Option Investor
Newsletter

Daily Newsletter, Wednesday, 7/31/2013

Table of Contents

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

Market Wrap

Bulls Hold Onto Month's Gains

by Keene Little

Click here to email Keene Little
Watching the price action for the past several days about the only bullish thing that could be said of the market is that at least it didn't give up the month's gains. Now what?

Market Stats

This morning provided a perfect example of the stock market acting bullish. It's never the news that matters; it's the reaction that matters. We know the market has been fretting about the Fed's desire to start tapering their asset purchases by the end of the year (not going to happen) and therefore the market does not want to see strong economic/employment numbers because that would only embolden the Fed to start getting serious about backing off. So a good economic report is bad for the stock market in its perverted state of being right now.

But this morning we got some good economic reports and the market rallied anyway. Hmm, good is good even when bad is good. Bulls were thinking that's good! The ADP employment report came in better than expected, showing a +200K increase vs. the +179K that had been expected. May was also revised higher from +188K to +198K. Actually I can see +200K monthly number as just right -- one that will keep the Fed actively buying while showing some positive growth in the economy.

GDP was better than expected, coming in at +1.7% for Q2 vs. expectations for +1.1%. The prior estimate was +1.8% that had been revised down to +1.1%. So it was slightly positive but not very strong. Just right.

The Chicago PMI also came better than the expected 51.5, climbing up to 52.3, which was an improvement over June's 51.6. So all in all the numbers were good but not so good as to scare the Feds into their silly taper talk again.

The Fed told us absolutely nothing new from the FOMC meeting and changed nothing. All that buildup...wait for it...wait for it...sppplllllgggghhhhh (the was the air quickly let out of the balloon as it raced up and down before falling onto the ground). Rates stay the same, purchases stay at $85B/month, economic growth remains "modest" and they'll continue to monitor the employment picture and inflation to determine future actions by the Fed, etc., etc.

Bullish sentiment remains high, at least among the retail crowd. The professional money managers maybe not so much. Hat tip to Bob S. for bringing to my attention a Tyler Durden (zerohedge.com) article about the "Love-Panic Index" from BNP Paribas bank. It was an interesting look at sentiment and market measurements that collectively shows where the market is on the "Love" vs. "Panic" cycle. This chart is from the beginning of June so it's already old data but I just wanted to show what they're measuring. I tried to blow up BNP's chart showing the various measurements they use in their collective index but it's still hard to read:

BNP measurements for their Love-Panic index

When the composite of these measurements is then plotted vs. SPX you can see how it correlates with the stock market (no surprise here). For the index, in the top portion of the chart, zero is in the middle and the index extremes are at -60 and +60. The green dashed line at -40 indicates "Panic" and a good time to buy while the red dashed line at +40 indicates "Love" and a good time to sell. This index actually peaked at the beginning of this year following the January rally. The rally since then has been on a declining "Love" scale, which indicates less enthusiasm in buying and a warning sign.

BNP Love-Panic index

As with any sentiment indicator, it's not a timing model but is instead just another tool to help warn of impending danger (or opportunity at the bottom). As BNP noted, "When in 'love' mode, the average drop in stocks has been -12% in the next six months." This also ties in with what we've been hearing about professionals selling the most stock in the last 4 weeks that BofA has seen, while their private clients have been on a buying spree (professionals handing off inventory to the retail crowd, which we've been seeing in the distribution patterns, such as morning rallies, afternoon selloffs, strong bounces followed by strong reversals into the close, rinse and repeat).

All of the whippy price action over the past two weeks has given us some doji candlesticks on the daily and weekly charts. We can see on the charts that the market hasn't moved much in the last 2-3 weeks. For SPX, price has stalled at a potentially important price level, near 1689, which is the first target price for the rally from June (5th wave equals 62% of the 1st wave in the move up from June 2012). Once complete it will complete the final leg of the rally from October 2011 (which is the completion of a 3-wave move up from 2009) and then we'll be looking at the start of the next major bear market leg back down. For now we continue to wait for evidence of a top or if instead we'll be looking for one at the next upside target at 1768 (5th wave equal to 1st wave in move up from June 2012). I continue to see weakness on the weekly chart but nothing rolling over yet.

