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Daily Newsletter, Saturday, 07/16/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

New Highs, Now What\?

New Highs, Now What?

Bullishness was breaking out all over for most of the week. The Nasdaq closed at 2157 and a new high for 2005. The SPX closed at a new four year high at 1227 to cap seven straight days of gains. The Dow closed at a four month high at 10640 and had the best run since the elections. The SOX sprinted to a new 52-week high at 463 and well over resistance. The VXN closed at a new historic low at 13.32 and the VIX closed at 10.33 and levels not seen since 1995. The VXO (old VIX) dipped to 9.80 intraday and closed at 10.04 also a level not seen in over ten years. All the markets at new highs and the volatility indexes at new lows. What is wrong with this picture?

Dow Chart - Daily


Nasdaq Chart - Daily


SPX Chart - Daily


So many factors, so little space. The markets rallied on positive economic news according to the talking heads on TV. I agree the news has definitely turned strongly positive but I have a hard time believing it powered the markets to these levels. If economics are so strong then the Fed is far from done and traders seem to be forgetting that factor. Instead of a 4% top rate we could see 5% or more if the economics continue to improve sharply.

Headlining the economic reports on Friday was the PPI, which came in unchanged and well below the +0.4% consensus. Prices failed to rise despite a +2% jump in energy prices for the period. Crude goods prices actually fell -3.3%. The core rate actually fell -0.1% with intermediate goods rising only +0.1%. Crude materials like iron and scrap steel fell -19.9% and cotton fell -13.7%. If prices are not rising despite higher energy costs it definitely shows inflation is almost non-existent. Competition in a slow economy is driving the prices down and while this is Fed friendly it could be trouble if it continues. Price pressures eventually pressure profits.


On the flip side the Industrial Production number soared by +0.9% and three times the consensus estimates and the headline number for the prior month. Again the headline number is not to be trusted with +0.5% of that number being an increase in output by utilities companies. Manufacturing output, a better gauge of economic health still rose a robust +0.4% and more than the consensus for the overall headline number. Capacity utilization rose to 80% and the first time in this cycle to reach that high. This is the highest level since Dec-2000 but still a point below the 1972-2004 average and two points below the 82% average for most of the 1990s. This is a very strong report BUT it suggests the economy will be at full capacity within the next year and that could lead to higher inflation pressures. When there is no slack in production, manufacturers can command higher prices for products.

Business Inventories increased only +0.1% and it was the smallest gain in 16 months. This marks a continued decline from the 0.9% growth in January. This is a May number and as such carries little weight with the current market and was influenced strongly by the growing auto inventory levels at the time. June's report should be substantially different.

The NY-Empire State manufacturing Survey soared to 23.9 compared to June's 10.5 level and a minus -11.1 in May. It appears the soft spot is over in NY and they are gaining traction quickly. The headline number was well above the 10.0 consensus. New orders, shipments and backorders all rose sharply. Shipments for example jumped to 20.9 from only 1.0 in the prior month. The six-month outlook jumped from 34.0 to 47.0.

July Consumer Sentiment came in at 96.5 and almost flat with June's 96.0 and right inline with consensus estimates. Consumers seem to believe that the jobs market is improving and they are becoming immune to the higher gasoline prices. The recent market rally also contributed to the sentiment levels.

Friday the Dow was impacted by three story stocks. GE reported earnings that were inline with estimates but Q3 guidance was less than analysts had expected. All eleven divisions grew at double-digit levels and CEO Jeffery Immelt was very upbeat about the U.S. economy. Still the stock was under pressure most of the day due to the Q3 guidance.

McDonald's raised its Q2 guidance to 51 cents after a charge and that was three cents better than analysts expected. MCD reports next week. The company reported that same store sales trends were up +5.4% in the U.S. and profits were bolstered by strong sales in Germany and France. MCD jumped +1.39 to $31 and a six-week high.

The biggest news was probably from HPQ. The company said it was about to slash 15,000 jobs on Monday and could cut another 5,000 before its coming earnings report in August. HPQ said it could save $1.5 billion from the cuts. HPQ closed near $25 and a new 52-week high.

With the Dow hostage to the story stocks and trading at four-month highs at 10650 there was little excitement to power it higher. The Dow gained only +11 points and spent most of the day in negative territory. Only three Dow stocks posted changes greater than 50 cents. Those were all gains from MCD, AIG and HD with MCD the only change over a buck. It was not an exciting day despite the close at a new four-month high.

