Option Investor
Newsletter

Daily Newsletter, Saturday, 10/22/2011

Table of Contents

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

Market Wrap

Headline Rally

by Jim Brown

Click here to email Jim Brown

I believe there were more traders scared of holding short over the weekend than there were traders who wanted to be long. The result was yet another short squeeze.

Market Statistics

Rallies can take many forms and technically a breakout is still a breakout. Most bull markets begin with a series of short squeezes as bears still in denial continue to short the highs only to cover over and over again as the market moves higher.

Expiring October options also provided a boost because most hedge funds and institutions had bearish positions. Closing those positions produces a bullish bounce. There is also the fiscal year end for most mutual funds next Friday. Funds have to adjust positions before next Friday to reflect their year-end objectives and reduce cash on the books. With hedge funds still predominately short in a rising market, short covering is a necessary event. Hedge funds are currently only 45% net long. Add in the potential for a resolution in Europe and the incentive to cover shorts was increasing.

Economic reports are improving and earnings have been surprising to the upside. Thomson Reuters said Friday 133 S&P-500 companies have reported and 68% have beaten estimates with 19% missing estimates and 13% reporting in line. S&P numbers are slightly different at 70% beating, 11% in line and 19% missing estimates. The earnings growth is still more than +12% and the forecast for the full quarter is close to +15%. The sector dragging down the numbers is the financials.

Improving economics, strong earnings despite several high profile disappointments and the potential for some kind of resolution in Europe was a good recipe for continued gains. Obviously it could have gone either way with traders loading up on shorts and exiting longs ahead of an expected disaster in Europe but in this case the market moved higher. Just because the Dow and S&P closed at two months highs does not mean a case of foot and mouth disease from some overzealous politician in Europe won't crash the markets on Monday.

We still have to get past the EU headline events this weekend. There are numerous events culminating with an EU meeting on Sunday and then another one on Wednesday. Getting all 17 finance ministers from different countries to agree on what to have for lunch would give an event coordinator a nervous breakdown. Getting them to agree to spend a few hundred billion more so Greece does not have to pay all its debts is going to be a significant challenge. The markets are pricing in a positive result and that solution remains undefined, unapproved, unimplemented and unproven.

The most likely outcome of the scheduled meetings is that the decision will be put off past Wednesday, possibly until the G20 meeting the following week. The markets would not react well to another delay.

Helping to improve sentiment over Europe was news on Friday the EU finance ministers had approved the next tranche of loans to Greece of eight billion euros. This was the sixth tranche for Greece and will take them into 2012 without any further cash infusions. Considering the on again off again status of this payment over the last two months this was a positive milestone.

In the U.S. next week there are four more key economic reports as we close in on month end and the next nonfarm payroll report. Monday has the Chicago Fed National Activity Index. Tuesday is the Richmond Fed Manufacturing Survey. Thursday has the first look at Q3 GDP and that could be a whopper of a problem. Current estimates have risen to +2.5% compared to +1.33% for Q2. Did we really double our GDP over the last three months? The markets could be in for a big disappointment there. Thursday also hosts the Kansas Fed Manufacturing Survey. That one should do well as a result in the increase in auto production. If economic conditions really picked up starting in late September then those reports should be the evidence.

Economic Calendar

Fed Vice Chair, Janet Yellen, gave a speech on Friday where she raised the possibility of more asset purchases by the Fed. She said the Fed could buy a broader range of securities "it if wants to bolster economic growth in the future." She said U.S. growth in the second half of 2011 could be "noticeably stronger." However, she warned the U.S. is still growing at a "disappointingly slow pace" and "there are significant downside risks."

Fed Governor, Daniel Tarullo, said on Thursday the Fed should consider buying mortgage backed securities to push mortgage rates even lower and support the depressed housing market. His remarks came after Eric Rosengren, president of the Boston Fed, suggested on Thursday the Fed should buy mortgage backed securities. Charles Evans, president of the Chicago Fed has also suggested broadening the Fed's purchases.

Do you think the Fed heads are trying to talk the market up or are they staking their positions out ahead of the November meeting so a new announcement by the Fed will not be such a surprise? They are not talking about preventing another dip but accelerating the recovery. That would be bullish for the markets so these comments are probably making the shorts nervous.

