HOTS Weekly Options Commentary

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Pete Stolcers

Last week we had the choppy price action and the bullish bias that I forecasted for the week of option expiration. The economic numbers had little impact on the market. Tuesday was a classic example. The CPI came in lighter than expected and the initial rally was reversed by the end of the day. The real impetus for the week came from option related buy programs. Next week the economic numbers are fairly light and I don't believe the Durable Goods number or the GDP will have a big impact.






The earnings releases will also be fairly light. They are predominantly retail companies. Based on the recent retail sales numbers, the expectation for "light" numbers is already built-in. The overall guidance from these companies might indicate the strength of the consumer. Those companies that miss their number are likely to blame it on the weather and high gasoline prices. Here are some of the companies that will announce:

AZO, BJ, LOW, SNDA, ADI, MDT, GME, MW, ANF, DKS, TGT, GYMB, ZUMZ, MYL, ARO, LTD

The interest rate and earnings front will be relatively quiet so let’s take a look at some of the other market influences. Energy is the hottest market sector. Unrest in Nigeria is driving oil prices higher. Currently that country is our third largest source of oil. The market is oblivious to higher commodity costs and the inflation indicators seem to be keeping a lid on those concerns. M&A continues to keep a strong bid in this market. The shorts are running scared and it has been almost impossible to make money on bearish trades. In the chart you can see that the SPY is close to an all-time high. The market has a parabolic feel to it and it has rallied 22% in less than a year. In the chart you can also see that interest rates contributed to a lengthier decline in 2006. During that period the market wanted the Fed to stop raising rates. That finally happened in August. This year, the rates are stable and the market recovered very quickly. The market is so strong that it erased the losses and made new multiyear highs in the course of a month. This type of setup can lead to a "melt up" and a sharp decline. If that happens there will be plenty of money to be made on the upside, but you'd better be quick to pull the trigger once the peak is established. I have a couple of stocks this week that I believe will rally with the market and hold up well if it declines.

Equity Index Update

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Brad Sullivan

The index markets opened higher and stayed firm throughout Friday’s option expiration session. Mega-Cap issues continued to dominate the trade as the SPX came within a whisper of its All-Time closing high of 1527ish and the DJIA just kept on trucking into unknown territory. The session itself was pretty mundane, but the buy side pushed pretty aggressively over the final 30 minutes of trading to create new high prints. This morning we are called to open around UNCH as Shanghai was able to gain another +1% in spite of a rate hike…the rest of the global indices are trading – on balance – slightly higher as well. On the currency front, the dollar continues to catch a bid in here and one has to wonder, given the sharp correlation the last few months between a falling dollar and rising equity market, whether or not there will be any “give” in the equity trade this week.

It is on this front that I am examining the SPREADS…simply put, the movement between the SP and DJIA vs. the small cap Russell 2000 is astounding. Last week alone, a single unit (for my purposes) pushed into the stratosphere of expected returns. I have included a spread table with explanations in today’s chart section.

In my opinion, this spread action is about the only game in town. Is the shift into mega-caps the final leg of this 5 year old bull market? How much more is on the table in these spreads? Is it time to play a reversion-to-mean trade? One thing I do know from years of index trading…a shift out of one area/sector of the market typically requires a several week period of overall market disruption. The disruption is characterized with higher volatility and increased trading setups for those making a living in this game. So far, we have not seen any extended periods of this action. I would suggest that we may have a summer trade that surprises many with the above listed characteristics.

For today in the SPM contract, here is what I am looking for…on the upside, the index should find solid resistance between 1528 and 1531 as this zone should halt the market in the short run. If we get a 30 minute close above this zone, I will not chase ‘em up intentionally but one has to be prepared for a potentially buy stop rally above the cash closing highs in 2000 (call the trigger zone 1528 to be safe). Up here…it is pure guesswork. I would suspect stopping points to be 1535, 1538 and 1541. I must state that I put this rally scenario’s odds in the longshot category.

On the support side of the equation…1526 to 1524 is a key zone…any 30 minute close below this level should shift the trade to bounce selling. Accordingly, I would look to get short on any bounces into the aforementioned zone. Targets for this trade would be scale down from 1522.50 to 1519.50. Below this level we hit our old friend 1518.50 to 1515. This zone has now become a neutral/transition zone. Let this area play out and examine to see if it becomes support. An HOURLY close above 1520 (after testing this zone) would do the trick. Keep an eye on the SPREADS.

