P&F Trend Indicator Simulation

-Last week, I recommended buying Jul 120/110 put spread on NFLX for $4.10, just on the basis that the P&F Trend Indicator changed from 1 to -1. Based on experience, I have utilized this indicator as a signal that the stock price is likely to move away from the price level at the time of the signal. On Jun 21, NFLX stock was around $118.77 at time of my post, and it is now $112.65 at this moment. That July 120/110 put spread is worth $5.55, or 35.4% return in one week. So, P&F Trend Indicator has been profitable in this instance.

-I decided to run another simulation separate from the Relative Value Simulation (that utilizes the Estimated Future Volatility Indicator to look for undervalued/overvalued options) I began yesterday .

-The new simulation based on P&F Trend Indicator is looking to: 1) gauge the reliability and profitability of the indicator towards either stock or options strategy purchasing either the at-the-money straddle/strangle or selling the at-the-money butterfly, 2) assess the possibility of utilizing the indicator as part of Dispersion strategy, wherein I purchase options of stocks that have changes in the P&F Trend Indicator, while simultaneously selling options on an index, in this case SPY.

-I have selected 7 stocks to observe, A, GCI, HIG, HON, ISRG, MET, PCLN. For each of these stocks, the P&F Trend Indicator changed as of yesterday's closing prices. The options prices were derived using market prices as of this morning.

Options Relative Volatility Simulation

- I have made adjustments to my TEMA Chart & Indicators. Most notably, I substituted volatility #2 indicator with my "Estimated Future Volatility" indicator. The EFV indicator can be utilized for many purposes. Mainly, 1) the trend of the EFV indicator signifies whether volatility in the underlying is increasing or decreasing, 2) EFV can be compared to the implied volatility of the options on the underlying, and perhaps could be used to determine which are undervalued/overvalued.

- The latter is a work-in-progress. I have begun a simulation choosing 10 stocks out of the top 40, whose options implied volatility are below the EFV value, and 10 stocks out of bottom 40, whose options implied volatility are above EFV value.

- I have disregarded certain drug stocks or stocks with big upcoming events and tried to diversify the list of stocks among differing sectors. I also plan to add/remove these stocks as their EFV value and Implied Volatility Values change. I do not know how this simulation is going to turn out, but I will share it with you on a weekly basis. My hope is that EFV indicator could be useful when utilized as a tool within a Relative Value Arbitrage portfolio.

Volatility High. VIX>30, SPY IV 27

- Stock market is testing previous lows again. Due to terrible housing sales data, SPY has fallen below what I thought would be the lower level of the new trading range I set last week 108.4 - 115.3. But when I draw short-term trend lines, I see that 107 & 104.75 are next support levels.

- VIX has risen above 30 again and IV on the SPY has risen to 27. My model estimating future volatility trend, on the otherhand, has continued to decline. Not that this has not happened before over very short duration, but the way I read it, the market is pricing in high volatility (usually associated with the market falling rapidly, which assumes that SPY will fall below previous significant support level of 104.75 ), while my model is reflecting that whether the market rises or falls, the volatility of the movement would not be so high.

- Sovereign debt concerns in Europe are not new. The Euro vs Dollar has stabilized. Unless market is expecting really bad news from G20 or the financial reform bill or terrible US economic news next week, I would think that implied volatility in front month options are overvalued. I would look to see whether 107 or 104.75 support levels hold, then look to sell front month options next week. We shall see.

Lumber Liquidators as Play on Housing Weakness

- Existing and new home sales numbers for May were extremely weak. Home Depot stock appears to have broken down from its bullish channel. I expect Lumber Liquidator's stock (LL) should follow. Homebuilders (XHB), & building materials stocks (AWI, USG, etc.) all have fallen 20 - 30% from their recent highs, as well. I do not see why LL stock has shown such relative strength.

