Option Investor
Newsletter

Daily Newsletter, Saturday, 10/30/2010

Table of Contents

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

Market Wrap

Trick Or Treat

by Jim Brown

Click here to email Jim Brown

The markets struggled to hold their gains all week as we wait to see if the Fed is going to give us a treat or a trick.

Market Statistics

Friday was a strange day with more emphasis put on a couple of bombs from Yemen than the handful of meaningful economic reports. Volume was mediocre and the Dow traded in a very tight 55-point range. Despite a couple of sharp intraday declines fund managers were able to close the Dow over support at 11,100 and the Nasdaq stretched its string to eight consecutive days of gain. Okay, it only gained +0.04 points on Friday but it still counts. The Nasdaq gained +28 points for the week but most of that was on Thursday. Managers just wanted to close it over 2500 and near the highs for the year at 2520. They held off the bears all week and Monday starts a new fund fiscal year.

The economics were mixed with the headline GDP number for Q3 coming in at +2.0% compared to growth of +1.7% in Q2. However, if you remove the inventory-rebuilding component the GDP would have been only +0.6%. Investment growth slowed dramatically from +2.1% to only +0.1%. Government spending accounted for +0.7% of the overall GDP. That means government spending is the only thing that kept the ex-inventory GDP positive. Exports improved to a -2.0% from -3.5% in Q2. That offset a +1.8% gain in personal consumption.

The inventory rebuild phase is nearly over. Inventories were allowed to decline to very low levels during the recession. When the rebound began last March it took several months for wholesalers to feel better about future demand and begin placing orders to replenish inventories. That replenishment cycle has run its course but consumers have not stepped up their buying as they have in previous rebounds. That means future quarters will not have the inventory crutch to keep them positive. When that inventory is sold in Q4 it will detract from GDP. Building inventory adds to GDP, declining inventory detracts from GDP. Also, this is for Q3 and you may remember that most of the stimulus spending ended at the end of Q3. The government will not be nearly as big of a contributor as in Q3.

Recently we have been plagued with multiple downward revisions. The Q2 GDP started out at 2.4% but was revised down repeatedly until the +1.7% final. This will probably happen to the Q3 number as well. Some economists are predicting a +1.6% final of which government spending will be nearly half and ex-inventory would be almost flat.

Until employment picks up the GDP should remain at or below the 2% level. This is not expected until late in 2011. For reference, normal GDP at this stage of an average recovery would be around 5%.

On the positive side we have seen some upside guidance with the recent earnings reports so there is economic activity. It is not the consumption graveyard many analysts would have you believe. Businesses are still reluctant to invest until the growth begins to accelerate. It is the basic chicken and egg story. Consumers can't consume until they have a job. Businesses won't hire until consumers begin to consume.

We are creating what could be a massive explosion of pent up demand but it is well out into the future. Just because consumers are not spending today does not mean they don't want to spend. They have to be cautious until jobs improve. Once the economy does start to improve significantly there will be a release of all that pent up demand and it could be explosive. However, it takes a GDP of around 3.5% before decent employment numbers will appear.

The GDP numbers are one more guarantee the Fed is not going to raise rates for a long time. Most analysts are now expecting the Fed to be on hold possibly until 2012.

GDP Chart

Reinforcing the gloomy outlook by consumers was an 11-month low in October Consumer Sentiment at 67.7 compared to September's 68.2. The decline was driven by a three-point drop in the current conditions component from 79.6 to 76.6. It will be extremely interesting to see how the November sentiment changes after the elections.

Consumer Sentiment Chart

The ISM Chicago surprised to the upside with a 60.6 reading. That was only a +.2 improvement over September's 60.4 but analysts were predicting a decline to 58.5. New orders improved to 65.0 from 61.4 but backorders were flat at 49.2 and slightly in contraction territory for the second month. Employment improved better than a full point to 54.6. The biggest gain was the production component, jumping +5.5 points to 62.8.

Regional manufacturing reports have been weak and the Chicago ISM was a real surprise. Obviously it was buoyed by auto manufacturing in the area while other regions don't have that support base.

ISM Chicago Chart

The ISM New York was also up strongly with the headline number gaining 7 points to 477.9. This was the largest gain in the ISM-NY since June. The current conditions component spiked from 58.3 to 64.7 and the six-month outlook rose from 64.8 to 69.8. The employment component gained a point to 54.4 and consistent with the employment gain in the ISM-Chicago.

The ISM New York is more of a services index where Chicago is a manufacturing base. New York has added 60,000 jobs this year and 40,000 were in the services sector. Hotel occupancy rose to 85.7% in September and the highest level since September 2006 according to Smith Travel. Room prices are also rising with a +12% gain for the year. There are green shoots in the economy but they are scattered and not yet turning into a lawn.

The national ISM will be released on Monday and it is expected to rise from 53.3 to 54.5.

The economic calendar for next week has some major events. The first group is the ISM Manufacturing followed by Factory Orders and ISM Non-Manufacturing.

The biggest event for the week is the FOMC meeting and the statement on monetary policy on Wednesday. In theory this is when the Fed will outline its new quantitative easing program the market is all hyped up about. This could be a seriously pivotal event for the markets. If the Fed announces a big program the market will probably breathe a sigh of relief the hype was valid and eventually move higher.

If they announce some minor program with incremental purchases based on economic indicators at the time, the market will probably go into short-term free fall. Eventually it will recover but with less emphasis. This is not the option the market prefers.

Regardless of what they announce I expect a sell the news event. I could be mistaken but I think there could be a bunch of fund managers looking to take profits now that they are in a new fiscal year.

Lastly we have the Non-Farm Payrolls on Friday. The consensus estimate is for a gain of 62,000 jobs compared to the loss of 95,000 in September. I am actually leaning towards a higher number and possibly in the 100,000 range. We have seen the employment components improve slightly in the regional reports and the large-scale census terminations should be over.

