I believe that it is important to point out to all my readers, especially those who are not already members of S.O.M.E. (as members are already well-aware of my trading strategy!), that the more volatile the market becomes, whether it trades up or down, is more beneficial to us, as the returns on our options increase dramatically, as observed throughout May and again last week.
I must say I am a great supporter of the bulls, but will play-along with the bears to extract as much value from our options plays, as possible. I am a great believer in things moving forward and improving as time progresses but I also know that we have to play-the-game to extend our profits. The only catch in this type of market is “knowing” or realizing in which direction it will take, and it seems that we have been able to fulfill this decision in most cases, to gain our profitability.
Key Events This Week
Note:-All earnings dates listed below are tentative and subject to change.
This Week’s Economic Reports
There are still quite a few major economic indicators available this week, which are: -
• There are no major economic reports scheduled for release today.
• May's existing home sales
• Weekly crude inventories,
• The Federal Open Market Committee's interest rate decision.
• The initial jobless claims,
• May's durable goods orders.
• Initial third-quarter gross domestic product reading and
• June's final University of Michigan consumer sentiment index.
This Week’s Major Earnings Reports
• Sonic Corp. (SONC) and
• Steelcase Inc. (SCS)
• Carnival Corp. (CCL),
• Walgreen Co. (WAG),
• Adobe Systems Inc. (ADBE),
• Jabil Circuit Inc. (JBL), and
• Red Hat Inc. (RHT)
• Canadian Solar Inc. (CSIQ),
• CarMax Inc. (KMX),
• Rite Aid Corp. (RAD),
• Bed Bath & Beyond Inc. (BBBY),
• Darden Restaurants Inc. (DRI), and
• NIKE Inc. (NKE)
• Discover Financial Services (DFS),
• Lennar Corp. (LEN),
• H&R Block Inc. (HRB),
• Oracle Corp. (ORCL), and
• Research In Motion Limited (RIMM).
• KB Home (KBH)
Outlook for This Week
Last week saw another weekly win for the bulls - the second in a row for the Dow Jones Industrial Average (DJIA). The Dow made a strong push above 10,400 on Tuesday, and managed to hold that gain through to the end of the week. Moreover, the S&P 500 Index (SPX) finished the week above 1,100 for the first time since mid-May.
Picture: A cold Wall St. still on the move up gradually?
The sentiment landscape has taken a drastic turn since April, implying that we have moved into a low-expectation environment, which can be viewed as a positive... The technical backdrop, however, remains mixed.
The S&P 500 Index (SPX) gained 2.4% last week, following the script of bullish tendencies during triple-witching expiration weeks, but deviating from the negative returns during June expiration week that we experienced in the last decade.
The low-expectation investing environment alluded to above was confirmed in last week's trading, as jobless claims and housing starts data came in weaker than expected, in addition to a softer-than-expected report from the Philadelphia Federal Reserve. However, the stock market did not react negatively to the poor economic news, as it would when investor expectations are high. Meanwhile, well-received debt offerings in Spain and Ireland sparked a Tuesday rally that defined last week's gain.
Tuesday's rally was so powerful that the SPX closed back above its 200-day moving average for the first time since May 19, 2010. So, for the second time in two years, the index moved above this trend line in the month of June. The crossover above this popular moving average in June 2009 was nothing more than a short-term sell signal, but the jury is still out as to whether or not June 2010's breakout is the real thing or simply a “fakeout” in the short term.
With the SPX coming into the week at 1,117.51 and above its 200-day trend line, the 1,120-1,125 area could be the next challenge from a technical perspective. For example, the 160-day moving average is sitting at 1,126.10 – note on the chart below that this moving average marked the February 2010 low.
Therefore, the risk to the bulls is that this trend line becomes resistance on the rally. Moreover, the 1,120 area marked resistance in November and December 2009 during a narrow trading range.
There are a couple of notable differences between June 2009 and June 2010 that bulls should view positively. First, in June 2009, customer-only, equity option buyers on the International Securities Exchange and Chicago Board Options Exchange were more optimistic than they had been all year, whereas sentiment among this group now is at a pessimistic extreme for 2010. Our data shows that when this crowd is at an optimistic extreme relative to prior months, the market is most vulnerable to a short-term decline. The market is more apt to surge higher when a pessimistic extreme is identified.
