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Daily Newsletter, Saturday, 08/06/2005

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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

Porridge Too Hot

The Goldilocks economy burned its tongue on Friday on a hearty serving of hot jobs. The not too hot, not too cold economy found itself sweating after the Jobs report showed a jobs gain of +207,000 in July. Suddenly the looming Fed meeting next Tuesday took on an accelerated risk and traders decided to take profits.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The big headline for Friday was the Jobs report blowout and every mention carried the Fed meeting footnote. Jobs for July surged +207,000 and well over the consensus estimate of +180,000. The numbers for May and June were also revised upward by +42,000. The unemployment rate remained stuck at 5.0% mostly due to many workers dropping out of the job market rather than getting new jobs. While this appears to be a strong report based on the headline number there are some problems under the hood. You know I rarely take the headline numbers of any report at face value. The Bureau of Labor Statistics periodically adjusts the real survey numbers based on historical/seasonal trends. For July nearly 100% of the gains were the result of a seasonal adjustment. While the impact of the headline number was an immediate knee jerk reaction the reality of the report was much less severe. The second problem area was the +0.4% jump in hourly earnings. This sharp increase suggests wage inflation may be starting to creep into the economy. Wage inflation feeds price inflation and this is one more reason to worry about the Fed meeting next Tuesday.

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The strong Jobs report sent expectations of Fed hikes another notch higher with the odds for a removal of the measured pace language jumping strongly. Analysts are mixed over the expected ending point for the hikes with the range from 4% to 4.5% with the 4.5% camp gaining followers. One point everyone should remember is that Greenspan will be retiring in January. Nearly everyone expects the Fed to halt its hikes before he retires. This will leave the new Fed head a neutral Fed prepared for any future crisis. The current front-runner for the position is Ben Bernanke. That suggests the Fed may accelerate its rate hikes to meet its neutral ceiling by January. There are four meetings remaining in 2005, Aug, Sep, Nov, Dec. If the Fed is going to target 4.5% then one of those meetings will have to be +50 points. If the economy is really accelerating as fast as it seems with a +5% Q3/Q4 GDP as many suggest then the Fed may want to target something in the 5% range instead. That would setup a race against the clock for those remaining four meeting. Never go to 5% you say? Remember also that the Fed historically always goes too far when they enter a hike cycle and that better than 75% of hike cycles end in a recession. The ECRI Future Inflation Gauge also released today jumped +1.3% for the second consecutive month of increases. Other FIGs from around the globe also showed a jump in inflation risk. Energy prices are the primary driver. The Euro-zone jumped to a 51 month high at 99.9, still below the U.S. at 119.0 but the trend is clearly in place. This is yet another reason for the Fed to remove the measured pace restriction.

Despite the headline Jobs numbers and the jump in hourly wages the American consumer is still being squeezed. In the Personal Income report earlier this week it showed that the savings rate had fallen to zero and the second lowest level since the great depression. With interest rates rising and energy prices soaring the minor +0.4% jump in hourly wages is like finding a penny on the parking lot. It is hardly worth the effort to stoop over and pick it up. If the Fed does accelerate its rate hikes we are coming dangerously close to a real economic meltdown. Hopefully they understand this and will stop early for once.

The sticker shock over the Jobs report sent bonds over the cliff dragging the stock market behind it. There was one real standout and that was Baidu (BIDU). This small Chinese Internet stock hopes to be the Google of China. It IPOed on Friday at $27 and soared to $150 intraday with a close at $123. This was a +350% gain making it the most successful IPO in years. The relatively small float of only four million shares changed hands many times with volume on Friday of over 22 million shares. On the surface it would seem every share was traded five times but analysts claim over two million shares were held by institutions and not traded. This means the other two million were traded over ten times each. Those trying to short the initial open to $65 were squeezed for every penny as it became impossible to find shares to cover. Since the company only has $30 million in sales and $12 million in cash flow the instant jump to $4.4 billion in market cap is not likely to last. Venture capitalists own 45% of the company and are currently in lock up. Founder and CEO Robin Li owns 22.4%.

