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Daily Newsletter, Monday, 11/28/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Options 101

Market Wrap

Dow 11K Party Dashed

The mainstream financial press ran headlines welcoming the imminent "arrival" of Dow 11K for today, but the market didn't cooperate. Overnight strength succeeded only in running short stops, and the opening bell marked the high of the day. The Dow never touched 11K and the S&P never touched 1270. A steep morning decline consolidated and bounced weakly on the way down, but the bias was to the downside throughout the session.

Breadth was negative, with the number of declining issues nearly doubling advancing issues on the NYSE and more than doubling on the Nasdaq. New highs outnumbered new lows, but volume breadth was strongly negative throughout the day, with declining volume leading 2.75:1 on the NYSE and 2.4:1 on the Nasdaq. Option volatility rose, and volume was heavier than in recent sessions.

Today's lone economic report was Existing Home Sales for October. The National Association of Realtors reported that sales of existing US homes fell a seasonally-adjusted 2.7% from 7.29 million in September to 7.09 million in October, with a 3.5% rise in the number of unsold homes to 2.87. This latter was the highest reading in 20 years according to Marketwatch, and represents a 4.9 month supply at current rates, the highest in more than 2 years. The median sale price rose to $218,000, 16% higher than in October 2004 and the quickest price rise since July 1979. Condominium and co-op sales declined a seasonally-adjusted 4.4%. On a non-seasonally adjusted basis, Existing Home Sales fell 10.2%, and condo/co-op sales fell 14.8% from last month. Chief economist for the NAR, David Lereah, was quoted as saying that this data signals that the housing sector has likely peaked.

Daily Dow Chart

**Due to a timing discrepancy with my data provider, the attached chart displays a closing print of 10885.67. This print is INCORRECT: the official close was 10890.72.

The Dow got clipped for a 41 point loss to finish at 10890, failing from its opening high at 10952. On the daily chart, the drop from 35-day Keltner resistance took out the previous session's low, but did not seriously threaten what remains a very steep rise off the October lows. The oscillators remain pinned to the ceiling in overbought territory, overdue for a downphase and still trending. However the violation of the recent lows is the first step in a daily cycle reversal, and a break back below rising linear support at 10860 would bring the previous highs at the 10700-10710 Fibonacci line into view.

Daily S&P 500 Chart

The SPX lost 10.78 to close at 1257.46. Unlike the Dow, the SPX's decline took out the previous 2 sessions' lows, and generated the first sign of trouble for the day cycle, with the 10 day stochastic printing a preliminary sell signal. However, because this cycle has been trending for several weeks, there's a higher than usual chance of its being a false print. More weakness tomorrow, or at least a failure to bounce, would result in a more reliable sell signal. Today's 1257.17 low is light support above the stronger 1245 level at the August highs.

Daily Nasdaq Chart

The Nasdaq buried Friday's and Wednesday's lows, losing 23.to close at 2239.37, 3 basis points off the session low. As with the SPX, this drop generated the first suggestion of sell signals in the trending oscillators, but its too early and still too deep within the ongoing steep rising price trend to rule today as The reversal. The toppy QQQQ:QQV ratio (QQQQ price divided by NDX volatility) suggests further that today could have been it, but it too can carry further along a trend than traders expect. A break of 2225 support would likely be sufficient to seal the deal. However, today's low came at former resistance turned support connecting the January and August highs, and if it holds, a continuation of the rally could take the COMPQ to rising parallel trendline resistance at the 127% retracement off last year's low- up at 2308.

Daily TNX Chart

The Treasury auctioned $34 billion of 13- and 26-week bills to refund $31.87 billion maturing, raising $2.13 billion of new cash. Also announced was the size of this week's 4-week bill auction- $20 billion in 4-week bills will be auctioned to refund $15 billion in maturing bills, for net new borrowing of $5 billion. Foreign central banks purchased $9.95 billion of the 13- and 26-week bills, a respectable showing but weaker than we've seen recently (last week's participation was for $12.7 billion). The 13-week bills sold for 3.9% yielding 3.994% and received 2.34 bids for each awarded. The 26-week bills set a high-rate of 4.155% yielding 4.303% and generated 2.31 bids for each awarded.

