A number of CallWriter.com members are long Amazon (AMZN) and short November calls and are feeling a bit trapped due to the stock’s bottle-rocket takeoff. Obviously, we have to be prepared to sell the stock when covered calls are written, because these things happen. What these members are experiencing is the regret that arises from thinking about all the money being “left on the table.” But it frequently is not left on the table.

One member, short the NOV 90 Calls, wrote to ask how to handle this situation. For those of you living just a little too far back in the deep woods, AMZN announced great earnings a few days ago. The stock gapped nearly $18 on October 23rd to open at $111.05 from all the orders piling up before the open. It has since hit a high over $125 and has pulled back to about $120 as I write this. The chart is the final authority, though. Note on the chart below the huge gap on 10/23, then the meteoric rise after that. Note also the spiking and then disappearing volume, and the exploding MACD.

Amazon looks to me as though it has to come down.

1) Notice that it has made a huge gap up from the 20-day moving average, which it will likely pull back to fill.

2) The trading after the gap is classic witch hat, meaning sharply up on just a few (two, in this case) candles, back down the same way.

3) This event happened on earnings, and the euphoria will burn off once all the buyers are in, which may already have happened. AMZN was thought to be a hot buy below $90; is it still? This is not Apple we’re talking about.

This price action does not appear sustainable, and my money is on the witch hat.

Naked Puts

If you had a naked put on before the 10/23 gap, you should close it, if you have not already done so. This locks in about as much profit as the position can produce and frees your cash for other action. If you wrote a naked put after the gap, CLOSE it. Your situation is not going to improve from here on out if my assessment above is correct.

Covered Calls

If you react to the price move – say, by rolling up, buying calls or buying a vertical call spread, all bullish modifications – you increase your capital committed to the stock, especially by rolling up. Rolling from the 90 Calls to the 120 calls would add over $30 to trade basis. Adding more than a few percent to your cost basis is almost never a good idea, and it’s no better an idea to chase a price spike like this one.

Make any of these mods and you become a bettor, betting the stock rises further. All three mods, in order to work, require the stock to keep rising. If it falls you would be hurt; and hurt badly, if you have rolled up and increased cost basis. When a stock delivers this kind of shock to a covered call writer, it is better to wait and get your bearings.

If you don’t want to lose the stock as expiration approaches, you can always roll the calls out to the next month and see if time and tide cures the problem. I will be very surprised if AMZN holds where it is for very long.

Yesterday’s post early afternoon suggested that we are at a resistance level and that the market will pull back to test the lower trend line or even its 50-day average. Today I’m no more bullish. I offer into evidence the following:

1) Last Thursday, the INDU touched the upper trend line, followed by small congestion candles, after a nice run up. The market usually stalls at this point.

2) Yesterday was lousy, and yesterday’s open was almost the same as Monday’s close. If there was any strength there, it would have opened higher than Monday’s close.

3) The INDU opened low this morning, below yesterday’s close - and yesterday was a down day, too, remember. In fact, the market opened today below Monday’s close, also.

4) The market shot up briefly today to a higher level than yesterday, but intraday highs on a bad day like this only mark a high point in irony… what might have been.

5) In candlestick analysis (see the free chart school on Stockcharts.com for lessons on this), Monday’s white candle was important. In order to continue the trend, even briefly, the market needed to break above it and not below it. Although it doesn’t look much like much of a candidate for an engulfing candle, it’s all we had.

Okay, the little devil on my left shoulder whispers that the market could come back after just a couple of punk days. But the problem isn’t just yesterday and today, but the context. Look at the second week of August for an example of the market topping at the upper trend line and coming back - but that comeback lasted only two days.

Covered Calls

My thoughts for covered call writers in yesterday’s “futile” post still stands. If we are wrong to close positions now and the market rockets right on up, we’ll have taken a loss for nothing. If the market does pull back to support, we’ll feel kind of silly to ride it down.

We always want to trade WITH the market, because any other approach makes less sense. But because we are neither psychic nor in possession of tomorrow’s newspaper, the timing of trade entries and adjustments inevitably involves making educated guesses. You have to ask yourself: what are the odds favoring now?

We can’t always be right. We’ll misjudge weakness and have a stock collapse on us that we could have gotten out of. Or we underestimate strength and get out at a needless loss. These things WILL happen. But that just means our timing was off. Once we have a feel for direction after being wrong, we know when to ride the bronc again (with the market), and those can be some of the best profits.

As far as I’m concerned, the current market action is the rattler’s rattle.

Well, the old market is at resistance again. It made a nice run up after bouncing off the 50-day average. However, it hit the upper trend line on Thursday of last week and has been inching up the trend line hand-over-hand ever since. When this happens, it has tended to signal another down-leg in the trend. Here’s a daily chart from about 1:40p ET today:

The market could break higher, but the 10,000 mark is a choke point, and I expect another run down to test the bottom of the trend line.

