Option Investor

Daily Newsletter, Wednesday, 9/14/2011

Table of Contents

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

Market Wrap

Opex Wednesday Produces Strong Rally on Lighter Volume (again)

by Keene Little

Click here to email Keene Little
Market Stats

The stock market has been reacting to news out of Europe and acting like a ping-pong match as news about more plans to save the banks, um, I mean countries (most are giving up on Greece even if they say so differently now), comes out and then denied, then a new plan and then denied. Each news item spikes the market up and then back down and the result has been a very choppy market stuck in a trading range for over a month.

Last night's futures showed the same response and ES (S&P 500 emini) sunk to 1148 after closing the day near 1165. News that all is right with the world sent ES up to 1175, for a 27-point rally in the pre-market. That was just the overnight session! Not to be outdone, the cash market initially sold off, with the S&P dropping down to 1162 and then proceeded to rally 40 points to 1202, helped by some positive news about Greece -- Germany's Merkel and France's Sarkozy reaffirmed their support for Greece and assurance that they would help it avoid a "disorderly default". Funny what we consider good news these days.

We of course have opex shenanigans this week but basically the market is being news driven at the moment and that makes it difficult to trade, especially holding anything overnight. Mix up some low volume, opex and European news and it's a recipe for chop and whipsaws. The 3-day rally this week has been on successively lower volume, not a healthy sign. With a choppy price pattern it's very difficult to figure out whether the choppy consolidation is going to continue, with new highs for the bounce, or break down from what looks like a bearish consolidation pattern. Today's rally, typical on a Wednesday of opex week, was strong and it makes me wonder how much stronger it could have been had we had some GOOD economic news to report.

Starting off the day's economic reports were the two PPI numbers, which were benign. PPI was flat at 0% and the core PPI (less energy and food) was only +0.1%. This gives the Fed some wiggle room to say they can inject more liquidity into the market without fear of stoking inflation, which the market likes.

Retail sales came in flat as well -- 0% and +0.1% excluding auto sales. This is a little disappointing considering even the small expectation for a +0.2% increase (down from July's +0.3%). Consumers spent more at the pump and in grocery stores (where prices aren't, cough, going up). July sales were revised down to 0.3% from the prior estimate of +0.5% and June's was revised lower from +0.3% to +0.2%. So it's not good news for retailers and by extension for the economy. Consumers are hunkering down again.

The only thing that surprises me is that consumer spending has stood up as well as it has. When you consider the high level of unemployment and the rapidly declining consumer sentiment I would have thought retail spending would be much lower. And the employment picture is not expected to get any better any time soon. What's amazing is to see how dismal the employment picture has been since the start of the recession. Joe Weisenthal posted his Chart of the Day last week, which shows the recovery in employment following previous recessions (it might be hard to see the numbers in the chart below but it's the number of week's past the start of the recession, running from 0 to 47. Each recession since 1948 is shown on the chart and how deep it got and how long it took to recover. A picture is worth a thousand words and the current unemployment streak speaks volumes about how this recession is clearly different than anything experienced since WWII (since the Great Depression actually).

Post WWII Recessions and Unemployment, chart courtesy calculatedriskblog.com

So the economy continues to cause worry for the stock market. Recessions are typically met with stock market declines averaging about -40%. We've had only half that so far. Since the decline into the August 9th low emotions have been running high and we've had a market reacting to news. Between hope and fear we've seen an increase in volatility, including today. Europe is currently one of the bigger worries since we're all so interconnected these days. The market's various asset classes have been tightly correlated and the world's stock markets have been mostly in synch with one another.

The worry about Europe is the spreading contagion with multiple countries having unsustainable debt. Right behind Greece is Italy and then Spain and of course there's still Portugal and Ireland on deck. Even France is now being threatened with a downgrade based on its debt load. The problems in Europe are significant and they're going to be with us for a long time (especially considering the tight global financial linkages). Solving Greek's debt issue will not make this problem go away, no matter how much we wish it would.

