Option Investor

Daily Newsletter, Monday, 10/17/2005

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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

Op-ex Monday

The October expiration week kicked off with a downward grind that climaxed in a brief drop around noon, followed by a bounce that extended to the final minutes of the session before pulling back. It was a difficult, frustrating session in which the usual time and price cycles were distorted and ineffective- a perfect start to op-ex week.

Volume was well below the levels seen last week, and there was no conviction to any direction other than sideways. Traders didn't believe either the dips or the bounces. Volume breadth remained positive on the NYSE for the entire session, while on the Nasdaq it flipped positive and negative several times. At the close, advancing volume outpaced declining volume 1.85:1 on the NYSE and 1.41:1 on the Nasdaq.

Daily Dow Chart

The Dow took a good bounce off the 10269 low to close +60 at 10348. The high at 10350 was obvious enough, and for the moment the daily cycle downphase continues. But the indicators are oversold, and anything less than a complete reversal of today's gain should see the first bullish kiss or even cross on the next daily cycle upphase. With strong resistance at 10350, however, it's not obvious which will prevail. A gap up open could solve the problem, but with the intraday indicators overbought and due for at least a correction, there would be good reason to be wary of an apparently bullish move at the open tomorrow.

Daily S&P 500 Chart

The SPX ground out a 3.51 gain, bouncing from a low of 1184.48 to close at 1190.08. As with the Dow, the current bounce is stopped at first resistance, but that resistance is weaker than the Dow's 10350. The equivalent would be overhead at 1204-05. For the moment, the current bounce is a mere "return to the scene of the crime" at the 1190 breakdown area, but a close above it could line up with the first bullish signals from the daily indicators.

Daily Nasdaq Chart

The Nasdaq gained 5.47 for the day to close at 2070.30, bouncing at midday from a 2054 low. The high confirms resistance to 2080, while the low lines up with the range bottom from June-July. As noted above, the intraday cycles are overbought and due for downside that never materialized today and was overdue as of the close. If the bulls can keep them pinned to the ceiling tomorrow, there will be reason to expect a strong daily cycle upphase to follow. But the daily cycle downphase hasn't relented yet, and with strong resistance overhead, the more likely move will be to the downside tomorrow. The strength or weakness of that move will give us more clues as to the likely shape of the daily cycle upphase to follow.

Daily TNX Chart

The lone economic report this morning was the October Empire State Manufacturing Index, which fell to 12.1, missing expectations in the 20-22 range. September's result was revised down from 17 to 15.6. While new orders rose after their sharp decline last month, the prices-paid component rose again this month to 57.3, close to a record high, and the employment component fell from 11.7 last month to 9.3. Gold jumped on the news, and bonds rose slightly.


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Following this report was a statement from the Conference Board to the effect that while the hurricanes (and the other impediments for the economy) haven't touched off a recession, they could slow the economy enough "to make it feel like one." Higher energy costs could "put holiday retail sales at risk." The Conference Board finished off by noting that if the Fed doesn't raise rates beyond 4% and energy prices don't "spike" higher, stronger growth should return next year. I disagree with any characterization of the rise in energy prices since 1998-1999 as a spike, and I'm sure that the lines of filers comprising the latest record highs in bankruptcy filings this past weekend ahead of the legislative amendments would disagree with the Conference Board as well.

The Fed, possibly responding to tremors from the Refco situation, released a $6.25 billion overnight repo against no expiries this morning, bringing tomorrow's expirations to a respectable $13.75 billion. The stop out rate on treasury collateral rose to 3.74, however, 8 basis points above Friday's rate and one bp below the target rate, indicating an escalating demand for liquidity on the part of the Fed's dealers.

The Treasury auctioned $18 billion in 13-week bills and $16 billion in 26-week bills. Foreign central banks took $8.6 billion of the total, with the 13-week bills generating 2.05 bids for each awarded, at a high-rate of 3.785% yielding 3.875%. The bid-to-cover ratio on the 26-week bills was 2.08, with a high-rate of 4.015% yielding 4.155%.

For the day, ten year note yields (see chart above) finished fractionally lower by .2 bps at 4.489% after another test of 4.5% resistance. What was looking like a routine bear flag for the TNX has extended into an upside trending move to challenge key resistance at 4.5%. Above that level, 4.64% comes into view for a possible test of the year highs for the ten year note yield. 4.4% is key confluence and rising wedge support.

