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Daily Newsletter, Saturday, 11/12/2005

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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

Winning Streak Continues

The markets continued their climb higher with the Dow and S&P posting gains for the last three weeks and the Nasdaq stretching its gains to four weeks. While those statistics are exciting the Dow transports are really blazing a trail higher. The Transports have broken the 4000 barrier and are setting new all time highs. The decline in oil prices is aiding this move but oil at $57 is still not a bargain. This suggests the economy is healthier than the reports would indicate and any further drop in oil should light the next stage of this rocket.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

Friday was Veterans Day and the bond markets were closed. This led to very low volume in the equity markets, the lowest since August 29th. The low volume did not keep the markets from moving higher but the moves were somewhat muted as the indexes neared very strong resistance levels. A critical earnings report from Dell may have held the Nasdaq to only a +5 point gain but that was enough to post a close over 2200 and only 17 points away from a multi year high at 2219. The Thanksgiving rally is still alive and well despite its advancing age.

The rally has shaken off several bouts of negativity from individual stocks and from some stressful economic worries. This week Dow component GM warned of an accounting problem and the need to reinstate earnings for past years. This is never a positive event and GM fell -$2 on Thursday. The Dow shook it off and ran for big gains anyway. Dell reported earnings on Thursday that disappointed the street and suggested that Dell may be losing its momentum in the PC space. As the PC price wars heat up for the holidays Dell finds itself playing catch up instead of leading the sector. Dell had already warned on Halloween and suffered a -10% drop so the actual earnings on Thursday may have depressed the sector but Dell stock actually posted a small gain.

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Also slowing the Nasdaq bounce may have been memories of the disappointing earnings from Cisco on Wednesday. The Cisco impact was felt early Thursday but traders shook it off on the afternoon rally ahead of Friday's holiday. Those few traders actually in the market on Friday may have seen it as questionable confirmation of a slow tech rebound. Much of Cisco's sales gain was due to government orders rather than strong sales to businesses. Given the negativity from Dell and Cisco, two of the largest tech heavyweights, the Nasdaq gains were actually more bullish than they appeared on the surface.

The energy sector shook off a sharp drop in oil on Thursday and rallied on Friday despite an embezzlement scandal at PTEN. The company said Thursday a former officer might have embezzled $70 million over five years using payments for equipment that was never delivered. The company fell from $34 on Tuesday to touch $29 on Friday. Up until the news broke PTEN had been very close to setting a new high at $36 and was one of the strongest charts in the sector.

Dow theory always wants the transport sector to confirm any Dow breakout for that move to gain traction and increase velocity. In times when the transports confirm a Dow breakout the combination typically produces a Dow move of +14%. However this is not the case in the current rally. The transports have broken to a new high while the Dow languishes below multi year highs and more than -1000 points from its all time high. Typically a breakout by the transports ahead of the Dow results in a minimal Dow gain of less than +4%. Statistics are fun, informative and provide additional insight but you should not rely on them for trading.

That is not keeping the truckers and airfreight companies from moving higher with FDX near a new high at just over $100. This is not just a move on lower oil but that definitely helps. Freight loads are improving and not just in loads headed for the hurricane zone. Overseas airfreight is picking up as well, most likely due to last minute product deliveries ahead of the holiday season.

Chart of Dow Transports - Weekly

Even the homebuilders are trying to rebound despite the lowered profit outlook by Toll Brothers last week. Mortgage interest rates are comfortably over 6% with bridge loans and construction loans at 8-9% or even higher. There is a new analysis viewpoint starting to make the rounds concerning the 10-year note. In 1994 when the Fed was within 2-3 months of ending their hikes the yield on the ten-year note peaked on Nov-4th and started trending lower. Typically the ten-year yield leads the Fed funds futures by several weeks in predicting the direction of future rates. The ten-year yield has plateaued just under 4.65% for the last three weeks after a two month climb. The high at 4.68% was on Nov-4th. Bear in mind it is only a three-week pause but that 4.65% range is strong resistance and the high seen last March. The ten-year could be telling us that the Fed is closer to ending their measured pace hike than the Fed futures are suggesting. This is all speculation but analysts are comparing this hike cycle with the +300 point rate cycle in 1994 and hoping for a similar outcome. The "neutral rate" then was 6.0% after the last hike in Feb-1995 but was quickly followed by three cuts of -25 points each after the Fed decided they went too far.

I mentioned last week that the -22% drop in auto sales at Ford and GM was likely to take a significant chunk out of Q4 GDP if they did not launch a new round of incentives to push inventory out the door. On Friday GM announced it was going to have a Red-Tag Sale from this Sunday until Jan-3rd. It will feature sharp markdowns on all 2005 and 2006 GM vehicles except the Corvette, Buick Lucerne and Pontiac Solstice. Dealers said the new prices offered even bigger savings than the employee pricing incentive because of the larger overall discounts. This comes just in time for the new SUV lines to benefit from the drop in gas prices. Consumers will undoubtedly decide that the gas spike was completely hurricane related and just another once a decade spike like the prior energy spikes in the 70s and 80s. They will jump into those SUV and CUV models and happily head to the filling station to get some $2.25 gas. Enjoy it while you can because it is only temporary.

I spent two days at a PEAK Oil conference this week and the outlook is not good. We heard from Matthew Simmons, Chairman of the investment-banking firm Simmons and Co, Jeremy Gilbert, Chief Petroleum Engineer for BP (ret), and Henry Groppe, from Groppe, Long and Littell, a 50 year participant in the energy industry. Also presenting were Chris Skrebowski, Editor of Petroleum Review and Tom Petrie of Petrie Parkman. These were just a few of the industry experts attending and all were in agreement that there is permanent trouble ahead. I am not going into a long discussion here but I will hit some highlights. I will put all my notes into a new paper over the next couple weeks and make it available to everyone.

The bottom line to the endless flow of charts and grafts presented by the experts was a coming end to cheap oil. Not an end to oil but an end to cheap oil and everything that implies. Currently OPEC is pumping flat out over 30 mbpd with Saudi Arabia carrying the brunt of the load. Various sound bites, print comments and excerpts from producers around the globe continue to paint the picture that we could see the global peak in production as early as September 2006. Output problems are continuing to crop up in mature fields with accelerated depletion rates and sharp drops in previously stable flows. Current global production is averaging about 84 mbpd with spikes to 85. This is offsetting the nearly 1 mbpd still offline in the Gulf. Current official estimates for excess production capacity are in the 1.0-1.5 mbpd range and just enough to offset the Gulf loss as long as the demand destruction caused by the hurricanes remains in place.

