Option Investor
Newsletter

Daily Newsletter, Saturday, 8/14/2010

Table of Contents

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

Market Wrap

SmackDown At the Federal Reserve

by Jim Brown

Click here to email Jim Brown

Kansas Fed President Hoenig is no stranger to dissent but he blasted "Bernanke and his allies" on Friday for keeping rates low for an extended period.

Market Statistics

Hoenig has been a dissenter at the FOMC meetings but now he has taken his arguments to the people at a Nebraska town hall meeting. In these comments Hoenig joined a growing group of Fed heads including Bullard, Plosser, Fisher and Lacker in speaking out against the current Fed policy. The highly visible and highly critical comments about "Bernanke and his allies" reminds me of the buildup to a WWE tag team grudge match where the two sides spend a couple weeks spouting testosterone fueled remarks and criticisms at the other before they actually show up in the ring.

Some of Hoenig's remarks included:

I wish money was really free and that there was a painless way to move from severe recession and high leverage to robust and sustainable economic growth, but there is no shortcut.

A zero rate after a year of recovery adds to uncertainty.

Zero rates during a period of modest growth are a dangerous gamble.

Slow growth is not a decline in growth and we should not act hastily.

The Fed is inadvertently adding to uncertainty.

A continued zero interest rate is as likely to be a negative as a positive.

Bernanke and allies are trying to use monetary policy as a "cure all" for "every problem faced by the U.S. today."

Keeping rates too low for too long will lead to another severe recession in a few years.

Hoenig is obviously tired of just being a dissenter at the FOMC meeting and has decided to take his feelings public. You can imagine the climate in the room the next time the Fed meets on September 21st. Hoenig believes the economy is on track and growing modestly while at least half the Fed is more concerned about the potential for deflation. I would love to be a fly on the wall in that next meeting.

The Hoenig comments were about the only excitement on Friday and most of that was generated by the talking heads on stock TV simply to have something to talk about.

The economic reports were actually positive but they did not get much press. The Consumer Price Index headline number rose +0.3% after three consecutive monthly declines. The spike was mostly due to a jump in energy prices so the good news was muted. Energy prices at the consumer level rose +2.6%. The core CPI rose only +0.1% and barely over a deflationary reading.

The CPI showed that inflation was nonexistent and deflation is a moderate fear. As long as even modest GDP growth continues then deflation will not be a problem but we are teetering on the brink. Goldman Sachs upped their estimates for a double dip to a 25-30% chance on Friday.

Retail Sales for July rose by +0.4% and slightly better than consensus estimates of 0.3%. Again, a rise in energy prices pushed sales higher at service stations to inflate the headline number. Out of the eleven top sectors auto sales and parts rose +1.6%, service stations +2.3% and eight sectors had sales declines. The remaining two sectors, food services and nonstore retailers were up only +0.2%. If you remove autos and gasoline the headline number would have been a decline of -0.1%. There was no reason to cheer about retail sales in July.

Next week we will get earnings from about ten major retailers including HD, LOW, TGT, ANF and others. Last week we saw JCP, KSS, DDS and JWN lower guidance so the results from the big stores next week are not expected to impress traders.

The first reading of the Consumer Sentiment for August showed an unexpected +1.8 point rise to 69.6 after the nearly -10 point decline last month. The early month gains in the stock market to 10,700 on the Dow were probably responsible for the minor increase in sentiment.

Unemployment, the limited access to credit and weak home prices remain the biggest drag on sentiment. Add in the constant economic gloom and doom in the news the last couple weeks and I am surprised the number did not drop another 10 points.

Consumer Sentiment Chart

Economic reports for next week will give us a couple housing reports and the Philly Fed Manufacturing survey. The housing reports will be bad so no big surprise there unless there is a change to the upside. The most watched report of the week could be the jobless claims since last week's 484,000 was the highest since February and the second consecutive week over 480,000. That suggests companies are not staffing up for the holiday manufacturing and shipping season, which occurs over the next two months. It actually looks like they are cutting back from prior plans.

Economic Calendar

It was Friday the 13th but workers at one company found some good luck when the alarm clock went off. IBM announced it was buying marketing software company Unica (UNCA) for $400 million. It is not a big deal for IBM but it was a big deal for investors and any employee holding Unica stock. Unica shares rallied +118% to $21 on the news. Yes, it more than doubled on the announcement.

Unica Chart

Blackstone Group announced it was going to buy Dynegy (DYN) for $4.7 billion. The three-way deal will also have Dynegy sell four power plants to NRG Energy. Dynegy has been under pressure of late and sold eight plants in 2009 for $1.5 billion in cash and stock. They have lowered guidance several times over the last year. The CEO of Dynegy said the deal would give shareholders a satisfactory exit ahead of rising commodity pressures, challenging capital markets and environmental and regulatory uncertainties. Shares of DYN rose +63% on the news. Given the ugly chart I suspect any remaining shareholders were glad to get the news. There was a 1:5 reverse split back in May that did not even slow the decline.

Dynegy Chart

Cisco (CSCO) did not bounce on Friday and closed the week at $21.37 after disappointing investors with cautious guidance on Wednesday night. CEO John Chambers told analysts "We are seeing a large number of mixed signals in both the market and from our customers' expectations, and we think the words "unusual uncertainty" are an accurate description of what is occurring." Normally John Chamber is a cheerleader for Cisco and the market and this was not the case on Wednesday.

The CFO said in an interview on Thursday "Our customers are just taking a slight pause. But a pause does not mean a stop. It just means they are pausing, they are holding back." However, the CFO said the slowdown came in June and early July and orders improved towards the end of July.

