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Daily Newsletter, Wednesday, 07/09/2008

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Table of Contents

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

Market Wrap

Crazy Action

I think that the title sums up not only today but the various markets general volatile movements. Over the weekend I read an article in some other publication by McMillan about how and why the CBOE Volatility Index (VIX) has been so subsided as compared to huge spikes the index experienced during Marchs decline. While it appears that some investors are in panic mode calling for a recession or possible crash the VIX isnt really reflecting the fear. Mr. McMillan referenced option traders tendency to hedge with Options and Futures on the VIX and VXN (Nasdaq 100 Volatility Index) as well as buying the Ultra Short Proshares of the S&P 500, Nasdaq 100 and Russell 2000 (symbols: SDS, QID, & TWM, respectively). In the article he pointed out many variables that could possibly cause the VIX (S&P 500 Implied Volatility) to stay close to the actual volatility of the S&P 500. I tend to emphasize the VIX versus many of the other contrarian/sentiment indicators because of the long term consistency of the signals it has given. The main point is that while many of the sentiment and technical indicators out there are suggesting the market is oversold the market hasnt capitulated as suggested by the VIX spiking to around 30. The VIX moves higher as option traders buy SPX puts to hedge their portfolios and buy calls to speculate a bounce. Basically when everyone has thrown in the towel and pays whatever it takes to hedge the volatility spikes. Once the panic subsides as indicated by the VIX contracting from its highs a tradable long may be established (but use stops at either price levels or a break out of volatility).

As the chart above shows the VIX spiked up to over 26.90 which is just below the candle wick from March 24th. The close lower on Monday signaled a long entry. The exit is always the hardest part. We could have covered the trade at the close with a nice profit or set a trailing stop at a break above 24.09 on the VIX itself. How do we trade this? A long trade can be done many ways. We can buy SPX Calls, Buy a SPX Call Diagonal Spread, Sell an SPX Put Vertical, buy the Ultra Proshare S&P 500 (SSO), Sell the SSO puts or put spread, Buy a Call Diagonal on the SSO, Buy the VIX Puts, Sell the VIX Calls, etc. It really depends upon your time horizon, ability to trade intraday, ability and knowledge of trading complex spreads and available risk capital. As for the exit, a break below the 20 day simple moving average (SMA) (red line) is usually a confirmation of continued contraction. Since the VIX found support and bounced significantly from it today the trailing 10 day SMA or the previous high of 24.09 would be a good trailing stop so as not to get whipsawed and give back all of yesterdays hypothetical profits.

News Today

I heard rumors about Bank of America today that covered that the stock is one of the greatest value investments available from the company having to cut its dividend. At todays close of $22.06 the current yield is 11.60%. The CEO spoke after the close and squashed the dividend cut theory and the stock is trading up to about $22.84 in after hours trading. CNBC even had a round table discussion regarding the stock as either a great dividend play or an eventual drag on the economy from potential unforeseen write downs. The options market has put a heavy price on the future movement of the stock by setting Implied Volatility on the front month July options at 95.06%. According to Yahoo! earnings are expected to be released on July 21st while options expire on July 15th. You could sell the July 20 puts for $0.44 per contract and the July 25 Calls for $0.23 per contract to create a slightly positively biased short strangle. A strangle is similar to a straddle except the calls and puts have different strike prices. The trade brings in about $0.67 per contract or $67 for an initial margin requirement of approximately $240 per contract. This is about a 25% return for 7 days left.

In the technology sector Cisco Systems (CSCO) declined 1.32 to 21.56 on news that UBS said that CSCO faces challenges due to slowing sales in the U.S. and Europe. UBS cut their price target to $25.50 from $27.00.

The above chart is the 5 minute S&P 500 CME eMini futures contract. As the chart shows the market started the day with a little gap up but filled in within the first five minutes of todays New York Session. We saw a bounce back to the pre-market highs but by noon the market had begun to fall and break down below the 10:00 AM lows. The European Markets all closed strong.

FTSE: 5528.3 +87.8 +1.6%, DAX: 6395.4 +91.0 +1.4%, CAC: 4339.7 +64.1 +1.5%.

