Option Investor
Newsletter

Daily Newsletter, Monday, 12/3/2012

Table of Contents

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

Market Wrap

Bears Maul the Gap Up

by Keene Little

Click here to email Keene Little
An overnight rally in equity futures led to a nice gap up and the bears decided it was a nice treat for them too. By the end of the day the gap up turned into key reversals to the downside.

Market Stats

I'm filling in for Linda today, who will be back with you next week.

It was a relatively quiet day in the markets today and the only disappointing thing for the stock market bulls was that a gap up to start the day was immediately sold into. And it was just the opposite for bonds, which gapped down and then rallied for the rest of the day in an attempt to close its gaps. The worrisome thing for the bulls at the moment is the fact that the reversal of the gaps, with the close below Friday's close, gave us key reversals in most indexes.

I went looking for news to see what might have been acting as a catalyst for today's moves but there really wasn't any, which explains why the market wasn't able to make it too far in either direction. The overnight gap up in the stock market came from traders hoping we'd see some bullish follow through to last week's rally as well as some positive news out of China and Europe.

Chinese manufacturing improved and its index rose from 49.5 to 50.5, putting it marginally back into growth instead of contraction. That didn't help the Chinese stock market, which closed down about -1% but U.S. equity futures continued to hold up.

Greece believes it will be able to get about half of the private investors holding Greek bonds to sell the bonds back at 34.1 cents on the dollar (the bonds are currently trading for 30-35 cents. Greece is hoping to use a Dutch auction to buy back an estimated 62B to help lower their huge debt, which then puts it in a position to borrow more from the IMF/ECB. What a country.

Spain has formerly requested 40B euros from the European bailout funds (EFSF/ESM) to help its banks' capitalization but this doesn't trigger the need for the ECB to step in with its OMT program (Outright Monetary Transactions).

All of these actions were treated as a reason to rally by the European markets (before selling off in their afternoon sessions) and that helped boost U.S. equity futures higher into the open. I guess it will take a new global central bank program to help bail out the banks, named the Outright Money Grab (OMG), before we see the stock market react negatively to all these debt-relief programs. Oh wait, that program has been in existence for years now; the market is just too blind to see it.

At 10:00 AM the market got a little jolt to the downside when we got the ISM index, which was not good. From October's 51.7 the market was expecting a minor drop to 51.2 but instead it dropped into contraction territory at 49.5, which is the lowest level in the past three years. But hey, that should have been good news because now the Fed will amp up the money supply for the stock market. Maybe everyone will come to their senses on Tuesday (wink).

The other 10:00 report was Construction spending and it ticked up nicely from September's +0.6% (revised up from +0.5%) to +1.4% for October. But this data is old and the market doesn't pay much attention to it. Other than those two reports we were supposed to get auto/truck sales this afternoon but I haven't seen any numbers. Maybe tomorrow.

Starting off tonight's chart review with the DOW, its daily chart is showing a bearish setup at the moment but the bulls could save this, at least for a little bit longer, if they come back in to do some buying on Tuesday. A H&S pattern, with the neckline running from September 4th through the October 26th low, was back tested today with this morning's gap up. The immediate selloff from the back test leaves a bearish kiss goodbye at the moment. A gap up to a new high followed by a close below Friday's close leaves an outside down day for what could be a key reversal day. Today's candle is a bearish engulfing candlestick pattern that engulfs Thursday's and Friday's candles and the close is below the 200-dma at 12996 and slightly below price-level support/resistance near 12975. This can be saved by the bulls but they'll need to step back in quickly on Tuesday, in which case a rally to the 13300 area remains the upside potential for now (possibly much higher). But no delays from the bulls -- if they don't start buying immediately we could be looking at the start of the next decline (or at least a deeper pullback).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 13,100
- bearish below 12,765

The weekly chart of the DOW keeps the moves in perspective and the chart below shows the bounce off the November low testing the H&S neckline but on a weekly basis that looks like weak resistance. Stronger resistance would be a back test of its broken uptrend line from October 2011, near 13300 at the end of this week.

