Option Investor
Newsletter

Daily Newsletter, Tuesday, 11/2/2010

Table of Contents

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

Market Wrap

Market Continues to Chug Higher Into Elections/FOMC

by Keene Little

Click here to email Keene Little
Market Stats

I'll be filling in for Jim for tonight's wrap.

The stock market started with yet another gap up to start the day but unlike yesterday it didn't immediately give it back. The initial rally was over in 20 minutes (not much was added to the gap up) but after a pullback to around 10:30 AM the market started inching its way higher again, with techs leading the way. NDX continues to make new highs but the others have not been quite as strong. SPX tested yesterday's high which was a test of the October 25th high but both the DOW and the RUT remained short of the October 25th highs. Essentially the market has been in a consolidation/topping pattern (depending on your perspective) since mid October and is pressing the high side of the trading range. Pressing higher into a major news announcement (tomorrow's FOMC) is usually a recipe for disappointment but obviously we can't know for sure how the market will react.

Many market pundits now believe we'll see a sell-the-news reaction to the election and FOMC announcement. That alone should have us doubting that expectation. Have you heard anyone say the market is going to rally on the news? We could see the market rally into Friday and then sell off on the jobs report. It's something to think about for your own trading plan this week.

While there's great interest in how the elections turn out, the market has already factored in gridlock in our government. It's sort of a non-factor at the moment (unless there's a major election surprise, such as the Democrats keeping both Houses). Instead the market is now focused on what the Fed might share with us tomorrow. Everyone knows the Fed will implement a second round of Quantitative Easing (QE2) but everyone's guessing how much, now quickly and what securities will be purchased. So the market is essentially on hold, at the high side, while it waits for the Fed to come down from the Mount.

Last Friday there was an article in the Bloomberg news, Fed Polls Dealers, about the Fed essentially asking bond dealers and investors what they should do. Never mind that the Fed is supposed to make fiscal policy decisions based on what it believes the monetary system and economy require. Never mind that the Fed has always and consistently stated publicly that they don't make policy decisions in order to influence the stock market. It is now abundantly clear that the Fed is making policy decisions to support the stock market (while worried about the bond market's reaction). Any notion of a free market should now be considered dead -- the Fed is in control of the stock market now. Well, that's what they'd like to believe anyway.

But think back to the days when Greenspan would constantly deny any interest in what the stock market does and that Fed policy did not take into account how the stock market would react. Everyone knew it was a lie but no one seriously challenged the Maestro about this. Now we have the Fed fully admitting that their interest is in how the markets will react to the creation of trillions of dollars. In reality this should come as no surprise to anyone but it is a bit surprising how blatant it has become for both the government and the Fed to manipulate the markets. And it will always be a bit unnerving to understand the fact that the Fed now believes it should influence how the stock market behaves. It goes against the whole premise of a free market.

Consumer sentiment is influenced to a large degree by the people's perceived wealth. The value of their homes and stock holdings (whether it's only in their retirement plans or more actively managed funds) will have an impact on whether people feel bullish or bearish the economy and that of course affects their spending habits. The Fed does not care about people and their savings accounts. The Fed cares about people spending their money. In fact the Fed, with the historical low interest rates, has made it very clear they do not care about people who have to live off their savings. They want people to invest in stocks instead of bonds, even though stocks are riskier, and they want them spending instead of saving.

So when it comes to the next round of QE, the Fed is very concerned about how the market will react. This is very much like a politician polling people for their reactions to a decision before the decision is made. Instead of doing the right thing, following a moral compass, they do the politically expedient thing. The Fed is now playing the political game of telling the market what it wants to hear instead of following a moral compass and telling the market what it needs to hear. It's a huge difference.

Bernanke is a very intelligent man and is the acknowledged expert when it comes to figuring out what happened during the 1930s depression. I think the piece he's missing is that the problem is not just numbers. If the economy suffers a slow down and GDP drops 2% I do this... or if the inflation rate drops to 1% I do that... What Bernanke and most economists don't seem to understand is the enormous influence of social mood. It's why I've been saying for years that the Fed is pushing on a string and that they can lead the horse to water but they can't force it to drink.

