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Daily Newsletter, Wednesday, 07/27/2005

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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

Buyers show durability

>

Buyers show durability

Stocks finished broadly higher with record home sales, upbeat durable goods data and the Fed's Beige Book showing economic growth in all 12 districts helping the very broad NYSE Composite (NYA.X) 7,465.44 +0.50% close at an all-time high.

The tech-heavy NASDAQ-100 Tracker (NASDAQ:QQQQ) $39.72 +0.76% edged above of its recent four-day range to close at its highest level of the year! Bears look very complacent, or think they know something as recent short interest data (07/15/05) released shows short interest rising to just over 213 million shares with days to cover building to 2.37. Current short interest readings come close to matching that found on February 15, 2005.


Volatility measures plunged with the widely followed CBOE Market Volatility Index ($VIX.X) 10.36 -5.73% looking to revisit last week's decade low reading of 9.88.

While some firmly believe the lower volatility measures are being created by bullish optimism, recent short interest readings may also hint that some overly complacent bears are looking to hedge some bets in the options markets.

U.S. Market Watch - 07/27/05 Close


The Dow Jones Home Construction Index (DJUSHB) 1,080.05 +0.71% would get my "turnaround of the day award" after testing its rising 21-day SMA at 1,055 in early session trade. The Commerce Department reported that single-family home sales jumped to a record annual pace of 1.37 million units in June, up 4% from May.

The report on new home sales did show new home prices declining for a second consecutive month in June with the median price dropping by 5.5% to $214,800 in June, down 0.4% from a year ago. New home prices had set a record at $232,600 in April.

Michael Carliner, senior economist at the National Association of Home Builders, said the decline in new home prices could be an indication that demand is strengthening in the lower-end of the market.

Early buying among the major Treasury maturities turned to selling as orders for big-ticket items posted a strong 1.4% increase last month, while this afternoon's release of the Fed's Beige Book (anecdotal) showed a number of the districts describing the current economic expansion as "solid."

The North American Telecom Index (XTC.X) 716.41 +1.43% was atop today's list of index gainers with Sprint (NYSE:FON) $26.37 +5.6% surging to a new multi-year high. Second-quarter earnings more than doubled and the wireless service provider raised its guidance for 2005. Nextel Communications (NXTL), with which Sprint is in the process of merging, rose $1.64, or 5%, to close at $34.15.

The Airline Index (XAL.X) 51.05 -1.19% reversed early morning gains, but finished just about in the middle of its day's range. Shares of Delta Air Lines (DAL) $2.99 -11.79%, which are also a component of the Dow Transportation Average (TRAN), plunged amid unconfirmed reports that recent cost cutting efforts would keep the company from filing for bankruptcy.

Toot! Toot! In last Wednesday's Market Wrap I thought Canadian National Railway (CNI) $65.22 +0.94% had sparked some renewed interest in the "rails." Wouldn't you know it! The very next day, shares of Dow Transport component Union Pacific (UNP) $69.10 +0.84% gapped higher from its closing price of $65.93.

Today, FreightCar America (RAIL) $28.88 +23.36% blew its horn to a post-IPO high after the designer and manufacturer of railcars reported Q2 earnings that easily outpaced expectations.

Energy equity sectors finished in the green, while the commodities traded mixed-to-higher. In today's Market Monitor, fellow analyst Tab Gilles noted that the Energy Department's latest weekly report showed crude oil stocks fell by 2.3 million barrels to 317.8 million barrels, or 7% above year ago levels. The supply of distillates grew by 3.1 million barrels to 125.8 million barrels, or 5% higher than last year. These figures could calm trader's fears who believe we are in a shortage. According to the DOE back in July of 2002 we had 304 MB in storage of crude oil, in July 2003 we had 283 MB in storage and the U.S. has 6% more supplies than '02 and almost 14% more inventories than '03 yet prices are doubled from the same time period.

