The stock markets began the week in a sour tone with the S&P 500 dropping 25 points to 1,266 and the NASDAQ Composite dropping 49 points to 2,365. Volume was very light on the New York Stock Exchange today with only 865 million shares traded. That is far less than the 50 day moving average of 1,328 million shares traded each day. The internals were weak on this late Summer Monday. There were 12 new 52-Week Highs and 101 new 52-Week Lows. Decliners outpaced advancers over 3 to 1 with 2418 versus 700, respectively.
As mentioned in last Mondays commentary, when the $TRIN closes above 2.0 the probability for a morning bounce increases significantly. The best way to trade the TRIN is to be prepared about 5 15 minutes prior to the close and place either a short put spread (bullish) on the S&P 500 (SPX) or S&P 100 (OEX) options or buy long the S&P eMini futures. With the options there is no way to have over night risk management on the options themselves but a trader with a futures trading account could have a stop order set to sell short the appropriate number of contracts that represent the cumulative Delta of the short put spread. For instance, you placed a short put spread on the OEX September 570/560 Put Spread for a net credit of $2.25 per contract and an 11 contracts. The position has a delta of 100.22 which suggests that the position will lose $100.22 per point decline in the OEX. Therefore, we can sell short 2 contracts of the S&P 500 eMini futures (the futures have a delta of 50 or a change in value of $50 per point in the S&P futures) to hedge the position if the futures drop below our overnight risk management level. So either way the TRIN long position can be hedged and have risk management. Our upside target is either closing the position at the open or at an 8 point profit target with a 4 point stop. By the way, last weeks TRIN trade did get stopped out.
Onto the NASDAQ internals, todays advance/decline had almost 4 losers to 1 gainer. The actual numbers are as follows: Advancing Issues = 632, Declining Issues = 2,228. There were 39 new highs versus 104 new lows on a very low volume day. Todays volume clocked in at 1,455 million shares versus the 50 day moving average of 2.08 million shares.
While I am on the internals I am going to cover the Open Interest readings as of today. The SPX closed at 1266.87 or about 17 points above the peak open interest (291,406 contracts open) strike price of 1250 on the September puts. The peak open interest on the calls is at the 1300 strike price with 218,628 open. The peak levels on the calls represent resistance while the peak levels on the puts show support.
As in most downtrends there are significantly more puts open than calls. This is because portfolio managers often purchase S&P 500 puts to hedge their portfolios. They do this according to their overall correlation to the S&P 500. For instance, if your diversified stock portfolio is $1,000,000 with a Beta of 1.30 then you would need to buy enough puts to hedge a $1,300,000 ($1 million X 1.30 Beta) portfolio. Hopefully those of you reading this realize that most option contracts represents 100 shares of stock or 100 times the value of the index. Therefore, the notional value of the S&P 500 at 1266.84 equals $126,684 per contract. A quick lesson in Deltas is necessary to figure the next part out. Delta is a theoretical value assigned to an option that represents the options potential change in price relative to a one point change in the underlying securitys price. For instance, assume we join the crowd and buy the 1250 September Put options for $19 per contract. Each contract has a Delta of negative 0.38 or profits $38 per contract for each point the SPX declines. By dividing the Beta adjusted portfolio value ($1,300,000) by the S&P 500 notional value ($126,684) we get a portfolio multiple of 10.26 or the Beta adjusted portfolios value per S&P 500 contract. To determine the number of contracts to buy to fully hedge the portfolio, we take the portfolios multiple and divide it by the Delta (0.38) to get 27 contracts. Therefore, we would buy 27 contracts of the 1250 puts to fully hedge the portfolio. In more stable markets we might see the S&P Open Interest Put/Call ratio to be skewed toward 1.0 suggesting that there are fewer put buyers protecting their portfolios and more call buyers adding positive deltas to increase their portfolios Alpha.
The NASDAQs open interest shows that there is support at 1850 as provided by the peak open interest of 12,211 contracts open. In addition, the absolute peak open interest is at the 1700 strike level with 17,725 options open. There is resistance at 1950 and again at 2100. But the 1950 strike price has the highest peak open interest with 17.960 opens contracts.
Today in Review
I believe that the market started off in a sour note this morning partly due to American International Group (AIG) having their third quarter earnings estimate cut to a loss of $0.86 per share by Credit Suisse. Fitch Ratings placed the insurance companys credit ratings on a negative watch. AIG dropped to its lowest level in thirteen years today and closed down $1.09 to $18.78.