Earnings on Friday were not specifically exciting but Friday earnings rarely are. General Electric (GE) earnings hardly ever create any excitement. The company said earnings were 31-cents and that was in line with estimates. In reality the earnings were weaker than that but they were offset by a lower tax rate that added 2-cents to the headline number. Margins were also under pressure because the majority of their industrial order backlog was booked over a year ago and prices for components have risen over the last year. Margin declines were evident in every GE division. GE said the wind turbine business was especially weak because of competition. Order backlogs rose to $191 billion, an increase of 16%. A key analyst said many of those older orders were sold at bargain rates to get the business and keep plants operating. It could be another 12-18 months before the low priced orders flow through the system and GE gains any operating leverage. GE said on the call the "outlook for earnings and margin growth were stronger for 2012" but it was a generic statement. GE shares declined -2% on the earnings report. This stock is dead money for the time being.

GE Chart

Honeywell (HON) posted a nice +6% gain after posting a 44% increase in profits. HON earned $1.10 per share compared to 76-cents a year ago and estimates of $1.00 by the street. Revenue increased +14% and margins increased +120 basis points to 18.2%. Honeywell predicted full year earnings would rise to $4.05 and a +35% increase over 2010. They also raised revenue guidance to $36.6 billion. Guidance was strong and analysts covering Honeywell had only positive comments.

Honeywell Chart

McDonalds (MCD) posted earnings of $1.45 compared to estimates of $1.43. Revenue rose to $7.17 billion and well above estimates of $7.03 billion. Same store sales in the U.S. rose +4.4%, Europe +4.9% and Asia +3.4%. October sales are expected to rise between 4% to 5%. The company said it was expanding its menu and will be raising prices to offset higher beef costs. McDonalds said its expanded beverage and breakfast menu now accounted for 25% of its U.S. sales and the smoothies, coffees and healthy options like oatmeal were attracting new customers. Shares of MCD rallied +4% to a new all time high.

McDonalds Chart

Disappointing the street on Friday was oil services company Schlumberger (SLB). The company posted earnings of 98-cents and three cents short of street estimates. Basically the weakness came from the Middle East where oil activity has slowed due to the Arab spring and events in Libya. Elsewhere the U.S., Canada, Iraq, Saudi Arabia, Mexico, Brazil, Russia and Angola were strong. The most important part of the Schlumberger call was the guidance. The CEO said that although the weak global economy was expected to "slow" demand growth in 2012 "there is a tight cushion of excess supply that will continue to support exploration activity." If anyone should know there is a supply problem it should be Schlumberger since they service in some form almost every major oil field in the world. "Tight cushion of excess supplies" is a politically correct way to say oil production is barely keeping up with rising demand.

Schlumberger Chart

Earnings for next week have a little bit from every sector. Most notable would be the ones highlighted in green. CAT on Monday could tell us about the economic growth on a global basis. UPS on Tuesday will tell us how package traffic (economic activity) is shaping up for the holidays. COP, CVX, XOM, OXY and about a dozen other energy stocks will summarize the sector. There is also a big list of healthcare and drug stocks reporting with Merck closing out the week.

This is the busiest reporting week of the cycle and it should create some additional volatility as the stocks react to the short term overbought conditions after each company reports.

We really know how the quarter is going to end since 26% of the S&P have already reported. By the end of next week that will be closer to 60%. I think the market is going to react more to Europe than earnings although the individual stocks are sure to move sharply when they report.

Earnings Calendar

Mortgage insurer PMI Group (PMI) was seized by Arizona insurance regulators because of a serious capital deficiency. Two months ago two PMI units were ordered to stop writing new business due to their failure to meet capital requirements. PMI has suffered throughout the housing crisis as foreclosures mounted. The homes being foreclosed were normally those where companies like PMI and MGIC had written mortgage insurance to protect the lenders from a default. The lenders have buried these companies with claims for reimbursement and the volume of new business plus their capital reserves have been insufficient to cover the losses. Mortgages being written today only go to the best credits and with enough money down to not require mortgage insurance. It is a tough market for the insurers and it does not look like it will improve any time soon. PMI competitors include MGIC Investment (MGIC), Radian Group (RDN) and Genworth Financial (GNW).

The Arizona Department of Insurance said PMI claims would only receive 50% of the claim and the remaining claim amounts deferred. As current mortgages continue making their monthly payments the monthly insurance payment will go into a fund to cover deferred losses and new claims.

Most states allow a maximum of 25:1 risk to capital ratio. MGIC was at 24:1 at the end of September. The company said it was going to add $200 million in capital and that could lower its consolidated risk to 21.3 to 1.

PMI shares closed at 31-cents on Friday and MGIC at $4.30.

