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Newsletter

Daily Newsletter, Saturday, 10/16/2010

Table of Contents

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

Market Wrap

Don't Fight the Fed

by Jim Brown

Click here to email Jim Brown

All of my investing life the only axiom that always proved to be true was don't fight the Fed. They have an unlimited supply of money and investors have limits.

Market Statistics

When the Fed wants the market to react in a certain way they can apply all the power they need to make it happen. It may not be an immediate reaction but they will apply pressure until they get the desired result. Their influence on the markets can outweigh and cancel prevailing historical trends both on the upside and the downside.

For instance the markets normally decline in September and October but an aggressive Fed can negate that trend as we have seen in 2010. The markets normally rally in November and December but a Fed with a strong tightening bias can create a bear market in any environment.

It all boils down to the cost of money. If the Fed decides to launch a major quantitative easing program to drive down rates and stimulate the economy then the dollar suffers. Dollar denominated assets like metals, oil, commodities, real estate and even stocks are forced to rise in dollar cost in order to maintain parity with their prior real valuations. An ounce of gold is still an ounce of gold and it worth the same today as it was the same time last year. It just takes more cheap dollars to buy the same ounce of gold today. The reverse for everything is true when the Fed is raising rates. Our dollars rise in value and that pushes down the price of everything denominated in dollars because it takes fewer expensive dollars to purchase those items.

Everyone reading this should understand this relation between Fed actions and the reaction of the stock market. As commentators we get caught up in the technical and fundamental reasons for market movements or lack of movements. It is hard to mentally make the continued connection on a daily basis between an extremely overbought market that continues to rise for no specific reason and a three-cent drop in the dollar. Most investors don't really understand the complex linkage that goes on in the currency markets. Hedge funds, institutional investors, sovereign funds, large banks and even companies like Berkshire Hathaway play the currency game with trillions of dollars in trades.

A 3-cent drop in the dollar may not seem like much but when played using billion dollar trades in the derivatives market that is a big move. There are roughly $653 trillion in outstanding derivatives contracts and much of that is currency based. Traders are shorting the dollar, which produces cash they use to go long another currency, commodities or stocks. This is a VERY crowded trade today but it is still gathering momentum. Suffice it to say there are thousands of entities still leveraging up these trades as each day passes. That is putting upward pressure on everything denominated in dollars including stocks.

For the time being this trade will continue. Bernanke alluded to another QE program in his speech on Friday. As long as the Fed is applying pressure to rates and the dollar the market will continue higher. Eventually it will end badly. Probably very badly but that could be weeks, months or even a year down the road. Don't fight the Fed.

One of the most common quotes used in the market came from John Keynes. "The market can remain irrational longer than you can remain solvent." He was making a case that the markets could remain overbought or oversold for a very long time and far longer than an investor who was betting against the market could remain solvent.

Every investor has a bias. It is either bullish or bearish based on the tone and content of the articles they read. If you only paid attention to the whining about the U.S. debt and unemployment you could not help but be bearish. If you only paid attention to the random green shoots in the economics and S&P company guidance then you could be bullish and have blinders on to the things the bearish investor was seeing. It is what makes a market. If you only listened to Larry Kudlow and Jim Cramer you would probably be a raging bull today. If you only listened to Robert Prechter and Nouriel Roubini you would probably be turning all your assets into gold and hiding it under your bed. Your bias depends completely on what information sources you listen to daily.

At Option Investor we have always prided ourselves for giving a balanced view by having a different commentator do the market wrap every day. That way you can profit from receiving input from multiple sources. If we were all bullish or all bearish we would not be doing our readers a service. There are some times when there is overwhelming evidence for one direction or the other but that is rare. We nearly always have a difference of opinion and that is a positive point for readers. That also means some of the writers may not be correct in their bias on any given week. If we were always 100% right the newsletter would cost $10,000 a month and be worth every penny. Nobody is ever right 100% of the time even when they are making seven figures for their services like analysts at Goldman Sachs.

In this period of Fed induced market rally I have asked everyone on staff to make an extra effort to present both sides of the market. Every market has three potential outcomes and by knowing the factors that could influence each direction you can make a better decision in your personal trades. Our goal is to produce the best independent market analysis possible. If you feel we are not achieving that goal please click on the email link at the top of the page and let us know.

Friday's economic reports were led by the NY Empire State Manufacturing Survey for October, which rose to 15.7 from 4.1 in September. This was a very strong rebound and the internal components were explosive. The new orders component surged to 12.9 from 4.3 in the prior month. Inventories fell sharply to -11.5 from +1.5 producing a monster inventory/order gap of 24.6 suggesting business is increasing significantly. The headline number was the highest since June. If the rest of the regional manufacturing reports come in this strong it would indicate a significant improvement in conditions.

NY Empire State Manufacturing Survey

That was the only report with a major gain. The Retail sales for September rose +0.6% compared to +0.4% in August. In this report August was revised higher to +0.7%. Sales rose +7.3% over September 2009 but that comparison was more favorable because of the post cash for clunkers decline in 2009. That is the strongest year over year performance since April. Electronics and appliances had a strong monthly gain at +1.5% with motor vehicles and parts rising +1.6%. Despite the decent results most retailers reported a lackluster back to school shopping season.

Consumer Sentiment for October declined fractionally to 67.9 from 68.2 in September. This is the preliminary report and will be revised in a couple weeks. The present conditions component declined to 73.0 from 79.6 and offset a rise in the expectations component from 60.9 to 64.6.

Consumer Sentiment Chart

Consumer Prices were nearly flat again in September with a +0.1% gain. The core rate was zero for the second consecutive month. This pushed the core inflation rate to the lowest in nearly 40 years at 0.8%. This is what the Fed is fighting with the additional policy accommodation. Headline inflation should increase due to the rise in grain prices and the price of oil but the core rate is stuck in a rut. The threat of deflation is low but the Fed wants to make absolutely sure there is no chance for it to occur. Just the threat of further Fed easing is already pushing prices higher because of the falling dollar. I am not sure this is a winning situation to artificially inflate the price of goods by making dollars cheaper but we don't get a say in the matter.

