Option Investor

Daily Newsletter, Monday, 12/29/2008

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Table of Contents

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

Market Wrap

Painting the Tape

[Image 1]

By looking at the close on the S&P 500 and Dow Jones, you might not know that the markets made a run up to the close again. However, prior to 3:00 PM Eastern, the markets were still looking pretty weak. Our own James Brown set out an intraday alert pointing to the fact that the Russell 2000, the last index to fold, had broken below the down trend line. While the S&P and Dow managed to climb back near solid, unchanged ground the NASDAQ and Russell both closed down 1.04% and 2.23%, respectively. With so little volume on the exchanges, it is easier to manipulate the closing prints by buying the more represented stocks on the indices. I have inserted a 60 minute chart of the $RUT and drawn the uptrend line. It is difficult to speculate on the direction of the market for the rest of the week when there is likely to be decreasing volume and no economic reports to speak of. But the tape might be showing dissention in the ranks. The stocks in the S&P and Dow Jones have traditionally been the largest companies in the stock universe. However, more than three of the generals have been wounded (mainly AIG, Citigroup and General Motors all trading near 0), so there are only a few more than 20 stocks that can lead the markets. As with most historic battles, the minions march into battle first with the generals leading from behind the wall of warriors.

[Image 2]

The true internals of the markets show that there were nearly 2 to 1 decliners on the New York Stock Exchange (NYSE). There were 1189 advancing issues versus 1889 declining issues on the NYSE. It was a slow day with the volume posting only 877 million shares versus the 50 day average of 1.48 billion shares. The NYSE had only 3 New 52 Week Highs and 40 New 52 Week Lows. The $TRIN or ARMS index closed at 1.25. Postings above 1.0 show declining volume and declining shares outpacing the advancing issues.

The NASDAQ Composite fell 1.3% or 19.92 points to 1,510.32 on 1.18 Billion shares; which is almost a billion less than the 50 day moving average of 2.12 Billion. Almost a three quarters of the shares on the NASDAQ Composite fell today. The actual number of number of advancing issues was 835 which 2081 shares declined. The actual ratio is in the graphic above. Not a lot of stocks posted new 52 Week Highs either. In fact, my source shows that 4 made new highs and 121 stocks made new 52 Week Lows.

Had today been a high volume day, these results would definitely point to a distribution day and suggest that more downside risks remain prevalent. But the low volume suggests that most traders are just taking the rest of the horrendous year off. Therefore, not much can be gained from analyzing the internals beyond the obvious suggestion of very few participants wanting to buy up only the big names that pay dividends and have had relative strength versus the market.

News Brief

The amount of news was relatively low today with the exception of news from the Middle East causing added volatility to stock prices. Israel's escalating attacks against Gaza's Hamas rulers made traders more hesitant to buy. However, the tensions aided oil prices by pushing the January Light Sweet Crude contract to an intraday high of $42.20 per barrel. But the run couldn’t last and oil prices pulled back to Friday’s closing levels before closing up $2.31 to $40.02.

[Image 3]

The other main story that hit the wires today was from Dow Chemical (NYSE: DOW). Kuwait Petroleum and Petrochemicals Industries told DOW about a decision made by the Kuwait Supreme Petroleum Council to reverse its prior approval of the agreement between Dow and Petrochemicals Industries that would have created K-Dow Petrochemicals, a 50-50 joint venture co. The partnership for Kuwait Petroleum to provide DOW with about $15 billion which DOW was looking to reduce its debt from the ongoing merger with Rohm and Haas (NYSE: ROH). ROH reiterated that the completion of the K-Dow Petrochemicals partnership is not a closing condition for the proposed merger between ROH and DOW. Obviously the market didn’t believe the companies because DOW fell $4.02 to $15.32 while ROH fell $10.22 to $53.34. Originally, ROH agreed to be acquired by Dow Chemical in an $18.8 Billion dollar merger ($15.3 Billion in equity value). The terms to shareholders value the company at more than $78.00 per share in a cash buyout. While some sources say that the merger is off due to the companies’ inability to achieve financing, there is still an arbitrage trade opportunity. It might be that ROH was originally sought after by other chemical players as well as Warren Buffett. The trade setup if you think that DOW and ROH will complete the merger in the future is to purchase ROH stock and Sell DOW. That way if ROH is acquired, the positive shares will convert to the equivalent DOW shares at the achieved merger price and flatten out the short DOW shares.

