Trade of the Day: Electronic Arts (EA)

Try puts, as the market might show us a bearish turnaround

   

Stock indexes managed to bounce off key support at their 50-day moving averages and move higher Thursday. But amid ongoing global economic uncertainty, how many more times can those support levels hold?

More troubling is the action of our internal indicators, primarily the 200-day moving averages index. It has been tracking below its own 50-day moving average for a few months, at one time even dipping below its 200-day moving average. But stock prices continued to hold up. However, the indicator’s 50-day moving average has now fallen below the 200-day moving average, causing a primary sell signal. This signal last occurred in the summer of 2011, in front of a double-digit percentage drop by the stock indexes. It also happened in the summer of 2010, also ahead of a double-digit percentage decline in the indexes.

And unlike earlier this year, the increased weakness in the 200-day moving averages index is now accompanied by weakness in the Advance/Decline Index, which has fallen below its 50-day moving average. And volatility indexes are rising, generally a sign of increasing investor skittishness. On the upside, the Cumulative Volume Index remains bullish.

The primary reason for the skittishness remains the same as it has been, concern over the direction of interest rates, which has now spilled into the currency markets as well as stock markets. It is somewhat amusing to see investors worried over rising rates while global economies continue to struggle. Generally, struggling economies argue for lower interest rates. But it is an example of what can happen when central banks interfere too much with free markets. Logic can get out of whack. By the numbers, the long-term Treasury Bond Fund (TLT) is bearish and won’t begin to reverse that trend until it rises above $117. A bearish TLT means Treasury yields and interest rates in general are rising.

With our indicators continue to weaken, options players should continue to step up their use of bearish positions. That means buying more puts than calls.

Recommendation: Buy Electronic Arts (EA) September $20 put options at $1.20 or lower. After entry, take profits if the stock price hits $19.20 or the option price reaches $2.20. Exit if the stock price closes above $22.70 or the option price falls to 90 cents.

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