NASDAQ-100 Tracker (NASDAQ:QQQQ) - Daily Intervals


The QQQQ dialed up a new 2005 closing high as buyers look to gain further ground against sellers. I was snooping around and noticed that short interest figures are starting to be posted on various securities. With QQQQ short interest at very similar levels found in February, but market internals as depicted by the narrower NASDAQ-100 Bullish % ($BPNDX) headed in a different direction (rising now, falling then) it shouldn't be assumed that IT IS JUST COMPLACENT BULLS BUYING. The short interest comparisons, at VERY SIMILAR PRICE levels would suggest some complacent bears may be picking up their short covering, or buying call options/selling put options, which can drive volatility measures lower to try and get squared up.

Upbeat earnings and the raising of guidance had online retailer Amazon.com (AMZN) $43.65 +15.65% a percentage gainer, which follows a big upside move from eBay (EBAY) $41.99 +3.88% last week.

Biochemical maker Sigma-Aldrich (SIAL) $64.96 +12.6% surged to an all-time high after reporting earnings late Tuesday.

Electronic manufacturer Sanmina (SANM) $4.64 -11.78% was a percentage loser among NDX/QQQQ components after Tuesday evening's earnings release suggested the company's turnaround was delayed as demand for its semiconductor manufacturing equipment remained anemic.

S&P Depository Receipts (SPY) - Daily Intervals


Same retracement shown in last Wednesday's Market Wrap, where I placed a "reverse head and shoulder" retracement, with a HORIZONTAL neckline at $121.76. Now... today's close above $123.70 would be deemed bullish at the close, as demand has finally been strong enough to outstrip supply (sellers) at that level.

But Jim Brown's trend drawings in (note the direction of these trend lines) had me wondering if my earlier analysis and use of retracement might be too BEARISH? Perhaps the neckline of the pattern isn't horizontal as I had depicted, but was ascending.

S&P Depository Receipts (SPY) - Daily Intervals


A little different look, but do you see how the "neckline" could be moved higher to Jim's ascending bullish resistance trend? Hey, if you were using my "bullish fitted 38.2% retracement technique" (anchor at a low/high point, then fit 38.2% at a relative high close), we can perhaps see where that comes in. "I like" that as it makes some sense with what the MARKET is doing.

What I don't like is how retracement doesn't "explain" whey the SPY stopped on that pullback to about $119.

What do you think? Using Jim's bullish resistance trend as a near-term projection to the future, and the above retracement, maybe $126.00 by the end of August?

Banks and healthcare haven't been participating of late, and that's actually WEIGHED on the SPY/SPX.X. If they get turned

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.
 

New Puts

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Las Vegas Sands - LVS - close: 38.46 chg: +0.47 stop: 36.99

LVS managed a nice rebound from this morning's lows near its simple 50-dma. This may prove to be another bullish entry point but we remain skeptical consider the stock's recent weakness. More aggressive traders may want to consider new positions here. Time is running out though as LVS is due to report earnings on August 3rd and we do not want to hold over the event.

Picked on July 21 at $ 40.31
Change since picked: - 1.85
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 934 thousand

---

Pediatrix Med Group - PDX - cls: 77.25 chg: -0.76 stop: 74.25

No change from our previous update. Our target is the $80-82 range. We would not suggest new plays at this time. We plan to exit before its August 3rd earnings report.

Picked on July 11 at $ 76.10
Change since picked: + 1.15
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 158 thousand
 

Put Updates

AutoZone - AZO - close: 97.85 chg: +0.24 stop: 100.01

No change from our previous updates. AZO continues to look poised for more declines with what appears to be a double-top pattern. Our target is the simple 50-dma currently at 92.88.

