Option Investor

Daily Newsletter, Wednesday, 5/12/2010

Table of Contents

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

Market Wrap

Looking Under the Hood

by John Gray

Click here to email John Gray
When the nearly $1 trillion economic stabilization package for Greece (and other troubled southern European countries) was announced on Sunday the markets around the globe roared their approval on Monday with the largest one-day rally in years. In reality, of course, what actually occurred was that all of the day's gains happened in the futures market before the cash market opened. This forced fund managers to buy the stocks in the underlying indexes. Once the huge gap up opening occurred, the markets simply traded flat for the rest of the day. This is not unlike what happened on last Thursday (except in reverse).

Now that the dust has settled it is time survey the landscape and see what really happened and assess the new realities. The problem started with Greece, who economy is about the size of the Dallas/Ft. Worth metroplex (insignificant in the grand scheme of things). Of course it was evident to most intelligent observers that Greece was merely a symptom of a larger malady that affected the entire region. The European finance ministers' decision to monetize the debt did little to address the structural changes that will be necessary (and difficult) to return the region to a sound financial footing. Jim's analogy in last night's Wrap was probably pretty accurate when he said that it was like taking a cash advance on one credit card to pay off the balance on another credit card.

Since the end of WW II most European countries (including England, Ireland, and Scandinavia) have opted for what, I shall euphemistically refer to as a "progressive" form of government. Some might be offended if I called it socialistic. They like 35-hour work weeks; they like two months of paid "holiday' per year; they like to be paid when they don't work; they like free universal health care; they like labor unions because labor unions do what labor unions always do - negotiate contracts that provide more benefits for less work, and make it harder to fire or lay off workers; they like generous pensions that can be taken early. All of these "entitlements" have been woven into the social fabric for decades. It all works well and good until an economic downturn occurs and governmental tax revenues are slashed.

My oldest son heads the internal audit division for a Seattle-based equipment manufacturing business that has plants in Europe, South America, and Australia. His job requires a lot of travel. He complains that when he goes to Europe he is often frustrated because the people with whom he must interact come in late and leave early or are absent because they are on "holiday". The point is that it is going to be very difficult to get Europeans to accept the new reality and do the things necessary to straighten out their mess. I predict widespread social unrest. Witness what is already happening in Greece with strikes, protests, fires, etc.

Australian Treasurer, Wayne Swan, unveiled a national budget Tuesday that forecasts a return to a surplus in two years and retiring the country's debt by 2019. Wow, does Australia occupy the same planet as Europe (or the United States)? Australia has raised interest rates twice.

NEW YORK (MarketWatch)-- Shares of Wall Street investment banking giant Morgan Stanley /quotes/comstock/13*!ms/quotes/nls/ms (MS 27.29, -1.09, -3.84%) fell about 4% on Wednesday morning after the Wall Street Journal reported that federal prosecutors are conducting a preliminary investigation of the firm's mortgage trading business. Morgan Stanley told the paper is has not been contacted by the government regarding a probe, and its Chief Executive James Gorman reiterated that point at a press conference on Wednesday in Tokyo, the paper said. Morgan Stanley shares fell 3.98% to $28.38 in preopen trading.

That's the way they do it in Washington - pile on and kick 'em while they are down. The public outrage over Goldman Sachs has no doubt emboldened Federal prosecutors to launch additional witch hunts.

The U.S. Senate is poised to pass a bill that would direct the GAO to conduct a one-time audit of the Federal Reserve. This would be the first time in the Fed's 95-year history that they have been audited. While the Congress and the American people were fretting and debating about the $700 billion TARP package last year, the Federal Reserve was quietly and secretively loaning out over $2 trillion. They have refused to disclose to whom it was loaned, in what amounts, and the terms for repayment. Congress would like the answers to those questions (and so would I). My only question is, "Why did it take you so long and why limit it to only one audit?"