Daily Chart of Crude oil

Weekend news was grim, as the death toll in Pakistan broke 54,000 with over 2 million people now homeless. Romania and Turkey reported cases of the H5N1 bird flu, and a strain resistant to the current Tamiflu treatment was discovered in a Vietnamese girl who had been infected by her brother. The World Health Organization has maintained its pandemic alert level at "3" to indicate a new influenza subtype capable of infecting humans. The WHO stated that it will only change the alert level should it observe that the virus has become more infectious. US Health Secretary Mike Leavitt was in Jakarta today, where he stated that in his view, no nation is adequately prepared a pandemic avian flu. Later in the day, it was reported that Greece has confirmed its first bird flue case as well.

Tropical Storm Wilma was gathering strength in the Carribean Sea today, and the National Hurricane Center said that it could be in the Gulf of Mexico by the end of this week. Oil and natural gas prices were up strongly this morning as traders contemplated the 21st named storm of the hurricane season, the most since 1933. Reuters reported that as of Friday, 67% of US Gulf production is still shut in, and 6 refiners representing 10% of US refining capacity are still offline.

OPEC revised its 2005 and 2006 demand forecasts for crude oil by 200,000 bpd in 2005 and 400,000 bpd in 2006. OPEC does not expect any "dramatic drop in consumption," and cited market sensitivity to refinery outages.

Crude oil opened strongly, pulled back within positive territory, and launched to close 10 cents off its 64.425 high, +1.7 or 2.71% for the day. Natural gas gained .65 or 4.92% to close at 13.87. On the daily chart, the current bullish-divergent bounce is testing 50 day EMA resistance, above which the descending channel top just below 65 comes into view.

In corporate news, Citigroup (C) reported a 35% rise in Q3 profits, which rose from $5.31 billion or $1.02 per share in the year-ago quarter to $7.14 billion or $1.38 per share. Revenues rose 15% to $21.5 billion in the period. Estimates were for EPS of 98 cents on revenue of $21.2 billion. Earnings from continuing operations were 97 cents per share, down a penny from last year's Q3 and missing First Call estimates by a penny. The company attributed its gains to record revenues from corporate and investment banking, compensating "sluggish" revenues in consumer banking, which fell 13% to $2.72 billion. Some noted that the company's per-share earnings were boosted by stock repurchases. The stock popped in the morning, but had reversed to negative territory by noon. C closed lower by .51% at 44.81.

Saks (SKS) reported Q2 earnings that rose from a year-ago loss of $25.3 million or 18 cents per share to a profit of $8.2 billion or 6 cents, but $57 million or 40 cents were contributed by one-time items The company sees "flat to low single digit" growth. SKS gained 1.99% to close at 16.93.

GM reported a Q3 loss exceeding $1.6 billion or $2.89 per share. Excluding special items, the loss was $1.92, blowing out estimates for a loss of 81 cents. The beleaguered automaker cited rising costs in raw materials, healthcare, and of course gasoline prices, the net result of which is a huge squeeze both on the input side and the sale side. Quarterly revenue rose, however, by 5% to $42.7 billion, presumably on the deep discounts and sales incentives of this summer. News reports didn't cite management's own questionable vision in adhering to a strict design agenda of muscle- and SUV gas-guzzlers, even in the face of steadily escalating fuel prices over the past several years. Is it any wonder that demand is falling, even amid aggressive marketing and sales-incentive campaigns?

GM also announced a tentative deal with the United Auto Workers union to cut annual healthcare expenses by approximately $3 billion per year and healthcare costs for retirees by $15 billion while establishing a fund to help mitigate the effect thereof. The company will reduce its payroll by approximately 25,000, and will close more plants. The stock rallied more than 10% in the premarket on this news, breaking back above the 31 level. GM finished +7.04% at 29.95.

The toymakers announced as well, with Mattel (MAT) reporting disappointing results on waning Barbie sales, while Hasbro (HAS) cited strong Star Wars sales but missed estimates by 4 cents. MAT lost 4.51% to close at 15.23, while HAS gained .37% to close at 18.79.

Krispy Kreme (KKD) got slammed as its majority-owned franchisee partner Freedom Rings LLC unit filed for Chapter 11 protection. This news follows an official "No Comment" statement just 5 days ago when KKD stock dropped 22% in a single day following an 8% drop the day before. KKD will fund Freedom Rings through its restructuring process. Later in the session, KKD disclosed that it had acquired the remainder of the company, an additional 30% of the equity, and by doing so eliminated the $24.1 million that Freedom Rings owed to it. According to the company, that eliminates substantially all of the indebtedness at issue, leaving the outcome or even the necessity of a Chapter 11 filing in question. KKD closed -5.35% at 4.60.