Interestingly, the tech indices - Nasdaq 100 and Nasdaq Composite - are showing even less strength, after having shown more strength than the INDU and SPX since March.

Yes, the market could be making a head-fake preparatory to a fresh advance. But these crux points are not a good point to buy stock.

Covered Calls

This is not a time to be putting on covered call positions. The market has to break higher before justifying a long stock position. Advances and declines since March of this year have tended to be of short duration, just a few weeks. My approach this year has been to trade with the market, getting in at support points and writing OTM calls. Please don’t ever feel as though you just have to find a trade at any point in time. Like a sniper, pick your shots.

If the market does pull back, then wait until it finds SUPPORT at the lower trend line or 50-day average before putting on any more positions. Higher-than-normal volume on the INDU (and your stock) at the lower trend line will be a signal for a new advance.

If you have open positions, be prepared to close them if the market starts pulling back and get back into the stock when SUPPORT is found - let the market do the lifting.

We just had a CallWriter members’ trading lab conference last night and I talked (among other things) about how the market needs to break conclusively above 10,000 in order to keep the 2009 uptrend intact. Well, the DOW’s close at 10,015 today was a good start, because the even-thousand numbers are very important, whether the index is northbound or southbound.

In fact, the DOW closed just 10 points south of the day’s high today. Very nice, but we need to see more of this action. One close above resistance doth not a continuation make. The daily chart below indicates how the index stuttered at the 9,830 resistance level yesterday and Monday, then made a strong upmove for a close above resistance today.

The weekly chart below shows the strong 2009 trend since early March. It took about 3.5 months to get the June/July correction. At some point we can expect another correction of equal or greater magnitude, though the recent pullback should have bled off some steam. Notice also how the upper and lower trend lines are converging toward each other,

The same thing is of course happening with the SPX and NDX.

I intend to give the market a day or two - at least - of time to consolidate before writing any calls, since I like to write with the market. We may see some irrational exuberance now, but many don’t believe the DOW can stick above resistance. There may be a little more stuttering before the market moves up, assuming it can live in the above-10,000 stratosphere.

My plan upon confirmation of the break in resistance will be to pick strong stocks off CallWriter’s Global Select list that are following the market (or even stronger) and write OTM calls. This allows a very profitable close early - if the stock moves up as expected - due to the OTM call’s low delta.

There certainly is no shortage of opinion about whither the market! I have CNBC on all day in the background, which is mostly useless - it’s for news. I certainly wouldn’t make any judgment calls about the market from any of the commentary featured.

It is interesting how some of the biggest email-based promoters differ. For example, one commentator is breathless about China. Another also breathlessly extols China and points out how they are buying up raw materials, and then in the bottom part of the same email says China is an ecological nightmare (true) and has stopped buying raw materials. So which is it?

This last pundit, whose name rhymes with Dick Young, also says the dollar is a dead duck and warns of an impending crisis of such immense proportions we will be nostalgic for the Great Depression - but don’t worry, his time-tested stock picking strategies will save us. Well, the dollar is in deep doo for a number of reasons, probably unfixable. But it’s the only dollar we have. Who else’s currency would you rather have? Brazil’s? The Euro?

He makes the coming crisis sound like the Zombie apocalypse so beloved by Hollywood. But, if this crisis is imminently upon us, should we be buying stocks? Maybe items like guns, ammo, water, non-perishable food would be more practical. I don’t have anything against fear-based marketing, but come on. If American ever turns into the dog-eat-dog apocalypse world of the old movie Escape from New York, I’m guessing stocks will be the last thing on our mind. (Honey, there are armed and hungry men outside, I think they want our stocks…)

Jon Markman, on the other hand, points to some more upbeat facts. Domestically, housing sales are up 7.2% and new housing sales even higher, unemployment has peaked at 9.8% just missing the magic 10, corporate profits are up 24% in the first six months of this year and durable goods orders are up 4.9% month over month. Internationally, industrial production and manufacturing numbers are up in Singapore, the Philipines, Spain, Germany, Japan the UK and in many other countries.

But the trend does not care about pundit predictions. The thing we must remember is that trends remain intact until they end. And until it clearly ends, you play the trend.

The major indices recently rebounded beginning on October 5th. My philosophy is to write covered calls with the market. When the market is pulling back, I tend to close open positions - so I can repurchase the stock lower and ride the rip. I don’t usually write calls on market pullbacks.

However, the market has to reach higher highs to keep the trend intact. For example, the DOW recently hit an intraday high of 9,917.99. We have to move above this high to keep the uptrend intact. The DOW closed at 9,786 today. Breaking through this might not be pretty, but if it does, this trend may last a while.