The Fed's open market desk had no repos maturing today, but added a $5 billion overnight repo. Demand for the money was unchanged from Friday, with the high rate for treasury collateral at 3.99% and the stop out rate 3.97%, just below the overnight target rate. The Fed remains accommodative via its open market desk, perhaps to assist with the stepped up pace of Treasury borrowing this week.

Ten year notes were firm throughout the day, and yields (TNX) fell below 4.4% for the first time since the brief trendline test in October. With the daily cycle downphase oversold and looking bottomy, bond bulls/yield bears will seek to begin protecting profits. However, the weekly cycle is only starting to roll over from overbought territory, suggesting possible sideways chop as the opposing cycles resolve. For the day, the TNX finished lower by 2.5 bps at 4.406%, while the 13-week rate (IRX) fell 2 bps to close at 3.83%.

Daily Chart of Crude oil

Warm weather was credited for a steep drop in the price of crude oil this morning, as well as last week's inventory data. A drop to 56.725 at the morning low remained easily above last week's lows, however, and there was no indication that the weakness was anything more than a shallow pullback within the new daily cycle upphase. A break below the 56 level would cause a bearish whipsaw and target 54 next, but so far the decline has been shallow. Crude oil closed -1.3 at 57.40

Black Friday's retail sales results were released Sunday. ShopperTrak, which tabulates sales at 45,000 mall-based retailers, reported that the day after Thanksgiving saw a 0.9% decline in sales from last year's figure, to $8.01 billion. Below the surface, big-box discount chains outpaced smaller mid- to higher-end merchants. Wal-Mart estimated that its November sales will rise 4.3%, at the high end of its 3%-5% growth estimate, and reported that 10 million shoppers had entered its stores before noon on Friday. Also, credit card sales rose, with Visa reporting a 14% jump from Black Friday 2004 to $3.9 billion. Some attributed the disparity between the discount store surge and the smaller merchant's weaker results to advertising patterns, with the big-box sellers conducting an ad circular blitz, opening their stores earlier and emphasizing high-demand items such as LCDs and digital cameras. Others saw the pattern as indicating tougher times for consumers seeking bargains and labouring under higher energy prices, higher debt levels and a tighter job market.

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That report was quickly followed up with stories of melees and mobs of insatiable shoppers, and a report from the National Retail Federation that consumers were spent 22% more over the weekend ($27.9 billion) than they did one year ago. The NRF predicts that consumers will spend 6% more this holiday season than they did during last year's. ComScore Networks estimates that today, "CyberMonday," being the Monday following Black Friday, will see a 24% rise in online consumer spending over last year's Monday figure. The thinking is that online shopping takes place predominately at work rather than at home. Akamai (AKAM), provider of online content delivery, reported that online retail shopping traffic has been rising 3.6% per week since October 31, with peaks occurring on Monday afternoons. In any event, the story will be told as the sales figures trickle out this week. WMT closed lower by .97% at 50.00.

In corporate news, Merck (MRK) made headlines with an announcement confirming its intent to implement a global restructuring plan that will see the closure or sale of 5 out of 31 manufacturing plants. To be completed by the end of 2008, the plan will result in the termination of 7,000 jobs and the accrual of $1.8 billion to $2.2 billion in charges. The company expects to realize savings of $3.5 billion to $4 billion in 2006-2010. MRK also announced a 2005 EPS target of $2.47-$2.51, compared with prior analyst expectations of $2.50. MRK closed lower by 4.58% at 29.56.

New York A-G Eliot Spitzer announced that Federated Investors (FII) has agreed to pay $100 million in settlement of state and federal investigations into improper mutual fund trading practices at clients' expense. The settlement is comprised of $35 million in restitution, $45 million in civil penalties and a $20 million in management fee reductions over five years. FII had been accused of "market timing" with three groups given an unfair advantage over FII's individual clients, as well as illegally processing certain orders after the market's close. FII collected fees on these groups' assets. FII lost 2.3% to close at 35.62.

