Option Investor

Daily Newsletter, Wednesday, 8/28/2013

Table of Contents

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

Market Wrap

Small Oversold Bounce

by Keene Little

Click here to email Keene Little
Following some strong selling off Monday's highs into this morning's low we got an oversold bounce. But it was weak and it appears the dipsters are wary.

Market Stats

Today's bounce was off some important support levels for the indexes but it certainly did not have much punch. Where did the dipsters go? As we head for the holiday weekend I think we'll find the market getting quieter as traders make a long weekend rather than deal with a slow and/or low-volume market. We should all consider the same.

It was a quiet day for economic reports but the two housing related reports continued the weak showing from the housing sector. The MBA Mortgage index was at least "less bad" by improving over the previous week's -4.6% to last week's -2.5%. It's of course the slowing part that's not good. Following the dismal report on New Home sales last Friday, today's report of Pending Home sales for July was also not good. From June's -0.4% and expectations for +0.2%, today's -1.3% was a major disappointment. Of course it didn't matter to the market because it had already sold off hard before this morning and an oversold bounce was due. The home construction index was one of the few sectors in the red today, along with the REITs and the metals.

I need to jump right into tonight's charts because I lost a lot of time preparing for tonight's wrap because of a computer failure. Besides, I know you read this just to see the pretty pictures anyway. ;-)

SPX found support at its uptrend line from November through June, which was an untested trend line until this morning. But it held and it could be good for a bounce into early September. As I'll review on the other charts, the move down from the August 5th high looks like a completed 5-wave move and that confirms a trend change. A bounce should be followed by another leg down, which is what I'm showing. Note that on a weekly basis the RSI has broken its uptrend line from November, which is typically seen before price breaks its trend line. But it's the heads up that price will likely follow.

S&P 500, SPX, Weekly chart

It's easier to see a 5-wave move down on the daily chart below (and even easier on the 60-min chart further below). Following the completion of the wave count to the upside into the August high (the reason for calling THE top in early August) the 5-wave move down creates a larger degree 1st wave down. It should be followed by a correction to the decline, which is what I'm showing, for the 2nd wave and then a strong decline to follow in the 3rd wave. From a timing perspective, the 2nd wave typically takes about 62% of the time as the 1st wave (it's only a guide) and interestingly that falls on 9/11 for a high for the bounce. But there are some other possibilities for a smaller bounce before heading lower so the bounce will have to be watched carefully for clues.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1670
- bearish below 1627

Coming into this morning I thought a real nice reversal setup would be a quick new low so that SPX could tag its uptrend line from November-June near 1627. It hit a low of 1627.47 and then started its bounce. Rarely does the market accommodate a trade setup so nicely but this morning was one of them. The 5-wave move down from August 5th tells us the new trend is to the downside and that means playing a bounce off this morning's low is a counter-trend play. It should be a choppy upward correction that will not be easy to stick with but hopefully it will work its way higher into September 11th (ideally), perhaps retracing about 50% of the August decline (to 1668) and then set up a nice short entry for us.

S&P 500, SPX, 60-min chart

Note the options shown with the dashed lines on the above chart. It's possible we're looking for a larger A-B-C move down from August 5th with the a-wave at the August 21st low and the bounce into Monday's high was the b-wave. That would mean the decline into this morning's low is the 1st wave of wave-C and we should expect only a small bounce and then head strongly lower (red dashed line). I'm trying not to make this too complicated (corrections can be very difficult to figure out in real time) but one other possibility is for a larger b-wave, which requires a strong bounce up into the first week of September before reversing hard and selling off strongly (green dashed line up to 1678). The bottom line is that each day will have to be evaluated on an intraday basis to try to determine the most likely path for the bounce. Trade lightly in the meantime.

