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Daily Newsletter, Saturday, 08/13/2005

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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

Volatility, The August Curse

What a week! If a week of alternating triple digit moves in both directions does not put those trader emotions into a high state of agitation then you need to find another hobby. While the August through October period is known for its increase in volatility the last week has been strange. Normally the increase in volatility produces a directional move but this week's action produced a tie. The Dow and S&P moved higher but the Nasdaq, SOX, Russell and the Wilshire moved lower. None made a directional move and the Dow and S&P closed right in the middle of the congestion range that has lasted for more than a month.

Dow Chart - Daily

Nasdaq Chart - 30 min

SPX Chart - 60 min

The economics for the week were mixed but as the week dragged on the trickle of earnings reports took the spotlight. Sometimes it is best that some earnings reports never get their 15 minutes of fame as intense scrutiny sometimes produces negative results. This is what we saw this week but before I get into that lets recap the economics.

On Friday we saw the beginning of cracks in the Consumer Sentiment as it fell to 92.7 from 96.5 for the first August reading. It does not take a rocket scientist to realize that soaring gasoline prices were finally starting to take their toll on consumers. Add in rising interest rates from the high profile FOMC meeting and the constant reporting on rising oil prices and it is not surprising that consumers were feeling under attack. With the average price for a gallon of gas moving from a cycle low of $1.11 on 12/24/01 to this weeks average of $2.37 it is enough to cause a serious drag on consumer spending. Unfortunately that $2.37 level is likely to rise sharply over the next week and $2.50 is not out of range. Prices in California are already over $3.00. Home prices are also beginning to weaken with several real estate officials expressing concern this week that the bubble is bursting. We are no longer facing the "is it a bubble" question as evidence suggests the house of cards is beginning to fall. Multiple condo developments in previous hotbeds of activity, Florida and Las Vegas, have been cancelled due to suddenly softer sales. Real estate surveys are showing more houses coming to market and staying on the market longer. Yes, sentiment is showing signs of cracking and there is no easy solution.

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Retail Sales for July posted an increase of +1.8% in the headline number but you can't tell a report by its cover. If you take out the cars they gave away at cost and the jump in gasoline sales due to higher prices the real retail sales growth for July was ZERO. Year over year growth for the headline number was a whopping +10.3% but oil prices are up an even +100% for the same period. The average cost of oil for July-2004 was $33.50 a bbl. On Friday that same bbl broke $67 intraday. 72% of consumers polled claim they are having to cutback on other purchases to have enough cash to fill their tank. In another poll of 1000 adults conducted for the Associated Press between Aug-9th and 11th had 64% saying rising gas prices would cause a financial hardship for the next six months. In April the same poll only had 51% of respondents make that statement. That alone should be enough to keep sentiment under pressure for quite sometime.

Business Inventories fell in June as reported on Friday and International Trade deficit soared to -$58.8 billion from -$55.3 billion for June due almost entirely to the jump in oil prices. Mortgage applications fell for the week and the Job Openings and Labor Turnover Survey (JOLTS) showed that hiring declined in almost every area of the country. Hiring activity weakened to 4.635 million from 4.74 million in the prior month. I know the Jobs report last Friday showed a gain in jobs in July of +200,000 but remember the entire +200K was due to a seasonal adjustment, a pencil and eraser move, not from evidence of real hiring. But, this is summer and hiring is not a priority for most firms. Those out of work tend to want to stay out of work until the summer is over. We can't conclude too much from these numbers but they should be noted as one additional point to ponder when discussing stocks.

Ah, yes, stocks, earnings and specifically tech earnings turned out to be the second biggest problem for the week. Cisco and Dell may have led the list of stinkers but there were plenty of others. Multiple chip stocks confessed led by ADI and the mood was further depressed by tepid reports from EMC and NTAP. The poster children for the tech sector let us down and that sent the Nasdaq plummeting to 2144 on Friday and well off the 2220 highs from last week. Should this surprise anyone? I think not given the clear challenge techs have had for the quarter. Cicso saw strong competition in Asia and actually saw sales fall in several regions. Cisco is no longer able to command its previously high margins as Asian copycats and newcomers chip away at its base.
Dell told us that IT spending in the U.S. was light, consumer spending was weaker and growth was stronger in other areas of the globe specifically Asia. Unfortunately Asia is a very low priced region where price competition is very fierce. Despite a +25% jump in unit sales these lower prices caused Dell's revenue growth to fall under +50% for the first time in 12 quarters. Desktops remain the bulk of Dell's sales at 38% but growth in those units was the slowest in three years. Is this a change in economic climate or something else? Hold that thought for a minute.

Eventually the rise in energy prices is going to take its toll on not only the consumer but businesses as well. Higher oil/energy prices make products more costly and transporting them adds to the already higher prices. The news was full of high gas price stories on Friday stretching from trucks to trains and even ships. The fuel surcharge for shipping a 20 ft container to the U.S. is rising from $304 in July to $531 in October. Those same containers are hit with other surcharges as they move across the country by truck or train. In Florida a trucker blockade captured the news attention while they complained about the high price of diesel. In Colorado it is approaching $3 and over $3 on the West Coast but on the road prices are still just under $2.50. This is a +40% increase in the last twelve months.

