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Daily Newsletter, Saturday, 10/08/2005

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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

Market Wrap


New Plays

New Option Plays

Call Options Plays
Put Options Plays
GDORLY
PPD 

New Calls

General Dynamics - GD - cls: 119.59 chg: +1.09 stop: n/a

Company Description:
General Dynamics, headquartered in Falls Church, Virginia, employs approximately 70,800 people worldwide and had 2004 revenue of $19.2 billion. The company has leading market positions in mission-critical information systems and technologies, land and amphibious combat systems, shipbuilding and marine systems, and business aviation. (source: company press release or website)

Why We Like It:
We like GD as a strangle play. We're putting it in the calls section because our bias is bullish. The stock did breakout from a multi-week trading range in late September and the long-term trend continues to look positive for GD. Yet instead of just buying calls on the stock we're choosing to play a strangle where we buy a call out of the money and a matching out of the money put. This way we don't care what direction GD moves as long as it moves enough to make one of these positions profitable. GD is an attractive candidate for a strangle because the stock has a history of producing sizeable moves following its earnings report. The company is due to report earnings on October 19th before the opening bell and Wall Street expects GD to turn in profits of $1.76 a share. The worst-case scenario is that GD does not react to earnings and churns sideways.

Suggested Options:
We are suggesting the following options for this strangle play.

BUY CALL NOV 125.00 GD-KE OI= 709 current ask $0.85
-and-
BUY PUT NOV 115.00 GD-WC OI= 589 current ask $1.15

Our total investment should be close to $2.00. Therefore it should not take a huge move following the October 19th earnings report to make this a profitable play. These options expire on November 18th. Our target is a $3.00 profit on this $2.00 investment. If either option hits $5.00 we'll exit.

FYI: you could try a $120.00 straddle play where you buy one call and one put at the same strike but the investment would be closer to $5.50 and GD would have to move even farther to make it profitable.

Picked on October 09 at $119.59
Change since picked: + 0.00
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

---

Pre Paid Legal - PPD - close: 39.35 chg: +0.75 stop: 37.85

Company Description:
We believe our products are one of a kind, life events legal service plans. Our plans provide for legal service benefits provided through a network of more than 50 independent law firms across the U.S. and Canada, and include unlimited attorney consultation, will preparation, traffic violation defense, automobile-related criminal charges defense, letter writing, document preparation and review and a general trial defense benefit. We have an identity theft restoration product we think is also one of a kind because of the combination of outside vendors and our provider law firms. (source: company press release or website)

Why We Like It:
PPD is a short squeeze waiting to happen. The latest data puts short interest at 32.5 percent of its 15.4 million shares outstanding. What drew our attention to PPD was the rally on September 30th where the stock appeared to breakout over its three-month trendline of resistance. Yet at the same time PPD had not yet broken out over its simple 200-dma. The stock churned sideways under the 200-dma until this Friday with a 1.9% rally pushing PPD over technical resistance at the 200-dma. The 200-dma is a classic support/resistance level so the move higher on Friday has probably got the bears nervous. We suspect that if PPD can breakout over the $40.00 level a short squeeze may ensue. Our strategy is to use a trigger at $40.10. If PPD trades at or above $40.10 we'd suggest buying calls. Our target is the $44.00-45.00 range. We will plan to exit ahead of the October 24th (unconfirmed) earnings date. FYI: Normally we would not play a stock with daily average volume this low but the opportunity here looks too tempting.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 37.50 PPD-KU OI= 81 current ask $3.40
BUY CALL NOV 40.00 PPD-KH OI= 50 current ask $1.85
BUY CALL NOV 42.50 PPD-KV OI= 0 current ask $1.00
BUY CALL NOV 45.00 PPD-KI OI= 21 current ask $0.75

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/05 (unconfirmed)
Average Daily Volume = 72 thousand
 

New Puts

O'Reilly Auto. - ORLY - close: 28.23 chg: +0.06 stop: n/a

Company Description:
O'Reilly Automotive, Inc. is one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States, serving both the do-it-yourself and professional installer markets. Founded in 1957 by the O'Reilly family, the Company operated 1,399 stores within the states of Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, North Carolina, North Dakota, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Virginia, Wisconsin and Wyoming as of June 30, 2005. (source: company press release or website)

