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Daily Newsletter, Monday, 08/08/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Options 101

Market Wrap

Oil Slick

Crude oil printed new record highs today, and a weaker than usual showing from indirect bidders at the Treasury auctions saw bond yields rise. Equities continued their slide from Wednesday on the light volume that has characterized this summer's trading.

Volatility rose, but not by much, and volume breadth was lightly negative (-1.41:1 on the NYSE and -1.72:1 on the Nasdaq) as equities retraced another chunk of the rally, turning the clock back to the latter half of July. With a solid slate of market moving data scheduled for tomorrow, including an FOMC announcement, the most surprising thing about today's trading was not the weak volume or ambiguous internals, but rather the fact that it produced an unambiguously directional move. That's not to say that today's light volume losses might not be reversed tomorrow, but in the meantime, the price action was decisive where the secondary measures were not.

Daily Dow Chart

The Dow lost 21 point to close at 10536, bouncing from a lower low of 10524.91. The morning bounce failed below Friday's high, and the daily cycle downphase crossed the midpoint of its range. 20-day Bollinger support is at 10514, below which is confluence support at the 10440-50 level. Bulls need a close back above 10630-40 to stall the downphase, but in the meantime, and as the weekly cycle downphase (not shown) gets underway, the benefit of the doubt goes to the bears.

Daily S&P 500 Chart

The SOX logged its third day of lower lows and lows lower highs, failing below 1232 and rising less than a point off its low to close at 1223.13, -3.29 for the day. 1218 support is in view below today's low, lining up with confluence support from June and July, as well as the bottom of the 20-day Bollinger channel. As with the Dow, the synchronous daily and weekly downphases favor more downside from here, but longer cycle tops are less certain than those in shorter timeframes. A return to test or even briefly exceed the current August high would change nothing in those longer timeframes- only a strong upside break on a weekly basis close would suggest a more bullish trending move.

Daily Nasdaq Chart

The Nasdaq got clipped for a 13.52 loss to close at 2164, also less than a point from its low and outperforming its peers to the downside. The decline since last Wednesday's close fits well with a bear wedge interpretation, which in this case would imply a target as low as 2050. The daily cycle downphase is less far along than that of the Dow, and 20 day Bollinger support is at 2134. Below 2200, the bears should continue to press. While an intraday corrective upphase is overdue, the market had a "heavy" feel again today, with the bounces flaggy and short.

Daily TNX Chart

Bonds were weaker today as well. UPI reported ominously that Saudi Arabia will be seeking to repatriate $360 billion "invested abroad" during the past year and a half. Foreign Minister Price Saud al-Faisal seeks to return these Saudi funds in the hope of attracting foreign investment, characterizing the money as "national assets".

This follows the theme expressed in recent weeks and months by Asian central banks seeking to diversify their investments away from US assets. As seen in CNOOC's attempted acquisition of Unocal, foreign countries may be losing their appetite for a US-treasury-only diet. However, if they're blocked from spending those US dollars on other US-dollar-denominated assets, (such as Unocal) then the risk is that they may seek to acquire other currencies in exchange for their production, be it consumer items, petroleum products, automobiles or labor. Bonds were weak following the Saudi announcement, but it received next to no coverage in the financial press and probably had little to do with today's rise in yields.

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The Treasury auctioned $52 billion of debt today, via 13-week and 26-week bills, and 3-year notes. $18 billion of 13-week bills generated a bid-to-cover ratio of 2.09, with a high-rate of 3.46%. The 26-week bills generated 2.07 bids for each accepted, a high-rate of 3.68%. These were the highest rates for the year, and while my data is only quarterly before January 2005, these appear to be the highest rates since 2000. Indirect bidders (foreign central banks) purchased $7.4 billion of the total.

On the 3-year notes, the bid-to-cover ratio was 2.31, the high-yield 4.204%, also a new high for the year. Foreign central banks were bigger buyers of this longer-dated debt, purchasing $5 billion of the total, but that 28% participation rate was well below the 40.3% it purchased at the May auction and the 45.6% it averaged in 2004. 3-year notes were not issued between 1998-2003, but today's high-rate easily broke the previous high at 3.821%- the next highest level was set in 1998, at 5.524%. The combination of high-yield and weaker foreign demand was obviously not bullish for treasuries overall.