In my Oil Crisis Report last Fall I mentioned that higher oil prices would eventually cause airlines to either cut back on routes or go out of business due to the cost and lack of fuel. It was widely reported this week that jet fuel demand was up sharply as discount, low cost carriers continued to add to their routes. Jet fuel was in such short supply that many airports were receiving the fuel only hours before the flights were due to depart. Some airlines reported having to fly with reduced fuel loads to allow enough fuel for other planes in their fleet. Delta was signaled out as headed for bankruptcy if fuel prices did not abate quickly. Other airlines said they would be forced to cutback on flights if fuel prices continued higher. You heard it here first last November and now it is beginning to come true.

So, are Dell's problems related strictly to Dell or are they just the leading edge of the problem because they sell high dollar items directly to the consumer? I believe it is a business and consumer problem rather than a Dell problem. On the Larry Kudlow show on CNBC on Friday they showed charts of various shipping indexes and it was very informative. The Baltic Dry Index, a commodity-shipping index has fallen from a reading of 6000 in early Q4 to just over 1500 in July indicating far fewer commodity shipments. The freight tonnage shipped by truck has fallen from 20% growth in January to nearly zero in July. The railroad car loadings have fallen from +6% growth in December to nearly zero in July. With oil prices up +52% year to date the global economy is beginning to feel the pain.

Oil prices have a direct impact on the manufacture and delivery of products and an impact on corporate profits. Not only do companies and consumers spend less money when oil prices move to extreme levels but profits fall and so does the market. When the first gas crisis appeared in late 1973 the price of oil soared to $12.45 and an unheard of price at the time. In 1974 the market retreated as spending patterns changed and profits dropped sharply. In 1979 when the Iran hostage crisis caused another spike in oil to a new high at $30.75 the markets recoiled sharply and dropped over -10% in early 1974 as gasoline prices doubled almost overnight. That high is $94.77 in today's inflation adjusted dollars. It should also be noted that these were sharp increases not a gradual increase. History also shows us that gradual increases in a time of strong economic growth does not always produce an immediate market drop. However, cycles of extreme high oil prices do tend to produce recessions more often than not. The estimates of a +5% Q3 GDP should also be questioned given the recent change in the economic picture. The chart below is the inflation adjusted oil chart with gray areas indicating recessions brought on my oil spikes and/or the events that caused the spikes.

Inflation Adjusted Oil Chart from ChartoftheDay.com
Data source is Dow Jones

While the $67 price of oil today may not be an all time high in inflation adjusted prices it is still a major detriment to business and consumption. Consumers don't have as much discretionary income today as in prior spikes. Consumer debt is at all time highs. Every dollar counts and our society has broadened into a car dependent commuter society much more than in 1973 and 1979. I confess I have two large vehicles and I have come very close to $100 fill ups more than once. I probably have a little more discretionary cash than the average person but that $100 gas bill is a killer. I can imagine how it is impacting John and Jane Doe, the two income, 2.4 kids, commuter family.

Companies trying to produce products have to fight rising prices on not only oil/energy but other commodities as well. The CRB Commodity Index reached a 20-year high on Friday and that mean higher costs for nearly any manufactured product. Gold hit $450 and the dollar fell making the cost of dollar denominated commodities even higher. Higher costs equals lower profits unless the company can pass those costs on to the consumer. Inflation is nowhere to be seen and companies do not have any pricing power. This suggests that profits for this cycle will be going lower.

September Light Sweet Crude Chart - Daily

December Natural Gas Chart - Daily

Unleaded Gas Chart - Daily

Copper Chart - Daily

Oil prices are showing no signs of a retreat despite a +7% rise this week alone. There are so many problems impacting not only oil prices but energy in general that there is not enough space to print them. The International Energy Association said on Thursday that there was less than 200,000 bbls of excess capacity in the market and that excess capacity was in sour crude that few could refine. We knew that but it gets worse. BP announced this week that the fire on their North Sea platform would keep production of 120,000 bbls per day off the market until the end of August. They are not the only ones with challenges. The IEA said more than 10% of North Sea production was on hold for various reasons. Gasoline prices are soaring because there have been 13 refinery outages in the last three weeks due to fires and breakdowns. Over 500,000 bbls of daily gasoline production has been removed by these outages. Those refineries still in operation are running at 100% capacity in an effort to keep up with demand for gasoline and jet fuel. They can't continue to run at 100% 24/7. It is technically impossible. Things break and that is why we have so many refinery problems today. Refineries have been running between 98-99% for months.

Remember I said it was going to get worse? Jet fuel demand has risen +3.4% in 2005 and gasoline demand is up +1.6%. That may not sound like a lot for gasoline but we consume nine million bbls of gasoline per day. That is an increase of about 150,000 bbls per day without adding any new refinery capacity. There is no clean number for jet fuel consumption as it is considered a middle distillate, which includes diesel and fuel oil. BP said U.S. airlines consumed 18.5 billion gallons in 2004. They arrived at this number by a complicated calculation based on removing reported consumption of the other components and the balance was assumed to be jet fuel. Airbus went at it a little different and came up with a 2 billion barrel number in 2004 for passenger and air cargo. This excludes military usage and those planes tend to be real gas-guzzlers. However you cut it the answer is the same. Demand is continuing to rise for refined products, jet fuel, heating oil, gasoline and diesel. Unfortunately refinery capacity is not rising to meet the challenge. There have not been any new refineries in the U.S. since 1980. This fixed refiner capacity can't keep up with the rising demand. This is also complicated because most of the refineries can only crack light sweet crude making this type of oil even more critical for continued supply and forces the prices higher.