S&P 500, SPX, Weekly chart

Each day's update this week has been with few changes to the charts since we're only getting little doji's. The market's been a choppy mess for more than 2 weeks now and as can be seen on the SPX daily chart below, we've got lots of little doji candlesticks near the 1689 level. The last time we had a similar run-up into a pattern like this was in February, which then led to more rally into the May high. Is this one going to do the same or is instead a topping pattern? I think topping but I also know the market couldn't care a bit about my opinion. We follow price.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1705
- bearish below 1676

I show a break below the July 26th low at 1676 as an important break but there will be one thing to keep in mind if it breaks down from here. Because it's difficult to evaluate whether or not this afternoon's high could be THE high for the rally, one consideration is that we're still in a correction off the July 23rd high that will be followed by the next rally leg. So a sharp pullback could set a bear trap and we'll have to monitor that possibility carefully.

The 30-min chart shows more detail of the sloppy trading, especially in the bounce off the July 26th low. The choppy rise is an ending pattern but ideally, for the completion of the 5th wave in the move up from June, I think it needs another leg up, which is what I'm depicting. One more new high could finish off the pattern so don't get pulled into buying it if it happens (like many did this afternoon, only to get the stock stuffed down their throats again). However, because this is an ending pattern it can end literally at any time, including this afternoon's high. A break below the July 26th low would be a strong bearish warning and if it happens I'll be watching for key levels that the bears will need to defend and see broken. Assuming we'll only see one more attempt at a new high we should see the completion of the rally this week, maybe next Monday.

S&P 500, SPX, 30-min chart

The DOW made a new high above its July 23rd high, which makes the bounce off its July 26th low either the final 5th wave or part of a larger a-b-c pullback pattern. The DOW's short-term pattern suggests we're going to see a breakdown on Thursday, which would negate the "one more high" for SPX. If we do get a breakdown then the next question is whether or not it will be the real deal. Because of a clear 3-wave bounce off the June 26th low to today's high it looks like the b-wave bounce of a larger a-b-c pullback from July 23rd and NOT the final high. But the risk in buying the next pullback is that it's not going to bounce as depicted on my chart. If it drops below 15300 I wouldn't buy it even if I was using your money.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,600
- bearish below 15,300

The first sign of trouble for the bulls would be a break of the uptrend line from July 26th, now near DOW 15522, which is what happened into the close. Only an immediate rally Thursday morning can save the bulls from at least a short-term selloff. If Tuesday's low at 15479 breaks then the higher-odds probability would be to the downside into Friday, with a downside target at 15312. That's where the c-wave of a larger a-b-c pullback from July 23rd would be 162% of the a-wave. Today's new high, completing the b-wave of an a-b-c pullback from July 23rd, makes this an expanded flat correction and notice it reversed at the 113% extension of the prior decline (July 23-26), which is a common reversal Fib (that and the 127%). A strong decline to the price projection at 15312 followed by a v-bottom reversal back up into a rally would certainly flip a few bears' heads. But the pattern calls for nothing lower than 15300 so a drop lower would be trouble for the bulls. We're going to have to read and react in the next 1-2 days before this clears up a little more.

Dow Industrials, INDU, 30-min chart

If you've ever wondered where these 113% and 127% Fibs come from, it has to do with the reciprocal and square root relationships between the Fibonacci ratios. For example, we know the .382 and .618 are the golden ratio numbers and added together we get 1.0. The .618 (or 1.618) is of course the ratio of each of the last two numbers in the sequence of Fib numbers (1,2,3,5,8,13,21,34,55...keep adding the last two numbers to get the next one) But did you also know the square root of .382 is .618 (.618 squared is .382)? The reciprocal of .618 is 1.618 and the reciprocal of .382 is 2.618. The square root of .618 is .786, the number I usually refer to as the line in the sand -- any retracement beyond that is a virtual guarantee that the previous move will be completely retraced but in this market it has typical been the completion of large retracements before reversing back in the original direction. The reciprocal of .786 is 1.272, the common reversal Fib following a head-fake break of a previous high/low. The 113% is actually 112.8% and is the square root of 1.272. Many traders have no idea how much the stock prices react to these magical numbers (in time as well as price).

On Monday and Tuesday I was pointing out an upside target at 3105-3115 by Wednesday for NDX and today's high at 3110 did a nice job of it. A trend line along the highs from September 2012 and May 2013 fits well as the top of a rising wedge pattern for its 5-wave ending diagonal move up from June 2012 and it's currently near 3105. The 3115 is the 127% extension of the May-June decline. This one might be done but I wouldn't rule out one more attempt. Today's shooting star candlestick could be pointing to its next move - down.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3116
- bearish below 2825

The RUT is no different than the other indexes and it's too difficult at the moment to figure out if it's going to put in just a minor new high to complete its rally or if it will head higher (in which case I could argue it has an upside target zone at 1069-1089). If it pulls back sharply it might only be to complete a larger corrective pattern off its July 23rd high before it too resumes its rally. At the moment I'm leaning short based on what looks like a topping pattern. The RUT is likely to lead whichever direction identifies itself.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1053
- bearish below 1036

Treasury yields created a key reversal day by gapping up and then dropping and closing below yesterday's closing prices. The rally in the bond market, especially following the FOMC, could be the kick off to a stronger rally and knock yields back down. The lack of taper talk has bond players feeling more bullish.

