Our index indicators are giving bullish to neutral readings, a downgrade from last week’s bullish readings. Most prominent in the ratings change is the continuing weakening of our internal indicators. The 200-day Moving Averages Index remains bearish, and the Advance/Decline Index and Cumulative Volume Index are both bullish to neutral. Also, seven of nine S&P sector funds are now bullish. While that’s still a healthy percentage, it is one fewer than a week ago and it means a slight change in our options strategy.
Although our internal indicators are weakening, the indexes remain in primary bullish trends, but just barely. As we’ve mentioned, the index’s 50-day moving averages represent the first line of defense, and they are now under pressure. The Dow has fallen to its 50-day average of 15,730. The S&P 500 remains above its average of 1,765, and the Nasdaq is also above its 3,935 average. Also, over the past year, the indexes have fallen below those averages on three or four occasions and then recovered, so breaching this first line of defense would not mean the bull market has ended.
Interestingly, what appears to be hurting stocks the most right now, aside from the profit taking that should be expected at this time of year, is the recent budget agreement made in Congress. This agreement seems to have cemented in options traders’ minds the idea that the Fed will begin tapering its bond purchases sooner rather than later, and interest rates will rise as a result. While we believe that other hurdles must still be overcome — primarily the effects of the new health care law — before tapering becomes a reality, it is what the market believes that counts.
Along those lines, long-term iShares 20+ Year Treasury Bond (TLT) continued to fall over the past week (bond prices move in the opposite direction of interest rates), and TLT is again threatening to break below key support at $102. While this has been the case since August, and that support has thus far held strong, it is becoming just a matter of time before it breaks. And a break could be the start of a steady decline to the $96 area, which in turn would raise serious questions as to how much of a rise in rates the economy and stock market can withstand.
With our indicators showing signs of weakness, options traders should look toward balancing bullish and bearish positions. That primarily means buying more put options to balance your current long stock and call positions.
My system has uncovered a bearish opportunity to play put options in a small-cap software name with a high likelihood of downside profit: Ixia (XXIA). Buy the XXIA Feb 12.50 Puts at $1.00 or lower. After entry, take profits if XXIA stock price hits $11.20 or the options price hits $1.70. Exit if XXIA stock price closes above $13.20 or the options price hits $0.70.
I should also note that my system has deemed several other software stocks as short-term and mid-term bearish including Microsoft (MSFT), CA Technologies (CA), and NetApp (NTAP) but it did not uncover any under-priced options in these names as it did with XXIA.
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