Option Investor
Newsletter

Daily Newsletter, Wednesday, 5/8/2013

Table of Contents

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

Market Wrap

Market Reaches Next Turn Window

by Keene Little

Click here to email Keene Little
The break above the March/April highs looks very bullish. But there are several signals now that require caution.

Market Stats

The market has actually been very quiet this week. There haven't been any big economic reports to jolt the market and overseas has been quiet and supportive for the bulls. Consequently the market continues to melt up higher. In last week's update I showed the potential for a move higher into this week and that's obviously what the market has done. At this point we're seeing indexes hit upside targets so it's going to be a time to watch very carefully what happens this week.

I say the market has been melting higher because one could hardly say we've seen robust buying. The volume has been very low and the market is rallying on an absence of selling as much as anything else. To the bulls they don't care -- just keep it coming. Bears are flummoxed and can't understand how or why the market can just keep going the way it is. We've had plenty of signs the market is tired, overbought, too much bullish sentiment, etc. and yet the bulls just thumb their noses at the bulls as they drive by.

I keep hearing pundits say this is the most hated rally and that no one believes in it and that's why it will keep heading higher. If many don't believe in the rally it probably has to do with the fact that it's entirely disconnected from reality. The economy is not doing well and the false high in the stock market only makes people confused and wonder why the Fed feels the need to keep propping the market higher. But trader sentiment, especially among fund managers, is anything but bullish.

The chart below shows the level of NYSE margin debt since 1992. The bottom portion of the chart shows similar information but inverted and represents the net free credit balance, which is currently negative. Around the free credit bar chart is essentially a Bollinger Band showing 2 standard deviations and the current amount of debt has pierced the BB, which in the past has led to a reversal. The top portion of the chart shows margin debt vs. SPX and like in 2007 it has increased at a faster rate than SPX. That hasn't been a good sign in the past and likely means trouble not far ahead this time.

S&P 500 vs. Margin Debt, chart courtesy Bank of America

As reported by Bank of America's Stephen Suttmeier to his clients, the peaks in margin debt preceded both the 2000 and 2007 market peaks. It has increased more than 28% from a year ago and as of the end of April it stood at $380B, only $1B less than the 2007 peak (and probably exceeded by now). Cash balances in hedge funds have dropped sharply to the lowest level since 2000. All those who want in on the rally are in and the low volume that we're seeing in the current rally simply means we're running out of buyers. When the last one is let aboard the southbound train is anyone's guess but when they lock the doors and start heading south there's going to be a stampede out the only an only emergency exit.

Today marks an important date for the market although most don't realize it. W.D. Gann is a famous market technical analyst and I've referred often to the Gann Square of Nine chart in past updates, which does an uncanny job at identifying strong relationships between dates and prices. His methodology was based on what he considered "Natural Law" and geometric proportions based on the circle, square and triangle. He referred to many number relationships and one of the important numbers that he used was 7 and multiples of 7 and especially 7 squared (49), which he felt was very important when watching for a trend change. He considered 49 the death zone. "Coincidentally" the Fibonacci numbers 13, 21 and 34 are close to or equal to multiples of 7.

So here's a little Gann thrown at you when looking at the number 49:
1. today is 49 calendar days since the spring equinox (March 20th), which Gann considered an important date in the year.
2. yesterday was 49 trading days from the February 26th low
3. this week is 49 weeks from the June 2012 low
4. April completed 49 weeks from the March 2009 low

The confluence of timing indicators tell us to look for the possibility of a trend change and considering the price pattern, which I'll review, I'd say there's a real good chance we'll see an important trend change this week.

Adding to the numbers game, the Fibonacci sequence (1,2,3,5,8,13,21,34,55,89,144,233,377,610) suggests today/tomorrow could be important. The weekly chart of SPX below shows the number of Fibonacci days from prior market turns and the fact that all point to this week is something that's likely more than coincidental.

