Option Investor

Daily Newsletter, Wednesday, 4/17/2013

Table of Contents

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

Market Wrap

Volatile Opex Week

by Keene Little

Click here to email Keene Little
Opex weeks in the recent past have been relatively quiet and bullish. This week's opex has been volatile and bearish, perhaps indicating a change in character for the market.

Market Stats

Monday started with a big gap down and sold off hard. Tuesday started with a big gap up and continued higher for the rest of the day, finishing at its high (although not with the speed or volume of Monday's selling). Today started with a big gap down and sold off hard into a midday low before grudgingly bouncing back up some into the close. Any guesses for Thursday? It's actually set up for a higher bounce and this one could at least make it a little higher than Tuesday's.

Tuesday's close at the high of the day, followed by an immediate reversal this morning, is a common pattern in this market. Whether it's HFTs or something else, we're seeing the market oftentimes finishing at the high or low of the day and then immediately reverse the following day. Tuesday's finish looked bullish and very likely had more than a few traders leaning long into the close. But in fact the better play was to enter a short position at the close. Usually it feels like absolutely the wrong way to go but more often than not it's a winning trade.

Tuesday's bounce was very likely mostly short covering, with a lot of dipsters in there as well. Buying the dip has been a working strategy for so long that it will continue to pull in traders for some time to come. But when the market finishes at the high it's often because shorts have been forced to cover into the close once it becomes obvious they're not going to get a pullback to let them out. That leaves the market vulnerable the following day and without more buyers the market simply sells off. It works the same in the opposite direction. Use this pattern to make some trades and you'll see it works most of the time.

This morning's decline was blamed on a bad earnings report from Bank of America (BAC), which had disappointing earnings. But in fact the decline was well underway during the overnight session before BAC reported this morning. Yesterday's relatively weak bounce (on lower volume) was followed by more selling. But market pundits have to have a reason to report why it's selling so they pick the most convenient news piece to help make sense of it. There were no economic reports that had any impact on this morning's trading.

In the afternoon, at 2:00, we got the Fed's Beige Book report and the good news is that most districts showed moderate growth in the period of late February to early April. Those districts benefitting from residential construction and automobile manufacturing had the best growth. Those districts involved with defense sectors were weak. Consumer spending grew modestly but was suppressed by the tax increases. The residential and commercial real estate market showed some signs of improvement but loan demand remains somewhat subdued. The employment picture remains weak. In other words there was nothing new that we haven't already heard and in fact the market barely moved when the report was released. Interestingly, the U.S. dollar took a big jump after the report was released but not much else reacted.

For a general sense about what's happening to the economy here are a group of charts I recently ran across, showing the state of our economy. As the title of the chart states, it's really a sign of the economic depression we've been in and will continue to be in until the cycle runs its course.

Signs of an Economic Depression

I squeezed the charts smaller so they might be a little hard to read but the first chart (top left) shows the labor force participation rate and it's very apparent that the decline since 2008 has been steady, currently below 64% and the lowest it's been for the past 34 years (1979). The stock market recovery since 2008 has meant nothing for people looking for a job but has instead only further enriched the lives of those who work on Wall Street.

The 2nd chart (top right) shows the decline in real household income since 2008. We supposedly have been out of the recession since mid-2009 but you wouldn't know it by household income levels. The 3rd chart (middle left) shows the increase in the number of U.S. households in poverty, which has been climbing (this chart is old and today's number is even higher).

The 4th chart shows the personal savings rate. After the 2007 housing bubble peaked Americans were starting to save again but the first three charts help explain why the savings rate is heading back down again. The last chart (bottom) is the number of Americans on food stamps, which shows steady growth since 2007. The number of people on disability has increased dramatically as people seek some form of government help when they can't find employment. We continue to create a very large government-dependent class of people and I'm sure most would rather have gainful employment if they could find it.