After the bell, the Treasury issued its report on Chinese currency activity, and found that China could not be labelled as a "currency manipulator" because of the "initial step" it has taken to allow its currency to float within a narrow price band. Secretary Snow warned, however, that China must continue to "reform" its forex regime to avoid being labelled as a manipulator. Secretary Snow stated, "The adjustment of global imbalances is a shared responsibility that must be undertaken in a way that maximizes sustained global growth. America's open trade and capital markets and the corresponding flexibility and adaptability of our economy -- allow the United States to sustain sizable current account imbalances. However, it would be imprudent to test the limits of our ability to absorb these imbalances." The complete report is available at http://www.treas.gov/press/releases/js3024.htmm.

Although this was a light day for economic data, it's going to be a busy week. Tomorrow we get Durable Orders, Consumer Confidence and New Home Sales. On Wednesday, it's the GDP, Chicago PMI, weekly Crude Inventories, weekly Mortgage Bankers Association data, and the Fed's Beige Book. On Thursday, we get the Auto and Truck Sales, Initial Claims, Personal Income and Personal Spending, Construction Spending and the ISM Index. On Friday, it's the Employment Report, with Nonfarm Payrolls, the Unemployment Rate, Hourly Earnings and Average Workweek.

TTomorrow's session will hopefully confirm or deny the weakness seen today. Any further weakness would likely kick off the overdue daily cycle downphases, and with the weekly cycles also toppy, traders following these longer timeframes will be interested in the closing print. With the intraday cycles oversold and trying to turn up as of today's close, a weak open would be a clear break from this November's trend of rewarding buyers on every dip. However, with the steep price trend still not violated, it's early for bears to turn their backs on the bulls. We'll be following it tick-by-tick in the Market and Futures Monitors. See you there!
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
NNone None None

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Dominion Res. - D - close: 77.20 chg: -1.04 stop: 74.75

D is both an electric utility and a natural gas producer so the stock was somewhat insulated from the sharp sell-off in oil and natural gas stocks today. The overall pattern remains bullish for D but traders may want to wait a bit on initiating new positions. It looks like the stock is going to pull back and retest support in the $76.00-76.50 region (we're watching the $76.40 mark). Look for signs of a bounce before considering calls. More conservative traders may want to wait for a move over the simple 50-dma (78.85) or even the $80 level before considering longs.

Picked on November 27 at $ 78.24
Change since picked: - 1.04
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 1.8 million

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Goldman Sachs - GS - close: 131.10 chg: -3.02 stop: 128.49*new*

Broker-dealer stocks were hit with profit taking today. Seems that investors rushed to lock in profits after the Thanksgiving peak. Shares of GS lost 2.25% and pulled back toward its simple 10-dma. Nothing moves in a straight line so the occasional pull back is okay with us but we're going to tighten the stop a bit in case this decline sees any follow through. We're raising the stop loss to $128.49 and more conservative traders may want to put it closer to $130. A bounce from the $130 level could be used as a new bullish entry point. In the news GS confirmed that it will report earnings on December 15th. We plan to exit the day before. We are targeting a move into the $139-140 range.

Picked on November 20 at $131.58
Change since picked: - 0.48
Earnings Date 12/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Hovnanian - HOV - close: 49.37 change: -1.98 stop: 47.45

This morning the existing home sales report came out and the numbers were a bit under analysts' expectations. Investors used the report as an excuse to lock in profits on the housing stocks, where many have rebounded from their October and November lows. HOV is one such stock that lost 3.8% and fell back under the $50.00 mark. We do expect the decline to continue and we're watching HOV's 10-dma near $48.65 to offer the first line of support. Readers can watch for a bounce from the 10-dma or the $48 level as a new bullish entry point. Until then we would not begin new long positions.