- Implied Volatility on Aug options are slightly high, but I expect IV to rise once LL stock also breaks below its bullish channel support line. I recommend buying Aug 25/20 put spread for $1.40 or better. For more sophisticated investors, I would buy XHB and sell LL as a long/short strategy to seek alpha.

NFLX Sell Signal?

-NFLX fell 5.9% yesterday to close at 118.99 without any significant news. The stock drop may have been due to simple profits taking on overbought situation. It seems foolish to be bearish on NFLX on just technical sell signal, but CSTR, another high flying stock of late is breaking down, again without any negative news reported.
- Whenever P&F Indicator changes, it's a signal that the stock price is likely to move away from the current price and/or stock price may show high intraday volatility within the next several days. There are a few ways to play this indicator. I could buy July $120 straddle and scalp gamma or bet on a call or put spread buying $120 call/put and selling either higher strike call/lower strike put, depending on your view of probable short-term direction of the stock.
- Volatility in July is a bit high, especially considering the July 4th holiday weekend, but if NFLX price drops below $114.7, we could see a stock price drop to $105 easily, again purely on technical stock price movement.
-I recommend buying the July 120/110 put spread for $4.10 or under, current stock price is $118.77 and spread mid market is around $4.0.

Market Undercurrents Changing Fast

- As a follow up to last Friday's posting, today I have included some other companies that have significant business exposure to the state of Florida and SouthEast Region in general. No way of knowing to what extent oil floating ashore would damage this regions economy, but fears are only growing...

- I woke up this morning and heard the news about China allowing its currency to appreciate against the dollar. I immediately thought stocks of basic materials and other commoditiy stocks would rise, CLF, RTP, AA, FCX. Then I heard Meredith Whitney talk on CNBC about a possibility of a double-dip in housing slowing economic recovery in the U.S. Homebuilder stocks as reflected by SPDR S&P Homebulders ETF (XHB) have been one of the weakest sectors falling from high of $20 on April 26, to its current price of $15.92 and has shown relative weakness during the current rebound in the overall market. I quickly came to awareness that the market environment has turned 180 degrees from beginning of May.

- Throughout the market correction, fears of relative economic weakness in Europe and China with hopes of continued strength in the U.S. dominated. Now, I believe these fears and hopes are reversing, where fears of economic weakness is with the U.S. and hopes of continued economic strength is with China and other BRIC countries. As for Europe vs. U.S., equity prices have discounted the fears in Europe, I am not sure if stock prices are yet discounting the fears of U.S. economic slowdown.

-If market currents have indeed reversed, then expect to see relative strength in commodities, global industrials and global tech companies, relative weakness in retail, homebuilders, financials & stocks of companies predominantly geared towards U.S. economy.

Secondary/Tertiary Plays on BP Oil Spill (ALGT)

- Fears of potential economic disaster caused by the BP oil spill are growing. There are reports of widespread cancellation in hotel reservations along Florida's west coast. You tube has a video showing simulation of the projected path of the oil spill

http://www.youtube.com/watch?v=aeTie2CWHJ8.

- Stocks of BP, APC and other oil service names, whether directly or indirectly affected have already plunged. I believe secondary and tertiary stocks that could be affected by the oil spill are beginning to fall, as well.

- I am looking at stocks of Tourism, SouthEast Regional Banks & REITs that are likely to fall further as fears of economic calamity grows, particularly in Florida. Spirit Airlines came to my mind immediately, but it is not a public company.

- Looking at Regional Airlines, I noticed Allegiant Travel Company (ALGT). Allegiant provides complete vacation packages to vacationers from small cities to major destinations in the US. Unfortunately, 5 of the top 12 destinations are in Florida and Myrtle Beach, SC. Furthermore, management gave a bullish presentation at the Bank of America Merrill Lynch Global Transportation Conference on June 15, but investors are driving the stock price down anyways.

