The following is a reprint of the market commentary from the November edition of The Option Advisor, published on Oct. 24. For more information or to subscribe to The Option Advisor, click here.
As regular readers of these commentaries well know, I am a big fan of determining "price levels of interest" as a prerequisite for success in options trading. You simply cannot be a successful options trader without a well-constructed price forecast for the underlying security, as well as a specific time frame during which you expect this price forecast to be achieved. Without a price forecast within a time frame, you have no idea which strike to select, how much time to buy, or whether a particular month and strike is too richly priced for the reward achieved to be worth the risk, even if your price forecast proves correct. And without price forecasts that are intelligently constructed, you are simply rolling the dice or flipping a coin when you trade.
Since most options traders look to purchase time that's measured in days and weeks (as opposed to months and years), the so-called fundamentals of the stock must by definition take a distant back seat to technical factors (such as moving averages and levels of chart support and resistance) in developing this price forecast. And I have very often found that some deceptively simple price levels -- such as those derived from round number year-to-date gains and round number price levels of all sorts -- can provide very effective roadmaps that can help explain past price movement and serve as a framework for developing a price forecast for the weeks ahead.
For example, stocks and market indices often encounter price hesitation or "congestion" at round number price levels (such as $70.00) for a number of logical reasons. Traders will often target overhead round number levels for at least initial profit taking on rallies. And the fact that activity in call and put options is most often the heaviest at round number strike prices (as measured by the open interest levels at these strikes) adds further to the "congestion," as adjustments by those holding (or hedging) options positions often have a tendency to create mean-reverting movement toward the strike price. And while technicians who trade options usually focus on short-term indicators to match their abbreviated time horizon, by so doing they can miss out on some very significant long-term phenomena that can come into play over the short term. For example, rallies will often hesitate at multiples of a previous low and market declines at fractions of a previous high. Common areas of hesitation would include twice the most recent major low (or half the most recent high), but higher multiples and lesser fractions (sometimes as small as 10%) can also come into play.
With this serving as our background, let's take a look at the road maps for some of the major worldwide market indices. (Charts courtesy of Google Finance, click to enlarge.)
KOSPI Composite Index (Korea) – Note on the accompanying chart the significance throughout 2013 of the round number 2,000 level. And for the most part this year, there have been just minor deviations from 2,000 and from the 2012 KOSPI closing level of 1,997. This market recently reached a new 2013 high, but it is still less than 3% above its 2012 close and the odds probably favor a return to the top of this year's range. But the follow-through from a breakout (above, say, the +10% year-to-date level at 2,196) could be huge.
S&P BSE SENSEX (India) – The trading range pattern this year of the SENSEX has been very similar to that of the KOSPI – just substitute 20,000 for 2,000 as the major level of interest. Note the October rally to 2013 highs has thus far fallen short of the +10% year-to-date level, and a breakout above this level (at 21,368) could lead to impressive additional gains.
Euro Stoxx 50 (Europe) – The accompanying 30-minute chart depicts the battle by STOXX to claim the "turf" above the round number at 3,000. The STOXX is also grappling with the +15% year-to-date level at 3,021. Often when there are two separate key levels within close proximity, the difficulty in surmounting them is compounded (see my S&P 500 comments below).
Nikkei 225 (Japan) – Note the "spike" rally in May briefly exceeded the +50% year-to-date level at 15,593, but then did an abrupt (and huge) about-face 58 points shy of the round number 16,000. And since July, resistance has developed at round number 15,000.
PowerShares QQQ Trust (QQQ) – I inserted into the accompanying chart the +20% and +25% year-to-date levels for QQQ to illustrate how QQQ has taken out these potential "speed bumps" and quickly retested them before resuming its rally. I consider this price behavior to be quite bullish. The most recent retest for QQQ actually occurred on Wednesday of this week, with QQQ at its lows holding above $81.41 (representing +25% year-to-date). Also shown is the fact that the recent QQQ high was 20 cents shy of $83.10 -- twice the major QQQ low established in May 2010 at $41.55.
iShares MSCI Emerging Markets Index (EEM) – The so-called emerging markets have been very weak this year compared to the major U.S. markets. And there can be no better illustration of this year's struggle than the failure of the EEM rally this week just shy of its 2012 closing price of $44.35, as well as the fact that EEM rallies terminated at similar levels in March and May. The inability of a stock or an index to move into positive territory on a year-to-date basis in the midst of a strong overall market environment is always troubling, and should be a major consideration before taking any form of bullish stance.
Dow Jones Industrial Average (DJIA) – The DJIA has landed on 15,500 as its round number resistance level of choice this year instead of the "rounder" 15,000 level. Note also from the accompanying chart that the DJIA high so far this year fell 16 points shy of the +20% year-to-date level at 15,725.
S&P 500 Index (SPX) – As was pointed out in my STOXX discussion above, an overhead area that contains more than one level of interest can be especially difficult to overcome, and this was the case for the S&P until just recently. Note that the S&P struggled for months at the 1,700 round number level, quite likely because yet another level of interest -- 1,712, representing the +20% year-to-date level -- lurked in that same vicinity.
The Case for Big Moves in IWM and QQQ
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