Option Investor
Newsletter

Daily Newsletter, Monday, 8/5/2013

Table of Contents

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

Market Wrap

Consolidation Before Another (Final?) Rally Leg

by Keene Little

Click here to email Keene Little
The price pattern was set up for a consolidation day on Monday, which should be followed by another rally leg, potentially the final one. So far the pattern is looking good.

Market Stats

I'm sitting in for Linda tonight and I'll be back with you on Wednesday. Considering how critical I think the market is right now (as far as putting in an important high early this week), it will be a good time to review where we are today and then update that view on Wednesday. In between we could see a market high.

The day was very quiet, which followed a very quiet overnight session. We had only one economic report today and only one on Tuesday (Trade Balance). The ISM Services report this morning showed a nice bump to the upside -- coming in at 56 and well above the 50 mark. It's the best reading since February and better than the expected 53.2 and a nice improvement over June's 52.2. The one bad part of the report is the "prices paid" component but so far it's an outlier and hopefully not a new trend, which would obviously squeeze companies' profits.

As we study the market and where it might be headed and when we might anticipate a pullback (at a minimum), there are a plethora of cycles that traders talk about. Presidential cycles, seasonal, moon, Kondratieff, bull and bear, Fibonacci time series and many more. There are so many to consider that it can be very confusing when trying to figure out which one will hold sway over the market.

A trader buddy of mine, Ed Carlson, has done some really good work resurrecting George Lindsay's work, who used cycles in the market and was most famous in the 1970's and 1980's. Carlson's recent book George Lindsay and the Art of Technical Analysis does a great job in explaining his work and he's probably most famous for his "3 peaks and a domed house" pattern.

Carlson did some work over the weekend and identified an interesting pattern using Lindsay's methodologies. He looked at the cycle work found in the Stock Trader's Almanac and combined their election year cycle work with George Lindsay's concept of the Long Cycle. As he noted, "I quickly decided that comparing all post-election years to one another is similar to comparing apples to oranges. After all, why would we expect similar results from those post-election years in secular bear markets as those in secular bull markets? The current secular bear market began at the low in 2002. Other secular bears ran from 1921-1942 and 1962-1982. These may not be the dates you commonly associate with secular markets as they were determined using Lindsay’s long cycle. I next created the chart [below], which includes all 13 post-election years in the two previous secular bear/long cycles as well as 2005 and 2009."

Stock market performance during post-election year in secular bear markets, chart courtesy Ed Carlson

True to form we've seen a strong rally in the first half of this year, which typically peaks in August and sells off into November. We're now into August and by this pattern we are warned of a pending change in trend. Since the May-June pullback I've been looking for a final rally into what I thought was a good turn window in July but the final 5th wave continues to push higher and we're now into August. The pattern shown above combined with the EW (Elliott Wave) count that I've been tracking are now closely aligned. We're at the point where we should be looking for a major reversal.

I'm going to kick off tonight's chart review with the RUT. I'll run through why I think the stock and bond markets are setting up for reversals and what to watch for to get confirmation of that.

The RUT has been leading us higher, indicating fund manager bullishness, and I think it will also lead us to the downside (fund managers panicking). The weekly chart shows price has pushed marginally above the top of a parallel up-channel for price action since the October 2011 low, near 1041, which was broken in mid-July and held as support at the end of the July (which is bullish). Only slightly higher now is the trend line along the highs from March-May, currently near 1068-1069. The completion of the leg up from June should be the completion of the triple zigzag wave count (three a-b-c's separated by x-waves). There are no quadruple zigzag patterns and therefore the wave count is now "used up" and we're waiting for the completion of the leg up from June.

Russell-2000, RUT, Weekly chart

The daily chart below shows how price used the top of the up-channel from October 2011 as support so it remains bullish above that, which is currently where its 20-dma is located, near 1045. It's getting pinched now between trend lines and showing bearish divergence against the July high, which fits with the final 5th wave in the move up from June.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1057
- bearish below 1045

Looking more closely at the move up from July 29th, which fits as the 5th wave in the move up from June, the 30-min chart below shows where we are in the wave count. All the little squiggles since August 1st make it a bit of a challenge so this is my best guess at the moment. It says we should be into the final 5th of the 5th wave following this afternoon's low. The 5th wave in the move up from July 29th would be 62% and 100% of the 1st wave at 1064 and 1067, resp. As mentioned above, the trend line along the highs from March-May is currently near 1068-1069 so that too is a possibility. A shorter-term trend line along the highs from July 25th through August 1st is near 1065 Tuesday morning. All of these give us an upside target zone of 1065-1069 for a final high. The only thing we wait for is confirmation with an impulsive decline from the target zone.