I may be overly optimistic but the JOLTS report showed an improvement, as did the Mass Layoffs report. All the improvements have been minimal but they show a rising trend.

Employment is about to get a lot worse but it won't show up in the payroll report. After multiple emergency extensions to state and federal unemployment benefits the crows are coming home to roost. Currently a person can qualify for a total of up to 99 weeks of unemployment compensation when combining state and federal programs. Those extensions end on November 30th. Nearly one million people will quit receiving checks in December and another 3-4 million will lose benefits by April. Roughly five million people will no longer get their weekly checks. Since the average check is about $300 that equates to a loss of $80 billion in spendable income over the next several quarters and could knock another sizeable chunk off the GDP.

Most analysts doubt the lame duck Congress will extend the tax cuts although most consumers expect that to happen with a republican win. They don't understand the process and the animosity that may restrict any bipartisan agreements. They may get another round of unemployment benefits passed but I am not holding my breath on that either.

Economic Calendar

In stock news Chevron reported earnings that disappointed with profits down -2%. Chevron said costs related to the drilling moratorium and monster currency charges were the reason for the disappointment. Chevron reported earnings of $3.77 billion or $1.87 per share. That compares to $1.92 in the year ago quarter. Analysts were expecting $2.15 per share. Revenue rose +7% to $49.7 billion.

Chevron took a charge of $367 million on currency translation issues related to the drop in the dollar. That has cost them $600 million over the last two quarters alone. Chevron said production in the Gulf fell by 10,000 barrels per day due to the moratorium. Every well suffers production declines as time passes. If you are not drilling new wells to replace that lost production your profits will suffer. Total U.S. production fell -7% or 53,000 boe per day. The company said the drop was due to "normal field declines."

Chevron said exploration costs jumped +74% to $420 million for the quarter because of expenses in the Gulf and dry holes in Canada and Turkey. Chevron is forced to continue paying leases for its nine rigs in the Gulf even though they are unable to work. The company said it could be months before drilling resumed in the Gulf because of new permitting rules.

Chevron did warn that the refining business still faces difficult years ahead with "tepid" growth in the demand for refined products. The reasons given were the global recession, government mandates for alternative fuels and increased fuel efficiency for new vehicles. Chevron shares lost -2% for the day.

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Merck (MRK) reported disappointing sales and took a $1 billion charge related to its Vioxx arthritis drug. Merck had already agreed to pay out $4.85 billion in damages to people who had taken the drug. Despite the weak sales and charges the company still beat analyst estimates for profits. Merck reported profits of 85-cents excluding items and analysts were expecting 82-cents. That minor beat did not help the stock with a -2% loss for the day.

Nasdaq (NDAQ) reported earnings of 50-cents compared to analyst estimates of 47-cents. That was still a 2-cent decline from the comparison quarter. Gains in market data fees and new products were offset by lower overall volume after the flash crash. Nasdaq raised its estimates for operating expenses and the guidance was not exciting. After an opening spike shared of NDAQ closed with only a fractional gain.

Blended earnings growth for the S&P-500 rose to 30.1% on Friday. This compares to the estimates for 23.8% growth back on October 1st. Of the 335 (67%) of companies reported 77% beat estimates and 17% missed estimates. This pushed the earnings growth rate for all of 2010 to +32%. For a recessionary low growth environment I don't see how we could have asked for much more other that a little better revenue numbers.

With 67% of the S&P already reported we know how this cycle will end. The few major companies left to report will not change the outcome significantly. The bloom is off the earnings rose for Q3 and it will be increasingly harder for a positive surprise to move the market.

The market handled the Yemen bomb news with barely a hiccup. Despite wall-to-wall cable TV news coverage the volatility was minimal and the Dow remained in its 55-point range. As of late Friday night the devices are still being called bombs although there appears to be considerable confusion. In a news conference President Obama said the packages contained explosive material. One was setup to be triggered by cell phone and the other had a timer. The New York Times reported they were printer cartridges filled with PTEN, the same explosive used in the underwear of the Christmas bomber over Detroit. After the scare both UPS and FedEX announced a cutoff of shipments from Yemen. In return Yemen closed down the FedEx and UPS facilities in the country. Several European nations were also canceling all airline flights involving Yemen.

Trimtabs.com reported on Friday that investors put $759 million into U.S. equity funds in the week ended on Tuesday. That may not seem like a lot of money compared to the $4 billion on average they have been taking out every week but it marked a special event. It was the first week in over six months where fund flows went into U.S. equity funds instead of exiting those funds. Think about that. The market is at the highs for the year and the retail investor has been taking out an average of $4 billion a week from equity funds and putting it into bond funds and emerging market funds. If that trend were to reverse the impact on our markets would be huge.

Portfolio managers claim the phones started ringing about ten days ago and with the market about to make new highs clients are asking if they should get back into the market. Clearly the herd is always wrong but that does not mean we can't profit from that trend.

Since Ben Bernanke announced QE2 on August 27th the S&P is up +13%. The QE2 roller coaster has not only left the loading ramp but has reached the top of the first major hill. What next is the key question? The QE trade is very overbought and we have not had a decent bout of profit taking since August. Conventional wisdom suggests we should see a sell the news event that knocks 5% or more off the indexes. Conventional wisdom is normally wrong when it comes to the stock market.

A 5% decline would be an ideal scenario because it would give everyone waiting on the sidelines an opportunity to buy. I believe we will see a sell the news event next week and there are plenty of news events to sell. The biggest of course is the Fed statement. Since it comes after the election we will know what the next two years is going to look like in the House and Senate and be able to project the political and regulatory environment and its impact on the markets.

