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Daily Newsletter, Monday, 06/13/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Options 101

Market Wrap

Op-ex Week Kickoff

Op-ex Week Kickoff

This month's option expiration week began with a whimper, with light volume and, save for one hour this morning, quiet rangebound trading. The markets opened within Friday's range, chopped sideways-lower, then launched at 10AM, peaking just past 11AM, following which a slow grind lower ensued.

As is so often the case during op-ex week, most of the moves today seemed to be false and in the end, the net change for the day was minimal. The big story was the in the currency markets as the US Dollar hit nine month highs against the Euro and Yen. The US Dollar Index surged as European Central Bank chief Otmar Issing told a reporter that soft growth in Europe could prompt the ECB to cut European rates. This effect was compounded by comments from Philadelphia Fed President Anthony Santomero in a speech on Saturday to the effect that US rates may continue rising at a measured pace, and Greenspan's similar comments last week.


In equities, the internals started negative-to-mixed and spent most of the day in positive territory, with volume breadth finishing 2.1:1 in favor of advancing NYSE volume and 1.45:1 in favor of advancing Nasdaq volume. Overall, however, volume was light, as it has been for most of the past month. The combined NYSE and Nasdaq total fell way short of 3 billion shares at 2.74 billion. QQQQ came in 10 million shares below its average daily volume of 92.5 million.

Daily Dow Chart


The Dow rose as high as 10589 on the morning blast, only to settle back to a gain of 10 points at 10522. The 10474 low came just after the cash open. Today's tall doji star resulted in yet another confirmation of the 150 point range that has prevailed for the past month, with price continuing to hug the 10500 level. Op-ex week is usually a bad time to expect a significant range break, as option writers attempt to steer the price toward whichever strike will allow their short contracts to expire worthless. Unfortunately for bears, the current range has so far coincided with the ongoing daily cycle downphase, which appears to be entirely corrective. If this sideways range is the extent of the daily cycle's downward force, then the next upphase could pack a wallop. 


Daily S&P 500 Chart


The SPX fared better today, adding 2.71 points to close at 1200.82. The opening dip bounced from 1194.51, failing at a high of 1206.03. 1194 has held for a number of tests this month, with 1192 the current range bottom. As with the Dow, the downside has been minimal despite the daily cycle sell signal that printed at the beginning of the month. I would expect a break of either end of the range to be directional if confirmed by a surge in volume- so far, volume has been in very short supply since last month.

Daily Nasdaq Chart


Nasdaq bears are faced with an even narrower range, with 20 points separating today's high and low. Today's candle mostly overlapped all of last week's range. If indeed the Nasdaq will be held in this area for Friday's op-ex print, we can only hope that there will be more range within which to work before then. So far, the past week has been a fine example of "tractor-beam" trading, except that it appears to have commenced a week early. Beyond the 2060-80 range, upside resistance is at 2095-2100, support at 2040 and 2025.

Chart of QQQQ with $QQV overlay


In last week's Market Wrap, I correlated the ratio of QQQQ to the QQQQ volatility index (QQQQ:$QQV) with recent tops and bottoms for QQQQ. I've tried a different format and came up with a different but similar relationship, with the QQV (NDX volatility index) overlaid in blue on a daily chart of the QQQQ, with trendlines applied to the QQV's range. Note how the trendline touches corresponded with recent tops and bottoms for QQQQ. This relationship is not perfect, as we saw with the signal in December. But during the past year, the two upper trendline touches for the QQV have coincided with relative lows for the QQQQ, the lower trendline touches with relative highs. Obviously, it remains to be seen whether such will prove to be the case with the beginning-of-June QQQQ high. 

