Option Investor

Daily Newsletter, Thursday, 07/07/2005

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Table of Contents

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

Market Wrap

PPT Stand by Me

PPT Stand by Me

After the bombing in London, our overnight futures got spanked bad. Our hearts and prayers go out to all the families personally torn apart by the terrorists. I swear I'll never understand the sadistic self-gratifying stupefying stupidity of the terrorists. I dream that their 40 virgins will be the she-devil in disguise who will make them feel the pain and suffering they caused in perpetuity. OK, now that that's out of my system, thanks for listening. Unless the terrorist act happens on our shores though, traders are able to look past it quickly and decide whether or not it should have that much of an impact on our markets. Whether that's short-sighted or not is a wholly different discussion.

The title of this report says what many bulls were praying for this morning. Some were saying, "if there's a god, please save me." Others were saying, "if there's a PPT, please save me." We've often talked about this "PPT" and I know many think we're crazy but there is in fact a group of high-powered bankers, led by the Fed, which was organized soon after the 1987 stock market crash. They're a highly secretive bunch and like the reconnaissance satellites capable of reading your license plate that "don't exist", this group doesn't exist either. They're the market's equivalent to the tooth fairy, or so many believe. But let's assume for the moment that this group does in fact exist--the PPT is the Plunge Protection Team and their charter is to prevent another market melt-down that could threaten the national banking system. Their function is to "stabilize" the market. Unfortunately they've become the wizard behind the curtain, trying to maintain an "orderly" market on a near continual basis now. Even their attempt to play with the nation's money supply (as measured by M-3 which accounts for money in all of the various bank accounts) is evidence of their attempt to smooth out the wrinkles in our economic system. Unfortunately they tend to make mountains out of mole hills but that's for another discussion.

Back to the PPT. Because of the highly exposed banks (banking regulations that were implemented after the 1929 stock market crash have been largely abolished), our banking system is actually more vulnerable today than pre-1929. The use of highly leverages derivatives can be a great help when used properly for hedging risk. Unfortunately many are using them now to goose the bottom line by playing the market with them. It's like a neatly arranged set of dominos and when one tips over it threatens the rest down the line. The PPT is credited with saving the system after the near-collapse of Long Term Capital Management (LTCM) back in September 1998. The Fed got several large banks, including foreign ones, to kick in some $3.5B to rescue the hedge fund which if allowed to collapse would have taken banks down with it since they were all heavily exposed. Ever since that episode the Fed has felt increasingly pressured to inject capital whenever it's needed. Was today's gap down rescued by the Fed? We may never know but one thing that can be said is that this Fed "protection" has emboldened many to take even more chances. It's like the automobile. The safety improvements over the years, certainly since I started driving 35 years ago, have been remarkable. And yet the death toll remains virtually the same when measured as deaths per driven mile. The reason is because as the safety improvements are made drivers become more emboldened to drive recklessly. They think they have all this protection around them and don't take as much care as they might have when there wasn't much between them and the outside world. Same with our markets and as long as they think they have put protection through the Fed, they'll play with riskier trading tools. Whether the Fed kicked in money this morning or people "knew" they would, the result is the same and many jumped in and bought the market.

So after today's price action we're left wondering what it all means. Oil is not letting go of its highs, bonds are not letting go of their highs (low yields), equities are not letting go of their highs (relatively speaking). There seems to be a lot of money available for buying lots of stuff. And here again the Fed may have some influence. I've discussed M-3 money supply several times here and it continues to increase at a rate faster than inflation's growth rate. If the Fed was so worried about inflation they wouldn't be creating enough money to float several countries' economies. The word on the street is that the Fed is worried about the housing bubble (gee, and who do you suppose caused it?). Supposedly they're pressuring banks to unload Fannie and Freddie paper. These are typically longer-term securities instruments for financial institutions. This could help explain why bonds keep rallying (banks are buying them to replace the longer term securities) and why the Fed is injecting so much liquidity into the system. The Fed is apparently very concerned about all the derivatives and leveraged risk of these Mortgage Backed Securities issuers (Fannie and Freddie) that they're keeping pressure on long term interest rates so that the banks have an incentive to get rid of those securities. The gains from those sales helps the banks' balance sheets, reduces their exposure and therefore risk to the mortgage market and the liquidity pumping helps grease the skids to get all these transfers done with minimal interruption. But it says a lot about the Fed's concern about the risk created in the housing market. Buyer beware at this point in that market, be it a house or stocks.

