Option Investor

Daily Newsletter, Thursday, 4/22/2010

Table of Contents

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

Market Wrap

The Market Wedges Higher

by Keene Little

Click here to email Keene Little
Market Stats

The market did its usual--it gapped down which provided another buying opportunity for the dipsters. This week has seen a lot of buying power going into recovering from an intraday selloff. The daily candles point to topping action and the waning momentum is more evidence that the buying is going into holding the market up, and even providing new highs for the techs and small caps, but it's clearly running low on fuel. We could be close to hearing the music stop so be sure you're eyeing the chair you want.

The news from overseas about Greece (again) knocked the wind out of the sails of the futures and the market started in the hole. But by the end of the day, with the market closing near its highs, the headlines were able to add another winning day for the DOW, up a whopping 9 points. And that was after recovering from a triple-digit loss. The result this week is a pattern we've seen at previous highs for the year-long rally--a consolidation that looks bullish but then fails suddenly. We wait for evidence of which way it will go this time.

It's very common for a rising wedge pattern to form at market tops. There's usually a battle going on between the bulls and bears as they each argue their case as to why the market is overvalued or undervalued and why it should rally or why it should decline. The bulls tend to win the arguments in a bull market but they start to lose steam and each high is a little lower even while higher lows are being made. The result is a rising wedge. Along with the pattern you look for negative divergences with lower highs in the oscillators such as RSI and MACD. When the patterns appear it's important to watch for other clues about the market topping.

A very good example of a rising wedge can be seen in the bounce off the initial decline off the March 2000 high. As with most triangle pattern you will see a 5-wave move (not the same as an impulsive 5-wave advance or decline but still the same number of waves). In the rising wedge pattern shown below, the wave labels are for a corrective count, which is what the bounce was, but you can count the moves from top to bottom of the wedge and see that it was a 5-wave move. The high in early September was followed by a swift decline that completely and quickly retraced the rising wedge. It's one of the reasons why they make for good trading patterns and why I like to look for entries at the top of the wedge.

S&P 500, SPX, Daily chart in 2000

The pattern for the rising wedge for the 2009-2010 rally is slightly different but still essentially the same. We're currently into the 5th wave of the triangle pattern and therefore I'm looking for an end to it. For the past two weeks SPX has been pressing against the top of the wedge and therefore the risk for longs is that it could start to break down quickly at any time. Within the rising wedge I'm showing some Fib relationships between the moves--near 1158 and 1223. A rise up to 1223 (are we close enough for government work?) or 1224, the 200-week moving average or 1229, the 62% retracement, would have me on high alert for a reversal. Actually I'm already on high alert for one.

S&P 500, SPX, Weekly chart

If the rising wedge is the correct interpretation of the pattern then you can see why I believe the entire rally will be retraced and will be done so relatively quickly, certainly is less than a year's time. There are certain cycles and other factors lining up this summer-fall that could see the market below the March 2009 low before October. Needless to say, it would be a great trade even if it would be devastating to our economy (actually the economy is already devastated; most traders just don't seem to be aware of it). The devastation would be to the highly leveraged banks (again).

So take a look at that rising wedge pattern on the weekly chart above and notice the one from February on the daily chart below--the daily one looks like a small fractal of the larger one. Notice that the rising wedge on the daily chart is also into the 5th wave of it when price poked above both where the tops of both wedges where they crossed last week. That was followed by a swift decline on Friday (on Goldman's news but that was just a catalyst). The market has been saved (again) this week but can it hold up much longer in the face of waning momentum? If yes then we could see SPX get its ticket punched at the higher target area around 1225-1230. But it doesn't have to get there since all the requirements have been met to call a top at this point. It's a big reason I'm suggesting longs exit the market now and not worry about another 1/2 or 1% move to the upside. Start putting some money to work on the short side.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish up to 1225-1230
- bearish below 1183

The 120-min chart below shows a possible sideways triangle pattern playing out since last Thursday's high, which if correct calls for another leg down (notice also a 5-wave move inside the triangle pattern in that case) to about 1193-1194 and then a thrust higher into next week that tags the 1225-1230 area. Sideways triangle patterns lead to the last thrust of the move, up in this case so it would be a good ending.