The DOW's pattern looks the same as SPX but if anything is different it's that it has a cleaner 5-wave move down. A 2nd wave correction, following the 1st wave down from August 5th, has an upside target near 15200 by September 11th and then strongly lower from there. Notice where the DOW found support today -- just above its uptrend line from March 2009 - October 2011. This is an important long-term uptrend line and once broken will confirm the bounce off the 2009 low has completed.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,320
- bearish below 15,250

NDX has been a choppy whippy mess for weeks. After threatening to break down it gapped up on Friday and then on Monday it came within a little more than a point of making a new high. NDX had gapped down on August 15th, consolidated and then gapped up last Friday, which created a bullish island reversal pattern. But after only two days near the high the gap down on Tuesday left another island reversal, which negated the first one. In fact the failure of last Friday's bullish reversal is strongly bearish. And if it now breaks below 3053, which held on Tuesday, it could lead to a quick trip down to its uptrend line from November-April, currently near 2950 (the 3 peaks since mid-July create a lopsided H&S top).

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3150
- bearish below 3053

The RUT has a pattern that is not the same as the blue chips (or the NDX) and at the moment is not as clear. The move down from August 5th is a 3-wave move down to the August 21st low (the bounce into Monday's high overlapped the August 7th low, which negated the 5-wave move down to today's low). We could see a higher bounce to match the ones for the blue chips or we might see just a small bounce, such as up to its broken uptrend line from June through the August 21st low, near 1033, before turning sharply lower (light red dashed line). At the moment I'm leaning long into September but will be wary about this more bearish potential.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1045
- bearish below 1000

Bonds could soon give us a sense of where yields will be headed into the end of the year and next year. Last week the 10-year, TNX, rallied slightly above its long-term downtrend line from 1981-2007, currently near 2.8%, but is now back down for either a bullish back test or it will leave a failed breakout attempt. The move up from July 2012 is either an a-b-c bounce correction to its longer-term downtrend, in which case the bounce will be completely retraced, or it's a 1-2-3 in what will become an impulsive (5-wave) rally into the end of the year, in which case it would mean a generational low (in July 2012) is already in place. If we get a choppy pullback over the next couple of months (assuming it's ready for a pullback) it should indicate another rally into the end of the year is probable (selling in bonds). But if it starts coming down sharply, especially if it drops below the March high at 2.08%, it will mean new lows are coming in 2014. We wait for the bond market to tell us what it's going to do.

10-year Yield, TNX, Weekly chart

Getting a little closer with the daily chart of the 30-year yield, TYX, you can see the overlapping highs and lows since late June. This is typically a good indication the move is ending and the bounce back up to the broken uptrend line from May 1st was back tested repeatedly since breaking in mid-July. The August 22nd high left a bearish divergence and while there's a possibility it will try one more time with a minor new high and another lower high for the oscillators I wouldn't say that's a high-odds expectation. But a drop below the August 12th low at 3.602 is needed to confirm a high is in place. From there we'll have to see what kind of pullback/decline develops so that we can get some clues about the longer-term pattern (head down for new lows next year or pull back correctively before heading higher again).

30-year Yield, TYX, Daily chart

The banks have been skating (getting away from having to be responsible) for a long time, thanks to the Fed. This is probably even truer in Europe, as one of John Mauldin's recent newsletters outlined. The European banking system is a house of cards and the first ill wind is going to knock it all down. Perhaps the selling this week is evidence that some are beginning to feel a wee bit nervous about owning the banks (let alone having your hard-earned money invested with them).

The banking index, BKX, has dropped down to its uptrend line from October 2011 through the June 2012 low (using log price scale) and other than a minor break this morning the trend line is holding. There have been minor breaks (November 2012, April 2013) but it held in June and is currently holding. Therefore a break below this morning's low at 61.97, without a quick recovery, would be more bearish. The short-term pattern is subject to interpretation so for now I'm just watching its trend lines and I see the potential for a rally back up to its broken uptrend line from April-June, which it broke decisively on Tuesday (as well as its 50-dma at the same place -- 64.21), perhaps up to about 65.50 by September 11th, to stay in synch with a similar bounce for the broader indexes.