The Financial Sector dropped about 3% today on the AIG news as well as news that South Korean regulators told the Korean Development Bank to be cautious about taking over any overseas banks. The Korean Development Bank expressed interest in Lehman Bros (LEH) last week. Shares of LEH dropped $0.96 to $13.45.
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The only three companies that posted a gain in the financial sector were Freddie
Mac (FRE), Fannie Mae (FNM) and MBIA (MBI). The $2 billion debt offering by
Freddie Mac was well received by investors. Fannie and MBIA apparently rose in
sympathy as there was no news surrounding the stock.
Tomorrows Reasons for Moving
Most of the stocks reporting earnings tomorrow are international stocks that I dont trade. Frankly, I dont many of the stocks reporting tomorrow. I used to trade Chicos FAS (CHS), Corinthian Colleges (COCO) and LTX Corporation (LTXX) many moons ago. There are a few consumer discretionary stocks reporting tomorrow including AEO, BIG, BGO, CHS and JCG. Consumer Staple stocks include SFD and SAFM.
The S&P 500 (SPX)
Today the SPX closed down more than 25 points at 1266.84 on light volume. The lighter trade suggests that the day was not a distribution day. Another reason for the light volume was that many traders are taking their vacation the week before Labor Day.
In this weeks newsletter, I am using a different background color and layout for the charts. The chart shows three moving averages, the 50, 89 and 200 day Simple Moving Averages (SMA). The longer term moving averages aid in determining the overall trend of the underlying security. The SPX is obviously in a long term downtrend as indicated by all three moving average intervals. As the chart above shows the market appears to have peaked short term at 1313.15 on August 11th. I have drawn a Fibonacci retracement from the July low to the peak. The SPX has been maintaining just above the 50% retracement level as it tries to break above the 50 day SMA, currently at 1278.82 (green line). If the SPX breaks below Last Wednesdays low of 1261 then the 50% retracement is the target line. But we need to see a breach of that level (currently at 1256) and a hold of the 61.8% Fibonacci level before taking a long position. A breach of the 50% level could be traded with a partial position with the 61.8% level, less a couple ticks, the stop loss. There are a number of ways to trade the SPX which include SPX options, futures, the S&P SPDR (SPY) and the Ultra Long Proshares (SSO). The next price level support after 1261 is at 1247 which is the August 4th low. Money Flow remains steady in the 50s but took a dip lower on todays decline in the market. The Money Flow Index shows that if the market begins to decline that there is still a lot of room for the indicator to fall before suggesting a selling stampede.
As of the close the 8 day Exponential Moving Average (EMA) closed just above the 21 day EMA. A breach of the 21 day EMA by the 8 day EMA would therefore suggests a negative bias. As a trader, when this bias shifts to negative short trades should be placed on the initial breach as well as when the price tests the 8 day EMA. For instance, a short trade on the SPX would be entered at the closing confirmation of the moving average cross over. Then a buy stop would need to be placed at a break of the recent high or some other parameter that meets your risk appetite. The Bollinger bands are squeezing together which is a reflection of the recent bit of lower volatility. The low Bollinger band is providing support at 1249 while the upper Bollinger band has the resistance at 1307. Slow Stochastics ticked down but hasnt confirmed a sell signal. That will occur once the Stochastics line closes below the moving average (green line). RSI is falling fast bust has support at 34. A break below that will suggest further weakness in the SPX.
The Russell 2000 (RUT)
I want to look at a different market this week. The RUT has held up stronger than the Dow Jones Industrial, S&P 500 (SPX) and the NASDAQ (NDX). As the charts below show the RUT did dip down quit a bit in March and July but have had phenomenal relative strength versus the SPX and Dow.
The RUT has posted a higher low and higher high since the July 15th low, barely. Stochastics appear different on the RUT chart when compared to the SPXs. For instance, the RUT is still on a long confirmed because the Stochastics line is above 20 after re-emerging from below 20 and the Stochastics line is also above the moving average. However, RSI isnt confirming the long as of todays close. The Lower Bollinger band is indicating the uptrend and is providing support at 700. There is also support neat 700 from the early August lows. We need to watch the 8 day EMA as it is approaching the 21 day EMA. A cross would suggest weakness in the small caps.
The RUT came down just below the 200 day SMA (719.99) intra day but closed just above it at 720.54. In addition, the 38.2% Fibonacci retracement at $719.88 provided support today. A break of the 200 day SMA and the 38.2% level would suggest the 50% retracement level and coincidentally the 50 day SMA as the next support level. Even though the RUT is showing decent relative strength it remains in a slight downtrend overall.
