In This Issue:

Dear Momentum Options Subscriber,

Panic selling hit Wall Street at the start of last week, as the major averages tested their October 2014 lows. The Dow breached its October low before holding crucial support into Monday’s close, while the S&P 500, Nasdaq and Russell 2000 all held their respective October 2014 lows.

It was nearly a given that one last swoosh to the downside would come, but Monday’s 1,089 point drop in the Dow that happened in just five minutes was unpredictable. This was followed by a 500-point rebound in about 10 minutes, and there were numerous triple-digit swings afterward and into the close.

Tuesday offered some hope before a late-day fade kept traders on the sidelines. However, Wednesday and Thursday produced the biggest gains of the year, leading into Friday’s end-of-week battle between the bulls and bears.

The Dow dipped 11 points, or 0.1%, to end at 16,643 on Friday. The blue-chips struggled at the open before making a run into positive territory to 11,669 intraday. The 15-point gain fell shy of resistance at 16,700-16,800 and quickly faded afterwards. The bears pushed a low of 16,535 late in the day, with support at 16,400-16,350 easily holding. There is risk to 16,200-16,000 on a close below the latter.

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The S&P 500 added a point, or 0.1%, to settle at 1,988. The index opened lower at 1,986 before rebounding to reach a peak of 1,993 ahead of Wall Street’s lunch break. Resistance at 2,000-2,010 held firm before a back test to 1,975. Near-term support at 1,975-1,970 stuck like Chuck, but a close below the latter could lead to a retest of 1,960-1,940.

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The Nasdaq gained 15 points, or 0.3%, to close at 4,828. Tech was choppy throughout the session following a trip to 4,788 shortly after the open. Support at 4,800-4,750 was tested before the bulls pushed a high of 4,836. Short-term resistance at 4,850-4,900 and the 200-day moving average held. A close above 4,915-4,925 would be a bullish signal. A close below 4,700 could lead to a retest of 4,500 or lower.

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The Russell 2000 jumped 9 points, or 0.8%, to finish at 1,162. The small-caps showed the most strength on Friday following an early morning dip to 1,149. Near-term support at 1,150-1,140 was slightly tested before a rebound to 1,163. The close above 1,160 was bullish, but further resistance lies at 1,170-1,175.

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The S&P 500 Volatility Index ($VIX, 26.05, down 0.05) stayed elevated throughout the session, but it did trade down to 25.77 intraday. The bulls failed to get the VIX below 25, but they held 30 as the bears pushed 29.20 ahead of the closing bell. The final minutes of trading saw the VIX drop sharply lower and into negative territory, which offered some hope for this week. However, if the VIX clears 30 again, there will be further risk to 40-50. A close below 25 today would be a positive development, but the bulls can’t relax until the VIX gets back below 20.

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The Dow suffered the most technical damage during last week’s action, although the index closed with a 184-point gain for the week. Last Monday’s low reached 15,370 before the Dow closed at 15,871. The October 2014 bottom touched 15,855. Tuesday’s close at 15,666 breached this level before a quick recovery above the 16,200 level on Wednesday.

I was quick to point out the “death cross” on the Dow a few weeks ago, and last week’s development of the 50-day moving average closing below the 100-day moving average also looks bearish. A subsequent drop below 16,200-16,000 could lead to another selloff. It will be hard to trust the blue-chips until they can recover the 200-day moving average.

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The S&P 500 was up 18 points for the week. I talked about the index slipping into a death cross last Thursday morning. By Friday’s close, it was official, as the 50-day moving average settled a point below the 200-day moving average. It might be hard to correct this setup, as both moving averages are curling lower, with the 50-day moving average picking up steam.

The S&P’s low from last week reached 1,867 twice and may have formed a temporary “double bottom.” The index easily held the October 2014 low of 1,820. If the bulls fail to hold 1,867-1,865 going forward, 1,820-1,800 will likely be tested.

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The Nasdaq advanced 122 points last week. The bears scored a 414-point drop to 4,292 on Monday’s open, with the bulls recovering half of the losses and holding 4,500 into the close. The 50-day moving average is now below the 100-day moving average, which formed a mini death cross, and it is also spiraling lower. The October 2014 low on the Nasdaq reached 4,116, and any retest and close below 4,500 should be the clue to go short.

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For a potential trade, there are several put options to look at, if and when the 4,500 level cracks on the Nasdaq, to play a possible 400-500 point shellacking. The PowerShares QQQ Trust (QQQ, $105.62, down $0.02) tested a low of $84.74 on the Nasdaq’s dip to 4,292 last Monday.