KBW Bank index, BKX, Daily chart

The home builders have been getting crushed since their highs in May. The Home Construction index is down nearly -30% from its May 20th high and it looks like it's got a lot lower to go. A downtrend line from May 20th through its July 12th high hasn't been touched, nor has its 50-dma, which was broken on May 31st. There's some price-level support at the November 2012 low at 389.70 but there's really not much until it gets to its April 2010 high near 334. A trend line along the lows since February has been resistance since breaking in early August and that trend line can be viewed as a H&S neckline, which has downside price objective to about 305. Its 200-week MA is currently near 319. This one says "short me" on every bounce as long as the series of lower highs continues to hold.

DJ Home Construction index, DJUSHB, Daily chart

The pattern of the Transports looks similar to the RUT's -- you can see a 3-wave move down from the August high into the August 15th low that was then followed by a high (also a 3-wave) bounce into Monday's high. This suggests an a-b-c pattern to the downside and the c-wave is in progress. If the decline from Monday is the 1st wave down then we're due a relatively small bounce, perhaps back up to the broken 50-dma and uptrend line from June through the August 15th low, both near 6390 in a few days, and then sharply lower. The TRAN and RUT are the two indexes that tell me the blue chips might not get their bigger bounce into September 11th time frame.

Transportation Index, TRAN, Daily chart

The U.S. dollar is either consolidating on support (uptrend line from April 2011 - February 2013), and below its 200-dma, before breaking lower or it's in a basing pattern and getting ready to rally off support. I continue to lean long the dollar but it sure is trying my patience. A drop below its August 20th low at 80.77 would be a strong indication that it will probably head for the next support level near 79.50 (H&S neckline from February 2012).

U.S. Dollar contract, DX, Daily chart

Gold's rally in the past week has had it running up toward the price projection at 1441 for two equal legs up from its June 28th low. Today's high (during the overnight hours) was 1424 so it's close to the projection, as well as the 38% retracement of the 2008-2011 rally (1449). But the daily candle is a shooting star (actually a more bearish gravestone doji) near the top of its up-channel for the bounce off the June 28th low and could mean a reversal in the making. A red candle on Thursday would confirm the reversal and from there we'd have to see if it will be just a small 4th wave pullback in the move up from June or if instead it starts its next leg down. A drop below the July 23rd high at 1348.70 would leave the bounce as a 3-wave correction and confirm lower prices are likely coming. But a continuation of the rally above 1450 could see the 200-dma at 1508 tested next (or higher).

Gold continuous contract, GC, Daily chart

Silver's bounce has been much stronger than gold's (it's typically more volatile than gold). I can easily call its rally from June 28th a 5-wave move and therefore a bullish indication that the June low was a longer-term low. This is Not confirmed by gold and therefore requires caution. In any case, once the 5-wave move up completes we will then get a pullback to correct the rally and as shown, we could see a pullback to the $20 area before the next stronger leg up will be ready to go. This might create a larger A-B-C bounce off the June low and that's how both gold and silver could stay in synch (the 3-wave move up for gold and 5-wave move up for silver would both be their wave-A and now we need to see a wave-B pullback). Like gold, today's shooting star candlestick is bearish, especially since it nearly tagged the projection at 25.27 (with an overnight high at 25.12), which is where the 5th wave of the move up from June 28th is equal to the 1st wave. Price-level resistance near 24.50 is holding on a closing basis.

Silver continuous contract, SI, Daily chart

Oil spiked up about +3.25 during the overnight session to 112.24, which was above its March 2012 high at 110.55 but it did not hold. Just as quickly it gave up its gain and traded flat during today's session near 110. Today's high hit the top of its up-channel from June 2012 as well as the top of its up-channel from April. Not holding above either one, especially with a shooting star for today's candle, has it looking like a capitulation of shorts and now a reversal in the making. A red day on Thursday would confirm the reversal. The larger pattern is not clear enough to make a call other than that it looks ready for at least a pullback following a 5-wave move up from April. At a minimum we should expect a pullback correction and if it stays very choppy then we'll have a better sense that there will be higher highs. But a sharp decline could be one of the first signs that the entire bounce off the June 2012 low (77.28) is just one big a-b-c bounce that will get retraced. For now I'd be very careful if you're in bullish positions in oil.