Delphi started a bonfire with a draw down of $1.5 billion of a $1.8 billion line of credit only a couple days before it is to file its 10Q. Normally this would not be a problem except that Delphi has covenants allowing it to use the credit line only as long as certain conditions are met. The 10Q is expected to show a violation of those conditions and void the credit line. By making the draw down just before what is expected to be an ugly 10Q the company could be trying to hoard liquidity ahead of a bankruptcy. All the credit agencies cut Delphi's debt and the bankruptcy watch is on. Delphi may be loading up on cash to strengthen its hand as it negotiates with GM and the unions in an effort to avoid bankruptcy. A Delphi bankruptcy could put an additional $9 billion pension liability back on GM so you can bet GM will be pulling strings to keep its 1999 spin-off afloat. DPH lost -15% on the news and GM accelerated its four-day dive. It appears the news leaked out early given the sudden drop in GM on Tuesday.

September Crude Oil - Daily

December Natural Gas - Daily

Oil closed at another new high at $62.31 after touching $62.50 intraday. December Natural Gas closed at $9.61 and a strong new high with $10 not far away. Over the past week seven refineries with total capacity of 1.7 mbpd experienced unplanned shutdowns. This was 10% of U.S. refining capacity and gasoline stocks fell by -4 million bbls stretching the decline to five weeks. It is almost a sure thing that $70 oil (sweet crude) is right around the corner. The Iranian Deputy Minister quoted that number this week when he said OPEC has no spare capacity. The problem continues to be not only oil production but an increasing dependence on refining capacity. TSO said this week that its refineries have been running at 100% capacity and that echoes the same types of comments from all the major refiners. There is not enough refining capacity to allow the refiners down time for repairs and upgrades. As a result we are seeing outages from equipment failures, many resulting in fires that are impacting not only the price of gasoline but the supply. September gasoline futures closed at $1.83 and only -3 cents from its record high last month. With only a few refiners capable of processing the excess sour crude from OPEC the increasingly tighter supplies of sweet crude are in even higher demand. Oil stocks were hit with the same profit taking hitting the broader markets but a break of oil over $62.50 next week should give them new life. There is a new depression in the Gulf, which will be called Irene if it turns into a hurricane. Historically we are just moving into the strongest period for storms Aug-Sept and the predictions are for 7-11 more hurricanes this year. The odds are very good that one of them will do substantial damage to the oil sector. It is simply the law of averages. Continue to buy the dips until the trend changes.

Rumors are flying that Microsoft is going to announce another huge dividend and that has powered the stock to a new three-year high in only five days. Microsoft has been seen as dead money for several years and has been locked in a $22-$27 trading range. Last Friday MSFT closed at $25.59 and right in the middle of its range. This Friday MSFT came within six cents of $28 and closed at $27.77. This may not seem like a lot when compared to the daily moves in the oil sector but with nearly 11 billion shares outstanding that represents an increase in market cap of nearly $24 BILLION. I guarantee that is far more than they will pay out in a dividend and anyone holding Microsoft should raise their stops quickly. As we have seen so many times in the past, the ramp on expectations of good news is normally stronger than the actual news.

Microsoft Chart - Weekly

The market exists to confound the most traders at any given time. This week was a definite example. For nearly two months I cautioned that we could see a market turning point in the week ended July 22nd. The Dow top occurred on the 29th instead of the 22nd with the other major indexes following a couple days later. The SPX hit a four-year intraday high of 1245.15 on the 28th and repeated that top four days later. What frustrates me more than missing the turning point by a week was my reaction to the Tuesday action this week. I reported that we finally saw a confirmation day with decent volume and great internals. New highs hit 738 on strong volume. I was almost ready to put my fur coat up for the summer and I actually increased some of my longs. Unfortunately that was climax peak in its purest form. I mentioned the earnings warnings in the chip sector after the close and the potential for some profit taking. There was also fear of the Jobs report and the impending Fed meeting. We all know that when the markets want to take profits they seize on any event as a reason for selling. As the week progressed the number of reasons to take profits grew into a laundry list as the talking heads on TV tried to appear all knowing. On Friday the new 52-week highs fell to only 169 and decliners beat advancers 5:2. Down volume was better than 3:1 over up volume. This was an even stronger show of conviction than the Tuesday rally.

