Option Investor

Daily Newsletter, Wednesday, 2/27/2013

Table of Contents

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

Market Wrap

Bulls to Bears: Not So Fast

by Keene Little

Click here to email Keene Little
If you don't like the market's direction one day just wait since it will probably change the next. The market is getting very whippy with big moves and it's clobbering both sides as we're left to wonder if we have signs of topping or just consolidation before heading higher again.

Market Stats

Following a relatively quiet overnight session and no scary stories from Europe the bulls went back to work this morning and just kept at it all day long. The rise off yesterday's low has been a steady accumulation of stocks by fund managers believing the worst is over and whatever ails us will be solved. And if the problems aren't solved to the market's satisfaction we all know Uncle Benny and the Feds will bail us out and not let anything bad happen to us. He said so in his testimony to Congress and I believe him (cough). Certainly the market believes in the Fed's all-mighty power to not let the stock market decline.

After seeing the big spike in VIX on Monday I thought it was not a good sign for the bears. Each time traders panic and pile into short positions (buying puts) we've seen a market bottom. Granted, the decline from last week was very short in time (but almost equal to the December pullback in points for SPX) but it was enough to scare investors out of their long positions. That offered a buying opportunity for many of the fund managers, especially those who were interested in padding their accounts as we head into month-end (tomorrow).

Helping the bulls were economic reports from yesterday and this morning. Housing sales were strong yesterday (new homes) and very strong today (existing homes). Instead of an expected improvement from December's -1.9% to +1.0% we actually had a +4.5% increase in pending home sales. Between yesterday's and today's reports on home sales we got a very positive showing from the housing market. If that continues into the spring I'll have to back down from my negative view for the housing market this year but I suspect we have just a positive blip in what will be a negative year.

The other positive report, at least without transportation (aircraft) orders, was the Durable Goods report. It was -5.2% for January, down significantly from December's +3.7% (which had been revised lower from the previously reported +4.3%) and worse than the expected -3.5%. But taking out transportation the number was +1.9%, which was better than expectations for +0.2% and better than December's +1.0% (which was a downward revision from the previously reported +1.3%). The chart below shows both numbers since 1998 and the decline from the 2010 peak does not look encouraging but at least ex-aircraft (lower chart) is back above zero. I suspect it will continue to drop into negative territory as the economy continues to slow down.

Durable Goods Orders, 1998-January 2013, chart courtesy briefing.com

The whippy price action in the past week has seen SPX break some important trend lines and as can be seen on the daily chart below it's been flailing around broken trend lines since the top on February 19th. Last week it had briefly popped above the trend line along the highs from April-September 2012 by breaking above 1524 on February 19th but then right back down on February 20th, leaving a throw-over finish. On February 21st it then dropped below its uptrend line from October 2011- June 2012, which was then followed by Monday's quick burst back up to tag the April-September 2012 trend line before dropping sharply lower again, leaving a bearish kiss goodbye. It then solidly broke its uptrend line from October 2011-June 2012 and tagged the bottom of its up-channel from November (the bottom line is parallel to the line across the highs from November), which has now been followed by a sharp bounce back up to the broken Oct 2011-June 2012 trend line. Will it set up another bearish kiss goodbye?

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1526
- bearish below 1485

Today's rally got SPX up close to testing its downtrend line from last week, near 1521 by the close. If it can climb above that level it should be able to get above Monday's high near 1526, which would then point to new highs for SPX (1537 and 1551 upside targets). At the moment we're left to wonder if this is just another high bounce in the bull/bear battle or something more bullish. I had recommended shorting the bounce near today's high if only because resistance hasn't broken and the risk is small (to a stop just above 1526) while the reward potential is large. The bearish wave count calls for a very strong decline in a 3rd of a 3rd wave down, the one that would likely take SPX down to the 1450 area within a few days. It's possible we'll only get a pullback before heading higher so any decline from here (with a lower high below Monday's) should have shorts lowering their stops on short plays to the lower high). The pattern could go either way here.