The problem remains in the production levels that OPEC must maintain to keep ahead of demand. The swing producer is still Saudi with several other OPEC countries unable to maintain prior flows as depletion takes its toll. This means Saudi must open the valves to dangerous levels to keep up, currently 9.51 mbpd and a four year high. Whenever they stress their aging fields to this extent they are risking a catastrophe. Over producing causes reservoir damage, sometimes irreparable damage that can cause significant drops in future production due to increased water flow, loss of pressure or sudden acceleration of the gas cap. The best way to maximize production from any field is to pump at low levels for a very long time but that does not satisfy current demand. This allows the oil to seep through the formation without disturbing the fragile balance of conditions that allow the oil to flow. Saudi can't afford the luxury of slow production. They are depended upon to fill the gaps left by other producers.

For EVERY field ever found there is a natural bell curve where production begins at a low level as initial wells are drilled and completed, a rise to peak production as the full build out of wells come online and then a decline back to zero as the field becomes depleted. It is a function of simple math. There is only so much oil in every field. As you take it out the pressure declines until it reaches zero. Water or gas can be pumped into the edges of the field to push the remaining oil towards the wells and pumps are used to apply a vacuum to lift that remaining oil to the surface. Once the well goes wet the end is near. Of the many thousands of fields ever found they all have the same characteristics. The only difference is the speed of the decline. The faster you took the oil out the faster the decline will be when it appears. This is called depletion.

DDepletion Curve

Historical depletion rates once a field begins its decline are in the 4-6% range per year with acceleration to 8-10% in fields that were produced very quickly. If a field produced 100,000 bpd at its peak then it will initially decline at an average of -5% or -5,000 bpd the first year, -4,750 the second, etc. Typically there are some late term production efforts that prolong initial post peak production once the decline begins but once those efforts pass the decline can accelerate to the 8-10% range. After several years this decline pattern slows and some fields can produce at drastically lower levels for decades to come as the remaining oil is coaxed toward the wells. The following table shows hypothetical production from a 100,000 bbl field for ten years past its peak. Some will deplete slower, some faster depending on the prior rate of production and the geologic factors of the field but they all deplete. This is just an example.

It does not seem particularly damaging as long as new fields are coming online at the same time to offset this decline. It should be noted that dozens of oil producing nations have been in decline for decades. Only five countries are reportedly still capable of producing at their peak levels. Most experts doubt that four of them are telling the truth since they have not produced at peak for some time. Only Saudi is supposedly capable of increasing production and that is doubted by many.

Let's take that example table above and apply it to our current global production of something less than 85 million barrels per day. (mbpd) For the sake of argument I am going to illustrate the depletion rate at a straight line 5% rate. I am also going to add to that number the anticipated production coming online from known mega projects scheduled for completion between now and 2010. That total is thought to be between 9-12 mbpd by 2010. I am going to go with the 12mbpd number and be optimistic that the 3 mbpd rate will continue through 2015 despite no official visibility past 2010. There are a couple major products coming online in 2006 and 2007 with a void in 2008 and another group arriving in 2009. From that point the calendar is bare. New oil to be produced after 2010 has not been discovered yet. Chevron took out a full-page ad in the New York Times and Business Week in October. They said the world is consuming two bbls of oil for every one discovered. Since 1998 the four major oil companies have spent $8 billion on exploration for every $4 billion in oil discovered. The last major oil discovery was in 1964 and discoveries have been decreasing in number and quality ever since. The table below assumes global oil demand remains at 85 mbpd but we know without a doubt that the eventual rise in price projected by this scenario, likely to $200 a bbl or higher, would effectively destroy a significant amount of demand making the actual shortage less than illustrated but still a shortage.

ScSchedule of Global Production Depletion at 5%

You can modify this table in any fashion you desire EXCEPT by adding additional new production. Nobody, including the major oil companies, all the most optimistic experts and the OPEC nations expect any new finds to add more than an average of 3 bpd during any future year. You can guesstimate a smaller depletion rate or maybe even a series of natural disasters to wipeout significant demand but the end result remains the same. Only the dates on the calendar change. The table below illustrates the same problem with only an absurdly laughable 2% depletion rate and NO CHANGE in demand.

DDepletion Table 2%

Current IEA Demand Estimates Compared to 2004/2005

Global demand is increasing at the rate of +2% per year. Where do the 2006 demand estimates fit on the -2% depletion chart above? They don't. We are rapidly reaching a point where there will not be enough oil to satisfy the demand. This will result in a bidding war of extreme ferocity. Even that is not the end of the story. A fear among the experts that is growing day by day is the emergence of nationalism once that first real shortage is seen. As long as quasi-legitimate organizations like the EA and EIA continue to project "conceptual" reserves of trillions of bbls of undiscovered oil and OPEC nations continue to claim 2-4 times their actual reserves we are locked in a theological battle. It is a global version of the "emperor has no clothes". The emperor, OPEC, claims vast amounts of imaginary oil reserves to satisfy quota arrangements while the IEA and EIA overstate future production and demand based on these fictitious reserves in order to prevent a panic. The world blindly accepts these reserves rather than face the truth and world commerce in oil continues.

The theological battle over peak oil is fought between those claiming the peak is near and those claiming technology will prevail. It is fought between those counting the actual numbers and coming up short and those claiming that additional rising demand will produce miracles in exploration and production. Until the first shortage actually appears it will remain a "we said, they said" controversy fought in print and cyberspace and ignored by 7 billion people. Until the shortage appears and everybody accepts the truth there is nothing we can do to correct it. Once the world accepts it we can move on to resolve the problem rather than argue about its existence. The resolution to the problem is an entirely different discussion I will reserve for a later article.

The nationalism card I mentioned above is the trump card to the entire debate. There have been several recent comments by various officials that lead analysts to expect that countries will quit exporting oil once the true shortage picture appears. I have mentioned this many times as a danger in past articles and the analyst community is finally starting to see it as a serious danger. Why should a growing country continue to sell oil that they cannot replace later? Even at grossly inflated prices likely to hit triple digits within weeks of the first shortage they would be faced with paying double or triple years later IF they could replace it at all. Countries may continue to sell oil but in much smaller volumes because they are dependent on the dollar income and still retain a large portion of the oil for their future use. Since the price will soar they can continue to maintain their dollar flow while continually reducing the amount of oil they sell. It will be the proverbial sellers market until the end of time and sellers can decide how much they want to sell or even IF they want to sell. Countries with oil will be in charge of their own destiny and those importing will be at the mercy of the wolves. In the table of importers below note that 30% of the worlds population (India and China) are on the list. Japan has already gone to war once over oil and was second only to the U.S. in daily demand. China moved ahead of Japan in 2005. Demand in China grew by +15.4% last year (+860,000bpd) but demand this year had risen only +260,000bpd up until a couple months ago. However, in 2005 demand in the rest of Asia is on track to equal China's pace from 2004. On Thursday the IEA said Chinese oil demand in September surged +9% led by a huge jump in gasoline consumption of more than +14%. This brought China's oil demand to 7 mbpd in September. Note in the chart below that China only imported 2.9 mbpd in 2004.

