Option Investor

Daily Newsletter, Saturday, 05/07/2005

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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

Jobs Surprise

WE 05-06


WE 04-29


WE 04-22





+  34.80


+ 77.37



+  45.70


-  10.54


+ 24.04

S&P 100


+    5.46


+    1.34


+   3.64

S&P 500


+  14.50


+    4.73


+   9.29





+  26.22


+ 90.52



+  11.17


-    3.70


+   6.66



+  17.14


-  10.15


+   8.78





-  13.61


+ 60.27















Jobs Surprise

Surprise, surprise, surprise! The jobs numbers for April came in at +274,000 and blew past estimates of +175K with ease. This was a major miss by those analysts who read their tealeaves and predicted weak numbers. Not only was the April number a blowout but February and March were also revised higher. The markets rallied back to their highs for the week on the news but could not hold those highs.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

Confusion reigned on Wall Street on Friday. The blowout Jobs report caught everybody off guard and the excessive good news sent stocks sharply higher at the open but resistance held and fear of the Fed came back to haunt traders. February jobs were revised up +57K to 300,000 and March was revised up +36K to 146,000. This good news was matched by the household survey showing a gain of +598,000 jobs. This job explosion sent the bulls into a buying frenzy on thoughts that the economy was much stronger than previously thought. This bounce was almost immediately capped by fears that the Fed would accelerate their rate hikes given the strong jobs. The Fed funds futures had been showing a strong possibility of a Fed pass at the September meeting. After Friday's jobs numbers those futures jumped to a 33% chance of a 50-point hike by that same September meeting.

The jobs components were positive with the Manufacturing workweek rising to 40.5 hours, the overall average rising to 33.9 hours and the average hourly earnings rising +0.3% to $16. The 33.9 number is the highest level since 2002. The unemployment rate held steady at 5.2% due to a large influx of 605,000 new workers into the labor pool. Service businesses created the most jobs with the manufacturing sector still weak.

With the April job gains of +274K, February upward revision of +57K and March revision of +36K that represents a net gain of 367,000 jobs over prior assumptions. Add in the 598K from the household survey and you have nearly one million new jobs to factor into the economic picture. The worries about the Q1 soft patch appear on the surface to have been severely overdone. Analysts spent countless hours and wasted plenty of digital ink documenting their projections only to have the Jobs numbers turn the conclusions upside down. Weak economies don't produce jobs of this magnitude.

Unfortunately a very large portion of Friday's job gains were the result of a Bureau of Labor Statistics paper adjustment. Jeffrey Saut of Raymond James reported that the BLS birth/death adjustment added +257,000 of the reported 274,000 new jobs. Without that adjustment Friday's market action and economic outlook would have been very different. This particular adjustment attempts to estimate how the birth of new companies and death of old ones have impacted the workforce. This massive "adjustment" to the jobs number was overlooked by almost everyone but the bottom line was a massive improvement in economic sentiment thanks to a government adjustment, not verifiable new jobs. That will not be reflected in the weekend news reports and I doubt it will be mentioned ever again. That leaves us with the official number showing a very surprising gain and that is what investors will be using to make their decisions.

Unfortunately the Fed's measured pace may be in jeopardy since the measured pace of job growth has taken on the appearance of a race rather than a pace. With the next Fed meeting nearly two months away on June 28th it will give analysts plenty of time to stress over the next chapter in this saga.

The positive jobs surprise whether real or artificial went a long way towards improving investor sentiment. Ned Davis Research said pessimism going into last week was at an 11 year high and similar to that seen in 1994. For those with a short memory the Fed raised rates six times in 1994 ending with the rate at 6%. This hike cycle capped the equity markets with the Dow trading in a 500 point range all year and a total gain for the year of just over +100 points. However, once the Fed rested the markets exploded from Dow 3800 in Jan-1995 to nearly 12000 in Jan-2000.

Rate Hike Graph 1994-1995

Dow Chart 1994 - Weekly

Dow Chart 1994-2005 - Monthly

I wanted to refresh everyone's memory of that bull market because that is exactly what bulls want to see happen when the Fed rests again. So far the Fed has hiked 25 points at each of its last eight meetings beginning in June 2004. The Fed rate was at a decade's low level of only 1.00% when they began. Given the similarity of market action, economics and stated Fed policy it now appears they will continue to hike for at least four of the five remaining meetings this year. If the jobs data continues to show strong gains it is conceivable at least one of those hikes could be 50 points. From various Fed speeches we have heard that the Fed would consider something in the 4.0%-4.5% range as optimal and that would put us around that level as 2005 ends.

