Option Investor
Newsletter

Daily Newsletter, Monday, 12/05/2005

HAVING TROUBLE PRINTING?
Printer friendly version

Table of Contents

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

Market Wrap

Distribution Done

Last week's Nasdaq rally extended to this morning, as the futures held at and slightly above Friday's closing highs. The Dow and SPX were weaker but also held Friday's closing levels until the opening bell. The music stopped at the open, however, and a grind to the low end of the premarket range quick dissolved into a flush below Friday's lows. Thursday's range was partially retraced on the Nasdaq and SPX, and entirely reversed on the Dow prior to a closing bounce.

Volume was strong on the indices while weaker on the ETFs, and volume breadth was solidly negative on the Nasdaq, less so on the NYSE. Volume breadth finished with 1.4 declining shares for each advancing on the NYSE, 2 declining shares for each advancing on the Nasdaq. Today's print constituted a key reversal and bearish engulfing print for the day.

At 10AM, the Institute for Supply Management released its ISM Services index. The ISM index showed an increase in activity from purchasing managers in November that was less than expected at 58.5%, down from 60% in October. Economists had been expecting a reading of 59.2%. Readings above 50% indicate growth in this diffusion index. The Price-paid component fell from 78% to 74.2%, a persistently high level. Marketwatch quoted the ISM as saying that "There is still significant concern about the relatively high level of energy prices and its impact on freight costs and on the prices of other materials and services."

Daily Dow Chart

The Dow was looking a lot more bearish at 2PM than it did at the close, with a sideways bounce retracing part of the previous drop. What would have been a complete reversal of Thursday's gains was corrected by that bounce, but below 10855-875, 10800 looms large as next support. The Dow was the weakest link last week, with Friday's action clearly negative where the Nasdaq was positive. Bulls need to see a violation of the bearish triangle, on a break above 10875, while bears will look for a break of 10800 to target 10700-710 confluence. For the day, the Dow closed lower by 42.5 at 10835.01.

Daily S&P 500 Chart

The SPX lost 2.99 to close at 1262.09, breaking Friday's range but failing to retrace even half of Thursday's tall candle. The descending trendline connecting the rally highs has resulted in a slow roll in the 10-day stochastic, technically a downphase but more of a trending move that remains overbought. Descending resistance is at today's 1265 high. It's very early to consider this as a descending triangle, though it might be. A break below 1257 will target potential triangle support at 1249-50.

Daily Nasdaq Chart

The Nasdaq lost 15.73 to close at 2257.64, declining from an opening high of 2269.48. Steeply rising trendline support was tested but not broken. The daily cycle oscillators continue their slow roll, printing what still appears to be a bearish divergence against the higher price highs. Note that there's no possibility of a declining triangle interpretation here at the highs, because the highs have been rising. Rising trendline support is at 2250.

Daily TNX Chart

The Treasury announced the size of the upcoming 4-week bill, 5- and 10-year note auctions this morning, giving us some indication of the liquidity picture for the remainder of the month. The next 4-week bill auction will be in the amount of $16 billion, refunding $22 billion in maturing bills for a net paydown of $6 billion- adding to liquidity available to the market. However, the 5- and 10-year note auctions in the amount of $13 billion and $8 billion respectively will raise new cash of $21 billion, for a net drain of $15 billion. However, with the cash management bills auctioned on December 1st and 2nd maturing December 15th, $38 billion will be paid down, resulting in a net paydown of $23 billion. Overall, the Treasury should become a net contributor to the market, which would support a positive seasonal bias for mid-December. Of course, the Treasury isn't the only player affecting liquidity flows, but we should see it exert a supportive influence on the market.

Also, note that the paydown/adds will be from short-dated cash management and 4-week bills, while the new cash/drains will be from longer-dated 5- and 10-year notes. This combination exploits the flattened yield curve, by adding liquidity via paydowns of short-dated debt and raising cash via longer dated notes. It should encourage short rates to decline and longer rates to rise, all things being equal.