TTop Ten Importers in 2004

In the export table below note that the OPEC countries are in red and those happen to be the same countries that are not especially friendly to the U.S. and not in favor of the Iraq war with the exception of Kuwait. Those OPEC countries accounted for 25 bpd of daily world exports in 2004. Currently that number is over 30 mbpd and amounts to 35% of total daily consumption. They control the price of oil. Not speculators, not traders. They alone have the power and we will be at their mercy once the decline in production begins.

TTop Twelve Exporters in 2004

Talking about next week's market action while the PEAK Oil debate continues is like watching TV while an electrical wire smolders in a basement wall. Ignoring truth does not make it less true. Fortunately that PEAK Oil truth should not bite us for some time and we can go on with our current lives as though it did not exist. Just don't forget that the U.S. could go from importing our current 14 bpd to 5 mbpd in a matter of weeks once the OPEC trap slams shut. Would $10 gas change your driving habits?

Oil prices are trading on short-term supply and demand rather than long-term expectations. Crude futures for Dec-2006 are still trading at $60 when historically distant years normally trade at a significant discount. While the short term December 2005 contract suffered a substantial haircut on this weeks inventory numbers with a drop to $57 and below the 200-day average the future December contracts for years 2006-2009 are still well above that level. I am sure there are some fund managers nibbling away at the December 2009 contracts and dreaming about the profits at multiples of the current price. But, for us normal traders we are faced with a warm November and a buildup of crude levels headed into the winter. With refining capacity offline there is nothing to do with the crude but store it pushing inventory levels above the five-year averages for this time of year. Warmer temperatures have prevented the normal draw downs which historically begin on November 1st. We had the perfect storm in the Gulf to erase supply and now the perfect calm is allowing that supply to catch up. Amazing how fate tends to control the numbers on the dice. Had we seen a couple of early blizzards the outcome of the Katrina/Rita story and the price of oil could have been much different.

DDecember Crude Chart - Daily

Chart of S&P Energy Spyder (XLE) - Daily

The fair-weather traders are abandoning oil positions daily and even prior bulls are now predicting lower prices. Boone Pickens who correctly predicted each of the recent price spikes said on Thursday that oil could "head toward $50" as the economy slows crimping demand. An interesting call from Pickens, not that oil could dip, but that the economy was going to slow. It will be interesting to see how that prediction works out. Various futures houses are targeting $55 as a level where buying should begin but it is all in the inventory numbers rather than the price. I believe OPEC will reduce supply under $55 in an attempt to limit damage to reservoirs and maintain that $50 level now that the world has grown accustomed to higher gas prices. The shock of $3 gas has given way to relief at $2.30. That gives them a free pass to use $50 as a floor in the future. br>
The equity markets celebrated the break of $59 on Thursday with the Dow breaking into the 10600-10725 resistance range followed by a penetration to nearly 10700 on Friday. After more than a week of aimless wandering with a barely perceptible uptick the index finished firmly in the green on two days of gains with +155 points for the week. With the transports in breakout mode and oil prices falling the Dow should be clear to make a strong break over the summer resistance highs at 10719 and head for higher ground ahead of Thanksgiving week.

The Nasdaq broke out of its weeklong resistance at 2180 to close over 2200 and could easily attack the August high at 2219 early in the week. The Nasdaq overcame the negativity of Cisco and Dell and the bulls do not appear to be interested in taking profits. Considering the lagging SOX and Russell I consider this a major change in tech sentiment that could have been stimulated by the +5 point jump in consumer sentiment on Thursday. It is November and the tech bulls are feeling an early surge of that holiday cheer.

The SPX also made a critical break above 1225 and closed on Friday above downtrend resistance at 1230. Both are very positive signs. 1245 is the only remaining resistance before the S&P breaks out to new multi-year highs. Even the lagging NYSE Composite got into the act with a strong rebound from a five day low to set a new six-week high at 7566.

I could not find any negativity in any index other than oil and it appears the markets have shaken off the higher interest rates, falling home sales and prices and fears of any economic weakness. There is so much bullishness it is scary ahead of a full slate of economic reports next week. We have the PPI and CPI, several regional surveys including the Philly Fed with Industrial Production and the Semi book-to-bill to fill out the calendar. New residential construction numbers will be released on Thursday and that could rock the sector once again on any substantial drop in starts. Expectations are for a drop of -48,000 starts to 2.06 million on an annualized basis from 2.108 in September. We are hearing almost daily that builder backlogs are dropping and they should be slowing starts to prevent a buildup of inventory until the Fed quits raising rates. We also have 2.5 million existing homes for sale and an all time high if I remember the statistic correctly. For those looking for a bargain the foreclosure rate is also at an all time high. Don't expect too harsh of a slowdown because 1.2 million new households are formed each year as kids move away from home and new families are started. That is a permanent demand cycle unless zero population growth suddenly makes a surprising comeback. Using the numbers above it still appears that a surplus has developed and that is why the Thursday numbers will be examined carefully.

The estimate for the PPI is for no change in prices compared to a jump of +1.9% in September. The CPI is expected to show only a +0.1% gain after a sharp jump of +1.2% in September. Both are expected to slow as a result of the drop in energy prices. The September reports showed significant spikes as a result of a +12% gain in energy in the weeks following Katrina. That spike has now been erased and there are whisper numbers expecting a drop in both indexes.

With positive economic numbers expected, oil targets below the current price and the holidays ahead there appears to be little reason to doubt the markets will move higher. That is always a scary proposition when all the stars line up for an expected rally and no roadblocks are in sight. Nearly every time some unexpected event arises to spoil the party. Unfortunately my crystal ball is clear and I don't see any immediate danger on the horizon. I would continue to buy the dips until warning clouds appear. I will get out my long-range telescope and report back on Tuesday night but until then party hats appear to be the adornment of choice until the turkey bones hit the trashcan.