Moreover, our analysis of option activity on exchange-traded funds such as the iShares Russell 2000 Index Fund (IWM), PowerShares QQQ Trust (QQQQ) and S&P Depositary Receipts (SPY) suggests that institutional players are in the early stages of accumulation, whereas in June 2009 the same analysis suggested these players no longer saw value in the market.
In addition to the statement from the Fed's rate-setting meeting, investors will take in data on the housing and labor markets, consumer sentiment and the final reading for first-quarter gross domestic product.
Investors will be looking for further signs that the economic recovery is on course, after a recent batch of disappointing indicators rekindled fears of a double dip recession.
Existing Home Sales
Existing home sales are likely to show a gain for May because the National Association of Realtors counts sales actually closed.
The reason: The homebuyer tax credits expired on April 30, and sales are supposed to close by June 30. There's been lots of activity to get deals done. Look for a seasonally adjusted sales rate above 6 million units.
The sales are expected to rise to 6.15 million units from 5.77 million the month before.
New Home Sales
The Commerce Department will probably show a decline in new home sales dipping to 420,000 units from 504,000, according to a Reuters poll.
That's because the department counts contracts signed but not yet closed. And builders have been reporting that slowing activity since April 30.
Weekly Initial Claims
Weekly initial claims on Thursday are expected to ease to 464,000 from 472,00 the week before.
Also Thursday, durable goods for May are expected to fall by 1.1 percent, compared to a gain of 2.8 percent in April.
Orders for new Boeing (BA) commercial aircraft fell to just five in the month. Metals prices were lower.
Rounding out the week, the final reading of first-quarter GDP is expected to show a gain of 3 percent, in line with the previous reading.
Analysts see this holding at around 3%. Anything lower would hit markets hard.
June Consumer Sentiment
The final reading of June consumer sentiment is expected to come in at 75.5, also in line with its earlier reading.
The question is whether the gloom from BP's oil spill plus the worry about the euro turmoil will dampen consumer spirits.
Homebuilder Toll Bros. (TOL) made that argument this week in reporting disappoint results.
Federal Open Market Committee - Interest Rates
The Fed's two-day rate meeting should end Wednesday with no policy changes, but the Fed may give a nod to the risks the ripples from the European debt crisis pose for the economy.
The Fed is expected to reiterate its commitment to keeping interest rates "exceptionally low" for an "extended period" at the end of its two-day meeting on Wednesday.
Right now, the target on the Fed's federal funds rate, on which most domestic interest rates are built, is 0% to 0.25%.
Last month's disappointing payrolls figure make it all the more unlikely the central bank will change its stance, said Phil Orlando, chief equity market strategist at Federated Investors, in New York.
"We think the Fed's forced to reset the clock and wait for a better, more consistent string of nonfarm job creation," said Orlando.
"We're not thinking the rate hike cycle commences before 2011, at the earliest."
Investors are also watching to see if the Fed discusses the sovereign debt crisis in the euro zone and its impact on the U.S. economy.
"If the FOMC comments indicate that they're not too concerned about the fallout from Europe on the U.S., we will continue to see the market in an upward trend," said John Praveen, chief investment strategist at Prudential International Investments Advisers LLC in Newark, New Jersey.
"The most important things, broadly speaking, that are going to drive the markets over the next couple of months are going to be [financial regulation] and the employment picture," said Jason Trennert, chief investment strategist with Strategas Research.
The Energy Crisis
BP (BP) - Investors will continue to watch BP's mile-deep oil gusher in the Gulf of Mexico, as it increasingly becomes an economic concern and a negative for markets. The energy sector did recover 2.7 percent in the past week.
"It's hard to watch the circus that was before Congress yesterday (Thursday) and feel bullish about buying stocks regardless of your feelings about BP's culpability...So much of this comes down to policy, and there's a relatively small amount of officials and policy makers in Washington, Brussels and Beijing that are casting a very wide shadow over the financial markets," said Trennert.