Picked on July 25 at $ 98.13
Change since picked: - 0.28
Earnings Date 09/20/05 (unconfirmed)
Average Daily Volume = 748 thousand

---

Best Buy Co - BBY - close: 77.89 chg: +3.00 stop: 76.61

Today's action in BBY is a good reason why we have been suggesting triggers for these more aggressive put plays. We are currently still sitting on the sidelines waiting for BBY to trade at $73.25 so today's 4% rally is not a problem. However, we are surprised that BBY rallied so strongly. The only positive press we could find was an analyst reiterated their "buy" rating on the stock. It's possible BBY rallied on the positive comments in the Fed's Beige book report about the economy today. The sudden spike higher looks like a possible short squeeze. We're going to leave the play open as a potential for now with the same trigger at $73.25 but we may end up adjusting the entry later if the broader market indices start to consolidate lower. Don't forget that BBY is due to split 3:2 on August 4th.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 3.3 million

---

Fannie Mae - FNM - close: 56.70 chg: -0.74 stop: 59.51

Wednesday proved to be a down day for FNM. The stock declined through most of the session and broke down intraday below technical support at its 100-dma. Shares of FNM hit our trigger to buy puts at $56.49 this afternoon before rebounding from its intraday low at $56.18. The play is now open but traders can watch for a potential bounce back to the $58 region before FNM turns lower again. Patient traders might use a failed rally under $58 as a new entry point.

Picked on July 27 at $ 56.49
Change since picked: + 0.21
Earnings Date 00/00/05 (unconfirmed)
Average Daily Volume = 3.3 million

---

Infosys Tech. - INFY - cls: 71.91 chg: -0.64 stop: 75.01

No change from our previous update. We would not suggest new bearish positions until INFY traded back under the $70.00 level.

Picked on July 20 at $ 69.92
Change since picked: + 1.99
Earnings Date 07/12/05 (confirmed)
Average Daily Volume = 922 thousand

---

KB Home - KBH - close: 81.27 chg: +0.23 stop: 82.51

Tomorrow could be another rough day for bears in the homebuilding stocks. When we originally added KBH to the play list we specified the upcoming Pulte Homes (PHM) earnings report as one of the biggest risks to buying puts in KBH. Well, it may prove to be true. PHM reported earnings after the closing bell today and earnings were good. The company beat estimates, announced a 2-for-1 stock split and raised their earnings guidance. PHM will likely soar tomorrow pulling the DJUSHB index and KBH with it. Shares of KBH were already trading near $82.00 in after hours markets tonight. We are not suggesting new plays with KBH above the $80.00 mark and fully expect to be stopped out tomorrow.

Picked on July 26 at $ 79.85
Change since picked: + 1.42
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = million

---

Lehman Brothers - LEH - cls: 106.37 chg: +0.43 stop: 108.01

News that Prudential started coverage on LEH with an "overweight" rating lent the stock (LEH) early strength this morning but it quickly faded. Unfortunately, LEH continues to find support at the $105.00 level and the afternoon rally in the markets helped power a rebound in LEH. More conservative traders can probably sit out and wait for LEH to trade under the $105.00 mark before considering new put positions.

Picked on July 21 at $105.13
Change since picked: + 1.24
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 2.7 million

---

3M Co. - MMM - close: 73.65 change: -0.13 stop: 77.51

No change from our previous update. MMM continues to under perform. Previous support at $74.00 acted like overhead resistance this afternoon during the bounce. Our short-term target is the $70-68 range.

Picked on July 19 at $ 74.29
Change since picked: - 0.64
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million

---

Children's Place - PLCE - cls: 45.21 chg: -0.90 stop: 47.51

PLCE displayed some relative weakness today with a 1.95 percent decline on above average volume. The early move lower hit $44.80, which opened the play at our trigger of $44.90. While we are not excited about the late day bounce back above the $45.00 level we are going to leave our strategy intact. Our target is now the $40.50-40.00 range near its simple and exponential 200-dma's. More aggressive traders may want to put their stop at $48.01, since the $48.00 level has been clear resistance over the last two weeks. We'll leave our stop at 47.51 for now. Remember that we plan to exit before PLCE's August earnings report.

