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Daily Newsletter, Saturday, 5/7/2011

Table of Contents

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

Market Wrap

Rough Week For Commodity Traders

by Jim Brown

Click here to email Jim Brown

The equity markets may have seen some minor profit taking last week but anyone with commodity positions probably ended up at a bar on Friday drinking their troubles away.

Market Statistics

Commodities other than oil were relatively tame on Friday but the better than expected jobs report sent oil prices on another wild ride. Crude traded as low as $94.63 and as high as $102.38 before crashing back at the close to $97.30. More jobs means more people driving to work every day but it was not long before the underlying bad news came back to haunt the energy sector.

The headline number on the Non-Farm Payrolls showed a gain of +244,000 jobs compared to a gain of +221,000 in March. The private sector created 268,000 jobs but that was offset by a -24,000 decline in government positions. February and March numbers were upgraded by another 55,000 jobs.

The service sector added +57,000 jobs and the most since 2000. Leisure and hospitality also grew significantly by +46,000 and professional/business services gained +51,000. Manufacturing grew by +29,000.

Non-Farm Payrolls

The bad news came from the normally bullish household survey. Household employment fell by -190,000 and full-time employment fell by -291,000. This spiked the unemployment rate from 8.8% to 9.0%. The actual number of people out of work remained the same at 13.7 million (officially on the unemployment rolls) and more than 20 million if you count those who have given up looking for work and are off the unemployment rolls or took a part time job to pay the bills. There are more than 8.6 million people in that classification.

If you only look at the Non-Farm numbers at +244,000 it appears the economy had defied the payroll declines in the recent regional reports and actually added jobs. However, if you combine the numbers from the Non-Farm and Household surveys it was a negative month. You have to love statistics like this because reporters can produce any story they like just by using a subset of the statistics.

We all heard in April about McDonalds hiring 62,000 workers. Those were not included in this report because the hiring came after the survey was completed.

To put the April report even more into perspective you have to realize that the labor force expanded by 235,000. That means if you just look at the +244,000 non-farm additions and the increase in workforce additions of +235,000 unemployment only decreased by -9,000 jobs. Obviously it is positive to create more jobs than there were people entering the workforce but at that rate it would take the rest of the century to eliminate the 20+ million unemployed. The majority would die from old age before they got a job.

I am really worried about the direction of the economy based on the Household Survey and the recent decline in employment in the regional economic activity reports. I think the non-farm numbers are a smoke screen that could disappear in the May report. Remember we saw sharp declines in economic activity in almost all the regional reports. Something does not compute and I hope I am wrong on the direction. Nothing would please me more to see a rebound in the household employment next month and a continuation of non-farm payroll gains but I will not be holding my breath.

Next week has a relatively benign economic calendar with the most watched reports closer to the end of the week. The two price indexes will be watched for inflation pressures but after the commodity implosion this week any gains in those reports will be ignored.

The earnings cycle is drawing to a close and there are only a few names reporting that most people will recognize. Cisco is the big dog on Wednesday but they have already lowered expectations so I doubt they will move the market.

Economic Calendar

The big news last week was of course the commodity implosion caused by the silver crash. I wrote on Thursday night that I believed the corresponding crash in oil, copper, etc, was caused by silver and not because of a specific weakness in fundamentals for those other commodities.

The silver crash was caused by the CME more than anything else. Yes, silver was over extended but markets and commodities get overextended all the time without a 27% drop in four days.

The CME raised the margin requirement for silver five times in two weeks or roughly every 48 hours. Every margin hike created thousands of margin calls that had to be covered immediately either by selling silver or some other commodity position. Add in the crash in the price pushing accounts into negative margin and it turned into an implosion. Any other futures asset in trader's accounts was sold in a panic attempt to avoid forced liquidation by the brokers. Traders were in panic mode to cover those margin calls and they could not do it fast enough with equities and they did not want to disrupt long term positions to cover a short-term problem. Selling futures was the only answer.

To complicate this problem the dollar exploded and the Euro imploded. Since QE2 was announced we have seen nearly every hedge fund and speculative trader with any clout shorting the dollar to buy commodities and equities. After all if the government is printing money that is the logical trade. The dollar fell to nearly three year lows with traders leveraging up on every downtick and every Fed speech saying QE2 would continue.

Then the ECB failed to raise interest rates on Thursday and that sent the Euro into freefall and the dollar exploded. Add in the rumor that Greece would leave the Eurozone and now everyone short the dollar and long commodities had another reason to panic sell. Sometimes when it rains it pours.

Currency traders are normally leveraged between 10 and 100 times more than commodity traders. When things go bad for them they go really bad and this was an example of really-really bad. That accelerated the margin call problem significantly as they tried to cover the growing back hole in their accounts.

Euro ETF Chart

Dollar Chart

I repeated the explanation from my Thursday night commentary to explain why the other commodities are not broken. Specifically I am going to talk about oil since it was the second biggest decliner with a 13% drop. Oil was over extended. In the Oil Slick newsletter we had been expecting a decline for the last 3-4 weeks and had exited nearly all our positions in anticipation of the drop.

Being overextended is different than being parabolic as we were seeing in silver. The Dow was also over extended but that did not mean a new bear market was going to appear in just a week. It just means that prices needed to cool before moving higher.

In the oil sector the second quarter is typically the low oil prices for the year. That trend was broken when the unrest in the Middle East starting with Egypt and Tunisia and ending with the loss of production from Libya. That pushed the prices to two-year highs rather than let them sink over the normal spring refinery maintenance period. The cycle was out of alignment and needed to see the pressures equalized.

I seriously doubt we would have seen anything close to the correction we got in oil without the margin panic from the silver crash. Oil does not drop $10-$12 in one day. That is not a normal move in any cycle. We basically saw a mini flash crash in commodities where the interrelationships among certain types of trades and traders removed the fundamentals from consideration.

That commodity flash crash may be behind us but it may not be over. Just like with the Japan earthquake there may be aftershocks for days or weeks to come in the commodity sector. Just like the May 6th 2010 flash crash in the equity markets the current flash crash has severely shaken the confidence of commodity traders. The crash probably severely crippled thousands of brokerage accounts as well. Billions of dollars were lost in the decline. That will have repercussions for months to come for many accounts. Some may be out of business. It was a once a decade type of event. Maybe even longer.