"A veteran is someone who, at one point in his life, wrote a blank check made payable to the United States of America, for an amount up to and including his life". Now that is honor, courage and commitment. Please don't ever, ever let this country treat its service men and women the way my brothers and I were treated when we returned from Vietnam. They work very hard, for very little pay, in some of the harshest conditions imaginable. They deserve your respect. Remember, they are following orders. If you don't like what they are doing take it up with the people who sent them there.

Gold has gone absolutely bonkers. It makes new highs every day. Presumably, these goldbugs are betting that the shiny metal will protect them from the perceived threat of future inflation coming out of China or the monetization of the European debt. In any event gold has disconnected from the dollar and is marching to the beat of its own drummer. Despite prediction from various talking heads that see gold going to $1500 or even $2000 I would be hesitant to buy at these nose-bleed levels. It could be forming a double top here.


One of the proposed provisions that are being considered by the Senate as they debate financial regulatory reform is a ban on proprietary trading (trading their own account as opposed to trading their client's account). This primarily would affect the five or so large banks (formerly investment banks). This will probably cause a hue and cry from those institutions because last quarter their huge earnings were largely attributable to massive profits made by their trading desks. I can envision legions of lobbyists being assembled, getting ready to go into battle to thwart this attempt. In my humble opinion Glass-Stegall should never have been repealed.

Boeing Aircraft (BA) unveiled today its latest design for a new UAV (unmanned aerial vehicle). They will call it the "Phantom Ray". It employs stealth technology and uses the "flying wing" design used by the B-2 bomber. The "Ray" will be able to operate at 40,000 feet and travel at 640 mph (Mach .8). Its mission could either be reconnaissance or direct interdiction. Military procurement has dropped off for manned (piloted) aircraft but continues at a high level for UAV's.

Phantom Ray

Last week's blood bath did considerable technical damage to the major indexes. Previous levels of support were easily broken and have now turned into resistance. The first level that SPX must regain and close above is the 1170-1171 area. The 50 DMA and the 62% retracement level reside in this area. If it can successfully conquer this level it will run into heavy resistance again at the 1180-1185 area which had previously acted as support since the first of April. SPX charged boldly out of the chute this morning and headed for its first test. It briefly touched 1169 at 11:06 AM and promptly bounced back and retested it again in the early afternoon.

SPX - Daily

It is rather interesting that a fractal pattern very similar to the one that exists today happened in October, 2008. In that previous instance the market imploded (like Thursday and Friday). It gapped up huge on the following trading day (think Monday) on news of a big bank rescue (I think). What happened after that is what I find interesting (and perhaps instructive). SPX lost almost 300 points over the next month before it began a recovery. I have borrowed one of Keene's charts from yesterday's Market Monitor to illustrate the point.

SPX - 2008

Jim did a masterful job of covering the oil spill in the Gulf in yesterday's Wrap so I won't go into any more details other than to say that the "blame game" has already begun. We could probably tag this as the "Lawyers' Relief Act of 2010". The Goldman Sachs (and now Morgan Stanley) case will enhance the solicitors' bank accounts as well. I smell a new "cottage" in the Hamptons.

Yesterday a friend emailed me a picture of an order that he was contemplating placing with E-trade. I have attached the picture below, but it may be difficult to read. Essentially, he wanted to buy 10 contracts of the March, 2011, 87 put on SPY. He was placing the order as a market order which would mean that he probably will be filled at the "ask" price. He wanted my opinion on the trade. He obviously has a very bearish view of the future. I pointed out to him that there is almost a 100% chance that he will lose his money if he plans to hold it until expiration in March, 2011. However, if he is willing to trade the position at any time he could make some good money if the market took a major dump (like last Thursday).

E Trade

Buying deep OTM options is a crap-shoot, but they can yield huge dividends (percentage-wise) if they make a big move in your direction. I was struck by something that Linda said in her Trader's Corner article last Friday. Since she primarily trades credit spreads and Iron Condors, directional trading is not something she does routinely except that she sets aside 10%-15% of the credit she receives to buy long puts. Now, that's a good plan.

