Everyone is aware that on January 20th, the market generally went into a swoon. This is no big deal from my perspective, and here’s why. Markets have to retrace periodically. After a period of uncorrected up (down) movement, the market periodically retraces some of the gain (decline) from the last correction bottom (top). The market shot up after the March 9. 2009 low and then corrected in June and early July.

Since that correction, the market had a solid advance without a serious correction. Note that movement within a trading range does not constitute a retracement. Real retracements (extensions, in the case of a downtrend) tend to give back 38, 50 or 62% of the uncorrected rise. On February 5th, the S&P came within 1 point of a 38% retracement, but the Dow didn’t come nearly so close.

So the question is, do traders believe the correction is over? In late January and early February the market advanced, only to sell of again. That brief advance clearly was a bear flag.

What about the latest advance off the February 5th bottom? It looks much like another bear flag, with lots of hammer candlesticks indicating sell-offs during the day and a close close to the day’s high. Today’s price action (1:45pm ET) as I write this is a large white candle on a daily chart peeking above (but just barely) the 20-day and 100-day everages.

On a weekly chart, the INDU and SPX both appear to be bouncing off the 100-week average on rising volume.

Today’s action seems to have moved higher than we would expect from a bear flag, so we may have seen the end of the retracement. I’m not putting on any trades today, because I view the market as being on a knife’s edge. I want to see a couple of solid closes above the 100-day average.

It is a well-known fact that when a large, heavily traded company sells off for an extended period, a rebound usually is in the offing. I found a number of such potential candidates on our Real-Time Lists of the highest-returning covered call trades, and will share them with you here.

MOS/POT/AGU - all are testing the 100-day or 200-day (POT) average. POT reports earnings today, AGU on February 9th, MOS in April.

X - Steel has sold off like a runaway freight train. It does not make money, but technically may be ready for a heady (and not long-lasting) turnaround. It next reports earnings in April.

NEM - Newmont is oversold at a 30 RSI and accumulation is turning up. It is hanging on to the 200-day average and testing the 50-week average, but had huge climax volume on this test of major support. NEM reports on 2/25, after February expiration.

Confirmation would make these good for naked puts, also. Since we want to stay diversified, one should write only one of the MOS/POT/AGU group.

I caution that, since we make no wine before its time, confirmation of price recovery is necessary. I may very well play some of these with OTM covered call writes for February, but I want to see some recovery, and the market doldrums are pulling most things down. OTM writes give me low delta and enables a profitable close if the stock snaps back as expected. I can’t say I expect turnarounds in these just yet. We wait for turnaround confirmation in case they want to look for new lows.

I didn’t like the looks of this market top yesterday and closed my remaining open position in Philip Morris (PM), for a 1.5% profit, better than a sharp stick in the eye. I’m at a 3.5% return on covered call trades for the month, not great but not bad.

The market has risen in its trading range since early November, rather sluggishly except for a couple of large candles, and may have topped out. I will be on the road to Tampa this afternoon when the market closes, and may not have a chance to blog further on the subject today.

The market has sold off this morning, although it rose steadily on a 5-minute chart from 11:00 to 12:30 ET, and now is tipping over again as I write this. The Dow Jones Industrials daily chart below shows how the market has been ranging. The red rectangles illustrate how the market has tended to congest at the top of the trading range:

But maybe not this time. If I had positions open, I would probably see how today goes and make a decision tomorrow. If today closes positive, that is a good sign for a little longer stay at the top of the range. If it closes down but not by much, that also is good, because the bears couldn’t keep the pressure on. If the market is close to the low later in the trading day, it might make sense to exit, but then tomorrow might be an up day, which is why I usually wait for confirmation.

If the market closes close to the low and opens weak tomorrow, I would get out, and look for a re-entry once support is reached within a couple of weeks, which will lower cost basis and set up a really nice profit. This works best with top-quality stocks, however.

Boy, this up-cycle in the range didn’t take long to unfold, and one reason is that the range is narrowing. Those who wrote ITM calls in early November are of course in much better shape, which is one reason they write them!

The market has been moving up from its late-November lows, as I foretold in previous posts. In retrospect, I was too conservative. And I am usually not that conservative. In fact, I usually get in once the market touches the bottom of its range on volume and starts to move back up - into stocks doing the same.

