Option Investor

Daily Newsletter, Monday, 12/15/2008

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

A Day Away

[Image 1] A Day Away

In my opinion, much of today's volatility to the downside is attributed to the market pricing in tomorrow's earnings reports from Goldman Sachs (GS) and Best Buy (BBY) as well as the FOMC meeting on Tuesday. We are really a day way from most of this week's exciting news. Too bad I don't get to cover tomorrow's Wrap. Other than a few analyst updates, there wasn't a lot of new news. While on the subject of analysts, Schlumberger (SLB) was upgraded to an outperform by RBC. BB&T Capital upgraded Covenant Transport (CVTI) and Knight Transportation (KNX) to Hold and Buy, respectively. RBC Capital downgraded Noble (NE) and Flotek Industries (FTK). The news on the automakers is that there is no news. The White House commented that a more thorough relief plan was on the way but not immanent.

In today's economic release, November industrial production was about in line with expectations, but slipped 0.6%. The decline reflects the underlying weak economic trend. Manufacturing output fell a sharp 1.4% in November.

Telecom Stocks were down mostly from a downgrade of AT&T by Goldman Sachs. Generally, the sector outperforms due to its relative strength and defensive nature. The Financial Sector was weak from JP Morgan (JPM) and Bank of America (BAC) being downgraded to under perform by analysts at Merrill Lynch. That's funny; the analysts at Mother Merrill downgrading their company's acquirer.

Looking above, you can see that the internals were weak on both the NYSE and NASDAQ Composite. There were 3 to decliners on both exchanges. More specifically, 760 stocks advanced while 2281 declined on the NYSE. The NASDAQ Comp had 727 declining stocks and 2137 advancing. Volume was somewhat subdued on both exchanges. The NYSE had 1.2 Billion shares while the NASDAQ had 1.68 Billion.

[Image 2]

We get to see the CPI for November tomorrow morning. The Market expects a decline of 1.5% from the CPI and a flat reading from the Core CPI. As would be expected, Housing Starts continue to decline. The market expects 725K starts versus October's 791K. But the big news is the FOMC Policy statement due at 2:15 PM. The Fed Funds futures are predicting a 66% chance for a decline to 0.25% from 1.0% and a 34% chance of a 0.50% cut.

[Image 3]

As mentioned earlier, Goldman Sachs and Best Buy report earnings before the market opens tomorrow. Morgan Stanley (MS) reports on Wednesday morning. I looked at the BBY EPS trade but it didn't provide the desired level of risk/reward for the December strike prices. Looking onto the next day, MS December 11 Puts are trading at $0.30/contract and the 16 Calls are at $0.25/contract. The total credit is at $0.55 with an initial margin of $140 per contract. The front month Implied Volatility is at 216% versus April 09’s 152%. I expect MS to move on its earnings, so going wider is better. If you want to sell farther strikes, there is a 25% difference between the January and April Implied Volatility. Selling the JAN 7.5/19 Put/Call Strangle yields a $0.82 initial premium and a $94 initial margin per contract. The assumed profit on a 25% decline in the Implied Volatility is about $40 per contract. Therefore, if you sold 10 contracts, the Delta is -23 with an initial margin of $940. The assumed profit on Wednesday morning with MS opening within 2 points of today's close is about $400 on 10 contracts. Earnings season is coming in another four weeks. I love these trades because it is simple in structure and concept; Sell high/Buy low. Plus, it is a quick trade.

The S&P 500 (SPX) fell 11 points to 868.57. At one point today, the SPX was down 23 points or 2.6%. The SPX had a 26.91 range versus the 21 day Average True Range (ATR) of 43 points. Something to note is the ATR is the actual average volatility of the index. The CBOE Volatility Index or VIX is the Implied Volatility of 30 day at the money options. Mind you, this is a simplistic explanation, but the VIX is at 56.76 while the actual volatility is at 43. A lot of times, these two correlate nicely within only a few points. Basically, option traders expect more volatility to come versus what we have been experiencing.