I explained the scenario to show that oil is not broken despite the decline from $114 to $97. Nothing changed in the fundamentals. Supply is still shrinking and demand is still growing. It may be growing slower than it was 90 days ago because of the high prices but it is still growing.

In reality the drop in prices will be good for demand. Gasoline futures dropped 40-cents to $3 a gallon before rebounding to close the week at $3.09. The high for the week was $3.42 on Monday. This will have a dramatic affect on the price at the pump. Where the U.S. average price was $3.985 last week it could decline 25-cents over the next couple weeks. Also, the refinery maintenance cycle is over and they will be ramping up production of gasoline for the summer driving season that begins in three weeks. That will also depress prices with more gas on the market. Both of these events are good for demand because prices could drop back to $3.50-$3.60 per gallon and after seeing that $4 handle last week a $3.50 price will look positively cheap.

The major brokers were tripping all over each other to recommend buying the dip in oil. Goldman, who had been recommending selling oil just three weeks ago said oil should make new highs after the correction is over. They said prices will surpass recent highs by 2012 because of shrinking capacity and increasing demand. "It is important to emphasize that even as oil prices are pulling back from their recent highs, we expect them to return to or surpass the recent highs by next year." Also, "We continue to believe that the oil supply-demand fundamentals will tighten further over the course of this year, and likely reach critically tight levels by early next year should Libyan oil supplies remain off the market. The sell-off yesterday (May 5th) has likely removed a large portion of the risk premium that we believe has been embedded in oil prices, which could suggest further downside may be limited from here." They did not rule out a further short-term decline but suggested this was a buying opportunity.

Barclays said the current levels represented a good buying opportunity."While further downside weakness cannot be ruled out, the general trend should be higher rather than lower. Fundamentals have not changed. We have diminishing spare capacity, global demand increasing and supply side issues so the factors pushing prices higher are still there."

JP Morgan actually raised its estimates on Friday saying Brent crude will rise to $130 in the third quarter and that would restrain demand in the fall. JPM said, "While financial bushfires or perhaps a rapid resolution to the Libyan civil war could radically alter market dynamics, the balance of both risks and fundamentals still points to a supply-constrained world."

JPM said its current supply and demand projections show a supply shortfall of 600,000 bpd in Q3, even assuming OPEC increases output by 1.2 million barrels per day in the coming months. They believe that shortfall could narrow to 300,000 bpd in Q4 if Saudi can raise production to 9.5 mbpd, Angola 1.7 mbpd and Iraq 3.0 mbpd. That may be wishful thinking.

There is an OPEC meeting in June to discuss production quotas. We heard on Thursday that OPEC may change their quota system and announce an increase in production. It will be only for show. They are already producing more than 2.5 mbpd over their official quotas so anything less than a 2.5 mbpd increase will be purely political theater. If they announce a 3.5 mbpd increase the level of the actual increase will only be 1.0 mbpd. However, if countries like Venezuela and Iran continue to have the same or higher quotas as they have today then the whole process is even more bogus. Those countries and several others can't even produce up to their quota today so giving them any more production permission is just more theater meant to appease those who blame OPEC for the high prices.

Driving season begins on Memorial Day and the hurricane season on June 1st. Those are just a couple more reasons why oil may not move lower.

Register for the OilSlick.com newsletter and receive free daily updates and commentary on the energy sector. Register here

Crude Oil Chart

Brent Crude Chart

One last comment on the commodity crash. The silver ETF (SLV) saw inflows of $726 million from January until last week. Prices rose from $26 to $48 over that period. Last week the ETF saw outflows of $1.2 billion. On Thursday the ETF closed -9% below its net asset value. Since this is the favorite silver vehicle for retail traders it is a clear example of how involved the retail investor was with silver speculation.

Silver ETF

Citibank (Nyse:C) will no longer be the volume leader on the NYSE beginning on Monday. The stock will open at $45 and well over the $4.52 close on Friday. The reason of course is the 1:10 reverse split undertaken by Citi in an attempt to regain respectability. In theory Citi will then be able to pay a dividend with the Fed's blessing. Many stock funds and investment accounts are prohibited from buying stocks under $5 and some can't buy anything under $10. That keeps a lot of buying power sidelined with Citi stock under $5.

Obviously nothing changed overnight at Citi and this is only a cosmetic fix to an age-old problem. There is nothing to prevent shares of Citi from plunging after the split. AIG did a 1:20 reverse split to avoid delisting in 2009 and they declined after the split. Citi currently has 29 billion shares outstanding. After the split that will drop to 2.9 billion. Citi posted $10.6 billion in profits in 2010 and CEO Pandit expects $20 billion in 2012. Citi Chart

Berkshire Hathaway (BRK.B) is not having a good year. First there was the problem with David Sokol and the insider trading and Buffett was beat up over that at the annual meeting last month. On Friday they reported earnings that declined -58% to $1.5 billion for Q1. That is down from $3.6 billion in the year ago quarter. The company took a $1.7 billion hit for insurance losses related to quake damage in Japan, the New Zealand earthquake and the floods in Australia. Berkshire said given the potential for hurricanes in the U.S. this year it is unlikely the insurance unit will achieve a profit in 2011.

Berkshire Chart

Priceline reported earnings of $2.66 per share compared to estimates for $2.46 and beat on revenue. However the stock lost -$14 (-3%) on the news. The Goldman analyst cut her rating from buy to neutral saying "the anticipated deceleration" in their online business "may arrive sooner than expected." She feels the rising market share Priceline has seen in recent years is coming to an end. Priceline's share of hotel bookings in Europe is approaching 50% and given the number of competitors she sees it topping out soon. Priceline also said Q2 international growth will decline from 80% in Q1 to 56% in Q2. Priceline is moving from a strong growth company to just a company with moderate growth in what is now an established business model.

