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Daily Newsletter, Monday, 10/31/2005

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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

End of Month Volatility to End the Month of Volatility

Wow, good riddance to October! For anyone trying to hold onto a trade, especially over the past two weeks, it's been a wild ride and every other day it seems we saw a complete reversal of a reversal of a reversal of... Today's rally itself was reversed, especially after the market's close when we saw the day completely reversed in the DOW futures. Back to flat on the day. Futures rallied back up into the evening so perhaps tomorrow won't see follow through to the downside. But it looks like the market hit some important resistance levels as we'll see in the charts and today's late-day sell off now leaves us wondering if the buying on Friday and today was just end of month/quarter/fiscal year buying for some of the mutual funds.

If the buying was largely done for window dressing, we could see some of that reversed tomorrow before we head to new highs. But if the resistance levels reached was the end of a corrective rally that started from the October 13th low, then we'll now start heading for new lows. We don't know which yet but it could be an interesting week ahead.

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Futures had been up over night, thanks in large part to the strong rally experienced in the European markets and we saw prices spurt higher from a gap open that lasted all of 30 minutes. The rest of the day was spent consolidating near the high which was actually bullish and sure enough, we then rallied into the end of the day or at least until the last 20 minutes of the day. Starting at 3:40 PM we saw an unloading of some stocks that the mutual fund managers really didn't want but bought them for their portfolios to show what smart people they are. After 4:00 PM the DOW futures finished selling off which took prices back to where the day started.

Before the market opened we got some favorable earnings reports for the third quarter from Occidental Petroleum (OXY 78.82 +1.98), Humana (HUM 44,27 +0.47) and Valero Energy (VLO 105.20 +5.74) all of whom reported upside numbers. There was news from Novartis (NVS 53.81 +0.42) who agreed to purchase the balance of Chiron (CHIR 44.12 +0.80) shares that it does not already own, for $5.1B. A host of analyst upgrades lent early support to the open--WAG, SIRI, QLGC, HSII, WFT, PNC, and SPF. Nothing like a little boost from your friends on the last day of the month. Barrick Gold (ABX 25.31 -1.95) announced its $9.2B bid for Placer Dome (PDG 19.87 +3.44) which sent ABX tumbling and PDG rocketing higher. Saks (SKS 18.16 +1.49) was lifted on its announcement of its sale of its Northern department stores.

Caterpillar (CAT 52.67 +1.52) lifted its share price by announcing it expects dramatically improved performance, which includes $50B in sales by 2010. In 2010? Most companies have trouble with forecasts for the next year. That's like a weatherman forecasting rain on this date in 2010. OK, if you live in Seattle maybe that's not such a hard forecast. Brewers did well after Barron did a positive article on Anheuser (BUD 41.27 +0.69) while Molson Coors (TAP61.70 +0.80) gained ahead of its Q3 earnings report scheduled for tomorrow. But I guess it's better to drink than eat cereal--Kellogg (K 44.16 -2.29) got smacked after its disappointing FY05 and FY06 guidance that followed a better than expected Q3 report. Maybe if Kellogg suggests pouring beer into your corn flakes instead of milk, they'll do better.

September personal income and spending data was released at 8:30 AM and showed income rose 1.7% (consensus was 0.4%), while the spending rose 0.5% which matched expectations. The increase in income was attributed to the rebound from August which was down due to the uninsured losses from Hurricane Katrina. The rise in September followed a -0.9% decline in August which was attributed to the drop in rental income caused again by Hurricane Katrina and the uninsured real estate losses. If these hurricane related losses are stripped out, economists figure we had a +0.5% rise in September that followed a +0.3% rise in August.

The +0.5% gain in spending followed a -0.5% decline in August so it was a wash between these two months. The extra spending was attributed to extra gasoline expenditures. Stripping away inflation, which removes the energy component, spending actually dropped -0.4% after falling -1.0% in August. This makes it the first back-to-back drop in spending since 1990. Uh oh, the drop in consumer spending is not going to be good for the market if it continues. Normally this might have had a very negative reaction from the market but instead the market had an agenda today--paint that tape!! Let's get as much out of October as we can.

The personal consumption expenditure price index jumped +0.9% in September due in large part from the increase in energy prices. This was the biggest jump in almost 25 years, since February 1981.

