Option Investor

Daily Newsletter, Saturday, 12/14/2013

Table of Contents

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

Market Wrap

The Fed Stole Our Rally

by Jim Brown

Click here to email Jim Brown

Hawkish Fed heads convinced some high profile analysts there could be a taper in December and Santa's sleigh hit a roadblock.

Market Statistics

Fear of the Fed caused investors to take some profits ahead of next week's FOMC meeting. You would think a December taper was almost a done deal by the way the market reacted but it is far less than that. Reuters polled 60 economists found 32 expected the taper in March, 22 expected a January move and only 12 expected a December announcement. One month ago 37 were targeting March, 16 January and only 3 saw a move in December.

That small increase in December expectations was enough to derail the normal December rally. The markets have only closed positive three times in the month of December. That is hardly a bullish event but on the flipside the Dow is only down about -2% since the last closing high. Given the +22% gain for the year it was due for a rest ahead of year end.

For the last two days the Nasdaq has stubbornly refused to give up the 4,000 level and the S&P refuses to remain below 1,775. The Russell 2000 has battled the 1,100 level for three days and won with a close at 1,107 on Friday.

The daily declines for the last two weeks have been painful but more like a damaged cuticle than a sprained ankle. You can put a band-aid on the cuticle and continue through your day but with a sprained ankle you are constantly reminded of your lack of mobility. The December decline has been a nuisance rather than a real market drop.

However, if the Fed actually puts on the QE brakes next week the market weakness could take on an entirely new aspect. Currently the street is giving the Fed a 23% chance of a December taper. I am in the group still expecting March but anything is possible.

This is the last meeting for Bernanke with a press conference to follow. This could be his last opportunity to take credit for starting the QE unwind. However, with Yellen's confirmation vote scheduled for Wednesday or Thursday there are other considerations. Conventional wisdom has Yellen being confirmed and Bernanke immediately resigning to avoid complicating Yellen's plans for the future. Even if the Senate vote does not occur because of the floor fight on every item on the calendar I doubt Bernanke will drop a stink bomb ahead of Yellen's confirmation.

The Washington budget deal removes one more economic cloud for the Fed but it is not yet law. The Senate will take up the budget bill on Tuesday and the vote is going to be very close. There are senators on both sides of the isle that don't like the compromise and are vowing a fight. News from the senate will be considered in the FOMC deliberations on QE. If it appears it will pass that could remove some objections to a taper.

However, I still believe there are too many factors that are not yet strong enough for the "data dependent" FOMC to act. Employment has improved slightly with the three month average at +193,000 jobs but considering a lot of those jobs were temporary holiday positions the expectations are for weaker numbers in January and February. Also, the weekly jobless claims spiked unexpectedly from 300,000 to 368,000 and that was the largest jump since the week after Hurricane Sandy destroyed hundreds of businesses. That was the highest level since the 373,000 claims during the October government shutdown.

It is far too early for these claims to be the result of holiday worker terminations. Some analysts believe it was adjustment issues surrounding the Thanksgiving weekend but that is just a guess.

Also, the broader U6 unemployment rate is at 13.6% with more than two million long term unemployed workers scheduled to lose their benefits over the next three months. That is far from a bullish economic trend.

The November ISM Services report last week showed activity fell to the lowest level since June at 53.9. That is hardly an accelerating economy especially when services normally rise in Q4 as a result of holiday events.

Lastly there are some cracks beginning to form in the "accelerating economy" hypothesis. Reuters tracks earnings guidance and warnings and the guidance warnings for Q4 are the worst since they begin tracking the data. Historically they are about 2.2:1 or 2.2 negative guidance events for every company with positive guidance. For Q4 they are currently at 11.4 to 1 and still growing. This is not an encouraging sign and could influence the Fed to keep the stimulus flowing. In January the analyst consensus estimates for Q4 were for earnings growth of 18%. Currently they have been revised down to 6.4% growth. That is still decent but given all the warnings we have to take that estimate on faith rather than on hard evidence.

While I am on the earnings topic I need to make another point. Stock buybacks announced in 2013 are over $635 billion. That is the largest amount since 2006. Stock buybacks increase earnings per share since they reduce the number of shares outstanding. Analysts claim buybacks have accounted for 2.4% of the earnings growth for 2013. So far in 2013 S&P earnings growth has averaged +4.6%. That means actual earnings from increased sales has been minimal. That is hardly a bullish point for the Fed's QE deliberations.

On Friday the Producer Price Index (PPI) for November fell -0.1% for the third consecutive monthly decline. Year over year prices were up only +0.7% and the weakest pace since September 2009. There is no inflation. What we are seeing is the potential for deflation and the Fed fears that more than inflation. This is a reason to maintain stimulus even if they don't want to.

The Fed wants to end QE. When they released their balance sheet on Thursday it was $3.994 trillion as of the end of November. The December QE purchases will push it over $4 trillion and that could be a magic number for the Fed. At some point they have to stop buying treasuries simply because of the stupidity of monetizing the U.S. debt. The ratings agencies and global investors are eventually going to say enough is enough and they will force the U.S. to change course. It will be very painful if we don't take control of the situation in advance instead of waiting for global investors to force action upon us.

The Fed may want to end QE but the data is not supporting their wishes. Yellen said she was not in a hurry to end QE and wanted to see sustainable economic improvement. If the Fed sees improvement in those metrics above we are in trouble.

To summarize the Fed wants to begin tapering QE but the data does not support it. While they may be looking at it through rose colored glasses I hope there is enough clarity to make the right decision rather than the political one. If the economy is actually improving then is will still be improving in January and March and they can taper then with stronger convictions.