S&P 500, SPX, 60-min chart

So how does this all fit in the larger picture? The weekly chart of SPX is shown below and you can see the battle that's been going on at multiple trend lines over the past few weeks. It's either in a topping pattern or consolidating in preparation for breaking through resistance. The trend line along the highs from April-September 2012, currently near 1527, remains resistance. The uptrend line from March 2009 through the August 2011 low (closing prices) was marginally broken but held and at about 1531 another test of it would be a test of last week's high. The uptrend line from October 2011-June 2012 is currently near 1518 and it held as resistance on a closing basis today. The weekly dojis for the past 4 weeks (including this week) indicate a real battle going on and at the moment there's some upside potential but bigger downside risk. Play it accordingly.

S&P 500, SPX, Weekly chart

An interesting way to look at the stock market is in relationship to the dollar. If we view the stock market rally as primarily driven by the Fed's efforts to inflate the stock market with newly created dollars then the value of the market is directly related to the value of the dollar, which is what the chart below shows. As the wave labels for the moves show, the entire rally from 2011 has been one big corrective mess of 3-wave moves. It's a 5-wave move up inside a rising wedge pattern and it can be called complete. The 5-wave move is an ending diagonal for the c-wave of a large A-B-C bounce off the 2009 low and is confirmation that the 2009-2013 rally is a correction and not a new bull market (it's a cyclical bull within a secular bear), which simply means we have to accept the fact that the whole thing could be retraced.

SPX/U.S. dollar, Daily chart

This chart shows the final high was actually on February 1st with a lower high on February 20th. The break of the uptrend line from November is likely significant and while we could see a back test of the trend line and another tag of the top of its rising wedge pattern I think that's unlikely. Notice the Fib relationships between the waves at each new high, especially the last two. Wave-3 is a 127% extension of wave-1 and wave-5 is a 127% extension of wave-3. This all adds credibility to the idea that the final high is in place.

From a timing perspective last week's high for SPX also fits well as an important high, if not THE high. There are several Fibonacci time relationships between important highs and lows since the 2009 low. One example is the time for the rally from the October 2011 low to the February 1st high on the chart above is 61.8% of the time it took for the rally from March 2009 to the April 2011 high. That's the A-B-C move up from 2009 and wave-C = 62% of wave-A in time. And as the chart above shows, wave-C (the rally from October 2011) now has a completed 5-wave structure (ending diagonal, or rising wedge, which explains all the 3-wave moves inside the wedge). For the move up from June 2012, the two rally legs were equal in time at last week's high. So we've got time and price both saying that an important top is occurring now and all we're waiting for is confirmation (until we get the confirmation the trend is of course still up).

Like SPX, the DOW is battling with several trend lines, acting as both support and resistance (but mostly resistance). The megaphone pattern that I've been watching has widened a bit to accommodate Monday's low but the top is still holding as resistance on a closing basis (it poked above it on Monday and again today). Megaphone patterns like the one drawn on the daily chart below are topping patterns until proven otherwise. Prices tend to get very whippy as the price range expands and then after the top the price range often contracts before breaking lower, which typically forms a diamond topping pattern. That could mean we'll stay in a whippy topping pattern through much of March so consider that potential in your trading plans.

We'll have to see if the right side of the pattern develops from here, especially since we don't know yet if price will negate the pattern and rally higher out of it. A decline below the bottom of the megaphone, currently near 13760, would also tell us a stronger decline will come sooner rather than later. The broken uptrend line from October 2011- June 2012, like SPX, is currently resistance and was nearly tagged today. It will be near 14136 on Thursday and 14143 on Friday. The all-time high at 14198 is acting as a siren song for the bulls right now. Also acting as resistance at the moment is the top of its parallel up-channel from 2010, which is where the top of the megaphone pattern is. Until price breaks up or down from this pattern it's a time for both sides to be very careful. Let the big boys duke it out here and we'll pick up the pieces when the direction becomes clearer. Just understand that for now it's a topping pattern.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,100
- bearish below 13,760

With the DOW pushing to a new high today, again all by itself, we naturally wonder if the other indexes will follow. It's actually been quite common for the DOW to make marginal new highs by itself, which makes sense when you think about this index being the go-to index when fund managers are worried about a coming decline. Many funds are required to be long all the time. Only a small amount of cash and no short positions are allowed in many funds so what's a fund manager to do if he must be invested but is worried about protecting his account? Get into the bluest of the blue chips and park your money there just in case the market takes a swan dive. It's a lot easier to exit a large position from a large blue chip than a small cap.

