Don, bpNDX would not be absolutely overextended until it reaches between 70 to 80 in my opinion. It could even go higher but that is not likely until we get more evidence of an economic recovery. Here is some interesting reading on the market from InvestmentHouse in their weekend update where they explain how we could easily rally back higher after a little additional selling early this week:
Weekend Market Summary
investmenthouse.com
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8/23/02
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TONIGHT:
- Friday ends the week without ever seeing positive light.
- Low volume is nice, but large point loss tarnishes consolidation session.
- Low volume, volatility on through September 11.
- Economic reports roll in this week.
- Subscriber Questions.
No rally attempt to close the week.
The Thursday momentum did not carry over to Friday for even 5 minutes. The market had staged a good run for the week and we knew it was ready for a bit of a pullback. After the solid move Thursday, however, we thought it would move up for a few hours Friday before turning back lower.
A passel of pre-market analyst downgrades put a lid on the action. Without many investors hitting the floor Friday the negative mood set pre-market hung over the market. Semiconductors have been the easy target of late, and the chip equipment stocks were downgraded again. Then came a load of what we call ‘valuation’ downgrades on stocks such as WFMI and CCR that had just moved to highs. INTC was cut at Bear Stearns who announced that ‘channel checks’ indicated it was going to be at the low end of the range.
It was the morning of negatives where analysts, now trained to be pessimists after 28 months of burning in a bear market, felt it better to play it safe. That meant downgrading stocks that had risen from the July low because they were now supposedly overvalued. Once again we heard the phrase ‘there isn’t anything different now from a few months back.’ No, just sentiment indicators at extreme levels, a solid rally with follow through on good price/volume action, breakouts holding up well, the dollar climbing again. Of course there is no lock on this rally; we have been concerned about a re-test as well. To make a blanket statement of that nature, however, flies in the face of some facts that certainly indicate that something is different, and it is another reason to tune out the 96% of analysts that cannot differentiate between inspiration and constipation.
In any event, the market had risen, it was going to need a breather, and the waves of downgrades made the choice easy for a lot of investors. All morning it sold, and then it bottomed around lunch and started to work higher. It looked as if the pattern of early selling then late rallies was about to take place. The move up stalled twice, however, forming a quick double top that sent the indexes on a plunge to session lows. They did managed to stem the selling in the last hour, but the rally up was less than impressive and not nearly strong enough to be convincing that buyers had returned.
Low volume points to consolidation, but the point loss is uncomfortable.
What exacerbated the selling was the very low volume. Now low volume selling in a rising market is what you want to see. In an overall low volume session, however, once a trend is established, it can really run. That was the situation Friday. First, it was a Friday in late summer, already a low volume scenario. Moreover, buyers had a good run. When a series of downgrades came out it was enough for them to pack up and decide not to buy more. Bids were cancelled, meaning that no one was willing to put a low bid out there to buy if a stock fell down to meet it. With no buyers with outstanding bids, the sellers had their way, and the action snowballed as the session wore on. The lower volume shows there were fewer players and thus fewer sellers than the recent buyers. Again, that sounds good and it is what you want when playing upside.
Problem is, the price losses for a single session were getting excessive. The Dow and Nasdaq undercut the 200 day MVA while the S&P 500 put on the brakes right above that point. Minimum loss was the Dow at 2%. The SOX was hit hardest again (-5.9%), and that again was the major drag on the Nasdaq. Important: you want to see the down days stingy; you want to see small price losses during a consolidation, not big plunges lower. For starters, that makes further consolidation harder as any further selling and the indexes and stocks start breaking support levels, and that can give shorts an opening. The pullbacks need to be orderly both in volume and price. Friday was more plunging than simply a lazy pullback. On top of that there was no attempt at rallying back up; just a shove down and then it stepped on it a bit more in the late afternoon.
We don’t want to sound as if Friday was a deathblow to the rally; it wasn’t. It was, however, more selling than the prior consolidation, and it was a big point loss to kick off the action. There is still a lot of room between the indexes and next support, but we want to point out it was just not a session to ignore because of the light volume. We did not get to close out a lot of our plays that would have been close to targets with another half day of rallying, and thus we have to pay close attention this week to where the indexes hold.