Priceline Chart

Intel and Apple were in the news amid the rumors of a potential breakup of their partnership. The rumor has Apple switching to ARM chips in its laptop computers and dumping the Intel processors. While this has been rumored there is no confirmation. Reportedly Apple is waiting for the next generation of ARM chips with 64bit addressing capability before making the switch. That update is expected in Q4-2012 to Q1-2013. Obviously it is not going to impact Intel sales any time in the near future. Intel is also working on a competitive chip to the ARM processor and could have its own chip in place before ARM.

Other analysts believe Apple won't jump to ARM because Intel is the mainstream and they continue to be the leading edge of computing. Intel just announced its Tri-Gate transistor technology that will produce smaller, faster chips that will consume less power. That is exactly what Apple will need for its next version of laptops. Intel's stock declined slightly on the news.

Another interesting story for the tech sector is a massive surge in components orders since the earthquake in Japan. The "just in time" supply chain of the last decade has changed. PC makers of all types plus TV and mobile phone manufacturers have seen the slowdown in parts to automakers and some electronics manufacturers and they don't like what they saw. In recent years manufacturers ordered just enough parts to manufacture products for days to maybe a couple weeks at a time. By ordering smaller amounts to be delivered continuously they reduced the cost of inventory and were able to upgrade to new models or different suppliers almost instantly.

After seeing parts for nearly every U.S. product slow to some extent because of the quake in Japan they are changing their order patterns. More than 22% of all chips used in the U.S. come from Japan. Despite the recent mega-quake scientists are predicting another major quake within the next ten years. This has prompted manufacturers to increase orders significantly on Japanese parts so companies won't be shutdown by a lack of supplies when the next quake hits.

This is being called hoarding by analysts and they warn it could impact profitability in future quarters and mask a slowdown in PC and electronics sales. Inventorying hundreds of thousands of parts costs money and reduces flexibility. Analysts predict sales growth of the manufactured products by monitoring sales of the components. The rapid increase in component sales for backup inventory will make that task more difficult. Also a slowdown in component sales could mean a slowdown in product sales or simply that inventories became too high. I suspect this component hoarding will run its course pretty quickly. The disadvantages in the long run far outweigh the advantages. Once the quake headlines disappear and inventory balances begin to weigh on earnings I believe companies will return to the just in time method but they will buy from multiple sources in order to protect their supply chain from a localized event. Meanwhile the component makers are being besieged by monster orders. That has to be encouraging for them.

The Greek tragedy playing out in Europe helped to roil the markets again on Friday after an article in the German magazine Der Spiegel claimed Greece was going to withdraw from the Eurozone. This caused additional volatility in the Euro but the claim was widely denied by everyone concerned. The claim had taken on additional significance when it was learned there was a secret meeting planned on Friday night with various EU finance ministers including ministers from France and Germany. The secret meeting gave credibility to the rumor. After the meeting everyone continued to deny that a withdrawal by Greece was even discussed.

There is little or no probability that Greece will bail from the EU. Because of their current financial situation they have no access to the financial markets. Their only lifeblood is the $160 billion aid package from the EU and IMF and withdrawing from the Eurozone would end that bailout. What will probably happen is an extension of the terms on the bailout in order to get Greece past the first few years of austerity.

The current austerity program has pushed them into a severe recession where the economy shrank faster than expected. However, that shrinking economy pushed the budget deficit from 9.4% to 10.5% of GDP. Greece is going to end up with loans of more than 150% of GDP and a debt problem that almost everyone believes is insurmountable.

Most analysts believe Greece and Ireland will eventually default and be forced to restructure their debt to pay pennies on the dollar. That will weigh on the Euro for years to come. The only way out is for the major debt holders, which include France, Germany and the ECB, to exchange their existing debt for securities with longer maturities and a lower interest rate rather than be forced to accept only a partial payment and have to raise taxes on their citizens to pay for the Greek shortfall.

Last weekend I wrote I was hoping for a 2-3% pullback so traders could reload. From the prior Friday's close to Thursday's low at 1330 was a -2.4% pullback. In theory this was the perfect amount of profit taking to keep bullish sentiment alive and allow new buyers an opportunity to enter new longs.

Obviously we will not know if it was a buying opportunity or just the beginning of a bigger decline until several weeks have passed. The economics are clouding up again and there is less conviction the recovery is moving forward. The headline number on the jobs report was bullish but the household employment survey was bearish. These numbers did not have the 62,000 McDonald boost. Those will be in the May report.

Last week as a big week for consumer sentiment. Osama Bin Laden was eliminated along with his plans for a tenth anniversary attack in the USA. Oil prices imploded and gasoline could decline to $3.50 in June. Those should provide a big sentiment boost for consumers but they both came after the completion of the sentiment survey that will be reported next Friday. That means $4 gasoline will be the lead story in that report.

Corporate earnings have taken a significant turn. The first two weeks of blue chip reports were very positive. Once those big cap reports faded the tone of earnings turned progressively negative. It is not that earnings are not decent because they are but the guidance has been questionable for the smaller companies. Analysts have been quick to downgrade on the slightest hiccup in the reports. Even many oil companies reported disappointing results despite triple digit prices.

The earnings parade is slowing and the economics next week are mostly noise. There is little to stimulate bullish sentiment. The aftershocks from the commodity crash could linger for weeks. It was not as shocking as the flash crash last May because it did not hit as many traders. However for the traders and hedge funds it did hit the damage may be long lasting. Equity traders were afraid of the markets for months after the flash crash. Commodity traders are more experienced and quicker to adjust but I am sure it was a mind searing experience for quite a few.

I talked to Leigh Stevens on Friday and we were both of the mindset that the equity declined stopped where it should have stopped. However, I remain skeptical until we see a new uptrend begin. Thursday was a disaster and Friday was the dead cat bounce. Monday will probably see some testing of support and by Tuesday's close we should have a better idea on market direction.

This is the "sell in May and go away" period and there is even more incentive to take profits ahead of the end of QE2 in June. However, if the economic recovery is still on track then there is also a reason to remain invested. Will those reasons over power the coming summer doldrums? The next couple weeks will tell the tale.