Business owners will be able to project how the changes will affect their businesses and act accordingly. You may remember last week when the Job Openings and Labor Turnover Survey report showed an increase in job openings. The openings spiked significantly but there was no material increase in hiring. I theorized at the time that businesses were planning for a specific election outcome and maybe the impact of QE2 and had authorized the new positions but were waiting for the results of the two events before actually hiring anyone. They have been accepting resumes and doing interviews so actually hiring people could occur very quickly. Well, next week is the week where the rubber meets the road. The economic and political outlook should be very different by next Friday. Hopefully it will be a positive change.

Yes, the market has now priced in the election, a new Fed QE2 program and some pretty decent earnings surprises. Conventional wisdom would suggest it is time to take profits. That assumes of course that you are in the market. For the millions of investors who pulled their money out of the market they are seeing those three things as signs they should go back into stocks. With the conventional wisdom traders shorting the market next week the sidelined investors could be their worst nightmare. Remember, the market can remain irrational far longer than we can remain liquid.

There is also a historical factor pushing those market timers back into the market. Since 1942 in the 12 months following a midterm election the market has averaged a 24.7% gain. That is a hefty average considering some years did significantly worse. The normal Q3 to Q3 gain is only 8.9% so there is something to be said for buying into the election.

Taken another way the average annual market gains since 1942 work out to 6.3% for the first year of a presidency. The second year averages 4.9%, third year 17.1% and fourth year 5.7%. We can see in those numbers that the post midterm year is three times stronger than the other three. Those averages cover booms, busts and recessions so more often than not the historical trend repeats.

I personally have some very strong views about the financial mess the country is in with rampant spending and debt and I worry that we are in for some really tough times before the decade is out. I know a lot of readers also feel that way. However, I do believe we are going to see a continued rally if the Fed announces another QE program as expected. They have to force the dollar lower to stimulate inflation and the economy sooner rather than later. The cheaper dollar and the surplus of cash will force people out of bonds and money market funds and back into the market. This will eventually create a wealth effect and investors (consumers) will start feeling prosperous again and spending money. Eventually it will end badly but in the short term we could see an explosive market. I can't tell you how many times I heard S&P 1300 even 1350 for a year-end target last week. I hope they are right.

The S&P slammed into resistance at 1185 the prior week and after a week of trying was unable to move back over that level. I think it is remarkable that fund managers were able to just hold it at that level given the couple serious intraday declines. Every time they fought point-by-point to push it back to that resistance but the bears mounted a successful goal line stand and would not let them pass.

Even the golden cross of the 50-day average back over the 200-day average was not enough to give the bulls an edge. OR, maybe it was the edge that helped them recover the high ground day after day.

The term bad news bulls has never been more appropriate. Time after time the economic news, currency spike or earnings surprises produced a temporary decline but nothing seems to keep them down more than a few minutes. You can imagine them repeating their mantra day after day, "Don't fight the Fed!"

I am kidding about the bull's impact here but I am sure they helped. In reality I believe it was more year-end window dressing by the funds than a new stampede by the bulls.

For next week initial resistance is 1190 followed by 1210. Initial support is 1175 followed by 1160. A 5% correction would target support at 1120 and I would be extremely surprised if that level broke.

S&P-500 Chart

The Dow actually spiked over 11,200 for a few minutes last Monday and that was it for the week. We closed on Friday after four consecutive days of lower highs. The bears are sitting on resistance and that resistance was slipping lower every day. This is called a heavy market by the bears and consolidation by the bulls. Fund managers did not care what you called it as long as they could end the month over 11,100.

Support is pretty solid at 11,025 but I would be very surprised if we didn't see 10,925 in early November. After 3M lost $7 I am surprised they could push the index back over 11,100. I scanned all 30 Dow charts and 11 of them are pretty ugly.

Dow Chart

The Nasdaq came to a dead stop at just over 2500 but has managed to extend its string of positive gains to eight consecutive days. I don't know if you could actually call this formation a cup and handle but the outlook is clear. After several months of profit taking from the recession low rebound the Nasdaq is poised to break over fib resistance and the two prior resistance highs at 2519. If it succeeds in breaking over 2520 the resulting short covering and price chasing could be explosive. There is no immediate resistance over 2520 and we could be in for an amazing run if it happens.

Initial support is 2490 followed by 2480 then 2420. Dragging on the Nasdaq is Apple at 7% of the Nasdaq Composite and 20% of the Nasdaq 100 ($NDX). Apple declined to $300 on Friday and has been in steady decline since their earnings report. With new tablets coming to market almost every week there is plenty of competition and margins are shrinking. The Nasdaq will have a tough time moving higher if Apple does not break out of its slump.

Nasdaq Chart - Weekly

Nasdaq Chart - 15 min

Apple Chart

Powering the Nasdaq over Apple's decline is the remarkable recovery in the semiconductor sector. The SOX gained a whopping 4.4% last week when most of the indexes were flat. This is surprising to me since several chipmakers warned about future sales and the slowdown in PC growth. Offsetting those worries were a few chip companies that are producing chips for phones and things like the new tablets coming to market. Business is good for them. The bad news bulls obviously picked what information they felt was relative and jumped on the chip express.

If the SOX breaks through resistance at 375 we could see some short covering and a race to 400. That level will probably prove tougher to overcome. Support is well below at 350 and I would be surprised to see a dip of that magnitude.

Semiconductor Index Chart

The Russell 2000 has encountered some serious congestion between 700-710. For two weeks now the index has been unable to break out of that range and resistance at 710 is proving formidable. This is due to the age-old problem of window dressing. The majority of the cash goes into the highly liquid blue chips in the last couple weeks of a quarter or in this case of the funds fiscal year end. Small caps get the leftover change.

Once we are past any sell the news event next week I expect that to reverse. Big caps will be sold and that money will find its way into the small caps in expectations of that big post midterm election rally.

At least that is the theory. In the 60 min chart there is a pattern of higher lows on each succeeding dip and I believe that is telling us which way the pattern is going to resolve once the news volatility is over.