Dow Industrials, INDU, Weekly chart

Like so many indexes today, SPX hit its 50-dma at this morning's open but was immediately knocked back down, which clearly is not bullish. The risk is for bearish follow through on Tuesday and a drop below 1400 would be a break of Fib support (50% retracement at 1403.68) as well as its H&S neckline that it climbed above last Wednesday, which is currently near 1407. There are a couple of short-term Fib price projections for the consolidation/pullback from Thursday that point to 1406-1407 to complete the pullback. Therefore a drop below 1406 would be a bearish heads up and below 1400 would confirm the rally leg from November's low has very likely finished. It takes a drop below last Wednesday's low to confirm the bounce high is in place. If it starts back down from here it will be the pattern of the decline that will provide some needed clues about whether we should expect just a pullback before heading higher again or a more serious decline instead.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1424
- bearish below 1385

Today SPX closed slightly below its uptrend line from November 16th but could quickly be recovered if 1406-1407 holds and we see it immediately start back up. Assuming it will not break down from here I see upside potential to at least the 1434 area, possibly 1440-1450. Higher than 1450 would confirm a bullish pattern that could take us to new highs into the new year. But if this morning's high is a truncated finish to the double zigzag wave count (a-b-c-x-a-b-c) for the bounce off the November 16th low then it's even more bearish since it shows extreme weakness in the bounce attempt. Considering the downside risk for a strong decline to at least the 1290 area this month it's a time for caution if thinking about the long side. Respect your stops.

S&P 500, SPX, 60-min chart

NDX also presents a bearish picture on its daily chart but one with hope for the bulls. It's another bearish engulfing candlestick following a gap up to its 50-dma and then a close below Friday's. It looks like another key reversal day in the making. But bearish follow through will be key here and since NDX was able to hold its 200-dma at 2670 there remains the potential for the bounce to continue. It's clearly a battle between the 50- and 200-dmas and remember that it's the closing price that matters. Intraday breaks don't count (too much HFT activity driving the market in one direction that doesn't necessarily mean anything -- they're out by the close).

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2700
- bearish below 2613

Another index, another bearish daily chart. The RUT gapped up to its broken uptrend line from October 2011 and peeled away and closed below Friday's close. It's another key reversal at resistance and this time it follows the 3rd day in a row that the RUT back tested its broken uptrend line. Three drives to a high is a common reversal setup so the bulls need to step back in right now in order to save this. Any further decline will be a drop into last Thursday's gap up, in which case I suspect we'd see a quick closure of that gap. If that happens I would then look for a drop back down to the broken downtrend line from September, currently near 810, to see if it will provide support to launch another rally leg.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 827
- bearish below 798

Bonds did the opposite of what stocks did today by gapping down and then rallying the rest of the day. This of course had yields doing the opposite and bond yields mirrored the stock market's pattern. At this morning's high the 30-year yield (TYX) came very close to its 50-dma and then dropped back down and almost closed the morning gap and finished near the low of the day. I see a little more upside potential though and two equal legs up for its bounce off the November 16th low would have it up to 2.89% and would match its 200-dma in the next day or two. That would result in a small break of its downtrend line from June 2011 so much higher than 2.9% would have me thinking a little more bullish about TYX (bearish on bond prices, bullish on stocks) but not yet.

30-year Yield, TYX, Daily chart

While the shorter-term pattern for bonds is difficult to decipher (there's a lot of sideways chop since August) it's the longer-term pattern that keeps me bearish yields right now. The weekly chart below keeps all of this in perspective and I think it's due another leg down to complete the descending wedge pattern from 2010-2011. I would feel much less sure of this pattern if TYX rallies above 3.01% and it would be negated with a rally above 3.11%

30-year Yield, TYX, Weekly chart

The banking index, BKX, is stuck between two key levels following the November low where it failed to drop through support at its uptrend line from October 2011, and then failure to get through price-level resistance at 49 last week. If the bears can close the November 19th low, at 47.15, which would also be a break of its uptrend line from October 2011, then I think we'll see much lower lows. If the bulls can break BKX above its 50-dma, at 49.50, which would be a break of its downtrend line from October 5th that would increase the probability for a run up to a new high in the new year. Mind the chop in between.

KBW Bank index, BKX, Daily chart

Today the U.S. dollar broke below its 50-dma, at 80.20, as well as the bottom of a potential up-channel from October. It looks to be headed for its uptrend line from October 2011, near 79.60. I will turn more bearish the dollar if it breaks below 79.50 and return to bullish with a rally above 81, which is where it would close its November 23rd gap (80.97). I continue to lean bullish on the dollar but recognize we could see a lot of chop between 79.50 and 81.