The S&P dipped to the support of the 30-day average on Thursday at 1330. The more recognizable support at 1340 held on Wednesday but the commodity crash forced a closing dip below that level on Thursday. Friday saw an opening spike and then a further sell off began at noon as traders began to clean up the pieces of the Thursday disaster. Support at 1340 held again at the close. If this support breaks the next material support level would be the 100-day average at 1304.

S&P Chart

The Dow closed -250 points off its highs from Monday and after a +700 point rally that should be enough to ease the pressure. However, "should" has an entirely different meaning in the stock market. The indexes rarely do what they should or at least not in the timeframe anyone expects. I am still worried that the commodity crash aftershocks could force a test of support at a lower level. The Dow appears unsupported on its current uptrend but then new highs are normally unsupported. The process of breaking out to a new high leaves all recent support in the rear view mirror.

The biggest gainers in the Dow on Friday were CAT, IBM and BA. CAT and IBM were coming off a week of declines and were due for a rebound. Both were lackluster with IBM the biggest gainer at +1.18. For a $170 stock that is pocket change.

I think there was enough discontent over the underlying components in the payroll report that investors were thinking twice about the industrials. Of course the debris from Thursday's commodity crash was still littering the landscape and I am surprised we didn't end in negative territory.

I am neutral on the Dow until we get a couple more days of trading behind us.

Dow Chart

The Nasdaq was relatively insulated from the commodity crash and only gave up -1.6% for the week with the Nasdaq-100 declining only .9%. Compared to the Russell 2000 at -3.7% it was nearly untouched. Support at 2800 held on the Thursday dip and the slide after Friday's rebound held at 2825. I consider this the most bullish performance of the major indexes. The NDX is only about 40 points away from a new high. Considering tech stocks are not normally good performers in Q2 this resilience is bucking a decent headwind.

Cisco could be the challenge to the Nasdaq on Wednesday. Since they already warned you would think any surprise would be to the upside but then they may have not wanted to release all the bad news at once.

Nasdaq Chart

Nasdaq 100 Chart

The Russell may have lost -3.7% for the week but it did it all in the first three days. There was very little drop on Thursday and a decent rebound attempt on Friday. Support at 830 held as well as the 50-day average at 828. The Russell has honored that average several times in 2011.

The Russell remained mostly between 830-840 for the last three days. This gives us a good range to watch for market sentiment. If the Russell moves over 840 it suggests fund managers are not afraid of the summer doldrums. If it falls below 830 I would immediately go to cautiously bearish and below 820 I would be solidly bearish. That 820 support level held for over a week in April. If it breaks we are in trouble.

Russell 2000 Chart

Since the Dow's July low at 9,614 the index had gained +3200 points to close at 12,810 on the prior Friday. There were only three material bouts of profit taking since the July low. Even with that profit taking the index has rebounded +33% in less than a year. That is a lot even when economic conditions are perfect. They are far from perfect today.

Dow Chart

Uncertainty about economics is a major problem. April reports produced a lot of discrepancies suggesting the economic rebound had developed a flat tire. The engine may be intact but there is no power reaching the road. Until the economics show improvement again I believe the worry is going to be weighted towards a second recessionary dip caused by the rising fuel prices. If oil remains reasonable and gasoline really does decline 50-cents into June then we could be fine. However that is a couple of big IFs.

We still have the uncertainty of what will happen to interest rates when QE2 ends in June. QE 1.5 will still be active but that is well below the current rate of buying. QE2 is $60 billion a month and QE 1.5 is $15-$20 billion a month. (QE 1.5 is the reinvestment of the payoff proceeds from earlier QE1 purchases.)

There are a lot of data points ahead and the next 60 days could be a period of consolidation in the markets rather than a continued rally. I believe we are entering a cautionary period rather than a bullish expansion. Investors have been betting on an accelerating recovery for two years now and growth appears to be slowing rather than accelerating. If May's data confirms that slowing then we are in for trouble in the markets. For this reason I think we have entered a trading market rather than a buy and hold environment. Time will tell.

Enter passively, exit aggressively.

Jim Brown

Send Jim an email

"You can avoid reality, but you cannot avoid the consequences of avoiding reality."
Ayn Rand


Index Wrap

Knock Back From New Highs

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

With the move to new highs, chart aspects suggesting taking profits on bullish index option strategies were the rally failures at or near resistance implied by previously broken up trendlines. This was especially relevant when the RSI indicator reached overbought readings. You will see these aspects on my individual stock index charts that follow. Summing up this past week's technical picture that suggested profit-taking, I note the following:

Indexes getting NEAR resistance implied by previously penetrated up trendlines (possible 'kiss of death' trendlines) this past Monday, were the S&P 500 (SPX), the S&P 100, the Nasdaq Composite (COMP) and the Nasdaq 100 (NDX). All but the Nas 100 ALSO reached 13-day Relative Strength Index (RSI) readings of 70, which is the beginning of an overbought zone. The Dow 30 (INDU), which had been leading the overall market, got to 74 in the RSI and hit resistance implied by the TOP end an uptrend price channel. The Russell 2000 (RUT) didn't quite reach a 'typical' overbought RSI extreme (at 67.8) but did EXACTLY hit resistance AT its previously broken up trendline.

The above technical/chart aspects were reason enough to take profits on long calls and/or to sell covered calls, etc. Mostly I want to emphasize that there were two good reasons to take profits on calls. This is NOT to say that the larger chart picture has turned bearish, since there's a pattern of higher relative highs and higher pullback lows.

Regarding further bullish potential, the recent pullbacks were only TO but not BELOW technical support levels, as you will also see notated on my individual daily index charts. The prospect for another rally is present. There may however be another somewhat lackluster short-term rally, followed by another minor sell off before there's a stronger and more prolonged rally attempt.

On the bearish side: if prices start falling to still lower levels than seen this past week and there's a break of key near support levels highlighted on my charts, it would suggest potential for a second down leg. I myself don't see a major downside move ahead and think it more likely the indexes either continue the rally interrupted this past week OR move into a trading range market, which would then suggest index option strategies appropriate to a range-bound market.