Various analysts echoed the thought that corporations are very gun shy and they are poised to spend money if the economy improves but they are also poised to slash spending quickly if the U.S. falls back into recession. Nobody wants to get caught very over extended like they did in 2008. That was a management lesson for many new managers and for some it was probably terminal. For those that escaped with their jobs intact they are not going out on that limb again until the recovery is on solid footing.

Cisco's sales are a leading edge of the IT build out cycle. The networks have to be in place before any servers or PCs will function. If Cisco is seeing a pause in orders then everyone else is seeing the same thing. We are likely to see this when Hewlett Packard reports earnings next Thursday. Personally I believe Cisco is a buy at $21 for longer-term holders. They have no real competition although there are several competitors. They are the 800-lb gorilla in the space.

Cisco Chart

On Friday research firm Gartner cut their IT sales projections for the rest of 2010. Overall they expect IT spending to hit $2.4 trillion in 2010, up from $2.3T in 2009. However, they cut their estimates from a +4.1% growth rate to a 2.9% growth rate. It was just a few weeks back they were expecting a 6% growth rate. Gartner said companies were still cautious about committing to new projects and were still worried about the potential for a double dip recession. Decision-making cycles were still long and many companies had contingency plans for the next 12 months, which could see more projects suspended if the economy continues to weaken. This is just another confirming data point that the economy is not well. The patient may be off life support but still not out of the hospital.

In another Gartner survey the company found that the Android smartphone had moved into third place worldwide and pushed Apple's iPhone into fourth place. Gartner rated the smartphones by operating system to cover all the phones in a certain class and Symbian was first with 25 million units in Q2 followed by Research in Motion at 11.2 million and Android at 10.6 million. Apple came in at 8.7 million. Following in distant fifth was the Windows Mobile at 3.1 million. A total of 61.6 million smartphones were sold in Q2. Android was the top selling phone in the North American market but RIMM squeaked ahead overall because of its sales overseas.

When actual units were counted by brand the number of phones of all types sold jumped to 325.5 million. That is a phenomenal number to me and this is in a weak global economy.

Gartner Mobile Device Statistics

J.C. Penney (JCP) warned on Friday that earnings this quarter would be below street estimates. JCP expects to earn between 16 to 20 cents and the street was expecting 24 cents. Penney also lowered the full year estimates.

Joining JCP in sharing weaker guidance and/or flat sales was Kohl's (KSS), Nordstrom (JWN) and Dillards (DDS). Penney reported a sharp drop in same store sales in July and was forced to slash prices to generate traffic. Kohl's beat the street estimates on earnings but guided to lower full year profits than analysts were expecting. Kohl's said the biggest problem for their middle class customers was unemployment. Even those who had jobs were spending less because they were afraid they could lose their jobs if the economy slowed again.

It is pretty clear by any metric you care to use that the U.S. economy is on shaky ground. There are dozens of indicators and plenty of anecdotal evidence that consumers and corporations are worried about what the future will bring. The election battle is heating up and there is a stark difference between the opinions and actions of the candidates. The general election tactic is to paint a picture of how bad it is and then claim the ability to fix it. What consumers remember is the picture of how bad it is now. They seldom remember the proposed fixes because the description of the fix is normally disguised in political speak so that candidates can't be pinned down on the specifics. The bottom line is that the next two months is going to be filled with a lot of political whining and finger pointing and a further decline in consumer sentiment.

The uncertainty has confused investors. Add in the flash crash, the politics and new regulations plus the major increase in taxes several months from now and cautious investors are now petrified. They would rather put their money in bonds or TIPS and get a half percent than risk it in the stock market. The yield on the ten-year TIPS is roughly 1% and the five-year just barely over zero.

TIPS Yield Chart

Why are investors so scared of the equity market? First this is historically the worst two months of the year. Secondly every single news item these days is a discussion of the potential for a double dip or even worse the onset of deflation and a lost decade like Japan suffered through. The Fed can't create inflation today despite their efforts. Fed rates are at historic lows and the Fed tells us every month that they will remain there for an "extended period" because of an "unusual uncertainty" in the economy. That is not particularly confidence building.

Corporations are sitting on a monster pile of cash but they refuse to spend it because of the painful memories of 2008. Banks are sitting on a pile of cash and they are hoarding every penny because of the real estate problem. A large majority of their loans are underwater loan to value but regulators are looking the other way to avoid another banking crisis. They know that once the economy starts accelerating the real estate problem will solve itself. Until then the banks have to hoard reserves just in case that recovery doesn't come anytime soon. Eventually regulators will have to recognize the underwater loans and banks will have to add to reserves. The FDIC closed another Illinois bank on Friday. The Palos Bank and Trust Company was the 110th bank closure of the year. There are more tan 700 banks on the FDIC problem list.

When one of these banks is closed the FDIC sells the assets to another bank in the region. This is another reason banks want to hoard reserves. They might get a golden opportunity to acquire some market share and choice assets if another bank in their area fails.

Most people believe the Fed stimulates the economy with its rate cuts. Those do provide a sort of stimulus but the real economic stimulus is bank lending. When a bank raises $1 million and then leverages it into $20 million in loans it creates a huge amount of activity. Those borrowers buy equipment and supplies, pay salaries, rents, etc and business activity skyrockets. We are not seeing that now. Banks are hoarding the money. They claim they are making loans but the numbers don't lie. You have to have perfect credit and a golden balance sheet to get any bank funding. Few small businesses and startups have either after the last three years of crisis.