And lest we think this is strictly a European problem, do not forget that Japan is in even worse financial shape. Their debt-to-GDP ratio is above 200% and the only reason they've been able to sustain this level of debt for as long as they have is because the Japanese are huge savers and they own most of the debt. The U.S. is not so fortunate -- much of our debt is owned by foreigners and when they get worried and stop buying our debt there's going to be trouble. The chart below shows debt for the troubled European countries (PIIGS) and no surprise we see Greece at the top of the list, followed by Italy. But look who's tied with Ireland -- the U.S. with a debt-to-GDP greater than 100% (projected by 2012).

European and U.S. Gross Debt as % of GDP, chart courtesy caseyresearch.com

Carmen Reinhart and Kenneth Rogoff wrote a book "This Time Is Different: Eight Centuries of Financial Folly" in which they state no country has ever been able to get itself out of trouble once the national debt exceeds 90% of GDP. It's considered the point of no return. Unless it is different this time you can see by the above chart that we're all in this together and we'll likely all fail together (the end of fiat currencies as they exist today). It's a sobering thought.

The strongest of the European countries is Germany, an exporting powerhouse and relatively wealthy as compared to several other European countries. So the fact that its stock market has lost a third of its value since July it should be of concern to all of us. The chart below compares the DAX and SPX to show that the U.S. stock market will either join the DAX or the DAX is due a big bounce. As I'll point out, it might be a little bit of both. When the DAX lost its June low near 5800 it would be like SPX dropping below 1010. Instead its flirting with 1200 in the current bounce. Granted, Germany's banks are on the hook more for European sovereign debts but our banks are not immune since we're all connected (and our banks are responsible for a lot of swaps (insurance) on the debt).

Germany's DAX vs. SPX, Weekly chart

The good news for the DAX at the moment is that it looks like it's going to get a decent bounce, which could obviously help the U.S. stock market. Following a bullish descending wedge pattern, with confirming bullish divergences, we could see the DAX bounce back up to the 5800 area, at least, for a back test of broken price-level support.

Germany DAX Composite, DAX, Daily chart

One other thing that could provide a lift for the stock market is the sentiment picture. Simply put, too many have turned bearish for the bear's comfort. It's not a timing tool and with negative consumer sentiment and a poor economy/jobs picture, the bearish sentiment could in fact be a harbinger of a bad moon risin'. Speaking of the moon, did you notice the market turned back up on the full moon on Monday. Highs on new moons (next one is September 27th) and lows on full moons is the pattern so far this year. But I digress. For now the bears need to pay attention to the fact that they have a lot of company.

Bullish vs. Bearish sentiment, AAII data, chart courtesy schaefferresearch.com

Moving to my regular charts, the SPX weekly chart hasn't changed much from last week since price is still stuck in a trading range. While I've pointed out a few reasons above why we could see a market bounce, the bigger price pattern warns me to expect another leg down. We could go higher for a week or so but the path of least resistance is going to be down. In other words, in this news-driven market, one news break about Europe could send our stock market spinning to the downside.

S&P 500, SPX, Weekly chart

SPX poked its head out of its down-channel today and must have been scared up there -- it closed back inside the channel after the late-day selloff. Somebody didn't like it out there. Upside potential remains 1250-1270 if SPX can get above 1205. Otherwise another breakdown could drop it below 1136, which would be a sell signal. There are multiple support levels starting at 1100 on down to a potential downside target near 950.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1205
- bearish below 1136 and more bearish below 1090

The 120-min chart below shows price poked above the top of its down-channel but now it looks potentially bullish since it has pulled back to the top of the channel. This could be setting up a bullish back test if tomorrow rallies. However, a drop back below 1188 would leave a head-fake break and bull trap. It could signal the end of the correction, with the throw-over finish, and I'd want to be short with a stop at today's high. Confirmation of a breakdown doesn't come until 1136 gives way.