Ten year notes were under pressure all day, only briefly dipping into positive territory in the morning, but the strong surge in crude oil (see below) made a 4.40% yield look less substantial than it did last week. Ten year note yields closed higher by 2.7 bps for the day at 4.419%, breaking the key 4.4% resistance level which now becomes support. Next resistance is at 4.44%.

Fannie Mae (FNM) announced that US home prices rose at an annualized rate of 16.5% in Q2, up 14.1% from Q2 2004. This shows upside acceleration, with Q1's annualized rate 12.5%. FNM stated that it sees no sign of slowdown, with Marketwatch quoting FNM's chief economist David Berson as saying that price gains in the middle of the country "were relatively normal" compared with the 20%+ gains in the Pacific, Southwest and Mountain regions.

Daily Chart of Crude oil

Over the weekend, supply fears were renewed by news of a tropical depression threatening the Gulf of Mexico as well as the closing of US embassies in Saudi Arabia today and tomorrow due to terrorist threats. This morning, crude oil opened higher and set a new record (in 2005 dollars). Traders opened their screens to see Sept. crude testing the 63 level. Reuters reported that two years of "unexpectedly strong demand for gasoline" have US refineries struggling to satisfy demand "after a decade of underinvestment." This supply-demand gap has been exacerbated by several unplanned refinery outages during the past few weeks, ConocoPhillips and Valero's being the most recent, and this at the peak of the US easy-motoring season.

Compounding the problem is a widespread, "say it to the hand" denial of the problem. Ever-more powerful and consumptive vehicles are still be produced and promoted by the automakers. Petroleum, of finite and ever-dwindling supply, remains the global energy source of choice, with woefully little progress having been made to date in the development of viable alternatives to power the Western world's, and particularly North America's current lifestyle and expectations. Potentially huge demand from China and India has yet to assert itself, but increasing industrial and economic prosperity in those regions make such development likely if not inevitable. Add in the fact North America's greatest suppliers of the lightest, sweetest oil are in parts of the world that are currently "hot" and not particularly sympathetic to North America's aspirations, as well as the usual environmental and logistic factors that can and routinely do threaten vulnerable infrastructure, and the picture is as bullish for oil as can be.

President Bush signed the energy bill into law today, characterizing the Act as a "critical first step" while conceding that it offered little in the way of short term relief for high prices. The law is said to boost US nuclear power, oil drilling, encourage the conversion of coal into cleaner energy and boost biofuels such as ethanol. Critics noted the Act's wide-ranging assistance and incentives for energy companies already enjoying record profits. Reuters quoted Anna Aurilio, legislative director of the US Public Interest Research Group, saying that "Big energy lobbyists may be cheering the bill's enactment, but ordinary Americans had better hold fast to their wallets. As gasoline prices careen out of control, the bill keeps America speeding down the wrong road toward more oil consumption, more drilling, and more pollution."

Against this backdrop for crude oil prices is the impressive gain already recorded during the past few years. While bearish arguments for the price of oil can be easily refuted on the facts, on a technical basis it's possible that the price has gotten ahead of itself in the shorter term. Bullish traders will continue to buy the dips at support, secondary support in the 59 area and the primary daily trendline at 53. Note the rising triangle on the daily chart below the 62.50-63 area, broken today on the upward surge. Sept. crude futures printed a high at 63.95, pulled back and ran back to touch 63.975 in the 2 minutes before the afternoon close at 63.90, +1.60 or 2.57% for the day.

In corporate news, Alcan (AL) announced earnings which declined from $285 million or 77 cents to $208 million or 56 cents in the current quarter. These were earnings from continuing operations, net of derivative and foreign currency factors. Sales declined from $6.21 billion in Q2 2004 to $5.21 billion this quarter, exceeding estimates by $300 million. On EPS, estimates were for earnings of 61 cents. AL rose 2.17% to close at 33.89, off an intraday high of 34.82 printed in the morning.

Energy company El Paso (EP) reported a Q2 loss of $246 million or 38 cents, down from a $5 million or 1 cent profit in Q2 2004 on revenue which fell 20% from $1.52 billion to $1.22 billion during the period. Analysts were expecting a profit of 13 cents. The cherry on top (for bears) was an SEC request for information relating to its oil-for-food program in Iraq. This was the second SEC request since November 2004, when the SEC inquired about its acquisition of Coastal Corp. EP lost 2.12% to close at 12.03.

