Option Investor

Daily Newsletter, Monday, 03/28/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Bulls Advance on Light Volume

Bulls Advance on Light Volume

Despite a sharp end-of-session selloff, the equity indices closed green today. Volume was light, with QQQQ trading just over half its daily average.

Breadth was mixed despite the positive close, with the number of declining issues exceeding advancers 1.3:1 on the NYSE and 1.1:1 on the Nasdaq. However, advancing volume exceeded declining volume 1.1:1 on the NYSE and 1.2:1 on the Nasdaq.

Daily Dow Chart

The Dow closed higher by .41% at 10486, rising from its opening low of 10440. The session high printed at 10534 at 3PM, following which an ominous declined followed, picking up steam in the futures after the cash close at 4PM. Despite the end-of-session selling, both the index and the futures closed in the green, with the Dow printing a nominally higher high and higher low from Thursday. This action lines up with the opening stages of a daily cycle upphase, and the 10-day stochastic finished with a bullish kiss. A positive close tomorrow would likely yield the first bullish cross, and a close above 10560 would confirm the new daily cycle upphase. On the other hand, a close below the 10440 level would set up the bounce from last week as a bear flag/deadcat bounce.

Daily S&P 500 Chart

The SPX rose all of .24% to close at 1174, also printing its low at the open (1172) and peaking at 1180 at 3PM. The session high was fractionally higher than Thursday's high, not the bullish stairstep higher that daily cycle bulls are anticipating, but an advance nonetheless with the 10-day stochastic trying to turn up from oversold. Provided that 1170 holds, the bias should shift from bearish to bullish, with 1185 the goal for an upside confirmation. However, the light volume and the failure at 1180 are a problem for bulls fighting the declining trend on the daily chart. While the oscillators want to turn up from here, the pattern of higher highs and higher lows is just two sessions old within a nearly 3 week downtrend, on very light volume.

Daily Nasdaq Chart

The Nasdaq held within a 12 point range for an inside day following Thursday's candle. Unlike for its peers, the 1993 low came at the close following the 3PM decline, with the high printed in the morning at 2005. Support at 1975-80 was not tested, and bears want to see that level violated to generate a bear flag breakout off last week's low. Bulls want to see a close above 2010, with confirmation of a new daily cycle upphase above 2025 resistance. The inside day printed today highlights the fact that the expected return of volume tomorrow after the Easter weekend will likely set the tone, either confirming or invalidating the light volume bounce attempt off last week's low. He daily cycle hangs in the balance.

Weekly TNX Chart

Despite the promise of the bearish stochastic divergence on the daily chart, ten year treasury yields (TNX) gapped up this morning and held their gains through the session, with TNX finishing the session higher by 3.4 bps at 4.625%. An unimpressive showing at the 13-week and 26-week t-bill auctions no doubt contributed to the weakness, as a total of 36B was auctioned off. The 17B 13-week t-bill auction generated a bid-to-cover ratio of 2.5 at a high rate of 2.78%, with foreign central banks taking 2.5B of the total. For the 17B 26-week t-bill auction, there were 1.99 bids for each bid accepted, with a high rate of 3.09%. Foreign central banks took 3.9B of the total sold.

The daily TNX chart shows a trending, bearish divergent sell signal on the 10-day stochastic. As we've seen in other bullish trending markets, the price can continue to rise significantly in spite of the indicator, and in such cases the price is the final arbiter. Here, any weakness within the uptrend should be mistrusted, and bond bulls will want to see the TNX back below the 4.53% area at minimum before believing any pullback. With the treasury auctions reflecting better-than-recent but only mediocre demand, the bullishness in the TNX is very convincing above that 4.532% line.

Weekly chart of Crude oil

With little in the way of geopolitical news today, the financial press was attributing the day's decline in crude oil prices to "easing supply concerns" and hopes that stronger economic data would continue to lift the dollar. The day's weakness had oil print a doji candle inside Thursday's range, within the ongoing daily cycle downphase that launched early last week. Immediate support is in the low 53 area, below which is stronger confluence from 51-52.25. May crude finished the day lower by 1.4% or 80 cents at 54.05.

European markets were closed for Easter, and it was a very quiet session with no major US economic reports. Even the corporate news ticker was slow today. Walgreen reported its fiscal Q2 results, announcing earnings of $490.9 million or 48 cents per share, meeting consensus estimates. Revenue was up 12% to $11 billion, with same-store sales up 7.7%. Last year's Q2 earnings came in at $431.6 million or 42 cents. WAG closed lower by 2.42% at 45.11.