SP-500 Cash Index 7 Weeks of Higher Highs

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Jason Roney

This is note worthy:
A) SP 8 higher lows weekly into expiry. Monday close down 4 of 4. week close down 3 of 4.
B) SP just 6 higher lows into expiry. Monday close down 78.5% 15 times and week close down 73.33%.





Editors' Note: This was posted in our Virtual Trading Room on Thursday, May 17th about 1106 PDT.

Equity Index Update

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Brad Sullivan

The index markets spent most of the session in range trading conditions before a spirited push to new contract highs in the mega-cap SP and DJ contracts. However, the buying power was offset by long liquidation (whether or not this was day trade long selling remains to be seen) in the final 30 minutes of trading. When the session was finished, the SP finished nearly -3.00 on the session and -6.00 from the daily high reached during the afternoon. HOWEVER, this morning finds the market bid sharply higher with the SPM contract trading +5.25 at 1520.50 – only -1.25 to the contract high made yesterday at 1521.75. The news is limited; however, retailers JCP, KSS and JWN reported solid earnings last night and GE agreed to sell its plastics division for a smooth $11bln and INTC was upgraded to a buy at MLynch. In addition, European indices are rallying nearly +1% across the board.

While all was quiet on the domestic index front during yesterday’s action, the commodity markets went wild. Copper was down nearly -5% on the session, while the energy complex shot higher on a couple of production disruptions. As far as the indices are concerned, the Copper story, in my opinion, is where the potential issues lie. Why, simple one word CHINA. Copper inventories in Shanghai have risen to over 14,000 tons, suggesting that we may have economic growth slowing in the belly of the beast. Obviously this China slowdown has been discussed widely…but it has not shown its face the past few years. Is this the time for a Chinese recession? It’s doubtful…but for the short term trader it is worth focusing on what Shanghai does each and every session. So far…not much, but keep your eyes open the next few weeks for some disruption in the Asian rally.

Option expiration today and EVERY NOW AND THEN a potential trade comes into the zone around the opening bell. Today may be such a day. With the market trading around yesterday’s high zone watch FOR A POTENTIAL PRE-MARKET PUSH TO NEW CONTRACT HIGHS AROUND 1525. THE OPENING SHOULD BE VIOLENT AND CHOPPY IN A ZONE BETWEEN 1524 AND 1526 BEFORE REVERSING COURSE BELOW 1521.50 TOWARDS 1518.50. THIS TRADE SHOULD NOT TAKE MUCH LONGER THAN 30 MINUTES TO COMPLETE. Keep in mind that the SPM needs to trade well above yesterday’s highs for this SCENARIO to be worth betting on. In addition, it must happen before are immediately after the opening bell of trading.

As for today’s levels in the SP contract…pretty much the same as we have had the past several sessions. On the upside…1520.50 to 1522 is a Mild resistance zone, above this comes the 1524 to 1526 level which should provide a tougher test to get through. On the extreme upside today, 1528-1531 is an excellent target area to liquidate trading longs. Keep in mind that expiration sessions typically get very stagnant after the first 90 minutes of trading is completed.

On the downside…1518.50 to 1515 is now a Neutral/Transition Zone. The first key support zone lies between 1512.50 and 1510.50. Only a 30 minute close below this zone is a negative…and that brings us to the ballgame support area of 1507 to 1504.

When all is said and done…expiration Friday’s are normally sessions to keep it close to the vest. If the opening trade I outlined plays out, it typically creates the entire session’s range within its boundaries…so be wary of playing any “follow” trades after the morning is complete.

I have included 3 charts today…one is a 1 minute SPmini chart with volume from yesterday’s high print. Also the weekly OIH chart, as the oils continue to explode and finally the monthly gasoline futures.

Behind the REITs Slide

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Fil Zucchi

As the drumbeat of falling REIT stock prices picks up steam, here is a look at the Commercial Mortgage Backed Securities' (CMBS) spreads as calculated by Morgan Stanley. The first shows AAA rated credit, the second BBB. Without getting into the underlying quality of properties for specific REITs, purely from a capital structure point of view REITs' stock prices probably correlate better to the BBBs than the AAAs credit.

