Option Investor

Daily Newsletter, Tuesday, 07/05/2005

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Table of Contents

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

Market Wrap

Walmart Surprises Bears

Walmart Surprises Bears

Wal-Mart surprised the street on Tuesday with a report of better than expected June sales. This sudden improvement provided a boost to market sentiment given the record energy prices. If consumers boosted spending while staring down $60 oil and gasoline at $2.25 then maybe there is hope for the economy. Maybe the economy is actually stronger than analysts had been led to believe. 

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The Wal-Mart surprise and +1.50 gain helped the blue chips climb higher after closing last week in the doldrums. Also helping the tech stocks rally was an upgrade for Apple, which also added +1.50. Adding to the bullish sentiment was a strong Factory Orders report, which jumped +2.9% compared to the April reading at only +0.7%. Analysts were hoping for a +3.0% gain and came very close with their estimates. Unfortunately like the Durable Goods Orders last week the majority of the gains came from Boeing sales. Boeing received orders for nearly 200 airplanes and that spiked the Aircraft and Parts component of the report by a whopping +125%. Aircraft was the ONLY positive component. Non-defense capital goods fell -2.50, computer equipment -11.92, communications equipment -0.04, industrial machinery -14.61 and metals -0.01. Obviously the headline number did not reflect the true state of the manufacturing economy. Granted Boeing sales do help the economy but a -12% drop in computer orders suggests the corporate buyers have zipped their wallets heading into summer. 

The strong headline number helped add to the Wal-Mart sentiment but it was based on a misleading info since 99% of investors don't look under the hood of these economic reports. All most investors heard was the Factory Orders came in at a 14 month high. In reality if you exclude aircraft the remaining orders have fallen for the last two months and have trended down since January. 

Semiconductor billings fell for the second consecutive month with a -0.5% drop. This was less than the -1.4% drop in April but still trending downward since early 2004. Analysts continue to predict a resurgence for the semiconductor sector but instead it continues to report discouraging news. The SOX rallied to resistance at 425 early in the day but struggled to hold that level into the close. 

With earnings just ahead the bearish analysts were breaking out all over. They took Oracle's prediction of a -2% currency impact on future earnings as the first in a long line of estimate cuts. A Bank of America analyst said global earnings for U.S. companies have peaked and multinationals profits will begin to slide. High energy prices are expected to depress global economies and the high dollar will continue to make U.S. products more expensive. 

The energy problem will not go away and in Colorado we are seeing $2.50 diesel and $2.25 regular unleaded with prices much higher in other states. Crude oil rose to break $60 again on the August contract on multiple fears. The December contract spent most of the day at $62.50. The current problem is the weather with tropical storm Cindy heading for Louisiana. BP, Shell, Chevron, Total and Marathon spent the day evacuating rigs in the gulf and shutting in production once again. Right behind Cindy is tropical storm Dennis also heading for Louisiana. Dennis is expected to be a major storm developing into a hurricane and possibly the strongest July storm in many years. It is interesting that all the 2005 storms are heading for Louisiana after Fox did their "Oil Storm" made for TV movie last month focusing on damage to the U.S. economy resulting a major storm hitting LA. Regardless of any damage caused by future storms the impact of having the Gulf platforms shut down for several days as a precaution will continue to prevent any significant build in inventories. With the storms stacking up back to back in the gulf this accentuates the problem and greatly enhances the potential for eventual damage. 

Another problem for the energy business is the current weather over the U.S. June ended with a surge of hotter than normal weather and July predictions are for a broad band of hotter than normal weather across much of the country. Estimates are for temperatures better than +5% above normal. The problem is in the width of the band of heat. Normally electric companies in the middle of the heat wave can draw excess power from the national grid to compensate for the higher usage. Areas where the weather is mild contribute excess energy into the grid. With much of the country expected to be fully involved in the heat wave there will not be any excess capacity available. This means plants will be running at full capacity and burning coal and gas in record amounts. 

There was some good news with BP announcing its Q2 production rose +3.5% compared to 2004 levels. This was slightly higher than analysts had expected. BP said it was on track to meet its 2005 production goals of 4.1-4.2 mbpd including oil equivalent. Q2 production levels were 4.11 mbpd. The BP update followed positive production comments from COP and UCL last week. The Unocal war is heating up with China officially requesting on Friday that CFIUS review the deal. CFIUS will not agree to look at the deal until it receives what it calls a "complete notification". Once that is received the committee can take up to 30 days to decide if they want to do a full review. From my point of view they could easily stall until after the August 10th vote on the Chevron bid and avoid any political fallout. Today China basically told the U.S. administration to "butt out" of the deal and let shareholders decide if they wanted to accept the deal. I suspect China will get a better outcome if they ask nicely through the proper channels than with blustery outbursts in the media. 