At 1789 million the NYSE volume exceeded the 5o day moving average of 1613 million shares. However, todays level is less than yesterdays volume of 2098 million shares. There were 1103 advancing stocks versus 2112 declining stocks. The ARMS index or TRIN spiked up at 2.42. A close above 1.50 is a good buy signal while a close above 2 is an even better signal. The TRINs high number reflects a flush out on high selling volume.

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On the Nasdaq Composite the volume barely exceeded the 50 day moving average. Todays volume of 2254 million shares was slightly above the 50 day average of 2096 million shares. There were 940 advancing stocks versus 1936 declining stocks today. The TRINQ also exceeded 2 to suggest a buying opportunity. However, it should be noted that the TRIN trade is a short term profit target trade and not a long term signal. Another method of trading the TRIN is on an open high above 1.5 buy the Dow or S&P Futures or options and sell all or part once the TRIN bottoms out and begins to head back up.
Crude Inventories were released today and seemed bullish for oil in that the inventories declined 5,840,000 barrels versus the 1,982,000 barrels that were expected. However, crude declined about 0.4% and spurred a decline of 2.1% in the energy sector.

The S&P 500 (SPX)

After choppy trading up until lunch time the SPX dropped suddenly to lose yesterdays entire advance up. The chart below shows the daily price of the SPX with moving averages.

The upper level of resistance is at 1292 from two intraday highs. A close above 1292 would help the pending bounce camp sound sane. Tuesdays low of 1240 stands as our near term support. However, the 127.2% Fibonacci level at 1207.13 stands as the next price extension level. Another decline like today would put the SPX near that level and set a significant new low. However, for now the SPX seems to be congregating near the 100% retracement level. The longer term moving averages are very far from being in play. The 50 day Exponential Moving Average (EMA) is at 1335.98 at the close. A run to that would require a quick 90 point (7%) move up to even test that level.

The above chart is a daily SPX chart with Slow Stochastic, Bollinger bands and RSI. I also have the 8 day EMA embedded into the 21 day EMA Bollinger band indicator. I programmed the EMA Bollinger bands in order to get a more responsive standard deviation measurement. That is the upper and lower bands. The lower band is at 1227 and has provided a nice gentle slide down. The 8 day EMA, on the other hand, has provided consistent resistance on the slide down. A close above the 8 day EMA may provide a confirmation long entry. Notice that today the SPX traded above the 8 day EMA but obviously failed to hold. It is hard to wait for the market to move up over 30 points prior to buying but at least there would be a reason to buy and a risk management level to sell (recent low). At yesterdays close the Stochastics and RSI both indicated a strong re-emergence. The indicators are suggesting that the SPX still has more room to drop before the long is confirmed.

This is a weekly chart of the SPX and shows support from 2006 at 1219.29. A test of this level along with a close above the lower Bollinger band from the daily chart would provide a decent early entry of a partial position. Both weekly RSI and Slow Stochastics are oversold.

The open interest support levels are indicated in bight yellow. The 1250 strike price level is the peak put open interest at 24,080 contracts. 1250 is slightly above todays close (1244.69) but has been somewhat of a magnet for the SPX as indicated by the discussion on the 100% Fibonacci retracement level. The 1300 strike has the peak open interest at 77.266 open contracts. But 1275 comes in next as a peak in open interest. 1275 should continue to provide resistance as it has for the last few trading sessions. Todays high on the SPX was 1277.36.

The Nasdaq 100 (NDX)

The daily chart of the NDX above shows price support levels and moving averages. The NDX has been more range bound and less trend setting than the SPX. Nevertheless the NDX is still down over 14% year to date. The 1801 gap from April 15th has been the recent support level. However, the NDX has a gap down at 1751 that may need to be filled while we are so close. That requires a 70 point drop to fill which would cause more damage to the technical health of the NDX. There is resistance at the 89 day SMA (1888) and again at 1910 from the gap down on June 26th.

Looking at the chart above the NDX doesnt look that bad. RSI and Slow Stochastics are out of oversold territory and the lower Bollinger band is trying to stabilize. The recent low is our support level and if broken would put the 1751 gap as the downside short target. The 8 day EMA (pink line) has also flattened and therefore made the closing confirmation above it more achievable than that of the SPXs.