While I could see the need for one more push up for the TRAN, to hit a price projection at 6515 for two equal legs in its bounce off its July 25th low, this afternoon's high at 6506 is close enough and the bounce pattern can be counted as complete. Following an impulsive decline from July 22nd and the 3-wave bounce correction it looks ready for the next leg down. So far it looks like the TRAN is leading the way down and it shouldn't take long for the RUT to join it (they typically trade more in synch than out of synch).

Transportation Index, TRAN, Daily chart

For 4 days the U.S. dollar has been trying to hold support above the 81.50 area. Today was the first day it tagged its 200-dma since bouncing off it in June. I believe it will hold but we're still waiting for it to turn back up.

U.S. Dollar contract, DX, Daily chart

I see the potential for gold to make it up to its broken uptrend line from April-May, which it broke when it crashed lower in June. Currently near 1368 it's not a lot more upside but it would do a nice job completing a corrective wave count for its bounce off the June 28th low and set up the next leg down (1155 downside target). There are plenty of reasons to feel bullish about gold right now but so far the price pattern says not yet.

Gold continuous contract, GC, Daily chart

Silver continues to have a bounce off its June 28th low that looks very much like a small 4th wave correction, which calls for at least one more leg down in its pattern.

Silver continuous contract, SI, Daily chart

Oil remains bearish as long as it stays below its price projection at 108.75 (two equal legs up from June 2012), which was achieved two weeks ago, but the bounce off its broken downtrend line from 2007-2011 on Tuesday is bullish that so far. That's a successful back test and could launch another rally leg. The light green wave count calls for a minor new high, probably a test of the March 2012 high at 110.55 before pulling back and then heading higher. But a drop below Tuesday's low at 102.67 could spell a little more trouble for oil bulls.

Oil continuous contract, CL, Weekly chart

We've got a busy two more days of economic reports and now that the market can relax about the Fed's buying spree not ending anytime soon we might start to see economic reports have a more "normal" response. Tomorrow's ISM index, construction spending and auto/truck sales might have some impact. Friday's Payrolls report certainly will. And after the bell on Friday we'll get the Factory Orders report, another report that should help or hurt depending on it looks.

Economic reports and Summary

We've been in a very choppy price pattern that's been full of whipsaws. If you don't like a direction just wait 30 minutes. This of course makes it very difficult to figure out the next move and there's a reason topping patterns are equal opportunity trade bashers.

For where we are in the larger price pattern we appear to be in the ending 5th wave. As shown on the DOW's chart in particular, there is the potential for a quick drop down, perhaps as low as 15300 by Friday, and then a new rally into early- to mid-August so beware of that potential. The more bearish potential is that we're in an ending pattern that could literally end at any time, including today's high.

The thing tipping me in favor of an earlier top is the amount of distribution and professional selling (as reported by BofA last week) that's been going on. I can't see them wanting to buy all that stock back in early August to jam the market back up into the middle of the month. That's obviously speculation on my part but I know if I worked hard to get rid of my inventory at top dollar I could not be interested in the least in buying it back at only minor new lows. Call me in September and/or after we've seen at least a 10%, maybe 20%, pullback and I'll see if I'm interested yet. Trade very carefully in the next week since it could get a little volatile with wider price swings.

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

Fill The Gap

by James Brown

Click here to email James Brown


NEW DIRECTIONAL PUT PLAYS

Illumina Inc. - ILMN - close: 79.82 change: -1.07

Stop Loss: 81.55
Target(s): 75.25
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
ILMN is in the biotech industry. The company recently reported earnings on July 23rd and the news was bullish. ILMN beat the bottom line and top line estimates. Management then raised their revenue guidance. The stock reacted by gapping higher and rushing to a new all-time high near $80.

Unfortunately for the bulls there has been no follow through. Shares have been languishing sideways ever since. Now you could argue that the sideways consolidation in ILMN is due to a similar sideways churn in the market's major indices. Big picture the story seems bullish for ILMN. Yet short-term we suspect the stock could fill the gap. That means a dip toward $75.00.

We are suggesting a trigger to buy puts at $79.50. Our target is $75.25. I would keep our position size small to limit risk.

NOTE: Once ILMN fills the gap we can re-evaluate it for a potential bullish entry point.