I do not believe there are any "bombs" waiting to go off in REIT land. The elephant in the room however may be the large pension/insurance groups which have dumped billions and billions in private and public REIT's as a failsafe source of double digit returns. Those kind of returns are equal part greed and need, the latter as an effort to balance their returns to their long term liabilities. If these guys don't get their double digit returns on a consistent basis, they're gonna have "issues". It stands to reason that they may have a short fuse if things start moving against them, as any drawdowns would totally screw up their models. We also know that real estate is not exactly the most liquid of asset when "katie starts looking for the door".

Equity Index Update

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Brad Sullivan

The index markets chopped back and forth in a rather uneventful morning session before turning on the headlights and pushing to high contract closes in the SP and DJIA. Mr. Buffet and Buffet Jr. (Eddie Lampert) both made splashes with investment stakes in JNJ and C respectively. That news gave investors another reason to be buy stocks as the general assumption is that if two value oriented players are raising stakes in equity holdings, why not me? Amidst the buying in mega-caps came a sharp move lower in metal based commodities. It is worth noting that over the last three months there has been a “linked” move with these commodities and domestic indices. If the metals roll over…will equities follow? I hardly think it will be that smooth, however, this divergence is worth keeping close tabs on over the next few weeks.

Overall, the SPM market remains contained within a tight trading range…essentially 1518 to 1505 with some outside push attempts. From a trading perspective this has been an excellent pattern as the market continues to bounce off the 1507-04 zone and fail in the 1518.50 to 1515 zone. Given the strength of yesterday’s close in the large cap SP and DJIA one has to wonder if today will be the day to finally break above our resistance. Keep in mind that – TYPICALLY SPEAKING – the Thursday prior to expiration is a one-way street. In other words, the odds are suggesting a choppy morning, followed by a late morning push into the close of trading.

Accordingly, the zone of resistance from 1515 to 1518.50 remains crucial for the session. Any 30 minute close above this zone should be purchased – HOWEVER, if it is early in the session (within the first 2 hours of trading) I will not chase ‘em up. I will try and get long in that zone with some reasonable breathing room for a stop (30 minute close below 1513 would do it for me). IF the index takes off higher and does not allow entry, we should be on the cusp of a strong one-way street rally session. Typically, I would look for a net change greater than one Standard Deviation…now my 8 day reading in STDEV are very small (only a net of +5.50 would take it out) however the 22 day reading is at a more reasonable +10.20. Essentially, if a one-way street develops I would look for the market to trade +10.50 to +1300 on the session or 1528 to 1531 in a zone for exiting longs. Along the way look for some stoppage around the 1525-1526 level, but expect any dips to be shallow.

On the downside, if the market fails to make any inroads above the key resistance zone, one has to play for a move back towards the 1512 to 1510.50 support zone. Below this, look for a choppy move for a trade into the familiar 1507-1504 zone. Only a 30 minute close below this zone will open up the selling door for a move towards 1496. HOEWEVER, much like I wrote yesterday, in this scenario expect lots of chop and spike oriented action.

I have gone a little chart crazy today and have included several that are worth examining. One of the key elements in trading is focusing on what the market is focusing on. Accordingly, I have the resurgent IBM (now 6.5% of the DJIA weighting), the Yen Futures vs. SP futures chart, a possible divergence in the Copper and SP chart as well as potential blow off top move in the long DJIA vs short Russell 2k chart. These charts represent a nice cross section of what has moved the market the past few months.

Equity Index Update

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Brad Sullivan

The index markets suffered a lunchtime reversal from higher levels in action that was whippy and aggressive. Volume flows were heavy, particularly around certain price zones in each contract. After the market pushed lower from its lunchtime high prints, the selling was reminiscent of the old days (think mid 1990’s) when the markets would have big swings during expiration week. The last couple of years volatility during expiration week has been infrequent…however, when it has appeared the moves have been violent and typically on the downside. I recommend caution on any rally buying for the remainder of the week.

Yesterday’s trading action continues to show that we are in a trading range. How long we stay and the size of this range remains the proverbial X factors. However, it is worth noting that given the sharp rally over the past 8 weeks (wasn’t it just March’s expiration week when the indices printed collective lows during Wednesday’s lunch hour?) we SHOULD expect some type of sideways to downside action. In fact, that downside action has been playing out in the Russell 2000 and NDX. The Russell is essentially trading at UNCH for the month and the NDX is holding just above its flat line level for May. Both indices are severely underperforming against the SP and DJIA. If this rotation out of small and into large caps continues it should bode very well for higher ground in the world of mega-cap indices.