Knowledgeable investors understand these problems and they have been conditioned over the last 80 years to fear deflation much more than inflation. The Fed went for years and would not even say deflation. Now the word is in every sound bite. Baby boomers who survived the recession crash and escaped with some of their portfolio intact have been selling those stocks and stashing the cash. They have to count on that cash when they retire over the next few years and they don't want to risk it in the market. If a boomer planning to retire on the result of his last 40-years of investments saw his million dollar account turn into a half million account during the crash then he was scared to death that his retirement may have to be postponed. When the rebound came and those accounts reinflated those potential retirees are cashing out and putting cash in the safety of bond funds and TIPS.

Remember in the years leading up to the crash consumers treated their homes like automatic cash machines. Refinancing annually to extract more cash was a common event. That cash fueled the last decade and created the bubble we all enjoyed. That unlimited cash machine no longer exists and consumers are forced to live on what they make instead of what they can borrow. It is a sharp decline in lifestyle and for boomers getting ready to retire they now have that mountain of debt and a loan to value that may require cash to close rather than be a cash generator. The volume of cash extracted from real estate has declined by nearly $1 trillion since 2008. Times have changed and the easy life of buy and flip home ownership is gone. This is called deleveraging and it is happening on a nationwide scale. As long as deleveraging is the primary driver of the economy growth will be minimal. Deleveraging is deflationary.

Cash Extracted from Real Estate

The era of easy credit, liar loans and sub prime buyers is gone. In order to sell merchandise whether it is houses, cars, motorcycles or golf clubs the prices have been slashed and then slashed again. Prices are falling on everything. This is called deflation but we are not quite there yet. We are hovering on the brink but there is still hope of a recovery. The Fed is going to make money so cheap that a new round of inflation appears. Some analysts believe the Fed is going to push the yield on the 10-year treasury to 2.5% in order to create inflation and a new home buying, home refinancing bubble. They want to recreate the real estate cash generation wave. It is the easiest way to put cash in consumer pockets in enough quantity that they will again feel confident and spend the money.

This won't help the boomer generation because most are only 5-7 years from retirement. When people retire they trade down in house size. The money they get from selling their pre-retirement property goes into saving for retirement expenses. There are some analysts that believe the entire next decade, when 42 million boomers will retire, will be a deleveraging decade. That is far too long term a time horizon for this commentary but it does make sense.

Right now the key is to decipher how this affects our markets. In the absence of government stimulus the economy is going to grow slowly. I am not in the double dip camp but I believe the economic growth will be slow. There are simply too many people unemployed to put them all back to work in less than three years. Add in the deleveraging and the conversion of stocks to bonds for risk free retirement cash and we have an up hill battle but it is one we can eventually win.

I was amazed that so many analysts were surprised the market declined last week. You would have thought they were living in a cave and ignorant of the external influences. The simplest of those influences was option expiration. I told everyone last week that the most volatile week is the week before option expiration and to be aware. The economic reports and poor earnings guidance helped grease the slide. Now that we are into the slide and the uptrend has been broken the path of least resistance is down.

I have heard analysts use nearly every bearish pattern or technical indicator they could come up with as the reason the market broke and why it will continue. Guys, it was time for the market to rest. The excuse did not matter and there were plenty of excuses.

Now we have to decide where to make a stand and go long because daylight always follows darkness. Problem is we don't have a reliable market clock so we don't know how much darkness is left. The clear target on the S&P is 1050 followed by 1014. Neither level represents the end of the world. It is just normal Q3 market movement made more volatile by the frequent use of the word deflation in the news and those conditions I described above. I believe we will see 1050 and I would like to see 1014.

The remaining weak holders need to be removed from the market but more importantly fund managers need to be given a defining "reason to buy" as we head into the fourth quarter. A continued decline to 1050 could produce another trading range swing while a serious drop to 1014 could be a defining moment for the rest of 2010. I would love to see that happen. We don't want to see 1014 broken but definitely tested.

Initial resistance on the S&P is 1087 and the 50-day average followed by 1100, 1115 (200-day) and 1130.

S&P-500 Chart

The Dow broke under prior resistance at 10350 at the open on Thursday and remained stuck there through Friday's close. The good news is that support at 10300 was also firm. The reason the Dow failed to move appreciably on Thr/Fri was a lack of volume. Volume on Friday was the second lightest day of the year at 5.9 billion shares. The lowest day of the year was Monday's rally. Those days were bookends to Wednesday's 8.5 billion-share day. That was 33% more volume on Wednesday but only 500M shares were up volume. It could have been a capitulation reversal day but the bulls failed to show. The big cap techs in the Dow along with the materials stocks and energy stocks were too weak for any rebound to materialize.

There was a discussion of the TRIN in the Market Monitor on Wednesday. The TRIN hit 6.31 on Wednesday and according to Art Cashin there have only been six higher readings in the last 28 years and one of them was the 1987 crash. In theory a reading that high is followed by a rebound. In theory a 16:1 volume imbalance day like Wednesday is also followed by a rebound. Obviously theory and reality were not in agreement on Thursday.

I am surprised there was no real attempt at short covering at Friday's close. After a -350 point decline you would have expected some short covering before the weekend. That gives you an idea what traders are thinking when they have no fear about holding over over a weekend.

A break of support at 10300 targets 10100. I really don't have a target after that. If the decline continues it would not be unreasonable to see 9800 again. The last few months on the Dow have been so choppy there is no clear support at least for me. Dow 9614 was the July 2nd low. That seems like months ago to me instead of just six weeks.

Dow Chart

The Nasdaq is under serious pressure. Big cap techs are broken as evidenced by the collapse in Cisco and Intel. The chip sector has broken down to a new six month low and there were more than a dozen downgrades last week. For an investor to buy any PC related stock today would require a serious leap of faith.