U.S. Dollar contract, DX, Daily chart

I continue to believe the path of least resistance for gold from here is to the downside. A break below 1704 would reinforce the bearish picture but a higher bounce cannot be ruled out. It would turn bullish with a rally above its November 23rd high at 1755.

Gold continuous contract, GC, Daily chart

Today oil spiked up to the trend line along the highs from November 6th but then sold off for the rest of the day, following (leading?) the stock market. While I consider it a lower probability move, it could chop its way marginally higher in the coming month. If it rallies much above today's high at 90.33 I'd turn a little more bullish but not aggressively so until it got back above its 200-dma near 93. The bounce off the November 7th low looks like a correction and therefor another leg down is what I'm expecting. It would be confirmed with a drop below last Wednesday's low at 85.36.

Oil continuous contract, CL, Daily chart

There will be no major economic reports tomorrow but then the rest of the week will be busy with employment-related numbers. If the employment numbers are on the soft side it's not going to help the bulls. Or maybe it would if there's speculation that the Fed is going to up its QE monthly allowance for the market and needs bad economic data to support their move.

Economic reports and Summary

December is a seasonally bullish time so the bulls have that going for them. Most people are expecting Congress and the President to agree on at least something before year-end and probably kick the can down the road on the rest for later debate (it's worked well for Europe so why not?). These factors have helped the market rally.

On top of the bullish expectations we know the Fed is supporting a rally by pumping lots of money into the system. The $45B/month for Operation Twist, while net neutral, has prevented money from coming out of the market. Throwing an additional $40B/month from QE-I into the market, which will probably be increased following the December FOMC meeting, adds a lot of liquidity.

But what if all these bullish expectations and Fed money doesn't give us an expected rally? If no rally now, then when? If the rally from November 16th is just a correction to the October-November decline (and sharp rallies like this one are typically bear market rallies) then the next leg down is going to be very strong as those traders leaning long into the end of the year could be forced out en masse (the 3rd wave is the recognition wave).

It's too early to tell whether the current bounce has some additional legs, or if it will only pull back slightly before heading higher again or starts back down in earnest. Short-term trading is called for, with tight money management, until the bigger pattern clears up some. Once we get a deeper pullback it should provide some clues as to whether we should buy the dip in expectation for another rally leg or look for bounces to sell into. In the meantime trade carefully.

Good luck and I'll be back with you on Wednesday with hopefully a few more clues for what December might look like.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying


New Option Plays

Consumer Goods

by James Brown

Click here to email James Brown


NEW DIRECTIONAL CALL PLAYS

Ingredion Inc. - INGR - close: 64.96 change: +0.01

Stop Loss: 63.25
Target(s): 69.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
INGR is in the consumer goods sector. The stock spent the first two weeks of November consolidating sideways while most of the market was declining. Since then the stock has broken out to new highs. I am suggesting we use a trigger to buy calls at $65.25. If triggered our target is $69.00.

Trigger @ 65.25

- Suggested Positions -

buy the 2013 Jan $65 call (INGR1319a65) current ask $1.85

Annotated Chart:

Entry on December xx at $ xx.xx
Average Daily Volume = 504 thousand
Listed on December 03, 2012



In Play Updates and Reviews

Early Monday Gains Fade

by James Brown

Click here to email James Brown

Editor's Note:

The stock market's early Monday morning rally faded and most of the market closed in negative territory.

We did see HD hit our entry trigger.

Current Portfolio:


CALL Play Updates

Dover Corp - DOV - close: 63.06 change: -0.53

Stop Loss: 61.75
Target(s): 67.50
Current Option Gain/Loss: + 0.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/03/12: DOV tried to breakout past resistance near $64.00 but the early morning market rally faded. Shares of DOV pulled back to a -0.8% decline and closed under their 10-dma. The next level of support looks like $62.00. I am not suggesting new positions at this time.