Trigger @ 79.50 *small positions*

- Suggested Positions -

Buy the Sep $75 PUT (ILMN1321u75) current ask $2.05

Annotated Chart:

Entry on July -- at $---.--
Average Daily Volume = 1.2 million
Listed on July 31, 2013



In Play Updates and Reviews

HAR Hits Our Target

by James Brown

Click here to email James Brown

Editor's Note:

Shares of Harman Intl. (HAR) hit our bullish exit target today.
Our bullish trades on PII and XLNX were triggered.
We want to exit our HAIN trade at the open tomorrow.


Current Portfolio:


CALL Play Updates

The Hain Celestial Group, Inc. - HAIN - close: 72.96 change: -1.13

Stop Loss: 71.95
Target(s): 79.50
Current Option Gain/Loss: -60.0%
Time Frame: exit PRIOR to August expiration
New Positions: see below

Comments:
07/31/13: HAIN underperformed the market again on Wednesday with a -1.5% decline. Shares have not closed back below their 10-dma. It is possible that shares could bounce at $72.00 but we are suggesting an early exit now (tomorrow morning) to cut our losses.

- Suggested Positions -

Long Aug $75 call (HAIN1317H75) entry $1.50

07/31/13 prepare to exit tomorrow morning.

Entry on July 25 at $74.40
Average Daily Volume = 420 thousand
Listed on July 22, 2013


Johnson & Johnson - JNJ - close: 93.17 change: -0.04

Stop Loss: 91.90
Target(s): 98.00
Current Option Gain/Loss: Aug.call +19.7% & Sept.call: +14.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
07/31/13: Another day another new all-time high for JNJ. Today the stock hit $94.42 before paring its gains. JNJ has been trading higher in a very narrow channel since the start of July. We are moving our stop loss to $91.90. More conservative traders might want to raise their stop toward the $92.50 area.

- Suggested Positions -

Long Aug $92.50 call (JNJ1317H92.5) entry $1.37

- or -

Long Sep $95 call (JNJ1321i95) entry $0.82

07/31/13 new stop loss @ 91.90

Entry on July 29 at $93.05
Average Daily Volume = 9.0 million
Listed on July 27, 2013


Polaris Industries - PII - close: 112.14 change: +2.05

Stop Loss: 108.49
Target(s): 114.85
Current Option Gain/Loss: + 9.5%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
07/31/13: As expected the upward momentum in PII continues. Today shares got a boost from bullish analyst comments after PII unveiled its 2014 product line and a handful of new products. Shares gapped open higher at $110.78. Our trigger to buy calls was hit at $111.05. Our exit target is $114.85. More aggressive traders may want to aim higher.

*small positions* - Suggested Positions -

Long Sep $115 call (PII1321i115) entry $2.10

Entry on July 31 at $111.05
Average Daily Volume = 765 thousand
Listed on July 30, 2013


Xilinx Inc. - XLNX - close: 46.69 change: +0.45

Stop Loss: 44.99
Target(s): 49.85
Current Option Gain/Loss: - 3.7%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
07/31/13: The semiconductor sector index is starting to rebound and XLNX managed to breakout from its sideways consolidation. Our trigger to buy calls was hit at $46.65. As long as the market opens positive tomorrow we would still consider new bullish positions here.

Earlier Comments:
I would keep our position size small since bears could argue that XLNX is overbought with a significant five-week rally already underway.

*small positions* - Suggested Positions -

Long Aug $46 call (XLNX1317H46) entry $1.06

Entry on July 31 at $46.65
Average Daily Volume = 3.5 million
Listed on July 25, 2013


PUT Play Updates

Accenture Plc - ACN - close: 73.81 change: +0.07

Stop Loss: 75.21
Target(s): 70.25
Current Option Gain/Loss: -29.4%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
07/31/13: ACN hovered near its 200-dma most of the session. Then in the last two hours the stock spiked higher but the rally rolled over under the $75.00 level.

FYI: The Point & Figure chart for ACN is bearish with a $54 target.

- Suggested Positions -

Long Aug $72.50 PUT (ACN1317T72.5) entry $0.85

Entry on July 24 at $73.80
Average Daily Volume = 4.9 million
Listed on July 23, 2013


Darden Restaurant - DRI - close: 49.05 change: +0.03

Stop Loss: 49.35
Target(s): 44.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
07/31/13: DRI rallied toward resistance at its 200-dma before rolling over and closing virtually unchanged on the day. Traders could interpret this as a failed rally pattern. More aggressive investors might want to buy puts on a drop below $48.75. Currently we are waiting to buy puts at $47.75. Please note that I am moving our option strike from the August $50 to the September $50 put.