Daily TNX Chart


The Treasury auctioned $32 billion today comprised of $17 billion in 13-week bills and $15 billion in 26-week bills. The 13-week bills had a high yield of 2.975%, and a bid to cover ratio (the ratio of bids tendered to bids accepted) of 2.16. The 26 week bills generated a high rate of 3.12, with a bid to cover ratio of 2.16. Foreign central banks took $4.78 billion of the 13-week bills and $3.88 billion of the 26 week bills, or $8.6 billion of the $32 billion auctioned today. This was back into a normal range after the weak 10% participation seen in last week's ten-year note auction.

Ten year treasuries were weak at the open, with the ten year note yield (TNX) gapping higher and holding the bulk of its gains throughout the session to close +3.9 bps at 4.086%. Above 4.09%-4.1%, next resistance is at 4.14%-41.6%.

Chart of Crude oil


Associated Press reported that OPEC is considering another quota increase of 500,000 barrels per day (bpd) to bring the limit to 28 million barrels per day. However, with current production in the vicinity of 30 million bpd, the move is of limited significance, and intraday prices remained firmly positive following the announcement. Current global demand is estimated by the IEA at 84.3 million bpd. The June OPEC meeting is scheduled for this Wednesday in Vienna.

Crude oil rose throughout the day to peak at a high of 55.775 just before the close, breaking descending upper resistance on what appears to be a pennant at the top of the May rally. Pennants generally being continuation patterns, the upside breakout could presage a bullish trending move for the toppy daily cycle. Above the pennant apex to 53.50, the bias remains to the upside. For the day, July crude oil gained 2.075 to close at 55.625.

There were no economic reports released today, but it's scheduled to be a much heavier week than last week, with Retail Sales and the PPI tomorrow, the CPI, Industrial Production and Capacity Utilization as well as the Fed's Beige Book on Wednesday, Housing Starts and Building Permits, Initial Claims and the Philly Fed on Thursday, and the Q1 Current Account and Michigan Sentiment on Friday.

It was a very quiet day for corporate news as well. The big story was an announcement from Morgan Stanley (MWD) on the departure of current CEO Philip Purcell. Purcell will leave as soon as a successor can be found but in any event no later than the next annual meeting. The stock rallied on the news overnight as rumors of his departure circulated. This news was followed up with a profit warning for fiscal Q2, as the company now expects earnings for the quarter to come in 15%-20% below Q2 2004. The firm cited poor market conditions for the warning. 

Notwithstanding, MWD held its gains throughout the session, despite a soap-opera's worth of stories as to whether Purcell retired or was fired, with Challenger & Gray characterizing his ouster as a "mutiny" to illustrate the exigencies to which CEOs can be subjected. Marketwatch estimates that Purcell can expect to receive as much as $62.3 million for his termination, in addition to equity, stock options and pension benefits totaling just over $60 million. Exigencies indeed. But the fact that this story made headlines throughout the day underscores how thin a news day it actually was.

MWD gapped higher at the open and remained positive to close +2% at 50.88 on nearly 3x its average daily volume.

Warner Music Group (WMG) reported that it became profitable in Q2, reversing last year's Q2 loss of $48 million. The company earned $4 million in the current quarter on revenue that rose 4% to $767 million. The company reported gains bother in recorded music and publishing as well as digital revenue, which rose from $32 million for the full year in 2004 to $35 million in the current quarter. The stock closed lower by 1.77% at 16.65.

Marketwatch reported new research from IDC to the effect that global storage software sales totaled $2.1 billion in Q1 2005, up 14.9% from Q1 2004. The top 6 storage software vendors were EMC, whose sales rose 18% to $625 in the quarter, followed by VRTS, IBM, NTAP and HPQ. EMC rose 1.72% to close at 14.79 on average volume, VRTS +.17% to 23.72, IBM gained .37% to close at 75.05, NTAP +1.56% at 29.89 and HPQ rose 2% to close at 23.89.