- Suggested Positions -

Long 2013 Mar $65 call (DOV1316c65) entry $2.10

11/28/12 new stop loss @ 61.75
11/19/12 triggered @ 62.30

Entry on November 19 at $62.30
Average Daily Volume = 1.7 million
Listed on November 17, 2012


FMC Corp - FMC - close: 53.89 change: -1.57

Stop Loss: 53.80
Target(s): 59.50
Current Option Gain/Loss: - 58.8%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
12/03/12: Ouch! I could not find any news to explain the relative weakness in FMC today. I did hear generic comments about how basic materials and especially chemical stocks were underperforming today. FMC makes chemicals. The stock reversed at resistance near $56.00 and plunged past several moving averages including the 10, 20, 30, 50 and 100-dma. The low today was $53.83 and our stop is at $53.80. If there is any follow through tomorrow we'll see FMC hit our stop loss.

- Suggested *Small* Positions -

Long 2013 Jan $57.50 call (FMC1319a57.5) entry $0.85

12/03/12 FMC is underperforming and poised to hit our stop loss

Entry on November 27 at $55.31
Average Daily Volume = 642 thousand
Listed on November 26, 2012


Home Depot - HD - close: 64.98 change: -0.09

Stop Loss: 62.90
Target(s): 69.50
Current Option Gain/Loss: - 8.2%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
12/03/12: HD spiked higher this morning and almost hit $66 before completely reversing and giving back all of its gains. Our trigger to buy calls was hit at $65.35. At this point, given the intraday reversal, readers may want to wait to buy a bounce off $64.00 or a new close over $65.25 as an alternative entry point.

- Suggested Positions -

Long 2013 Jan $65 call (HD1319a65) entry $1.95

Entry on December 03 at $65.35
Average Daily Volume = 8.5 million
Listed on December 01, 2012


O'Reilly Automotive - ORLY - close: 93.32 change: -0.76

Stop Loss: 89.95
Target(s): 95.75
Current Option Gain/Loss: -18.4%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
12/03/12: ORLY's early morning gains faded and shares posted a -0.8% loss. Look for a dip to $92.00. I am not suggesting new positions at this time.

- Suggested Positions -

Long DEC $95 call (ORLY1222L95) entry $1.90

Entry on November 20 at $92.05
Average Daily Volume = 1.8 million
Listed on November 19, 2012


Precision Castparts - PCP - close: 181.75 change: -1.64

Stop Loss: 176.90
Target(s): 188.00
Current Option Gain/Loss: -16.2%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
12/03/12: The rally in PCP failed at resistance near $185 and the stock produced a bearish engulfing candlestick reversal pattern today. I would expect a dip back toward likely support at $180 soon.

NOTE: PCP will begin trading ex-dividend on December 5th. It should be nothing to worry about. It looks like the dividend is only three cents.

I have listed the December calls but you might want to use the January calls instead.

- Suggested *Small* Positions -

Long DEC $185 call (PCP1222L185) Entry $1.85

Entry on November 29 at $182.04
Average Daily Volume = 762 thousand
Listed on November 28, 2012


Pharmacyclics Inc. - PCYC - close: 55.93 change: +2.88

Stop Loss: 51.45
Target(s): 56.50
Current Option Gain/Loss: - 13.8%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
12/03/12: PCYC displayed relative strength today with a +5.4% surge. Today's move is a bullish breakout past resistance near $55.00. Please note our new stop loss at $51.45. Our target is $56.50. More aggressive traders could aim for the $59-60 zone instead.

Honestly, the option spreads are too wide at the moment and we are unlikely to post any gains on this trade even if PCYC does hit our target at $56.50.

Earlier Comments:
I do consider this a more aggressive, higher-risk trade. Anytime you trade a biotech stock it can be a high-risk trade since you never know when a negative headline could send the stock crashing.

- Suggested *Small* Positions -

long Dec $55 call (PCYC1222L55) entry $3.60

12/03/12 new stop loss @ 51.45
11/20/12 new stop loss @ 49.65
11/19/12 trade opened with PCYC's gap open higher @ 52.21

Entry on November 19 at $52.21
Average Daily Volume = 1.0 million
Listed on November 17, 2012


Starbucks Corp. - SBUX - close: 51.79 change: -0.08

Stop Loss: 49.95
Target(s): 55.85
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Comments:
12/03/12: SBUX continues to churn sideways under resistance near $52.00 and near its 200-dma. I am suggesting a trigger to buy calls at $52.50. We will aim for $55.85 since there was resistance near $56.00. More aggressive traders may want to aim for the $59-60 area instead.

