AU Editorial: Gold Shining Again?

By Tom Scollon, Optionetics.com.au
On 11:05 am EST, Friday November 6, 2009

Gold is back in the headlines again with India's purchase of 200 tons of gold being regarded as newsworthy.

Forever the cynic, I always reckon when financial markets hit the headlines it is time to do the opposite. Journalists are always able to find someone to give them an outlandish quote and one this week was that gold would head to US$2000 an oz. Well, maybe. Which year, which decade, which millennia? Why not US$5000? Both are equally crazy.

True, gold may be a safe haven for those who have serious doubts about the US's ability to manage its budget, its deficit and just about any other indicator you can think of in the coming few years. You wonder when it will all hit the fan. 'Trillion' was a word we used as kids when we really wanted to be very silly and off the planet. But now it is real. It is an oft-used word in US economic parlance.

But let's see what the charts say as they speak no evil - well" not much:

Chart 1

click here to enlarge

This simple line chart with Elliott suggests a couple of scenarios. Firstly it points to the possibility that for the time being gold is just about there. That is, there is not huge upside from here for the foreseeable. That is what the 'grayed' 5 is saying.

The other scenario is that it could head to about $1120/1180 in the coming months. Some may ask "how useful is that?" Well, no software or indicator can be any more definitive. It is all about probabilities.

With commodities, I especially like to look at the big picture and for this I use a weekly:

Chart 2

click here to enlarge

And this says, yes, we may see US$1200 or US$1300, but it could be a while away and in any case we may well see a decent pullback along the way.

Great for the traders as all that traders want is plenty of movement - either way.

So we have movement - and that is enough 'shining' for the months ahead.

Enjoy the ride

Tom Scollon
Chief Analyst
Trading Tutors Team

finance.yahoo.com

Platinum Tools: Hedges and the Correlation Analyzer

By Clare White
On 1:04 pm EST, Thursday November 5, 2009

Platinum provides users with quick access to a security correlation tool which can help traders in a few ways. This article focuses on assessing the extent of diversification in a portfolio and if it makes sense to look at a broad index exchange traded fund [ETF] to hedge portions of the portfolio. This tool is available in the Stock Rankers section.

Correlations

Correlation is a statistical measure, in this instance supplying information about movement between two pairs of securities. It provides both the magnitude and direction of movement, for securities which include individual issues (i.e. a stock) or baskets of securities taken together (i.e. an index or portfolio). It’s important to note that correlation data provides expected movements and is not causal.

When considering stock/ETF movement, returns are used to take advantage of a normal distribution that generally emerges from this data. Correlation values range from -1 to +1, with +1 indicating a perfect positive relationship and -1 indicating a perfect negative relationship. In other words, if a pair of securities has a +1 correlation, a 5% move upward in one means the trader would expect a 5% upward move in the other.

When extreme movements in the overall market occur, you may find stocks rising or falling together. While this can occur on both the upside and the downside, there are bearish periods that can result in strong positive correlations across the board. For instance correlations that include market data from last fall will skew pairs towards a +1 correlation due to the movement occurring over that period.

Proxy ETFs

The three main broad index ETFs associated with the US stock market include:

1. DIA: Diamonds Trust, for the Dow Jones Industrial AverageSM
2. SPY: Standard & Poor’s [S&P] Depository Receipts for the S&P 500® Index
3. QQQQ: PowerShares QQQ Trust NASDAQ-100® Index

While correlations across all three of these are strongly positive using daily and weekly data over a variety of timeframes, the recent bear market has slightly weakened QQQQs relationship with DIA and SPY. This is due to index construction which excludes financial stocks; names that were particularly volatile over the period. It’s helpful to consider such market conditions when assessing your results.