For tomorrow, the question will be whether anything will happen at all as SPX hugs the 1200 line, Dow 10500 and Nasdaq 2070. With the currency markets churning and oil breaking out, I'm expecting more action than we saw today. While the daily cycle downphases have been weak so far and the sideways patterns on the daily charts potential bull flags, the extremely low volatility and low volume readings suggest that those downphases could start kicking in. On the other hand, there are precedents for volatility rising along with price, and none of these indicators can be treated as absolutes. Better is to respect the price action. In this case, with the ranges so well defined, a break of support or resistance on high volume stands an excellent chance of being directional. With bulls and bears getting chopped to ribbons inside these ranges, waiting for a trendline break (or patiently buying support and selling resistance with tight stops) is a good alternative.

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
ABC None
NTES

New Calls

AmerisourceBergen - ABC - close: 65.57 change: +1.01 stop: 63.85

Company Description:
AmerisourceBergen is one of the largest pharmaceutical services companies in the United States. Servicing both pharmaceutical manufacturers and healthcare providers in the pharmaceutical supply channel, the Company provides drug distribution and related services designed to reduce costs and improve patient outcomes. AmerisourceBergen's service solutions range from pharmacy automation, bedside medication safety systems, and pharmaceutical packaging to pharmacy services for skilled nursing and assisted living facilities, reimbursement and pharmaceutical consulting services, and physician education. With more than $49 billion in operating revenue, AmerisourceBergen is headquartered in Valley Forge, PA, and employs more than 14,000 people. (source: company press release)

Why We Like It:
The trend is your friend and until it changes we'll play along. The trend in ABC over the last couple of months has definitely been a bullish one and now after a three-week consolidation the stock is bouncing from support. The bounce has also sent ABC above resistance at its three-week trendline of lower highs. We also like the Point & Figure chart, which shows a triple-top breakout buy signal with a $93 target. We'd probably label this a momentum play. We'll suggest new positions here over the $65.00 level but more conservative types may want to wait for ABC to produce a new relative high over $66.70 before considering new positions. Our short-term target is the $69.50-70.00 range but it would not surprise us to see ABC push past the $70 level. The recent consolidation looks like a bull flag pattern, which would point to a move above $70.00. In the news ABC said it will present at the Goldman Sachs conference on June 15th. We do not plan to hold the play over ABC's July earnings report.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 60.00 ABC-HL OI=1400 current ask $7.10
BUY CALL AUG 65.00 ABC-HM OI=1036 current ask $3.50
BUY CALL AUG 70.00 ABC-HN OI=1044 current ask $1.25

Picked on June 13 at $ 65.57
Change since picked: + 0.00
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million 

---

Netease.com - NTES - close: 57.29 chg: +2.18 stop: 53.95

Company Description:
NetEase.com, Inc. is a leading China-based Internet technology company that pioneered the development of applications, services and other technologies for the Internet in China. Our online communities and personalized premium services have established a large and stable user base for the NetEase Web sites, which are operated by our affiliate. Our average daily page views for the month ended March 31, 2005 exceeded 439 million. (source: company press release)

Why We Like It:
The sideways consolidation in the Dow and the S&P 500 over the last few weeks could be labeled as boring. We decided to spice things up a bit and offer an aggressive play on an old favorite for the momentum crowd. NTES is a Chinese Internet stock that is breaking out over resistance to hit new one-year highs. The P&F chart confirms the bullish trajectory with a $65.00 target. We're willing to go long at current levels and target a move into the $62-63 range. An alternative entry would be to wait for a possible decline back toward the $56 or $55 level and buy a bounce. 

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 50.00 NQG-GJ OI= 927 current ask $7.60
BUY CALL JUL 55.00 NQG-GK OI=2736 current ask $3.60
BUY CALL JUL 60.00 NQG-GL OI=2114 current ask $1.15

Picked on June 13 at $ 57.29
Change since picked: + 0.00
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 752 thousand 

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

Amer. Intl Group - AIG - close: 55.50 chg: +0.41 stop: 53.95 

It was a lackluster day in the markets on Monday with the Dow's early strength fading. Shares of AIG, while out performing the Dow Industrials, followed a similar pattern. We see no change from our weekend update.

