Option Investor

Daily Newsletter, Monday, 06/20/2005

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Market Wrap



The much-anticipated end of op-ex week started promisingly enough, with oil reaching new highs and equities set for a gap-down open. Gap down they did, and the decline accelerated in the wake of the disappointing Leading Economic Indicators report at 10AM, breaking Friday's lows. That drop was quickly bought, however, and a low-volume, low-credibility rise ensued for the remainder of the day, chopping its way to a gap-fill and new session highs within Friday's range. A selloff in the final hour closed the indices back to their early-afternoon levels.

Light volume remains the rule, as does low volatility. There appear to be simply no sellers of any significance, each drop quickly and easily bought. No doubt today's Fed open market operations, which added a net new $4.5 billion to its dealers' reserves, helped it along. But the market continues to hold its upside bias. Even on a daily basis, the charts below show an overdue daily cycle downphase generating very poor price traction and now turning up prematurely. Unless and until some actual selling appears, bears will have no choice but to be vigilant on their stops and quick to exit. For the past month, buying (not selling) the dips has been the directional strategy of choice.

Volume breadth was negative for most of the day and only shifted to positive territory at 2:30PM for the Nasdaq, while on the NYSE it took until after 3PM. The closing dip reversed it, the NYSE finishing with 1.27 declining shares for each advancing and the Nasdaq 1.06 declining shares for each advancing.

Daily Dow Chart

The Dow closed lower by 15 points at 10608, failing at a high of 10637 in the late afternoon. The post-10AM low came at 10562. More bearish than today's minor loss was the lower high and lower low for the day, the first in several sessions. It was that rising pattern that aborted the daily cycle last week, and while bears might cheer the lower high/lower low today, it's going to take a strong downside closing break of the rising wedge support at 10570 to threaten the buy signal on the 10-day stochastic. As bearish as the light volume, low volatility might feel, the recent price pattern has been anything but.

Daily S&P 500 Chart

The SPX lost .86 to close at 1216.10, testing neither the top or bottom of the bear wedge apex with today's doji star. As with the Dow, the SPX's daily cycle indicators point higher, and bears need a break of 1210 wedge support confirmed by a move below 1205 confluence to threaten it. 1220 remains immediate upside resistance, confirmed again by today's 1219.10 high.

Daily Nasdaq Chart

The Nasdaq lost 1.98 to close at 2088 after failing at the afternoon high of 2096. This was a lower high and lower low for the day as well, and brilliant distribution job if that's what it was. The daily cycle upturn is weakest here, and another down day should be enough to stall it. However, that's offset by a potential reverse head and shoulders neckline at 2100, potentially very bullish if broken on high volume on a daily closing basis. Without getting into the cycle behind it, reliable reverse head and shoulders formation are extremely rate at or near the top of an upleg. That's the case here, as the current pattern commences right after the December 2004 high. Reverse head and shoulders are much more reliable patterns at the bottom of a downleg, and for this reason, I'll be skeptical of the current setup unless and until 2100 has been broken with authority.

Chart of QQQQ with $QQV overlay

This chart, with QQQQ price candles overlaid with the NDX/QQQQ volatility index (QQV) in blue, is very telling. The QQV is at record lows. While the "when it's high, time to buy/when it's low, time to go" mantra is not without exception, the general rule has been that lows in volatility tend to coincide with highs in price. 

Is it possible that the relationship has become too well known to work? Possibly- just as I've wondered at other times prior to strong declines. However, there will come a time when the relationship doesn't work, and this could well be it. More likely, in my view, is that extended will become more extended before the correction. While this relationship could invert, my guess is that it's mere delayed. In fact, looking closely at the timing of the QQV lows (see highlighted bands) of the past 6 months, we see that the lows generally preceded the relative QQQQ high by several sessions. If so, the eventual upturn in the QQV will give us a heads-up for a possible downleg for QQQQ.

What is clear is that option premiums are as low as they've been in many, many years, helped along by aggressive premium selling. At some point, the tight, low-volume, quiet range will break, and premiums will begin to rise. Nothing prevents volatility from rising along with price, however- until the market breaks out of this range and volume returns to normal, it's only a sign of more exciting times to come, and hopefully soon. Price remains the primary indicator.