This is only a small sample of charts that reflect the true nature of our "recovery" since 2008. As Jim and I have often stated recently, when the Fed is no longer able to support the stock market on fluffy nothingness it's going to crash. The big correction still needs to run its course and the Fed's efforts have only made the situation worse. There's a bad moon rising

One thing I often hear is how much cash is sitting on the sidelines and how bullish that is for the market. All we need is an excuse for them to come rushing in to send the market to the moon (not the bad moon rising). This is especially true when people talk about the hordes of cash held by companies. The opinion of most is that the cash will be used to buy back stock (to improve earnings per share), pay out dividends, buy capital equipment, create more M&A activity, etc. The below chart caught my eye because it says it isn't so -- Citi's High Grade Credit Strategist Jason Shoup considers this belief to be one of the more popular finance myths of our time.

Shoup says "What's misguided is the narrative, in our view, in particular among equity investors. What we most take issue with is the implication that corporates have lots of cash to return to shareholders. Indeed, there's plenty of data to the contrary that challenges the prevailing notion that corporates are the picture of good health." He looks at cash relative to debt, which is useful for measuring a company's ability to service its debt and as he points out, the cash-to-debt ratio has been dropping since 2005 and is headed lower again after a small bounce off the 2009 low. The important takeaway here is that corporations are Not hording large stockpiles of cash.

Cash-to-Debt Ratio, chart courtesy MoneyGame

We've got numbers showing people in worse shape than they've been for a long time and companies that have shrinking cash levels relative to their debt levels, all while the stock market rallied to new all-time highs. See the severe disconnect here? One will correct to the other and I might be going out on a limb here but I think it will be the stock market that corrects to reality rather than the other way around. I know, that's a bold prediction and I might have to eat my words but that's the way I'm casting my ballot. The stock market will soon be kicked off the island.

For the week there's not much of a change since Monday's update and in fact SPX closed only 35 cents below Monday's close. The weekly candle therefore looks the same (except for a small shadow under the body with today's new intraday low). Friday's close will be important to see if the candlestick pattern between last week and this week becomes a tweezer top.

On Monday I showed my expectation for a test of its 50-dma and then a bounce into the end of the week and today we got the test so now we'll see if we get the bounce. A bounce into Friday before a stronger decline next week is what I'm expecting but it's possible it will waste no time and simply decline from here. The wave count for the decline from last week looks set up for a bounce but if there's no bounce we could see a very strong selloff from here instead. In addition to the wave count and its 50-dma SPX also tested the bottom of a parallel up-channel based from February 26th, which is based off the trend line along the highs since late January. A bounce back up to the 1575-1580 area, maybe as high as 1585 if the market does its usual high (78.6% retracement) bounce is a possibility and a 1575 settlement price Friday morning would not surprise me.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1595
- bearish below 1540

The 60-min chart below shows how a bounce into Friday might look. The little bounce off today's low looks corrective and it should develop into a larger bounce pattern if the 5-wave move down from last week is complete. But as labeled in light red, if the decline is a 1-2, 1-2 then we're about to see a very strong decline in 3rd waves, which could drop SPX down to the 1475 area before Friday. If you're in spread positions stay aware of that potential. Take any selloff from here seriously. Otherwise the selloff should wait until next week.

S&P 500, SPX, 60-min chart

It's the same pattern for all the indexes. The DOW held support near 14550 and closed on its uptrend line from December-February, which should be good enough for another bounce. If support breaks then look out below -- a quick move down to 14200 should result.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,865
- bearish below 14,550

NDX also bounced off support at the top of the S/R band we've been watching since January, at 2750-2770. It closed on its 50-dma but below its uptrend line from November-February. As with the others, continued selling from here would be confirmed breaks of support but first I'm looking for a bounce and then a breakdown next week. Assuming we get the bounce into Friday I would look at as a gift to the bears, especially if it closes at the high of the day/week (the pattern I mentioned at the beginning of tonight's report).

