Option Investor

Daily Newsletter, Thursday, 05/05/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Hit by a GMC Truck

Hit by a GMC Truck

The market seemed to be doing fine this morning, dealing with a little consolidation after yesterday's big rally, looking like it was getting ready to rally to yet another new high. But then from around the corner came a one of those big GMC dump trucks and dumped a pile of junk (bonds that is) on the market. Everyone has known for quite some time that GM's bonds were going to be downgraded to junk bond status but it looks like the timing of the announcement by the S&P took the market by surprise. The announcement that Ford's bond rating was also cut to junk status only fueled concerns about the potential negative consequences of this action. S&P stated the move "reflects its conclusion that management's strategies may be ineffective in addressing GM's competitive disadvantages, though GM should not have any difficulty accommodating its near-term cash requirements." S&P stated the recent bid by Kirk Kerkorian's Tracinda Corp. to increase its stake in the company was not a factor in its decision. There was an attempt to rally the market after the spike lower but it remains to be seen tomorrow whether or not the bounce was merely a upward correction in a new leg down.

The morning started off with some early economic numbers. The U.S. initial jobless claims were reported to have increased to 333,000, up 11,000 which is in the noise range. The 4-week average initial claims dropped 2,000 to 321.500 and continuing jobless claims rose 38,000 to 2.6M. Nonfarm productivity for Q1 was up 2.6% versus 1.9% expected (and up from Q4's 2.1%) while unit labor costs were up 2.2%. The labor costs are a key measure of inflationary pressure from compensation. Hourly compensation was up 2.4% when adjusted for inflation. Q4 manufacturing productivity was up 3.9%. All of these numbers generated a ho-hum response from the market. Other than the excitement of the GM-inspired spike down during the lunch hour, the day was mostly filled with slow consolidating moves and ended relatively mixed. Looking at the slightly longer term picture, the picture is just as mixed but with a slightly bearish tone.

DOW chart, Daily

The DOW has been attempting a bounce over the past two weeks and got a pretty good shot in the arm the previous 3 days. This brought the DOW up to its 200-dma and a horizontal resistance line that runs across from the September 2004 high and the January and April lows. If the DOW falls back from here and starts dropping quickly it will look like a bearish kiss goodbye at stiff resistance. That kind of bearish price action would lead me to believe the market is headed for new annual lows. However if the market can consolidate the recent gains and then rally above 10400, there's a very good chance we'll see significantly higher prices. I would say long above 10400, short below.

SPX chart, Daily

SPX is currently looking a little more bullish than the DOW. It has rallied above its 200-dma, is back above its broken uptrend line from August 2004 and has broken its downtrend from March. The nearest resistance looks like its 50-dma at 1180.55. Any rally above this level would be bullish as it will have put most of its resistance levels behind. However, a drop back down below the trend lines at about 1167, and more importantly below its 200-dma near 1157, will make the bounce from April 20th look like just a correction against the decline. Longer term traders might want to key off DOW's 10400 level for guidance but I would suggest long over 1180, short below 1157.

Nasdaq chart, Daily

The NAZ has been stuck in the same trading range as October 2004. This is important because the consolidation in October 2004 led to a continuation higher into the end of the year. The question now is whether or not the current consolidation will lead to another leg lower. Based on the corrective pattern of this consolidation I'm guessing it will lead to another decline. The NAZ needs to rally above its downtrend line and 200-dma (both near 2000) to turn its chart bullish. In the meantime it's in a downtrend and that's the way you should trade this one--short the rallies/protect profits on longs.

SOX index, daily chart

The SOX is bound and determined to give its long term uptrend line (from October 2002) another kiss. This broken uptrend line is currently near 400 and any push up to this level would make a good short. You at least know where your stop should be.