The SOX closed nearly unchanged despite a major hit to Rambus of -7% that pushed it back to $13.50 support. RMBS reported earnings that were lower than last year and did not please the street. They also said future guidance would be difficult due to the various court battles and negotiations in progress.

Electronic Arts (ERTS) was also crushed after saying it would delay the release of its Godfather video game. The company now expects to miss the early holiday season with a release tentatively slated for the fourth quarter.

Much of Friday was spent rehashing the HPQ/GE news and the new initiative to stop the CNOOC/Unocal deal. Senator Byron Dorgan mounted a new attempt on Friday to block the deal on the basis of national security. There are separate attempts in both the house and the senate to block the deal by various means. As the opposition builds the price of UCL shares dropped a buck from their highs at $66.79 on Thursday. The board is reportedly reviewing the CNOOC offer but continues to delay their recommendation as the outside battle swirls around them. I continue to expect Chevron to raise its bid as we draw closer to the August 10th shareholder vote. This is pressuring the price of Chevron's shares, which closed at $56.60. Should Chevron get the nod on August 10th I expect a significant rebound in CVX stock since it currently trades at a strong discount to the market as the battle rages. Given the current opposition over the CNOOC bid it would be beneficial to everyone if Chevron raised its price and eliminated the pressure from the board. The board could then rubber-stamp the deal and coast into the vote only three weeks away. The government would not have to block the acquisition and make China angry at a time when they are trying to work out the Yuan revaluation.

In an unrelated event a Major General in China's Peoples Liberation Army, Zhu Chenghu, said China was prepared to use nuclear weapons against the U.S. if the U.S. interfered in any Taiwan conflict. He said China will prepare itself for the destruction of all cities east of Xian but the U.S. will have to be prepared to lose hundreds of cities as well. OK, is there any question why we need to block the Unocal acquisition? Giving any communist country talking about waging war against you the strategic resources to fuel their war machine is really dumb. Representative Jim Saxon on Thursday said war with China was inevitable and likely by 2014. According to several international think tanks China appears to be readying its forces to wage war with the only superpower left, the U.S., over oil. Unbelievable, I have been saying it for months and I see others are coming to the same conclusion. http://www.indiadaily.com/editorial/3598.asp

Other articles show how China is applying pressure to its neighbors who are friendly to the U.S. For instance Unocal is a small player in the U.S. energy market but it is a big supplier of natural gas in Southeast Asia. Its pipelines run through several Asian republics friendly to the U.S. If China gained control of those pipelines it could threaten to cut off critical gas supplies to those countries if they did not drop relations with the U.S. This would give China a wider buffer zone around its borders and eliminate potential bases for U.S. attacks. This is already happening according to General Richard Myers, Chairman of the Joint Chiefs of Staff. He said last week that Russia and China, (remember I told you they signed a joint declaration of mutual support against the U.S.), were applying pressure to countries in their sphere of influence. They are pressuring countries that currently allow the U.S. to host forces in the war on terrorism or maintain stop off bases. The statement last week by the Shanghai Cooperation Organization was interpreted by some as an attempt by Russia and China to push the U.S. out of a region that Moscow regards as historically part of its sphere of influence and in which Beijing seeks a bigger role because of the region's extensive energy resources. That is enough of my soapbox ranting for this week but you get the picture.

Hurricane Emily turned towards the South American coast and oil platforms in the Gulf breathed a sigh of relief. Oil prices fell to support at $58 and traders took profits on the recent oil run. This gave anybody interested another buying opportunity as the season progresses. There will be more hurricanes and more disruptions from other reasons before the fall demand season appears. Next week we will get the inventory levels from the Dennis shut in and they should be bullish for prices once again. Time is counting down to the switch over to heating oil and that is when the trouble is really going to start. Continue to buy the dips until the picture changes. This would be an excellent chance to buy the BP Oil Trust (BPT) to qualify for the next dividend payment in October. The trust is currently paying nearly 10% per year plus stock appreciation. July 13th was the ex-dividend date ($1.728) for Q2 and the stock dropped -$5 on the ex-dividend and the drop in oil prices. It was up +$20 since the April ex-dividend drop so a -$5 ex-dividend drop this week was not a problem.

Natural gas spiked over $8 in the current contract but has been bouncing off $9 in the December contract. Current gas prices are slightly over $7 and the December chart indicates heating this winter is going to be expensive regardless of your energy source.

