Option Investor

Daily Newsletter, Saturday, 5/8/2010

Table of Contents

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

Market Wrap

Abundance of Excuses

by Jim Brown

Click here to email Jim Brown

When the markets want to go down they will always find an excuse. Last week there were plenty excuses to choose from.

Market Statistics

There are some ugly numbers in those statistics above. The Nasdaq has entered correction territory with a 10.3% decline since the April 23rd close at 2529. The Dow is down -7.4% for a total of 830 points from the April closing high. The damage for the week was bad and it came on top of a significant decline in the prior week. Volume has been extreme with Thursday trading almost 19 billion shares and Friday was 17.5 billion. The bears have forsaken the elevator down in favor of a bungee plunge.

The Dow's spike into positive territory from the jobs report had a hang time that could have been measured in milliseconds. Almost immediately the Dow rolled over to sink -279 points to 10,241 before any buyers appeared. This was probably forced margin selling by those who saw their positions implode on Thursday. When the opening spike did not hold there was no option but to sell and raise cash. Dip buyers appeared at 10,240 and they managed to push the Dow back into positive territory but that brief green candle was immediately sold again. The bullish payroll report was unable to support the market.

The Jobs report showed the economy added 290,000 jobs in April. The consensus estimates were for a gain of 200,000 jobs compared to the 162,000 jobs added in March. April was the best month for jobs since November 2005 when there was a gain of 354,000 jobs.

Also positive was a revision for March from +162,000 to +230,000 and a revision for February from -14,000 to +39,000 jobs. I know you are waiting for the census shoe to drop. Actually the census only added 66,000 jobs and much less than expected. Government hiring actually declined and the private sector added 231,000 jobs. This is very bullish.

Manufacturing has been a drag on employment for several years and that sector added an astounding 44,000 jobs in April. Construction added 14,000, business/professional +54,000 and leisure/hospitality +45,000 jobs. The percentage of industries adding jobs jumped from 48.9% in November to 64.3% in April and the highest since March 2006.

The unemployment rate rose +0.2% to 9.9% but that comes from an increase in the labor force participation rate. More people were looking for jobs. Many of those who had given up on looking for a job have started looking again.

The separate Household Employment report showed a gain of 550,000 jobs for April and the most in almost three years.

This was a very strong report. After including the revisions and the household survey the economy added 962,000 jobs and only 66,000 of those were census workers. This should have been a very strong boost to the markets but the market was focused elsewhere.

Payroll Chart

The markets were a prisoner of the events in Europe. The civil breakdown in Greece was setting the stage for a potential economic breakdown in the rest of Europe. Various countries and organizations still have to approve the potential $140 billion bailout of Greece. They watched as the riots grew in intensity in protest of the required austerity programs. Greek airports, trains, schools and many businesses were shutdown.

Countries and institutions that were due to vote on the Greek bailout were expressing concerns that Greece would not be able to enforce the austerity programs. Did they really want to be part of a $140 billion loan package if Greece was simply going to take the money and then default on the austerity deal?

The market hates uncertainty and the three-ring circus that is the Eurozone last week is uncertainty squared. Analysts are claiming the breakdown in Greece could lead to a contagion that spreads across the zone and lead to future chapters with a different country failure in each chapter.

Analysts were comparing Greece to Lehman and how everyone thought Lehman would be ok until suddenly it was gone. Within days Merrill Lynch was also gone and there were rumors of others ready to fail.

The problem in the EU has been explained many times in these pages so I am not going to repeat that detail. The worry is simply that Greece is going to default and restructure its debt and possibly exit the Eurozone. Once an EU country defaults and/or exits the union then other countries like Ireland, Italy, Portugal and Spain would also find themselves without funding on fears they would follow Greece back to a country currency.

The EU was supposed to be this collection of strong countries with rigid financial guidelines and they had the implied guarantee of being part of the bigger financial unit. Greece has proven the model is not working and analysts are worried there will be a Lehman like disaster any day now.

Until the EU and the IMF actually provide cash to Greece this day-to-day news driven market is going to continue to worsen. Greece has an $11 billion payment due on the 19th and various EU officials have promised Greece will have cash before that date and Greece will not default. Those promises are falling on deaf ears since there are so many pieces to the approval puzzle that have not fallen into place. We have had a dozen or more agreements in the last 90 days and all have either failed or changed materially. Greece was found to have been lying about their debts and habitually understating their cash requirements.

Last weekend we were told that Germany would approve the deal on Thr/Fri of this week. The EU would hold another financial summit this weekend to approve the final deal and work out the funding details. The IMF was supposed to give its final approval this weekend. All the details were to be released on Sunday in order to calm the global markets on Monday.

As of this weekend French President Nicolas Sarkozy and German Chancellor Angela Merkel said early Saturday that Europe would setup an intervention mechanism before Monday to calm the markets. The pair also said the EU leaders would have a plan in place before Monday to defend the Euro against speculation. They pledged to stave off attacks on the financial systems of weaker nations including Spain and Portugal. "The euro is an essential element of Europe. We cannot leave it to the speculators." The EU finance ministers are scheduled to hold an emergency meeting on Sunday to work out the details of the anti-speculator plan. Merkel said, "We will make use of the EU mechanism to protect ourselves against speculation."

Sarkozy warned that the crisis had gone beyond Greece and was now focused on the very roots of the euro currency. President Obama and Canadian Finance Minister Jim Flaherty urged the EU on Friday to resolve this quickly to avoid further global contamination. I believe the crisis has gotten to the point where the EU countries have to quit bickering and get something done or the collapse of the euro is going to cause them more pain than having to give money to Greece that they may never get back.

