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Daily Newsletter, Monday, 08/04/2008

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Table of Contents

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

Market Wrap

Market Wrap

Market Wrap

For those of you that pay attention to who is writing I want to let you know that you didnt enter a time warp and miss Tuesday and Wednesday. Jeff Bailey and I have swapped Market Wrap days due to ongoing scheduling conflicts. The equity markets were down most of the day but got a little pop after noon when crude dropped to its lows. Actually the Dow Jones was the only index that went positive for more than 5 minutes. Both the NASDAQ 100 and Russell 2000 opened weaker and stayed that way throughout the day. The crude affect isnt causing the market to advance on declining oil prices. Last Thursday I mentioned that the inverse affect may be over since last Wednesdays advance and Thursdays decline in the equity markets and the crude oil contract. My read on this movement is that the energy complex has become such a major component within the market averages that declines in the prices of energy and material stocks are pulling the equity markets down further. Not to mention the impending financial sector turmoil. Tomorrow should stay fairly constant until about 2:15PM when the Federal Reserve Board of Governors report their economic bias. It is widely assumed that there will be no change in the Fed Funds or Discount interest rates at tomorrows meeting. However, the Fed may choose to input some confusing statement which may affect the markets direction for the remainder of the day.

As for today the market fell on concerns regarding financials and the June Personal Income and Spending report that showed higher than expected inflation. Personal Income rose 0.1% versus the prior 1.8% increase. The market was expecting a -0.2% decline in Personal Income. Personal spending increased 0.6% versus the 0.4% consensus estimate and last months 0.8% reading. The consumer is spending with money they dont have. Reduction in income growth can signal a recession.

On the New York Stock Exchange (NYSE) there were 2 to 1 losers. More specifically there were 2101 declining issues and 1048 advancing issues on 1,526 million shares traded, which is below the 50 day average of 1,596 million shares. The NYSE fell 1.32% to 8268.65 and the S&P500 (SPX) fell 0.90% to 1249.01. There were 22 new 52-week highs and 100 new 52-week lows. The NASDAQ Composite fell 1.1% on 1,954 million shares, which is less than the 50 day average 2,197 million shares. There were 28 new highs and 110 new lows today. Finally, 965 issues advanced against 1909 decliners. In summary a fairly negative day occurred. The only bright side is that todays declines occurred on less than average volume.

Crude Trading

Oil was trading fairly flat in early trading today. All of a sudden at about 11:25 am the market dropped over 4 points to a low of $119.50 a barrel. There was no real news that triggered the sudden sell off. However the rumor is that a hedge fund had to take off their long positions. Something like that would cause the market to drop that fast.

I have been reading about how many of the hedge funds that posted stellar returns in 2007 have barely made any profits this year so far. Those that are about breakeven have done so by reportedly selling short financials and going long energy and agricultural commodities. With capital further tightening up hedge funds may be in a crunch to raise capital for distributions or post gains on something that worked. That would explain the sharp declines we are seeing in the commodity markets.

Lets review my assessment from last week. I said it looked like crude oil could increase to its 21 day moving average (green line) and then possibly the 133 area for a 50 percent retracement of the July 11th high to Wednesdays low. The 50 day moving average (blue line) also served as resistance if the crude contract had broken above the 21 day moving average. Therefore I was somewhat wrong about a breakout up to resistance but kind of right on the fact that crude really needed to break above the 21 day EMA. The 8 day EMA (pink line) continues to decline quickly and widening the spread between it and the 21 day EMA. Bollinger bands are beginning to contract after two weeks of expansion. The lower band is at 113.

Coincidentally the 127.2% Fibonacci retracement is also at 113. However, the 120 area has served as good support and must be broken significantly for oil to reach down another 8 points. By the time oil dips down to 113 (if it does this time) the 200 day moving average should also be near 113 and serve as support. Both RSI and Stochastics have turned over and have room to decline until becoming oversold. My call is down oil. What does this do for the equity markets? It could continue to pull the markets down further for a few days until the consumer related sectors can find support and strength on their own to pull the markets back up. The majority of investors and the financial advisors I talk to think that down oil equates to an up market. As a contrarian I might take the opposite stance because down oil is due to decreased oil demand and which might mean that decreased demand to go shopping.