S&P 500, SPX, 120-min chart

While the DOW is not challenging the top of its down-channel it did challenge its shorter-term downtrend line from September 1st. The daily chart shows this is potentially bearish but like the intraday chart for SPX, it could be a bullish back test if the market rallies tomorrow.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 11,477
- bearish below 10,700

NDX did a little better against its 50-dma today than it did on August 31st and September 1st. It was able to rally above it and its broken uptrend line from March 2009 - August 2010. Too bad it wasn't able to hold it. Once again, the daily chart looks bearish with resistance holding but the intraday chart looks potentially bullish with a back test to support if tomorrow rallies. If the market declines tomorrow it will leave bull traps behind and the potential for a strong selloff to follow would mean those who bought the breakout had better sell at the open and get what they can.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2253 and more bullish above 2330
- bearish below 2139

The downtrend line from July 22nd for the RUT is the line in the sand for the bears here. The RUT broke above the line, near 704 but couldn't hold it. Or will it with an intraday back test? It's a common theme tonight and tomorrow could give us the direction for the rest of the month. I'm showing a slightly different idea for a decline into month end -- a descending wedge pattern that sets up a stronger multi-month (into year end) correction of the decline from May/July. It's just an idea at the moment but consider the possibility since it will be a choppy affair.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 704 and more bullish above 775
- bearish below 665

Last week I showed the possibility for a minor new low for TNX, the 10-year yield, to be followed by a stronger bounce that should lead to a multi-month rally. The rally will either be just a correction of the leg down from February or a much stronger rally that will take TNX to new multi-year highs (above the 2007 high near 5.3%). A break above 2.6% is needed to at least give the bond bears a foothold (bearish bonds gives us higher yields). But a bounce up to the 2.6% area would be a back test of the broken uptrend line from December 2008 and a 38% retracement of the decline from February. The longer-term bearish pattern (bullish for bond prices) calls for the back test to fail and a continuation lower (towards 1%). There remains the possibility for TNX to work its way a little lower (dashed red line) before setting up a bigger bounce.

10-year Yield, TNX, Weekly chart

If the Fed starts rolling out their debt to longer maturities, as they say they plan to do, their demand for those bonds could certainly press rates lower over the next year or two. They've made it abundantly clear that they want investors in the riskier assets, such as stocks, instead of bonds. And if they're very successful at doing this it could push bond buyers out the longer-term maturities (30-year) in an effort to get the higher yields. This would also please the Fed since lower 30-year rates should help the mortgage market (sorry retirees, you don't fall into the "I care about you group"). Looking at the longer-term down-channel since 1994 for TYX, the 30-year yield, I can see the potential for a drop down to the bottom of the channel in 2013-2014, which would be near 1.5% (for a 30-year bond!!). It takes a rally above 4.38% to show the bond vigilantes are in complete disagreement with the Fed and abandoning the bonds (driving prices lower, yields higher).

30-year Yield, TYX, Monthly chart

I wider look at the bank index tonight shows a pattern I think will play out this year and into next. Ideally, for a 5-wave count for the leg down from February, the current consolidation since August should be followed by a 5th wave, with a downside target at 27.65 (wave-5 = wave-1). From there a larger bounce correction into the end of the year followed by another leg down to below 20.

KBW Bank index, BKX, Weekly chart

The TRAN was successful in breaking its downtrend line from July and holding above it today. That keeps the door open for the completion of a 2nd leg up for an a-b-c bounce off the August low. The upside target is its 50-dma near 4844, which is also where the a-b-c bounce would have two equal legs. But a drop back below 4500 would be a bearish heads up.

Transportation Index, TRAN, Daily chart

Last week I pointed out the similarities between the basing pattern in 2008 and the current one in 2011. Price came bounding out of the pattern last week and so far is only chopping its way back in a bull flag, pointing to higher highs. We could see a test of the 200-week MA near 78.75 before pullback back again. There remains the possibility we'll see a slightly larger descending wedge pattern with one more new low (dashed line) but at this point the higher-probability is for the dollar to rally into year end and beyond. There is significant upside potential (98-100) and that would place some serious pressure on other assets (unwinding of the dollar carry trade for one thing).