[Image 4]

The daily chart above shows the 50, 89 and 200 day Simple Moving Averages (SMA). Now that the 50 day SMA (blue) is within reach, it is now providing additional upside resistance. After the 905 resistance, the November 14th and December 8th highs at around 917 provide some decent resistance. As for support, there is some at around 814 and Friday's test of the uptrend line. However, it appears as though the SPX closed just below that uptrend line. At 50.42, the Money Flow Index is declining toward distribution levels while the SPX is consolidating. The ADX is still confirming no trend. A new trend will be established once the ADX begins upward. According to the above brackets, you might short at the 50 day SMA and setting a stop on a close above the upper bracket. Otherwise, go long at a test of the 814 levels and set a stop if the SPX closes below the lower line.

[Image 5]

Unfortunately, the Bollinger Band chart isn't providing a defined pattern either. The 8 day Exponential Moving Average (EMA) has slipped below the 21 day EMA. But the two have been crisscrossing one another for a week. The RSI is declining and would signal further weakness if it breaks below the December 1st low around 40. However, the Slow Stochastics is slowing its decent and looking like it may begin to curl upward. While neither oscillator is in oversold territory, they are both declining which supports a continued sell off. There isn't really any trend other than the long term down trend. But that may soon be averted if the market finds itself in a Santa Claus rally. It is difficult to determine a directional trade with the information provided. That is the beautiful thing about options. We can sell premium at support and resistance levels and get paid on a non-directional trade. The NDX chart resembles the SPX chart in that they both have upside resistance and are still on downtrends.

Gold Futures Glitter. The February contract gained 19.5 points to close the day at $839.50. The chart below is the daily gold futures chart. The 8 day EMA is spreading away from the 21 day EMA which confirms the uptrend. Gold broke above the 833 resistance level. RSI is still advancing with a shallow slope. Sharp increases in an oscillator represent quickly overbought conditions while shallow ascents provide the market to uptrend while becoming overbought for a longer duration.

[Image 6]

If the risks to the economy persist, gold may rise back up to the previous highs seen on the chart. Why is gold moving upward? I believe that it is becoming a safe haven investment for those that do not want to buy into an overbought Treasury bond market. I also believe that the risks of deflation aren't as high as the risks of higher inflation as the cost of money declines to nearly nothing. As of the close, the 10 Year Treasury Yield (TNX) is at 2.533%. The inflation play is not ready yet, but other asset classes such as the Metal, Energy and Agricultural commodities are beginning to show signs of support. We might see a similar situation to earlier this year when equity and fixed income asset investments declined and commodity prices increased as interest left traditional investment classes into real assets (alternative investments). If you agree, then adding exposure to gold via ETFs, futures or the commodity itself may be done on pull backs to the 8 EMA. If you choose to use ETFs, you can use the SPDR Gold Shares (GLD) for a non-leveraged approach, the Deutch Banc-DB Gold Double Long (ETN) Exchange Traded Note (symbol: DGP) or the Proshares Ultra Long Gold (UGL). While I think gold still has some legs, I believe it may be time for some profit taking. Be patient and try to buy around the 8 day EMA.

Crude Oil isn't pretty like gold, but it still has some relative price movement in relation to the weakening dollar. The Crude chart below is of the 2 hour NYMEX Mini Contract. I placed a Heikin-Ashi bar as the style to reflect trend tendencies. After the strong open all the way up to $52.525, the January contract fell down to about $47.50 by the close on news that OPECs reduction in production was no longer speculation but the news. This was a classic case of buy the rumor sell the news! Jim Brown is the oil expert at OptionInvestor.com. But I will try my best to do it justice. Ever since the TARP was revealed, I have been calling for a weaker dollar. Usually, a weaker dollar translates to higher commodity prices. Inflation hits from two places, an oversupply of the currency and the increased demand for commodities at reduced dollar denominated prices. Actually, the US economy can benefit a little from a weaker dollar because it spurs foreign investments and consumption. As long as the US Dollar remains weaker, the chance for Oil to run up to the low 70s remains high. I see the dip down an opportunity to buy the commodity for a trade.