To be clear I am not a fan of QE but it does move the market and that is what we care about. I published this chart a couple weeks ago and I am reprinting it here just so everyone understands. Contrary to what some analysts are saying about how the market will understand the taper is for the right reasons in an improving economy, I disagree. When the taper occurs it will be negative for the market. Since 2009 the only time the market really went down was when QE programs had ended. After the spike in 2013 on the latest version of QE I don't see how anyone can conclude there will not be a market impact when it ends. However, it won't end on day 1. It could take all year of progressively lower steps in treasury purchases. This is the wild card. We don't know how the market will react to $75 billion in purchases instead of $85 billion and then $65 instead of $75, etc. Just be prepared for some volatility around each announcement.

In 2013 the Fed purchased 70% of all new treasuries that were issued. Since the recession the Fed has printed/created over $3 trillion in new money, the equivalent of 20% of GDP, and spent it all on treasuries and mortgage backed securities. When the music stops the equity party is over.

The red line is the S&P and the blue line is the total purchases by the Fed.

The economic calendar for next week is a hodgepodge of reports. Obviously the FOMC announcement and Bernanke press conference on Wednesday will be the key events. Following that in order of importance will be the Philly Fed Manufacturing, Kansas Fed Manufacturing and the three housing sector reports. New home sales, existing home sales and the Housing Market Index.

The final revision of the Q3 GDP on Friday is not a critical event. It will probably be revised slightly lower. The next GDP report will be for Q4 and estimates are running from 0.7% to 1.4% growth and significantly lower than Q3.

The German ZEW economic sentiment number on Tuesday could be a market mover. It came in at 54.6 for November and the highest level since October 2009. We want that number to continue climbing.

The Eurozone manufacturing PMI on Monday is also key. The number came in at 51.6 for November and the fifth consecutive month of gains as Europe pulls out of recession. That is the fastest pace of growth since June 2011. Most of that positive input came from growth in Germany.

I don't want to spend the entire commentary on the FOMC but there was another event last week. President Obama is going to nominate Stanley Fischer as Vice Chairman to fill the seat vacated by Yellen. He is somewhat of a rock star in the financial community. He was the head of the Bank of Israel during the global recession. He also worked at the IMF and the World Bank. He is a close associate with Mario Draghi of the ECB and Bernanke once called him a "role model." As one analyst put it, "He may be the only person every nominated to the Federal Reserve that was over qualified." He is very well known in financial circles all over the world.

Some have called Fischer a hawk but he did oversee the recent QE program at the Bank of Israel. He and Yellen have generally the same view over the use of QE. Where he differs from Yellen is in forward guidance. You may remember that Bernanke was a fan of forward guidance and transparency at the Fed. That guidance and transparency has gotten him into trouble more than once. Yellen is a big fan of guidance but Fischer is not.

He said recently, "If you give too much forward guidance you take away flexibility." Also, "We don't know what we will be doing a year from now, it is a mistake to try and get too precise." Fischer's views may have to take a backseat since the Fed will depend a lot on forward guidance to convince investors that tapering is not tightening. Yellen is expected to guide explicitly for low interest rates for a long time to try and convince investors not to panic when QE begins to shrink. She will try to convince investors that reducing QE from $85 to $75 billion is still stimulus. It is and in any other reality $75 billion in QE would be very agreeable to the market. It is just that by starting to taper it will prove to investors that QE is not permanent and the removal has begun. It may take the Fed a year to remove it all so we can expect some volatile moments throughout 2014.

I think Fischer is an outstanding pick for the vice chairman position. It gives the Fed international credibility and removes some of the stigma attached to Yellen. She may be a great economist and she is married to a Nobel Prize winning economist but she is barely over five feet tall and nearly 70. She appears timid on the surface and more like a grandma than the leader of the Federal Reserve. She does have impeccable credentials and has more time in a Fed chair than any other Fed official. She started out as a Fed governor in 1994. She taught economics at Harvard in 1981 and Larry Summers was one of her students. She has the best track record for economic forecasting of anyone at the Fed. The combination of Yellen and Fischer is going to carry a lot of weight in the global markets.

In stock news Cisco (CSCO) took advantage of its analyst day and cut sales forecasts for "the next several years" from 5%-7% growth to 3%-6% per year. Profits are still expected to grow at 5% to 7% per year. CEO John Chambers said Cisco was going to use an architectural approach to beat back challenges from the so-called white box networking equipment. He also said the services business would grow to offset the slump in the core routing and switching business. He did pledge to pay out half Cisco's free cash flow every year in the form of dividends and share repurchases. Analysts applauded the more "realistic and somber tone" of the guidance but were evenly split on whether Cisco was going higher or lower.

Cisco is suffering the same fate as IBM in that the NSA spying scandal has forced many companies and governments in Asia and abroad to rethink their purchases from American companies. It is one thing to have somebody hack into your network to spy on you but it is now widely believed that American hardware comes complete with a backdoor for the NSA to access at will. Countries like China that don't want America to eavesdrop on their private conversations are balking at buying American technology.

Lastly, Cisco and others are suffering from the clone wars. Manufactrers in Asia where there is no intellectual property protection are pumping out clones of nearly every piece of technology produced by the leading edge companies. They can copy a router or switch just as fast as a Nike shoe or a Rolex watch.

Cisco did say they were going to spend $4 billion and hire 1,700 people in Canada. The Ontario operations would staff up to around 5,000 workers. Chambers has been plugging Canada for several years saying the U.S. could learn something from them. The corporate tax rate is 15% and profits made overseas are not taxed when they come back home. Cisco has terminated more than 10,000 in the U.S. since 2011.

Ford (F) said it intends to hire 11,000 workers for 2014 to handle the launch of 23 new models. The company is also opening three new manufacturing facilities, two in Asia Pacific and one in South America. The company will hire 5,000 workers in the U.S. and 6,000 in Asia. More than 80% of the U.S. workers will be in white collar positions. Ford plans to launch 16 vehicles in the USA. Ford shares have been stuck in a rut around $17 for the last four months.