If further squabbling prevents a concrete solution before the markets open on Monday we are probably going to see another triple digit decline. If the finance ministers can present a concrete plan by Sunday night then the global markets should rally on Monday. Until the problem is resolved we are going to remain a prisoner of Europe.

Most readers are probably wondering why Greece is so important. It is because Greece is the canary in the EU coal mine. Of the five weakest EU countries Greece is the smallest by a wide margin. Whatever happens to Greece could easily happen to the other five only there is no possibility of a bailout except for the possibility of Portugal. The others are simply too large. Greece has roughly $236 billion in debt. The other four countries, Italy, Ireland, Spain and Portugal have $2.6 TRILLION in debt. Spain has $1.1 trillion in debt, 20% unemployment and one of the weakest economies in Europe. Greece is the first and probably the smallest of the EU debt problems. It has taken three months to get the other EU countries to agree to invest a few billion each to bail out Greece to protect the euro. It would be impossible to get them to spend $100 billion each to bailout Spain. Check out this graphic: LINK

The euro sank to 124.88 on Thursday and a level not seen since January 2009. This is strong support but only if the EU acts quickly. The 125 level has been support but another failure to act this weekend could cause that support to be broken under a global speculative onslaught.

Euro Chart

The +6.2% spike in the dollar over the last four weeks is a direct result of the crisis in the euro and our recovering economy. It was probably the reason for the -998 point crash in the Dow on Thursday. It has crushed commodities with crude prices falling -13% in a single week and copper prices losing 15%. For stocks with a substantial amount of their business coming from overseas the spike in the dollar is going to seriously impact earnings in Q2. Intel receives 70% of its revenue from overseas.

Dollar Index Chart

While nobody knows exactly why the market imploded on Thursday there is a very good chance it was a capitulation event by somebody that was deeply underwater in the currency carry trade. Hedge funds around the world had been shorting the dollar when it plateaued around 80 on the dollar index and using the cash to buy commodities and equities. When the big spike came last week these funds were in serious trouble. Currencies don't move in 5% increments per week but the dollar did last week. These funds construct highly leveraged trades and then they go bad they go really bad. The Yen carry trade also unraveled last week.

My guess, and it is just a guess since nobody really knows for sure except for the trader who pulled the trigger, is that a fund or funds were really upside down in a currency trade of some sort. They finally reached the point where they were forced by their clearing broker to liquidate. Since the market was already in a downward spiral the addition of a major sell program was more than the system could bear.

They could have been leveraged to S&P futures, crude futures or any combination of dollar denominated instruments. With those going south at a high rate of speed their problems were growing worse by the hour. Eventually their leverage capability was exceeded and the computers hit the sell button.

The CME said there were $16 billion in E-mini futures traded in a 20 min period. This was four times their previous record volume. When futures contracts are sold there is a computer somewhere that is tracking those contracts and selling the equivalent S&P stocks. That is an incredible simplified explanation but you get the picture. The same is true with ETFs.

The SPY ETF is the most heavily traded ETF on any exchange. The SPY traded 637 million shares on Thursday and most of that was down volume with 60 million shares sold in a 15 min period. That means the fund manager was deluged with ETF shares coming back home to roost and he had to redeem those shares and sell the corresponding shares of the S&P-500. The SPY is only ONE of more than 1,000 ETFs. Some analysts claim that more than 40% of all trading volume is ETF related. ETFs have become the trading vehicles of choice because they are highly liquid and regardless of what you want to trade there is probably more than one ETF that fits the scenario.

The NYSE and Nasdaq put out a list of 296 stocks where the trades were canceled on Thursday's drop. 69% of those stocks were ETFs. The NYSE list of 173 tickers had 111 ETFs. The bids for those ETFs disappeared during the drop and were responsible for shares being traded for as little as a penny. Market makers were so deluged with sell orders they could not supply quotes. When you consider all the things going on behind the scenes it is not surprising.

The largest ETFs with canceled trades were the Vanguard Total Stock Market Index (VTI), iShares Russell 1000 (IWB), iShares Russell 3000 (IWV), iShares S&P-500 Growth (IVW) and iShares S&P-500 Value fund (IVE).

The vast majority of the selling on Thursday was related to equity futures and index ETFs. As sell volume on those products increased by several hundred percent the associated computer related selling of the baskets of stocks related to the ETFs also exploded.

The NYSE said the sudden crash tripped the Liquidity Refreshment Point or LRP on many of the stocks traded on the exchange. The LRP works like a time out switch when it slows trading but it does not stop trading. When a stock price suddenly drops the LRP kicks in to short circuit the electronic trading and revert to a manual auction process where trades are matched to orders rather than continue electronically at the bid. The process is designed to prevent unreasonable price swings. Trades can take more than a minute rather than the milliseconds electronic trades require.

The LRP prevented Proctor & Gamble (PG) from trading below $56 on the NYSE but it traded as low as $40 on other exchanges. The LRP is triggered on a few stocks every day as news events cause price fluctuations. The NYSE prides itself on the "human factor" that limits errors like we saw on Thursday.

Unfortunately the Nasdaq blamed the NYSE for the problem. For stocks that are listed on the NYSE that is the primary exchange where the vast majority of shares are traded. Some trades are routed to the other exchanges when there is a better price. The NMS rules put in place a couple years ago requires trades to be routed to the lowest price regardless of what exchange is showing the price. There are some qualifications but that is the general idea.

For a NYSE listed stock like PG that trades nine million shares a day the vast majority of those shares would be routed through the NYSE. That is especially true of the large institutional orders. They could also trade on the Nasdaq but prices can be slightly higher than the NYSE because of the much lower volume.