PMI Chart

Yahoo (YHOO) finally broke through resistance at $16 last week but that level is still exerting drag on the stock. Yahoo perplexed potential bidders by preventing them from talking to each other by using a clause in the confidentiality agreements to stop cross talk. In theory this was supposed to keep a climate of competition among the bidders. Instead it drove some of the bidders away. Yahoo has a lot of parts and nobody wants all of the parts. To make a deal work a bidder will have to joint venture with other bidders to organize a post acquisition breakup where everyone gets the piece they want. If the bidders can't talk to each other then the potential for a joint venture that maximizes the value is going to be harder to achieve. That means any single bidder is likely to lowball the bid and then hope they can sell off the pieces after the deal is completed. Yahoo management is so incompetent it is no wonder the company is declining in value. The no cross talk provision is said to have come from founder Jerry Yang.

Google is rumored to be considering a bid in conjunction with several private equity firms. In theory Google will provide financing and the PE firms will divide the carcass after the deal is completed. It is doubtful Google could keep any of the parts since there would be a significant antitrust considerations. Microsoft has also been rumored as working on a deal where it would finance the acquisition and several PE firms would sell off the parts they did not want. Microsoft's interest in the deal is to protect an existing joint venture between Yahoo and Microsoft.

Even in the current state of confusion the value of Yahoo continues to be estimated at $19 to $31 per share. At the current $16 price there is still room for a profit if a deal is announced but you never know when Yang might go off on an ego trip and reject any bid like he did with the $31 Microsoft offer several years ago.

Yahoo Chart

Oil prices may rise again on Monday after the heir to the Saudi throne died in New York over the weekend. Crown prince Sultan bin Abdul-Aziz Al Saud, 80, died of an unspecified illness suspected to be colon cancer. He had been treated for that in New York off and on for the last two years. King Abdullah, 87, also in poor health must name a new successor from the royal family. The king has 40 sons from multiple wives and an unknown number of daughters. FYI, the Sultan had 32 children with multiple wives. One of which is Bandar, former ambassador to the USA.

Traditionally the king names his successor. However, king Abdullah had created a 33 person Allegiance Council, composed of his brothers and cousins, as one of his reforms and gave it the mandate to choose the heir but not until after the Sultan had assumed the throne. In other words the king chose his heir but the Sultan's heir would have been chosen by the council. It is unknown if king Abdullah will now turn to the council for a replacement for the Sultan.

The assumed next in line for the throne is the Sultan's 78 year old half brother Prince Nayef. The prince is a more controversial figure and is against some of the reforms the king has put in place like giving women voting rights starting in 2015. Nayef has in the past referred to Israel as the "Zionists" and spoke negatively of Jews in interviews. Nayef is the Mukhabarat official (secret police) and he is in charge of internal governmental affairs. He is also very outspoken and critical of Iran. Nayef was involved in the decision to send troops to Bahrain in March to crush Iranian sponsored pro-reform Shiite demonstrators.

Having Nayef become king would create a Saudi Arabia with a short temper against its neighbors and open hostility towards Iran. Nayef is seen as more independent and resistant to change and desirous to return to the Saudi customs of decades past. How that will play out in its dealing with OPEC and with its sales of oil is unknown. The uncertainty should cause at least a temporary spike in oil prices even though there is no immediate change forthcoming. It could be years before King Abdullah dies and the succession details are known.

Crude prices rose on Friday on short covering ahead of the weekend meetings in Europe. Oil is currently stuck under resistance at $90 but a positive resolution in Europe could produce a breakout that could be strong.

Crude Oil Chart

Groupon has reactivated its IPO plans and is expecting to receive less than they initially wanted. The company will sell 30 million shares between $16-$18 per share and now expects to raise $479 million. That is down from the $750 million expected when the IPO was first launched. The SEC and prospective purchasers questioned its accounting practices and the company had to pull the IPO and restate the earnings. Groupon rejected a $6 billion acquisition offer from Google. Recent filings show Groupon posted revenue of $430.2 million in Q3 but it is still not profitable. That is up from $81.8 million in revenue in Q3-2010.

Groupon claims 142.9 million subscribers of which 29.5 million had made a purchase in Q3 and 16 million made more than one purchase. Groupon admits it has a lot of competitors, nearly 600 of them. Groupon is selling shares but insiders are not giving up control. There will be two classes of shares with A shares having one vote and B shares having 150 votes per share. Insiders will hold the B shares and retain more than 58% of the voting power. The class A shares will list on Nasdaq with the symbol GRPN. The IPO is expected to price the first week of November.