Picked on November 21 at $ 49.25
Change since picked: + 0.12
Earnings Date 12/07/05 (unconfirmed)
Average Daily Volume = 1.5 million

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Intl. Bus. Mach. - IBM - cls: 89.11 chg: +0.31 stop: 84.85

IBM displayed some relative strength today by closing in the green amid a market-wide decline. The stock's upward trend is still intact and shares could hit our target in the $89.90-90.00 range at any time. At the same time IBM looks short-term overbought and we would not be surprised by a dip to its 10-dma (87.30). More conservative traders may want to think about exiting early right here for a profit. We are prepared to hold IBM through the end of the year.

Picked on November 15 at $ 85.25
Change since picked: + 3.86
Earnings Date 01/16/06 (unconfirmed)
Average Daily Volume = 5.6 million

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Novastar Fincl. - NFI - cls: 30.25 chg: -1.88 stop: 29.24

Ouch! NFI was not immune to Monday's market pull back. Shares under performed the market with a 5.85% decline. The stock may have been affected by the existing home sales report, which came in under Wall Street's estimates. If NFI can bounce back above the $30.50 level we would consider new bullish positions. More conservative traders may want to wait for a rebound back over the $31 level. NFI's next earnings report is not until February so we're going to target the 200-dma near $35 over the next eight weeks.

Picked on November 23 at $ 31.65
Change since picked: - 1.40
Earnings Date 02/06/06 (unconfirmed)
Average Daily Volume = 621 thousand

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NovAtel Inc. - NGPS - close: 30.11 chg: -1.40 stop: 27.75

NGPS has pulled back to broken resistance now new support at the $30.00 level, which is underpinned by its simple 10-dma. A bounce from here could be used as a new bullish entry point. If NGPS trades under the $29.50 level more conservative traders may want to exit early although traders should keep in mind that NGPS should also have support at the $28 level, which was the bottom of its previous trading range. Our target is the $35.00-36.00 range by year-end.

Picked on November 21 at $ 30.45
Change since picked: - 0.34
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 292 thousand

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Phelps Dodge - PD - cls: 131.48 chg: -3.22 stop: 124.99

PD experienced the same profit taking most of the market did. Shares of the copper producer pulled back toward the $131 level. Readers can use a bounce from the $131 or $130 levels as a new bullish entry point. More conservative traders might want to consider tightening their stop losses. Our year-end target is the $139.90-140.00 range. More conservative traders may want to target the October high near $138.50.

Picked on November 18 at $131.25
Change since picked: + 0.23
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 2.7 million

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Polaris Ind. - PII - close: 49.15 change: -0.29 stop: 45.95

PII held up relatively well considering the market's weakness. If PII declines any further look for the $48 level to offer support. A bounce from $48 could be a new bullish entry point. Our year-end target is the $54-55 range under its simple 200-dma.

Picked on November 21 at $ 48.47
Change since picked: + 0.68
Earnings Date 01/12/06 (unconfirmed)
Average Daily Volume = 467 thousand

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Rockwell Autom. - ROK - cls: 56.15 chg: -0.70 stop: 54.80

There are no surprises here. We're expecting ROK to pull back and retest the $55 level, which should be support. We see no changes from our weekend update.

Picked on November 03 at $ 55.90
Change since picked: + 0.25
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand

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Walter Inds. - WLT - close: 50.26 change: -1.40 stop: 45.95

WLT has pulled back to what should be support at the $50.00 level. A bounce from here can be used as a new bullish entry point. If the stock continues to fall the next level of support would be the $48 level. The P&F chart looks very bullish with a $67 target. We believe shares can run into the $57-58 range before year's end.

Picked on November 20 at $ 51.50
Change since picked: - 1.24
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 927 thousand
 

Put Updates

Invitrogen - IVGN - close: 62.36 chg: -0.70 stop: 66.05

So far so good. IVGN lost another 1.1% today on above average volume. The afternoon bounce began to fail, which is consistent with its trend of lower highs. The next challenge is potential support at the $60 level. We see no changes from our weekend update. We're going to aim for a decline into the $57.50-56.50 range. Our time frame is eight weeks. We do not plan on holding over IVGN's late January earnings report.