The uptrend has broken and the Nasdaq lost more than 5% for the week. Initial support is 2140 followed by 2063.

Nasdaq Chart

SOX Chart

The Russell gave up -6.3% for the week compared to only -3.3% for the Dow. The dramatic decline for the Russell is a clear indication fund managers are bailing on the market. In times of stress they do not want to be in small caps. The Russell closed at the low for the week and appears to be targeting 590 for support. A break under 590 would be VERY bearish. It is amazing to think that just three days ago the Russell was comfortably over support at 640 and the 200-day average. Market sentiment has deteriorated rapidly and the Russell is our leading indicator of fund manager sentiment.

Russell Chart

In summary the uptrend from July 2nd has broken. The chips stocks are at six-month lows and the big cap techs are broken. There is very little anyone could say positive about this market. Earnings were better than expected but came from cost cutting rather than sales and guidance was less than stellar.

The economy is not broken but is weaving its way forward like a drunken sailor. There are faint signs of improvement in the last two weeks of July and early August but the recent reports from companies like Cisco and probably Hewlett Packard next week may have killed off those improvement hopes. A two-point improvement in consumer sentiment can easily be erased by weak guidance from Cisco.

I am still in the "why buy" camp until we get a little farther into the quarter and traders start to position themselves for a Q4 rally. Whether we actually get a Q4 rally is problematic but traders will be positioning for one in late September anyway. Keep your powder dry and lets see how this decline shakes out.

Jim Brown


Index Wrap

Failed Rallies at Resistance Preceded Sharp Decline

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

To 'confirm' that the intermediate-term trend had reversed from down to up would have taken a move above the June highs and instead we got a big sell off. 'Double Dip' talk resurfaces and I'm not talking ice cream.

I wrote last week that the Nasdaq Composite was facing resistance at the top end of a broad downtrend channel dating from its April highs. It has been downhill since the April top as each rebound has fallen short of the prior rally peak. Since the tech heavy Nasdaq had been leading the market, it was likely going to be quite a drag on the overall market if investors decided current tech valuations were too high. The PE's of leading tech firms (the Nas 100) were justified only if there was continued economic expansion, implying no double dip recession. Recently the Fed hasn't sounded too sure about the durability of the current recovery as economic momentum slows down.

The fundamental and technical pictures are in synch currently. The 'lid' on the market suggested by the various reporting on peak 2010 output possibly being behind us, was matched exactly and graphically by the double tops apparent both in the S&P 500 and the big-cap tech sector represented by the Nasdaq 100 (NDX). Looking at the short-term picture (next 2-3 days) suggests a rally should set up early in the week, say by Tuesday as the 21-hour RSI would suggest; not shown and oversold.

As I looked at all the major index charts after the week just ended, broad downtrend channels were what I was 'seeing' on the charts. Rallies in the major indexes this past week 'failed' (reversed) at the top end of downtrend price channels as will be seen below on my slightly redrawn upper trendlines in some cases; such reversals usually then see prices at least retreating back to the middle of the channel.

The bullish wedge pattern I had been seeing in earlier weeks, implying a strong likelihood of a further good-sized rally to carry ABOVE the June highs recedes into the background and is no longer the pattern to focus on. I'm back to looking at a simple downtrend channel. This pattern makes finding future resistance relatively easy; i.e., it's at the top end of the channel. Conversely, if there was a move to new lows for the year, support could be looked for at the bottom of the downtrend channel.

Speaking of new 2010 lows, which I tend to doubt will occur in the next few weeks, it would take the Dow falling under 9500 to 'signal' a break of the neckline of a possible major Head & Shoulder's (H&S) top pattern that is traced out on the weekly Dow chart below. While I don't think the market has built a massive top, I did notice that formation of the so-called Right Shoulder (RT) of the third high has gone on long enough and recent highs have pushed up far enough so that the Left & Right Shoulders now are more symmetrical, which further takes on the 'right' shape. It's worthwhile to see what's being talked about out there, as long as you keep in mind that the reason someone technically oriented talks about a POSSIBLE double top or a 'possible' H&S Top is that the formations sometimes don't end up making the further move that is thought to 'confirm' the pattern; e.g., in the case of the H&S top, the neckline has to be decisively penetrated to 'signal' a major further down leg.

Since I'm most focused on the week to week chart and indicator picture, time to move on to the various daily charts.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) formed a possible double top at this past week's high and the index remains in a downtrend as traced out by the broad downtrend price 'channel' outlined on my next chart. Defining the dominant pattern with two downtrend lines as seen below allows us to now focus on pretty clear cut lines of potential support and resistance.

I wrote last week (8/7): "While SPX hasn't shown any bearish reversal, it hasn't 'proven' it will have a significant new up leg either until or unless it can substantially pierce a line of resistance at 1128-1130. A new up leg above 1130 suggests upside potential perhaps then to the 1170 area. A dip or close below 1100 sets up a test of 1080 support." Hey, that's were we are in SPX, knocking on the door of 1080. Next lower support is noted at 1060. Major support begins in the 1010-1020 area. Just going by the low end of the downtrend channel, major support could be closer to 960-965.

Pivotal resistance remains at 1130, same as last week and where the last rally failed. I didn't mark the next lower resistance on my SPX daily chart below, but I'd say it's at the recent 'breakdown' point in the 1112-1110 area.

MARKET SENTIMENT:

Given the recent sell off, bullish sentiment remains relatively high in my estimation. On the Wednesday sell off the ratio did dip, but not one suggesting wholesale bearishness.

