Option Investor
Newsletter

Daily Newsletter, Saturday, 12/17/2005

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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

Trade Your Plan

The markets played out pretty much as expected last week and the game plan I laid out last Sunday produced gains for those who followed it. The major hiccup in the middle was the court news for Altria (MO), which produced a significant Dow/SPX spike on Thursday's open and shocked the other indexes into paralysis. The decline from Wednesday's high was interrupted but only temporarily. The indexes closed at the lows on Friday just as we expected.

Dow Chart - Daily

Nasdaq Chart - 30 min

SPX Chart - 60 min

NYSE Composits Chart - 60 min

Friday lacked any market moving economic reports and the indexes were left to digest the combination of a triple witching expiration, Nasdaq reconstitution and S&P rebalancing. For most of the day the markets remained in neutral with the Dow in the green, Nasdaq red and the S&P walking the flat line. As the close approached and rebalance volume increased the Dow gave up its gains and all the indexes finished in the red but the losses were minimal. All in all this was a bullish week for the markets despite the mixed results listed above.

The game plan I left you with last Sunday was to remain long into Wednesday morning and then short a Wednesday bounce and hold it into Friday's close. That would have been a textbook plan except for the court news on Altria at Thursday's open. Dow component MO spiked nearly $5 at the open on Thursday, which equates to roughly +40 Dow points. This interrupted the Dow's decline from Wednesday's high but the decline reappeared before days end. Option expiration sent the Dow and S&P back to the highs at Friday's open but the rebalancing activity again weighed on the indexes knocking the S&P and NDX back to close at the post Wednesday lows.

Using my recommendations for the last ten days you would have waited to enter long positions until the Friday after the Intel update around SPX 1255. I suggested exiting those longs on any post Fed spike on Wednesday, which came at 1275. The plan was to hold that short into the close on Friday, which we now know, was 1267. The MO spike on Thursday interrupted that plan but otherwise it worked as expected. I was personally stopped out on the Friday morning spike but was able to reenter and hold into the close.

SPX Game Plan Chart - 20 min

Expiration and rebalancing activity was especially harsh for the energy sector. Despite strong draws from storage the gas stocks and big cap oils were hammered severely. The combination of all the expirations and rebalancing was too much for the sector to bear. The big cap oils were hit with a double whammy by falling oil prices and by the S&P changes. Big cap oils have been buying back billions of dollars of shares and that lowers their market cap. The S&P rebalancing forces funds to lighten up on those stocks whose market cap has shrunk and add to positions of those who have grown. Exxon, Conoco and Chevron all lost about -$1.50 on Friday to end a week of an oil related slide. Oil prices fell to $58 and a two week low despite a record cold snap and more cold weather on the way. The three day expiration related slide in oil prices saw it fall from the $61.95 high on Tuesday to $58 on Friday. This -6% drop should be temporary but I would not look for any new highs this month. I told you on Tuesday night I expected a sell the news event when the gas storage levels were announced and that is exactly what we got. There was a -202 bcf drop in storage and much higher than the official estimates. It was simply profit taking related to expiration and the approaching year end.

Crude Oil Futures Chart - Daily

Natural Gas Futures Chart - Daily


To highlight the impact of options expiration we only need to look at gold prices. Gold hit a high on the December contract at $538.50 on Monday and then the bottom fell out to settle at $503.50 on Friday. It was a great run as the contract matured and profits needed to be taken.

December Gold Chart - Daily

Volume on Friday was huge at 5.352 billion shares and a full billion over Thursday's levels. It was weighted slightly 3:2 to the downside but that was a function of expiration/rebalancing pressures. The A/D line was nearly flat with decliners edging out advancers only slightly at 38:33. Given all the negative undercurrents I consider this a bullish day.

I believe the market strength we saw this week in the face of heavy selling pressure suggests next week will be bullish. The Dow and SPX are very close to their recent highs with better internals than we have seen in the last two weeks. The Nasdaq is dormant at 2260 but should wake up next week once the NDX rebalance pressures fade.

Next week is a full week of trading and while there are some major economic reports I believe they will be ignored as long as there are no surprises. The markets are closed for the Christmas/Chanukah holiday on Monday 12/26. Volume will be anemic ahead of the holidays with many institutions running only a skeleton staff for the rest of the year. This bodes well for the indexes since program trades will be scarce after Monday. This is the two weeks of the year where retail traders thrive and push the markets higher. Those year end bonuses will be put to work and the odds are very good we will see new highs on the Dow and SPX.

