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Daily Newsletter, Saturday, 11/05/2005

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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

Don't Worry, Be Happy

That was the mood on the floor of the NYSE today as traders brushed off Friday's early weakness after four days of strong gains. It was a good week with the major averages pushing higher on decreasing volatility. The current rally leaves a lot to be desired in the conviction category but we are not going to complain as long as the trend higher continues. Economic reports continue to pose more questions than they answer but traders are turning a blind eye to the numbers. Declines in energy prices helped trader sentiment but declines in energy stocks helped feed the market weakness. Sometimes you just can't have your cake and eat it too.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The big report for Friday was of course the non-farm payrolls. There was a gain of +56,000 jobs in October and September was revised higher to a loss of only -8,000 jobs. Previously the job loss for September was estimated to be -35,000. August job gains were revised down by -63,000 to +148,000. The +56K job gains for October was only about half of what analysts expected. The separate household survey showed that employment rose +214,000 in October following a drop of -17,000 in September.

The slower than expected jobs growth cast some doubts on the strength of the Q3 economic rebound. It had been thought that the rebound out of both the Q2 slump and then the hurricane slump was stronger and this was not the needed proof. The Commissioner of the Bureau of Labor Standards, Kathleen Utgoff, said jobs growth outside of the hurricane region appeared to have been below trend. Why? Was it just a ripple of uncertainty as the impact from the hurricanes was felt in the economy? Or was it a reaction to higher costs from higher energy prices that caused a pause in hiring? These are the questions analysts were posing with no answers available. Another jobs component was also causing concern. Average hourly earnings jumped +0.5% and the biggest one month jump in years. A sharp rise in wage growth is a prelude to inflation and a component the Fed watches closely. The Economic Cycle Research Institute said on Friday that inflation was rising sharply and currently at a five year high.

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The ECRI Future Inflation Gauge rose for the fifth straight month. This months gain of only +0.2 to 124 was substantially less than the gains for the prior four months of +2.4, +1.4, +1.7, +0.8. The 124 headline number is also a five-year high. High commodity prices, energy prices and higher interest rates were the major components of the increase. The FIG for other countries rose across the board with the exception of Canada and the UK.

The Weekly Leading Index fell for the second consecutive week. The index was pushed lower by rising interest rates and a sharp decline in mortgage applications. The smoothed annualized growth rate dipped to +1.9% according to this index. The economic growth rate topped in August according to the WLI at +3.2% and has been declining steadily ever since. The NYSE composite is also linked to the WLI and declines in the market until mid October had influenced declines in the WLI. This week's rebound plus the drop in natural gas prices should have a positive impact on the WLI for next week.

Other releases this week produced conflicting reports of economic health. On Thursday there was a sharper than expected drop in Factory Orders of -1.7% in September compared to a gain of +2.9% in August. This could be directly attributed to the hurricane disruption. At the same time Q3 Productivity jumped to 4.1% and well over estimates of 2.5% and Q2 levels at 2.1%. ISM Services reported on Thursday also jumped to 60.0 from only 53.3 in September while the manufacturing ISM on Monday fell -0.3 from 59.4 to 59.1.

While the reports conflict the general consensus of opinion is that the economy is continuing to grow and is rebounding out of the Katrina/Rita dip. The Fed said they continued to see growth sufficient to support continued rate hikes. Earnings for Q3 are basically over with 90% of S&P companies reporting and growth has been in the 15% range with 65% of companies giving positive guidance. That guidance level is right at the low end of normal levels but still suggests future growth. Any further deterioration of that guidance could push the viewpoint back towards a possible recession.

What everyone should derive from this boring economic discussion is that the economy is growing but the pace has slowed. We did rebound from the Q2 dip but that rebound may be running out of steam. Earnings are positive but earnings momentum is slowing. In the short term it will allow the markets to continue this moderate rally pace but the growth is not strong enough to generate any acceleration. The first look at Q3 GDP showed growth rose to +3.8% from the Q2 level at +3.3%. This was mainly credited to a sharp increase in auto sales during the employee incentive program. I fear that Q4 could be a challenge. October is now history and auto sales fell off a cliff with GM and Ford both seeing more than a -22% drop in sales. They will come up with some new program to sell cars before the quarter is out but we are already nearly half way through the quarter and the auto lots are still a graveyard.

There was an interview on CNBC on Friday with several economists and all were projecting a drop to 2.5% GDP in 2006 give or take half a point. Earnings were projected to fall into single digits in Q3. The Fed was expected to continue its rate hikes past March. Conventional wisdom suggests Bernanke will have to continue the hike cycle at least two more meetings to prove he has the guts to take hard action if needed. Since the Fed typically goes too far this seems to guarantee that any Bernanke hikes will push us over 5% and into high risk of a recession. This is the risk institutional investors are facing and probably the reason the rebound from the October lows has been so choppy and lethargic.