- Options on ALGT are illiquid and the bid/ask spread wide, so it would be difficult to put on an options trade. I do not know if ALGT is easy to borrow for shorting, but the stock price looks weak and looks likely to continue it's fall. First price target is $37.50 with stop/loss at $51.70. The stock is currently $46.11, and I would look to short ALGT as stock rebounds.

FSLR Upgrade to Outperform by Credit Suisse

- I alluded to FSLR as a speculative Buy back on June 3 although the timing was a bit early. I was getting alerts past couple of days in my model that FSLR could potentially move. Today, Credit Suisse was reported to have upgraded FSLR to outperform from hold.

-The technical picture of FSLR and underlying currents within the stock market agrees with Credit Suisse's upgrade, and if they are right on their fundamental call, I see FSLR going up to $155 after next earnings announcement scheduled July 29.

-FSLR, however, has come up from its recent low of $100.19 to current price at time of this post to $124.14. That's already a significant rise in very short time, so it would be difficult to put on a bullish trade at this very moment. I would look to buy FSLR under $120 with a stop/loss of $114 up until and before earnings announcement. Another good position would be selling the July 125/115 put spread for $3.80 or higher and selling the July 135/140 call spread for $1.10 or higher (collect $4.90 or higher on this slightly bullish spread). This position would make money if FSLR stock price closes between $120.2 and $139.80 with maximum gain of $4.90 between stock prices $125 and $135 and maximum loss of $5.10 if stock price stays below $120.1 by July 16. This trade assumes that the overall market is not going to fall below 105 in SPY level, volatility of FSLR will come in and the stock price of FSLR will trend up steadily to around $135 in the next 5 weeks.

FDX Earnings Conference Call

-FDX continues to see strength in international load volumes, still seeing double digit growth in Europe, and things are not bad as some people portray them. They are forecasting 3.3% US & 3.1% global economic growth. FedEx projects earnings to be $0.85 to $1.05 per diluted share in the first quarter and $4.40 to $5.00 per diluted share for fiscal 2011. This guidance assumes the current market outlook for fuel prices and a continued moderate recovery in the global economy. Their below consensus EPS forecast for FY 2011 was due to anticipated higher employee costs.
-Based on FDX management's outlook, I believe that fears of global economic downturn is overblown and as these fears continue to subside, stocks that are leveraged to "the very large trend of emergence of middle classes in India, China, and Brazil" should continue to perform well.
-As for FDX, I do not expect the stock price to fall below the recent low of $76 based on management's bullish outlook. Assuming FDX stock price not to go below $76 and rise slowly for the next few months, I would buy the Oct. 80 calls, sell 2 Oct.90 calls and buy Oct 95 calls (1x2x1 spread). At current prices, this could be done for $3.32. Maximum loss on this position is $332 for 1 spread if FDX stock price remains below $80 with maximum gain $668 if FDX closes at $90 on Oct 15.

Technical Snapshot of SPY

-Overall market has seen a strong rebound from SPY level of 105 to close at 112.0 today. Although expected, the speed of the rebound has been much stronger than I had thought several days ago.

-Two indicators of fear, VIX & the strength of the US Dollar have both come down considerably, as indicated by my volatility chart on SPY and price of UUP (ETF that seeks to track the price and yield performance of the US Dollar against major currencies).

-I still feel as though it is too early to turn bullish on the overall market, but I am adjusting the trading range going forward to 108.4 to 115.3 from 105 to 111. SPY 112.0 is right at the middle of my expected trading range. Furthermore, according to my model, implied volatility, that has fallen to current levels (23 in SPY) is no longer overvalued. Market chaos equates to market opportunity, but that chaotic energy has dissipated. At current levels, I do not have a strong bias to direction of the overall market, either in price or volatility. Finding trading strategies that produce quick profits would be difficult for the time being, but I will still try to find individual stock names for you.

