taken tomorrow could have a stop at a break above today’s high of 975. The upper and lower Bollinger bands are closing in on the current price and shrinking the range associated with the bands. Basically, the bands are pinching together and squeezing the volatility out. The 8 day EMA is curling upward now and getting close to crossing above the 21 day EMA. Once the crossover starts, the only short signals to watch for will be at over bought levels and/or the upper Bollinger bands. The oscillators aren’t overbought though. The RSI closed today at 61.44; down from Friday’s 62.64. Until the SPX can get above the 21 day EMA the RSI doesn’t need to reach up over 70 to signal overbought. It is all relative. However, the Slow Stochastics looks to have had a flat day. The magenta line actually declined marginally. If the Stochastics line crosses below the green line (3 bar moving average), the signal will turn to a downward one. The only thing that is consistent is that the SPX is looking to be running out of momentum. Personally, I believe that the markets will eventually run up to resistance and then fall back down to these levels before making any recovery. But a recovery depends upon the banks adoption of the economic stimulus package and Wall Street’s interpretation of the election tomorrow.

[Image 5]

The chart below shows a longer term perspective by viewing the 50, 89 and 200 day Simple Moving Averages (SMA). The 50 day SMA, at 1,104, is the lowest and closest SMA to the SPX's current price. The SPX will have to break above the 10/14 high of 1044 before attempting to test any moving averages. The good thing about using moving averages as support and resistance is that they offer dynamic price levels; and when they coincide with fixed levels both can provide a substantial basis for using that price level. In addition, at times when oscillators, fixed price levels and moving averages all suggest the same indication, there is a lot of reason to trade off of that level. I think that the 50 day SMA will be about the same level as the price resistance from 10/14. That may be a good time to take some newly invested capital off the table and/or hedge existing positions. One may choose to short such a coincidence of resistance. If it happens, we will have to look at all of the components that brought the market up. The Money Flow indicator shown below has bounced aggressively off it's oversold levels and has begun to level off. We need to watch to see if the indicator suggests that selling is coming back. Finally, the ADX has finally trending lower. However, a declining ADX only suggests that the previous trend is subsiding. If the ADX begins to move upward while the overall market is too, the indicator suggests that there is an uptrend.

[Image 6]

The NASDAQ 100 appears to be making a similar chart pattern as that of the SPX. The NDX had a 24 point range today and closed just shy of its 21 day EMA. Perhaps the NDX will sell off to the 8 day EMA at 1304 before making a run on the 21 day EMA again. The lower volatility is slowly translating into the Indexes volatility index. The VXN is the NDX's Implied Volatility measure established from the NDX options on the CBOE. As with the VIX, the VXN calculates the continuous implied volatility of a hypothetical option contract that always expires 30 days out.

[Image 8]

The Slow Stochastics has curled over and is only a couple of percentage points above the 3 day average. There will be some negative sentiment from the indicator once the crossover occurs, if it does. The RSI that I use is only 5 bars or one week of market data. My RSI is usually choppier than others but the shorter time frame provides a quicker response to volatile environments. My take on the RSI is that it is indicating that the upward momentum has decreased. However, neither of the indicators are overbought yet and could shoot up from a post election rally. The difference between the upper and lower Bollinger bands is 234 points or 17% from top to bottom. While volatility has declined a lot in the past week, it is still very high.

[Image 7]

The above chart shows the longer term moving averages. The blue dots on the price bar are from an embedded Doji indicator. My readings of the meaning of this indicator suggest that a large counter trend move is about to occur as indicated by the indecision to advance any higher. But I am probably wrong. Another indicator to watch here is the MoneyFlow. It has been unable to break above the 50 threshold and actually ticked lower today's action. The ADX suggests that the downtrend has ended but has yet to indicate a new trend.

The 10 Year Treasury Note or TNX bounced nicely since last week's test of 3.5% yield. The TNX closed at 3.904% today. Assuming the Federal Reserve has to reduce the rates again next month, the TNX could drop again as investors are forced to rebalance to safer, lower yielding assets such as the 10 Year and TIPs (Treasury Inflation Protected Securities). [Image 9]

Crude Oil (CL) has been relatively choppy over the last week or so. Oil declined $3.43 on continued demand reduction. As the 60 minute chart below shows, there has been a series of higher lows followed by lower highs. Stochastics and RSI are both oversold and may suggest a long entry on any bounce above the 8 bar EMA (64.27). One way to play a long oil trade is to buy the Ultra Long Oil & Gas Proshare (DIG) or buy the United States Oil Fund, LP (USO). The USO is supposed to track the underlying price while DIG tends to move up with the components of the Oil and Gas sector. A strong market bounce can move DIG up while the commodity is declining. As many of you know there are options on both ETFs. You may choose to sell the premium or create a stock replacement position by purchasing longer term calls and selling shorter term out of the money calls as a volatility hedge.