Historically the second year of a second presidential term produces a bear market. Promises and mistakes made in the first term have to be fulfilled or corrected to set the stage for the next election. Outgoing presidents not up for reelection are more concerned about making changes and protecting their legacy than being nice. They tend to take the hard line because they have nothing to lose. The exception was 1998 and Clinton's second term. Buying ahead of Y2K and the Internet bubble negated that historical dip. Greenspan gave Bush a little push this week by warning again that uncontrolled deficits would eventually produce a disaster. He used his face time on camera to warn that now was not the time to be passing tax cuts that were not paid for with revenue from other areas. Since there are no other areas available to generate that kind of income he was warning the administration not to take the plunge. Voters are on the edge of their seat from this week's news about a new, simplified tax code and lower rates. Greenspan's warning was an attempt to head off that move. Greenspan's continued attack on administration policies are an example of how lame duck politicians tend to become more vocal and take unpopular actions. If Greenspan had the power he would be taking decisive action now to clean up deficits as his days wind down. He does not have the power but Bush does. 2006 is that second year of a second term and all the factors are lining up for a rocky market year. That leave us with two months in 2005, which are normally bullish and conditions are still positive for that trend to remain intact.

One problem we face is the continued rise in yield on the ten-year note. Friday's close at 4.66% was the highest close since June-2004. Given the potential for a rocky 2006 this has got to be attracting the eyes of institutional investors. The closer we get to Dec-31st the more likely we will be over 5% and those institutions will begin moving funds from equities and into treasuries. It is only a matter of time before we start seeing asset allocation programs in the market if yields continue to rise. It is only a question of which comes first, 5% or Dec-31st. Both will likely produce selling in equities.

There is no selling in Google despite multiple lawsuits about its proposed scanning of copyrighted books. Google has been rising almost vertically since earnings on Oct-20th. GOOG has risen +$87 since that Oct-20th pre-earnings close at $303 to close at $390 on Friday. It appears to be immune to any criticism, legal action, threats or legislative attacks. With multiple brokers calling for $450 as a price target the gains just keep coming. The +4.50 gain today added $160 million to the net worth of each of its founders. They must have been feeling prosperous because they bought a Boeing 767 for their personal use. The used wide body cost $15 million and will be refitted to seat 50 with a large galley, multiple showers and other creature comforts. Only 18 of those seats will be considered first class. To put it in perspective they could have bought ten of those with Friday's gains.

Google Chart - 90 min

Apple Computer has a similar chart with nearly vertical gains since its Q2 earnings in July at $38.35. Friday's close at $61 represents the latest dip in its upward path. The dip was courtesy of a Prudential downgrade to neutral based on price. This may be a buying opportunity given the new market opening up for the iPod. Vivid.com has already started releasing video clips from its vast inventory of porn. The porn industry is more than $11 billion a year and the opportunity presented by the iPod video player is too good to pass up despite Steve Jobs attempts to keep them off the iPod. The Vivid CEO said on Friday they would have dozens of titles available soon and they were converting titles to the iPod format as fast as they could. Jobs may not like his device used for porn but there is little he can do to stop it. Apple is selling two million songs a day for their devices and the video market is still young but is expected to explode as well. The initial offering, movie clips of Desperate Housewives, will quickly be surpassed by tens of thousands of other offerings from sports clips, news events, music videos and yes, porn. Personally I would like to see a dip back to $57 for an entry point but that may be wishful thinking.

Friday's Jobs report may have provided an excuse for profit taking but the most serious selling was in energy stocks. On Thursday oil jumped more than $2 a bbl as demand expectations for the winter were raised. This capped a four-day run for oil stocks after earnings produced some strong gains. Gas stocks continued to be weak but selected oil stocks had been recovering. On Friday the CEO of BP said oil above $60 was unsustainable and prices could return to $40. Right or wrong he rocked the market. Crude retreated from its Thursday high of $62.15 to close at 60.50 on Friday. In retrospect this was not that bad given the comments. However, there was some serious carnage in those stocks that had seen the most gains for the week. TSO -5.43, VLO -4.75, SUN -4.14 etc. Refiners were hit the worst as warm weather continued to postpone the winter demand cycle.

Mr. Browne related that OPEC needed a price above $40 to keep their economies afloat and they were pumping at the highest level in 25 years. Given the ability of OPEC to set the price and the general acceptance of oil in the $60 range I seriously doubt we will see $40 again. If the market has grown used to paying $60 why would OPEC let it decline to $40? It is a declining resource and there is no reason to give back those price gains. Would you take a -33% cut in revenue if you did not have to? Prices could still retreat some as the Gulf production comes back online but end user demand will continue to grow as long as the price of gasoline moves up slowly. Sticker shock will ease until a new level of acceptance is found. Oil production still offline in the Gulf has fallen to 52% and natural gas to 47%. These are still very high numbers for two months after Katrina. We are lucky demand has also been offline or prices could be much higher. On December 9th a movie called Syriana will open staring George Clooney and Matt Damon. The movie is a thriller loosely based on declining global oil production and its consequences. I suspect it is very loosely based and more fiction than reality but it is interesting that the topic is appearing more and more in print and the media. Next weekend I will have more input from the front line after I attend the Peak Oil Conference this coming week.

December Crude Oil Chart - Daily

Selling in the broader market was also weak as investors held their positions afraid to miss the next leg up while traders took some profits ahead of the weekend. This was proven out late in the day as the indexes recovered from the morning weakness and rallied to close back in the green. The Nasdaq closed at 2168 and only -4 points off a two month high. The NYSE Composite ($NYA) was the only major index to finish in negative territory at -27. I am not counting the -0.61 on the Russell after a strong finish. That is close enough for me.