This sets up 2006 as a theoretical springboard except for a one major difference. Remember Y2K? The Y2K problem and the advent of the Internet for consumers spawned a technology boom that will not likely be repeated in our lifetimes. Without that catalyst the markets can still rally but they are going to have to do it on normal market moving facts. Earnings and growth rates. We have seen the earnings for Q1 and it appears we are going to end up somewhere in the +12.3% range for earnings growth. Very few large companies are left to report with Dell and Cisco the exception in the coming week. What we have seen from those companies that have already announced was better than expected earnings but weak guidance after Q2. The technology spending picture continues to be cloudy and the tech bulls will be watching Dell and Cisco for comments that suggest this weak demand is improving. The markets want to go higher but there is still little justification for a summer rally. Markets normally anticipate six months ahead so any bets placed now are counting on a stronger economy and stronger profits in Q4 of this year. So far that projection is still cloudy with a bias to minimal growth in earnings. Should we see a change in guidance to the high side I believe we would see a very strong market later this year.

The major indexes only closed with a +5 point gain on Friday despite the supposedly good news. Fear of the Fed coupled with fear of the summer doldrums kept most investors on the sidelines. Volume was very light on Friday almost dropping to holiday levels with only 3.5B shares across all markets. Hardly a confidence-building rally. The A/D line was dead even at 3569:3543. Without the takeover rumor in Honeywell the Dow would have closed at -7 for the day. A rumor hit the floor that UTX was going to make a bid for Dow component HON and the race was on. HON started from its support low just over $35 and soared all the way to $37.71 before the excitement cooled. CNBC reported several times that there was very heavy options activity in the May/June calls and that just fed the fire. When the smoke cleared there were about 113,000 May options and 56,000 June options traded. Average daily volume is around 2,000. Although CNBC reported that call volume was 5:1 over puts that is not how the day ended. Put volume beat call volume better than 2:1 at 118,500:51,500. This rumor has been around the block numerous times at about six month intervals. Both UTX and HON declined to comment and UTX went so far as to say they are not interested in aviation assets. That put an end to the bounce and HON finished -$1 off its highs. Had the market been open a few minutes longer it may have retraced its gains completely.

The Dow was also helped by a new order for Boeing 787 Dreamliners. Northwest Airlines placed an order for up to 68 planes and BA finished up $1.27. Boeing and Honeywell were the only two Dow components gaining over a buck for the day. The Dow struggled to retest 10400 despite the supposedly good Jobs news and the lonely tick to 10400 was sold immediately. For three days this has been strong resistance and shows a real lack of confidence from the buyers. Stronger resistance exists at 10500-10550 but there appears to be a lack of buying volume sufficient enough to push us higher.

The volume is light because the fund inflows are light. For the last two weeks inflows have barely broken $800 million with only $400 million going into U.S. equity funds in the prior week. The U.S. funds are living on a very strict allowance and there is little cash to throw at the market. The headline jobs number could seduce some retail traders to put a check in the mail next week. However, I would expect funds to be reluctant to simply spend what they receive. With summer ahead they may feel more like building up their cash reserves instead of living dangerously at 100% invested. Should fickle investors start drawing out money for the spring home buying season or vacation expenses then any stock bought next week could just as quickly get sold.

Tech funds have not the beneficiary of that meager cash inflow. Techs have now seen 16 consecutive weeks of outflows and it would take some strong comments from Dell/Cisco next week to reverse that flow. Summers are just not tech friendly and tech investors have been moving to safety. Despite the outflows the Nasdaq hit 1890 early last Friday and has been moving steadily upward ever since. The prior resistance at 1960 was broken for three days but the Nasdaq can't seem to get over 1970. I believe traders are looking at that +75 point rebound and stronger overhead resistance from 1980 to 2020 and finding it difficult to buy tech stocks. If the 1890 dip was the low for this year then buying 1960 would be the wise thing to do. Unfortunately we all know that yearly lows are seldom made in May but in the months that follow.