The chart below compares the DOW to SPX at recent tops since 2011 and as the arrows point out, the new highs for the DOW without the others following has actually been a good topping signal. A fractured market is an unhealthy market and at the moment that's what we have. That can change quickly but right now the DOW's new highs remain unconfirmed and that's bearish.

INDU vs. SPX, Daily chart

Along with the other indexes, NDX has been whippy since last week's high and today it bounced right back up into resistance, continuing its trading range between 2700 and 2750. In addition to price-level resistance at 2750, at the same location there is its broken uptrend line from November-December, the bottom of its broken up-channel from January 8th and its 20-dma, near 2748. The bears have some work to do to power through this brick wall but if they do then we'll know they mean business. As labeled in green, another choppy rally for the 5th wave of the move up from November will likely play out if NDX can get above 2758. It might make it only as high as 2800 or it could head up toward 2900. That will have to be figured out if and when it breaks higher.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2758
- bearish below 2689

The Nasdaq Composite index looks very similar but has been a little stronger since December (slightly steeper up-channel following the January 2nd gap up). Like NDX the COMPQ has bounced back up to the broken uptrend line from November-December (closing slightly above it) but it's also fighting its 20-dma at 3167 and its broken longer-term uptrend line from March 2009-October 2011, near 3175. If it drops back down from here it will leave a bearish kiss goodbye and could drop hard if the bearish wave count is correct.

Nasdaq Composite, COMPQ, Daily chart

The RUT also bounced back up to its broken 20-dma and is close to testing the top of its parallel up-channel from March 2012, near 916. If it can rally above 920 it could press up to the 950 area by mid-March. Otherwise a failure of the rally from here and back below 894 would likely be followed by strong selling, with the first stop probably near 850.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 920
- bearish below 894

The 10-year yield (TNX) looks to have completed a 3-wave bounce off its July 2012 low and achieved two equal legs up at 2.054% (to the tick) on February 14th and retested on the 20th. Since then it has dropped back down and broke its uptrend line from December. The larger pattern, shown on the weekly chart below, calls for a decline to about 1% by the summer and that should complete the 30-year decline in yields (meaning the end of the bond market rally). It takes a drop below 1.67% to better confirm the bearish setup for yields here whereas a rally above 2.13% would indicate higher rally potential. If TNX does drop down to the 1% area it will be a time to lock in rates that won't be seen in your lifetime again. From there I suspect the Fed will lose what little control they think they have since the market will dictate higher yields for the higher risk for U.S. debt (and the U.S. will not be alone in suffering higher borrowing costs starting later this year).

10-year Yield, TNX, Weekly chart

Banks appear to have confirmed a trend reversal by the looks of the BKX pattern. A 5-wave move down from the February 13th high is a good signal that the high for its rally from November is in place. Once the current bounce correction finishes, perhaps near its 20-dma at 54.59, it should then tip over and sell off stronger. Follow the money whichever direction it heads from here.

KBW Bank index, BKX, Daily chart

Yesterday's and today's home sales numbers boosted the home builders but the damage to the home construction index may have already been done. The pullback from its January 29th high is only a 3-wave move and therefore could be just a correction to a longer-term bull run and that potential needs to be respected. But the longer-term wave count calls the January top an important one and suggests the selloff will continue. This week's bounce has the index back up to its broken uptrend line from October 2011-November 2012 and a drop back down from here would leave a bearish kiss goodbye.