S&P 500, SPX, Weekly chart with Fibonacci days from prior turns

The daily chart below zooms in on the leg up from November and shows two parallel up-channels, the tops of which intersect tomorrow near 1641. The top of the larger channel is parallel to the uptrend line from June-November 2012 and attached to the previous high in May 2012. The smaller channel is for price action since the November low. Intersecting the intersection of the tops of the channels is a price projection at 1640.68, which is where the 5th wave of the move up from November would equal the 1st wave. After showing this projection last weekend I was beginning to think yesterday it wouldn't make it but now it's within spitting distance and we could see that level tagged tomorrow if there are no nasty overnight surprises. Will it stop there? That's what we'll find out but it would be a good setup to short it there if tagged and rolls over, especially considering the timing window discussed above. And oh by the way, tomorrow is a new moon and solar eclipse, both of which have been known to affect the market.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1597
- bearish below 1581

A trend line along the highs from late January was tagged at today's close, thanks to late-day push higher into the close. Was it a small capitulation into today's close? Sometimes that's bearish since it leaves nothing for follow through the next morning. And with price finishing right at the trend line there is the potential for an immediate reversal Thursday morning, and potentially a very good shorting opportunity. Otherwise wait to see if the 1641-1642 target zone is reached. An impulsive decline, either from here or slight higher, followed by a corrective bounce to a lower high would be a good time to try the short side. In the meantime the bulls have done nothing wrong here and bears need to stay cautious. Bulls on the other hand can ill afford to get complacent.

S&P 500, SPX, 60-min chart

As Jim mentioned yesterday, trading volume has been pitifully low and that continued today. It doesn't mean the rally must fail here but it's a warning. Even though the bears have gone into hiding and it doesn't take much volume to lift the market, tops are typically put in on low volume as it simply runs out of buyers. Looking at the SPY chart below you can see how volume has dropped off dramatically following the April 18th low. And now that SPY is up against the top of its up-channel from November is this really a good time to be thinking long the market? Or perhaps you might be thinking about taking some profits. I'm sure you're not alone if you're thinking it's time to cash in some chips and once the selling starts it could quickly cascade lower since all those who are long the market are now classified as sellers-in-waiting.

SPY daily chart

The DOW has possible expanding triangle playing out (for a broadening topping pattern), the top of which is near 15280. I don't know if it will get there but watch for a possible high if it does

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,887
- bearish below 14,687

The Nasdaq has now rallied up into a potentially tough wall of resistance, as shown on its weekly chart below. There are three lines of resistance it's now facing, crossing between 3405 and 3425, and today's high at 3413 in in the middle of the nest. The broken uptrend line from March 2009-June 2012, which was broken in November 2012, has held down the rally since November and is currently near 3405. Today was the first close above it so a reversal back down on Thursday would leave a sell signal. Near the same level is the long-term trend line from the highs in 1983 and 1987 (blue on the chart). This line has held down rallies since February 2011. The other long-term uptrend line from 1974-2002 is currently near 3425. The weekly and daily charts are overbought so pulling a Clint Eastwood on you, "do you feel lucky" here?

Nasdaq Composite index, COMPQ, Weekly chart

Moving in closer to look at the rally from November, the Nasdaq has rallied up to the top of its parallel up-channel, poking marginally above it today near 3410. Call me crazy but I'm thinking this is a good sell setup. Either that or we're in the early stages of a monster blow-off move, one that clearly wouldn't end well but has to be respected if it doesn't roll over from here.

Nasdaq Composite index, COMPQ, Daily chart

Key Levels for COMPQ:
- bullish above 3425
- bearish below 3296

There's an idea I've been toying with lately for how the next few months might play out. A good trading buddy does some really good cycle work and for about a year now he's been thinking we won't see a final market high until the first week of July (fwiw, his work then points hard down into 2014, a bounce and then continue lower into the end of the decade). I kept thinking we'd see an important top sooner than July, including the potential for one as soon as the current rally finishes. But now I'm beginning to wonder if he's going to be correct.