Applying the Correlation Analyzer

Using the List Tools menu, create two new lists which include the following securities:

1. Names in the portfolio you wish to hedge using a proxy ETF (Portfolio List)
2. DIA, SPY and QQQQ (ETF Proxy List)

If you’re uncertain as to whether you include a specific stock in the hedge, add it to the Portfolio list. ProfitSource users can transfer a folder of portfolio names into Platinum to create their list.

Go to the Correlation Analyzer from the Stock Rankers menu and select your Portfolio List and ETF Proxy list for analysis. To obtain correlations for the last year’s worth of trading, select 250 for the Correlation Days Length. Allow the analyzer to use the default Daily Rate of Return data.

Select Run and review the table of results which provides the correlation for each name in the portfolio list with each of the three ETF proxies. You can also cut and paste the data to a spreadsheet for analysis.

Values of +0.80 or higher indicate a strong positive, correlation while those with a value of -0.80 or lower indicate a strong negative, correlation. If the correlation values exceed +0.90 or are less than -0.90, the respective relationship is consider very strong. As a slight aside, when the analyzer was run before the close of trading on 11/3/09, the last 250 days of trading resulted in a strong positive correlation between both DIA & SPY (+0.98) and QQQQ & SPY (+0.94).

Diversification

When the value between a pair of securities is close to zero, they are considered not correlated. There is no relationship between the movement of one and that of the other in statistical terms. In portfolio diversification, investors seek to combine non-correlated securities or negatively correlated securities so that declines in one can be off-set by advances in the other. In a two security portfolio of non-correlated securities, the effect of losses in one security may or may not be dampened by the movement in the other.

The main goal of the correlation analysis is to identify securities that are positively correlated to the ETF proxies. This will allow the trader to hedge a group of stocks using options for a liquid ETF, rather than having to hedge all of the individual names separately. This assumes that the trader does not have a delta neutral focus since the hedge will be approximate rather than more precise.

Using the +0.80, strong positive level as a cut-off, consider which securities can be included in the ETF proxy hedge. The individual can decide if they wish to use more or less stringent criteria given their preference for a less or more precise hedge (lower correlations will likely lead to less precise hedge).

A sample portfolio is used in this portfolio to test two different hedge approaches long with a “no hedge” approach. The stock list or sample portfolio I use is based on names that have recently appeared in LiveTrade case studies and represent a random group. The names and techniques provided here are not recommendations. Remember that portfolio selection and decision-making is a very personal thing and if you feel uncomfortable with your current holdings, take some time when the markets are closed to assess this separately. Create active management plan that will get you to the appropriate portfolio as a starting point.

Portfolio Correlations

Figure 1 provides the correlations for each stock/ETF in the sample portfolio versus each of the three ETF proxies using daily returns for the last 250 days. The first column (List 1 Stocks) provides the portfolio stocks. Note that SPY is also a security in the sample portfolio.

Figure 1: Sample Portfolio with ETF Proxy Correlations (250 days of Daily Returns)

To gain a sense of the diversification that already exists in the portfolio, Figure 2 displays a test of the correlation of daily returns (250 days) for each security versus the other securities in the portfolio. Using the +0.80 threshold to identify a strong positive correlation, you can see that there is only one security pair that meets this criteria (EBAY-SPY @ +0.795).

Figure 2: Sample Portfolio with Paired Correlations (250 days of Daily Returns)

Given only one security pair in ten with a strong positive correlation, there is some inherent diversification built into the portfolio which should result in losses realized by one security to be dampened by smaller losses in another.

Hedge Approaches

Five different portfolios will be tracked on a weekly basis for the next four weeks. These include three that are hedged and two that are not hedged. They include:

1. SPY plus SPY put hedge
2. Sample Portfolio with SPY put hedge for strong positively correlated securities
3. (Remaining securities hedged with individual puts)
4. Sample Portfolio with SPY put hedge corresponding to security correlation
5. SPY alone
6. Sample Portfolio with no hedge

Since the focus is a comparison of different hedge approaches the portfolio values will vary to start. Results will be compared from changes in each portfolio. Jan 2010 options are available for each of the portfolio securities, so this month is used for the hedge. Portfolios 2 & 3 use a delta neutral hedge when the individual security’s put is used and the security’s correlation to SPY when SPY is used. No adjustments are made to the hedge during the holding period (11/3 – 11/27).