THE LONGER-TERM CHART PICTURE:

In terms of SPX, the index has been tracking higher WITHIN a broad weekly chart uptrend price channel. Recent lows held the more minor up trendline as noted by the higher green up arrow. To date, SPX has retraced more than 66% or 2/3rds of the October '07 to March '09 bear market decline. Exceeding a 2/3rds retracement of the prior decline tends to bode well for a move to still higher levels and even back to re-test the highest prior top.

One forecast is for a retest of the 1440 area, especially by the fall or year end. Beyond 1440, there's longer-term potential for a move to the 1500 area again. There is no suggested violation or bearish break of the long-term trend unless 1215-1200 is penetrated on a weekly closing basis.

A cautionary note (highlighted above) for the bulls and relative to the direction of prices in the next few weeks, is suggested by a bearish price/RSI divergence, as the recent higher relative highs were not matched by a corresponding new high in the 13-week RSI. This divergence doesn't loom large in my current thinking but it should be noted.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) is bullish in its pattern given the pattern of higher highs and higher pullback lows. What hasn't happened is a move back above the long-term up trendline, which isn't bearish per se. Rather, this pattern suggests that upside momentum, while bullish, hasn't equaled the strong ascent seen in prior months. Momentum has slowed from what it was prior to the March sell off. Given that we're entering a seasonally choppy period, we should wait for trades with compelling technical aspects.

To maintain a bullish near term outlook, look for prices to turn up from the 1335-1340 area, or what was the area of prior tops and prior resistance. A decline below 1320 and to below support extending to the previous low at 1295 would be bearish.

Conversely, a move back above 1370 would be a bullish plus. An even stronger bullish 'signal' is for a move to above 1388 on a closing basis and to above 1400 on an intraday basis.

While I remain predominately bullish, I no longer want to be long calls. In any directional trade that counts on further upside, I like to assess the trade as if it was a new position and whether the further upside potential was significantly greater than the downside risk. I figure my exit point on a new trade is to 1290, and the maximum reward currently is to 1400, so a 50 point risk relative to a 60 point upside is too close to a 1 to 1 risk to reward, rather than a 1 to 3, more favorable, ratio.

RSI and TRADER 'SENTIMENT'

The 13-day RSI hit an overbought 70 (seen above) at the beginning of this past week, followed by weakness after that. This suggests to me that buyers are getting more skittish and sellers more aggressive. The market is hitting a period of more cross currents based on fundamental factors.

Also seen at the beginning of this past week was an overly bullish sentiment reading of 2.0 and the beginning of an 'overbought' trader sentiment. In a stronger trend, sentiment will get into my overbought zone repeatedly. Instead, bullishness fell fast in terms of the CBOE equities call to put ratio (in a daily call/put volume comparison), which suggests uncertainty as to future market direction. Periods of uncertainty in bullish sentiment can lead to choppy two-sided trading.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) is bullish in its pattern in that we continue in a pattern of stair step higher highs and higher reaction lows. Read my commentary above on the S&P 500, for a broader view of the S&P. I was more bullish last week in that I thought that OEX could move back into its uptrend channel that existed prior to the March sell off. Instead, once prices got NEAR to resistance implied by the previously broken up trendline, prices reversed. The indexes tend to either get TO, or above, such trendlines OR rally failures often occur when an index is only within a close proximity of this line.

I noted last time that a 'measured move' objective, where the most recent up leg would equal the last advance, would have been to 617; instead, the intraday high last week was 611.

Support in the OEX developed more or less in the area of its prior highs, which is a bullish plus if it continues. I've noted support at around 590, extending to 580. A close below 580 would be bearish. Conversely, resistance is apparent in the 610-611 area, extending to 620.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) average reached the top end of its uptrend price channel and reversed from there. I would say that the further near-term upside potential for the Dow 30 is not big, although we could see a move yet to 13000. A decisive upside penetration of 13000 would be a more move than I'm anticipating currently.

When INDU got to its upper trend channel line, it was accompanied by an overbought RSI reading. To nail down profits on long DJX calls was a good move at that juncture. If INDU rallies again up toward resistance implied by the upper channel line, take call profits and run. Buying some puts around Dow 13000 would look to have a favorable risk to reward; risk 100 points, with a downside objective to the 12500 area.

Technical support is noted in the 12460 area, with next support seen at 12200. I've noted resistance at 12800, extending to the prior recent intraday 12876 high; resistance then extends to the 13000 area.

Dow charts with bullish patterns, and not having turned more questionable relative to this past week's action, is seen with AXP, BA, IBM, INTC, JNJ, KFT, MMM, T, TRV and UTX.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) chart is bullish in its pattern of higher highs and lows. COMP did reverse this past week in an area of at resistance implied by its previously penetrated up trendline, the second time rallies have reversed at this line. This pattern of highs has formed what looks to be the TOP end of a new uptrend price channel.

Resistance implied by the upper channel line suggests possible strong resistance comes in around 2925 currently, as noted by the higher down arrow. Nearer resistance is implied in the area of the prior recent high around 2887.

Key support remains 2800, extending to 2765, at a possible 'emerging' up trendline, but with only two lows currently; better is 3 or more lows to define an up trendline. Nevertheless, a break below this line would imply more weakness to follow. Fairly major support than could be expected in the 2700 area.

Overbought extremes in terms of the RSI and my bullish sentiment indicator were seen at the recent minor top. The pattern seen since prices rebounded a bit from the 21-day moving average, doesn't yet suggest a robust rally and looks to be a possible bear flag with a possible 2750 downside objective.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) is bullish as with all the other major indexes that in that the pattern is one of higher highs and higher reaction lows. We could see some further weakness ahead, such as for a test of support beginning around 2350 and extending to 2300 support implied by the up trendline.

Resistance in NDX is implied by recent highs in the 2415-2417 area. Next resistance is noted at the intersection of the upper channel line intersecting at 2463 currently. I have two channels highlighted currently, one dating from the stronger trend that existed before the early-March weakness, but NDX doesn't look like it is going to regain this higher channel and I'll likely stop featuring all but the middle line bisecting the two channels, old and new.