When a large number of NYSE stock tripped the LRP at the same time in response to the computer generated futures and ETF sell orders the LRP stopped the trades to allow a human to respond to the price imbalances. When the orders were halted and sales were not being executed in the normal electronic time the computers instantly looked for another bid. The bids it found were on the thinly traded "alternate" exchanges.

Hypothetically if the NYSE handled nine million shares of PG every day then the NYSE market depth of the open bids hoping to get a better price could total a couple million shares. On the alternate exchanges that may handle less than a million shares of PG per day the order depth could have been only in the tens to hundreds of thousands.

When the program selling began there may have been millions of shares of PG suddenly looking for a bid. PG actually traded 28.5 million shares on Thursday, three times normal. The computers found bids on the Nasdaq and instantly routed those sell orders for millions of shares to the Nasdaq and other exchanges. If the market depth on the Nasdaq was only 500,000 shares then the next order found no bid. The order routing system instantly tested all the other exchanges and found that all their bids had disappeared as well. All of this happened in milliseconds while the NYSE specialist was still waking up the fact that his board was suddenly filled with sell orders for millions of shares and the LRP process was asking him what to do.

Because the market depth away from the NYSE was so small and instantly absorbed by the order routing system there were several stocks that actually returned a no-bid condition while others actually sold for as little as a penny because somebody had a dormant order lingering in the system.

It is a common practice for many traders to park orders for a stock they want with a ridiculous price just in case somebody enters a crazy price. Many times I have seen fills well away from the market price simply because the bid was left open. When markets are really volatile this happens a lot with options. If your sell stop is hit during a crash the market order that is triggered can be filled several dollars away from the listed price.

To summarize, I suspect the market crash was triggered by a fund liquidation because of an extremely overleveraged position with a dollar denominated component. With fund leverage as much as 20:1 a rogue position can be unwound by the clearing broker with serious consequences. Since the main trade for last couple months has been long oil and commodities, highly leveraged trades, the explosion of the dollar and implosion of commodities could have been a toxic mix.

The sell program is triggered in an already seriously bearish market and stop losses begin to be hit by the millions. Since all the volume is on the sell side the bids dry up, the prices dip sharply and the LRP halts trading for 90 seconds or longer. That is an eon of time when computers are making ten thousand trades a second. The system short circuits when the NYSE trades fail and these billions of shares for sale are suddenly dumped off to the alternate exchanges with no fail-safe for excessive volume. Prices go to zero with no bid and the computers calculating the value of ETFs based on the value of the S&P or Russell 1000 are suddenly launching sell programs of their own in an effort to adjust to market prices.

It is a wonder the system did not crash completely. Many people have reported they tried to sell stocks when they saw the crash beginning and they could not get a bid. They were probably lucky when you consider that bid could have been pennies on the dollar.

Fortunately the greed factor quickly rectified the problem. Within minutes of the crash trading floors were literally filled with traders screaming, "buy anything." When prices are suddenly being quoted 20-25% off the price five minutes earlier that is a major incentive to buy something. Over 18.8 billion shares were traded and the highest volume day ever.

We may never know what started the dominoes falling on Thursday but once the cascade began it was astounding to watch. I can't tell you how many people initially though a nuclear bomb had gone off. I heard that several times. For the Dow to drop 998 points, 700 in less than five minutes, it had to be a terrorist attack with a nuclear component. Not even another 9/11 style attack would have had the same immediate impact.

To say that bullish sentiment was damaged would be an understatement. It was the proverbial perfect storm. A market already trending sharply lower on geopolitical events most traders don't understand was hit by a complex convergence of seemingly unrelated computer programs, which I guarantee 99% of traders don't understand.

The system broke in a way nobody expected and it may have broken the back of the bulls.

Once sentiment is broken it may be very difficult to recover. Equity funds are up strongly from the March 2009 lows. People were feeling a little more confident about their finances and suddenly the system let them down. The Greece problem had already blunted the market advance and now Dow is down -800 points in little more than a week. The sell in May strategy is suddenly looking a lot better.

For those in taxable accounts the capital gains tax is going up at year-end as well as higher income taxes for 2011. This may be the perfect time to take those gains and move to the safety of tax-free bonds. What happens if Greece really does default? What happens if China's slowing growth suddenly turns into a bursting bubble as many have predicted? Is the U.S. really going to avoid the double dip recession? There are dozens of questions plaguing investors and few answers.

We know that Q2 earnings are going to be weaker than Q1 but still decent. The suddenly stronger dollar is going to apply additional pressure to those Q2 earnings. Unfortunately Q3 and Q4 are going to be even weaker because of tougher comparisons from last year. The market tends to discount six months in advance and that means it is looking at Q3 earnings today.

I don't want to be the voice of gloom and doom but I think once in a while we need to look farther ahead than next week. Personally I think the economy is going to continue growing at roughly a 3% clip. I think the addition of more than 900,000 jobs in April is far more than we could have hoped and very bullish. The Fed is still on hold today but with jobs numbers like that they may not be on hold much longer.

If the Greek problem is resolved this weekend I think the markets will rebound but I doubt they will begin a new bullish trend. It will be like the quarterback that gets sandwiched between two tacklers and carried off the field on a stretcher. He may be walking under his own power at Monday's practice but he is probably not going to be strapping on pads for several more days. Investors were blindsided on Thursday and the weekend papers are going to be full of negativity. It is not an atmosphere conducive to adding to positions on Monday.

