Option Investor

Daily Newsletter, Monday, 11/10/2008

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Table of Contents

  1. Market Wrap
  2. In Play Updates and Reviews

Market Wrap

A Busy Company News Day Provides Volatility

[Image 1]

The markets gapped higher on news that China would provide a fiscal stimulus package worth $586 billion or 18% of their GDP and that AIG’s government bailout being restructured. However, stocks fell today as concerns regarding the automakers and financial companies overshadowed the positives from China. There is a two year term to the Chinese fiscal package that will target various industries including housing, infrastructure and health care. The new government deal for AIG is that the aid will expand to $150 billion from $123 billion and better loan terms. The changes are meant to give AIG more time to sell assets after losing $24.5 billion in the third quarter. In addition, the revised deal stands to reassure investors that the insurance giant will be able to satisfy its counter party obligations. AIG closed up $0.17 to 2.28.

Another positive story came from McDonalds (MCD) gaining ground from their relatively low price food offerings. MCD said October same store sales increased by 5.4% and global same store sales rose by 8.2%. The US counted for 35% of McDonald’s 2007 revenue. MCD closed up $1.01 to $56.48.

While it wasn’t exactly positive, UPS and FedEx (FDX) gained on news that they will have less competition in the U.S. from DHL U.S. Express starting early next year. DHL said it will discontinue domestic-only air and ground services to only focus on international offerings. DHL is owned by Germany-based Deutsche Post World Net and will cut 9,500 more U.S. jobs, on top of the 5,400 jobs it has already eliminated.

On the negative side, which seems to get a lot more attention, was that Merrill Lynch decided to close its stand alone proprietary trading business. Merrill Lynch dropped 1.24 to $15.51. Goldman Sach’s (GS) had its fourth quarter earnings estimates cut to a loss of $2.50/share from a profit of $2.71/share by Barclays on concerns from dramatic equity market declines. GS dropped $6.57 to 71.21.

General Motors (GM) tumbled to its lowest level in six decades after Deutshe Bank downgraded it to Sell from Hold. In addition, Deutche Bank cut GM’s price target to $0 from $4 stating that GM may not be able to fund its U.S. operations beyond December without government intervention. Ford (F) dropped $0.09 to $1.93.


The NYSE declined 69.93 points to 5,802 on 4.663 billion total shares today. There were 1,155 advances (32%) and 2,372 decliners (66%) as well as 4 new 52-Week Highs and 192 new 52-Week Lows. The NASDAQ Composite (COMP) fell 30.66 to 1,616.74 on 1.7 billion shares. There were 8 new 52-Week Highs and 219 new 52-Week Lows. The COMP had 857 Advancers (29%) and 1,985 Decliners (67%).


There were no economic reports released today and there won’t be any tomorrow due to the Veterans Day. There was talk that the bond market might close tomorrow but the stock markets will be open. This week is a slow economics week because there isn’t anything released until Thursday. The markets are watching the employment reports very carefully for any sign of stabilization. If things go as they have been, the Fed may have to reduce another quarter point. The Michigan Sentiment is expected to decline a little from the last report. However, last week’s Consumer Sentiment numbers came in well below the expectations at 37.

[Image 2] The Index Report

As always, we will begin the review with the S&P 500 (SPX). I prefer to analyze the charts on a daily time frame to see the broader picture and then focus in by using the 2 minute charts. Last week I wrote that the SPX had failed to break and close above the 21 day Exponential Moving Average (EMA). However, the SPX trusted upward Tuesday following the Fed’s latest move to improve the countries situation. There is a trade scenario that I have to try that says to fade the reaction move of the markets following a Fed decision. In this case, sell the market at the close. Had it dropped the trade would be to buy the market. As a trader, you should have a number of trade setups in your arsenal to take advantage of consistent market tendencies. But don’t have too many strategies that your funds and attention are diluted and you can’t keep track of what is what. My advice here is to list the strategies and create a menu of sorts. At the beginning of each day, go through your menu to determine what strategy might be available that day and visit the existing strategies to review profit targets and risk management. [Image 3]

As the above chart shows, the SPX dropped below the 21 day EMA on Wednesday and then the 8 day EMA on Thursday. Both the RSI and Slow Stochastics were near overbought territory as of Tuesday’s close. While the RSI hasn’t dip down to oversold territory yet, the Stochastics closed below 20 on Friday and closed up at 24 today. RSI dipping downward while the Stochastics is bouncing upward shows some divergence in the oscillators. The Bollinger bands have narrowed quite a bit from just a few weeks ago. The current spread on my 21 day EMA Bollinger Bands is at 154 points and narrowing. Once the narrowing stops and begins to increase, there is another strategy that suggests trading in the direction of the momentum. With the 8 day still below the 21 day EMA, the trend is still down. The trend signal was close to reversing last Tuesday, but the quick reversal stopped that technical signal from occurring. Our first level of resistance is at 936 (8 day EMA), followed by 952 (today’s high) and then at 958 (21 day EMA). Support is from Thursday’s low at 899.73. There is a low grade uptrend line from the 10/10 low to the 10/28 low that is currently around 880. With so much anticipation for a bounce into the end of the year, I suspect that the smart money may stop that from happening. We’ll have to see.