Few Stocks Ready to Move in a Range-Bound Market

- The overall market rebounded last week, and as of this morning, SPY was near its resistance level of 111.0. I still believe the market will continue to move in a trading range until mid July (3Q earnings season), even though the upper/lower levels of the trading range may differ from the current 105 - 111.
-In range bound markets, only a few cluster of stocks or sectors show strong trends. Even during the violent market fall over the past several weeks, few individual stocks are at or near their most recent highs. CRM, NFLX, AAPL, many REITs, LVS, auto parts stocks, CMG, etc.
-I mentioned the Natural Gas sector as having potential to move up in the next several weeks. Many Natural Gas plays are on this list. These companies also drill and explore for oil, but much of that is land-based (not offshore based) drilling. There are also many ADRs on this list, which makes sense if we assume that the strongest economic growth will remain with China, Brazil, & India.
-But the common factors among all these stocks are that each is at or above both their 50 & 200-day moving averages. Furthermore, each stock's price has been moving within a range for the past 6 months or longer. I also looked at Volume by Price indicator on Weekly charts, provided by http://stockcharts.com/h-sc/ui?s=CHL&p=W&b=5&g=0&id=p32746176393 When a stock starts to move away from the price range it has recorded the most volume, it tends to meet relatively little resistance to moving much higher (or possibly lower) before it settles down at a new price range.

Clues To Fundamentals Next Week, FDX & PX Charts

- The overall market is trading within a range, SPY level 105-110. Volatility is still very high, but has been slowly coming in since beginning of May. FedEx Corp. (FDX) Q4 earnings announcement is scheduled June 16, and what they say may give some clues to the overall strength of the global economy...and perhaps future market direction.

- Praxair Inc. (PX) is an industrial gas supplier that serves about 25 industries globally. Sales during 1Q 2010 within Europe comprised just 13.9% and marginal growth comes from Asia and South America. The CEO is scheduled to discuss Praxair's growth strategy and business outlook during William Blair's 30th Annual Growth Stock Conference on June 15. I would be very interested to hear what he says, given global economic uncertainty and currency fluctuations, and to see how the stock price reacts.

-Perhaps the news will have little affect on the stock price, but I am looking at PX because my analysis (in this case timing) tools alerted me to PX as a stock that has potential to move in the near future. PX is not a stock that hedge funds play with. It is held by long-term focused funds, and I do not believe they are exiting. The price range between $74-$79 has shown the greatest volume, but if PX stock price starts to fall below, it would likely be due to selling by these long-term investors.

-I believe the explosive rise and decline in the market since February has been due to short-term, hot money chasing quick returns. What happens going forward the next several weeks will be determined by more longer-term focused money. If PX stock goes up, that would be a positive sign for the overall market.

Estimating Future Volatility Direction with TEMA Indicators

- All options traders want to know future volatility. All options pricing models try to estimate future volatility. Firms invest millions in the latest high-tech supercomputers and pay a battalion of PhDs that use GARCH, multivariate regression, neural network models, etc. to estimate future volatility. Why? Because if you knew or can accurately estimate what future volatility would be, then you could determine if current implied volatility of options (hence current options prices) is too low or too high. You could buy/sell undervalued/overvalued options and make billions of dollars.
- Well, I am highly analytical, but I am no scientist. And I cannot predict what future volatility would be. But I do have options trading experience, some expertise in technical analysis, and a good sense of what direction future volatility is likely to be.
- Most options traders dismiss technical analysis as alchemy. I do not blame them because most of technical analysis (i.e. chart pattern reading, fibonacci, etc.) you hear often about is worthless. Heck, many so called technical analysis experts do not even know how to draw trendlines properly. But there are simple but very powerful tools in technical analysis that you could use as a guide, rules of thumb. You live your life that way, why would you not incorporate guides to your trading and investing?
- Jeffery Owen Katz, Ph.D. writes in his oft read book ("Advanced Option Pricing Models...", McGraw Hill); "Future volatility is also affected by the location of a stock's price relative to its moving average, by the slope of the moving average,...by where the current price lies with respect to recent highs and lows,..." Well that reads to me that technical analysis could be very useful to estimating future volatility!
- The graph above shows the weighted average of implied volatility for SPY (taken from LiveVolPro) since the beginning of 2010. I also graphed the estimated future volatility calculated by using my indicators shown on TEMA charts. My estimated future volatility is determined by a function of Volatility 2 Indicator,Volatility 1 Indicator, and the Linear Regression Indicator. What I see is that my future volatility estimates often turn higher/lower before it is reflected in the trend of implied volatility!
- I need to do more analysis on other stocks and for longer time periods to make a more definitive conclusion. But I am sharing this with you now because I feel strongly that TEMA charts and indicators are fundamentally sound when used as a guide. At least, I hope to educate and bring about greater awareness to equity/options traders....

