Option Investor
Newsletter

Daily Newsletter, Thursday, 5/27/2010

Table of Contents

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

Market Wrap

China Comes Bearing Gifts

by Keene Little

Click here to email Keene Little
Market Stats

We have heard for quite a while now how important China is to the global economic picture. They've become a manufacturing powerhouse and we watch their financial policies as closely as we watch our own. So when China speaks, everyone listens (remember the E.F. Hutton commercial?). The Wednesday afternoon selloff was blamed in large part because of China, which had been rumored to be selling European bonds. Supposedly China is very concerned about being invested in the euro and wants to limit its exposure. At least Americans can feel that China wouldn't be just picking on the U.S. by selling its Treasuries out of fear about the stability of the U.S. dollar. Could it be that fiat currencies in general are turning to dust? Say it isn't so.

During the U.S. overnight session China said the rumors were untrue and that they were maintaining their current fiscal policy. China didn't quite say that they were not going to sell European bonds but only that they haven't changed their policy (which may include lightening their exposure to the euro). But it didn't matter--it was good enough to get the shorts to cover and bulls to do some buying on the "good news" from China. That news gave the European markets a huge lift, greater than +3% and that in turn shot U.S. futures higher. The S&P futures shot up +30 points off its overnight low.

The European markets have taken a beating recently so a relief rally was just waiting for any piece of good news. How long it will last is the bigger question. For the U.S. market there was only a little bit of follow through in the morning as the big gap up was followed by a stalled at market through the lunch hour. After lunch the market worked its way higher and SPX was able to tack on another 8 points to its morning high, making for a +35 day (+3.3%, matching Europe's gains).

This market has been very jumpy lately and big opening gaps, and reversals of reversals, are becoming the norm. If it weren't for overnight rallies in the futures the past year's rally would have been significantly smaller. The gaps of course make it very difficult to trade this market as well. Of the +35 points for SPX today, 20 of them happened overnight. The rest of the day kept both sides wondering whether we'd see another leg higher in the afternoon.

The euro also got a relief rally and that depressed the price of the U.S. dollar (which did not help the price of gold, probably because gold has been rallying more out of fear of what's happening in Europe and some of those fears subsided today). The sentiment towards the euro is bearish at the moment. Back in November 2009 the U.S. dollar was the hated currency. At that time the bullish sentiment for the euro had reached 93%. Today it stands at about 3%. The reversal in sentiment has been astounding and obviously ripe for another reversal. The price pattern calls for a little lower in the euro (I'll review the mirror picture for the dollar later) but it should now be getting close to a bigger bounce to correct the leg down from November.

So the stock market is looking for any excuse it can find to pump up the bullish sentiment which is quickly fading. The shorts, always nervous about something, are quick to cover and ask questions later. Bullish investors buy and hold and it's hard to shake them out of the trees. But bearish traders (there are very few bearish investors) are easily shaken out of the trees. I think the government really enjoys doing that--they're expert tree shakers. Today's news from China, like the news about Europe coming up with a trillion dollar bailout package, spiked a lot of shorts out of the market but as before, there may not be much follow through after the "good news".

Comparing today's market to Monday, May 10th (following the European bailout news), there are other similarities. The NYSE advance-decline line went through the roof this morning, peaking out near +2600 (and stayed there all day). The last time it was this high (a little higher) was on May 10th when it reached about 2900. Two days later the rally was finished. These spikes to the upside cause a lot of buying as the shorts cover but unless real buying comes in behind it the market has only an air pocket below it and it quickly gets filled. I strongly suspect the exact same thing will happen to today's big rally. The big question in my mind is whether or not we'll see two more days of rally before it falls back down.