I take 1-day or 5-day average readings that drop to near 1.2 (or under) as a 'signal' for an oversold reversal within 3-5 trading days. A low reading like this suggests traders are exhibiting a bearish extreme as regards their market outlook. Since the herd is not often right or at the right time, this rule of thumb has mostly worked over the years. The foregoing always assumes that price action within that period also suggests bottoming action, as well as an oversold RSI indicator.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) has been 'clarified' chart wise in a bearish way as the index remains in a downtrend, as seen visually by both the broad downtrend channel formation and by the fact that OEX pierced the up trendline dating from the rally from the early-July low up to recent highs. Admittedly it did seem that OEX was going to climb above its prior intraday high at 510. The index did go to new closing highs but couldn't gain more than 2-3 points above 510. The longer the churn in the same area, especially with the 13-day RSI up near overbought levels, the greater the potential for a downside reversal.

I noted the increased risk of a sell off last week and not to 'bet' on much further upside. I equate the 'risk' of staying in calls bought at lower levels to the risk to reward equation if you were to buy OEX calls fresh today. If you won't take the risk of new positions, what about the risk to profits on calls bought early on in the rally?

Resistance is noted around 508, but not noted (by my usual red down arrows) at 505, then at 495.

Initial technical support is at 490, than at 480, which was a prior (down) swing low. Fairly major support begins in the 460 area and extends to 440, at the bottom of the downtrend channel.

DOW 30 (INDU) AVERAGE; DAILY CHART:

Based on this past week's price action it became appropriate to 'define' the Dow 30 Average (INDU) recent rally failure as hitting resistance at the top end of a broad downtrend channel. Once that bearish process completed, the sharp break of this past week knifed through the up trendline dating from the last low. The STEEPER a trendline is the bigger the price correction at the end of it.

Given the reversal patterns involved, bearish looking Dow stocks include CAT (potential double top), CSCO, DD, HPQ (still), IBM, KO, and WMT. MCD is the only stand out bullish Dow chart.

Last week I considered that INDU had cleared its prior rally high by enough to suggest a renewed intermediate uptrend, joining a short-term and long-term uptrend. WRONG! Or, more precisely, it was too soon to tell on the Dow with the S&P indexes not 'confirming' the same pattern. I did note (last week) that INDU hadn't "cleared near resistance or congestion around 10700." And, only if the Dow could climb above 10700 (to the point where this same level shows up as a new support) would a new up leg be suggested. Never happened and hopefully Dow Index call holders bailed because of it and maybe some puts got bought too. As I already said with S&P comments, the longer the churn the greater the burn. Especially when the 13-day RSI is nearing, or at or above, 65-70.

Near resistance is in the 10400 area, then at 10600-10630, extending to 10685. Near support is at 10200, then in the 10000 area.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The top end the Nasdaq Composite (COMP) Index bearish downtrend channel stopped the rally coming into this past Monday. If you took Monday close in isolation, it would look like a bullish breakout. The fact that it wasn't is why I always emphasize holding fire for the 'two consecutive day' rule on supposed 'breakouts' and 'decisive' penetrations of trendlines.

Last week I opined that COMP would NOT pierce near-term resistance, at its upper channel line and that was the way it went (fortunately for me), except for the minor rally at the beginning of the week. The most common outcome based on what I've seen in years of trading, is that reversals at the top end of price channels get pulled to at least a move back to the midpoint of the channel.

2150 is support, than 2100. Resistance is seen in the area of COMP's 200-day moving average and at the trendline; i.e., at 2270-2280.

MARKET SENTIMENT:

Repeating what I said in my SPX comments regarding overall Trader Sentiment, as seen in my indicator above: Given the sharp recent sell off, bullish sentiment remains relatively high in my estimation. On the Wednesday decline the ratio did dip, but not one suggesting wholesale bearishness.

I take 1-day or 5-day average readings that drop to near 1.2 (or under) as a 'signal' for an oversold reversal within 3-5 trading days. A low reading like this suggests traders are exhibiting a bearish extreme as regards their market outlook. Since the herd is not often right or at the right time, this rule of thumb has mostly worked over the years. The foregoing always assumes that price action within that period also suggests bottoming action, as well as an oversold RSI indicator.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart is bearish in its pattern. The reversal both from a potential double top as well as from its upper (channel) trendline was bearish, with a next bearish 'trigger' its break under a multiweek up trendline. Once pierced, steeper (up) trendlines tend to bring steep declines.

I'm anticipating lower levels for NDX, but not necessarily right away, given a short-term oversold condition as we may see an early week rally attempt; e.g., by Tuesday.

Near support/buying interest looks like 1785, at a prior (down) swing low, then in the 1750 area. Fairly major support should be found at the 1700 prior low. If evaluated by the current intersection of the lower channel line, major support is suggested around 1635.

Near resistance is in the 1850 area, then around 1882-1883, with major resistance beginning at 1900 to 1910.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

The Nasdaq 100 (QQQQ) tracking stock is of course showing the same bearish patterns as NDX, but I'll go through the key levels of potential support and resistance. It would take an initial breakout above 47, then to above 47.7, to suggest a turnaround to the current bearish chart.

Near support: 44.0 - 43.8

Next support: 43.0

Major support: 42-42.15

Near resistance: 46

Next resistance: 46.6

Major resistance: 47.15-47.7

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) chart shows a declining trend dating from its 672 high; subsequent highs then were touching the upper line of a projected downtrend channel made after that peak. Such upper channel lines often prove to be a substantial line of resistance.

When RUT then went on to break its 55-day moving average (my one exception to use of a 50-day setting) it was a further bearish 'signal' and not usually suggesting just a little price dip. A substantial sell off at some point so often follows reversal(s) at the upper end of a downtrend channel anyway. A move back to the middle of the channel tends to be a 'minimum' objective.