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2870
- bearish below 2744

AAPL broke down today and that didn't help the techs. It had been holding support at its March 4th and April 5th (3-4 and 4-5 so maybe we should look for the next important low on 5-6) but that support snapped like a twig this morning and AAPL lost 28 to an intraday low of 398 before bouncing a little and closing near 403. The next leg down looks underway and I've got a downside target at 346.77, which is where the 5th wave of the move down from September 2012 would be 62% of the 1st wave. A trend line along the lows and the bottom of a parallel down-channel are currently near 360 and 350, resp., so those lines will be important to watch if reached. Several months ago I showed a weekly chart with downside projections, based on Fibs, H&S projection and a previous 4th wave in its rally, all pointing to the 300-350 area so now we've got a shorter-term projection pointing to the same zone. The completion of a 5-wave move down would then set up a buying opportunity (for a trade since it will continue lower following a multi-month bounce correction).

Apple Inc., AAPL, Daily chart

The RUT continues to be the more negative of the four horsemen as it sits well below its 50-dma and today left a bearish kiss goodbye following the back test of its broken uptrend line from November-April. But another bounce up to that trend line by Friday could see it back up to test its broken 50-dma as well, near 929 by then. Perhaps its 20-dma will be crossing down through the same level at the same time. Watch for that kind of bounce as a shorting opportunity.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 943
- bearish below 908

Last Friday's decline in the TRAN left a bearish kiss goodbye following the back test of its broken uptrend line from November-December. Today it left a bearish kiss goodbye following its back test of its broken 50-dma. If the market bounces look for a back test of its 20-dma, currently near 6106 to see if it leaves a setup for another bearish kiss goodbye. It's a battle between those who are buying the dip and those who are selling the rallies.

Transportation Index, TRAN, Daily chart

Bonds have been relatively quiet this week and has had the 30-year yield (TYX) trying to get back above its 200-dma at 2.911% since breaking below it on Monday. It looks like it should be setting up for a big bounce into early May to correct the decline from March 8th. A 50% retracement would have it back up to about 3.05-3.06%, which would also have it back testing its broken uptrend line from July 2012 and its 50-dma by the time it gets there.

30-year Yield, TYX, Daily chart

As mentioned earlier, the U.S. dollar got a big jump off this afternoon's low once the Beige Book came out (as to why, I do not know). The dollar had been selling off all day and the sudden short squeeze retraced all of the day's loss and then some. As can be seen on its daily chart, it jumped from tagging its 50-dma, at 82.04 (the low was 81.89), up to its 20-dma at 82.75 (with a high of 82.81). I'm depicting a big choppy sideways triangle from here into June but that's obviously just a guess at the moment. It would fit well as the 4th wave correction in the move up from September 2012, which would have it chopping up and down between about 82 and 83.50 for the next couple of months. We'll find out over time whether or not price has something else in mind.

U.S. Dollar contract, DX, Daily chart

On Monday I showed the weekly chart of gold and where I think we are in the wave count for the move down from September 2011. Basically I see the need for gold to stair-step lower for at least a few more months before it finds a good bottom to consider for a trade (not a long-term hold yet -- that will come in a few years). Cycle studies point to an important low in May so I'll be watching carefully for correlation.

The daily chart zooms in on the move down from October 2012 and shows the series of 1st and 2nd waves to the downside. The breakdown that started last Friday and then through Monday was the meat of the decline as the multiple degrees of 3rd waves started to unfold. I think there's a good chance gold will test the 1300 area before a multi-week bounce/consolidation before heading lower. The January 2011 low, at 1309, and the 50% retracement of the 2008-2011 rally, at 1302, should be solid support for at least a bounce. Notice that this week's bounce was stopped at the bottom of its broken parallel down-channel from 2011, which is typical to see.