The market (using the NYSE) has retraced about a third of its 2009-2010 rally and declined almost 17% (not quite into what's generally recognized as bear-market territory with a 20% decline). There are very few market analysts even entertaining the thought that the March 2009 lows could be tested, let alone broken. The way the wave pattern for the decline is developing I'm thinking not only will they be tested but they'll be broken and it could happen this year (before the fall). I could argue lots of fundamental reasons why the 2009-2010 rally was just a hope-filled rally (remember, hope is a 4-letter word in the stock market) with nothing supporting it except volumes of money from the Fed. The money had to go somewhere and what wasn't going to wasteful government spending headed for the financial markets. The big banks and their trading desks were recipients of a lot of cash infusion. And since the money wasn't going out to businesses we haven't seen much, if any, economic growth where it matters--putting people to work.

So with weak fundamentals and a bearish technical price pattern I have to lean towards what could be a difficult year for the stock market. If the rally has been based on hope and that hope is dashed, how quickly do you think people will run for the exits? We've already gotten a taste of that with the flash crash, strong down days and relatively weak up days. People are now primed for exiting quickly. With a plethora of shorting vehicles, including ones you can use in your retirement accounts (inverse ETFs), along with selling of long positions, it doesn't take a wild imagination to see the downside potential.

The wave pattern is developing a series of 1st and 2nd waves to the downside and the next major move should be strongly down as it "unwinds" the wave count and completes a couple of degrees of 3rd waves. That's a bunch of mumbo jumbo for look out below. I don't say that to scare anyone but only to inform you of the setup. Predicting crashes is usually a sure way of looking foolish but the setup at the moment is pointing in that direction. It doesn't mean it will happen but the risk is the highest it's been since the setup following the August 2008 high. Following that high was a crash leg lower into the October 2008 low.

There are no guarantees in life and certainly not in the stock market. So the only thing I can do is show setups and potential outcomes. Tonight I want to start with a weekly chart of the utility index. It's showing relative weakness as compared to the broader averages and that shouldn't be if the economy was improving. Improving businesses need more utilities and vice versa. So I've been watching its pattern for any telltale signs and we got one this week. The UTY index has developed a H&S topping pattern since its left shoulder was formed in July-October 2009. It made a new high in December 2009 but a lower high in May, which was a bearish non-confirmation of the new highs being made by the broader averages.

Utility index, UTY, Weekly chart

The neckline of the H&S top for UTY was broken this week on a closing basis and today's bounce took it right back up to it near 382.50 (it got a final push into the close to just above the neckline). It's also dealing with its downtrend line from January 2008. Any failure from here will be a bearish kiss goodbye at support-turned-resistance and it would confirm the break. The downside price objective out of the pattern is to about 329, which is near the March 2009 low near 305. To me this is a clear heads up (down?) that the market/economy is not healthy.

Seeing the right shoulder on the UTY weekly chart it has me wondering if we'll get a higher and longer-lasting bounce now to complete a right shoulder on SPX (and the other broader averages). I think it would be far too obvious to most of the world and therefore will not happen. In fact I'll bet there are a lot of bulls hoping for a right shoulder as an opportunity to exit their positions. If only the market were so accommodating. Bullishly I see a weekly hammer forming for this week at its 50-week moving average and long-term uptrend line from 1990-2002. So we might see some follow through to the upside next week. But as I see it, it's a big if at the moment.

S&P 500, SPX, Weekly chart

The current bearish wave count calls for a strong decline to start at any moment now. The market could press higher and SPX could even make it back up to the 1120-1130 area but when the bounce is finished we should see a strong decline into the early part of the summer.

SPX has bounced back up to its broken 200-dma near 1104. Needless to say, a drop back down from here would leave a bearish kiss goodbye at that important moving average. Slightly higher is the 20-ema, which did a good job supporting the bulls and may now do a good job supporting the bears, is a little higher near 1122. That level also coincides with the 62% retracement of the leg down from May 13th. The wave count is set up for a strong 3rd of a 3rd wave down, which if correct will mean a strong decline well below 950 support.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1145
- bearish below 1040

I've seen many reporting on an inverse H&S shoulder pattern that can be easily seen on the 60-min chart below. The bullish price objective out of it is to 1143. The chart is a little messy but there are a couple of things I want to point out. First is the 50% retracement of the leg down from May 13th, near 1107 (close to its 200-dma near 1104). Then there is gap close at the May 19th closing price of 1114.63. This coincides with the top of a parallel up-channel for this week's bounce. The top of the parallel channel crosses a downtrend line from April's high near 1124 Friday afternoon. Once this bounce finishes, which is a smaller degree 2nd wave correction of the move down from May 13th, we should see an acceleration of the selling into June. That's why I have MOAP above the current bounce--it's a setup for the Mother Of All Put opportunities.