Auto parts makers were hurting as they reported earnings for the quarter. Delphi (DPH) got slammed for more than 14% in premarket trading as it reported a net loss of $338 million or 60 cents per share, down from a profit of $143 million or 25 cents in the year-ago quarter. The company warned that bankruptcy is possible, and cited lower demand as a result of waning production from GM, high raw-material costs and obligations for pension and health care benefits. The company's non-GM business outside the United States performed well. While the hyenas were tearing into DPH, Visteon (VC), which was spun off from F in 2000, warned of an expected $1.2 billion or $9.49 per share loss but noted that sales to customers other than Ford rose 29% in the current quarter. In DPH's case, the loss was attributed to production cuts from GM. DPH rose 2.42% to close at 5.08, while VC rose 15.63% to close at 9.84. GM closed lower by .63% at 34.97, while F closed unchanged at 10.36.

Tomorrow is scheduled to be a doozy of day, with the preliminary Productivity report for Q2 and Wholesale Inventories for June in the morning and the FOMC policy announcement in the afternoon, followed by Cisco's quarterly report. In recent announcements, we've seen a relatively muted response to the Fed's announcement. A 25 bp increase is widely expected, and participants will be paying closer attention to the accompanying policy statement. On the one hand, the Fed's been consistently denying inflation-risk, particularly net of "volatile food and energy prices." On the other hand, rallies in the price of energy, food, real estate, healthcare and virtually everything else that people need in the ordinary course of their lives indicate differently. If the Fed is too easy, those rallies will be more likely to gain strength. If the Fed is too tight, so the argument goes, those rallies will be pressured, as will the credit bubble and the many markets it supports. Boil this dilemma down to the hundreds of millions of trading decisions being made in the currency, treasury, commodity and equity markets in the minutes and hours following the FOMC announcement, and you have the makings of a choppy, treacherous tape. Be careful, and as Jim says, enter passive, exit aggressively.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None BBY

New Calls

None today.
 

New Puts

Best Buy Co - BBY - close: 49.31 chg: -1.09 stop: 52.51

Company Description:
Best Buy Co., Inc. is an innovative Fortune 100 growth company that continually strives to create superior customer experiences. Through more than 840 retail stores across the United States and in Canada, our employees connect customers with technology and entertainment products and services that make life easier and more fun. We sell consumer electronics, home-office products, entertainment software, appliances and related services. A Minneapolis-based company, our operations include: Best Buy (BestBuy.com and BestBuyCanada.ca), Future Shop (FutureShop.ca), Geek Squad (GeekSquad.com) and Magnolia Audio Video (Magnoliaav.com). (source: company press release or website)

Why We Like It:
We are going to try again with a bearish play on BBY. We tried in mid-July but the play was never opened as BBY spiked higher on July 27th after some positive analyst comments. We're not bearish on the company but feel that the stock has gotten ahead of itself with a run from $32 in April to $53 in July (post-split prices). Now that the major stock averages are beginning to retreat into the seasonally bearish August-September time frame this looks like a chance to scalp a few points any consolidation for BBY. We're going to target the $45.50-45.00 range but admit the simple 50-dma near $46.20 could be a problem for bears. If BYY surprises us with a bounce we'll watch the $51.00 level to act as short-term resistance. Considering the relative strength that BBY has displayed over the last few months we have to label this a more aggressive play.

Suggested Options:
We are suggesting the September puts because we plan to exit ahead of BBY's earnings report expected in mid-September.

BUY PUT SEP 50.00 BBY-UJ OI= 15 current ask $2.50
BUY PUT SEP 47.50 BBY-UW OI= 1 current ask $1.40
BUY PUT SEP 45.00 BBY-UI OI= 0 current ask $0.75

*Confirm stock symbols as there are several odd symbols resulting from the recent stock split.

Picked on August 08 at $ 49.31
Change since picked: + 0.00
Earnings Date 09/13/05 (unconfirmed)
Average Daily Volume = 5.0 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Danaher - DHR - close: 56.21 chg: +0.19 stop: 53.99

DHR is trying to resist the market's recent weakness. So far it is holding up near the $56.00 level and its simple 10-dma. Yet we're not convinced that this is the best place to buy calls. We are not suggesting new plays at this time. Readers can watch for a potential dip into the $54.00-54.50 region.

