Wednesday, February 17, 2010

9:25 PM

In focus: Slow-motion rally

Plus: Option expiration, SQNM and CROX
By Lawrence G. McMillan
The rally that began from a deeply oversold condition a week ago Friday has now reached the 1100 level on the
Standard & Poor's 500 Index (INDEX:SPX) .
This is a resistance area, and we expect the market to find some trouble at this point. However, if SPX were to
close above this level, it would turn the chart more to a neutral or trading range chart, than the bearish chart that
it is right now. To the downside, the 1060-1080 area represents support, for that is the area in which the market
"worked" before moving higher.

Equity-only put-call ratios remain on sell signals. As long as they are rising, that statement will be true. Some might
consider them a bit oversold since they are relatively high on their charts -- especially when compared with where
they've been in the last year or so. But it is not the level of the put-call ratio that is important. Rather, it is the
trend. For now, that remains upward, and that is bearish.

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 Market breadth measures have gone from oversold to overbought. Breadth has been positive for six straight days.
The market can certainly go higher when breadth indicators are overbought, so that condition by itself is not a sell
signal. However, if we experience a couple of days in which declines dominate advances, and SPX is unable to
penetrate through the resistance at 1100, a sell signal will be generated for the broad market. It was exactly with
this thought in mind that, in the previous issue, we made a contingent recommendation to buy SPY puts.
The volatility indexes (INDEX:VIX) (INDEX:VXO) have continued to decline as this rally has unfolded. However,
they can still be considered to be in uptrends, and that has bearish connotations for the time being. If VIX closes
below 21, that would turn the chart neutral from bearish.

Volatility futures have been mostly bullish even during the decline, and that continues to be the case. The February
futures went off the board today, as the expired in an "a.m." settlement. That means that the March VIX futures
are the front month. They have a modest premium of 1 point, and the succeeding months have larger premiums.

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 are the front month. They have a modest premium of 1 point, and the succeeding months have larger premiums.
As a result the term structure slopes upward, and that continues to reflect the bullish case.
In summary, the broad stock market correction that started in January may be ready to resume. If SPX can't get
through 1100 and breadth sell signals arise, that would be bearish. But if the 1100 is overcome, then we are likely
to be in a trading range environment, bounded by resistance at 1130-1150 and support at 1060-1080.
Recommendation: Sequenom (SQNM)
Sequenom (NASDAQ:SQNM) broke out from a basing formation, overcoming multiple resistance at 4.60. Stock
volume patterns are very strong, and there was extremely heavy and speculative call option volume (at least
seven-times normal call volume). We would like to buy the calls on a pullback towards support at 4.60, but we may
not get that pullback, so let's use a two-step approach:
Buy 6 SQNM Mar 5 calls (OPRA:QJQ100320C00005000) at a price of 88 cents or less.
In addition, if SQNM pulls back to 5.00 or lower, then double the size of your call position.
SQNM: 5.34 -- Mar 5 call: 0.88

Recommendation: Crocs (CROX)

Crocs (NASDAQ:CROX) is a name from the high-flying past. The stock is nearing its yearly high, and a close above 8
would be a breakout to new highs. Stock volume patterns are very strong. There is support at 7 to 7.50. So, let's
use a contingent recommendation:
If CROX closes above 8.10, then buy the CROX Mar 8 calls (OPRA:CZL100320C00008000) at that time.
CROX: 7.98 -- Mar 8 call: 0.70 offered.
If bought, stop yourself out on a close below 7.

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 Trader's Insight: Option expiration
This is February option expiration week for both regular stock and index options (third Friday), as well as VIX
options (today). Moreover, it is a holiday-shortened week in the U.S., with Monday having been President's Day. As
a result, there are usually some rather strange market movements in a holiday-shortened expiration week. This
week has been very dull so far, but perhaps some fireworks will emerge on Thursday and/or Friday.
As far as options influencing the stock market at expiration, we normally look at the open interest of expiring index
in-the-money calls vs. expiring in-the-money puts. Specifically, we look at the relatively imbalances of the S&P 100
index (INDEX:OEX) options for this purpose, because those are American-style options and -- more importantly --
they do not have futures or ETFs (of any consequence), so the open interest is pretty much what you see and is not
hedged by other derivatives.
At the present time, there is a slight bullish bias to this expiration. There is a preponderance of open interest in the
calls anywhere above 505 on OEX, which is roughly where it closed tonight. If OEX should be above 510 by Friday,
expiration day, then there could be a significant bullish bias to expiration.
Of course, these projections are subject to the vagaries of trading, meaning that traders can roll OEX options out to
other expirations or close out their positions prior to Friday. But, if they don't, there should be a bullish bias to
expiration.
Follow-Up Action:
All stops are mental closing stops unless otherwise noted.
AIG May 29 straddle (long put and call): continue to hold without a stop, as we have ample time for AIG to make a
volatile move.
SPY Feb 113 puts: were stopped out today.
4 UFS Feb 55 puts: were stopped out today.
TLB Mar 12.5 calls: the stop remains at 10.50.
FLS Mar 95 puts: we bought these puts today, as they finally traded down to our limit of 4.80. Stop yourself out on
a close above 98.
SPY Mar 110 puts: were bought today, when SPY traded at 110. Stop yourself out on a close above 113 by SPY.
UAUA March 14 calls: were bought last week. Raise the stop to 14.
All stops are mental closing stops unless otherwise noted

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