You have heard us preach for months now how market declines can be swift and vicious. If you didn't believe it before, you just witnessed three month's worth of gains wiped out in three days. Sometimes you simply don't have time to do something to protect yourself. You buy insurance for your cars; you buy insurance for your house. Why not buy some insurance for your portfolio? As with your car and your house you hope you never have to file a claim, but it is comforting to know that it's there.

What is mankind's greatest invention? If you answered "The Wheel" or "Beer" I would give you high marks, but that's still not the right answer. For someone who spent the first sixteen years of his life growing up in Florida without air-conditioning, the answer is obvious - A/C. Without it, Florida would still be a steamy, insect and reptile-infested swamp. When the first window units showed up, my parents bought one and installed it in their bedroom. My brother and I had to do with the attic fan. If that were today I would march right down to my local office of Health and Human Services and file a child abuse complaint.

So, where is this market headed? I don't know the answer, but I have an opinion. I think we will see lower (and maybe much lower) before the April 26th high is breached again. The 14-month rally from March, 2009, came too far, too fast (IMO), and was not consistent with the economic realities on the ground. The last leg of the rally was characterized by low volume on up days (like today), and much higher volume on down days. This all suggests waning momentum and a lack of participation by the bulls. If proprietary trading is ever banned (don't hold your breath), the markets will be less manipulated than they are today (maybe). I don't mind telling you that some days (like today) I hate this market, and wish that I were doing something else for a living.

New Option Plays

A Bet On Volatility

by Scott Hawes

Click here to email Scott Hawes


Powershares QQQQ Trust - QQQQ - close 48.62 change +0.90 stop 49.60

Company Description:
PowerShares QQQ Trust, Series 1 (the Trust) is a unit investment trust that issues securities called PowerShares QQQ Index Tracking Stock. The Trust holds all of the component securities of the Nasdaq-100 Index (the Index). The Investment objective of the Trust is to provide investment results that generally correspond to the price and yield performance of the Nasdaq-100 Index. Invesco PowerShares Capital Management, LLC is the Sponsor of the Trust and The Bank of New York Mellon is the Trustee. (source: company press release or website)

Target(s): 46.80
Key Support Areas: 47.20
Key Resistance Areas: 49.00, 49.30
Time Frame: 1 to 2 weeks

Why We Like It:
The snap back rally from last week's plunge has been nothing short of incredible. But I believe it is time for a snap back down and I suggest readers take advantage of it by initiating PUT positions in QQQQ. The ETF is approaching the 20-day SMA from below and has also retraced over 61.8% of the decline from the April 26 highs of $50.65 to the May 7 low of $44.28. I threw out the long bottom wick from Thursday's plunge because it may or may not have been "real." In any event, anyone who has held positions throughout the past couple of weeks has to be thinking about selling positions now that the retracement back up has come so far. And if they were stopped out they are probably hesitant to jump right back in. In addition, QQQQ is approaching a a secondary and primary downward trend line and volatility has been sucked out of the option premium over the last several days. An increase in volatility will be good for our option premium. Volume has been lighter than normal on this impressive rally which is also a bearish signal. I believe now is a good time to initiate PUT positions at current levels or a failed rally into the $49 area just overhead. This also gives us a good reference point to place a stop at $49.60 which is above the downtrend line and the 20-day SMA. I will be surprised if QQQQ can break through this congestion but if it does we should have a relatively small loss. The trade also set up a good 2:1 risk reward ratio. We are risking $1.00 to make $2. Our stop is $49.60.

Suggested Position: JUNE $48.00 PUT, current ask $1.27

Annotated chart:

Entry on May xx
Earnings N/A
Average Daily Volume: 100 million
Listed on May 12, 2010

In Play Updates and Reviews

IMAX Target Hit

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. We closed IMAX today as our target was hit. It appears the volatility was sucked out of our premium over the last few days so the gain is small, but it is still a gain. Please review the TGT play as I am suggesting we close this position tomorrow. We are currently up +92% on this position and I want to protect profits.

