Option Investor

Oil and Equities Push Higher

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Oil got a nice bounce this week from Monday's low of $48.05 (July contract) to a high of $52.00 on Friday. At the same time the broader equity market continued to climb slightly higher for the week as well. The fact that oil climbed back above $50 didn't seem to make equity bulls particularly nervous and that helped the oil stocks which saw a very nice rebound this week. The oil index (OIX.X) has rallied from its 428.62 low on May 16th to close at 462.07 on Friday, for a 7.8% rally in two weeks. On Friday it also broke its downtrend line from the March high and closed slightly above its 50-dma. This is clearly bullish action and if next week shows a retest of the broken downtrend line, currently at about 454, that holds, I would say there's an excellent chance we'll see the rally continue higher. Oil is also threatening to break its downtrend from the April high but it doesn't look quite as bullish yet as the index. The charts are looking a little extended at the moment so a pullback is expected soon, including in the broader market, and that pullback should give us some clues as to whether or not we should go ahead an close out our insurance put options.

These insurance puts will continue to protect us if we get more downside and with the broader market looking especially vulnerable to a pullback, it's too early to cash in on the insurance puts. We'd like to take profits on the puts so as to decrease our cost in the LEAPs but only when it has become more certain that the downtrend has been broken. The US dollar continued its rally this week before pulling back on Friday but this didn't negatively affect the price of oil whereas previous rallies in the dollar had depressed commodities in general, including oil Commodities also rallied this week so it was just a bullish week all around. Something will give next week and that's what we'll wait for instead of making decisions on our LEAPs portfolio this weekend.

At the beginning of last week I had thought the broader equity market looked tired and was ready for a pullback. But the market chugged a little higher after a small pullback. If you look at the DOW and SPX and draw an uptrend line from March 2003 through their October 2004 lows, you'll see that price broke that uptrend line in April and have now come back up to test the underside of that uptrend line. After last week's test of the trendline, we have another higher test this week but with negative divergences on the charts. We either have a perfect short entry at that line (support now turned resistance), or the Bulls are prepared for an assault on the Bears and will breach that line of defense causing the Bears to panic which will create a strong short covering rally. How this plays out will have an effect on our portfolio.

The only change to our portfolio from last week was the drop of OSTK since it rallied up and hit our stop the previous week. I still view this stock bearishly and price did drop back down below our stop level of $39 but it could find support from its 20 and 30-dma's near $37.40. We'll watch this one a little longer.

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