Everybody is raving about the energy bill but they are not telling you that it will make the refinery problem even worse. Once the bill is signed the refineries have 270 days to remove MTBE from all gasoline. Since this additive has been found to cause cancer and severe ground water pollution they have to remove it. This change will cause a severe drop in output by U.S. refiners. Valero, soon to be the largest U.S. refiner when it completes the Premcor acquisition said removing MTBE will cut gasoline production by -6%. A six percent drop in current gasoline production is just over 500,000 bbls per day. Now if you were reading the comments above instead of just glancing at the high points it would seem obvious to me that there is a serious problem ahead. If refiners can't keep up at 100% capacity today what will happen to gasoline prices when we lose another 500,000 bbls of production by next summer?

While I am ranting on about the current oil problems I should also tell you that the IEA said this week that global non-OPEC production growth for oil has ONLY risen +670,000 bbls per day for 2005. At the same time they said global demand for 2005 would rise +1.6 million bbls per day and another +1.8 mbpd in 2006. In case you are keeping score I reported the IEA release earlier that said there are only 200,000 bbls of excess capacity today and that capacity is sour crude. If global production is only rising +670,000 but global demand is rising +1.6 mbpd plus another +1.8mbpd in 2006 then somebody needs a math lesson. Demand can't increase more than supply. It is one of those facts of life that the IEA seems to have forgotten. For those of us that can count the answer is clear. Buy oil stocks on any dip and forget them.

I attended the Enercom energy Conference in Denver last week and listened to analyst presentations on the state of the oil/gas sector and future predictions. Over 90 energy companies presented their outlook for their production, prices and the sector in general. I really enjoyed it and there were several strong views that continued to appear in nearly every presentation. First, everybody with a drilling rig is drilling as fast as they can move the rigs from hole to hole. Rig counts are at multiyear highs and rig manufactures are backordered for the foreseeable future. Day rates have doubled in many cases and they are continuing to rise. There are a few well-managed companies with well sites already plotted for several years to come. The wells they are drilling are harder, deeper, faster and smarter than the ones before. Technology has progressed to the point where they are getting the oil/gas out of the ground much faster but they are still behind the production curve with no hope of ever catching up. Gas production in North America has declined for the last two years despite gas wells being drilled at a rate of 22,500 per year. Gas demand has risen sharply over the same period and will continue to rise sharply since it is the drug of choice for utility companies.

I know this sounds like more of the same comments we have been hearing for quite a while but there is a key point I need to make before I move on. Despite the record high prices of oil at $67 and gas at $10 there were very few hedged positions against future production. Hedges ran about 5-6% of total production where hedges existed at all. I think this is key point. If these very smart multibillion-dollar energy companies felt oil/gas prices were going lower they would be hedging every barrel at these historical highs. With average costs of produced gas at $1.83 and oil under $20 a bbl they would be passing up billions in profits by not taking the hedge if they thought prices would fall. Where hedges did exist they were normally offsets to debt and required to insure the debt payments were covered. You can listen to the analysts on TV tell you oil is going back to $35-$40 or you can listen to the energy companies who actually live it every day. I heard $20 gas mentioned several times for 18-24 months out due to the accelerating demand and declining U.S. production. Oil prices were officially in the $50-$65 band but the whisper numbers were $75 to $100 over the same period. Why hedge $65 oil if it will be $100 before you can get it drilled, produced and delivered? Buy oil stocks on the dip.

I don't have the space to go into detail on the individual stocks today but I will list the ones that I believe are the strongest. I can't see any way these companies should not prosper given the conditions and the plans they have in progress. I would have no problems buying any of these on any dip. I will expound on these individually in future editions of the LEAPS section.

Recommended Energy Stocks

HP - Helmerich Payne - Very strong driller
VLO - Valero - Largest U.S. refiner, can process sour crude
AHC - Amerada Hess - acquisition target
UPL - Ultra Petroleum - Unbelievable outlook
COP - ConocoPhillips - Very aggressive integrated oil
CNQ - Canadian National Resources - Strong reserves
CHK - Chesapeake Energy - Very strong
TLM - Talisman Energy - Diversified producer
KMI - Kinder Morgan - Strong gas pipeline story
MRO - Marathon - Diversified, very strong
NOV - National Oilwell Varco - Rig builder, large backlog
SUN - Sunoco - Strong refiner
RDC - Rowan Companies - Driller
STR - Questar - Natural gas
ECA - Encana - E&P gas
PTEN- Patterson-UTI - Strong driller