S&P 500, SPX, 120-min chart

If it's not a sideways triangle playing out then it's a more immediately bearish wave count that calls for a strong move lower on Friday, one that easily and quickly breaks below 1183 and probably doesn't stop until 1150 where it would consolidate before heading lower again. So 1183 is the key level for the bears to break but below 1190 would be a bearish heads up.

To show you that this market is wedging up on multiple time frames, which could be uber bearish, even today's rally has formed a rising wedge pattern. It too has a 5-wave count where each of the 5 waves has touched the boundary of the rising wedge pattern. That means the high at today's close should be the last and if the rising wedge pattern is correct it will be quickly retraced (so back below 1194). Then we'll get to see if the sideways triangle on the 120-min chart above will be in play or not.

S&P 500, SPX, 5-min chart

While SPX has a little room to run to the upside to tag its 200-week moving average, the DOW has been banging its head on its 200-wma at 11134, which is where it closed today. Like SPX it has been wedging up inside two rising wedge patterns but leaves the door open for a little higher into next week where it would tag its 62% retracement at 11246. But that hanging man doji today looks a little bearish...

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11250
- bearish below 10977

Keeping our eye on the big picture with the techs, the Nasdaq has made it up to its 78.6% retracement of the 2007-2009 decline, at 2519.97. Slightly higher it would close its June 6, 2009 gap and test its May and June highs near 2550. It has now poked out the top of its rising wedge pattern and weekly RSI is more overbought than it's been since December 1999, more than 10 year. And that's at the culmination of a rally that remains below the 2007 high. That's a lot of energy for essentially a retest of the previous high.

Nasdaq Composite, COMPQ, Weekly chart

Key Levels for COMPQ:
- cautiously bullish to 2520-2550
- bearish below 2451

A look at the RUT shows more nested rising wedges. Today's rally took the RUT right up to the top of both wedges and just shy of a Fib projection for it’s A-B-C move up from November where the c-wave = 162% of the a-wave, at 735.56. As with the other indexes it can always push higher but the negative divergence at this week's high suggests caution at the very least.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish up to 735-750
- bearish below 702

As a poster child for the bulls, AAPL has had a heckuva run up from February, from about 190 to 266 (+40%). When gravity takes back over and AAPL falls from its tree it could be a signal for the rest of the market as well. AAPL made a new high today above its post-earnings spike high and in so doing has done a nice job completing a 5-wave move up from Monday. That makes it ready for at least a pullback correction. But it might, just maybe, could be ready for something more to the downside. It may be completing multiple degrees of 5th waves and therefore it's time to be ready for a much more significant correction.

The rally has taken AAPL up to the top of two parallel up-channels, one from March 2009 and the other from February (at least they're not rising wedges). The tops intersect tomorrow near 268, which it got close to today. Watch for resistance to hold (or not) and the start of something more serious back down.

Apple, AAPL, Daily chart

I wanted to take a look at a couple of other stocks which could be a good mirror for the market. And what better mirror for the economy than General Electric. The pattern for its price action since last November is an expanded triangle, which is an ending pattern. Last Thursday's high poked through the top of the pattern and tagged two important Fib levels, each within 9 cents of the other. The 38% retracement of its 2007-2009 decline is at 19.64. An A-B-C move up from November has the c-wave = 162% of the a-wave at 19.73. Last Thursday's high was 19.69, right in the middle, and it left a throw-over finish with bearish MACD divergence. It is finding support at its 20-dma but if today's low breaks we should see it head for its 200-dma near 17.50. So GE is telling me that the market has topped or is topping, whether or not the major indexes try for one more new high into next week.