American Airlines (AMR) declined -6.6% on Friday after a Morningstar analyst said bankruptcy is inevitable. He said the airline is at a disadvantage to its peers and the carrier's viability is in jeopardy. Another analyst at CRT Capital said there was no immediate bankruptcy risk because they have plenty of cash and ways to borrow more. AMR ended Q3 with $4.3 billion in unrestricted cash. They could also have a sale on frequent flier miles for future use or borrow against planes and spare parts when those assets are freed up in 2012. AMR is trying to avoid bankruptcy by renegotiating union contracts with pilots, attendants and ground crews. Unlike United and Delta AMR did not file bankruptcy over the past decade so their costs are higher.

AMR Chart

Regardless of the reason for the Friday rally the result was a bullish breakout above multiple levels of resistance. ANY higher close on Monday would be a technical confirmation and suggest the markets are going higher.

The S&P broke over recent resistance at 1225 plus resistance highs at 1230 from August and the 100-day average at 1232 to close at 1238. The key to future gains will be another positive close on Monday. If the S&P can avoid a decline back below those resistance levels and post a higher close over 1240 the remaining shorts should begin to cover in volume. I would bet the majority were in denial on Friday and fully expected a dip at the close or worst case a major gap down on Monday after some kind of failure at the talks in Europe. If that gap turns into a gap up instead of a gap down we could get a major continuation of the short squeeze.

However, there is still risk until a comprehensive deal is announced on Wednesday. That could keep some shorts on board until after the Wednesday summit. It could be a very painful ride.

Support is now old resistance at 1225 followed by 1200. Resistance is 1250 followed by the 200-day average at 1274.

S&P Chart

The Dow also duplicated the strong breakout of the S&P with prior resistance at 11,625 left well in the dust with a close at 11,808. The 100-day average at 11,692 did not even cause a blink. The next resistance is 11,925 followed by the 200-day average at 11,965.

This is a clear and convincing break of resistance and ANY positive close on Monday should be a confirmation of a bullish change in market sentiment.

Dow Chart

Dow Transports Chart

The Nasdaq is the weak link in the market picture. Continued declines in Apple are keeping the Nasdaq from breaking free with its index brethren. Friday's gain was decent but the index was coming back from some serious Apple inspired losses.

Eventually Apple is going to attract bargain hunters. The decline on Friday was only a couple dollars but that was with a very positive market. If a negative market appears we could see a retest of $370 on Apple shares and that would be a decline of -$23 with a corresponding weight on the Nasdaq. I am also concerned that funds could sell Apple after month end.

However, if the other techs are successful in dragging the Nasdaq above resistance at 2665 I think the Apple faithful will reconsider their bearish views and we could see a strong rebound on Apple push the Nasdaq even higher.

That is a lot of "if" statements and the Nasdaq does not depend on Apple for all its gains. However at 20% of the index it would definitely help if Apple could at least show some small gains.

Support is 2600 and resistance 2665.

Nasdaq Chart

The Russell closed right at short term resistance at 712. The Russell has been lagging the large cap indexes and has so far failed to break out of the congestion range from last week. A lack of buying on the small caps means no confidence in the rally by fund managers.

The Russell needs to break over 720 and eventually over 740 to catch up with the Dow/S&P gains. When the Russell begins to accelerate higher we will know a real rally has arrived.

Russell 2000 Chart

With 133 S&P companies reported the current expectations for the full quarter are for +14.7% earnings growth. That compares to a +13.1% estimate on October 1st. Projections for Q4 are for 12.5% growth, down -3% from October 3rd. The first quarter of 2012 is only projected to grow by +7.6%, down from +10.2% in early October. If the Q3 earnings and guidance continues to beat expectations those Q4/Q1 numbers will have to be raised and possibly significantly. That would mean current stock valuations, already cheap, would become even more undervalued compared to future earnings.

This suggests that not only are we seeing a technical breakout in the markets but the rally is also based on improving earnings fundamentals. Add in the slight improvement in the U.S. economic picture and the rally could have legs.

The only thing really holding back the markets is the radioactive cloud over Europe. If the EU leaders could actually agree on a comprehensive plan this week it would go a long way towards improving the global economy. The financial systems of many nations are bound up in what might happen in Europe. Once that cloud is lifted we could see a significant improvement in the global markets. Obviously that depends on the heads of 27 diverse nations setting down and deciding how to protect their assets from the chronic overspending of five errant nations. They have to pledge enough assets to cover the debts and future needs of those few while fencing in their financial systems to prevent further personal losses down the road. They can do it but getting 27 leaders to agree on anything is next to impossible. Hopefully they have seen the events of the last several months and it has scared them enough to bring out the big guns to end the problem once and for all. While I seriously doubt it will happen next week I can at least hope for a resolution.