Today, 13- and 26 week T-bills were auctioned, $34 billion in total to refund $31.9 billion maturing for a net paydown of $2.09 billion. Indirect bidders purchased $8.4 billion of the total for a respectable 25% participation. The 13-week bills sold for 3.93% yielding 4.025% and generating 2.34 bids for each awarded. The 26-week bills sold for 4.185% yielding 4.335%, setting a 2.5 bid to cover ratio.

Bonds were weak throughout the session, with ten year note yields gapping up at the open and finishing strong, +4.8 bps at 4.567%. The daily cycle indicators are showing preliminary buy signals on the bounce from 4.4% support, and a break back above 4.6% would suggest a move to the top of the rising linear channel at 4.7%.

Daily Chart of Crude oil

Crude oil gapped higher overnight and held above the descending linear regression channel off the Katrina high at the end of August. The intraday high was 60.825, but even the end of session pullback held above gap. Oil bulls need to see the 59 area hold if retested, and a break above 61.30 to confirm a new uptrend off the 56 lows. For the day, February crude oil closed higher by .625 at 59.95.

Traders returned to their screens this morning to find an early morning report from Ford (F) to the effect that the automaker intends to close 8 North American assembly and parts plants. Like GM, which is eliminating 30,000 jobs and closing 12 North American facilities, F cited "soaring" raw material and health-care costs as well declining North American market share. Reuters reported that F has lost more than $1.4 billion from its North American unit. It's worth noting that the Fed has been iterating and reiterating its view that inflation is "well-contained," and, along with government, has been a supporter of the elimination of global barriers to employment. It is my own view that reality can be seen in announcements such as this: every consumer sees the price of pretty much everything other than consumer electronics rising, and increased competition from international, particularly Asian labour is pressuring wages. With North American wages not growing as quickly as the price of commodities, consumers here have relatively less money to spend, and it's pressuring North American manufacturers who must pay more for inputs and cannot charge correspondingly more for their finished products. F closed lower by 1.1% at 8.06, while GM gained .14% to close at 22.13.

Advertisement

Bonus Gifts with your ONEPASS to Option Investor Newsletters

Now you can upgrade to the six newsletters offered by Option Investor and get a big discount. PLUS - get these free bonuses with your order:

- Option Calendar Mouse Pad
- Stock Trader's Almanac - 2006

Click here for the details, and to upgrade:

http://www.OptionInvestor.com/newsletters/onepass.aspx?aid=150

JPM announced that it intends increase its staff in India by 4,500 during the next two years. Marketwatch reported that these new graduates will be hired instead of "replacing staff somewhere else." INTC announced that it will invest more than $1 billion over the next 5 years in India and, more particularly, Indian tech companies. Craig Barrett said that this includes a $250 million venture capital fund to exploit the rapid growth in Indian information technology. Currently, INTC employs 3,000 engineers and professionals in its Bangalore-based design center.

In other news, NTL (NTLI) announced that it would offer $1.4 billion to purchase Virgin Mobile. NTLI gained 1.16% to close at 60.80. Later in the morning, Boston Scientific (BSX) announced its $25 billion bid for Guidant (GDT). The bid equates to $72 per share in cash and BSX stock for all of the outstanding GDT stock, and exceeded JNJ's previous $22 billion or $63.43 per share bid by roughly 14%. Both Fitch and S&P placed BSX on credit watch negative, citing their expectation that the unsolicited offer would result in BSX's incurring excessive debt leverage to finance the deal. BSX lost 3.59% to close at 26.35, while GDT gained 9.96% to close at 67.98.

Calpine traded huge volume today as the NYSE announced its intention to suspend trading in and seeking delisiting of CPN shares tomorrow due to its "abnormally low selling price" and the possibility that the company could be pushed into bankruptcy. This follows a Delaware court ruling requiring CPN to repay $313 million in mis-spent proceeds from the sale of its natural gas supplies. The company characterized the sum as "ruinous" and requested a suspension of the order, which motion was dismissed on Friday. The company now has until January 22 to comply with the ruling. CPN lost 14.29% to close at .24.

