Option Investor

Daily Newsletter, Tuesday, 09/02/2008

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Table of Contents

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

Market Wrap

Bulls Couldn't Hold Back the Flood

Market Wrap

Jim is under the weather today and I'm filling in. While he has a virus attack on his body I had a virus attack on my computer and therefore I'm behind the power curve in trying to get a newsletter out tonight. I'll provide as complete a summary of today's activities and what the charts look like and then get into my more thorough market wrap on Thursday.

It wasn't just Hurricane Gustav that caused some flooding over the Mississippi levees. After the bulls flooded the market with buy orders the bears decided to cause a little flood of their own with some selling and soon the selling overflowed the buying. A nice +237-point rally in the DOW turned into a negative 30-point day. At this afternoon's low the DOW had a 311-point reversal off its high so the low-volume volatility of last week became a higher-volume volatile day today. It was not a high-volume day today but at nearly 8.2B shares trades it was certainly more than any day last week.

The complete reversal of this morning's rally was certainly discouraging for those who had done some early buying at this morning's open. When we see this kind of selling into rallies we know it's bearish for the market. Big money uses the rallies to offload some of their inventory and while we could certainly see additional rallies, including higher into opex week (which I'll show on the charts), stay aware that liquidation of inventory is probably the number one goal of many fund managers. If they can get higher prices to sell into it will be all the better.

The reversals of rallies, like today's, is a reason I've been cautioning that it's better to only trade the long side and not hold onto positions (if you want to trade the long side that is). As we head into the vulnerable period of the year--September through November--and especially with the continuing bad news in the credit markets there are a lot of nervous money managers who are hoping for rallies but more fearful of declines. The coming months have historically been unkind to bulls. Dodging the decline into the fall and loading up for a year-end rally can give one's portfolio a powerful boost.

The trouble of course with jumping out of the market in August is that it doesn't always play out with a decline into October. In fact the years between 2003 and 2007 saw either benign declines in September or downright bullish moves. Last year saw a strong rally off the August lows into the October highs. Of course 2003-2007 was a cyclical bull market. Unless you believe we're heading back into a bull market you agree we're in a bear market for at least a little longer period. And in bear markets the months of September and October have been particularly cruel to investors.

Expectations for a bearish September/October could of course be bullish. The market has a wicked sense of humor about such things as expectations. When too many expect something (and prepare for it with trading positions) we often see the boat flip over and watch everyone scramble to unwind their positions that are suddenly going against them.

So here we are in a recognized bear market and we've got many people suggesting we could see a nasty downturn (hence they're selling into rallies). But what if Ms. Market decides the timing is not quite right and wants to catch all those with September options positions leaning bearishly into options expiration (September 19th). It's possible we could see a rally instead into the middle of the month, catch the bears napping, bop them on the head, get the bulls all excited about the potential for another early and strong rally into October or into the end of the year, get them scrambling to join the buying since they'll feel they're late and then proceed to bop them on the head with a nasty reversal into strong selling. The potential for some violent price swings in the next month is significant.

Not only do I see the potential for the above scenario from a psychological perspective but I also see the potential in the EW (Elliott Wave) pattern, at least for the blue chips whereas the tech indexes actually look more bearish right here. I'll review the primary indexes that we track and then a couple of other charts to help us get an idea of where the market might head next, or at least what clues to watch for the broader market. I'll skip my normal sector charts tonight as I did not have the time to get them updated. I'll be sure to update them on Thursday night.

One of the other charts I'll review tonight is the 10-year yield as it's nearing a level of potential support so it might be a good time to lock in a rate on your home if you've been waiting to do so. However, just like the stock market I see a strong possibility that yields are going to drop hard. I'll give the key levels to watch.