One further caution. The LEAPS Trader portfolio has migrated to a 100% energy position over the last few months. In fact we are considering converting it into an Energy newsletter with multiple strategies. Many of those positions are VERY profitable. I am constantly asked when I expect to exit these oil positions. While I believe oil is a long-term play for everyone there will always be cycles and new entry points. The cycle I am currently playing I expect to end in September. Given the rapid ramp it could possibly end earlier. While oil prices may continue to stay high they may not continue to advance once we get past the hurricane season and the switch to heating oil demand. As long as production remains even marginally ahead of demand we could wander at these high levels for months without making any further progress. Spring normally produces a decent decline as demand eases. That would be my target to enter any long-term positions. Any positions you take now should be trading positions with a trailing stop. I was planning on exiting in September but without a hurricane in sight and the September contract expiration on August 22nd I am considering a potential exit early next week. See the LEAPS section for my reasoning and narrative. If forced to take profits we will buy the next dip when it appears.

Current LEAPS portfolio

I apologize for the extended energy coverage today but with it so critical to our future and the fate of the markets I believe we should remain highly focused on its impact.

For those that shorted BIDU at $150 I offer my congratulations with Friday's close at $94. Hang in there I don't think the drop is over yet.

BIDU Chart

SOX Chart - Daily

The trickle of chip earnings with a negative bias to guidance helped push the SOX back to support at 460 that has held for the last month. Two downgrades of Intel this week also helped to pressure chip stocks. Intel has retreated back to support at the June lows at $26 and given the CSCO/Dell news it is not likely to rebound sharply any time soon. It would be nice for the SOX to hold on to 460 but that is also unlikely.

A definite trend has developed for tech stocks and the Nasdaq is showing the typical August weakness profile. Technically we have fulfilled the historical early August dip I was expecting and we could rebound from here but I believe we are beginning to see some additional strain from various sources. Financials are weakening as the Fed continues its measured pace scenario. Futures are now suggesting a 4.50% rate as the projected ceiling. Homebuilders are sagging as news of the highest insider selling on record hits the wires along with the news of cancelled projects due to soft sales. Manufacturers like MMM are sinking on the prospect of increased costs from high oil. Retailers are soft on weakening consumer buying. Kohls rallied slightly on Friday after beating the street but it did little to rally the sector.

Hewlett-Packard will release earnings next Tuesday and they have the opportunity to either put the last nail in the market coffin or perform a resurrection miracle. Joining HPQ on the podium will be AMAT and WMT and either or both of those could cause trouble as well. Wal-Mart has already pre-announced so guidance is the only question there. The combination of HPQ and AMAT could be the lifeline for the SOX at 460 or the anchor that drags it beneath the waves.

The market has come a long way since the early July lows and it is due for a rest. Typically a correction of -5% to -10% is in order but it appears the bulls are determined to buy every dip. When I look at the SPX chart I feel like I am in one of those time distortion fields so prevalent on the old Star Trek shows. I have seen 1225-1230 so many times over the last month I feel like my charts are stuck. The SPX refuses to die or breakout for that matter and we have been stuck in a little more than a 20-point range for over a month. This is actually a good thing given the weakness in techs. One analyst I heard on Friday said there was a +3% support factor from all the gains in the energy sector. He said the S&P energy stocks had accounted for a little more than 37 points in the S&P since early July. Without them the SPX would be trading around 1190. I agree completely with that analysis as it correlates with what I have been saying for weeks. I think we would be looking at a completely different set of market stats were it not for the artificial support of the energy stocks. I say artificial since it is only one sector and the reason for their gains is putting substantial pressure on the rest of the market.

My outlook is neutral for next week. As long as oil continues higher the odds of a meaningful rally are slim. However as we have seen several times this week the bulls are definitely in a buying mood on any dip. How long that will last is the $64 question. I think the oil traders have targeted $75 and the momentum players are helping press for that goal. The sheer volume of cash riding on the continued rise in oil prices is enormous. There were dozens of hedge funds at the energy conference and plenty of money managers. The problem with a spike like we saw last week is the profit buildup. It is not profit until it is sold and that could appear at any time. While I believe prices will eventually continue higher I believe the next dip could be serious. The fundamentals, demand, production, refining, etc, continue to point to increasing prices once that dip passes. That means any real dip will be bought aggressively but there could be a lot of money change hands on the next dip. The wild card here is the hurricane season. Everyone is holding their breath and their positions hoping for a monster to come straight through the Gulf. As long as nothing appears those type A traders may get bored and exit. A word to the wise, don't jump in on the first drop because the first bounce may be sold again.

AMAT Chart - 30 min

For tech traders all eyes should be on HPQ and AMAT and given the beating Dell and Cisco received I believe expectations could have been lowered substantially. This suggests there may not be much downside even if they disappoint. Small caps took a monster hit last week and have traded mostly sideways since but we are seeing a pattern of lower highs and lows. This is not small cap season and I would look for continued profit taking as the summer closes. Look to buy the dip somewhere in the 630-640 range with the 100 and 200 day averages converging at 627. I mentioned the SPX is stuck at 1230 due to support from the energy stocks. If we do get a profit cycle on energy it could remove that support and 1190-1200 would be my initial target. HOWEVER, the only reason for energy stocks to sell would be falling oil prices and that could provide alternate support for the index as those ignorant of the long-term facts jump in thinking the oil crisis is over.