Please be cautious with your positions and use small position size to limit risk. This volatility is incredible and I feel like the rug could be pulled out from underneath the market at any moment. I have been listing multiple support/resistance areas I see on charts (both daily and intraday) to help guide you with potential entries and exits. I hope this helps when managiing positions. We have a good balance in the portfolio so please stay nimble and take profits when presented with the opportunity. Keeping your powder dry is also an option until more normalized conditions return.

Current Portfolio:

CALL Play Updates

Cliffs Natural Resources - CLF - close 57.34 change +0.68 stop 54.75

Target(s): 58.95, 60.95, 65.90, 69.50
Key Support Areas: 54.75, 52.75
Key Resistance Areas: 58.95, 61.00, 66.00
Current Gain/Loss: -38%
Time Frame: 1 to 2 weeks
New Positions: Yes, with tight stop

CLF traded down to its intraday high from January 11th and reversed immediately. The stock also broke through intraday downtrend line. Hopefully CLF can get some legs from here, otherwise we need to exit this trade and protect capital. I expect the stock to gravitate towards its 50-day and 20-day SMA the recent volatility has me concerned. We are still down -38% since yesterday's shellacking. If the stock can somehow find the strength to rally from here readers should consider exiting the position at $58.95 which is about where CLF reversed back down on Monday. The next level would $60.95 which is just below yesterday's highs. Hanging on to the position and hoping it recovers further is not a smart strategy. All of these targets are listed above.

*Note: Please use small position size due the high volatility of this stock and political risks involved from the Australian government's proposed miner tax.*

Current Position: Long JUNE $65.00 CALL, entry at $3.10

Entry on 5/10/2010
Earnings Date 7/29/2010 (unconfirmed)
Average Daily Volume: 8.7 million
Listed on 5/8/2010

JP Morgan - JPM - close 41.69 change +0.14 stop 39.50

Target(s): 43.75, 44.70, 46.50
Key Support Areas: 41.00, 40.50, 39.75
Key Resistance Areas: 42.05, 43.75, 45.00, 47.00
Current Gain/Loss: -18%
Time Frame: 1 to 2 weeks
New Positions: Aggressive traders only

It took awhile to get JPM going today but it finally got going in the last 2 hours of trading. The result is a bottoming tail candlestick on its daily chart. JPM has entered an intraday resistance area and downtrend line. The price is coiling on the intraday charts and the gap higher on Monday was closed today, which right when JPM started to lift. The symmetrical triangle on the intraday charts should be resolved tomorrow. If it is to the upside we are looking for quick trip up to our first target of $43.25. I am looking for JPM to bounce from here so we can book a quick profit. $43.25 is just below the 20-day and 50-day SMA's which should provide resistance. With the market volatility showing no signs of waning this is a logical place to exit the position. If JPM is weak in the coming days I expect $40.50 to hold as support. This is where an upward trend line that began on July 6, 2009 and horizontal support dating back to August 2009 converge.

Current Position: JUNE $42.00 CALL, entry at $1.95

Entry on May 11, 2010
Earnings Date July 15, 2010 (unconfirmed)
Average Daily Volume: 46 million
Listed on May 10, 2010

Target Corporation - TGT - close 57.13 change +0.85 stop 55.48 *NEW*

Target(s): 58.00
Key Support Areas: 56.50 (20-dma), 54.75, 52.30,
Key Resistance Areas: 56.75, 58.00
Current Gain/Loss: +92%
Time Frame: 1 to 2 weeks
New Positions: No

TGT had its highest close since April 29th today. We have now gained +92% on this trade. The stock is approaching a downtrend line from its April 26th highs and there is also overhead resistance. I urge traders to be careful here and suggest taking profits. Squeezing out another 85 cents on the trade will become stressful and may not happen. I would like to move up our stop again to $55.48 to protect capital. If TGT trades below this level the stock will probably fill the gap higher from Monday. A tighter stop could be placed at $56.48 which is just below the 20-day SMA. I suggest traders that do not have access to intraday trading place a stop at this level. For those that can monitor the position this is how I suggest exiting: wait for the first 5 or 15 minutes of trading to open, depending on your style. After the first candlestick is closed see how the next one closes. If the 2nd's close is below the 1st's traders may want to exit. If the 2nd's close is higher than the 1st's close traders probably want to trail their stop up. Another strategy would be to place one cancels the other (OCO) order and place sell orders below and above the current bid. Please protect profits on this position and email me with any questions.