I am encouraged by the rally and I think it has possibilities but we are still hostage to headline risk. The wrong headline could kill this rally just as quick as the ones that started it.

Sell too soon!

Jim Brown

Send Jim an email

" Obstacles are those frightful things you see when you take your eyes off your goal."
Henry Ford


Index Wrap

S&P Takes the Lead

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

The S&P 500 (SPX) and the Nasdaq Composite (COMP) have diverged a bit, with SPX achieving both a bullish weekly Close that is comfortably over resistance implied by the top end of its prior trading rangeAND keeps the S&P above support implied by its prior up trendline, as you'll on the SPX chart further on.

COMP also managed a weekly Close that was above the top end of its prior range, just not as decisive. (The continued play in energy stocks and the strong rebound in some of the key financials helped boost SPX.) The Nas Composite DIDN'T manage to regain its prior up trendline, minor league bearish. However, the key big cap Nasdaq 100 (NDX) rebounded from its (regained) up trendline, so all markets are looking ok for further gains as will be discussed with the individual indexes.

The S&P and Dow are short-term overbought, nearing that zone on an intermediate-term (2-3 week), but are closer to 'neutral' midrange readings on a longer-term (2-3 month) basis. The question is whether a strong European bank and sovereign debt solution (if it comes about) is fully priced into the market. The old 'sell the fact' kind of ruse could come into play and by Tuesday let's say we see some weakness.

Moreover, in another way of looking at how 'extended' prices might be short-term, COMP and NDX backed off from their 5% upper envelope lines at their highs this past week. SPX and the Dow 30 (INDU) closed above the upper envelope band I use at 4% (above a 21-day moving average), which is not to say they won't spurt somewhat or well above these parameters. There is a tendency for corrections to come at levels that get extended above (or below) these envelope values such as within a few trading sessions; alternatively the pattern tends to be a slow down in further gains once the indexes get well over their 21-day averages and a more modest rate of ascent occurs. We also saw a spike in my bullish sentiment numbers on Friday which is supports a view of a market getting somewhat overheated.

The charts are bullish, with the S&P and Dow leading the charge this time, but we could soon get into a period of froth and churning so I advise caution in putting on new bullish strategies. The ideal in terms of putting on new bullish positions is to buy substantial dips toward or into support levels discussed and identified with the individual index charts.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) chart is bullish with the index's continued ability to hold above it's prior broad multimonth trading range, a so-called rectangle in technical terms. When a rectangle pattern forms AFTER a decline, it's assumed to be a rectangle bottom but the main thing is the direction of a breakout above (or below) such a well-defined trading range. This recent upside move bodes well for an eventual objective back to the 1350 area.

Tough overhead resistance, where substantial supply exists, is at 1300. To pinpoint an area of implied resistance between the 1238 weekly close and 1300 needs looking back further than the chart below is showing, or to the 1250-1265 price zone.

As I noted in my initial 'bottom line' commentary above, SPX is getting somewhat 'extended' in terms of its upper (4%) envelope. This is not resistance in the sense of a prior area where sellers came in but does provide an idea of where an index starts getting over or well above where it's been trading in recent weeks or months in terms of a percentage value above the centered (21-day) moving average. Indexes tend to revert back to a mean eventually.

The same kind of 'overbought' dynamic registers with Relative Strength Index (RSI) readings that hit 65-70 or above on a 13-day basis. Moreover, traders are getting more bullish again; maybe a bit too bullish given the state of our economy. Still, earnings have been good overall. Bad economy, good earnings, go figure.

Support is indicated at 1200; below the key 1200 level (especially on a daily/weekly closing basis, a next substantial support looks like 1150 currently.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) chart continues to be bullish. The final push higher at week's end pulled the weekly Close (at 558) to its best gains yet above the prior 548-553 line of resistance.

While prices look headed higher, factors working against a further dramatic advance are an approaching overbought condition suggested by the 13-day RSI indicator nearing its common upper range as well as the 'extended' nature of current prices as OEX hits the upper (4%) envelope line that tends to suggest a slowing advance at a minimum. The odds of another major up leg look less likely than it would for a more modest further week to week gain.

I've pegged next resistance at 563, then well above that in the 580 area. Near support is 540, with next support well under this at 520.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) chart is bullish, more so than last week as INDU's Friday strong close at the intraday high took the Average well above the cluster of prior recent highs in the 11600 area.

There's good reason for the renewed push as AXP, HD, CVX, DIS, INTC, MCD, MMM, MRK, PG, WMT, TRV and XOM all especially spurted higher either continuing strong moves or making breakaway type advances above prior congestion.