Why We Like It:
We like ORLY as another strangle candidate. We're putting it in the puts section because our bias is bearish. The MACD indicator for ORLY looks poised to turn lower but its short-term oscillators are churning sideways, which isn't a surprise since ORLY stock price has been coiling into a tighter and tighter pennant-type pattern. We do admit that ORLY has certainly out performed its peers like AutoZone (AZO) and Pep Boys (PBY). Yet odds are investors may respond negatively to earnings, which have probably been negatively impacted by hurricanes Katrina and Rita. As a strangle candidate we don't care what direction ORLY moves as long as it moves enough to make one-side of our investment profitable. The company is due to report earnings on October 26th. We are going to suggest the November options so we can hold over the earnings report and benefit from any reaction to the earnings news. FYI: competitor AAP has been consolidating in a similar pattern and could also be used as a strangle candidate.

Suggested Options:
This is a strangle play so we want to buy one out of the money call and one out of the money put. We're suggesting the November options.

BUY CALL NOV 30.00 OQR-KF OI= 335 current ask $0.50
-and-
BUY PUT NOV 25.00 OQR-WE OI= 71 current ask $0.25

Our investment here is $0.75. Our goal is for one of these options to trade for $2.50-2.75 before they expire.

Picked on October 09 at $ 28.23
Change since picked: + 0.00
Earnings Date 10/26/05 (unconfirmed)
Average Daily Volume = million
 


Play Updates

In Play Updates and Reviews

Call Updates

BP Prudhoe Bay - BPT - close: 73.95 chg: +1.76 stop: 72.49

As of Thursday's close the OIX oil index and OSX oil services index had both fallen to their 100-dma's. Shares of BPT followed suit and tested (actually broke) its 100-dma. This past week the energy sector experienced a very sharp sell-off so Friday's oversold bounce was not a surprise. The real question for traders is whether this is a bounce worth buying. Looking at shares of BPT we see that the stock is rebounding from the bottom of its recent trading range ($70-$80) and this may indeed be a bullish entry point. Until now we've been suggesting that readers buy a breakout over resistance at the $80.00 level, which has kept us on the sidelines. More conservative traders may want to stick to that plan. We're going to suggest a new strategy. We'll suggest longs if BPT can trade over the $75.00 level. Our trigger to buy calls will be $75.05. If triggered we'll target a move into the $79.75-80.00 range. We'll adjust our stop loss to $72.49.

Suggested Options:
We are suggesting the November calls, although December calls would work well too.

BUY CALL NOV 70.00 BPT-KN OI= 0 current ask $5.10
BUY CALL NOV 75.00 BPT-KO OI= 37 current ask $2.30
BUY CALL NOV 80.00 BPT-KP OI=105 current ask $1.10

Picked on October xx at $ xx.xx <-- see Trigger
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 175 thousand

---

Broadcom - BRCM - close: 46.47 chg: +0.58 stop: 44.49

Looking back over the past week shares of BRCM displayed great relative strength and only fell lower on Thursday. That dip looks like a new bullish entry point. The stock has a steady trend of higher lows and its Point & Figure chart points to a very bullish $86 price target. We are only targeting a move into the $49.00-50.00 range. Our time frame is down to two weeks as we want to exit ahead of BRCM's October 20th earnings report. If the SOX semiconductor index can rally from the bottom of its trading range then BRCM has a stronger chance of hitting our target. If the SOX breaks down under its 100-dma and the 450 level then BRCM may become a target for profit taking. FYI: technical traders will note that BRCM does show a bearish divergence between its rising stock price and its MACD. Be sure to play with stop losses in place!

Suggested Options:
We are suggesting November calls. October would work but they expire on October 21st.