At 10:0O AM we got the Chicago PMI for October and it came in at 62.9 versus September's 60.5 so a slight improvement. It came in better than expectations of 57.2 as new orders jumped to 72.6 (vs Sept. 63.4) and new deliveries rose to 68.3 (vs Sept. 57.4). Prices paid was 79.6 (vs Sept. 60.5).

SOX got a nice little boost today off news that semiconductor sales for September rose 5.6% to $19.6B from a year earlier. Sales were up 5.2% since August, largely driven by consumer products being built for the Christmas season.

The wild ride in the indices continues so let's see if today's move, tacked onto Friday's huge rally, makes sense in the larger picture:

DOW chart, Daily

The DOW looks like it was finally able to break back above its uptrend line from October 2004--that's bullish. It failed to get back above its uptrend line from April--that's bearish. It close 3 points above its 50-dma at 10437--that's nothing. The sharp pullback from today's high does not leave a bullish taste in my mouth, especially after finding resistance at the top of a parallel up-channel that is containing price action since the October 13th low. Needless to say, it's critical for the DOW to hold above 10330 which is that uptrend line from October. If the bulls can't hold that line on another test, it could totally frustrate those who are trying to get long. If the DOW manages to bounce a little further, it runs into resistance at its 200-dma just under 10500.

SPX chart, Daily

SPX also looks bullish, having rallied above its 200-dma and sticking this time. It found resistance at its 50-dma. The job for the bulls is to first defend the 200-dma on any pullback from here, as well as the uptrend line from August 2004, both of which are just under 1200. The next task is to get above its 50-dma just under 1210. As shown below, there's another reason SPX may have failed where it did today.

SPX chart, 120-min

SPX has been contained in a broadening formation, commonly called a megaphone pattern. These are typically marked with lots of volatility (sound familiar?) and in its current location within the larger pattern is usually a continuation pattern. That would mean down out of this pattern. Notice price rallied up to, and pulled sharply back from, the top of this pattern. Along with bearish divergence on the daily chart and this 120-min chart showing overbought, we should get at least a pullback. The EW count inside this pattern shows today's rally finished the pattern and that suggests we will now head for new lows.

Nasdaq chart, Daily

Like the SPX and DOW around their uptrend lines from last year, the COMP has been consolidating around the support/resistance line at 2100, and between its 200 and 50-dma's. If the COMP can rally a little further, it will test resistance at its downtrend line from August at 2145. It's 200-dma at 2073 needs to be defended by the bulls so we've got a potential range to watch for a break to then give us some longer term clues.

SOX index, Daily chart

The SOX remains inside a steep down-channel that looks a little like a descending wedge which should be bullish. But before it breaks out to the upside it's looking like it will head lower and I would look for potential support at its uptrend line from October 2002 through the April 2005 low, currently near 410. A lower uptrend line from August 2004 sits just below 400. If the semiconductors can instead rally a little more, it will be able to get above its 200-dma at 435 which would be a bullish statement.

BKX banking index, Daily chart

The rally in the banking index since the October low has been nothing short of stellar. Speaking of short, it looks like short-covering. This rally is way too much too fast. If it manages to rally a little higher, it will test resistance at its downtrend line from December 2004, currently near 100.45. But watch to see what we get tomorrow. Today left a potentially bearish spinning top doji candlestick. If tomorrow produces a red candle, that would be a reversal signal.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing index continues to consolidate near its low and the consolidation could continue a little longer, maybe over to its downtrend line. I expect this index to head down for a test of its longer term uptrend line, currently near 775.

Oil chart, December contract, Daily

Crude oil has been consolidating near its low, and just under its broken uptrend line. It could consolidate a little longer and may work its way over/up to its downtrend line. This looks like it will drop down to test its 200-dma, which may coincide with another test of the bottom of its down-channel, currently at 57.50.

Oil Index chart, Daily

As expected, it looks like the oil index is breaking out of its down-channel. After getting a 5-wave move to the downside, it appears we're in a corrective bounce against that decline. I'm expecting a 3-wave bounce which should set up the next shorting opportunity. If you're long any oil stocks, the way I'm reading this pattern, the end of the current bounce will be an excellent opportunity to get out. As I look for potential upside targets I see the 50-dma at 540 but keep an eye on 538--this is where we'd have two equal legs up in the bounce from the October low. Just below that is 534 which is a 50% retracement of the Sept/Oct decline. So watch 534-540 for potential topping of any bounce from here. I expect the 200-dma to be broken to the downside on the next decline. Now, I'm basing my opinion strictly on the chart pattern and not on fundamental reasons. Jim does an excellent job at covering the oil stocks so by all means follow his lead as well. He's done an outstanding job following the stocks in this industry.

