Options Trader: Thursday Morning Ideas

by: Philip Davis

Please read the previous post on stops. It will give you an idea of my main concern at this time.

The reason we went for October portions early was that we were expecting a correction when the big boys returned—this is just a little more violent than we thought it was going to be.

There is no reason to panic yet, maybe tomorrow...

All we have so far is a big, postponed sell-off in the energy sector, and a drop in commodities and homes. Are we surprised? We certainly weren't long on any of these for over a month, and anyone who reads this column regularly knows I feel it is long, long overdue.

That being said, housing prices in the UK have gotten surprisingly firm. I don't expect the US to have the same trend, as the UK is uniquely crowded but I expect NY, LA, NJ and perhaps some other cities to hold up better than expected as land is still at a premium in some places:

Asia is off about a point with Sony's Playstation delays causing a ripple effect in several sectors, and Europe is down around a point despite the EU significantly raising growth forecasts for 2006 and 2007. The very positive report carries a warning: "A disorderly unwinding of global imbalances continues to be a threat to the world growth outlook, particularly if the U.S. housing market slows down more markedly." For goodness sakes Europe, stop watching us and make your own market!

The whole point of forming the EU was to create an economic block that was the equal to the US to remove Europe from the thrall of the US markets. Looks like that plan's going a bit slowly...

Asia ignores us, other than sensible things like electronic exports, and the Nikkei has risen from 11,000 in late '04 (just 500 points ahead of the Dow) to 16,500 currently (having pulled back from 17,500 in April). While US traders would be jumping out of windows if we had the kind of swings they do, the fact that their markets can prosper—on the very same planet we're on—is one of the main reasons I remain generally bullish.

What caused the break in early '05? As I have said in past articles, it is the culture of fear that is feasted upon by the U.S. media that force us to climb "a wall of worry" in order to make the slightest market gains.

The Nikkei had a healthy Fibonacci retracement of half their one-year gain between April and June, and has just moved back over the 200 dma of 16,000:

There would be no reason to panic if the Dow fell all the way back to 11,150 (it's 200 dma), as it would still be in a nice, long-term uptrend (but it sure wouldn't feel like it, would it?):

We may make a nice turn back up at this point (over the next 5 sessions), but if not we will need to wait it out and go back to picking our spots in another bearish downturn.

Without the transports the Dow is doomed, and the transports look as bad as the SOX did earlier in the quarter, but check out that cute little triangle—it's forming on the weekly chart! Think of it as a gun that is about to fire:

The S&P is resting right at 1,300, and anything under that means we don't buy. On the whole, I will be very pleased if it holds 1,290, which provided good support since it was crossed on 8/15.

The NYSE has a real test at 8,300 for the same reason; a break below this level means we will certainly be heading back close to 8,100. There will be plenty of short plays to make if this happens, but hopefully it won't come to that:

The Nasdaq is showing us why it's called a death cross, as the index bounced away from the 200 dma, and has nothing preventing it from heading back to the 50 at 2,125:

Only SOX can save the Nasdaq, but who will save the SOX as congress turns up the heat on the options scandal? Remember I said there were only 80 companies being formally investigated (now 103) out of 2,000 possible targets. In the end, expect 400 companies to show up on a formal list. With the average scandal dropping a stock 8%, which time bombs are in your portfolio?

We can get more in depth on this later, but suffice to say that, in reading back a month, I'm actually not that unhappy with where we are now. We just need to wait and see if our bottoms hold.

The bottom is not holding on oil as it dips below its 200 dma of $67.77, even as the dollar remains very, very flat. I still expect the dollar to rebound, but I wait and wait and wait...

Someone said perhaps Valero Energy Corp. (NYSE:VLO) is different because they are a refiner, but integrated oil companies are refiners too, as well as gas station owners, and the party may be over there as well:

The heat will be on BP PLC (NYSE:BP) today as they testify to Congress on their Alaska debacle, but this may be the least of their problems as the CFTC has subpoenaed them regarding market manipulation, and a class-action suit has been filed against them in Federal Court alleging they monopolized the Cushing, OK national fuel depot to drive oil prices higher:

Let's keep a good eye on the $67.50 line on crude. Analysts (boo, hiss) are expecting a drawdown of 1m barrels, as we just had the second biggest demand weekend of the year, so any build in crude or gasoline will be a huge negative for that market. We get natural gas inventories today as well, and zman is targeting a build in the 50s, which brings us dangerously close to the point where we simply cannot put any more gas in the ground!

Gold is being goosed up on any excuse, and I think it is just edging closer and closer to the diving board. $640 has again proven to be a very firm top, and the 50 dma is now $630, so a minor blip can drop it back below resistance.

KB Home (NYSE:KBH), Beazer Homes USA Inc. (NYSE:BZH), and Hovnanian Enterprises Inc. (NYSE:HOV) all lowered forecasts (again) so expect more pain for the builders today.

Today's Picks:
Let's look for the Oil Service HOLDRs ETF (NYSEARCA:OIH) to catch up to Valero (down 10% in 5 days), or vise versa, so follow the still reliable Valero Rule, but lets' think about the Oct $130 puts for $3.60—keeping in mind this is a crazy oil inventory day.

I made my long plays yesterday and I will be mostly watching and waiting today. We will follow the Valero Rule, keeping a close eye on Chevron Corp. (NYSE:CVX), who is right on their 50. If there is a draw of over 1M barrels in inventory, oil may bounce back.

Our BP PLC (BP) $70 puts should do well today, they were repicked on Friday at $2.15 ($3.60 yesterday). I have very, very tight stops on all the oil puts and will be half out of most ahead of inventories.

Core Laboratories N.V. (NYSE:CLB) at $76.40 is not optionable, but seems like a good short. Stop at $80.50. 50 dma is $67.50.

CVX has a long way to fall, and is right on the 50 dma of $65, miles above the 200 dma at $60. I like the $65 puts for a daytrade at .80 as well as the Oct $60 puts for .35.

Someone needs to send a memo to McDermott International (NYSE:MDR) and tell them the party is over! I'm not playing it, but let's watch them closely for a sign of the last oil service company giving up.

Petroleo Brasileiro S.A. (NYSE:PBR) faces a test of the 200 dma at $85 - let's watch that action closely!

We had such a good time with the $70 puts, let's try the Royal Dutch Shell (NYSE:RDS.A) Oct $65 puts for .65.