BUY CALL NOV 42.50 RCQ-KS OI= 6254 current ask $5.10
BUY CALL NOV 45.00 RCQ-KI OI=10455 current ask $3.30
BUY CALL NOV 47.50 RCQ-KR OI= 4754 current ask $1.90
BUY CALL NOV 50.00 RCQ-KJ OI= 5403 current ask $1.00

Picked on September 25 at $ 45.05
Change since picked: + 1.42
Earnings Date 10/20/05 (confirmed)
Average Daily Volume = 7.0 million

---

Bear Stearns - BSC - close: 105.25 chg: -1.10 stop: 102.49

It is decision time for traders. Do you stay or do you go? The reversal in shares of BSC has been sharp. The stock broke out to new multi-month highs in late September but was unable to push through the $110 level, which looks like the neckline to an inverse or bullish head-and-shoulders pattern. A crashing stock market this past week didn't help matters and now BSC is down five days in a row. The sell-off has turned BSC's technicals bearish and produced a new MACD sell signal. Plus, shares broke down under what we expected to be short-term support near the $106 level. These seem like good reads to go. The only reason to stay would be to speculate on a bounce. After five declines in a row BSC is in a good spot to produce an oversold bounce, especially from the $105.00 level, which could act as round-number support. So far the Point & Figure chart remains bullish and still points to a $117 target. This alone isn't very compelling but the major averages could produce a stronger oversold bounce next week so we're not ready to give up just yet on shares of BSC. We are not suggesting new plays although more aggressive traders might want to buy a bounce from the $105 level. More conservative types may want to tighten their stop loss toward the $105 level.

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

Picked on October 02 at $109.75
Change since picked: - 4.50
Earnings Date 09/15/05 (confirmed)
Average Daily Volume = 1.2 million

---

Cardinal Health - CAH - close: 63.55 chg: +0.49 stop: 59.85

Healthcare stocks tend to be more defensive and this was evident in CAH's relative strength as it weathered the sell-off last week. We remain bullish given its technical breakout over major resistance in the $60.00-61.00 region. The Point & Figure chart is also very bullish with a breakout over resistance and a suggested bullish target of $75.00. We are only targeting a move into the $66-67 range and we plan to exit before the company's October 26th earnings report. Readers may want to consider new bullish positions on another dip to the $62.50 level.

Suggested Options:
We're not suggesting new positions at the moment. Interested traders may want to play the November calls.

Picked on September 25 at $ 61.95
Change since picked: + 1.66
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 2.0 million

---

Cameco Corp - CCJ - close: 52.03 chg: +1.65 stop: 49.49

Uranium miner CCJ continues to produce volatility. The stock dipped toward support near the bottom of its trading range at the $50 level, bolstered by its rising 50-dma on Thursday. Friday witnessed a relatively sharp rebound back toward the middle of its range. At this time we're not suggesting new bullish plays although aggressive traders may want to speculate on the bounce from $50. We are more defensive since Thursday's intraday low produced a new P&F chart sell signal.

Suggested Options:
We are not suggesting new plays at this time. We will plan to exit ahead of CCJ's early November earnings report.

Picked on September 18 at $ 53.30
Change since picked: - 1.27
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 862 thousand

---

Cigna - CI - close: 115.77 change: +0.02 stop: 111.49

Health insurer CI continues to look attractive as a bullish candidate. The stock broke through the top of a multi-week trading range in late September. Shares then rallied to what we expected would be short-term resistance at the $120.00 level. This past week's sell-off has pulled CI back toward rising technical support near its rising 40 and 50-dma's. We see the dip as a new entry point although our readers may want to wait for CI to trade back above $116.50 before initiating new positions. We plan to exit before CI's early November earnings report. Our target is the $124.00 level.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 115.00 CI-KC OI= 132 current ask $4.70
BUY CALL NOV 120.00 CI-KD OI= 280 current ask $2.15
BUY CALL NOV 125.00 CI-KE OI= 422 current ask $0.85

Picked on September 29 at $116.51
Change since picked: - 0.74
Earnings Date 11/02/05 (unconfirmed)
Average Daily Volume = 991 thousand

---

Altria Group - MO - close: 72.46 change: -0.29 stop: 69.90

We're moving into crunch time with MO. The company is due to report earnings on October 19th and we do not want to hold over the report. There are usually too many unknown variables to make it worthwhile holding directional option positions. The stock's relative weakness on Friday is a bit discouraging but MO did produce a decent intraday bounce from its lows, which tested support at its rising 40-dma. We only have seven trading days left so we are not suggesting new plays at this time. Our target remains the $78.00 level. More conservative traders may want to think about raising their stop loss toward $70.75, which was support twice last month.