Charts of Basic Materials Stocks, AA,CLF,FCX,RTP

- The overall market found support once again at around SPY level 105 yesterday. We are seeing a technical rebound, and as I expected, basic materials sector is leading the rebound. This sector has been beaten down hard by confluence of fears; 1) European Economic collapse and 2) Chinese economy's hardlanding. The strength/weakness of the US dollar/Euro has been the telltale signal reflecting the level of these fears. UUP is an ETF that follows the strength of the US dollar, and its price fell yesterday and is down today as well at the time of this post.

- Looking at the charts on 4 basic materials stocks, AA, CLF, FCX, RTP, I see that the short-term price trend has been extremely bearish. As prices of each of these stocks are rebounding, I would expect bearish traders to short these stocks once each stock price rebounds to the top of each channel trend lines. But I am a long-term bull on the basic materials sector. http://www.miningweekly.com/article/demand-for-iron-ore-copper-to-double-in-15-years-rio-tinto-2010-05-26 The CEO of Rio Tinto on Wednesday, May 26, stated that demand for iron-ore, aluminum and copper to double over the next 15 years. That averages out to 4.75% growth in demand per year, which is not out of this world, but nevertheless represents a secular growth story.

- Relatively speaking, CLF chart shows the most strength, then RTP, then AA, then FCX. The reason is that while FCX stock prices have seen lower lows, CLF stock prices are showing higher lows. I would not doubt, that if these stocks continue to rebound, CLF would be the first to break out of the current extremely bearish trend. I would keep watch on these stocks over the next few weeks, confirm that they have broken out of the extremely bearish trend, and look for opportunities to accumulate these stocks when prices dip.

Chart of UNG & SWN

- Natural Gas is the only sector that is looking bullish right now. The oil spill catastrophe, offshore oil drilling moratorium, & growing government support of the "Pickens Plan" (greatly increasing tax incentives for natural gas vehicles) are all fundamental factors that are making natural gas and natural gas sector stocks more attractive.
- Furthermore, the price trend of Natural Gas, as reflected by UNG (a natural gas fund ETF that tries to mirror changes in percentage terms of the natural gas spot prices using natural gas futures), has shown that the fundamental factors driving the prices of natural gas are very unrelated to the fundamental factors driving the overall stock market, which is good because the overall market is very weak right now. And also, that price of UNG is about to breakout of its long-term bear market.
- There are many ways to play natural gas. You could go long UNG which is currently $8.19 with stop/loss of $7.40 or buy the Oct 8/10 call spread (buy Oct. 8 call $1.09 and sell Oct. 10 call for $0.42). I still like SWN as a play on natural gas, I believe SWN is taking a pause around it's 200-day moving average before breaking upwards.

Chart of AMZN

sorry for delayed post today, my blogger service was having technical difficulties...

- According to news reports early this morning, Goldman Sachs added AMZN to its Conviction Buy List. I do not have a strong view on AMZN, but I thought it would be worthwhile to take a look at the technical picture of AMZN. Especially in light of the fact that Goldman put U.S. Steel (X) in its Conviction Buy List (reported by Briefing.com on morning of May 13 with previous day close of $55.03) and downgraded to a Buy (on June 4, Briefing.com, previous close $45.28) just days later. I guess their conviction was not that strong....