After the bell, IBM reported Q3 earnings that rose from 92 cents in the year-ago quarter to 94 cents. Revenue declined from $23.35 billion to $21.52 billion. Earnings from continuing operations was 94 cents per share, declining from $1.55 billion to $1.52 billion. Excluding items, EPS was $1.26 per share. Estimates were for EPS of $1.13 on revenue of $21.7 billion IBM was up .98% at 83.16 after the report.

RMBS reported earnings which rose from 10 cents or $10.4 million in the year-ago quarter to 14cents or $14.5 million on revenue that fell from $38.8 million to $36 million. RMBS was up 4.63% at 12.20 following the release.

NVLS reported a 64% decline in profits, from 45 cents or $64.7 million in Q3 2004 to 17 cents or $23.4 million. Estimates were for 21 cents. Gross profit fell from 48.4% to 43.4% in the current quarter. NVLS was down .68% at 24.67 as of this writing.

Earnings will continue to outpace economic data, as a light week is scheduled. The inflation picture will be completed by the PPI tomorrow, followed by Housing Starts and Building Permits, the weekly petroleum report and the Fed Beige Book on Wednesday. On Thursday, we'll get Initial Claims, Leading Economic Indicators and the Philadelphia Fed.

For tomorrow, the big question is whether the bulls can follow through on today's advance, or whether the intraday cycles will get a chance to assert themselves. With the daily cycle downphases not yet reversed, the ordinary expectation would be for a correction, possibly deep, to exhaust the last of the daily cycle sellers. With the weekly cycle indicators still declining, that would be my ideal outcome. However, this being op-ex week, and with significant October short put positions to be defended by their writers, there's a much better than usual chance that the ideal cycle picture will not come to pass. By the same token, I am skeptical of the chances of a sustainable rally from here. If today is any indication, the intraday swings will be most likely to net out close to where they started.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Burlington North/Santa Fe - BNI - cls: 57.47 chg: +0.04 stop: 55.99

We highly suggest traders keep one eye on the exit door. Our strategy outlined over the weekend said that if BNI doesn't produce any bullish follow through on Monday or Tuesday this week we're going to bail out early. Today's 4-cent gain on a day most of the market closed higher is not what we call follow through. If BNI doesn't turn in a strong performance tomorrow we'll close the play early! Our short-term target is the $59.95-60.00 range.

Picked on October 00 at $ 00.00
Change since picked: + 0.04
Earnings Date 10/25/05 (unconfirmed)
Average Daily Volume = 2.0 million


Biosite Inc. - BSTE - close: 67.21 chg: +2.29 stop: 61.49*new*

Target achieved! BSTE continues to out perform and the stock surged again today with a 3.5% gain on above average volume. The rally stalled at $67.50, which is the May 2005 high. The $67.50 mark was also out first target. According to our play description we are suggesting that traders sell half their position here at $67.50 (which will probably be short-term resistance). Our secondary target is the $69.50-70.00 range. We are raising the stop loss to $61.49. We are not suggesting new plays at this time.

Picked on October 13 at $ 63.39
Change since picked: + 3.82
Earnings Date 10/25/05 (unconfirmed)
Average Daily Volume = 261 thousand


Cardinal Health - CAH - close: 63.25 chg: -0.23 stop: 61.95*new*

Lack of follow through on Friday's gain is not a good sign for CAH. We would be very cautious about initiating new bullish positions here. Putting action behind our caution we're raising the stop loss to $61.95 (breakeven). We are targeting a move into the $66-67 range before the company's earnings report on October 26th.

Picked on September 25 at $ 61.95
Change since picked: + 1.30
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 2.0 million


Pre Paid Legal - PPD - close: 40.44 chg: -0.09 stop: 37.85

PPD's lack of follow through on Friday's breakout is disappointing but the intraday rebound from the $40.00 level could be used as a new bullish entry point. Our target is the $44.00-45.00 range. We do plan to exit ahead of the October 24th earnings report but at this time that date is unconfirmed.