A market looking for a reason to go down will always find one. Once that profit taking process has begun it almost always ends up overdone. We have already seen the momentum stocks get crushed over the last two weeks. PCLN, GOOG, AAPL, FLS, WLT, FSLR, BIDU, etc. Did the fundamentals change for those stocks? No, market sentiment changed.

The Nasdaq has already moved into correction territory with a -10.3% decline. The Russell fell -12%, the Dow is close at -7.5% and the S&P at -8.8%. Volume is off the scale and severely imbalanced. In theory this is capitulation volume but without the corresponding trend. Eight days of declines is painful but not really a trend. I suspect there is more pain ahead.

Internals table

For next week the economic calendar is fairly bland until Friday. The biggest event for next week is the Cisco earnings on Wednesday. That could help rekindle interest in tech stocks.

There are several business metrics on Friday including production, orders and inventories. I don't believe Friday will be material for market direction. Whatever is going to happen will be over long before Friday.

Economic Calendar

Nobody was really paying attention to stock news last week but news on Friday that Nokia was suing Apple for patent infringement on the iPhone and iPad was good for a headline. An initial suit by Nokia was updated to include the iPad. Nokia claims the devices infringe five Nokia patents related to the technology that allows the devices to be more compact.

Apple has already responded with its own suit against Nokia claiming Nokia's products infringe on 13 Apple patents. Apple claims Nokia chose to copy the iPhone in order to recapture some high-end market share. Apple has also sued the HTC Corporation, a leading producer of the cell phones that run on Google's Android software.

This will probably turn into a case where the company with the highest priced lawyers will prevail but not until several years have passed and the technology is no longer relevant. Apple shares lost $10 on the news but it is hard to say is was the news or just the weak market.

Apple Chart

Friday was not a good day for BP. The hastily constructed 74-ton containment structure is now resting on the ocean floor in the gulf beside the leaking well. The box is designed to sink 15 feet into the ocean floor in order to provide additional stability when the floating rig a mile above attempts to attach the two pipes that extend to the surface. The box was lowered into position on Friday and BP said as soon as it was in place over the leak the frozen gas hydrates immediately clogged the pipe out of the top of the box. The hydrates formed so quickly and so aggressively that they were starting to add buoyancy to the 74-ton box. BP had to quickly remove the box from over the leak and move it off to the side while they figure out what to do next.

When methane gas is released from the well it quickly freezes into ice crystals at the extreme pressure and cold under a mile of water. The original plan was to pump warm water and antifreeze into the box to keep the gas and oil in a liquid state for its trip to the surface. They said the ice crystals formed so quickly that the pipe out of the box was immediately clogged and the box began filling up with ice. BP said they have not given up on the project but said it could be 48 hours before they will be ready to try a different approach. Before they can try again they have to remove the ice from inside the box.

BP says the device could begin capturing the leaking oil within 48 hours of finding a solution to the frozen gas. The rig on the surface can process 15,000 bpd of oil and water and separate the components. The rig can also store 139,000 barrels of oil while waiting for a tanker to take the oil to the BP refinery in Texas City.

BP is unsure they can get this to work since it has never been successfully tried at these depths. They have nearly 100 scientists and engineers working on multiple approaches to stopping the smaller leak at the blow out preventer. The third leak was halted when it was capped on Thursday by a remote sub.

Containment box being lowered into the water

The Dow has lost -837 points since the high close on April 26th. This chart shows the 200-day average at 10192 but the stronger support is the 10300 level where the Dow consolidated in November and December. Who would have thought last weekend that we would have seen a cascade decline of this magnitude? I have been predicting market weakness but this far exceeded my expectations.

Now the focus shifts to pinpointing where the decline will end. The Thursday decline stopped at almost exactly the support from February at 9900 but I don't think Thursday was a valid print. That was a system failure and not normal investor selling. Friday's decline was about half of the day's intraday loss but there was no buying at the close. Shorts did not attempt to cover and longs did not appear interested in adding to positions ahead of the decision on Greece.

If there was no geopolitical component and we had arrived here from the normal selling process I would expect 10250-10300 to be tested again on Monday and a possible rebound on Tuesday. Since we are a prisoner to the drama playing out in the EU I don't think there is a coherent scenario unless the EU suddenly gets motivated and actually follows through with a plan.

Dow Chart

The S&P is more likely to respect the 200-day average than the Dow. The Dow is too dependent on individual stocks to respect moving averages. The S&P typically responds to the 50 and 200 day as support. Fund managers use a cross of the 200-day as a major buy/sell signal. Should the 200-day fail to be support I would expect managers to look for confirmation with a break of 1085 before pulling the exit trigger.

The S&P has lost -105 points over the last two weeks for an 8.8% decline. A 10% correction would take the S&P to exactly 1095 and the 200-day average. The convergence of the 10% decline at the 200-day and the horizontal support from November should provide a strong base if the bulls have any fight left.

S&P-500 Chart

The Nasdaq has strong convergence at 2200. The 200-day and the prior support stopped the Thursday decline exactly where it should have been halted. The Nasdaq is suffering from big cap flight as the high dollar momentum stocks like Apple, Priceline and Google seem to have lost their leadership ability. In reality those big cap techs are quick cash for funds that are trying to stave off margin calls. In times of crisis, taking profits in multi hundred dollar stocks has always been a valid strategy to raise cash. Until these stocks begin to find a bid the Nasdaq should remain weak.

Nasdaq Chart

After a -12% decline the Russell found support at 650 and exactly where it should have paused. A break here targets the 200-day at 620. I am concerned that the small caps have suddenly surged to the top of the losers list but that is what happens in bear markets. Low liquidity small caps find themselves being tossed overboard in order to reduce the clutter and lower risk. Exiting small caps in heavy traffic is always a problem.