August Crude Chart - Daily

December Crude Chart - Daily

Bausch and Lomb announced on Tuesday that it was buying a 55% stake in China's Shandong Chia Tai Freda Pharmaceutical Group. In addition BOL has an option to buy another 15% at a later date. BOL already does business in China with 20% of its income from Asia and 37% from Europe. Now we will see if China holds up any further purchases of Chinese companies for national security concerns as payback for the Unocal criticism. 

GM announced that it was continuing its employee pricing deal through August. It did exclude some of its best selling models. It only took a few minutes before other companies followed suit. Ford excluded its new Mustang and a couple other models. The suddenly lower prices on the majority of cars sold in the U.S. sent GM sales to 19-year highs in June. With the price wars firmly in price for August the analysts were quick to predict slow sales for the rest of the year. The surge of buying came generally from buyers already planning to buy in the fall. 

We are in the last week of warning season and all eyes are on the giants led by IBM. Back in April IBM disappointed the street and the stock fell from $90 to $71. It has done nothing in three months and remains fixed at the $75 level. There are persistent rumors that IBM has seen a slowdown in sales and could miss estimates again. They are rapidly running out of time in the warning window if they plan to guide estimates lower ahead of earnings. This worry and the lack of excitement in semiconductors is keeping tech investors from getting too excited about putting money into the market. 

The Dow posted a decent day with a gain of +68 points but most of it was due to short covering at the open on the news about Factory Orders, Wal-Mart and Apple Computer. The Dow surged to 10350 in the first hour of trading and then wandered in the 10350-10370 range the rest of the day. This was well below the 10400-10425 resistance highs we saw last week. Support remains at the 10300 level but despite today's gains there is no real direction. 

The Nasdaq did manage to ease over last week's highs at 2075 but ran into trouble as it tried to move higher. The Apple news helped the Nasdaq tack on gains of +21 points but that 2075 resistance was firmly in control. 

The SPX also managed to move over last week's levels by a couple points but resistance at 1205 maintained a solid grip. The real winner for the day was the Russell-2000, which soared another +10 points (+1.58%) to 653 and only three points away from an all time high. I mentioned on Sunday that I expected the Russell to maintain an upward bias as the week progressed as laggard funds continued to balance positions to the new index weighting. The exact index weightings were not known until the close of trading on Friday, June 25th. Normally index funds have acquired the majority of the stock they need by that close but have to adjust those positions over the next week once the exact weightings are known. With over a trillion dollars pegged to the various Russell indexes the rebalance typically provides a positive bias for a couple weeks. The S&P small cap and mid cap indexes both hit all time highs today on this Russell buying. Small cap buying is infectious and retail traders add to the pressure as they see small caps rising without really understanding the reasons. We could see the Russell find some technical resistance when it hits the 656 all time high. 

Russell-2000 Chart - Daily

The remainder of the week should be governed by any remaining earnings warnings with real earnings not beginning in earnest until next week. Friday has the June Jobs Report with the current consensus in the 180,000 range. With May's jobs falling to 78,000 there are some serious concerns that June could also be weak. This is the proverbial good news bad news joke. Another month of low jobs would almost guarantee the Fed will pause after the August meeting but that would also require a weak July report in early August. Do investors want a weak economy and weak earnings or a Fed that adds another 50-75 points? Personally I would vote for the stronger economy and let the chips fall where they may. 

As for market direction I think any earnings news will govern our direction. If the market does move higher I am looking to get short in the 1210-1215 range on the SPX. 1220 is material resistance and I want to beat the rush and try to avoid picking a top. I took a small short position in the futures at 1209 this afternoon. Volume remains weak and there is a serious lack of conviction on both sides. With July-Oct typically weaker than the rest of the year there is waning interest by the bulls in buying the dips. Funds not required to be fully invested will start easing out of unwanted positions to raise cash for an October entry. It is early for this process to begin with late July early August typically the timeframe. The wild card here is the strength in the energy sector. With 15% of the S&P comprised of energy stocks they could almost support the S&P on their own once oil breaks above $60. Funds seeing energy continue to rise could use their excess cash in that sector and provide a soft landing for the S&P as the summer progresses. Unfortunately all of that is just a calculated musing and anything is possible. Watch any bounces over SPX 1210 for signs of weakness and be ready to capitalize on any failures. 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
NX None