Near support is in the low-600 area; if reached, there could be a rebound from there. A short-term rebound looks due so whether from 600 (maybe too 'obvious' a level) or higher, a short-term rally looks due. Below 600, the prior low at 587 is potential next support. If there was a new low made (below 587), 553 is support implied by the current intersection of the low end of RUT's downtrend channel.

Key near resistance is at 640, representing RUT's Wednesday 'breakdown' point, which, not surprisingly was noted as near support last week. Next resistance is seen at the top end of the price channel, in the 655 area currently.



GOOD TRADING SUCCESS!



NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS

CHART MARKINGS:

1. Technical support or areas of likely buying interest and highlighted with green up arrows.

2. Resistance or areas of likely selling interest and notated by the use of red down arrows.

I WRITE ABOUT:

3. Index price areas where I have a bullish bias or interest in buying index calls, selling puts or other bullish strategies.

4. Price levels where I suggest buying index puts or adopting other bearish option strategies.

5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only (CPRATIO) with the S&P 100 (OEX) chart. However, this indicator pertains to the market as a whole, not just OEX. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I tend to favor At The Money (ATM), In The Money (ITM) or only slightly Out of The Money (OTM) strike prices so that premium levels are not as cheap as would otherwise be the case, which helps in not overtrading an account. Exit or stop points, as well as projected profitable index price targets, are based on my technical analysis of the underlying indexes.


New Option Plays

Something for Everyone

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. The market is at a tough spot here and I believe it could go either way. I'm leaning towards a bounce back up into SPX 1,110. Tonight's new plays are designed to exploit the moves and I believe they have some potential. Please email me with any questions.


NEW DIRECTIONAL CALL PLAYS

Cameron International - CAM - close 37.94 change +1.05 stop 35.45

Company Description:
Cameron International Corporation (Cameron) is a provider of flow equipment products, systems and services to worldwide oil, gas and process industries. The Company’s operations are organized into three business segments: Drilling & Production Systems (DPS), Valves & Measurement (V&M) and Compression Systems (CS).

Target(s): 40.50, 42.00, 43.95
Key Support/Resistance Areas: 45.00, 42.50, 41.00, 38.75, 36.00
Time Frame: Several weeks

Why We Like It:
CAM was caught in the middle of the drama of the Gulf of Mexico oil spill. The stock has been beaten down because they built the blow out preventer (BOP) on the Horizon well. However, the BOP was heavily modified by RIG/BP so they don't really have any exposure to the damages. CAM is world's largest seller and manufacturer of BOP's so any new rules from the government means a lot of new business for Cameron. And the company recently reported over a $1 billion in new orders. I suggest we capitalize on the gaining momentum and initiate long positions now. Our stop is $35.45 which is below Thursday's low, and the 50-day SMA. At a minimum I'm looking for CAM to retest its recent swing high and possibly charge up to its 52-week highs if the broader market cooperates.

Suggested Position: Buy September $40.00 CALL, current ask is $1.05

Annotated Chart:

Entry on August xx
Earnings Date 11/3/2010 (unconfirmed)
Average Daily Volume: 4.6 million
Listed on August 14, 2010


FMC Technologies, Inc - FTI - close 61.97 change +0.89 stop 58.25

Company Description:
FMC Technologies, Inc. (FMC Technologies) is a global provider of technology solutions for the energy industry. The Company designs, manufactures and services systems and products, such as subsea production and processing systems, surface wellhead production systems, high-pressure fluid control equipment, measurement solutions, and marine loading systems for the oil and gas industry.

Target(s): 65.25, 67.00
Key Support/Resistance Areas: 69.00, 65.50, 62.40, 59.00
Time Frame: Several weeks

Why We Like It:
This is another play on the Gulf oil spill as FTI stands to benefit from new regulations in underwater robotics. The company reported solid earnings results in July and this past week's dip is a buying opportunity. The stock is maintaining an upward trend line while the broader market has not, which is a sign of overall relative strength. I believe FTI should easily retest its recent swing high which is just above our first target of $65.25. Our more aggressive target is $67.00 but if the broader market is strong FTI could even make a run at its YTD highs. Our stop is $58.25 which is below the upward trend line and the 200-day and 50-day SMA's. I see some potential in this trade and am going to push the suggested option out to October, but that doesn't mean we can't take quick profits should FTI break higher soon.

Suggested Position: Buy October $70.00 CALL, current ask $1.30

Annotated chart:

Entry on August xx
Earnings 10/27/2010 (unconfirmed)
Average Daily Volume: 1.5 million
Listed on August 14, 2010


NEW DIRECTIONAL PUT PLAYS

Apple, Inc - AAPL - close 249.10 change -2.69 stop 267.50

Company Description:
Apple Inc. (Apple) designs, manufactures, and markets personal computers, mobile communication devices, and portable digital music and video players, and sells a variety of related software, services, peripherals, and networking solutions. The Company sells its products worldwide through its online stores, its retail stores, its direct sales force, and third-party wholesalers, resellers, and value-added resellers.

Target(s): 240.00, 233.00, 226.00
Key Support/Resistance Areas: 21.50, 20.50, 19.80, 19.00, 18.50
Time Frame: Several weeks

Comments:
AAPL has been in a fuzzy cloud recently and I believe it looks vulnerable at these levels. Recent reports on smart phone market share point to the Android capturing 18% market share compared to Apple's 14%. Technically, AAPL had a daily and weekly close below its long term upward trend from its March 2009 lows for the first time this past week. I believe AAPL should test its 200-day SMA which is below our two most conservative targets. I also think this is a good hedge against some of our long positions in the model portfolio. I suggest we initiate short positions in AAPL on strength if it trades to $255 or on weakness at $245.95. This is a position that I suggest being quick to tighten stops and/or tale profits.