Well, that's all long term stuff (next month). Let's see if today's price action gives us any clues as to where we're headed tomorrow and next week.

DOW chart, Daily

That's a nice hammer doji on support, or actually an even more bullish dragonfly doji. What it depicts is how the selling couldn't hold and the buyers reversed it hard. Support is the uptrend line from March 2003 through the low in April. Daily stochastics looks ready to turn back up from oversold. The flip side of this bullish picture is of course the technical damage done by such a hard drop. If this uptrend line doesn't hold over the next 1-2 days, then the bears take possession of the ball again. The next hurdle for the bulls is to get the DOW back over price level resistance near 10365 and then its 200-dma just under 10450. Let's say they have their work cut out for themselves.

SPX chart, Daily

After stabbing below its 50-dma and dropping to 1183.55, the SPX recovered back above its 1191 level. This is a level that has acted as both support and resistance since April. Like the DOW it could be argued both ways as to whether the bulls got the ball back or the bears still have it. As seen in the closer view below, it's a close call this evening.

SPX chart, 120-min

Depending on how the uptrend line from May 13th is drawn, the bulls can claim they recaptured the uptrend by the end of the day or the bears can claim they stopped prices right underneath the uptrend line. They way it's drawn on this chart, through the low on June 30th, that's where price stopped yesterday so I'm thinking it might have a little more credence. We'll know tomorrow.

Nasdaq chart, Daily

The NAZ continues to consolidate underneath resistance and this makes it look bullish (sharp rally followed by sideways consolidation usually leads to another leg up). As drawn on the chart, the current consolidation also looks like it's building the right shoulder of an inverse H&S pattern with the neckline at 2100. The upside potential on a break above the neckline would be about 2300. That would surely get all the bulls yelling from the roof tops what a golden buying opportunity it is to buy. If we get to 2300 I'll be shorting it with everything I've got.

SOX index, daily chart

The SOX has found support by its 50 and 200-dma's and was downright bullish today considering the early morning carnage. This chart continues to look bullish.

BKX banking index, daily chart

Financials got hurt today and recovered to break-even, which was actually a great accomplishment. The chart doesn't help me much at the moment. It's flopping around here like a fish just hauled out of the water. Financials got a boost from Charles Schwab (SCH 12.68 +0.70), which surged as much as 13% earlier in the session amid renewed takeover talks (possibly by HSBC). And this of course helped the broker index which continues to be on fire:

XBD Securities Broker Dealer index, weekly chart

Since Jeff mentioned this index 2 weeks ago, it has continued to climb to new highs. It's a very steep climb and I'm afraid it's going to slip and fall to its death but so far so good. There's a potential ascending wedge pattern though and the combination of the steep ascent and ascending wedge spells trouble for this index down the road. It looks like it can go a ways before running into trouble but watch the top of this pattern if this index gets there.

This morning, before the bell (and not that it mattered since there were far more pressing concerns from the terrorist action in London) Moody's said it may downgrade GM and GMAC. They said that it is reviewing for possible downgrade the Baa3 long-term and Prime-3 short-term ratings of General Motors Corp. and the Baa2 long-term and Prime-2 short-term ratings of General Motors Acceptance Corp. The agency said the review of General Motors was prompted by its concern that escalating incentives, shifting consumer preference to more fuel-efficient vehicles, and long-term pressure on the automaker's U.S. market share will make it increasingly difficult for GM to deliver credit metrics that are consistent with the Baa3 rating by year-end 2007. Moody's said its review of GMAC reflects concerns at the GM level, as significant business and financial ties between GM and GMAC link GMAC's ratings to those of its parent. Moody's said it expects that it will maintain the one-notch differential between the long-term ratings of GM and GMAC.

Retails got a psychological lift early when A.G. Edwards announced they see robust retail earnings. They lifted their group rating on the retail sector to overweight from even weight, noting that average earnings for the group look like they'll outpace the average S&P 500 earnings projections. A.G. Edwards is estimating the group will turn out 12% earnings growth this year compared with the S&P's expected 8%; next year retailers as a group will deliver 11% gains against the S&P's projected 5% expected increase. The retail group's stronger results come partly because of easier comparisons with last year's anemic numbers. U.S. retailers have turned in their best same-store sales performance in months. Target (TGT) has reported a 9.0% increase in June comps (consensus 6.9%) and sees a July same-store increase of 4-6% while Wal-Mart (WMT), which reported a 4.5% rise in June comps over the weekend, has reaffirmed Q2 EPS guidance of $0.63-0.67. Good weather and a recent boost in consumer confidence helped June same-store sales record their best performance since May 2004. According to the International Council of Shopping Centers (ICSC), June retail comps surged 5.3%, well above previous forecasts of 4.5%. Better than expected June comps have come from TGT, GPS, JCP, COST, KSS, LTD, JWN, AEOS and ANF while MAY, FD, DG and TJX have missed forecasts.