Consumer Price Index

Another green shoot was the slightly better than expected gain in Business Inventories. The headline number showed a +0.6% gain for August. This is a lagging number so little attention was paid to it but this was the eighth consecutive month of gains.

Next week has two reports that should get the market's attention. The Fed Beige Book is the latest update of economic conditions in the various Fed districts. This is a detailed report that should tell us if the August soft patch is really behind us or still dragging us down. I suspect, based on the Fed speakers recent tone, that it will show only minor improvement. Otherwise they would not be talking up QE2 in every appearance. You know the various Fed presidents talk to each other and they know which districts are improving and which are not.

The second report is the Philly Fed Manufacturing Survey. This is viewed as a proxy for the national ISM at month end. The Philly Fed will give analysts a last chance to alter estimates before the end of October. Expectations are for a minor improvement in the Richmond district.

Economic Calendar

It was a tale of two markets on Friday with the Nasdaq posting a +33 point gain while the Dow posted a 31 point loss. The problem with the Dow was the decline in Bank of America, JP Morgan and GE. Pushing the banks lower was a downgrade on Bank of America by S&P due to the new mortgage foreclosure crisis. GE was suffering from disappointing earnings.

On Friday S&P cut Bank America to a hold from a strong buy due to ongoing foreclosure woes. The problems stem from the major banks using robo-signers to sign tens of thousands of foreclosure documents without adequately researching each loan. These employees simply signed thousands of affidavits testifying to facts about the loans when they actually had no real knowledge of the specific loan. They were just pushing paper as fast as they could in order to process foreclosures.

The use of robo-signers has prompted foreclosure halts by the major lenders until a review of the process can be completed. At least one state has already sued Ally Financial and expects to sue the other major banks. The allegations of fraud at "every level of the process" is prompting thousands of homeowner suits as well as suits from the investors who bought the packaged loans. Earlier this week attorneys general from all 50 states launched a joint investigation into allegations that mortgage companies mishandled documents in foreclosing hundreds of thousands of homes. There were foreclosure proceedings on 930,437 properties in Q3 according to RealtyTrac. One in every 139 homes received a foreclosure notice in Q3 and a record 288,345 homes were actually seized by the banks.

Dick Bove, with Rochdale Securities, said the banks could lose up to $80 billion from the various suits and forced buybacks. The investors who bought the original loans may have a way to force the banks to buy back all the mortgage securities at face value if they can prove there was fraud at any point in the process. The Federal Home Loan Bank of Chicago sued the major lenders claiming they failed to disclose various underwriting standards and had errors in the documentation. They are trying to recover more than $3.3 billion they paid for residential mortgage bank securities that soured.

Banks were struggling to post decent profits before this mess and now they are faced with having to take charges for litigation expenses and potential settlements. If this progresses to the point of having to buy back previously packaged loans it could set them back several years in the recovery process. The halt in foreclosures as the mess is sorted out will slow down the housing market even more as the nearly 300,000 homes slated for foreclosure in Q4 are pushed out into Q1 or even Q2 with an associated slippage of even more distressed sales in Q1. Since more than a third of home sales are distressed homes this delay will be a serious blow to the housing industry. The same homes will eventually be foreclosed but it will be many months down the road. When the foreclosure halt is eventually ended there will be an even bigger surge of homes in foreclosure and all those homes coming on the market at the same time will depress prices. Banks have to pay an estimated $1,000 per month for every home in foreclosure to cover upkeep, property management and legal fees. Extending the foreclosure period for 3-6 months on hundreds of thousand of homes will be very costly to the banks.

We are also likely to see the major lenders like BAC, WFC and JPM slow or even halt making new loans until they decide what the impact of the foreclosure problem will be to their balance sheets. That will retard the home market even more than the foreclosure halt. The housing sector is 20% of the economy and this mess could be a material impact. This could be the next shock that pushes us back into a recession. For that reason the administration should be proactive in making sure the investigation and resolution is done quickly and with a minor amount of pain to the system.

Bank America Chart

Late Friday is was revealed the SEC has opened a probe into the banks foreclosure practices. This is in addition to investigations by the Department of Justice, Office of the Comptroller of the Currency and the FDIC.

While on the subject of banks, Countrywide CEO, Angelo Mozilo, agreed to settle with the SEC over insider trading charges. His trial was due to start on Tuesday but Friday's settlement ended that proceeding. He agreed to pay $67.5 million in penalties to settle civil fraud and insider-trading charges while admitting no wrongdoing. Actually Mozilo will end up paying ony $22 million of the fine. Bank of America will be forced to pay the rest under an indemnification agreement signed when BAC acquired Countrywide in 2008. Bank of America said in a statement it will advance funds on Mozilo's behalf as required by the agreement. BAC is insured to some extent for this loss. Mozilo, otherwise known as the "tan man" for his frequent tanning visits will be banned for life from being an officer or director of a public company. At age 71 I suspect he will spend the rest of his life living large on the remnants of the compensation he received from 1998 to 2008 of $250 million plus an additional $406 million from sales of Countrywide stock.

Angelo Mozilo

GE earnings disappointed with revenue of $35.9 billion and $1.7 billion short of estimates. Earnings per share of 29-cents was 2-cents over analyst estimates but disappointing for retail investors. CEO Jeffrey Immelt said both equipment and service orders increased for the first time in two years and he projected better results in 2011. He said they were seeing a "slow recovery in a few areas." Income fell -18% over the same period in 2009. GE had to put up an additional $1.1 billion in reserves for a finance subsidiary and that dragged down earnings. GE shares gave back 86-cents to close at $16.30.

