Option Investor

Daily Newsletter, Wednesday, 4/10/2013

Table of Contents

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

Market Wrap

Ramping Up

by Keene Little

Click here to email Keene Little
The DOW's move up from November is starting to go a bit too vertical for its own good. This week's rally is starting to look dangerously vulnerable. Everyone is now expecting DOW 15K.

Market Stats

The CNBC party hats are out -- DOW 15K here we come. But many are now looking for much higher and while they could be right we have to keep in mind that the market feels the most bullish at the top. Whether or not we're making a top this week can't be known yet but it's starting to feel like one -- a blow-off move to the upside as the last players throw in the towel and run to climb aboard.

There's lots of speculation as to why the market is rallying strongly this week, with everything from the Fed's money, better expectations for earnings, all the bad news is priced in, it's a new bull market, etc. The FOMC minutes were out much earlier than expected this morning, before the opening bell at 9:00 AM and it got the credit for today's rally. There wasn't anything new or unexpected and the market is simply relieved that the direct injection of drugs into the market will continue. Some Fed members voiced their opinion that asset purchases should start to taper off around mid-year but others call for a wait-and-see until we get into the fall. Lots of drugs still available? Let's party!

Economist John Hussman, whose recent analysis was included in John Mauldin's letter, discussed this bullishness and the expectation by most that the Fed's money will help keep the market rally alive. He discussed how disconnected the stock market is with reality. While the market is rallying on expectations, the reality is the economy is not doing well and the stock market will soon wake up to that reality.

The chart below shows U.S. economic activity since 2000 that is based on the ISM and Fed indices (Empire, Philly, Richmond and Dallas). The main takeaway from the chart is that each round of QE has given the economy a little lift but each peak in activity is a lower high. As Hussman says, each round of QE has been to kick the can further down the road but now we're back at the can. Can the Fed successfully kick it further down the road? They'll sure try. But the next lower high on the chart points to another coming correction for it and the stock market.

U.S. Economic Activity and QE, 2000-present, chart courtesy John Hussman

The stock market is one of the few areas where people get excited about buying higher prices. In everything else we buy we look for discounted prices so that we feel like we got a deal. But in the stock market the higher the price the better we feel. It can only go higher! When that sentiment pulls in the final players who were holding out, and bullish sentiment reaches a peak, the market simply flames out from a lack of more buyers. Again, whether or not we've hit that point is open for debate but keep in mind that a strong rally that's not based on any particularly good news to fuel that rally, especially at the tail end of a longer-term rally, is ripe for a blow-off top and it's starting to feel like we're in that now.

As one trader friend said to me today, "RUT and TRAN have completed double tops, HGX (housing sector) has broken its uptrend line from October 2011, SOX and BKX are not confirming new highs in the DOW/SPX. What does it take to scare a bull?" Good question, Ed. In a conversation with another trader, who has been trading since before the 1987 crash and notes some eerily similarities today, he noted that "Unlike the specialist/market-maker days in 1987, liquidity today is provided by the HFT guys (who if there is a meltdown, will be the scapegoat du jour this time around) who may well step aside if and when things stumble, and can do it quick, fast and in a hurry. I think there is a very high probability of a liquidity issue here on the slightest pullback." Hat tip to Ralph for the reminder.

The flash crash in May 2010 was basically a liquidity issue -- the buyers stepped aside and the program selling simply kept selling. There was nothing in the programs to tell the computer to do otherwise. Supposedly there are now some circuit breakers being designed into the system for ETFs to stop the trading for a short period of time (5 minutes) to allow humans to get in the middle but it hasn't been rolled out yet and it's untested. Whether it's the Fed's easy-money policies or the new program-driven market, we're in unchartered waters and I believe the downside risk becomes more elevated the longer we go without a decent correction. The "decent" correction is more likely to turn into a devastating one.

