Option Investor

Daily Newsletter, Thursday, 05/19/2005

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Table of Contents

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

Market Wrap

A Day for a Snooze

A Day for a Snooze

After overnight futures barely budged in a very tight trading range, today's trading didn't do much better. But the bulls have to be happy--we've had a very strong week this week after bouncing hard off last Friday's low and the positive consolidation today looks bullish. The rally this week was the largest 3-day rally since last November. There are some mixed chart signals about how much more bullishness we can expect but the bulls have thrown a nice party this week. Today was a snoozer and with all the choppy price action we saw it was a market better left untraded. If you're long the market it looks like you should stay there but tighten up your stops. If you're short the market you might have to sustain a little more negative pressure but I think your turn is coming soon.

The morning started with a couple of economic reports that just fed the market another sleeping pill. There was barely a ripple in the pre-market futures as the jobless claims numbers were posted. The number of workers filing state unemployment claims fell 20,000 to 321,000 in the week ending May 14th, a drop that was larger than forecast. The estimate was for only a small drop to 331,000. The previous week's claims were raised slightly higher to an increase of 5,000 to 341,000 compared to the estimate for a gain of 4,000. The 4-week moving average of new claims rose by 5,500 to 329,750 while the 4-week average of continuing claims dropped by 7,500 to a 4-year low of 2.58M.

Also before the bell there was news out about Greenspan laying down more warnings at a housing conference in Atlanta (via satellite) about the vulnerability of our mortgage industry. The two largest government-sponsored entities (GSEs), Fannie Mae (FNM) and Freddie Mac (FRE), were specifically cited by Greenspan as needing some tighter fiscal controls from Congress (and this from a Congress which doesn't understand the meaning of tighter fiscal responsibility). Greenspan might as well be talking to a brick wall but at least he puts himself on record as having issued the warnings. No one can say this man is dumb. Inflated ego and a political animal? Yes. Dumb? No. He basically told Congress they should rein in the unrestrained growth of the portfolios at Fannie Mae and Freddie Mac, stating "Huge, highly leveraged GSEs subject to significant interest-rate risk are not conducive to the long-term financial stability that a nation of borrowers requires." That statement in a nutshell is the huge risk that our banking industry faces. And as we all know, this country is up to its eyeballs in debt and that banking fiascos in the past have caused major "disruptions" in the stock market.

We then had the Philly Fed Index numbers come out at 12:00 and that forced another sleeping pill down the market's throat. Even though the numbers were awful, the market was too sleepy to notice. The Index came out at 7.3 versus 17.9 expected--growth but anemic and slowing down from previous months. This compared to 25.3 in April. The shipments number was 15.0 versus 20.3 expected, new orders 15.0 versus 20.3, employment 5.4 versus 16.8 and prices received 15.7 versus 28.0. These poor numbers reinforce the poor numbers we heard from the NY Empire index 3 days ago which were at their lowest level since April 2003. These numbers are not heading in the right direction but the market just doesn't care right now--it has an agenda and that is to push the market higher. It's just another example of how news doesn't drive the market, but instead it is investor mood that causes the swings in the market. It's getting close where fear will again become the stronger emotion and even good news will get sold.

At 10:00am we got the April leading indicator numbers and these numbers try to project economic performance over the next 3-6 months. It fell -0.2% as expected and was the 4th consecutive monthly decline and the 8th decline over the past 11 months. And yet we still hear economists reporting what strong and robust growth we're experiencing in our economy. It's no wonder the economists are typically wrong in their forecasts--they typically view things in the rear view mirror and try to guess where they're driving. If you're on the road with them (trying to trade their signals) you're going to have a crash. The reaction from the market to this continued poor growth news was just another ho hum, don't both me, I'm napping. In actuality this number rarely moves the market because it's pretty much known what it's going to be by the many different measurements that go into that number that have been previously reported. It's a lagging indicator, as most are, which is why I use the rear view mirror analogy.