However, the market had broken out of its primary range in late October and tested the 50-day average. This made me want a little more confirmation that the market was in fact climbing back into that range. Too conservative.

Entering trades on Friday, November 6th would have been much smarter. And I would be in great profit. I put on several trades last week, and closed two today. I legged in to all three, meaning I intended to write calls higher, but closed instead. Here are the results:

11/9 - Bought Smith Int. (SII) @ 29.37, closed today 30.89, 700 shares
Profit: 1.52 (5.2%) $1,064

11/10 - Bought Caterpillar (CAT) @ 58.55, closed today 60.81, 400 shares
Profit: 2.26 (3.8%) $904

11/10 - Bought Philip Morris (PM) @ 49.66, , 500 shares, trade still open. Will close this week when profit sweetens up.

Had I written calls, the premium would have been negligible, and the profit much smaller due to buying back the calls. And so close to expiration, OTM calls are really losing time value - so every day the stock stutters is more loss of time value.

My trading-with-the-market approach works pretty well. It isn’t flawless, but when do covered calls make more sense than when the market is rising?

More on the market tomorrow.

The markets closed strongly today - well, not the inverse ETFs, chuckle. Today should be confirmation for even the most timid soul (me) that the market is in a new up leg after bouncing off support last week. Actually, today would have been a lovely time to enter covered call and naked put positions. For that matter, Friday would have been, also.

There always is this tension: get in when the market trend is the fattest (close to support), or get in with more confirmation once the rally back up into the trading range has “proven” itself. The former can yield more profits, the latter is somewhat more conservative.

I put on a trade in QQQQ again, both long stock and “other”. The CC trade was a purchase at 43.14; I would have liked to sell the NOV 46C, but the premium was pennies. So I legged in. I will either write calls at a higher level or simply close when an acceptable profit is presented. A 3% (raw) return suffices, but I will, ahem, accept more.

OTM is better, because the calls’ low delta makes an early close possible and very profitable. Getting a 5-10% raw return in doing so is not difficult. An ATM write works well and could be closed early, also, but the higher delta makes it tougher, and the return less. ITM should work well, too. Note that November expiration (21st) likely will come a little before the market and many stocks top out at the upper trend (range) line.

Great time for naked puts, too. Try to write a strike below the 20-MA, or if the stock is not above the 20-MA, below the 50-MA. Leave enough room that a typical (for the stock) wide-ranging day will not stop you out of the trade.

WHAT TO TRADE?

There are stocks that bottomed a little bit ahead of the market, with it and behind it. Those ahead of the market I will not touch, because I want a little more travel left in it. Here are some November trades that I like, all of which I would write either OTM or leg in:

SII Smith International - has broken back above the 50-MA, low premium, leg in
PM Philip Morris - has broken back above 20 and 50-MA, low premium, leg in
CAT Caterpillar - ATM 60, 2.8%, has broken back above 20 and 50-MA
BTU Peabody Energy - ITM 44, 2.9%, has broken back above 20 and 50-MA

There are others. Baker Hughes (BHI) just broke above the 50-MA today, well behind the market, and could also be a good trade in the next day or so. I found these by sorting for MADI, looking for stocks 00:00 or better, then doing a secondary sort for flat return.

These stocks came off our Global Select (Dividends) list, and none of these have earnings coming before expiration on November 21st.

I would set a stop, or mental stop, below the 50-day average - preferably below the lowest late-October close. We don’t want to be stopped out too soon on a wide-ranging day.

Good luck.

I’m writing this from the road, heading for this weekend’s seminar venue. The market continues stuttering. Yesterday was a big day up for the Dow Jones Industrials and saw it close both back into its trading range and above the 20-day moving average. Other major indices also had a good day yesterday, if not quite so strong.

Today, jobless claims first went over 10%. And since we all know the real jobless rate is much higher, this has seriously dampened today’s action - which should have been a great day.

I put on a long call trade in the QQQQ yesterday for fun, just 30 contracts, and closed it today for a 51.6% profit. Not a lot of money, but a nice return. As I write this the Dow is up 12, the Nasdaq Composite is up 5 and the SPX is up a measly 1. Best case is a positive close above yesterday’s close.