The Healthcare sector has been the darling of the Select SPDRs so far this year. However, the XLV closed below the 21 day EMA which suggests rotation into another sector may be occurring.
The Consumer Staples SPDR (XLP) is the only sector represented in the Select
Spiders that is still above its 50 and 200 day SMA. One could buy the XLP on
dips and sell short the weaker Sectors like financials (XLF) and materials (XLB)
on spikes. Trade the trends direction. If the trend is down as indicated by the
50 or 200 day SMA sell the sector short on overbought signals. Cover the
position at a risk level that you are comfortable with. For instance, if the ETF
closes above the
21 day EMA or the 8 day EMA closes above the 21 day EMA.
Another method may resemble a Turtle by placing a stop at the break above the 20
day high. Another stop may be relative to volatility of the security. For
instance, on a short trade, one could set a stop at a break of 150% of the 20
day ATR on an up bar. Theses are just some examples. Good trading!
New Long Plays
UltraShort Midcap - MZZ - close: 57.94 chg: +1.94 stop: 55.65
Why We Like It:
FYI: This might be considered an aggressive play since the MZZ is going to be twice as volatile as the Midcap index.
Picked on August xx at $xx.xx <-- see TRIGGER
New Short Plays
NYSE Euronext - NYX - cls: 39.41 chg: -1.73 stop: 41.51
Why We Like It:
Picked on August 25 at $39.41
Financial Sector SPDR - XLF - cls: 20.01 chg: -0.73 stop: 20.75
Why We Like It:
Picked on August xx at $xx.xx <-- see TRIGGER
Long Play Updates
Alon USA Energy - ALJ - cls: 11.27 chg: +0.38 stop: 9.95 *new*
ALJ continues to show relative strength. The stock leapt higher after testing the $10.50 level intraday. Over the weekend we suggested readers look for a dip near $10.50 as a new entry point. ALJ closed up almost 3.5% on a down day in the market, which is impressive. We are adjusting our stop loss to $9.95. Our target is the 100-dma or $12.50, whichever ALJ hits first. FYI: The Point & Figure chart is bullish with a $17 target.
Picked on August 22 at $10.75
AMR Corp. - AMR - close: 10.52 change: +0.84 stop: *see details*
Right now there are a lot of analysts expecting crude oil to dip back toward $110 and probably $100 a barrel before moving higher, especially after Friday's big bearish reversal. If oil does move lower it would be bullish for the airlines. Yet if I were just looking at a chart of AMR I would expect AMR to move lower. The stock produced a failed rally at its 10-dma today, which looks like an entry point for shorts. We are not suggesting shorts at this time because of the short-term pressure on oil. Right now our play is to buy a dip in AMR in the $8.15-8.00 zone. The $8.00 region is both price support and technical support with its converging 50 and 100-dma. If triggered at $8.15 we'll use a stop loss at $7.55. We're setting several targets. Our first target will be $9.90. Our second target will be $11.90. Our third target will be $14.90. We have also listed an alternative strategy for risk-averse traders. You can lower your risk with a collar on AMR. When you buy the stock sell an out of the money call option (per 100 shares of AMR that you own) and use this money from the call option to help pay for a put option to protect you should AMR suddenly plunge lower. It's not a perfect strategy. You limit your upside and will not see all the targets we listed but you also limit your downside, which may help some readers sleep better at night. Of course if you're having trouble sleeping over your trades you should focus more on money and position-size management.
Picked on August xx at $xx.xx <-- see TRIGGER
CNX Gas - CXG - cls: 30.32 chg: -0.14 stop: 29.35
In spite of the broad-based market weakness shares of CXG managed to hold its Friday's lows around $29.80. This move looks like a new bullish entry point or readers can wait for a bounce from here (over $30.50 or over $30.80). More conservative traders may want to use a tighter stop closer to Friday's low (29.83). Our target is the $34.00-35.00 zone.
Picked on August 21 at $31.05 *triggered
Exterran Holdings - EXH - close: 46.97 change: -0.53 stop: 48.75
If EXH doesn't bounce tomorrow we're going to drop it as a bullish candidate. Right now our strategy calls for readers to wait for a breakout over $50.00. Our suggested entry point is $50.25. More nimble traders could try buying a bounce over $47.50 with a very tight stop loss! If triggered at $50.25 our target is the $54.00-55.00 zone. More aggressive traders may want to aim higher. There isn't any clear resistance until the $60 region. FYI: The latest data listed short interest at 8% of the 33 million-share float.