Shoving helicopter loads of cash into the money system will not accomplish the normal expansion of the money supply if that money is not lent out (the fractional reserve banking system is dependent on leveraging the money in order to create the growth). If we collectively (people and businesses) are too worried about taking on more debt we will simply not borrow more, no matter how cheap the interest rates are. It's why ZRP (Zero interest Rate Policy) has done nothing to help the housing market, business expansion or consumer spending.

We've been in a very different kind of recession than what we've experienced over the past 50-60 years (it's actually a depression but it won't be recognized as such until a couple more years, after the Great Recession II). This one is not the result of the normal business cycles but is instead due to a severe credit contraction following a blowout credit expansion. These credit-induced recessions are relatively rare and do not respond to the same stimuli from the Fed as normal business-cycle recessions. Hence Bernanke's conundrum (and Greenspan's before him). It's why QE2, 3, 4, etc. will not work either. We have to simply go through the credit contraction (deflation) in order to get to the other side of it.

But Bernanke and politicians will try everything they can, using the traditional arsenal of weapons that don't work in this environment, which typically involves throwing more money at the problem (which is what people like Krugman call for). And now we've got Bernanke wondering what to do so he's asking the bond dealers and investors for guidance. That's a bit like asking a junkie how many drugs he would like. The last thing our economy needs is more debt and that's exactly what Bernanke is proposing.

An article in the NYT came out today, Fed Poised to Act, discussing the fact that the Fed is getting ready to do some more QE but the consensus of many economists seems to be that it might not help. Even the Fed has already acknowledged the same in a statement in August, saying "central bankers alone cannot solve the world's economic problems." James K. Galbraith, an economist at the Lyndon B. Johnson School of Public Affairs at the University of Texas, Austin, said "Quantitative easing will accomplish nothing beyond flooding the banks with cash which they will use, if at all, for speculating rather than lending." I think there are more than a few of us who would agree with that statement. Most of us also acknowledge that the eye-popping bonuses to the banks' proprietary traders and bank managers, thanks in large measure to this flood of money coming to them, has resulted in additional strife between Wall Street and Main Street.

Most people will also acknowledge that even if another round of QE will not have a significant positive impact on the economy, Bernanke has no choice but to try. He doesn't want to stand accused later of not trying everything he could possibly think of to stop the deflationary spiral. The acknowledged expert in depressions will learn over time, in my opinion, that it's a cycle that must run its course and cannot be stopped by monetary policy. The failure of Bernanke to stop this train will be part of our collective loss in faith in government, the Fed and other institutions designed to manage the public. And then we'll start the healing process for the next cycle.

The latest estimates for the next round of QE still range between $500B and $1T. From my reading I think the consensus is for $100B per month and that amounts to $1.2T in the next year. If there's any hint that it will be less than that the stock market could take a hit (and the dollar rally). But the bottom line is that there's no clear idea on how quickly it would be implemented or what securities would be purchased. The primary dealers would of course love to see several trillion coming their way (they borrow at 0% and make whatever the rate happens to be for the securities they purchase) so asking them how much the Fed should offer is again like asking a drug user how much he wants. Most others are very concerned that too much money coming into the system will spark too much inflation. That's a reason Bill Gross at PIMCO came out last week with his prediction for the end of the bond bull market.

In fact the 10-year yield (TNX) has been on the rise since October 8th and broke a downtrend line from April (and as yields rise, bond prices fall). This is causing a dilemma for investors who have been running out of stocks and into bonds. If the bond market is topping, is now a good time to get out of the bond market? That's a tough question to answer right now and last week I showed two long-term monthly charts of TNX. I'm not convinced we've seen the lows for yields yet and it will take a 10-year rate above 4% to confirm, in my mind, that we have indeed seen the bottom for yields/top for bond prices.

I continue to caution investors about the stock market -- I believe we've got another leg (or two or three) down in the secular bear market that we're in. Certainly historical patterns, including most recently Japan's market since 1990, suggest we will continue lower. Therefore it's a trader's market and the run back up from August is probably the 2nd best opportunity this year to take profits on the run up from March 2009. I've been suggesting investing in U.S. Treasuries as a way to be in cash and to protect yourself. That's still my recommendation but be aware of the possibility that bond prices may have peaked.

