Options Trader: Monday Morning Ideas

by: Philip Davis

I've been accused of being bullish lately...

I suppose I am in the bigger picture, but the reason I called out of September positions on Thursday and Friday is that we are reaching critical test levels and, while I hope my Dow 12,000 prediction holds up, I'm not silly enough to bet my portfolio on it without further evidence!

We still have Tuesday's or Wednesday's Jihad to contend with (when is the proper time of day to declare Jihad anyway?) along with (not coincidently) the UN deadline, still 9 days away, on Iran. As I said on Friday morning, it would have been better do have a consolidation day as the positive day we got is throwing indicators into a short-term overbought status.

This week will be all about the home sales report and whether the dollar can hold up. The Wall Street Journal used the word "Bubble" to describe the oil market (and didn't even send me a check) for the first time.

I was all set to do a full-out rant on what BS this week's rise in oil prices is going to be but if you're not going to believe the Journal, then I really can't help you. I had a lot of good points lined up but I swore off oil rants over the weekend so for now I will just leave you my evidence to digest. Here is the IEA "Medium-Term Oil Market Report." (.pdf)

Please read this if it is your kind of thing and let me know what you read as bullish because I see this as just chock full of evidence that supply is outstripping demand and demand numbers are based on the insane use scenario we discussed this weekend.

You can see from these other charts (.pdf) that the reality of European demand drop-off cannot be denied yet expectations remain for a 7% rise in North American consumption and continued demand at 2004 levels worldwide (even with prices up 200%).

If a US corporation tried to post these kind of demand growth figures in their projections they would be blasted by analysts, yet oil traders (who probably never actually read the report) take it as gospel. Why did the IEA not graph supply for Q2? Clearly it was building up significantly, we already know they upped the US figures due to a "miscalculation" that failed to account for 79M barrels, which is a lot considering the last few graphs are measured in changes of just 100,000 barrels a day!

So Friday's call remains, we are not going to short oil or long stocks into a Jihad (and it's Katrina's anniversary so beware of hurricane warnings too) nor are we long on stocks at the moment, despite my generally bullish disposition. Let's keep a good eye on our technicals to see how well the markets handle this week's adversity.

If we get off to a good start it will be game on very quickly but I am expecting a consolidation of sorts into Labor Day at this point but we need to be ready just in case the markets get rally fever at the end of this week so cash is king again! I would rather sit on the side with cash than waste time trying to pick short positions...

Short positions were apparently the way to go in Asia this morning as the tightening by the Chinese Central Bank we were concerned about last week finally got the investors nervous about a regional slowdown. The Hang Seng dropped close to 2% while the Nikkei pulled back 136 points and is very close to its 200 dma at 15,867. China has a windfall profits tax and took in $2Bn from its largest oil producers! There are meetings in Malaysia about establishing an Asian version of the EU by 2015, it will be amazing if they can pull this off!

Europe is indecisive ahead of the US open (which is down in the 7 am futures) as oil prices jump back up into the October deliveries.

The Dow has the strongest chart at the moment and we will see if we can hold 11,300 but the Dow could pull back all the way to 11,100 and still look like it's breaking out. The S&P will hopefully have support at 1,300 and must hold 1,266 for the week. The NYSE should get strong support at 8,300 but doesn't touch the 50 dma until 8,100. The Nasdaq will have a very hard time breaking 2,200 without testing 2,100 again but let's just watch the SOX which are hopefully just consolidating around 450.

You shouldn't read much into the rise in oil prices until they get back to $73.50 as it is the same effect as taking any option contract a month further, you are paying for the time value of the delivery.... I am hoping for a nice, irrational jump in the oil sector and will likely be stocking up on puts tomorrow. About 80% of all oil traders believe Iran will not back down to the UN - if they do - WATCH OUT BELOW!

Gold is up on the potential explosion in the Mid-East but is getting some fundamental support from the metals sector with the BHP strike looking worse and Nickel actually in short supply. This will put pressure on the steel sector as not only will costs rise but they may actually run out of the stuff! Unlike gold, which is in plentiful supply, we are physically running out of Nickel as there are only 6,156 tons in inventory at the LME against a daily demand of 3,500 tons - that is cutting it very close! Before you go out and buy nickel though, I will point out that it would take very, very, very little effort to manipulate this price and there is already a huge bullish play on this market so let's just watch it as a general metal indicator.

In the "News You Won't Hear on Fox" category, snipers opened fire on Shiite pilgrims marching through downtown Baghdad yesterday killing 22 (hardly worth a mention in Iraq) but injuring hundreds of people. I'm sure that someone is bound to spin this as an improvement over last year when over 1,000 people were killed during the annual pilgrimage.

And speaking of secret nuclear weapons programs - we just started one of our own as the White House has suddenly decided to stop disclosing our own stockpiles. This is a great example of "Do as we say, not as we do" and sends the most mixed of all possible messages to Iran.

Watch and wait today. We closed out last week with a bang and I have no desire to buy back in at these prices if I don't have to. If this is a real rally, we have a couple of more weeks like last week ahead of us but it would be much healthier to have a little consolidation first!


TOL brothers reports today and we will see how they get treated on what is bound to be a steep decline from last year's earnigns. Outlook will be key, of course, and they have been fairly conservative this year. We get existing home sales and prices this week and it is possible we will see the first price decline in a decade. A more telling figure will be changes in inventory, which have risen alarmingly all year - if they don't slow, we may be in for a hard landing.

LOW had good earnings but cut outlook which may give us a nice reentry into HD this week.

I'm starting to accumulate RSTO as my first pick against my Consolation Prize Theory (see weekend post). I am hoping for a drop back to the 200 dma of $6.15 but if it holds $6.40 this week I will be biting the bullet there for the long haul. This is a very long term play and I will ease into the position slowly unless we break above $6.75.

In line with a possible move in gold back above $640 and the runaway nickel situation, I like FCX $55s for $1.90 as a quick trade but it must break and hold the 50 dma at $52.50 and get out if it goes below.

PKX has been drastically sold off on speculation that they have been shorting nickel, a charge the company says is "overblown." Consider this the other side of the FCX trade as a drop in prices will send Posco flying while I think the downside is already priced in. November $65s for $2.55 should hold value even if we have to get out at the 200 dma ($59) but will be a nice hold if we break to the upside.