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

Picked on September 18 at $ 73.14
Change since picked: - 0.68
Earnings Date 10/19/05 (unconfirmed)
Average Daily Volume = 6.7 million
 

Put Updates

Black & Decker - BDK - close: 78.69 chg: -1.11 stop: 83.05

BDK is almost there! The stock tried to rally on Friday but failed at short-term resistance near the bottom of its October 5th gap down. The stock then sank to a new five-month low and came within 20-cents of our target in the $78.00-77.00 range. Readers may want to strongly consider exiting right here for a profit. We are not suggesting new plays with BDK so close to our exit.

Suggested Options:
BDK is close to our target. We are not suggesting new plays.

Picked on September 14 at $ 83.31
Change since picked: - 4.62
Earnings Date 10/25/05 (unconfirmed)
Average Daily Volume = 636 thousand

---

Ryland Group - RYL - close: 64.38 chg: +1.03 stop: 68.75

The homebuilding stocks managed a bit of an oversold bounce on Friday but the trend remains bearish. Concerns over the impact of inflation and higher interest rates on mortgage rates and consumer spending sparked a sharp reaction in the sector. The DJUSHB index broke down below its simple and exponential 200-dma's in addition to support near the 900 level. Meanwhile shares of RYL fell through the bottom of its recent trading range to hit new four-month lows. RYL was already trading under its 200-dma's. The P&F chart for RYL is bearish with a $56 price target. We are targeting a move into the $60.50-60.00 range and we plan to exit ahead of the company's October 18th earnings report. That only gives us six more trading days. With such a brief time frame we're not suggesting new positions. However, more aggressive traders may want to consider new bearish positions if RYL produces any sort of failed rally under resistance at the $66.00 level.

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

Picked on October 05 at $ 65.70
Change since picked: - 1.32
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 1.0 million

---

Wynn Resorts - WYNN - close: 42.85 chg: +0.67 stop: 45.11

WYNN is a new bearish candidate from the Thursday night newsletter. We see no changes from our original play description so we're reposting it here:

It has taken four days of market wide declines but shares of WYNN have finally joined the pack. Shares broke down from its 12-day sideways trading range and dropped to a new one-year low under its May lows. Volume on today's breakdown was very heavy suggesting more weakness ahead. The Point & Figure chart is already bearish and points to a $33.00 target. Traders have a choice on entry points. The major market averages all look short-term oversold. The late day bounce today suggests that the markets might produce an oversold bounce tomorrow. If that is the case then readers might want to wait and see if WYNN bounces back toward the bottom of its recent trading range near $43.50, which should now act as new resistance. A failed rally near $43.50 could be used as a new bearish entry point. The alternative is to open new bearish put positions while the stock trades under $42.50. We do expect the $40.00 mark to act as round-number, psychological support but we expect it will eventually break down. Our end of October target for WYNN is the $37.50-37.00 range. We will exit ahead of the company's earnings report.

Suggested Options:
We are suggesting the November puts.

BUY PUT NOV 45.00 UWY-WI OI=191 current ask $3.80
BUY PUT NOV 40.00 UWY-WH OI=176 current ask $1.40

Picked on October 06 at $ 42.18
Change since picked: + 0.67
Earnings Date 10/31/05 (unconfirmed)
Average Daily Volume = 1.3 million
 

Dropped Calls

None
 

Dropped Puts

Whole Foods Mkt - WFMI - cls: 130.97 chg: +2.21 stop: 133.01

The Thursday night newsletter said that if the markets produce an oversold bounce on Friday we would expect WFMI to participate. Well participate it did. The stock rallied 1.7% and closed back above the $130.00 level. This alone isn't so remarkable and the stock remains under the simple 50-dma. However, we suspect that WFMI will continue to show strength next week so we're choosing to exit early and minimize any losses.