Picked on October 10 at $ 40.10
Change since picked: + 0.34
Earnings Date 10/24/05 (unconfirmed)
Average Daily Volume = 72 thousand


Target Corp - TGT - close: 53.26 change: -0.23 stop: 51.49

Retail stocks produced an anemic rally today as investors continue to worry over inflation. Shares of TGT did not breakout over technical resistance at its 50-dma and thus the stock has not hit our trigger to go long (buy calls) at $54.01. Don't forget that TGT has an analyst conference on October 18th! Meanwhile in the news TGT did announce that October same-store sales appear to be inline with its +3-5% forecasts.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/10/05 (unconfirmed)
Average Daily Volume = 3.8 million

Put Updates

Teleflex Inc. - TFX - close: 66.84 chg: +0.48 stop: 69.01

There are no surprises here. We've been warning readers to watch for an oversold bounce. A failed rally under $68.00 could be used as a new bearish entry point. We see no changes from our weekend update.

Picked on October 13 at $ 66.49
Change since picked: + 0.35
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 174 thousand

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)


AmerisourceBergen - ABC - cls: 75.52 chg: +0.71 stop: n/a

So far so good. It's not too late to consider new strangle positions on ABC. The stock is at a pivotal level hovering around the $75 mark. We are suggesting the November $80 call and the November $70 put. Once ABC trades above $76 or under $74 we would not suggest new positions. We do plan on holding over the November 3rd earnings report, which should produce more volatility.

Picked on October 16 at $ 74.81
Change since picked: + 0.71
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand


E*trade Financial - ET - close: 16.35 chg: +0.07 stop: n/a

Shares of ET produced some volatility this morning as traders reacted to a positive earnings report from rival Schwab (SCH) that came out before the opening bell. However, the rally failed at the $17.00 level and shares of ET closed back under its 10 and 50-dma's. We would continue to suggest new strangle positions here with the November $17.00 call and the November $15.00 put. You'll want to have your positions set before ET reports earnings this Wednesday.

Picked on October 16 at $ 16.28
Change since picked: + 0.07
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 3.4 million


General Dynamics - GD - cls: 120.22 chg: +0.14 stop: n/a

It's not too late to consider launching strangle positions in GD. The stock continues to trade sideways on either side of the $120.00 mark. Once shares move past the $121 level we'll stop suggesting new entries (or under $118.75). We're suggesting the November $125 call and the November $115 put.

Picked on October 09 at $119.59
Change since picked: + 0.63
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand


Google Inc. - GOOG - close: 305.00 chg: +8.86 stop: n/a

GOOG is doing what it does best and that's create volatility. Some positive analyst comments about the company's earnings estimates helped inspire the oversold rebound from its simple 100-dma. At the $305 mark GOOG is near the top of our suggested range to consider initiating strangle positions. Our weekend play description outlined two alternatives - a strangle using November strikes and a strangle using December strikes. Please see our weekend play description for more details.

Picked on October 16 at $296.14
Change since picked: + 8.86
Earnings Date 10/20/05 (confirmed)
Average Daily Volume = 8.1 million


Legg Mason - LM - cls: 103.08 chg: -1.70 stop: n/a

The pull back in shares of LM today is another opportunity to consider initiating new strangle positions on the stock. If you choose to open a strangle here be sure to do so before LM reports earnings on October 24th (still unconfirmed). However, we would truly prefer to see LM pull back to the $100 region ($101-99) if you're thinking about launching a new strangle position but that would require the stock to breakdown under its simple 100-dma. Please see our weekend update for more details.

Picked on October 12 at $102.59
Change since picked: + 0.49
Earnings Date 10/24/05 (unconfirmed)
Average Daily Volume = 966 thousand


3M Co. - MMM - close: 72.47 chg: +1.75 stop: n/a

Looks like someone is placing some bullish bets on MMM ahead of tomorrow's earnings report. Today's big gain has ended our window to initiate new strangle positions. It's time to sit back and watch. MMM is due to report earnings tomorrow before the opening bell. Wall Street is looking for $1.08 a share. Remember, we are planning to exit if either option in our strangle trades into the $1.60-2.00 range. More aggressive traders may want to hold out for more.

Picked on October 12 at $ 70.38
Change since picked: + 2.09
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 3.0 million


O'Reilly Auto. - ORLY - close: 26.64 chg: +0.26 stop: n/a

We have nothing new to report on for ORLY. At this point we're in a "wait-and-see" mode. We're not suggesting new strangle positions since the stock has fallen out of its neutral consolidation pattern. We're expecting to see more movement following the October 25th earnings report.