An example of using the security’s correlation to SPY, consider Portfolio 2. The only security that will be hedged with SPY is EBAY, with a strong positive correlation of +0.80. As a result, the SPY put requires -180 deltas to hedge both SPY and EBAY (100 + 80). Portfolio 3 will use each security’s correlation to add to the SPY hedge; these values can readily be reviewed using the last row in Figure 2 (=393 deltas).

Figure 3: Hedged Portfolios

The goal of using SPY puts to hedge as much as the portfolio as possible is to reduce costs from slippage and commission. If all it accomplishes is reducing costs, while providing in inadequate hedge, it’s not worth the savings. A midterm update will be posted to my discussion boards on November 17th.

Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site

finance.yahoo.com

Option Watch: November 4 Cisco Earnings Central

By Chris Tyler
On 7:38 am EST, Wednesday November 4, 2009

If there's one name this week which holds the promise of finding investors either uniformly celebrating or "sell-e-brating", it's likely Cisco (CSCO). The NASDAQ 100 component and world's largest network communications concern is reporting after the close Wednesday evening. Analysts expect the company to report profits of $0.31 per share.

The consensus view is down about 25% from the year ago period's levels. More important, traders will be keen to hear management's outlook going forward. Typically, Cisco's market / business heft can yield strong clues regarding overall IT business spending.

However, overall investor reaction to Cisco's report might be a bit more subdued this time out. According to Barron's The Striking Price, analysts at Goldman wouldn't be surprised to see a more positive outlook for 2010. But slighter end customer demand for enterprise networking equipment versus other tech hardware, should put a lid on shares near-term.

"You've come a long way baby." Taking a look at the weekly price chart shown below in Figure 1 and this strategist agrees with Goldie about limited upside. Technically, shares of CSCO have completed a Fib-based two-step (AB = CD) pattern. Looking at potential Fibonacci, trend and gap support for a spot where profit-taking or outright disappointment would find likely support, the $20.50 - $20.60 and roughly 10% below Tuesday's close, looks interesting.

Figure 1: Cisco (CSCO) Weekly Two Step Complete

Analysts at Goldman go on to suggest selling the Nov 23 put / 25 call strangle based on what they anticipate to be a tempered reaction to Cisco's report, as well as front month implieds at a fairly decent premium to actual historical or statistical volatility. Shown below is a visualization of that interpretation using a comparison of front month implieds relative to both short and longer-term movements in the stock.

Figure 2: Cisco (CSCO) 7-30 Day IV / SV

Compared to the short-term 10-Day SV and 100 reading, November implieds are priced theoretically rich by about 50%. The 6 and 20 day comps also suggest a pricey situation with levels overvalued by about 25% to 70%. As much and seeing in the same chart how pre-report and bid situations in CSCO options do translate into a typical volatility crush, a drop of 30% to 40% and closer but still above statistical volatility is anticipated.

On the other hand or of a different mind, this strategist doesn't think selling the strangle is the best candidate for Cisco. What's been left out thus far are the actual historical levels of statistical volatility in shares, as well as implieds. Both look quite similar on the two year chart, so I've taken the liberty of pulling up the SV view in Figure 3.

Figure 3: Cisco (CSCO) Statistical Volatility

Easily visible on the Cisco SV chart of the past two years is how far volatility has pulled back in and is now just off its lows. That's not unique of course, as more names than not find themselves in similar "Monbacky!" situations. As well, volatility can keep trending lower, at least up to a certain point and as past incidents of single digits in the VIX are a fleeting reminder.