Transportation Index chart, TRAN, Daily

Most of you know I'm longer term bearish the equity market. This chart has me on the edge of my seat and makes me a very nervous bear. Today's break of the downtrend line from March is potentially very bullish. It's only 1 day and I like to see confirmation of a break by seeing this hold above the line for 3 days and preferably a retest of the line that holds. This could be a head fake and a result of the 2-day rally for end of month window dressing. If TRAN does not hold here and rolls back over, it could leave a bearish divergence on the chart. But if it manages to hold, we'll need to see confirmation of the DOW rallying as well, otherwise it will be a non-confirmation of the rally as per Dow Theory. And as per Dow Theory, this year has been full of non-confirmations between the DOW and the TRAN. This one requires very careful watching.

U.S. Dollar chart, Daily

The U.S. dollar continues to consolidate under resistance and continues to look bullish. No change in outlook here as I expect the dollar to rally to new highs--the eventual upside target should be in the mid to upper 90's before the bear market for the dollar resumes (probably next spring).

Gold chart, August contract, Daily

Gold needs to hold near current pullback levels in order to maintain at least a short term bullish outlook. I expect gold to hold above 465 to finish its current pullback. If it drops to a new low below 462, certainly below its 50-dma at 461, I would turn more immediately bearish gold. If instead this will be able to turn around and get another leg to the upside in progress, I'm thinking a high around 495 and that could be a high that lasts a long time. In other words, longs should pull their stops up tight at that time and I would look to short the new high.

Tomorrow's economic reports include the following:

Tomorrow's economic reports include auto and truck sales and shouldn't offer any surprises. Construction spending and certainly ISM could be a market mover. But the market may just go on hold for most of the day while waiting to get FOMC out of the way. Again, no surprises are expected (+0.25%, no change in wording) so the market may not react much. But the typical pattern is for a slow rise into FOMC, thrash about for an hour and then sell off.

Today was a day where almost all sectors were positive. Wal-Mart (WMT 47.30 +1.80) issued guidance for October and increased their same store sales to +4.3% and this contributed to a 2.5% surge in the retail index (RLX). At the top of the sector list were the airlines with nearly a 4% gain today. Following these two sectors were the computers, biotechs, securities brokers, SOX and telecoms. The only red sector on my list was the gold bugs index (HUI). Laggards today, but still green, were the financials, drugs and pharms, natural gas and gold and silver. All in all it looked like a pretty bullish day.

After the bell Dell (DELL) came out with some guidance which did not please investors. Dell closed the regular session at 31.86 and after hours dropped as low as 29.96 before closing at 30.50. They forecast 3rd-quarter pro forma earnings to come in at 39 cents a share, which is at the low end of its previous forecast. Expected revenue of $13.9B is below its prior outlook of $14.1-14.5B. Analysts had been expecting earnings of 40 cents a share on revenue of $14.28B. Dell blames the shortfall on its U.S. and U.K. businesses. Dell also plans to take a 3rd-quarter charge of $450M, or 14 cents a share, which will cut their net earnings in half. More than $300M of the charge is related to the cost of servicing systems which of course immediately raises the question why there is suddenly an unexpected increase in these servicing costs.

Looking under the hood of this market the past two days leaves me with the impression that there may have been some "false" buying, as in buying just to lift the market's indices for month/quarter/fiscal year end, but not everyone participated. For example, for the NYSE on Friday's strong rally there were 50 new 52-week highs while 139 new 52-week lows. Today was a little better at 100 new highs versus 71 new lows. Volume on such a strong up day on Friday was average, as was today's. So these relatively weak internals, combined with the resistance levels reached by the indices suggests caution to those in long positions. On the surface it seems a rally above SPX's 200-dma is positive. However, watch to see if it sticks on Tuesday. The DOW pulled back sharply at the end of the day and closed right at its broken uptrend line from April, the same line of resistance where the DOW failed on its rally attempts on October 19/20 and the 26th. The daily charts are full of bearish divergences. Not all is well (yet) in equity land so be careful. The volatility of the past month may continue into November so watch out for whipsaws, head fakes, reversals, retracements, you name it. Trade fast and trade light until we get a better sense of where this market is headed. Good luck in your trading.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None STRA None

New Calls

None today.
 