S&P 500, SPX, 60-min chart

Zooming in closer to this week's price action, the 15-min chart below shows the parallel up-channel and a wave count that makes the most sense to me at the moment. It's called a double zigzag count (a-b-c-x-a-b-c) and equality within the count points to 1115.56-1118.40 for an upside target. It has already met the minimum requirement to be considered complete and therefore there is a risk of reversal at any time.

S&P 500, SPX, 15-min chart

It's that time of the month again, no not that. It's the lunar cycle and today (6:03 PM EST) we had a full moon. We rallied up into the full moon so could it signal a reversal? Only time will tell.

S&P 500, SPX, Daily chart with MPTS

The DOW has rallied back up to just shy of its broken 200-dma at 10278 (the high of the day was 10264). There are higher potential targets: to the 50% retracement of the 2007-2009 decline (10334) and its 20-ema at 10468. Looking at a similar pattern as SPX, shown on its 15-min chart, I get an upside target zone of 10357-10398 if it continues higher on Friday.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10675
- bearish below 9771

NDX came within about 10 points of closing its gap from May 20th at 1873.42. A little higher is its 20-ema near 1888. Otherwise it's in the same pattern as the blue chips (as are most indexes and sectors) and the risk is for a hard reversal back down at any time now.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 1935
- bearish below 1756

The RUT also came close to closing its May 20th gap at 674.79 (today's high was 670.51). Its 20-ema is also close, currently near 676. Same pattern, same setup.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 700
- bearish below 617

The RUT 60-min chart below shows a nice Fib confluence if it's able to rally up to 680. Two equal legs up from Tuesday's low is at 680.69 and a 62% retracement of the leg down from May 13th is at 680.70. If tested watch for resistance and an opportunity to pile on short. As noted on the chart (and again true across the board), if the wave count is correct and we're due a 3rd of a 3rd wave down then this is a MOAP (Mother Of All Put) opportunity. We haven't had this good a setup since August 2008, just before the crash leg down into October 2008. If you've never shorted the market before this is a good opportunity to try it--buy a couple of July puts, slightly OTM, on your favorite stock/sector/index and let's see if we can make some money.

Russell-2000, RUT, 60-min chart

The banking sector is also sporting the same pattern and XLF has bounced back up to its broken 200-dma. Its 20-ema, near 15, is diving down to meet it and then a little above that, near 15.30, is its downtrend line from April 29th. Lots of resistance above and lots of air below.

Financial sector SPDR, XLF, Daily chart

Our economy is reliant on consumer spending (I still don't understand the concept of spending our way to wealth) but the retail sector is looking just as weak as the rest of the market (this after testing its 2007 high, one of the few sectors to do so). If it can make it a little higher it will test both its 20-ema and broken uptrend line from March 2009, both near 99 (about a $1 higher).

Retail Holders, RTH, Daily chart

The Transports at least look marginally stronger in that the TRAN found its 200-dma to be support. But now it will have to deal with its 20-dma and downtrend line from May 4th, both near 4400 round-number resistance. A break below 4000 should usher in very strong selling.

Transportation Index, TRAN, Daily chart

The U.S. dollar has remained strong as concerns about Europe have driven traders to the relative safety of the dollar (I have to keep myself from laughing when I put the dollar and safety in the same sentence). Bullishly the dollar broke out the top of its parallel up-channel from November and is using it now as support. We should see another leg up to complete the 5th wave of its move up from November and then start a larger pullback to correct the November-June rally.