I think an important reminder about what sentiment can do to a market is what happened to bitcoin today. Here's a market (for an alternative global currency that is not controlled by any central bank) that has been getting more attention since February and the bullishness for bitcoins has been driving the market in a parabolic climb. It climbed from about $20 at the beginning of the year to about $30 by the beginning of March. From there it started to go ballistic as more and more people became aware of it and the fact that global central banks are now in a race to devalue faster than the other guy. The belief has been that fundamentally it was good for the value of bitcoins (instead of gold it was now bitcoins). The result has been a strong climb, hitting a high of $266 today before starting a correction.

Bitcoin price (in USD), November 2012-April 9, 2013, chart courtesy bitcoincharts.com

When warned about the parabolic rise, the favorite phrase by supporters has basically been "it's different this time." There's been a race for the bottom in global currency values as central banks try to stay in front of the other in their debasement efforts. Japan's latest QE is aggressive and it will force all other central banks to respond in kind in order to keep the value of their currencies "competitive." So the argument that bitcoins will rise hundreds of dollars more is soundly based. But sentiment can be a dangerous thing, especially for late-to-the-party buyers.

I read a few days ago that a 22-year old sold his inherited house so that he could buy bitcoins. He, like so many others, were reading that bitcoins were headed for $1000 if not much higher (for all the right fundamental reasons, and it might someday, but it's too bad he didn't know how to read a chart). We all know what's going to happen next. There is no "it's different this time" and all parabolic rallies end the same way, no exceptions. The value will likely drop to the start of the parabolic rally, near $50 where it broke out of its consolidation in mid-March, before it will be possibly a good value again.

After hitting a high of $266 this morning someone decided to sell and that triggered stops all the way back down to a low of $106 (-60%) before bouncing at the end of the day and appears to be settling around $165 this evening. It's already being renamed bitcrash and while it's recovered about half of its decline this evening I have little doubt that it will drop further, even if it first makes a new high. It could get very volatile from here.

Bitcoin price (in USD), 15-min chart, 4 days, chart courtesy bitcoincharts.com

Did something fundamentally change to cause the panic selloff? No. Someone simply decided to sell and the sell stops triggered more selling which triggered more stops, etc. It's usually as simple as that and when we look at the stock market I see the same risk. Tie in excessive bullish sentiment with a complacent attitude that the Fed will protect us and all we need is one big sell order to start the ball rolling. It could start out as a news event or simply a big player deciding he's had enough risk and wants out. Sell stops trigger more sell stops, HFTs get out of the way (pulling their liquidity out of the market in the process) or get behind the down move and suddenly people will look back wondering why the market sold off so strongly. It's coming; I just don't know when.

After last week's high and the relatively strong drop into Friday's low I thought that might have marked the high for the stock market. But Monday's rally left a confirmed 3-wave pullback and pointed higher. Now, with this week's rally, SPX has pushed up into the target zone that I had been watching for last month -- 1580-1600. On the weekly chart below I show the price relationship between the two a-b-c moves up from August 2011, which are equal at 1587.58 (achieved today). Even the 62% projection at 1465 matched up well with the September 2012 high. The trend line along the highs from 2000-2007 is currently near 1595 so that's potential resistance if reached.

S&P 500, SPX, Weekly chart

The wave pattern for the move up from November does not count cleanly with the latest new high but for now I'm sticking with the 5-wave move up and the 5th wave being the leg up from February 26th. The 5th wave is equal to the 1st wave at 1589.66, missed by 59 cents with today's high at 1589.07. The trend line along the highs from January 30th is currently near 1597 so a small throw-over above it could easily tag 1600. If we get a rally through opex week (next week) I see the potential for a rally up to the top of a parallel up-channel for the rally from February, near 1635 next week. It could obviously achieve higher if the rally is going to last through April as it has done in recent years. The bulls remain in control until last Friday's low near 1539 is taken out.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1571
- bearish below 1539

Getting in closer and looking at the leg up from February 26th I will say again I do not like the EW count that I have on it at the moment but nothing is making much sense from an EW perspective at the moment and the count does not violate any EW rule. Using the current count, the 5th wave in the move up from February 26th, which is the leg up from last Friday, is now equal to waves i-iii, at 1588.08, which is a common relationship and it lines up nicely with the daily and weekly projections near the same level. Keying off trend lines, the one along the highs since January 30th, near 1595, matches up with the trend line along the highs from 2000-2007 shown on the weekly chart. That level is also a 162% extension of the previous decline (April 2-5), which is often a reversal level. That makes 1595 potentially strong resistance if reached.