What's especially important, as far as bond investments go, is to stay away from high-yield bonds (junk bonds). Many fund managers, including money-market managers, have gone into high-yield bonds in an attempt to pump up their returns. The pursuit of returns of at least 8% (still in the charter of many pension funds) requires the managers to hunt down these riskier bonds. These are probably riskier than the stock market. At this time the consensus is that it's a slam-dunk investment to be in junk bonds and when the majority feel this way you know it's ready for a major correction.

One way to track the price of high-yield corporate bonds is by following HYG, the iShares ETF. In the rally off the August low it briefly exceeded the highs made in January and April, near 90.30. It made its own little triple top last week on October 26, 28 and 29, effectively mimicking the triple top against the January and April highs. Price then collapsed yesterday and in so doing it dropped back below the January/April highs and broke its uptrend line from May. It has left a false breakout above 90.30 although today's rally has brought it back up to just above the April high. But it stopped at its broken uptrend line and therefore what it does from here will be important. If it leaves a bearish kiss goodbye at the trend line and drops back below Monday's low at 89.95 it could be the canary in the coal mine for the rest of the stock market.

High-Yield Corporate Bond ETF, HYG, Daily chart

The reason I say HYG could be a canary in the coal mine is because this fund is a measure of investors' willingness to assume more risk, be it in higher-risk bonds or in the stock market. Selling in the riskier junk-bond market should coincide with selling in the stock market, and vice versa. So keep an eye on this to help you decide how to be invested, or not, in the stock market.

SPX continues to struggle near its 200-week moving average, now located at 1193.38 (today's close was 1193.57). Even if it will eventually break above this important resistance it would probably fare better with a pullback first so as to relieve some of its overbought indicators. Certainly I'd be uncomfortable going long here and that means at a minimum you should have stops on long positions pulled up tight.

S&P 500, SPX, Weekly chart

The daily chart below shows SPX also struggling with the 88.6% retracement of the April-July decline. This is a level commonly associated with a double-top pattern. It's also trying to push back up to its broken uptrend line from August through the October 19th low. By Friday that trend line will be closer to 1208 which is what I'm currently projecting, although the rally could fail at any time, hence the dashed line showing a decline from here (or maybe one more stab higher to tag 1200).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1195
- bearish below 1177

The 60-min chart below shows just one idea (I can't put them all on the chart) for how the market could hold up into Friday. This suggests the market will rally a little further tomorrow, pull back after the FOMC and then push higher Thursday. A selloff (on the jobs report?) would follow on Friday. Or we could have a wild gyration around tomorrow's FOMC, put in a final high around 1200-1202 and then sell off. Or we could spike down on the news and rally to the moon. You get the idea -- it's anyone's guess in this kind of market. Price action has been nothing but 3-wave chop which is usually a very good indication of an ending pattern. Where that end will be is anyone's guess but as noted on the chart, the Fib convergence zone between 1194 and 1208 gives us a relatively wide range but a zone that I expect to see a market high. It takes a break below Monday's low near 1177 to confirm we've seen the high.

S&P 500, SPX, 60-min chart

Sticking with the same pattern and expectations for the DOW as I'm showing for SPX, we could see a quick high test the April high and then sell off (dashed line), or we could get a little more upside action into Friday and top out around the top of its parallel up-channel, near 11315 by Friday. It takes a drop below 11062 to confirm we've seen the high so let that happen before you get aggressively short. Back below 11K would be a bummer for the bulls so that's another level to wait for before getting aggressively short (meaning short the bounces after that).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,185
- bearish below 11,062

Again, the same picture as the DOW and SPX is pointing NDX to about 2175 to hit the top of its rising wedge pattern by Friday. Watch for the possibility of a test of the top of the wedge, especially with a throw-over above it and then drop back inside, after the FOMC announcement and then a selloff -- that would be bearish. A break below 2117 would confirm we've seen the high. Today NDX came within less than two points of 2157.17, which is the 127% Fib extension of the April-July decline, a level that commonly sees a reversal.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2117