DJ U.S. Home Construction index, DJUSHB, Daily chart

The dollar's break above the price projection at 81.70 (two equal legs up from September 2012) without any bearish divergence suggests it will head higher. The price pattern calls for a brief consolidation before it heads higher and only a break below its 200-dma (and its up-channel from February 1st), at 81.03, would have me questioning the bullish pattern.

U.S. Dollar contract, DX, Daily chart

Despite concluding testimony from the seeker of inflation, Mr. Bernanke, gold did not react as if gold bugs believed inflation is coming. It reversed most of yesterday's rally and did not confirm the stock market rally (a warning sign for the stock market). The bearish wave count calls for gold to stair-step lower into April with a downside target for now at its 200-week MA, currently near 1416. But there's a larger bullish triangle pattern, the bottom of which is price-level support near 1525 so if gold approaches that level in the coming week I'd be careful about pressing any downside bets from there.

Gold continuous contract, GC, Daily chart

Unlike gold, silver has not broken below the trend line running along the lows from November, currently near 27.90. I see the potential for silver to drop down to that level, bounce into mid-March and then break through support, including price-level support near 26.15, on its way to much lower lows in April/May. But like gold, there's a potentially bullish triangle pattern running from the September 2011 low so a drop to 26.15 would be a good time to take any profits on short positions. Some had been watching a sideways triangle pattern, the bottom of which is the uptrend line from October 2008 but that was broken last week and yesterday and today that trend line is acting as resistance on the back test. A drop back down today leaves a bearish kiss goodbye.

Silver continuous contract, SI, Daily chart

Oil looks bearish from here. Since last week's update it dropped below its 50-dma and the top of an earlier up-channel from November, currently near 93.30. If that line, or the 50-dma, act as resistance the next downside test should be the 200-dma at 90.40.

Oil continuous contract, CL, Daily chart

The rest of the week is full of potentially important economic reports and the bulls will want (need) to see this week's good numbers continue. Tomorrow we've got the usual unemployment claims numbers and then GDP and Chicago PMI. Following the strong bounce back up the last thing the bulls need is a very disappointing GDP number (before the bell). Friday morning we'll get some personal income and spending numbers, PCE prices (inflation measure), Michigan Sentiment, ISM index and construction spending. We've got some potential land mines in there or it will keep the bulls feeling justified in buying more.

Economic reports and Summary

Tomorrow is the end of the month and the buying the past two days may have been end-of-month related -- there's still a need to keep the public interested in bellying up to the bar with their investment money and putting it into the stock market. Scaring away the sheeple is not a good way to keep the market elevated. Then we'll have new-month money coming in on Friday so the market could stay elevated and if it heads any higher on Thursday it will offer convincing evidence that all the indexes will head higher with the DOW. Look out 2007 highs, here we come.

But if the end-of-month buying is done and if we get some disappointing news from overseas or tomorrow morning and if Monday's highs stand (DOW excluded) then there is the risk that a strong selloff could follow. The whippy price action is typical in a topping pattern (and the DOW's megaphone pattern supports the idea that it too is topping) and it's a time for caution -- both sides are getting whipped out of their positions. Let the direction establish itself from here and then pick a direction to trade. Trade safe (if at all while waiting for clarity) and good luck. I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying

New Option Plays

Multi-Year Highs

by James Brown

Click here to email James Brown


Home Depot - HD - close: 68.06 change: +0.50

Stop Loss: 66.40
Target(s): 74.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The home improvement giant has bounced back to multi-year highs following its recent earnings report. HD beat estimates by three cents with a profit of 67 cents a share. Revenues were also a beat at $18.25 billion for the quarter. Same-store sales were up +7% in the fourth quarter. Investors ignored management's bearish, downside full year guidance and instead applauded HD's +34% rise in the quarterly dividend to 39 cents a share and a $17.0 billion stock buy back program.

I am suggesting a trigger to buy calls at $68.50. It is possible that the $70.00 level could act as round-number, psychological resistance especially since the stock failed their multiple times in the 1999-2000 time frame. However, we are going to set our sights on a run to $74.00. FYI: The Point & Figure chart for HD is bullish with a long-term $95 target.