Britain's Chancellor of the Exchequer, Gordon Brown, lowered his forecast for UK GDP growth from 3%-3.5% to 1.75% in 2005. Brown expects 2006's GDP to grow 2% - 2.25%. He cited "tough" economic conditions exacerbated by the oil rally and the downturn in the housing market. British pound futures were trading higher by .5% at 1.7423 as of this writing.

The President addressed what the Associated Press characterized as a "friendly" crowd at the Deere-Hitachi Construction Machinery Corp. in North Carolina, calling on companies to fund their pension obligations and on Congress to clarify applicable rules to ensure that US workers get paid their pensions as promised by their companies, and not by taxpayers via federal pension insurance. Bush, whose approval rating on the economy was at a low of 37% in the latest AP-Ipsos poll, cited last week's job numbers and reiterated that the economy is strong, with brighter days ahead. That poll and others have shown that a majority of Americans are pessimistic about the economy, however. The President also called upon Congress to extend the tax cuts due to expire, and to implement the Administration's pending health and energy plans.

This is scheduled to be a lighter week for economic data. Tomorrow will see the releases of Q3 Productivity and Factory Orders, followed by Wednesday's weekly mortgage and petroleum data, as well as Consumer Credit in the afternoon. On Thursday, it's the weekly Initial Claims report and on Friday, Michigan Sentiment and Wholesale Inventories.

For tomorrow, traders will be watching this morning's highs carefully. With the daily cycle indicators in various stages of their slow-motion rollovers, a failure to regain yesterday's high will put today's lows in peril, opening the door to daily cycle downphases lasting potentially for weeks. On the other hand, positive seasonality, a friendlier Treasury, and a so-far unbroken rising price trend suggests that it's still early for bulls to be worrying. Barring a break of today's lows, the rising trend remains intact. We'll be following and analyzing the action 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
None None None

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cummins Inc. - CMI - close: 90.83 chg: +0.77 stop: 87.75

CMI fared better than most on Monday. The stock dipped to $88.90 near its rising 10-dma before bouncing sharply this morning. The rebound back over the $90.00 level looks like a new bullish entry point to consider buying calls. Our target is the $97-100 range. However, technical traders may want to hesitate before initiating new long with the DJIA producing a new MACD sell signal on its daily chart today.

Picked on December 01 at $ 91.32
Change since picked: - 0.49
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 611 thousand

---

Centex Corp. - CTX - close: 72.92 chg: -0.94 stop: 71.39

The rebound in homebuilders paused today as bond yields and interest rates (and thus mortgage rates) crept higher. Shares of CTX spent most of the session consolidating sideways and still in its upward channel. We are trying to limit our risk with a relatively tight stop loss so if CTX falls out of its bullish channel we'll be quickly stopped out. Readers may want to wait for a move over $73.50-74.00 before considering new long positions. Our target is the $78.50-80.00 range.

Picked on December 04 at $ 73.86
Change since picked: - 0.94
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 2.6 million

---

Dominion Res. - D - close: 76.53 chg: +0.55 stop: 74.75

Shares of D are starting to rebound after testing technical support at its 200-dma on Friday. Today's move looks like a new bullish entry point to buy calls but traders should note that D still has some resistance near 78.30 and its simple 50-dma. Our target is the $84.50-85.00 range.

Picked on November 27 at $ 78.24
Change since picked: - 1.71
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 1.8 million

---

FMC Corp. - FMC - close: 54.12 chg: -1.29 stop: 51.95

FMC did not escape the profit taking today and shares fell 2.3% back under the $55 level and its simple 200-dma. We would not be surprised to see FMC dip back toward the simple 10-dma near $52.80-53.00 before rebounding higher. Traders may want to wait and see where FMC bounces before initiating new positions. This is especially true considering the rally in oil prices today. FMC is a chemical manufacturer and rising oil prices increases their costs and probably lowers their margins. Our six-week target is the $59.85-60.00 range.