Trigger @ 52.50

- Suggested Positions -

buy the 2013 Jan $55 call (SBUX1319a55)

Entry on November xx at $ xx.xx
Average Daily Volume = 8.1 million
Listed on November 29, 2012


Trimble Navigation - TRMB - close: 55.39 change: -0.25

Stop Loss: 53.40
Target(s): 59.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Comments:
12/03/12: There is no change from my prior comments on TRMB. We are waiting for a bullish breakout higher.

I am suggesting small bullish positions if TRMB can trade at $56.15 or higher. If triggered our short-term target is $59.75.

Trigger @ 56.15

- Suggested Positions -

buy the 2013 Jan $57.50 call (TRMB1319a57.5)

Entry on November xx at $ xx.xx
Average Daily Volume = 708 thousand
Listed on November 28, 2012


Whirlpool Corp. - WHR - close: 100.96 change: -0.88

Stop Loss: 99.40
Target(s): 108.50
Current Option Gain/Loss: -23.4%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/03/12: WHR is fading back toward support near $100 again. Our stop remains at $99.40 for now. Readers may want to wait for another bounce off the $100 level before considering new bullish positions.

Our multi-week target is $108.50.

- Suggested *Small* Positions -

Long 2013 Jan $105 call (WHR1319a105) entry $3.75

Entry on November 26 at $101.89
Average Daily Volume = 1.3 million
Listed on November 24, 2012


PUT Play Updates

Humana Inc. - HUM - close: 65.06 change: -0.35

Stop Loss: 66.51
Target(s): 60.25
Current Option Gain/Loss: -36.8%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
12/03/12: HUM's rally past short-term resistance at its 10-dma and the $66 level failed. This can be used as a new bearish entry point or you could wait for a new drop under $64.85 (today's low).

- Suggested Positions -

Long DEC $65 PUT (HUM1222x65) entry $1.98

Entry on November 28 at $64.20
Average Daily Volume = 3.0 million
Listed on November 27, 2012


InterOil Corp. - IOC - close: 54.66 change: -1.00

Stop Loss: 60.15
Target(s): 50.50
Current Option Gain/Loss: +11.1%
Time Frame: 3 to 5 weeks
New Positions: see below

Comments:
12/03/12: Monday was a relatively quiet day for IOC but the down trend continues. I am not suggesting new positions at this time.

I want to remind readers that this is a more aggressive, higher risk trade. IOC is volatile and has a high amount of short interest.

*Small positions* - Suggested Positions -

Long DEC $55 PUT (IOC1222x55) entry $2.70

11/28/12 new stop loss @ 60.15

Entry on November 21 at $58.50
Average Daily Volume = 790 thousand
Listed on November 20, 2012


Sears Holding - SHLD - close: 42.11 change: +0.10

Stop Loss: 44.05
Target(s): 40.25
Current Option Gain/Loss: + 9.3%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/03/12: Most of the market rallied this morning and then faded lower. SHLD didn't see a rally until midday but traders sold that rally as well. We are worried that SHLD is oversold and due for a bigger bounce. Readers may want to exit early now. I am lowering our stop loss to $44.05. I am not suggesting new positions.

- Suggested Positions -

Long 2013 Jan $45 PUT (SHLD1319m45) entry $2.15

12/03/12 new stop loss @ 44.05
12/01/12 new stop loss @ 45.25
11/28/12 triggered

Entry on November 28 at $45.75
Average Daily Volume = 1.2 million
Listed on November 26, 2012


Teradata Corp. - TDC - close: 58.52 change: -0.96

Stop Loss: 62.10
Target(s): 55.15
Current Option Gain/Loss: +25.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/03/12: TDC produced a failed rally at resistance near $60.00 (the high was 60.34) and shares reversed to a -1.6% decline. I would still consider new positions now.

Our target is $55.15. More aggressive traders could aim a lot lower. The Point & Figure chart for TDC is bearish with a $44 target.

- Suggested Positions -

Long 2013 Jan $55 PUT (TDC1319m55) entry $0.86

Entry on December 03 at $60.00
Average Daily Volume = 2.2 million
Listed on December 01, 2012