At 8:30 we got several economic numbers but again, not many were listening. The Labor Dept. reported that initial claims rose 7K to 319K (consensus 320K), checking in below 320K for the third straight week to leave a 4-week average of 321K, the lowest since early March. Investors are likely more concerned about tomorrow's more influential monthly jobs report.

Traders locked in profits early in the day (from another new record high of $62.10/bbl) amid worries that today's bomb blasts may slow travel. But then it too recovered like the rest of the market amid concerns of further supply disruptions in the Gulf since Dennis was upgraded to a hurricane. At 10:30 we got the inventory reports. Economists were expecting a 1.6M barrel draw in crude oil supplies and a 1.5M build in distillates while gasoline stockpiles were expected to come in unchanged. But the EIA reported a larger than anticipated decline in crude supplies of 3.61M and a large decline of 974K in gasoline stockpiles. Distillates rose by 4.1M barrels, much better than an expected, which was a result of refineries running at 98.1% capacity last week. You know they're not getting much maintenance done at those run rates. Oil closed the day at $60.73/bbl (-$0.55).

Oil chart, August contract, Daily

Oil continues to march higher and I don't see much to stop it from reaching up towards $65. Oil could then be due for a large downward correction so watch for negative divergences and loss of buying momentum as it reaches up there. The oil index may also give an early warning in that regard.

Oil Index chart, Daily

Despite consolidation in crude oil the Energy sector paced the way higher. Expected to record aggregate EPS growth of about +27% from its 29 S&P components, energy stocks are providing support as we head into earnings season. Like oil's chart, this one looks like it will press to the top of its channel. But watch for evidence of slowing momentum, negative divergences to give you a heads up about taking some profits in this sector.

Transportation Index chart, TRAN, Daily

The Trannies continue to look more bearish than the other indices but if it starts to break its downtrend it could be giving us a heads up that it's going to make a run higher also. In the meantime I don't like this sector as compared to others, unless you're thinking short.

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

Like the Timex watch that takes a licking and keeps on ticking, this index just goes and goes and goes. The price pattern makes me think we've got one more high in this one. If it is accompanied by negative divergences, which are apparent now, I'd be looking for shorting candidates in this sector. Just don't be trying to catch the rising knives. Pulte Homes (PHM 87.43 +3.02) and MDC Holdings (MDC 85.02 +2.54) reported quarterly order increases of 26% and 14%, respectively.

U.S. Dollar chart, Daily

The price pattern in the dollar also makes it look like it's got at least a minor new high yet to go. But it's overbought and running into potential resistance at the top of what could be a bearish ascending wedge. If we get a throw-over to the top side and then price collapses back down inside that would be a sell signal. A break of its uptrend would be a confirmed sell signal.

Gold chart, June contract, Daily

I thought gold was going to make it out of there as it broke the uptrend line but alas it was a head fake. It's consolidation could go either way and I don't have enough clues at this time to help figure this one out. Wait for a break either way.

In sector action, most were green by the end of the day. The winners were led by the energy indices, biotech and the brokers. The losers were the airlines, networkers, telecoms, and the Trannies, all marginally red. Consumer Discretionary, which is estimated to turn in the worst Q2 earnings performance (-4%) also traded higher. Providing the bulk of the sector's strength were gains throughout the retail group.

With the market looking for payrolls of around 195K, with a wide range of 95K to 300K, there's a good chance that only a significant increase in the nonfarm payrolls figure could generate the type of selling power one would normally expect, since a terror risk premium has most certainly returned. Solid gains in Energy have also helped improve sentiment. Leadership from this group, which is expected to turn in the highest EPS growth (+27%) among the ten economic sectors, may also be reminding investors that upcoming Q2 earnings of about 7.0% (versus Q1 and Q404 EPS growth of 13% and 21%, respectively) probably won't be as bad as many have estimated.