[Image 7]

As with gold, we can look to the futures contract, options on the futures, or ETFs to trade the directional tendencies. For instance, last month we sold the DEC puts on the US Oil Fund (Symbol: USO) with a 35 strike. Unfortunately, oil declined further than I calculated and the position was stopped out. However, I was able to sell the DIG Puts and roll down the USO puts to a lower strike price so that upside on Oil from the low 40s could be enjoyed. Selling Short DIG Puts represents the affects of the commodity on the Oil and Gas Sector rather than oil prices directly. Therefore, if I see the market bouncing at the same time that Oil is moving upward, I sell the DIG Puts to benefit from the upside of both markets. But DIG can decline while the commodity price declines. So choose your weapon accordingly.

Currency Trading with options on ETFs can be done by selling puts and calls on the CurrencyShares. For instance, if you believe the Dollar will regain its strength versus the Japanese Yen you can sell the FXY Calls. As the chart below shows, the Yen has had the Dollar in a stronghold for the last three months. For instance, you can sell the FXY January 115 Calls about $1.45 per contract. Because the underlying asset is the ETF, you would just be short FXY at 115 rather than the dollar itself.

[Image 8]

This week should be filled with increased volatility due to option and futures expiration. Therefore, the increased implied volatility could be pricing in this assumed increased daily price range. Be patient with entries and quick to exit bad positions. It may take three or more tries at a position entry before getting the right parameters set to trade the next trend. Have a nice week!

New Option Plays

Play Editor's Note: Monday Night

Play Editor's Note:
The market appears to be holding its breath as investors wait on tomorrow's FOMC decision on interest rates. Most analysts believe that the market has already baked in a .50 cut and some are expecting 0.75% cut from 1.00% to 0.25%. More importantly are the FOMC's comments and how investors will interpret them. Another event that will have an impact on the markets tomorrow is the early morning earnings report from Goldman Sachs (GS).

We are not adding new plays tonight but will wait and see how stocks perform tomorrow. I will note that some of the coal stocks look like potential bullish candidates. ACI and JRCC might be worth adding to your watch list.

In Play Updates and Reviews

Stocks Churn Lower

CALL Play Updates

Apple Inc - AAPL - close: 94.75 change: -3.52 stop: 92.40

Shares of AAPL were hit hard today after Goldman Sachs downgraded the stock from a "buy" to a "neutral" this morning. AAPL gapped open lower at $95.99 and quickly fell under what should have been short-term support near $95.00. The stock did manage to find support near $93.00 so the play remains open. A new rise over $95.00 can be used as another entry point to buy calls. More conservative traders might want to raise their stops toward $93.00. Our first target is $99.85. Our second target is $107.50.

Picked on December 12 at $ 92.80 *gap down entry 
Change since picked:      + 1.95
Earnings Date           01/22/09 (unconfirmed)
Average Daily Volume =      52.8 million  

Amazon.com - AMZN - close: 48.85 change: -2.40 stop: 47.49

AMZN suffered some profit taking today. Shares lost 4.6% but managed to bounce from its 10-dma near $48.15. The stock is holding on to its short-term, bullish channel for now. If the market continues lower tomorrow AMZN will probably hit our stop loss. Wait for a new rise over $50.00 before considering new bullish positions.

Our first target is $54.95. Our second target is $59.50. More aggressive traders may want to aim for the 100-dma. FYI: The P&F chart is bullish with a $73 target.

Picked on December 13 at $ 51.25
Change since picked:      - 2.40
Earnings Date           01/28/09 (unconfirmed)
Average Daily Volume =      12.9 million  

China Mobile Ltd. - CHL - close: 51.70 change: +0.05 stop: 49.75

The Chinese markets were higher on Monday and that allowed CHL to out perform the U.S. indices. CHL is holding above round-number support at $50.00. We don't see any changes from our weekend comments.

CHL has already hit our first target at $51.75. We're currently aiming for the $57.00 level.

Note: I was unable to find an earnings date for CHL, which does raise our risk since we prefer to avoid holding over an earnings report.

Picked on December 03 at $ 47.11 /gap down entry
Change since picked:      + 4.59 /originally listed at $47.85
Earnings Date           00/00/08 (unconfirmed)
Average Daily Volume =       3.9 million  

Covance Inc. - CVD - close: 39.46 change: -1.12 stop: 37.97

Wow! The action in CVD was a little surprising. Over the weekend we listed a trigger to buy calls at $41.55. What was the intraday high today? Yes, you guessed it. It was $41.55. CVD tagged a new high this morning and then reversed lower. Shares lost 2.7% by the end of the day. I suggest waiting for a new rise over $40.75 or $41.50 before initiating new bullish positions. We have two targets. Our first target is $46.00. Our second target is $49.50. Don't forget that CVD has a relatively high amount of short interest at 7% of the 62 million-share float.