Russell Chart - Daily

Russell Chart - 60 Min

Last but not least the Dow Transports are also poised for a breakout over 4800. We see a similar pattern of consolidation after the post recession rebound and now the transports are poised to breakout of that consolidation period and start a new trend higher. Next resistance is 5400-5500 but once out of this consolidation pattern we should also conquer those 2008 highs.

I am hearing stories of a severe lack of drivers and trucks. As the recession deepened the marginal drivers were sent home and the marginal equipment was retired. Now that business is improving those companies are short. Drivers are being offered bonuses to switch companies and rates are rising. This is another green shoot that is going unnoticed by the general public but based on the solid string of green candles on this chart somebody got the message.

Dow Transport Chart

In summary I expect a sell the news event next week. "IF" we get a dip on other than a deficient QE2 program I would be a buyer. I believe the Fed is going to flood the system with money now that the stimulus programs are over. How they will do it should be clearer after Wednesday's announcement. I believe the combination of cheaper dollars and the end of election uncertainty will eventually push the markets higher. I want to buy the dips with expectations of a longer-term hold.

There are only 64 days until Christmas. Did you know that Black Friday sales have already started? Yes, stores like Sears and Target have already started advertising sales as Black Friday sales even though they started last week. It is going to be a bitterly competitive shopping season as the majors try to coax shoppers off the couch and into the mall. I believe the early holiday shopping hype will help to improve consumer sentiment and add to market sentiment.

So, what are you giving as gifts this year besides an iPad?

Jim Brown

The pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. Winston Churchill


Index Wrap

Two Tiered Market

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

In terms of the S&P indexes and the Dow, prices were either unchanged to off slightly on the week. Meanwhile, the Nasdaq market continues to gain; not a lot but both the Composite and the Nas 100 (NDX) continue to maintain their steep up trendlines as you'll see highlighted on those charts below.

The S&P and Dow are stalled. The S&P and Dow have been in an area of significant supply (of stock for sale) for nearly 3 weeks. Meanwhile, the Nasdaq continues to gain. Not a lot but gains have been ongoing and steady.

Any significant overall market correction isn't likely to occur until tech stocks sell off. In Elliott wave terms, by my assessment of the pattern, the leading NDX index is in a fifth and final wave higher. The point to make about this pattern is that the current advance looks like it's a final rally before a significant correction sets in. This isn't the powerful midpoint advance such as occurs typically in a 'wave 3'; conclusion of a wave segment is the number at the end point. The lagging S&P and Dow would also suggest that without the still strong technology stocks, this market would be selling off. Stock valuations tend to come back into line with each other at some point.

I don't often analyze the market in Elliott wave terms but there does seem to be an obvious wave pattern. I wrote a part 1 primer on basic Wave theory in my most recent (10/28) Trader's Corner article. I'll include my weekly NDX chart here with the wave highlights as I see them.

The other point to make related to the above weekly NDX chart is that even NDX is nearing a longer-term overbought extreme. If/when the weekly MACD gets to 80 and above, the index is in a high-risk zone for a correction.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) daily chart continues in its pattern of a lateral or sideways trend, which has extended to nearly 3 weeks now. While I usually assume that the direction of a next move will be consistent with the strong prior uptrend, there reaches a point where I start to assume that a top may be forming. There is the reality that buying interest hasn't been able to churn through overhead supply between roughly 1182-1l90 and 1220. If earnings releases have kept the market afloat, what happens when most of these have been announced? The market is a seasonal period when tops occur; i.e., October-November.

While there's no definite chart action that suggests a trend reversal, I'm on alert for a pullback. A move to the prior high that faltered would set up a possible double top. Conversely, a breakout above recent highs that continues on above 1220 could be a final leg up before there was a reversal.

Bullish sentiment picked up this past week as traders likely perceive the sideways trend in the S&P as possibly bullish (i.e., a consolidation) before another advance and there's of course definite bullishness toward the tech heavy Nasdaq.

Initial support is projected at the 21-day moving average (at 1172 currently), with pivotal technical support at 1140, extending to 1131-1130. Near resistance begins at 1182, extending to 1189-1186. Major resistance begins around 1220.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) chart is showing no ability to churn through ITS 'supply' zone (with significant stock for sale) above 537 and extending to 554. This pattern leans toward a bearish top building interpretation. A decisive upside penetration of 537-540 is needed to suggest at least a retest of the prior top. To suggest an extended up leg OEX would of course have to break out above its prior highs in the 554 area.

Near support continues to be assumed in the area of OEX's 21-day moving average, currently at 529. Next support should come in around 511, extending to the 500 area.

Near resistance is at 535 to 539, with major resistance projected for the line of prior highs at 554.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) has been unable to break out above the upper resistance boundary of its broad uptrend price channel as highlighted on its daily chart. There were a couple of intraday penetrations of the upper channel line, rallies which lacked follow through. The rising upper channel line is also approaching the prior INDU high at 11258 and is a key test for the Dow. Based on the 30 stocks, I don't interpret enough of those charts as bullish enough to propel the Average to a decisive new high. Without IBM and just a few others of the 30 Dow stocks, the Average wouldn't be holding up so well.

Near resistance is in the 11200 area, then at the prior intraday high at 11258.

Near support is at 11044, at the current 21-day moving average; Wednesday's low (and the low for the week) occurred after the intraday low touched this aver age. Next support is figured in the area of the (down) swing low at 10917.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) Index chart remains bullish. The upward advance has just managed to maintain its steep up trendline. The slow upward creep of late is likely explained by the fact that the index is nearing potential resistance implied by its 12-month high at 2535 as buyers take on more caution.

The RSI extreme suggests caution in adopting further or new bullish options strategies in key Nasdaq stocks but being overbought alone doesn't provide a compelling reason in adopting bearish strategies. Nevertheless I'm more tempted to short a potential double top (around 2535) than not, with 'risk' to just over the COMP prior high.