Picked on December 01 at $ 55.04
Change since picked: - 0.92
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 270 thousand

---

Hovnanian - HOV - close: 50.71 change: +0.01 stop: 48.99

HOV displayed some relative strength today. Many of the homebuilders slipped lower as interest rates ticked higher. HOV dipped toward the $50 level, consolidated there for a few hours, and then rebounded higher into the afternoon. This looks like a new bullish entry point, unfortunately, we're running out of time before HOV reports earnings on December 7th. We do not want to hold over the report. Our plan is to exit on Wednesday afternoon near the closing bell.

Picked on November 21 at $ 49.25
Change since picked: + 1.46
Earnings Date 12/07/05 (unconfirmed)
Average Daily Volume = 1.5 million

---

Kerr Mcgee - KMG - close: 90.43 chg: +0.13 stop: 84.99

Oil stocks were a green spot in the markets today as crude oil rose toward the $60/bbl. Yet even the early strength in oil stocks could not hold and KMG drifted back toward the $90 level. We remain bullish and readers can choose to buy this dip or look for a bounce from the $90 level. Our mid January target is the $98.50-100 range.

Picked on December 02 at $ 90.26
Change since picked: + 0.17
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.8 million

---

Kinder Morgan - KMI - close: 93.88 chg: +0.88 stop: 87.45

KMI fared better than some of its energy stock peers because of its exposure to natural gas. The XNG natural gas index rose 0.7% after a cold spell across much of the nation renewed concerns over supplies. Our target is the $98.50-100 range.

Picked on December 02 at $ 92.75
Change since picked: + 1.13
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 749 thousand

---

NovAtel Inc. - NGPS - close: 28.73 chg: -1.39 stop: 27.95 *new*

This looks like bad news. NGPS broke down more significantly under the $30 level and technicals are looking even worse. The stock does have some support at the $28 level but more conservative traders may want to seriously consider exiting right here. If you're feeling more aggressive NGPS could bounce from the $28 level and give us a chance to exit near the $30 level. We're going to bet on a bounce from $28 but we're raising our stop loss to $27.95. We are not suggesting new positions.

Picked on November 21 at $ 30.45
Change since picked: - 1.72
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 292 thousand

---

Polaris Ind. - PII - close: 52.90 change: -0.34 stop: 48.49

Sellers tried to take PII lower today and the stock gapped lower to open at $52.19. Fortunately, PII quickly rebounded and volume came in well above the average. Our target is the $54.00-55.00 range.

Picked on November 21 at $ 48.47
Change since picked: + 4.44
Earnings Date 01/12/06 (unconfirmed)
Average Daily Volume = 467 thousand

---

Companhia Vale de Rio - RIO - close: 44.10 chg: -0.98 stop: 41.85

RIO continued to consolidate today. Watch for a bounce from the $43.00 level as a new potential entry point to buy calls. More conservative traders may want to ratchet up their stops toward $43, which is near the multi-week trend of higher lows. The company announced it will hold, and broadcast, its analyst day on Thursday, December 8th. More conservative traders might wait for a new move over $45 before initiating new positions.

Picked on December 02 at $ 45.45
Change since picked: - 1.35
Earnings Date 03/14/06 (unconfirmed)
Average Daily Volume = 2.7 million

---

Rockwell Autom. - ROK - cls: 59.39 chg: +0.38 stop: 55.75

ROK displayed some relative strength and hit a new relative high at $59.73 today. Our target is the $61-62 range but more conservative traders may want to exit near $60, which could be round number, psychological resistance. We would not suggest new positions here.

Picked on November 03 at $ 55.90
Change since picked: + 3.49
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand

---

Sunoco Inc. - SUN - close: 83.75 chg: +0.93 stop: 76.45

Oil refiners were a bright spot in the markets today and SUN added 1.12% to close at a new all-time high. We don't see any changes from our previous update. Our target is the $89.90-90.00 range.