The geopolitical risk remains with everyone waiting for the next series of bombings and possible sanctions against Iran. Our current place on the calendar does not suggest buyers will appear in enough strength to overcome the problems above but stranger things have happened. This is the dog days of summer and trading these low volume whiplashes can be dangerous. I would continue to watch SPX 1225 for guidance and be ready to get short if that level breaks. There is just enough growing instability in the market and the economy that a real surprise could lay just ahead. I would love to see a real washout to 1185-1190 and a drop in oil to $58 but then I would also like to find a 100-pound bag of $100 dollar bills on my doorstep. I doubt either will happen next week. Enter passively and exit aggressively and definitely don't get married to your positions.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
SHLD UPS

New Calls

Sears Holdings - SHLD - cls: 145.92 chg: +2.96 stop: 139.99

Company Description:
Sears Holdings Corporation is the nation's third largest broadline retailer, with approximately $55 billion in annual revenues, and with approximately 3,800 full-line and specialty retail stores in the United States and Canada. Sears Holdings is the leading home appliance retailer as well as a leader in tools, lawn and garden, home electronics and automotive repair and maintenance. Key proprietary brands include Kenmore, Craftsman and DieHard, and a broad apparel offering, including such well-known labels as Lands' End, Jaclyn Smith and Joe Boxer, as well as the Apostrophe and Covington brands. It also has Martha Stewart Everyday products, which are offered exclusively in the U.S. by Kmart and in Canada by Sears Canada. The company is the nation's largest provider of home services, with more than 14 million service calls made annually. (source: company press release or website)

Why We Like It:
The RLX retail index was one of the few sector indices that managed to close in the green on Friday. Part of retail's strength was due to a strong bounce in shares of SHLD. Sears has been climbing higher in a very wide and often volatile channel. Friday's rebound marked a rebound from the bottom of its channel near $140.00, which is also boosted by its 200-ema. This looks like a trading opportunity to catch a bounce in SHLD back toward the simple 50-dma near $151. We're going to suggest buying calls here with a target at $151.00-152.00 range. We do need to label this an aggressive play due to SHLD's volatility and our bias that the major indices (DJIA, SPX and NASDAQ) all look poised to consolidate lower. Plus, we plan to exit ahead of Sears earnings report on September 8th and that doesn't give us much time.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 140 KTQ-IW OI= 3862 current ask $11.50
BUY CALL SEP 145 KTQ-IV OI= 3056 current ask $ 8.60
BUY CALL SEP 150 KTQ-IU OI=11051 current ask $ 4.40

Picked on August 14 at $145.92
Change since picked: + 0.00
Earnings Date 09/08/05 (confirmed)
Average Daily Volume = 3.2 million
 

New Puts

United Parcel Svc - UPS - cls: 73.06 chg: -0.16 stop: 74.21

Company Description:
UPS is the world's largest package delivery company and a global leader in supply chain services, offering an extensive range of options for synchronizing the movement of goods, information and funds. Headquartered in Atlanta, Ga., UPS serves more than 200 countries and territories worldwide. (source: company press release or website)

Why We Like It:
The rebound in shares of UPS from its July lows has stopped dead at the $74.00 level. Investors shouldn't be surprised. As the largest delivery company in the world the record high oil prices and thus fuel prices have to be taking a toll on its bottom line. Yes, it's true that UPS is benefiting from the growth in the U.S. economy and growth overseas (especially China) but short-term we believe the transports as a group will struggle to make new highs. Technicals are already bearish on UPS with a new MACD sell signal in just the past two trading days. Our strategy is to catch a breakdown from UPS' four-week trading range between $72.50 and $74.00. Our suggested entry point will be $71.99. If UPS hits our trigger then we'll target a decline near the bottom of its wider trading range in the $68.00-67.00 range.

Suggested Options:
We are suggesting the October puts although Septembers would work as well.

BUY PUT OCT 75.00 UPS-VO OI=2854 current ask $3.30
BUY PUT OCT 70.00 UPS-VN OI=9896 current ask $1.15

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 2.6 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Anadarko Petrol. - APC - close: 90.67 chg: +0.77 stop: 85.98*new*

If you haven't heard yet crude oil hit another all-time high on Friday. This sent the oil/energy sector index to a new high as well but the rest of the market was hit with some profit taking. Some of the oil stocks also found some profit taking on Friday despite the strength in crude. Shares of APC touched a new high Friday morning before turning lower. The effect is a small bearish engulfing candlestick and that is usually interpreted as a bearish reversal. We would look for some more profit taking in APC early next week but the dip can be viewed as a new buying opportunity. We will watch for a bounce in the $87.50-88.00 range. More conservative traders may want to sit back and watch for another new relative high before considering longs. More aggressive traders may want to just widen their stop loss to avoid being stopped out on an intraday spike lower. As a matter of fact, because we believe that the highs in oil haven't been seen yet we are going to widen our stop. We rarely do this (because we hate to) but to give this play a chance APC may need a bit more room to maneuver. We're going to use a 5% stop and that puts it at $85.98. We do note that the recent action has produced a new P&F buy signal (that currently points to a $117 target) plus the MACD indicator on APC's daily chart is very close to a new buy signal as well. We are going to list some suggested calls but wait for the dip and/or bounce before initiating positions. Our short-term target is the $94.75-95.00 range. FYI: keep an eye on crude oil. There is a growing chance that traders may take profits if it hits what could be round-number resistance at $70.00 a barrel and chances get a lot higher if it hits $75.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 85.00 APC-IQ OI=1450 current ask $6.20
BUY CALL SEP 90.00 APC-IR OI=1558 current ask $3.20
BUY CALL SEP 95.00 APC-IS OI=2417 current ask $1.50