The small caps saw some strong buying interest today -- the RUT was up +2% while the blue chips struggled and rallied less than 1%. Even the techs rallied less than half what the RUT managed. That could certainly be viewed as bullish for the market. But it's been lagging a little during the past week so it might have been more or less catching up rather than leading to the upside. Trend lines converge near 719 by Friday so as long as it doesn't rally strongly from here we could see it chop its way a little higher into Friday. A quick tag of its trend line across the highs since October 13th, near 717 tomorrow afternoon, followed by a break below 693 would tell us the top is in place. Wait for the breakdown.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 693

With the stock market holding near its highs, if not pressing higher, the VIX is not showing the same level of complacency as it did at its low on October 13th. This supports my contention that the choppy price action since then has been a period of distribution rather than accumulation, which may include some put buying/call selling as fund managers prepare for a pullback. The rallies are quickly sold into by big money distributing stock to the masses, which is how tops are formed. And then in a decline, when the masses can't stand the pain anymore and disgorge their stock at the lows, big money is ready and able to do the buying. Rinse and repeat. With the VIX breaking its downtrend line from July it looks ready to take off to the upside. What might trigger such a "rally" in the VIX? Hmm, so many choices...

Volatility index, VIX, Daily chart

Keep an eye on a couple of the generals for some market clues. I see two stocks in the tech sector, each having a broader economic impact -- IBM and INTC -- that hit potentially important levels today.

Following the sharp gap down on October 19th, IBM has not only clawed its way back but has been able to make new highs for the move up from August. Someone really likes this stock. It has managed to test its broken uptrend line from August and today it came within 4 cents of tagging a potentially important Fib level -- the same 127% extension I mentioned earlier for NDX, but this one is for just the drop on October 19th, which is likely the orthodox high and now it's being retested. Today's candle is a shooting star (or more bearish gravestone doji) at that Fib level. So it's a bearish setup for a top to its rally but confirmation will not come until it breaks below 138.53. But be aware that this stock could foretell us something if its starts back down from here.

International Business Machines, IBM, Daily chart

Yesterday INTC closed its August 10th gap at 20.65, with 2 cents to spare. This morning it did it again, with 5 cents to spare, and promptly sold off, creating a key reversal day with the gap up, new high and then closing lower. In addition to closing its gap it also tagged its 200-dma at 20.66. The bearish engulfing candle looks, well, bearish. You can see by the daily candles that rallies are being sold into. Any follow through to the downside tomorrow will confirm the reversal. If IBM and INTC are selling off while the tech indexes try to push higher, don't trust the rally in the indexes. A rally needs its generals.

Intel Corp, INTC, Daily chart

The banks continue to be MIA during the rally attempt. The sideways coil in BKX is breaking down and any continuation below 44.66, Monday's low, would be confirmation of the breakdown. Follow the money if the banks start selling off harder.

KBW Bank index, BKX, Daily chart

And remember, as with all the charts, while I'm showing an ending pattern with a top very close, or already in as in the case with the banks, it's just a guess based on typical ending patterns with waning momentum. This market has had some unusual influence and there's no telling where an irrationally exuberant market could take us. This is why it's important to see breaks below the key levels to confirm we've seen the highs. Until that happens we have to continue to respect the upside. I may not agree with the reasons for the rally, and I do believe that the buyers are going to end up very disappointed if they don't protect their positions (which of course includes going to cash), but the bottom line is we deal with price wherever it goes, regardless of the reason.

The TRAN continues to hold above its uptrend line from August and is pushing back up towards the top of its rising wedge pattern from the October 13th high, which will be near 4880 by Friday. A break below 4715 would tell us the high has been made.

Transportation Index, TRAN, Daily chart

With everyone expecting the Fed to announce another major QE program it has an overcrowded pair-trade getting even more overcrowded. That pair trade is of course short-the-dollar-long-everything-else. The dollar has been getting beat lower in anticipation of further devaluation because of the amount of new money expected to come into the system. So traders have been shorting the dollar and using the proceeds to buy other assets. Commodities and the stock market have been beneficiaries of this trade. The big question of course, especially with such a large percentage of bearish sentiment towards the dollar, is what happens when this pair trade starts to unwind. There will be a rush to cover the dollar short trade, which will cause a spike in the dollar, and the money to buy back the dollar will come from selling other assets, namely commodities and equities.