U.S. Dollar contract, DX, Weekly chart

Gold is holding up and the pullback is choppy enough to support the idea that it will at least chop its way higher this month. I'm showing an ascending wedge as just one idea for what could happen if it holds up but continues to chop up and down. A break below 1793 would be a sell signal.

Gold continuous contract, GC, Daily chart

Silver is trying to hold onto the bottom of its rising wedge pattern and just below it is its' 50-dma near 40.10. So a break below 40 would be a bearish heads up and below 39 would create a sell signal. Another leg up within the wedge remains a possibility.

Silver continuous contract, SI, Daily chart

Oil's little rising wedge pattern should resolve the same way as its previous wedge and triangle -- down. A break of the uptrend line from August 9th would be a bearish heads up and below 83 would create a sell signal. In an "all the same" market, a breakdown in oil should be accompanied by a breakdown in the stock market.

Oil continuous contract, CL, Daily chart

Tomorrow morning will be a busy one with potentially important economic reports, especially the Empire Manufacturing and Philly Fed. But we're in one of those times when bad news could be good because the market will expect the Fed to give us some more happy juice to make the pain go away, even if it is temporary relief. Good numbers might get the Bronx cheer (the 3 finger, minus 2, salute).

Economic reports, summary and Key Trading Levels

Selling is on increasing volume and buying is on decreasing volume. The price pattern has been very choppy (corrective) since the August low. The spike down into the August low followed by corrective price action tilts the odds heavily in favor of another leg down, whether directly from here or from a higher bounce. The higher bounce could mean SPX 1250-1260 so respect that possibility if you're playing the short side (above 1205 is potentially bullish).

The next leg down, assuming we get it, could be just a test of the August low (SPX 1101) or it could drop down to 950, with several support levels in between. What that means is the potential for a short play is large but it will have to be managed on the way down and protect/take profits along the way.

Good luck during the rest of opex week and I'll be back with you next Wednesday.

Key Levels for SPX:
- bullish above 1205
- bearish below 1136 and more bearish below 1090

Key Levels for DOW:
- bullish above 11,477
- bearish below 10,700

Key Levels for NDX:
- bullish above 2253 and more bullish above 2330
- bearish below 2139

Key Levels for RUT:
- bullish above 704 and more bullish above 775
- bearish below 665

Keene H. Little, CMT

New Plays

Semiconductors Outperform Again

by James Brown

Click here to email James Brown

Editor's Note:

Stocks are up three days in a row. The recent strength is encouraging but we could see another sell-off soon. The last couple of Fridays have seen the market drop sharply as investors bail ahead of the weekend. Now the rally seems to have stalled at resistance. What are the odds we'll see another decline in the second half of this week?

We want to trade carefully. If you have gains, consider taking some money off the table. A close over 1206 on the S&P500 would bolster my confidence in the market but the larger pattern (like the bear-flag pattern) could still be in play.

Semiconductor stocks continue to show relative strength. If you're looking for bullish candidates check out that sector although I'm starting to wonder if they need a rest soon. (chip stocks: ALTR, KLAC, LRCX, LLTC, XLNX, INTC, and TXN).

A few more stocks that might be setting up for a trade soon are: RHT, LIFE, FAST, CSCO and VMED

No new trades tonight.

- James

In Play Updates and Reviews

Beware RIMM's Earnings

by James Brown

Click here to email James Brown

Editor's Note:
Investors do not seem very excited for RIMM's earnings tomorrow night. The stock did not participate in the market's widespread rally today. It was our plan to exit RIMM positions at the close today.

Elsewhere the HNSN and NVDA trades are open. STMP hit our first profit target.


Current Portfolio:

BULLISH Play Updates

CBOE Holdings, Inc. - CBOE - close: 26.82 change: +0.00

Stop Loss: 24.75
Target(s): 29.50
Current Gain/Loss: + 1.4%
Time Frame: 6 to 8 weeks
New Positions: see below

09/14 update: Trading action in CBOE today was disappointing. The stock failed at the $27.00 level twice and closed unchanged for the day. If a widespread market rally can't help fuel a move past $27.00 then CBOE may be poised for a pull back. Readers may want to wait for a dip or a bounce near $26.00 or $25.50 before considering new positions.