Picked on October 05 at $129.62
Change since picked: + 1.35
Earnings Date 11/10/05 (unconfirmed)
Average Daily Volume = 983 thousand
 


Trader's Corner

The Best Fit

Perfectly fitted suits or dresses boost confidence, giving wearers the sense that they're people who are going places. A perfectly fitted Fibonacci bracket can do the same, giving traders the sense of where prices might be headed. They help set targets.

For those unfamiliar with Fibonacci numbers, here's a recap from my Saturday, May 14 TradersCorner article. The term refers to the series of numbers (1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 . . . .). After the first two numbers, each new number in the series is calculated by adding the previous two numbers. As my previous summary noted, this series of numbers predicts everything from the number of rabbits born to a single pair n months after they begin breeding to the number of petals on a flower. Flowers tend to have 3, 5, 8, 13, 21, 34, etc. petals.

After the first five numbers of the series, the ratio of one number to the next in the series is 0.618, making each number 61.8 percent of the number that will follow it. This number and proportions of this number turn out to have relationships to all kinds of thing, too, including movements of the financial markets. After a rally or decline, prices sometimes reverse and retrace part of the prior movement before resuming the rally or decline. Often those retracements stop at Fib numbers or the ratios between the numbers. For example, a 61.8 percent retracement is sometimes seen.

Annotated 30-Minute Chart of CSCO:

Newbie traders might conclude that there's nothing more to the relationship of Fib numbers to prices than self-fulfilling market action. That would happen if all participants lean toward selling or buying at a well-known Fib number just because they're . . . well, well-known as potential support or resistance. However, as that previous summary noted, that wouldn't go far in explaining the relationship of Fib numbers to flower petals. Something more might be at work.

Most charting services make it easy to determine where Fib levels might come into play. Most include a tool that allows a bracket to be snapped onto the chart.

Annotated 30-Minute Chart of CSCO:

After a rally or move completes, the Fib bracket can be used to predetermine where support or resistance might lie during a reversal. Take another look at that second chart, however, and imagine extending the 38.2% retracement to the left. It's easy to see that historical support/resistance had already existed in that $17.95 area. Frequently, after a strong move has finished and a Fib bracket is snapped on the entire move, those Fib levels will hit points at which the rally or decline had temporarily stalled, producing levels of historical support or resistance. That observation can be used to extrapolate the point at which a move might end.

Fitting a dress or suit requires tailoring it to shoulders, waist and hips. Until the waist and hips fit right, the garment shouldn't be hemmed because the hem might be too short or long. Fitting a Fibonacci bracket to determine where the move might end requires a little tailoring, too.

Annotated Daily Chart of the RLX:

Although my fitting of a Fib bracket on July 21 was a few points shy of the actual high hit on July 29, it did predict, more than a week before the actual high was hit, that the rally might be topping out. It's apparent from the RLX's chart that it would have been possible to hit the top target more precisely if the bracket had been fitted with the 50 percent level closer to 440, snugged under those candle bodies in early June rather than at the top of May's candle shadows and the bottom of early June's.

Annotated Daily Chart of the RLX:

Fitting a Fib bracket to extrapolate a target requires some judgment and discretion. On July 21, when I was trying to find an upside target, I thought the fit displayed in the first chart was the better fit, but the second version turned out to be the correct one.

Such a fitting of a Fib bracket would have warned bulls to protect their profits, although it would not have been enough evidence to suggest new bearish entries. Setting such a target does allow bears to begin watching for a reversal. Such was the case with the Russell 2000 this summer.

Annotated Daily Chart of the Russell 2000:

Signs of a reversal in the making did not take long to appear and included a breaking below the ascending trendline off the May low.

Fitting a Fib bracket to extrapolate a possible upside or downside target can be as much art as science, but still proves helpful. Make the fit as close as possible around the midsection and the hem should fall right, too.
 

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.

DISCLAIMER

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.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

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