Citigroup chief U.S. equities strategist Tobias Levkovich said the crisis in the Gulf is negatively impacting companies and stocks, and creating long-term uncertainty about the future shape of the oil industry, and its regulation. But he said the decline in energy stocks has also created a buying opportunity in the sector, which has also been hurt by a stronger dollar.
BP Raising Fresh Capital
The oil giant has lost nearly half of its market cap since the April 20 explosion that sank the Deepwater Horizon rig and set off what's believed to be the worst environmental spill in history.
There are lots of concerns about BP's future as a result of the market-cap loss and the $20 billion it agreed to put up to help pay for the spill.
A big test comes this week when it tries to raise $10 billion in fresh capital.
Banking reform will likely overshadow the Fed in the coming week, as Congress edges closer to a new financial regulatory reform bill whose effect on the financial sector is still murky.
The shape of financial regulatory reform is still unclear, as conferees meet on major aspects of the legislation next week. The committee is aiming to reach a compromise that would combine the House and Senate legislation by Thursday, with floor votes the following week.
"Obviously, the desire is to get it done before July Fourth because they all go on vacation. I don't know if you hear a lot more than you've heard this week but you'll probably get a sense of what the bill will look like," Trennert said. The most important issue to resolve is what happens to the swaps businesses of banks, which the Senate bill required be separated from the rest of the business. Under a compromise version, those assets could be retained by parent companies but isolated.
"That's the most important part of it in terms of its immediate potential impact on the financial markets. They're going to obviously be forced to have enough capital so they're going to have to recapitalize that part of the bank. It is also going to be a fairly meaningful earnings hit. It's the devil in the details," he said. "If it's going to raise capital requirements for financial institutions that are already worried about having adequate reserves, it may eventually be good policy, but I'm not sure it's the best policy right now."
On Tuesday, the conferees will take on consumer financial protection and whether to limit fees on debit card transactions.
"If you look at the stocks that haven't made it back above the 200-day moving average, financials are one of them and that's due to [financial regulation]," said Art Hogan, managing director at Jefferies. The S&P financial sector was up 2.3 percent in the past week, but it's down more than 8 percent in the past two months and has been one of the worst performers since April.
Levkovich said he likes regional banks but is staying away from the diversified financials that would be impacted by the bill. "Regional banks...don't have to worry about derivatives, swaps, too big to fail or prop trading for the most part," he said.
Progress on financial reform legislation would also give President Obama a blueprint to share with other world leaders when he reaches the G-20 meeting in Canada next weekend. Obama meet with G-8 leaders in Huntsville, Ontario at the end of the week, ahead of the G-20 meeting in Toronto. G-20 finance ministers have been working toward a more unified approach to regulating the global banking system though an agreement is not expected until the end of the year.
"I'm not sure he'll have anything definitive although I think he can credibly go to G-20 and indicate the U.S. is well on its way to establishing a 21st century regulatory process and I think Europeans will come and say we're addressing our fiscal issues and we have provided reassurance to the markets about the status of the banking sector. I think everybody is addressing the issues that come up in their part of the world," said Robert Sinche, chief strategist at Lily Pond Capital.
Financial Reform Bill
The House and Senate will continue negotiations over the financial overhaul bill on Tuesday. The bill currently is in “conference committee’ and plenty of issues remain. House Financial Services Committee Chairman Barney Frank, D-Mass., said he wants to wrap up work on the measure by the end of next week.
Gold finished last week at a record for a second day in a row, with jitters continuing over debt and currency issues in Europe and the BP Plc (BP) oil spill in the Gulf of Mexico.
"Things we can't control are still looming," said Frederick, who believes that while the short-term picture may well involve a pullback, "long term the recovery is still intact."
Reassurances from world leaders over the European debt situation ahead of the G20 summit in Toronto on June 26-27 could also soothe investors' nerves.
"China has clearly focused on its issue and said leave us alone on the currency," he said. The U.S. had been pushing China to let its currency appreciate against the dollar.
Research In Motion (RIMM)
With all the hype about Apple's iPhone 4, the question is where Research In Motion stands.
Its BlackBerry device has huge fans among corporate users. It has a pretty good consumer audience. But there's lots of talk that Apple (AAPL) is finally making inroads into the corporate market, and the worry is that Apple will overwhelm the Canadian company.