Picked on July 27 at $ 44.90
Change since picked: + 0.31
Earnings Date 08/11/05 (unconfirmed)
Average Daily Volume = 775 thousand
 

Dropped Calls

None
 

Dropped Puts

None
 


Trader's Corner

Relationships Between Different Indices and 'Markets'

OIN SUBSCRIBER QUESTION
Just wondering if you could tell me what the relationship between different indices/commodities are. What is the significance of divergences between major indices if any? An obvious example would be oil vs. transports.

RESPONSE:
This is a complex and big subject. One on which I have not done a lot of research myself. John Murphy has, another technical analyst whom I know who is widely known in fact. John has written on this subject in his book "Intermarket Analysis", which is a broad study of the relationship between equities, bonds, currencies, and commodities. This is sort of a 'macro' view.

I am at times curious and interested in specific comparisons and a 'micro' view, such as the relationships between oil or gold versus specific indexes; e.g., the Dow Transportation Average (TRAN) versus crude oil futures.

Or, BETWEEN indices as you note, like comparing the Semiconductor index (SOX) and the Nasdaq 100 (NDX); or, between the Russell 2000 (RUT) and the S&P indices. My interest is primarily whether a commodity or index may be acting as a 'bellwether' for the major trading indexes like OEX, DJX and OEX, tipping us off that an advance or decline will continue, 'consolidate' or reverse its present trend.

Some relationships are NOT intuitive, easily understood or obvious. For example, you would think that RISING prices in crude oil would tend to cause the Transportation Average (TRAN) to FALL. That this would be an INVERSE relationship; i.e., they move in opposite directions.

Fuel prices are a major cost to railroads, trucking companies and especially airlines. If a substantial portion of a companies costs go DOWN, their profits should go UP; right? More money to the bottom line, rising earnings, will cause stock prices to rise.

If this reasoning is correct and there are not some other, less obvious SIGNIFICANT other factors, how do we explain the below chart: a comparison of crude oil (nearest futures) prices for the past year approximately AND the Dow Transports (TRAN).

Its immediately apparent, slightly helped by my up or down lines signifying the direction of the broad price trends, that the
TRAN transport stock average is often (mostly) going up when crude oil prices are ALSO going up; and, vice versa: when oil prices fell during this period, TRAN was also generally falling. Go figure!

It can be seen on the above chart that a fall in oil prices has been ahead ('led'?) a further rise in TRAN, such as was the case from early-Nov into late-Dec; but the direction of the overall trends have tracked each other for long periods of time. There are probably lagging effects, seasonal considerations, what the overall market is going, etc., that are also key.

While this is only a brief and recent comparison between crude oil and the Dow Transports, it's not like the obvious INVERSE relationship that tends to be the case for overall commodities prices (e.g., the 'CRB' index) and bonds. You can overlay these charts and see that bonds tend to RISE (yields fall) in price when commodity prices FALL.

Now, perhaps I have not had my thinking cap on long enough (or, am not smart enough) to figure any reason why this more 'direct' (not 'inverse') relationship would be occurring between crude oil prices and the transportation stocks. Perhaps someone reading this can hazard a guess or pinpoint why the various ups and downs are moving in the SAME direction. If so, please write in.

One point I want to make is that relationships between indices and key commodities are not so easy to figure. John, by the way, in his work, has done comparisons more between the overall commodity price index and equities and, especially, bonds.

COMPARISONS BETWEEN INDEXES: 'confirmation' and 'divergence'
The relationship between the Semiconductor Index (SOX) and the Nasdaq, especially the Nasdaq 100 (NDX) provides some useful confirmations or divergences at times. I wouldn't say that SOX is exactly a 'bellwether' index for the Nasdaq, in that it doesn't always move ahead of NDX.

But these two indexes do fill the useful role of confirming or not-confirming tops or bottoms; or, to alert us to a significant trend reversal ahead, extremely useful in terms of taking out major call or put option positions at various times during the year.

This is part of my 'less is more' theory of trading index options: the less you trade, the better, by taking only high-potential trades. Hey, you only need a few of these to make a very profitable year!