December Crude Chart - Daily


December Natural Gas Chart - Daily


The rally appeared to be running out of steam as the weekend drew to a close. The only volume increasing was option volume as expiration Friday extracted its pound of flesh from those on the wrong side of their trades. I believe that much of the rally was due to this option expiration cycle and many traders being caught leaning the wrong way. Market breadth declined substantially with advancers barely edging out advancers 3582 to 3455. A/D volume was almost dead even but the real news was in the new highs. After a spectacular start to the week with 868 new highs on Monday and 695 on Tuesday those numbers declined the rest of the week to end with only 216 new highs on Friday. Ironically it was on Friday that the indexes eked out further marginal gains to new highs. It was an option expiration gasp at the close that pulled the indexes out of negative territory and sent the VIX/VXO/VXN to decade lows. I alluded to this in the opening paragraph as something being wrong with this picture. Very wrong!

VIX Chart - Monthly


VXN Chart - Weekly


VXO (Old VIX) Chart - Weekly


Historically the combination of new highs on the market indexes and extreme lows on the volatility indexes spelled danger. The fact that this occurred on an expiration Friday in July is even more critical. Add in slowing volume, barely positive market breadth and a monster rally over the last two weeks and you have a recipe for disaster. Don't get me wrong. I would love to see a bull market all the way to January but the odds of that happening are exceedingly slim without at least a couple corrections in the process. It would also be nice if we could plan those corrections and have them appear only when all the signs aligned and everybody was ready to take profits and shift into different positions. Unfortunately nobody can ever tell us exactly when the next correction will occur. Even having all the factors I mentioned above in perfect alignment does not guarantee a sudden fall from grace. All we know is that there is a certain point n our future when the major players will decide they are done buying and push the sell button instead of buy and the drop will begin.

Just like breaking out or closing at a new high will not guarantee a continued rally as technicians might have you believe the pause and apparent failure at those highs will not guarantee a correction. However, the question most asked on Friday was "should we buy the top?" That top was represented by the SPX at 1225 and a four-year resistance high. The Dow was at 10650 and also a four-month high. Those types of resistance highs tend to attract selling even when the other factors don't contribute. The other factors are the extremely low volatility, decreasing volume and narrowing breadth after a two-week rally. That makes this resistance top especially critical. Add in the approaching August-October doldrums and it appears as almost a perfect storm for the bulls.

The bulls might argue that earnings shift into full swing next week and nearly all the heavy weights will take their turn at bat. The bears would claim that the rally over the last two weeks has already priced good earnings into the market and we are setup to fail. Zacks has predicted that Q2 earnings will come in at 12% growth. This is slightly higher than estimates from S&P and First Call just two weeks ago. The earnings this week have been mixed with high profile winners and losers but no shining stars. As always at this point the bulls want to know what you are going to do for us in Q3 and Q4 rather than Q2. Just don't tell us you tripped in Q2 or it is a haircut for your stock price. Guidance next week is going to be the key and GE started it on Friday with lower than expected Q3 estimates. Will that carry forward to the other reporters? Is there going to be a group letdown for Q3? Will the chip sector move higher after a +45 point gain in the SOX in only two weeks? The calendar is packed full for next week with nearly all the majors reporting. Monday leads off with MMM and IBM. On Tuesday we will see INTC, YHOO, NVLS, AMGN and about 150 others. Wednesday has EBAY, QCOM, MO, UTX and about 200 more. Thursday is headlined by MSFT, GOOG, MRK and over 250 others. By Friday's close over 750 companies will have announced earnings for the week and there will be no further mystery. We will know what the final earnings projections are and the complete guidance picture for Q3. In short despite a thousand more companies to report over the next few weeks the Q2 earnings story will be over except for a few footnotes to follow as CSCO, HPQ and Dell close out the cycle in early August.

I think market direction will also be established before the Friday close. Despite the SPX close at 1227 on Friday that 1225 resistance we have been watching still has a firm grip. Every spike over that level is quickly sold and 1225 returns. I continue to see 1225 as our line in the sand. I continue to believe that we should remain short below that level and cautiously long if we do finally make a break over that threshold.

The Dow has rebounded back to challenge the 10650 high from June and from late March. There is a huge void over that level should a breakout occur and 10875 becomes the next resistance battle. The 10650 level should be substantial resistance but not insurmountable if the rally is real. The Nasdaq has been acting like it was possessed given the dual support of the SOX and the Russell. The Nasdaq closed just under 2160 and only 30 points from a new 2005 high and a level not seen since June-2001. If that 2191 level can be broken the next real resistance is not until 2250 and a level most traders never expected to see until late 2005. Supporting the Nasdaq is the SOX and its recent spike is even more pronounced than the Nasdaq's. The SOX has rallied +45 points from the July lows and is only 35 points away from a 25% retracement of the entire bear market drop at 495. Significant resistance awaits at that 490-500 level and without some kind of catalyst I can't comprehend a break through that level until Q4. Personally I could not comprehend a break over 450 without any bullish signs in the chip fundamentals but it happened anyway. All indications of chip activity are still weak including orders and billings and shipments are still being delayed. We will get the Semi book-to-bill next Tuesday after the close but the index has already priced in a monster improvement.