General Electric, Daily chart

In the recent past I've shown charts of the TLT, which is the 20+ year Treasury ETF. Tonight I'll show the chart of the 10-year Treasury yield (TNX) since we often see this number reported and so many other loans are based off it. It's close to an inflection point and bears watching here, especially if you're at all interested in what yields do from here. A couple of weeks ago I had pointed out resistance for both TYX (the 30-year yield) and TNX and mentioned a break of resistance would likely lead to a strong rise in Treasury yields. Those resistance levels are 4% for TNX and 4.85% for TYX and they held. Yields have pulled back (with a bounce in bond prices) so the question now is whether they'll get a running start from here to punch through resistance or if instead we'll see a longer term decline in yields, which would actually support the deflationists' beliefs.

TNX is now approaching what should be strong support, near 3.7% so if that level breaks, confirmed with a break below 3.62% (the low on March 18th), we should see bond yields head considerably lower this year (and bond prices higher). That would be good for borrowers, especially the governments and others who need to sell bonds in order to cover budget shortfalls. But a rise back above 3.89%, confirmed with a move above 4%, would likely lead to a strong rally in yields this year (and would likely mean bond auctions are not going well). That would clearly put a damper on those who must borrow. And it would affect all borrowers--from homes to education to consumer loans. So we watch and we wait for the signal as to how the year might unfold.

10-year Treasury Yield, TNX, Daily chart

Another yield to watch is the high-yield corporate bonds, otherwise known as junk bonds. A greater willingness to take on more investment risk can be determined by watching the prices of junk bonds. When investors get nervous about owning junk bonds they'll very likely get nervous about owning stocks. A look at a weekly chart of HYG shows it making a double top against its January high with negative divergence. It's an early call but it's looking like HYG may soon be heading south.

High Yield Corporate Bonds ETF, HYG, Weekly chart

Now we look at HYG relative to SPX to see whether or not it's been holding up relatively well. It hasn't been. The RS chart shows HYG has been significantly underperforming SPX since January 2009, especially this year as the SPX has been on a tear to the upside. The drop out the bottom of the descending wedge, along with a quick retest of the bottom trend line, looks bearish and says investors will be dumping junk bonds at a faster clip.

RS of HYG vs. SPX, Weekly chart

For me there are two takeaways here: one, HYG is a good shorting candidate (and it has options) since it's underperforming the market and looks to be double topping; two, it indicates that the stock market could soon follow HYG down if that's where HYG is heading next. Again, as a reflection of willingness to take risks in the market, this one could be a good canary to watch to see if it falls off its perch.

Moving on to the banking indexes, they're fairly similar and painting a similar picture, one that says we may have seen the highs for the banks. The BIX hit the top of two of its parallel up-channels, one from July and the other from February. The tops of the channels intersected near 165 yesterday and the high was 165.89 which was then followed by a hard selloff. Today's bounce so far looks like a correction of yesterday's decline from the high and if so then we should see it turn back down and break its key level at 153.79. I do see the possibility for one more test of its high or slightly higher but the rally is looking complete here.

S&P Bank index, BIX, Daily chart

Jim's recommendation last weekend to do a bullish play on Goldman Sachs apparently resulted in a maelstrom of responses to Jim and I'm guessing most were not in agreement about doing a bullish play on such a "vile" company. Emotions are running strong in this market and all I can suggest is that you do not get yourself personally vested in the stock market or its outcome. I may have a bias about the market (OK, I do have a bias about it) but in reality we need to play both sides of the market and individual stocks based on whether or not we think we can make money off them. A stock or the market is not good or evil, it just is. And we only want to know the direction of it so we can make money off it. The good thing is we get to choose our poison (stock/sector/index) and if you don't like GS then don't play it.

But all the news about GS over the past week, how it's a great company and that they're just being picked on and how well they they've done, etc., prompted me to look at them vs. their sector. A RS (relative strength) chart of GS vs. the banking index shows they've been underperforming the market and the banking sector since last July. The market has been sniffing out a problem with this stock for a long time and it looks like it's about to get worse for them.