Citing changes in market conditions, eggs distributor CALM reported Q3 earnings of $2.4 million or 10 cents per share, down $23.9 million or 98 cents in Q3 last fiscal year. CALM attributed the sharp decline to lower demand for eggs, in part because of a shift away from high protein/low carb diets. CALM closed lower by 7.12% at 7.44.

Pharmaceutical wholesaler ABC warned that fiscal Q2 earnings will miss expectations of $1.10 EPS, estimating earnings of $0.75-.85 per share. For the full year, ABC is forecasting earnings of $3.10-$3.50 per share, down from its previously projected $4.00-4.10 range. The company attributed the reductions to changes in its contractual relationships with drug makers, whereby wholesalers are now limited in the amount of inventory they can buy and are required to charge a per-transaction fee. CEO David Yost noted, however, that these changes should increase ABC's cash from operations for fiscal 2005 from $375-$475 million to between $900 million and $1 billion. ABC gapped lower and stayed there, closing lower by 11.59% at 54.03 on just over 5 times' its average daily volume.

The rumors were confirmed today, with Reuters reporting that a group of 7 private firms have agreed to purchase SunGard Data Systems Inc. for $10.9 billion. The group will pay $36 per SDS share, representing a 14% premium to Thursday's close, and will assume $500 million of the company's debt. Equity capital firm Kohlman Kravis Roberts & Co. is among the buyers, and this transaction is the largest leveraged buyout since it bought RJR Nabisco for $25 billion in 1989. SDS closed higher by 8.91% at 34.36 on nearly 10 times its average daily volume.

SNE took a hit in the first hour of the session, with its gaming unit (Sony Computer Entertainment) announcing that it has been ordered to stop selling PlayStation units in the US and to pay $90 million in damages for patent infringement to Immersion Corp. (IMMR). SNE will continue selling the units as the order has been stayed by the appeal it said it intends to file. The infringement arises from SNE's use of technology to make game controllers vibrate in response to events in its video games. SNE closed flat at 41.16, while IMMR rose 9.57% to close at 6.30.

There was more bad news for insurer AIG over the weekend, with news that the company restate financial results to an estimated amount of $3 billion, and that subpoenas have been issued to 12 of its executives. Currently, the beleaguered company is under investigation by the SEC, the Justice Department and other regulators. The stock opened weak but rose following a story in the WSJ which suggested, among other things, that even a negative multibillion restatement would not damage the company's long term financial stability. AIG closed higher by 2.54% at 57.02.

In other news, the symbol for the new Sears Holdings Corp. resulting from the acquisition of Sears by Kmart announced Thursday will by SHLD. Reuters reported that under the terms of the deal, Kmart shareholders will receive shares of SHLD on a 1-for-1 basis, while Sears shareholders will receive SHLD shares for approximately 59% of their shares, with the remainder of their holders exchanged for $50 cash per share. Later in the day, S&P assigned a BB+ rating to SHLD, the highest junk rating, and announced its debt outlook as "negative." SHLD closed its first day lower by 1.05% at 131.11.

Tomorrow, the lone economic report is Consumer Confidence, scheduled for release at 10AM with economists expecting 103. Thursday and Friday saw gains for the indices despite weak internals and very weak volume. Those gains have resulted in bullish signals printing on the daily charts as discussed above, but they are preliminary and subject to reversal until confirmed by higher prices as indicated above. The heavy hitters return tomorrow, and those gains will be on trial. Today's post-4PM selloff looked bad for tomorrow's prospects, but the afterhours futures are ticking up as I type.

Any weakness at the open could result in a rush for the exits as bulls try to protect last week's profits and bears try to catch the whipsaw down. On the other hand, strength through next resistance will add volume confirmation to the gains and send shorts covering. Because the daily cycle is due for a bounce and has been acting sold out since last week's downside doji spike, I'm ready to believe a bullish bounce- but tomorrow's early stance should set the tone. Traders seeking to avoid a potentially whippy battle for direction will look to follow either a break of upside resistance as noted above, or a downside bear flag breakdown should support fail to hold. Whichever occurs, tomorrow promises to be an exciting session.