Picked on December 02 at $ 81.75
Change since picked: + 2.00
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 2.8 million

---

Tractor Supply - TSCO - cls: 55.52 chg: +0.37 stop: 51.45

TSCO continues to ignore the weakness in the retail sector and shares hit a new four-month high today. If TSCO pulls back then the $53.00-52.50 level should act as support. Our five-week target is the $57-58 range.

Picked on November 30 at $ 52.75
Change since picked: + 2.77
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

---

Walter Inds. - WLT - close: 51.39 change: -0.42 stop: 45.95

Weakness in the major averages seemed to stall the bounce in WLT today. The stock continues to look bullish and we are targeting a run into the $57-58 range by year-end.

Picked on November 20 at $ 51.50
Change since picked: - 0.11
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 927 thousand
 

Put Updates

Magna Int. - MGA - close: 67.47 chg: -0.67 stop: 70.31

MGA continues to sink and its technical picture is looking pretty bearish. However, the stock is testing short-term support near $67. We would not be surprised by a bounce tomorrow. Readers can watch for a failed rally under $69 as a new bearish entry point to buy puts. Our target is the $63-62 range.

Picked on December 04 at $ 68.14
Change since picked: - 0.67
Earnings Date 02/07/06 (unconfirmed)
Average Daily Volume = 318 thousand

---

Netflix - NFLX - close: 27.70 chg: +0.01 stop: 28.55

NFLX continues to consolidate sideways along the bottom of its rising channel. This heavily shorted stock could see some strong selling if it broke down under this support. Alternatively traders may want to consider buying calls if NFLX trades over $29.50 or $30.00. More aggressive traders may even want to get bullish on a move over $29.00 in an attempt to catch the next short squeeze. Our strategy involves a trigger to buy puts at $25.99. If triggered we'll target a drop to the $22.50 mark.

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 1.4 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.)

---

AmerisourceBergen - ABC - cls: 81.00 chg: +1.54 stop: n/a

ABC showed lots of relative strength today with a 1.9% gain and a new all-time high over the $80 level. The ABC-LP Dec. $80 calls are trading at $1.60bid/$1.75ask. Our estimated cost is $2.80. Our current target is $5.00 but we have less than two weeks before December options expire.

Picked on October 16 at $ 74.81
Change since picked: + 6.24
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

---

Amer. Eagle Out. - AEOS - cls: 20.57 chg: -0.43 stop: n/a

AEOS posted another loss. We're not suggesting new plays. 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. FYI: currently the January $22.50 puts are trading at $2.50bid/$2.60ask.

Picked on November 13 at $ 25.47
Change since picked: - 4.90
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

---

Abercrombie&Fitch - ANF - close: 61.42 chg: -0.68 stop: n/a

ANF continues to drift toward the $60 level, which should be support. We have about seven weeks to go before January options expire. 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: + 1.75
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

---

Blue Coat Sys. - BCSI - cls: 45.77 chg: +0.34 stop: n/a

BCSI continues to consolidated sideways near the $45 level. We see no changes from our previous update. Our suggested entry window is the $46-44 range but the closer to $45.00 the better. We're suggesting the January $50 call and the January $40 put. Our estimated cost is $3.25. We're aiming for a rise to $5.50.

Picked on December 04 at $ 45.43
Change since picked: + 0.00
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 416 thousand

---

Chicago Merc. Exchg. - CME - cls: 362.00 chg: -7.80 stop: n/a

CME sank back toward the $360 level and its simple 50-dma during today's 2.1% loss. We have about seven weeks left before January options expire. 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: -13.90
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

---

D.R.Horton - DHI - close: 36.32 chg: -0.20 stop: n/a

Shares of DHI experienced some profit taking this morning but the stock was bouncing back by the close. 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: + 3.76
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million

---

Four Seasons - FS - close: 48.73 chg: -0.95 stop: n/a

Good news. It looks like our patience might finally be rewarded here with FS. The stock lost another 1.9% and closed at a new low. More importantly it has fallen out of its three-week long consolidation near the $50 level. 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. FYI: the FS-MJ puts are trading at $2.65bid/$2.85ask.