Picked on November 27 at $ 63.06
Change since picked: - 0.70
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 1.2 million
 

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: 79.31 chg: -0.08 stop: n/a

ABC weathered the market decline today pretty well. We see no changes from our weekend update. We are not suggesting new strangle positions at this time. Our current strangle involves the December $80 calls (ABC-LP) and the December $70 puts (ABC-XN). Our estimated cost was $2.80. Our current target is for a rise to $5.00 in the strangle.

Picked on October 16 at $ 74.81
Change since picked: + 4.55
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

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Amer. Eagle Out. - AEOS - cls: 23.12 chg: -0.99 stop: n/a

Retailers slid lower on Monday. Early cries that sales on "Black Friday" were better than expected were questioned by the market on Monday as more data became available. The RLX retail index lost 1.58%. Shares of AEOS lost 4.1% and is now testing support at its two-month trendline of higher lows. We are not suggesting new strangle positions at this time. The current strangle has an estimated cost of $2.35 with the January $27.50 calls (AQU-AY) and the January $22.50 puts (AQU-MX). We are targeting a rise to $4.70.

Picked on November 13 at $ 25.47
Change since picked: - 2.32
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 61.60 chg: -1.27 stop: n/a

Shares of ANF were also affected by the weakness in the retail sector on Monday. The stock is testing support at its 10-dma. We wouldn't be surprised to see a dip back toward support at broken resistance near $60.00. We are not suggesting new strangle positions at this time. The options in our strangle are the January $65 calls (ANF-AM) and the January $55 puts (ANF-MK). Our estimated cost was $5.15. We're looking for a rise to $8.50.

Picked on November 13 at $ 59.67
Change since picked: + 2.80
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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Chicago Merc. Exchg. - CME - cls: 371.30 chg: -25.60 stop: n/a

Amazing! We said that CME was volatile and the stock has certainly shown us why over the past few days. Last week's rally has been reversed by today's sharp sell-off. Today's move was fueled by a downgrade this morning based on valuation concerns. Volume today was well above normal. We are not suggesting new strangle positions at this time. Our current play involves the January $400 calls (CMJ-AK) and the January $350 puts (CMJ-MA). Our estimated cost was $26.70. We're aiming for a rise to $40.00 in the strangle before January options expire.

Picked on November 20 at $375.90
Change since picked: - 4.60
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

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D.R.Horton - DHI - close: 35.57 chg: -1.05 stop: n/a

DHI is another homebuilder that experienced some profit taking following this morning's existing home sales data. The stock could pull back even further before reasserting its current up trend. We are not suggesting new strangles at this time. Our current play involves the January $35 calls (DHI-AG) and the January $30 puts (DHI-MF). Our estimated cost was $3.15. We're aiming for a rise to $6.00.

Picked on November 13 at $ 32.56
Change since picked: + 3.01
Earnings Date 11/16/05 (confirmed)
Average Daily Volume = 3.2 million

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Four Seasons - FS - close: 50.01 chg: -0.30 stop: n/a

FS failed to truly participate in today's market decline. If we don't see a move in the next several days we may need to start thinking about an early exit to try and salvage the play. We are not suggesting new strangles at this time. 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.

Picked on November 08 at $ 55.37
Change since picked: - 4.64
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

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Hutchinson Tech. - HTCH - cls: 26.85 chg: -0.00 stop: n/a

One could argue that HTCH's close at "unchanged" is bullish. Short-term it looks like HTCH could turn lower, especially if the NASDAQ continues today's consolidation. We are not suggesting new strangles at this time. 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 have adjusted our initial target from $3.00 to breakeven at $1.65 since the post-earnings reaction was not as big as expected.

Picked on October 26 at $ 24.89
Change since picked: + 1.96
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 666 thousand

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Lear Corp - LEA - close: 27.93 chg: +0.05 stop: n/a

The consolidation in LEA is narrowing so we can expect a move, either direction, pretty soon. Odds are the prevailing, bearish trend will continue. We are no longer suggesting new strangle positions. 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.