Gold continuous contract, GC, Daily chart

For gold traders it's not a good time to chase gold lower from here. We could see a higher bounce and/or a lot of chop as gold works its way lower (assuming it's got lower prices ahead). The Daily Sentiment Index (DSI from trade-futures.com) is showing only 3% bulls, the same level reached on February 20th, which is when a countertrend bounce started (into the March 21st high). Silver is showing only 2% bulls, which is lower than any reading since the DSI has been in existence since 1987. The metals are oversold on many indicators and while it doesn't prevent a further selloff (the readings were very low before the crash) it is reason for caution. The dipsters are lurking.

The gold miners have a somewhat similar pattern as gold itself but comparing the two charts shows a much more significant run-up in the metal than the miners into their September 2011 highs. And the miners have been coming down much harder than the metal, which were giving an early warning about what the price of gold was going to do. But there are now a couple of things of interest where the miners group (GDX) is currently located.

So far the move down for GDX from 2011 is an A-B-C pullback and it achieved two equal legs down today at 27.35 (today's low was 27.27). Only slightly lower, at 26.77, is the 78.6% retracement of the 2008-2011 rally (the equivalent retracement for gold is down at 947 but it has only retraced a little less than 50%, which is at 1302). So it's possible GDX is going to find support near 27, especially if we've seen a capitulation event in the miners this week.

Gold Miners ETF, GDX, Weekly chart

What I don't like about GDX right now, as far as thinking about the long side, is the fact that it has entered an "air pocket" zone from the October 2008 low (15.83) to about 30. Buying the "dip" could prove costly if the decline has much more to go and it's rare for a downside spike like this to stand alone. It's more typical to see the low get tested at least once (even with a minor new low) before it will be ready to rally. I'd say it's way too early to be thinking long the miners and in fact there's still considerable downside risk remaining.

Oil has seen a sharp breakdown from its sideways triangle from June 2012, as well as its 200-dma. I see the potential for a little lower, perhaps down to the price projection at 83.38 where it would complete a 5-wave move down from April 1st and that leg down might be the 3rd wave of a larger decline from January 30th (where the 2nd leg down would be 162% of the 1st leg).

Oil continuous contract, CL, Daily chart

Thursday's economic reports include the unemployment claims, the Philly Fed index and Leading Indicators. After today's Beige Book there are not likely to be any surprises. There will be no major economic reports on Friday so it will be left to overseas news and earnings reports.

Economic reports and Summary

If the short-term wave count is correct, calling the move down from last week a 5-wave decline, then we have our proof that the trend has changed. Not only are important trend lines and moving averages breaking (and in some cases back tested) but an impulsive decline also tells us the trend is now down. It might mean we'll only get a larger pullback into May before heading back up to new highs but it does mean we should get another leg down following a bounce correction of the decline, which I'm expecting to see into the end of this week.

If instead of a bounce on Thursday/Friday the market sells off it will likely sell off strong. It's always a little risky shorting in the hole but it should work if that's what we're presented with. Ideally, for a good trade setup, we'll see a bounce/consolidation into Friday to set up a very good shorting opportunity for next week. Good luck with the rest of opex and watch the volatility. 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

Losing Steam

by James Brown

Click here to email James Brown


Dow Jones Transportation ETF - IYT - close: 105.87 chg: -1.62

Stop Loss: 107.05
Target(s): 100.25
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Worries about a global growth slowdown have sparked selling pressure in the transportation sector. The IYT is the iShares transportation ETF. The IYT peaked in mid March. Now the ETF is creating a new bearish trend of lower highs. Shares are currently hovering near support in the $105.00 area.

I am suggesting a trigger to buy puts at $104.75. If triggered our target is $100.25.

Trigger @ 104.75

- Suggested Positions -

buy the May $105 PUT (IYT1318Q105) current ask $2.20

Annotated Chart:

Entry on April -- at $---.--
Average Daily Volume = 904 thousand
Listed on April 17 2013

In Play Updates and Reviews

Up Trend In Trouble (Again)

by James Brown

Click here to email James Brown

Editor's Note:

There was no follow through on yesterday's market bounce. Stocks reversed in another widespread decline.