Russell-2000, RUT, 30-min chart

As with the RUT I'm looking for only one more new high for SPX to complete its wave count. Depending on the time frame and wave pattern I'm looking for an upside target zone of 1715-1722. The daily chart below shows a 5-wave move up from June and we're into the 5th wave since the July 26th low. The 127% extension of the May-June decline is at 1721.68 and makes for a good upside target, although there are few reasons why it might not get there. A drop below 1695 would now indicate the high is in place and keep in mind that this will be a MAJOR high, a level that will not be revisited for many years (decades?).

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1705
- bearish below 1695

The 5-wave move up from June is shown in more detail on the 60-min chart below. The projections for the 5th wave are at 1717 and 1742, which is where the 5th wave would be 62% and 100%, resp., of the 1st wave. Based on the shorter-term pattern I'm thinking the lower target is the higher-probability projection, although as I'll show on the 15-min chart next, there is agreement for a move to 1721.

S&P 500, SPX, 60-min chart

I normally don't get down into the weeds for the market wraps but because of the importance of the coming high I thought I'd show what to watch for on Tuesday and how it could put in its final high. Today's consolidation fits as the 4th wave in the move up from July 26th, which means we're looking for the final 5th of the 5th wave up. I had been thinking SPX would pull back to about 1701 and then from there the 5th wave in the move up from July 26th would be equal to the 1st wave at 1717, the same upside projection as on the 60-min chart, so there's nice correlation if that plays out. In fact my thought this afternoon was that we'll see a pullback in the futures during the overnight session, create a gap down to get some selling going Tuesday out of the gate and then watch it get hit with a couple of buy programs to get short covering to help launch the next rally leg. I know, we've never seen that happen before but there's always a first time (wink). But if the 4th wave finishes as a little sideways triangle (common for 4th waves) then the 5th wave would equal the 1st at 1721, which lines up nicely with the 127% extension shown on the daily chart.

S&P 500, SPX, 15-min chart

Depending on how this plays out on Tuesday (and of course it could do something completely different), I see upside targets at either 1717 or 1721. From there watch for a rollover and a shorting opportunity. More conservative short entries will be after we get an impulsive decline, indicating a trend change to the downside, followed by a bounce correction -- short that against the previous high.

The DOW has had a very choppy pattern since July 26th and as it works its way higher in this choppy pattern it looks like an ending pattern, which fits as the final 5th wave. There is a price projection at 15728, where the 5th wave in the move up from June would be 62% of the 1st wave but I'm starting to wonder if that can be reached. Back below 15490 would tell us the high is already in place.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,600
- bearish below 15,490

NDX has marched steadily higher since its July 23rd low with barely a pullback. But the bearish divergence against the mid-July high is warning us the rally is tiring. Marginal new high on Tuesday?

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3160
- bearish below 3076

As a "sentiment" stock I like to keep an eye on AAPL, especially as it reaches S/R. It has now bounced up to potential resistance and the wave pattern supports the idea we'll see another leg down. AAPL and the broader market have diverged many times but a market rally without AAPL will always be a little suspect. Today's high achieved the price projection at 469.52 for two equal legs for a possible a-b-c bounce off its April low. That a-b-c bounce could be a 4th wave in the move down from September 2012 or perhaps more likely it's a b-wave in a large a-b-c pullback from September for a larger-degree wave-A down. Either count calls for another leg down with a downside target at either 300-310 or 273 (62% retracement of the 2003-2012 rally).

If the pullback from September 2012 is to be an a-b-c (labeled in light red), the next leg down would be the c-wave and it would achieve 62% of the a-wave at 273, the same as the 62% retracement, so there's good correlation at that level if it starts back down from here. Notice too that the bounce has now almost made it up to its broken H&S neckline, currently near 473. The 200-dma is currently near 475 so there's a lot of resistance in the 469-475 area. Are AAPL bulls prepared for another 200-point decline? For the moment I'd say AAPL is bullish above 475, bearish below 470.