SOX Chart - Daily


Russell Chart - Daily


Also supporting the Nasdaq is the Russell, which broke out to a new all time high on Monday at 672 and followed it up with another punch to 674 on Tuesday. This remarkable performance was a continuation of a rally dating back to the April lows at 570. A +100 point, +17% gain off those lows. The Russell experienced four bouts of selling in that run with the latest the week of the Russell rebalance. Since the London terror dip it has been vertical until Tuesday's near touch of 675. Weakness has appeared and were it not for what I believe was expiration pressure at Friday's close it could have ended much lower.

The weakness in the Russell ahead of the late summer doldrums could be the first crack in the Nasdaq foundation. The Russell rallied out of its rebalance dip on late buying by the index funds and may now be running out of steam. The SOX rallied on what I am assuming is Q2 earnings expectations and the hope of some positive guidance from the chip companies when they report. That leaves us with both supporting pillars for the Nasdaq in shaky territory. They could quickly firm up again should the earnings and guidance be miraculous but that may be too much to wish for.

My commentary for the last two weeks mentioned that I was looking for next week to be a turning point in the market. I picked next week as post expiration and the telling point for earnings. Once we see how the majority of earnings and guidance is going to play out I believe funds are going to position themselves for an Aug-Oct buying opportunity. A trader with Pacific Crest Securities said late Thursday he was already seeing funds begin to lighten up and hedge funds were positioning themselves to get short. This is exactly what I am expecting. The funds had to get past options expiration before they could make a position change. Now they are hoping for some strong earnings to provide one last boost of volume to allow them to exit unwanted longs gracefully and start getting ready to buy the Aug-Oct dip. It is mid July, the beaches are calling and the vacation schedule is compressing into the six remaining weeks of summer. Traders thoughts are less on trading and more on time off.

I went back and researched the summer lows on the Dow and Nasdaq for the last ten years. Unless there was a major earnings miss that dumped the indexes during the July earnings the summer low normally occurred in the first two weeks of August. That dip was normally bought with a bounce into September. Since 1997 and not counting 2001 there was a lower low in Sept/Oct six times with five of those lows in October. 2003 was the only exception where the August low was lower than the Sept/Oct low. In 2001 we were already heading south at a high rate of speed before 9/11 interrupted the markets. 9/10 was already a five month low before the attack. That makes it seven out of eight years where there was a lower low after the August dip. To carry that one step further all eight years saw an August dip. Granted, history does not have to repeat itself but the odds are in favor of the bears at this point. The only questions are "from what level will that August dip occur" and "when will it occur"? Baring any major earnings miss to kick us off the ledge I would lean toward a high being set next week and a dip beginning soon. The Fed meets again on Aug-9th only three weeks away. If the economic indicators continue to move higher then there could be some fear that the Fed would change its language to allow a bigger move at the September 20th meeting. Instead of reading tealeaves or getting my bias from CNBC I am going to continue to watch 1225 for a signal of market direction. I plan on remaining short below 1225 and cautiously long over that level. I am buying oil on the dips and that gives me something to do until the broader market either breaks out or down. Enter passively and exit aggressively if the market goes against you.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None MLM

New Calls

Editor's note:

It was a tough job searching for new plays to add to the newsletter this weekend. We looked at several hundred stocks and found very little that looked like a decent play that didn't have earnings in the next few days or so. The major averages (DJIA, S&P 500 and the NASDAQ) all look short-term overbought and due for a correction. Considering the last statement we really hesitate to add new bullish positions here. The same factors make picking bearish candidates a hazardous task as well. The market can always get more overbought. We are adding one new bearish candidate but suggest that our readers use caution heading into the first real week of the Q2 earnings season.
 