Unfortunately I am not seeing much confirmation among the indexes. The Nasdaq is the most bullish with a close right at its highs and right at resistance from Oct-3rd at 2168. The Nasdaq is only one good day away from a real breakout possibility at 2188. Once that level is broken the remaining psychological resistance at 2200 and the spike high at 2219 are the only bumps in the road before resistance at 2250 dating back to April 2001 is tested. Bad economic news or not there should be a race to jump on the train as each of those mileposts are passed. That may be wishful thinking but I doubt I am the only one with that thought this weekend.

The other indexes exhibit lesser stages of bullishness with several formations taking on what could be considered risky attributes. This is not unusual in situations like this where there is still some doubt about the outcome. There are still some institutions taking advantage of the rallies to lighten up as we saw in the strong selling on Thursday afternoon when the Dow dropped -70 from its intraday high. On Friday the NYSE Composite fell -65 points at the open and only managed to recover half of that amount. However the NYSE Composite has a large number of energy stocks, which could have accounted for the Friday weakness.

The Dow continues to zigzag slowly higher with two weak days for every strong one but still maintains its positive trend. Current Dow resistance is 10565 with much stronger resistance at 10700-10725. I believe we will test that level next week. The S&P is also creeping higher mostly propelled by two strong buy programs that triggered short covering on the 28th and the 2nd. Without active buy programs the index is having trouble moving forward. Strong resistance is just ahead at 1230.

I believe the internals are showing us the true strength with strong volume on Wednesday and Thursday of more than five billion shares each. Up volume was 4:1 on Wednesday and 2:1 on Thursday. Friday's choppy session was barely over 4B shares and advancing volume was only slightly better than declining. Still the indexes battled back to positive territory to end with strong gains for the second consecutive week. Profit taking was light and provided entry points for those bargain hunting.

With a little over two weeks remaining before Thanksgiving the bullish sentiment should continue to grow with every upward tick. Converts will grudgingly abandon the short side and start following the herd. Next week is light economically and there are only a few bellwether companies left to report earnings. Those of note for next week are PIXR and TOL on Tuesday, CSCO Wednesday and Dell on Thursday. Dell already warned so that leaves Cisco as the focus of attention and the next indicator of health for the tech sector. There are plenty of smaller companies still to report and that should keep the newsrooms busy but there should not be any real market movers.

This should be a pivotal week. The rebound from the October lows is nearing four weeks old and it has definitely been light on conviction except for those two days last week. With major resistance just ahead on the Dow and Nasdaq this will be a critical test of that conviction. Can the rebound stretch into the normally bullish Thanksgiving week? Will Santa reach down from test flying his new sleigh and pull it into December? Nobody knows for sure but I was encouraged by the lack of real selling and the recovery on Friday. I am growing increasingly wary of our chances once we get past Thanksgiving but a solid performance next week could go a long way toward easing those concerns. I would continue to maintain a long posture and I would add to those longs over SPX 1230. I would look to reduce positions under 1200. That is going to be the key directional indicator for the rest of November. A failure back below 1200 would increase sentiment worries and that bond yield nearing 5% would look increasingly attractive for institutions.

NYSE Composite Chart - Weekly

Fund managers faced with a mostly range bound market under 1245 for the entire year are no doubt looking at that level with longing as the year draws to a close. As long as it looks like a breakout is possible they will likely stick with their longs with hopes of larger bonuses on a breakout. If we stagnate at 1245 there would likely be a mass exodus as they try to capture as much profit as possible, move to cash and lock in what bonuses they can from the October rebound. 2006 is not looking good and hedge funds may want to switch sides as soon as possible once the bullish trend fades. Bear in mind this is only my long term musings and my outlook into Thanksgiving is still bullish. I just don't want everybody to bet the farm and then get married to their positions thinking there are still a good seven weeks remaining in the rally. Historically that is the trend but I believe this is one trend we should not count on this year.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BTU CECO LEA
INTC    
SHLD    

New Calls

Peabody Energy - BTU - close: 81.36 chg: -1.24 stop: 76.99

Company Description:
Peabody Energy is the world's largest private-sector coal company, with 2004 sales of 227 million tons of coal and $3.6 billion in revenues. Its coal products fuel more than 10 percent of all U.S. electricity and 3 percent of worldwide electricity. (source: company press release or website)

Why We Like It:
Many of the energy stocks took a beating on Friday but we see the pull back in coal-producer BTU as a potential entry point. The stock didn't see the same sharp sell-off that many of the oil companies did. The recent rally on Wednesday looks like a breakout from its month-long consolidation pattern. Technically BTU's MACD indicator is in a new buy signal and its Point & Figure chart points to a $105 target. We would use the bounce from $80.00 on Friday as a new bullish entry point. If you're feeling cautious look for signs of confirmation (like a move over $82) before going long any calls. Or tighten your stop. Our seven-week target is the $89.50-90.00 range.

Suggested Options:
We are suggesting the December calls.