The Dow retreated to fill its gap at 10550 from July 14th and trade at a four week low. It did NOT trade out of its range despite the drop from multiple tests of 10700. The Whilshire 5000 retreated to 12262 and right back to its range bound congestion range and comfortably above strong support at 12200. No worry here yet. Despite an implosion in the chips and the Russell the Nasdaq gave back only a weeks of gains to come to rest at 2175 and well above the bottom of its range. Still no problem here either.

Russell Chart - Daily

I mentioned on Tuesday that no +10% move goes unpunished and the Russell was up nearly +20% from its lows. Well the punishment definitely arrived with the Russell crashing -27 points from 688 to 661 in only three days. That -4% drop was clearly some mutual fund profit taking as the dog days of August finally appeared. The disappointing chip earnings on Tuesday night knocked the SOX back into its prior range with support at 470 and effectively ended the assault on 485-490 resistance. But, all of that news is now history and the real question is where do we go from here?

I would like to say that the dead stop on 10560, 2175, 1225 was the end of the selling. Unfortunately as much as I would like to see a rebound from here there may still be more weakness ahead. According to the Stock Traders Almanac August has been the worst month for the S&P for the last 15 years. It is also the second worst month for the Dow and the third worst for the Nasdaq. In six of the last eight years the losses in just the last five days averaged -3% for the major indexes. Has the selling just begun? Nobody knows but what we do know is that there will be a lot of volatility as the month progresses. Both sides will battle for control while funds reshuffle their portfolios in advance of the September/October buying opportunity. If the selling does continue the Dow has risk to 10250, Nasdaq 2050 and SPX 1185. My recommendation still stands to be cautiously long over SPX 1225 and short below that level.

Regardless of whether we go up or down I still believe the oil sector will be the best performer. Historical trends in crude pricing typically see gains in August/September and we want to be onboard for those gains. Once a post September decline in crude prices begins I think we exit our longs and begin targeting some buying opportunities on any major dip. The same scenario exists for the broader market. With the historical cycle suggesting weakness over the next two months we should be ready to exit any positions outside the energy sector and look for buying opportunities in Sept/Oct. For me the market turning point came a few days later than I expected but it still came. I was prepared for it and I hope you were as well. Now that the markets are back in their ranges we need to refrain from emotional entries hoping for a snapback and take our time picking targets. Keep your eyes on SPX 1225 and remember that markets go down faster than they go up. With the Fed meeting next Tuesday there is severe market risk should they eliminate the measured pace clause. Should they retain it we should rally again but watch out for a lower high.

I am going to be at an energy seminar this coming week where 90 companies will be giving their views on their future and the future of oil. I am doing continuing research on the coming oil crisis in preparation for an update to my oil report for Q4 of this year. I will probably have a lot to tell you next Sunday and hopefully some new oil plays for the next cycle. Until then watch SPX 1225, enter passively and exit aggressively if the market turns against you.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None AET
  NBIX

New Calls

None today.
 

New Puts

Aetna - AET - close: 75.55 chg: -1.22 stop: 79.01

Company Description:
As one of the nation's leading providers of health care, dental, pharmacy, group life, disability and long-term care benefits, Aetna puts information and helpful resources to work for its approximately 14.435 million medical members, 12.976 million dental members, 9.117 million pharmacy members and 13.662 million group insurance members to help them make better informed decisions about their health care and protect their finances against health-related risks. Aetna provides easy access to cost-effective health care through a nationwide network of more than 684,000 health care professionals, including over 405,000 primary care and specialist doctors and 4,135 hospitals. (source: company press release or website)