Key overhead resistance remains the same, at the prior 12-month high at 2535. Near support comes in around 2440 or the area of the 21-day moving average, with pivotal support, especially on a closing basis, at 2400.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart remains bullish. Repeating last week's comment that, while upside momentum is slow, it's also been very steady. NDX continues to climb at a rate keeping daily price ranges above its steep up trendline and that's a key technical aspect to this chart.

Overbought RSI readings continue and in this kind of super strong advance, this indicator is discounted in terms of its predictive value for a top at any specific level. As seen in my FIRST chart of the weekly NDX, prices could go still higher before there was a 'major' overbought condition. The RSI extreme does suggest caution in adopting further or new bullish options strategies but being overbought alone doesn't justify adopting bearish strategies. If the Nasdaq Composite traces out a potential double top, I'd consider buying some NDX puts, with an exit point just above the prior COMP high. A break of the NDX trendline would be another initial bearish 'signal'.

What had been anticipated resistance in the 2100 area now looks like near support in NDX. Next support is at 2050.

Near resistance may come in around 2150, with fairly major resistance at the high made almost exactly 3 years ago at 2239.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

There's little to add for the QQQQ tracking stock in terms of bullish comments made for the underlying Nasdaq 100. The Q's are 'maintaining' the steep up trendline.

Daily trading volume has slowed noticeably in the past 6 trading sessions. I usually discount low volume figures for QQQQ and mostly emphasize a continued move in the On Balance Volume (OBV) line in the direction of the price trend. However, continuation of a prolonged advance in an overbought market on LOW volume isn't the usual volume 'confirmation' (of the price trend) that keeps me confident in a continued bullish trading stance.

Near support: 51.0

Next support: 50.0

Near resistance: 53, then projected at 54.0

Major resistance: 55.0

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT), unlike the Nasdaq, its mentor-sister index, is drifting sideways, more in keeping with the S&P indexes and somewhat unusual. I'd call this chart mixed in its pattern.

There's no technical breakdown yet of the bullish trend, but there's some risk that a top is forming. This recent pause may simply be a consolidation ahead of a rally to retest 720 resistance. A breakout above 720 suggests that prior highs in the 740-746 area could be retested.

Conversely, a decisive downside penetration of 690 and certainly 680 would set up a potential retest of support in the area of RUT's 200-day moving average intersecting at 657 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

Warning! Volatility Ahead

by James Brown

Click here to email James Brown

Editor's Note:

In addition to tonight's new plays I would keep an eye on CAT, RIMM, and XEC.

CAT's upward momentum has stalled and shares are ripe for some profit taking. CAT should find some support in the $72-70 zone, which is where I would look for a bullish entry point. Nimble traders could buy puts under $76.00 to catch a short-term move.

RIMM has seen a sharp move higher following the breakout over resistance near $50.00. I suggest looking for a dip back toward $52-51 as a potential bullish entry point with a stop under $50.00.

XEC has been showing relative strength. Traders can put this one on their watch list. A dip back toward the 50-dma or the $71-70 zone could be a new bullish entry point. You need to be aware that earnings are due out on November 3rd.

- James


NEW DIRECTIONAL CALL PLAYS

Volatility Index - VIX - close: 21.20 change: +0.32 stop: 17.45

Target(s): 24.90, 29.00
Key Support/Resistance Areas: 18.00, 21.00, 25.00, 30.00
Current Option Gain/Loss: +0.00%
Time Frame: Two or Three weeks
New Positions: Yes

Company Description:
The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500Ã’ stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.With historical data back to 1990, the VIX Index reached its all-time intraday high of 89.53 on October 24, 2008. In the first half of 2009, CBOE VIX options had an average daily volume of 96,185 contracts (33,023 puts and 63,162 calls for a 0.52 put/call ratio) and period-end open interest of 1,764,113 options.

Why We Like It:

Stocks have been climbing for weeks on expectations the Federal Reserve will launch a new round of quantitative easing. Expectations are too high and odds are very strong that no matter what Ben Bernanke says on Wednesday that the market will see a sell-the-news reaction. Obviously a market sell-off will help push the VIX higher.

I am suggesting new bullish positions now but nimble traders could try and launch positions anywhere in the $19-23 zone. The key here is to make sure you have your bullish position open before the FOMC announcement on Wednesday afternoon. Personally I would want to do it on Monday morning but you could wait until Tuesday afternoon before the election results are out.

The VIX moves fast. I am suggesting our first target to take profits at 24.90. Our second target is 29.00. We'll use a relatively wide stop loss at 17.45. Keep in mind that VIX options do not expire on the normal expiration schedule.

Suggested Position(s)

-Take your pick-

BUY the November 22.50 calls (VIX1017K22.5, expires 11/17/2010) ask $1.30
BUY the November 25.00 calls (VIX1017K25, expires 11/17/2010) ask $0.75

BUY the December 25.00 calls (VIX1022L25, expires 12/22/2010) ask $2.45

Annotated Chart:

Entry on November 1st at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = xxx million
Listed on October 30th, 2010


NEW DIRECTIONAL PUT PLAYS

Millicom Intl. - MICC - close: 94.60 change: -0.13 stop: 98.25

Target(s): $90.25, and the 200-dma
Key Support/Resistance Areas: 98.00, 96.00, 92.00, 90.00
Current Gain/Loss: +0.00%
Time Frame: Three weeks
New Positions: Yes,

Company Description:
Millicom International Cellular S.A. is a global telecommunications group with mobile telephony operations in 14 countries in Asia, Latin America and Africa. It also operates cable and broadband businesses in five countries in Central America. The Group's mobile operations have a combined population under license of approximately 266 million people. (source: company press release or website)

Why We Like It:
The long-term trend for MICC is bullish but short-term the bulls have lost their focus. MICC has a bearish double top formed in the last six weeks and now shares are failing at the 50-dma in what almost looks like a bear flag pattern. I am suggesting we buy puts now to capture a move toward its long-term trendline. Then we can think about switching directions and buying calls.