BUY CALL DEC 80.00 BTU-LP open interest= 6404 current ask $6.30
BUY CALL DEC 85.00 BTU-LQ open interest= 1369 current ask $3.90

Picked on November 06 at $ 81.36
Change since picked: + 0.00
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 2.6 million

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Intel Corp. - INTC - close: 23.99 chg: +0.10 stop: 22.75

Company Description:
Intel, the world's largest chip maker, is also a leading manufacturer of computer, networking and communications products. (source: company press release or website)

Why We Like It:
Intel has broken out from its three-month bearish channel. This looks like an entry point for call positions but we need to play January strikes since the stock doesn't move very quickly. Readers have a choice to look for another dip back toward $23.50 as their entry point or wait for a move over short-term resistance at $24.00 or its 50-dma (24.21). Our target is the $26.00-26.50 range. The P&F chart points to a $41 target.

Suggested Options:
We are suggesting the January calls.

BUY CALL JAN 22.50 NQ-AX open interest= 69887 current ask $2.15
BUY CALL JAN 25.00 INQ-AE open interest=167608 current ask $0.70

Picked on November 06 at $ 23.99
Change since picked: + 0.00
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 51.6 million

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Sears Holding - SHLD - cls: 124.00 chg: +1.19 stop: 121.99

Company Description:
Sears, Roebuck and Co., a wholly owned subsidiary of Sears Holdings Corporation, is a leading broadline retailer providing merchandise and related services. Sears, Roebuck offers its wide range of home merchandise, apparel and automotive products and services through more than 2,400 Sears-branded and affiliated stores in the United States and Canada, which includes approximately 870 full-line and 1,100 specialty stores in the U.S. Sears, Roebuck also offers a variety of merchandise and services through sears.com, landsend.com, and specialty catalogs. Sears, Roebuck offers consumers leading proprietary brands including Kenmore, Craftsman, DieHard and Lands' End -- among the most trusted and preferred brands in the U.S. The company is the nation's largest provider of home services, with more than 14 million service calls made annually. (source: company press release or website)

Why We Like It:
Fears that high gasoline prices and high heating bills will dampen America's Christmas spirit and holiday shopping are easing. While SHLD has not enjoyed the same sort of strength the rest of the retail sector has had the past week or so shares of SHLD do appear to have built a new base or bottom with its $114-128 trading range. We are going to suggest a trigger at $128.51 to open call positions. Until then we'll sit on the sidelines and watch. More conservative traders may want to wait for a move over $130.00. If triggered we'll target a move into the $139.50-140.00 range. FYI: the Point & Figure chart points to a $142 target. We would consider this a higher-risk, aggressive play since the stock can be pretty volatile. We do not plan on holding past the December 7th earnings report.

Suggested Options:
We are suggesting the December calls. Our trigger to go long is $128.51.

BUY CALL DEC 125.00 KTQ-LE open interest=3515 current ask $8.00
BUY CALL DEC 130.00 KTQ-LY open interest=2886 current ask $6.00
BUY CALL DEC 135.00 KTQ-LX open interest=1871 current ask $4.30

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 12/07/05 (unconfirmed)
Average Daily Volume = 3.2 million
 

New Puts

Career Educ. - CECO - cls: 33.80 chg: -0.34 stop: 35.01

Company Description:
Career Education Corporation (www.careered.com) is one of the largest providers of private, for-profit, post secondary education and has a presence in both on-campus and online education. CEC's Colleges, Schools and Universities segment operates more than 80 campuses in the U.S., Canada, France, the United Kingdom, and the United Arab Emirates and offers doctoral degree, master's degree, bachelor's degree, associate degree, and diploma programs in the career-oriented disciplines of business studies, visual communication and design technologies, health education, information technology, and culinary arts. The Online Education Group operates American InterContinental University Online and Colorado Technical University Online and offers a variety of degrees in information technology, business, visual communication, and education. CEC's total student population as of October 31, 2005, was approximately 107,300 students. (source: company press release or website)

Why We Like It:
Investors were not happy with the company's latest earnings report and guidance. Shares gapped down following the report and at least one analyst firm downgraded the stock. Technically CECO doesn't look very healthy. The recent spike higher failed under its simple 100-dma. The MACD is nearing a new sell signal and weekly indicators are also turning south. The Point & Figure chart points to a $25 target. We are going to suggest a trigger to buy puts at $32.95, which is under support at the $33.00 level. If we're triggered we'll target a move into the $30.00-29.00 range although more aggressive traders may want to aim a lower, longer-range target.

Suggested Options:
We are suggesting the December puts. Our trigger to buy puts is at $32.95.

BUY PUT DEC 35.00 CUY-XG open interest=1130 current ask $2.70
BUY PUT DEC 30.00 CUY-XF open interest= 326 current ask $0.75

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/02/05 (confirmed)
Average Daily Volume = 1.3 million
 

New Strangles

Lear Corp - LEA - close: 30.24 chg: +0.01 stop: n/a

Company Description:
Lear Corporation is one of the world's largest suppliers of automotive interior systems and components. Lear provides complete seat systems, electronic products and electrical distribution systems and other interior products. With annual net sales of $17 billion in 2004, Lear ranks #127 among the Fortune 500. The Company's world-class products are designed, engineered and manufactured by a diverse team of more than 110,000 employees in 34 countries. Lear's headquarters are in Southfield, Michigan. (source: company press release or website)

Why We Like It:
Shares of LEA have been consolidating into a neutral pattern of lower highs and higher lows. The tighter the stock coils the closer it gets to a breakout and some say the bigger the move. Even LEA's earnings report on October 26th failed to push the stock out of this narrowing consolidation. We would normally expect the prevailing trend, which is bearish, to dictate direction when LEA does breakout but the stock is throwing off conflicting technical signals. One signal that seems pretty clear is the sell signal in the P&F chart, which points to an $11 target. We're going to try and capture any future move with a strangle. We'll use a $30.50-29.50 entry window.