Apple Inc., AAPL, Weekly chart

TNX had a key reversal day on Friday and as can be seen on its daily chart below, the big red candle created an outside down day -- gap up to a minor new high and close at or below the body of the previous day's candle. The close was a slight break of its uptrend line from May 1st. The bond bears kept up the pressure today (lifting yields back up slightly) but I think bonds are about to start rallying and we'll see TNX break below 2.60, which should lead to a large pullback if not the start of the next leg down for yields. Unless and until TNX can get above its downtrend line from 1981-2007, currently near 2.81, I remain bearish yields (bullish bonds) and believe we'll see 1% next year before the bond market finally puts in a final low for yields.

10-year Yield, TNX, Daily chart

The bonds I do expect to see further selling in are the junk bonds, which should widen the yield spread between the Treasuries and junk bonds (the spread had narrowed significantly until May, showing strong complacency in junk bonds). The price pattern for HYG (the junk bond ETF) since May shows an impulsive decline into the June low followed by a 3-wave bounce to the July 22nd high. It has rolled back over and HYG is now providing another heads up for what's coming for the stock market. The next leg down for HYG should be sharp and strong and quickly make it down to the 82.50 projection shown on the chart (the November 2011 low).

High Yield Corporate bond ETF, HYG, Weekly chart

While there may be some fear showing up in the junk bonds it's certainly not showing up in the VIX. Even though SPX was in the red all day today the VIX continued to drop lower, now below its previous low in April. The At 11.84 it's now getting closer to the trend line along the lows from March 2012, currently near 11.26. That line was pierced once in March 2013 but then jumped right back up the following week. I've drawn a descending wedge for the VIX from the March 2012 low and June 2012 high. The current leg down from June 2013 is the 5th wave inside this wedge and will be the last one. The bullish divergence inside this wedge supports the bullish interpretation. When the VIX starts to rally again it's going to come flying out of that wedge and quickly get back to the beginning of it (the June 2012 high at 27.73) and it will catch most market participants by surprise.

Volatility index, VIX, Weekly chart

The big-picture view of the banking index, BKX, supports the idea that we're now very close to a top. If BKX gives us one more leg up, like the broader averages, we could see it tag the price projection at 67.95, where it would achieve two equal legs up from April 18th to complete the final a-b-c of a corrective rally pattern from October 2011 and finish its rally from 2009. Near 68 it would also hit the tops of its two up-channels, one from the October 2011 low and the other from the April low.

KBW Bank index, BKX, Weekly chart

The price pattern for the TRAN supports the need for one more high, which fits with the broader indexes. It should be only a minor new high, perhaps just above 6700 to complete the wave count and then the setup would be for the start of a major decline. It's possible that last Thursday's high is already the final high and if I see an impulsive decline, especially with a break below the key level at 6474 (the July 26th high), I'll be looking for failed bounces from there.

Transportation Index, TRAN, Daily chart

There's not much to add to last week's comments about the U.S. dollar. It is struggling to get off support at its broken downtrend line from 2010-2012 as well as the bottom of its up-channel from the end of last year, both near 82. Its 200-dma at 81.58 is support until proven otherwise.

U.S. Dollar contract, DX, Daily chart

Gold's price pattern continues to support the idea we'll get another leg up for its bounce off the June low, perhaps up to its broken uptrend line from April-May, currently near 1370. It is also possible the June low was an important low and a rally above 1400 would convince of that.

Gold continuous contract, GC, Daily chart

Oil could go either way here and it's not much better than flipping a coin to figure out which way. A drop below last week's low at 102.67 would indicate a top is in, potentially a longer-term one. But if it pushes up to its 2012 high at 110.55 and consolidates there we should see oil continue higher into the end of the year.

Oil continuous contract, CL, Daily chart

There are no important economic reports tomorrow so the market will be on its own to make up stories for why the market moved (if it moves).

Economic reports and Summary

Today's volume was the lowest of the year for SPY (the same as December 24th last year). If we get another leg up as depicted on my charts we should at least see a little more volume. But we're at the end of the rally, traders are tired, there's little reason to buy but even fewer reasons to sell (in the minds of most traders). I think there's a big reason to sell but that's me. There's too much stacking up against a continuation of a market rally and therefore button up stops on long positions and get ready to rock and roll to the downside.

Good luck and I'll be back with you on Wednesday to see if a high has been put in.