I would open positions now. However, you could wait and try and time your entry point on a bounce near $96.00. There is some support near $92.00 but our first target is $90.25.

Suggested Position:
BUY the 2010 November $90 puts (MICC1020W90) ask $1.55 (expires in 3 weeks)

- or

BUY the 201 December $90 puts (MICC1018X90) ask $2.95

Daily Annotated Chart:

Weekly Annotated Chart:

Entry on November 1st at $ xx.xx
Earnings Date 02/01/11
Average Daily Volume = 490 thousand
Listed on October 30th, 2010


VMWare Inc - VMW - close: 76.46 change: -0.11 stop: 80.25

Target(s): 72.25, 68.50
Key Support/Resistance Areas: 80.00, 78.65, 75.00, 72.00, 200-dma
Current Gain/Loss: +0.00%
Time Frame: 3 to 4 weeks
New Positions: Yes

Company Description:
VMware delivers virtualization and cloud infrastructure solutions that enable IT organizations to energize businesses of all sizes. With the industry leading virtualization platform -- VMware vSphereâ„¢ -- customers rely on VMware to reduce capital and operating expenses, improve agility, ensure business continuity, strengthen security and go green. With 2009 revenues of $2 billion, more than 190,000 customers and 25,000 partners, VMware is the leader in virtualization which consistently ranks as a top priority among CIOs (source: company press release or website)

Why We Like It:
VMW has seen an incredible two-year fun but it appears that the upward momentum has reversed. The stock started selling off days ahead of its earnings report. When VMW reported on Oct. 18th shares gapped down again. Now traders are selling into strength and VMW has a bearish trend of lower highs and lower lows. I do think VMW could be a bullish candidate again but it might take a correction toward $70 or its 200-dma before shares find any real support. In the meantime the short-term trend is down.

I am suggesting bearish positions now. We'll use a stop at $80.25 but more conservative traders might be able to get away with a stop close to $79.00. Our first target is $72.25. Our secondary target is $68.50 (or the 200-dma, whichever VMW its first).

Suggested Position:

BUY the November $75.00 put (VMW1020W75) ask $2.35 (expires in 3 weeks)

- or -

BUY the December $70.00 put (VMW1018X70) ask $2.10

Annotated Chart:

Entry on November 1st at $ xx.xx
Earnings Date 01/25/11
Average Daily Volume = 4.5 million
Listed on October 30th, 2010


In Play Updates and Reviews

T-Minus Three Days

by James Brown

Click here to email James Brown

Editor's Note:

Actually we have less than three full trading days before the FOMC decision on Wednesday afternoon. Odds are pretty strong the market could see a sell-the-news reaction.

FYI: New trades for FSLR and MTL were opened on Friday.

Current Portfolio:


CALL Play Updates

Archer Daniels Midland Co. - ADM - close 33.32 change -0.13 stop 31.90*new*

Target(s): 34.15, 35.15, 35.95. and possibly higher
Key Support/Resistance Areas: 38.00, 34.15, 33.00, 32.00
Current Option Gain/Loss: +25.6%
Time Frame: 2 to 4 weeks
New Positions: No

Comments:
10/30 (James): Shares of ADM continue to consolidate sideways. The stock saw some volatility on Friday after Credit Suisse downgraded the stock on valuation concerns and yet the analyst kept their $37 price target. I agree with Scott that traders will want to consider an early exit on any strength next week. ADM is due to report earnings on Tuesday morning (Nov. 2nd) before the opening bell. Wall Street is looking for a profit of 75 cents a share. Holding over earnings is a higher-risk strategy so I am raising our stop loss to $31.90, just under the 50-dma (currently 32.32). FYI: The Point & Figure chart is very bullish with a long-term $53 target.

10/28: Our option position is performing very well considering the 40 cent gain from our entry point. I continue to be cautious and expect a broader market pullback, perhaps after the FOMC meeting week. Our immediate target is $34.15 which should give us another 30 cent gain in our option, which would represent 70%+ gains in the position. ADM reports earnings before the bell on Tuesday. I expect the report to be positive but the reactions to some of the positive earnings reports lately have not made sense. If you plan on holding positions I would use any strength in ADM between now and the earnings report as an opportunity to take at least a portion of your profits off of the table. This enables you to book a gain, reduces risk, and allows you to participate in further gains if the stock trades higher.

10/27: ADM hit our trigger to enter bullish positions at $33.05. We are long December $34.00 calls at 77 cents. The stock has solid support $33 down to $32 and I would view dips as buying opportunities. Since we were triggered on our lower entry I have added an immediate target of $34.15 and adjusted the more aggressive targets. If the stock breaks higher I suggest taking profits or tightening stops to protect them, especially considering the overbought broader market conditions.

Note: ADM reports earnings before the market opens on 11/2. The company has beaten earnings estimates in 3 of the past 4 quarters and I am expecting another surprise beat. Holding positions is a higher risk play so please consider using small position size.

Current Position: Long December $34.00 CALL, entry was at $0.77

Annotated Chart:

Entry on October 27, 2010
Earnings Date 11/2/2010 before market (confirmed)
Average Daily Volume: 5 million
Listed on October 25, 2010


ATP Oil & Gas Corp - ATPG - close 14.35 change +0.39 stop 13.75

Target(s): 16.10, 17.00, 17.90, and possibly higher
Key Support/Resistance Areas: 18.00, 17.00, 16.25, 14.75, 14.10
Current Gain/Loss: -37%
Time Frame: 1 to 3 weeks
New Positions: No

Comments:
10/30 (James): We remain very cautious on ATPG. The stock appeared to breakdown under support at the $14.00 level on Thursday. Fortunately, shares saw a strong bounce (+2.8%) on Friday but I would not buy it. The stock has been underperforming its peers in the oil sector. If the OIX oil index rolls over it will make it even tougher on ATPG to maintain its current share price. The situation could change soon with ATPG reporting earnings on Thursday, Nov. 4th before the opening bell. Wall Street expects a loss of 58 cents a share. Although I have to say ATPG's earnings report could be completely ignored if the market is moving on the FOMC announcement from Wednesday afternoon. I am not suggesting new positions and more conservative traders will want to strongly consider exiting ahead of the earnings report (or even the FOMC meeting).