[Image 4]

The ADX in the above chart is suggesting that the previous trend has all but subsided. If the indicator begins to advance, a new trend may be emerging. Also suggesting the decline is over, for now, is the MoneyFlowIndex. A break above 60 would help confirm this assessment. Finally, there is some resistance just above 1000 and then the rapidly dropping 50 day moving average (currently at 1070). As the chart shows, the 68.2% Fibonacci has provided the recent support for today’s bounce from the lows. The SPX had a volatile day again traveling from a high of 951.95 to a low of 907.47 and finally ending the day at 919.21. That is a 44 point range. While pretty wide, it is actually less than the Implied Volatility or $VIX has priced in; which closed up 3.88 today at 59.98.

The NASDAQ 100 or NDX showed some relative weakness today. For instance, the NDX dropped 20.62 points to 1251. The NDX chart below is very reminiscent of the SPX daily chart. Both indices 8 and 21 day EMAs are in a decline. The slope isn’t very steep which signals that the momentum downward is slowing. The near term support on the NDX is at 1235 while the resistance is at the 8 day EMA (1284) and the 21 day EMA (1314). One difference from the NDX and the SPX is that the Slow Stochastics failed to break above or re-emerge from oversold territory. This may end up indicating that there is still more weakness to come for the technology sector. The Bollinger bands are pinching together as each day’s range subsides closer to normality. I believe it will be a while until Volatility is back to normal. So we have to get used to trading within these extremes. Where a $VXN (NASDAQ 100’s CBOE Volatility Index) would have peaked around 40 – 45, that is now the bottom range of volatility in which to sell the market. As with most trades, this may work until the break down. Be careful to not over think the trade. Set stops and stick to them. If you short the NDX on the $VXN’s next test of its low, make sure a stop is in place in case the $VXN dips and closes below support.

[Image 5]

The Russell 2000 (RUT) chart is shown below. The main difference in the daily pattern is that the RUT closed lower than Thursday’s low. The RUT opened strong today and moved higher intraday above the 8 day EMA (508). However, the weakness in the smallcap sector over concern for these companies inability to raise operating capital or even revisit previously established credit lines. In my opinion, the broader markets need to see support from the small caps before any sustained move upward can exist. While the Slow Stochastics ticked up a little, it failed to break out of oversold territory (20). The current view of the market is that it may sell off again before Thanksgiving and then run up into the end of the year as all of the money sidelined comes back in to play. However, anything can happen overnight to cause the current picture to change.

[Image 6]

Crude oil has been quite volatile over the last few trading sessions. However, for once the charts of the commodity as well as the United States Oil Fund (Symbol: USO) have been showing some signs of support. I mention the USO because it is tradable as a long/short stock play as well as an option play that most accounts should be able to trade. It tracks the commodity closer than the Proshare Ultra Long and Short ETFs, DIG and DUG, respectively. For instance, if you believe that oil will move higher from the low 60’s, then you may want to buy the USO, Buy USO calls or Sell USO puts. With 11 days until expiration, the USO November 45 puts are trading at $1.00 to $1.10. That is some interesting premium. You could be bold and sell the 51 strike for about $3.20/contract. Selling puts, by the way, is an option contract that obligates the seller to purchase the shares of the underlying security at the strike price on or before expiration.

[Image 7]

In Play Updates and Reviews

Semis sink, meanwhile two new plays are triggered

Play Editor's Note: I would be cautious here. A large number of stocks and indices produced bearish engulfing candlesticks after Friday's inside day. The afternoon bounce was encouraging but overall Monday has painted a bearish shadow on the week.

BULLISH Play Updates

Ameron Intl. Corp. - AMN - close: 48.55 change: +0.38 stop: 44.45

Action in AMN mirrored the market. The stock gapped higher, faded lower throughout most of the day and eventually bounced in the last hour. Fortunately for AMN the stock displayed some relative strength and closed with a gain. While we don't see any changes from our previous comments it might pay off to wait and watch for a dip into the $46.00-45.00 zone as a new entry point before initiating positions.

We are setting two targets. Our first target is $54.50. Our second target is $57.50. The stock has an extremely small float and while short interest isn't too big at 5% of the float it could be a catalyst if bears decide to cover.