Our SNDK, ULTA, and WDC trades were stopped out.
AAWW was triggered.

We want to exit our KMB trade at the opening bell tomorrow.

Current Portfolio:

CALL Play Updates

American Tower Corp. - AMT - close: 79.78 change: -0.81

Stop Loss: 78.75
Target(s): 84.75
Current Option Gain/Loss: -26.8%
Time Frame: Exit prior to earnings in early May
New Positions: see below

04/17/13: The market's weakness weighed on AMT and shares traded sideways after the morning gap down. Shares ended the day off -1% but managed to hold short-term technical support at the 10-dma. I am not suggesting new positions at this time.

Our target is $84.75. More aggressive traders could aim higher. FYI: The Point & Figure chart for AMT is bullish with a $94 target.

- Suggested Positions -

Long May$80 call (AMT1318E80) entry $2.05

Entry on April 11 at $80.25
Average Daily Volume = 2.2 million
Listed on April 09 2013

Gilead Sciences - GILD - close: 51.94 change: -0.07

Stop Loss: 49.75
Target(s): 56.50
Current Option Gain/Loss: - 6.7%
Time Frame: Exit PRIOR to earnings on May 2nd
New Positions: see below

04/17/13: Three days in a row now GILD has garnered bullish analyst comments. This may have helped shares rebound from their morning lows. The stock bounced back to close almost unchanged on the session. More conservative traders might want to adjust their stops closer to the $50.50 level.

Earlier Comments:
I do consider this a more aggressive entry point. More conservative traders may want to wait for a pullback near the $50.50-50.00 zone as an alternative entry point. Our target is $56.50 but we'll plan on exiting prior to the May 2nd earnings report.

- Suggested Positions -

Long May $52.50 call (GILD1318e52.5) entry $1.94

Entry on April 15 at $52.25
Average Daily Volume = 11.7 million
Listed on April 13 2013

Kimberly-Clark - KMB - close: 100.66 change: -0.92

Stop Loss: 99.45
Target(s): 104.00
Current Option Gain/Loss: +12.2%
Time Frame: Exit PRIOR to earnings on April 19th
New Positions: see below

04/17/13: KMB succumbed to the market's widespread weakness on Wednesday. Shares gave back -0.9%. The trend is still up for now and KMB should have support near $100 and its 10-dma. Unfortunately we are out of time. Tonight we are adjusting our exit strategy. Instead of exiting tomorrow at the closing bell we will exit at the opening bell tomorrow.

- Suggested Positions -

Long May $100 call (KMB1318E100) entry $2.45

04/17/13 Strategy change: ready to exit tomorrow at the opening bell!
04/16/13 prepare to exit by Thursday's closing bell
04/15/13 new stop loss @ 99.45
04/13/13 new stop loss @ 98.75
04/11/13 new stop loss @ 97.85

Entry on April 10 at $100.25
Average Daily Volume = 2.3 million
Listed on April 06 2013

L-3 Communications - LLL - close: 80.31 change: -2.37

Stop Loss: 79.90
Target(s): 84.85
Current Option Gain/Loss: -75.0%
Time Frame: Exit prior to earnings on April 25th
New Positions: see below

04/17/13: Our LLL trade looks like it's in trouble. The stock underperformed the major indices with a -2.8% decline. LLL has broken down below its 20-dma and looks poised to test the $80.00 mark soon. Our stop loss is at $79.90. If the market continues to sink tomorrow we'll likely see LLL hit our stop. More conservative traders may want to exit at the opening bell tomorrow.