New Calls

Quanex - NX - close: 54.75 change: +1.30 stop: 52.45

Company Description:
Quanex is an industry leading manufacturer of value-added engineered materials and components for the vehicular products and building products markets. (source: company press release or website)

Why We Like It:
NX is a simple buy the breakout play. The stock soared back in 2004 and topped out near $63 back in March 2005. Since then shares of NX have consolidated its gains. The recent trading range between $46 and $55 might be considered a new base for NX to build on its next leg higher. The breakout we want to buy is a breakout over the $55.00 level. If NX can push past the $55.00 mark it will produce a new quadruple-top breakout buy signal on its Point & Figure chart. These types of patterns can be very powerful, especially if the market cooperates. More aggressive traders might want to consider buying calls here with today's move over the $54.00 level. We're going to suggest a trigger at $55.10. Our target will be the $59.50-60.00 range although it would not surprise us to see NX rally toward its peak near $63. We do not plan on holding past its August earnings date. 

Suggested Options:
We are suggesting the August calls although Novembers are also available.

BUY CALL AUG 50.00 NX-HJ OI= 10 current ask $5.90
BUY CALL AUG 55.00 NX-HK OI= 85 current ask $2.70
BUY CALL AUG 60.00 NX-HL OI= 15 current ask $1.00

Picked on July xx at $ xx.xx <-- see Trigger
Change since picked: + 0.00
Earnings Date 08/25/05 (unconfirmed)
Average Daily Volume = 337 thousand 

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Ashland - ASH - close: 61.78 change: +1.63

We want to provide some more details on the Ashland call play that we closed over the weekend. If you have been following the play you will remember that ASH sold off its stake in an oil refinery to Marathon Oil (MRO) for $3.7 billion last week. The actual asset swap occurred on Friday and shares of ASH were adjusted lower (about $12) from $71.87 to a closing price on Friday of $60.15. We know that many traders have stops set based on the stock and not their option price and assuming a worse case scenario we closed the play as a loss. In reality the adjustment in ASH also included an interest in MRO stock. Thus each contract now reflects 100 shares of ASH and 23 shares of MRO. The adjustment also changed the root symbol for ASH's options to GFU-. We continue to recommend that you call your broker to verify how these adjustments have been made in your account if you were long ASH calls. We appreciate our readers who emailed in regarding this play and congratulations on those traders told us they are currently profitable on the play!


Chubb Corp - CB - close: 86.63 change: +1.19 stop: 82.99 

A strong day for the broader markets helped fuel a 1.39 percent rebound in shares of CB as well. The stock look poised to breakout over the $87 level. Our target is the $89.50-90.00 range. 

Picked on June 10 at $ 85.05 
Change since picked: + 1.58
Earnings Date 07/26/05 (confirmed)
Average Daily Volume = 1.2 million 


Rockwell Collins - COL - close: 47.49 chg: +0.25 stop: 46.49 

COL may have out performed its peers in the defense sector but the stock under performed the broader market. We reiterate our suggestion that more conservative traders wait for a move over $48.25 before initiating new positions. 

Picked on June 27 at $ 46.75
Change since picked: + 0.74
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 800 thousand 


Cummins Inc - CMI - close: 74.85 change: +0.09 stop: 70.95

CMI dipped toward the simple 200-dma this morning but traders were there to buy the dip. We see no change from our weekend update. Our target is the $77.50-80.00 range. 

Picked on June 19 at $ 74.03
Change since picked: + 0.82
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 970 thousand 


Coventry Hlth Care - CVH - cls: 72.84 chg: +2.24 stop: 68.49

CVH is showing lots of strength today with a 3.17 percent rally on volume above its average. The move pushed CVH through resistance in the $72.00-72.50 range and hit our entry point to buy calls at $72.75. The play is now open. Our target is the $77.50-80.00 range. 

Picked on July 05 at $ 72.75
Change since picked: + 0.09
Earnings Date 08/02/05 (unconfirmed)
Average Daily Volume = 1.0 million 


Fording Candn Coal - FDG - cls: 93.35 chg: -0.25 stop: 88.49 

No change from our previous update.