I always recommend watching the small caps for market direction. This week is no different. I don't expect them to lead on a rebound but they could easily lead us lower. A break under 650 should be a signal to remain in cash.

Russell Chart

In summary, the initial market direction on Monday will be based on the weekend news concerning Greece and the euro defense plan. Greece is the key. No firm plan, no firm market. I would love to never have to write about Greece and the EU again this year but I doubt I will be that lucky.

The earnings are basically over with Cisco on Wednesday the only major report that could impact the market in a material way. Chambers is always bullish and based on the other tech earnings he should give positive guidance. Whether it will make any difference is unknown.

I don't think the market decline is over. Even if we rally on Monday I would be surprised to see it last. I believe investor sentiment has been damaged and at a bad period for the market. When traders are trying to decide whether or not to "sell in May and go away" it is not a good time for a major sell off. If you step out on the front porch to see if the weather is good for golf and narrowly miss getting hit by lightning it may not be a good idea to head for the course. Investors dodged a lightning bolt on Thursday but were still pummeled by the hail. I doubt they will be rushing back into long positions.

Last week's crash may have created a buying opportunity but it may take a few days for that to be come clear for most investors. I am not convinced that a buy here would be anything more than a short-term trade. I remain cautious until proven wrong.

Jim Brown

Index Wrap


by Leigh Stevens

Click here to email Leigh Stevens

There was a bearish scenario AND a bullish one (just barely) before this past week's debacle as I wrote last week. I also pointed out that lower prices were the path of least resistance. I thought a sinking spell would be to 50 points lower once the S&P 500 (SPX) fell below 1080/1085. This was a mild understatement(!), although the potential under right conditions (illiquid) for wrecks caused by the large current percent of average daily volume accounted for by high-velocity computerized trading is unprecedented; figures at around 60-66 percent of total daily trading volume. Pretty amazing, all this money sloshing around and moving fast!

SPX only showed about 6 minutes when it's 'price' was under 1100 on Thursday and I was watching. On a closing basis, at Friday's 1110 Close, SPX has fallen 70 points so far since 1180 was breached. This was not far out of line with my 50 point downside expectation, which of course assumed a more 'orderly' market.


Latest press I see late Friday indicates: "Through the day and into the evening, officials from the SEC and other federal agencies hunted for clues amid a tangle of electronic trading records from the nation’s increasingly high-tech exchanges. But, maddeningly, the cause or causes of the market’s wild swing remained elusive, leaving what amounts to a $1 trillion question mark hanging over the world’s largest, and most celebrated, stock market."

The only technical indicator that pointed to the potential for a wicked sell off was the extremely high bullish sentiment figures I'd been highlighting for some time. It drives me crazy, because no matter how tempered I get at such extremes, these kind of crazy periods usually go on for long periods and as a timing model, such spikes in sentiment are tricky to cash in on. It will often be after the 2nd or 3rd spike up on my (CPRATIO) graph to above some extreme (call volume well over 2 times puts) before the market caves finally. Use of the CPRATIO 5-day average helps some; it peaked at 2.5, its highest high, on 4/15. The second single-day peak (2.4) on 4/26 occurred on the day SPX hit 1220.

If I were 110% disciplined I suppose I would just accumulate puts given extremes that were getting crazy and hang in. As it was I exited SPX 1200 puts, only to go back in on the dip below 1180 and buy that strike. Fortunately, and the only thing I found fortunate about giving up puts bought on prior rallies above 1200, SPX consolidated in a minor bear flag type pattern between about 1176 and 1170 for a few hours on Tuesday. It gave some time to think about strategy for more than a few minutes. I wouldn't have needed to watch intraday price action so much if I had just kept what I had and sat tight. As Jesse Livermore said, "I always made more money by 'sitting tight' than not".

Low-volume trades resulting from low-volume crosses off the (NYSE) floor on PG and MMM and a few others knocked as much as 400 points off the Dow 30 (INDU) at the 5/6 intraday low. The lows in the Dow are computed based on the lowest intraday lows reported for the 30 stocks that day. All trades reported onto the NYSE ticker also include new type electronic exchanges that trade lightening fast with each other.

I adjusted my daily and hourly Dow charts to a 10241 low for Thursday, not the exchange reported 9869.6 low. In the arithmetic INDU, as few as two stocks can have a huge effect. You only have to cross a trade of a block (10,000 shares or more) to distort the whole market. I adjusted my charts to a low for the week of Dow 10241 as it's important to me to have charts that reflect what I consider to be 'real' trading and volume. Unfortunately the S&P and Nasdaq are too big to estimate a closer to 'real' low. So it goes. Most chartists aren’t so picky but as they say about data: "garbage in, garbage OUT"!


Not so much in terms of dipping under the early-February lows, which would be the biggest technical damage so to speak. Prices did fall below their long-term up trendlines with the dips under 1144 in SPX, below 525 in OEX, under 10700 in INDU, below 2325 in the Nasdaq Composite (COMP), under 1900 in the Nas 100 (NDX) and not at all in the Russell 2000 (RUT).

An aside on RUT: the Index held the low end of its multimonth up trendline in the 647 area on Thurs. (with minor slippage under this line intraday) and Friday, where it held its up trendline dating from March '09. If there was anything you felt compelled to buy, buy RUT. It's 'fully' oversold again too which we haven't seen since its last (early-Feb.) low in the 580 area.

Technical damage also isn't yet done by closes under the 200-day moving average, a key indicator for portfolio/fund managers.