S&P 500, SPX, 60-min chart

If the rising wedge pattern from February is correct, the little throw-under below the bottom of the wedge (last Friday) could be matched by a little throw-over above the top of the wedge, which is the projection I'm showing near 1602. A pop above the wedge followed by a quick drop back below it would create a reversal signal, one which can be shorted and use the high for your stop. The wedge could be retraced very quickly (back to 1485) so trying to short a reversal could be a very good trade, including right from here if the market rolls over on Thursday. Just manage your risk since the market could blow off to a much higher high before it runs out of buyers.

The DOW's latest stair-step higher in its rally from February is showing no strength at all (big bearish divergence shown on MACD on its chart below), which fits for the 5th wave of the move. The top of its rising wedge pattern is currently near 14900 and if the bulls hold on into opex, the top of the wedge crosses 15K next week. But are too many expecting 15K now? The market usually spanks the majority when they all line up together. The bulls remain in control above 14550 but that's already a lot of points to give back. Tighten stops on long positions.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 14,680
- bearish below 14,550

Bulls are feeling bullish enough to jump back into the techs and we've seen a strong rally in the past four days. The wave count for the NDX rally from November is a double a-b-c move and the 2nd a-b-c is the leg up from February. It achieved 62% of the 1st a-b-c at 2848 and for the 2nd a-b-c it has two equal legs up at 2867, which was nearly achieved with today's high at 2862. It closed its September 4th gap at 2861.64 but stopped just short of the September closing high at 2864. The intraday pattern supports at least another jab higher Thursday morning but a drop back inside its rising wedge, the top of which is the trend line along the highs from January 2nd and currently near 2848, would create a reversal signal. Short it if that happens and place your stop just above the high.

Nasdaq-100, NDX, Daily chart

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

At least the RUT got into the act today with a strong rally of its own, matching the tech indexes. But unlike the others it has not made a new high and if it doesn't it will leave a bearish non-confirmation. Today's high is a back test of its broken uptrend line from December so a down day on Thursday would leave a bearish kiss goodbye. The bulls need to keep up their buying and then watch for the possibility of just a test of the high before turning back down.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 950
- bearish below 910

Bonds sold off in the past three days as the stock market rallied and the 30-year yield (TYX) has bounced back up to its broken uptrend line from July, which it broke last Thursday. It's a good setup for a reversal back down in yields (buying in bonds), which could coincide with a reversal in the stock market as well.

30-year Yield, TYX, Weekly chart

The TRAN also got a nice bounce today and also is up against a broken uptrend line, this one from November. Its intraday chart supports at least one more little pop higher tomorrow and I've got a price projection for it at 6200, which would be another test of its broken uptrend line. A drop away from it is the signal the bears want to see. At the moment we have a clear bearish non-confirmation between the DOW and TRAN.

Transportation Index, TRAN, Daily chart

The U.S. dollar has been a choppy mess since mid-March and I don't think that's going to change for a while. I'm looking for it to consolidate its rally from February but it doesn't turn potentially bearish until it drops back below 81.80. Following what could be a multi-month consolidation it should then head higher again.

U.S. Dollar contract, DX, Daily chart

The stock market rallied but that didn't help the metals, or commodities in general. The dollar was up marginally but that didn't help explain gold's big move down today (it lost about $26). The important level for gold bulls to hold is the bottom of a potential descending triangle shown on its weekly chart below. The bottom of the triangle is near 1524, which was almost tested with last week's low at 1539.30 (interestingly, SPX hit a low of 1539.50). Commercial traders have been increasing their net long position, which should be a bullish indication that support is going to hold, in which case I see the potential for a bounce at least up to the top of its triangle pattern, currently near 1725. But if support doesn't hold and all those commercial traders are forced to cover we could see a blood bath in gold. Interesting times for gold dead ahead.