Picked on May 26 at $ 55.05
Change since picked: + 0.45
Earnings Date 02/09/05 (confirmed)
Average Daily Volume = 15.5 million 

---

Caterpillar - CAT - close: 97.58 chg: +0.56 stop: 92.49 

CAT managed to hit a new relative high this morning at $99.05 but it was not enough to tag our target range of $99.25-100.00. We are not suggesting new plays. Instead we're suggesting that traders exit here for a profit or prepare to exit as CAT nears our target. 

Picked on May 18 at $ 92.35
Change since picked: + 5.23
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.8 million 

---

Chubb Corp - CB - close: 84.37 change: -1.22 stop: 82.49

CB hit some profit taking today. We would watch for a bounce in the $83.50-84.00 region before considering new plays here. 

Picked on June 10 at $ 85.05 
Change since picked: - 0.68
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.2 million 

---

Rockwell Collins - COL - close: 48.25 chg: -0.00 stop: 44.95

The early morning rebound in COL failed and the stock looks poised to trade lower. We're still waiting for the stock to decline towards our suggested entry point in the $46.50-45.75 range near the 100-dma. 

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 800 thousand 

---

Eagle Materials - EXP - close: 90.95 chg: +1.15 stop: 86.95

Monday was another decent session for EXP and the stock managed to bounce from the $90.00 level this morning and later this afternoon. Shares look poised to continue higher. Our target is the $97-99 range.

Picked on June 09 at $ 90.45
Change since picked: + 0.50
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 134 thousand 

---

Occidental Petrol. - OXY - close: 75.82 chg: -0.19 stop: 71.95

We're a little surprised that today's rise in crude oil didn't push shares of OXY higher but we remain bullish and see no change from our weekend update. 

Picked on June 09 at $ 75.51
Change since picked: + 0.31
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 2.7 million 

---

Teekay Shipping - TK - close: 44.10 chg: -0.46 stop: 42.45

No change from our previous update. We continue to wait for TK to breakout over resistance at the $45.00 level and its 100-dma. Our trigger to go long is at $45.05. 

Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 681 thousand 

---

Total S.A. - TOT - close: 114.92 chg: +1.23 stop: 110.95

Monday was a positive session for TOT with the stock clearing minor resistance at the $114.50 and $114.75 levels. We see no change from our previous weekend update.

Picked on June 09 at $114.00
Change since picked: + 0.92
Earnings Date 08/04/05 (unconfirmed)
Average Daily Volume = 857 thousand 

---

United Technologies - UTX - cls: 52.72 chg: +0.25 stop: 102.45

UTX reaffirmed its earnings guidance on this first day of trading post 2-for-1 stock split. Shares rallied to $53.37 before fading lower. The inability to hold its gains over the $53 level might warrant some caution here. 

Picked on May 23 at $ 53.12
Change since picked: - 0.40
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.0 million 

---

Wellpoint Inc - WLP - close: 68.50 chg: +0.70 stop: 64.90

No change from our previous update. WLP continues to trade within its range and above its short-term trend of higher lows. 

Picked on June 05 at $ 68.40
Change since picked: + 0.10
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million 

Put Updates

ITT Industries - ITT - close: 94.82 chg: +0.37 stop: 96.01

Monday's bounce doesn't look good for the bears but so far ITT remains under resistance near the $96 level. We might draw some similarities between the DJIA's overhead resistance at 10,600 and ITT's at $96.00. A breakout for the Industrials will probably fuel a breakout in ITT. We would not suggest new plays at this time. 

Picked on June 08 at $ 93.85
Change since picked: + 0.97
Earnings Date 07/22/05 (unconfirmed)
Average Daily Volume = 581 thousand 

---

MedcoHealth Sol. - MHS - close: 50.35 change: +0.60 stop: 52.21

No change from our previous weekend update. 