U.S dollar contract, DX, Daily chart

Even while the dollar has been rallying it has not stopped gold from rallying with it. Gold is the vehicle of choice when people get scared about currency problems and the worries over the euro have driven many traders into gold. Today the euro bounced a little and gold paused. I think gold's bounce could be nearing an end soon if not already. It has made it back up to the top of a parallel up-channel from February, which it broke out of in May and then collapsed back inside, and therefore it may be ready to turn back down. If it can push a little higher I see resistance around the December high near 1227. We should see gold sell off soon and drop well below 1000.

Gold continuous contract, GC, Daily chart

Zooming in closer to gold's bounce off the May 20th low, it has formed a nice parallel up-channel. The current wave count calls for one more leg up to the 1227-1230 area before heading lower again. But any break below 1205 would indicate we've probably seen the high for the bounce.

Gold continuous contract, GC, 60-min chart

While gold held up in the face of the dollar rallying, oil did not fare as well. It sold off sharply from its May 3rd high, broke its uptrend line from July 2009 and found support at its longer-term uptrend line from 1998-2002. It has bumped into its 20-ema and slightly higher it will meet resistance at its broken 200-dma and uptrend line from July, both near 76.70. Once this bounce is complete we should see oil join stocks in a selloff.

Oil continuous contract, CL, Daily chart

This morning's economic reports were ignored. Initial jobless claims climbed more than expected and GDP was revised down more than expected. Other than a brief spike down in the futures at 8:30, which was then lifted back up into the cash market open, there was little attention paid to these reports. The market has much bigger things to worry about, and get excited about. The whole rally for the past year has been built on hope and it's certainly not going to let any bad news ruin that hope (wink).

Friday morning we'll get some numbers on personal income and spending, Chicago PMI and Michigan Consumer Sentiment and if any of these drop more than expected we could get a little nasty reaction but again, the market seems more focused on overseas news right now.

Economic reports, summary and Key Trading Levels

I'll show a couple of more charts to scare you. Just kidding, well, not really. As you know, I like to look for fractal patterns and history really is one of our better guides as to where the market may be headed. Many of us have looked at the price pattern from the 1929 crash to see if there are any clues for what might happen now. Our environment is very similar (big credit bubble followed by debt destruction and depression). The chart of the 1929 crash, followed by the big bounce in 1930 and then the real decline into 1932 shows how simple trend line breaks could have helped traders stay on the right side of the market.

DOW daily chart, 1929-1932

What's amazing is that traders didn't use charts like this back then and yet you can see how a simple trend line break worked well for an exit signal (or shorting). As you can see, the real devastation came after the 1930 bounce. Now we look at our current market, which is a weekly chart instead of daily so that we can keep the time frame in perspective but see the similar pattern. This DOW chart is actually from two weeks ago and shows a closing price slightly above our current price.

DOW weekly chart, 2004-2010

We got the big move down from the 2007 high and the big bounce back up. The DOW has recently broken its uptrend line from March 2009. Notice too that the DOW failed at its 200-week moving average.

If I place one on top of the other it might be easier to compare the forms of the decline and bounce to see the fractal nature of the moves.

DOW charts, 1929-1932 and 2004-2010

So the question now is what will happen to the stock market if it follows the same path as it did from 1930-1932. I know most of us don't want to even entertain that possibility but what if? What if people back in 1930 had been given a heads up about what's coming? What if you could help your friends and family get out of the way of a devastating move in the stock market, one that will wipe out all retirement and investment accounts. What if it happens and you could have done something about it? I have no idea if we'll see something similar, but what if?

I can essentially summarize tonight's charts in one paragraph. I am seeing amazing similarity across the board in almost all sectors and indexes. Rarely do I see so many in synch like they are. My interpretation of this is bearish as I see the market getting in synch for a hard selloff. Once the current bounce is finished we should see a strong decline into June and then a stair-step pattern lower into July. It of course might not happen; we could rally to a new high instead. I was fooled in February and I could be fooled again. But what if I'm right and we get a move down that takes SPX down to 750 in July and the DOW down to 7500. Might you want to play it a little safe here and protect your investments? Moving to cash and even nibbling on the short side is a strong recommendation from me tonight. Batten down the hatches because the wave pattern says a bad storm is coming.