Nasdaq Convergence Chart - 2005 Daily

SOX Chart - Daily

Crude Oil Chart - Daily

This was a good week for the markets. They were due for a rebound given the very pessimistic sentiment we saw last week. I told you on Tuesday we were due for a bounce and that came to pass as expected. Now it is decision time again. I believe we could see a minor jobs bounce on Mon/Tue if Ma and Pa investor believe the jobs story in the weekend newspaper. Any bounce from our current levels will run into very stiff resistance at 10500, 2000, 1190 and fear of that resistance will likely keep us from reaching it. My bias has switched from Tuesday's neutral back to bearish and I would look to short any Monday/Tuesday bounce to resistance. I believe the economy is picking up again but that will only make the Fed bolder about its coming hikes. Good economic news is bad news for the market until fall. Despite the artificial jobs blowout you may have noticed that Jobless Claims have risen for the last two weeks. This tells me that real employment is still weak. We also have oil refusing to drop and hold below $50. Every day that passes we get closer to draw downs in inventory levels as the gasoline season draws near. Once oil finds a bottom and returns to the highs the feeding frenzy will begin again and we could easily see $70 oil by year-end. If the economy really is picking up speed then oil consumption will only grow faster. Once oil begins its climb it will provide more negative sentiment for equities. I am still a buyer of oil stocks with any dip below $50 but I am avoiding other sectors until we see what summer brings. Definitely enter passively and take profits quickly.


New Plays

New Option Plays

Call Options Plays
Put Options Plays
CVH None

New Calls

Coventry Hlth Care - CVH - close: 69.52 chg: +0.93 stop: 66.99

Company Description:
Coventry Health Care is a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental / managed care services companies, and workers' compensation services companies. Coventry provides a full range of risk and fee-based managed care products and services, including HMO, PPO, POS, Medicare Advantage, Medicaid, Workers' Compensation and Network Rental to a broad cross section of employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico. (source: company press release)

Why We Like It:
We have had our eye on CVH as a bullish candidate for days but we wanted to wait until after the company reported earnings. CVH turned in its Q1 report on May 3rd and beat Wall Street's estimates. The company also guided higher for the next quarter. Technically the stock is bullish with a strong up trend. CVH has been slowly consolidating higher along its rising trendline of support for the last three weeks but we suspect this is a pause by investors waiting for the earnings report. CVH's P&F chart has produced a bullish triangle breakout but the target is only $72. We suspect that this time CVH will surpass its P&F target. We suggest readers use a trigger at $70.51 to confirm the breakout over the $70.00 level. Our short-term target will be the $74.75-75.25 range.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 65.00 CVH-FM OI=241 current ask $6.10
BUY CALL JUN 70.00 CVH-FN OI=206 current ask $2.85
BUY CALL JUN 75.00 CVH-FO OI=102 current ask $1.05

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/03/05 (confirmed)
Average Daily Volume = 973 thousand

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Avalonbay - AVB - close: 72.74 change: -0.26 stop: 69.49 *new*

Friday was a very lackluster day for the markets despite the positive jobs number. Shares of AVB, which had shown strength through most of the week, pulled back a tad on Friday. We remain bullish but don't be surprised to see AVB fade back toward its simple 10-dma before continuing higher. Our target is the $75.00-76.00 range. The 10-dma is near $71.77 so look for a bounce in the $71.50-72.00 region. We're raising the stop loss to $69.49.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 65.00 AVB-GM OI= 761 current ask $8.80
BUY CALL JUL 70.00 AVB-GN OI= 567 current ask $4.70
BUY CALL JUL 75.00 AVB-GO OI= 157 current ask $1.90

Picked on April 24 at $ 70.05
Change since picked: + 2.69
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 345 thousand


Chubb Corp - CB - close: 83.55 chg: +0.69 stop: 79.49

The insurance sector was a strong performer this past week with a number of companies turning in very positive earnings results. The IUX insurance index rebounded sharply and shares of CB broke out to new multi-year highs. Currently both the IUX and shares of CB look a little overbought so we would not be surprised to see both pull back a bit next week. We would watch for CB to dip toward the 10-dma before bouncing higher. Readers can use a bounce from the 10-dma as a new entry point. Our six-to-eight-week target is the $88-90 range. Currently CB's Point & Figure chart shows a triple-top breakout buy signal with a $107 target.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 75 CB-FO OI=214 current ask $9.10
BUY CALL JUN 80 CB-FP OI=504 current ask $4.70
BUY CALL JUN 85 CB-FQ OI=636 current ask $1.50

Picked on May 01 at $ 81.78
Change since picked: + 1.77
Earnings Date 04/25/05 (confirmed)
Average Daily Volume = 1.2 million