Oil continuous contract, CL, Daily chart

The next two days will bring us some economic reports that will have tongues wagging about what it will mean for the Fed and their taper talk. Tomorrow we'll get the usual unemployment claims, which are not expected to change much, and then the 2nd estimate for GDP and GDP Deflator for Q2. Expectations are for little change to a slight uptick. Then on Friday we'll get Personal Income and Spending, core PCE prices (a measure of inflation), the Chicago PMI and the Michigan Sentiment (final) reading. No big changes are expected so there's the potential for a surprise reading.

Economic reports and Summary

Going with the blue chip indexes (and the granddaddy index, the Wilshire 5000) we have a clean impulsive (5-wave) move down from the August 5th highs. That sets the intermediate trend to the downside and the August decline will be followed by at least another leg down. This also confirms my August 7th call for THE top. But we're now set up for a bounce and the best projection at the moment is for a 50% price retracement in 62% of the time. That points to SPX 1668 by September 11th (interesting date to say the least).

Some other indexes, such as the TRAN and RUT (and perhaps the NDX), suggest smaller bounces into early next week and then strongly lower. The bottom line is that we should expect today's bounce to continue but it will set up a shorting opportunity, either next week or the week after.

Playing the long side from here is playing a counter-trend move and it could be very choppy and whippy. Trade carefully and if you'd like to avoid the chop, keep your powder dry until the better trade sets up in a week or so (on the short side). We're at a time now where you'll want to trade with the bears since down will be the path of least resistance.

I suspect trading volume is going to die as we get closer to the holiday weekend and that will either make a very boring market or a volatile one. Today's volume was low and it turned out to be a slow day. Good luck in the coming week and I'll be back with you next Wednesday. Have a great holiday weekend.

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

Going Once, Going Twice, Sold!

by James Brown

Click here to email James Brown


eBay Inc. - EBAY - close: 50.43 change: -0.18

Stop Loss: 51.75
Target(s): 46.00
Current Option Gain/Loss: Unopened
Time Frame: exit PRIOR to September option expiration
New Positions: Yes, see below

Company Description

Why We Like It:
We are bringing EBAY back for another shot at a bearish trade. The last time we tried our EBAY trade did not open. Yet it looks like the stock's bounce from technical support at its simple 300-dma is failing. Shares closed below this long-term moving average for the second day in a row. EBAY is now approaching major support near $50.00. A breakdown here could be very significant (see the weekly chart below).

We are suggesting a trigger to buy puts at $49.75. If triggered our target is $46.00. More aggressive traders may want to aim lower.

NOTE: We are listing the September puts, which expire in less than four weeks. You might want to play the Octobers instead.

Trigger @ 49.75

- Suggested Positions -

Buy the Sep $50 PUT (EBAY1321u50) current ask $1.04

Annotated Chart:

Weekly Chart:

Entry on August -- at $---.--
Average Daily Volume = 8.2 million
Listed on August 28, 2013

In Play Updates and Reviews

Stocks Manage to Bounce

by James Brown

Click here to email James Brown

Editor's Note:

The U.S. market managed a bounce following a two-day decline. Yet the S&P 500 index struggled with resistance near 1640 today. Investors remain worried about U.S. involvement in Syria.

RGR was triggered. MCD was stopped out.

Current Portfolio:

CALL Play Updates

Sturm, Ruger & Co. Inc. - RGR - close: 52.75 change: +0.43

Stop Loss: 49.95
Target(s): 57.50
Current Option Gain/Loss: - 7.2%
Time Frame: 4 to 6 weeks
New Positions: see below

08/28/13: Our new play on RGR was triggered this morning. Unfortunately I can't find any headlines to explain the gap open higher this morning. Shares opened higher and spiked toward $54 before paring its gains. RGR did outperform the market with a +0.8% gain but the gap higher hurt our entry point. We wanted to buy calls at $52.65 but RGR opened at $53.45.