Picked on October 09 at $ 28.23
Change since picked: - 1.59
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = million


Verifone Holdings - PAY - cls: 19.98 chg: +0.22 stop: n/a

Today offered traders another entry point to launch new strangle positions on PAY. The stock is coiling sideways near the $20.00 mark. We're suggesting the January $22.50 call and the January $17.50 put. More aggressive traders might want to consider the November strikes (see our weekend play for more details).

Picked on October 12 at $ 19.98
Change since picked: - 0.00
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand

Dropped Calls


Dropped Puts


Options 101

Option Strategies in Defined Benefit and Defined Contribution Plans

If you are the sole owner and the plan is self-directed there is no limit as to what you can do.

The Theory Behind the Practice

Most option strategies are geared around varying philosophies. Some use options as leverage, others to hedge existing or established positions, some by calls or puts strictly as a speculative vehicle, but the bottom line is that they all want to generate income to varying degrees. We know that no matter how successful you become as an option trader, you eventually share your prosperity with your favorite uncle in Washington, endearing called Uncle Sam. While I guess, paying a lot of money isnt a bad thing, because that must mean you are making a lot of it in the process. We all know you cant pay much tax if you dont generate the cash flow. We mentioned in earlier articles about the advantages of Traditional IRA and ROTH IRAs offer to investors that generate income. They were Tax-deferment (in a traditional IRA) and None taxation (in a ROTH IRA). The concept is wonderful. The problem with IRAs is basically their size. In an examination of all the IRAs in this country there are roughly only 10% that have assets over $100,000. That means a majority of these accounts are small to middle size investors who have been able to accumulate modest sums of money over a period of time, but not to the size that they ultimately would like to see there assets grown to. In addition, IRAs limit the scope of the type of option opportunities that are available for one to trade. It certainly would be nice to have an investment vehicle like a traditional IRA where you could at least defer all of your option premiums. In addition to that, one where you could be able to utilize just about any option strategy you so desire. Wouldnt the be grand!

Enter the Self-directed Defined Contribution and Self-Defined Pension Plan

Yes, it does exist, however but it has its limitations.

In these type of plans you can trade basically any type of option strategy, including selling spreads (credit and debit), combinations, butterflies, condors, and even naked puts and calls.
There is basically no limit on the investment strategy that you can use, as long as you follow the basic agenda for its use.

1. It must be a Defined Contribution or Defined Pension Plan that is self-directed with you as the sole individual in the plan and the trustee and fiduciary of the plan.
2. The plan must state specifically what types of transactions are suitable for the plan. (So if you are going to buy calls, sell or buy spreads, or sell naked puts or calls, this must be spelled out in the trust documents clear and concisely.)
3. You will be still under normal guidelines of option trading, which will include margin requirements, being marked to the market for naked or uncovered positions.
4. You must also be aware of the fact, that unlike normal accounts, you will not be able to contribute to this account if you lose more then is in the account, because this is a retirement account and you are only able to make limited contributions annually. So ultimately, you must adhere to strict number of positions so that in the event of a risky strategy turning ugly, you dont find yourself in a situation where your account losses everything (by being too aggressive and non prudent) and you are forced to come up with funds that even if you do have, can not be contributed to a Defined Pension Plan or a Defined Contribution Plan, as they have strict limitations. The only exception around this situation is if you were to over fund these funds, and with that act there are penalties assessed against the plan by ERISA (the overseer of Pension and Profit Sharing Plans.

The Real World So how do these plans help me

These plans only can be utilized by the self-employed who have complete control over the funds and are the only member of their company. These plans to be utilized for all types of option strategies need to be either DBAs or one-man corporations. The trust documents need to be drawn up by an attorney with pension or profit sharing plan background and should be advised by both their attorney and Certified Public Accountant. The documents should clearly explain that the trustee (you) are experienced and will make prudent decisions based on what a PRUDENT MAN would do for this type of account. Just because you are the only individual in the plan it doesnt mean you get to slide around ERISA rules regarding the FIDUCIARY RESPONSIBILITY of the TRUSTEE.

The Bottom Line

The basis of this article is to point out that under special situations the limits as to how one may use an option strategy need not exist. With the right type of self-employment income and Defined Contribution or Defined Benefit Plan you can have all the choices you desire, as long as you have the proper paperwork set up to define what types of investment vehicles can go into your plan. With a little help form your CPA and a good trust attorney and the conditions above, you could be well on your way to sitting up a plan that would allow complete utilization of all the strategies available in the options market.

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.


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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