Anadarko Petroleum (APC) got a nasty surprise from a judge handling a 2009 case resulting from the bankruptcy of Tronox. That was a spinoff from Kerr McGee in 2006. Kerr-McGee spun off the specialty chemicals maker in 2005. Along with the Tronox assets was a legacy problem of some manufacturing site pollution. In 2006 Anadarko bought the energy assets of Kerr-McGee. Tronox filed bankruptcy in 2009 claiming Kerr-McGee had knowingly packaged all of its environmental problems in the Tronox spinoff in an effort to escape the future cleanup expenses. Tronox ended up with cleanup costs for properties that closed decades ago under different owners.

Tronox sued Kerr-McGee and Anadarko saying the spinoff was cleverly packaged to unload all the problem assets to Kerr-McGee could then sell what was left of the company to Anadarko without any environmental problems. Tronox said Anadarko should be liable for buying assets that were fraudulently transferred by Kerr-McGee. Anadarko defended itself and was confident the acquisition had followed all the rules. In bankruptcy if assets were fraudulently transferred prior to the filing they can be recovered or levied against by the court.

The judge ruled that Kerr-McGee fraudulently packaged the good assets and bad assets and set Tronox up to fail. The judge is giving all parties the opportunity to submit damage claims and rebuttals to those claims in a prelude to establishing a dollar amount of liability by Anadarko. The judge said the award could be between $5 and $14 billion dollars. Anadarko had been so confident of their position they had not posted any reserves for the case. The company said it "vehemently" disagrees with the verdict and would pursue "every avenue available to us through the appellate process to protect the interests of our stakeholders, once a final judgment has been rendered." The appeals process could take up to ten years. Tronox said 88% of the proceeds would go into trusts to help remediate the legacy sites and 12% would go to compensate those injured "as a result of Kerr-McGee's environmental failures." APC shares declined -6% on the news.

Late Friday afternoon the Wall Street Journal released a story claiming Sprint (S) was preparing to make an offer for T-Mobile (TMUS). The story said Sprint had not made a decision and was mulling over the regulatory implications. Not only would the deal have regulatory problems but Dish Networks could also step in with a bid. They have frequently been mentioned as a possible suitor because of their desire to get into the wireless business.

Sprint is 80% owned by Japan's Softbank and T-Mobile is majority owned by Deutsche Telekom. The unnamed source said Sprint believes it cannot compete effectively against Verizon and AT&T and the acquisition of T-Mobile would provide a competitive scale. Sprint is the number 3 carrier and T-Mobile is number 4. Shares of both companies spiked on the news.

There are conflicting signals coming out of Europe and Asia on the strength of the recovery. One month the indicators are up and the next month they are flat. One thing for sure the Baltic Dry Shipping Index (BDI) is suggesting a dramatic increase in shipping rates for dry commodities. Since these rates are quoted every day based on actual rates in the industry this would appear to mean there is an uptick in actual commodity demand.

The BDI closed at a three year high on Friday. There are so many conflicting signals in the normal economic reports it is nice to have something that is relatively accurate.

However, the Baltic Index is for dry goods like iron ore, coal, grain, coffee beans, etc. Since coal shipments to China, India and Japan are increasing significantly this could be a factor in the sharp rise in the shipping rates. This does not mean that the global economy is rebounding because increased demand for dry commodities is only a small portion of the commodity picture.

However, another indicator of global demand is copper and copper prices are still stuck in the low range of $3.20-$3.40 where they have been over the last six months. There has been no material rebound that would suggest manufacturing activity has increased significantly. A breakout over $3.40 would be a key indicator of increasing demand.

The Goldman Sachs Commodity Index ($GCSI) is also lackluster and suggesting demand has not yet increased. The index has been in decline since 2011 and a drop below 600 would suggest we are entering a new period of global weakness.

The Reuters/Jefferies CRB Index ($CRB) is also showing a lack of economic rebound. The index is only slightly above its three-year low set in June 2012.

The $GCSI and the $CRB have more components than just dry commodities so they don't track well with the Baltic Dry Index. For instance the CRB has these 19 commodities: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gas and Wheat.

The decline in gold and silver alone would have been enough to push these indexes lower. However, even accounting for the decline in the precious metals I think it is troubling that both the indexes are not showing a rebound in global demand.

Be careful with what you hear in the press about a global recovery. It may have started but it is far from significant. It could be several more years before it advances beyond crawl speed.

So why do all the U.S. analysts believe the economy is accelerating? There was an interesting article by Comstock Partners this weekend titled, "Been Down So Long, It Looks Like Up To Me." That has also been the title of a book, song and movie in years past but today we are focused on economics. The article basically says that economics have been so lackluster for so long that any minor blip in a number is heralded as a major change in direction. The article talks about the +203,000 new nonfarm jobs last month. Analysts and the market seemed to think it was a breakout that would force the Fed to taper. However, if that level of employment lasted a full 12 months it would only create 2.436 million jobs or +1.78% of the total employed population. Compared to prior recessions this is hardly a recovery. The National Bureau of Economic Research (NBER) looked at past business cycles and found that we averaged an increase of +2.94% at this stage in the cycle. This amounts to a monthly average of +335,000 jobs. Using this comparison for where we should be the +203,000 jobs is rather anemic. This same analysis can be carried forward to the other economic indicators with the same result. The U.S. economy is hardly accelerating and with inflation falling we could be headed for a new challenge.

David Rosenberg, chief economist at Gluskin Sheff & Associates believes differently. He believes the underappreciated economy is going to surprise to the upside in 2014. He cites a number of economic points in this weekend's article. Read it here He claims the ISM numbers are consistent with +3.5% GDP growth. He expects job gains over 300,000 in at least one month in 2014. He admits to being ridiculed at a high profile blue-chip dinner last week when he stated his forecast. He cites the rapid increase in auto sales as an offset to the weak holiday shopping saying what is more important to economic growth a car or a cardigan? All I can say is I hope David is right and everyone else is wrong.