Better earnings news came from Google on Thursday night and the stock gained +60.52 on Friday to close at 601.45. Google's earnings garnered a $700 price target from Goldman Sachs and after Friday's gains they are well on their way.

Google Chart

Amazon blasted off to another new high with a +$9 gain after news broke that margins on e-books were improving significantly. Evidently Amazon's volume has increased to the point where they have even more clout with publishers. Also, I have noticed prices for e-books rising. One I bought last week was $12.99 and the highest price I have paid for an e-book although I have seen some higher. Since they are selling more e-books than paper books the rise in margins is a good sign. Citigroup raised their price target to $194 and the stock closed just under $165.

Amazon Chart

It must have been new high Friday in the tech sector. Apple also broke out to a new high with a $12 gain after Goldman gave them a new price target at $500. Apple will report earnings on Monday and they are expected to beat estimates by a mile. Sales of the iPhone, iPad and Mac computers are improving briskly. This will be the first full quarter of sales for the iPhone 4 and it has been sold out all quarter with most sales backordered. Net income is expected to rise +130% to $3.83 billion. That equates to earnings per share of $4.09 on revenue of $18.9 billion. IPad sales are expected to be 4.8 million units. IPad was about the only tablet in the market in Q3 but that will change dramatically in Q4 as everyone else rushes to get products out for the holidays. Should Apple stub its toe when it reports earnings the drop could be dramatic.

I did see an advertisement for the iPad from Verizon on Friday. That will help their sales somewhat but the catch is the device has to be anchored to a hotspot rather than 3G. Since all the Verizon Android phones are also hotspots it makes any Verizon Droid customer a prospect for an iPad.

Apple Chart

Shares of Seagate (STX) rose +22% on Friday after news broke they could be taken private by either KKR or Bain Capital. Sources at Seagate said on Thursday it was in talks with TPG Capital about a potential buyout. Silver Lake Partners reportedly held talks with Seagate in September about a buyout. With all this activity it is only a matter of time before they get a deal done. Seagate is the leading disk drive maker and has a market cap of about $7 billion.

One problem all the manufacturers have is the high drop out rate of the new drives. The extremely dense media on 1TB through 2TB drives means there is no margin for error. I have heard of extremely high reject rates and very high failure rates upon installation. If you go to the sites with a large quantity of user reviews like NewEgg.com there is a very large number of RMA requests for drives that were DOA or died in the first couple weeks. The tolerances are simply so close there is little margin for error. This has got to be impacting margins.

Seagate Chart

Chip stocks posted only a minor gain on Friday after an analyst expressed worries that the falling dollar would impact margins on a product that was already commoditized. Earnings are already depressed due to competition and excess capacity and another hit from currency translation could be deadly. An 8% to 10% currency hit could be the difference between profits and losses. Texas Instruments reports on the 25th and several other chip stocks including LSCC, XLNX and CREE report earnings next week.

The dollar rebounded on Friday after Bernanke's speech. Bernanke warned that a prolonged period of high unemployment could delay the U.S. recovery and the low level of inflation presented an uncomfortable risk of deflation. "There would appear, all else being equal, to be a case for further action." This was seen as a guarantee that the Fed would add some more bond purchases when it meets in November.

Ironically interest rates on treasuries ROSE along with the dollar after the speech. Analysts claim the rebound was due to expectations the Fed would be successful in its actions. Personally I believe it was just a sell the news event. Bond traders knew the Fed was planning to act and they knew the speech was Friday. It was simply a sell the news event given the already record low yields and severely oversold dollar.

Bernanke also left himself an escape clause saying the Fed was still analyzing the costs, limitations and risks of a new program. One risk is the 10-month low on the dollar on Thursday night. This is causing some severe irritation to emerging market economies as capital chases yields around the world and forcing other countries to react to this capital flight.

Dollar Index Chart

Gold Chart

Gold prices declined slightly after hitting an intraday high of $1388 on Thursday. Goldman Sachs raised its twelve-month target price to $1,650. Goldman said gold could rise another 28% by the end of 2012, also Silver +30%, Copper +28% and Cotton +54%. Their estimate was based on rising demand in Asia and the falling dollar.

After a strong rally crude oil has been stuck under resistance for the last two weeks and gave up -$1.44 on Friday as the dollar rebounded and demand faded. U.S. gasoline demand for last week fell to the lowest level since November. Oil demand may be rising around the world but the U.S. is still mired in the quicksand of high unemployment. The various factors supporting prices last week including the dollar, hurricane, OPEC, closing of the Houston ship channel etc, have all faded from view and the current November contract expires next Wednesday. I would expect some volatility over the next three days.

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Crude Oil Chart

The Business Council, a group of the CEOs from the 150 largest U.S. corporations, said a recent survey of members showed a decline in sentiment. Only a third believe their industries will improve over the next six months. This is down from two-thirds in the prior survey back in May. The Council said the majority of members now believe the acceleration phase of the recovery is over. More than 75% of the CEOs expressed some hesitancy about the ability of the economy to grow at all.

The survey results did not project another recessionary dip but suggested 2011 would be more like 2010 in terms of overall economic growth. Over 70% of CEOs said the Federal budget deficit, the increased risk of regulation and unemployment were the biggest problems. 27 million Americans are either out of work, underemployed or too discouraged to even look for work according to the Labor Department. Jamie Dimon, JPM CEO, penned the introduction to the survey saying, "The momentum in the U.S. and global economy evident in recent surveys has subsided." Let's hope he is wrong.

Earnings are now expected to increase +24.2% over Q3-2009. This was a slight improvement from the 23.6% estimate just a week ago. A total of 109 S&P-500 companies report next week along with 11 Dow components. Only 46 S&P companies have reported with 83% beating estimates and 9% missing their targets. Since 1994 an average of 62% normally beat. That has risen to 77% over the last four quarters due to easy comparisons in the prior year.