Picked on June 19 at $ 90.30
Change since picked: + 3.05
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 384 thousand 


Fortune Brands - FO - close: 91.98 chg: +1.47 stop: 86.95

FO is off to a strong start this week with a 1.6 percent rally on volume well above the norm. Our target is the $95-96 range. The company had some headlines today. Allied Domecq's shareholders okayed FO's takeover of the company and FO announced that the acquisition would be complete by July 26th. 

Picked on July 03 at $ 90.51
Change since picked: + 1.47
Earnings Date 07/22/05 (unconfirmed)
Average Daily Volume = 648 thousand 


Noble Energy - NBL - close: 78.85 chg: +1.23 stop: 73.99

Fears that an active storm season off the Atlantic coast and in the gulf helped push crude oil prices higher again today. Hurricanes in the Gulf of Mexico can disrupt our incoming oil supply and actually damage infrastructure both offshore and on the coast. Meanwhile shares of NBL continued to rally and broke through weeklong resistance at the $78.00 level. Our entry point to buy calls was at $78.15 so the play is now open. Our target is the $84-85 region.

Picked on July 05 at $ 78.15
Change since picked: + 0.70
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 1.0 million 


Rio Tinto - RTP - close: 124.42 chg: +1.44 stop: 119.99

RTP is showing lots of strength today. This is especially true considering the weakness in some of the metal and mining stock today. This still looks like a bullish entry point to us. Our target is the $129.50-130.00 range. 

Picked on June 27 at $123.33
Change since picked: + 1.09
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 160 thousand 


SLM Corp - SLM - close: 49.89 change: -0.36 stop: 48.95

This is not a good sign. SLM lost ground on a day the markets were widely positive. Furthermore SLM broke back below the $50.00 mark, which should have acted as round-number support/resistance. There is still additional support with the 200-dma near $49.25 and the 50-dma near $49.00 but more conservative traders may want to eye the exits here. We are not suggesting new bullish plays with SLM under $50.

Picked on June 20 at $ 50.92
Change since picked: - 1.03
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.8 million 


Sunoco Inc - SUN - close: 121.09 chg: +3.22 stop: 114.49*new*

Up, up and away! As discussed in the NBL update the fear of tropical storms and hurricanes potentially disrupting the oil supply helped send crude prices higher again today. That helped fuel the breakout in SUN today. We see no changes from our weekend update. Our target is the $124.50-125.00 range. We are going to raise our stop loss to $114.49. FYI: other stocks we like in this group and considered adding over the weekend are AHC and VLO, both of which are up today. 

Picked on July 03 at $117.87
Change since picked: + 3.22
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million 


Molson Coors - TAP - close: 60.97 chg: -0.62 stop: 59.49

We are not excited about TAP's under performance today but it's nothing alarming. We've been suggesting that readers watch for a dip back toward the $60.00-60.50 region as a potential entry point for bullish plays. 

Picked on June 29 at $ 61.38
Change since picked: - 0.41
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 909 thousand 


Wellpoint Inc - WLP - close: 70.35 chg: +0.53 stop: 65.90 

No change from our weekend update.

Picked on June 05 at $ 68.40
Change since picked: + 1.95 
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million 

Put Updates

Ambac Fincl. - ABK - close: 70.76 chg: +0.50 stop: 71.51

We remain on the defensive here. The broad market rally today fueled another rebound back above the $70.00 mark. We are not suggesting new positions until ABK trades under $69.65. 

Picked on June 26 at $ 69.62
Change since picked: + 1.14
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 992 thousand 


ESCO Tech. - ESE - close: 101.41 chg: +1.81 stop: 101.65 

Heads up! It may be time to head for the exits here. The market's strength today helped push ESE back above the $100 mark again and erase Friday's decline. The stock is not far from our stop loss at $101.65. We are certainly not suggesting new positions here. 

Picked on June 26 at $ 97.80
Change since picked: + 3.61
Earnings Date 08/10/05 (unconfirmed)
Average Daily Volume = 102 thousand 


KLA-Tencor - KLAC - close: 44.37 chg: +0.77 stop: 45.76

It was a tough day to be a bear, especially in tech stocks. The NASDAQ Composite added more than one percent and the SOX semiconductor index rebounded for a 1.5 percent gain and closed back above support/resistance at the 420 level. Meanwhile KLAC rallied as well, bouncing from its 50-dma, and back above the $44.00 level. This does not bode well. We are not suggesting new bearish plays at this time. 

Picked on June 29 at $ 43.88
Change since picked: + 0.49
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 5.4 million

Dropped Calls


Dropped Puts


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


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