Picked on November 06 at $ 30.24
Change since picked: - 2.31
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 1.8 million

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Loews - LTR - close: 97.38 change: -0.42 close: n/a

The action in LTR was a bit of a surprise. The stock's momentum has stalled and shares looked ripe for some profit taking back toward the $95 level. Instead LTR closed with a minor loss. Short-term technicals remain bearish. We're not suggesting new plays. 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 plan to exit if our strangle rises to $5.00 or if shares of LTR hit 99.90.

Picked on October 23 at $ 89.94
Change since picked: + 7.44
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

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Verifone Holdings - PAY - cls: 22.85 chg: -0.31 stop: n/a

PAY still looks poised for a dip toward the $22 level. PAY is expected to report earnings on December 1st. Wall Street's estimates are for profits of 19-cents a share. Our current strangle involves the January $22.50 calls (PAY-AX) and the January $17.50 puts (PAY-MW). Our estimated cost was $2.60 and we're aiming for a rise to $4.50 or more.

Picked on October 12 at $ 19.98
Change since picked: + 2.87
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

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Protein Design Labs - PDLI - cls: 27.80 chg: -0.89 stop: n/a

We expected a dip toward $27.50 and that's what we got today. Shares of PDLI were already beginning to rebound into the afternoon. We see no changes from our weekend update. We are not suggesting new strangle positions. The options in our strangle are the December $30 calls (PQI-LF) and the December $25 puts (PQI-XE). Our estimated cost was at $1.80. We'll plan to sell if either side rises to $3.25.

Picked on October 30 at $ 27.70
Change since picked: + 0.10
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million

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Spectrum Brands - SPC - close: 18.16 change: -0.26 stop: n/a

SPC drifted lower again today and we see no changes from our weekend update. We are not suggesting new strangle positions at this time. 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.

Picked on November 08 at $ 20.63
Change since picked: - 2.28
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 576 thousand

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Questar Corp. - STR - close: 74.31 chg: -3.78 stop: n/a

Hope that this winter may be warmer than expected pushed natural gas prices lower. This move in the commodity helped force STR through the bottom of its recent trading range. We are no longer suggesting strangle positions in the stock. Our strangle involves the January $80 calls (STR-AP) and the January $70 puts (STR-MN). Our estimated cost was $5.10 and we're aiming for a rise to $9.50 or more.

Picked on November 20 at $ 76.25
Change since picked: + 1.94
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

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Texas Ind. - TXI - close: 49.40 chg: -0.17 stop: n/a

TXI is still offering an entry point to launch new strangles. The stock is stuck in a sideways trading range as we approach its December earnings report. Our suggested entry window is the $49.00-51.00 range although the closer to $50.00 the better! The options in our strangle are the January $55 calls (TXI-AK) and the January $45 puts (TXI-MI). Our estimated cost is $2.70. We're looking for a rise to $5.00 or more.

Picked on November 27 at $ 49.57
Change since picked: - 0.17
Earnings Date 12/15/05 (unconfirmed)
Average Daily Volume = 354 thousand

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Valero Energy - VLO - close: 95.27 chg: -6.01 stop: n/a

A sharp drop in oil prices under $57 a barrel pushed shares of VLO to a 5.9% decline. Today's decline in VLO also pushed the stock out of its narrowing consolidation pattern and under technical support at its simple 100-dma. We are not suggesting new strangle plays any longer. Our current play involves the January $110 calls (VLO-AB) and the January $90 puts (VLO-MR). Our estimated cost was $5.85 and we're aiming for a rise to $9.50. VLO is due to split 2-for-1 on December 16th so our post-split target will be a rise to $4.75.