It's possible the April 18th low is the 4th wave in the move up from November and all we're looking for is a final high to complete the rally from November and in turn the rally from March 2009. But so far the pattern supports the idea that we're going to get a larger 4th wave correction off the March high, in what's called an expanded flat correction. The move down from March into April is a 3-wave move. The rally from April 18th is a 3-wave move (so far) and making a slightly higher high than the one in March and so far these moves fit an expanded flat correction.

The 127% extension of the March-April decline is near 969 and two equal legs up from April is 969-971, depending on where I consider the start of the rally (today's high was 970.41). That's good correlation to be looking for a high in this area so a rollover from below 971 could spark a strong selloff in the c-wave of this a-b-c pullback from March. The c-wave would typically achieve 162% of the a-wave in a sharp move, which points to the 880 area by the end of the month. That kind of move would scare a lot of bulls out of the market and suck in a lot of bears. If it were then followed by one more rally leg into July, getting slight above 1000, it would then spit out the bears (convinced the market will never go down) and really pull in the bulls, just in time to set up a major (years-long) high with both the bears and the bulls not believing in a high.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 970
- bearish below 924

This idea for a sharp decline in May followed by another rally leg into July is simply speculation at this point but it's food for thought for now. If we were to get a sharp 5-wave move down into the end of the month it would be followed by at least a bounce correction before heading lower. That would mean bears would want to cover their short positions at the end of the month and play the long side for either a bounce correction or one that will take us to new highs. I'll update this idea if and when it develops.

The 10-year yield (TNX) looks to have either finished its bounce correction of its March-April decline or has only finished wave-a of what will be a larger a-b-c bounce. The March-April decline is an impulsive 5-wave move, which supports the idea that we'll see at least another leg down once the correction finishes. So far it has retraced 38% of the decline (to the penny at 1.79%) and back-tested its broken uptrend line from July-December 2012. Today's candle is a bearish engulfing pattern and could lead to the next leg lower from here and another equal leg down would break below the July 2012 low (1.394%). A decline in TNX (rally in bond prices) could put some downward pressure on the stock market, although the March-April decline only resulted in a sideways consolidation for the stock market. Maybe it will be different this time (wink).

10-year Yield, TNX, Daily chart

Back in February/March, when reviewing the banking index (BKX) chart, I mentioned there was a resistance zone at 57.25-58.99. This was based on price projections for the wave pattern in the move up from 2009, Fib retracement and the April 2010 high. The March 15th high was 57.60 and looked like a good finish to its rally. But wait, there's more. BKX has now pushed marginally higher and is up near the upper end of this resistance zone, making a high of 58.85 today. The shorter-term wave pattern is not clear so it's hard to call a top here but any turn back down from here has the potential to make today's high THE high that completes its correction to the 2007-2009 decline (with the possibility of a sharp pullback this month and then a final high in July, as discussed on the RUT's chart and shown in light green on the weekly chart below).

KBW Bank index, BKX, Weekly chart

I mentioned earlier the potentially bearish expanding triangle (broadening top) for the DOW and we have the same pattern for the home builders. The high on May 3rd was at the trend line along the highs from January-March, with bearish divergence, and looks ready to roll back over. The wave count for the leg up from October 2011 counts complete, which should be the completion of a large A-B-C bounce off the November 2008 low. What I don't know is how the index will come back down (assuming it will start down from here). Just as an idea of what to watch this year will be the possibility of a lot of volatility in a diamond topping pattern.

DJ U.S. Home Construction index, DJUSHB, Weekly chart

The TRAN has rallied back up to the top of its up-channel from October 2011, poking slightly above it at 6385. It has also pushed marginally above the projection at 6402 (today's high was 6416), which is the 127% extension of its March-April pullback. As explained on the RUT's chart, I'm showing the potential for a sharp pullback this month and then a rally to a new high into early July. You can see how that pattern would make another expanding triangle for a broadening topping pattern (with lots of volatility associated with this pattern). If it turns down from here, which is the setup, we'll have to see how the first leg down plays out.