Earlier Comments:
We need to label this as a slightly more aggressive trade. While things look good on a short-term basis the long-term weekly chart is showing potential resistance. Readers may want to wait for a close over that trendline before considering new bullish positions.

Current Position: Long CBOE stock @ $26.43

- or -

Long OCT $27 call (CBOE1122J27) Entry $0.99

Entry on September 13 at $26.43
Earnings Date 11/03/11 (unconfirmed)
Average Daily Volume = 703 thousand
Listed on September 12, 2011

Hansen Medical Inc. - HNSN - close: 4.03 change: -0.18

Stop Loss: 3.90
Target(s): 4.85, 5.20
Current Gain/Loss: - 5.1%
Time Frame: 6 to 8 weeks
New Positions: see below

09/14 update: Warning! HNSN met our entry point requirements this morning but shares reversed lower early on. The move today and the -4.2% decline now looks like a bearish reversal pattern. I am turning defensive on this trade given today's relative weakness. We'll raise our stop loss to $3.90, just under the 10-dma. I'd wait for a bounce from the $4.00 level before considering new bullish positions.

Earlier Comments:
The stock can be volatile so we want to keep our position size small. Conservative traders may want a stop closer to today's low (3.90) while aggressive traders may want a stop under Friday's low (3.61).

Current Position: Long HNSN stock @ $4.25

09/14 new stop loss @ 3.90

Entry on September 14 at $4.25
Earnings Date 11/03/11 (unconfirmed)
Average Daily Volume = 963 thousand
Listed on September 12, 2011

NVIDIA Corp. - NVDA - close: 15.28 change: +0.75

Stop Loss: 13.49
Target(s): 16.75
Current Gain/Loss: +2.4%
Time Frame: 6 to 12 weeks
New Positions: see below

09/14 update: The relative strength in NVDA today is encouraging but the gap open this morning makes me wish we'd bought the bounce two days ago. Shares opened at $14.91 and rallied t $15.47 intraday. I suspect we could see NVDA fill the gap so readers may want to wait for a dip toward the $14.60 area before initiating new positions.

Please note that I am raising our stop loss to $13.49.

Current Position: Long NVDA stock @ $14.91

- or -

Long OCT $15 call (NVDA1122J15) Entry $1.10

- or -

Long 2012 JAN $15 call (NVDA1122A15) Entry $2.28

09/14 new stop loss @ 13.49
09/14 gap open higher entry point @ 14.91

Entry on September 14 at $14.91
Earnings Date 11/10/11 (unconfirmed)
Average Daily Volume = 19.3 million
Listed on September 13, 2011

SodaStream Intl. - SODA - close: 42.82 change: +0.57

Stop Loss: 37.20
Target(s): 45.75, 49.75
Current Gain/Loss: +4.8%
Time Frame: 4 to 8 weeks
New Positions: see below

09/14 update: SODA gapped open higher again. Shares opened at $43.32 and rallied to $44.72 before paring its gains. It looks like the stock struggled with its descending 30-dma this morning. I am not suggesting new positions at this time. Wait for another dip or a bounce near the $40.00 level before considering new positions.

Earlier Comments:
If this stock can rally then SODA could see a huge short squeeze. The most recent data listed short interest at more than 75% of the very, very small 14.6 million-share float.

Remember, we want to use small positions to limit our risk.

Current Position: Long SODA @ $40.84

- or -

Long OCT $45 call (SODA1122J45) Entry $3.00

09/13 new stop loss at $37.20
09/13 trade is open. SODA @ 40.84

Entry on September 13 at $40.84
Earnings Date 11/29/11 (unconfirmed)
Average Daily Volume = 3.8 million
Listed on September 8, 2011

Stamps.com Inc. - STMP - close: 23.15 change: +2.23

Stop Loss: 18.45
Target(s): 22.25, 24.50
Current Gain/Loss: +14.1%
Time Frame: 6 to 10 weeks
New Positions: see below

09/14 update: Target hit. STMP saw big gains today (+10.6%) and on really strong volume of 1.0 million shares versus the average of just 248 thousand. The stock hit an intraday high of $24.10. Our first target to take profits was hit at $22.25. The option was trading with a bid near $2.70 (+80%).