However, analysts are expecting earnings of only $20.46 for the S&P-500 and that would be the first quarter-to-quarter decline since the recession. This reflects the soft patch experienced in August.

There are some important earnings next week with Apple, IBM and Citigroup starting the week off with a bang. I expect to see more upside surprises and I hope to see them from IBM and UPS. IBM is important because of the number of big ticket service contracts that will give us an idea on whether companies are going to spend some of their cash hoard. From UPS we will get an idea of package flow and the rate of business shipping. Hopefully it is increasing.

There is a pretty diverse array of companies reporting next week and by Friday we will know how the earnings season will end.

Earnings Calendar

When you look at the indexes for Friday it was a six stock story. Google, Amazon and Apple powered the Nasdaq 100 to a new high and BAC, JPM and GE tanked the Dow. We have not seen such a strong divergence between the two indexes in a long time.

The clearest evidence of the tech strength came on the Nasdaq 100 where Google, Apple and Amazon forced a breakout of major proportions. After two days of being pinned to the prior resistance at 2050 the index tacked on more than 40 points for a major breakout. This would be extremely bullish if the gains were not focused in just those three stocks. On a technical basis it looks great but on a macro basis there is reason to worry. With Google posting a $60 point one day gain what will it do for an encore next week?

Hopefully Apple will copy Google's performance with earnings on Monday and keep the move alive. Then we have to wait for Thursday and Amazon to have another chance for a big move on the index. I personally find it unlikely that anyone would choose to go long on Google early next week after a 60-point gain. Same with Apple after a 12-point gain on Friday and the potential for another big move on Monday. In normal times these would be perfect setups for the shorts. Eventually this insanity will run its course and we will see some profit taking.

Nasdaq 100 Chart

The Nasdaq Composite moved to a new five month high on the strength of those same three stocks. Unfortunately it has yet to return to the same resistance high at 2519 that the NDX succeeded in crossing on Friday. The chip stocks are holding it back. Of course "back" is a relative term with the +33 point gain on Friday.

Even though the composite is over extended I could see it running to 2519 on the strength of Apple and others next week. There are dozens of Nasdaq companies reporting so plenty of reasons for the normal trader to remain long.

Nasdaq Composite Chart

The S&P is far less bullish than the tech indexes. Friday's minimal gain of only two points was held back by the financial sector. The mortgage mess is going to be a drag on financials for weeks and we need to prepare ourselves now for some tough times ahead unless BAC and JPM mount a strong offense against the claims and do it quickly. As long as analysts like Dick Bove and Meredith Whitney are quoting liabilities in the $70-$80 billion range the banks are not moving higher. This is a major blow to market sentiment. Other sectors may continue higher but we will be dragging the financials along behind us.

The S&P closed out the week still shackled to the prior resistance at 1175. We closed over that level twice in the last three days but only by a couple of points. There is still a gravitational pull at that level. Should it break free the next major resistance is 1210-1220 and that could be a difficult level to cross even with the Fed cheerleading from the sidelines. A breakout there could run to 1300. I know that sounds crazy but don't fight the Fed and the anticipation of the elections.

S&P-500 Chart

For the Dow I believe we will test 11,200 next week even with the drag from JPM and BAC. The initial shock value of the mortgage mess has passed and it will require another chapter in the saga to knock another 10% off those banks in a single day. They will probably be laggards but they should not sink the Dow. There are 11 Dow components reporting next week and all should beat street estimates. Unfortunately that is now expected so anything less than a really good report could produce some selling in the individual stocks.

The Dow has support at 10,975 and resistance at 11,200. As long as we stay in that range next week I would be a happy camper because it would allow individual stocks to move without being hampered by a big Dow decline.

Dow Chart

Over the last 62 years the S&P averaged a +4.7% gain in Q4. Only 14 times in those 62 years has the S&P been negative. While that sounds promising, prior performance is no guarantee of future results. Also, 4.7% is only 55 points and the S&P has gained +35 since October 1st. That only leaves another 20 points to meet the average. Fortunately this is probably going to be an above average year.

Most analysts believe the market will finish the year higher. I believe Abby Joseph Cohen is expecting 1275-1300 on the S&P. I have heard a lot of analysts talking in that 1250-1300 range. The positive factors are of course the Fed and the election. I have already discussed the Fed so the election is the next topic.

Most polls have the republicans gaining control of the House and polls are split on control of the Senate. For the market to continue moving higher only one body needs to switch to republican control. That would guarantee gridlock for the next couple years and a lot of regulatory efforts would die a slow death. That would be bullish for the markets. How much of that is already baked into the current rally is unknown.

What we do know is that any continuing rally will struggle without the participation of the financials. Secondly we know that there is a potential for the mortgage mess to cause another shock to the system that could be seriously damaging. We are at that point where accusations and flying and government agencies are gearing up to make a nuisance of themselves. Unless this escalation of intensity is ratcheted down really quickly I fear we could have another crisis on our hands. Fortunately $80 billion, to use Dick Bove's number, is not the end of the world. It would be painful for the banks but they would survive. I am just not sure they would survive another cycle of investor flight. Mutual funds are still reporting withdrawals from equity funds and another crisis of confidence could accelerate that process.

We made it through option expiration without any major volatility and that is slightly bullish. The Dow declined nearly 100 points on Friday and recovered once again. That is slightly bullish because it had plenty of excuses to stay down. Volume accelerated beginning on Wednesday to nearly nine billion shares per day with expiration Friday trading 9.56 billion shares. Obviously the increase in volume for all three days was expiration related but higher volume is normally positive. Unfortunately two of those days were lopsided with 2:1 declining volume to advancing volume. Even with the selling imbalance the markets broke out to new relative highs and that is also bullish.

I believe the majority of traders are still in denial that the rally has come so far in the last six weeks and denial is normally bullish because it means many people are still shorting the rally. Until proven wrong I am still in buy the dip mode.