Here are today’s levels for the SP : On the upside…Resistance should be found between the 1510.50 and 1512.25 zone. I suspect that this zone will find many willing sellers that are looking to capitalize on yesterday’s selling from contract highs. A 30 minute close above this zone brings us back into the critical 1515 to 1518.50 zone. Only a 30 minute close above this area will turn the dial to “buy”…however, at the risk of sounding like a broken record, DO NOT CHASE ‘EM UP HERE. Wait for the trade to settle back into the 15-18.50 zone and attempt to position build for a sharp bid into the close of trading. If unable to build the position, wait for the final 30 minutes before playing the “chase” game. In this scenario we should see a continuation move higher into the close of trading. The levels would be a guessing game, but I think 1525 to 1526.50 would be worth targeting.

On the support side of the equation, 1507 to 1504 remains my CRITICAL SUPPORT ZONE. Any 30 minute close below this zone should produce a CHOPPY downward push towards 1496. Be on the lookout for violent program trading spike moves both higher and lower in this scenario. In other words…1502 new low, 1505.50 trade, 1501 new low, 1504 trade is a sequence that could play out. Accordingly, one should get the chance to build a short position on any 30 minute close below the zone, in the actual zone itself at a later time (1504-1507). HOWEVER, I would look to put on a partial position on the first 30 minute close below this zone – at levels lower than 1504-1507 – in case the above scenario does not play out. If the market moves above 1510 after creating a 30 minute close below 1504, then all bets are off. On the way to 1496 look for support points at 1501.50-1500…1498.50 and 1497.

I have included three charts today…one 5 minute SP mini chart over the last 4 sessions with comments, a NDX daily chart and the spread chart that keeps on giving of long SP-short Russell 2k.

Equity Index Update

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Brad Sullivan

The table above was all the excuse needed for the index markets to move sharply higher at 7:30:02 CST. Currently the SPM is trading higher by 1.80 at 1510.50…however, that does not tell the whole story as the contract was trading around 1504 before the CPI release. The question now becomes this for today’s trade…can the indices hold this pre-market turnaround bid?

On Friday I wrote that the odds were moving towards a trading range type of environment of roughly 2% in SPM…essentially 1519 to 1488ish. We have yet to test the downside of that target range and actually came within a whisper of challenging the high level of the upside range yesterday morning. However, the indices could not sustain any buying at higher pricing zones and the SPM failed to generate anything but SELLING interest in the key 1515 to 1518.50 resistance zone. That zone is becoming more powerful with each failed attempt to push above it. The subsequent selling yesterday took the SPM to a shade under 1503 where it challenged a 30 minute close below the KEY 1507-1504 support zone. HOWEVER, the contract could not generate any sustained selling underneath 1504 and it proved to be a solid entry point for a trade higher into settlement as the SPM contract finished at 1508.70.

When looking at yesterday’s trade in the SPM it is becoming more evident that the contract is biding time between the 2 key zones 1515-18.50 and 1504-1507…whichever zone breaks first should produce “follow” price action. In “follow” I simply mean a momentum based push higher or lower. Once again, I will be using a 30 minute close for these zones to initiate any follow positioning.

On the resistance side today…1510.50 to 1512.20 should be a difficult zone to get above for SPM…if it moves higher in here the contract should once again challenge the key 1515 to 1518.50 zone. I suspect that any probing of this zone will take TIME as the long side will quietly use a supporting bid at/underneath trading levels to exhaust the sellers. Once/if the index gets into this zone, all bets are off as it should provide a choppy 2-way trade that gets a little bit higher than yesterday’s 1516ish trade. Look for a probe into 1517.50 and some short sales to push the index back down. If we get the holy grail 30 minute close above 1518.50 I still will not chase ‘em up. Rather wait for a pullback into the key zone to establish longs for a late session push higher. If this pullback does not materialize, wait for the final 30 minutes to establish a run higher into the bell position.

On the support side…look for the 1509 to 1507.50 zone to be the first support zone. This zone was the first level at which the market traded after CPI was released. Underneath 07.50 we have the critical zone of 1507 to 1504. Again, a 30 minute close above this zone should lead to a push towards 1496. Along the way, 1501 to 1499.50 is support and minor levels are found at 1498 and 1497.20.