Despite what's just been said however and without making any "recs or wrecks", I don't see the short strangle as optimistically as Mr. Market does. Instead and with the likes of heavyweight peers Amazon (AMZN), Microsoft (MSFT), First Solar (FSLR) and Baidu.com (BIDU) all having overcompensated for option bids in front of their reports, I'm giving some weight to another trend that's ultimately enjoyed a good run in the real world.

Chris Tyler
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

finance.yahoo.com

Morning Watch, Nov. 3

By Jody Osborne
On 6:30 am EST, Tuesday November 3, 2009

Mega acquisition by Berkshire Hathaway not enough to push stocks higher Tuesday. Normally, merger activity provides a positive tone, but negative comments about the chip sector at Morgan Stanley and disappointing earnings from UBS (UBS) have left stocks lower. Overseas markets are also lower with markets in Europe suffering from a decline in bank stocks.

Overall, traders are a bit cautious ahead of the FOMC statement Wednesday and the always important jobs report on Friday.

Warren Buffet made a huge statement about his belief in an economic recovery. Mr. Buffet’s Berskshire Hathaway (BRK.B) will purchase railroad Burlington Northern (BNI) for $44 billion. The deal values BNI shares at $100, which will be paid in cash and Berkshire shares. BNI shares are up nearly 30 percent on the news with BRK.B shares up 1.5 percent to a price above $3,300. Berkshire’s board also its approval to split the “B” shares 50-to-1. This move is a big bet by the world’s most renowned investor, so it says a lot about his view of the future.

Unfortunately, the chip sector, another very important sector of the economy, is seeing declines this morning. Morgan Stanley cut Intel (INTC) shares to “Equal-Weight” from “Overweight” and lowered the entire sector to “Cautious” from “Attractive.” Morgan is concerned about rising inventory levels. Intel shares are down about two percent with the Semiconductor HOLDRs (SMH) also off two percent.

UBS shares are off nearly 7 percent after the bank announced disappointing earnings results in the quarter. This news was a surprise given the strength seen in European competitors Credit Suisse (CS) and Deutsche Bank (DB) when they reported. Nonetheless, CS shares are down nearly 3 percent with DB off 4 percent. Financials in the U.S. are suffering as well with the Financial Select Sector SPDR (XLF) down 1.5 percent in early trading.

Johnson & Johnson (JNJ) announced a restructuring plan this morning that will result in the loss of 7,000 jobs globally. The move is expected to save the company nearly a billion dollars in 2010. JNJ shares are higher on the news, up nearly one percent, to a price near $60. JNJ shares have not been able to participate in the gains this past year with the stock sporting a three percent loss in the past 52-weeks.

Economic news Tuesday isn’t as heavy, though traders are interested in the motor vehicle sales report. Ford (F) reported stronger than expected results this week and the hope is that auto sales will show strength after seeing weakness in September following end of the “cash for clunkers” program. Traders did get good news about same-store sales this past week with both the Goldman/ICSC report and the Redbook release showing strength. The FOMC began its two-day meeting this morning and this will culminate in a statement from the committee Wednesday afternoon.

Jody Osborne
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

finance.yahoo.com

Swing Trading: Adding More Time

By Tim Walker, Optionetics.com.au
On 9:49 am EST, Monday November 2, 2009

A few weeks ago an example was given of taking a time frame of 360 days and dividing it into increments of 30 days. Why take 360 days as a time frame? Why divide it into 30-day increments? The answers lie in WD Gann's basic view of markets and what were the motive forces that powered them. Gann believed in the old dictum that 'history repeats' and that 'what has been in the past will be again.' You may even have heard the expression 'there is nothing new under the Sun.'

Another way of saying this is that markets move in cycles, and that these cycles repeat periodically. David Bowden often said that a circle and a cycle were the same thing; it was only the spelling that was different. If we think of a circle, it is measured as a cycle of 360 degrees. This is why we use the number 360 for our count of days.