Picked on August 03 at $ 56.67
Change since picked: - 0.46
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.5 million
 

Put Updates

Aetna - AET - close: 74.88 chg: -0.67 stop: 79.01

AET hits a new two-month low this afternoon before producing a meager bounce. We see no change from our weekend update. Our target is the $70.50-70.00 range.

Picked on August 07 at $ 75.55
Change since picked: - 0.67
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 2.0 million

---

CR Bard - BCR - close: 63.25 chg: -0.30 stop: 66.05

No change from our weekend update.

Picked on August 03 at $ 64.45
Change since picked: - 1.20
Earnings Date 07/19/05 (confirmed)
Average Daily Volume = 553 thousand

---

Eastman Chemical - EMN - close: 53.29 chg: -0.20 stop: 56.01

EMN hit another new three-month low today. We see no changes from our weekend update. Our target is the $50.50-50.00 range.

Picked on August 05 at $ 53.90
Change since picked: - 0.61
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 872 thousand

---

Fedex Corp - FDX - close: 84.65 chg: +0.05 stop: 86.01

The consolidation in shares of FDX appears to be narrowing. We expecting a breakout soon - either up through resistance at its 50-dma or down below short-term support at the $84.00 level. Aggressive traders may want to buy puts on a decline under $84.00. Our suggested entry point is $82.99.

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

---

F5 Networks - FFIV - close: 38.05 chg: +0.88 stop: 41.01

FFIV bucked the downtrend in technology today. Shares added 2.3% to erase Friday's decline. The move higher was sparked by an upgrade and a new $49 price target by Kaufman Bros. We noticed that the rally appeared to reverse late Monday afternoon and this may prove to be a new bearish entry point. Our weekend update did suggest that readers look for an oversold bounce back toward the $39 or $40 levels as a new entry point to buy puts. The high today was $39.17. Remember, that the biggest risk here is unexpected news out of CSCO tomorrow after the company reports earnings.

Picked on August 03 at $ 38.76
Change since picked: - 0.71
Earnings Date 07/20/05 (confirmed)
Average Daily Volume = 1.4 million

---

Fannie Mae - FNM - close: 54.20 chg: -0.76 stop: 57.01

So far so good. FNM lost another 1.38% today and confirmed the breakdown under the $55.00 level. Investors were probably not happy to hear that J.P.Morgan had taken FNM off their Focus List. A brief CBSMW article quoted JPM as saying FNM's weakness pushed it below their internal guidelines to stay on the list. Sounds good to us! We are targeting a decline into the $51.50-50.00 range. If FNM bounces look for short-term resistance near $55.00.

Picked on July 27 at $ 56.49
Change since picked: - 2.29
Earnings Date 00/00/05 (unconfirmed)
Average Daily Volume = 3.3 million

---

Google - GOOG - close: 291.25 chg: -1.10 stop: 300.01

We remain on the sidelines waiting for GOOG to breakdown. Shares are struggling with its simple 50-dma at the moment near $291 but we're waiting for GOOG to hit $284.50 as our suggested entry point. It is worth noting that one analyst today told their investors to buy GOOG on weakness and bolstered their argument that GOOG would likely be added to the S&P 500 within the next year. We want to remind readers that this is a very high risk play and should only be considered with risk capital.

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

---

Lehman Brothers - LEH - cls: 102.56 chg: -0.83 stop: 107.01

LEH continues to show weakness despite a bounce in the XBD broker-dealer index. The intraday chart shows LEH poised for more declines tomorrow. Our target is the $100.50-100.00 range. We are lowering the stop loss to $107.01. More conservative traders might want to consider the $106 region.

Picked on July 21 at $105.13
Change since picked: - 2.53
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 2.7 million

---

3M Co. - MMM - close: 72.34 change: -0.65 stop: 76.01

We see no changes from our weekend update. Our target is the $70.00-68.00 range.

Picked on July 19 at $ 74.29
Change since picked: - 1.95
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million

---

MicroStrategy - MSTR - close: 72.66 chg: -0.73 stop: 77.51

MSTR tried to bounce this morning but it quickly failed. That's good news for the bears as is today's breakdown under the simple 10-dma. We see no changes from our weekend update. Our target is the $70.50-70.00 range.