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

Financial & Healthcare

by James Brown

Click here to email James Brown


NEW DIRECTIONAL CALL PLAYS

Ameriprise Financial - AMP - close: 91.15 change: -0.06

Stop Loss: 89.75
Target(s): 98.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
AMP is in the financial sector. The stock didn't react much to the company's recent earnings beat in late July but the trend has been steadily higher. Lately shares have been hovering just above round-number resistance at $90.00, which has been acting as new support the last couple of sessions.

We are suggesting a trigger to buy calls at $91.40. If triggered our multi-week target is $98.50.

Trigger @ 91.40

- Suggested Positions -

Buy the Sep $95 call (AMP1321i95) current ask $1.15

Annotated Chart:

Entry on August -- at $---.--
Average Daily Volume = 760 thousand
Listed on August 05, 2013


CR Bard Inc. - BCR - close: 115.89 change: +0.12

Stop Loss: 113.95
Target(s): 119.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
BCR is in the healthcare sector. They make and distribute medical supplies and equipment. The current rally in BCR has pushed shares to new all-time highs. The stock has spent the last three days hovering just below resistance at the $116.00 level. A breakout would likely signal the next leg higher.

We are suggesting a trigger to launch positions at $116.25. If triggered our short-term target is $119.75.

Trigger @ 116.25

- Suggested Positions -

Buy the Sep $120 call (BCR1321i120) current ask $0.85

Annotated Chart:

Entry on August -- at $---.--
Average Daily Volume = 475 thousand
Listed on August 05, 2013



In Play Updates and Reviews

Sideways Session

by James Brown

Click here to email James Brown

Editor's Note:

The better than expected ISM services report this morning failed to lift stocks after last week's breakout to new highs.

SRCL has been triggered. SPY was closed at the open.


Current Portfolio:


CALL Play Updates

Capital One Financial - COF - close: 69.50 change: -0.09

Stop Loss: 68.25
Target(s): 74.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
08/05/13: COF produced a very quiet session on Monday with shares drifting sideways in a narrow range. We are waiting for a breakout higher.

We are suggesting a trigger to buy calls at $70.25. If triggered our target is $74.75.

Trigger @ 70.25

- Suggested Positions -

Buy the Sep $70 call (COF1321i70) current ask $1.76

Entry on August -- at $---.--
Average Daily Volume = 3.1 million
Listed on August 01, 2013


Costco Wholesale - COST - close: 120.07 change: +0.70

Stop Loss: 117.90
Target(s): 124.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Comments:
08/05/13: Bullish analyst comments helped COST outperform the broader market on Monday. Shares are flirting with a breakout past the $120.00 level yet the high today was only $120.20.

We are suggesting a trigger to buy calls at $120.25. If triggered our target is $124.75.

NOTE: COST is due to begin trading ex-dividend on August 7th. The dividend should be 31 cents.

Trigger @ 120.25

- Suggested Positions -

buy the Sep $120 call (COST1321i120) current ask $2.40

Entry on August -- at $---.--
Average Daily Volume = 1.4 million
Listed on August 03, 2013


Johnson & Johnson - JNJ - close: 93.80 change: -0.59

Stop Loss: 92.75
Target(s): 98.00
Current Option Gain/Loss: Aug.call +18.2% & Sept.call: + 2.4%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
08/05/13: JNJ gave back most of Friday's gains with some profit taking on Monday. Shares are still respecting short-term support at the rising 10-dma for now.

- Suggested Positions -

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

- or -

Long Sep $95 call (JNJ1321i95) entry $0.82

08/03/13 new stop loss @ 92.75
08/01/13 new stop loss @ 92.35
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


Shire plc - SHPG - close: 110.45 change: -1.32

Stop Loss: 108.95
Target(s): 118.50
Current Option Gain/Loss: -30.7%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
08/05/13: After hitting new highs on Friday SHPG saw some profit taking Monday. Shares underperformed the market with a -1.1% decline but traders did buy the dip this afternoon near the $110 level. More conservative traders may want to raise their stop loss.

Earlier Comments:
SHPG is overbought at current levels but it can always grow more overbought. I would keep position size small to limit risk.