Why We Like It:
AET has been a huge winner for investors since it bottomed back in October 2004. Yet now it appears that the stock has peaked in the $86.00 range after it consolidated under that level for about a month back in June-July. The current short-term trend is a bearish one and now that the broader markets look poised for some profit taking we believe AET will test support near $70.00 and its 200-dma. The Point & Figure chart is also bearish and points to a $64.00 target. While we are suggesting entries here more conservative traders may want to wait for AET to hit a new relative low under $74.50 first. Our official target will be $70.50-70.00.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 80.00 AET-UP OI= 270 current ask $5.40
BUY PUT SEP 75.00 AET-UO OI=1288 current ask $2.25
BUY PUT SEP 70.00 AET-UN OI= 936 current ask $0.75

Picked on August 07 at $ 75.55
Change since picked: + 0.00
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 2.0 million

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Neurocrine Bio. - NBIX - cls: 47.30 chg: -0.98 stop: 50.01

Company Description:
Neurocrine Biosciences, Inc. is a product-based biopharmaceutical company focused on neurological and endocrine diseases and disorders. Our product candidates address some of the largest pharmaceutical markets in the world including insomnia, anxiety, depression, diabetes, multiple sclerosis, irritable bowel syndrome, eating disorders, pain, and autoimmunity. (source: company press release or website)

Why We Like It:
NBIX reported better than expected earnings but like many stocks the reaction was negative as investors sold the news. We think NBIX looks like a tempting bearish candidate because the biotech sector has been the leadership group over the past two months and looks poised for profit taking. Technicals in NBIX are bearish and the stock has broken its trendline of support. There is potential support near the $45.00 level but we are going to target the $43.00-42.00 range near its simple 200-dma. Traders can choose to buy puts here or look for a possible bounce back toward the $49.00-49.50 region and then enter on a failed rally.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 50.00 UOT-UJ OI=1203 current ask $3.90
BUY PUT SEP 45.00 UOT-UI OI= 867 current ask $1.35

Picked on August 07 at $ 47.30
Change since picked: + 0.00
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 543 thousand
 


Play Updates

In Play Updates and Reviews

Call Updates

Danaher - DHR - close: 56.02 chg: -0.34 stop: 53.99

The recent action in the markets looks like a bearish reversal and this is bad news for our bullish play in DHR. It is true that DHR is holding up better than most of the market but if the major indices pick up speed as they move lower we would expect DHR to follow suit. Technical indicators for DHR are beginning to turn bearish. We see short-term risk in DHR in the $54.00-54.50 region. We are not suggesting new bullish plays at this time. Very conservative traders may actually want to exit now and then wait to see if DHR bounces from its simple 200-dma (near 54.50) as a future entry point for calls.

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

Picked on August 03 at $ 56.67
Change since picked: - 0.65
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.5 million
 

Put Updates

CR Bard - BCR - close: 63.55 chg: -0.07 stop: 66.05*new*

S&P raised its credit ratings for BCR on Friday and that may have been responsible for the stock's lack of participation in the market's decline. Shares of BCR continue to look very vulnerable to further selling but we all know that nothing moves in a straight line. We suspect that BCR could bounce a bit more before turning lower again especially since it is testing a short-term trendline of support (see chart). We would suggest that readers watch for a bounce into the $64.50-65.00 range as a new bearish entry point to buy puts. The $65.00 level should now act as round-number, psychological resistance, which is also reinforced by its exponential 200-dma. Meanwhile we are going to lower our stop loss to $66.05, just above its simple 200-dma. Our target is the $60.50-60.00 range compared to the Point & Figure chart, which points to a $55.00 target.

Suggested Options:
We are suggesting the September puts although Octobers would work as well.

BUY PUT SEP 65.00 BCR-UM OI=143 current ask $2.65
BUY PUT SEP 60.00 BCR-UL OI= 99 current ask $0.65

Picked on August 03 at $ 64.45
Change since picked: - 0.90
Earnings Date 07/19/05 (confirmed)
Average Daily Volume = 553 thousand

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Eastman Chemical - EMN - close: 53.49 chg: -0.66 stop: 56.01

EMN is a new bearish candidate added to the newsletter on Thursday night. The stock has broken down under support at the $54.00 level and hit our trigger to buy puts at $53.90 opening the play. This has also created a new sell signal on EMN's Point & Figure chart. We see no change in our strategy so we're reposting the Thursday night play description here:

