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Daily Newsletter, Tuesday, 05/10/2005

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Table of Contents

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

Market Wrap

Rumors Pressure Conviction

05-10-2005

High

Low

Volume

Adv/Dcl

DJIA

10281.11

-103.20

10382.94

10250.23

1.87 bln

1023/2196

NASDAQ

1962.77

-  16.90

1971.25

1957.29

1.63 bln

1002/1985

S&P 100

555.21

-    6.11

561.32

553.54

Totals

2025/4181

S&P 500

1166.22

-  12.62

1178.84

1162.98

 

 

SOX

394.43

-    4.10

398.16

392.85

 

 

RUS 2000

595.04

-    7.87

602.91

593.86

 

 

DJ TRANS

3498.56

-  60.50

3555.75

3487.23

 

 

VIX

14.91

+    1.16

15.11

14.03

 

 

VXO (VIX-O)

14.17

+    1.56

14.75

13.54

 

 

VXN

18.11

-    0.26

18.34

17.75

 

 
Total Volume

3,780M

 

 

 

 

 

Total UpVol

781M

 

 

 

 

 

Total DnVol

2,870M

 

 

 

 

 

Total Adv

2336

 

 

 

 

 

Total Dcl

4782

 

 

 

 

 

52wk Highs

142

 

 

 

 

 

52wk Lows

179

 

 

 

 

 

TRIN

2.14

 

 

 

 

 

NAZTRIN

1.33

 

 

 

 

 

PUT/CALL

0.84

 

 

 

 

 

Despite several days of gains the conviction of buyers was tested as rumors of another Long Term Capital type of hedge fund failure filtered through the markets. Impact to hedge funds from the GM events of last week became the subject of much speculation as large trades were seen being unwound in global markets. Regardless of any truth behind the rumors it was simply a case of a lack of conviction that contributed to the drop.

Dow Chart - Daily

Nasdaq Chart - Daily

The rumor making the rounds suggested that a major hedge fund, GLG, was in serious trouble on a GM trade. There were many funds in the arbitrage trade in question, which was to be long the GM bonds and short the stock. The theory being that one side would offset a move in the other. The Kirk Kerkorian news last week spiked the stock +$5 and that spike has held. The following day S&P slashed the debt rating for GM. With GM soaring and its bonds collapsing those in the arbitrage trade were getting killed on both sides. Some of these positions were very large and fears of another Long Term Capital meltdown caused traders to run for cover. With Cisco earnings on tap as the after hours earnings headliner there was additional risk for techs.

Bonds soared on a flight to quality on fears of the unknown. While GLG was the name most mentioned in the rumor the real fear is that there could be a domino effect where the unwinding of large positions could move prices far enough to cause other funds to blow up as well. When large positions need to be unwound in a hurry it requires somebody to take the other side of the trade. Once the smell of blood starts to creep into the market the players who would normally be buyers tend to move to the sidelines until the smoke clears. This removes liquidity from the market and intensifies the problem. Funds then have to broaden their asset sale to raise cash to cover shortfalls. This could have been another factor in today's drop as equities were sold to raise cash. When rumors surface about hedge fund liquidity those high net worth investors are not bashful about withdrawing their cash. Memories of LTCM are vivid and nobody wants to be the last investor left holding the bag.

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With 8000 hedge funds holding over $1 trillion in assets there is plenty of risk if more than a few firms find themselves on the wrong side of the same trade. Many if not most are highly leveraged, which increases the risk. You may remember that LTCM was leveraged 100:1. This means for every $1 of assets they had $100 in risk. Much of that risk comes from borrowed money. Few if any firms are leveraged to that extreme today after several rounds of rule tightening but there is still extreme risk to the derivates market. Financials dropped on Tuesday as fears mounted that the majors could be exposed to credit risks from large funds in trouble. Deutsche Bank (DB) fell -2.67 on news that they were a lender to a large hedge fund in serious trouble. GS, BSC and LEH were also hammered on these worries.

I personally believe the market drop was simply a lack of conviction by last week's buyers. These fair weather buyers abandoned ship at the first sign of trouble. We have repeatedly seen weak advances on low volume with resistance holding firm for the last four sessions. Monday's advance was on the highest up volume we have seen in a week but the total volume was barely 3.5B shares. Today's numbers were 4:1 declining over advancing with volume of 3.8B shares. Still light but very lopsided in favor of decliners.