The Markets

Per usual we are going to review the S&P 500 first and then cover the NASDAQ 100. Because the Consumer Discretionary and Staple sectors were among the only standouts today we will look those charts to see where there is support and resistance. The S&P 500 has declined three days in a row since last Wednesday while the Money Flow has continued to advance higher (see chart).

Todays low on the S&P 500 (SPX) of 1247 came close to the 50% retracement level of the July low to high range. As the chart above shows the low was from an intraday dip to 1200.44 while the high occurred six days later and 90.73 points higher. The past three day decline is the second sell off to occur since the low on July 15th. So far the lows are higher and the highs are relatively the same. Therefore we are potentially looking at an advancing wedge forming. But a break below last weeks low and the 61.8% retracement level (1235) may put the SPX down to the previous low.

The Lower Bollinger band in the above chart is beginning to curl downward. This indicates an increase in volatility and might provide greater downside range for the SPX to achieve. The Stochastics have confirmed their intention to revisit oversold territory. It was assumed that the 8 day EMA would be crossing above the 21 day EMA within a day or so when I last wrote about the SPX. It goes to show us all that technical analysis primarily represents visual representations of supply and demands (a.k.a. price) tendencies to repeat historical patterns. Charting is important to determine price points to enter and exit as well as confirmation for maintaining or reducing existing positions. If you bought last Wednesday according to the uptrend and potential breakout technical analysis you might set a stop loss at the break of the uptrend line (the black line). Therefore that position would have been stopped out today. Even thought both RSI and Stochastics are heading south the market could go up tomorrow and pull those indicators upward. You would want to set a reason to cover a short position. Technical levels and indicators are really reasons to make a trade. If your reason to short is that the SPXs 8 day EMX failed to break above the 21 day EMA then a reason to cover that short would be if the SPX bounced back and closed above the 21 day EMA.

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A long time ago I was introduced to tracking the support and resistance levels of an index or equity by looking at the peak open interest levels. Peaks in put option open interest indicate support while peaks in call option open interest indicate resistance levels. The assumption is that the majority of the open interest is from short options and the institutions that placed these short bets dont want them assigned. Therefore those that have the big bucks will sell short the market in attempt to keep the short calls from being assigned and buy the market in attempt to keep the short puts from being assigned. I realize that not all of the volume is from selling to open. When I was trading the market neutral allocation for the hedge fund I would try to sell the premium at or slightly below the peaks in open interest to increase the probabilities of profiting the maximum.

The SPX closed at 1249 today which is slightly below the peak put open interest at the 1250 Put Strike. There are 132,770 options open there. There is support at 1225 and 1200 as referenced by the yellow highlight. The peak call option open interest is at the 1300 strike price. The resistance seen at 1290 has proven that price resistance and open interest resistance is at work. There are currently 1.5 puts open to each call open. The market is usually oversold at ratios near 2 puts to 1 call.

The NASDAQ 100 (NDX) continues to trade within the range between 1752 and 1875. Money flow continues to reach higher even though the market maintains stuck trading within 125 points. Last Thursday the NDX ran up to the 50 day EMA and closed lower on the day. That is a negative signal and was confirmed with Fridays and todays sell off. There is still major resistance at 1875 from price and the 50 day EMA. After that the 50 day SMA and the 89 day SMA will be heavy resistance to break. There will have to something good out of technology stocks to push the market up through these levels. Since CSCO is one of the only major stocks yet to report we may need to wait another two and a half months for the good news.

The chart below shows the NDX with Bollinger bands, RSI and Stochastics. In addition I have drawn the trend lines that defined the previous upward pennant. Notice that the lower line (uptrend line) was broken today. In my opinion, the break of this support is negative and may put the NDX down to the 1752 support. My lower Bollinger band is currently serving as support but appears to be turning downward. RSI and Stochastics are also heading sharply lower and have room to travel until becoming oversold. The 8 day EMA failed to close above the 21 day EMA on the NDXs last thrust upward. Having a positive bias on the contrarian signals is tough when the markets arent behaving.