EMN has been slowly consolidating sideways the last three months but with a trend of lower highs. Technically all of its indicators point lower and the share price recently broke down below technical support at both its simple and exponential 200-dma's. We also see that its P&F chart is bearish and points to a $49.00 target but this could move lower as a decline under the $54.00 mark would produce a new double-bottom breakdown sell signal. We are going to suggest a trigger under support at the $54.00 level. Our suggested entry point to buy puts will be $53.90. We'll start with a stop loss at $56.01. Our target will be the $50.50-50.00 range.

Suggested Options:
We are going to suggest the September puts.

BUY PUT SEP 55.00 EMN-UK OI=680 current ask $3.20
BUY PUT SEP 50.00 EMN-UJ OI=668 current ask $0.80

Picked on August 05 at $ 53.90
Change since picked: - 0.41
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 872 thousand

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Fedex Corp - FDX - close: 84.60 chg: -0.40 stop: 86.01

We remain bearish on FDX but are currently still sitting on the sidelines waiting for shares to breakdown and hit our trigger to buy puts. Fortunately, odds of FDX turning lower are improving. Not only has crude oil prices hit a new high but the Dow Transportation index just broke its five-week up trend and its MACD has produced a new sell signal. Looking at FDX its technical indicators are suggesting a turn lower and its MACD is nearing a new sell signal. We also see that FDX is still struggling under technical resistance at its simple 50-dma. We are going to adjust our suggested entry point to buy puts from $82.85 to $82.99. More aggressive traders may want to consider buying puts in FDX if the stock trades under short-term support at $84.00. Our two-month target is the $76-75 range. Currently the bearish P&F chart points to a $71.00 target for FDX.

Suggested Options:
We are not suggesting puts until FDX hits our trigger. If the play is opened we like the October 85 and 80 puts.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 09/22/05 (unconfirmed)
Average Daily Volume = 2.0 million

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F5 Networks - FFIV - close: 37.17 chg: -0.88 stop: 41.01*new*

Networking stock FFIV continues to show lots of relative weakness with another 2.3% decline on Friday. The P&F chart is looking very bearish with a $22.00 price target. We remain bearish on the stock but FFIV is starting to look a little oversold here. Our target is only the $35.00-34.00 range so traders looking for a new entry point might want to wait for an oversold bounce back toward the $39.00 or $40.00 levels. We are going to lower our stop loss to $41.01 just above the simple 10-dma, which should act as technical resistance. The $40.00 mark should also act as round-number resistance. Traders need to be aware that CSCO's earnings on August 9th (after the closing bell) does represent a risk. If CSCO comes out with some unexpected positive news it could lift the whole industry group.

Suggested Options:
We like the September puts but we're not suggesting new plays at the moment.

Picked on August 03 at $ 38.76
Change since picked: - 1.59
Earnings Date 07/20/05 (confirmed)
Average Daily Volume = 1.4 million

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Fannie Mae - FNM - close: 54.96 chg: -0.91 stop: 57.01*new*

FNM continues to decline in a steady fashion but Friday brought good news to the bears. Shares of FNM broke down and closed under round-number support at the $55.00 level. There is still a chance for an oversold bounce but we would expect the simple 10-dma near 56.30 to act as overhead resistance. We are going to lower our stop loss to 57.01, which is above its simple 100-dma (also overhead resistance). Our target remains the $51.50-50.00 range.

Suggested Options:
The only options available are January strikes.