The QQQ September 94 puts (QQQ150918P00094000, $0.49, down $0.05) are super cheap and can be used to play a breakdown to Chinatown. These options would be worth $10 if the QQQs test $84 by mid-September. The one caution I have with these options is that they expire in three weeks, and I often call this period of time the “danger zone” for options. If the QQQs stay above $94 by mid-September, these options will expire worthless.

The QQQ October 90 puts (QQQ151016P00090000, $0.80, up $0.03) offer another month of time premium and might be the “safer” trade. These options would be $6 “in the money” if the QQQs test $84 by mid-October, which would be, as Peter Lynch would say, a “7-bagger” from current levels. These options traded nearly 17,500 contracts on Friday, while the QQQ September 94 puts traded nearly 5,000 contracts.

On the flip side, if the Nasdaq clears 4,900-4,925 and the 200-day moving average, bullish traders could target QQQ call options.

If the QQQs can get past $107, the QQQ September 110 calls (QQQ150918C00110000, $0.72, down $0.02) could be used to play a possible run to $110 or higher and a move past the 50-day moving average.

The QQQ October 112 calls (QQQ151016C00112000, $0.96, up $0.04) are a little more expensive and represent a higher strike price than the QQQ September 110 calls. To break even on the trade, the QQQs would need to trade up to $113. The 52-week and July high for the QQQs reached $114.39. If $114 triggers by mid-October, the QQQ October 112 calls would be $2 “in the money,” which would mean a double from current levels.

As a potential strangle option trade, the QQQ October 112 calls and the QQQ October 90 puts would cost roughly $1.75 if purchased together. If the QQQs test $114 by mid-October, the trade would net a small gain and would double if $117.50 is reached.

If the QQQs trade down to $88, the aforementioned trade would make a decent gain, and it would double if the QQQs kiss $86.50 by mid-October.

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As far as the Russell 2000, the small-cap index added a 6-pack for the week, but it was also the weakest link. The index fell 5% on Monday’s open to a low of 1,105 while holding the 1,100 level. Tuesday’s close at 1,104 also looked like a short-term double bottom, with the small-caps regaining 5% by Friday’s close.

The Russell’s 50-day moving average is rapidly descending and is within 7 points of breaching its 200-day moving average. The October 2014 low on the Russell 2000 reached 1,040. It’s a good bet that if 1,100 fails, 1,040 will be tested. If so, it would represent a 10% pullback from current levels.

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The S&P 500 Volatility Index ($VIX, 26.05, down 0.05) finally woke up Wall Street following Monday’s trip to 53.29. The VIX gave the best clues that the action was going to get ugly, as I warned any closes above 20 could cause panic selling. The close at 19.14 on Aug. 20 was a big red flag, as the VIX closed at 28.09 the following session ahead of Monday’s open. The October 2014 high reached 31.06. If 31-32 trips this week, it would be a very bearish development.

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The zombies took a backseat to last week’s market turmoil, as most of the Fed heads gathered in Jackson Hole, Wyoming. The leader of the pack, Janet Yellen, wasn’t there, however. Of course, many of the Fed officials spoke throughout the week, as the debate to raise or not to raise interest rates continues.

In July, Yellen said that a rate hike this year would be appropriate, but she has been mum on the subject this month. Other members of the Fed now seem hesitant to raise rates given the recent market turmoil as well as China’s surprise decision to devalue its currency.

It has been nine years since the Fed has hiked rates, and the odds were high in July that one might come in September. I have said all year long that the Fed has been scared to hike rates, as many have feared a market correction would follow. With the slick-talking pros now begging the Fed to hold off on higher interest rates as a way to protect stock prices, they will likely get their wish. However, the market might still be in trouble even if it doesn’t raise interest rates.

The next few weeks will likely lead to more talking and debating before the zombies meet on Sept. 16 and 17. As a side note, the regular September options expire on Sept. 18, so volatility will likely stay elevated into the announcement.

The technical picture for the market and the major indices looks extremely bearish. At best, it appears as though the bulls might be able to continue a run towards the 200-day moving averages. It would be hard to imagine a break and continued rally above these levels, but anything is possible. However, with Washington D.C. and a vacationing Wall Street coming back in September, along with the Fed’s decision on interest rates, the bears are licking their chops.

I will be covering the updated 10-year charts from the Feb. 23 Pre-Market Update next weekend, as I get an extra day to work and relax thanks to the U.S. Labor Day market holiday on Sept. 7.

As another side note, I mentioned in February that a close below 17,000 on the Dow, a close below 2,000 on the S&P, a close below 4,500 on the Nasdaq and a close below 1,100 on the Russell 2000 would all be bearish signals.

The Dow fell below 17,000 on Aug. 19, while the S&P 500 dropped below 2,000 two sessions later. Last week, the Nasdaq fell below 4,500 to 4,272, but it held this level in back-to-back sessions. As far as the small-caps, they held 1,100 for three-straight sessions last week. These were slightly bullish signals in an otherwise bearish week.