Quite a few people are expecting a sharp increase in volatility in the coming months. There are numerous reasons that I won't go into here but many of these people are very confident in their beliefs. For instance an investor bought 40,000 April 22 calls on the VIX for $1.28 each. That cost him a cool $5.12 million. With the VIX at 15 today it would have to rise about 50% for that trader to make any real money. The option premiums on the VIX don't behave like regular option premiums so he needs the VIX to move very close to 24. I actually think this is a good bet given the potential for the Fed to taper in March or before.

The S&P declined -29 points last week to close at 1,775. This is critical support and a breakdown here could hit 1,760 or even 1,750 very quickly. This is material because the high on Monday was 1,811 and right at the closing high for the year. This is a significant change in sentiment that was caused by more than one event. The rapidly changing outlook for the Fed was the main reason given in the press but there was another reason. This is tax selling season and multiple money managers reported very strong tax selling by individuals. Winners were being sold to capture profits to offset the losers.

Balanced funds are restructuring. If you have a fund where you have a certain percentage allocated to stocks, bonds, commodities, etc then your allocations are broken. Stocks have gone up 20% to 35% in 2013 and bonds have been flat to down. This means fund managers have to sell equities and buy bonds to bring the allocations back into line. This can be done in December or January. Personally that is scary to me since we all pretty much agree that interest rates are going a lot higher and bonds are going lower. However, many retirement and pension funds don't have the ability to time the market and are required to maintain the allocations.

Regardless of the reason stocks are being sold and the markets closed not far from their lows on Friday. We can theorize all day long as to why but why does not matter. What matters is future market direction.

According to the Stock Trader's Almanac the December quadruple witching option expiration week and the week after has the most bullish record of any expiration week. Of course this week will be dependent on the FOMC decision but historically this is a bullish week.

I would follow the charts rather than the headlines next week. We saw 1,772 as the intraday low on Thursday and Friday. That makes it our line in the sand. A breakdown below that level is a sell signal. The prior support level at 1,780 is now short term resistance and could be seen as a buy signal on a break higher.

The fly in the ointment is the expected volatility. We could trade all over the map next week with both support and resistance broken more than once. It would be very difficult to specify a hard and fast rule this weekend and then stick with it. In this case I would follow the volume. The volatility spikes tend to occur on low volume and then reverse. If we get a directional move that lasts with a sharp increase in volume then I would follow that trend.

For investors not able to follow the market intraday the safe position would be on the sidelines. I know that is not fun but preservation of capital is always preferred. Once past the FOMC decision the market should become directional again.

The Dow broke through two support levels last week to lose -265 points and close at 15,755. That was only about 35 points off the low and not an encouraging sign. We normally see markets rebound on Friday's due to short covering or crash at the close on fear of weekend darkness. Neither happened and that suggests shorts were content to hold their positions.

The 15,800 support level has now become resistance. The odds are good we will see a breakdown to 15,600 which is strong support.

The Nasdaq performed a heroic feat on Thr/Fri with a goal line stand at 4,000. The index refused to move below that level for more than a few minutes and only by a few points. Buyers showed up on every dip below that level. However, as you can see in the chart the close at 4,000.90 was far from convincing. They were barely able to recover the 4K level and avoid a hit to sentiment in the weekend newspapers.

The Nasdaq lost -61 points for the week but remains the strongest of the big cap indexes. The Nasdaq is normally the strongest index in December along with the Russell 2000. Fortunately the Nasdaq is maintaining that ranking. When analysts are asked about their picks for 2014 the vast majority are naming Nasdaq stocks.

A breakdown of the 4,000 level could target strong support at 3,895. Resistance is well above at 4,070 so there is plenty of room to run should market sentiment turn positive again.

The Russell 2000 made the same goal line stand at the 1,100 level last week and then ticked up ever so slightly into Friday's close. Real support is 1,096 but it was not tested. Of all the indexes I believe the Russell is the one to watch. A break below 1,096 could suggest a bigger market breakdown in progress.

Eventually traders are going to find a level they believe will hold regardless of the Fed outcome. The closer we get to the FOMC decision on Wednesday the more aggressive the dip buyers will become. If the Russell holds 1,100 and Nasdaq 4,000 on Monday I would expect traders to become more aggressively bullish on Tuesday. Conversely if those levels fail the Fed decision may be mute.

On the world stage the U.S. and Japan are setting up for a confrontation with China. I previously wrote about the new Air Defense Identification Zone (ADIZ) established by China over international waters and the various intrusions into that zone by U.S., Japanese and South Korean planes and vessels. On Dec 5th the U.S. guided missile cruiser the USS Cowpens was challenged by Chinese vessels. The Chinese vessels attempted to halt the cruiser in international waters. The Chinese hailed the cruiser and ordered it to stop. When it did not comply Chinese vessels sailed directly in front of the Cowpens and tried to force it to stop. The cruiser was forced to abruptly change course and take on a more aggressive posture. The encounter eased and the Chinese forces moved away.

Most military officials believe the U.S. and China could be at war by the end of the decade. Most wars begin with minor events and then escalate abruptly. We can never assume that in the age of nuclear nations that a war is unthinkable. China has decided a U.S. presence in the South China Sea is no longer acceptable. Rick Fisher, a China military affairs expert, said China is deliberately staging these confrontations to test the U.S. resolve. Fisher expects them to escalate until there is an actual confrontation where shots are fired. The Chinese leadership believes President Obama does not have the will to stand up to China and they will use his final three years as president to increase their aggression and try to push the U.S. and its allies into backing off from the East Asian theater of influence. Eventually somebody will cross a line and go too far in one of these confrontations. While I would not worry about it today I would pay attention to the future headlines. Don't be caught unaware.

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Index Wrap

Correction Reborn

by Leigh Stevens

Click here to email Leigh Stevens

I headlined my week ago commentary as "correction over" but wondered at the time if I should have ended that thought with 'correction over ?'; yes! The last rebound looked good (maybe 'too' good) but the major indices may be too overbought on a long-term basis to tack on another immediate up leg.