Earlier Comments:
We do want to keep our position size small. If we are triggered at $47.75 our target is $44.50.

Trigger @ 47.75 *small positions*

- Suggested Positions -

Buy the SEP $50 PUT (DRI1321u50) current ask $2.10

07/31/13 adjust the option strike from Aug $50 to Sep $50

Entry on July -- at $---.--
Average Daily Volume = 1.3 million
Listed on July 24, 2013


iShares Russell 2000 ETF - IWM - close: 103.65 change: +0.17

Stop Loss: 106.05
Target(s): 97.00
Current Option Gain/Loss: - 6.7%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
07/31/13: It was a volatile afternoon for the IWM. The small cap ETF rallied only to reverse lower late in the session. Is this a short-term double top forming? Traders might want to wait for a drop under $103.00 before initiating positions.

Earlier Comments:
I do expect to see some support and a temporary bounce when the IWM hits the $100 level and its 50-dma but we are going to aim for a drop to the rising 100-dma (currently near $97).

While this looks like a good set up for puts there are always risks. Short interest in the market has hit levels not seen since December 2012. If the FOMC statement or the Q2 GDP estimate on Wednesday or the jobs data on Friday surprise the market it could spark some short covering.

- Suggested Positions -

Long Sep $100 PUT (IWM1321u100) Entry $1.48

Entry on July 30 at $103.69
Average Daily Volume = 31 million
Listed on July 29, 2013


SPDR S&P 500 ETF - SPY - close: 168.71 change: +0.12

Stop Loss: 172.75
Target(s): 165.25
Current Option Gain/Loss: + 7.5%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
07/31/13: The SPY eked out a small gain today. Yet intraday this ETF produced another failed rally at resistance near the $170.00 level.

We have a stop loss at $172.75. Cautious traders may want to use a stop; loss closer to the $170.00 level instead.

NOTE: There are a lot of different option symbols for the SPY. Make sure you get the right one. We're choosing the regular August $170 put that expires on the 17th.

- Suggested Positions -

Long Aug $170 PUT (SPY1317T170) entry $1.98

07/24/13 trade opened with the SPY gapping higher at $169.79
07/23/13 adjust entry strategy. Do not wait for a trigger. Buy puts at the opening bell tomorrow.

Entry on July 24 at $169.79
Average Daily Volume = 123 million
Listed on July 22, 2013



Longer-Term Play Updates



Chicago Bridge & Iron - CBI - close: 59.58 change: -0.12

Stop Loss: 55.75
Target(s): 74.50
Current Option Gain/Loss: - 7.8%
Time Frame: 4 to 6 months
New Positions: see below

Comments:
07/31/13: Uh-oh! We were expecting some volatility today in reaction to CBI's earnings last night. I suggested CBI would likely bounce. The stock did rally this morning but it failed by lunchtime. The intraday reversal looks bearish. CBI should have support at the 100-dma currently near $58.70. More conservative investors may want to adjust their stop loss higher.

*Small Positions* - Suggested Positions -

Long 2014 Jan $65 call (CBI1418A65) entry $2.55

07/20/13 new stop loss @ 55.75
06/29/13 CBI might be poised to dip into the $57-55 zone again.
06/24/13 triggered @ 56.75
06/22/13 adjust entry trigger to $56.75
06/15/13 entry strategy change: change the breakout trigger at $65.25 to a buy-the-dip trigger at $56.50. Adjust the stop loss to $53.75.
Adjust the option strike to the 2014 Jan. $65 call

Entry on June 24 at $56.75
Average Daily Volume = 1.8 million
Listed on June 01, 2013


CLOSED BULLISH PLAYS

Harman Intl. Industries - HAR - close: 60.53 change: +1.38

Stop Loss: 57.40
Target(s): 59.50
Current Option Gain/Loss: +77.7%
Time Frame: Exit PRIOR to earnings on August 6th
New Positions: see below

Comments:
07/31/13: Target achieved.

The rally in HAR continued on Wednesday and shares hit our exit target at $59.50. The stock kept going and broke out past the $60.00 level. The stock is on track for its sixth weekly gain in a row.

- Suggested Positions -

Aug $57.50 call (HAR1317H57.5) entry $1.80* exit $3.20 (+77.7%)

07/31/13 target hit
07/30/13 new stop loss @ 57.40
07/25/13 new stop loss @ 55.90
07/23/13 new stop loss @ 55.40, adjust the exit target to $59.50
*option entry price is an estimate since the option did not trade at the time our play was opened.

chart:

Entry on July 18 at $56.10
Average Daily Volume = 785 thousand
Listed on July 13, 2013