- Suggested Positions -

Long May $85 call (LLL1318E85) entry $0.80

04/17/13 LLL is showing relative weakness. More conservative traders may want to exit at the open tomorrow

Entry on April 10 at $82.50
Average Daily Volume = 600 thousand
Listed on April 08 2013

PUT Play Updates

Atlas Air Worldwide - AAWW - close: 38.04 change: -0.69

Stop Loss: 40.05
Target(s): 33.50
Current Option Gain/Loss: -11.7%
Time Frame: 3 to 4 weeks
New Positions: see below

04/17/13: Just as expected shares of AAWW have continued to move lower. The stock hit our entry trigger to buy puts at $38.00. I would still consider new positions now at current levels.

Our target is $33.50 but more conservative traders could exit early near $35.00 instead. FYI: The Point & Figure chart for AAWW is bearish with a $29 target.

- Suggested Positions -

Long May $37.50 PUT (AAWW1318Q37.5) entry $1.70

Entry on April 17 at $38.00
Average Daily Volume = 262 thousand
Listed on April 16 2013

FedEx Corp. - FDX - close: 94.12 change: -1.02

Stop Loss: 96.25
Target(s): 86.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

04/17/13: The transportation sector continues to look vulnerable. FDX broke down to a new relative low but bounced near its simple 200-dma. The intraday low today was $93.59. Readers might want to consider new bearish positions now but the newsletter is suggesting a trigger to buy puts at $93.50.

Trigger @ $93.50

- Suggested Positions -

buy the May $92.50 PUT (FDX1318Q92.5)

Entry on April -- at $---.--
Average Daily Volume = 3.3 million
Listed on April 15 2013


SanDisk Corp. - SNDK - close: 55.72 change: -1.77

Stop Loss: 55.75
Target(s): 59.75
Current Option Gain/Loss: -21.2%
Time Frame: exit PRIOR to earnings on April 17th
New Positions: see below

04/17/13: We were planning to exit our SNDK trade at the closing bell tonight. Unfortunately technology stocks were underperformers. Shares of SNDK followed the NASDAQ lower right from the start. Both plunged through the first half of the session before trying to pare their losses. SNDK hit our stop loss at $55.75. The company reported earnings after the closing bell.

- Suggested Positions -

May $57.50 call (SNDK1318e57.5) entry $2.35 exit $1.85 (-21.2%)

04/17/13 stopped out at $55.75
04/16/13 prepare to exit tomorrow (04/17/13) at the closing bell
04/13/13 new stop loss @ 55.75


Entry on April 10 at $56.75
Average Daily Volume = 3.3 million
Listed on April 09 2013

Ulta Salon - ULTA - close: 84.47 change: -2.18

Stop Loss: 84.95
Target(s): 92.00
Current Option Gain/Loss: -48.7%
Time Frame: 3 to 4 weeks
New Positions: see below

04/17/13: The market's widespread market weakness on Wednesday crushed ULTA for a -2.5% decline. The stock has broken its bullish trend of higher lows and ULTA hit our stop at $84.95.

Earlier Comments:
I do consider this an aggressive, higher-risk trade so we do want to limit our position size to reduce our risk.

*Small Positions* - Suggested Positions -

May $90 call (ULTA1318e90) entry $1.95 exit $1.00 (-48.7%)

04/17/13 stopped out


Entry on April 15 at $87.50
Average Daily Volume = 1.78 million
Listed on April 13 2013

Western Digital Corp. - WDC - close: 50.57 change: -1.46

Stop Loss: 50.90
Target(s): 57.50
Current Option Gain/Loss: -39.4%
Time Frame: Exit PRIOR to earnings on April 24
New Positions: see below

04/17/13: Technology stocks were some of the market's worst performers today. WDC underperformed with a -2.8% decline. Shares managed to hold above the $50.00 mark but our stop loss was hit at $50.90.

*Small Positions* - Suggested Positions -

May $55 call (WDC1318E55) entry $1.85 exit $1.12 (-39.4%)

04/17/13 stopped out


Entry on April 12 at $52.41
Average Daily Volume = 2.4 million
Listed on April 11 2013