[Image 10]

The CBOE Volatility Index (VIX) dipped below the 200 day upper Bollinger band. The Bollinger bands have provided a consistent long term range that the VIX has cycled within. However, since the SEC removed the uptick rule last year, the box that contained volatility within a 10 low and 50 high was been busted. My suggestion in today's intraday Contrarian post was to wait to add Positive deltas to your portfolio until the VIX bounces up to the 20 day SMA. The 10 day SMA has begun to decline and is at 66.31 while the 20 day SMA closed today at 63.93. Along the way down, a prudent trader would have headed my advice and added Negative deltas on the VIX tests of the 10 day SMA. No signal or indicator is perfect. That's why we use so many in concert with one another. If multiple indicators of various types suggest the same thing, it is probably in the trader's interest to trade according to the suggested directional bias of all of those coicidence indicators. But always use stops. Finally, scaling into and out of positions has been especially useful in more volatile environments. Be safe at the polls. Good trading tomorrow!!

[Image 11]

In Play Updates and Reviews

A Sideways Session

Play Editor's Note: The markets were relatively calm as the world waits for the U.S. elections to take place tomorrow. I am expecting another sideways day as investors wait to see who wins the White House. I would be focused on finding candidates for "buy the dip" strategies.


CALL Play Updates

Apple Inc. - AAPL - close: 106.96 change: +0.63 stop: 94.45

AAPL marked a third day in a row that investors were buying dips in the $105.00 region. Volume was light but it was light for the whole market. We are still expecting a dip toward $100 so we're sticking to our plan. 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 are 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.

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  


Burlington Northern - BNI - cls: 87.44 chg: -1.62 stop: 82.45

With a lackluster market on Monday it is not a surprise to see BNI struggle with resistance near $90.00. At this time I would look for another dip near $85.00 as a new entry point to buy calls. 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. Our target is $94.00.

Picked on October 30 at $ 86.59
Change since picked:     + 0.85
Earnings Date          10/23/08 (confirmed)
Average Daily Volume =      5.1 million  


CSX Corp. - CSX - close: 45.01 chg: -0.71 stop: 43.45

Right on cue shares of CSX dipped toward the $44.00 level. The intraday low was $44.15. Over the weekend we suggested readers buy calls on a pull back into the $44.25-43.75 zone. Our target remains unchanged at $49.90.

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

Position #1
Picked on October 23 at $ 40.41 /gap down entry
Change since picked: + 4.60 /originally listed at $43.74

Position #2
Picked on November 03 at $ 44.25
Change since picked: + 0.76

Earnings Date          10/14/08 (confirmed)
Average Daily Volume =      6.5 million  


Lockheed Martin - LMT - close: 83.98 change: -1.07 stop: 77.45

LMT drifted sideways on Monday. We are waiting on a dip toward the $81.00-80.00 zone. If triggered at $81.00 Our target is the $89.00 mark.

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  


Energy SPDR - XLE - close: 49.81 chg: -1.59 stop: 44.75

Energy stocks were drug lower by a sharp decline in crude oil on Monday. The XLE lost about 3% on low volume. Over the weekend we suggested buying calls on a dip 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.

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


PUT Play Updates

Volatility Index - VIX - cls: 53.68 chg: - 6.21 stop: n/a

Volatility continues to decrease and the VIX saw a 10% drop today. If this was a stock we would look for a bounce from "support" near the 50% volatility level. Alas, it's not a stock but markets might be due for a dip soon that could produce a spike in the VIX.

We have just under two and a half weeks left before November VIX options expire.

We're still not suggesting readers buy VIX puts. Instead look for a spike toward 63 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.

Picked on September 16 at = 30.30 first position
Change since picked:       +23.38
Picked again Sept. 29 at =  46.72 second position
Changed since picked:      + 6.96
Picked again Octo. 08 at =  57.53 third position
Changed since picked:      - 3.85
Earnings Date            00/00/00
Average Daily Volume =        --- million  


Strangle & Spread Play Updates

CBOE Volatility Index - VIX - cls: 53.68 chg: - 6.21 stop: n/a

The VIX is contracting quickly but nothing really moves in a straight line for very long. I would expect another spike into the 60s. The real question is how low will the VIX fall by November VIX option expiration.

We don't see any changes from our weekend comments.

Readers could use another intraday spike 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?

Update: We'll make that VIX spread #4. If the VIX "trades" over 62.50 we want to sell the November 50 calls and buy the November 65 calls as a hedge.

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
Update 11/03/08 open 24.50, high 24.50, closed 21.50bid

-and-

BUY CALL NOV 50.00 VIX-KJ.
Monday 10/13/08 open 1.61, high 2.10, closed 1.50
Update 10/15/08 open 2.00, high 3.60, closed 3.60 
Update 10/16/08 open 3.70, high 5.50, closed 3.65
Update 10/17/08 open 4.50, high 5.30, closed 5.50ask
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
Update 11/03/08 open  8.34, high 8.34, closed 7.00ask

Picked on October 12 at $ 69.95
Change since picked:     -16.27 
 

-

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
Update 11/03/08 open 19.31, high 19.31, closed 19.10bid
-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
Update 11/03/08 open 4.60, high 4.81, closed 3.50ask

Picked on October 12 at $ 69.65
Change since picked:     -15.97 


DISCLAIMER

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

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