Jim Brown

The government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. - Ronald Reagan.


Index Wrap

Nasdaq 100 Sprints Way Out Front

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

Back in a different era, before the periodic dominance of tech stocks there were periods of market strength mostly centered in the big cap Dow stocks as that Average was the one mostly shooting higher. This pattern was sometimes described as a 'solitary walk of the Dow'. We can now wonder if the Nasdaq 100 (NDX) is doing the same thing. Of course Google's 11% gain on Friday accounted for much of the Friday sky shoot in the Nasdaq 100 (NDX).

The end of the week NDX spurt negated my Thursday concern mentioned in my Trader's Corner column , that there was a pronounced bearish price/RSI divergence in that index especially. With the Nas 100's strong Friday finish, RSI has just about, not quite, 'confirmed' the index in a similar new high. There's certainly no longer a wide divergence.

Many of the technical indicators put this extended rally in a high risk (for a) correction area. That doesn't mean that prices won't go still higher, just that further expectations of a lot more upside is countered by the risk to high risk of a shakeout. There does reach a point where all bullish news is priced into stocks.

A potential shakeout ahead is forewarned in daily sentiment readings that spiked higher into my 'extreme' bullish zone on 2 days this past week. Ultra bullishness on key tech stocks is what is driving this, whereas the S&P and the Dow are struggling to break out above technical resistance. Can the Nasdaq just go its own way and not have the S&P coming along for the party? There's some precedence for serious decoupling of a key index from the rest of the market. Stay tuned on that!

Many of the major indexes are in the 'red' (overbought) RSI zone on a daily chart basis, where length setting is 13 days. However, on a weekly chart basis, even the red-hot NDX is not yet at an 'overbought' extreme as measured by the 13-week Relative Strength Index (RSI) and the MACD indicator, as seen on my first chart. Is the next stop for NDX a re-test of its 11/2/07 weekly high at 2239? It's certainly a next looming target given that NDX has achieved a decisive upside penetration of the two prior highs (2056 & 2059) made since that 3-year ago peak.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) daily chart is still somewhat mixed in that the Index hasn't been able to break out above a key 1173-1182 resistance zone as noted on the chart. This is not to say that the uptrend isn't very much intact. But breaking out above prior pivotal resistance is a milestone for SPX's ability to challenge or retest its prior 1220 high.

Given the recent overbought RSI readings and this past week's 2 daily spikes into high bullish extremes in my trader sentiment indicator, SPX has some risk of a shakeout. Of course the recent consolidation in the 1180 area may just be that; i.e., a 'consolidation' before there's another leg higher. Pointing out the risk of a pullback, temporary or otherwise, is a cautionary note here.

Besides the 1173-1182 zone, I've noted resistance on the chart at the prior 1220 high. Major resistance is in the 1300 area. Near support is projected for the 1150 area, then at 1120.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) has been lagging the S&P 500 somewhat, as OEX has stalled at the low end (at 532) of what I've defined as its 532-537 key resistance zone. I have to believe that strength in the big cap Nasdaq stocks is what is supporting OEX, but isn't enough currently to pull OEX up on the most recent Google inspired shot higher in the Nas 100. If the Nasdaq falters, it's hard to believe that the S&P won't weaken, perhaps more than the tech heavy Nasdaq. Again, as with the larger S&P 500, the uptrend in the big cap S&P 100 is very much intact.

The question in my mind at this juncture is whether there's going to be a pullback before OEX can challenge its prior 12-month highs in the 554 area. As I've said often before, once the retracement of a prior major decline exceeds 2/3rds of that decline, there is an increased likelihood that a recovery rally will at least make it back to the prior top.

Key near resistance is at 532, extending to 537, with more major resistance implied by the prior top in the 554 area.

I've noted near support this week at the 21-day moving average once again, which is currently at 520. A modest pullback would take OEX back into this area, which is also the top end of 2-week consolidation. Major support likely begins in the low-500 area.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) is bullish in its pattern but may be stalled here at the top end of its uptrend channel. This isn't to suggest that having come this far, INDU won't retest its prior 12-month high in the 11258 area. The rate of increase from here could continue to be slow however. However it gets there, whether after a near-term correction or not, the Dow seems likely to at least retest its prior top.

Assuming there a sizable next up leg in the Dow beyond 11200-11258, a next major target for INDU is to the 11700 area. With some key bellwethers like GE and JPM faltering, I don't envision such a substantial further advance ahead currently.

I've highlighted near support at 10877, at the 21-day moving average, with fairly major support beginning around 10600.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) Index chart remains quite bullish in its pattern. COMP's up trendline is showing a steep rate of ascent and this trendline has stayed intact. When the index reached the area of its bullish trendline, after the recent mostly sideways move coming into this past week, COMP shot higher again.

Just on price action alone, it looks like there should be another spurt higher that carries COMP to a retest of its prior 12-month high. If I look at the 'overbought' indicators like the 13-day RSI and, recently, the upward spike of bullish sentiment, I wonder how the index can maintain such a renewed strong upswing.

When bullish sentiment readings on my CPRATIO indicator stayed moderate, prior to this past week, I thought it a good omen for a continued advance and that's sure happened. Yes and double check! Assuming bullishness continues to build up, both overall and with some daily upward spikes, I become less confident that the Nasdaq can keep charging higher. I'm also aware that a 'bit in its teeth' (pardon horse metaphor) charging ahead bull, will often be accompanied by a lot of bullish conviction for some time; e.g., for 2-3 or more weeks.

The next potential technical resistance for COMP is in the 2518-2535 area, at its prior highs; 2535 was the highest intraday high and is highlighted on the chart. The 2535 area marked a major double top relative to highs made in late-May/early-June 2008. The big cap NDX has already exceeded its similar double top. However, COMP carries a lot of 'baggage' so to speak in that all Nasdaq market stocks are contained in the index. Not all tech stocks are seeing the earnings growth of an Apple or Google.