New Puts

Strayer Educ - STRA - close: 89.51 chg: -1.24 stop: 92.51

Company Description:
Strayer Education, Inc. is an education services holding company that owns Strayer University and certain other assets. Strayer's mission is to make higher education achievable and convenient for working adults in today's economy. Strayer University is a proprietary institution of higher learning that offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration to more than 27,000 working adult students at 37 campuses in 9 states in the eastern United States and worldwide via the Internet through Strayer University Online. Strayer University is committed to providing an education that prepares working adult students for advancement in their careers and professional lives. Founded in 1892, Strayer University is accredited by the Middle States Commission on Higher Education. (source: company press release or website)

Why We Like It:
Earnings may have beat estimates last week but STRA's guidance was not very enthusiastic. The company guided lower and shares have failed to participate with the market's rally since. The action in the stock today looks like a failed rally under resistance at its simple 100-dma near $92.25 and the drop under $90 suggests more weakness ahead. We're going to suggest bearish put positions with the stock under $90.00 and target a drop to the $85.00 region (85.50-85.00).

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 95.00 SDQ-XS open interest= 10 current ask $7.30
BUY PUT DEC 90.00 SDQ-XR open interest= 5 current ask $4.30
BUY PUT DEC 85.00 SDQ-XQ open interest= 20 current ask $2.25

Picked on October 31 at $ 89.51
Change since picked: + 0.00
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 158 thousand
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

None
 

Put Updates

Bard C.R.- BCR - close: 62.38 change: +0.48 stop: 64.25

Another positive day for the markets pushed BCR above the $62 level and the move certainly improved the short-term technical oscillators. However, the rally in BCR seemed to struggle around the $62.50 region so we're not giving up yet. BCR continues to trade under a trend of lower highs. Watch for the simple 10-dma near 62.85 to act as short-term resistance. We remain hesitant about initiating new positions especially with the market setting back to back gains but a failed rally under $63 could be used as a new bearish entry point. Our target is the $58.00 level but more aggressive traders might want to target the $55 region. Currently the Point & Figure chart points to a $55.00 target. Our time frame is less than six weeks.

Picked on October 26 at $ 61.70
Change since picked: + 0.68
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 745 thousand

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Broadcom - BRCM - close: 42.42 chg: +1.00 stop: 44.11

As we expected shares of BRCM continued to bounce. The action in the stock looks very similar to the move in the SOX. The three-day pattern in both looks like a short-term bullish reversal. We would not suggest new bearish positions in BRCM at this time. More conservative traders may want to tighten their stops or exit early to avoid further losses. However, keep an eye on the SOX. The SOX is still under resistance at its 200-dma (near 435) and the 440 level, which could be resistance, so we are going to keep the play open for now.

Picked on October 24 at $ 41.95
Change since picked: + 0.47
Earnings Date 10/20/05 (confirmed)
Average Daily Volume = 7.3 million

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Infosys Tech. - INFY - close: 67.14 chg: +1.62 stop: 70.51

Software stocks rallied for the second day in a row and the GSO software index is testing significant resistance at the 170 level. Meanwhile shares of INFY continued to bounce. Watch for a failed rally under the 200-dma near $70 as a new bearish entry point - but keep in mind that if the GSO does breakout over the 170 level we would strongly hesitate to launch new bearish positions in the sector.

Picked on October 26 at $ 67.95
Change since picked: - 0.81
Earnings Date 10/11/05 (confirmed)
Average Daily Volume = 698 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.)

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AmerisourceBergen - ABC - cls: 76.27 chg: +0.93 stop: n/a

Technical indicators are turning bullish on ABC with today's breakout over the simple 50-dma. We are not suggesting new strangle positions at this time with the stock outside our 74.50-75.50 entry window. ABC is due to report earnings on Thursday. The options in our strangles are as follows for November the Nov
$80 call (ABC-KP) and the November $70 put (ABC-WN). We plan to sell if either side rises to $3.50. If you're playing Decembers the options are the December $80 calls (ABC-LP) and the December $70 puts (ABC-XN). We would sell if either side rises to $5.00 or more.

Picked on October 16 at $ 74.81
Change since picked: + 1.46
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

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Abercrombie&Fitch - ANF - cls: 51.99 chg: +2.41 stop: n/a

Retailers turned in a big day on Monday. Concern over the upcoming holiday shopping seasons eased after news that prices at the pump have fallen sharply and that Wal-Mart (WMT) raised its same-store sales forecast. We are not suggesting new strangle positions in ANF at this time. Our suggested entry window was the $49.50-50.50 range. The options in our strangle are the December $55 calls (ANF-LK) and the December $45 puts (ANF-XI). We plan to sell if either side hits $5.00 or more.