10/28: The slide in ATPG continues and we are on the verge of getting stopped out. The stock has lost its 20-day and 200-day SMA's as well as a couple of support levels. It is do or die time or we will have to step aside and close the position. The bullish case of a descending wedge remains but the stock may headed for its 50-day SMA prior to breaking higher, which is below our stop.

Current Position: Long December $16.00 CALL, entry was at $1.00

Annotated Chart:

Entry on October 25, 2010
Earnings Date 11/4/2010 (unconfirmed)
Average Daily Volume: 2.7 million
Listed on October 23, 2010


First Solar Inc. - FSLR - close 137.68 change -13.47 stop 134.75 *new*

Target(s): 145.00, 147.50, 149.75
Key Support/Resistance Areas: 137.50, 140.00, 145.00, 147.50, 150.00
Current Gain/Loss: -19.7%
Time Frame: 3 to 4 weeks
New Positions: Yes, but look for a bounce

Comments:
10/30 (James): Bingo! Scott was right on the money expecting a post-earnings dip in FSLR. Shares gapped open at $139.15 (our new entry point). There was a brief bounce toward $142 but FSLR eventually settled under potential support near $140, under its 50-dma, and under the bottom of its bullish channel. All of those "unders" in the previous sentence make me a little nervous but there is a decent chance FSLR could fill the gap. Since we got a better than expected entry point (139.15 instead of 141.00) I'm adjusting our stop loss down to $134.75. More conservative traders may want to keep their stops tight and closer to the $136 level.

10/28: FSLR reported earnings today after the bell and the stock is down -$10 in afterhours trading as of the time of this writing. The report looked good to me as FSLR beat earnings by 9 cents, revenues were better than expected, and guidance was slightly above analysts' estimates. However, the company said they see some uncertainties in Europe which explains the weakness. The stock closed the extended session right at $141.00 to the penny which was my anticipated support level for the stock. I suggest we use the weakness to our advantage and open small positions tomorrow. This is a higher risk play so I suggest using smaller positions size. We are targeting a bounce and have close targets. If buyers step in these targets could be reached quickly so be ready to take profits.

Current Position: Long December $155 CALL, entry was at $2.48

Annotated Chart:

Entry on October 30th at $139.15
Earnings Date 10/28/10 (confirmed)
Average Daily Volume = 1.5 million
Listed on October 16th, 2010


Genco Shipping - GNK - close 16.55 change +0.17 stop 15.50

Target(s): 16.10 (hit), 16.80, 17.35, 17.95
Key Support/Resistance Areas: 18.25, 17.75, 16.90, 16.25, 15.75
Current Option Gain/Loss: -12.5%
Time Frame: 1 to 3 weeks
New Positions: No

Comments:
10/30 (James): GNK does have a steady, bullish trend of higher lows. However, shares don't move very fast and I would not open new positions ahead of the company's earnings report. GNK is due to report on November 3rd, after the closing bell. Wall Street is looking for a profit of 98 cents a share. Unfortunately, this report will be completely lost in the shuffle as the market tries to digest the FOMC decision earlier that afternoon. There is a chance that GNK's earnings could surprise given the sharp improvement in shipping rates back in August but in September and October prices leveled off.

10/27 & 10/28: GNK is forming a symmetrical triangle as prices are coiling. This is not good for option premium that expires 3 weeks from Friday. We need the stock to follow through higher and if it does I suggest readers use the opportunity to close positions or tighten stops to protect capital.

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


Humana Inc. - HUM - close: 58.29 change: +0.45 stop: 49.75

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

Comments:
10/30 (James): Wow! The rally in HUM has been very impressive. Unfortunately, we're still sitting on the sidelines as spectators since the stock never pulled back. I think that's about to change. HUM is due to report earnings on November 1st (Monday) before the opening bell. Analysts expect a profit of $1.66 a share. Odds are very good HUM should see some profit taking on Monday. Plus, we're expecting a market-wide pull back on Wednesday and Thursday this week. While I'm tempted to raise the trigger to buy calls I am actually going to lower the trigger down to $53.00 (from 53.80).

Suggested Position:

Trigger to buy calls at $53.00 <-- new trigger!

BUY the 2011 January $55 calls.

Annotated Chart:

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


PUT Play Updates

Fastenal Co. - FAST - close: 51.48 change: +0.12 stop: 53.40

Target(s): 51.20 (hit), 50.25, 49.65, 48.25, maybe lower
Key Support/Resistance Areas: 55.00, 52.00, 50.00, 48,00,
Current Option Gain/Loss: -25%
Time Frame: 3 to 4 weeks
New Positions: Maybe

Comments:
10/30 (James): Scott is right. We have three weeks left before November options expire and the time decay is going accelerate. If you are looking for a new entry point I'd wait for another failed rally under $53.00 and then use December options. On a very short-term basis FAST has found support near its 100-dma three days in a row. A breakdown under this level would be great news for us but I wouldn't be surprised to see a bounce soon.

10/28: Not much has changed from my comments below. FAST is barely hanging on to its 50-day SMA. If the stock breaks below $50.85 we should reach easily our second target of $50.25. Readers should begin to exit positions as we have options that expire in November and time decay will start to erode our premium.