I've noted near support again at the fast rising 21-day moving average, currently at 2381. I didn't note these levels on the chart, but 2332 should be a next key support, with pivotal lower support if a pullback carried to as low as the 2250 area.

NASDAQ 100 (NDX) DAILY CHART:

As I wrote last week: "The Nasdaq 100 (NDX) has made a new Closing high and appears to be ready to achieve a decisive upside penetration of the top end of the index's recent narrow 1970-2030 trading range." And, another 'no brainer' was my add-on that: "Unlike the S&P and the Nas Composite, NDX has retraced nearly ALL its entire prior decline. It is unlikely that the index is going to get this close and not retest its prior high..." I think this prediction was a no-brainer in the sense that stocks and indexes repeat these patterns so often; i.e., retracing 66% of a prior move and then going on to achieve a 100% 'round-trip' retracement. Not so easy is to predict the NEXT move for NDX!

I've noted what may turn out to be minor resistance in the 2140 area assuming this rally keeps on track. The major next test for the index looks to be the top made 3 years ago, as of early-November, around 2239. The NDX chart is impressive technically, enough so that a further 50-100 point, or more, advance looks possible.

I will be watching the steep up trendline. When the current rate of change or momentum starts to slip and prices dip below that line, especially on a closing basis without a strong snap back rally the next day, I'll be anticipating a further correction. Such a correction is 'due' but it always looks that way when a strong trend goes on to being a super strong trend. It's hard to predict where these things will end, where a top will develop in this kind of market. A trendline break is often the first clue.

I've pegging near support in the low-2000 area, with next support (not highlighted) around 1963, then at 1900 even.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

Bullish, bullish, bullish: the pattern of a decisive upside penetration of a prior key high, with the index or stock then taking off in a strong further spurt higher. You can see the effects of short-covering and renewed buying, probably at least initially on buy-stops (to also take on new or added long positions) placed just over 50.6.

52.6 may offer some resistance if this rally keeps up its furious pace higher, with fairly major resistance coming in around 55.0, which marked the high of nearly 3 years ago. November tends to be a month when fall highs often occur on a seasonal basis.

Near support: 49.4

Next support: 48.2, then 46.7

Near resistance: 52.6

Major resistance: 55.0

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT), as it turns out, has had a remarkably consistent and strong advance, with several intraday lows that were 'touches' making up a well-defined up trendline. I didn't note it as immediate support, as levels just below the relatively steep up trendline will keep changing day to day, but on Monday for example a drop below 694-695 would be an initial (downside) penetration of RUT's steep up trendline. I've noted 680 on the chart as support, then at 654, at the 200-day moving average.

Resistance is still noted at 720 from last week, then at the prior 12-month intraday high at 746.

As with the Nasdaq, it seems unlikely that RUT would exhibit the kind of buying power underlying the multiweek strong rally (dating from the late-August double bottom low) and get so close to its prior top without challenging or retesting that peak. However, watch the up trendline for signs of a break.



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

Solar, Healthcare, Construction Supplies

by James Brown

Click here to email James Brown

Editor's Note:
I'm filling in for Scott this weekend.

- James


NEW DIRECTIONAL CALL PLAYS

First Solar Inc. - FSLR - close: 144.56 change: +2.29 stop: 135.95

Target(s): 145.00, 147.50, 149.00
Key Support/Resistance Areas: 137.50, 140.00, 145.00, 147.50, 150.00
Current Gain/Loss: +00.0%
Time Frame: 3 to 4 weeks
New Positions: Yes, see entry point below

Company Description:
First Solar manufactures solar modules with an advanced semiconductor technology and provides comprehensive photovoltaic (PV) system solutions. The company is delivering an economically viable alternative to fossil-fuel generation today. From raw material sourcing through end-of-life collection and recycling, First Solar is focused on creating cost-effective, renewable energy solutions that protect and enhance the environment (source: company press release or website)

Why We Like It:
Shares of FSLR have been marching higher after producing a huge (bullish) double bottom pattern with the lows in February and June. Now the stock has created a more bullish pattern of rally, consolidate, rally, consolidate. After two weeks of correcting traders are now buying the dip in FLSR near support in the $137-140 zone.

Aggressive traders could launch positions right now following Friday's bounce from $140. However, I suspect we'll see a better entry point on a minor dip this week. I'm suggesting we use a trigger at $142.50 to buy calls. If triggered we'll use a wide stop loss at $135.95 since FSLR can be so volatile (as an alternative more conservative traders could put their stop closer to $140). If triggered our first target is $145.00. Our second target is $147.50. Our final target is $149.75. More aggressive traders could aim for the $160 area. FYI: Investors should note that FSLR is due to report earnings on October 28th. Earnings reports can significantly raise our risk.

Suggested Position:

Trigger to buy calls @ $142.50.

BUY the November $150 calls.

Annotated Chart:

Entry on October xxth at $ xx.xx
Earnings Date 10/28/10 (unconfirmed)
Average Daily Volume = 1.5 million
Listed on October 16th, 2010


Humana Inc. - HUM - close: 54.84 change: +0.53 stop: 49.75

Target(s): 54.95, 57.50, 60.00
Key Support/Resistance Areas: 50.00, 51.00, 53.50, 55.00
Current Gain/Loss: +00.0%
Time Frame: 6 to 8 weeks
New Positions: Yes, see entry point below

Company Description:
Humana Inc., headquartered in Louisville, Ky., is one of the nation’s largest publicly traded health and supplemental benefits companies, with approximately 10.3 million medical members and approximately 7.3 million specialty-benefit members. Humana is a full-service benefits solutions company, offering a wide array of health and supplementary benefit plans for employer groups, government programs and individuals. Over its 49-year history, Humana has consistently seized opportunities to meet changing customer needs. Today, the company is a leader in consumer engagement, providing guidance that leads to lower costs and a better health plan experience throughout its diversified customer portfolio. (source: company press release or website)

Why We Like It:
Check out the HMO healthcare index. Investor sentiment for the healthcare sector has changed. Fears about the healthcare reform seem to have faded and now the sector is breaking out to new three-year highs. HUM is helping lead the way. Shares have been very strong this past week with a rally toward the top of its bullish channel. We want to hop on board but wait for a better entry point.