I also wrote last time about the importance of the 4000 level in the Nasdaq Composite (COMP). COMP had of course previously rallied strongly above this pivotal level and now is back to it. From mid-week on this past week, COMP has held at 4000. This level in COMP should be watched as a harbinger of either strength if this level is a springboard for another rally attempt or as sign of further Market weakness if COMP pierces this level decisively.

The S&P 500 (SPX), our other Market bellwether, has key support in the 1750 area, extending to around 1720 at the current intersection of its up trendline. I'd watch for what happens if SPX dips into the 1750-1720 zone.

With the tendency for buying support related to portfolio 'window dressing' into the end of this month and end of the quarter, I don't look for any major sell off. January could be a time the time for a more significant pullback.

Last but not least in my overall comments about the Market being overbought at recent highs, I lead off my charts with the longer-term S&P 500 (SPX) weekly chart, with the Relative Strength Index (RSI) applied with a '13' length setting; i.e., the indicator uses the last 13 weeks Closing levels in its calculation.

You can see easily compare the most recent RSI peak to the one prior to it in May that was at a similar 'overbought' extreme. After that prior high extreme, SPX had a 100 point dip; and the last time the Index saw that much of a correction. The RSI will sooner or later come down from high 'overbought' RSI levels on either a substantial pullback AND/OR just from a leveling off of prices for a period of a few weeks.



The S&P 500 (SPX) chart has turned bearish short-term after a double top was made in the 1809 area, followed by a dip below SPX's most recent downswing low. Intermediate-term support is seen in the 1750 area. Below 1750, trendline support is the next technical area of importance with the trendline currently intersecting around 1720.

Pivotal technical resistance is at 1809-1810 and a Close above this level which, if followed by holding this area on the following day, would suggest potential back up to 1840, at the upper end of SPX's broad uptrend price channel.

Bullish sentiment has finally declined some from high extremes as traders realize that there's no immediate expected economic news that would likely move stock prices all that much. Time to nail down some profits even! Certainly there's stocks being sold that have either over-performed and reached likely objectives or stocks that have underperformed the market.

It looks like the S&P path of least resistance is down currently.


The S&P 100 (OEX), like big brother SPX, has a bearish short-term chart pattern given the recent top and formation of a line of resistance at 808-810. Above this near resistance, I've highlighted next resistance at the upper channel line, currently intersecting around 817.

OEX has likely technical support in the 790 area, then more pivotal support at 780. Fairly major support at OEX up trendline, comes in at 763 currently.

As with SPX, OEX's path of least resistance looks lower but not dramatically lower in my estimation. 790 could hold up as a support and buyers come in but the low-780 area looks more solid technically for the bulls to hold.


Enough of the 2/3rds of the Dow 30 (INDU) stocks that were in strong uptrends have paused and/or started retracing some of their prior advances to cause INDU to lose ground and take out near support in the 15800 area. I've highlighted next support at the 50-day moving average at 15660, extending to 15600.

A weekly close below the 50-day average would be widely perceived as bearish. Next lower support below the 50-day average comes in at 15400, extending to support implied by the current intersection of INDU's up trendline, at 15265.

I anticipate a continued drift lower based on INDU not yet being in an area that will bring in strong buying. In terms of a bellwether stock, you can watch General Electric (GE), which is holding up well. However a GE Close below $25 would reverse its current bullish advancing momentum.

Turning things back to a more bullish INDU chart would be a recovery to 15800 and the ability for the Dow to hold this area as support. Next resistance then comes in around 16000-16050, extending to the 16150 area.


The Nasdaq Composite (COMP) has lost it prior strong bullish momentum as seen in its inability to pierce highs made in the 4073 area. On a short-term basis the trend has shifted to neutral/sideways. On the bullish side, COMP has managed to hold the key 4000 level on the last 3 intraday lows. Stay tuned on COMP's ability to then mount a rally from 4000.

I would rate the odds of a dip to next support around 3950 or even to more 'solid' technical support implied in the 3900 area, as better than the probability of COMP rebounding to new highs in the near term.

I didn't highlight expected resistance on my COMP chart above 4073, but selling pressure would likely next come in at 4100. The upper (3%) moving average envelope line at 4145 is a possible target if COMP were to find some reason for a new up leg.


The Nasdaq 100 (NDX) chart has lost some its smoking hot upside momentum as it was bound to do. If only we knew at just what level and if a downside correction would turn into a substantial (i.e., 'tradable') pullback.

Of interest is how high extremes in the 13-day RSI have come ahead of any meaningful downturns, whether that was more of a leveling off or a significant dip. RSI peaks occurred in early-August, mid-September, late-October and recently. Based the RSI/price pattern, there's no compelling and immediate reason to jump back into bullish NDX strategies. Prior corrections, whether more sideways than down, have tended to go on for a 2-3 week period.

Support is anticipated at 3450, at 3400 and finally in the 3360 area, at the lower (3%) moving average 'envelope' line, a computed level that's each day plotted at 3 percent below the centered 21-day moving average. Technical resistance can be anticipated at 3500, extending to 3520, with next higher resistance then projected at 3570.

I don't see 3450 holding up as the low point of the current correction, although there could be a short-term rebound ahead from the 21-day average. If so, another dip may follow, such as to 3400 or a bit lower with intraday lows near 3360 perhaps.


The Nasdaq 100 (QQQ) tracking stock went from strongly bullish to a short-term lower trend as QQQ closed below it most recent minor downswing low. The first potential support I look to is at the 21-day moving average but the odds of 84.7 holding up as a rallying point is questionable. Better technical support is suggested at 84-83.6. Next key chart support comes in at 82-81.9, extending to 81.5-81.4.

Overhead resistance begins at 86 and extends to 86.5 with further resistance anticipated around 87.6.

There has not been the spike in daily trading volume that we could see if 84 gets pierced. There has been some orderly selling, without a panic button getting tripped. The On Balance Volume line is pointing lower and I anticipate prices are going to follow. Stay tuned for a test of 84 at a minimum I think, perhaps after a short-term rebound.