Good luck in the next week and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1145
- bearish below 1040

Key Levels for DOW:
- cautiously bullish above 10675
- bearish below 9771

Key Levels for NDX:
- cautiously bullish above 1935
- bearish below 1756

Key Levels for RUT:
- cautiously bullish above 700
- bearish below 617

Keene H. Little, CMT
Chartered Market Technician


New Plays

Long Play on a Shipper

by Scott Hawes

Click here to email Scott Hawes

Diana Shipping, Inc - DSX - close 13.99 change +0.66 stop 12.90

Company Description:
Diana Shipping Inc. is a holding company. The Company is a global provider of shipping transportation services. It specialize in transporting dry bulk cargoes, including such commodities as iron ore, coal, grain and other materials along worldwide shipping routes. As of December 31, 2009, its fleet consists of 22 dry bulk carriers, of which 14 are Panamax and eight are Capesize dry bulk carriers, having a combined carrying capacity of approximately 2.4 million dead weight tons (dwt). As of December 31, 2009, its fleet consisted of 13 modern Panamax dry bulk carriers and seven Capesize dry bulk carriers that had a combined carrying capacity of approximately 2.2 million dwt. Each of its vessels is owned through a separate wholly owned subsidiary. In January 2010, the Company established its wholly owned subsidiary Diana Containerships Inc. (DCI), with the purpose of acquiring containerships.

Target(s): 14.35, 14.75
Key Support/Resistance Areas: 15.00, 14.40, 14.15, 13.50, 13.30, 13.00
Time Frame: 1 to 2 weeks

Why We Like It:
DSX found long term support near the $12.35 area and has bounced nicely. The stock broke through its recent downtrend line and I am looking for it to retrace some of the recent gains prior to entering long positions. DSX has good fundamentals trading at a PE below 10 and has beaten earnings estimates in recent quarters. The stock has surged higher with the market this week but I don't suggest chasing it at these levels. I am looking for a pullback near $13.50 which I suggest readers use as a trigger to enter long positions. This would also be a logical area for the stock to make a higher low and then proceed higher. We are looking to make about a dollar in this trade. I have listed two targets at $14.35 and $14.75. We'll place a stop at $12.90.

Suggested Position: Long DSX stock if it trades down near $13.50

Option Traders:
Suggested Position: Buy July $12.50 CALL, current ask $2.00, estimated ask at entry $1.75

Annotated Chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.4 million
Listed on 5/27/10, 2010


In Play Updates and Reviews

RINO & PRGO Opened

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Console Energy - CNX - close 37.10 change +2.04 stop 34.50 *NEW*

Target(s): 37.50, 38.80, 40.75
Key Support Areas: 36.00, 34.90
Key Resistance Areas: 37.55
Current Gain/Loss: N/A
Time Frame: 1 to 2 weeks
New Positions: Waiting to be triggered

Comments:
CNX gapped open higher again today and has almost reached our first target of $37.50. I don't think it is prudent to chase the stock but I would like to adjust our entry up a bit to take advantage of a pullback. Let's use a trigger to enter if CNX trades down near $36.25 which is just above today's lows. I'm also going to tighten the stop to $34.50 to limit risk and I've listed a third target at $40.75. If CNX does not trade down to our trigger in the next couple of days I will most likely drop it from the portfolio. My comments remain the same from the play release. I believe the sell off in coal stocks was overdone and they appear to be building momentum for a move higher. CNX double bottomed with lows on Friday and Monday and has responded nicely. The stock also has longer term support dating back to resistance in late 2008 (see weekly chart). All of our targets are below the stock's 50-day SMA and also below the recent primary downtrend line. This is a countertrend trade that has potential but I also view it as aggressive and quick so please use small position size to manage risk.