I am suggesting readers use a trigger to buy calls at $52.50. More cautious traders could look for a dip closer $51.00 but I don't think we'll see HUM pullback that low. If we are triggered at $52.50 I'm suggesting a stop loss at $49.75. Our first target is $54.90. Our second target is $57.25. Our third, longer-term target is $59.00. Time frame is six to eight weeks. Technical traders will note that the P&F chart is bullish with a $66 target. FYI: HUM is due to report earnings on November 1st. We normally want to avoid holding over earnings but I would make an exception for HUM.

Suggested Position:

Trigger to buy calls at $52.50

BUY the November $55 calls - or - BUY the 2011 January $55 calls.

Annotated Chart:

Entry on October xxth at $ xx.xx
Earnings Date 11/01/10 (confirmed)
Average Daily Volume = 2.1 million
Listed on October 16th, 2010


NEW DIRECTIONAL PUT PLAYS

Fastenal Co. - FAST - close: 52.10 change: -0.61 stop: 54.25

Target(s): 50.25, 48.25, maybe lower
Key Support/Resistance Areas: 55.00, 52.00, 50.00, 48,00,
Current Gain/Loss: +00.0%
Time Frame: 3 to 4 weeks
New Positions: Yes, see entry below

Company Description:
Fastenal sells different types of industrial and construction supplies in the following product categories: threaded fasteners and miscellaneous supplies; tools; metal cutting tool blades and abrasives; fluid transfer components and accessories for hydraulic and pneumatic power; material handling; storage and packaging products; janitorial, chemical and paint products; electrical supplies; welding supplies; safety supplies; and metals, alloys and materials. Fastenal operates more than 2,400 stores located primarily in North America with additional locations in Asia, Europe, and Central America. The Company operates 11 distribution centers in the United States - Minnesota, Indiana, Ohio, Pennsylvania, Texas, Georgia, Washington, California, Utah, North Carolina, Kansas, and three outside the United States - Ontario, Canada; Alberta, Canada; and Nuevo Leon, Mexico. (source: company press release or website)

Why We Like It:
Traders were disappointed with FAST's recent earnings report and guidance. Shares had soared from $45 to $55 in just a few weeks and the stock plunged on the earnings news (Oct. 12th). The bounce attempts this week were also sold sharply and FAST looks poised for a much deeper correction.

I am suggesting new bearish positions now at current levels. We'll use a stop loss at $54.25. Our first target is 50.75 near the simple 50-dma. Our second target is $48.25, but watch for potential support at the rising 200-dma. It is possible that FAST actually sinks lower since the larger pattern on the weekly chart is one of lower highs and lower lows.

Suggested Position:

Buy the November $50.00 puts, current ask $1.05

Annotated Chart:

Entry on October 18th at $ xx.xx
Earnings Date 10/12/10
Average Daily Volume = 1.0 million
Listed on October 16th, 2010


In Play Updates and Reviews

Banks Continue to Lag

by James Brown

Click here to email James Brown

Editor's Note:

I am filling in for Scott tonight who returns on Monday.

-James

Current Portfolio:


CALL Play Updates

Dresser-Rand Group - DRC - close 38.36 change +0.13 stop 36.15

Target(s): 39.00, 39.95, 41.40
Key Support/Resistance Areas: 42.00, 40.00, 39.15, 37.50, 36.30
Current Option Gain/Loss: +7.1%
Time Frame: 2 to 3 weeks
New Positions: Yes

Comments:
10/16 (James): There is really no change from my comments on Thursday. DRC is bouncing around the $38.00-39.00 level with short-term support at $38.00. The pattern is bullish with a trend of higher lows as the stock tries to breakout over $39.00. If DRC can breakout from this pattern I would expect shares to challenge their all-time highs in the $42-44 zone so readers may want to adjust their targets higher. However, cautious traders do not want to hold over the earnings report. I can't find a specific date but DRC is expected to report on the Oct. 27-30th time frame.

10/12: DRC is finding resistance at $38.25 but it appears it only a matter of time before this is broken to the upside. I'm looking for DRC to move to our first target of $39.00 in the coming days and if the market remains strong we should see $39.95, perhaps next week. I suggest traders use strength to begin to exit positions or tighten stops to protect profits. A move to $39 should produce a +55% gain while a move to $39.95 should produce a +90% gain.

Current Position: Long November $40.00 CALL, entry was at $0.70

Annotated Chart:

Entry on October 6, 2010
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 570,000
Listed on October 5, 2010


Genco Shipping & Trading, LTD - GNK - close 16.45 change +0.06 stop 15.50

Target(s): 17.70, 18.05, 18.50
Key Support/Resistance Areas: 18.25, 17.75, 16.90, 15.75
Current Option Gain/Loss: -25.0%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
10/16 (James): There is no change from my Thursday comments on GNK. Traders bought the dip again for the second day in a row near GNK's 100-dma and short-term support near $16.20. If this stock can rally past the October highs it could see a significant short squeeze. I wouldn't be surprised to see a rally toward $20.00. The Baltic Dry Goods shipping index, a measure of shipping rates, has been improving recently, which should bolster GNK shares.

10/14: Hmm... I am definitely seeing some mixed signals on GNK. The trend from late September is up with traders buying the dips, like they did today. However, on a very short-term basis, GNK has produced a bearish double top at $17.10. At the same time short-term support near $16.20 held up today. I do think GNK offers a lot of potential. The most recent data lists short interest in this stock at more than 18% of the very small float (27.7 million shares). That is a recipe for a short squeeze if GNK can show any strength. If the market pulls back again I would look for a potential entry point on a bounce from what should be support near $16.00 and its 50-dma.