Dow Industrials, INDU, Daily chart

I referred to a bullish sideways triangle pattern last Thursday and I'm still tracking that possibility. The pattern called for one more leg down inside the triangle and then a strong rally leg out of it, shown in dark red and Friday's and Monday's price action has the DOW working its way lower. The bottom of the triangle is near 11400 so that's the downside potential but the last leg in a triangle (wave e) is very unreliable--it can stop short of the bottom or do a throw-under (or throw-over in a bearish triangle pattern). If this is a bullish triangle the upside Fib projection out of it is very close to the 62% retracement of the May-July decline.

As long as 11125 is not violated I have to consider the bullish potential out of this pattern as a good possibility, especially with all the 3-wave price action going on inside the triangle pattern. But regardless how corrective the price action looks, a drop below the August low near 11290 would be a heads up that the triangle pattern will probably get negated.

Key Levels for DOW:
- cautiously bullish above 11718
- bearish below 11340, confirmed bearish below 11125

S&P 500, SPX, Daily chart

For SPX I'm showing the same bullish sideways triangle pattern, the bottom of which is near 1270 tomorrow morning (closer than the DOW's). If it breaks below 1269 tomorrow morning and doesn't immediately reverse higher (leaving a throw-under) it will be bearish. The next level to watch would be 1251 (two equal legs down from August 11th high, which will be support if we're going to get another rally leg into the middle of the month). But basically a break below 1261 would be the time to look to short all rallies unless the bulls can get it back above 1300.

Key Levels for SPX:
- cautiously bullish above 1300
- bearish below 1261

S&P 500, SPX, 120-min chart

The 120-min chart shows the triangle in more detail and the levels to watch. I've included a couple of other trend lines (dotted) since they're still having an influence on traders. For example, SPX bounced off its uptrend line from July 15th through the August 26th low but closed back below its downtrend line from May 19th.

Nasdaq-100, NDX, Daily chart

NDX (and the COMP) broke below its uptrend line from July 15th. Last week I had pointed out the break of the RSI uptrend line and then the retest of the line (which failed). RSI typically breaks its trend line before price and is always a very good heads up for a trend change. The retest was good confirmation that the bulls are losing it here. But so far the pullback for NDX from its August 11th high remains in a parallel down-channel and bounced off the bottom of it today after failing at the top of it this morning. The price action inside this down-channel can be interpreted as very bearish (a series of 3rd waves to the downside is about to unfold) or it's corrective within a bull flag. The bearish scenario requires a hard breakdown from here while the bullish (pink) scenario requires an immediate bounce back up. Therefore we could have an answer soon on Wednesday morning.

Key Levels for NDX:
- cautiously bullish above 1938
- bearish below 1800

Russell-2000, RUT, Daily chart

I could argue equally strongly for a bullish or a bearish resolution out of the current pattern. It takes a break below 716 to put the bears in control and in that case we should see strong selling.

Key Levels for RUT:
- cautiously bullish above 739
- bearish below 716

NYSE, NYA.X, Daily chart

I continue to watch the NYSE for a broader market picture and so far the bounce off the July low remains a bear flag. The only question is whether or not we'll see another bounce to the top of the flag near 8724 or a continuation lower right from here. A break below 8180 says the latter.

I also like to keep my eye on what bonds are doing since they often telegraph the direction of the market before equities. For a while we've seen yields and equities track together (e.g., selling in bonds drives yields higher which frees up cash which then heads into equities so equities rise with yields). This direct relationship (or inverse relationship between the prices of equities and bonds) will not always hold but for now it is and therefore worth watching. The 10-year yield dropped sharply today after a brief rally from the open (just as equities did) so I'm watching for where support might be found.

10-year Yield, TNX, Daily chart

The direction of interest rates for the past month has been a bit of a challenge (along with equities--the market is definitely confused at the moment). I've been eyeing a downside target of 3.619% for the 10-year and I think that's still a good target based on the pattern from the July high. That's the level where the decline in rates from June would have two equal legs down. Whether TNX gets down to that level, or stops there, we'll just have to wait and see. But a quick drop down to 3.6% and then reversal back up would mean a selloff in bond prices and that could mean a rally in equities into September opex.