BUY PUT JAN06 60 WFN-ML OI=12542 current ask $6.20
BUY PUT JAN06 55 WFN-MK OI=20448 current ask $3.30
BUY PUT JAN06 50 WFN-MJ OI=32945 current ask $1.70

Picked on July 27 at $ 56.49
Change since picked: - 1.53
Earnings Date 00/00/05 (unconfirmed)
Average Daily Volume = 3.3 million

---

Google - GOOG - close: 292.35 chg: -5.38 stop: 300.01

On your mark. Get set. Wait! Thus far GOOG has spent the last week consolidating between $287 and $300. The failure to breakout back above the $300 level may be a telling clue that its upward momentum has stalled. Yesterday we suggested that aggressive traders may actually want to open bearish positions if shares broke down under the $295 level. It will be interesting to see if that proves to be a successful entry point or not. Our strategy here is to try and catch a breakdown in GOOG, which looks very overbought from its April to July rally from $183 to $315. We are suggesting that readers use a trigger at $284.50 to open bearish positions in GOOG and target a consolidation back toward the $250 region (255-250). The Point & Figure chart is currently bearish and points to a $256 target for GOOG. We feel that due to GOOG's volatility that even using a trigger under $285 still makes this an aggressive and high-risk play. If you're a very aggressive trader then you may want consider buying puts if GOOG breaks down under its simple 50-dma near $291.

Suggested Options:
We are not suggesting plays at this time. Our trigger to buy puts is $284.50. If triggered we like any of the September 290, 280, 270, 260 puts.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 13.6 million

---

KB Home - KBH - close: 74.50 chg: -3.86 stop: 82.01

Homebuilders got hit hard on Friday after the jobs report suggested that interest rates will continue to climb to help cool the economy. Shares of KBH lost almost 5% and broke down under its 40 and 50-dma's on big volume about double its average. We see no change in our strategy so we're reprinting Thursday's play description below. However, traders looking for new positions can probably look for an oversold bounce back toward the $78.00 region. A failed rally there near $78 could be used as a new bearish entry point. The option prices below have been updated to reflect Friday's decline. Thursday's play description begins here:

Here we go again. The rally in the homebuilders has stalled. While we remain bullish on the group we are going to try and scalp a few points from KBH as it consolidates lower. The stock has broken its three-month trend of support and all of its daily technical indicators have turned south. This is an aggressive, high-risk play so treat it with caution. Traders may want to consider waiting for a bit before entering positions just to see if KBH bounces back toward the $80.00 level again before moving lower. However, it is worth noting that the DJUSHB home construction index has also broken its three-month trendline of support, suggesting a short-term change in direction. We are going to target the $71.50-70.00 range.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 80.00 KBH-UP OI=1150 current ask $7.10 +2.60
BUY PUT SEP 75.00 KBH-UO OI=1368 current ask $3.90 +1.35
BUY PUT SEP 70.00 KBH-UN OI= 358 current ask $1.95 +1.10

Picked on August 04 at $ 78.36
Change since picked: - 3.86
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = 2.4 million

---

Lehman Brothers - LEH - cls: 103.43 chg: -1.77 stop: 108.01

...And there was much rejoicing! LEH has finally broken down under three-week old support at the $105.00 level. Friday's decline also broke technical support at its 21-dma. Suddenly our target at the $100 level doesn't look so far away. This has been a speculative high-risk play gambling on a consolidation in LEH back toward the $100 level before the August options expire on August 19th. Traders can still play the August options but September strikes work too. If you chose not to open positions in the previous weeks you might want to watch for a bounce back toward $105.00, which should now act as resistance.

Suggested Options:
We have been suggesting the August $100s but now we're adding some more strikes.

BUY PUT AUG 100 LES-TT OI=3623 current ask $0.40
BUY PUT AUG 105 LES-TA OI=3712 current ask $2.30
BUY PUT SEP 100 LES-UT OI= 958 current ask $1.25
BUY PUT SEP 105 LES-UA OI=1067 current ask $3.30

Picked on July 21 at $105.13
Change since picked: - 1.70
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 2.7 million

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3M Co. - MMM - close: 72.99 change: -0.36 stop: 76.01*new*

Dow-component MMM continues to slowly consolidate lower. The stock hit new one-month lows on Friday and was sinking faster on rising volume toward the close. We also notice that its MACD has produced a new sell signal. Our short-term target is the 70.00-68.00 range. We are lowering the stop loss to $76.01, above the simple 50-dma.

Suggested Options:
Readers might want to consider the September strikes below.