Picked on November 21 at $101.00
Change since picked: - 5.73
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Dropped Calls

Amerada Hess - AHC - close: 122.71 chg: -8.52 stop: 124.49

The move in crude oil and oil stocks today looks like an overreaction. Crude oil slipped more than two-percent to under $57 a barrel and natural gas dipped toward $11.00/mbtu's as traders speculated that the warm weekend in the northeast may be a sign of a warm winter. The reaction in oil stocks was sharp. The OIX oil index lost 3.56% and the OSX oil services index lost 3.89%. Shares of AHC were harder hit with a 6.49% drop, which pushed shares through multiple levels of short-term support at its 10-dma, 50-dma, 100-dma and its multi-week trendline of higher lows. We have been stopped out at $124.49.

Picked on November 16 at $128.49
Change since picked: - 5.78
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.9 million

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Apache Corp. - APA - close: 66.23 chg: -3.27 stop: 64.95

We're going to exit early in APA. Shares of APA fell for the same reasons shares of AHC did. Traders produced a knee-jerk reaction in oil and natural gas prices on what some believe are hopes that we'll see a mild, warmer winter this year. The sell-off in the oil group was relatively sharp and APA lost 4.7% while falling through short-term support at its 50-dma. There is still potential support near $65 and its 200-dma for APA and we'll keep an eye on the stock for a rebound there. Yet in the meantime we're going to exit early to avoid further losses.

Picked on November 22 at $ 69.05
Change since picked: - 2.82
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 3.7 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Options 101

The Roth IRA and the use of options

No tax on any income, what a great haven for the covered call writer.

The Theory Behind the Practice

The Individual Retirement accounts have come a long way since their inception. The government has increased the amount an individual can put away from $2,000 up to $4,000. In addition, the introduction of the ROTH IRA, where you dont get the tax deduction for your contribution, however you dont pay ANY TAXES when you withdraw your money has opened a lot of opportunities to investors who are able to generate income and profits on a short term or continuous basis. The ROTH IRA, which is the perfect vehicle for the individual who is income generating motivated, is the way to go. Thus, opening the door for
COVERED CALL WRITING

IRA accounts, both traditional and ROTH, do have certain limitations as to what type of investments can be put into them. Several custodians may be more liberal then others, but the bottom line is there are restrictions. Limitations on the use of options are included on that restricted list. However, the use of the covered call is not restricted.

Covered Call Writing

The ROTH IRA is the perfect place for covered call writing. One has the opportunity to sell covered calls for premium (income) against his underlying securities. Even the investor who owns only a few hundred shares of an individual stock can participate in this strategy.

For Example: Jim Brown (fictional investor) owns 200 shares of HJK in his ROTH IRA, which is trading at $33 a share. John has had this stock for several years and is getting a small dividend of around $0.20 a share. HJK usually trades in a point range between $30 - $35, or maybe slightly higher or lower at any given time. Jim watches his stock go thru this cycle or slightly up and down ever quarter. Jim, obviously, is making no money from this stock, except the same dividend, which he receives. What should Jim do?

Enter.The Covered Call

Jim has the opportunity to generate income on a quarterly, monthly or even yearly basis if he so desires. Jim can sell call options against his HJK stock. For example: Jim decides he would like to sell a one-month out call option on his HJK stock. Jim decides to sell a HJK November 35 call for the price of $1.50. Jim has now given the right to someone to exercise or take his 200 shares of HJK stock away at the price of $35, between now and the third Friday, before the third Saturday in November (roughly 7 weeks). So what happens?
First, Jims ROTH account is immediately credited with $300 for the two HJK November 35 options he sold against his HJK stock. This gives the holder of the options Jim sold, the right to take Jims stock away at anytime before the November expiration at a price of $35.
Lets take a look at what Jims account looks like after he sells the two (2) HJK November 35 calls

FIGURE 1-1: JIMS ROTH IRA NOW LOOKS LIKE THIS.

As you can see Jim now has $350 in his ROTH IRA and owns 200 shares of HJK at $33.