We still have a secondary target but I am moving it from $24.50 to $24.75. We'll also move our stop loss to $19.75.

Current Position: Long STMP stock @ $20.29

- or -

Long OCT $20 call (STMP1122J20) Entry $1.50

09/14 1st target hit @ 22.25 (+9.6%)
option bid near $2.70 (+80%)
09/12 STMP gapped open at $20.29, above our entry point.


Entry on September 12 at $20.29
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 248 thousand
Listed on September 10, 2011

WABCO Holdings - WBC - close: 47.22 change: +0.28

Stop Loss: 43.60
Target(s): 49.50, 54.00
Current Option Gain/Loss: + 1.9%
Time Frame: 4 to 8 weeks
New Positions: see below

09/14 update: Hmm.... I found the trading in WBC to be disappointing. Shares only added +0.5% versus the S&P 500's +1.3%. The stock is still struggling with its 30-dma. Readers may want to consider an early exit tomorrow. I am not suggesting new positions. Monday's low was $43.67. I am moving our stop to $43.60.

- Suggested Positions -

current Position: Long WBC stock @ $46.32

09/14 new stop loss @ 43.60
09/08 1st target hit at $49.50 (+6.8%)
09/07 trade now open. WBC gaps higher at $46.32
09/06 trade not open yet. Try again. New stop loss 43.40. new targets 49.50 and 54.00

Entry on September 7 at $46.32
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 900 thousand
Listed on September 3, 2011

BEARISH Play Updates

Greif, Inc. - GEF - close: 47.75 change: +1.20

Stop Loss: 50.60
Target(s): 44.00, 40.50
Current Gain/Loss: -1.7%
Time Frame: 6 to 8 weeks
New Positions: see below

09/14 update: Another big day of market gains finally fueled some short covering in GEF. The stock rallied +2.5% but it struggled with short-term resistance near $48 this afternoon. If the stock declines from current levels we can use it as a new entry point for bearish positions.

Earlier Comments:
FYI: The Point & Figure chart for GEF is bearish with a $30 target. I am not suggesting the options. The spreads are too wide.

*Small Bearish Positions*

Current Position: short GEF stock @ $46.93

Entry on September 12 at $46.93
Earnings Date 12/07/11 (unconfirmed)
Average Daily Volume = 247 thousand
Listed on September 10, 2011


Research In Motion - RIMM - close: 29.72 change: -0.41

Stop Loss: 28.90
Target(s): 34.75
Current Gain/Loss: -6.0%
Time Frame: exit before Sep. 15th
New Positions: see below

09/14 update: There seems to be a healthy dose of skepticism regarding RIMM's upcoming earnings tomorrow. No one is placing any big bets either way. The stock continued to churn sideways and settled with a -1.3% loss.

Nimble traders may want to consider a neutral trade like an option straddle at the $30.00 strike or a strangle (buying an out of the money call and out of the money put) to capture any post-earnings volatility. If you really wanted to get aggressive you could buy Septembers options before the closing bell on Thursday and sell them before they expire after Friday's close (you'd only have one day before Septembers expired).

It was our plan to exit our RIMM positions tonight at the close.

FYI: Analysts are expecting a profit of 88 cents a share.

closed Position: Long RIMM stock @ $31.64, exit 29.72 (-6.0%)

- or -

OCT $33 call (RIMM1122J33) Entry $2.40, exit $1.51 (-37.0%)

09/14 planned exit at the close
09/13 prepare to exit tomorrow at the close
09/10 Remember, we want to exit prior to earnings (9/15)
09/07 trade is now open. RIMM gapped open at $31.64
09/06 trade not open yet. try again. New stop @ 28.90


Entry on September 7 at $31.64
Earnings Date 09/15/11 (confirmed)
Average Daily Volume = 26.9 million
Listed on September 3, 2011