The current trends could quickly reverse as traders scurry to unwind their trades. We can't know when the unwinding will begin, or what might spark it, but it's not farfetched to think it could happen around the FOMC's QE announcement, especially if the announcement is for something less than the currency market expects. The stock market could be just the tail that gets wagged by the currency dog so if the dollar starts rallying and trades start unwinding, it's not going to matter how the stock market participants feel about the economy, the Fed or anything else. Selling in the stock and commodity market will be driven by the currency market.

And of course it's just the opposite if the dollar sinks lower on fears of devaluation as a result of too much QE. A sinking dollar will embolden traders to pile on short and that money will go into more buying of commodities and equities. But again, if that happens in a hurry it should be the final move and then get ready for a very fast reversal.

In fact, with the dollar chopping up and down since the high on October 19th, which coincides with the choppy price action in the stock market, it looks like it could give us one final move lower to finish the decline from June. I show a brief pop up and then final low this week in order to finish a small 4th and 5th wave for the leg down from August but that's just a best guess for now. A finish around 76 would be a good setup for the rally to begin (and the unwinding to begin). This up-and-down-and-then-rally kind of move could easily occur around and after the FOMC announcement.

U.S. Dollar contract, DX, Daily chart

Gold has a clean 5-wave move down from the October high to October 22nd and then a clean 3-wave bounce to yesterday's high. It's a clean setup for the next leg down to begin. Now all we need to see is for price to agree. But beware if you're long gold since the next move could be a strong decline down to its uptrend line from October 2008, currently near the June high near 1262.

Gold continuous contract, GC, Daily chart

Another important indicator of economic health, as well as dollar strength/weakness, comes from copper, which looks vulnerable to a breakdown. Looking at its weekly chart, last week was the 4th week in a row that it tagged its broken uptrend line from the beginning of 2009 and could be close to leaving a bearish kiss goodbye at that trend line. A break of last week's low at 370.35 would be confirmation that the top is in.

Copper continuous contract, HG, Weekly chart

Tomorrow will be a busy day for economic reports, some of which could be market moving before we even get to the Fed in the afternoon. Of course we have no idea what the market will consider good or bad news since each will be considered in the context of how it might affect the Fed's decision. Just be aware that we could see some volatility in the morning and then of course you can bet on it in the afternoon.

Economic reports, summary and Key Trading Levels

Summarizing tonight's charts, I see further upside potential but not a lot. The choppy price action as the market struggles to make it higher is classic topping action. If the market blows out the top of the rising wedges that we see across the board it will be very bullish and probably the beginning of a final blow-off move. But a blow off could tack on another 1000 points to the DOW. You don't want to short a move out the top of rising wedges.

But betting on that kind of upside move is simply betting against the odds. It would be like picking the horse with lousy odds of winning -- you'll probably lose your money but you could win big. The higher-odds play is a reversal of the rally and it's "simply" a matter of finding the top. I keep raising the key levels to the downside because it's a way to trail this market higher. I don't like the risk:reward ratio to enter a new long trade but I also know it's risky picking a top in this market, especially with some underlying influences that we don't completely understand. For example, who's doing all the buying in the futures during the overnight session, which then causes the cash market to gap up which then immediately gets sold into? How long can that continue? Your guess is as good as mine. I've shown my guess on tonight's charts and now we'll let price show us the way. Start playing the short side after the key levels are broken. In the meantime keep your powder dry.

It seems everyone expects a sell-the-news reaction to the Fed's announcement. I have been expecting the same but now I'm not so sure. I hate playing with the crowds and the crowded expectation is for a selloff. If everyone is expecting it, and placing bets that way, the market could be ripe for a flare-up as "someone" gooses the market with some big buy programs and then watches the fireworks go off as the shorts scramble to cover. Will that happen? Who knows but I'd sure be careful about the possibility.