THE ECONOMY
A very mild economic week is followed by a hectic one. Home sales, durable goods, consumer confidence, GDP, income and spending, Chicago PMI; a full schedule. Expectations are pretty much higher across the board, fairly strange given most everyone has badmouthed the economy and its prospects the past two weeks. Confidence does not mean a lot, but it will be a focal point. Expect it to be a slight surprise higher as the recent market recovery helps buoy spirits. GDP will also garner attention; there will be a correction for the big import buildup from the prior report and the fact that exports picked up ground on imports. Friday Chicago PMI is released, and that is considered the harbinger of the national number the following week. We don’t expect much improvement from that one yet.
THE MARKET
The momentum did not carry through after Thursday’s move over resistance. It was rather easily derailed by some early bad news, something that is a bit of a change in character. Again, light volume can exacerbate a move once it starts and that is what happened Friday. It also shows that the volume Thursday on the NYSE was not as strong as needed to clear the resistance and put it behind it. It was still too close and could not hold on the first test. The short term moving averages look as if they will be tests and the late July high.
Sentiment Indicators
If Friday was any indication, it does not take much to stir the negative feelings. Many analysts were out saying the market was dangerous, a test was coming, etc. Others were saying the rally was real, etc. It was a pretty even split, but it was good to see the pessimists out as well. The put/call ratio jumped right back up on the first hint of selling. Again, a test may indeed come; Friday had some negative attributes to it. There are still a lot of bears and pessimists out there, and as noted before, those provide fuel for continuing upside.
VIX: 32.81; +1.85
VXN: 47.62; +2.62
Put/Call Ratio (CBOE): 0.8; +0.25. Jumped right back up on the first sign of selling as it has been doing. Does not mean the market is ready to rally, but it shows there is continued anxiety about the rally thus far.
Nasdaq
The SOX again hurt the Nasdaq, and Friday there were no reserves to pick up the slack as on Thursday. When the smoke cleared it had closed below the 50 day MVA on lower volume.
Stats: -42.33 points (-2.97%) to close at 1380.62
Volume: 1.5B (-18.34%)
Up Volume: 248M (-997M)
Down Volume: 1.191B (+671M)
A/D and Hi/Lo: Decliners led 1.97 to 1. Showed more downside strength on Friday than Thursday’s upside action.
Previous Session: Advancers led 1.39 to 1
New Highs: 25 (-27)
New Lows: 51 (-5). Not many new lows even on this pretty strong price selling.
The Chart: (Click to view the chart)
Even with the steady climbs on better price/volume action the past week, the Nasdaq turned and in one session gave back more than all but two of the August up days. Lower volume was okay, but the price loss washed away the two prior up sessions and took out the 50 day MVA (1389.66). Still plenty of support below with the 10 and 18 day MVA (1367.25 and 1349.69) as well as the October bear market low at 1357 and price highs and lows from July from 1350 to 1354. That gives the index roughly 30 more points to play with and still maintain a good trend up; not much given Friday’s move, but enough if it is going to hold (could get an intraday test lower followed by a higher close). There most likely will not be definitive volume this week with the continued late summer, pre-holiday, pre-September 11 trade. The near term support and trendlines thus become even more important as to the direction the index takes. The market needed a pullback and it got one Friday; it will need to pullback more early this week.
S&P 500/NYSE
Turned lower and fell on reduced volume, the only major index managing to hold its 50 day MVA on the close.
Stats: -21.84 points (-2.27%) to close at 940.86
NYSE Volume: 1.056B (-23.37%). Big drop in volume. Unfortunately, a big drop in price as well.
Up Volume: 154M (-889M)
Down Volume: 909M (+600M)
A/D and Hi/Lo: Decliners led 2.03 to 1. Decliners were just as plentiful in the selling as advancers were in the rally.
Previous Session: Advancers led 1.82 to 1
New Highs: 22 (-8)
New Lows: 14 (-3)
The Chart: (Click to view the chart)
Back below some resistance at 950 as well as the September 2000/May 2001 downtrend line. Two very solid sessions just about wiped away on one move. It did manage to hold the 50 day MVA (936.92) and volume plummeted to its lowest level since August 12. What does that mean? Well, there were more sellers than buyers in the market Friday, but not nearly as many sellers as buyers on the previous up sessions. Overall that is a positive as it indicates buyers are overall in the majority. Volume has not been super on those moves up, however, and as we noted earlier, the inability to marshal really solid volume on the break through 950 did not cement the hold broke through 950 and the 50 day MVA. It still has that 50 day MVA, the 10 and 18 day MVA, and the high in the wedge pattern at 911.64. Solid support that should hold if the moves is for real. It looks to be tested.