Key support is highlighted again this week in the 2350 area, then at 2300, at the current intersection of the up trendline. As long as this trendline is not pierced I remain bullish on the dominant trend.

NASDAQ 100 TRACKING STOCK (QQQ); DAILY CHART:

The Nasdaq 100 tracking stock (QQQ) is bullish in its pattern but like the underlying NDX index, the Q's are hitting resistance and upside looks limited from here, but with downside potential equal to a bit more than upside possibilities currently.

If QQQ was to clear immediate resistance in the 59.3 area, then at 60, at the current intersection of the upper channel line, with next resistance estimated at 61.

Support levels are 58, then at 57.0, extending to 56.5, at the current intersection of the up trendline.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) got back to resistance implied by the 'kiss of death' trendline, the more colorful name applied to the previously broken up trendline dating from the early-March sell off when the uptrend got pierced.

I see RUT upside potential as limited currently. Resistance has to be assumed to lie at the 868 recent high, extending to the early week intersection of the same trendline which comes in around 880. is at the recent chart is bullish given its move to new highs. Major resistance is seen in the 900 area.

Near support is comes in around the 50-day moving average and recent lows, at 825-827 currently. Fairly major support begins in the 800 area, extending to the prior downswing low at 776.

I see more likelihood for further weakness such as to 800-780 than I do for another immediate challenge ahead to the 880 area.



GOOD TRADING SUCCESS!


New Option Plays

Tech, Rails, and Oil

by James Brown

Click here to email James Brown

Editor's Note:

Additional stocks that caught my eye as possible bullish candidates this weekend are: HSIC, ESRX, EL, ZMH, and COH.

- James


NEW DIRECTIONAL CALL PLAYS

NetApp, Inc. - NTAP - close: 53.30 change: +1.80

Stop Loss: 50.75
Target(s): 58.00
Current Option Gain/Loss: + 0.0%
Time Frame: about 3 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
NTAP is a data storage company. The stock has spent the last two weeks consolidating sideways between overhead resistance at its 100-dma and short-term support at the $51.00 level. That changed on Friday with NTAP's bullish breakout. I am suggesting we buy calls now with a stop loss at $50.75. More aggressive traders could put their stop lower under the 200-dma or the $50.00 mark. I do see potential resistance near $55.00, which is the bottom of NTAP's gap down in February and there is potential resistance at the top of the gap near $58.00. However, if the wider market rallies I expect NTAP to power past the $55 level. We're setting our exit target at $58.00. FYI: The Point & Figure chart for NTAP is bullish with a $68 target.

NOTE: We do not want to hold over the late May earnings report. The date is still unconfirmed. This gives is about two or three weeks as our time frame.

- Suggested Positions -

Buy the June $55 calls (NTAP1118F55) current ask $1.88

Annotated Chart:

Entry on May 9th at $ xx.xx
Earnings Date 05/25/11 (unconfirmed)
Average Daily Volume = 5.8 million
Listed on May 7th, 2011


Union Pacific - UNP - close: 102.34 change: +0.63

Stop Loss: 98.95
Target(s): 109.00, 114.00
Current Option Gain/Loss: + 0.0%
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Railroad stocks helped fuel the Dow Jones Transportation average to a new all-tie high in the last two weeks. UNP was a part of that move with a breakout past major resistance at $100. Now broken resistance is new support. This dip is a bullish entry point to buy calls. I am suggesting new positions now. Cautious traders may want to wait and hope for a dip into the $101-100 zone as their entry point instead. Our targets are $109.00 and $114.00. FYI: The Point & Figure chart for UNP is bullish with a $116 target.

- Suggested Positions -

Buy the June $105 call (UNP1118F105) current ask $1.78

Annotated Chart:

Entry on May 9th at $ xx.xx
Earnings Date 07/21/11 (unconfirmed)
Average Daily Volume = 3.4 million
Listed on May 7th, 2011


SPDR Oil & Gas ETF - XOP - close: 57.97 change: +0.68

Stop Loss: 55.99
Target(s): 61.00, 65.00
Current Option Gain/Loss: + 0.0%
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The XOP is an exchange traded fund (ETF) designed to track the oil and gas exploration and production industry. So why buy calls on the XOP now? The sell-off last week was terrible and fueled by big volume. By all accounts it looks like a bearish breakdown and change in trend. Normally I would be tempted to look for the next failed rally at resistance as an entry point to buy puts. However, we have a strong suspicion that the sell-off in oil was overdone due to the weakness across the commodity sector. It may have been influenced by traders needing to liquidate something to make their margin calls for their silver positions.

We are suggesting calls here but this is a very aggressive and high-risk trade. I like the XOP because we don't have to deal with any one stock struggling due to company specific news. You'll notice the XOP bounced at support near its early February and early March lows. I'm suggesting we buy calls right here with a stop loss at $55.99. Our first target is $61.00. Our second, more aggressive target is $65.00 but the XOP will have to climb through a cloud over overhead resistance to get there. Keep an eye on the U.S. dollar. If the dollar continues to rise it will put downward pressure on oil prices and oil stocks could follow it lower.

I would keep our position size small to limit our risk. We can buy May calls for the short-term bounce and exit soon since May calls expire in two weeks. The June calls would be a little less risky.

- Suggested Positions - (Small positions)

buy the May $58.00 call (XOP1121E58) current ask $1.50

- or -

buy the June $60.00 call (XOP1118F60) current ask $1.64

Annotated Chart:

Entry on May 9th at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 4.8 million
Listed on May 7th, 2011


In Play Updates and Reviews

Oversold Bounce Fades

by James Brown

Click here to email James Brown

Editor's Note:

Friday's oversold bounce across the market faded lower but stocks ended the day generally higher.