New Plays

New Option Plays

Call Options Plays
Put Options Plays
AIG None

New Calls

Amer. Intl Grp - AIG - cls: 57.02 chg: +1.41 stop: 55.95

Company Description:
American International Group, Inc. (AIG) is the world's leading international insurance and financial services organization, with operations in more than 130 countries and jurisdictions. AIG member companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. (source: company press release)

Why We Like It:
Dow-component AIG gets a truckload of headlines on a daily basis with the on going investigation by the government into numerous transactions and its CEO Greenberg is coming under heavy fire. We think the stock is ready to bounce purely on a technical basis but the play is not without risk. Just today UBS stated they believe AIG could still see more weakness as the government probes even deeper. Yet the WSJ stated that the AIG could be close to cutting Greenberg lose as the company's chairman and if that occurs the stock could see a knee-jerk reaction whether it's warranted or not. On a purely technical basis AIG is very oversold falling for almost two months from $73 to under $55 this morning. More importantly the stock bounced from support dating back to the October lows. Plus, today's bounce produced a bullish engulfing candlestick reversal pattern on very big volume about three times the average. However, these reversal patterns need to see follow through to make them worthwhile and AIG has a small gap down from March 22nd that could be overhead resistance. We want to capture any oversold bounce but we plan to use a TRIGGER at $58.01 to open the play. AIG could see some resistance in the $60.00 region and its 10-dma near $59.00 but we suspect that any oversold bounce could make it to the $61.50 level, which would be a 38.2 percent Fibonacci retracement of its February-March decline. Please note that this is a higher-risk play due to the short time frame. We do not plan to hold over the April earnings report.

Suggested Options:
We do not plan to hold over its April earnings report so we are suggesting the April calls.

BUY CALL APR 55.00 AIG-DJ OI= 923 current ask $3.20
BUY CALL APR 60.00 AIG-DL OI=12820 current ask $0.60

Picked on March n/a @ $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 9.2 million

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

PalmOne - PLMO - close: 26.14 chg: -0.46 stop: 22.99

PLMO is showing a little bit of profit taking today. Look for shares to pull back to the $25.00 level, which should be support. A bounce from $25.00 could be used as a new bullish entry point.

Picked on March 23 at $ 25.71
Change since picked: + 0.43
Earnings Date 03/17/05 (confirmed)
Average Daily Volume = 3.2 million


Red Robin Burger - RRGB - cls: 50.23 chg: +0.43 stop: 44.99

RRGB continues to show strength and the stock climbed back over the $50.00 level in the last hour of trading. The company did have some news after the closing bell. Management announced it was still reviewing its accounting policies regarding leases with its accounting firm and RRGB would delay its 10-K filing. The stock was trading lower about $49.75 after hours.

Picked on March 10 at $ 48.00
Change since picked: + 2.23
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand

Put Updates

Allergan - AGN - close: 70.76 chg: -0.04 stop: 76.05

No change from previous update.

Picked on March 13 at $ 73.09
Change since picked: - 2.33
Earnings Date 04/29/05 (unconfirmed)
Average Daily Volume = 777 thousand


Beazer Homes - BZH - close: 52.20 chg: -0.07 stop: 54.01

If you watched CNBC today then you probably heard the bull-bear debate on the homebuilders. Both analysts offered some interesting points but we find the lack of strength in the housing sector as a clue that there is more consolidation ahead. Still we remain cautious as BZH is not seeing much follow through to the downside either. Look for a move under $51.00 before considering new positions. We may still exit this play early if BZH doesn't get moving soon.

Picked on March 17 at $ 51.43
Change since picked: + 0.77
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 742 thousand


Fedex Corp - FDX - close: 94.60 chg: +0.71 stop: 96.01

FDX and the Dow Transports slowly drifted higher on Monday but both began to fade in the last hour. Shares of FDX were unable to hold its gains over the $95.00 level. A drop back under $94.00 could be used as a bearish entry point.

Picked on March 27 at $ 93.89
Change since picked: + 0.71
Earnings Date 03/17/05 (confirmed)
Average Daily Volume = 1.8 million


Google Inc - GOOG - close: 181.42 chg: +2.17 stop: 185.01

GOOG finally gave us some excitement this morning. Shares shot higher after the open following positive comments from Goldman Sachs. The GS analyst following YHOO and GOOG issued positive comments on both Internet stocks suggesting traders buy them ahead of their April earnings reports (source: CBSMW). We were happy to see that the $185.00 level, bolstered by its 100-dma, acted as overhead resistance. The failure to hold most of its gains is probably good news for GOOG bears but we would be careful here. Today's rally did push GOOG above its two-month trendline of resistance (see chart). Look for a move back under $177 before considering new bearish positions.

Picked on March 10 at $179.49
Change since picked: + 1.93
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 10.9 million


Cheniere Energy - LNG - close: 66.30 chg: -1.06 stop: 72.01

LNG is still drifting lower but keep a close eye on the 100-dma, which could be support near the $64 level.