Picked on October 28 at $ 49.50
Change since picked: + 0.08
Earnings Date 11/15/05 (unconfirmed)
Average Daily Volume = 2.6 million

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Administaff - ASF - close: 42.32 change: +1.03 stop: n/a

Tomorrow is ASF's earnings report. The company should announce before the opening bell. Analysts are looking for profits of $0.23 a share. We are not suggesting new plays. The options in our previous suggested strangle are the November $45 call (ASF-KI) and the November $35 put (ASF-WG). We plan to sell if either side of the strangle rises to $2.75 or more.

Picked on October 23 at $ 39.40
Change since picked: + 2.92
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 433 thousand

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Black Box - BBOX - close: 40.12 chg: +0.72 stop: n/a

The rise to the $40.00 level offered a great entry point to launch new strangle positions in BBOX ahead of its earnings report. Tomorrow is the last day to do that since BBOX reports earnings after the closing bell. Estimates are for 70 cents a share. Our suggested entry window is the $40.75-39.25 range but anything within 25 cents of the 40.00 mark should work even better. The options we're suggesting are the December $45 calls (QBX-LI) and the December $35 puts (QBX-XG). We're aiming for a rise to $2.85.

Picked on October 30 at $ 39.40
Change since picked: + 0.72
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 124 thousand

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Genentech - DNA - close: 90.60 chg: +2.88 stop: n/a

DNA turned in a big gain today rising 3.28% and closing over the $90.00 mark. The gain was fueled by news that the FDA had granted DNA and partner BIIB a priority review status to their application for Rituxan to be used as a treatment for rheumatiod arthritis. We are not suggesting new strangles at this time. The options in our strangle are the December $95 call (DWN-LS) and the December $75 put (DWN-XO). We plan to exit if either option rises to $4.50-5.00 or more.

Picked on October 20 at $ 84.83
Change since picked: + 5.77
Earnings Date 10/10/05 (confirmed)
Average Daily Volume = 3.9 million

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eBay Inc. - EBAY - close: 39.61 chg: +1.18 stop: n/a

Strength in the Internet sector today did not help us out. EBAY rose more than three percent and is trading back near the $40.00 level. This sideways churning is killing the option premiums. The options in our suggested strangle are the November $45 call (XBA-KI) and the November $35 put (XBA-WG). We are adjusting our price target for either side of the strangle from $2.00 to $1.65.

Picked on October 18 at $ 40.42
Change since picked: - 0.81
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 18.3 million

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General Dynamics - GD - cls: 116.30 chg: -0.35 stop: n/a

There is no change from our weekend update on GD. We're not suggesting new strangles. Our strangle strategy involves the November $125 call (GD-KE) and the November $115 put (GD-WC). We plan to sell if either option rises to $4.00 or more.

Picked on October 09 at $119.59
Change since picked: - 3.29
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

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Harman Intl - HAR - cls: 99.86 chg: +1.01 stop: n/a

Monday proved to be a relatively quiet day for HAR. The stock traded sideways most of the session just under the $100 mark. We are not suggesting new strangles but this sort of consolidation makes the HAR look like a strangle candidate. Of course this sideways churning is not helping our current strangle with the November $110 call (HAR-KB) and the November $90 put (HAR-WR). Over the weekend we adjusted our target to $4.00 to try and breakeven (which is $3.80).

Picked on October 18 at $100.80
Change since picked: - 0.94
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 739 thousand

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Hutchinson Tech. - HTCH - cls: 24.80 chg: +0.44 stop: n/a

The move back toward the $25.00 level pushed HTCH into our suggested entry window of $24.75-25.25. The company is expected to report earnings after the closing bell tomorrow so traders have one more day to try and initiate a position. The options we were suggesting are the January $30 calls (UTQ-AF) and the January $20 puts (UTQ-MD). We would try and keep the costs around $1.75 or less. We'll target a rise to $3.00.