The European Markets had a good day today. The Closing Prices for the London FTSE was 4299.7 or up 83.2. The German DAX climbed 2% or 69.1 points to 4698.5. Finally, the French CAC had a more subdued pace (+0.5%) with a close up 69.1 points to 3130.7.

The S&P 500

I am going to spend some time discussing the SPX a little more today. First of all, the SPX has been in a consolidation phase for most of December. While the SPX has tried to close above the 50 day Simple Moving Average (blue line in chart below), it hasn’t defined a new uptrend as of yet. I realize the dark blue line is advancing, but the SPX still has some work to do before the trend can be confirmed. For one, the 50 day SMA needs to be breached again. The 50 day SMA (890) provides a dynamic resistance level to watch. I actually think that we will see another leg down before this happen, but that is another story about the $VIX. As you can seem the Money Flow Index is quickly declining toward oversold territory. This is a good sign for the bulls. As the advance/decline data showed us today, the market scraped by with a slight loss even though the internals were weak. Furthermore, as the MFI shows the majority of the volume on the SPX must be selling. However, we have to watch the ADX histogram closely because it ticked upward today after weeks of declining. A break above 25 should provide us with more clarity on the direction of the market’s trend. With the slow decline over the last week, the ADX may be suggesting the SPX is about to re-enter a downtrend. That would make a lot of the bulls on TV crazy. So many professionals are expecting the markets to bounce in January that the opposite may prove true. If you expect a bounce, prepare for a decline because everyone seems to be in the same boat. If the majority believe that the market is going up, that usually suggests that they have already bought. Who else is left to actually buy?

SPX Daily Chart [Image 4]

The next view is a more detailed view of the past few weeks. I have drawn a Fibonacci retracement on top of the SPX 2 hour chart as well as the uptrend line. If you can zoom into today’s close, it was really a breakdown rally to the previous support/uptrend line. The bullish interpretation of the chart shows that the SPX managed to selloff below the 50% retracement only to climb back up and close above it. In addition, the low of today tested last Monday’s low. The SPX is finding a lot of resistance in the 915 – 918 area while finding support around 860. A break below 855 may put the SPX down near 810 while a break above 880 may help the index break back up to 918 or higher. I wouldn’t buy or sell here. I think it is prudent to wait for some confirmation from the prices. The problem with that is there might not be any real moves until next Monday.

SPX Two Hour Chart – 20 days [Image 5]

Finally, let’s look at the SPX daily chart with more indicators. I do like my toys. Anyway, the chart below is a Daily chart. I present this chart each week in order to provide some sort of consistency. I use a 21 day Exponential Bollinger Band with an overlapping 8 day EMA. The crisscross of the moving averages aids in determining shorter term trends. For instance, the current trend is indicated as a downtrend because the 8 day EMA is below the 21 day EMA. The Slow Stochastics helps to filter out overbought and oversold levels. I use both oscillators to provide confirmation of a re-emergence. Furthermore, I prefer to wait for the Slow Stochastics and RSI to bounce upward from oversold territory and downward from overbought territory prior to entering a long or short trade, respectively. That way I avoid trying to catch a falling knife scenario. The Slow Stochastics is showing upside after crossing above its slow moving average, while the RSI declined. There is a bit of divergence between the two. With the ongoing consolidation, neither of these indicators is providing much clarity. Therefore, when I can’t see out the window, I pull the car over. If we really want to be patient, the price levels identified by the blue dotted lines could be traded. For instance, buy a test of the 850 level and short a break. Or short a test up to the 915 line and buy a break out. But, since the short term indicator (i.e. moving average crossover) is negative, we should short at resistance and buy on oversold bounces. The first short term resistance level is at the 8 day EMA (875) and then at the 21 day EMA 877. There isn’t much spread there. Finally, it should be noted that the upper Bollinger band is at approximately the same level as the upside price resistance. Two indicators coincidently suggesting resistance provides added pressure.