RS of GS vs. BKX, Weekly chart

The decline in GS relative to the BKX, which is what this chart shows, has dropped below both a trend line along the lows in August and January and this week it has now dropped below the bottom of a parallel down-channel. Whenever I see price action like this, it indicates weakness that will likely continue. So whether or not I like GS (for the record, I do not like the banks in general), this RS chart says you should pick on them if you're interested in shorting the banks.

Now looking at the chart of GS itself I see that it failed to hold the penetration of the downtrend line from October 2007 last week. If it were to rally back above last week's high it would be bullish. But as long as it remains below both its 50 and 200-week moving averages (not labeled on the chart), near 163 and 168, resp., there should be more downside pressure on the stock.

Goldman Sachs, (GS), Weekly chart

The home builders have had three strong days this week, helped today by the housing report showing a strong rise in resales of existing homes and condos, up +6.8% in March and up +16.1% vs. a year ago March. Most are crediting the tax credit subsidy for home buyers, which ends this month. So we could see improved sales in April as well. The big question on everyone's mind is what sales will look like after April. Will it be like the cash-for-clunkers program which saw auto sales fall drastically lower after pulling in future sales? That's certainly a risk.

But for now buyers of the home builders' stocks are in a good mood and that has driven the index above its March 26th high and back up to the trend line along the highs since January, which is where the March rally ended. Price finished slightly above the trend line today and what bulls do not want to see is a sharp drop back down on Friday, which would leave today's move a throw-over finish above the rising wedge pattern for the rally from December.

U.S. Home Construction Index, DJUSHB, Weekly chart

If the rally continues on Friday then it would turn the short-term pattern bullish and as you can see on the weekly chart above, there is a larger rising wedge pattern for the move up from November 2008, the top of which is near 375. Also near that level is the downtrend line from 2005-2007 and its 200-week moving average is heading down to that level also. Therefore the 375 area makes for a good upside target if the rally continues from here. A bullish resolution from here for the home builders I would think make for a bullish stock market in general so that's why I continue to watch this index for clues.

The dollar, metals and oil continue to chop up and down and not really going anywhere yet so I'm waiting for a break in one direction or the other. Right now the dollar looks like it might try for a break to the upside but its pattern doesn't look bullish yet. So the bounce off last week's low could be part of a larger downward correction that will take a few weeks to finish playing out. In the meantime we've got the metals jerking up and down and undecided which way to go. Another week and hopefully I'll have some more clues by then (I do continue to lean longer-term long on the dollar and short on the metals and oil).

Of all the economic reports this morning the only one that riled the market was the one about Greece, well before our 8:30 AM reports, which barely budged the pre-market futures. Futures had been down on the news (again) that Greece may not be able to be saved. The spread between their bonds and the German bonds continues to widen, which makes it very expensive for Greece to borrow. The cost to insure the Greek bonds (credit default swaps) gets more expensive with each passing day. The worry about the EU and the euro is helping the dollar right now but it's a fickle situation. The bigger problem of course, and the elephant in the living room, is what to do with the other countries lining up behind Greece. Each is waiting to see how Greece is bailed out and any bailout is going to tank the euro. If the dominoes start falling in Europe it's not going to stop in Europe. Frankly I'm surprised the stock markets are holding up as well as they are. A little manipulation perhaps to keep the sheeple calm?

Economic reports, summary and Key Trading Levels

Friday morning we'll get the durable goods orders which are expected to have declined from February. It will be interesting to see if new home sales follows the upside pattern for existing home sales. If yes then look for another shot higher for the home builders index. If the numbers disappoint I think we'll see a nasty reaction out of the home builders and with the price for the index pressed up just above the top of a potential rising wedge pattern, a sharp drop lower would leave a throw-over finish, which in turn would point to a strong leg down coming.

Summarizing the charts posted tonight, I tried to show the patterns, especially the rising wedges, which typically lead to a fast reversal back down. I think when this market breaks down it's going to happen quickly. This market and all the quants behind the program trading seems to know just one direction. The big houses are essentially momentum players. When the market flips we'll have everyone and their brother trading from the same side but the opposite one. That could result in relentless selling just like we've seen relentless buying.