- What I immediately see is the wide, but rising channel lines with support around $119 level. If the overall market were in just a correction within a bull market, I would say now would be a great time to put on a Long trade at around the current price of $122 with stop/loss point at $114.0. Although I don't show it in this chart, the 200-day MA level is around $120. But is now the right time to BUY AMZN?

- SPY and QQQQ, ETFs that represent the S&P500 and the Nasdaq-100 indices closed at 105.49 and 44.27, respectively. These levels are right at the support levels of trading ranges that I described in previous posts. And I would not be surprised if we see a technical bounce this week. But the tug-of-war continues, between investors betting on a global economic downturn and others betting on continued recovery and relative health of the U.S. economy, but with the former showing greater strength.

- Below the surface, I see a pattern commonly used by hedge funds as a long/short strategy. They are selling aggressively Basic Materials such as FCX & X and other stocks that are negatively affected by the strong dollar, and buying U.S. domestic economy related stocks which are less affected by the strong dollar, such as CRM, SLG, HD, & perhaps AMZN, etc. This would explain why stocks in the former category are well under their 200-day moving average, while the latter category stocks are above their 200-day moving average.

- Given this observation, I believe that this long/short strategy will eventually reverse itself, meaning that the beaten down stocks like FCX & X would outperform in a market that stabilizes, and/or the relatively stable stocks will fall more rapidly in a market that continues to fall going forward.

- So going back to AMZN, I believe right now is not the right time to buy AMZN. But if Goldman is right about the fundamentals of this company, then perhaps after the July 4th holiday would be a better time to look at AMZN.

Explanation of TEMA Charts

This is a chart of CLF. The top indicator is Linear Regression which shows the short-term trend in stock prices. I use 12-day LR with a 12-day Moving Average. Why 12 & 12? Front month options (the most liquid) expire each and every month, and gamma scalping and position hedging by options traders dominate the marginal liquidity of each stock that has options.

The Point & Figure Trend also reflects the short term trend, although this indicator seems more reliable not to pointing out the future direction of prices, but rather to indicate that prices are likely to move away from the current price. Buying at-the-money straddle in options, whenever this indicator changes could be a good strategy.

The second and third indicators are volatility indicators that I use to determine whether a stock is moving or not moving (whether prices are trending or range bound). These indicators have a leading component in that often a jump in volatility from low levels forecasts a change in the established trend. They can also be used to forecast short-term future volatility in stocks, thus helpful in estimating whether implied volatility in options are overvalued/undervalued. Finally, I use trend lines to show the short-term trend or range and where the support and resistance levels are.

Daily QQQQ chart

Negative news from Hungary and less than expected job gains have pushed US markets lower to start the morning. The tug of war between fears of European economic troubles and China slowdown mixed with hopes of continued economic recovery in the U.S. plays out. Here is how QQQQ daily Chart looks. Technology stocks have been very strong relative to the beating commodity and oil services stocks have been taking. It is a matter of time before we break up or down from this current trading range...

For today, 46.16 level is significant because it is where MA support/resistance lies on the weekly chart for QQQQ. 108.4 -109.0 level is significant in SPY because it would give a signal of how weak the overall market is likely to be going forward...

Technical Snapshot of SPY, SWN

Overall market is stabilizing, with support around 105 and resistance defined by falling trend line, which is right now around 112. Volatility indicators are slowly falling. Expect SPY to move within decreasing triangle until economic fundamentals give a clearer picture. Few technology stocks remain strong, CRM hitting new highs today. SWN seems to have broken out to the upside. Look for strength in few alternative energy names due to fallout from oil spill tragedy. FSLR seems to be speculative buy with tight stop.