I'm cautious about how long it might take for the indexes to ready for another rally attempt. How I see the charts now to not expect a lot more downside but also just floundering for a while, with meager rally attempts. This sort of wide-ranging trading range is part of 'basing' activity in stocks, which I expect over time. It is still a primary bull market. One now in a short-term and intermediate-term downtrend.

It didn't surprise the faithful that an extreme sell off came, not the way it did (it never quite does) given that the recent tidal wave was the FIRST correction of over 4% in a 14-month rally. I anticipate that, after a period of chopping around, a not surprising guess with the CBOE Volatility Index (VIX) above 40 (levels not seen since before the major bottom of 2009), prices will find stability at or near recent closing lows. For example, SPX should find some support on dips at or not too far below 1180-1100, Nasdaq at or near 2200 and so on. More on the individual charts below.



The S&P 500 (SPX) has turned bearish (duh!) but there was warning for those that heeded them. I've felt a little like chicken little saying the sky was falling, the sky was falling, during the period highlighted in the yellow circle below during raging/rampant bullish fever. The market then made a V-top. The tip off of WHEN to sell most safely, or when the trend had definitely tipped, was the break of the key trendlines at 1180-1185. After that break and a look at the hourly chart, there was an apparent 'bear' flag that formed; seen above. This occurred over a few hours: a time window in which to to buy puts. I recall the Monday after a bad currency weekend (black Monday) in 1987 when I was visiting at the CBOE. That Monday opening was still in 'time' to make a good deal by buying puts and more by shorting the wild and wooly index futures on the opening.

I said last week that: "Working against the idea of merely a shallow or sideways correction at this juncture is the rampant bullish sentiment figures occurring before this recent volatility. The fire of such bullish sentiment extremes often are dampened by LOWER prices for a while."

SPX is back down to key support in the 1100 area. We've been in this area before and stocks have found buying interest. 1100 is also the current intersection of SPX's 200-day moving average. I also see support down a bit, around 1080. If it hadn't been for the trading of the e-exchange networks in trade crossing (only then routing the trade to the NYSE ticker, practically instantaneous today), the S&P wouldn't have dipped under 1100. Maybe there's a touch to the 1060 area, where I'd be a buyer.

Pivotal resistance now looks like 1140, then 1180 prior support, with major resistance at 1200.


The S&P 100 (OEX) chart did stay bullish for a day this past week, by opening higher and forming a daily low that was ON OEX's up trendline. The next day (Tuesday) came the break and there was time to do some selling in a still mostly orderly market. A nervous market, especially when, for some reason, big downside trading triggers got let go when SPX broke 1150. Rather than at the trendline break at 1180-85; but computers don’t draw trendlines!

The key break at 540 in OEX was the first substantial break of the 21-day moving average. As downside momentum accelerated, OEX piercing the 50-day average then got noticed next. Without the illiquid trade of those few minutes of Thursday afternoon, as we all stood more or less mesmerized by the screens, OEX would have had less of dip under its 200-day moving average. The chart is the chart and I'm not trying to modify this weekly low, just put it in perspective. The off-exchange share of volume and hyper-fast trading run by algorithms may get reined in after this incident where relatively little money pushed the market so low.

Potential 'support' in quotes is most apparent at 500, extending down to the low-480 area. This area could get re-tested again. The likelihood of a big new down leg that takes OEX to a weekly close below 480 doesn't look as likely of an event.

Near resistance, 517, then more pivotal resistance begins in the 530 area, with major resistance around 544-545.

As with SPX, OEX is now 'fully' oversold on a 2-week basis and 2-3 more weeks of lower prices or even sideways action would bring down the 2-month oscillators to an oversold zone as well.


When pierced this last time, breaching 11000 was the beginning of the 'waterfall' decline in the Dow 30 (INDU); the pattern that we almost always see in panic situations that keep buyers frozen in place at a certain spot and when computerized trading then magnifies the downward spiral.

Once 11000 gave I was looking for 10800 on the downside, possibly to 10600. Given that 400-500 points down on the ticker on Thursday for a crazy 6-10 minutes was accounted for by a few sparse flash trades, this estimate wasn't completely crazy.


A low around 10240 low calculated to take out a few 'official' lows for the most 'artificially' suppressed component stocks based on minuscule trading. This by 'backing out' some crazy key INDU stock lows (e.g., PG, MMM) in order to re-calculate the Dow Thursday low. This lets us see that the low of Thursday was actually nearly identical to Friday's low. I wanted one chart where I could regain some perspective.

Key near support is in the 10200 area, with expected major support at 10000, where the Index 'based' at the last major low, with exceptions of a few intraday or select closing dips in February that carried to the 9900 area or a bit lower (9835) at a final bottom.

Assuming that the recent volatility doesn't go away, practically 'immediate' overhead resistance looks like 10600 currently, with more price discovery coming in this coming week. 10800 looks like pivotal resistance, a bullish game changer if the Dow were to surmount this level. How about flopping around like a wet fish between 10200 (with possible dips to 10000 later) and 10700. This market now needs to see where the buyers will come in over more than in a panic fall. One thing you usually can predict about the length of a first rally attempt: it won't be prolonged. That level of confidence has been shattered.


Nosedive for the Nasdaq Composite (COMP) Index like all the rest of the market, but COMP clearly held its 200-day moving average (currently, 2204). The next day (Friday) was down on the day, but up from the lows. Not looking like a rout here ahead but the market has been highly bruised.

The 2100-2150 area might remain a key test of support ahead but I don't anticipate a drop below this on a closing basis. I've noted near support on the chart at 2200.