Gold continuous contract, GC, Weekly chart

Silver came close to testing the bottom of its descending triangle pattern (slightly different than gold's but the bottoms come from the same lows in 2011-2012, at 26.10-26.15), with a low of 26.57 last week. As with gold, I see the potential for a rally up to at least the top of its triangle, currently near 33.30, but a break below 26 would likely hit lots of stops, which could result in a very strong selloff.

Silver continuous contract, SI, Weekly chart

Oil rallied with the stock market today but ran into its broken 50-dma and broken uptrend line from March 6th, both near 94.40. It could continue higher but it's a good setup for the bears if it drops back down from here.

Oil continuous contract, CL, Daily chart

There are no market-moving economic reports tomorrow but Friday's reports could have some influence. We'll get the retail sales, PPI numbers and Michigan Sentiment Friday morning.

Economic reports and Summary

We've got a nice rally going and it's been a fool's errand trying to short it. Stick with the trend is the best advice but the problem is that it depends on which index you're looking at. Some cracks include the RUT and TRAN, both of which have broken their uptrend lines and managed to bounce back up to back test their lines. A bearish kiss goodbye with a down day on Thursday would leave a confirmed broken uptrend. How long will it take the blue chips to follow in that case? Probably not very. Will it be the bend at the end of the trend for all indexes? We could find out shortly.

The blue chips have reached potentially important levels for their rallies and could be completing their final 5th waves (although the wave pattern is not clear enough at the moment to use it with much confidence). It's common to see a rally finish with a flare-up as it pulls in the last hold-outs. But then the market is vulnerable once there are not enough buyers to keep it going (as in the case of bitcoins). I consider holding long overnight not worth the risk for a downside surprise. When this market lets go I don't think it will look like bitcoins chart but I do think a lack of liquidity (from HFTs pulling out) is going to create an air pocket below the market. I'm struggling with when it's going to happen but I have very little doubt that it will. Trade very carefully from here (both sides).

Good luck and I'll be back with you on Monday (filling in for Linda).

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 Plays

Not Participating

by James Brown

Click here to email James Brown


CoreLogic, Inc. - CLGX - close: 24.16 change: -0.95

Stop Loss: 25.25
Target(s): 22.15
Current Gain/Loss: unopened

Entry on April -- at $--.--
Listed on April 10, 2013
Time Frame: 2 to 4 weeks
Average Daily Volume = 861 thousand
New Positions: Yes, see below

Company Description

Why We Like It:
CLGX is in the financial sector but the stock is clearly not participating in the sector's rally. Shares of CLGX have produced a very volatile first quarter and now they're breaking down through significant support to hit new multi-month lows.

CLGX's lack of participation in the market rally is pretty bearish . The stock had been consolidating sideways the last few days but shares broke down past support near $24.50 and its exponential 200-dma today. I am suggesting new bearish positions now at current levels. Our short-term target is $22.15. More aggressive traders could aim for the $20 area.

current Position: short CLGX stock @ (the open)

- (or for more adventurous traders, try this option) -

buy the July $22.50 PUT (CLGX1320s22.5) current ask $1.05

Annotated chart:

In Play Updates and Reviews

Rally Picks Up Speed

by James Brown

Click here to email James Brown

Editor's Note:
The U.S. market rally this week accelerated on Wednesday. Even the small caps joined in today.

We saw our STRZA trade open. I am removing AKAM. We want to exit WTI at the open tomorrow.

Current Portfolio:

BULLISH Play Updates

iShares Japan Index - EWJ - close: 11.21 change: +0.23

Stop Loss: 10.47
Target(s): 11.40
Current Gain/Loss: + 7.4%

Entry on March 12 at $10.44
Listed on March 11, 2013
Time Frame: 9 to 12 weeks
Average Daily Volume = 30 million
New Positions: see below

04/10/13: Stocks in Japan continue to rally with the yen slipping to another multi-year low. Shares of EWJ displayed relative strength with a +2.0% gain and another new 52-week high. Our target is $11.40. I am raising our stop loss to $10.58.