-James

Current Portfolio:


CALL Play Updates

Apple Inc. - AAPL - close: 346.66 change: -0.09

Stop Loss: 339.40
Target(s): 374.00, 395.00
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see trigger

Comments:
05/07 update: AAPL has been relatively immune to the market's sell-off this past week. However, the stock has developed a new trend of lower highs. I am adjusting our strategy on AAPL. Instead of waiting for a dip near $340 we are switching to a breakout entry point. I am suggesting we buy calls on AAPL at $352.50. There is possible resistance near $355 and $360 but if AAPL can breakout from this two-week consolidation I suspect it will launch into a new leg higher. We'll adjust our upside targets to $374.00 and $395.00. Our stop loss will change to $339.40.

In summary, instead of a buy-the-dip entry at $341.00 we want to use a breakout entry at $352.50.

Buy-the-breakout Trigger @ $352.50

- Suggested Positions -

Buy the June $370 calls (AAPL1118F370)

- or -

Buy the July $380 calls (AAPL1116G380)

chart:

Entry on May xxth at $ xx.xx
Earnings Date 07/20/11 (unconfirmed)
Average Daily Volume = 16.6 million
Listed on May 2nd, 2011


Fastenal Co. - FAST - close: 66.36 change: +0.44

Stop Loss: 63.75
Target(s): 69.50, 74.00
Current Option Gain/Loss: -13.6% & -20.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
05/07 update: FAST held up pretty well this past week. After consolidating sideways on either side of $66 and finding support near its 30-dma the stock looks poised to rally higher. I would buy calls here at current levels. Cautious traders might want to use a higher stop loss near $65.00 instead of our stop at $63.75.

Don't forget that May options expire in two weeks.

Our targets are $69.50 and $74.00. We should expect the $70.00 area to offer some resistance and FAST will likely pull back on the first test of $70.

FYI: FAST is due to split 2-for-1 on May 23rd. Plus, the Point & Figure chart for FAST is bullish with a $72 target.

- Suggested Positions -

Long the May $65.00 calls (FAST1121E65) Entry @ $2.20

- or -

Long the June $70.00 calls (FAST1118F70) Entry @ $0.75

chart:

Entry on April 26th at $66.25
Earnings Date 04/12/11 (unconfirmed)
Average Daily Volume = 1.1 million
Listed on April 23rd, 2011


Google Inc. - GOOG - close: 535.30 change: +1.03

Stop Loss: 518.75
Target(s): 549.00, 558.00
Current Option Gain/Loss: -25.0%
Time Frame: 2 to 3 weeks
New Positions: see below

Comments:
05/07 update: GOOG garnered some bullish analyst comments this morning and a $626 price target. Unfortunately the stock's early morning strength and rally over $540 faded. GOOG essentially spent the week bouncing around the $530-540 zone, which isn't bad considering the sell-off across the market. I remain very wary here and hesitant to launch new positions. We only have two weeks left before May options expire and we need to see GOOG make some progress pretty quickly or our May $550 calls will expire worthless. Currently our targets are at $549.00 and $558.00.

Prior Comments:
This is a very aggressive, higher-risk trade. Keep positions small.

(Very Small Positions) Suggested Positions:

Long the May $550 call (GOOG1121E550) Entry @ $3.00

04/30 Adjusted exit strategy. First target at $549.00. Final target at $558.00.

chart:

Entry on April 25th at $525.25
Earnings Date 04/14/11 (confirmed)
Average Daily Volume = 3.3 million
Listed on April 23rd, 2011


International Business Machines - IBM - close: 168.89 change: +1.18

Stop Loss: 164.75
Target(s): 174.00, 179.50
Current Option Gain/Loss: + 23.0%
Time Frame: 6 to 9 weeks
New Positions: see below

Comments:
05/07 update: The bounce in IBM (+0.7%) wasn't bad but shares struggled at the $170 level. Overall I don't see any changes from my prior comments. This past week's dip toward the $168-167 area is an entry point to buy the dip and I would still consider new positions now. Our targets are $174.00 and $179.50. FYI: The Point & Figure chart for IBM is bullish with a $208 target.

- Suggested Positions -

Long the June $170 calls (IBM1118F170) Entry @ $2.60

chart:

Entry on May 5th at $167.50
Earnings Date 04/19/11
Average Daily Volume = 4.8 million
Listed on April 27th, 2011


Intuit - INTU - close: 53.98 change: -0.57

Stop Loss: 53.45
Target(s): 58.75
Current Option Gain/Loss: -62.5%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
05/07 update: Readers may want to exit early. Nothing has changed from my Thursday comments on INTU. While the stock didn't see that big of a decline last week the tone has turned bearish and the stock is testing the $53.50 area. If there is any follow through lower on Monday we will likely get stopped out at $53.45. I am not suggesting new positions at this time. We do not want to hold over the mid May earnings date.

I would keep our position size small to limit our risk (1/2 or less than your normal trade size).

- Suggested Positions -

Long the May $55.00 call (INTU1121E55) Entry @ $2.40

04/30 Adjusted target to $58.75

chart:

Entry on April 20th at $55.25
Earnings Date 05/19/11 (unconfirmed)
Average Daily Volume = 2.4 million
Listed on April 14th, 2011


Jos. A Bank Clothiers - JOSB - close: 52.03 change: +0.00

Stop Loss: 49.95
Target(s): 59.50
Current Option Gain/Loss: - 71.4% and -34.2%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
05/07 update: JOSB closed unchanged on Friday near the $52 level. The stock fared better than most last week but JOSB has short-term resistance near $53.00. A breakout past this level might spark a short squeeze. Yet I'm reluctant to launch positions right here. I'd look for another bounce in the $50.50-51.00 zone as an entry point or a rally past its high near $53.40 as an entry point. Don't forget that May calls expire in two weeks.

FYI: The most recent data listed short interest in JOSB at more than 21% of the small 27.3 million-share float. Together the increase the risk of a short squeeze.

- Suggested Positions -

Long the May $55 calls (JOSB1121E55) entry @ $0.70

- or -

Long the June $55 calls (JOSB1118F55) entry @ $1.75

chart:

Entry on April 26th at $52.75
Earnings Date 06/02/11 (unconfirmed)
Average Daily Volume = 510 thousand
Listed on April 25th, 2011


O'Reilly Automotive - ORLY - close: 59.70 change: -0.17

Stop Loss: 57.75
Target(s): 62.75, 67.25
Current Option Gain/Loss: -28.5% & -12.1%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
05/07 update: ORLY tried to rally again and once again it failed. Even though ORLY hit another new relative high on Friday morning the move is short-term bearish for the stock. I would expect another dip to $59.00, possibly $58.00. Wait for the dip before considering new bullish positions. Look for additional short-term support near the rising 10-dma. The plan was to keep our position size small to limit our risk.