Daily TNX Chart

The Treasury auctioned $16 billion of 13-week bills and $14 billion of 26-week bills, below its recent string of $32 billion Mondays. The 13-week T-bills fetched a high discount rate of 2.965%, matching June 6th's high and 1 bp above last week's rate. The bid-to-cover ratio was 2.27, indicating the strongest demand since the April 25th auction, but the high rate on April 25th was only 2.88%. The 26-week bills were auctioned at a high rate of 3.175%, the highest discount rate in several months. The bid-to-cover ratio was 2.10, the lowest in a month. Indirect bidder participation was a respectable $9.16 billion of the $30 billion total.

Ten year treasuries were weak today, the yield (TNX) once again testing 4.14%-4.16% confluence resistance before doji-ing back down support at the 22 day EMA at 4.066%. For the day, the TNX finished higher by 2.5 bps at 4.103%.

Chart of Crude oil

The threats of sabotage in Nigeria from Islamic militants on Friday were not resolved, with the US, Britain and Germany closing their consulates in Lagos. Faced with the possibility of supply disruptions, traders hit the offers on Monday, driving the price of July crude to a high of 59.275 overnight following last week's more than 9% rally. Nigeria is the 8th largest exporter of oil and supplies approximately 10% of US imports.

Crude oil dipped later in the morning but bounced from a low of 58.10 to set a new afternoon high at 59.525, settling +.975 at 59.45. On the daily chart, we see the May rally continuing to new highs and challenging April's high. The daily cycle is in a trending upphase with a negative divergence on the 10-day stochastic, but bears will need to see a break back below the 55.50 level for confirmation and the start of a new downphase. 

It was a quiet day for economic data, and there will be no major reports due until Thursday's Initial Claims. Today, the Conference Board released Leading Economic Indicators, which showed that 9 of the 10 indicators declined in May, the LEI falling 0.5% compared with expectations for a 0.3% drop. The one indicator which rose was stock prices, while there were negative results from the other components such as factory workweek, new orders for consumer goods, new orders for nondefense capital goods, initial jobless claims, vendor performance, building permits, money supply, consumer expectations and the spread between the 10-year note and the federal funds rate. This is the 5th consecutive month without a grain from the LEI, though April's -0.2% drop was revised to unchanged.

Research firm Lipper reported that inflows to equity funds doubled from April to $21 billion in May, with investors targeting "riskier" funds and domestic funds to the exclusion of internationally focused funds. Senior research analyst Don Cassidy was quoted by Marketwatch as saying, "Once again investors showed they will wait to buy until they see a rally, rather than having the courage to buy on the dips."

In corporate news, the WSJ reported early this morning that Wyeth (WYE) may cut up to 30% of its sales force this year. The company has been long expected to reduce its number of sales personnel, and the current announcement could affect the jobs of 750 employees. WYE closed lower by .11% at 44.07.

Register.com (RCOM) rejected a bid to be purchased by RCM Acquisition for $7.10 per share, but indicated that it remains open to future bids both from RCM and others. CEO Peter Forman resigned from RCOM last week and was replaced by interim CEO David Moore. RCOM gained 1.52% today to close at 7.37.

Sony (SNE) took a tumble as the anticipated Supreme Court ruling in the MGM v. Grokster case was not issued, with Thursday the next potential date for the ruling. MGM, a subsidiary of SNE, has sued Grokster for enabling a network it claims to be used primarily for the illicit distribution of copyrighted content. SNE lost 2.48% to close at 35.39.

H.J. Heinz (HNZ) announced its agreement to purchase Danone's HP Foods, which owns HP and Lea & Perrins brands. The move helps to consolidate the two companies' brands, with HNZ emphasizing condiments, meals, snacks and infant foods, while France's Danone is focused on water, yogurt and biscuits. The deal will be for $855 million in cash. HNZ expects the transaction to be accretive to earnings in the first full fiscal year. HNZ gained a cent to finish at 36.34.