Suggested Options:
We are suggesting January options for this strangle. A straddle at the $30.00 mark using the same month would cost about $5.00. We can get a strangle position for $1.60. Try and keep your investment under $1.75. We will target a rive to $3.20 or more.

BUY CALL JAN 35.00 LEA-AG open interest=1142 current ask $0.70
-and-
BUY PUT JAN 25.00 LEA-ME open interest=3375 current ask $0.90

Picked on November 06 at $ 30.24
Change since picked: + 0.00
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 1.8 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Building Mat. - BMHC - cls: 88.06 chg: -0.26 stop: 83.49

BMHC hit some profit taking on Friday morning and dipped to $83.63 near short-term support at its rising simple 10-dma before rebounding. Fortunately, the rebound pushed the stock back above its 50-dma and previous resistance near $87.50. The dip did produce some weakness in the stock's technical oscillators but the rebound looks like a new bullish entry point. More conservative traders might want to wait for some confirmation that the bounce will continue by looking for a move over $89 or $90 before initiating new bullish positions. Our six-week target is the $98-99 range.

Suggested Options:
We are suggesting the December calls.

BUY CALL DEC 85.00 BGU-LQ open interest= 597 current ask $9.40
BUY CALL DEC 90.00 BGU-LR open interest= 456 current ask $5.60
BUY CALL DEC 95.00 BGU-LS open interest= 605 current ask $3.70

Picked on November 02 at $ 87.55
Change since picked: + 0.51
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 536 thousand

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Legg Mason - LM - cls: 113.57 change: +1.88 stop: 106.95 *new*

The broker-dealer sector continues to look strong and the XBD index set a new closing high. Shares of LM also turned higher on Friday adding 1.6% but volume was light. We are bullish on the stock after its break through resistance at the top of its $100-110 trading range. There is still a chance that LM will pull back and retest the $110 level as support before continuing higher but if you wait for the dip it may not appear. You have to decide if you're comfortable chasing LM here or if you'd rather wait. The Point & Figure chart is pretty bullish with a $138 price target. Our seven-week target is the $119-120 range. We are raising the stop loss to $106.95.

Suggested Options:
We are suggesting the December calls.

BUY CALL DEC 105.00 LM-LA open interest= 135 current ask $9.50
BUY CALL DEC 110.00 LM-LB open interest=1732 current ask $6.30
BUY CALL DEC 115.00 LM-LC open interest= 190 current ask $3.80

Picked on November 02 at $111.69
Change since picked: + 1.88
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 904 thousand

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Rockwell Autom. - ROK - cls: 55.74 chg: -0.16 stop: 53.49

ROK is a new play from the Thursday night newsletter. We do not see a lot of change from our original play description so we're reposting it below. However, it's worth noting that traders bought Friday's intraday dip near $55.00 and the late afternoon bounce on Friday looks like a new bullish entry point! Plus, the early high on Friday over the $56 mark produced a new triple-top breakout buy signal on its P&F chart.

We normally try not to immediately chase an earnings move but the technical pattern on ROK looks pretty bullish. The company reported earnings this morning that where inline with Wall Street estimates. Typically a lackluster earnings report like that can spark a "sell the news" type of reaction. Not so with ROK today. The stock continued yesterday's rally and broke out over significant resistance at the $55.00-55.25 level. The Point & Figure chart was already bullish with a $72 target but a move over $56 will produce a new triple top breakout buy signal. We are going to suggest new call positions with the stock over the $55.00 level. However, odds are pretty good that ROK may pull back and retest broken resistance at $55.00 as new support. More patient traders may want to wait for that dip back to $55 before initiating positions. ROK should have support at $55 and again at $54 near its simple 200-dma. We're setting our stop loss at $53.49. Our eight-week target is the $61.00-62.00 range.

Suggested Options:
We are suggesting the January calls because they have more open interest than Decembers.

BUY CALL JAN 55.00 ROK-AK open interest=848 current ask $3.30
BUY CALL JAN 60.00 ROK-AL open interest=235 current ask $1.15

Picked on November 03 at $ 55.90
Change since picked: - 0.16
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand
 

Put Updates

Bard C.R.- BCR - close: 62.97 change: -0.04 stop: 63.55

BCR's oversold bounce has stalled under its 21-dma and the $63.50 level. Even though the stock has failed to participate in the market's strength over the last couple of days we are in jeopardy of seeing the stock hit our stop loss at $63.55. We have seriously considered closing the play early to avoid further losses and more conservative traders may want to give this plan some additional thought. Due to BCR's relative weakness we're going to keep the play open but we're not suggesting new positions. If BCR continues lower our target is the $58 level.