If TNX drops much lower than 3.6% I suspect we'll see it drop to the March low just below 3.3%. That would also likely mean a selloff in equities. But a rally back above 4.0% would likely mean a rally to new highs above June's and that could be a bullish sign for stocks.


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Therefore, if you're watching rates in hopes of locking in a lower rate, keep an eye on the TNX chart if and when it reaches 3.6%. If it keeps dropping lower you could get a nice break on your loan as rates drop (unless the spreads continue to increase as they have been in which case all consumer and home loans will continue to get more expensive).

One other chart worth reviewing this evening is the volatility index. It has risen sharply the past two days and that could be a bearish sign for what's coming. Either that or too much fear is entering the market and there's lots of put buying going on. From a contrarian perspective we need to stay aware of the potential bullishness from that. Also, notice that VIX is nearing potential resistance (potentially bullish for stocks):

Volatility index, VIX, Daily chart

The uptrend line from December 2006 through the June 2007 low has seen VIX tagging it repeatedly since April as it breaks it, climbs back above it, breaks it, etc. Today's "rally" in VIX stopped dead at the trend line again, and it's just below the 50 and 200-dma's. If VIX reverses back down from here it will be accompanied by a stock market rally. That's the setup anyway. The bulls now need to take advantage of the setup.

Economic reports, summary and Key Trading Levels

Today's economic reports were blamed for the reversal of the early rally this morning but to me it looked like an early setup for a bull trap. Equity futures were jammed higher from a low near 4:00 AM, especially the DOW's futures, and it looked "fabricated". The lack of participation of the tech stocks had the market showing intermarket bearish divergence and the combination had me warning on this morning's live Market Monitor to not trust the move up. At any rate, the trap was set and the subsequent selling hurt a lot of early buyers. The economic reports had nothing to do with it.

Tomorrow should also be benign as far as economic reports go. We might see some action around the reports on Thursday and Friday. But ignore the news--news is for, well, not for chartists. We trade the charts and let the noisy news play out.

The market has been trading in a very choppy manner since the July lows and essentially sideways for the past six weeks. This log jam will soon break and it will be good for at least 700-800 points on the DOW (as much as 100 points for SPX) in a matter of a couple of weeks. If it ends up being a rally into September opex it will be a fantastic short play setup for a huge move down into November. If it ends up being a selloff right from here it will be a huge move down into November.

The only difference between those two scenarios is when the selling will begin in earnest and from what level. Be careful in positioning too early for the move--let the market tell us when it's ready for us to climb aboard the southbound train. In the meantime, if we start seeing some key levels to the upside break, join with the bulls but take profits often and early. Surprises will be to the downside. Keep repeating that to yourself and don't get complacent about any rally.

Good luck and I'll be back with you on Thursday.

Key Levels for SPX:
- cautiously bullish above 1300
- bearish below 1261

Key Levels for DOW:
- cautiously bullish above 11718
- bearish below 11340, confirmed bearish below 11125

Key Levels for NDX:
- cautiously bullish above 1938
- bearish below 1800

Key Levels for RUT:
- cautiously bullish above 739
- bearish below 716

Keene H. Little, CMT
Chartered Market Technician

New Plays

Most Recent Plays

Click here to email James
New Plays
Long Plays
Short Plays

New Long Plays

None today.

New Short Plays

Expedia - EXPE - close: 17.65 change: -0.01 stop: 18.35

Company Description:
Expedia, Inc. is the world's leading online travel company, empowering business and leisure travelers with the tools and information they need to easily research, plan, book and experience travel. (source: company press release or website)

Why We Like It:
Worries over a global slowdown appear to be impacting shares of EXPE. The stock is in a long-term down trend and recently broke down from a multi-week consolidation pattern. We are tempted to launch shorts right here but we're going to wait and suggest readers use a trigger to open bearish positions at $17.25. If triggered we have two targets. Our first target is $15.10. Our second target is $13.50. Be sure to take some money off the table at our first target since the $15.00 level might be round-number support. The Point & Figure chart is bearish and forecasts a $9.00 target. FYI: The latest data listed short interest at 5% of the 205 million-share float. That is just under three days worth of short interest.