Cablevision (CVC)'s controlling shareholders, the Dolan family, proposed a $7.9 billion deal to take the company private. Under the terms of the deal, which would see a number of businesses including its cable networks and sports teams spun off, CVC shareholders would receive $21 per CVC share in cash as well as shares of Rainbow Media. Reuters reported that on the basis of a presumed value of $12.50 per Rainbow Media share, the deal would set a price of $33.50 per CVC share, a 25% premium above Friday's closing price. CVC rose 19.09% to close at 32 on more than 17 times its average daily volume.

For tomorrow, the question is whether today's last-hour decline will continue. Volume was strongest at the open and at the close as the indices declined. I noticed the same thing on Friday morning, when QQQQ declined on heavy volume. There was much lighter volume on the rise that followed. This would look much more bearish if price were actually declining for longer than a few minutes at a stretch. 

My feeling is that this nothing more than expert distribution at the top of a rally, as confirmed by the recent intraday volume patterns as well as the generally light volume we've had for much of the past month and a half. Although it's far from perfect, I find the QQQQ:QQV to be a compelling indicator at least for caution among bulls, if not of a strong decline potentially brewing. The key there, however, is "potentially." In the meantime, the price trend remains up until support has been broken on a closing basis.


New Plays

New Option Plays

Call Options Plays
Put Options Plays
JOE None

New Calls

St Joe Co - JOE - close: 82.56 change: +2.21 stop: 79.45

Company Description:
The St. Joe Company, a publicly held company based in Jacksonville, is one of Florida's largest real estate operating companies. It is engaged in town, resort, commercial and industrial development, land sales and commercial real estate services. JOE also has significant interests in timber. (source: company press release)

Why We Like It:
If you've been looking for a way to play the real estate boom in Florida then JOE may be the answer. A Barron's article was published over the weekend highlighting JOE's prime position to benefit from the housing rush in Florida. The company has a huge amount of land it can develop that has already appreciated considerably, which gives it a huge boost to its margins when it does develop it into housing. Of course the stock has already appreciated considerably along with the rest of the housing market. The stock had been consolidating sideways the last couple of weeks as bulls and bears fought over the $80.00 level. The Barron's highlight helped push JOE to a new all-time high while the rest of its peers turned lower in profit taking on Monday. Pure and simple this is a momentum play. We would much prefer to buy a dip somewhere near the 50-dma or 100-dma but that may not occur for quite some time. We are willing to buy calls at current levels but more patient traders might want to wait for a dip. The DJUSHB home construction index looks poised for some more profit taking before it continues higher. A decline in the DJUSHB could weight on JOE and pull it back toward the $80.00 level again, which we could use as a new entry point. We're going to try and limit our exposure by using a relatively tight stop loss at $79.45. We do not plan on holding over JOE's July earnings report. Our target is the $87-90 range. 

Suggested Options:
August strikes recently became available but there is no volume or open interest yet so we'll suggest the September strikes even though we plan to close the play in mid July.

BUY CALL SEP 75.00 JOE-IO OI= 928 current ask $9.70
BUY CALL SEP 80.00 JOE-IP OI=1009 current ask $6.10
BUY CALL SEP 85.00 JOE-IQ OI= 409 current ask $3.40

Picked on June 20 at $ 82.56
Change since picked: + 0.00
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 507 thousand 


SLM Corp - SLM - close: 50.92 change: +1.14 stop: 48.95

Company Description:
SLM Corporation is the nation's No. 1 paying-for-college company, managing nearly $112 billion in student loans for 8 million borrowers. Sallie Mae was originally created in 1972 as a government-sponsored entity (GSE). In 2004, the company terminated its GSE charter, ending its ties to the federal government. Sallie Mae remains the country's largest originator of federally insured student loans. Through its specialized subsidiaries and divisions, the company also provides debt management services as well as business and technical products to a range of business clients, including colleges, universities and loan guarantors. (source: company press release)

Why We Like It:
We're adding SLM to the list as a bullish candidate following today's technical breakout. The stock had been consolidating sideways under resistance at the $50.00 level for weeks. The stock got a pop higher on Friday with strong volume, but we suspect that was due to option expiration. The rally continued today and when SLM finally pushed past the $50.00 mark it really took off with another flood of volume. This looks like a bullish entry point for a run toward its January highs near $55.00. Readers can choose to go long here or hope for a dip back toward the $50.00 level, which should now act as support. We will target a move into the $54.50-55.00 range before its mid July earnings report. 