New Puts

Martin Marietta - MLM - cls: 68.16 chg: -0.26 stop: 70.51

Company Description:
Martin Marietta is the nation's second largest producer of construction aggregates, a leading producer of magnesia-based chemical products and is developing structural composites products for use in a wide variety of industries. (source: company press release or website)

Why We Like It:
MLM is an aggressive bearish candidate. The stock has been a pillar of strength over the last eight weeks but now the stock is overbought and extended. If you believe the technical indicators the next move should be lower. The RSI and stochastics point lower and its MACD indicator produced a sell signal about five days ago. Considering the overbought condition of the major stock indices we're going to suggest buying puts on MLM. Any correction in the markets could easily pull MLM lower as traders lock in profits. However, just to be safe we're going to suggest a trigger under the $68.00 level. Our entry point will be $67.85. Our target will be the $63.00-62.00 range, which is close to a 50% retracement of its May-July rally. The biggest challenge here for the bears is potential technical support at its simple 50-dma near $64. Plus, we have a short time frame. MLM is expected to report earnings in early August and we don't want to hold over the report.

Suggested Options:
We are suggesting the August puts as this should be a short-term play.

BUY PUT AUG 70.00 MLM-TN OI= 5 current ask $3.00
BUY PUT AUG 65.00 MLM-TM OI= 0 current ask $0.95

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 313 thousand
 


Play Updates

In Play Updates and Reviews

Call Updates

Chubb Corp - CB - close: 86.97 change: +0.22 stop: 84.40*new*

Time is growing short for CB. The company is due to report earnings on July 26th and we do not want to hold over the announcement. That only gives us six more trading days. Considering the slow down in CB's upward momentum and the fact that the major stock averages are short-term overbought and extended and poised for some profit taking, we would not suggest new bullish positions here. Instead more conservative traders may actually want to do some profit taking of their own. We'll keep our target in the $89.50-90.00 range but we're raising our stop to $84.40, just under the simple 50-dma.

Suggested Options:
We are not suggesting new bullish plays at this time.

Picked on June 10 at $ 85.05
Change since picked: + 1.92
Earnings Date 07/26/05 (confirmed)
Average Daily Volume = 1.2 million

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Coventry Hlth Care - CVH - cls: 71.41 chg: +0.57 stop: 69.49

We remain cautiously bullish here on CVH. The stock has pulled back toward support near $70.00 and its simple 50-dma. Shares have been showing relative weakness all week long and we suspect that if the major indices pull back that CVH could break down under support and stop us out at $69.49. We are not suggesting new bullish plays here although more aggressive traders may want to reconsider new positions if CVH can trade back above the $72.50 level. The P&F chart is still bullish (for now) and points to an $89 target.

Suggested Options:
We are not suggesting new bullish plays at this time.

Picked on July 05 at $ 72.75
Change since picked: - 1.34
Earnings Date 08/02/05 (unconfirmed)
Average Daily Volume = 1.0 million

---

Fortune Brands - FO - close: 93.33 chg: -0.75 stop: 90.51*new*

Time is running low on our FO play. FO is due to report earnings on Friday, July 22nd. We do not want to hold over the report. Currently the stock has been struggling with resistance at the $94.50 level. We suspect that any dip in the major averages will give traders an excuse to sell FO and the stock could pull back toward the $91-90 region. Conservative traders may want to seriously consider taking some profits here. We're going to hold on for a couple of more days and we're raising our stop loss to break even at $90.51. Our target remains the $95-96 range although another bounce toward 94.50 sounds like an attractive exit.

Suggested Options:
This close to earnings we are not suggesting new bullish positions.

Picked on July 03 at $ 90.51
Change since picked: + 2.85
Earnings Date 07/22/05 (confirmed)
Average Daily Volume = 648 thousand

---

Lowes Corp. - LOW - close: 63.65 chg: +0.75 stop: 59.90 *new*

LOW continues to show great relative strength. The stock added another 1.19 percent on Friday to mark its sixth gain in the last seven sessions. The stock looks pretty short-term overbought and due for a pull back. Traders, not just conservative ones, may want to seriously consider taking some profits here. We suspect the next move for LOW is lower thus we are not suggesting new bullish positions at this time. Instead we are raising the stop loss to $59.90. Our target remains the $64.50-65.00 range.

Suggested Options:
We are not suggesting new bullish plays at this time.

Picked on July 11 at $ 60.73
Change since picked: + 2.92
Earnings Date 08/15/05 (unconfirmed)
Average Daily Volume = 3.4 million

---

Quanex - NX - close: 56.45 change: +0.51 stop: 52.99

So far so good. NX broke through major resistance at the $55.00 level on July 7th. This move produced a new quadruple-top breakout buy signal on its Point & Figure chart, which now points to a $74 price target. We believe shares can climb toward our target range of $59.50-60.00. Friday's bounce from the simple 10-dma may be a new bullish entry point. However, we hesitate to consider new longs here because the major stock indices (DJIA, S&P 500, NASDAQ) all look overbought.