Picked on November 08 at $ 55.37
Change since picked: - 5.38
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

---

Lear Corp - LEA - close: 27.18 chg: +0.09 stop: n/a

We see no changes from our previous update on LEA. We have about seven weeks left and by keeping the play open we're betting that LEA will trade near $24-23 before the options expire. 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). Our estimated cost was $1.60. We are targeting a rise to $3.20 or more. FYI: the LEA-ME puts are trading at $1.00bid/$1.10ask.

Picked on November 06 at $ 30.24
Change since picked: - 3.06
Earnings Date 10/26/05 (confirmed)
Average Daily Volume = 1.8 million

---

Loews - LTR - close: 96.96 change: -0.56 close: n/a

We don't see any changes from our previous update on LTR. 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. Currently the LTR-LS calls are trading at $$2.40bid/$2.65ask.

Picked on October 23 at $ 89.94
Change since picked: + 7.05
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

---

Verifone Holdings - PAY - cls: 23.30 chg: -0.90 stop: n/a

Hmmm.. PAY produced a failed rally at the $25.00 level on Friday. Today's 3.7% decline pulled the stock down toward the $23 level and filled the gap higher from Friday morning. Will bulls buy the dip here or has PAY produced sort of a double-top? We have about seven weeks left before January options expire. We're not suggesting new positions. 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. Currently the PAY-AX calls are trading at $2.00bid/$2.25ask.

Picked on October 12 at $ 19.98
Change since picked: + 3.32
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

---

Protein Design Labs - PDLI - cls: 27.80 chg: -0.60 stop: n/a

We see no change from our previous update on PDLI. This is shaping up to be a losing position. 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 have adjusted our target to breakeven at $1.80.

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

---

Spectrum Brands - SPC - close: 18.30 change: +0.23 stop: n/a

We don't see any change from our previous update on SPC. We have two weeks left before December options expire. To make this play a winner we need to see SPC trade under the $16 level in the next couple of weeks. More conservative traders may want to plan an exit near breakeven. 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. Currently the SPC-XW puts are trading at $0.25bid/0.35ask.

Picked on November 08 at $ 20.63
Change since picked: - 2.14
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 576 thousand

---

Questar Corp. - STR - close: 76.59 chg: +0.80 stop: n/a

Strength in natural gas stocks has pushed STR back toward the middle of its previous trading range. If natural gas continues to climb then STR could easily breakout over the 50-dma and then the $80 level. There are seven weeks left before January options expire. 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: + 0.34
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

---

Texas Ind. - TXI - close: 52.22 chg: -0.63 stop: n/a

TXI dipped to $50.70 near its 10-dma and 50-dma but bulls bought the dip and pushed the stock back above the $52 level. Volume came in well above its average. We are not suggesting new strangle positions. 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. TXI is due to report earnings around December 15th.

Picked on November 27 at $ 49.57
Change since picked: + 2.65
Earnings Date 12/15/05 (unconfirmed)
Average Daily Volume = 354 thousand

---

Valero Energy - VLO - close: 104.49 chg: +2.69 stop: n/a

Strength in crude oil helped push VLO over short-term resistance near $103 and its simple 50-dma. The stock is now challenging resistance at its two-month trendline of lower highs. If the energy sector continues to rally then we'll obviously be looking for the call side of our strangle to be the winner. 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: + 3.49
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Options 101

The underlying security of my long call options has just announced a spin-off

What happens to the options to the options that I am long in?

The Theory Behind the Practice

Historically, Stocks that trade for a period of time, may announce a stock split, as we all know. However, now and then for a corporate reason some companies will announce what is known in the investment world as a Spin-off. A spin-off occurs when a corporation decides to spin-off or separates a company or a performing asset in the form of a company and has it trade as a public traded corporation on its own. Lets look a hypothetical example.