Picked on November 09 at $48.17 
Change since picked:     + 0.38   			
Earnings Date          01/26/09 (unconfirmed)    
Average Daily Volume:       176 thousand   

Anadarko Petroleum - APC - close: 38.15 change: +1.82 stop: 33.99

We were expecting APC to move higher but we were not expecting the stock to gap open at $38.36. Our suggested entry point to buy APC was at $37.25. The play would have opened first thing this morning.

Driving oil stocks higher was a very volatile day in crude oil, which also gapped higher, dipped to a new low and then bounced back again. The Chinese stimulus news drove oil higher on thoughts Chinese might see an increase in demand. That eventually faded.

Overall APC displayed a lot of relative strength. The intraday dip found support at $36.85, very near the prior resistance and what should now be support at $37.00.

We would consider new bullish positions here but you may want to tighten your stop loss. Our stop is at 33.99 for now.

We have two targets. Our first target is $39.95. Our second target is $42.50 or the simple 50-dma, whichever one the stock hits first.

FYI: Monday's move over $37.00 produced a brand new Point & Figure chart buy signal with a $54.00 target.


Picked on November 10 at $38.36 *triggered/gap higher entry
Change since picked:     - 0.21   			
Earnings Date          11/03/08 (confirmed)    
Average Daily Volume:      10.7 million     

Chesapeake Energy - CHK - close: 23.67 change: +0.28 stop: 21.75

CHK continues to see a bullish pattern of higher lows. Traders bought the dip twice today albeit on low volume. We don't see any changes from our weekend comments.

Our target is $27.75. More aggressive traders may want to aim for $30.00 or its 50-dma. Traders should take note of the trendline of resistance currently near the simple 40-dma. You may want to tighten up your stop loss as CHK nears that trendline.

Picked on November 09 at $23.39 
Change since picked:     + 0.28   			
Earnings Date          10/30/08 (confirmed)    
Average Daily Volume:      36.5 million     

FMC Corp. - FMC - close: 44.02 change: -0.13 stop: 40.85

FMC held up reasonably well after the morning gap higher faded away. Our concern today is the new lower high. If we redraw the trendline and ignore the September 19th spike then FMC just produced a failed rally at resistance, which is bearish. Traders may want to tighten their stop loss significantly. If you are looking for a new entry point then wait for a dip to and bounce from the $42.50 region.

Our target is $48.85. More aggressive traders may want to aim higher but the $50.00 mark and its 50-dma could be tough resistance to break. FYI: The Point & Figure chart is bullish with a $90 target.


Picked on November 09 at $44.15 
Change since picked:     - 0.13   			
Earnings Date          10/28/08 (confirmed)    
Average Daily Volume:       1.8 million     

Corning Inc. - GLW - close: 9.95 change: -0.46 stop: 9.75

In "Monty Python and the Holy Grail" there is a scene where the knights all cry out, "Run away!" That's what today's action in GLW is screaming, "run away!" The stock gapped higher and then crashed back to earth painting yet another bearish engulfing candlestick pattern. The stock came close but did not break support at $9.80.

More conservative traders, if you opened positions today, may very well want to run away and cut their losses. We are going to hold on and see if support will stick. If GLW breaks down under $9.80 then readers might do well to consider bearish strategies and target the $8.00 or $6.00 levels.

I would wait for a new move over $10.25 before considering new bullish positions. Our first target is $11.70. We'll set a secondary, more aggressive target at $13.00 but the $12.00 region could be rough level for the stock to break.

Picked on November 09 at $10.41 
Change since picked:     - 0.46   			
Earnings Date          10/29/08 (confirmed)    
Average Daily Volume:      23.7 million     

Perdigao S.A. - PDA - close: 33.31 change: -0.99 stop: 29.49

Our plan was to buy a dip in PDA in the $32.00-30.00 zone and shares complied. The stock slipped to $31.50 before paring its losses. More conservative traders may want to inch up their stops closer to the $30.00 level. We don't see any further changes from our weekend comments.

Our first target is $36.00. Our second target s $39.50. We'll need to keep an eye on the 50-dma, which may be overhead resistance. FYI: The Point & Figure chart is bullish with a $54 target.


Picked on November 10 at $32.00 *triggered on the dip
Change since picked:     + 1.31   			
Earnings Date          10/28/08 (unconfirmed)    
Average Daily Volume:       245 thousand    


Lam-Research - LRCX - close: 19.94 change: -1.10 stop: 19.95

The SOX semiconductor index continued to sink to new two-week lows and LRCX followed suit. The stock fell through what should have been round-number, psychological support at $20.00 and hit our stop loss at $19.95. At this point readers will want to watch for failed rallies as potential bearish entries with a target of the October lows.


Picked on November 06 at $22.00 *triggered     	
Change since picked:     - 2.06	  
Earnings Date          10/22/08 (confirmed)
Average Daily Volume:       4.0 million   


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