Therefore I think it's very important to see the patterns and see why I'm so bearish the market. It may be taking a whole lot longer than I figured it would to find a top, and we might not have it yet, but when the bell is rung we're going to see a flood of sell orders. I don't know about you but I hate shorting into the hole. I much prefer shorting bounces because I feel like I can control my risk better. But we'll soon be facing a time when it will pay to simply put in a sell stop order to trigger on a break of support, set your stop just above support and let 'er rip. The risk, especially in this market, is that the whipsaws will nail your stops repeatedly. There's no easy answer and you have to simply find what works for you and do it consistently.

With the potentially short-term bearish pattern on the blue chips, which have not made new highs above last Thursday's, a strong break down on Friday could result in heavy selling. But as I pointed out on the SPX chart, a sideways triangle could mean we'll get a shot higher into next week after one more pullback (which needs to stay above 1190). The new high next week will be the one that would be a slam-dunk setup for a short play so either down tomorrow or down after a new high next week. I think we're that close now.

Stay cautious, take profits on longs and start stabbing at the short side. That's my recommendation this evening. Good luck and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish up to 1225-1230
- bearish below 1183

Key Levels for DOW:
- cautiously bullish above 11250
- bearish below 10977

Key Levels for COMPQ:
- cautiously bullish to 2520-2550
- bearish below 2451

Key Levels for RUT:
- cautiously bullish up to 735-750
- bearish below 702

Keene H. Little, CMT

New Option Plays

Healthcare Has Been Weak

by Scott Hawes

Click here to email Scott Hawes


Bard (CR), Inc – BCR – close 85.42 change -1.57 stop 88.50

Company Description:
C. R. Bard, Inc. (Bard) is engaged in the design, manufacture, packaging, distribution and sale of medical, surgical, diagnostic and patient care devices. The Company sells a range of products worldwide to hospitals, individual healthcare professionals, extended care facilities and alternate site facilities. Bard has four product group categories: vascular, urology, oncology and surgical specialties. On November 18, 2009, the Company acquired Y-Med, Inc. (Y-Med), a company focused on the development and manufacture of specialty percutaneous transluminal angioplasty (PTA) catheters. On June 15, 2009, the Company acquired worldwide rights and related assets of the hernia products business of Brennen Medical, LLC.(source: company press release or website)

Why We Like It:
Healthcare related companies have been under pressure recently and I expect this to continue as details about the healthcare reform bill surface and uncertainty remains. BCR is forming a bearish wedge pattern on its daily chart and looks vulnerable. The stock bounced nicely off of its 50-day SMA today but that probably had more to do with the market rebounding more than anything else. BCR closed just below its 20-day SMA. The stock is also approaching a congestion zone from late 2007 through early 2009 that I believe will hold. BCR reported earnings in line with expectations today so I am not too worried about investors getting overly excited about the stock at these levels. I suggest traders initiate June $85.00 PUTS if BCR trades to $85.95. We'll place a stop above recent highs at $88.50. Our target is $83.05 and our time frame is several weeks.

Suggested Position: Trigger to Buy BCR JUNE $85 PUT, current ask 2.65, estimated ask at entry 2.40

Annotated Chart:

Entry on April xxth at $ xx.xx
Earnings Date July (unconfirmed)
Average Daily Volume = 1.5 million
Listed on April 22, 2010

In Play Updates and Reviews

The Markets Test the Will of Traders

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. Wow! The buyers are still stepping in doing everything they can to keep the market propped up at these levels. I mentioned last night that often times when markets whipsaw back and forth it is a warning signal that a trend change may be happening. All of this back and forth means there is a lot of indecision and it has been quite a battle between the bulls and bears. Earnings reports from Amazon and Microsoft looks like it will put more pressure on the indices overnight as investors were not enthused. So until we find out who wins stay nimble with your position management and be sure to protect profits.