Picked on August xx at $xx.xx <-- see TRIGGER
Petrohawk Energy - HK - close: 33.84 chg: +0.41 stop: 29.90
HK continues to show relative strength. The stock looks poised to move higher if the market is willing to cooperate. More conservative traders may want to raise their stop to breakeven or higher. We have two targets. Our first target is $34.85. Our second target is $38.50.
Picked on August 20 at $30.55 *triggered
Monster Worldwide - MNST - cls: 19.04 chg: -0.47 stop: 18.45
Some of MNST's short-term technical oscillators are suggesting the next move will be lower. Considering the market's behavior today more conservative traders may want to abandon ship right now and just exit early. We would expect a dip to the $18.75-18.65 level. We are not suggesting new positions at this time but if you are feeling adventurous look for a bounce near $18.70 or a dip near $18.70 and then buy the bounce back above $19.00-19.25. Our short-term target is the $21.75 mark.
Picked on August 20 at $19.11
Titanium Metals - TIE - cls: 12.92 change: +0.73 stop: 11.49
It was an interesting day for TIE. The stock was steadily falling during the first half of the session. Selling seemed to pause near $11.60 midday. Then suddenly, without warning, the stock just explodes higher and volume floods into the stock. TIE closed up almost 6% on strong volume more than double its normal trading. We are aiming for $14.50 but more conservative traders may want to exit at the descending 100-dma.
Picked on August 21 at $12.47
Short Play Updates
Bank of America - BAC - cls: 28.96 change: -1.25 stop: 31.05*new*
Financials stocks were leading the market lower on Monday. BAC gave up about 4%. There is still technical support near its 50-dma but today's move looks like another entry point for shorts. We are dropping our stop loss to $31.05. Our target is $25.25. We're going to set a secondary target of $22.50 but strongly suggest readers take some money off the table at our first target.
Picked on August 18 at $29.30
Cinci. Fincl. Corp. - CINF - cls: 27.64 change: -0.56 stop: 28.05
We don't see any changes from our weekend comments on CINF. Aggressive traders could short it now with a stop above Friday's high. We are currently waiting for a breakdown under $27.00 with a trigger for shorts at $26.85. Nimble traders might want to consider shorts on a failed rally near the top of the trading range around $29.00. If triggered we have two targets. Our first target is $25.05. Our second target is $23.00.
Picked on August xx at $xx.xx <-- see TRIGGER
Capital Trust - CT - close: 12.03 change: -0.96 stop: 14.01 *new*
It was another painful session for CT shareholders. Bears, on the other hand, had a great day. CT lost more than 7.3% and closed near its lows for the session. We're inching down our stop loss to $14.01. If you have not taken any money off the table yet we would strongly suggest you do so now. The stock has already exceeded our $12.55 target. We are adjusting our secondary target from $10.25 to $10.75. Volume on today's sell-off was approaching three times the normal flow, which is very bearish. This remains an aggressive play because the stock is so volatile. The most recent data listed short interest at almost 28% of the small 19 million-share float. That definitely raises our risk for a short squeeze.
Picked on August 04 at $14.38 /1st target hit $12.55
Merrill Lynch - MER - close: 24.20 change: -1.02 stop: 27.25
Broker-dealer stocks followed the rest of the financials lower. The XBD index lost 2.9%. MER gave up 4% and closed near its lows for the session. News that the S. Korean government warned Korean banks against making any acquisitions in overseas financials put the kibosh on last week's talk of a LEH buyout from a state-run Korean bank. More conservative traders may want to use a tighter stop. Our first target is $22.50. Our second target is $20.25. The Point & Figure chart is bearish with a $7.00 target.
Picked on August 07 at $26.10
Closed Long Plays
Carpenter Tech. - CRS - cls: 37.86 chg: -1.29 stop: 37.95
It was a negative day for CRS. This morning the company announced it was raising its litigation reserve from $5 million to $21 million as the company plans ahead for a potential loss in court. The decision followed a court ruling over CRS' alleged disposal of waste in Bucks County, PA back in 1973 and 1974. We are dropping CRS as a bullish candidate because shares broke down from their $38-40 trading range. We had been waiting for a bullish breakout over $40.00 with a trigger at $40.25. A trigger CRS failed to hit. More aggressive traders may want to consider bearish positions now.
Picked on August xx at $xx.xx *never opened
Closed Short Plays
Today's Newsletter Notes: Market Wrap by Robert Ogilvie and all other plays and content by the Option Investor staff.
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