Weakness in the Russell 2000 (RUT) index did turn out to be a bit of harbinger for related weakness in the S&P and Dow. While RUT has reached support implied by the low end of its uptrend channel (at its up trendline), I don't put heavy odds on 1100 containing the current correction. It is an area of expected technical support, but better support probably is closer to 1080, and maybe ultimately closer to 1050.

Near resistance is highlighted at 1120, extending to 1140-1147.

I anticipate the Russell working lower, such as to 1080 at a minimum and to around 1050 as a 'maximum' current downside objective.


New Option Plays

Specialty Retail, Tech, & Defense

by James Brown

Click here to email James Brown


Advance Auto Parts - AAP - close: 109.85 change: +1.92

Stop Loss: 107.95
Target(s): 117.50
Current Option Gain/Loss: Unopened
Time Frame: exit PRIOR to January option expiration
New Positions: Yes, see below

Company Description

Why We Like It:
AAP is in the services sector. They run a specialty retail operation for auto parts with almost 4,000 stores. Looking at the chart of AAP you might notice the big gap higher back in October. That was the market's reaction to news that AAP was buying General Parts International in an all-cash deal worth about $2 billion. That's impressive since usually the stock of the acquiring company goes down on a deal. The market obviously approved.

Shares have been showing relative strength and they're currently up five weeks in a row. Friday's +1.7% display of relative strength left AAP at a new all-time closing high. We are suggesting a trigger to buy calls at $110.65. If triggered our short-term target is $117.50. Longer-term traders may want to aim higher since the Point & Figure chart for AAP is bullish with a $140 target.

Trigger @ 110.65

- Suggested Positions -

buy the Jan $110 call (AAP1418a110) current ask $3.60

Annotated Chart:

Entry on December -- at $---.--
Average Daily Volume = 923 thousand
Listed on December 14, 2013

3D Systems - DDD - close: 80.97 change: +0.61

Stop Loss: 78.90
Target(s): 89.00
Current Option Gain/Loss: Unopened
Time Frame: exit PRIOR to January option expiration
New Positions: Yes, see below

Company Description

Why We Like It:
DDD is in the technology sector. The company is one of the major players in the growing field of 3-D printing. The company made headlines on Friday with news they acquired Village Plastics, a provider of 3D printing materials. DDD stock has been showing strength the last couple of days. If this rally continues the stock could see some short covering. The most recent data listed short interest at almost 20% of the 95 million share float.

Friday's high was $81.93. Tonight we're suggesting a trigger to buy calls at $82.05. More conservative traders may want to wait for DDD to trade above its December 11th high of $82.65 before initiating positions.

If our trade is triggered our target is $89.00. Keep in mind that DDD shares can be volatile. I am suggesting we keep our position size small to limit our risk.

Trigger @ 82.05 *small positions*

- Suggested Positions -

buy Jan $85 call (DDD1418a85) current ask $3.40

Annotated Chart:

Entry on December -- at $---.--
Average Daily Volume = 5.7 million
Listed on December 14, 2013

Lockheed Martin - LMT - close: 139.03 change: +1.05

Stop Loss: 137.75
Target(s): 149.00
Current Option Gain/Loss: Unopened
Time Frame: 6 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
LMT is in the industrial goods sector. The company is a major player in the aerospace and defense industries. News this past week that congress has passed the new two-year U.S. budget deal that eliminates the defense-sector sequestration cuts should be bullish for the defense stocks. It is widely assumed that the senate will vote in favor of the new budget this coming week.

Currently shares of LMT are hovering below short-term resistance at the $140.00 level. I am suggesting a trigger to buy calls at $140.25. If triggered our multi-week target is $149.00. Keep in mind that the $144-145 area is currently overhead resistance.

I'm listing the March calls. If you want to take a more short-term approach then the 2014 January calls are much cheaper.

Trigger @ 140.25

- Suggested Positions -

Buy the Mar $145 call (LMT1422C145) current ask $3.00

Annotated Chart:

Entry on December -- at $---.--
Average Daily Volume = 2.0 million
Listed on December 14, 2013

In Play Updates and Reviews

Lows For The Week

by James Brown

Click here to email James Brown

Editor's Note:

Stocks closed near their lows for the week with Wall Street wondering why the Santa Claus rally is late.

QCOM has been removed. STZ was stopped out. Our long-term trade on VGK was closed Friday morning.

Current Portfolio:

CALL Play Updates

Allergan, Inc. - AGN - close: 96.83 change: +1.18

Stop Loss: 94.95
Target(s): 102.50
Current Option Gain/Loss: -40.0%
Time Frame: Exit prior to January option expiration
New Positions: see below

12/14/13: Friday proved to be a relatively quiet day for AGN. Shares bounced off their morning lows near $96.00 but didn't make it back into positive territory (much like the S&P 500). Shares appear to be consolidating sideways in a more neutral pattern of lower highs and higher lows. I'm starting to lean towards the idea of an early exit. I am not suggesting new positions at this time.

Our multi-week target is $102.50. More aggressive traders could aim higher. The Point & Figure chart for AGN is bullish with a $110 target.

- Suggested Positions -

Long 2014 Jan $100 call (AGN1418a100) entry $2.00

12/06/13 triggered on gap higher at $98.02, suggested trigger was $97.00


Entry on December 06 at $98.02
Average Daily Volume = 1.9 million
Listed on December 05, 2013

Aon Plc. - AON - close: 81.61 change: -0.29

Stop Loss: 80.75
Target(s): 85.00
Current Option Gain/Loss: -17.6%
Time Frame: 4 to 6 weeks
New Positions: see below

12/14/13: AON delivered a similar move with shares bouncing off their morning lows but failing to rebound back into the green. Shares look poised to drop back toward the $81.00 level. I am not suggesting new positions at this time.