Next resistance comes in around 11900-12000; with further resistance then estimated for the 12200 area. Technical support is at 11400, the current intersection of the Dow's up trendline; this support was 'proven' so to speak at Tuesday's intraday low which marked the lows and prefaced a substantial intraday rebound. Major support begins at the 11000 level.

INDU is again approaching a 'typical' overbought RSI level which begins around 70 and extends to 75. There's further room on the upside regardless of some suggested signs that the Dow may be getting overextended, including the march to my upper 4% envelope line. Nothing 'magical' about these levels as rally stoppers but they do tend to put me on a cautionary alert as far as jumping into new bullish positions.

NASDAQ COMPOSITE (COMP) INDEX; DAILY CHART:

The Nasdaq Composite (COMP) chart turned from predominately mixed to bullish prior to this past week. This past week saw COMP trade in a relatively narrow range with resistance seeming to come in after COMP hit my 5% upper trading band (envelope line).

The index came back fairly strongly after Thursday's intraday dip below 2600 support. This is a key support and top end of the prior trading range. Once prices break out above resistance, assuming a sustained advance follows, what you expect to see to stay bullish is support develop as what was previous resistance and that is on balance how it went. Hey, COMP is merely FOLLOWING the leader S&P for a change. It happens. To keep on a bullish track, the Composite ought to trade above 2650-2667 fairly soon.

Support is anticipated again in the 2600 area, then at 2550 on down to what should be substantial support in the 2500 area. Resistance comes in around 2700, then at 2750.

If the Composite stays mostly above the top end of its prior price range, this pattern suggests an eventual 'minimum' upside objective back to the 2880-2890 area. This based on another up leg that would be at least equal to the difference between highs and lows traced out in an apparent rectangle bottom; such a rule of thumb calculation is also called a 'measured move' objective which assumes that a NEXT price swing will equal the move from multiple highs to repeated lows when ADDED to the top end of the rectangle. 2-3 such repeated bottoms and highs make up the well-defined price range of a rectangle pattern.

NASDAQ 100 (NDX); DAILY CHART:

The Nasdaq 100 (NDX) remains bullish in its pattern but got a bit 'mixed' again as its upside momentum got arrested this past week as investors shifted some money to the more cyclical and economically sensitive bread and butter stocks of our consumer economy. Don't you love it when the government determines that we have no core inflation as it's JUST food and energy prices going up like gangbusters. The Chevron, Exxon, Kraft and McDonald's of the world do well because of this 'non'-inflation however!

On the bullish side, NDX pulled back just to technical support at its (regained) up trendline and rebounded and went to Close at its prior intraday high. You can see in my NDX daily chart how the last couple of rallies have reversed in the area of the upper 5% envelope line. Next resistance, based on this criteria comes in around 2400, then most definitely at the prior 2438 intraday high.

I've noted near support in the 2880 area, the current intersection of the aforementioned support/up trendline. Next support should come into play around 2250, extending to 2225. I didn't highlight it on my chart but fairly major support begins in the 2200-2190 area.

I anticipate higher levels ahead but the index could bounce around between 2300 and 2400 for a while. I doubt that NDX is going to get this close to its prior high without re-testing the same area however. Above the 3 multiple prior highs of 2011 (Feb-May-July) ranging from 2373 to 2438 there's a 'mountain' to climb represented by the extreme run up and equally extreme crash of 1999-2001. Better to stick to a possible challenge of the prior peak and leave what comes after to a later look.

NASDAQ 100 TRACKING STOCK (QQQ); DAILY CHART:

The Nasdaq 100 tracking stock (QQQ) continues bullish. QQQ remains within its uptrend channel but has dropped back from its recent high around 58, which is highlighted as near resistance. Near support is in the 56 to 55.3 area. Major resistance begins at 60-60.2.

Continued low volume is not your typical situation with rallies in 'ordinary' (i.e., company) stocks where daily trading volume tends to rise during rallies. If volume spikes well above the Q's daily average volume there's a sure sell off going on. If Thursday's dip to the 56 area was troubling to traders/investors, a spike in volume would have been a likely result and that didn't happen.

RUSSELL 2000 (RUT); DAILY CHART:

The Russell 2000 (RUT) continues bullish but the recent advance lost steam as prices slide sideways with RUT following the Nasdaq Still, the index had an end of the week Close near the top of its recent price range. I anticipate higher levels ahead as long as 680 continues to hold up as near support.

Next lower support comes in around 654-655; below this area, I anticipate support developing if there was pullback to the 640 area again, which is the current intersection of the prior down trendline; resistance and lines of resistance, once penetrated, tending to 'become' subsequent support.