Dow:
Stats: -180.68 points (-2%) to close at 8872.96
Volume: 1.056B (-23.37%)
Strikingly similar pattern to the S&P 500, but then again, they were both in ascending triangles on the way up. The Dow was of course unable to hold 9000, and it gave up the 50 day MVA (8880.81) after two attempts to hold that level in the early afternoon. When that filed it sold harder and could not quite recover that key level on the late blip higher. It did use the 10 day MVA (8833.51) as support on the low that bounced it back up at the close. The 18 day MVA (8746.90) and the late July high in the triangle (roughly 8750) would be nice as well. If the move is going to continue to climb, the index should try to bounce there. After that it is up to the July uptrend line at 8550 (currently). We wanted a more lateral move than this and may still get it, but it will need to check up quickly and keep downside volume to a minimum.
The Chart: (Click to view the chart)
THIS WEEK
Lots of economic news, a pre-holiday week, and then the pre 9-11 anniversary countdown. Expect trade to be slower ahead of the holiday and then slower ahead of 9-11. Slower means lower volume, not lower volatility. Lighter volume means the action can be influenced up and down as it was Friday. Overall the action has been positive with the market behaving in a ‘healthy’ manner with the right price and volume action. The uptrend in the overall downtrend thus remains intact, but the magnitude of the price loss raises question marks about just where the market is. About the only reason we are even really bothered about the action is the fact that the indexes rallied roughly 20% from the July lows at the Thursday close and they had not really taken much of a sustained rest of late. Most breakouts are still in tact, some holding onto all of their gains, others testing back to the breakout point. If the majority of those stocks start popping back down in their bases, the indexes usually are going lower as well.
This coming week we will thus keep an eye on where the indexes find support and how the breakouts perform. Friday was disappointing as it did not give that half day of gains we wanted to use to take some of the gains that were building. We waited for an afternoon move higher that looked to be developing, but that was cut short. Many positions have trailing stops that have been following the stock higher and are just below the short term moving averages. Those will most likely be tested and the decision must be made as to whether you want to close them out or ride it out. We will get a decent look at the market more or less when the stocks hit those levels; if the stocks and the market do not recover over they are not going to retake the near term support on the close, that is usually when we go ahead and close them out.
For now the uptrend is still in place, and the negatives are the large point loss Friday and simply the extent the market has rallied. We don’t like being afraid of our own shadow, i.e., we don’t like fearing success when the market has been rallying on good price/volume action; that is the emotion that gets analysts to downgrade stocks on valuation (it has to sell because it has gone up quite a bit; that, of course, is the same logic that made them buy stocks on the way down thinking they had to go back up). With that in mind we will watch where stocks and the indexes find support. If they hold at the short term moving averages on the close, no problems. If they do not (particularly if volume rises) we exercise caution and take what gains are there and preserve our capital for the next move.
Support and Resistance
Nasdaq: Closed at 1380.62
- Resistance: 1357.09, the October 1998 bear market low. The 50 day MVA (1389.66). The March/May downtrend line at 1400. 1418, the interim test after the September low. There is another downtrend line from the March and May highs at 1465. That is followed by price resistance at 1500.
- Support: The 10 day MVA (1367.25). The 18 day MVA (1349.69). The top of the wedge pattern at 1354.48. Some price support at 1300. The July lows at 1240 to 1230. Price support from 1190 to 1200 (the July intraday low is 1192.42).
S&P 500: Closed at 940.86
- Resistance: The September 2000/May 2001 downtrend line at 951. 950 is that barrier that was hard to break. 965, the September 2001 closing low. The next downtrend lines from March and April highs at 975. Then 1000 is psychological resistance.