Picked on June 01 at $ 49.90
Change since picked: + 0.45
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 2.0 million 

---

Whole Foods - WFMI - close: 114.30 chg: +0.76 stop: 118.51 

No change from our previous weekend update. 

Picked on June 08 at $117.40
Change since picked: - 3.10
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 859 thousand 

Dropped Calls

None

Dropped Puts

None


Options 101

The Butterfly Spread 

When you are right with your closing price at expiration, the butterfly Spread pays off in a very rewarding way.

The Theory Behind the Practice

We examined the use of the Condor last week, this week I would like you to take a close look at its cousin, "The Butterfly Spread". The butterfly spread is very similar to the Condor Spread. The main difference is that with a Condor spread you have a range where your issue may close at, and if you are between that range you receive the maximum return. However, with the butterfly spread, you need to close at expiration as near to the middle strike or the SHORT strike price as possible, without going over it. It sought of like playing "THE PRICE IS RIGHT! Your goal is to come as close to the actual short strike price that you chose to sell. Sounds a little more challenging then the Condor? Well, the difference is when you hit your strike or come very close to it. You are rewarded very handsomely. Let's take a hypothetical example of a Butterfly and compare it with a Condor to point out the slight difference.

Remember the Condor was made up or a Credit Spread and a Debit Spread with each leg being a different strike price. (See Figure 1 below)

Figure 1: THE CONDOR

Here the Condor is made up of the 102, 104, 106 and 108 Call Strike prices of the DJX Index option as shown above and from our Condor example last week.

Now let's take a look at what the Butterfly spread would look like using the same example as above.

Figure 2: THE BUTTERFLY SPREAD

Notice the difference instead of SELLING 10 June 106 Calls and 10 June 104 Calls
We sell 20 DJX JUNE 104 Calls. 

What this does is lowers out net out of pocket by. $0.30 per contract or a net reduction of $200. (Compare Fig. 1 against Fig. 2 above)

However, it also completely changes our maximum gain, loss and breakeven points. Let's us now examine why and how the butterfly changes the Risk/Reward Scenario.

As you can see there seems to be little difference between the two strategies, except that the butterfly has a slightly lower out of pocket cost and a lower maximum lost. The Condor seems to give one a more level return, as you don't have to hit the strike price as accurately as you do with the butterfly. However, it is when you do hit close to the strike price the butterfly maximizes its return (see at 104 close)

However the butterfly will offer some nice returns when it is used with a more volatile issue like a Google. Let's see how the butterfly strategy looks with a high flyer like Google.

The Real World Example: Actual Date: April 26th 2005

Figure 1: GOOGLE CHART


Google trading at 220.21

Let's see an actual Butterfly spread using the Google Jun contracts. Since Google is a highly volatile issue if our butterfly is successful, there are some nice profits to be made.

Let's take a look as we put on a Google Butterfly Call Spread.

Notice the nice Risk/Reward Ratio and the bonus if we hit close to the Google June 240 Strike at the June expiration. (Notice Chart #3 below for a complete breakdown of profit and lost at all prices come the June expiration.)

Chart #3: Risk/Reward Return of the Google Butterfly Spread at the June Expiration

The Bottom Line

As you can see, the butterfly spread has a tremendous potential the closer we are to our target price. Obviously, a trader utilizing the butterfly spread should take careful consideration as to trading ranges and support and resistance levels. The better a trader knows his underlying issue, the more promising the butterfly spread becomes. The butterfly spread maximizes the profit of the trader who can best determine the price of their issue come expiration time. Keep an eye on this one and see where we end up in Jun. 

PS. You don't have to hold it to expiration. I suggest if Google were sitting around 240 with even a week to go before the June expiration, I would not hesitate to close out the entire trade and take a good portion of the maximum return. 

Until Next Time

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Options 101 by Steven Gail, and all other plays and content by the Option Investor staff.

DISCLAIMER

Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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