Tomorrow's economic reports include the following:

It's always difficult to figure out whether a day like today has significant meaning and if so then which direction. Did the smash down and breaking of important support do enough technical damage to be able to claim the bears are in control? Or did the strong recovery off this morning's gap down low mean the bears fumbled the ball and the bulls recovered it? Your answer to those questions will depend on your bias and right now I would suggest you can't afford to have a bias. Trade short term until the picture clears up and be ready to switch directions to follow the market. Trade light, trade carefully and take profits early. Good luck.


New Plays

New Option Plays

Call Options Plays
Put Options Plays

New Calls

Intuit - INTU - close: 46.51 chg: +1.35 stop: 43.90

Company Description:
Intuit Inc. is a leading provider of business and financial management solutions for small and mid-sized businesses, consumers and accounting professionals. Its flagship products and services, including QuickBooks, Quicken and TurboTax software, simplify small business management and payroll processing, personal finance, and tax preparation and filing. ProSeries and Lacerte are Intuit's leading tax preparation software suites for professional accountants. Founded in 1983, Intuit had annual revenue of nearly $1.9 billion in its fiscal year 2004. The company has nearly 7,000 employees, with major offices in 13 states across the United States and offices in Canada and the United Kingdom. (source: company press release or website)

Why We Like It:
After a month of churning sideways it looks like INTU is ready for the next leg higher. Shares have been climbing since the late April lows but it's been somewhat of a slow, patience testing ride higher. Today's move and yesterday's rebound were both fed by above average volume suggesting the next significant move higher could have begun. We also like the Point & Figure chart which shows INTU in a bullish triangle breakout pattern that points to a $70.00 target. Looking at the weekly chart you can also see what looks like an inverse or bullish head-and-shoulders pattern with a slanting neckline. We are willing to buy calls at current levels and target a move toward the $50.00 region before the company's next earnings report.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 42.50 IQU-HV OI=120 current ask $4.60
BUY CALL AUG 45.00 IQU-HI OI=471 current ask $2.55
BUY CALL AUG 47.50 IQU-HW OI=779 current ask $1.10

Picked on July 07 at $ 46.51
Change since picked: + 0.00
Earnings Date 08/17/05 (unconfirmed)
Average Daily Volume = 1.7 million

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Chubb Corp - CB - close: 85.84 change: +0.39 stop: 83.49

CB traded lower at the open like most of the market but the stock rallied throughout the remainder of the session. We see no changes from our previous update. Our target is the $89.50-90.00 range but we plan to exit ahead of CB's July earnings report.

Picked on June 10 at $ 85.05
Change since picked: + 0.79
Earnings Date 07/26/05 (confirmed)
Average Daily Volume = 1.2 million


Cummins Inc - CMI - close: 74.50 change: -0.26 stop: 72.99

CMI held support at its simple 200-dma and managed a meager bounce from its lows. We see no change from our previous update although more aggressive traders may want to use today's bounce as a new entry point.

Picked on June 19 at $ 74.03
Change since picked: + 0.47
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 970 thousand


Coventry Hlth Care - CVH - cls: 74.86 chg: +1.53 stop: 69.49*new*

CVH displayed lots of relative strength today. There was no gap lower like many stocks on the bombing news. We are raising the stop loss again to $69.49. Our target is the $77.50-80.00 range.

Picked on July 05 at $ 72.75
Change since picked: + 2.11
Earnings Date 08/02/05 (unconfirmed)
Average Daily Volume = 1.0 million


Fording Candn Coal - FDG - cls: 94.80 chg: +1.18 stop: 89.49

FDG is also showing relative strength today with a 1.2 percent gain. The stock is nearing resistance at the $95.00 level. More conservative traders may want to strongly consider taking some profits here. Our target is the $97-100 range but we plan to exit before FDG's July earnings report.

Picked on June 19 at $ 90.30
Change since picked: + 4.50
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 384 thousand


Fortune Brands - FO - close: 91.60 chg: +1.07 stop: 86.95

Traders were quick to buy the dip in shares of FO this morning. This looks like a new bullish entry point here.

Picked on July 03 at $ 90.51
Change since picked: + 1.09
Earnings Date 07/22/05 (unconfirmed)
Average Daily Volume = 648 thousand


Noble Energy - NBL - close: 79.77 chg: +1.64 stop: 73.99

Oil stocks turned in another positive session despite a pull back in the price of crude today. NBL has rallied right back toward resistance at the $80.00 level while producing a bullish engulfing candlestick pattern. The MACD is very close to a new buy signal. Our target is the $84-85 range.