Picked on August 05 at $ 74.95
Change since picked: - 2.29
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 570 thousand

---

Neurocrine Bio. - NBIX - cls: 45.86 chg: -1.44 stop: 50.01

The biotech sector was hit pretty hard with some profit taking today and the BTK biotech index touched new three-week lows, which should confirm the recent bearish reversal. NBIX under performed its peers with a 3% decline on above average volume. This is good news for the bears but take note. The intraday chart shows a lot of volume on the very small bounce near the closing bell. We would not be surprised to see an oversold bounce in NBIX back twoard the $48.00 level. More patient traders can watch for a failed rally as a new bearish entry point. Our target is the $43.00-42.00 range.

Picked on August 07 at $ 47.30
Change since picked: - 1.44
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 543 thousand
 

Dropped Calls

None
 

Dropped Puts

KB Home - KBH - close: 72.45 chg: -2.05 stop: 82.01

The profit taking has been fast and fierce in the homebuilding sector. The DJUSHB home construction index lost another 3.3 percent today as investors worried over rising interest rates and its affect on the housing industry. Shares of KBH continued to drop and hit an intraday low of $71.50, which is the top end of our target range. We're closing the play per our game plan. The stock is looking a bit short-term oversold so traders still holding positions need to be ready for a bounce.

Picked on August 04 at $ 78.36
Change since picked: - 5.91
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = 2.4 million

---

Panera Bread - PNRA - close: 55.99 chg: -0.31 stop: 57.51

Time is up. We have been warning readers for days that our plan is to exit on Monday afternoon at the close to avoid holding over earnings due out Tuesday morning. Wall Street is looking for 33 cents a share.

Picked on August 1 at $ 57.49
Change since picked: - 1.50
Earnings Date 08/09/05 (confirmed)
Average Daily Volume = 601 thousand
 


Options 101

Delta The Backbone to Understanding How Your Options Move

Part I of III - It's All Greek to Me

The Theory behind the Practice

DELTA is usually related to options in terms of referring to the rate at which an option contract will move in tandem with the underlying security. DELTA was originally thought of as the hedge factor in determining how many options were needed to act exactly like the underlying. One of the biggest frustrations for an option trader is having an option that is in the money move maybe 1/2 to 3/4 for every point that the underlying security moves. This is a major frustration for traders, but must of this frustration is due to a lack of understanding of how DELTA works and influences their option contracts.

Every option has a DELTA value. They range from 0 to 100 in value. The put options have a value from 0 to 100 in value.

(Example, if a option has a DELTA of 50, this means that for every I point move in the underlying security, the option contract would move 50%, of in this case 1/2 of a point. Usually options that are near the money have DELTAS close to 50. In addition, as these option go deeper into the money the DELTAS on those options tend to be closer to 70 or 80. The deeper in the money, the higher the DELTA of the option.

(Example: KLK is trading at 47 and the KLK July 45 call is priced @ 4.50 with a DELTA of 70. Simply translated for every 1 point move in KLK the July 45 call (with a DELTA of 70, will move .70 or 70%. So if KLK went from 47 to 49, then the July 45 call, which was trading at 4.50, will have gone up to 5.90 (a 1.40 move, which is 70% of 2 or $1.40)
Add that 1.40 to the 4.50 and the option is trading at 5.90. This seems pretty simple, right? Let's take a look at a couple of situations so you can see if you have it down. Please take note that this figure is strictly for illustration purposes so that one can see how generally DELTA prices are figured. This is just a simple table to look over to get a visual of how DELTA is figured and let you look at various examples.

FIGURE 1-1: Look below to see how much the option will move based on the following underlying DELTAS.

The Real World Example:

There are many option programs that show DELTAS for all strikes and prices of every stock and index. Here is a sample from a Greek option program

Figure 1: OPTION PRICING SHEETS WITH DELTAS (SAMPLES)

The Bottom Line:

DELTA is just one of the calculations that help one understand why an option will move in the way it does. However, DELTA alone is not the only factor that determines option movement. DELTA is just the most common due to the fact that large traders to Hedge their positions at all time use it. Understanding why your options move as they do is an important part of the overall understanding of option pricing system. We will look at another important Greek term called GAMMA next time.

Until Next Time
 

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Options 101 by Steven Gail, and all other plays and content by the Option Investor staff.

DISCLAIMER

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