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
AZO SHLD AEOS
IBM   ANF
NGPS   DHI
PD    

New Calls

AutoZone - AZO - close: 86.74 chg: +0.51 stop: 84.95

Company Description:
AutoZone sells auto and light truck parts, chemicals and accessories through 3,592 AutoZone stores in the United States and 81 AutoZone stores in Mexico and also sells the ALLDATA brand automotive diagnostic and repair software. (source: company press release or website)

Why We Like It:
The auto parts industry has seen the stocks really turn higher over the last couple of weeks. Shares of AZO have helped lead the rebound and broke through its three-month trendline of lower highs in addition to resistance at its 50-dma and the $85 level. The recent bounce from the $85 level and its simple 10-dma looks like a bullish entry point to ride the rally towards the next level of resistance near $90 and its simple 200-dma. AZO's P&F chart is currently still in a sell signal but that signal is relatively close to being reversed. We are going to suggest calls here above $86 and target a move into the $89.90-90.00 range. This is a short-term play with a two-week time frame.

Suggested Options:
We are suggesting the December calls.

BUY CALL DEC 85.00 AZO-LQ open interest=10947 current ask $5.00
BUY CALL DEC 90.00 AZO-LR open interest= 1183 current ask $2.45

Picked on November 13 at $ 86.74
Change since picked: + 0.00
Earnings Date 12/08/05 (unconfirmed)
Average Daily Volume = 1.1 million

---

Intl. Bus. Mach. - IBM - cls: 84.55 chg: +0.56 stop: 81.95

Company Description:
IBM is the world's largest information technology company, with 80 years of leadership in helping businesses innovate. Drawing on resources from across IBM and IBM Business Partners, IBM offers a wide range of services, solutions and technologies that enable customers, large and small, to take full advantage of the new era of e-business. (source: company press release or website)

Why We Like It:
The hardware sector has been struggling for months under a trend of lower highs if you look at the GHA hardware index. You'll also notice that the GHA is poised for a breakout just under technical resistance at the simple 200-dma. Meanwhile IBM, one of the biggest components in the GHA hardware index, has rallied back toward resistance at the $85.00 level and looks poised to breakout to new seven-month highs. The chart pattern has a lot of bullish potential and the Point & Figure chart is already in a buy signal pointing to a $105 target. However, it's worth noting that the P&F chart also shows significant resistance at the $85 mark, which coincides with the daily chart (see below). We want to position ourselves to catch any future breakout in IBM. Therefore we are suggesting a trigger to buy calls at $85.25. If we are triggered our immediate target will be the $89.90-90.00 range.

Suggested Options:
We are going to suggest both the December calls and the January calls. If you choose Decembers we have about five weeks for the play to come to fruition. If you choose Januarys you can take advantage of any Christmas/year-end rally through the end of December. We like the Januarys but the Decembers are tempting because they look cheap. Bear in mind that we'll have to pay more once IBM crosses the $85 mark.

BUY CALL DEC 80 IBM-LP open interest= 1849 current ask $5.20
BUY CALL DEC 85 IBM-LQ open interest=11783 current ask $1.55
BUY CALL DEC 90 IBM-LR open interest= 7964 current ask $0.25

-or-

BUY CALL JAN 85 IBM-AQ open interest=39055 current ask $2.55
BUY CALL JAN 90 IBM-AR open interest=33339 current ask $0.75

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/16/06 (unconfirmed)
Average Daily Volume = million

---

NovAtel Inc. - NGPS - close: 29.85 chg: +1.37 stop: 27.75

Company Description:
NovAtel designs, markets and sells high-precision GPS and other positioning components and sub-systems used in a wide variety of commercial applications principally in the aviation, geomatics (surveying and mapping), mining, precision agriculture, marine and defence industries. NovAtel's solutions combine hardware, such as receivers and antennas, with software to enable its customers to fully integrate the Company's high-precision GPS technology into their respective products and systems. NovAtel, an ISO 9001 certified company, is focused on supplying core high-precision positioning technology to OEMs and system integrators who build systems for various end market applications. (source: company press release or website)

Why We Like It:
NGPS looks poised for another bullish breakout. The stock has been consolidating sideways between $22 and $30 for the past three months and that consolidation has narrowed to $28 to $30 over the past ten days. Now NGPS looks close to breaking out over resistance at the $30.00 level. The Point & Figure chart already shows the recent sell signal reversing into a buy signal that points to a $47 target. We are going to suggest a trigger to buy calls at $30.45. If triggered we'll target a move into the $35.00-36.00 range.

Suggested Options:
We are going to suggest the December calls because there aren't any Januarys available yet.

BUY CALL DEC 25.00 QAZ-LE open interest= 94 current ask $7.80
BUY CALL DEC 30.00 QAZ-LF open interest=434 current ask $2.20
BUY CALL DEC 35.00 QAZ-LG open interest=197 current ask $0.80

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 292 thousand

---

Phelps Dodge - PD - cls: 130.31 chg: +4.97 stop: 123.69

Company Description:
Phelps Dodge Corp. is one of the world's leading producers of copper and molybdenum, the largest producer of molybdenum-based chemicals and continuous-cast copper rod, and among the leading producers of magnet wire and carbon black. The company and its two divisions, Phelps Dodge Mining Co. and Phelps Dodge Industries, employ approximately 15,500 people worldwide. (source: company press release or website)

Why We Like It:
The volatile shares of copper-producer PD look poised for a new leg higher. The stock had been consolidating over the past month and Friday's move was a key turning point. The stock broke out from its consolidation pattern on volume three times the daily average. Technical signals turned bullish and its MACD indicator has produced a new buy signal. The Point & Figure chart looks pretty strong with a new ascending triple-top breakout buy signal pointing to a $150 target. We are suggesting bullish positions anywhere above $127.50. Our preferred entry point would be a dip back toward $127.50-128.00 but it may not occur. Our target is the $139.50-140.00 range. Our time frame is

Suggested Options:
We are suggesting the December or January options but our preference is the Januarys.

BUY CALL DEC 125 PD-LE open interest= 941 current ask $6.60
BUY CALL DEC 130 PD-LF open interest= 713 current ask $4.70
BUY CALL DEC 135 PD-LG open interest= 533 current ask $2.60

-or-

BUY CALL JAN 125 PD-AE open interest=2330 current ask $9.50
BUY CALL JAN 130 PD-AF open interest=7657 current ask $7.50
BUY CALL JAN 135 PD-AG open interest=1771 current ask $5.60

Picked on November 13 at $130.31
Change since picked: + 0.00
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 2.7 million
 

New Puts

Sears Holding - SHLD - cls: 114.80 chg: -3.48 stop: 119.01

Why We Like It:
We are switching sides with SHLD. A week ago the stock look poised to breakout through the top of its $114-128 trading range. The breakout never materialized and now SHLD, displaying lots of relative weakness, has fallen toward the bottom of its trading range. Technical oscillators are naturally looking bearish and its MACD just produced a new sell signal. If SHLD does breakdown to a new low the next leg down could be substantial. We're going to suggest a TRIGGER at $112.99. If we are triggered we will target a decline to the $100.50-100.00 range. It would be tempting to aim for a larger move but we do not want to hold over SHLD's earnings in the first week of December. Speaking of earnings rival Wal-Mart (WMT) is due to report earnings on Monday morning and WMT's news and guidance could be a big factor in the direction SHLD moves next. We also want to suggest an alternative strategy. If SHLD does not breakdown but instead bounce from the bottom of its range (say back over $116 or 117) then nimble traders could try and play a bounce to the top of SHLD's trading range near $128.