BUY PUT SEP 75.00 MMM-UO OI=1507 current ask $3.10
BUY PUT SEP 70.00 MMM-UN OI=1108 current ask $0.70

Picked on July 19 at $ 74.29
Change since picked: - 1.30
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million

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MicroStrategy - MSTR - close: 73.39 chg: -1.98 stop: 77.51

Our aggressive play to try and scalp a few points in MSTR as it fills the gap from late July has been opened. The breakdown under the $75.00 level on Friday hit our trigger at $74.95. Short-term technical indicators are bearish and its MACD is nearing a new sell signal. We don't see any changes from our strategy so we are reposting the Thursday night play description here:

MSTR is another candidate for aggressive players. The stock is prone to being volatile but we suspect the next move will be down. The stock got a big pop higher on July 29th after its better than expected earnings report. That rally stalled at the $80.00 level, which was resistance back in January 2005. After a week of trying to breakout over the $80 level shares are now testing the top of its gap near $75, which is acting as support. Given that the broader markets still look somewhat extended and overbought from their July lows and the fact that we're moving into the slow August-September time period for stocks we believe that odds are good MSTR will fill its gap before moving higher. We are suggesting a trigger at $74.95 to open the play. Our target will be the $70.50-70.00 range. We're not that happy with the stop loss because MSTR can be very volatile but we're not excited about putting a stop at $80.01, which is current resistance. Our readers should adjust the stop to best suit their needs.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 75.00 EOU-UO OI=291 current ask $5.70
BUY PUT SEP 70.00 EOU-UN OI=166 current ask $3.40

Picked on August 05 at $ 74.95
Change since picked: - 1.56
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 570 thousand

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Panera Bread - PNRA - close: 56.30 chg: -1.28 stop: 57.51*new*

No changes here. As expected the weakness in PNRA has begun to pick up speed with the recent declines in the market. Our target has been the $52.50 region but we are planning to exit early on Monday afternoon at the close to avoid holding over PNRA's earnings report on Tuesday morning. We are not suggesting new plays. Instead we are lowering the stop loss to almost break even at $57.51.

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

Picked on August 1 at $ 57.49
Change since picked: - 1.19
Earnings Date 08/09/05 (confirmed)
Average Daily Volume = 601 thousand
 

Dropped Calls

None
 

Dropped Puts

Alliance Res.Part. - ARLP - cls: 90.00 chg: +0.80 stop: 91.01

We still believe that ARLP is poised to consolidate lower, at least toward its simple 10-dma near 85.00, but it appears that our stop loss was too tight. ARLP was an aggressive, high-risk put play for us and we tried to mitigate our risk by using a relatively tight stop. Shares displayed too much volatility and stopped us out on Friday with the spike to $93.42. Our stop loss was $91.01. While we are closing the play readers may want to consider new bearish positions if ARLP trades under Thursday low of $88.69.

Picked on August 04 at $ 89.39
Change since picked: + 0.61
Earnings Date 07/27/05 (confirmed)
Average Daily Volume = 60 thousand
 


Trader's Corner

Put/Call Ratio

Put/Call ratios are funny animals. They tell us the degree of buying or selling pressure by monitoring the volume of puts and calls, then we flip the numbers around and interpret them opposite to what they are telling us. In this way Put/Call ratios are used as gauges of market sentiment, as they measure bullishness or bearishness by comparing the number of puts and calls traded. We interpret them upside down because when put volume becomes excessive in relation to call volume, it is an indication of excessive bearishness in the market, which can telegraph a market bottom and is usually bullish. But on the other side, when call volume becomes excessive in relation to put volume, it is an indication of excessive optimism and bullishness in the market, which is usually bearish. This is why the Put/Call ratio is called a contrarian indicator.

The Put/Call Ratio is simply the number of put options contracts traded in a given day divided by the number of call options contracts traded that same day. The put volume divided by the call volume yields the Put/Call Ratio.

In theory you will buy the market when the ratio gets too high and sell when the ratio gets too low. Thats the easy part the hard part is putting this into practice. First of all you have to define what is too high and what is too low. And then you have to think about how does the too high and too low change over time? And how does too high or too low change during a bull cyclical or bear cyclical or can this change from secular market to secular market.