Current Portfolio:

CALL Play Updates

Diana Shipping Inc - DSX - close 15.25 change +0.10 stop 14.32

DSX closed above yesterday's highs which helped our calls gain 10-cents (+15%). I am looking for the stock to follow through from here and re-test the highs from April 6, which is near our target of $15.65. A +40-cent move in the stock from here should garner another 25-cents in profit on our calls. This will represent a +50% gain. A second more aggressive target can be placed at $16.00. I suggest traders protect profits if DSX continues today's rally. I envision this as a fairly quick trade lasting about one week. Our stop is $14.32 which is below Monday's low and all of the stocks moving averages.

Current Position: CALL MAY $15, entry at $0.60

Entry on April 21, at $ 0.60
Earnings Date 5/6/2010 (unconfirmed)
Average Daily Volume = 1.2 million
Listed on April 20th, 2010

Goodyear Tire & Rubber Co. – GT – close 14.49 change -0.08 stop 13.50

GT recovered nicely today off of its lows, but was still down -0.55%. Our $1.90 calls our now worth about $2.10, or +10%. The stock almost hit our target on Wednesday trading up to $14.66 which was only $0.09 away from our target. Considering the whipsaws in the market continue I am suggesting readers tighten stops or sell their positions to protect profits. I still suggest the strategy I mentioned last night by placing a good til cancelled (GTC) sell order on the call option at $2.25. We are looking to exit the trade if GT trades into the $14.70 to $14.75 area which is our target. A more aggressive target is $15.90 but GT has earnings on April 28 so I doubt there will be enough time to reach this level. There is a key pivot level at $14.00 that I would expect to hold as support if there is any weakness in GT, but I would not let the stock reverse on you at this point. I am not recommending new positions at this time. Our time frame is now one or two days.

Current Position: Long MAY CALL $12.50, entry @ $1.90

Entry on April 20th at $ 1.90
Earnings Date 4/28/10
Average Daily Volume = 4.3 million
Listed on April 19th, 2010

Hanson Natural Corp. - HANS - close 41.32 change +0.08 stop 39.25

HANS traded down to $40.82 today and we are still waiting on our trigger. Here are my comments from the new play last night. HANS is approaching an upward trend line and a recent support/resistance level at about $40.50. In addition, the stock is forming an ascending triangle and is approaching the bottom portion of an upward channel that has been intact since mid 2009 (see weekly in new plays). I am waiting for HANS to trade to $40.50 which I suggest readers use as a trigger to buy calls. I believe the stock will bounce from these levels as long as the overall market is cooperating. The company reports earnings on May 6 so we will be out of this trade prior to the report. Let's use a stop of $39.25. Our target is $43.40 and our time frame is 1 to 2 weeks.

Trigger to buy calls at $40.50

Suggested Position: Buy MAY CALL $42, current ask $1.35, estimated ask at entry $1.00

Entry on April xx at $ xx.xx
Earnings Date 5/06/10
Average Daily Volume = 854,000
Listed on April 21, 2010

PUT Play Updates

SPDR S&P 500 Index - SPY - close: 121.02 change: +0.36 stop: 123.05

The whipsaws are relentless and testing our will on this position. However, we are still below the highs of the last few days and earnings reports from Amazon and Microsoft have the futures under pressure again. I mentioned last night often times when markets whipsaw back and forth it is a warning signal that a trend change may be happening. It is tough to tell if this truly happening but I feel buyers are getting exhausted and sellers show up whenever they push the market higher. Someone will eventually win. And there is plenty of resistance from last week just overhead, along with SPY's 200-week SMA. With that being said conservative traders should consider moving up their target to the $119.00 area which is near today's low and SPY's 20-day SMA. Should SPY trade to this level I will be looking to tighten stops and exit the position if SPY proceeds to spike higher again. Our stop remains 123.05 which is just above SPY's 200-week SMA.

Current Position: SPY PUT MAY $119.00, entry at $2.05

Entry on April 13th at $ 2.05
Earnings Date Not Applicable
Average Daily Volume = 164 million
Listed on April 12th, 2010