XYZ is trading at $50 when they announced that they would be spinning off their computer software division. The announcement further goes on to state that all record holders of XYZ before the record date of 10/03/05 will receive 10 shares of this spin-off company, Tangent for every share of XYZ that an individual owns as of that record date. That seems simple enough, unless of course you are long contracts of XYZ, then you have an issue to consider. Since, XYZ has been trading options for at least 6-9 months out and may additionally have LEAP option contracts out 1-3 years, you need to consider what is going to happen to those contracts that exist after the spin-off. Lets see if we can explain to you what occurs by setting up a hypothetical situation.

Lets say you own 10 XYZ November 40 calls at a price of $12.50. That would entitle you to exercise 1000 shares of XYZ at the price of $40. Everyone with me? Okay, XYZ announces it split and as of 10/03/05 will spin-off Tangent to sell as a stand-alone company starting on 10/03/05. You are probably saying to yourself, I have an option that doesnt expire until November, and they are going to spin off Tangent from XYZ before then, what happens to my option? I purchased an option with the intent to acquire XYZ as it existed before 10/03/04, not after it and certainly not with its software division not a part of the company.

For the people who thought the same thing, they are absolutely right, my option isnt the same thing as what I paid a premium for. So what gives?


The Real World

Here is what happens:

Your option will remain in play until your expiration date occurs. Lets say that XYZ NOV $40 Call option that was selling at $12.50 had a symbol of XYZ-KH (NOV $40 CALL). That symbol would remain the same, however you would not only be entitled to exercise you option and purchase 1,000 shares of stock at $40, but you would also be given the spin-off shares of Tangent as well. So in this case you would receive, for your 10 Long XYZ November call options the following:

1,000 shares of XYZ Corporation (which would include the 1,000 of the NEW Corporation XYZ after the spin-off and 10,000 shares of Tangent (TNG) at whatever the price the Tangent stock is trading out in the open market. So as you can see, you get all of XYZ, just like your option specified the new XYZ and the 10,000 shares of Tangent from the spin-off.

Now the next question that needs to be addressed is the following?

What happens if I want to buy options on only the NEW XYZ that now exists, no Tangent spin-off, just the NEW shares of XYZ after the spin off? What happens if I want to buy after 10/03/05 for November or later or even October?

Here is what happens. The exchange now introduces a new option symbol that designates the you will receive only the NEW 100 shares of XYZ corporation stock without receiving the spin-off stock of Tangent. Look at the chart below to get a better understanding of what happens.

FIGURE 1-1: CHART COMPARING THE ORIGINAL OPTION CONTRACT WITH THE NEW ISSUED OPTION CONTRACTS


In the real world everything is adjusted so as to keep the option buyer in relatively the same position he would have been had the spin-off not occurred. In addition, it give the option buyer who wishes to exercise his option, he will receive 100 shares of the new XYZ as well as the 1,000 shares of TANGENT for each 1 contract of the originally purchased option.


The Bottom Line

The issue here is very simple. In other spin-offs, partial shares and cash in lieu of shares can sometimes be involved to make the process just a little more confusing. Always remember your original option, that was purchased, allows you to all the spin-offs, dividends (cash or stocks) that the company originally owned before the spin off occurred, provided you are owner of record before our hypothetical record date of 10/03/05. If you want only the new XYZ shares, that are left after the company spins off Tangent, then you will purchase the NEW adjusted series of options, as shown on the RIGHT HAND column in Figure 1-1. In addition, because of reduction in new assets of the XYZ corporation, the NEW Adjusted option will take into consideration that adjustment and will obviously sell for less then the original option that entitled you to XYZ and the Tangent spin-off. As for how much that new adjusted contract will be trading for will be selling for, will vary depending on what the perceived value is of the Tangent stock in relationship to the remaining assets of XYZ corporation. This little discussion, hopefully; should give you a better understanding as to what happens to your option in a spin-off situation.

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.

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.

To ensure you continue to receive email from Option Investor please add "support@optioninvestor.com"

Option Investor Inc
PO Box 630350
Littleton, CO 80163

E-Mail Format Newsletter Archives