Looking at the weekly chart of the NDX the 1770 price level becomes even more of a target in that the 200 EMA closed there today. The volatility of the NDX is really represented in the chart above. It is still uptrending until the 50 week simple moving average (SMA) declines through the 89 week SMA. There is a coincidence level at 1910 from the gap down and the 89 week SMA (soon to include the 50 week EMA and SMA).

The NDX closed at 1819.18 today just below the 1825 put strike. Again the 1750 support level is represented by the 1750 put strikes peak open interest. The 1950 strike price suggests that there are a lot of calls sold at 1950 and therefore represent selling pressure. 1975 is the peak open interest at 13,001 contracts open. Signals on Index Put/Call ratios are generally higher than that of equity because of the tendency of institutional traders to trade them more often than amateurs. Therefore a 2:1 ratio generally signals a buy signal and 0.80 indicates a sell signal.

Upcoming Events

This week still has plenty of market moving data to come out of the government. Tomorrow morning the initial claims can either help or hurt any overnight strategies (like the TRIN trade). Michigan Sentiment and import/export trade data will be influencing market participants trading decisions.

The stocks above are the more widely held stocks that I thought you all would like to know are reporting over the next few days. Next week we will be in the middle of earnings season. That means I will show you some more examples of the short strangle and short iron condor volatility play I trade during earnings season. Just be patient for the long trade. Eventually the market will go back up. The question is from where. I am currently serving as portfolio manager for a branch of a major Registered Investment Advisory. The portfolios are basically balanced between Domestic and International equity and fixed income investments, real estate and commodities. I use non-correlating investments in assets traded through funds and ETFs. Anyway the point is that the advisers that I trade for are beginning to get nervous because their clients are scared that the end of the world is near. From my experience, most of the time when the adviser decides to throw in the towel and sell everything the end of the decline is near. They tend tell clients not to worry and to hold on tight because the investments are diversified and use strategic portfolio allocation. So when the market continues to fall and more people call they join the sentiment in a concerted effort to relate. Since the adviser was wrong the first time the clients called and the market drops another 10% then the adviser begins to believe the client is right and that they should sell everything. I heard the suggestion to sell everything at todays close. I didnt and wont. I will reposition into different vehicles that will advance faster than what I have now. Good luck and good trading.
 

New Plays

Most Recent Plays

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New Plays
Long Plays
Short Plays
None None

New Long Plays

None today.
 

New Short Plays

None today.
 

Play Updates

Updates On Latest Picks

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Long Play Updates

Rockwell Collins - COL - close: 51.00 chg: -0.27 stop: 49.25*new*

COL held up better than most during Wednesday's sell-off. The stock only lost 0.5% and kept the majority of Tuesday's gains. We do expect a dip back toward $50.00, which could be used as a new entry point. We are raising our stop loss to $49.25 since tomorrow is our last day. We plan to exit on Thursday at the closing bell. COL is due to report earnings on the morning of Friday, July 11th. We do not want to hold over the announcement.

Picked on July 07 at $49.25 *triggered
Change since picked: + 1.75
Earnings Date 07/11/08 (confirmed)
Average Daily Volume: 1.6 million

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DIAMONDS - DIA - close: 111.66 chg: -2.08 stop: 111.69

Yesterday we listed DIA as a new bullish play with a trigger to get long the ETF at $114.30. The intraday high today was only $114.20 so we're still sitting on the sidelines. Given the big reversal lower we're tempted to switch to a short position if DIA hits a new relative low around $111.00. If triggered at $114.30 our target is the $119.00 mark.

Picked on July xx at $xx.xx
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume: 15.7 million

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FLIR Sys. - FLIR - close: 42.88 change: +0.35 stop: 39.49

FLIR is still out performing the market but the rally in FLIR was fading this afternoon. We're not suggesting new positions at this time. Our target is the $44.95 mark. The P&F chart points to a $73 target. Please note that we're raising the stop loss to $39.49.

Picked on June 29 at $41.38
Change since picked: + 1.50
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume: 2.2 million

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Garmin - GRMN - close: 42.67 chg: -1.43 stop: 41.49

Ouch! The bullish "breakout" in GRMN yesterday has been reversed and the stock is back inside its multi-week trading range. Look for a bounce in the $42.00-41.75 zone or a new relative high as a potential entry point to buy the stock. More conservative traders may want to wait for a new rise over $45.15 before initiating positions. Our target is the $49.50 mark.