SPX Daily Chart [Image 6]

The Treasury Yield Trade

Over the past few weeks I have discussed the overbought tendency of the Long Term US Treasury bond. A patient person would have waited until a bounce down in the iShares 20+ Year Bond ETF (TLT). Since we are options traders, I like the concept of selling premium on puts to establish long positions and calls to establish short positions. Since the TLT is short on premium and there isn’t an UltraLong 20+ Year Treasury Bond Fund, we have to buy the UltraShort 20+ Year Bond Fund ETF (Symbol: TBT). The recent low is at $35.51. Therefore, we will sell the January 35 Puts to reflect a bullish position for the yield and a bearish position for the long bond. These puts are trading at:

January 35 Puts: TBT MI Bid - 0.65 Ask – 1.00 Open Interest 440

I like to try to sell in the middle, so that gives us a target price of $0.80 per contract. I see an upside target of $39. However, notice on the chart that there is resistance at the 8 day EMA at $37.39.

[Image 7]

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New Option Plays

Monday Night: No New Plays

Play Editor's Note: No New Plays Tonight.

In Play Updates and Reviews

Two Plays Triggered Today

CALL Play Updates

Alcon Inc - ACL - close: 86.10 change: +0.27 stop: 83.75

ACL is still trading sideways but if you look at the intraday chart the action is starting to turn bullish. Aggressive traders might want to jump in here and consider a tight stop under today's low (84.80). Otherwise lets stick to our weekend comments and wait for a rise over $87.00 as our next bullish entry point. If ACL can push past the $89-90 zone it would be a bullish breakout past the neckline of an inverse head-and-shoulders pattern with a potential bullish target of $110 or more. This coincides with the Point & Figure chart's bullish target of $110. Our upside target is $99.00.

Picked on December 22 at $ 85.25 *triggered     
Change since picked:      + 0.85
Earnings Date           02/04/09 (unconfirmed)
Average Daily Volume =       840 thousand 

Caterpillar - CAT - close: 42.34 change: -0.38 stop: 39.95

We remain cautious on CAT and would not open new positions at this time. The stock was higher this morning but gave into market weakness only to rebound late in the day. More conservative traders could raise their stops toward last week's low around $40.60. We're going to keep our stop under clearly defined support at $40.00 for now. Our target is $49.50. The Point & Figure chart is bullish with a $58 target.

Picked on December 16 at $ 43.80
Change since picked:      - 1.46
Earnings Date           01/29/09 (unconfirmed)
Average Daily Volume =      13.4 million  

Energizer Holdings - ENR - close: 50.16 change: +0.56 stop: 46.99

ENR displayed some relative strength. The early morning rally attempt at $50.00 failed but ENR did not see the same midday sell-off that the market did. Shares slowly ground their way higher and eventually broke through resistance this afternoon. Our suggested entry point to buy calls was at $50.05 so the play is now open.

We have two targets. Our first target is $54.50. Our second target is $59.00. The Point & Figure chart is already bullish with a $68.00 target.


Picked on December 29 at $ 50.05 *triggered     
Change since picked:      + 0.11
Earnings Date           01/29/09 (unconfirmed)
Average Daily Volume =       798 thousand 

Lockheed Martin - LMT - close: 80.54 change: -0.57 stop: 77.45

The weakness in the markets worked for us with LMT today. The stock dipped to $79.86 and bounced. Our suggested entry point was to buy calls on a pull back into the $80.00-79.00 zone. The play is now open.

Our target is $84.90. More aggressive traders may want to aim higher. FYI: The P&F chart is bullish with a $90 target.


Picked on December 29 at $ 80.00 *triggered     
Change since picked:      + 0.54
Earnings Date           01/22/09 (unconfirmed)
Average Daily Volume =       2.8 million  

Sunoco Inc - SUN - close: 42.49 change: -0.04 stop: 39.85

Rising tensions in the Middle East sent oil and natural gas futures higher. This lifted the energy sector and SUN, a refiner, rallied to $43.99 intraday. The trend is up but we would wait for another dip or bounce in the $40.75-40.00 zone before considering new bullish positions.

The P&F chart is very bullish with a $54 target. Our target is $47.00.

Picked on December 20 at $ 42.30
Change since picked:      + 0.19
Earnings Date           02/04/09 (unconfirmed)
Average Daily Volume =       4.2 million  

PUT Play Updates

AvalonBay - AVB - close: 55.15 change: -1.89 stop: 61.65 *new*

Target achieved. AVB sank to $54.00 intraday and our first target to take profits was $55.10. The stock managed to recover off its lows and settle with a 3.3% loss. We are adjusting the stop loss down to $61.65. More conservative traders may want to use a tighter stop near $60.00 instead. We're not suggesting new bearish positions at this time but another failed rally in the $59-60 zone would be an entry point to buy puts.