Comparing the same charts with the ones from a week ago shows a bullish surprise considering the amount of resistance the market was up against. So we're left trying to figure out how much higher.

DOW chart, Daily

The DOW is at an interesting point. The internals of the move point to a strong possibility that we could see the DOW rally up to 10,600 before it runs out of steam. As shown on the chart, that would take it up to the top of a parallel down-channel for the price action since the January 2005 low and the March high. Also located at the 10,600 level is the price support/resistance line identifying previous highs and lows. But notice the broken uptrend line from March 2003 through the October 2004 low. The DOW broke below this line in the April plunge and has since been in a very corrective (overlapping highs and lows) climb back up to the line. Support turned resistance could be playing out here if the DOW is unable to climb back above the line (near 10,515). In other words it could be getting ready to give the line a kiss goodbye. Watch this level carefully.

SPX chart, Daily

Like the DOW, the SPX looks like it's going to try to get up to the top of its parallel down-channel. There is a line across the highs from April 25th that crosses this line near 1200. If the DOW manages to rally up to 10,600 then the SPX will certainly rally up to 1200 so there is good correlation there.

Nasdaq chart, Daily

The Nasdaq looks the most bullish right now. It has broken above both the top of its parallel down-channel and the uptrend line from October 2002 which it had broken below back in April. There's very little resistance until 2100. If the market is going to pull back first, watch for support around 2025. Watch the SOX for some clues also--that one could be running into resistance again.

SOX index, daily chart

The SOX gave us one big head fake by breaking below its longer term uptrend line from October 2002. It then climbed back above that line and barely hesitated at either one of its 200-dma's. An index on a mission! It got close to its next potential resistance level at the downtrend line from January 2004, currently near 425. The oscillators are overbought so it's questionable how much energy is left to penetrate this line of resistance. I would take a stab at shorting this index (SMH puts) if it tags the line.

Last week's charts left me with a bearish feeling which is very likely the very reason we got such a strong rebound over the past week. It's a very typical and perverted market response--when so many are leaning one way, and I know there were many who were interpreting the charts as bearish (considering the strong resistance we seemed to be facing), the boat tends to tip over. You then get a bunch of traders scrambling to get their life preservers on (stop out of their positions) and in this case we got a lot of short covering. The very large market players know how to play this game and they are masters at setting up the market to create these moves. Or at least they know how to take advantage of it and helped in the buying in this case.

The market is getting a little overcooked to the upside but I wouldn't be the least bit surprised to see some resistance levels get broken to the upside which will create over enthusiasm for stock ownership. We'll probably hear the table-pounders screaming at us to buy stocks and to not let the train leave the station without us. The upgrades will start coming out fast and furious. In the background the big players will be quietly unloading to the retail traders and many large hedge funds will be building their portfolios of shorting candidates. When it turns back down it could be just as swift, if not swifter, to the downside. The volatility is obviously increasing over what we saw in 2004 and it's likely to get more volatile, not less. So be careful and don't be afraid to take profits early.

Stock news was relatively quiet today. A merger here (America West wants to buy US Airways), a buyout there (Ripplewood Holdings to acquire Maytag Corp for $2.1B), a stock buyback announcement (Motorola to buy back $4B or 10% of its stock over the next 3 years), a business exit from one to benefit another (Walmart to exit the online DVD rental business and direct customers to Netflix), a downgrade (Fords debt status to BBB), and renewed interest in junk bonds (buyers wanting to own GM's). The slight recovery in the price of oil helped the oil service index climb to the top of the sector list in the green today. Oil is at a potentially important support level.

Oil chart, June contract, Daily

As expected, oil continued its decline to its uptrend line and 200-dma's, around $47. There was no hard bounce from this level so we're left to wonder whether we'll just get a pause at this level before continuing lower or if we'll at least get a rally back up towards the top of its steep down-channel, the top of which is currently near $50.50. If it meanders its way back up, the $50 level could provide resistance. The bottom of this steep down-channel is another $2 lower near $45. Switching over to the July contract, which we'll do next week, shows the uptrend line and 200-dma both about $2 lower so I wouldn't be surprised to see oil drop a little lower.