The Scenarios

Scenario #1: HJK closes around the same price

Jims HJK stock trades as usual and closes at around $33.5 at the time of the November expiration. Since the stock closed at $33.5, it closed at less than the price of the November 35 option Jim sold.
The Result: The options Jim sold expired worthless and Jim keeps the $300. In addition because it is in a ROTH IRA, Jim will not have to pay any taxes on that gain when he eventually takes it out of his account. (The beauty a ROTH IRA, not taxes on any of your withdrawals or distributions.). Taking the scenario one step further, Jim will be able to then sell another option against his 200 shares of HJK for the month of December, if he so chooses, or any month further out that the HJK options are offered. Jim can also pick a different strike price (e.g. HJK December 40, HKL December 45, etc.). However if he picks a high strike price Jim will receive less premium because the option he is selling is less likely to be exercised because it is further out of the money then the 35-strike price Jim sold in November.

Scenario #2: HJK goes down!

Jims stock goes down. Stocks do tend to do that at times. In Jims case, because the option is under $35, the premium that Jim receives he keeps in his account, because the November 35 options he sold expired worthless. Once again, Jim has taxable event because all income earned in a ROTH IRA is tax-free when you take it out. REMEMBER TAX, not just tax deferred.

Scenario #3: HJK goes up over $35

Jim stock goes up to $36 an on the November expiration date, the buyer of Jims option to sell his stock at $35 exercises that option. What is the result?
Jim loses his stock at $35 (remember that is the strike price that Jim sold the option at.
So Jim receives $3500 for each of his 200 shares for a total of $7,000 plus Jim keeps the $300 premium he received for selling the November 35 options. So if Jim purchased his stock originally for anything less then $35, any gain Jim made is also TAX FREE, not just tax deferred, but TAX FREE. You are probably saying, but Jim doesnt have his stock! And you are correct. But Jim can go back and buy the same stock, maybe a little higher if he wants and do the same thing over, or better still just pick another stock of two and do the strategy with the new stock. REMEMBER, EVERYTHING JIMG MAKES IN HIS ROTH IRA IS TAX FREE.


The Real World

In the real world of option trading in your ROTH IRA you can do the same strategy that Jim does and you can do this with any stock that has options trading on them. (Believe me there are literally thousands and thousands). The unique thing about the ROTH IRA is all that income generated never gets taxed. No matter how profitable your ROTH IRA becomes, your withdraws and distributions are never taxed (Caveat: Remember you still have the same rules as the traditional IRA has and you will be subject to early withdrawal charges if you do so before age 57 )(There are a few exceptions, buy we will not go into them at this time).

The only downside with the covered write strategy is two fold.

1. You could have your stock called away from you. (Which isnt that bad, because you will have made a profit on the stock that was exercised and you will have earned the option premium. The only time you should not sell options against a stock is if you are buying and looking for a substantial move to a much higher price then you could receive for selling call options over the course of time. However, if you are not in love with your stock you should be prepared to have it called away and know that you will be receiving a profit for your stock and the option premium received.

2. Once you have sold an option you have to hold unto the option until the expiration date is reached and they either exercise your stock or the option expires worthless. However, you can always buy back the option that you sold either at a higher price it your stock has moved up or at lower price if the stock has gone done in price and keep a smaller amount of the premium, but you still would own the stock and could sell an option for another period of time down the road.

FIGURE 2-2: IBM EXAMPLE OF CALL PREMIUMS

Notice you can get $80 for just 3 weeks for the write for someone to take IBM at the price of $80 with it currently selling at close to only $80 a share.


The Bottom Line

The utilization of covered call writing inside a ROTH IRA is tailor made for this strategy, as all premiums received and all profit from stocks exercised at a profit will never be subject to any taxable consequence, because of the treatment of gains in a ROTH IRA are not taxed on withdrawal or distribution. The Covered Write and the ROTH IRA is a match made in heaven. Every individual that is eligible to have a ROTH IRA should definitely have one. This vehicle called the ROTH IRA becomes even more attracted when you incorporate the option strategy of call writing within it.

Until Next Time
 

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Options 101 by Steven Gail, and all other plays and content by the Option Investor staff.

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