Suggested Options:
We like the August calls.

Picked on July 07 at $ 55.10
Change since picked: + 1.35
Earnings Date 08/25/05 (unconfirmed)
Average Daily Volume = 337 thousand

---

Pediatrix Med Group - PDX - cls: 76.50 chg: -0.32 stop: 72.34

Unfortunately, we do not have much new to report on for PDX. The early May breakout over major resistance at the $70.00 level pushed the stock to new all-time highs. PDX spent the next eight weeks consolidating sideways in a trading range 72.35-76.00. Last week's breakout over the $76 level produced another triple-top breakout buy signal on its already bullish P&F chart. Thus far the pattern remains a bullish one but PDX has not been able to produce any sort of follow through on last week's breakout to new highs above the $76 level. The lack of follow through makes us cautious especially with the major averages looking overdue for a pull back. We hesitate to suggest new bullish plays here. Our target is the $80.00-82.00 range.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 75.00 PDX-HO OI=183 current ask $3.60
BUY CALL AUG 80.00 PDX-HP OI=186 current ask $1.20

Picked on July 11 at $ 76.10
Change since picked: + 0.40
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 158 thousand

---

Reynolds American - RAI - close: 81.78 chg: -0.10 stop: 76.49

This past week has been a strong one for RAI. Shares rallied from the bottom of their wide trading range near $76.50. Now RAI has rebounded back above round-number resistance at the $80.00 level and technical resistance at its 40, 50, and 100-dma's. The next hurdle for the bulls appears to be the $82.00 level. Traders looking for a new entry point to buy calls might watch for a dip toward the $80.50 region. Our target is the $84-85 range. Keep in mind that one of the biggest risks for RAI this week is the earnings report from larger rival Altria Group (MO) due out on July 20th before the opening bell. Investor reaction to MO's results could easily be mirrored in RAI.

Suggested Options:
We're not suggesting new bullish positions at this time. If a new entry point presents itself we like the August calls. We do plan to exit this play ahead of RAI's August 1st earnings report.

Picked on July 10 at $ 78.83
Change since picked: + 2.95
Earnings Date 08/01/05 (unconfirmed)
Average Daily Volume = 664 thousand

---

Rio Tinto - RTP - close: 125.18 chg: -1.21 stop: 123.33

Traders did some profit taking in RTP over the last couple of sessions. Now the stock has pulled back to its rising trendline of support over the last eight weeks. We are not suggesting new plays at this time although readers may want to watch for a bounce from the $124 or even $123 level. It would not take much for RTP to dip towards our stop loss at $123.33. Traders should double-check their stop loss placement.

Suggested Options:
We are not suggesting new bullish plays at this time.

Picked on June 27 at $123.33
Change since picked: + 1.85
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 160 thousand

---

Toll Brothers - TOL - close: 55.97 chg: +2.17 stop: 49.90

Friday proved to be another strong session for the homebuilders. The DJUSHB home construction index added 2.2 percent to close near its all-time highs. Shares of TOL out paced its peers with a four-percent rally to a new all-time high of its own. The move was fueled by positive comments from Merrill. Merrill Lynch raised its price target on TOL from $52 to $86, which coincidentally happens to be the same price target projected by TOL's Point & Figure chart. Our target is the $57.50-60.00 range but traders may want to seriously consider taking some profits here.

Suggested Options:
We are not suggesting new bullish positions at this time.

Picked on July 10 at $ 51.98
Change since picked: + 3.99
Earnings Date 08/22/05 (unconfirmed)
Average Daily Volume = 2.4 million
 

Put Updates

Ishares Global Energy - IXC - cls: 88.57 chg: -0.58 stop: 91.61

IXC is a new bearish candidate we listed on Thursday night. We don't see any changes from our original play description so we're reposting it below with an update on the option values:

Oil and oil stocks have been big winners over the last several weeks and they are overdue for a consolidation lower. Nothing goes straight up so it looks like it may be time for some profit taking here. News that hurricane Emily may not threaten the U.S. oil infrastructure in the Gulf of Mexico is contributing to the decline in oil today. However, probably the bigger news was the unexpected decline in China's oil consumption. We are longer-term bullish on oil but that doesn't mean we can't try and scalp some points on the pull backs. This is a very speculative, high-risk play. The IXC does not trade the normal amount of volume we suggest for an underlying equity and the option volumes are also very, very low. Trade with high-risk capital only! We are going to try and keep our risk low with a tight stop at $91.61 just above all-time highs. Our target is the $85.25-85.00 region or the 50-dma (84.03), whichever the IXC hits first. FYI: a 38.2 percent Fibonacci retracement of the May to July run up would be near $85.40.