Earlier Comments:
If this rally continues it could spark a short squeeze. The most recent data listed short interest at 30% of the very small 18.8 million share float.

- Suggested Positions -

Long Oct $55 call (RGR1319j55) entry $1.24

08/28/13 trade opened on gap higher at $53.45. Trigger was 52.65

Entry on August 28 at $53.45
Average Daily Volume = 341 thousand
Listed on August 27, 2013

PUT Play Updates

DaVita HealthCare - DVA - close: 108.02 change: -0.72

Stop Loss: 112.15
Target(s): 105.25
Current Option Gain/Loss: + 40.9%
Time Frame: 3 to 4 weeks
New Positions: see below

08/28/13: The weakness in DVA continued with a -0.6% drop today. This is a new low for the year.

Earlier Comments:
Our short-term target is $105.25. More aggressive traders could aim lower since the Point & Figure chart for DVA is bearish with a $96 target.

FYI: Investors should note that DVA does have a 2-for-1 split coming up on September 9th.

- Suggested Positions -

Long Sep $110 PUT (DVA1321u110) entry $2.20*

08/27/13 trade opens on gap down at $109.95
*option entry price is an estimate since the option did not trade at the time our play was opened.

Entry on August 27 at $109.95
Average Daily Volume = 833 thousand
Listed on August 26, 2013

iShares Russell 2000 ETF - IWM - close: 100.96 change: +0.20

Stop Loss: 105.25
Target(s): 99.00
Current Option Gain/Loss: +11.4%
Time Frame: 3 to 6 weeks
New Positions: see below

08/28/13: After the sharp decline yesterday most of the market produced a bounce. The IWM added 20 cents. There is no change from my prior comments.

The next challenge for the bears is potential support at the $100 mark. If the $100 level fails then the next level of support is the simple 100-dma current at 98.65.

- Suggested Positions -

Long Sep $100 PUT (IWM1321u100) Entry $1.48

08/27/13 adjust exit target to $99.00
08/24/13 new stop loss @ 105.25
08/19/13 new stop loss @ 104.25
08/15/13 adjust exit target from $97.00 to $98.50
08/03/13 readers may want to consider an early exit

Entry on July 30 at $103.69
Average Daily Volume = 31 million
Listed on July 29, 2013

ManpowerGroup Inc. - MAN - close: 65.40 change: +0.56

Stop Loss: 67.05
Target(s): 61.00
Current Option Gain/Loss: - 5.8%
Time Frame: 3 to 4 weeks
New Positions: see below

08/28/13: MAN recovered about a quarter of yesterday's decline. Broken support near $66.00 should be new short-term overhead resistance.

- Suggested Positions -

Long Sep $65 PUT (MAN1321u65) entry $1.70

Entry on August 27 at $65.75
Average Daily Volume = 530 thousand
Listed on August 21, 2013

Sherwin-Williams Co. - SHW - close: 169.37 change: +2.17

Stop Loss: 170.25
Target(s): sell half at 161.00, then exit the rest at $156.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

08/28/13: SHW managed a bounce today but it only recovered about half of yesterday's losses. Furthermore it looks like the bounce is failing near resistance at $170.00 and its simple 200-dma. There is no change from my earlier comments.

Earlier Comments:
SHW's long-term up trend is in serious jeopardy. The Point & Figure chart has turned bearish and is forecasting a $136 target.

The recent lows are near $166.00. We are suggesting a trigger to buy puts at $165.90. If triggered you could target a drop toward $160.00 and its 300-dma. I am suggesting we plan on exiting half of our position at $161.00. We'll plan on exiting the remain of our position at $156.00.