Picked on July 05 at $ 78.15
Change since picked: + 1.62
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 1.0 million


Quanex - NX - close: 55.05 change: +0.66 stop: 52.45

Ding! We have been triggered. NX broke out through resistance at the $55.00 level and traded at our trigger to buy calls at $55.10 opening the play. The move has produced a fresh quadruple top breakout buy signal on its P&F chart with a $68.00 target. Our target is the $59.50-60.00 range.

Picked on July 07 at $ 55.10
Change since picked: - 0.05
Earnings Date 08/25/05 (unconfirmed)
Average Daily Volume = 337 thousand


Rio Tinto - RTP - close: 125.65 chg: -1.20 stop: 121.49

Whoa! RTP is showing a lot of volatility lately. We warned readers to expect a potential "fill the gap" move but we didn't expect it so soon. RTP gapped lower like most stocks today due to the London bombing but shares of RTP were climbing higher throughout the rest of the session.

Picked on June 27 at $123.33
Change since picked: + 2.32
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 160 thousand


Sunoco Inc - SUN - close: 120.89 chg: +2.33 stop: 114.49

Last night we mentioned that we expected a dip toward the $118, maybe the $116 level, and SUN delivered. The stock traded to $116.31 near its simple 10-dma before rebounding. News that the company announced a 2-for-1 stock split certainly didn't hurt us either. Yet technically the split announcement didn't hit the wires until after the closing bell today so that should put an upward bias on the stock for tomorrow. The split date is set for August 1st. If you missed the initial entry point today's dip would have been a good one. More conservative traders may not feel like chasing it here but the move over round-number resistance at the $120 level is encouraging. Our target is the $124.50-125.00 range.

Picked on July 03 at $117.87
Change since picked: + 3.02
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million


Wellpoint Inc - WLP - close: 69.91 chg: +0.04 stop: 67.49

No change from our previous update.

Picked on June 05 at $ 68.40
Change since picked: + 1.51
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million

Put Updates

Ambac Fincl. - ABK - close: 69.30 chg: -0.34 stop: 71.51

ABK gapped lower like many stocks today but also began to rebound as well. We remain bearish on the stock but would expect the rebound to continue. Look for ABK to trade back toward the $69.65-70.00 range before any loss of momentum.

Picked on June 26 at $ 69.62
Change since picked: - 0.32
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 992 thousand


KLA-Tencor - KLAC - close: 45.36 chg: +0.45 stop: 45.76

We are still at red alert here. There was only minor weakness at the open and KLAC's push higher today only confirms yesterday's breakout over the 200-dma. The stock appears to be coiling for a push past the $45.50 level. We are not suggesting new plays. Instead we are suggesting that readers consider exiting early to avoid further losses.

Picked on June 29 at $ 43.88
Change since picked: + 1.48
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 5.4 million

Dropped Calls

Rockwell Collins - COL - close: 46.63 chg: -0.13 stop: 46.49

Normally one would have expected the defense stocks to rally on the news of today's London bombing. The group did turn higher by the close but shares of COL gapped lower at the open like many stocks today. The gap lower to open at $46.22 was below our stop loss at $46.49, so we would have been immediately stopped out. We might consider new long positions on the stock if COL can trade above the $48.00 level again.

Picked on June 27 at $ 46.75
Change since picked: - 0.12
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 800 thousand


SLM Corp - SLM - close: 49.60 change: +0.13 stop: 48.95

The market weakness this morning due to the terrorist attack in London was too much for SLM to bear. The stock traded under technical support at its 50-dma, 100-dma and 200-dma and it pierced the $49.00 mark as well. We were stopped out at $48.95. We might consider new bullish positions again if SLM can trade above the $51 level.

Picked on June 20 at $ 50.92
Change since picked: - 1.32
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.8 million


Molson Coors - TAP - close: 60.18 chg: -0.13 stop: 59.49

One might argue that our stop loss was too close but when implementing this play we really didn't want to get caught in a breakdown under the $60.00 level. This morning's gap down, like many stocks today, pushed TAP through our stop loss and closed the play. We would probably watch for a move over $61.00 before considering new bullish positions again.

Picked on June 29 at $ 61.38
Change since picked: - 1.20
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 909 thousand

Dropped Puts



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