Suggested Options:
We are suggesting December options since we plan to exit ahead of SHLD's December earnings report.

BUY PUT DEC 115 KTQ-XC open interest=3062 current ask $7.40
BUY PUT DEC 110 KTQ-XB open interest=3941 current ask $5.00
BUY PUT DEC 105 KTQ-XA open interest=2871 current ask $3.30

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 Strangles

Amer. Eagle Out. - AEOS - cls: 25.47 chg: +0.17 stop: n/a

Company Description:
American Eagle Outfitters is a leading lifestyle retailer that designs, markets, and sells its own brand of relaxed, casual clothing for 15 to 25 year olds, providing high-quality merchandise at affordable prices. AE's collection includes modern basics like jeans, cargo pants, and graphic Ts as well as a stylish assortment of cool accessories, outerwear and footwear. American Eagle Outfitters currently operates 793 AE stores in 50 states, the District of Columbia and Puerto Rico, and 71 AE stores in Canada. AE also operates via its Web business, www.ae.com, which offers additional sizes and styles of favorite AE merchandise. The company plans to open MARTIN + OSA, a new sportswear concept targeting 25 to 40 year old women and men, in the fall of 2006. (source: company press release or website)

Why We Like It:
The Q3 earnings parade has dwindled to just a trickle but there are still several opportunities for us to use a strangle and capture any post-earnings volatility. AEOS is one such opportunity. The company is due to report earnings on Tuesday, November 15th before the market open. That gives us one day to launch new strangle positions ahead of the report. We're going to suggest an entry window of $25.75-24.25.

Suggested Options:
We are going to suggest the January strikes for this strangle. Remember as a strangle we need to buy an out of the money call and an out of the money put option. At current prices this strangle should cost about $2.35. Try and keep your investment under $2.45. We'll aim for a rise to $4.70.

BUY CALL JAN 27.50 AQU-AY open interest=1691 current ask $1.40
-and-
BUY PUT JAN 22.50 AQU-MX open interest=1051 current ask $0.95

Picked on November 13 at $ 25.47
Change since picked: + 0.00
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 59.67 chg: +0.33 stop: n/a

Company Description:
The Company operated 354 Abercrombie & Fitch stores, 163 abercrombie stores, 297 Hollister Co. stores and 6 RUEHL stores at the end of fiscal October. (source: company press release or website)

Why We Like It:
ANF appears to be out doing its opponents in the retail space. The company recently released same-store sales for October that blew past analyst estimates at +31% growth. Since that report in early November the stock has been consolidating sideways as investors wait for ANF's earnings report due out next week. With ANF's report expected on Tuesday, November 15th after the closing bell that gives us two days to launch strangle positions. We're going to suggest an entry window of $59.00-61.00 but the closer to $60.00 the better!

Suggested Options:
We are going to suggest the January strikes. That way if ANF breaks out higher we can take advantage of the entire month of December. At current prices our strangle should cost about $5.15. Try and keep your investment under $5.25. We'll aim for a rise to $8.50. A similar strangle using December options would cost about $3.30.

BUY CALL JAN 65 ANF-AM open interest=1457 current ask $2.60
-and-
BUY PUT JAN 55 ANF-MK open interest= 934 current ask $2.55

Picked on November 13 at $ 59.67
Change since picked: + 0.00
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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D.R.Horton - DHI - close: 32.56 chg: +0.55 stop: n/a

Company Description:
D.R. Horton, Inc., America's Builder, is the largest homebuilder in the United States, delivering more than 50,000 homes in its fiscal year ended September 30, 2005. Founded in 1978 in Fort Worth, Texas, D.R. Horton has expanded its presence to include 71 markets in 23 states in the Midwest, Mid-Atlantic, Southeast, Southwest and West regions of the United States. The Company is engaged in the construction and sale of high quality homes with sales prices ranging from $80,000 to over $900,000. D.R. Horton also provides mortgage financing and title services for homebuyers through its mortgage and title subsidiaries. (source: company press release or website)

Why We Like It:
Toll Brothers (TOL) gave the homebuilding sector a jolt this past week with some bearish news about sales expectations. That surprise from TOL could have fears rising for similar news out of DHI. Whatever DHI does report it could spark the next move in the stock price. DHI is due to report earnings on November 16th before the market open. That gives us two days to try and launch a strangle position. We're going to suggest an entry window of $32.00-33.00.

Suggested Options:
We are going to suggest January options for this strangle. At current prices this should cost about $3.15 Try and keep your investment under $3.30. We'll aim for a rise to $6.00.

BUY CALL JAN 35 DHI-AG open interest=5004 current ask $1.65
-and-
BUY PUT JAN 30 DHI-MF open interest=8646 current ask $1.50

Picked on November 13 at $ 32.56
Change since picked: + 0.00
Earnings Date 11/16/05 (confirmed)
Average Daily Volume = 3.2 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Intel Corp. - INTC - close: 25.13 chg: -0.11 stop: 23.45

The semiconductor sector was the technology laggard on Friday closing fractionally in the red. Shares of INTC followed suit after failing to breakout over its simple 100-dma near $25.50. The stock looks short-term overbought and due for a dip. The simple 200-dma near $25 would normally act as short-term support but we suspect the dip will pull INTC toward the $24.50 region or even toward the $24.20 region near its simple 10 and 50-dma's. Readers can watch for the dip but we'd wait for a bounce before considering new entries. Our year-end target is the $26.00-26.50 range.

Suggested Options:
We are not suggesting new positions at this time. If a new entry presents itself we'd choose the January calls.

Picked on November 06 at $ 23.99
Change since picked: + 1.14
Earnings Date 10/18/05 (confirmed)
Average Daily Volume = 51.6 million

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Legg Mason - LM - cls: 116.16 change: +0.16 stop: 108.75

The broker-dealer sector continues to be a pocket of real strength in the markets. The XBD index hit another new all-time high on Friday. Unfortunately, LM seemed to lag behind most of its peers but the trend remains bullish. The stock is up significantly already from our picked price and we're not suggesting new plays. More conservative traders may want to think about taking some money off the table or consider exiting near $118, which is currently overhead resistance! Our target is the $119-120 range.