The consensus is that RIM will report $1.34 a share for its fiscal first quarter on revenue of $4.35 billion. The release is due after Thursday's close. That would be up from 98 cents a share and revenue of $3.42 billion a year ago. That's a 37% gain from a year ago on earnings and a 27% sales increase.
The stock is down 9.6% in 2010 while Apple is up 30%.
Nike reports fiscal-fourth-quarter results after Wednesday's close. The consensus estimates are for $1.05 a share in earnings, up from 99 cents a year ago, and revenue of $5.1 billion, up 8.8%.
The company saw decent U.S. results in its fiscal third quarter and great results from emerging markets like China. Europe was a problem.
What the company reports about Europe and the United States will be important. And watch to see if Nike has been seeing any extra pop from the World Cup in soccer.
Oracle (ORCL) and Sun Microsystems
Oracle, which will report Thursday, is seen posting strong results for its fiscal fourth quarter.
The estimate is 54 cents a share, up 17% from a year ago. Revenue will jump 38.4%, in part because of the addition of Sun Microsystems to its mix.
A question is the lawsuit charging that it gave discounts to some preferred customers but not to the government.
INDICATORS AND MARKET CONDITIONS
The U.S. stock market could be in for some softening in the weeks ahead if June follows its recent historical path, or Wall Street could take its cues from a few technical indicators that offer a more bullish signal.
The CBOE Market Volatility Index, or VIX , is a commonly used measurement of market volatility. It uses prices on S&P 500 Index (SPX) options to measure the volatility that the market is expecting over the next 30 days. The VIX typically trades above the actual volatility of the SPX, but last week the VIX fell well below the actual volatility figure. The graph below shows the VIX and 20-day volatility of the market over the last year. As the market was pulling back over the last couple of months, actual volatility was rising along with the VIX. Now the VIX has come down well below actual volatility.
VIX premium: It shows where the VIX is in relation to actual volatility. A positive VIX premium means that the VIX is higher than actual volatility, and a negative VIX premium means that it is lower. Below is a chart of the VIX premium along with the SPX. The spots marked on the SPX are where the VIX premium fell below -10%, as it did last week (Note: Only one signal in any given 21-day period is considered.)
Looking at the chart since 2008, those signals have been bullish at times and bearish at times, but the previous three occurrences happened at pretty momentous turning points for the market.
Interpreting the Signals:
Going back to 2005, there have been nine signals prior to the most recent one. You can see in the tables below that those have been very good times to buy in the short term. Look at the returns one month later. All nine times the SPX was up in that time frame, averaging a return of 3.4%. We know from the chart above that those signals can come before a huge drop in the market, but in the very short term they have been solid and safe buy signals.
***Further evidence of market conditions can be seen in representations of charts below.
The S&P 500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF had been running into problems every time it tested the $110.80 area over the past few weeks, and it was finally able to hurdle this level on Tuesday. This level also happened to coincide with the 200-day moving average, and SPY was able hold above this average the rest of the week. The $110.80 level should now act as support, and the fact that it has held on the first few tests is a positive. The next level to watch on the upside would be near $115 which coincides with the 50-day moving average and a prior high from January.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF which tracks the Dow Jones Industrial Average also managed to hurdle past near term resistance as it cleared the $103 level. Both DIA and SPY have managed to form small double bottoms and the short-term outlook is stabilizing. Both have managed to recapture their 200-day moving averages but remain below their 50-day moving averages. DIA is differing in that it surged past its double bottom and has put some room between itself and the breakout area. DIA will likely come back to retest this area as support in the near future and the $103 level should be watched to see it bulls step back in.
The Nasdaq as represented by the Powershares QQQ ETF (Nasdaq:QQQQ) also managed to close above a small double bottom base this week. One big difference between QQQQ and SPY/DIA is that QQQQ managed to defend its 200-day moving average before this week which shows some relative strength. The level to watch in the near future for support is the top of the double bottom near $46.70. Looking beyond the 50-day moving average, next level of significant resistance appears to be near $49.