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

Picked on October 26 at $ 61.70
Change since picked: + 1.27
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 745 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: 76.50 chg: -0.43 stop: n/a

ABC continues to produce some volatility but it just seems to be chopping up and down above the $75 level. The reaction to the earnings news was not as sharp as we would have liked. There are only two weeks left before November options expire. That means more conservative traders may want to adjust their target on the November strangle from $3.50 to $2.10(breakeven). The options in the November strangle were the November $80 calls (ABC-KP) and the November $70 puts (ABC-WN). We also suggested a December strangle and the options for the December strangle are the December $80 calls (ABC-LP) and the December $70 puts (ABC-XN). We are leaving our target at $5.00 for the December position. We are not suggesting new plays.

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

Picked on October 16 at $ 74.81
Change since picked: + 1.69
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

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Genentech - DNA - close: 93.95 chg: +1.11 stop: n/a

The BTK biotech index has climbed back toward its recent multi-year highs. Meanwhile DNA has climbed back toward all-time highs and is nearing resistance at the $95.00 level. We would not be surprised to see DNA climb to $95 and then sell-off as traders do some profit taking. The $90-91 region should act as short-term support. We still have seven weeks left before the December options expire. Our target was for a rise to $4.50-5.00 and the December $94 calls (DWN-LS) are trading near $3.30.

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

Picked on October 20 at $ 84.83
Change since picked: + 9.12
Earnings Date 10/10/05 (confirmed)
Average Daily Volume = 3.9 million

---

eBay Inc. - EBAY - close: 41.58 chg: +0.03 stop: n/a

We are still dealing with a worse case scenario here with EBAY. The stock has not launched on any new direction following its October 19th earnings report. Instead shares have channeled sideways between $37 and old resistance at $42. There are two weeks left before November options expire. We need to adjust our target to breakeven at $1.05. The options in our strangle were the November $45 calls (XBA-KI) and the November $35 puts (XBA-WG).

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

Picked on October 18 at $ 40.42
Change since picked: + 1.16
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 18.3 million

---

General Dynamics - GD - cls: 116.38 chg: +0.23 stop: n/a

Shares of GD have traded one trading range for another trading range and that doesn't work for our strangle play. Lately the stock has been stuck between potential support at its 100-dma near $115 and overhead resistance at its 50-dma near $117. We need to see GD pick a direction and move pretty soon. There are only two weeks left before November options expire. Therefore we are adjusting our target for the strangle from $4.00 to breakeven at $2.00. The options in our strangle were the November $115 puts (GD-WC) and the November $125 calls (GD-KE).

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

Picked on October 09 at $119.59
Change since picked: - 3.21
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

---

Harman Intl - HAR - cls: 100.83 chg: +2.19 stop: n/a

We are also fighting a worse case scenario here with HAR. There has been no follow through action following its earnings report. To make matters worse the stock has churned sideways in a tight range between $98 and $102 for the last several days. There are only two weeks left before November options expire. We are adjusting our target on the strangle to $2.75, which is under break even at $3.80. The options in our strangle were the November $110 calls (HAR-KB) and the November $90 puts (HAR-WR).

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

Picked on October 18 at $100.80
Change since picked: + 0.03
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 739 thousand

---

Hutchinson Tech. - HTCH - cls: 25.50 chg: -0.31 stop: n/a

HTCH's better than expected earnings report did not produce enough volatility to make our strangle play immediately profitable. This pull back to the $25 level may be a sign that conservative traders should consider exiting early. We did choose the January options so there is plenty of time for HTCH to make a move. The options in our strangle are the January $30 calls (UTQ-AF) and the January $20 puts (UTQ-MD). Our target is for a rise to $3.00. We are not suggesting new strangles at this time.

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

Picked on October 26 at $ 24.89
Change since picked: + 0.61
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 666 thousand

---

Inamed Corp. - IMDC - close: 74.87 change: -0.54 stop: n/a

IMDC finally felt some profit taking on Friday. The stock was looking short-term overbought so it's not a surprise. The $74 region looks like it could offer some short-term support. We are not suggesting new plays at this time. The options in our strangle are the December $75 calls (UZI-LO) and the December $65 puts (UZI-XM)). Our target is for a rise to $5.00 or more.

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

Picked on October 30 at $ 70.63
Change since picked: + 4.24
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 533 thousand

---

Kos Pharma - KOSP - close: 59.34 chg: -1.66 stop: n/a

Reaction to KOSP's earnings report on Thursday has been mostly negative. Yet the stock has not launched into any new trends. The failed rally at the 50-dma on Thursday is bearish but when KOSP broke down to a new relative low on Friday there was a quick rebound. We are not suggesting new plays. There are only two weeks left before November options expire and conservative traders may want to seriously consider adjusting their targets lower. Our target is for a rise to $5.00 or more. Our hypothetical cost in the play is about $2.90. The options are the November $65 call (KQW-KM) and the November $55 put (KQW-WK).