Near resistance is at 718-720, with pivotal resistance suggested in the area of the prior high around 738. Major resistance begins at 800.



GOOD TRADING SUCCESS!



NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS

CHART MARKINGS:

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

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

I WRITE ABOUT:

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

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

5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only options (CPRATIO) with the S&P 500 (SPX) and the Nasdaq Composite (COMP) charts. However, this indicator pertains to the market as a whole, not just SPX or COMP. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next 2-3 or more weeks) rather than just the next several days of the short-term trend.

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

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


New Option Plays

Wholesale, Financials, and Industrials

by James Brown

Click here to email James Brown

Editor's Note:

Nimble traders may want to take a look at BIDU. The stock has been underperforming the market. The last two weeks saw BIDU produced a bearish H&S pattern as well as breakdown under several key moving averages. I was ready to write a put play on BIDU but earnings are coming up on October 27th (after the closing bell). That doesn't give us a lot of time.

- James


NEW DIRECTIONAL CALL PLAYS

Costco Wholesale - COST - close: 85.30 change: +1.04

Stop Loss: 83.75
Target(s): 97.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
COST saw a big surge on Tuesday and then spent the rest of the week consolidating gains with a sideways trade above $84.00. I am tempted to buy calls now. However, I still see resistance in the $86.00-86.35 area from September. I am suggesting a trigger to open bullish positions at $86.50. If triggered we'll use a stop loss at $83.75. Our multi-week exit target is $97.50. Cautious traders will want to consider an exit near $90 or $94 instead. Keep positions small.

Trigger @ $86.50 (small positions)

- Suggested Positions -

buy the NOV $85 call (COST1119K85) current ask $2.19

- or -

buy the 2012 Jan $90 call (COST1221A90) current ask $1.85

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 12/07/11 (unconfirmed)
Average Daily Volume = 2.9 million
Listed on October 22, 2011


Goldman Sachs - GS - close: 102.09 change: +1.23

Stop Loss: 97.95
Target(s): 114.00
Current Option Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
GS just reported a terrible earnings report this past week. The company missed estimates by 68 cents a share. Instead of crashing the stock rallied! If investors are buying bad news then the bears are in trouble. The stock has broken one of its bearish trendlines of lower highs. It's currently in the process of breaking out past resistance in the $100-105 area and its simple 50-dma.

More conservative traders may want to wait for a rise past its 50-dma ($104.00) or a rally past last week's high (105.00) before initiating positions. We are suggesting traders buy calls now but only if both GS and the S&P 500 index both open positive on Monday. Keep in mind that there is no resolution in Europe yet so trading financial stocks can be risky. We want to keep our position size small to limit our risk.

Our target is $114.00. More conservative traders may want to exit near $110 instead.

*See Entry Point Details Above* (Small Positions)

- Suggested Positions -

buy the NOV $110 call (GS1119K110) current ask $1.80

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 10/18/11 (confirmed)
Average Daily Volume = 8.2 million
Listed on October 22, 2011


Rockwell Automation - ROK - close: 66.54 change: +2.85

Stop Loss: 61.90
Target(s): 71.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
After more than a week of consolidating sideways in the $62-66 zone shares of ROK look rested and ready to run. The stock was showing relative strength on Friday with a +4.4% gain and a breakout past the $66.00 level. I am suggesting bullish positions now but only if ROK and the S&P 500 index both open positive on Monday. If triggered we'll use a stop loss at $61.90. More conservative traders might want to consider a stop closer to $64 instead. I am somewhat concerned that the simple 100-dma or the exponential 200-dma could be overhead resistance. Let's keep our position size small. Our exit target is $71.75. FYI: The Point & Figure chart for ROK is bullish with a $91 target.

*See Entry Point Details Above* (Small Positions)

- Suggested Positions -

buy the NOV $70 call (ROK1119K70) current ask $1.90

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 11/08/11 (confirmed)
Average Daily Volume = 1.7 million
Listed on October 22, 2011


In Play Updates and Reviews

Stocks Surge on Friday

by James Brown

Click here to email James Brown

Editor's Note:

Stocks surge higher on Friday. A few market pundits were calling it a short squeeze. We saw BBBY tag new record highs. The IYT broke out and hit our trigger. SPW is improving. Our new market neutral trade on the IWM is open.