Today's trading left the charts looking like a stalemate today. Even the internals were mixed--the advance/declining issues and volume were for all intents and purposes even. The Nasdaq ended the day up less than a point. The small cap index, the Russell 2000, was up less than point. The DOW was hurt the most by GM'S news, just as it was helped the most yesterday by GM's news. Leading sectors today were the energy indexes followed by the biotechs and transports. But most of the sectors bled red today led by the disk drive and networking sectors, computer hardware and software, and the gold/silver index. But even the losers were marginally so. Not helping the disk drive index was Maxtor (MXO, 4.61, -0.36), which missed analysts' forecasts last night with a loss of $0.10 a share. Networking (-1.0%) was led lower by a decline in Qualcomm (QCOM, 35.17, -0.49) after China said it may delay 3G licenses to end of year. This seems to be a constant theme for Qualcomm. Retail hit a soft spot in April and reported same-store sales were the weakest since November. However, thanks to our teens, companies selling to the teen market (ANF, AEOS, BEBE) reported stronger sales. Some department stores (FD and MAY) also reported stronger sales.

The oil index benefited from the jump in oil prices today. But the oil chart looks like it too may still head lower.

Oil chart, June contract, Daily

Oil has been chopping lower and has been doing battle around the psychologically important $50 level. This $50 level for oil is like 10K for the DOW. The bulls and bears have been battling to be heard at this level. This one looks like the bears will win in the short term but not by much. There is a Fib projection for the decline at $47.71 and at the rate it's dropping it may hit it about the time the uptrend and 200-dma get up there. Current support by its uptrend and 200-dma is near $47 and I'm sure the bulls will be all over that if and when it reaches down to there.

Oil Index chart, Daily

Not surprisingly, the oil index chart looks similar to the oil chart, except that it's been holding up better. The pattern of its choppy decline is bullish so if it manages to get down to its uptrend line and 200-dma (which may happen by the time those supports rise to the 62% retracement level near 428), I'd be a buyer.

Transportation Index chart, TRAN, Daily

The Trannies have been struggling around its 200-dma and today got a bounce up to, and stalled under, its downtrend line from March. If the TRAN rolls over from here it will look like a failure at resistance. Any rally above the trend line, which would be a break of today's high, that is then able to stay above the trend line, would be bullish and probably bullish for the broader market.

U.S. Home Construction Index chart, DJUSHB, Daily

I like to watch the housing market for the same reason as the TRAN. This market could be a good proxy for the broader market. If the housing market suffers, that will likely be a good indication the consumer is pulling back. That would have negative consequences for our economy. This one could be our canary in the coal mine. The current bounce in the housing market looks bearish. It's currently stalled under its 50-dma so watch for a successful break above, or not, for some longer term clues.

Euro chart, Daily

The US dollar index is watched by many and derided by most. Therein may lie the reason the dollar will rally. The current pattern lends credence to the idea for a rally. By continuing to press up near $85 while building higher lows, it is creating an ascending triangle which is a bullish pattern. These are typically seen in the middle of rallies so it's not clear whether or not this pattern will have the same outcome. But a break above the top of this pattern (about $85.40) will also be a break above its 200-dma. It would be interesting to watch the shorts scramble for coverage since there are a lot of them out there. The impact this would have on the metals would likely be negative and cause them to fall out of their sideways triangle consolidation patterns.

Tomorrow morning starts with the Jobs report. While special emphasis will be placed on Non-farm Payrolls (consensus 175K), as well as Hourly Earnings (consensus +0.2%), a gain of even 125K (payrolls) should ease fears of a sharp economic slowdown while a gain of 175K or more would suggest that the economy is on a steady track for 3% real GDP growth. We continue to walk a fine line between enough growth to keep the market happy but not too much growth and inflation to make the Fed unhappy. An unhappy Fed makes for an unhappy market. So send them your happy pills and good luck trading this market as the bulls and bears duke it out near the lows. The next day or two should provide enough clues about the longer term (several weeks at least) direction. A further consolidation near current levels and then a push higher will give us a bullish pattern in the bounce off the lows. I would then look to buy the following pullback. But a sharp decline from here that takes out Tuesday's lows will look bearish and I'd be looking to short the rallies. Good luck and be quick to take profits when offered. This market is not rewarding longer term trades (those longer than a day or two).