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

Picked on November 02 at $111.69
Change since picked: + 4.47
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 904 thousand

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Rockwell Autom. - ROK - cls: 56.31 chg: +0.11 stop: 53.49

ROK's lack of follow through with the market's rally over the past two days does not bode very well for the bulls. The good news is that the stock has been consolidating sideways over support at the $55.00 level. The overall pattern would suggest the next move should be upward but obviously there is no guarantee here. The P&F chart, which cuts out a lot of the daily noise, looks very bullish with a triple-top breakout buy signal pointing to a $69 target. We are only targeting a move into the $61-62 range. We remain bullish but traders should consider new positions very carefully. More conservative traders might want to tighten their stop loss.

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=948 current ask $3.60
BUY CALL JAN 60.00 ROK-AL open interest=278 current ask $1.25

Picked on November 03 at $ 55.90
Change since picked: + 0.41
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand
 

Put Updates

None
 

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: 76.98 chg: +0.03 stop: n/a

We are very surprised by ABC's lack of movement. The market has been rising yet shares of ABC have consolidated in a very tight range, which is the worst possible scenario for our strangle position. There are only five trading days left before November options expire. If you're holding a November strangle it's time to think about damage control. Our estimated cost on the November strangle was about $2.10. The options in our November strangle were the $80 calls (ABC-KP) and the $70 puts (ABC-WN). The puts are virtually worthless now (0.00bid/$0.10ask) so we would not sell those to avoid paying a commission. Traders should give serious consideration to selling the Nov. $80 calls, which are currently at $1.10bid/$1.25 ask. That would redeem half our investment. We do give up the chance should ABC make a run higher next week but we're faced with time erosion that will pick up steam very quickly this week! If you are holding the December strangle, which had an estimated cost of $2.80 using the December $80 calls (ABC-LP) and the December $80 puts (ABC-XN), we would continue to target a rise to $5.00 or more.

Suggested Options:
We are not suggesting new strangle positions in ABC.

Picked on October 16 at $ 74.81
Change since picked: + 2.17
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

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Genentech - DNA - close: 94.74 chg: -0.14 stop: n/a

DNA is still struggling under resistance at the $95.00 level. While the trend looks bullish DNA may depend on the BTK biotech index to lead the next move. Currently the BTK index has also risen to prior resistance. A move lower in the BTK will probably be a signal to take profits in DNA. If the BTK breaks out then DNA will likely follow. The estimated cost for our December strangle was about $2.40. The options were the December $95 calls (DWN-LS) and the December $75 puts (DWN-XO). Currently the Dec. $95 calls are trading at $3.50bid/$3.60ask. If you don't want to wait for the breakout or if you don't want to risk DNA turning lower and never returning to the $95 level more conservative traders may want to exit right here! There are five weeks left before December options expire so we're going to keep the play open and our target in the $4.50-5.00 range.

Suggested Options:
We are not suggesting new strangle positions in DNA.

Picked on October 20 at $ 84.83
Change since picked: + 9.91
Earnings Date 10/10/05 (confirmed)
Average Daily Volume = 3.9 million

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eBay Inc. - EBAY - close: 43.89 chg: +0.58 stop: n/a

EBAY continues to rally higher following last week's breakout over the top of its previous trading range at the $42.00 level. The move was good news for us because EBAY's sideways chopping action had pretty much doomed our November strangle. Currently our position is still underwater but at least now there is a chance it could turn around. We have five trading days left before November options expire. The biggest challenge now is that EBAY looks short-term overbought and is facing resistance again at the $45.00 mark and the time premium decay is going to speed up significantly this week. Our estimated cost was about $1.05. The November $35 puts (XBA-WG) are virtually worthless so we would not waste the commission trying to sell them - just let them expire. The November $45 calls (XBA-KI) are currently selling at $0.35bid/$0.40ask. It's up to you, the individual trader, to decide at what price do you try and salvage some capital from this play. We're going to lower our target to $0.65.

Suggested Options:
We are not suggesting new strangle positions in EBAY.

Picked on October 18 at $ 40.42
Change since picked: + 3.47
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 18.3 million

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Four Seasons - FS - close: 49.80 chg: -1.61 stop: n/a

Shares of FS continued to sink on Friday and lost 3.13% on above average volume to close under round-number support at the $50.00 mark. The company reported earnings on Thursday morning and missed estimates by 15 cents. On Friday morning the stock was downgraded. The options in our strangle were the January $60 calls (FS-AL) and the January $50 puts (FS-MJ). Our estimated cost was about $2.60. We're aiming for a rise to $5.00 or more. The move under $50 is good news because the puts should now have a bigger delta and see a closer 1-for-1 move as the stock declines.

Suggested Options:
We are not suggesting new strangle positions in FS.

Picked on November 08 at $ 55.37
Change since picked: - 5.57
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

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General Dynamics - GD - cls: 116.35 chg: -1.15 stop: n/a

We're running out of time with GD. There are five days left before the November options expire. The stock spent way too much time churning sideways. The potential good news is that the recent rally attempt appears to have failed and its technical oscillators are pointing lower. We just need to see a breakdown under support at the 100-dma near the $115.00 level. The options in our strangle are the November $125 calls (GD-KE) and the November $115 puts (GD-WC). Our estimated cost was about $2.00. Currently the Nov. 115 puts are trading at $0.40bid/$0.50ask. A move to the $115 level will certainly help but time decay is going to speed up this week. We're going to leave our target to exit at $2.00 for now but more conservative traders may want to aim for $1.00 or $1.50 as a chance to redeem some capital.

Suggested Options:
We are not suggesting new strangle positions in GD.

Picked on October 09 at $119.59
Change since picked: - 3.24
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 713 thousand

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Harman Intl - HAR - cls: 102.54 chg: -1.65 stop: n/a

One of the many goals of a disciplined trader is to keep their emotions out of the picture. Yet that can be hard when a stock, like HAR, just seems to taunt us. Shares have continued to oscillate on either side of the $100 level following its earnings report, which was the worst possible scenario for our strangle position. The options in our strangle were the November $110 calls (HAR-KB) and the November $90 puts (HAR-WR). Currently both have eroded significantly and unless HAR makes a big move one direction this week we're faced with a big loss here. Traders should try to salvage what they can if HAR makes any attempt at a breakout either direction.

Suggested Options:
We are not suggesting new strangle positions in HAR.

Picked on October 18 at $100.80
Change since picked: + 1.75
Earnings Date 10/19/05 (confirmed)
Average Daily Volume = 739 thousand

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Hutchinson Tech. - HTCH - cls: 25.34 chg: -0.49 stop: n/a

Shares of HTCH have not responded to its earnings report as we might have expected. What we do not want is to see the stock continue to churn sideways and kill our already damaged strangle position. Fortunately, we did pick January options so there is plenty of time left for HTCH to make a move. The options in our strangle were the January $30 calls (UTQ-AF) and the January $20 puts (UTQ-MD). Our estimated cost was $1.65. We are adjusting our target from $3.00 to breakeven at $1.65.