Suggested Position: Long CNX stock if it trades down near $36.25

Option Traders:
Suggested Position: Buy July $35.00 CALL, current ask $4.10, estimated ask at entry $3.50

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 7.0 million
Listed on 5/25/10, 2010


Rino International - RINO - close 13.31 change +0.93 stop 11.70 *NEW*

Target(s): 14.50, 15.95, 16.90
Key Support/Resistance Areas: 14.50, 13.75, 13.30, 13.00, 12.75, 11.75
Current Gain/Loss: +4.80%
Time Frame: Several weeks
New Positions: Yes, if there is a pullback to support

Comments:
RINO gapped higher this morning but quickly pulled back to $12.68 which was very close to a key support/resistance area of $12.75 listed in the play release. This was enough for us to get long the stock. Traders can enter positions on pullbacks but I do not suggest chasing the stock, rather be patient and use the support areas above as a guide. I'll leave my comments from last night's play release. RINO has been taken out to the woodshed recently and I believe it is due for a turnaround. The stock appears to have found support in the $10.75 area which dates back to prior support in August 2009 and prior resistance in June of 2008. The stock bounced nicely off of this level and followed through nicely. In addition, the stock trades at a ridiculously low PE ratio of about 5. I think there is a lot of room to for this stock to run and I suggest readers take advantage of the building momentum. I think we can make $2 in this trade but there could be some volatility so please use proper position to manage risk.

Current Position: Long RINO stock at $12.70

Option Traders:
Suggested Position: July $12.50 CALL

Entry on May 27, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 926,000
Listed on 5/25/10, 2010


BEARISH Play Updates

Perrigo Company - PRGO - close 60.24 change +2.14 stop 61.75 *NEW*

Target(s): 59.00, 58.25, 57.25, 56.00, 54.30
Key Support Areas: 59.00, 58.00, 57.00, 56.00
Key Resistance Areas: 60.50, 61.50
Current Gain/Loss: -1.07% Time Frame: 1 to 2 weeks
Comments:
PRGO traded up to our trigger to enter short positions at $59.50. We currently have a small loss of -1.07%. Its amazing what a day can do to change sentiment in the market. As a result I am not as confident in this short position as I was yesterday so I am looking for quick exit, for either a small profit or small loss. In trading we must remain nimble and I believe it is prudent to make this trade a quick one. I would like to tighten the stop to $61.75 and I have listed several targets above which are great areas to tighten stops. Ironically, the support areas are near round numbers. If the market reverses lower from here which is a possibility I think PRGO could trade down to our original target at $54.30. However, I'm anticipating a higher low to be made in the market and I suggest buying short PRGO positions back an any weakness. I've also tightened the stop to preserve capital if PRGO doesn't turn down from here. Technically, PRGO is testing its 20-day SMA from below and it appears it wants to put in a lower high. If this in fact happens we will have a winner, but if it doesn't we need to step aside at our stop price of $61.75. There is also resistance at $60.50 and $61.50.

Current Position: Short PRGO stock at $59.60

Entry on May 27, 2010
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 1.3 million
Listed on May 22, 2010


CLOSED BEARISH PLAYS

Royal Caribbean - RCL - close 27.96 change +0.22 stop 28.45

Target(s): 27.80
Key Support Areas: 27.38, 25.00
Key Resistance Areas: 28.00, 28.85, 29.80
Final Gain/Loss: +1.22%
Time Frame: 1 or 2 days
New Positions: Closed

Comments:
RCL was actually closed on 4/26 as our stop at $18.45 was hit. I apologize for the error in not closing the play in yesterday's updates. I'll leave my comments from Tuesday: RCL traded down to its 200-day SMA and bounced nicely. Although the stock closed only -0.61% on the day, it closed +6.2% off of its lows. I'm sure short covering had something to do with this but how things can change so drastically in a matter of hours is beyond me, so we must deal with the circumstances. I suggest readers be cautious and prevent this trade from turning into a loser. My fear at this point is that RCL may rally all the way up to fill the gap down between 5/19 and 5/20. I suggest we place a tight stop at $28.45 and just get out of the way for a small profit if this is hit. I also want to list a lower target at $27.80 which is just above today's close.

Closed Position: Short RCL stock at $28.45, entry was at $28.80

Option Traders:
Suggested Position: Buy JUNE $28.00 PUT

Annotated Chart:

Entry on May 24
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 4.5 million
Listed on May 22, 2010