Oil Index chart, Daily

Other than the small bounce over the past couple of days the oil index has been following the price of oil and it too looks like it might work its way a little lower before finding a firmer floor. Both its uptrend line and 200-dma are closer to 420-425 and I would look to the 425 area to start nibbling on some long positions in your favorite stocks in this index.

Transportation Index chart, TRAN, Daily

The Trannies look downright bullish. This index broke above its downtrend line from the March high and closed above its 50-dma today. An internal Fib projection for the move up matches potential resistance at the 62% retracement of the March-April decline at 3688. But the form of the bounce (corrective) leads me to believe the rally from the April low is counter-trend and once it's finished we should see this index turn back down and head for new lows.

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

Like the Trannies, the home construction index has had a nice week. But also like the Trannies, and the broader market in general, the bounce from the April low looks very corrective. This has counter-trend bounce written all over it. The parallel channels for this index have done a good job at identifying support and resistance (other than the brief breakout in January and February) and price has bounced up to the top of its longer term up-channel. Watch to see if it's hitting resistance here.

U.S. Dollar chart, Daily

After breaking above resistance near $85.40 the dollar looks to be consolidating and getting ready for another push higher. The top of its current parallel up-channel is near $87.50 and rising and that could be where this is headed.

Gold chart, June contract, Daily

For you gold bugs, there could be a little more pain if the US dollar is going to rally further. When the dollar broke resistance, gold broke down below its long term uptrend. It hasn't been able to bounce back up for a retest but if it did (about 427) I'd be a seller. Watch the dollar at the same time for clues about where gold may be headed. Right now gold looks bearish.

Sector action saw the energy indexes at the top followed closely by the internet and computer indexes. Those in the red were few today but were led by the gold and silver index and the financial indexes.

We've had a very bullish week and today marked the 4th up day even though today was more of a consolidation day than anything else. But when we have days of consolidation following a strong move it's usually good for the existing trend, in this case that would be up. Those who wanted to take profits today were met by those who wanted in on the bullish party (the late comers). From an Elliott Wave standpoint, the next push higher is to be the 5th wave of the move up from May 13th. These 5th and final waves tend to have much weaker breadth than the preceding move (the 3rd wave is the strong 3-day rally we just finished). They're risky to trade because the buying, in this case, can suddenly stop and then the sellers overwhelm the buyers. The Fibs and resistance levels point to the possibility we'll see another 100 points up in the DOW. Or it could fail with a minor new high tomorrow. If you're long I would pull stops up to yesterday's/today's lows since the larger pattern of the decline points to a potentially hard move down right around the corner. The more I hear pundits screaming for me to buy this market the more bearish I will feel. Ideally we'd like to hear lots of reasons to worry about this rally so that we have a better chance of seeing it continue. With the expected higher volatility it will either require you to withstand large swings against your position, and potentially giving up your profits, or you'll need to be more of an active trader and enter and exit a little more aggressively. Be careful out there.


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Amerada Hess - AHC - close: 91.31 chg: +2.23 stop: 86.25

Energy-related stocks managed to rally anyway despite another decline in crude oil prices on Thursday. The sector's strength is partially due to yet another broad-market rally and an analyst comment suggesting the recent dip in energy stocks is a buying opportunity. The move over the $90.00 level in shares of AHC does look like a bullish entry point. Our short-term target is the $94-95 range.

Picked on May 17 at $ 89.41
Change since picked: + 1.90
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 1.6 million 


Caterpillar - CAT - close: 93.50 chg: -0.02 stop: 89.00

Thursday was a neutral session for shares of CAT. Now that the Dow is up four days in a row we would look for a dip. Readers can watch CAT for a dip toward the $92 level as a bullish entry point. 