We saw on Santos how projecting time frames of 30 days forward gave indications of dates to watch for turns in the market, whether minor or major. Let us now extend this analysis to another time frame. If you go back over previous articles in this series where we have talked about resistance cards in Price, you will notice that prices are divided into eighths - 12.5%, 25%, 37.5%, 50%, and so on.

So let's try our resistance card in Time using divisions of one-eighth. This would give increments of 45 days. In this case the starting point is the all-time high of 20.63 in Santos, which occurred on 3 June 2008. In this case, since we have come more than 360 days from this top, the counts are extended beyond 360. You could say we have moved into the second circle.

Chart 1 - Day Counts from June 2008 High

click here to enlarge

Once again I have labeled the dates of significant turns that occurred around these dates. The exact projected dates are listed at the bottom at the vertical lines, enabling you to know in advance which dates to watch. The top of 1 September was exactly 90 days from the all-time high, and the big plunge fell into a low on 17 October, which was 1 day before the projected turn on 18 October.

Most of these projected dates saw a turn within 1 or 2 days. A few were 3 or 4 days out, but only one, on 29 May, failed to produce any turn. In the case of the 9 July low, the projected date was 4 days later, on the 13th, which actually produced the first higher swing bottom. If you search back earlier in this series you will be able to add this indication to the other reasons for a reversal around this time.

I encourage you to have a play with these techniques. I know from some feedback I have received that some of you have made some exciting discoveries through being stimulated to look at the markets from a different perspective.

Knowledge is Power!

Tim Walker
Trading Tutors Team

finance.yahoo.com

Volatility Alert: Fear Soars as Stocks Lose Ground on Economic Worries

By Jody Osborne
On 5:00 pm EST, Sunday November 1, 2009

Week and month end negatively as traders take profits following huge gains since the March lows. The Dow (^DJI) fell.259.45 points, or 2.60 percent, to close the week at 9,712.73. The S&P 500 (^SPX) lost 43.41 points, or 4.02 percent, to 1,036.19. The Nasdaq (^IXIC) gave up 109.36 points, or 5.08 percent, to 2,045.11. For the month, the Dow was flat, but the SPX fell 1.98 percent and the Naz lost 3.64 percent.

Economic news this past week was mixed with earnings reports continuing to exceed expectations. Nonetheless, the bears took control of stocks, pushing the SPX and Nasdaq down this past month for the first time since February. There have been signs that the economy is not in a recession any longer, but weakness in the jobs market continues to be the major concern for traders. This means that the coming week could be very important, given the fact the October employment data is set for release Friday and the FOMC meets to discuss the economy and monetary policy in the middle of the week.

The fear indices have risen sharply this past week with the CBOE Market Volatility Index (^VIX) up 37.81 percent to 30.69 and the Nasdaq Volatility Index (^VXN) rising 31.79 percent to 29.81. The VIX closed above 30 for the first time since July and VXN also testing this key resistance point. In fact, both fear indices have tested this area on a couple of previous session in the past few months, but have been unable to continue their bullish ways. Economic data this week will be the key as to whether fear continues to rise and stocks continue to decline. The fact is many traders have been waiting for another chance to get into the stock market and this might be the decline they are looking for.

HIGH VOLATILITY RANKING 10-30-09
SYMBOL	COMPANY
TEVA	Teva Pharmaceutical
GRMN	Garmin Ltd.
COCO	Corinthian College
LEAP	Leap Wireless International
PCLN	Priceline.com
STEC	Stec Inc.
MA	Mastercard Inc
IRE	Governor & Co Bank Ireland
CECO	Career Education Corp
SWKS	Skyworks

High Volatility: We discussed TEVA last week, but the stock is still showing a pattern that is conducive to using a butterfly trade. The stock has been trading between $49 and $53 for nearly three months. The company is set to report earnings on Tuesday and this is why IV is high on TEVA options. However, the stock entered its current trading range following its last earnings report. Volumes have been average, showing few clues that the company's report will provide information that will result in a large move in either direction in the near term.