Trigger @ 165.90

- Suggested Positions -

Buy the Sep $160 PUT (SHW1321u160)

Entry on August -- at $---.--
Average Daily Volume = 781 thousand
Listed on August 27, 2013

Time Warner Cable - TWC - close: 108.03 change: +0.99

Stop Loss: 111.60
Target(s): 105.00
Current Option Gain/Loss: -31.9%
Time Frame: 3 to 4 weeks
New Positions: see below

08/28/13: There were new headlines today that the FCC was stepping in to mediate the feud between CBS Corp. (CBS) and TWC. The disagreement has left three million TWC customers without CBS programming since August 2nd (source: Bloomberg). Shares of TWC really didn't move much on the news or the fact that TWC began trading ex-dividend this morning.

I am not suggesting new positions. More conservative traders may want to scale back their position size even further.

Earlier Comments:
We do want to keep our position size small. There is potential support at $108.00. The next level of support is $104.00. If we are triggered at $109.50, our target is $105.00.

- Suggested Positions -

Long Sep $105 PUT (TWC1321u105) entry $2.35

Entry on August 16 at $109.50
Average Daily Volume = 2.3 million
Listed on August 15, 2013

Longer-Term Play Updates

Chicago Bridge & Iron - CBI - close: 60.97 change: +0.55

Stop Loss: 55.75
Target(s): 74.50
Current Option Gain/Loss: -15.6%
Time Frame: 4 to 6 months
New Positions: see below

08/28/13: CBI outperformed the broader market with a +0.9% gain. There is no change from my earlier comments.

*Small Positions* - Suggested Positions -

Long 2014 Jan $65 call (CBI1418A65) entry $2.55

07/20/13 new stop loss @ 55.75
06/29/13 CBI might be poised to dip into the $57-55 zone again.
06/24/13 triggered @ 56.75
06/22/13 adjust entry trigger to $56.75
06/15/13 entry strategy change: change the breakout trigger at $65.25 to a buy-the-dip trigger at $56.50. Adjust the stop loss to $53.75.
Adjust the option strike to the 2014 Jan. $65 call

Entry on June 24 at $56.75
Average Daily Volume = 1.8 million
Listed on June 01, 2013

Vanguard FTSE Europe ETF - VGK - close: 51.72 change: -0.06

Stop Loss: 51.25
Target(s): 58.50
Current Option Gain/Loss: Unopened
Time Frame: exit PRIOR to 2013 December option expiration
New Positions: Yes, see below

08/28/13: It was a rough day for European stocks. Almost all of the major markets closed in negative territory. This weakness sparked a gap down in the VGK this morning but the ETF managed to bounce off its morning lows. Shares are down three days in a row. There is no change from my earlier comments.

Earlier Comments:
We are taking a multi-month time frame with this trade. I am suggesting we wait for the VGK to close above $53.50 and then buy calls the next morning. If we are triggered our target is $58.50 but we'll adjust it as the trade progresses.

FYI: The Point & Figure chart for VGK is bullish with a $63 target.

Trigger: Wait for a close above $53.50,
then buy calls the next morning.

- Suggested Positions -

Buy the 2014 Mar $55 call (VGK1422L55)

08/24/13 adjust the option strike from 2013 Dec $55 to $2014 Mar $55.

Entry on August -- at $---.--
Average Daily Volume = 3.0 million
Listed on August 10, 2013


McDonald's Corp. - MCD - close: 96.08 change: +1.24

Stop Loss: 96.05
Target(s): 90.50
Current Option Gain/Loss: -46.7%
Time Frame: 3 to 4 weeks
New Positions: see below

08/28/13: MCD spent over a week not showing much volatility as it consolidated sideways in the $95-96 zone. The stock underperformed the market when the market was bouncing. Then when stocks reversed lower MCD did not perform as we expected. The last couple of days have been characterized by very brief but volatile spikes following the opening bell. Yesterday it was a spike lower toward its 300-dma. Today it was a spike higher up and through resistance near $96.00. Our stop was hit at $96.05.

- Suggested Positions -

Sep $92.50 PUT (MCD1321u92.5) entry $0.77 exit $0.41 (-46.7%)

08/28/13 stopped out at $96.05


Entry on August 27 at $94.75
Average Daily Volume = 4.8 million
Listed on August 24, 2013