Resistance is easier to calculate; on a rebound first to the 2325 area, with a pivotal next resistance at 2400. A close back above the 50-day moving average would be bullish for the near-term. Right now the short and intermediate-term trends are down, with the major trend still intact. This last statement on trend is providing that the 2141 close in the week ending 2/5 is not pierced. A close at or near that level keeps the major trend intact, below it shifts the major trend down as I figure it.

Trader sentiment is falling and should slide further since the bulls will typically get their confidence shaken to the core, after such a period of OVER-confidence for the prolonged period seen with single day and 5-day average upward spikes in late-March to late-April; per my lowermost (CPRATIO) indicator.


The Nasdaq 100 (NDX) has seen a nearly 100 percent retracement of the entire early-February to late-April advance. All in the span of a few days! Old trader saying: "they slide faster than they glide".

Would I step in and buy this index, such as on further dips to 1800 and under? Probably not. It could be too much ping pong match versus long drives on the links. Would I bet on a 'maximum' 1750 to 1950 range for the near future I was asked? Yes. As to whether upside or downside will get pinged first is harder to project. Recoveries off from lows typically happen faster than a major sell off from a prolonged advance.

Another technical factor with the Nasdaq is that, on a weekly chart basis, readings are only about neutral now in the overbought/oversold department. This market had the strongest and longest advance and this market may take longer to 'throw off' its prior overbought extreme. This factor is not apparent on a daily chart indicator like RSI, which is showing its first 'oversold' extremes since the lows seen in November '09 and then repeated in oversold terms at the early-February 2010 bottom.

Some type of rebound seems likely in the coming week; worth playing? Not by my trade strategies, but for those whose efforts benefit from volatility and forecast an expected range, I don't anticipate prices going below or much under 1750 to the low-1700 area or not for long. I'm anticipating that the long-term trend will remain UP by the Index not falling under its February lows. You may recall that April is a good month for stocks; after that, not so much, not for a while. Reminding me of the old saying: "sell in May (I gather ON the start) and go away ".


Wow, who would have thought it, a retest so quick of the February low that (if we can believe the prices!) followed by a decent sized rebound from those lows. I wonder how much of the Nas 100 (tracking) stock got bought at $42. I can guarantee not by me! Of course, although the Q's will normally track the NDX, as with the stock index futures, at times they deviate from 'fair value'.

So, QQQQ got stretched to the downside, but would I be a buyer or seller or not either? I wait. Buying around the 200-day moving average is tempting. Our recovery is still ongoing and only a crack has appeared in the Euro zone. These things get turned into bigger stories than they are when the market gets overvalued and ahead of its fundamentals. Stock prices tend to seesaw between an over-optimistic expectation for earnings and a more pessimistic estimate for the same.

I said last week that "If prices slid under 49-49.2, I anticipate selling to pick up as it would suggest to many a break in the advance going into the past 7-10 days of more volatile action." I didn't expect the market to get driven off a bit of a cliff. Just that shorts could be put on when prices broke below 49. A refreshing thing about trading single stocks is to forget time premiums, strikes, expirations, etc.

Big volume came out on the two days when the most damage was done, on Thursday and Friday. The dip to 42 may have fulfilled the bears blood lust for QQQQ. Near support is 44, key near resistance at 48.


As mentioned in my initial 'bottom line' commentary aside relative to the Russell 2000 (RUT), it gave ground grudgingly. The only Index so far that seemed to find support at its long-term up trendline; a 14-month up trendline in the case of RUT. We'll see... If the Index starts slipping below 648 to 638, a possible next support comes in around 620, or even at the February lows in the 600-580 price zone.

Near resistance may come in on rallies back to the 675-680 area. 705-700 was a key 'breakdown' point initially on the sell off so makes for my 'pivotal' resistance reference.




1. Technical support or areas of likely buying interest and highlighted with green up arrows.

2. Resistance or areas of likely selling interest and notated by the use of red down arrows.


3. Index price areas where I have a bullish bias or interest in buying index calls, selling puts or other bullish strategies.

4. Price levels where I suggest buying index puts or adopting other bearish option strategies.

5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only (CPRATIO) with the S&P 100 (OEX) chart. However, this indicator pertains to the market as a whole, not just OEX. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I tend to favor At The Money (ATM), In The Money (ITM) or only slightly Out of The Money (OTM) strike prices so that premium levels are not as cheap as would otherwise be the case, which helps in not overtrading an account. Exit or stop points, as well as projected profitable index price targets, are based on my technical analysis of the underlying indexes.

New Option Plays

Potential in Commodities

by James Brown

Click here to email James Brown


Cliffs Natural Resources - CLF - close: 56.12 change: +0.12 stop: varies

Company Description:
Cliffs Natural Resources Inc. (NYSE: CLF)(Paris: CLF) is an international mining and natural resources company. A member of the S&P 500 Index, we are the largest producer of iron ore pellets in North America, a major supplier of direct-shipping lump and fines iron ore out of Australia and a significant producer of metallurgical coal. With core values of environmental and capital stewardship, our colleagues across the globe endeavor to provide all stakeholders operating and financial transparency as embodied by the Global Reporting Initiative (GRI) framework (source: company press release or website)

Why We Like It:
The commodity-related names still offer some potential but it will depend on how the situation develops in Europe and how the euro and dollar react. If the dollar continues to rally commodities are going to struggle. Currently it looks like the euro has hit significant support and if the $140 billion bailout for Greece gets funded soon it should alleviate fears for further credit woes in Europe - at least for a while. I like CLF because the correction has stalled right where it should in the $50-55 zone, which as previous resistance should be new support. Yet before I go any further I have to warn readers that trading CLF is a high-risk bet. The Australian government is considering an extra 40% tax on profits for miners with operations in Australia and CLF is one of them. If that measure passes CLF could see further downside. I don't have a time frame on when this Australian tax might get voted on/approved. Keep your positions small!