Picked on August 11 at $ 90.51
Change since picked: + 0.16
Earnings Date 07/29/05 (confirmed)
Average Daily Volume = 2.0 million

---

Danaher - DHR - close: 55.92 chg: -0.39 stop: 53.99

DHR is sending out a lot of mixed message. Thursday's gain appeared to break its short-term six-day trend of lower highs but there was no follow through on Friday. The larger picture suggests that DHR is going to consolidate lower and we've been suggesting that readers watch for a dip toward the simple 200-dma near $54.50 as the next potential entry point. The MACD looks bearish but short-term stochastics are positive. The Point & Figure chart is also bullish with a $68 target but shares could retreat to $53 even $52 and still keep a buy signal on its P&F chart. Considering the market's decline on Friday we are going to continue to be defensive here. We would not suggest new plays at this time and traders with positions may actually want to exit and sit out to preserve their capital and wait for a better entry point. Our preferred entry point would be a strong bounce from its 200-dma. An alternative would be a new relative high over $56.50 or $57.00.

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

Picked on August 03 at $ 56.67
Change since picked: - 0.75
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 1.5 million
 

Put Updates

Best Buy Co - BBY - close: 49.61 chg: +0.93 stop: 52.51

Retailers showed some strength on Friday and traders used that as an opportunity to buy the dip in shares of BBY near the $48.00 level. It didn't help that A.G.Edwards reiterated their "buy" rating on the stock this past Friday. Given the rebound we would look for the bounce to continue a bit. Watch for BBY to find some resistance in the $50.50-51.00 region. We'd obviously prefer to see the rally fail at $50.00 but we don't believe that will happen. Traders looking for new positions can wait for the rally to run out of steam and fall back under the $50 level and then initiate new put positions. Our target is the $45.50-45.00 range but we are cautiously watching the simple 50-dma, since it could act as short-term support.

Suggested Options:
We are suggesting the September puts since we plan to exit ahead of BBY's September earnings report. Remember to confirm these symbols with your broker since there are some odd symbols available due to the recent stock split.

BUY PUT SEP 50.00 BBY-UJ OI= 217 current ask $2.35
BUY PUT SEP 47.50 BBY-UW OI= 583 current ask $1.35
BUY PUT SEP 45.00 BBY-UI OI= 121 current ask $0.75

Picked on August 08 at $ 49.31
Change since picked: + 0.30
Earnings Date 09/13/05 (unconfirmed)
Average Daily Volume = 5.0 million

---

Carnival Corp - CCL - close: 50.46 chg: -0.69 stop: 54.01

So far so good. CCL continues to show weakness after its bearish reversal on Wednesday. Volume has been just above average during the last three sessions. The P&F chart is bearish and points to a $38 target. While CCL appears poised for more weakness next week traders might want to wait. A short-term oversold bounce at the $50.00 level, which is normally round-number, psychological support or resistance (support in this case) should probably be expected. Traders can use another failed rally, this time under $51.00 or 51.50 as a new bearish entry point to buy puts. Our target is the $47.75-47.00 range.

Suggested Options:
We are suggesting the September puts since we plan to exit ahead of CCL's September earnings report.

BUY PUT SEP 55.00 CCL-UK OI= 537 current ask $4.90
BUY PUT SEP 50.00 CCL-UJ OI=1051 current ask $1.25
BUY PUT SEP 47.50 CCL-UW OI= 474 current ask $0.55

Picked on August 10 at $ 51.79
Change since picked: - 1.33
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = 2.5 million

---

Eastman Chemical - EMN - close: 52.33 chg: -1.46 stop: 55.01*new*

We have good news to report on for EMN. The stock did fail at resistance at the $54.00 level as we suggested. The move was a new entry point for traders to buy puts. Friday's 2.7% decline also strengthens the P&F chart sell signal that now points to a $49 target. We are going to lower our stop loss to $55.01. Our target remains unchanged in the $50.50-50.00 range.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 55.00 EMN-UK OI=703 current ask $3.70
BUY PUT SEP 50.00 EMN-UJ OI=386 current ask $0.95

Picked on August 05 at $ 53.90
Change since picked: - 1.57
Earnings Date 07/28/05 (confirmed)
Average Daily Volume = 872 thousand

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Fedex Corp - FDX - close: 84.65 chg: -0.70 stop: 86.01

We are not willing to give up just yet on FDX. We don't believe the transportation sector can continue to shrug off these record high oil prices, which are pushing up fuel costs. It's noteworthy that the bullish breakout on Wednesday quickly failed and now its MACD indicator is edging even closer to a new sell signal. We will continue to suggest that traders use a suggested entry point at $82.99 to open bearish positions on FDX but more aggressive traders might want to jump in early if FDX breaks down under $84.00. If we are triggered at $82.99 our target is the $76 level which should coincide with its trendline of lower lows. The rising challenge for traders in FDX is the upcoming earnings report due out in the second half of September. We will not hold over the report. FYI: if you don't like FDX as a candidate check out the new play in UPS this weekend.