Suggested Options:
We expect this to be a short-term play so we're suggesting the August puts.

BUY PUT AUG 90.00 IXC-TR OI= 0 current ask $2.85
BUY PUT AUG 85.00 IXC-TG OI= 0 current ask $1.00

Picked on July 14 at $ 89.15
Change since picked: - 0.58
Earnings Date 00/00/00
Average Daily Volume = 33 thousand

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Children's Place - PLCE - cls: 47.25 chg: +1.45 stop: 47.51

PLCE is a new bearish candidate we listed on Thursday night. The stock showed some unusual strength on Friday but it looks like a bounce from the 100-dma. We remain on the sidelines. Our strategy is to use a trigger under support at $45.00. A reprint of the original play follows:

The action in PLCE has been trending lower under a pattern of lower highs for the past four weeks. Today's decline of 4.2 percent came on above average volume and pushed the stock to a new six-week low. PLCE still has technical support at the 100-dma (45.29) and round-number support at the $45.00 mark. However, if PLCE can drop below the $45.00 level it will produce a new triple-bottom breakdown sell signal on its Point & Figure chart. We are suggesting that traders use a trigger under the $45.00 mark to catch any breakdown. Our suggested entry point will be $44.90. Our target is the $40.00 region and/or the simple 200-dma. We'll use a range of $40.50-40.00. We do not plan on holding past PLCE's August earnings report.

Suggested Options:
We are suggesting the August puts although September strikes are available.

BUY PUT AUG 50.00 TUY-TJ OI= 25 current ask $4.00
BUY PUT AUG 45.00 TUY-TI OI=242 current ask $1.35
BUY PUT AUG 40.00 TUY-TH OI= 30 current ask $0.40

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/11/05 (unconfirmed)
Average Daily Volume = 775 thousand

---

Wellchoice - WC - close: 68.50 chg: -0.96 stop: 72.51

WC is a new bearish candidate we presented on Thursday night. The stock has continued to decline following Thursday's breakdown. We don't see any changes from our previous update so we're reposting the play description below with updated option prices:

Are you ready to roll the dice. That's normally how we feel when trying to pick a top on such a strong stock. WC has been a huge winner the past six weeks. The major stock averages look overbought and extended and due for a pull back. Shares of WC are also overbought, extended and due for a pull back. What we are doing here is speculation that the recent weakness in WC and its drop back below the $70.00 mark and its simple 10-dma, which has been support for the past month, is the beginning of a short-term consolidation. Looking at the daily chart the next level of support looks like the $65.00 level or the 50-dma near $63. We're going to aim for the $65.50-65.00 range. To be honest some traders would equate this to gambling. We certainly don't suggest traders trying to call the top on such a strong stock. The last time WC broke down under its 10-dma after a big run up shares went sideways, not lower. However, if you're a technical trader it's hard not to see the big MACD sell signal and the bearish tint to the RSI and stochastics.

Suggested Options:
We are suggesting the August puts since we expect this to be a short-term play.

BUY PUT AUG 70.00 WC-TN OI= 32 current ask $3.10
BUY PUT AUG 65.00 WC-TM OI= 5 current ask $0.75

Picked on July 14 at $ 69.46
Change since picked: - 0.96
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 268 thousand
 

Dropped Calls

Intuit - INTU - close: 48.99 chg: +0.13 stop: 44.90

Target achieved. INTU managed an early morning spike higher on Friday and traded to $49.58. That was enough to hit our target range of $49.50-50.00. Shares look pretty overbought and extended here so we would not want to hold longs with INTU under round-number resistance at $50.00 and the major averages overbought.

Picked on July 07 at $ 46.51
Change since picked: + 2.48
Earnings Date 08/17/05 (unconfirmed)
Average Daily Volume = 1.7 million
 

Dropped Puts

None
 


Trader's Corner

Summing Up

It's time to sum up previous Traders Corner articles on candlestick charting methods. Those articles appeared in OptionInvestor editions from Saturday, June 11 through Saturday, July 9. They covered the basics of candlestick charting methods, including identifying important candlesticks and key candlestick patterns. Candles offer many advantages over traditional charting methods, enthusiasts feel. Some of those advantages concern the ability to quickly assess the health of the market and see a potential pattern setting up before it might be recognized on other charting methods. Some find accumulating basic understanding of how candlesticks work to be easy, also an advantage.