- Suggested Positions -

Long 2014 Jan $82.50 call (AON1418a82.5) entry $1.70

12/07/13 new stop loss @ 80.75
11/23/13 new stop loss @ 79.85
11/18/13 new stop loss @ 79.45
11/13/13 new stop loss @ 78.75


Entry on November 08 at $80.50
Average Daily Volume = 2.3 million
Listed on November 06, 2013

Illumina Inc. - ILMN - close: 102.43 change: +1.43

Stop Loss: 97.75
Target(s): 109.00
Current Option Gain/Loss: + 0.0%
Time Frame: Exit PRIOR to 2014 January option expiration
New Positions: , see below

12/14/13: ILMN continued to show relative strength on Friday with a +1.4% gain and a new closing high. The stock may have received a boost from news that ILMN will be added to the NASDAQ-100 index starting on December 23rd. Funds that track the NASDAQ-100 will need to buy shares of ILMN. As long as ILMN shares do not gap open higher on Monday I would consider new positions now at current levels.

Earlier Comments:
Further gains could spark some short covering since the most recent data listed short interest at 26% of the 125 million-share float.

If triggered our target is $109.00. More aggressive traders may want to aim higher since the point & figure chart is bullish with a $146 target. P&F chart readers will also notice that ILMN is about to produce a new triple-top breakout buy signal.

NOTE: Biotech stocks can be volatile and the wrong headline could send shares gapping lower. Investors may want to limit their position size.

- Suggested Positions -

Long 2014 Jan $105 call (ILMN1418a105) entry $3.40


Entry on December 11 at $102.00
Average Daily Volume = 931 thousand
Listed on December 09, 2013

ITC holdings - ITC - close: 94.34 change: +0.64

Stop Loss: 92.40
Target(s): 98.50
Current Option Gain/Loss: -21.0%
Time Frame: four to six weeks.
New Positions: see below

12/14/13: ITC managed to outperform the market on Friday with a +0.6% gain. Shares did see a midday spike lower that pierced the 100-dma and fell just low enough to fill the gap before rebounding. Given Friday's strength and the bounce from the $93 level I would be tempted to buy calls here at current levels. Please note our new stop loss at $92.40.

Earlier Comments:
ITC can be a volatile stock. I could not find any explanation for the gap down on November 13th. Therefore I am suggesting small bullish positions to limit our risk. It's also worth noting that the $96.00 area and its simple 50-dma (also near $96) could be overhead resistance.

*small positions* - Suggested Positions -

Long 2014 Feb $95 call (ITC1422B95) entry $3.80*

12/14/13 new stop loss @ 92.40
12/11/13 trade opened on gap higher at $95.19, suggested trigger was $93.50
*option entry price is an estimate since the option did not trade at the time our play was opened.


Entry on December 11 at $95.19
Average Daily Volume = 419 thousand
Listed on December 10, 2013

Michael Kors - KORS - close: 82.27 change: -0.38

Stop Loss: 79.90
Target(s): 89.00
Current Option Gain/Loss: -10.8%
Time Frame: 4 to 8 weeks
New Positions: see below

12/14/13: KORS spiked higher on Friday morning and shares hit new all-time highs before paring their gains. The $83.00 level remains short-term overhead resistance for now. Traders could use a new rally above $83.00 as an alternative entry point to buy calls. Tonight we're moving our stop loss to $79.90. More aggressive traders may want to leave their stop below the December 6th low of $78.59 instead.

- Suggested Positions -

Long 2014 Jan $85 call (KORS1418a85) entry $1.85

12/14/13 new stop loss @ 79.90
12/07/13 new stop loss @ 78.49, readers may want to consider an early exit right here
11/22/13 trigger hit at $81.05
11/21/13 adjust entry strategy. Instead of buying a dip at $76.50, move the entry trigger to $81.05. Adjust the stop loss to $77.75. Adjust the option strike to 2014 Jan. $85 call.


Entry on November 22 at $81.05
Average Daily Volume = 7.2 million
Listed on November 20, 2013

United Parcel Service - UPS - close: 101.38 change: +0.43

Stop Loss: 100.45
Target(s): 108.00
Current Option Gain/Loss: -46.9%
Time Frame: 4 to 8 weeks
New Positions: see below

12/14/13: UPS displayed a little bit of strength on Friday with a +0.4% gain but I would remain cautious here. The stock briefly traded to a new three-week low ($100.65) before bouncing. Unfortunately Friday's bounce stalled at short-term resistance near its 10 and 20-dma. Technically last week's performance has created a bearish engulfing candlestick reversal pattern on UPS' weekly chart. More conservative traders may want to abandon ship and exit early now.

I am not suggesting new positions at this time.

- Suggested Positions -

Long 2014 Jan $105 call (UPS1418a105) entry $0.98

12/12/13 new stop loss @ 100.45
11/23/13 new stop loss @ 99.75
11/20/13 new stop loss @ 98.95


Entry on November 14 at $101.25
Average Daily Volume = 3.8 million
Listed on November 13, 2013

Western Digital Corp. - WDC - close: 79.05 change: +0.19

Stop Loss: 77.70
Target(s): 84.75
Current Option Gain/Loss: Unopened
Time Frame: Exit PRIOR to January option expiration
New Positions: Yes, see below

12/14/13: WDC inched higher on Friday but shares remain below round-number resistance at the $80.00 mark. I don't see any changes from my earlier comments.

We're suggesting a trigger to buy calls at $80.25. If triggered our short-term target is $84.75. More aggressive traders may want to aim higher since the Point & Figure chart for WDC is bullish with a $100 target.

NOTE: I am listing the 2014 January $80 calls but you might want to consider the April $85 calls instead to give you more time.

Trigger @ 80.25

- Suggested Positions -

Buy the 2014 Jan $80 call (WDC1418a80) current ask $2.51


Entry on December -- at $---.--
Average Daily Volume = 1.9 million
Listed on December 12, 2013

PUT Play Updates

Intl. Business Machines - IBM - close: 172.80 change: -0.57

Stop Loss: 178.65
Target(s): 170.25
Current Option Gain/Loss: + 53.9%
Time Frame: 3 to 4 weeks
New Positions: see below

12/14/13: IBM had some interesting headlines on Friday. The Louisiana Sheriff's Pension and Relief Fund is suing IBM for its participation in the NSA surveillance program. The investors are claiming that IBM's participation has hurt the company's sales in China and thus hurting shareholders. In reality a lot of big U.S. tech companies participated in the NSA program and many believe this is hurting all sales outside the U.S. It's a curse that could haunt the U.S. tech industry for years to come.