The Fed is in the business of buying securities so who knows how much of that money has been set aside to "help" the market higher this week. But once that short-covering has ended (assuming that's how it will play out), and assuming we're not talking a huge rally out the top of the rising wedge patterns, that's when I'd start nibbling on the short side. If any flare-up results in a throw-over above the rising wedge patterns, followed by price collapsing back inside, start looking for shorting opportunities.

Good luck and I'll be back with you on Thursday for some post-FOMC analysis and to see how the end of the week will be setting up for us.

Key Levels for SPX:
- cautiously bullish above 1195
- bearish below 1177

Key Levels for DOW:
- cautiously bullish above 11,185
- bearish below 11,062

Key Levels for NDX:
- cautiously bullish above 2160
- bearish below 2117

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 693

Keene H. Little, CMT


New Option Plays

This is it.

by James Brown

Click here to email James Brown

Editor's Note:
I have no doubt that you've heard it a dozen times but I'm going to say it again. Tomorrow afternoon the Federal Reserve concludes their two-day meeting. No one expects any changes to interest rates through the Fed funds rate. Instead all the focus will be on the Fed decision to announce a new round of quantitative easing.

The size of this QE program could determine market direction for several days. If the program is too small then stocks will drop sharply. If the program is large then it's a coin toss whether stocks see a temporary spike higher or sell off any way. However a large QE program is what the market wants so if we see any profit taking investors will likely step in after a few days of consolidation.

With such a monumental decision in front of us I don't want to launch any new plays tonight. In the past we've seen some extreme volatility following a Fed announcement and sometimes the first market move following a Fed meeting is actually a trap. If you want to play in this market I think the VIX trade in our current play section is a good avenue for that.

- James


In Play Updates and Reviews

A Little Trim

by James Brown

Click here to email James Brown

Editor's Note:

Don't forget that the big event this week is the FOMC announcement tomorrow. Nearly everyone is expecting Ben Bernanke to announce a new round of quantitative easing. Market reaction to this announcement could be huge and odds are good stocks might see a "sell the news" move. Readers may want to scale back their positions or raise their stops on any bullish trades (except our VIX trade).

Current Portfolio:


CALL Play Updates

Cliffs Natural Resources - CLF - close: 67.31 change: +0.95 stop: 61.85

Target(s): 68.75, 70.75
Key Support/Resistance Areas: 71.25, 69.00, 65.00 62.00
Current Option Gain/Loss: Unopened
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
11/2 (James): I don't see any changes from yesterday's comments. We want to wait for a dip to $65.40 to launch bullish positions.

11/01: Manufacturing data from around the world was better than expected today, including here in the US. Companies like CLF should benefit from an uptick in manufacturing because the manufacturers need materials such as coal and iron ore to make their products. Technically, CLF has been trending higher since its lows in July and looks poised to move back towards its highs from early October if the broader market cooperates. The stock also broke and closed above a short term downtrend line today. Considering the overbought market conditions I consider this is an aggressive play, however, the trend in CLF is up and until proven otherwise the trend should continue. I suggest we use a trigger of $65.40 (near today's lows) to launch bullish positions. Our targets are +5% and +8% higher than our trigger.

NOTE: This is a good hedge against our short MTL position. I also consider this an aggressive trade so small position size is suggested to control risk if the stock reverses lower.

Trigger = $65.40

Suggested Position: Buy 2010 November $70.00 CALL, current ask $2.89

Entry on November XX
Earnings Date More than two months
Average Daily Volume = 4.3 million
Listed on November 1, 2010


Genco Shipping - GNK - close 16.42 change +0.22 stop 15.50

Target(s): 16.10 (hit), 16.70, 17.35, 17.95
Key Support/Resistance Areas: 18.25, 17.75, 16.90, 16.25, 15.75
Current Option Gain/Loss: -62%
Time Frame: 1 to 3 weeks
New Positions: No

Comments:
11/2 (James): GNK still acts like it wants to trade higher but I wonder what it's waiting for. The market's major indices are hitting new five-month highs and GNK is still inching along. I am not suggesting new bullish positions in this stock. More conservative traders may want to strongly consider exiting positions ahead of the FOMC announcement tomorrow afternoon!