Picked on July 08 at $44.10
Change since picked: - 1.43
Earnings Date 07/30/08 (confirmed)
Average Daily Volume: 3.0 million

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Masimo Corp. - MASI - close: 35.77 chg: +1.37 stop: 32.95

MASI really out performed the market today. Shares rallied 3.9% and broke through resistance at the $35.00 level. Our suggested entry point to buy the stock was at $35.65 so the play is now open. We're a little skeptical of the rally since we can't find any news to account for the unexpected strength on such a down day in the markets. The P&F chart is already positive with a $56 target. As expected the move over $36.00 (today) produced a new P&F chart triple-top breakout buy signal. Our target is the $39.95 mark. More aggressive traders could aim for the highs near $42.00 but we do not want to hold over the late July earnings report.

Picked on July 09 at $35.65 *triggered
Change since picked: + 0.12
Earnings Date 07/28/08 (unconfirmed)
Average Daily Volume: 461 thousand

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Terra Inds. - TRA - close: 46.74 chg: +1.30 stop: 40.99

The agribusiness and fertilizer/potash stocks got a boost today following some bullish comments out of a Goldman Sachs analyst regarding the extremely strong fundamentals for the group. Shares of TRA added 2.8% but failed to close over its 10-dma. If we see another dip back toward $45 or $44 we'd use it as another entry point. We have two targets. Our first target is $49.75. Our second target is $54.00. We do not want to hold over the late July earnings report.

Picked on July 08 at $45.44
Change since picked: + 1.30
Earnings Date 07/24/08 (confirmed)
Average Daily Volume: 4.6 million

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Wyeth - WYE - close: 48.55 change: -0.93 stop: 46.39

WYE was a big winner yesterday and the stock managed to hit $49.80 this morning before succumbing to profit taking. Look for a dip back toward $48.00 as a new bullish entry point. Our target is the $52.50 mark. We do not want to hold over the late July earnings report. FYI: The P&F chart has a $61 target.

Picked on July 08 at $48.31 *triggered
Change since picked: + 0.24
Earnings Date 07/23/08 (unconfirmed)
Average Daily Volume: 8.7 million

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Olympic Steel - ZEUS - cls: 56.96 chg: +0.40 stop: 53.49

Warning! The trading in ZEUS today was bearish. The stock produced a failed rally near $60.00 and gave back almost all of its intraday gains. Wait for a new bounce near $55.00 before considering new bullish positions. More conservative traders, if you did open positions this morning, will want to consider an early exit now to cut your losses early. We're setting our target at $62.50.

Picked on July 08 at $56.56
Change since picked: + 0.40
Earnings Date 07/31/08 (unconfirmed)
Average Daily Volume: 319 thousand
 

Short Play Updates

None
 

Closed Long Plays

Trina Solar - TSL - close: 28.59 chg: -1.54 stop: 26.35

We are giving up on TSL. The stock has been trying to find a bottom the last few days but shares can't power through minor resistance at the 10-dma. Today's failed rally at the 10-dma also produced a bearish engulfing candlestick. We are suggesting an early exit here to cut our losses.

Picked on July 03 at $29.50 *gap open entry/exiting early
Change since picked: - 0.91
Earnings Date 08/21/08 (unconfirmed)
Average Daily Volume: 1.6 million

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Textron - TXT - close: 47.14 change: -1.73 stop: 46.89

A news article out this morning suggested that the U.S. Army might terminate its $6.2 billion Bell-Textron helicopter development program due to rising costs. Shares of TXT reacted with a gap down to $48.00 and a plunge to $46.70. The stock hit our stop loss at $46.89 closing the play. If TXT trades under $46.50 it may be time to consider new bearish positions.

Picked on July 03 at $47.84 /stopped out 46.89
Change since picked: - 0.70
Earnings Date 07/17/08 (confirmed)
Average Daily Volume: 2.1 million
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Robert Ogilvie and all other plays and content by the Option Investor staff.

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