All right I'm suggest we take a two-prong approach to trading CLF. The correction may not be over yet and shares could easily hit the $50-47.50 zone again. Let's use a dip at $50.25 to open small positions with a stop loss at $44.90 (again, this is a high-risk trade). If triggered at $50.25 our first target is $59.50.

If instead shares of CLF rallies from here then let's use a trigger at $60.60 to open small positions with a stop loss at $54.75. If triggered at $60.25 our target is $69.50.

Trigger #1 @ 50.25

Suggested Position: Buy the June $55 calls (CLF 10F60.00)

Trigger #2 @ 60.60

Suggested Position: Buy the June $65 calls (CLF 10F65.00)

Annotated Chart:

Entry on May xxth at $ xx.xx See trigger(s)
Earnings Date 07/29/10 (unconfirmed)
Average Daily Volume = 8.7 million
Listed on May 8th, 2010


Range Resources - RRC - close: 43.85 change: -2.38 stop: 48.10

Company Description:
Range Resources is an independent oil and gas company operating in the Southwestern, Appalachian and Gulf Coast regions of the United States. The Company pursues a growth strategy that targets exploitation of its sizeable inventory of lower risk development drilling opportunities including an increasing number of projects that target shale and coal bed methane resource projects. These development activities are combined with a complementary acquisition effort. Range’s 2008 year-end drilling inventory included more than 12,000 proven drilling projects, and its leasehold position totaled 3.7 (3.0 net) million acres. Proved reserves totaled 2.7 Tcfe, a 19% increase over the prior year. (source: company press release or website)

Why We Like It:
In the CLF call play I just said that resource names offer potential and that's true. Yet oil names have been hit hard and the correction in oil may not be over yet. On a short-term basis crude oil looks oversold and it could bounce. Originally I was looking at oil names with a bullish bias and they may be bullish candidates eventually. Currently the trend is down. RRC has been in a major consolidation for months with higher lows and lower highs. Shares finally broke down this past week. We have to trade what the charts are telling us not what we want or expect to see.

I am suggesting bearish positions now or on a another failed rally in the $45-46 zone. Keep positions small since the market is volatile and oil looks a little oversold. I would not be surprised to see a bounce near the December low near $42.00. However, our first target is $40.25. Our second, longer-term target is $36.00.

Suggested Position: Buy the June $40 puts (RRC1019R40)

Annotated Chart:

Entry on May 10th at $ xx.xx(?)
Earnings Date 07/22/10 (unconfirmed)
Average Daily Volume = 3.1 million
Listed on May 8th, 2010

In Play Updates and Reviews

Friday Offers No Relief

by James Brown

Click here to email James Brown
Current Portfolio:

CALL Play Updates

IMAX Corporation - IMAX - close 17.36 change -1.54 stop 16.75

Uh-oh! The last few days traders have been buying the dips in IMAX. During Thursday's market plunge IMAX dipped to $17.50 and bounced. Unfortunately that strength has failed. Friday saw IMAX plunge more than 8% on no news. Shares tested the 50-dma and hit $16.96 on Friday afternoon. I find this trading action very discouraging and several of the short-term technical indicators just rolled over again (naturally after an 8% drop). I would wait for a bounce back above $18.00 before considering new bullish positions. More conservative traders may want to raise their stop or sell part of their position to limit their risk. Our target is $20.95 which is just below the stock's 52 week highs.

Current Position: Long JUNE $20.00 CALL, entry at $1.10


Entry on May 5th at $1.10
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.9 million
Listed on May 4, 2010

Target Corporation - TGT - close 54.30 change -0.72 stop 51.75 *new*

The bulls have not given up on TGT yet. Traders continue to buy the dips. Unfortunately this past week TGT continued to see lower lows. Shares fell to $52.69 on Friday morning before paring its losses. The larger trend is still up and we anticipate that this is merely a normal, healthy correction. However, I am going to adjust our stop loss just a bit. The simple 100-dma near $52.00 should offer some technical support. I am moving our stop loss from $52.10 to $51.75. Readers may want to wait for some signs of strength (like a move over $55.00) before considering new call positions. Our target is $58.00. Our time frame is a couple of weeks. Target reports earnings on May 20th so we plan to be out of the trade prior to this date.

Current Position: Long JUNE $57.50 CALL, entry at $1.20


Entry on May 6, 2010 at $2.00
Earnings Date May 20, 2010 (unconfirmed)
Average Daily Volume: 5.2 million
Listed on May 5, 2010

PUT Play Updates

Sina Corporation - SINA - close 32.74 change -0.26 stop $38.80

The Chinese markets have not been immune to stock market weakness and SINA has broken down to new seven-month lows. Shares hit our first target at $33.25 on Thursday and there should be nothing holding up the stock between here and the $30 level but SINA does look a little oversold. The European markets might bounce if the EU can offer some sort of plan to protect the euro this weekend. That could influence Asian markets. Broken support near $35.00 should offer some overhead resistance. More conservative traders may want to consider adjusting their stop loss down toward the $36.50 area. Currently our second and final target is $30.50. Our time frame was originally several weeks but we may want to exit early ahead of the May 17th earnings report (after the closing bell). Current Position: JUNE $35.00 PUT, entry at $2.20


Entry on May 4th at $2.20
Earnings Date June 9, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010