While the Russell 2000 as represented by the iShares Russell 2000 Index (NYSE:IWM) has been showing relative strength against the other market index ETFs, it actually underperformed this week. Even though IWM managed to hold above its 200-day moving average, it hasn't been able to decisively clear the double bottom it is trying to form. This is interesting because IWM has been leading the markets for several months now. IWM should be watched as it tests this level as a failure could drag the rest of the markets down with it.
***Whilst the past week was certainly positive for bulls, the markets remain vulnerable to further downside. In the shorter timeframes, the small double bottoms that have formed are basically confirming the recent lows as support. This is ultimately the primary level to watch moving forward.
Stepping back to intermediate timeframes, the markets are still well off their recent highs, and below a declining 50-day moving average. There is also a larger possible head and shoulders top that is forming in the indexes. While this pattern may be too obvious and thus may fail, sellers will likely appear as the markets tick higher in anticipation of this pattern.
Many individual stocks are starting to look much healthier, and traders should be patient and only take the best trading opportunities. By focusing on only the best patterns, traders will be able to take advantage of a possible bottom, or worst case, be able to limit their risk by focusing on the strongest of stocks.
***Volatility, as measured by the CBOE Market Volatility Index (VIX), needs consideration particularly in regard to where it is headed.
Indeed, the VIX declined during the past week, from 28.79 to 23.95 by Friday's close. With SPX 20-day historical volatility at 26.96, this would suggest volatility is still headed lower. There is one risk in this conclusion. If volatility is trending higher from a longer-term perspective, the current "pullback" in volatility could end here. This is because the VIX is now trading just above its closing "half-high" of 46.00 in mid-May, which is also around its upward-sloping 200-day moving average.
I point out the "half-high," because the pop in the VIX that began in January 2009 that lasted into March 2009 was from the 40 area, which was half the 80.08 closing high in November 2008.
The good news is that the cost of portfolio protection has been cut in half since this time last month. Use this plunge in the price of portfolio protection to your advantage, as June expiration may be an opportunity for you to replace expired put hedges at a cheaper cost than last month.
***U.S. stocks have momentum on their side this week, though seesawing sentiment could roil the markets and investors will scrutinize comments from the Federal Reserve to gauge the strength of the economic recovery.
"Historically the tendency for the markets is to be a little weak following June expiration," said Randy Frederick, director of trading and derivatives for Charles Schwab, who added that the trend has persisted for the past half-dozen years.
***Despite rapid intraday changes in direction, the market has managed to build a more positive tone since hitting a seven-month-low in early June. The S&P 500 decisively scaled its 200-day moving average last week, a key technical marker that could trigger more buying.
"A positive read on the 200-day moving average supplies an underpinning and support for market sentiment that has proven to be important to this particular period (of the) market," said John Stoltzfus, senior market strategist at Ticonderoga Securities in New York.
"Anything outsized, whether it's disappointing or positive, gets either punished or rewarded by the markets very quickly." Although the S&P 500 has held above its 200-day moving average since Tuesday, providing a bullish signal, it has bumped up against resistance around the 1,121 level, the point that marks the halfway point between the October 2007 historic highs and the lows of March 2009.
Phil Orlando, chief equity market strategist at Federated Investors, in New York, said the fact that the index retested and bounced off the low for the year earlier this month is another positive sign, as investors appear to be ignoring negative data in favor of cheap prices.
"If that's happening, that suggests we're going to be back in an uptrend because investors are ignoring near-term noise and are focused on what I think is a very attractive longer term valuation picture," said Orlando.
***But investors are expecting action to be choppy, particularly with volume drying up this week, which can make it easier to move the market around.
***Concerns over sovereign debt woes in Europe and the BP Plc oil spill in the Gulf of Mexico have been an overhang, and investors will be watching for comments from officials ahead of a meeting of the Group of 20 this week.
The bottom line is that the technical backdrop and momentum are showing signs to favor the bulls but until the markets break free of the current range, traders should continue to show patience and trade cautiously or take up the challenge with options trading.
Success is simple. Do what's right, the right way, at the right time.
Success is simple. Do what's right, the right way, at the right time.
Take control of your future prosperity the Easy way. Become a member of Stock Options Made Easy today!