Golden West Fincl - GDW - close: 62.94 chg: -1.19 stop: 60.95*new

Heads up! It may be time to go to yellow alert here. Both the banking indices appeared to breakout from their descending channels and above technical resistance at their 200-dma's midweek. In the last two sessions both indices have reversed course suggesting the move could have been a bull trap. Friday's session saw profit taking in the banking sector and shares of GDW followed suit with a 1.8 percent decline. GDW's breakdown below the 10-dma could be a reason for concern. We're watching the $62.00 level for support. If GDW trades under $62.00 we may exit early. More conservative traders may want to consider raising their stop loss toward the $62 region. We're going to raise our stop loss to $60.95.

Suggested Options:
We are not suggesting new bullish positions at this time.

Picked on April 26 at $ 62.55
Change since picked: + 0.39
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 1.3 million


Hovnanian - HOV - close: 53.89 chg: +0.52 stop: 49.99

HOV is a new bullish play from the Thursday newsletter. We suggested a trigger to go long/buy calls at $54.26 (above resistance near $54.00). Shares of HOV traded to $54.35 on Friday hitting our trigger and opening the play. The move also produced a fresh triple-top breakout buy signal on its P&F chart with a $63 target. A reprint of Thursday's original play description follows:

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= 526 current ask $5.70
BUY CALL JUN 55.00 HOV-FK OI=1875 current ask $2.65
BUY CALL JUN 60.00 HOV-FL OI= 299 current ask $0.95

Picked on May 06 at $ 54.26
Change since picked: - 0.37
Earnings Date 03/02/05 (confirmed)
Average Daily Volume = 1.2 million


Invitrogen - IVGN - close: 75.03 change: -1.49 stop: 71.49

IVGN has continued to show relative strength with gains in five of the last six sessions. This past Friday saw some profit taking, which isn't out of the norm. We remain bullish on the stock given its recent bullish breakout and its bullish P&F chart that currently points to an $85 target. However, we would probably look for shares to dip back toward the simple 10-dma (near $74) before continuing higher. Readers can use a bounce from the 10-dma back above the $75 mark as a new bullish entry point. Our target is the $80.00 level.

Suggested Options:
We are suggesting the June calls although Mays and August strikes have more open interest.

BUY CALL JUN 70.00 IUV-FN OI=174 current ask $6.70
BUY CALL JUN 75.00 IUV-FO OI=561 current ask $3.20
BUY CALL JUN 80.00 IUV-FP OI=184 current ask $1.10

Picked on May 03 at $ 75.51
Change since picked: - 0.48
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 888 thousand


Eli Lilly - LLY - close: 60.18 change: -0.26 stop: 57.49

The DRG Drug index has been out performing the broader market for weeks and avoided much of the recent weakness. Shares of LLY have also been out performing over the last few weeks and has managed to produce a bullish breakout above its trading range, its 200-dma, and resistance at the $60.00 mark. We remain bullish on the stock but we're expecting a dip next week. The DRG index is starting to show a little fatigue and the group could consolidate lower for a couple of days before continuing higher. We'll be watching LLY's $59 and $58 levels to act as support should the $60 mark fall. Readers can use a bounce from either level as a new bullish entry point but we'd probably wait for the stock to trade back above the $60 level before buying new call positions.

Suggested Options:
We are suggesting the July calls although Junes are available.

BUY CALL JUL 55.00 LLY-GK OI=11071 current ask $6.10
BUY CALL JUL 60.00 LLY-GL OI=41886 current ask $2.50
BUY CALL JUL 65.00 LLY-GM OI= 8281 current ask $0.60

Picked on May 04 at $ 60.15
Change since picked: + 0.03
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 4.7 million


Nucor - NUE - close: 53.52 chg: +1.21 stop: 49.95

We're starting to see NUE display a bit more strength and the stock is bouncing from the $50.00 level, bolstered by its 200-dma's. As we have suggested before more aggressive traders might want to consider bullish positions above the $52.50 level and/or its 21-dma. We are still waiting for a breakout over resistance at the $55.00 level and its 100-dma. Our entry point is currently at $55.05.

Suggested options:
We are not suggesting new plays at this time.