Picked on March 11 at $ 69.49
Change since picked: - 3.19
Earnings Date 03/10/05 (confirmed)
Average Daily Volume = 517 thousand


Intl Bus. Mach. - IBM - close: 91.04 chg: +0.34 stop 92.15

IBM failed again at the $92.00 level and its exponential 200-dma. We would still wait and watch for another drop below the $90.00 mark before considering new bearish positions. Don't forget that our time is growing short since we plan to exit before IBM's April earnings report.

Picked on March 17 at $ 89.86
Change since picked: + 1.18
Earnings Date 04/14/05 (unconfirmed)
Average Daily Volume = 4.8 million


Mcgraw Hill Cos - MHP - close: 88.36 chg: +0.57 stop: 90.21

We're not making much progress on MHP and plan to close it relatively soon if we don't see any follow through to the downside.

Picked on March 15 at $ 88.40
Change since picked: - 0.04
Earnings Date 04/26/05 (unconfirmed)
Average Daily Volume = 751 thousand


Millipore - MIL - close: 44.48 chg: -0.22 stop: 46.05

No change from previous update. MIL still under the 50-dma.

Picked on March 16 at $ 43.95
Change since picked: + 0.53
Earnings Date 04/19/05 (unconfirmed)
Average Daily Volume = 358 thousand


Pacificare Health - PHS - close: 59.03 chg: +0.60 stop: 62.01

No change from previous update.

Picked on March 20 at $ 59.04
Change since picked: - 0.01
Earnings Date 04/28/05 (unconfirmed)
Average Daily Volume = 1.1 million


Toll Brothers - TOL - close: 77.19 chg: -0.08 stop: 81.50

Wow! TOL gapped higher at the open but could not hold on to its gains despite a broker upgrade this morning. Banc of America upgraded TOL to a "buy" this morning with a $100 price target. The lack of reaction to the upgrade could be really good news for bears. We had been expecting an oversold bounce toward the $80.00 level and it's still a possibility but today's weakness or better yet, lack of strength, could be a clue to the rest of the week.

Picked on March 17 at $ 76.81
Change since picked: + 0.36
Earnings Date 02/23/05 (confirmed)
Average Daily Volume = 2.1 million

Dropped Calls

Cleveland Cliffs - CLF - cls: 74.56 chg: -2.69 stop: 74.49

CLF tried to bounce this morning but failed at the $78.00 level and then fell quickly from there. The stock broke support at the $75.00 mark and hit our stop loss at $74.49 closing the play. There is still a possibility that CLF could bounce from its 40-dma but we would be careful considering new bullish positions.

Picked on March 21 at $ 77.06
Change since picked: - 2.50
Earnings Date 02/16/05 (confirmed)
Average Daily Volume = 1.2 million


Parker-Hannifin - PH - close: 59.66 change: -7.89 stop: 63.99

Once again we are reminded about the importance of stop losses! There was no way to know that the company would lower its earnings guidance this morning and the market did not respond kindly. The company lowered estimates from $1.10-1.30 to $1.05-1.15 per share. At least one analyst downgraded the stock on the news and shares fell 11.6 percent. The stock actually gapped lower to open at $65.86 and then proceeded to break support at its simple and exponential 200-dma's, the $65.00 level and its two-month trend of higher lows. We have been stopped out at $63.99.

Picked on March 03 at $ 68.11
Change since picked: - 8.45
Earnings Date 01/18/05 (confirmed)
Average Daily Volume = 1.0 million

Dropped Puts


Trader's Corner

Point and Figure - Price Projections

Last week we talked about double tops and double bottoms, triple tops and triple bottoms, bullish catapults and bearish catapults and triangles. Today I would like to continue our discussion of Point and Figure charts and discuss how to use them to calculate a price objective.

I would like to add a caveat here; the price objectives we will calculate here should only be used as a guide for how much you could make out of a trade or a place where you should be thinking about taking profits. Frequently stocks will trade past these projections and also frequently not make it all the way to the projection. P&F charts are not crystal balls they are just very handy tools.

There are two ways of calculating a price objective; the Vertical Price Objective (VPO) and Horizontal Price Objective (HPO). With each type you can determine a bullish and bearish price objective.

Let's start with the Vertical Price Objective.

Bullish Vertical Count

In these examples I will be using the double top and bottom formations I talked about in my last article but you can use anyone of the other P&F formations for the first step.

1. Find a sell signal, which most times will be a double bottom because they are so prevalent, however, not all the time.
2. Next move to the right and find the first buy signal, of course, using a column of X's.
3. Then count the number of X's in it after the stock as retraced enough to build a column of O's. This ensures there will be no more X's added to the column. Multiply this number by 3 (for the three box reversal method)
4. Then multiply that product by the value per box.
5. Then add this result to the bottom X.