-James

Current Portfolio:


CALL Play Updates

Bed Bath & Beyond Inc. - BBBY - close: 61.81 change: +2.10

Stop Loss: 58.90
Target(s): 64.75
Current Option Gain/Loss: + 5.3%
Time Frame: 2 to 4 weeks
New Positions: see below

Comments:
10/22 update: It would seem that traders are not concerned with news out Thursday night that a couple of BBBY insiders sold one million shares for about $61 million. Normally word that corporate insiders are selling stock with the stock at all-time highs would be considered a bearish signal. Instead BBBY gapped open higher on Friday morning and soared to a +3.5% gain and another new high.

I am a little hesitant to chase the move but BBBY definitely looks poised for more gains next week.

*Small Positions*- Suggested Positions -

Long NOV $62.50 call (BBBY1119K62.5) Entry $1.50

chart:

Entry on October 14 at $61.00
Earnings Date 12/21/11 (unconfirmed)
Average Daily Volume = 3.4 million
Listed on October 12, 2011


iShares Transportation ETF - IYT - close: 86.22 change: +1.83

Stop Loss: 82.45
Target(s): 90.00
Current Option Gain/Loss: +11.6%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/22 update: Our new trade on the IYT has been opened. Transportation stocks were off to an early lead and the IYT gapped open higher on Friday at $85.33. Since our trigger to buy calls was at $85.25 the trade was opened immediately. The IYT closed up +2.1% and closed at new multi-week highs. The close above resistance at $85.00 is bullish but I will point out that this ETF closed exactly at the late August peak at $86.22. I would not be surprised to see the IYT retrace back toward the $85 level. Nimble traders may want to look for a dip back to $84.75 as their next entry point.

Our target is $90.00 but the exponential 200-dma and the 100-dma near $87 could be technical resistance.

Please note we are moving our stop loss higher to $82.45.

Earlier Comments:
Readers will want to keep our position size small since the transports are short-term overbought given the huge bounce from its October lows.

(small positions)

- Suggested Positions -

Long NOV $87 call (IYT1119K87) Entry $2.15

10/22 new stop loss @ 82.45
10/21 Gap higher entry @ 85.33

chart:

Entry on October 21 at $85.33
Earnings Date --/--/--
Average Daily Volume = 662 thousand
Listed on October 18, 2011


SPX Corp. - SPW - close: 52.79 change: +0.56

Stop Loss: 49.15
Target(s): 57.75
Current Option Gain/Loss: +11.1%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/22 update: SPW's +1% gain on Friday underperformed the major indices. The stock briefly traded above resistance near $53.55 before pulling back toward the $52 area gain. The overall trend would suggest SPW is coiling for a breakout from its two-week trading range. Readers might want to wait for a new move past $53.75 before initiating new positions. Cautious traders might want to up their stop loss closer to the $50.00 mark.

In the news on Friday SPW announced it was buying a German food-technology firm but financial details were not disclosed.

Earlier Comments:
This is an aggressive trade so we want to keep our position size small. FYI: The Point & Figure chart for SPW is bullish with a $78 target.

(Small Positions)- Suggested Positions -

Long NOV $55 call (SPW1119K55) Entry $1.80

10/20 trade opened.
10/19 Trade still not open. Try again.
10/18 New entry point on this bounce. See entry details above
10/17 Trade not open. Remove entry point for 24 hours, then re-evaluate.

10/20 trade opened at $51.80

chart:

Entry on October 20 at $51.80
Earnings Date 11/02/11 (confirmed)
Average Daily Volume = 701 thousand
Listed on October 15, 2011


PUT Play Updates

Currently we do not have any active put trades.


Market Neutral Play Updates

iShares Russell 2000 ETF - IWM - close: 71.13 change: +1.51

Stop Loss: n/a
Target(s): To Be Determined
Current Option Gain/Loss: +0.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/22 update: There were many traders that felt Friday's rally was nothing more than a short squeeze. Why market participants felt that the headlines coming out of Europe on Friday were bullish is a little bit of a mystery. The small caps gapped open higher. The IWM opened at $70.57, dipped back to $70.00, and then rebounded again.

Our plan was to launch our market neutral trade at the open on Friday morning. We are not suggesting new positions at this time.

FYI: A strangle involves buying both an out of the money call (OTM call) and an out of the money put (OTM put). The expectation is that the underlying equity (IWM in this case) will move enough to make one side profitable and cover the entire position and then some.

- Strangle Position cost: 4.55 current value: 4.37 (-3.9%)

Out-of-the-Money Call option:
Long NOV $72 call (IWM1119K72) Entry $2.30, current bid $2.50

- and -

Out-of-the-Money Put option:
Long NOV $68 put (IWM1119W68) Entry $2.25, current bid $1.87

chart:

Entry on October 21 at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 89 million
Listed on October 20, 2011