Suggested Options:
We are not suggesting new strangle positions in HTCH.

Picked on October 26 at $ 24.89
Change since picked: + 0.45
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 666 thousand

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Inamed Corp. - IMDC - close: 74.73 change: -0.54 stop: n/a

We are in a wait-and-see mode with IMDC. The stock broke out to the upside following its earnings report. Yet lately that rally has stalled. We're expecting shares to pull back into the $72-74 range before moving higher if it moves higher. We have five weeks left before the December options expire. 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 strangle positions in IMDC.

Picked on October 30 at $ 70.63
Change since picked: + 4.08
Earnings Date 11/01/05 (unconfirmed)
Average Daily Volume = 533 thousand

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Kos Pharma - KOSP - close: 58.92 chg: +0.33 stop: n/a

Following KOSP's earnings report the stock produced a failed rally at its simple 50-dma overhead and then hit new relative lows. We expected a bounce from the 200-dma and it looks like that bounce could fade under the $60 level. The estimated cost for our strangle was $2.90. We have five days left before the November options expire so we are adjusting our target to $2.25. The options are the November $65 call (KQW-KM) and the November $55 put (KQW-WK).

Suggested Options:
We are not suggesting new strangle positions in KOSP.

Picked on October 20 at $ 59.80
Change since picked: - 0.88
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 460 thousand

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Lear Corp - LEA - close: 28.33 chg: +0.55 stop: n/a

Dow-component GM produced a nice bounce on Friday and it rubbed off on shares of LEA, which added 1.9%. Unfortunately for shareholders the bounce just looks like a temporary reprieve. The options in our strangle are the January $35 calls (LEA-AG) and the January $25 puts (LEA-ME). We are targeting a rise to $3.20 or more.

Suggested Options:
We are not suggesting new strangle positions in LEA.

Picked on November 06 at $ 30.24
Change since picked: - 1.91
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 1.8 million

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Lowes Cos. - LOW - close: 61.97 chg: +0.97 stop: n/a

LOW has continued to bounce from the $60.00 level and the rally stalled on Friday afternoon near short-term resistance at the $62 mark. The company is due to report earnings on the morning of Monday, November 14th. Wall Street estimates are at $0.77 per share. We are no longer suggesting new strangle positions in the stock with it outside our entry window of $60.50-59.50. The options in our suggested strangle were the December $65 calls (LOW-LM) and the December $55 puts (LOW-XK). We are aiming for a rise to $2.40 or higher on the strangle. Our time frame is five weeks.

Suggested Options:
We are not suggesting new strangles in LOW.

Picked on November 09 at $ 60.33
Change since picked: + 1.64
Earnings Date 11/14/05 (confirmed)
Average Daily Volume = 4.3 million

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Loews - LTR - close: 96.36 change: -0.05 close: n/a

LTR closed near all-time highs but the rally is starting to look tired. Shares might dip back toward the $94 level before continuing higher. 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). Our estimated cost is about $3.05. We'll plan to exit if either option rises to $5.00 or more.

Suggested Options:
We are not suggesting new strangles in LTR.

Picked on October 23 at $ 89.94
Change since picked: + 6.42
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

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Microsoft - MSFT - close: 27.28 change: +0.19 stop: n/a

Software titan MSFT continues to climb despite being very, short-term overbought. The stock is nearing what looks like resistance at the $27.50 level so next week could see some profit taking. Our strangle is based on the December $27.50 call (MSQ-LY) and the December $22.50 put (MSQ-XX). Our estimated cost was $0.30 for the entire position. We are aiming for a rise to $0.80-0.90 for either side of the strangle. Currently the December $27.50 calls are already trading at $0.45bid/$0.50ask, which is a 50% rise in value for our position. More conservative traders may want to exit early right here.

Suggested Options:
We are not suggesting new strangles for MSFT.

Picked on October 25 at $ 25.03
Change since picked: + 2.25
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 64 million

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O'Reilly Auto. - ORLY - close: 30.89 chg: +0.13 stop: n/a

This is a crucial week for ORLY. The stock has shown great strength the last couple of weeks and bulls have been buying dips near the $30.00 level. Unfortunately, we only have five days left before November options expire. Our cost for the strangle was about $0.75. Currently the November $30 calls (OQR-KF) are trading at $0.85/0.95. Our current target is $1.25. Traders have to decide - do you exit here and protect your capital with a small gain or risk a pull back by trying to go for more money. It would not take much for ORLY to push the calls to our target but shares do look overbought.

Suggested Options:
We are not suggesting new strangles on ORLY.

Picked on October 09 at $ 28.23
Change since picked: + 2.68
Earnings Date 10/25/05 (confirmed)
Average Daily Volume = 513 thousand

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Verifone Holdings - PAY - cls: 24.46 chg: +0.06 stop: n/a

PAY experienced some profit taking on Friday morning with a decline to $23.50 but bulls were quick to buy the dip. We wouldn't be surprised to see more profit taking and traders can watch the $22.50 level to act as stronger support. We are targeting a rise to $4.50 for our January strangle. Currently the January $22.50 calls (PAY-AX) appear to be the winning side.

Suggested Options:
We are not suggesting new strangles for PAY.

Picked on October 12 at $ 19.98
Change since picked: + 4.48
Earnings Date 11/18/05 (unconfirmed)
Average Daily Volume = 259 thousand

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Protein Design Labs - PDLI - cls: 25.56 chg: -0.14 stop: n/a

PDLI continues to display relative weakness and is struggling under short-term resistance at the $26.00 level. We would not be surprised to see PDLI bounce back toward the $26.75-27.00 range before continuing lower again. 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. We have five weeks left before December options expire.

Suggested Options:
We are not suggesting new strangles in PDLI.

Picked on October 30 at $ 27.70
Change since picked: - 2.14
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million

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Spectrum Brands - SPC - close: 18.00 change: -0.00 stop: n/a

Investors were not happy with SPC's earnings report and guidance on Thursday and the stock gapped down sharply. We see the lack of an oversold bounce on Friday as a good sign that there is more weakness ahead. Our estimated cost for this strangle was $1.25. The options in our suggested strangle are the December $22.50 calls (SPC-LX) and the December $17.50 puts (SPC-XW). We are aiming for a rise to $2.50 or more.

Suggested Options:
We are not suggesting new strangle positions for SPC.