The open interest support from the puts is at the 1800 strike. The peak support level is at 1600 with 14,472 options open. The NDX closed at 1804.84 which using simple math is 204 points above the major support and 4.84 above the minor support level. The peak open interest is on the 2025 calls with 10,919 contracts. But the next resistance level in play is at 1900 with 6,240 contracts open.

Sector Rotation

As you can see Healthcare, Consumer Staples and Discretionary and Technology were the only sectors in the S&P that advanced. The energy and materials sectors were the main culprit for todays decline.

The SPDR Consumer Staples ETF (XLP) bounced nicely from the March lows and appears to be basing above the 50 day SMA (blue line). The 200 day SMA is the main resistance. Most likely the consumer stocks will move inversely to oil for a while. Strength in oil means weakness in the consumers.

The SPDR Consumer Discretionary ETF (XLY) only traded up 0.21 today. Discretionary stocks have less of a tendency to bounce at the first sign of reduced energy costs. Lets get real, oil is down from major extreme highs and is still too high for the economy to grow. Even at $110 a barrel the oil service stocks are vastly profitable. At $110 a barrel gas is still over $3.50 a gallon and will continue to reduce demand for shoppers to drive around to cruise the stores.

The SPDR Healthcare ETF (XLV) has remained within a very tight range over the last six months. At the beginning of the year healthcare was a dog versus energy and technology. The only negative is that the money flow on the XLV has peaked at 80 twice in the last few weeks. The last time the Money Flow reached this level the XLV declined from 32 to about 30.

I believe I counted about 300 companies reporting earnings tomorrow. The above list represents the companies that I follow and assumed most people do as well. Sorry if your company isnt on the list. Consumer discretionary related stocks that can move the markets include: EAT, WFMI, WEN, BID, RUTH, TAP, MGM and NILE. PG is one of the main staple stocks. UPL, VMC, PXD, HRS and DUK are some energy stocks that can move the respective sectors.

Tomorrow morning the ISM services for July will be released. The market expects a slight increase from last month to 48.7. As mentioned earlier the FOMC policy statement is released. At the close of this months expiration I plan on attempting to create and manage a market neutral position that follows the contrarian newsletter. So look for that. I will most likely run the trade as a Double Diagonal or a Short Iron Condor. Have a good day.
 

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

Cal-Maine Foods - CALM - close: 39.19 change: +0.21 stop: 37.95

Watch out! We may have just walked into a trap. For the second day in a row shares of CALM traded above resistance near $40.00 and today the stock hit a new all-time high. Unfortunately, shares gave back almost all of their gains. This sort of failed rally pattern is dangerous! The new relative high could have sparked a massive short squeeze but it failed to materialize. We are not suggesting new bullish positions until CALM trades above $41.00. More conservative traders may want to raise their stops. Our first target is $44.90. Our second target is $49.00. The P&F chart is bullish with a $56 target. CALM has HUGE short interest. The most recent data listed short interest at almost 92% of the 14.2 million-share float. A new high could spark another short squeeze.

Picked on August 04 at $40.75 *triggered
Change since picked: - 1.56
Earnings Date 07/28/08 (confirmed)
Average Daily Volume: 1.0 million
 

Short Play Updates

Broadcom - BRCM - close: 24.24 change: +0.25 stop: 25.55

Shares of BRCM managed to bounce after announcing a $1 billion stock buy back program. Yet the rally couldn't get past resistance near $25.00. We remain bearish. More conservative traders may want to tighten their stops. The last few days has seen BRCM consolidate sideways in what looks like a bear-flag pattern. More conservative traders may also want to consider waiting for a decline under $23.00 before initiating positions. A move under $23 should be a break down from the flag pattern. The Point & Figure chart is bearish with a $16 target. We have two targets. Our first target is $20.50. Our second target is $17.50. Expect the $20.00 zone to offer some round-number, psychological support.