LOW VOLATILITY RANKING 10-30-09
SYMBOL	COMPANY
SYMC	Symantec Corp
USO	United States Oil
MFE	Mcafee Inc
HAR	Harman International
VMED	Virgin Media Inc
DRE	Duke Realty Investment Inc
LINTA	Liberty Media Interactive
XL	XL Capital Ltd.
FNFG	First Niagara Financial Group
WYN	Wyndham Worldwide Corp

Low Volatility: Shares of MFE fell four percent on Friday after the computer security company reported its quarterly earnings. MFE announced that revenues in the quarter fell short of expectations, which led to large volumes and a lot of volatility in Friday's session. The stock did come off its lows Friday, but looks poised to move down to prior support near $38. Traders could take advantage of low IV on MFE options by entering a put that would best profit from this move. Other possible strategies to consider would be a directional butterfly. As is always the case, it is best to view the different risks graphs to see which strategy and set up would provide the best reward to risk ration.

Jody Osborne
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

finance.yahoo.com

Closing Wrap-Up, Oct. 30

By Jody Osborne
On 2:15 pm EDT, Friday October 30, 2009

Stocks see first monthly losses since February with weekly losses heavy as well. On Friday, the Dow (^DJI) gave up 249.85, or 2.51 percent, to a level of 9,712.73. The S&P 500 (^SPX) fell 29.92 points, or 2.81 percent, to 1,036.19. The Nasdaq (^IXIC) lost 52.44 points, or 2.50 percent, to 2,045.11. Volume was heavy on the session with the NYSE trading 1.65 billion shares and the Naz turning over 2.62 billion shares. Market breadth was negative on the session by a 4-to-27 and 5-to-22 margin on the Big Board and Naz respectively.

Third quarter earnings season got off to a good start, but traders have since decided to take profit. After rising for seven straight months, the major market indices suffered losses in October. The Dow did manage a flat month, but the SPX fell 1.98 percent with the Naz down 3.64 percent. This past week definitely went the bears way with the Dow off 2.60 percent; the SPX down 4.02 percent; and the Naz losing 5.08 percent.

On Thursday, stocks rallied sharply following a better than expected GDP reading for the third quarter. Friday saw the release of several economic reports, mostly better than expected, but traders still took profits heading into the weekend. Financials saw large losses with Bank of America (BAC) and JP Morgan (JPM) the biggest losers on the Dow.

Reports that Citigroup (C) may need to take another $10 billion in write-downs hurt the financial sector. Citi shares fell 5.1 percent with BAC off 7.31 percent and JPM losing 5.82 percent. Overall, the Financial Select Sector SPDR (XLF) gave up 4.68 percent to 14.05.

Consumer sentiment for October came in at 70.6 as measured by the Reuter’s/University of Michigan survey. This was better than expectations for a reading of 70.0, but down from September’s figure of 73.5. Though sentiment has come off its lows, consumers remained concerned about the jobs market. The Chicago PMI was also better than expected, rising to 54.2 in October from 46.1 in September. However, the employment component fell 5-tenths to 38.3. Next week traders will get two key reports with the ISM Mfg. Survey and Employment Situation report both on tap.

Oil stocks fell Friday thanks to falling crude prices and declines for Chevron (CVX) following its earnings release. Crude gave up almost four percent on the session to settle at $76.96, following the lead of the stock market. The commodity was also hurt by a stronger dollar against the euro. Shares of CVX fell 1.18 percent to $76.54 after the oil giant reported a 51 percent drop in profits. This news followed a disappointing earnings report from ExxonMobil (XOM) on Thursday.

Earnings will remain heavy next week, but the focus of traders will be on economic news. Besides the employment report, the FOMC will meet to discuss the economy and monetary policy. A rate change is not expected, but what the committee has to say about the state of the economy could have a major impact on stock prices.

Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

finance.yahoo.com