New Plays

New Option Plays

Call Options Plays
Put Options Plays
HOV None

New Calls

Hovnanian - HOV - close: 53.37 chg: +1.49 stop: 49.99

Company Description:
Hovnanian Enterprises, Inc., founded in 1959 by Kevork S. Hovnanian, Chairman, is headquartered in Red Bank, New Jersey. The Company is one of the nation's largest homebuilders with operations in Arizona, California, Delaware, Florida, Illinois, Maryland, Michigan, Minnesota, New Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Texas, Virginia and West Virginia. The Company's homes are marketed and sold under the trade names K. Hovnanian Homes, Goodman Homes, Matzel & Mumford, Diamond Homes, Westminster Homes, Forecast Homes, Parkside Homes, Brighton Homes, Parkwood Builders, Great Western Homes, Windward Homes, Cambridge Homes and Town & Country Homes. As the developer of K. Hovnanian's Four Seasons communities, the Company is also one of the nation's largest builders of active adult homes. (source: company press release)

Why We Like It:
We believe that comments about the demise of the homebuilders has once again been issued prematurely. Yes, the rise in interest rates has been a factor even if it only affected investor confidence. Currently Wall Street still expects the FOMC to raise rates again at the next meeting but beyond that the future of rates will be much debated and it's possible the Fed could halt its current strategy and leave rates in the 3.00-3.25 percent range. This will still leave mortgage rates historically low and we're approaching one of the best seasons of the year for homebuilders. Focusing more specifically on the home building sector there has been some positive analyst comments in the last month about a strong Q1 and Q2 for the group and using the recent weakness as a buying opportunity. HOV came out today and helped validate those claims. Here is an excerpt from HOV's press release out this morning:

"For the second quarter of fiscal 2005, the dollar value of net contracts, including unconsolidated joint ventures, increased 25.3%, and the number of net contracts increased 8.5%, when compared with the second quarter last year. The sales value of contract backlog at April 30, 2005, including unconsolidated joint ventures, increased 61.0% on a year-over-year basis, and the number of homes in contract backlog increased 35.7% when compared to the end of the second quarter of fiscal 2004. For the month of April 2005, the dollar value of net contracts, including unconsolidated joint ventures, rose 50.6%, while the number of contracts increased 20.1%, when compared with April 2004."

It doesn't sound like HOV is experiencing any sort of slow down and the stock price looks poised to breakout over resistance near $54.00. If HOV does trade above the $54.00 level it will reverse its P&F chart from a sell signal into a new triple-top breakout buy signal. Our strategy is to use a TRIGGER at $54.26 to open the play. Our short-term target will be the $59.00-60.00 range.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 50.00 HOV-FJ OI= 519 current ask $5.30
BUY CALL JUN 55.00 HOV-FK OI=1835 current ask $2.40
BUY CALL JUN 60.00 HOV-FL OI= 206 current ask $0.85

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/02/05 (confirmed)
Average Daily Volume = 1.2 million

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Avalonbay - AVB - close: 73.00 change: +0.65 stop: 68.49

AVB continues to show relative strength with another gain in spite of the market's losses today. Shares are only a couple of points away from our $75-76 target range. We see no changes from our previous updates on 05/04/05 and 05/01/05.

Picked on April 24 at $ 70.05
Change since picked: + 2.95
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 345 thousand


Chubb Corp - CB - close: 82.86 chg: -1.94 stop: 79.49

No surprise here. Yesterday we warned readers to expect a dip in CB as shares were a little overbought. We see no changes from our previous updates on 05/04/05 and 05/01/05. Our target remains the $88-90 range.

Picked on May 01 at $ 81.78
Change since picked: + 1.08
Earnings Date 04/25/05 (confirmed)
Average Daily Volume = 1.2 million


Golden West Fincl - GDW - close: 64.13 chg: -0.33 stop: 59.95

GDW experienced a little bit of profit taking today. No change from our previous update on 05/04/05. Our target remains at the $66.50 level.