- Suggested (Small) Positions -

Long the May $60 calls (ORLY1121E60) Entry @ $1.05

- or -

Long the June $60 calls (ORLY1118F60) Entry @ $1.65

chart:

Entry on May 4th at $60.15
Earnings Date 04/27/11
Average Daily Volume = 1.1 million
Listed on April 30th, 2011


Powershares QQQ ETF - QQQ - close: 58.47 change: +0.19

Stop Loss: 56.45
Target(s): 64.00
Current Option Gain/Loss: - 8.4% & - 7.0%
Time Frame: 8 to 10 weeks
New Positions: see below

Comments:
05/07 update: The QQQ posted a gain on Friday but the pull back from its morning high is worrisome and does not inspire a lot of confidence. Bigger picture I'm still bullish on the NASDAQ-100 index but I'm wondering if the QQQs will test the $57.50-57.00 zone before making any significant gains. I would still launch new bullish positions on dips near $58.00 but more conservative traders could wait and hope for a dip a little bit lower. Our upside target is $64.00. The Qs don't move very fast so we'll have to be patient.

- Suggested Positions -

Long the June $60 calls (QQQ1118F60) Entry @ 0.59

- or -

Long the July $60 calls (QQQ1116G60) Entry @ 1.00

chart:

Entry on May 4th at $58.15
Earnings Date --/--/--
Average Daily Volume = 50 million
Listed on April 30th, 2011


Ross Stores Inc. - ROST - close: 78.19 change: -0.36

Stop Loss: 74.75
Target(s): 77.25, 79.90
Current Option Gain/Loss: +157.7%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
05/07 update: ROST tagged a new all-time high at $79.63 on Friday morning and the drifted back toward the $78 level. The stock remains short-term overbought and probably due for more profit taking. I am not suggesting new positions at this time. More conservative traders may want to take profits now and exit completely. Our final target is $79.90. We do not want to hold over the mid May earnings report.

- Suggested Positions -

Long the May $72.50 calls (ROST1121E72.5) Entry @ $2.25

05/05 New stop loss @ 74.75. Adjusted 2nd target to $79.90 from $79.50.
05/05 1st Target Hit @ 77.25. Option @ $5.00 (+122.2%)

chart:

Entry on April 28th at $73.55
Earnings Date 05/19/11 (unconfirmed)
Average Daily Volume = 1.1 million
Listed on April 23rd, 2011


ProShares Ultra(long) S&P 500 - SSO - close: 54.46 change: +0.44

Stop Loss: 52.75
Target(s): 59.00
Current Option Gain/Loss: -10.6% and -11.0%
Time Frame: 8 to 10 weeks
New Positions: see below

Comments:
05/07 update: Friday produced an oversold bounce for the markets but the fade lower into the weekend does not inspire confidence. Overall nothing has changed for us. I would still consider bullish positions now at current levels. Or nimble traders could try and jump in on a dip near 454.00 or the $53.00 level, which should be underpinned by technical support with the 50-dma. The SSO is twice as volatile as the market so we want to keep our position size small. Our multi-week target is the $59.00 level.

Small Positions Only - Suggested Positions -

Long the June $56 call (SSO1118F56) Entry @ $1.60

- or -

Long the September $60 call (SSO1117I60) Entry @ $2.00

chart:

Entry on May 5th at $54.39
Earnings Date --/--/--
Average Daily Volume = 11.3 million
Listed on May 4th, 2011


United Technologies Corp. - UTX - close: 89.21 change: +0.68

Stop Loss: 83.49
Target(s): 89.50, 94.00
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see trigger

Comments:
05/07 update: UTX has seen above average volume the last three days, which might suggest distribution (a.k.a. selling) in this stock. I'm unwilling to chases it at these levels. Currently our plan is to buy calls on a dip at $86.50. If triggered at $86.50 we'll use a stop loss at $83.49. Our targets are $89.50 and $94.00.

Buy-the-dip Trigger @ $86.50

- Suggested Positions -

Buy the June $90 calls (UTX1118F90)

chart:

Entry on April xxth at $ xx.xx
Earnings Date 04/20/11
Average Daily Volume = 3.7 million
Listed on April 27th, 2011


PUT Play Updates

Molycorp - MCP - close: 68.93 change: +0.47

Stop Loss: 76.15
Target(s): 63.50
Current Option Gain/Loss: -25.0%
Time Frame: only 4 days
New Positions: See below.

Comments:
05/07 update: Like most of the market on Friday, shares of MCP were up in the morning and faded lower into the closing bell. Shares seem to be holding support at their 30-dma. We only have a couple of days left. We will exit on May 10th at the close to avoid holding over earnings.

Small Positions Only!

Long the May $65 put (MCP1121Q65) Entry @ $1.80

chart:

Entry on May 5th at $70.05
Earnings Date 05/10/11 (confirmed)
Average Daily Volume = 7.3 million
Listed on May 4th, 2011


Panera Bread Co. - PNRA - close: 119.39 change: -0.86

Stop Loss: 123.25
Target(s): 110.50, 102.50
Current Option Gain/Loss: -18.7%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
05/07 update: Entry point alert! PNRA, for the second day in a row, has failed near the $122.00-122.50 area. Friday's failed rally is a new entry point to buy puts. However, I would keep position sizes small. I suspect the market is poised to bounce this coming week. Our targets are the 100-dma (currently near $112.00, we'll take profits at $112.50) and the $102.50 level.

Suggested Positions

Long the June $110 PUTS (PNRA1118R110) Entry @ $1.60

chart:

Entry on May 4th at $119.00
Earnings Date 07/27/11 (unconfirmed)
Average Daily Volume = 647 thousand
Listed on May 3rd, 2011