The techs may have declined on rumors but with Cisco earnings after the close there may have been a little added concern. Cisco did announce earnings that beat the street with a slight beat in revenue as well but there was little excitement. Cisco guided analysts to an increase of +9% to +11% sales for the current quarter. This was slightly over analyst estimates but far from that needed to produce a buying frenzy.

Dreamworks Animation (DWA) was knocked for a loss around 1:30 when news broke that employees had been told of a coming earnings miss. The stock fell -2 to $36.50 (-5%) on the news but that was just the start of a serious problem. After the bell DWA reported earnings of 44 cents when analysts were expecting 58 cents. When DWA reopened for trading after earnings it dropped another -7 to close at $29.70 and well off the day's high at $38.79. Disappointing sales of the Shrek 2 DVD was blamed with a large number of returns from retailers.

The transports were knocked for a loss after Delta filed a 10K saying they would not have enough cash to make it through 2005 without major concessions from their debt holders. They projected a continuing substantial loss and blamed a lot of their troubles on oil prices. Delta was forced to sell their fuel hedges in an earlier crisis to raise cash and are currently unhedged against high oil prices. They said for every penny per gallon of price increase in jet fuel they would lose an additional $25 million dollars. With oil climbing to a high of $53.15 today before retreating a buck into the close the odds of lots more red ink at Delta are very good.

Crude Oil Chart - Daily

Ten-Year Note Index - 2 min

The OPEC Secretary General was on CNBC today repeating the OPEC party line that there was plenty of oil in the system. He said OPEC produced about 30 million bpd in April and currently have 8.8% of spare production capacity. He said spare capacity in Q2 should rise to 9.1% and 10.9% in Q3. He said OPEC had projected demand to grow +1.89 mbpd in 2005. He also pointed out that OPEC countries were going to invest more than $100 billion over the next five years to increase production by 4-5 million bpd. You might wonder why they are on such a crash program if they already have so much spare capacity? The answer is clear and twofold. Truth is a rare commodity in OPEC where lying has become an art form to justify production allocations and increase the perceived status of each country. Secondly, as I continue to point out in my articles, much of the oil they produce is not the grade of oil the world needs. You could have 50% spare capacity in sour crude and not be able to give it away. The world relies mostly on the light sweet crude for its fuel needs and this is the commodity in short supply. When listening to any OPEC spokesman it is easy for them to confuse the issue because the reporters don't know what questions to ask. So far the 100-day average at $50 has held as support but inventories are continuing to build. Until gasoline consumption ramps up next month we could continue to see inventories increase. That means we may still have a retest of that $50 level in our future but any dip under $50 is still a buying opportunity.

Commodity stocks fell hard after several downgrades hit the steel sector. Falling sales prices and higher raw material prices are seen to be pressuring profits. More importantly it appears that demand is slowing. If that is the case then it could suggest the global economy is slowing and that raises a lot of other issues. The American Iron and Steel Institute said steel production had dropped -10% since April 2004. German giant ThyssenKrupp announced a -10% production cut for Q2 in an effort to counter a downward price trend. Mittal Steel Co. the world's biggest manufacturer, said consumption in the United States was suffering from "an inventory overhang." US Steel dropped -2.94, NUE fell -2.63, STLD fell -1.50 and is only a couple ticks from a new 52-week low. Ironically STLD and NUE officers made very positive comments about the industry and their outlook just this morning.

Internet stocks have suffered several setbacks this week. JOBS, the China employment site dropped to $13.80 this week from Friday's close at 20.44. They reported only a minimal rise in earnings and much higher expenses. PCLN fell -10% to $23.50 after posting earnings that disappointed. TOO broke support at the 200-day average and fell to a new five month low at $22 on no news. EBAY slipped back under $33 and its weeklong bounce appears in danger of being erased. YHOO fell back to support at $34 and appears ready to violate its recent uptrend. However, YHOO claims they have an Apple killer in the works and will announce its new music download service on Wednesday. They will charge $6.95 per month for unlimited downloads of more than one million songs.

For the broader indexes the weeklong bounce appears to be fading. The Dow resistance at 10400 held on Friday and we have see a pattern of lower highs as this week unfolds. Today's lower low came after three days of stagnation just below that 10400 resistance. Support remains in the 10000-10100 range and that gives us plenty of room to wander with no real market moving economic reports to trip over until Friday.