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

Picked on October 20 at $ 59.80
Change since picked: - 0.46
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 460 thousand

---

Legg Mason - LM - cls: 113.57 chg: +1.88 stop: n/a

LM continues to rally after breaking out through the top of its trading range at the $110 level. This is very bullish and we added LM to the play list as a call candidate to capture the move. This play, a strangle, has been given new life. We suggested the November $110 calls (LM-KB) and the November $90 puts. Our current target is for one side of the strangle to rise to $5.00 or more. Currently the LM-KB calls are trading at $4.60bid/$4.90ask. Our cost was about $2.40. You, the reader, have a choice. You can sell now for a profit, or hang on for our target at $5.00.

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

Picked on October 12 at $102.59
Change since picked: +10.98
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 966 thousand

---

Loews - LTR - close: 94.53 change: -0.54 close: n/a

LTR was due for some profit taking and shares dipped back to broken resistance, now short-term support, at the $94 level. If the stock continues to pull back the $92.50 region should also act as support. We're not suggesting new strangle positions in LTR. 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.

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

Picked on October 23 at $ 89.94
Change since picked: + 4.59
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

---

Microsoft - MSFT - close: 26.66 change: +0.22 stop: n/a

MSFT turned in a very strong week following the previous week's earnings report. The stock is short-term overbought and due for a dip. 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.

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

Picked on October 25 at $ 25.03
Change since picked: + 1.65
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 64 million

---

O'Reilly Auto. - ORLY - close: 29.90 chg: -0.07 stop: n/a

ORLY continues to show strength by its lack of profit taking on Friday. The stock does look short-term overbought and due for a dip. The $29 level looks like short-term support. A breakout over $30 would be very bullish. The target for our strangle is $1.20 but more conservative traders may want to exit early around breakeven at $0.75. There are only two weeks left before November options expire. It may be prudent to just exit at breakeven if we get the chance. The options in our suggested strangle were the November $30 calls (OQR-KF) and the November $25 puts (OQR-WE).

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

Picked on October 09 at $ 28.23
Change since picked: + 1.71
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 513 thousand

---

Oshkosh Truck - OSK - close: 43.28 chg: +0.30 stop: n/a

Reaction to OSK's earnings report on November 1st was not as powerful as we would have liked. The lack of volatility is not good for our strangle and more conservative traders may just want to exit early. We're going to give OSK a few more days to breakout from its $41.50-44.00 trading range before we bail out. We are not suggesting new strangles. 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.

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

Picked on October 30 at $ 42.82
Change since picked: + 0.46
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 405 million

---

Verifone Holdings - PAY - cls: 24.32 chg: +0.23 stop: n/a

Target achieved! PAY posted its fifth gain in a row and another new high on Friday. When we launched the play we suggested two strangles. Our preferred play was the January strangle with the January $22.50 calls (PAY-AX) and the January $17.50 puts. We also suggested a more aggressive November strangle with the November $22.50 calls (PAY-KX) and the November $17.50 puts. Our target on the November strangle was for a rise to $2.00. On Friday the November $22.50 calls hit a high of $2.00 and are currently trading at $1.80bid/$2.30 ask. Our hypothetical cost was $1.15. The January strangle is still open. Our target for the Januarys is for a rise to $4.50.

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

Picked on October 12 at $ 19.98
Change since picked: + 4.34
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand

---

Protein Design Labs - PDLI - cls: 25.99 chg: -0.52 stop: n/a

Reaction to PDLI's recent earnings report has been negative. The stock is testing support near $25.50 and its rising 100-dma. A breakdown from here could send the stock toward $23 to fill the gap from August. We are no longer suggesting new strangle positions. The options in our hypothetical strangle are 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.

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

Picked on October 30 at $ 27.70
Change since picked: - 1.67
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Early Birds Get the Worms

When relatively new to trading, I once attended a conference and vowed to another attendee that I'd learned my lesson and would never trade amateur hour again. His face solemn, looking down his nose only a little, he intoned, "I make my best trades during amateur hour."

So do I, now. If I don't enter during the first hour, I often find a setup then.

Recently, a subscriber sent an instructive article on predicting strong closes, but the article by Brett Steenbarger focused on more than closes. It included calculations pinpointing the frequency with which the day's high or low was achieved within the first thirty minutes or hour of trading. Steenbarger referenced Mark Fisher's conclusion in THE LOGICAL TRADER that high and low prices for the day tended to congregate at the beginning or end of the market day.

That conclusion coincided with an observation I had made when studying breakout plays on Donchian channels. I noticed that Donchian channel breakouts that occurred at or near the open or close were often reversed. That would be true, wouldn't it, if the high or low of the day often occurred during the early morning period?

For those not familiar with Donchian channels, they're fairly simple. The charting service sets the top boundary at the highest high for a period set by the trader and the bottom boundary at the lowest low for a period set by the trader. Richard Donchian expounded on a breakout trading system in a booklet published in 1970, with the breakouts identified as closes outside the channels and with trades taken in the direction of the breakout. Donchian set his channels to show breakouts from a four-week period's highs and low, but I often use a 20-period setting on a 60-minute chart, so that I'm looking at breakouts above the highest high in the last twenty hours of trading or below the lowest low in the last 20 hours of trading. I offset the channels to the right by two periods, so that I see the breakouts sooner than I would otherwise. However, when backtesting the system, a system I eventually discarded as not suitable for my trading style, I found that my results suffered when including those early morning breakouts. They were too often reversed.