- Support: The 50 day MVA (936.82). The March down trendline at 916. The 10 day MVA (932.24) and the 18 day MVA (920.05). The top of the wedge at 911.64. The July up trendline at 900. The lowest channel line in the March downtrend channel (849). 850 to 855 has previously held (the October 1997 and Q2 1998 lows). 800 is next. Then the July low at 775.68. 750 to 760 with an intraday touch to 730.
Dow: Closed at 8872.96
- Resistance: Closed just below the 50 day MVA (8880.81), so it is hard to call it resistance or support at this point. 9000 is next. A range of resistance from 9000 to 9500, but specifically 9250 and then 9500.
- Support: The 50 day MVA (8880.81). The 10 day MVA (8833.51). The late July high that is the top of the ascending wedge at 8762.14. The 18 day MVA (8746.90). The March down trendline at 8705. The July uptrend line (8550). The May down trendline (8248) and the lowest bottom channel line of the March downtrend (8275). The September closing low at 8235.81. 8062, the September 2001 intraday low, has tried to hold on a couple of occasions. Then the July low (7532.66). The October 1998 lows are at 7400 and 7467. After that is 7000, some 1997 lows and highs.
Economic Calendar
8-26-02
- New home sales, July (10:00): 975K expected, 1001K prior.
- Existing home sales, July (10:00): 5.30M expected, 5.07M.
8-27-02
- Durable goods orders, July (8:30): 1.4% expected, -4.1% prior.
- Consumer confidence, August (10:00): 97.0 expected, 97.1 prior.
8-29-02
- GDP Preliminary, Q2 (8:30): 1.1% expected, 1.1% prior.
- Initial jobless claims (8:30): 385K expected, 389K prior.
- Help wanted index, July (10:00): 47 prior.
8-30-02
- Personal income, July (8:30): 0.3% expected, 0.6% prior.
- Personal spending, July (8:30): 0.8% expected, 0.5% prior.
- Michigan sentiment final, August (9:45): 88.0 expected, 87.9 prior
- Chicago PMI, August (10:00): 52.0 expected, 51.5 prior.
SUBSCRIBER QUESTIONS
Q: Should there be stop losses set on covered call plays in order to limit any loss should the stock take a dive? Also, according to my broker, Charles Schwab, I do not receive the ask price when selling a call using a buy/write. They also do not have a mechanism to automatically set a stop loss for the stock on a buy/write. Should I be finding another broker?
A: One of the things about covered calls is that you should, just as with other positions, keep stop losses of some sort (we use mental) in place. You are correct, a stock can still tank in a covered position just as with any other. What happens when the stock falls in value? The option does as well. If you are in an account that allows it and are qualified to ride calls naked (sold but no stock to cover), you can sell the stock when it hits your stop point and continue to ride the calls down as they will continue to lose value. You can then buy them back when the stock stops falling or let them expire if the stock falls and does not come back. We would prefer to just close it out when the calls are at a low value.
If you are in an account such as an IRA that does not allow you to be naked on calls, you will have to close the calls out when the stock is sold. As the calls will have lost value as well you will still be in decent shape. I don’t keep stops too tight on these longer term positions as they will fluctuate during the period and we want to have the time work for us.
As for getting buy/writes written, you are not the first to have a problem with Schwab on buy/writes. From the emails I have received, if Schwab is calling this a buy/write, then Schwab is making it up. One problem may be that they simply do not understand what you want to do by the name.
At first I had to educate some of the brokers as to what I was talking about, but the old pros knew exactly what it was I wanted to do. The head options trader at Schwab should know this method; you buy the stock at the ask and sell the call at the ask, getting a net debit on your trade. If you buy a stock at $20 and want to sell the $20 call option that is trading at 3.90 by 4.00, you tell your broker you want to do a buy/write covered call play, buying the stock and simultaneously selling the specified call for a net debit of $16. It is one transaction so you get a break; it may be on the option, it may be on the stock, but if your net debit is where you want it to be, what do you care? Your return is the same. The key is it is not two separate transactions and that is where the younger option brokers get thrown off. Again, I would think the head options trader at Schwab should be familiar with this. I am not, however, shocked to hear it because when I first started doing this the younger brokers did not know what I was talking about and they had to get the more seasoned brokers to educate them. It is as old as options themselves, but as with many solid techniques, it is overlooked by the flash and glitter of all the spreads, naked option sales, etc. Sometimes, however, the basic can be the best. |