Current Position: Long the EWJ @ $10.44

04/10/13 new stop loss @ 10.58
04/08/13 new stop loss @ 10.47
04/04/13 new stop loss @ 10.35
03/30/13 new stop loss @ 10.28
03/20/13 new stop loss @ 10.18

Gulfport Energy - GPOR - close: 48.27 change: +0.06

Stop Loss: 44.70
Target(s): 52.50
Current Gain/Loss: + 1.9%

Entry on April 08 at $47.35
Listed on April 06, 2013
Time Frame: 6 to 8 weeks
Average Daily Volume = 1.4 million
New Positions: see below

04/10/13: GPOR delivered a disappointing session with the stock essentially closing unchanged after a volatile open. The overall trend remains up but after today's lack of movement I am not suggesting new positions.

Our target is $52.50, but investors should note that the $50.00 level might be overhead, round-number resistance. FYI: The Point & Figure chart for GPOR is bullish with a long-term $70.00 target.

current Position: Long GPOR stock @ $47.35

Plum Creek Timber Co. - PCL - close: 51.80 change: +0.32

Stop Loss: 49.90
Target(s): 54.50
Current Gain/Loss: +2.5%

Entry on March 25 at $50.56
Listed on March 23, 2013
Time Frame: Exit prior to earnings on April 29th
Average Daily Volume = 732 thousand
New Positions: see below

04/10/13: PCL recovered most of yesterday's decline. Yet the stock seemed to struggle with yesterday's highs. I am not suggesting new positions at this time. The April 5th low was $50.72. I am raising our stop to $50.60.

*Small Positions*

Current Position: Long PCL stock @ $50.56

- (or for more adventurous traders, try this option) -

Long May $50 call (PCL1318E50) entry $1.40*

04/10/13 new stop loss @ 50.60
03/30/13 new stop loss @ 49.90
*option entry price is an estimate since the option did not trade at the time our play was opened.

Starz - STRZA - close: 21.77 change: +0.45

Stop Loss: 19.95
Target(s): 24.50
Current Gain/Loss: +0.1%

Entry on April 10 at $21.75
Listed on April 06, 2013
Time Frame: exit PRIOR to earnings on May 9th
Average Daily Volume = 1.6 million
New Positions: see below

04/10/13: STRZA displayed relative strength with a +2.1% gain today. Unfortunately most of that move was on the stock's gap open higher at $21.75. The gap higher was sparked by an analyst upgrade this morning. Since we had a trigger to launch small bullish positions at $21.55 the gap higher triggered our trade.

*Small Positions*

current Position: Long STRZA stock @ $21.75

04/10/13 trade opened on gap higher at $21.75
04/09/13 adjust entry trigger from $21.50 to $21.55

The TJX Companies - TJX - close: 47.51 change: -0.15

Stop Loss: 46.45
Target(s): 52.00
Current Gain/Loss: - 0.5%

Entry on April 09 at $47.75
Listed on April 08, 2013
Time Frame: 6 to 8 weeks
Average Daily Volume = 4.7 million
New Positions: see below

04/10/13: It was not the most inspiring performance for TJX today. The stock failed to participate in the market's rally and instead lost -0.3%. It could be that investors are cautious regarding the company's same-store sales numbers, expected out tomorrow morning. Readers may want to wait for a new relative high before launching new positions.

Earlier Comments:
If triggered our target is $52.00. However, there is a risk that the $50.00 mark could be round-number resistance.

Suggested Position: Long TJX stock @ $47.75

BEARISH Play Updates

Brunswick Corp - BC - close: 32.91 change: +0.34

Stop Loss: 34.25
Target(s): 30.30
Current Gain/Loss: + 2.9%

Entry on March 18 at $33.78
Listed on March 12, 2013
Time Frame: Exit PRIOR to earnings on April 25th
Average Daily Volume = 786 thousand
New Positions: see below

04/10/13: BC managed a bounce thanks to the market's rally but shares are still trading below short-term resistance near $33.00. There should be additional resistance near $33.50 and $34.00. I am not suggesting new positions at this time.