Suggested Options:
We are going to suggest the new August strikes even though they have very little open interest yet. 

BUY CALL AUG 45.00 SLM-HI OI= 0 current ask $6.50
BUY CALL AUG 50.00 SLM-HJ OI= 0 current ask $2.45
BUY CALL AUG 55.00 SLM-HK OI= 0 current ask $0.45

Picked on June 20 at $ 50.92
Change since picked: + 0.00
Earnings Date 07/14/05 (unconfirmed)
Average Daily Volume = 1.8 million 

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

AmerisourceBergen - ABC - close: 68.62 change: +0.45 stop: 63.85

ABC continues to show lots of relative strength with another gain during Monday's session. More conservative players may want to think about taking some profits here. The stock is nearing our target in the $69.50-70.00 range. 

Picked on June 13 at $ 65.57
Change since picked: + 3.05
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million 


Ashland Inc - ASH - close: 70.14 chg: +0.12 stop: 66.99

No change from our previous update. We would be long calls with ASH above the $70.00 level but keep in mind that the DJIA is short-term overbought and may continue to consolidate for the next couple of days.

Picked on June 16 at $ 70.05
Change since picked: + 0.09
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.1 million 


Chubb Corp - CB - close: 84.85 change: +0.05 stop: 82.49

No change from our weekend update.

Picked on June 10 at $ 85.05 
Change since picked: - 0.20
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.2 million 


Rockwell Collins - COL - close: 48.00 chg: -0.23 stop: 44.95

No change from our weekend update. Our suggested entry point is a dip into the $46.75-46.00 range near the simple 100-dma. 

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 800 thousand 


Cummins Inc - CMI - close: 74.23 change: +0.20 stop: 70.95

No change from our weekend update. CMI continues to climb following Friday's breakout over the 200-dma.

Picked on June 19 at $ 74.03
Change since picked: + 0.20
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 970 thousand 


Eagle Materials - EXP - close: 93.71 chg: -1.29 stop: 89.49 

EXP hit some profit taking today. Watch for support in the $90-92 region near its 10-dma. Our target is the $97-99 range.

Picked on June 09 at $ 90.45
Change since picked: + 3.26
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 134 thousand 


Fording Candn Coal - FDG - cls: 89.45 chg: -0.85 stop: 84.99

Monday's session did not produce the kind of bullish follow through we expected to see in FDG. More aggressive traders might want to watch for a bounce from the $88-89 region as a new entry point. More conservative traders can wait for a move over $91.25. Our target is the $97-100 range.

Picked on June 19 at $ 90.30
Change since picked: - 0.85
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 384 thousand 


Netease.com - NTES - close: 57.74 chg: -0.30 stop: 53.95

No change from our weekend update.

Picked on June 13 at $ 57.29
Change since picked: + 0.45
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 752 thousand 


Teekay Shipping - TK - close: 43.78 chg: -0.95 stop: 42.45

Lack of follow through on last week's Thursday-Friday rebound is bad news for TK. If we don't see a bounce tomorrow we're dropping it as a bullish candidate. Currently our strategy calls for a trigger to buy calls 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 


United Technologies - UTX - cls: 53.30 chg: +0.16 stop: 51.80 

No change from our weekend update. The good news here is that today's opening dip helped fill the gap from Friday morning.

Picked on May 23 at $ 53.12
Change since picked: + 0.18
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 4.0 million 


Wellpoint Inc - WLP - close: 69.65 chg: +0.01 stop: 65.90 

No change from our weekend update. WLP appears to be coiling for a breakout over the $70.00 level. 

Picked on June 05 at $ 68.40
Change since picked: + 1.25 
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million 

Put Updates

Quality Systems - QSII - cls: 46.75 chg: -1.27 stop: 50.26*new*

QSII continues to show relative weakness. The stock dipped to $45.25 early this morning before bouncing. The bounce appeared to be failing late this afternoon. We are going to lower our stop loss to $50.26. Our target is the $41.00-40.00 range. 