Transportation Index, TRAN, Daily chart

The U.S. dollar has been chopping up and down and could continue this way as it pulls back into June/July before heading higher again. Nothing to do but wait to see how it plays out from here.

U.S. Dollar contract, DX, Weekly chart

Gold has been battling trendline resistance since its April 25th rally. The bottom of a previous down-channel from September 2012 and its previous downtrend line from September 2011-February 2012, near 1470, have been a brick wall for gold bulls. I've been expecting gold to turn back down from this resistance but I'm starting to wonder if we'll see another leg up before gold resumes its decline. Today's rally was a bounce back up inside a trading range that looks like a bullish consolidation under resistance and a rally above its May 3rd high at 1487 could lead to a rally up to test its previous price-level support at 1525 or 1550. The alternative is a sharp breakdown from what looks like a bull flag pattern. Notice MACD is back up to the zero line and if it crosses back down from this line it's going to create a sell signal.

Gold continuous contract, GC, Daily chart

Oil has bounced back up to its downtrend line from September 2012, which appears to be the top of a small triangle within a larger triangle. Maybe a little Russian doll is going to pop out of this. A break above Monday's high at 97.17 would likely lead to a jump up to the downtrend line from May 2011, currently near 104. Otherwise I see the potential for oil to whip up and down inside a 80-100 trading range for months to come.

Oil continuous contract, CL, Daily chart

As for economic reports this week, zzzz.....

Economic reports and Summary

Tomorrow we have a new moon and a solar eclipse, both of which have been associated with market turns. Some astrologer-traders I work with tell me that May 8-9 is a very important time from a planetary alignment perspective (it has to do with gravity pulls). I've seen too many of these astrological setups mark important turn dates and while I don't have a clue how to interpret them I know it's foolish to ignore them, especially when they're lining up with signals I'm seeing on the charts. My MPTS is flashing a reversal signal for tomorrow so we'll see what happens.

SPX MPTS daily chart

The market could continue higher in a stronger blow-off top but the +6% rally for SPX off the April 18th low already qualifies for that. Signals are aligned for a reversal, which could be a very strong reversal so trade carefully here. Good luck and I'll be back with you next Wednesday.

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

The Bounce is Over

by James Brown

Click here to email James Brown


NEW DIRECTIONAL PUT PLAYS

Allergan Inc. - AGN - close: 103.31 change: -1.43

Stop Loss: 105.30
Target(s): 98.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
So far the month of May has been a rough one for shares of AGN. The company reported earnings on May 1st and beat estimates by one cent. Revenues were actually better than expected as well. Yet management lowered their Q2 guidance and the stock plunged on the warning. Since the report a couple of analyst firms have lowered their price targets on AGN. At the same time there have been a couple of analysts suggesting investors buy AGN on this weakness.

It looks like the sellers are winning. The oversold bounce in AGN has stalled at the $105.00 level. Shares have been stuck here for days in spite of the market's breakout to new highs and it looks like sellers are applying pressure again with today's underperformance.

I am suggesting we buy puts immediately and capture part of the next move down. There is potential support at $100.00, at the 200-dma near $97.85, and at the May 1st low of $96.77. I am suggesting we aim for $98.50.

- Suggested Positions -

buy the Jun $100 PUT (AGN1322R100) current ask $1.90

Annotated Chart:

Entry on May -- at $---.--
Average Daily Volume = 2.4 million
Listed on May 08 2013



In Play Updates and Reviews

Another Round of New Highs

by James Brown

Click here to email James Brown

Editor's Note:

Wednesday delivered another round of new all-time highs for the S&P 500, Russell 2000, the Dow Transportation Average and the Dow Industrials.

Our WLP trade has been triggered.

Retailers could move tomorrow. Before the opening bell several major retailers will share their monthly same-store sales numbers.