Trigger @ 68.50

- Suggested Positions -

buy the Apr $70 call (HD1320d70) current ask $0.87

Annotated Chart:

Entry on February -- at $---.--
Average Daily Volume = 6.9 million
Listed on February 27, 2012

In Play Updates and Reviews

The Rebound Continues

by James Brown

Click here to email James Brown

Editor's Note:

The buy-the-dip rebound continues with stocks up in another widespread bounce on Wednesday.

Our CP and FFIV trades have been triggered. We are adjusting the trade on the IYT. TWC has been removed.

Current Portfolio:

CALL Play Updates

Check Point Software Tech. - CHKP - close: 52.72 change: +0.68

Stop Loss: 50.75
Target(s): 54.50
Current Option Gain/Loss: +52.6%
Time Frame: 3 to 6 weeks
New Positions: see below

02/27/13: The stock market's widespread rally on Wednesday helped lift CHKP to a new multi-month high. Readers may want to start inching up their stop loss again. I am not suggesting new positions at this time.

*Small Positions* - Suggested Positions -

Long Mar $50 call (CHKP1316c50) entry $1.90

02/25/13 market looks weak, readers may want to exit now
02/20/13 new stop loss @ 50.75
02/16/13 CHKP looks poised to dip back toward support at $50.00
02/13/13 new stop loss @ 49.90
02/06/13 new stop loss @ 49.40

Entry on February 01 at $50.25
Average Daily Volume = 2.7 million
Listed on January 31, 2012

Canadian Pacific Railway - CP - close: 121.70 change: +3.95

Stop Loss: 116.60
Target(s): 124.75
Current Option Gain/Loss: +12.7%
Time Frame: 3 to 4 weeks
New Positions: see below

02/27/13: The transportation sector rallied sharply today and CP helped lead the charge with a +3.3% gain and a bullish breakout to new highs past resistance near $120.00. Our trigger to buy calls was hit at $120.25.

Earlier Comments:
FYI: On Friday, Feb. 22nd, CP announced a quarterly dividend of 35 cents (Canadian$) payable on April 29, 2013 to shareholders of record on March 28th.

- Suggested Positions -

Long Mar $120 call (MAR1316c120) entry $2.75

Entry on February 27 at $120.25
Average Daily Volume = 795 thousand
Listed on February 23, 2012

McDonald's - MCD - close: 95.73 change: +0.28

Stop Loss: 93.25
Target(s): 99.75
Current Option Gain/Loss: +40.9%
Time Frame: 3 to 6 weeks
New Positions: see below

02/27/13: Shares of MCD began trading ex-dividend this morning for its quarterly dividend (of 77 cents). The stock slowly rallied higher off its morning lows.

FYI: The Point & Figure chart for MCD is bullish with a $115 target.

- Suggested *Small* Positions -

Long Apr $95 call (MCD1320d95) entry $1.66

Entry on February 25 at $95.38
Average Daily Volume = 4.9 million
Listed on February 23, 2012

CBOE Volatility Index - VIX - close: 14.73 change: -2.14

Stop Loss: 11.45
Target(s): 19.90
Current Option Gain/Loss: - 7.8%
Time Frame: 8 to 9 weeks
New Positions: see below

02/27/13: The VIX is down over two points for the second day in a row and it still hasn't not erased Monday's gain. If the stock market continues to climb we could definitely see the VIX retreat toward its recent lows. I am not suggesting new positions at this time.

- Suggested Positions -

Long Apr $16 call (VIX1317D16) entry $1.90

02/25/13 adjust exit target to 19.90

Entry on February 10 at $13.37
Average Daily Volume = n/a
Listed on February 09, 2012

PUT Play Updates

Capital One Financial - COF - close: 51.59 change: +0.12

Stop Loss: 54.55
Target(s): 48.50
Current Option Gain/Loss: +28.4%
Time Frame: 3 to 4 weeks
New Positions: see below

02/27/13: COF did produce a bounce today but shares definitely underperformed the broader market and the financial sector. Look for short-term resistance at the descending 10-dma (currently 52.85). That's if COF can break out past what should be resistance at $52.00 now. I am not suggesting new positions at this time.