Picked on December 15 at $ 41.55 *triggered     
Change since picked:      - 2.09
Earnings Date           01/29/09 (unconfirmed)
Average Daily Volume =       1.2 million  

Express Scripts - ESRX - close: 58.80 change: +1.32 stop: 55.95

ESRX delivered a much-needed bounce on Monday so we are going to keep the play alive. Our stop loss under short-term support at $56.00 looks good. I would be tempted to buy this bounce but our weekend comments about waiting for a move over $59.00 or $60.00 still stand. Our target is $64.00.

Picked on December 06 at $ 59.36 /gap higher entry 
Change since picked:      - 0.56 /originally listed at $58.58
Earnings Date           02/19/09 (unconfirmed)
Average Daily Volume =       3.1 million  

FTSE/Xinhau China Index - FXI - close: 29.05 chg: -0.94 stop: 28.65

Our bullish play on FXI almost didn't survive Monday. Shares slipped to $28.71. Our stop loss is $28.65. Strength in the Chinese markets on Monday failed to have any impact on the FXI. If you just look at the intraday action for today FXI looks bearish but the stock did bounce from its 10-dma on the daily chart. Readers may want to consider buying a bounce from here but trade cautiously. FXI has already hit our first target and we are now aiming for $32.50.

Picked on December 03 at $ 26.27 /gap down entry point
Change since picked:      + 2.78 /originally listed at $27.25
Earnings Date           00/00/00
Average Daily Volume =      51.2 million  

Google Inc. - GOOG - close: 310.67 change: - 5.09 stop: 293.50

Early this morning GOOG rallied to a new relative high at $318.49 and then struggled to hold its gains. The stock pulled back and tried to hold support at $310 but eventually dipped toward $305.00 before bouncing back. Over the weekend we suggested that a dip back toward $310 or $305 could be used as an attractive entry point and we got it. Another alternative, if you want to see more confirmation of the short-term up trend, is to wait for a rally over $320 or its 50-dma (near $322) before initiating positions.

We have two strategies listed on GOOG. One is a directional call play with an exit target at $360.00.

Our second strategy is a naked put play where we sell the naked put and then buy it back for less and our target to exit the naked put play is $350. The suggested put to sell was the January $350 put (GGD-MJ).

Picked on December 13 at $315.76
Change since picked:      - 5.09
Earnings Date           01/29/09 (unconfirmed)
Average Daily Volume =       7.2 million  

Jacobs Engineering - JEC - close: 45.26 change: -1.54 stop: 42.45

JEC tried to bounce this morning but eventually turned lower as the major market indices slid deeper into the red. We remain short-term bullish on JEC but readers may want to wait for a bounce before initiating positions. Last week the stock hit our trigger to buy calls when it gapped down at $44.60. We're going to leave our stop loss unchanged at $42.45. We have two targets. Our first target will be $51.00. Our second target will be $54.90.

Picked on December 12 at $ 44.60 *gap down entry
Change since picked:      + 0.66
Earnings Date           01/21/09 (unconfirmed)
Average Daily Volume =       3.0 million  

Priceline.com - PCLN - close: 62.93 change: -1.76 stop: 59.75

PCLN failed to make any progress on Friday's bullish bounce. We would still buy another bounce from $60.00 if it appears. PCLN has already hit our first target near $65.00. We're currently aiming for $69.90. FYI: The Point & Figure chart is bullish with a $102 target.

Picked on December 06 at $ 61.60 /gap open higher
Change since picked:      + 1.33 /originally listed at $60.46
Earnings Date           02/12/09 (unconfirmed)
Average Daily Volume =       1.8 million  

NYSE Euronext - NYX - close: 26.54 change: -0.99 stop: 25.45

I don't see any changes from our weekend comments on NYX. We are still waiting for a breakout over resistance at $28.00. We are suggesting readers use a trigger to buy calls at $28.10. If triggered our target is the $32.50 mark or the simple 100-dma (currently 33.42), whichever one the stock hits first. FYI: The P&F chart is bullish with a $43 target.