Early Morning Donchian-Channel Breakouts

Admittedly, the period depicted in this chart encompassed a time when the SPX was alternating bullish days with bearish days, so reversals occurred one after the other, but those reversals weren't as easy to predict as markets opened each day as they are to identify in retrospect. When markets rise or drop sharply in early trading, the atmosphere at the time feels extremely bullish or bearish. That's what it's called amateur hour, because professionals often are running markets up to sell into the strength or down to buy into the weakness.

The tendency I observed for those early morning breakouts to reverse helped to identify the next market action. The same tendency depicted on this chart showed up in my study of charts for a longer period of time a couple of years ago. It wasn't new to this period when markets zigged one direction one day and zagged the other the next.

Some of those early morning breakouts on that previous chart were followed by pullbacks and not full reversals. How would one set a downside target if the move might result in only a pullback? I use Keltner channels to set targets for all my trades, whether short-term or longer term.

Don't confuse the different channels. For the purposes of this article, the Donchian channels are identifying the breakouts. The Keltners identify the targets for a reversal play.

For example, the first early morning breakout pinpointed on that Donchian chart was on October 17. Although I use different time intervals and nest various Keltner channels to set targets, depending on whether the trade is a scalp or a position to be held for several weeks, the simplest setup for an early morning reversal can be viewed on a five-minute Keltner chart. This Keltner channel uses the following parameters: Length, 120; Source AvgHLC; Exponential; Multiplier, 7.2.

Five-Minute SPX Keltner Chart:

Partial profit could be taken as the central basis line was hit, with stops lowered to breakeven on the rest of the position. A conservative trader might take full profit, depending on trading style, internals at the time of the trade, outlook and other parameters. Note that RSI had signaled oversold conditions as the central channel line was approached, so caution and profit-protecting measures were suggested.

The second early morning reversal play suggested by that Donchian channel chart was a bullish one on October 19, and it resulted in a move from one side of the Keltner channel to the other.

Early Morning Breakout on October 19:

The period on the Donchian channel chart encompassed a time when markets were zigzagging back and forth, as had been previously mentioned. Early morning breakouts were regularly reversed. What about a time when markets trended?

Turns out, there aren't too many breakouts during the first sixty minutes of the day when the move is going to trend, although I'm not certain why that's true. Both in the previous study I conducted when first testing Donchian channels a couple of years ago and in a current cursory look at trending moves since January, most trending moves tended to break out about midmorning or mid-afternoon. While I cannot verify that this pattern always exists, anecdotally, it appeared to be mostly true over the periods I've studied.

Even when those trending moves did occasionally begin on an early morning breakout, as one did on September 6, other differences often appeared to alert traders that this was the beginning of a trending move, and a reversal should not be expected.

Early Morning Donchian Channel Breakout without Stochastic
Confirmation

The RSI reading also failed to show overbought conditions as the breakout occurred, but because RSI changes so quickly and has no crossing lines, that fact was not as easy to see for illustration purposes. For that reason, stochastics were used on this chart, although I prefer RSI in my actual trading. RSI should be signaling overbought before bearish entries are considered on an early morning Donchian channel breakout and oversold before bullish ones. An early morning breakout without those signals might not be reversed or even see much of a pullback.

Other tactics can be used to identify early morning breakouts that might be reversed. Donchian channels don't have to be used. Those proficient in the use of Keltner channels can use nested channels to both identify breakouts and set targets. In addition, those who read my Market Monitor commentary know that I watch the advdec line's actions, too. On September 6, that action showed the advdec line opening near what I deemed to be support and rising, not indicating a likelihood of an early morning reversal. On October 17, however, the advdec line reacted differently, giving more corroboration to the possibility of a reversal than it had on September 6.

Traders should use their favorite indicators and methodology to decide whether they'll consider a countertrend play after an early morning breakout. The purpose of this article was to show that traders can benefit from the knowledge that market highs or lows tend to congregate either in the early morning or late-day periods, not to promote Donchian or Keltner channels.

No methodology is foolproof, and that includes the tools provided in this article. Just last Monday, October 31, the SPX set up one of these trades by creating a Donchian channel breakout during the first sixty minutes of trade. A pullback did begin, but it did not retrace all the way to the targeted support. Thursday morning's first Donchian channel breakout did finally succeed in producing a pullback that performed as expected, although the breakdown did not begin until the 12:40 five-minute candle, when the OEX finally broke through the five-minute Keltner channel line depicted above, located at 562.56 at the time the OEX slipped back below it. By the 2:40 five-minute candle, the OEX had dropped to the basis line located at 560.25, eventually dropping a little below that before climbing into the close. That setup worked perfectly, but Monday's hadn't.

Account-appropriate stops are needed to guard against days such as Monday. So is an understanding of some realities of options pricing. Options prices tend to be plumped up during amateur hour. That's the reason that I'd been so leery of entering new trades during amateur hour, although that plumping-up tendency can benefit someone exiting a position during amateur hour. Benefiting from an early entry often requires some skill in getting between the bid and the ask and a quick move of the underlying in your direction in order to profit.

Still, if I were to sit next to that same man at another seminar, I'd be able to hold my chin high, perhaps even high enough to look down my nose, only slightly.
 

Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.

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