Picked on October 26 at $ 24.89
Change since picked: - 0.09
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 666 thousand

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Inamed Corp. - IMDC - close: 71.28 change: +0.65 stop: n/a

IMDC continued to bounce from the $70 level today but shares did dip back to the $70.43 mark before rebounding. Technical oscillators are starting to look bullish again but everything depends on IMDC's earnings report. The company is expected to report after the closing bell tomorrow. Tuesday is our last chance to consider launching new strangles. Our suggested window is the $71.00-69.00 range. The options in our strangle are the December $75 call (UZI-LO) and the December $65 put (UZI-XM). We plan to sell if either side rises to $5.00 or more.

Picked on October 30 at $ 70.63
Change since picked: + 0.65
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 533 thousand

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Kos Pharma - KOSP - close: 60.00 chg: -0.79 stop: n/a

KOSP continues to consolidate sideways ahead of its November 3rd earnings report. Today's action offered another entry point to launch a strangle position. Our suggested window is the $60.50-59.50 range. The options for our previously suggested strangle are the November $65 call (KQW-KM) and the November $55 put (KQW-WK). We'll plan to exit if either option rises to $5.00 or more. FYI: if you're thinking about starting a new position we'd prefer to use the December options.

Picked on October 20 at $ 59.80
Change since picked: + 0.20
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 460 thousand

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Legg Mason - LM - cls: 107.31 chg: +3.31 stop: n/a

Monday was a strong day for the broker-dealers. The XBD index broke out to a new high. Hopefully this will give LM enough lift to breakout of its $100-110 trading range. We are not suggesting new positions. We are suggesting that more conservative traders think about adjusting their target to break even. The options in our previously suggested strangle were the November $110 call (LM-KB) and the November $90 put (LM-WR).

Picked on October 12 at $102.59
Change since picked: + 4.72
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 966 thousand

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Loews - LTR - close: 92.98 change: +2.23 close: n/a

LTR turned in a strong session rising 2.4% and breaking out above its recent highs. We're not suggesting new strangle positions but LTR is starting to look like a bullish candidate for call options. There is still some resistance in the $93.85-94.00 region. The options in our strategy are the December $95 calls (LTR-LS) and the December $85 puts (LTR-XQ). We'll plan to exit if either option rises to $5.00 or more.

Picked on October 23 at $ 89.94
Change since picked: + 3.04
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

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Microsoft - MSFT - close: 25.70 change: +0.17 stop: n/a

MSFT continues to climb following its earnings report last week. Today's gain pushed MSFT above technical resistance at its simple 200-dma. There were bulls ready and waiting to buy the dip this afternoon near $25.50. We are not suggesting new strangle positions. Our strangle is based on the December $27.50 call (MSQ-LY) and the December $22.50 put (MSQ-XX). We are aiming for a rise to $0.80-0.90 for either side of the strangle.

Picked on October 25 at $ 25.03
Change since picked: + 0.67
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 64 million

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O'Reilly Auto. - ORLY - close: 28.24 chg: +1.23 stop: n/a

ORLY produced a significant turn for the better today. The stock added 4.5% to push through resistance at $27.50, 28.00 and its simple 50-dma. This also appears to be a bullish breakout over its trend of lower highs. We are not suggesting new strangles at this time. We'll exit if either option in our strangle rises to $1.20. The options were the November $30 calls (OQR-KF) and the November $25 puts (OQR-WE). More conservative traders might want to consider just exiting at breakeven (0.75).

Picked on October 09 at $ 28.23
Change since picked: + 0.01
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 513 thousand

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Oshkosh Truck - OSK - close: 43.56 chg: +0.74 stop: n/a

OSK continued to rebound following Friday's gain but the stock remains inside its $41.50-44.00 trading range. Today was our only chance to initiate strangle positions ahead of the company's earnings report due out tomorrow morning. Estimates are at 57 cents a share. The options in our suggested strangle are the December $45 call (OSK-LI) and the December $40 put (OSK-XH). We're targeting a rise to $3.00 or more.

Picked on October 30 at $ 42.82
Change since picked: + 0.74
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 405 million

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Verifone Holdings - PAY - cls: 23.20 chg: +1.34 stop: n/a

Today was a big day for PAY. The stock added more than six percent and broke through its simple 200-dma to hit new relative highs. We're not suggesting new strangle positions. As a matter of fact traders with the November strikes should keep an eye on the November $22.50 calls (PAY-KX) as they are nearing our suggested target of $2.00 or more. Our suggested strangle was with the January strikes. The January $22.50 calls are PAY-AX and we're targeting a rise to $4.50 or more.