Suggested Position: short BC stock @ $33.78

04/03/13 new stop loss @ 34.25
04/01/13 new stop loss @ 34.75
03/18/13 triggered on gap down at $33.78. Trigger was $33.90

BroadSoft, Inc. - BSFT - close: 24.87 change: +0.03

Stop Loss: 25.25
Target(s): 20.75
Current Gain/Loss: unopened

Entry on April -- at $--.--
Listed on April 09, 2013
Time Frame: exit PRIOR to earnings in early May
Average Daily Volume = 854 thousand
New Positions: Yes, see below

04/10/13: Shares of BSFT barely even budged in spite of the stock market's widespread rally on Wednesday. The lack of participation in the market rally is bearish. There is no change from my prior comments.

I am suggesting a trigger to launch small bearish positions at $24.50. If triggered our target is $20.75. The 2013 low was $20.45.

Please note that we do want to limit our position size to reduce our risk. The most recent data listed short interest at 21% of the small 27.6 million-share float. Thus if BSFT were to suddenly turn higher it could spark a short squeeze. Furthermore there has been some speculation that BSFT is a takeover target. You may want to consider buying a put option instead of shorting the stock as a way to limit your risk.

Trigger @ 24.50 *Small Positions*

Suggested Position: short BSFT stock @ (trigger)

- (or for more adventurous traders, try this option) -

buy the May $25 put (BSFT1318Q25)

Cabot Microelectronics - CCMP - close: 33.35 change: +0.40

Stop Loss: 34.05
Target(s): 30.25
Current Gain/Loss: -2.0%

Entry on April 03 at $32.69
Listed on April 02, 2013
Time Frame: exit PRIOR to earnings on April 25th
Average Daily Volume = 104 thousand
New Positions: see below

04/10/13: The semiconductor sector was a strong performer today and shares of CCMP were lifted by the rising tide. I am not suggesting new positions at this time.

Earlier Comments:
We want to keep our position size small. We want to limit our risk because CCMP is arguably already short-term oversold. Of course it can get a lot more oversold. We are using somewhat of a wide stop loss at $34.05. Our target is $30.25.

*Small Positions*

current Position: short CCMP stock @ $32.69

W&T Offshore Inc. - WTI - close: 13.80 change: +0.34

Stop Loss: 14.25
Target(s): 12.15
Current Gain/Loss: + 0.4%

Entry on April 01 at $13.85
Listed on March 30, 2013
Time Frame: 6 to 8 weeks
Average Daily Volume = 696 thousand
New Positions: see below

04/10/13: WTI delivered yet another strong bounce today (+2.5%). The close above its simple 10-dma is short-term bullish. We are turning more defensive here and tonight we're suggesting an early exit at the opening bell. I'd rather exit now that see this trade turn into a loss. Although honestly there is probably a better than 50/50 chance that WTI's bounce will roll over in the $14.00 area, likely near its simple 20-dma. More aggressive traders may want to ride it out.

current Position: short WTI stock @ $13.85

04/10/13 prepare to exit at the opening bell tomorrow
04/06/13 readers may want to exit now to lock in gains. WTI looks poised for an oversold bounce
04/03/13 new stop loss @ 14.25


Akamai Technologies - AKAM - close: 36.04 change: +1.37

Stop Loss: 35.05
Target(s): 30.15
Current Gain/Loss: unopened

Entry on April -- at $--.--
Listed on April 04, 2013
Time Frame: Exit prior to earnings on April 24th
Average Daily Volume = 3.9 million
New Positions: see below

04/10/13: The stock market's surge on Wednesday helped fuel some short covering in AKAM. The stock outperformed with a +3.9% gain. Our trade has not opened yet. Given AKAM's rebound we are dropping it as a bearish candidate.

Trade did not open.

04/10/13 removed from the newsletter