ONE KEY TO REMEMBER DURING EXPIRATION WEEK…MUCH OF THE BUYING THAT TAKES PLACE COMES IN AFTER 10:00CST. IF THIS PATTERN HOLDS, LOOK FOR AN EARLY PUSH LOWER THAT CREATES A FIRST HOUR TRADING LOW, FOLLOWED BY A STEADY BID HIGHER INTO THE CLOSE OF TRADING.

Trade Sanctions & Commodities

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Sally Limantour

This morning we have a slew of more buy out news but so far the market is ignoring this and yesterday’s action was telling as we quickly gave up the previous day’s (Friday) value area which indicated a trend day down. Has anything changed other than Richard Russell who has been bearish for years has now turned bullish?

One thing bothering me in the background is potential protectionist measures. We need to watch the upcoming Chinese delegation on May 22nd to see if there is any rhetoric in this direction. Morgan Stanley’s Stephen Roach believes the US Congress has bipartisan support for trade sanctions against China and possibly Japan. In front of a tripartite Congressional hearing on trade issues last Wednesday he said, “My worst fears were realized. At the end of three hours of grueling give and take, I left capital hill more convinced than ever that the protectionist train has left the station.”

Today in FT there is an article titled Globalization’s losers need support which also hints at protectionist measures: http://www.ft.com/cms/s/3e39c1ca-022b-11dc-ac32-000b5df10621.html

Commodities were bashed across the board yesterday after their recent rally and this has a feel of across the board liquidation. Gold has the upcoming rollover from June to August which typically sees selling pressure. Physical demand is strong and any trade back to $655-660 should be supported. If not, this will be telling. Keep in mind that gold was nailed last year during this time frame and bottomed in mid June.

Equity Index Update

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Brad Sullivan

The index markets zigged when many a trader was looking for a zag on Friday. A tame headline on the PPI reading and a weak Retail Sales report may have rekindled some hope of a FED easing before the calendar year ends. However, Friday’s sharp bounce seems reminiscent of many moves during the past couple of years in the index world.

Seemingly many shorts, players on the sideline and active traders continue to wait for that elusive “green light” to get short. Days like Thursday get the interest going and players tend to walk into a bull trap type of session. The strong buying that hit the market around 9:10-9:20CDT (which remains a KEY time zone for relative highs/lows intraday) pushed the SPM7 back into the critical 1504-1507 trading zone. From there the index was able to register a 30 minute close above this key zone and turn bullish. However, as I pointed out on Friday, the odds were to get long back in the key 04-07 zone for a push higher. That push happened on heavy buying near the cash close of Friday’s trade, eventually leading to a settlement in the SPM7 at 1512.20 and all but erasing Thursday’s downdraft.

So…what was learned from Friday’s session? Simply the same pattern we have seen play out over and over the past couple of years in the marketplace – the comeback rally -lives on. And in each of these instances, the market has eventually found its way higher. The fact that we recovered so much of Thursday’s decline during one session and that we are heading into option expiration week, puts the potential for another round of higher highs clearly in view. Certainly CPI and Housing Starts (released on Tuesday and Wednesday respectively) will have something to do with that. But, keep in mind that option expiration weeks tend to trade one of two ways – a slow push higher…or a violent decline. The odds of the decline look small – however, we must register them with the data hitting the tape this week. If CPI were to come in “out of line” with inflationary readings, the snowball selling potential would be in play for the majority of the week.

As for today, here are the levels for SPM7. On the upside, look for a moderate choppy zone between 1512 and 1514 as players begin to establish their positioning in here. Above 1514 we hit the key zone between 1515 and 1518.50. Any 30 minute close above this zone is bullish – however, once again I will not be chasing ‘em in here. I will, however, use any dip back into the zone (15-18.50) to enter long positions with a potential trade towards the 1520.50 and 1522 zone. If there is no chance to enter the long side in this zone, wait for the final 30 minutes and look for an aggressive push higher into the bell.

Support zones are found from 1509.50 to 1508.50…below this is the key zone from 1507 to 1504. Any 30 minute close below this zone adds a certain amount of confusion moving forward and should be sold short with a target of 1496-1495.