*small positions* - Suggested Positions -

Long Sep $115 call (SHPG1321i115) entry $2.60

Entry on August 02 at $111.50
Average Daily Volume = 347 thousand
Listed on August 01, 2013


Stericycle, Inc. - SRCL - close: 117.38 change: +0.19

Stop Loss: 115.95
Target(s): 124.00
Current Option Gain/Loss: -18.9%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
08/05/13: SRCL continued to drift higher today and shares hit our suggested entry point to buy calls at $117.35. I do not see any changes from our weekend comments on this play.

Earlier Comments:
We suspect that SRCL will not only retest its highs but breakout past the $120 level. If triggered our target is $124.00. I do expect some resistance and a pullback near $120 but we have a four to six week time frame.

- Suggested Positions -

Long Sep $120 call (SRCL1321i120) entry $1.85

Entry on August 05 at $117.35
Average Daily Volume = 334 thousand
Listed on August 03, 2013


United Technologies - UTX - close: 106.64 change: -1.13

Stop Loss: 104.90
Target(s): 109.85
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
08/05/13: UTX produced a dip right on cue. Yet the low today was only $106.60. We are suggesting traders buy calls on a dip at $106.50. Odds are good that UTX will hit that entry point tomorrow. More nimble traders may want to wait and see if UTX dips as low as $106.00 before jumping in.

Our initial target is $109.85 but we will adjust the target as the play progresses.

FYI: UTX will begin trading ex-dividend on August 14th. The quarterly dividend should be 53.5 cents.

Buy the dip trigger @ $106.50

- Suggested Positions -

Buy the Sep $110 call (UTX1321i110) current ask $0.84

Entry on August -- at $---.--
Average Daily Volume = 3.2 million
Listed on August 03, 2013


Xilinx Inc. - XLNX - close: 46.13 change: -0.38

Stop Loss: 45.45
Target(s): 49.85
Current Option Gain/Loss: -33.9%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/05/13: XLNX spent most of the session hugging the $46.00 level. If there is any follow through lower then we'll likely see XLNX hit our stop loss at $45.45. I am not suggesting new positions at this time.

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

*small positions* - Suggested Positions -

Long Aug $46 call (XLNX1317H46) entry $1.06

08/03/13 new stop loss @ 45.45

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


PUT Play Updates

Illumina Inc. - ILMN - close: 78.37 change: +1.09

Stop Loss: 81.55
Target(s): 75.25
Current Option Gain/Loss: + 0.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/05/13: After a multi-day decline ILMN bucked the market's malaise today and produced a bounce (+1.4%). Readers may want to adjust their stop so it's closer to the $80.00 level. I am not suggesting new positions. Our exit target is $75.25.

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

*small positions* - Suggested Positions -

Long Sep $75 PUT (ILMN1321u75) entry $2.00

Entry on August 01 at $79.50
Average Daily Volume = 1.2 million
Listed on July 31, 2013


iShares Russell 2000 ETF - IWM - close: 105.52 change: +0.36

Stop Loss: 106.05
Target(s): 97.00
Current Option Gain/Loss: -46.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
08/05/13: IWM is not cooperating with us. The small cap ETF outperformed the S&P 500 and the Dow Industrials with a +0.3% gain and another new all-time high. I am not suggesting new positions and traders will want to seriously consider an early exit now.

- Suggested Positions -

Long Sep $100 PUT (IWM1321u100) Entry $1.48

08/03/13 readers may want to consider an early exit

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



Longer-Term Play Updates



Chicago Bridge & Iron - CBI - close: 60.10 change: +0.26

Stop Loss: 55.75
Target(s): 74.50
Current Option Gain/Loss: -11.7%
Time Frame: 4 to 6 months
New Positions: see below

Comments:
08/05/13: CBI produced a very quiet day with shares hovering just below $60.00. Then in the last few minutes the stock spiked higher.

I am not suggesting new positions at this time.

*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 BEARISH PLAYS

SPDR S&P 500 ETF - SPY - close: 170.70 change: -0.25

Stop Loss: 172.75
Target(s): 165.25
Current Option Gain/Loss: -50.5%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/05/13: After last week's bullish breakout past resistance at the $170.00 level we decided to close our SPY trade early. The plan was to exit at the opening bell this morning. The ETF opened at $170.57. The option opened slightly higher.

- Suggested Positions -

Aug $170 PUT (SPY1317T170) entry $1.98 exit $0.98 (-50.5%)

08/05/13 scheduled exit
08/03/13 prepare to exit on Monday morning
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.

chart:

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