Current Position: Long November $50.00 PUT, entry was at $1.00

Annotated Chart:

Entry on October 18, 2010
Earnings Date 10/12/10
Average Daily Volume = 1.0 million
Listed on October 16, 2010


Illinois Tool Works - ITW - close 45.68 change -0.24 stop 47.83

Target(s): 44.85, 44.15, 43.50
Key Support/Resistance Areas: 47.75, 46.10, 45.50, 44.60, 44.00, 43.00
Current Gain/Loss: +4.16%
Time Frame: 2 to 3 weeks
New Positions: Yes

Comments:
10/30 (James): The post-earnings, oversold bounce has failed. The new trend for ITW seems to be down. Shares are hovering near short-term support at $45.50 and a drop under this level could be used as a new entry point to buy puts. If the market corrects I wouldn't be surprised to see ITW hit the $42-41 zone.

10/26: Shareholders were unimpressed with ITW's earnings report on 10/19. The company narrowed guidance to the lower end of its range and the stock appears to be changing trends. Considering the overbought broader market conditions and the weakness being exhibited in ITW, I suggest readers initiate short positions in the stock on any bounces, or a break down below the stock's 200-day SMA and support near $46.00. Let's use a trigger of $46.40 on a bounce or $45.92 on a break down. Our initial stop will be $47.83 but it will be adjusted after the position is opened. Depending on our trigger, we are targeting more than a -$1 move lower, which will produce a nice gain if the set-up unfolds as expected.

Current Position: Long December $45.00 PUT, entry was at $1.20

Annotated Chart:

Entry on October 27, 2010
Earnings: More than two months (unconfirmed)
Average Daily Volume: 4.5 million
Listed on October 26, 2010


Mechel OAO - MTL - close 23.55 change +0.72 stop 24.60 *new*

Target(s): 22.30, 21.25, 20.25
Key Support/Resistance Areas: 24.25, 24.00, 23.60
Current Gain/Loss: +0.00%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
10/30 (James): Our new play on MTL is now open! The stock rallied from the bottom of its current range and tagged the 200-dma on Friday. MTL hit our trigger to buy puts (December $23 strike). If you missed the entry point I would still consider new positions now. Or you could wait for a bounce closer to what should be resistance near $24.00 and MTL's 50-dma. I am suggesting we move our stop loss to $24.60.

10/28: I was hoping for a bounce up towards MTL's 200-day SMA but it doesn't appear we are going to get it as the stock is hanging out in a bear flag. Let's lower the trigger to $23.30 which is near today's highs. My comments from the play release below remain valid.

10/27: The steel sector has come under pressure as earnings and guidance have failed to impress investors. MTL finds itself in a bear flag and is consolidating under its 200-day SMA, while its 50-day and 20-day SMA's are just overhead. Conservative traders will want to see the stock break below $22.25 before launching bearish positions. However, considering the overbought broader market conditions initiating positions on a bounce sets up a very good risk reward trade. There is solid resistance in the $23.60 to $24.20 area so I suggest launching bearish positions at $23.55 (lowered to $23.30). Our stop will be above the 20-day SMA at $24.47 (which is rolling over and declining). If triggered our first two targets are -5% and -9% lower.

Current Position: Long December $23.00 PUT, entry was at $1.30

Annotated Chart:

Entry on October 30
Earnings Date: More than two months (unconfirmed)
Average Daily Volume: 2.1 million
Listed on October 27, 2010


PNC Financial - PNC - close 53.90 change +0.26 stop NONE

Target(s): 53.00, 52.10, 51.05 (hit), 50.35
Key Support/Resistance Areas: 54.50, 53.50, 50.50, 49.50, 48.75, 47.00
Current Gain/Loss: -80%
Time Frame: 1 to 2 weeks
New Positions: Neutral

Comments:
10/30 (James): The larger trend for PNC is certainly down but the breakout over its 50-dma several days ago concerns me. I would hesitate to launch new positions with PNC trading above $52.50 (or even $52.00). We're expecting a market-wide correction soon and believe PNC will bet testing new lows for the year before November is done. Keep in mind we only have three weeks left before November options expire. If we see a new entry point I suggest the December or January puts.

10/27 & 10/28: Not much has changed from my comments below. PNC closed near its lows of the day while the broader market closed near its highs. We are looking for dip to close positions and salvage as much premium as possible, however, this may have to wait until next week's elections and FOMC announcement on Wednesday.

10/26: PNC closed flat in the day. Our position is deep out of the money and we are waiting to see if the stock corrects with the broader market, which we will use as an opportunity to close positions. The stock is holding an upward trend line that began from last week's lows. If it breaks the next support levels are $53.00 and $52.10. I doubt our option value is going increase a significant amount, but recovering 20 to 30 cents is certainly in the cards.

10/25: I do not see many changes from my comments below. PNC lost -1.3% today and printed a bearish dark cloud cover candle pattern which indicates a decline is imminent. Let's see if we get a healthy broader market correction see how far we can ride this lower.

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

Annotated Chart:

Entry on September 30, 2010
Earnings: 10/21/2010 (unconfirmed)
Average Daily Volume: 5 million
Listed on September 29, 2010


CLOSED BULLISH PLAYS

Jeffries Group, Inc - JEF - close 23.93 change -0.07 stop 22.75

Target(s): 25.00, 25.75
Key Support/Resistance Areas: 25.85, 25.25, 24.25, 23.50, 23.00
Current Gain/Loss: -4.5%
Time Frame: 3 to 4 weeks
New Positions: Yes

Comments:
10/30 (James): I am suggesting an early exit for JEF. On Thursday Scott also suggested that readers consider a potential exit. My concerns are JEF's bearish trend of lower highs. If the stock already has a bearish pattern what will it do when the market corrects lower (we hope) on Wednesday or Thursday this week? Therefore we want to exit now. You can keep JEF on your watch list in case the stock ever closes over $25.25 again. CLOSED POSITION: Long December $24.00 CALL, entry @ $1.10, exit @ $1.05 (-4.5%)

Annotated Chart:

Entry on October 29, 2010
Earnings Date 1/20/11 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on October 19, 2010