Current Portfolio:


CALL Play Updates

The Boeing Co. - BA - close: 94.04 change: -0.27

Stop Loss: 92.40
Target(s): 99.00
Current Option Gain/Loss: + 0.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
05/08/13: Hmmm... BA did not participate in the market's rally on Wednesday. Shares gapped open lower and spent the session hugging the $94.00 level. I would not be surprised to see shares dip toward short-term support at the rising 10-dma soon.

- Suggested Positions -

Long Jun $95 call (BA1322F95) entry $2.02

Entry on May 06 at $94.25
Average Daily Volume = 4.9 million
Listed on May 04 2013


HanesBrands Inc. - HBI - close: 50.45 change: -0.43

Stop Loss: 48.75
Target(s): 54.75
Current Option Gain/Loss: -17.5%
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Comments:
05/08/13: HBI produced a small gap down at the open this morning. That should have helped our entry price on the option. The stock quickly filled the gap and then drifted lower throughout the session. HBI's failure to follow the market higher is a bit surprising but the $50.00 level should be new support.

NOTE: HBI is scheduled to begin trading ex-dividend on May 16th. The quarterly cash dividend should be 20 cents.

- Suggested Positions -

Long Jun $50 call (HBI1322F50) entry $2.00

Entry on May 08 at $50.72
Average Daily Volume = 1.4 million
Listed on May 07 2013


Lumber Liquidators - LL - close: 84.55 change: +0.35

Stop Loss: 79.45
Target(s): 89.50
Current Option Gain/Loss: -7.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
05/08/13: LL fell toward $82.50 by lunch time. Yet traders bought the dip and shares rebounded to close in positive territory. LL looks poised to breakout past the $85.00 level soon.

Earlier Comments:
LLL had a lot of short interest prior to the company's earnings report and the good news sparked a short squeeze. The most recent data listed short interest at 27% of the small 26.2 million share float but that number may be out of date. If triggered our short-term target is $89.50. I would keep our position size small to limit our risk.

*Small Positions* - Suggested Positions -

Long Jun $85 call (LL1322F85) entry $4.10

05/07/13 triggered on gap open higher

Entry on May 07 at $84.35
Average Daily Volume = 761 thousand
Listed on May 06 2013


L Brands, Inc. - LTD - close: 53.21 change: +0.58

Stop Loss: 50.40
Target(s): 54.50
Current Option Gain/Loss: +59.2%
Time Frame: Exit PRIOR to earnings in mid-May
New Positions: see below

Comments:
05/08/13: Retailers continue to rally and LTD is outperforming many of its peers. Today saw shares gain another +1.1% and set another high.

Retail stocks could move tomorrow as several major retailers report their monthly same-store sales numbers.

Keep in mind we only have a couple of weeks, maybe less, before we need to exit prior to LTD's earnings report.

- Suggested Positions -

Long Jun $50 call (LTD1322F50) entry $2.26

05/07/13 new stop loss $ 50.40

Entry on May 03 at $50.85
Average Daily Volume = 2.7 million
Listed on April 27 2013


Ross Stores - ROST - close: 66.13 change: -0.37

Stop Loss: 64.15
Target(s): 69.00
Current Option Gain/Loss: + 3.2%
Time Frame: exit prior to earnings in late May
New Positions: see below

Comments:
05/08/13: ROST saw some minor profit taking today after yesterday's gains. Retail stocks could move tomorrow as several major retailers report their monthly same-store sales numbers.

Technical traders will note that the MACD on ROST's daily chart is rolling over and appears to have just turned negative, which is bearish. I am not suggesting new positions.

- Suggested Positions -

Long Jun $67.50 call (ROST1322F67.5) entry $1.55

05/04/13 new stop loss @ 64.15
05/01/13 new stop loss @ 63.90

Entry on April 26 at $65.25
Average Daily Volume = 2.3 million
Listed on April 25 2013


WellPoint Inc. - WLP - close: 75.05 change: +0.34

Stop Loss: 73.35
Target(s): 79.75
Current Option Gain/Loss: -5.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
05/08/13: Our brand new play on WLP has been triggered. The stock traded inside a $1.20 range and within that zone it was a choppy session. Traders bought the dip twice intraday. WLP managed to breakout past round-number resistance at $75.00. The stock hit our suggested entry point at $75.25. I would still consider new positions now.