Easy as pie - not!

Lets do an example.

1. The double bottom at 35 was a sell signal.
2. Move to the right and find the first buy signal - this is the triple top breakout at $40
3. Number of Xs in this column is 8. Multiple 8 * 3 for the 3 box reversal = 24
4. Multiple this number by the box size which in this case is 1 = 24
5. Add this number to the bottom X at 33 + 24 = 57

This stock has a price projection of 57.

Bearish Vertical Count

1. Find a buy signal, which most times will be a double top because they are so prevalent, however, not all the time.
2. Next move to the right and find the first sell signal, of course, using a column of O's.
3. Then count the number of Os in it after the stock as retraced enough to build a column of X's. This ensures there will be no more O's added to the column. Multiply this number by 2 (this is where the bearish count is different from the bullish count).
4. Then multiply that product by the value per box.
5. Then subtract this result to the top O.

1. The double top at 40 was a buy signal.
2. Move to the right and find the first sell signal - this is double bottom breakout $35
3. Number of Os in this column is 6 so Multiple 6 * 2 = 12
4. Multiple this number by the box size which in this case is 1 = 12
5. Subtract this number from the top O at 38 = 26

This stock has a price projection of 26.

Horizontal Price Objective

The second way of determining a price projection is using a Horizontal Price Objective (HPO). You should use the HPO for stocks that have formed a large base otherwise use a vertical count.

When calculating a HPO, measure the base a stock has created and broken. The break tells you the formation has completed and you can start your calculation. Sort of like the when doing the VPO, you have to wait for the bullish count to form a column of Os to confirm that the column of X's had completed or the bearish count you have to wait for the column of Xs.

To measure, count the horizontal columns filled with X's and O's without any spaces in between. Find the widest part of the base that is unbroken to count. The number of columns to count can very often be a judgment call.

There are no minimum columns required in the calculation.

The charts with the most powerful moves will be the on that have a large area of accumulation before the chart breaks out. These are considered powder kegs. The more it builds up the more explosive the breakout can be.

Bullish Horizontal Count

1. Find a buy signal
2. Count across the base the stock has built.
3. Multiply the number of columns across the formation by 3
4. Multiply that product by the value per box.
5. Add this number to the bottom of the formation.

1. Buy signal at $40
2. Count across the widest part of the base = 7
3. Multiply 7 * 3 (3 box reversal) = 21
4. Multiply 21 * 1 (box size)
5. Add 21 to bottom of formation 34 = 55

Bullish Horizontal count is 55.

Bearish Horizontal count

1. Sell signal at $33
2. Count across the widest part of the base = 7
3. Multiply 7 * 2 (this is the only time the bearish count differs from the bullish count) = 14
4. Multiply 14 * 1 (box size)
5. Subtract 14 from top of the formation 39 = 25

Bearish Horizontal count is 25.

Up to this point we have used a box size of 1, which begs the question "How do you calculate the Price Objective when the box size changes." Simply, if the box size was $5 then you would use a multiplier of 5 in step #4 instead of 1 or if the box size was $0.50 then you would multiple by 0.50 instead of 1.

Obviously a box size change affects the price objectives of the chart because we are measuring the strength of the move off the bottom or top and that is measured by the box size. However, when a chart crosses over two different box sizes you have to do the calculations twice and add them together. This is where the vertical counts can be confusing but as long as you understand the different calculations for the box sizes, you should be able to do this easily. You will not have this problem with the Horizontal count because it typically will not cross different box sizes so you should only run into this issue with the Vertical count. Let's start out with a review of the box sizes.

Let's take an example of a stock that moves from $18.00 to $23.00. Under $20 the box size is $0.50 but $20 and over it is $1.00.

In the above example we will assume the column of X's from $18 to $23 is the column we have determined to be the one to use for a Bullish Vertical Count. Firstly, you take the count from $18 to $20 = 5 and you do the calculations using a box size of $0.50. That would be 5 * 3 * 0.50 = 7.5. Then you take count from $21 to the top of the column at 23, which is 3. Now you do your calculation using a box size of 1. That would be 3 * 3 * 1 = 9. Now you add the two together 7.5 + 9 = 16.5. Add this number to the bottom X at $18 + 16.5 = 34.5 is your bullish vertical count.

So is your brain just about mush. You have just learned about all there is to learn on how to create a point and figure price objective horizontally and vertically. Next week we will continue on with this series and talk about some really cool ways to use P&F charts using relative strength.

Until then plan your trade and trade your plan.

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Trader's Corner by Jane Fox, and all other plays and content by the Option Investor staff.


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