An alternative strategy readers may consider on a short AAPL position is to buy a PUT spread. For example, buy the September $230 PUTS (current ask $3.10) and sell the September $210 PUTS (current ask $1.03) to finance the cost. This is a well defined risk strategy where your max loss is $214 (the amount you paid for the spread) and your max gain is $1,786 if AAPL closes at $210 at expiration.

Suggested Position: Buy September $230.00 PUT, current ask $3.20

Annotated chart:

Entry on August xx
Earnings: 10/21/10 (unconfirmed)
Average Daily Volume: 23 million
Listed on August 14, 2010


In Play Updates and Reviews

Positive Returns Looking to Take Profits

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Human Genome Sciences - HGSI - close 26.35 change -0.26 stop 24.65

Target(s): 27.20, 28.20, 29.20
Key Support/Resistance Areas: 29.80, 28.24, 27.80, 26.80, 25.00
Current Gain/Loss: -5%
Time Frame: Several weeks
New Positions: Yes

Comments:
8/14: We are long HGSI calls at 90 cents. The stock traded within yesterday's range so there not much to report. HGSI remains in its upward channel and above its 20 and 50-day SMA's. I'm looking for HGSI to bounce back up towards its 200-day SMA. My comments from below remain the same.

8/12: We're back for another long play in HGSI which produced a winner for us a few weeks ago. The biotech sector has been a relative strong performer recently as it has maintained its upward trend line from the 7/1 lows while the broader market has not. I like HGSI and I suggest we initiate long positions now. The stock is trading in an upward channel and bounced nicely today at the bottom of the channel. HGSI is above its 20-day and 50-day SMA's and looks poised to make another higher high. I'm looking to make $1.50 to $3.00 on this trade. We'll use a stop at $24.65 which is below the 50-day SMA.

Current Position: Long September $28.00 CALL, entry was at $0.90

Annotated Chart:

Entry on August 13, 2010
Earnings Date N/A (unconfirmed)
Average Daily Volume: 2.9 million
Listed on August 12, 2010


SPDR Gold Trust - GLD - close 118.74 change -0.03 stop 112.50

Target(s): 121.60, 123.00, 125.00
Key Support/Resistance Areas: 123.00, 119.10, 116.50, 113.50
Current Gain/Loss: +3.3%
Time Frame: Several weeks
New Positions: Yes

Comments:
8/14: GLD is consolidating in a tight range above its 50-day SMA. We need a break above $119.15 which should spark more buying. If readers are not in positions a break above this level could be used as a more conservative approach. There is a swing high of $119.54 from December that may also act as resistance but I think the aforementioned level is more important. I also like GLD on any weakness.

8/12: GLD gained +1.43% today. Unfortunately for us, the gains came overnight so we did not get filled at a better price. Nonetheless, gold is gaining momentum and if it trades above $119.15, which is near the July highs, GLD should be on the fast path to retest its YTD highs and possibly print new highs. We may see a pullback to close the gap higher today, and if it does it will present another opportunity to get in if readers aren't already in.

8/11: I'm not necessarily a longer term bull on gold, but if the Fed is going to monetize our country's debt gold is going to catch a bid, and I believe now is a perfect time to get in via GLD. Considering the events of the past few days gold and gold miners should catch a bid here and act as a defensive play. From a technical perspective GLD bounced perfectly off of its upward trend line from its lows on 8/17 to 2/5 to 7/28. And I think GLD will print new all time highs within the next several of weeks. I suggest readers enter long positions now. I've provided three realistic targets that will produce good winning trades if reached. Our stop is below the 200-day SMA at 112.50.

Current Position: Long September $120.00 CALL, entry was at $1.80

Annotated Chart:

Entry on August 12, 2010
Earnings Date N/A (unconfirmed)
Average Daily Volume: 12.4 million
Listed on August 10, 2010


Volatility Index - VIX - close: 26.24 change: +0.51 stop: 19.60

Target(s): 25.95 (hit), 27.20, 28.00, 31.50, 35.00
Key Support/Resistance Areas: 20.00, 22.00, 24.00, 26.00, 28.00
Current Gain/Loss: +25.4%
Time Frame: 1 week
New Positions: Yes, on weakness

Comments:
8/14: VIX closed near its highs of the day and we currently have a +25% gain in this position. Exiting this trade could become somewhat tricky depending on what happens next week. I suspect we may get a bounce in the broader market next week so we may need to exhibit some patience with this trade. However, if we head lower first I believe the chances of a hard reversal becomes higher. So if that happens I suggest tightening stops as the VIX heads higher and as our targets approach. $27.20 and $28.00 are likely exit points on a quick down move prior to a bounce.

8/12: The VIX came within 9 cents of hitting our second target so I am going to lower the target to $27.20. If we get further weakness in the S&P 500 prior to a bounce the VIX may spike up to our targets and then retreat like it did today. Therefore, taking profits or tightening stops if that happens is the smart play. If the market finds its legs and bounces from here we will need to exhibit some patience with the trade.

8/11: I spoke too soon thinking we caught a break yesterday when the VIX traded to within 1 penny of our trigger before backing off. It turns out it was a bad break as the SPX gapped lower today and hence the VIX gapped higher. So we would have gotten a better a fill yesterday had we been triggered. Nonetheless, it appears the market has spoken and this trade has some potential. We are long September 30 calls at $2.95. The VIX is now almost at its 50-day SMA and actually hit our first target this afternoon. Considering the massive sell-off today this trade is shaping up to be quicker than I thought.