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

Range Resources Corp - RRC - close 48.05 change +0.38 stop 50.75

Target(s): 45.00, 44.00, 42.50
Key Support Areas: 46.00, 45.00, 43.30
Key Resistance Areas: 49.00, 50.00
Current Gain/Loss: -15%
Time Frame: 1 to 2 weeks
New Positions: Yes

RRC rallied almost up to yesterday's highs but didn't quite make bfore turning back lower. The stock also reversed right at its 20-day SMA and a downward trend line that began on April 26th. RRC remains below a bunch of congestion near $49.00 that I don't think it can overcome, especially if the market gets weaker from here. All of its daily SMA's are overhead along with several downtrend lines and broken uptrend lines. I continue to like the way this trade sets up but we can't get too confident. We're keeping a tight stop at $50.75 and will step aside if it trades up to this level. We are looking for a $2.50 to $5.00 move to the downside which will garner a nice profit on the trade if it happens. We chose further out of the money options than usual to reduce risk in the trade. *NOTE: Please use small position due to the volatility in this stock and the recent sell off in oil oversold.

Current Position: JUNE $42.50 PUT, entry at $0.95

Entry on 5/11/2010
Earnings Date 7/22/2010 (unconfirmed)
Average Daily Volume: 3.1 million
Listed on 5/8/2010

Sina Corporation - SINA - close 35.11 change +1.35 stop $36.80

Target(s): 33.25 (hit), 32.50, 30.50
Key Support Areas: 32.50, 30.50
Key Resistance Areas: 35.30, 36.00, 37.60
Current Gain/Loss: -14%
Time Frame: 1 week
New Positions: Yes, but only as a quick trade

SINA rallied today and closed +4% today. After being in positive territory yesterday our position is now in the red. My technical comments are mostly the same. The stock remains below broken support near $35.30 and is also below all of its major daily and weekly SMA's. The 50-day SMA crossed below the 200-day SMA which is a bearish signal that confirms our outlook for this stock. I expect the overhead resistance and SMA's to hold. Our stop has been moved down to $36.80 to protect capital if SINA somehow manages to continue higher from here. SINA is approaching earnings on May 17th so we plan to be out of the trade on or before this date. I urge readers to book gains or tighten stops as SINA approaches $32.50. Our target is just above the low from Friday.

Current Position: JUNE $35.00 PUT, entry at $2.20

Entry on May 4th at $2.20
Earnings Date May 17, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010

Tempur-Pedic International - TPX - close 35.06 change +1.28 stop 36.25

Target(s): 31.50, 30.25
Key Support Areas: 33.25, 32.40, 31.30, 30.00
Key Resistance Areas: 34.25, 35.10
Current Gain/Loss: -25%
Time Frame: 1 to 2 weeks
New Positions:

Well, I guess all good things haven't come to an end just yet for TPX. The stock gapped higher at the open which triggered our entry to buy PUTS at $1.40. They are now worth about $1.05 and we have lost -25%. TPX proceeded to bust right through the downtrend line that started on April 23rd and closed +3.79% higher. Is this market really going to make more new highs after last weeks debacle? If it does we do not want to be involved with this stock. I see resistance right in the $35.20 area, which is where TPX reversed on April 30. Volume still looks bearish and signals distribution. The heaviest volume today by far was during the last 15 minutes of trading which is when the stock turned down. Overall volume was still lighter than recent down days. Lets see what happens tomorrow. If TPX is strong and the overall market continues its rally traders should consider exiting the position to protect capital. $35.52 is a logical place for a tighter stop. This is above today's high and the high on April 30th.

Current Position: JUNE $32.50 PUT, entry at $1.40

Entry on May 12, 2010
Earnings July 15, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 11, 2010