Suggested Options:
We are suggesting the October puts but will exit ahead of FDX's late September earnings report.

BUY PUT OCT 85.00 FDX-VQ OI=2139 current ask $2.95
BUY PUT OCT 80.00 FDX-VP OI=3597 current ask $1.15

Picked on August 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: 37.39 chg: +0.37 stop: 40.01 *new*

Networking stocks have continued to be weak after CSCO warned for the next quarter. Yet shares of FFIV, while not bouncing with the market on Thursday, are not sliding under the $36 region either. At this point the trend is still bearish but we would look for an oversold bounce back toward the $39-40 region. Such a bounce could be used as a new bearish entry point but wait for signs that the rally is fading first. We are going to lower our stop loss to $40.01. Our target is the $35-34 range.

Suggested Options:
We are suggesting the October puts but Septembers work well too.

BUY PUT OCT 40.00 FLK-VH OI=3064 current ask $4.60
BUY PUT OCT 35.00 FLK-VG OI= 856 current ask $1.95

Picked on August 03 at $ 38.76
Change since picked: - 1.37
Earnings Date 07/20/05 (confirmed)
Average Daily Volume = 1.4 million

---

Google - GOOG - close: 289.72 chg: +5.67 stop: 300.01

Right on cue! Actually shares of GOOG traded sideways for the first half of Friday's session but then a surge of buying interest pushed the stock up toward the $289-290 level in a late day flood of volume. Yesterday we predicted that GOOG might rebound back toward $290 in an oversold bounce. The question now is whether or not shares fail at $290 or continue to retest overhead resistance in the $295-300 level again. Remember, this is a speculative, high-risk play due to GOOG's volatility. The up trend appears to have been broken but the bulls aren't giving up without a fight. Inspiring some traders might be speculation that GOOG could be added to the S&P 500 and that the announcement could come as early as next week after GOOG's one-year anniversary as a publicly traded company. While many investors may have already bought shares assuming this will occur such an announcement could easily send GOOG gapping higher. It is a risk traders need to seriously consider. We are adjusting our target to be the $260.00-255.00 range to account for potential technical support at the simple 100-dma.

Suggested Options:
We are suggesting the September puts because the Decembers are just too expensive.

BUY PUT SEP 300.00 GGD-UT OI= 4456 current ask $15.80
BUY PUT SEP 290.00 GGD-UR OI= 5816 current ask $ 9.60
BUY PUT SEP 280.00 GGD-UP OI= 7672 current ask $ 5.20
BUY PUT SEP 270.00 GOU-UN OI=12230 current ask $ 2.70
BUY PUT SEP 260.00 GOU-UL OI= 9789 current ask $ 1.30

Picked on August 11 at $284.50
Change since picked: + 5.22
Earnings Date 07/21/05 (confirmed)
Average Daily Volume = 13.6 million

---

KOS Pharma - KOSP - close: 73.12 chg: -0.45 stop: 72.51

Thus far we remain on the sidelines with a trigger to buy puts at $68.25 for KOSP. The company reported earnings on August 4th and spiked higher but the rally quickly failed. The lack of follow through combined with what looks like a double-top pattern near $77.50 are definitely signs that the rally may be over. This last Wednesday more news came out with the company's 10Q filing that unveiled news that KOSP's sales and marketing practices are being looked at by the feds. That's usually not a good sign but we wanted to see some confirmation that the stock has actually reversed. That's why we're suggesting a trigger to open the play. If KOSP can trade under the $68.00 mark it will also produce a new P&F chart sell signal. More conservative traders may want to wait for KOSP to trade under $68.00 or even the simple 50-dma currently at 67.65 before opening bearish positions. Our target is the $62-60 range.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 70.00 KQW-UN OI=397 current ask $2.15
BUY PUT SEP 65.00 KQW-UM OI=398 current ask $0.85

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/04/05 (confirmed)
Average Daily Volume = 642 thousand

---

Lehman Brothers - LEH - cls: 104.76 chg: -1.61 stop: 107.01

There is no change in our strategy with LEH but traders holding the August $100 puts are running out of time. This was initially a speculative play to buy some cheap August $100 puts and bet that LEH will drop to $100 (or less) before August expiration. Well now there are just five trading days left before August options expire. We still suspect that LEH could hit the $100 level but it may take a couple of weeks or more. Traders may want to roll out to the September $100 puts for $0.85. One challenge even if you do buy September puts is LEH's next earnings report expected around September 13th. We would not hold over the report.

Suggested Options:
Traders might want to consider the September puts.