Although you can create a put/call ratio on any equity or index that has listed options the two that technicians use the most is the Index option put/call ratio and the equity only put call ratio.

The Index PC ratio is computed using only OEX options for that is the index used the most for speculation. Therefore the Index PC ratio will give the most clues as to what the average trader is doing. Larry McMillan, author of many books on options and what many consider to be the guru of options, has looked at the PC ratio of all index options and has found it not to be a useful number.

The next major PC ratio is the equity PC ratio and as the name implies, is a ratio calculated by using the volume of all stock options.

A third Put Call ration that some technicians will use is the combination of the two, the index added to the equity-only ratio.

It is not worth while to calculate the PC ratio on most individual stocks because there is just not enough volume to give you a number that would mean anything. Of course the exception to this rule is PC ratios for stocks like Microsoft, IBM or Intel, stocks that have very large volumes, can be of value but generally a stocks PC ratio is not too helpful.

The debate as to which PC ratio to use, Equity or OEX, goes on but here are a few of the arguments to consider. Speculators use the index PC and, as stated earlier, can give hints as to whether the average Joe Trader is bullish or bearish. But some analysts think that the equity only ratio is the purer of the two because there is so little arbitrage in equity options anymore and the most money managers dont buy equity puts for protection they buy index (OEX) puts. So the equity only ratio could give a clearer picture as to the average Joe Traders true intentions. A good example of these was when in 1987 many technicians discarded the PC ratio as a useful indicator altogether. The index PC ratio gave a sell signal in July of 1987, which was a good thing considering what happened in October 1987. But in August the ratio began to climb and gave a buy signal in September so if you were only watching only the index PC ratio you were long going into the infamous October 1987 crash. On the other hand if you had been watching the equity only PC ratio you would have had a heads up because it gave a sell signal in July and never did get back to a buy before the crash. So what caused the index PC ratio to give the buy in August? We will never know for sure but most speculate that it was the institutions buying puts to hedge their holdings.

Interpreting the PC ratio as a contrarian indicator is tricky and should only be used if you truly think the options are purchased for speculation but once you introduce the fact that options are used for hedging then the use of this indicator gets even murkier. So here is the question you have to ask yourself. If you see the index PC ratio bearish, is it because speculators are too bullish or is it because institutions are buying puts. Most assuredly it is the latter. Now you have to ask is the put buying by the institutions because they are bullish and using the puts to hedge their long positions or are they truly bearish. So as you can see this indicator although very useful cannot be used on a whim.

What I would like to propose is use the two differently. The majority of put volume represents bets against individual stocks by the small individual investors - the so-called "dumb money" that is usually wrong. On the other hand, since many institutions and professional traders (the "smart money") use the OEX options for hedging, when the OEX Put/Call ratio diverges from the Equity only Put/Call ratio, it can be a sign that "smart money" is moving counter to the trend. This makes the OEX ratio a non-contrarian indicator and the equity only ratio a contrarian indicator.

Here is the Equity only Put/Call Ratio with 21 MA overlay. As a contrarian indicator you could be having some worries here if you are bullish.

The 21 MA is trending down and in early July it did reach an extreme but is now back to normal levels.

Here is the Index Put/Call Ratio with a 21 MA overlay. As a non- contrarian indicator you could be having some worries here as well if you are bullish.

Here you see the 21 MA trending upwards but the ratio is not to extremes yet. It almost got there in early July but I think any print over 3.0 should awaken the bears and put the bulls on the defensive.

These charts also support my theory that you should use the Equity only and index put/call ratio in opposite ways. In early July the Equity only P/C Ratio hit extreme lows and the Index P/C ratio hit extreme highs.

I believe the Put/Call ratios are good predictors of market turning points. But beware of which ratio you are looking at. If using Equity Only Put/Call ratio use it as a contrarian indicator but if you are using the Index Put/Call ratio use it as a non-contrarian indicator.

Remember plan your trade and trade your plan
 

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

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