Picked on September xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume: 4.2 million

Play Updates

Updates On Latest Picks

Click here to email James

Long Play Updates

Basic Energy Services - BAS - cls: 28.10 chg: -1.13 stop: 27.59

News that hurricane Gustav had weakened as it approached the coast and that the storm may not have done as much damage as previously expected sent oil and natural gas plunging lower. When the market opened this morning all the energy stocks either spiked or gapped lower. BAS was no exception except the selling stalled near support around $28.00-27.75 and its 100-dma and 50-dma. This support might hold or it might be a speed bump on the way down. At this point it looks like oil is headed lower and that should have more conservative traders looking for an early exit right here. We are not going to exit just yet but we're not suggesting new bullish positions either. Our target on BAS is $31.50. FYI: The most recent data listed short interest at 7% of the small 21.7 million-share float.

Picked on August 26 at $28.34
Change since picked: - 0.24
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume: 437 thousand


Kansas City South - KSU - close: 51.02 change: -0.41 stop: 49.95*new*

Railroad stocks rallied this morning with the rest of the market and then plunged with the rest of the market. Today's move in KSU is bearish but if we can find a silver lining it was bulls buying the dip near $50.50 this afternoon. We are raising our stop loss to $49.95. We would buy this dip. Our target is the $54.90-56.00 range. FYI: The P&F chart is still bearish from the August correction. Calendar note: KSU is due to present at an investor conference on September 4th.

Picked on August 28 at $51.41
Change since picked: - 0.39
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume: 1.4 million


Monster Worldwide - MNST - cls: 19.97 chg: +0.43 stop: 18.94

Believe it or not MNST continues to show relative strength. Traders bought the midday dip near $19.60 and MNST almost closed over round-number resistance at $20.00. We are not suggesting new positions. The technical picture is actually mixed and not much help at the moment. We do have two targets. Our first target is $20.80, just under the August resistance. Our second target is $21.75.

Picked on August 20 at $19.11
Change since picked: + 0.86
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume: 3.1 million

Short Play Updates

Genuine Parts - GPC - cls: 42.62 chg: +0.20 stop: 44.01

It was a volatile day in the markets and GPC was no exception. The stock gapped open higher with the market but the rally stalled at resistance near $44.00 and then reversed lower. This definitely looks like a bearish double-top pattern but readers may want to wait for a new decline under $42.00 before initiating new short positions. After the bell GPC announced it was buying Drago Supply Company but we didn't see any significant after hours reaction to the news. Our target is the $38.50 mark. More aggressive traders may want to aim lower. The P&F chart is bearish with a $28 target. We don't see any significant levels of short interest.

Picked on August 31 at $42.42
Change since picked: + 0.20
Earnings Date 10/17/08 (unconfirmed)
Average Daily Volume: 1.1 million


Kimberly-Clark - KMB - cls: 62.88 chg: +1.20 stop: 63.51

KMB rallied to technical resistance near its exponential 200-dma and its previous August peak and then ran out of gas. Aggressive traders might consider shorts here. We are sticking to our plan. We are suggesting a trigger to short KMB at $60.75. More conservative traders may want to use a stop loss above last Thursday's high of 62.84. If we are triggered at $60.75 our target is the $56.00 mark. We do not see any significant short interest. The Point & Figure chart is bearish with a $54 target.

Picked on August xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume: 2.6 million


Merck - MRK - close: 34.83 change: -0.84 stop: 36.85

Concerns that Vytorin might be linked to an increase in cancer was not good news for MRK. Shares dropped 2.3% and look poised to move lower. We don't see any changes from our weekend comments and could still consider new bearish positions here. We're suggesting a stop loss a $36.85. More aggressive traders may want to use a stop loss above the 100-dma near $37.00. Our target is the $32.00 level. More aggressive traders may want to aim for $30.00. The P&F chart is bearish and points to a $23 target. We don't see any significant amounts of short interest.