BUY PUT SEP 105.00 LES-UA OI=1230 current ask $2.40
BUY PUT SEP 100.00 LES-UT OI=1513 current ask $0.85

Picked on July 21 at $105.13
Change since picked: - 0.37
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 2.7 million

---

3M Co. - MMM - close: 71.94 change: -0.42 stop: 75.11

We don't have much new to report on for MMM. There has been no signs of a bounce in MMM this past week and shares look poised to move lower heading into next week. Technical indicators remain bearish and its P&F chart points to a $63 target. We are targeting a decline into the $70.00-68.00 range. If MMM does surprise us with an oversold bounce we'd watch the $74 level to act as short-term resistance. FYI: technical traders should note that MMM's 200-week moving average is trading near $71.25. This could prove to be technical support and readers may want to consider exiting early or taking some profits near this moving average, especially since this appears to coincide with the July low.

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

Picked on July 19 at $ 74.29
Change since picked: - 2.35
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million

---

Neurocrine Bio. - NBIX - cls: 45.11 chg: -0.86 stop: 48.51*new*

Believe it or not we would have expected a strong oversold bounce in NBIX by now but shares continue to show relative weakness. The trend of lower highs appears ready to push NBIX under round-number support at its $45 level and technical support at its 50-dma. If NBIX surprises and does produce an oversold bounce watch for the stock to find resistance at its simple 10-dma near $47.50. Such a bounce could be used to consider new bearish positions. At the moment we would not open new plays. We're going to adjust our target from the $43.00-42.00 range to $43.25-42.00 to account for potential technical support at its 200-dma near $43.00. We are lowering the stop loss to $48.51.

Suggested Options:
We are not suggesting new plays at current levels.

Picked on August 07 at $ 47.30
Change since picked: - 2.19
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 543 thousand
 

Dropped Calls

None
 

Dropped Puts

Fannie Mae - FNM - close: 51.17 chg: -0.83 stop: 56.01

Target achieved. There has been no reprieve for shares of FNM, which sank to another new relative low on Friday. More importantly for us the stock traded into our target range of $51.50-50.00. The strong volume on the declines and intraday trends continue to suggest more weakness ahead but FNM is looking very short-term oversold and due for a bounce. Be careful if you haven't exited yet.

Picked on July 27 at $ 56.49
Change since picked: - 5.32
Earnings Date 00/00/05 (unconfirmed)
Average Daily Volume = 3.3 million
 


Trader's Corner

Easy, Breezy Identification of Historical Support and Resistance Using Donchian Channels

A 1970 booklet introduced one of the trader's best and easiest tools for identifying historical support and resistance: the Donchian channel. As originally developed, a Donchian channel sets the top boundary at the highest high for four weeks and the lower boundary at the lowest low for four weeks.

Note: Charts were prepared in advance, so do not reflect current values.)

Annotated Daily Chart of the OEX:

The 20-period default setting refers back to that four-week period that Richard Donchian used when developing his trading system, but most charting services that include Donchian channels also allow default settings to be changed. What could be easier than snapping a Donchian channel on a chart of any time period to identify historical support and resistance?

Knowing the location of historical support or resistance provides obvious benefits. Such support and resistance levels can corroborate support or resistance established by other means, such as pivot points, nested Keltner channels, regression channels, Bollinger bands, trendlines and formations.

Annotated Three-Minute Chart of the ES Contract:

Richard Donchian advocated using these support and resistance levels in a particular and simpler manner, however. He believed in an always-in-the-market system, and used the Donchian channels to determine the correct time to switch sides. He covered short positions and entered long ones when prices exceeded the top channel and liquidated long positions and entered short ones when prices violated the lower channel. Some studies conclude that trading systems that consistently pinpoint and act on breakouts prove the most profitable over the long run, and Donchian's system has been labeled the simplest of such systems.

A glance at the previous two charts displays a curious effect, however. Prices aren't closing above the channels. By the end of a period that nudged a Donchian channel either higher or lower, prices had closed back inside the channel. To help identify breakouts, some offset the channels, with many charting services allowing for such an offsetting.

Annotated Three-Minute Chart of the ES Contract:

Although the trade was profitable, it obviously did not capture the entire price run in this instance. When studying Donchian channels in 2003, I experimented with using a smaller Donchian channel to refine entries and exits, a tactic that turned out to be a recommended one.

Annotated Three-Minute Chart of the ES Contract:

This trade would have proved more profitable, but a further examination of the chart reveals that the trader using this system would have been whipsawed out of a couple of trades afterwards. My study of Donchian channels in 2003 indicated that the number of whipsawed trades proved to be one shortcoming of the system. Profitable overall, the ratio of profitable to unprofitable trades, the number of losing trades in a row and the drawdowns would have proven unpalatable for most traders. The system always identified the big moves early, but all trades had to be taken in order to catch those big moves. Those with deep pocketbooks, lots of patience and an unerring faith in the system despite an almost 50/50 win/loss rate could have profited from this system, but that combination of parameters doesn't describe most traders.

However, that fact doesn't change the usefulness of Donchian channels as an adjunct to other trading tools. The easy identification of historical support and resistance rates and early identification of breakouts make this a valuable tool for traders whose other charting methods have suggested an imminent strong move.
 

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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Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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