NOTE: September VIX options expire on Wednesday, Sept. 15th, not Friday

Current Position: Long VIX September $30 CALL, entry was at $2.95

Annotated Chart:

Entry on August 11, 2010
Earnings Date N/A
Average Daily Volume N/A
Listed on August 7, 2010


PUT Play Updates

Leggett & Platt - LEG - close 19.68 change -0.22 stop 21.75

Target(s): 19.85(hit), 19.40, 18.70 18.40
Key Support/Resistance Areas: 21.50, 20.50, 19.80, 19.00, 18.50
Current Gain/Loss: +46%
Time Frame: 1 to 2 weeks
New Positions: Yes, on strength

Comments:
8/14: LEG closed below the $19.80 support level I mentioned in Thursday's updates and our gain is now +46%. If there is weakness in the broader market early this week our $19.40 target could be hit fast, and it should give us a +65% gain so I suggest either taking profits or tightening stops to protect gains if we get there. I've added a more aggressive target of $18.40 for readers interested in riding this down farther but I doubt we get there before a some sort of bounce. You can always get back in later.

8/12: LEG hit our first target today and we now have a +33% gain in the position. The stock is finding support at the 7/19 and 7/20 lows which were just below $19.80. This is why my first target was $19.85. If it breaks here it should be a vacuum down to the $19.40 area which is our second target (raised 5 cents). This target should give us a +65% gain so I suggest either taking profits or tightening stops to protect gains if we get there.

8/11: LEG PUTS were initiated at the open for 75 cents as the stock traded below yesterday's low. LEG drifted down all day long and we currently have gain of +20%. Our targets are approaching which are near support areas so I suggest trailing or tightening stops on the way down to protect profits.

Current Position: Long September $20.00 PUT, entry was at $0.75

Annotated Chart:

Entry on August 11, 2010
Earnings: 10/21/10 (unconfirmed)
Average Daily Volume: 1.45 million
Listed on August 10, 2010


Occidental Petrol. - OXY - close: 75.39 change: -1.07 stop: 81.05

Target(s): 74.00, 71.50, 67.50
Key Support/Resistance Areas: 75-74.00, 70.00, 65.00
Current Gain/Loss: N/A
Time Frame: Several Weeks
New Positions: Yes, trigger at $77.50

Comments:
8/14: Hope is not a good strategy when you are in a position, but I suppose it's OK if you're not in yet. I sure hope OXY bounces to $77.50 so our trigger to enter short positions is reached. All we want is a bounce in the stock so we can exploit it. There is so much overhead congestion, moving averages, trend lines, etc. to keep this stock in check. I want to remove the lower trigger to enter for now. If OXY breaks down prior to bouncing the stock could reverse on us so I don't to get trapped. I like the short set up on strength and suggest looking for a quick move down to the adjusted targets above. I will also add that OXY could bounce higher than $77.50. It really just depends on the strength in the oil sector and how far the broader market can bounce. A bounce much over $79.00 doesn't seem likely.

8/12: OXY came within 25 cents of our trigger to enter short positions. I think this is a good entry and there is a lot of overhead resistance to keep any additional strength in check. My comments from below remain the same.

8/11: Considering today's broad based sell off I am inclined to suggest we take advantage of any strength in OXY to initiate short positions. The S&P 500 closed above its 50-day SMA today so we could get a bounce in equities before the selling continues. OXY's high on 8/10 was $78.14. All of the stock's major moving averages are also overhead and a downward trend line that started on 6/21. I am suggesting we use a bounce to $77.50 or on weakness to $73.90 as a trigger to enter short positions, whichever occurs first.

Suggested Position: Buy September $70.00 PUT, current ask $1.29, etstimated ask at entry $0.75

Annotated Chart:

Entry on August XX
Earnings Date 10/21/10 (unconfirmed)
Average Daily Volume 4.4 million
Listed on August 7th, 2010


Procter & Gamble - PG - close: 59.82 change: -0.17 stop: 63.26

Target(s): 59.50, 59.05, 58.05, 57.25
Key Support/Resistance Areas: 59.00, 61.00
Current Gain/Loss: +44%
Time Frame: 2 to 3 weeks
New Positions: Yes, on strength

Comments:
8/14: Rallies in PG keep getting sold into. We have a nice gain in this position and it could turn into a big winner if PG breaks below $59.00 which is below our 2nd target. I'm inclined to hang on to this position to see if the selling begins, however, that probably means enduring a bounce this week. PG is also a defensive play so the decline in the stock may take a while. If we get down to $59.05 I suggest tightening stops too see if we can get more out of the trade. If we do get to this level we should have close to a +100% gain. That's hard to beat.

8/12: This morning PG came within 8 cents of reaching our 1st target before reversing with the market. Positions could have exited for a +60%. So I've raised that target 20 cents to $59.50 should PG retest this area. The PG chart looks good to the short side but there is support near $59.00. Tomorrow we get CPI and retail sales data and this could spark selling if the reports are bad. If PG gets down to $59.50 again it may break through this support. There is more support $59.00 which are the January and July lows. PG bounced hard at these levels so I've added $59.05 as a target as well. I would be inclined to take profits or at least tighten stops as PG approaches these levels. We now have a +44% gain so protect profits if the weakness continues.

Current Position: Long September $57.50 PUT, entry was at $0.36

Annotated Chart:

Entry on August 10, 2010
Earnings Date 10/28/10 (unconfirmed)
Average Daily Volume 2.5 million