I am not putting on any covered call trades today. I want to see what Monday brings. But if the market continues stuttering, I have some trades in my back pocket of companies that lately have been strong despite the market’s pullback in the second half of October. Yes, they are out there. (Hint: I find them on our lists by sorting the list by our proprietary MADI indicator)

I hate making this post, but it must be done. After being up nearly 150 points today, the Dow Jones Industrial averages settled back for a close at 9802, just 30 points above yesterday. Other indices are looking as bad or worse: SPX, COMPX, NDX, RUT.

Chart 1 below of a few weeks of action on the S&P 500 illustrates my concern. Last Friday the market had a huge down day, the one marked on my chart as “engulfing candle?“.

Usually, a huge red candle like Friday’s after a several-weeks pullback signals a possible reversal in the opposite direction (North). But engulfing is as engulfing does. For that hoped-for reversal to happen, a series of rising white (positive candles) would be needed. The close of one of those white candles above the top of the engulfing candle would be the money candle! Note what happened at the August, September and November lows in the uptrend: engulfing candles followed by a series of up candles (the market went up):

Now, let’s turn attention to the three candles following Friday’s big red. Two advancing candles and then the long shadow. Today’s candle made a very long upper shadow than fell back to close almost at the day’s open, which indicates weakness. This could very likely be the “shooting star” pattern, which is bearish. These often show at the end of a move up. Is two white candles in a row enough of a move up to call this 3-candle pattern a shooting star?

We’ll soon know.

I don’t trade these candlestick patterns. I’m just trying to size what up is happening. I don’t know what’s next, anymore than you do, but price and volume are all we have.

Covered Calls and Naked Puts

Candlestick analysis is by no means foolproof. To paraphrase Ebeneezer Scrooge, they show us what may be, not what will be. But for now, unless and until we see more up candles and a close above Friday’s big red (which could also be a close above the 20-day moving average and back into the primary trend), there will be no entry signal for those who trade with the market.

Do not put on a covered call or naked put position now. Even if you are eyeing a stock that sneers at the market, its behavior could change if the market heads south.

Following up recent posts about the very real possibility that the market may be about to reverse to the upside, here is another Dow Jones Industrials chart from today, 11/3/09. Compare today’s green-circled price action to that of the retracement bottom in July:

A positive day today would have been lovely, but look at the resolution of the last touch of the major trend line, in July. Similar, wot?

So, another indecisive day… but notice that the DOW opened a just a couple points under yesterday’s positive close. And despite struggling all day, the market closed almost back at the open. Yesterday closed at 9,789, today’s open was 9,787 (I said a couple points) and today’s close was 9,771, almost 9,772. That’s 17 points off yesterday’s close. This little chart helps you see today’s bar better:

Covered Calls

If you are waiting, like me, to hammer some covered calls when the tide turns, the time is not quite yet. Keep watching. Remember, confirmation would be a close inside the primary trend, a little over 9900.

The market broke out of its primary trend last week and has declined to test both the 50-day moving average and lower (major) trend line. However, look at the last few reversals to the upside. You will notice that - except in late August, each time the market showed us a large red candle (down day), followed by an indeterminate candle, the market found support and headed north.

By “indeterminate” candle, I mean a small candle that indicated that neither the bulls nor bears had control. In late August, the candle was white, an up day, as it was TODAY. This could indicate that the market is finding support and ready to break back into its trend.

More evidence? Every time the CBOE Sentiment Indicator (VIX) has hit 30 or close to it, it has heralded an upside reversal. This happened in early July (33.05) and the beginnings of September (29.57) and October (29.56) The VIX today hit 30.70, its highest level since its July high.

Despite all the Aunt-Pitty-Pat handwringing on CNBC (remember, Aunt Pitty Pat collapsed and needed smelling salts in Gone with the Wind), it looks like the market could be about to recover back into its primary trading range.

Covered Calls

If this happens it will be a great time to write OTM calls, closing them early for a profit. How much profit? Well, how about 60% to 80% of the maximum possible profit if called out? Obviously, the stock should be reversing to the upside with the market.

For more information on this, please see our list help pages, particular on CallWriter’s proprietary indicators.

Our entry signal will be another white candle and a fall in the VIX to below the 27 level. At some point the market will make a serious retracement (see earlier posts), but if THIS IS NOT IT, then let’s make hay while the sun shines. Don’t jump the gun, though.

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.