Picked on April 26 at $ 62.55
Change since picked: + 1.58
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 1.3 million


Invitrogen - IVGN - close: 76.52 change: +0.78 stop: 71.49

IVGN is still show relative strength. The stock added another one percent today. We see no change from our previous update on 05/03/05.

Picked on May 03 at $ 75.51
Change since picked: + 1.01
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 888 thousand


Eli Lilly - LLY - close: 60.44 change: +0.18 stop: 57.49

LLY is showing a little bit of strength despite a down day for the DRG drug index. There are no changes in strategy from our previous update on 05/03/05.

Picked on May 04 at $ 60.15
Change since picked: + 0.29
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 4.7 million


Nucor - NUE - close: 52.31 chg: -0.39 stop: 49.95

We remain on the sidelines waiting for NUE to breakout above resistance near $55.00. Our entry point is $55.05.

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 3.3 million


Reynolds American - RAI - cls: 80.52 chg: +0.28 stop: 77.95

Almost but not quite. Shares of RAI rallied to $81.19 on an intraday basis before paring their gains. Our entry point to go long is at $81.31 so we remain on the sidelines. There is no change from our previous update on 05/04/05.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 866 thousand

Put Updates

Adobe Systems - ADBE - close: 56.92 chg: -0.63 stop: 60.01

Thursday was another down day for ADBE who under performed both the NASDAQ and the GSO software index. No change from our previous updates. Our target remains the $55.00 region.

Picked on April 26 at $ 59.12
Change since picked: - 2.20
Earnings Date 06/16/05 (unconfirmed)
Average Daily Volume = 3.3 million


CDW Corp - CDWC - close: 55.79 chg: +0.29 stop: 58.01

We were a little surprised to see CDWC close in the green today given the red across most of the technology sector. Shares of CDWC remain under resistance and we remain bearish. No change in strategy or from our previous update on 05/01/05.

Picked on April 24 at $ 55.68
Change since picked: + 0.11
Earnings Date 04/19/05 (confirmed)
Average Daily Volume = 920 thousand


Lehman Brothers - LEH - close: 91.10 chg: +0.60 stop: 94.05

The rally may not be quite yet over for LEH but its momentum is stalling. We would expect shares to encounter resistance in the $92.00-92.50 region near its 50-dma before turning lower again.

Picked on April 29 at $ 89.45
Change since picked: + 1.65
Earnings Date 03/15/05 (confirmed)
Average Daily Volume = 2.3 million


Marriot - MAR - close: 62.11 chg: +0.01 stop: 65.01

There was no follow through on MAR's Wednesday oversold bounce and that's good news for the bears. Our target remains the $60.00-58.00 range.

Picked on April 28 at $ 63.37
Change since picked: - 1.26
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 1.2 million


PACCAR Inc - PCAR - close: 67.09 change: -0.03 stop: 70.01

PCAR spent Thursday's session trading sideways. Thus there is no change from our previous update on 05/03/05.

Picked on April 27 at $ 66.45
Change since picked: + 0.64
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 1.0 million


Parker Hannifin - PH - close: 60.09 change: -1.52 stop: 62.01

As we expected shares of PH reversed under resistance near the $62 level. The stock completely erased Wednesday's gains. Readers can use today's weakness as a new bearish entry point although more conservative traders might feel better waiting for PH to trade back under the $59.00 level before initiating positions. After the closing bell PH announced it had signed a new distribution agreement with Aviation Power & Marine but we do not believe this will affect the stock price of PH.

Picked on April 28 at $ 59.08
Change since picked: + 1.01
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 1.2 million

Dropped Calls


Dropped Puts

Infosys Tech. - INFY - close: 61.19 chg: +1.64 stop: 60.26

It would appear that our caution was warranted. INFY did indeed pop above the $60.00 resistance level and shares ran to an intraday high of $62.32 before fading. The stock does still have technical resistance at its simple and exponential 200-dma's overhead. Meanwhile we were quickly stopped out at $60.26 shortly after the opening bell.

Picked on April 26 at $ 58.24
Change since picked: + 2.95
Earnings Date 04/14/05 (confirmed)
Average Daily Volume = 504 thousand


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