Picked on November 08 at $ 20.63
Change since picked: - 2.63
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 576 thousand
 

Dropped Calls

Sears Holding - SHLD - cls: 114.80 chg: -3.48 stop: 121.99

SHLD has completed ignored the strength in the retail sector and fallen sharply from the top to the bottom of its trading range. This relative weakness suggest that the next move in the stock is going to be down. We're going to switch sides from a bullish breakout play to a bearish breakdown play. Look for the new play details under new puts in this newsletter. This call play was never opened since SHLD never hit our trigger.

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
 

Dropped Puts

Career Educ. - CECO - cls: 35.57 chg: -0.38 stop: 35.01

Our Thursday update for CECO said that if the stock traded over $36.00 on Friday we would drop the play. Well shares did hit $36.02 but the rally, if you want to call it that, quickly failed near the 200-dma and 50-dma, which are converging together near the $36.00 level. Friday's session looks like a failed rally and more importantly it looks like a new bearish entry point. While we are going to drop CECO as a bearish candidate (unopened) our readers may want to keep an eye on the stock for further weakness. The $33.00 level is short-term support.

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
 

Dropped Strangles

None
 


Trader's Corner

Opex Action Every Week of the Month

Friday, October 28, strange symbols appeared on OEX and SPX options chains. Those symbols had nothing to do with the approach of Halloween. They didn't signal a glitch in the CBOE platform. They heralded the launching of the "WeeklysSM," the title of a new type of option that is listed one week and expires the next. If you want cheap options and the thrill of option expiration action every week, these are the options for you.

Offered for the time being only on the OEX and SPX, these options are listed on Friday and expire the next Friday. The CBOE does not list new Weeklys that would expire during expiration week for standard options, but you don't need them then. You have the real-deal option expiration.

According to the CBOE's press statement, the exchange wanted to offer a product that provides "an efficient means to trade options around specific time periods or certain news or events." I suspect that the CBOE also intends to increase options buying and selling, but that goal wasn't mentioned in the press release.

Like their familiar counterparts for the OEX and SPX, weekly options are cash settled. The CBOE set up the SPX Weeklys as European style and the OEX, American style, matching the standard options on these indices. SPX Weeklys stop trading on Thursday before their settlement and settle when all SPX components have opened Friday morning. OEX weeklies trade through Friday, and settle when all OEX components have closed Friday afternoon.

The CBOE created new symbology for the Weeklys, with the symbology recycled for each month. The first two letters of the option symbol will be "JX" for the SPX Weeklys and "RZ" for the OEX ones. Those first two letters will be followed by "A" for week 1, with those options listed the last Friday of the month prior to each expiration month. For example, the SPX Weeklys listed on that October 28 launch date carried the first three letters "JXA." Listed the last Friday of October, they stopped trading Thursday, November 3, and the cash settlement was determined upon the opening of all the component stocks the morning of Friday, November 4.

"B" serves as the third letter for week 2, listed the first Friday of an expiration month; "D" for week 4, listed the third Friday of each expiration month and "E" for week 5, listed on the fourth Friday of those expiration months that might be a 5-Friday month. Because standard options typically expire the third Friday of each month, no Weeklys would be listed the second Friday of each expiration month, because those would expire at the same time as standard options.

An interesting situation occurs with the American-style OEX Weeklys. Because OEX options trade through Friday and settle at the close of the day, the expiring and newly listed Weeklys overlap for several weeks of month. They do not do so the week before option expiration, because the CBOE does not list new Weeklys that week. This situation does not occur with the SPX Weeklys with their European-style exercise, since they stop trading on Thursday.

Because there's little time value built into Weeklys, they're cheaper than standard options. Those cheap options prices will appeal to many traders. The following chart compares bid, ask, and delta for a slightly ITM put and call for Weeklys and standard November options as of the close of trading Friday, November 4, when the OEX had a value of 561.97.

Comparing Price and Delta on Weeklys versus Standard Options

Bid and ask prove noticeably lower on the Weeklys, and the difference would be more pronounced earlier in the option expiration cycle for the standard options. Interestingly, delta, the ratio that predicts how much an option price would change for each one-point change in the price of the OEX, proves slightly higher for the Weeklys, too. This provides the more-bang-for-the-buck action previously seen only during option expiration week.

Weeklys also provide much of the danger. One danger comes from the quick decay that occurs with an option moving quickly toward expiration, as all have observed options prices do during option expiration week. Anyone trading about-to-expire options the last week of the option expiration cycle has observed the price visibly decaying if the index price did not move quickly in the right direction.

If an adverse move occurs, the effect can be worse and little time for recovery remains. On November 3, news of a Merck victory in a Vioxx case spiked MRK's stock and helped spike the OEX, too. The MRK news hit at about 10:15. That morning, the OEX had opened, climbed and then begun rolling over, with the advdec line volume doing the same. Both had reached potential support, and the MRK news helped the OEX support to hold despite the rollover in the advdec line. The short-term bearish OEX traders who though they'd found a great entry were to see the OEX spike to a new high of the day before finally tumbling, with that spike stopping out some bearish traders. Fortunately, for those not stopped by the Merck-driven spike, a profitable exit was eventually offered, but Weeklys provide little time for recovery from such a news-driven event.

Of course, the Weeklys don't offer all the excitement and frustrations of an opex week, since they're the only expiring options. For those who crave the danger of an opex week, however, they offer danger in another form other than limited recovery time: limited liquidity when compared to standard options. The following two charts showing RZA and RZB (Week 1 and 2) OEX options at the close of trading Friday, November 3, as the Week 1 class was expiring, display low open interest when compared to standard options.

Weeklys: OEX Calls

Weeklys: OEX Puts

The current week, ending November 11, shows little or no improvement over the previous Friday's results. With the OEX at 567.49 as this report was completed, the nearby Weeklys showed 555 open interest and 44 volume for the 565 calls and 648 open interest and 7 volume for the 565 puts.

The Weeklys also do not offer enough strikes to be particularly useful for those who prefer out-of-the-money credit spreads. As the two tables above illustrate, only five strikes are currently offered in each class.

They perhaps do a much better job at meeting the CBOE's stated purpose of offering an efficient method of trading near an important development that might occur any week, and not just during the expiration week for standard options. Perhaps these options will be welcomed by those heavily short or long a portfolio into a FOMC meeting, a GDP announcement or a controversial vote in the Senate that has economic weight, whether or not such developments take place during opex week.

Weeklys offer advantages, including a cheaper price and that intended ability to efficiently trade around potentially market-moving events. For now, few strikes and lower liquidity relative to other SPX and OEX options remain drawbacks to directional traders or those seeking OTM credit spreads, but keep them on your radar screen.
 

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

DISCLAIMER

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

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

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