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           02/09/09 (unconfirmed)
Average Daily Volume =       5.8 million  

Texas Industries - TXI - close: 32.97 change: -1.46 stop: 31.25

TXI came close to retesting last week's low but found support at the rising 10-dma. Monday's move looks like a new entry point for bullish positions. Don't forget that the stock is also a candidate for a short squeeze. The most recent data listed short interest at more than 20% of the very small 21 million-share float. We have two targets. Our first target is $39.50. Our second target is $43.00.

Picked on December 13 at $ 34.43
Change since picked:      - 1.46
Earnings Date           01/08/09 (unconfirmed)
Average Daily Volume =       745 thousand 

ExxonMobil - XOM - close: 79.95 change: -0.50 stop: 78.45

Crude oil rallied sharply higher this morning but quickly reversed lower to plunge more than 10% from its intraday high. The moves in oil failed to have much impact on shares of XOM. Shares of XOM remain under resistance at $82 and its 200-dma. We're waiting for a breakout. I'm suggesting readers use a trigger to buy calls at $82.25. Once triggered our target is $89.50. There is some resistance at $85.00 but I would expect XOM to push through it. FYI: The P&F chart is bullish with a $98 target.

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           02/05/09 (unconfirmed)
Average Daily Volume =        56 million  

PUT Play Updates

*Currently we do not have any put play updates*

Strangle & Spread Play Updates

SPDR GOLD Trust - GLD - close: 82.60 change: +1.79 stop: n/a

Another day of weakness for the U.S. dollar sent gold prices higher. The GLD rallied 2.2% and broke through resistance at $82 and its exponential 200-dma. The Dec. $75 call hit a high of $8.00 today. Readers may want to start taking profits soon because any downturn in the GLD will see our position turn into a loss. Our target to exit this play is $9.90 for the option.

We only have four trading days left before December options expire. More conservative traders will want to seriously consider exiting early right here to protect capital.

We are not suggesting new strangle positions in the GLD.

What is a strangle?
A strangle involves buying both an out-of-the-money call and an out-of-the-money put. We don't care what direction the stock goes as long as it moves one direction. If the stock moves far enough one side of our trade will rise in value and pay for the entire trade and make a profit.

-December Strangle-

We suggested readers buy the December $75 call (GVD-LW) and the December $70 puts (GVD-XR). Our estimated cost was $6.30. We want to sell if either option hits $9.90.

Picked on November 09 at $ 72.50
Change since picked:      +10.10
Earnings Date           00/00/00
Average Daily Volume =      19.3 million  

Ultra S&P500 ProShares - SSO - close: 24.68 change: -0.58 stop: n/a

The S&P 500 index lost about 1.25% on Monday. At this point, with only four days left, the outlook for our strangle doesn't look good. More conservative traders need to be looking for an exit either here or anywhere near breakeven.

We're not suggesting new strangles at this time.

Note: The SSO is an ultra-long ETF that typically moves twice the daily performance of the S&P 500 index.

What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.

-December Strangle Details-
We suggested readers buy the December $30.00 call (SOJ-LD) and the December $20.00 put (SOJ-XT). Our estimated cost is $3.75. We want to sell if either option hits $6.00.

Picked on November 12 at $ 24.84
Change since picked:      - 0.16
Earnings Date           00/00/00
Average Daily Volume =       126 million  


Wynn Resorts - WYNN - close: 40.76 change: -1.32 stop: 39.40

We've got good news and bad news with WYNN. The good news is that shares hit our first target this morning. Actually the stock gapped open higher at $45.29 and our first target to take profits was $44.75. The bad news is that WYNN produced a very bearish failed rally under its simple 50-dma and sank toward $39.00 hitting our stop loss at $39.40 along the way. Thus our secondary, more-aggressive target at $49 will not be reached. We would keep WYNN on your watch list for a breakout over the 50-dma or a breakdown under its trendline of higher lows.


Picked on December 11 at $ 40.75
Change since picked:      + 0.01
Earnings Date           02/12/09 (unconfirmed)
Average Daily Volume =       3.2 million  


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