We have two targets. Our first target is $55.10. Our second target is $50.55. FYI: The Point & Figure chart currently points to $50.00.


Picked on December 24 at $ 57.98 *gap down entry
Change since picked:      - 2.83
Earnings Date           02/04/09 (unconfirmed)
Average Daily Volume =       3.5 million  

Avon Products - AVP - close: 22.50 change: -0.18 stop: 24.05

AVP is still churning sideways but it's doing so with a bearish trend of lower highs. This remains an entry point to buy puts. I don't see any changes from our weekend comments.

More conservative traders may want to wait for a drop under $22.00 before initiating positions. The simple 50-dma overhead at $23.50 offers technical resistance and more conservative traders may want to tighten their stops closer to $23.50.

We have two targets. Our first target is $20.25. Our second target is $18.60. FYI: The Point & Figure chart is bearish with an $11 target.

Picked on December 23 at $ 22.46
Change since picked:      + 0.04
Earnings Date           02/05/09 (unconfirmed)
Average Daily Volume =       4.6 million  

Franklin Resources - BEN - close: 59.49 change: +0.06 stop: 63.11

It was a relatively quiet day for BEN. The stock slipped to $57.84 and then bounced back to unchanged on the session. We are suggesting readers buy puts now but you could also look for a failed rally at $60.00 or under $61.50 as a new bearish entry point to buy puts.

More conservative traders may want to wait for a little more confirmation with a low under $57.40 as your entry. We have two targets. Our first target is $55.25. Our second target is the $50.50 mark since the $50.00 level could offer support.

Picked on December 27 at $ 59.64
Change since picked:      + 0.06
Earnings Date           01/22/09 (unconfirmed)
Average Daily Volume =       1.4 million  

Equinix Inc. - EQIX - close: 51.03 change: -1.27 stop: 52.75

EQIX fell toward the $50.00 level but support there did not break. I do expect that EQIX will break down through round-number support and we'll be ready.

Our suggested entry point to buy puts is $49.75. If triggered we have two targets. Our first target is $45.05. Our second target is $40.50. More aggressive traders may want to aim lower.

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           02/11/09 (unconfirmed)
Average Daily Volume =       990 thousand 

Capital One Financial - COF - close: 29.31 chg: -0.17 stop: 31.51

Shares of COF are still asleep. The stock looks poised to move lower and we would still consider put positions now. However, you could wait for a drop under $28.75 as an alternative entry point. We don't see any changes from our weekend comments.

Our first target is $25.50. Our second target will be a new relative low at $21.00. FYI: The P&F chart is bearish with a $17 target.

Picked on December 23 at $ 29.38 /gap higher entry
Change since picked:      - 0.07
Earnings Date           01/22/09 (unconfirmed)
Average Daily Volume =       8.5 million  

Google Inc. - GOOG - close: 297.42 change: -2.94 stop: 311.00

After 30 minutes of hugging the $300 level, shares of GOOG dropped sharply toward last week's lows around $290. The stock bounced and managed to end the day with a 1% loss. I don't see any changes from our weekend comments. If you don't want to buy puts here then look for a failed rally in the $300-305 zone. More conservative traders could wait for a drop under $290.00 to initiate positions. We're going to play with what is a very tight stop for GOOG at $311. If you really want to tighten your risk then try a stop around $307. Our first target is $281.00. Our second target is $265. More aggressive traders could aim for $250. The Point & Figure chart points to $252.

Picked on December 27 at $300.36
Change since picked:      - 2.94
Earnings Date           01/29/09 (unconfirmed)
Average Daily Volume =       5.4 million  


Research In Motion - RIMM - close: 38.81 change: -2.04 stop: 39.45

RIMM was a huge laggard for tech-related stocks today. Shares plunged right from the open and fell past the $40.00 level to end with a 5% loss. RIMM hit our stop loss at $39.45 closing the play. One idea to consider is some sort of neutral strategy like a straddle or a strangle if RIMM bounces back to $40.00 or tests the December lows near $35.00.


Picked on December 22 at $ 41.50 /stopped out 39.45
Change since picked:      - 2.69
Earnings Date           12/18/08 (confirmed)
Average Daily Volume =        25 million  


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