- Suggested Positions - *Small Positions*

Long Mar $52.50 PUT (COF1316o52.5) entry $1.23

02/23/13 be careful here. COF is holding support at the $52 level. Shares could be poised to bounce.

Entry on February 20 at $52.25
Average Daily Volume = 5.9 million
Listed on February 19, 2012

F5 Networks - FFIV - close: 93.04 change: -1.60

Stop Loss: 96.75
Target(s): 86.50
Current Option Gain/Loss: + 5.7%
Time Frame: 3 to 4 weeks
New Positions: see below

02/27/13: Our new trade on FFIV has been triggered. The stock underperformed the market with a -1.69% decline and a new relative low. Our trigger to buy puts was hit at $93.50.

Earlier Comments:
It's possible the $90.00 level could act as round-number, psychological support but we are going to aim for the $86.50 level.

- Suggested Positions -

Long Mar $95 PUT (FFIV1316o95) entry $2.10

Entry on February 27 at $93.50
Average Daily Volume = 1.4 million
Listed on February 26, 2012

Fossil, Inc. - FOSL - close: 101.99 change: +1.68

Stop Loss: 103.30
Target(s): 93.25
Current Option Gain/Loss: -53.1%
Time Frame: 3 to 4 weeks
New Positions: see below

02/27/13: Our FOSL put play is not looking so great. Shares have bounced two days in a row. Today FOSL's rally stalled right at the $103.00 level where the 10-dma and 40-dma are converging. If there is any follow through higher we'll likely see FOSL hit our stop loss at $103.30. I am not suggesting new positions at this moment.

- Suggested Positions -

Long Mar $95 PUT (FOSL1316o95) entry $1.60

Entry on February 26 at $ 99.21
Average Daily Volume = 1.1 million
Listed on February 25, 2012

iShares Dow Jones Transports - IYT - close: 103.59 change: +0.20

Stop Loss: 108.25
Target(s): 100.25
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

02/27/13: Wow! You have to give the bulls credit for an impressive display in the transports today. The Dow Jones Transportation Average surged +2.9% and came close to hitting its recent all-time high set last week. In spite of this strength there is still a decent chance that the sector corrects lower.

We are modifying our entry point strategy and taking a much more aggressive trade. I am suggesting small bearish put positions now at the open tomorrow. The all-time intraday high on the IYT is 107.16. More conservative traders may want to put their stop loss about $107.25. I am suggesting a stop loss at $108.25. That's about 1% above the all-time high. We'll adjust our exit target to $100.25. I am also adjusting our strike price to the April $105 puts.

Launch Small Positions Now!

- Suggested Positions -

buy the Apr $105 PUT (IYT1320p105) current ask $2.20

Annotated Chart:

Entry on February -- at $---.--
Average Daily Volume = 610 thousand
Listed on February 26, 2012

Monsanto Company - MON - close: 100.40 change: +1.20

Stop Loss: 100.65
Target(s): 92.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

02/27/13: MON continued to bounce for the second day in a row. Yet the stock still seems to be struggling with resistance at its 40-dma. There is no change from my prior comments.

Last week's low was $97.90. I am suggesting a trigger to buy puts at $97.80. If triggered our target is $92.50.

Trigger @ 97.80

- Suggested Positions -

buy the Mar $95 PUT (MON1316o95)

Entry on February -- at $---.--
Average Daily Volume = 2.5 million
Listed on February 25, 2012


Time Warner Cable Inc. - TWC - close: 88.02 change: +1.56

Stop Loss: 86.30
Target(s): 80.25
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: see below

02/27/13: TWC is not cooperating. Shares are breaking out past the bearish trend of lower highs. Our trade has not opened yet so we're dropping TWC as an active candidate.

Trade did not open.

02/27/13 removed from the newsletter


Entry on February -- at $---.--
Average Daily Volume = 3.6 million
Listed on February 21, 2012