Picked on May 18 at $ 92.35
Change since picked: + 1.15
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.8 million 


Federated Dept Stores - FD - cls: 68.94 chg: +1.00 stop: 64.45*new*

Another round of positive earnings results in the retail sector and some positive comments from an analyst helped boost FD to yet another new high. Volume continues to come in above average. Shares are nearing our target and what could be round-number resistance at the $70.00 level. More conservative traders may want to plan an early exit in the $69.50-70.00 range. We will plan to exit if FD trades in the $69.95-70.00 range. The stock is short-term overbought and we're not suggesting new positions. We are raising the stop loss to $64.45.

Picked on May 17 at $ 66.60
Change since picked: + 2.34
Earnings Date 05/11/05 (confirmed)
Average Daily Volume = 2.9 million 


Hovnanian - HOV - close: 57.09 chg: +0.64 stop: 52.49 

No change from our previous update on 05/18/05. Our target is the $59-60 range. 

Picked on May 06 at $ 54.26
Change since picked: + 2.83
Earnings Date 05/31/05 (confirmed)
Average Daily Volume = 1.2 million 


Invitrogen - IVGN - close: 79.68 change: +1.08 stop: 74.85 

IVGN came within three cents of hitting our target at the $80.00 mark today. We hope some of the more conservative readers out there took our suggestion yesterday to exit early as IVGN approached the $80.00 level at what could become round-number resistance. We are not suggesting new bullish positions as we plan to exit once IVGN hits our target. Consider the following, the markets are up strongly over the last few days and IVGN is also looking overbought now up five weeks in a row. We are probably going to exit this play tomorrow at Friday's close even if IVGN does not hit our $80.00 target. 

Picked on May 03 at $ 75.51
Change since picked: + 4.17
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 888 thousand 


Eli Lilly - LLY - close: 59.94 change: -0.42 stop: 57.99 

The DRG drug index was one of the few sector indices that did not close positive on Thursday. This weighed on shares of LLY, which closed under the $60.00 level. However, as we suggested on Wednesday, LLY dipped just low enough on Thursday to fill the gap from Wednesday morning and the stock was rebounding by the late afternoon. We would still consider bullish positions if LLY trades over $60.00. More conservative traders may want to wait for a new relative high over $60.90 or 61.00 before considering new positions.

Picked on May 04 at $ 60.15
Change since picked: - 0.21
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 4.7 million 


Reynolds American - RAI - cls: 82.70 chg: +0.09 stop: 77.95

No change from our previous updates. Our target is the $85-86 range. 

Picked on May 16 at $ 81.31
Change since picked: + 1.39
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 866 thousand 

Put Updates

L-3 Comm. - LLL - close: 68.13 chg: -0.46 stop: 69.55 

Shares of Titan (TTN) rose strongly today on news that the company might be purchased LLL. The fact that LLL only lost 46 cents today seems to confirm some analysts' thoughts that the market will bless any such deal and both companies' stocks could rise if an acquisition is announced. This raises the risk for bears and traders should keep this in mind. LLL is still under technical resistance but we're not suggesting new put plays here.

Picked on May 10 at $ 68.01
Change since picked: + 0.12
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 855 thousand 


MGIC Invest. - MTG - close: 59.98 change: -0.09 stop: 61.11

No change from our previous update on 05/18/05. We're encouraged that resistance seems to be holding at the top of MTG's declining channel.

Picked on May 15 at $ 58.91
Change since picked: + 1.07
Earnings Date 04/14/05 (confirmed)
Average Daily Volume = 742 thousand 


Precision Castparts - PCP - cls: 75.03 chg: -0.13 stop: 75.05

No change from our previous update on 05/15/05. We are waiting for PCP to breakdown below support near $72.00 and hit our entry point at $71.95. 

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: - 0.00
Earnings Date 05/03/05 (confirmed)
Average Daily Volume = 492 thousand 


Parker Hannifin - PH - close: 60.38 change: -0.10 stop: 62.01

No change from our previous update on 05/18/05.

Picked on April 28 at $ 59.08
Change since picked: + 1.30
Earnings Date 04/18/05 (confirmed)
Average Daily Volume = 1.2 million 

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