The Nasdaq actually held support at 1960 despite the -17 point loss. This is a bullish sign but it is also fighting a strong downtrend line from January. With techs normally weak over the summer months this relative strength today in the face of the Dow drop was encouraging. The Cisco news was a mixed blessing with slightly higher earnings and guidance. They benefited from several big deals with British Telecom, Sprint and Merrill Lynch that help them produce those results. Overall the +10% guidance for the current quarter was higher than analysts expected but less than exciting. CSCO rose and fell in after hours and ended just about even. This should be neutral to the market but then without any CSCO excitement to pump up the market the fear of summer could hit soon. Chambers will be on CNBC tomorrow morning and he always tries to paint a positive picture so anything is possible. The SOX is clinging to the 395 level and refusing to drop and that always provides comfort to tech bulls.

The S&P futures took a dive after CSCO reported to trade at 1164.25 but have recovered slightly to 1166.50 and even for the session. This suggests the knee jerk reaction to the hedge fund story has not developed into a tsunami, yet, and there is nothing on the horizon tonight that spells doom for the bulls. I do not believe the hedge fund story is over yet. The WSJ said they were updating their hedge fund report with a new article in tomorrow's edition that will name names and provide more details. This could calm troubled waters or churn them up into whirlpool status.

On Sunday I suggested shorting any bounce to resistance on Monday/Tuesday and I hope everybody took that advice. I don't see any catalyst that could push us over Dow 10400 but if lightning strikes we have much stronger resistance at 10500. I would continue to be wary of any bounce and my bias is still negative until that resistance breaks. We had a nice rebound from the April lows but buyer conviction is still very weak. Until the bulls find enough courage to put some volume on the board any rally is likely to fail.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None LLL

New Calls

None today.
 

New Puts

L-3 Comm. - LLL - close: 68.01 chg: -1.93 stop: 70.55

Company Description:
Headquartered in New York City, L-3 Communications is a leading provider of Intelligence, Surveillance and Reconnaissance (ISR) systems and products, secure communications systems, aircraft modernization, training and government services, and is a merchant supplier of a broad array of high technology products. Its customers include the Department of Defense, Department of Homeland Security, selected U.S. government intelligence agencies and aerospace prime contractors. (source: company press release)

Why We Like It:
That's an interesting reaction. This morning LLL announced it has won a $50 million contract from the TSA and the stock sinks. The one-year contract is renewable and worth upwards of $250 million. Yet shares of LLL lose 2.75 percent on volume about three times the average. Furthermore LLL has broken down to a new four-month low and broken below technical support at its 200-dma. Technical oscillators are naturally bearish and its P&F chart points to a $63 target. Looking more closely chart readers will also see that LLL broke its almost two-year up trend a couple of weeks ago and the stock has arguably produced a double-top. We feel that today's decline makes a tempting entry point to buy puts. There is a chance that LLL will produce a short-term oversold bounce tomorrow but we'd expect the 69.50-70.00 range to act as overhead resistance. Readers can use a bounce towards this area as a new bearish entry point as well. Our target is the $63-62 range.

Suggested Options:
We are suggesting the July puts although June strikes are available.

BUY PUT JUL 70.00 LLL-SN OI=1964 current ask $3.80
BUY PUT JUL 65.00 LLL-SM OI=1069 current ask $1.55

Picked on May 10 at $ 68.01
Change since picked: + 0.00
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 855 thousand
 


Play Updates

In Play Updates and Reviews

Call Updates

Avalonbay - AVB - close: 74.22 change: +0.07 stop: 71.99*new*

AVB continues to show relative strength with another gain today albeit a small one. No change from our previous update on 05/08/05. We are preparing to exit in the $75-76 range. More conservative traders can exit early at current levels. We are raising the stop loss to $71.99. If you're feeling cautious consider a stop loss under the simple 10-dma near $72.50.

Picked on April 24 at $ 70.05
Change since picked: + 4.17
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 345 thousand

---

Chubb Corp - CB - close: 82.65 chg: -1.40 stop: 79.49

Insurance stocks were hit pretty hard today lead by another decline from Dow-component AIG. Shares of CB lost 1.66 percent but remain above the $82 level near its 10-dma, which could act as short-term support. We see no change from our previous update on 05/08/05.

Picked on May 01 at $ 81.78
Change since picked: + 0.87
Earnings Date 04/25/05 (confirmed)
Average Daily Volume = 1.2 million

---

Coventry Hlth Care - CVH - close: 68.73 chg: -0.88 stop: 66.99

We are still on the sidelines waiting for CVH to breakout over resistance at the $70.00 mark. Our entry point to go long is at $70.51. However, if the major market indices are trending lower then traders may not want to initiate new bullish positions even if CVH trades to our trigger.

