Options Trader: Friday Morning Ideas

by: Philip Davis

Are we going to have a down week?

I know. What’s a down week? We did have one - way back in the last week of March, when the Dow closed an annoying Q1 with a 150 point drop and we thought 12,500 was starting to look like pretty strong resistance. Low expectations D.R. Horton, Inc.'s (NYSE:DHI) (CEO said the year was going to "suck") on March 8th led to lots of earnings beats and the rest of the World carried the ball whenever we hesitated so far in Q2.


The last week of March was when we decided to turn bullish as I pointed out that the declining dollar and inflation would be GOOD for the market. My advice was to cynically go with the flow:

Let’s not think of it as fiddling while Rome burns, think of it as seeing a big fire (of burning dollars) and being savvy enough to grab a stick and start roasting some marshmallows.

I recommend rereading that article for anyone who is having a tough week, as I think the pattern we’re in this week is very similar (to be confirmed by a 50% retracement of yesterday’s drop).

If we do get a couple of weeks of consolidation around 12,500, then we will have played this perfectly as that’s about where we hedged out our positions, especially the calls we sold against our longer-term positions. But let’s keep alert and be ready to go with the flow as we are still in danger of a big break in either direction.


I missed yesterday’s 300-point Hang Seng drop prediction by 22 points. I promise to go over my charts this weekend and see where I went wrong. The Nikkei also pulled back 215 points, but I suppose they don’t watch the Shanghai B shares either because foreigners jumped back into that market, snapping back 1/3 (8%) of the week’s drop. How much money would we be able to make if the Dow went up and down 8% on two consecutive days? I’m organizing a field trip to Shanghai this fall so we can all open some options accounts over there! India, surprisingly, went up 120 points.

North Korea must have had puts on something as they ran some missile tests yesterday and Criminal Narrators Boosting Crude will make much of it, but it’s the same exercise they run every year at this time. North Korea said it was forced to develop nuclear weapons — and tested one last year — because of Washington’s threat of a pre-emptive nuclear strike, a plan it said was backed by Japan and South Korea. "The DPRK had no other option but to possess nukes," the report said, using the abbreviation of the country’s official name, the Democratic People’s Republic of Korea. "The DPRK will automatically not be in need of even a single nuclear weapon when the time comes when the normalization of DPRK-U.S. relations and confidence building is made," it said.

OPEC (and, as ZMan points out, the "C" stands for Cartel) stepped in to stop yesterday’s 2.4% drop in crude by indicating they would not be increasing output this summer. They rightfully pointed out that the real cartel at work here are the US refiners, who now mark up a barrel of oil 162% by the time it’s sold at the pump. Since OPEC nations do indeed incur some very real costs pulling oil out of the ground (let’s say $20 per barrel) and since a refined barrel of crude was recently (pre-Bush) available for just $42 per barrel ($1 per gallon at the pump), one could infer that $126 per barrel of the $168 per barrel we pay (at $4) falls under the the heading of "windfall profits."

From OPEC’s perspective, why do anything to decrease the cost of oil they sell to the President’s largest campaign contributors when all they do is use it to increase their margins? No drop in oil since Fall ‘05 has led to a drop in gasoline prices, as more than 10% of the nation’s refining capacity has been kept off-line for almost the entire last 18 months. While the refineries burn or get taken down for maintenance, Valero Energy Corp. (NYSE:VLO) (for example) bought back over $2B of its own stock while spending little enough on that maintenance (and fire prevention) to keep its average operating cost per barrel down to just $4 (I kid you not!).

Nigerian Militants

I have this same issue with Nigeria, where six more hostages were taken this morning, this time seizing six construction workers on a boat. This brings the count up to 200 foreign workers and 100 kidnapping incidents this year (once every 1.4 days on average) that has cut Nigeria’s oil production by 1/3, which is 800,000 barrels a day at $60 per barrel or $48M per day that is not being spent ON A FRIGGIN’ SECURITY GUARD! COME ON PEOPLE - THIS IS A TOTAL SCAM AND WE FALL FOR IT EVERY 1.4 DAYS!

Only by distracting you with non-stop fear and terror from Iraq, Iran, Nigeria, Hurricanes, etc. can the oil criminals get away with charging you four times more for the same amount of gas (within 3%) that we consumed when gas was under $1 per gallon.

Anyway, that’s more of a weekend topic, but it’s a holiday and you’ll be sending Exxon Mobil Corp. (NYSE:XOM) almost $10 in operating income every time you fill up your tank. So I figure it’s good to have something to think about - this is another topic you can forward to your Congressmen (including state and local) in our continuing series aimed at putting a stop to this nonsense. Keep in mind that CNBC Fast Money’s" Eric Bolling and other energy traders are licking their chops to get into the $400B water business, just another place where they can squeeze the life out of you by taking over a vital resource and then creating a series of "crises" to triple their profits.

Back home, we’ll be expecting a nice bounce at the very least as Asia did indeed hold up pretty well and Europe is turning up nicely this morning. If they’re going to dump the market, it will happen in the afternoon, when most of the traders go home. I’m sticking with my 50% retracement of yesterday’s drop and flat into the weekend prediction, though. It’s Tuesday I’m worried about, but we’ve already had a great week, cashed out tons of positions and remain very well hedged into the holiday travel weekend. So I'll be paying up at the pump with a smile on my face, knowing I got the money from VLO, Tesoro Corp. (NYSE:TSO) and XOM puts this week!



Day's Move

Must Hold

Comfort Zone

Break Out

Next Goal

Dow 13,441 -84 12,468 12,600 13,000 13,500
Transports 2,875 -50 2,825 2,900 3,000 3,250
S&P 1,507 -14 1,430 1,460 1,500 1,550
NYSE 9,812 -101 9,218 9,465 9,600 10,000
Nasdaq 2,537 -39 2,454 2,500 2,600 2,750
SOX 478 -7 477 490 500 560
Russell 823 -12 803 820 850 900
Hang Seng 20,520 -278 20,200 20,600 21,000 22,000
Nikkei 17,481 -215 17,400 17,500 18,300 18,500
BSE (India) 14,338 120 13,200 14,000 14,725 15,000
DAX 7,719 22 6,900 7,000 7,400 8,000
CAC 40 6,049 1 5,650 5,800 6,000 7,000
FTSE 6,561


6,325 6,450 6,600 7,000

US Markets

After all that we only added red boxes to the Dow, the Transports and the SOX, the same guys we’ve been worried about all rally. We did lose the FTSE, and that’s going to be the one to watch. Their close will have a big effect on our end of day positioning. Both the Hang Seng and the Nikkei slipped out of our "Comfort Zone" and that’s NOT GOOD, despite the "recovery."

Happy Trading and I agree that the SOX are where we hang our hat for the day and how they handle 475-485 will likely lead us for the next 10 days:

Click to Enlarge
Semiconductor - 3 Months - Daily

The Transports were our "canary in the coal mine" on Wednesday and we’ll be watching them too, but it’s up to oil to stay below $65 despite CNBC’s full-scale pumpfest. We’ll consider the SOX a slightly more independent indicator.

Oil finishing below $65 will be super bearish, and it was my plan all along to be shorting into this weekend (yesterday’s drop was a bonus) as our expectation is that it is unlikely that this weekend’s demand will meet inflated expectations and, even if it does, we should get a little "sell on the news" action.

The dollar continues to struggle at the 82.50 mark, but gold seemed to jump the gun and dove to $650 yesterday. I expect both of them to finish fairly flat into the weekend.

Oil and Dollar

Have an excellent holiday!

- Phil