The usual mindset is that you can only make money when the stock market is trading higher. A lot of investors don’t know how to make money when the market is crashing. I was one of them when I first starting investing my own money over two decades ago. I didn’t know how to play a market crash and most people don’t know you can sell a stock short at a high price (or at the current price), and then buy it back at a lower price.

In other words, if a stock is at $20 and you think it is going to $15, you have the ability to “short” it. Of course, you protect yourself if shares move against you by getting out of the stock, or by buying it back, if it clears $25. This is called “covering.”

Investors can also use put options if the technical outlook matches a continued decline in the market. This requires much more math and a tighter time frame, which is why options are much more risky (and why I love them). By playing both sides of the market, long and short, you will likely see the market in a different light.

The key to trading is not to panic and plan your trades. As I always say, “Plan the trade, trade the plan.” Focus on the next 100 points on the Nasdaq, up or down, as the next triple-digit move from current levels could set the next mini-trend heading into September.

The important point that I want to make about the aforementioned QQQ trade is this: It seems like every investor wanted to bail on the market when last week’s correction reality hit home. I certainly don’t want you to do that and hope you are excited about another possible nasty selloff. Of course, if last week was the bottom, Wall Street and investors might be playing another game of catch-up in September.

From desk to press, futures look like this: Dow (-120); S&P 500 (-14); Nasdaq 100 (-24); Russell (-6).

Special Notice: Futures were sharply lower overnight, so I could have a New Trade Alert on the QQQs with Limit Prices to take advantage of another pullback.

Momentum Options Play List

Closed Momentum Options Trades for 2015: 83-29-2 (73%). All trades are dated and time stamped so new subscribers can look at the past history to see how the trades have played out.

Do not risk more than 5% of your trading account on any one trade but do try to take all of the trades. Please remember, all “Exit Targets” and “Stop Targets” are targets. You should not have any “Hard Stops” entered to close any trades or “Exit Orders” in your brokerage account unless I list one. I will send out a “Profit Alert” or “New Trade” if I want you to close a position or if a new trade comes out. Otherwise, follow instructions at all times in the 9 a.m. and 12 p.m. – 1 p.m. updates. Also, I will usually give you a heads-up if I think I’m going to send an email outside of these time frames.

All prices given in this update are current as of 8:00 a.m. EST.

I hereby disclose that I will be participating in the following trade(s). Every Momentum Options recommendation is listed with the price at which I entered my own position. If the price is slightly different than my recommended entry or exit price when you receive the alert, don’t let that keep you from getting into or out of a trade. Occasionally, you might even get a better “fill” price than what is posted in the portfolio.

 

KB Home (KBH, $14.43, up $0.07)

KBH October 16 calls (KBH151016C00016000, $0.37, down $0.01)

Entry Price: $0.33 (8/27/2015)

Exit Target: $0.70

Return: 12%

Stop Target: None

Action: Resistance is at $14.50-$14.75, followed by $15 and the 200-day moving average. Friday’s high reached $14.72. Short-term support is at $14, with risk to $13.50 if breached.

Earnings are due out the third week of September, and I will cover the numbers ahead of the announcement.

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Trades on Hold — other 2015 Portfolio Open positions (3): These are trades that are still open in the portfolio but are down over 50%. They have longer expiration dates and are on “hold” but are not worth mentioning until they turn around. This means I would not open any new positions. I’m still keeping track of the trades and will record the results accordingly when the trade closes or if the options expire. Click on the Open Trades and Closed Trades pages to see all open and closed positions.

Bank of America (BAC) September 18 calls (from 8/17/15) — Shares need to recover $16.75 and the 200-day moving average before I will feel confident about a recovery. I still want to hold this trade open for another week or so, possibly longer, in case September is a bullish month — Continue to hold.

JPMorgan Chase (JPM) September 70 calls (from 8/10/2015) — Monday’s drop to $50 was mind-blowing, as was the rebound push to $65. I would normally close this trade and save the remaining premium, but I will likely hold this trade open into the Fed meeting. I mentioned that the options will expire the day after the Fed announces its interest-rate decision, and the banks could make an explosive move on the news — Continue to hold.

iShares Russell 2000 (IWM) September 123 calls (from 8/19/2015) — I mentioned that when I put all three of these trades on hold that we would have gotten better prices had we sold these options last week. I’m not sure if this will be the case going forward, but I want to keep a few call options open while opening new put positions as a sort of “strangle” on the market’s direction — Continue to hold.

Trade on!

Rick Rouse
Editor and Chief Options Strategist
Momentum Options