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

---

Golden West Fincl - GDW - close: 63.22 chg: -1.33 stop: 60.95

The action in the banking sector does not look healthy today. Tuesday's market decline lead GDW to a two-percent loss. GDW's short-term oscillators do not look healthy either. We are not suggesting new bullish plays. More conservative traders may want to exit early to avoid any losses.

Picked on April 26 at $ 62.55
Change since picked: + 0.67
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 1.3 million

---

Hovnanian - HOV - close: 53.42 chg: -0.79 stop: 49.99

After a multi-day run up the housing sector finally hit some profit taking and HOV was not immune. The stock lost 1.45 percent. We would watch for a pull back toward the $52.00-52.50 region and then look for a bounce as a new bullish entry point.

Picked on May 06 at $ 54.26
Change since picked: - 0.84
Earnings Date 03/02/05 (confirmed)
Average Daily Volume = 1.2 million

---

Invitrogen - IVGN - close: 76.52 change: +0.20 stop: 71.49

We are a little bit disappointed that IVGN, while closing in the green on a down day, still under performed the BTK biotech index. The BTK was the only major sector index to close higher and it did so with a large two-percent gain. We remain bullish and see no change from our previous update on 05/08/05.

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: 59.13 change: -0.63 stop: 57.49

We have been expecting LLY to pull back toward the $59 or $58 levels so today's decline is not a surprise. Readers can be patient and just wait to see where LLY bounces before considering new bullish positions.

Picked on May 04 at $ 60.15
Change since picked: - 1.02
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 4.7 million

---

Reynolds American - RAI - cls: 78.82 chg: -0.30 stop: 77.95

We remain on the sidelines here. RAI lost ground today with the market's decline. Our entry point to go long is at $81.31.

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

---

Research In Motion - RIMM - cls: 70.72 chg: +0.70 stop: 66.85

Ding! RIMM has hit our trigger to buy calls at $70.51. The stock also confirmed yesterday's breakout over the $70.00 level while also closing over its simple 50-dma. We're even more impressed with today's gains considering the weakness across the market. Fueling the move were comments from RIMM. The company said they plan to offer its Blackberry service in Africa, S. Asia, and the Middle East. Management also said the three millionth subscriber milestone was just the beginning and the company is projecting up to ten million subscribers. Remember this is a high-risk play and the risks are growing now that the NASDAQ is beginning to struggle under resistance near the 2000 level.

Picked on May 10 at $ 70.51
Change since picked: + 0.21
Earnings Date 04/05/05 (confirmed)
Average Daily Volume = 1.7 million
 

Put Updates

Lehman Brothers - LEH - close: 88.83 chg: -3.09 stop: 92.80

The volatility in shares of LEH continue. The stock has produced another reversal and this time it's bearish, which is of course a positive for us. The stock has fallen back under the $90.00 mark on volume well above average suggesting more weakness ahead. Readers can use this as a new bearish entry point. Our target remains the $86-85 range.

Picked on April 29 at $ 89.45
Change since picked: - 0.62
Earnings Date 03/15/05 (confirmed)
Average Daily Volume = 2.3 million

---

Marriot - MAR - close: 61.65 chg: -1.00 stop: 64.21

MAR has produced a failed rally at its simple 10-dma and is now back under very short-term support near the $62.00 level. Our target is the $60.00-58.00 range.

Picked on April 28 at $ 63.37
Change since picked: - 1.72
Earnings Date 04/21/05 (confirmed)
Average Daily Volume = 1.2 million

---

Parker Hannifin - PH - close: 59.06 change: -0.91 stop: 62.01

PH continues to sink following last week's failed rally at resistance. If you missed the entry point a couple of days ago today's decline looks like another entry point for new bearish plays. No change from previous update on 05/08/05.

Picked on April 28 at $ 59.08
Change since picked: - 0.02
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 1.2 million
 

Dropped Calls

Nucor - NUE - close: 53.65 chg: +0.13 stop: 49.95

We have run out of patience for NUE. The play was never opened as we waited for shares to breakout over resistance at the $55.00 level and its 100-dma. Today's decline of 4.9 percent was fueled by a downgrade from Keybanc from "aggressive buy" to a "buy" and a negative research report on steel from CSFB, who is worried about a soft patch for steel prices, especially in Europe.

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
 

Dropped Puts

None

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