Picked on October 12 at $ 19.98
Change since picked: + 3.22
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand

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Protein Design Labs - PDLI - cls: 28.02 chg: +0.32 stop: n/a

If you didn't initiate a position today then tomorrow is our last chance to start a strangle ahead of PDLI's earnings report, which is due out after the closing bell. Our suggested entry window is the $28.00-27.00 range. We're suggesting the December $30 calls (PQI-LF) and the December $25 puts (PQI-XE). We'll plan to sell if either side rises to $3.25.

Picked on October 30 at $ 27.70
Change since picked: + 0.00
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

Molson Coors Co - TAP - close: 60.90 chg: -0.00 stop: n/a

A cover article for BUD in Barron's appeared to give the beer makers a lift today. Shares of BUD gapped open this morning as did shares of TAP. TAP opened at $61.20 and continue to climb throughout the session. That's bad news for us. Our entry window to launch a strangle was $61.00-60.00 so we never got a chance to open any plays. TAP is expected to report earnings before the market open tomorrow morning. Estimates are at $1.23 a share.

Picked on October 30 at $ 60.90
Change since picked: + 0.00
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 553 thousand
 


Options 101

The Addition of the New Strike Prices

The Theory Behind the Practice

Eventually, all stocks go through a growth phase. This growth phase could be caused by any number of events. Usually, an increase in earnings, an introduction of an industry changing product, or a list of numerous other events in a corporation, could bring about this growth. When this growth occurs, an increase in the stocks price is usually never far behind. When this price increase occurs, it affects option trading on this stock as well.

So what happens when a stock starts a sustained growth pattern and the stock price reaches a new high or more specifically trades at the highest strike price that the stock offers?

What happens next!

New highs, New Strike Prices

There becomes a need for higher strike prices. The reason is true for the following:
Every transaction needs a buyer and a seller for the transaction to be complete.

If there exist no strike price that is economically attractive to the speculator in the market, then there can be nothing to sell to that buyer in return for the payment of his premium.

Hence, the addition of higher strike prices inherently solves the problem for both sides of the option transaction. The new and higher strike prices give the buyer an opportunity to speculate the prospect of higher stock prices by his continued availability of leverage, but it additionally gives the seller the opportunity to write those options in exchange for premiums for the premiums we will receive. For without consideration for both sides, there can be no meeting of the minds and no satisfactory reason for the transactions to occur.

The Real World

New highs, new strike prices

At this point, the exchange generally adds additional strike prices when the underlying security trades through the highest or lowest strike price available. Generally, the new option that will be listed is 2 1/2 points when the strike price is between $5 and $25, 5 points when the strike price is between $25 and $200, and 10 points when the strike price is over $200.

FIGURE 1-1: IBM strikes used for hypothetical example, showing if IBM or any stock that hits a new high and trades above its last strike price.

Notice that at this point a new January 170 Call would be issued with its appropriate symbol Ex. IBM-A ?

At this time the new strike begins trading with a bid/ask pricing and will trade just as the rest of the existing series of options currently trade. The exception to this addition rule is when a company fails to file timely financial reports. When a company fails to report these financials in a timely manner, the adding of additional strike prices are then nixed by the S.E.C. until this condition is satisfied.


The Bottom Line

The addition of additional strike prices helps to maintain and sustain interest in the trading of the options and the underlying stock. It serves as both a catalyst for the buyer of options as well as the seller. It gives the speculative buyer the opportunity to continue to speculate potentially a higher movement of the stock or if bearish, a pullback of the stocks price rise. It also gives sellers additional opportunities to continue selling out of the money-covered calls for premium, which generates income in their portfolios. Additionally, it affords the sellers of calls the opportunity to still achieve some additional appreciation in the price of the underlying stock price.

Without the addition of new strike prices, of calls and puts, as stock prices rise and fall, interest in covered call writing and speculative option buying would be significantly hampered.

What good is it to a speculator if he doesnt have additional choices to choose from if the stock price continues to rise? No buyer wants to buy a long call, when speculating, that is already 5-10 points in the money. The cost would be to prohibitive. Consequently, on the sell side, no owner of the underlying security, who is looking for some appreciation as well is going to want to sell a deep in the money call that allows his stock to be taken at a lower price than it is currently trading. In simple terms, the addition of new strike prices is mandatory in the existing option environment. They allow continued speculation both on the long side and the short side of the market. It gives the owner of the underlying security the opportunity to continue selling calls and puts to generate income and even some upward movement in the stock.

Until Next Time
 

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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