- Suggested Positions -

Long Jun $75 call (WLP1322F75) entry $1.91

Entry on May 08 at $75.25
Average Daily Volume = 2.0 million
Listed on May 07 2013


PUT Play Updates

Amgen Inc. - AMGN - close: 105.07 change: +0.61

Stop Loss: 106.75
Target(s): 96.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
05/08/13: AMGN managed to eke out a gain and actually outperform the NASDAQ composite and the biotech sector but shares have not broken the bearish trend of lower highs. We are still waiting on a breakdown.

Earlier Comments:
Last Tuesday's low was $103.85. More aggressive traders could buy puts now but I am suggesting a trigger to buy puts at $103.65. If triggered our target is $96.00. However, more conservative traders may want to exit near $100 since it's possible the $100 level could prove to be round-number support.

Trigger @ 103.65

- Suggested Positions -

buy the Jun $100 PUT (AMGN1322R100)

Entry on May -- at $---.--
Average Daily Volume = 1.4 million
Listed on April 30 2013


Expedia Inc. - EXPE - close: 57.18 change: +0.11

Stop Loss: 60.25
Target(s): 1st target: 55.10, 2nd target 53.00
Current Option Gain/Loss: +13.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
05/08/13: EXPE tried to bounce but traders sold the rally at $58 and its 10-dma. Overall EXPE looks poised to continue its decline. Keep in mind that shares of EXPE could be influenced by rival Priceline.com (PCLN). Friday morning could be volatile for the industry as the market reacts to PCLN's earnings report due out May 9th, after the closing bell.

Earlier Comments:
Please note I am listing two targets. Our conservative target is $55.10 since the $55 level has been support in the past. Our more aggressive target is $53.00. You choose which target you want to exit at. FYI: The Point & Figure chart for EXPE is bearish with a $55 target.

- Suggested Positions -

Long Jun $55 PUT (EXPE1322R55) entry $1.50

Entry on May 07 at $58.48
Average Daily Volume = 2.9 million
Listed on May 06 2013


Vertex Pharma. - VRTX - close: 75.43 change: -0.97

Stop Loss: 80.50
Target(s): 66.00
Current Option Gain/Loss: +16.6%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
05/08/13: VRTX continues to see profit taking with a -1.2% decline today. The stock has found round-number support at $75.00 again. Shares bounced at this level last week. It could happen again but look for resistance at the short-term trend of lower highs. I am not suggesting new positions at this time.

Earlier Comments:
The old 2012 highs were near $65.00. This could be new support. We will aim for $66.00.

- Suggested Positions -

Long Jun $75 PUT (VRTX1322R75) entry $3.60

Entry on May 02 at $76.30
Average Daily Volume = 3.8 million
Listed on May 01 2013



Longer-Term Play Updates



Chicago Bridge & Iron Co. - CBI - close: 57.08 change: +0.58

Stop Loss: 51.90
Target(s): 62.50
Current Option Gain/Loss: July's: +77.2% or Jan's: +44.8%
Time Frame: 3 to 4 months
New Positions: see below

Comments:
05/08/13: I am raising our stop loss to $51.90. More conservative investors may want to consider a stop closer to the $54.00 level, which should be short-term support if CBI retreats.

Please review our original play description on this page here.

- Suggested Positions -

Long 2013 Jul $55 call (CBI1320G55) Entry $2.20*

- or -

Long 2014 Jan $60 call (CBI1418A60) Entry $2.90*

05/08/13 new stop loss @ 51.90
*option entry price is an estimate since the option did not trade at the time our play opened.

Entry on April 22 at $51.53
Average Daily Volume = 2.5 million
Listed on April 20 2013