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: 80.09 chg: -0.43 stop: 77.95

We added RAI to the list a few days ago after it looked like the stock had built a new short-term base and was on the verge of breaking out into a new leg higher. Shares of RAI have been consolidating sideways the last few weeks between $77.00, underpinned by its exponential 200-dma), and the $80-81 levels. We suggested that readers use a trigger at $81.31 to open the play. In the last two sessions we've seen RAI try to mount a new rally but both times the stock failed to pierce resistance in the $81.25 region. We remain bullish but stick by our suggested entry point at $81.31. Our target is the $85-86 range. Currently the P&F chart has reversed into a new buy signal that points to a $90.00 target. Tobacco stocks could do well early next week after news came out on Friday after the bell about a new legal decision. According to a Reuters article a New York federal appeals court overturned a ruling that would have established a nationwide class action suit for smokers to file suit against cigarette companies seeking punitive damages.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 80.00 RAI-FP OI=2963 current ask $2.55
BUY CALL JUN 85.00 RAI-FQ OI= 414 current ask $0.70

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: 57.70 chg: +0.78 stop: 60.01

This next week could prove interesting for ADBE. The trend over the last few weeks has been a bearish one with ADBE dropping drastically and then bouncing back to fill the gap. This oversold bounce began to fade lower as we expected it to but shares found support near the 200-dma. Currently the P&F chart is very bearish with a $39.00 target. However, short-term technical oscillators are suggesting a bullish breakout could be just around the corner. Given these conflicting signals we would not suggesting new bearish positions at this time. We are going to leave our stop loss at the $60.01 mark for now. More conservative traders might want to consider a tighter stop either near $59.00 or at $58.51 or even at $58.26. Our target remains the $55.00 region.

Suggested options:
We are not suggesting new plays at this time.

Picked on April 26 at $ 59.12
Change since picked: - 1.42
Earnings Date 06/16/05 (unconfirmed)
Average Daily Volume = 3.3 million


CDW Corp - CDWC - close: 56.37 chg: +0.58 stop: 57.26 *new*

CDWC's little bounce has brought the stock right back toward resistance near its 40 and 50-dma's and its four-week trend of lower highs. This is where the stock should fail and turn lower again. However, if it does not we want to be stopped out. Therefore we're lowering the stop loss to $57.26. Readers can use a decline back under the $55.50 level as a new bearish entry point.

Suggested options:
We are not suggesting new plays at this time.

Picked on April 24 at $ 55.68
Change since picked: + 0.69
Earnings Date 04/19/05 (confirmed)
Average Daily Volume = 920 thousand


Lehman Brothers - LEH - close: 90.24 chg: -0.86 stop: 92.80*new*

Good news! LEH displayed some relative weakness on Friday and rolled over under its 100-dma. We're a little surprised as we expected the stock to continue to bounce on Friday like the XBD broker-dealer index, which added another one percent. This bodes well for next week. Aggressive traders may want to consider new bearish positions here. We would suggest that readers wait for another drop below the $89.50 mark before buying puts. Our target remains the $86-85 range. We're expecting the $85 level, underpinned by its 200-dma, to act as support. We are lowering the stop loss to $92.80.

Suggested options:
We would suggest the June puts.

BUY PUT JUN 95.00 LES-RS OI= 243 current ask $6.00
BUY PUT JUN 90.00 LES-RR OI=2953 current ask $3.00
BUY PUT JUN 85.00 LES-RQ OI=3179 current ask $1.40

Picked on April 29 at $ 89.45
Change since picked: + 0.79
Earnings Date 03/15/05 (confirmed)
Average Daily Volume = 2.3 million


Marriot - MAR - close: 61.93 chg: -0.18 stop: 64.21 *new*

It would appear that the oversold bounce in MAR is already beginning to fade. We're even more encouraged by MAR's relative weakness on Friday after reading that CIBC issued positive comments on Friday morning suggesting that investors use the recent weakness as a buying opportunity. Looking more closely at the intraday chart we see that very short-term support near $62 broke down late on Friday afternoon. Our target remains the $60.00-58.00 range. We're lowering the stop loss to $64.21 near the 100-dma. We are not suggesting new positions at this time. However, nimble traders might want to consider another failed rally under the $63 level as a new bearish entry point. The P&F chart does point to a $55.00 target but we suspect the 200-dma near $58 will be technical support.

Suggested options:
We are not suggesting new plays at this time.