Picked on August 31 at $35.67
Change since picked: - 0.84
Earnings Date 10/22/08 (unconfirmed)
Average Daily Volume: 17.8 million


Rockwell Autom. - ROK - close: 47.14 chg: -0.07 stop: 50.05

ROK was unable to avoid the market volatility. Shares gapped open, spiked to $48.92 and then gave it all back. We don't see any changes from our weekend comments. However, more conservative traders may want to place their stop loss above today's high near $49.00. More conservative traders may want to wait for a breakdown under short-term support near $46.00 as a new entry point. If we don't see a break under $46.00 soon we'll abandon the play early. Our target is $43.00. More aggressive traders may want to aim lower ($41-40). The P&F chart is actually still bullish from the summer rebound. Short interest is at 2.2% of the float.

Picked on August 31 at $47.21
Change since picked: - 0.07
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume: 1.7 million

Closed Long Plays

AMR Corp. - AMR - close: 11.50 change: +1.17 stop: *see details*

We are giving up on AMR as a bullish play for now. It was our plan to buy a dip in AMR near $8.00 and then ride the bounce higher. If crude oil had risen more sharply ahead of hurricane Gustav last week we probably would have done okay. Of course Gustav could have strengthened and hit the oil facilities a lot harder over the weekend and then oil could have soared higher instead of cratered and that would have been bad news for the airlines. As it stands now oil is falling and the airlines are set to climb. Nimble traders might want to try catching a dip in the $10.75-10.50 zone as a possible bullish entry point. We are dropping AMR as a bullish candidate with the play unopened. FYI: Today's move looks like a breakout from a bull flag pattern.

Picked on August xx at $xx.xx *never opened
Change since picked: + 0.00
Earnings Date 10/15/2008 (unconfirmed)
Average Daily Volume: 24.6 million


CNX Gas - CXG - cls: 29.26 chg: -1.08 stop: 29.90

It was a rough day for energy stocks as crude oil and natural gas got hammered. Shares of CXG gapped open lower at $29.42. This was under our suggested stop loss at $29.90 so the play would have been closed at the open.

Picked on August 21 at $31.05 *stopped out/gap open lower 29.42
Change since picked: - 1.79
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume: 373 thousand


Hornbeck Offshore - HOS - cls: 38.79 change: -5.27 stop: 41.45

Ouch! Shares of HOS had been creeping higher last week ahead of hurricane Gustav. The company was expected to be a beneficiary as oil companies called on HOS to help rebuild from the damaging storm. Over the weekend we were led to believe that Gustav did not do as much damage as anticipated. Crude oil plunged on the news. HOS gapped open lower at $42.84 and then crashed to a new relative low losing almost 12% on the session. The stock hit our stop loss at $41.45. There are currently three more hurricanes currently headed our direction over the next couple of weeks so keep an eye on HOS.

Picked on August 26 at $43.10 /stopped out 41.45
Change since picked: - 4.31
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume: 815 thousand

Closed Short Plays

NYSE Euronext - NYX - cls: 40.40 chg: -0.19 stop: 41.51

The NYX ended the day in the red but that didn't help us. This morning's widespread market bounce fueled a pop in NYX. The stock opened at $41.39 and hit $42.30 before reversing. Our stop loss was at $41.51 so the play has been closed. The long-term trend in NYX is still bearish so we'd keep an eye on it.

Picked on August 25 at $39.41 /stopped out 41.511
Change since picked: + 0.99
Earnings Date 11/03/08 (unconfirmed)
Average Daily Volume: 5.0 million

Today's Newsletter Notes: Market Wrap by Keene H. Little and all other plays and content by the Option Investor staff.


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