Meanwhile shares of IBM are essentially testing the October lows near $172.60. More conservative traders will want to seriously consider an early exit right now to lock in gains since IBM might see a bounce here (near the October lows). The newsletter's target is $170.25 but more aggressive traders could aim for the bottom of its bearish channel, currently near $165 (see chart).

- Suggested Positions -

Long 2014 Jan $175 PUT (IBM1418m175) entry $3.15

12/14/13 readers may want to take profits now with IBM testing its October lows.
12/09/13 new stop loss @ 178.65


Entry on December 03 at $176.90
Average Daily Volume = 5.1 million
Listed on December 02, 2013

Kansas City Southern - KSU - close: 117.44 change: +0.39

Stop Loss: 120.50
Target(s): 114.00
Current Option Gain/Loss: - 8.3%
Time Frame: 3 to 4 weeks
New Positions: see below

12/14/13: Railroad stocks bounced on Friday. KSU pared its gains and the move on Friday looks like a new lower high. More conservative traders may want to lower their stop closer to the simple 10-dma near $119.00.

Our target is $114.00. More aggressive traders may want to aim lower for the simple 200-dma instead.

- Suggested Positions -

Long 2014 Jan $115 PUT (KSU1418m115) entry $2.40*

12/11/13 triggered @ 117.75
*option entry price is an estimate since the option did not trade at the time our play was opened.


Entry on December 11 at $117.75
Average Daily Volume = 486 thousand
Listed on December 07, 2013

Sears Holdings - SHLD - close: 45.36 change: -1.25

Stop Loss: 50.05
Target(s): 40.15
Current Option Gain/Loss: + 3.0%
Time Frame: 3 to 4 weeks
New Positions: see below

12/14/13: SHLD's attempt at a bounce on Friday morning failed. The stock reversed and underperformed the market with a -2.6% decline. It is possible that SHLD might find some short-term support at the $45.00 mark but we would expect any bounce to be short-lived.

Earlier Comments:
Our short-term target is $40.15. Keep in mind that there are already a lot of bears in this stock. The most recent data listed short interest at 56% of the 50.7 million share float. That's plenty of fuel for a short squeeze if the stock can bounce. It's another reason to keep your position size small.

- Suggested Positions - *small positions*

Long 2014 Jan $39 PUT (SHLD1418m39) entry $1.66


Entry on December 12 at $46.18
Average Daily Volume = 1.5 million
Listed on December 11, 2013

Longer-Term Play Updates

Currently we do not have any active long-term trades


QUALCOMM Inc. - QCOM - close: 72.58 change: -0.15

Stop Loss: 71.75
Target(s): 79.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: see below

12/14/13: QCOM is not cooperating. Overall sentiment on the stock remains bullish but shares were unable to breakout past resistance near $74.00 this past week. The recent action looks like a reversal. Our suggested entry point at $74.25 has not been triggered.

Tonight we are removing QCOM as an active candidate but I would keep it on your watch list. The $70.00 level should be significant support so a dip near $70.00 could be our next potential entry point to buy calls.

Trade did not open.

12/14/13 removed from the newsletter. suggested entry trigger was $74.25.


Entry on December -- at $---.--
Average Daily Volume = 11.5 million
Listed on December 07, 2013

Constellation Brands Inc. - STZ - close: 69.32 change: -0.77

Stop Loss: 69.40
Target(s): 74.75
Current Option Gain/Loss: -45.7%
Time Frame: 4 to 6 weeks
New Positions: see below

12/14/13: There was no follow through on yesterday's intraday bounce in STZ. The stock underperformed the market on Friday and broke down to new two-week lows. Shares hit our stop loss at $69.40.

STZ is another stock I would keep on your watch list to buy after it is done correcting lower.

Earlier Comments:
Our plan was to limit our risk by using small positions.

*small positions* - Suggested Positions -

2014 Jan $72.50 call (STZ1418a72.5) entry $1.75 exit $0.95 (-45.7%)

12/13/13 stopped out
12/03/13 new stop loss at $69.40


Entry on November 25 at $70.55
Average Daily Volume = 1.3 million
Listed on November 23, 2013


Vanguard FTSE Europe ETF - VGK - close: 55.36 change: -0.04

Stop Loss: 54.90
Target(s): Sell half @ $58.00, sell the rest at $63.00
Current Option Gain/Loss: + 0.0%
Time Frame: exit PRIOR to 2014 March option expiration
New Positions: see below

12/14/13: European markets continued to sink on Friday. The VGK opened two cents higher at $55.42 and closed virtually unchanged on Friday. Our plan was to exit on Friday morning to avoid or minimize any losses.

- Suggested Positions -

2014 Mar $55 call (VGK1422C55) entry $1.80* exit $1.80 (+ 0.0%)

12/13/13 planned exit Friday morning
*option exit price is an estimate since the option did not trade at the time our play was closed.
12/12/13 prepare to exit positions at the open tomorrow
11/30/13 new stop loss @ 54.90
10/22/13 Strategy Update: Plan to exit half @ $58.00 and exit the rest at $63.00. New stop loss @ 53.90
10/19/13 new stop loss @ 52.75
09/11/13 trade opens. VGK @ 53.60
*option entry @ 1.80 is an estimate. Ask closed at $1.75 yesterday
09/10/13 entry trigger met. open positions tomorrow.
09/10/13 new stop loss @ 50.95
08/24/13 adjust the option strike from 2013 Dec $55 to $2014 Mar $55.


Entry on September 11 at $---.--
Average Daily Volume = 3.0 million
Listed on August 10, 2013