10/11: Basic materials have been exploding as investors are flocking to hard assets and the stocks that mine and produce them. However, the shippers haven't fared as well and I believe they are due for a run higher as these materials need to be stored and shipped around the world. GNK has been forming an ascending triangle over the past six weeks and closed near the top of its base today. I would prefer to catch a pullback in the stock but a breakout play is also a good set-up. I suggest we enter long positions if GNK trades to $17.15 (a breakout) or $16.55 (a pullback). Our stop is below the stock's 20 and 50-day SMA's and an ascending trend line and will be adjusted as the trade develops.

Current Position: Long November $17.00 CALL, entry was at $0.80

Note: Readers who want to give this more time to work may want to consider buying the JAN 2011 $17.50 CALLS

Annotated Chart:

Entry on October 12, 2010
Earnings 11/1/2010 (unconfirmed)
Average Daily Volume: 1.2 million
Listed on October 11, 2010


Thompson Creek Metals - TC - close 11.61 change -0.07 stop 10.45

Target(s): 11.75, 12.40
Key Support/Resistance Areas: 12.60, 11.80, 11.00, 10.55
Current Gain/Loss: +5.5%
Time Frame: 1 to 3 weeks
New Positions: Yes, on pullbacks

Comments:
10/16 (James): TC experienced some volatility on Friday morning but shares settled into a sideways churn heading into the weekend. A little pullback toward the $11.15-11.00 zone could offer a new bullish entry point to buy the dip. I'm optimistic that this stock could trade toward $12.75 before hitting any significant resistance. FYI: I can't find any data on an earnings date for this company. Cautious traders will want to avoid holding over earnings, which makes this somewhat more risky.

10/9: It seems there is no stopping the basic materials sector as the lackluster employment report is sure to be followed by additional stimulus. Molybdenum is high strength metal and is used to make aircraft parts, electrical contacts, industrial motors and filaments to name a few. Technically, TC broke through resistance near $11.00 and touched its 200-day SMA on Friday. I would like to see the stock retrace some of those gains and suggest we enter long positions with a trigger of $11.10 which is -18 cents lower than Friday's close. Our targets are about +6% and +11.5% higher than our trigger.

Current Position: Long November $11.00 CALL, entry was at $0.90

Annotated Chart:

Entry on October 12
Earnings 10/4/2010 (unconfirmed)
Average Daily Volume: 1.7 million
Listed on October 9, 2010


PUT Play Updates

Alliant Techsystems - ATK - close 73.82 change +0.05 stop 76.25

Target(s): 72.25, 71.50, 70.50
Key Support/Resistance Areas: 76.00, 74.00, 72.00, 71.25, 70.00
Current Gain/Loss: -34%
Time Frame: 1 to 2 weeks
New Positions: Yes, with tight stops

Comments:
10/16 (James): Shares of ATK continue to churn sideways under resistance near $75.00 and its descending 200-dma. I don't see any changes from my Thursday comments. Readers may want to wait for a move under $73.25 before launching new positions. FYI: ATK is due to report earnings on November 4th, before the opening bell. Wall Street expects a profit of $2.81 a share.

10/14 (James): I can certainly see why Scott picked ATK as a bearish play. The rally has stalled at significant resistance near $75.00, which just happens to include resistance at the 68.2% Fib retracement of the summer sell-off. This same level is now seeing additional resistance with the simple 200-dma overhead. ATK produced a failed rally on Oct. 1st and it appears the stock just did it again today with a miniature bearish engulfing candlestick pattern. Now usually these patterns need to see confirmation. Readers may want to wait for a move under $73.25 before launching new positions. I wouldn't be surprised to see ATK retest $70 over the next few weeks. 10/9: ATK formed a perfect bearish head and shoulders pattern on its hourly chart turned lower right where it should have. Now we follow through to the downside. The stock remains below its 200-day SMA and I am ultimately looking for a move towards its 50-day SMA and our second target of $71.25. I do think a sell-off will likely get bought so be prepared to take profits or tighten stops to protect them.

Current Position: Long November $70.00 PUT, entry was at $1.45

Annotated Chart:

Entry on October 4, 2010
Earnings: 11/11/2010 (unconfirmed)
Average Daily Volume: 310,000
Listed on October 2, 2010


PNC Financial - PNC - close 51.32 change -0.43 stop 54.92

Target(s): 51.05, 50.35, 49.50, 48.75
Key Support/Resistance Areas: 54.50, 53.50, 50.50, 49.50, 48.75, 47.00
Current Gain/Loss: -19.8%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
10/16 (James): Financial stocks continue to under perform the rest of the market with the BKX and BIX banking indices both down more than -2.3%. Shares of PNC only lost -0.8% on Friday as the stock found some support at its late September low. Readers could look for a bounce back toward the $52.50 area as a new entry point to buy puts. The simple 50-dma is very clear overhead resistance. Keep in mind that PNC is due to report earnings on October 21st, before the market's opening bell. Analysts are looking for a profit of $1.36 a share. Normally, we prefer to avoid holding over an earnings report. FYI: The Point & Figure chart is bearish with a $48 target.

10/14 (James): Bingo! PNC has started to breakdown again. Financials were the market laggards today as investors worried about the state of foreclosures in this country. Shares of PNC lost -2.2% and broke down under a short-term bullish trend of higher lows. It looks like our first target was hit $51.05 this afternoon (the option was trading near $1.10 at the time). Personally I would aim for the August lows and beyond.

Current Position: Long November $48.00 PUT, entry was at $1.26

Annotated Chart:

Entry on September 30, 2010
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 5 million
Listed on September 29, 2010