However, some points from previous articles need reiteration. For example, wait for a reversal signal's confirmation before assuming that it will confirm. A doji at the top of a climb may be a signal of indecision or waning strength, but that indecision might be resolved the next day with another climb.

Also, consider the market climate when deciding on the reliability of candlestick reversal patterns. Previous articles pointed out that reversal signals prove more reliable when they occur at known or likely resistance or support. Conversely, a reversal signal occurring in the midst of a strong trend and signaling a reversal from that trend, perhaps not at support or resistance, may not be as reliable.

Note: Charts were searched over several weeks to find appropriate charts to illustrate the formations and do not indicate current prices.

Annotated Weekly Chart of the SPX:

Annotated Monthly Chart of TIE:

Obviously, account management skills prove as important with candlestick signals as they would with other technical analysis methods. The first account management skill to be addressed concerns whether a trader would open a trade based on a first reversal signal following a strong trend, with that reversal signal not at proven resistance or support. Just as with traditional charting methods, reversal signals against the trend might warn of a need to hedge positions or alter stops rather than suggest new entries against the trend. Steve Nison mentions this way of utilizing candlestick reversal signals in BEYOND CANDLESTICKS.

Because TIE's reversal signal indicated on the last chart was against trend and occurred at a new high without known resistance levels to guide traders, prudent traders would not have entered a bearish trade on the reversal signal. However, imagine that cowboy (or girl) traders, seeing that the reversal signal occurred as $20.00 was being challenged, decided to test the waters with a bearish play. Such traders might have felt that they could set a reasonably close stop for their plays if they were basing them on a reversal signal produced at possible round-number resistance. TIE's chart demonstrates that such traders needed a logical stop. Aggressive trader or conservative trader, candlestick pattern or more traditional pattern, logical stops are needed.

Nison probably wouldn't have liked the risk versus reward parameters of a bearish entry on TIE as it was testing $20.00, and neither would this writer. However, Nison does offer guidelines for setting stops. He suggests that in an instance such as this one, when a bearish trade would have been entered on the evidence presented by a bearish engulfing candle, that the stop be set on a close above the bearish engulfing candle. He points out that sometimes prices are pierced on an intra-period basis, but the bulls or bears may not have enough strength to invalidate the reversal signal on a closing basis, so he emphasizes closing values. Traders must evaluate whether waiting for a close works for their trading and account-management styles if prices are moving strongly against a trade intra-period, of course.

Similarly, if the reversal signal had been an evening-star formation, the stop might have been set at a close above the doji that formed the central candlestick of that three-candle formation. Setting a stop at a closing value that invalidates the reversal signal helps determine risk, but what about the reward? While candlestick charting methods provide many advantages, one disadvantage comes to mind when matching risk versus reward to one's preferred trading style. Unlike some other types of technical analysis, candlestick reversal signals offer no targets. The candlestick chartist must rely on other types of technical analysis to establish likely targets. For example, consider the morning-star formation depicted in this article's first chart, the SPX weekly chart showing last summer's action.

Annotated Weekly Chart of the SPX:

The points made in this article include considering preceding action when deciding whether to trust a candlestick reversal signal. Has a security been trending strongly higher within a rising regression channel, just now testing the top of that regression channel? A bearish reversal signal might not represent a good risk versus reward parameter. Such a signal might precede sideways consolidation or a brief pullback to the other side of the regression channel rather than a strong decline. Has an entity been trending strongly downward, bouncing back after each test of a 21-pma? A bullish entry on a morning-star formation just below that 21-pma might not represent a good risk versus reward parameter, either.

Since candlestick charting methods do not offer targets, traders' favorite tools for determining targets must be combined with candlestick charting methods to determine risk versus reward parameters. Good account management is as necessary for trades entered on candlestick reversal signals as for any other type of trade. Set stops on closes that violate the reversal signal.

Whether or not one elects to take trades based on candlestick signals, they offer many advantages, including easily assessed visual clues as to the market's strength or weakness. Even if you do not anticipate ever taking a candlestick buy or sell signal, they offer enough advantages to argue that they ought to be utilized. If these articles have interested you in this method of charting, consult Steve Nison's JAPANESE CANDLESTICK CHARTING TECHNIQUES, Greg Morris' CANDLESTICK CHARTING EXPLAINED or other books on candlestick charting.
 

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

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