11/1: Friday's price action in GNK was promising, however, the gains were erased as the stock printed a bearish engulfing candlestick on Monday. In early trading the stock came with 5 cents of our $16.80 target before falling apart. GNK is finding support at its 50-day SMA. If the stock bounces I would use the strength as an opportunity to close positions or tighten stops. The 2nd target has been lowered slightly.

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

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: 60.64 change: +1.96 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:
11/2 (James): Grrr! Talk about buyer's remorse. I regret not buying HUM when we listed it the first time. This stock continues to surge without us! The stock added another +3.3% to close at two-year highs after being upgraded this morning. Expectations for the Republicans to gain a majority in the House in today's elections was also boosting the healthcare stocks. We do not want to chase HUM and may end up dropping it as a candidate before the week is out. For now our trigger to buy calls remains at $53.00 although I'm starting to think a dip to $55 or $54 might work.

11/1: HUM crushed earnings today on the bottom line but fell just short on revenue. The stock gapped higher but immediately began to trade lower. We are keeping our trigger at $53.00 and will use dips as buying opportunities. $53.80 could also be considered an entry point.

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.

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


Volatility Index - VIX - close: 21.57 change: -0.26 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: -6.6%
Time Frame: Two or Three weeks
New Positions: Yes

Comments:

11/2 (James): Tomorrow is the big day. I expect stocks (and the VIX) to drift sideways in a very narrow range tomorrow until the FOMC announcement in the 2:00-2:15 p.m. time frame. That's when the fireworks should start. If you want to be in this trade then open positions ahead of the announcement.

10/30: 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.

Current Position: Long 2010 December 25.00 calls (VIX1022L25), entry was at $2.25

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


PUT Play Updates

Fastenal Co. - FAST - close: 53.10 change: +1.34 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: -70%
Time Frame: 3 to 4 weeks
New Positions: NO

Comments:
11/2 (James): Homebuilders were some of the best performers today with the DJUSHB index up +4.2%. I think some of the builder's strength rubbed off on FAST and the stock gained +2.5% on no news. On a very short-term basis today's close over its 10, 20, and 30-dma is bullish. If I wasn't expecting a market sell-off in the next 48 hours I would consider an early exit right here and now! However, since we are looking for a market decline soon we'll stick it out but readers may want to adjust their stops. Currently our stop is at $53.40 and it wouldn't take much for FAST to stop us out tomorrow. No new positions at this time.

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

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 46.49 change +0.26 stop 47.83

Target(s): 44.95, 44.15, 43.50
Key Support/Resistance Areas: 47.75, 46.10, 45.50, 44.60, 44.00, 43.00
Current Gain/Loss: -25%
Time Frame: 2 to 3 weeks
New Positions: Yes

Comments:
11/2 (James): ITW is still trying to bounce higher and managed a +0.5% gain today. I would keep an eye on the $47 level and the 20-dma (47.40) and 30-dma (47.25) as potential overhead resistance. A failed rally near these levels could be a new entry point.

11/1: The bounces in ITW keep getting sold. We need a break below $45.50 to get things moving towards our targets. I've raised the first target to $44.95 to account for the 100-day SMA. A move to this level should produce a +33% gain.

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.

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

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 23.90 change +0.22 stop 24.60

Target(s): 22.30, 21.25, 20.25
Key Support/Resistance Areas: 24.25, 24.00, 23.60
Current Gain/Loss: -23%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
11/2 (James): We need to be nimble here. The $23.50-24.25 zone should be overhead resistance for MTL. The stock has managed to rally past $23.50 and its 200-dma and today saw shares challenge its 50-dma and $24.25 area. This could be a new bearish entry point but I'd like to see the stock roll over first!

11/1: Friday's bounce in MTL continued on Monday and the stock closed above its 200-day SMA. The stock rallied up to touch its 50-day SMA from below for the first time since it broke below on 10/21, which is where today's selling began. There is resistance at current levels but we are going to need to see the broader market correct to see MTL make new lows and reach our targets.