Picked on June 15 at $ 47.75
Change since picked: - 1.00
Earnings Date 06/13/05 (confirmed)
Average Daily Volume = 330 thousand 


Semiconductor Holders - SMH - cls: 34.29 chg: -0.15 stop: 35.05

No change from our weekend update. We are not suggesting bearish positions until the SMH trades back under the $34.00 level. Our target is the $32.25-31.75 range. 

Picked on June 15 at $ 33.95
Change since picked: + 0.34
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 26.3 million 

Dropped Calls


Dropped Puts


Options 101

When things get a little rough, who says you can't at least have a chance to bail out of a disaster

If it ain't broke, don't fix it! However, when it is, here's a little repair that might at least give you an opportunity to get out even, if you still believe in the stock, but purchased it at the wrong time and at the wrong price.

The Theory Behind The Practice

The concept of fixing something that needs to be fixed seems to be a concept that a lot of traders, even the most savvy; forget to consider when things get bad. Unfortunately, our emotions have a tendency to get the better of us at times. Especially at times when it involves the parting of our money from our portfolios in the form of a loss. Here is a case in point. Let's say you just purchased this great hypothetical company called Health Innovations at the price of 80 (SYMBOL: HINN). On paper everything looked great. The company had great earnings, fantastic balance sheet and 5 earth scattering innovative health products that could change the face of Healthcare, as we know it. It was just too good to be true. That's right! It was too good to be true. The FDA didn't approve one of its drugs and the stock plummeted 20 points to a price of 60. Well needless to say, with the stock now at 60 we are not too happy. So what do we do? Well we could sell the stock and take the loss or maybe hold on to the stock since the response to the news did seem a little too reactionary. Here is a little strategy you might want to try, especially if you belief the stock is due for a bounce back, back not to the point that you will every see 80 again for a long while. This strategy is called the "Repair" and works like this. We just purchased HINN at 80 and now it is trading at 60. Here's what we do. For the sake of example I will just work with 100 shares. 

Step 1: You purchase 1 HINN June 60 call for a price of 6 or a Debit of $600.00.
Step 2: You then sell 2 HIN June 70 calls for a price of 3 or a Credit of $600.00.

So your net position now looks like this:

Long 100 shares of HINN a @ 60
Long 1 HINN June 60 Call @ 6 = Debit $600.00
Short 2 HINN June 70 Calls @ 3 = Credit of $600 (2 times $300.00)

Remember you now have basically a covered call position and a bull spread, so no margin requirement is needed to maintain this position. However, examine the chart below and you will find out something quite amazing is now possible. (See Figure 1)


Notice the Stock only has to get back to $70 for the position to break even, where if you just hold the stock waiting for something to happen, the stock has to get all the way back to $80. 

I think you can see the advantage to this strategy. Let's take a look at an actual stock.

Let's look at IBM after it came down from the $95 price area to its currently traded range of around $75 a share

Real World Example: Actual Date: May 5th 2005 IBM trading at 75.50

Figure 1: IBM CHART

Here we go will go out to October and Buy 1 IBM Oct 85 call and pay $450
And then sell 2 IBM Oct 95 calls and take in a credit of $360. In this example we have a net debit of around $90. In more cases than not, we usually get a breakeven to a slight credit. The reason for the slight variance is the underlying volatility of the underlying common issue. Stocks like Google, etc would give us a breakeven or even a slight net credit for the position. Nevertheless, the position still works as well with the only variation the slight debit that accounts for us only able to get $94 a share instead of the 95 we originally purchased it for.

See Figure 2 Below:



Once again notice the breakeven point is almost reached with the call strategy, 10 points lower at $85. If, on the other hand, you just buy and hold the stock; you need the stock to bounce all the way back to $95. 

(For the sake of example all transactions are shown without commissions, which should be considered in an actual trade.)

The Bottom Line:

Once again you see, how a little repair, or innovative thinking at least gives you a chance to salvage, what looks to be a badly timed purchase in one's portfolio. However, with a little help from our friend, the CALL option, we may be able to get out of this one almost whole. Just as in life, there are no guarantees. But at least with strategy you have a fighting chance.

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.


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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