Picked on August 03 at $23.99
Change since picked: + 0.25
Earnings Date 07/22/08 (confirmed)
Average Daily Volume: 15.5 million

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Capital Trust - CT - close: 14.38 change: -2.35 stop: 16.90*new*

Darn it! We thought CT was going to roll over but we were looking for a bounce first to open up new short positions. Our suggested entry point was $17.85. The stock never made it that high. Shares hit $16.88 and then plunged more than 14% to a new low. We are going to jump on the bandwagon here but we're adjusting the stop loss to $16.90, just above today's high. We have two targets. Target one is $12.55. Target two is $10.25. The Point & Figure chart is bearish with an $8.00 target.

Picked on August 04 at $14.38
Change since picked: + 0.00
Earnings Date 07/29/08 (confirmed)
Average Daily Volume: 278 thousand

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Nordstrom - JWN - close: 28.19 chg: -0.73 stop: 30.51

JWN continues to look weak. We would consider new shorts right here. More cautious traders may want to wait for a drop under $28.00 to initiate positions. Don't forget that we do have some risk of a short squeeze. The latest data put short interest at 17% of JWN's 160-million share float. That's close to five days worth of short interest. Our short-term target is the $25.05 mark. More aggressive traders may want to aim lower. We do not want to hold over the mid August earnings report. FYI: We're adjusting our stop loss to $30.51.

Picked on July 27 at $28.94
Change since picked: - 0.75
Earnings Date 08/14/08 (confirmed)
Average Daily Volume: 5.4 million
 

Closed Long Plays

Buckle Inc. - BKE - close: 48.22 change: -2.20 stop: 48.90

We didn't like how BKE performed on Friday so we raised our stop loss over the weekend. Shares of BKE under performed the market again on Monday with a sharp sell-off Monday morning. The midday bounce began to roll over and it looks like it's setting up for another decline tomorrow. BKE hit our new stop loss at $48.90 closing the play.

Picked on July 22 at $51.69 /stopped out 48.90
Change since picked: - 3.47
Earnings Date 08/21/08 (unconfirmed)
Average Daily Volume: 456 thousand

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iShares China 25 index - FXI - cls: 44.17 chg: -1.21 stop: 44.99

The FXI continues to weaken so we're dropping it as a bullish candidate. We had been waiting for a breakout over its trendline of lower highs but that may take longer than previously thought. Under $44.00 readers might want to consider bearish strategies. Expect support near $40.00. Our suggested trigger to buy the FXI was $47.65, which has not been hit.

Picked on July xx at $xx.xx *never opened
Change since picked: + 0.00
Earnings Date 00/00/00
Average Daily Volume: 19.9 million

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Masimo Corp. - MASI - close: 37.24 change: -0.56 stop: 36.75

It was our plan to exit today at the closing bell to avoid the risk of holding over MASI's earnings report, which was due out tonight. The company's results beat estimates by 5 cents and management actually guided higher. This sent the stock shooting past the $40.00 mark in after hours trading. Don't feel bad. The company could have missed and shares could have dropped to under $35 in after hours.

Picked on July 27 at $37.57 /exit early ahead of earnings
Change since picked: - 0.33
Earnings Date 08/04/08 (confirmed)
Average Daily Volume: 622 thousand

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Terra Industries - TRA - cls: 45.94 chg: -7.97 stop: 49.95

It was an extremely painful day for the agriculture names. The combination of a widespread sell-off in agriculture commodities and a sharp down turn in natural gas and oil was a powerful one-two punch for the fertilizer stocks. Many of the fertilizer equities were down double-digits and TRA lost 14.7%, crashing through round-number support near $50.00. The stock hit our stop loss at $49.95. TRA had previous hit our early target at $56.00.

Picked on July 28 at $51.30 /stopped out 49.95
Change since picked: - 5.36
Earnings Date 07/24/08 (confirmed)
Average Daily Volume: 4.8 million

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United States Nat.Gas - UNG - cls: 40.53 chg: -3.28 stop: 40.99

A sharp, midday sell-off in oil pushed an already weak natural gas ETF toward the $40 zone. The UNG hit our stop loss at $40.99. If you were watching this happen on TV today we were told that floor traders were confused by the sudden weakness in oil and gas. We warned readers that this was an aggressive, higher-risk trade and that proved to be right.

Picked on July 30 at $43.39 /stopped out 40.99
Change since picked: - 2.86
Earnings Date 00/00/00
Average Daily Volume: 2.9 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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