Looking at the SOX versus NDX charts below, what is often seen is that NDX will form a bottom or top first; e.g., a bottom in August '04, a top in late-Dec '05. The two bottomed at the same time approximately, this past April, thereby 'confirming' the trend change or reversal in each other, which was useful and somewhat unusual. Notice that the Nasdaq 100 didn't really get into a major uptrend UNTIL the SOX index finally bottomed.

In two instances SOX formed a 'strong' (in terms of predictive value) technical pattern with first a 'double top' and later a 'double bottom'. The double top was not only a 'sell signal' (buy puts) for SOX, but suggested that NDX was very likely going to continue to go lower. The double bottom in SOX was not only a solid 'buy signal' for SOX calls, but a MAJOR confirmation for the likelihood that NDX had also bottomed.

We don't have to look too hard to find why the semiconductors might show, at times, a more definitive buy or sell 'signal' for the Nasdaq 100, as semiconductor chip sales strength is so important in suggesting that technology stocks are and will be doing better by selling more products requiring semiconductor chips.

INDEXES ACTING AS 'BELLWETHERS'
The Russell 2000 Index (RUT) of mid to small-cap stocks, sometimes acts as a bellwether, making a move AHEAD of the S&P 500 index of (all) big-capitalization stocks; not so, the Nasdaq Composite and Nasdaq 100, as RUT trades in line with, not ahead of, the Nasdaq almost exclusively.

The charts below are weekly close-only 'line' charts, so the 'line' is not finished so to speak, until the Friday (weekly) close. In a weekly line chart, today's close is temporarily equal to the weekly close.

Back in 2000, the mother of all 'sell signals', was not only the weekly closing double top in SPX, but the quite pronounced divergence of RUT, as it failed to 'confirm' (by a country mile) a close that was anywhere near its prior peak. RUT was way ahead of the S&P here. Of course, any double top is a potent sell signal. The combination of RUT's price pattern and the SPX double top was a major confirmation of a major top.

The most recent instance of the Russell 2000 acting as a bellwether and 'leading' the S&P, was the decisive upside penetration of RUT's prior high some days ahead of SPX; enough so to make it useful for trading, by keeping to a bullish market outlook. Of course this story is not written or completed yet, in the S&P 100 (OEX).

Perhaps, more emphasis on this leadership role of the Russell would have kept me MORE bullish on my Nasdaq 100 (NDX) calls, not so ready to take my profit, since I've been unconvinced or unsure that NDX would ALSO make a new high for this year. Stay tuned on that! And, well, I always get out when I've captured a good part of a move and an index is near an old important peak. Let the other guys fight it out for a final potential spurt through an old high. But I digress!

The DAILY chart comparison of the two indexes (RUT + SPX) below, also tells an interesting story. First of all, it's easier to see the leading role of the Russell in breaking out to a new yearly high.

The other instance of where a divergence in the price action of the two indexes was very useful in trading (leading to a quite profitable index put purchase), was when the S&P 500 (SPX) went to a decisive new high, whereas the Russell 2000 (RUT) hit a decisively lower peak.

Of course, it remains to be seen whether RUT's strong move to a new high will also be a harbinger for the narrower S&P 100 (OEX) index or for either the Nasdaq Composite (COMP) or Nasdaq 100 (NDX), since neither has pierced its early-January high. I don't give AS MUCH weight to RUT leading to a new high or new low, per se, but more to whether it DOESN'T lead to a new high or new low. This pattern, this type 'divergence' is often a possible sign of a top or bottom, respectively.

Lastly and summing up on comparing different MARKETS and difference INDEXES, there is no often no simple formula for how comparisons between markets or between indexes will translate into what one market or index does versus the other.

Often, the relative performance or patterns of two 'RELATED' indexes (e.g., SOX and NDX) can tip us off to a trend reversal; OR, give us more to go on in staying in a position since there is are some added reasons or evidence for our course of action.

Good Trading Success!

NOTE -
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Contact Support with 'Leigh Stevens' in the Subject line.
 

Today's Newsletter Notes: Market Wrap by Jeff Bailey, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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