Picked on April 28 at $ 63.37
Change since picked: - 1.44
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 1.2 million


Parker Hannifin - PH - close: 59.75 change: -0.34 stop: 62.01

The recent failed rally under resistance near the $62.00 level in the last few days looks like a new bearish entry point. Plus we're seeing the technical oscillators beginning to validate this pull back and we wouldn't be surprised to see the MACD produce a new sell signal this coming week. The P&F chart is already in a sell signal pointing to the $44.00 level. We would open new bearish plays at current levels. Our target remains the $55-54 range.

Suggested Options:
We are suggesting the June puts although the May and August strikes do have more open interest.

BUY PUT JUN 60.00 PH-RL OI=318 current ask $2.35
BUY PUT JUN 55.00 PH-RK OI=128 current ask $0.65

Picked on April 28 at $ 59.08
Change since picked: + 0.67
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 1.2 million

Dropped Calls


Dropped Puts

PACCAR Inc - PCAR - close: 68.04 change: +0.95 stop: 70.01

One could still argue that PCAR is still in its two-month down trend of lower highs but we don't like the relative strength displayed on Friday. Earlier this past week we suggested that more conservative traders may want to exit if PCAR trades over $68.00 and we think that sounds like a good idea. The stock does still have resistance near $70.00 in addition to its exponential and simple 200-dma's in the $69-70 range so PCAR may end up rolling over again anyway.

Picked on April 27 at $ 66.45
Change since picked: + 1.59
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 1.0 million

Trader's Corner

Keltner-Style Divergence

Technical traders often learn to recognize price/oscillator divergence early in their trading careers. Reading any given website devoted to technical analysis turns up mentions of price/MACD or price/RSI divergence. Nested Keltner channels also display a form of divergence.

Note: Those new to nested Keltner channel analysis might review articles in the Sunday, March 20 and Sunday, May 1 Traders Corner articles for background information and chart settings.

Annotated Daily Chart of the OEX:

Prices produced bearish divergence when the blue channel could not pierce the black channel on last spring's approach. Price action proved weaker in this respect. This proved true even though a close study of the price action reveals that prices moved higher in March than they did in December. Relative to the positioning of the Keltner channels, however, price action proved weaker. In this case, the action also produced bearish price/MACD divergence, corroborating the Keltner-style bearish divergence, but regular price/oscillator divergence does not always accompany Keltner-style divergence.

Another form of Keltner divergence can be discovered on the above chart. Note that when the blue channel was retesting the upper black channel boundary in February and March, that black channel was farther away from the purple channel line than it had been on a similar test in December. That's divergence, too.

Intuitively, these divergences hint that the OEX was not as strong on the second attack of the top black channel line as it had been on the first attack of that channel line. Indeed, the second attack marked a swing high.

Annotated Daily Chart of the OEX:

A higher price high on the second swing high or test of Keltner channel lines isn't required for Keltner-style bearish divergence.

Annotated Three-Minute Chart of the SOX:

As has been apparent from the choice of different time frames for these charts, bearish divergences can be produced on a chart of any time interval. Of course, greater significance can be attributed to bearish divergence showing up on a longer-term chart than on a shorter-term one. Traders should tailor the time intervals watched to a preferred style of trading. Scalpers will watch shorter-term charts while swing or position traders will lengthen the time intervals watched. Even swing or position traders can tailor entries or exits by watching for these divergences on shorter-term charts, however.

Just as is true of other types of divergences, bearish divergences occur at swing highs while bullish ones occur at swing lows. Nested Keltner channels can also produce bullish divergences, as they do in the following chart.

Annotated Three-Minute Chart of the ES Contract

No bullish price/MACD divergence existed to show that prices might be more likely to move up toward the top black channel line than drop again to the bottom black channel line. Keltner-style bullish divergence was the only sign that might happen as prices coiled.

As with all types of divergence, whether signaled by nested Keltner channels or price/oscillator differences, divergences warn that a thrust might be losing momentum. They tell traders to pay attention. If the trend remains a strong one, that divergence can be resolved by sideways price movement, so an immediate reversal cannot be assumed. Sometimes, despite divergence, the original movement resumes.

Annotated 60-Minute Chart of the TRAN:

On this chart, the TRAN's price action failed to follow through on the clear Keltner-style bullish divergence. Traders should not act blind faith, on Keltner-style divergences alone, any more than they should with other types of divergence. However, the warning provided by Keltner-style divergences offers an opportunity to make exit or entry plans ahead of a reversal if one is to occur. Those traders employing nested Keltner channels will find this another useful tool.

Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.


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