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

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


Millicom Intl. - MICC - close: 96.10 change: +1.10 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: -14.2%
Time Frame: Three weeks
New Positions: Yes

Comments:
11/2 (James): MICC is providing a potential entry point here. Over the weekend I suggested that readers may want to wait for a bounce toward $96.00 and MICC delivered that bounce today. Shares are also testing overhead resistance near their 50-dma. Aside from the new entry point I don't see any changes from our prior comments.

11/1: MICC is consolidating under its 50-day SMA and declining 20-day SMA (both at $96.50). There is also resitance at $96.00 so this is a logical spot for the stock to turn lower and make a lower low. The 100-day SMA is just under $93.00 which may provide support on weakness. I like new positions to play for a pullback but we are most likely going to need help from the broader market.

10/30: 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: Long December 2010 $90 puts (MICC1018X90), entry was at $2.45

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


PNC Financial - PNC - close 52.90 change -0.27 stop NONE

Target(s): 53.00(hit), 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:
11/2 (James): Moody's issued some bearish comments on the banks this morning, which depressed the financial sector. The banks were the worst performers on Tuesday. PNC followed the group lower with a -0.5% decline. I am almost tempted to launch new positions here but readers may want to wait for a move under $52.50 first.

11/1: PNC lost -1.35% today and printed a bearish engulfing candlestick. However, the stock is finding support at its 20 and 50-day SMA's. We have three weeks for PNC to break down and are playing for a move back towards the recent lows. We are most likely going to take a loss on this trade but if we can gain another 20 to 30 cents in premium I suggest exiting the position.

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 be 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.

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

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


VMWare Inc - VMW - close: 77.66 change: +1.03 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: +10%
Time Frame: 3 to 4 weeks
New Positions: Yes

Comments:
11/2 (James): So far so good. VMW has seen a little bit of a bounce but it's still trading inside the trend of lower highs. I would still consider new positions at current levels.

11/1: VMW reached Friday's high in early trading and immediately turned lowere. The stock is consolidating just below its 100-day SMA and declining 20-day SMA. The first level of support is near $75.00. If the stock breaks this level it may find support at $73.00 but I would be surprised if $72.25 is not reached.

10/30: 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).

Current Position: Long 2010 December $70.00 put (VMW1018X70), entry @ $1.85

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


CLOSED BULLISH PLAYS

Archer Daniels Midland Co. - ADM - close 31.19 change -2.20 stop 31.90

Target(s): 33.75, 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: -61%
Time Frame: 2 to 4 weeks
New Positions: No

Comments:
11/2 (James): The action in ADM today is another good example of why we normally want to avoid holding positions over an earnings report. The company missed expectations by 21 cents! Wall Street was expecting a profit of 75 cents and ADM delivered 54 cents. Revenues improved significant (+12.6%) to $16.8 billion, which was better than expected but that fact was not enough to save the stock price.

Shares of ADM gapped open lower, under multiple layers of support. The stock opened at $32.06, briefly traded down to $31.75, hitting our stop loss at $31.90 closing our play in the first few moments this morning. The call option was trading near $0.30 when we were stopped out.

Closed Position: Long December $34.00 CALL, entry @ $0.77, exit @ 0.30 (-61%)

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 14.36 change +0.27 stop 13.75

Target(s): 14.70, 15.10, 15.40, 16.10
Key Support/Resistance Areas: 18.00, 17.00, 16.25, 14.75, 14.10
Current Gain/Loss: -38%
Time Frame: 1 to 3 weeks
New Positions: No

Comments:
11/2 (James): Hmm... after much thought I am suggesting an early exit out of our ATPG position. Here's why: First, the stock has continued to underperform its peers in the energy sector. Shares did gain +1.9% as traders bought the dip this morning but overall the short-term pattern remains one of lower highs. Bulls could argue that ATPG is poised to rally from recent support near $14.00. However, I'm expecting the market to sell-off tomorrow or Thursday on the QE2 news. What will ATPG do during a market-wide decline? Next, I'm concerned about earnings. We just saw what happened to ADM after its earnings report this morning. ATPG reports earnings in the next few days. I'd rather exit now than see ATPG gap down on us. More aggressive traders may want to ignore these issues and ride it out. Closed Position: Long December $16.00 CALL, entry @ $1.00, exit @ $0.62 (-38%)

Annotated Chart:

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