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Late on Friday Time Warner announced that Google was in talks to buy 5% of AOL for $1 billion. Time Warner said Microsoft was no longer a contender and a deal with Google on AOL and an increased advertising presence was near completion. This helped to power Google to a new intraday high at $432.50. Google was also added to the Nasdaq-100 this week and buying for that index produced a +$13 gain over the last two days. I would be cautious on Google next week as arbitragers dump any excess stock they could not sell to funds as Friday closed. Offsetting any dumping could be late buying by those funds that refused to buy at the new high on Friday. Typically the index funds have three days to complete index adjustments but most are either early or done at the close on rebalance days.

Acquisitions in the energy sector continue to make the news with Southern Union (SUG) paying $1.6 billion for Sid Richardson Energy Services. This adds 4600 miles of pipeline to Southern's network bringing their total to over 22,000 miles in 17 states. Because of the high price paid for SR, Southern bought $45 million in gas options to hedge against gas falling below $11. Energy analyst Kenneth Stern of FTI Consulting did not expect the price of gas to crater and said more deals were in the pipeline. Earlier in the week Conoco agreed to pay $35.6 billion for Burlington Resources adding to Conoco's already growing gas reserves. Constellation Energy spiked on Wednesday's news that FPL Group was in talks to acquire them for $11 billion. CEG has 10 power plants and is trying to get permission to build a giant nuclear reactor as a showcase for a new generation of reactors they hope to build around the country. FPL needs more capacity as more than 100,000 new customers move into its Florida power base every year. That will increase substantially as boomers begin to retire.

AMR Chart - Daily

The falling price of oil helped push American Airlines (AMR) and Continental Airlines to new highs. Both charts resemble an Internet chart from 1999 or maybe the flight path of the new 787 Dreamliners from Boeing. The Indian Cabinet announced on Friday that it had approved the purchase of $8.2 billion for 68 Boeing planes. Boeing had a good week also signing a deal with Cathay Pacific for $2.85 billion and Qantas for $15 billion.

Software was in the news as Oracle posted disappointing results and took a sharp dip at Friday's open. Revenues rose +19% but profits fell -2.1%. Adobe jumped +3.89 or +11% after posting stronger than expected results.

The potential economic bumps next week are the PPI and New Home Construction on Tuesday, GDP on Wednesday and CFNAI and Mass Layoffs on Thursday. Friday closes with Durable Goods, Consumer Sentiment and New Home Sales. We are expecting a drop in the PPI of something in the -0.4% range due to falling energy prices. New Residential Construction is also expected to fall slightly to 2.01 million units, down from 2.014 in October. The GDP revision on Wednesday is not expected to change at +4.3%. Consumer Sentiment on Friday should rise slightly to 89.0 from 88.7 due to the improving stock market, falling gas prices and the holiday season. New Home Sales could be the challenge for the week. They are expected to fall to 1.3 million annual units, down from 1.424 in October. This is a material drop and could put the pop back into the housing bubble conversation after weeks of talk about a less damaging slow deflation.

The game plan for next week is simple. Buy any opening dip on Monday and hold it the rest of the week. The week after the December triple witching expiration has been up 10 of the last 13 years with Wednesday and Thursday the strongest days of the week. The first three days of the following week are typically bullish but Friday the 30th has a skull and crossbones on my calendar. The last nine years has seen some serious losses on four of those years. 1996 -101, 1997 -8, 1998 -93, 1999, +44, 2000 -82, 2001 -115, 2002 +9, 2003 +29, 2004 -20. The more recent trend over the last three years has been neutral with an average gain of +6 points. While you can't count on any specific day repeating past performance you can expect long term trends to exert pressure on the present. For this reason I would look to either be flat or have really tight stops should any post Christmas/Chanukah bounce appear tired late in the week.

BTU Chart - 30 min

If you are looking for something to trade next week I would look at healthcare, specifically United Health (UNH). That sector typically outperforms during this period. I would also look at Whole Foods Markets (WFMI), which has a 2:1 split after the close on the 27th. This is a retail trader favorite and there is a strong potential for a pre-split rally. Valero would be another option after splitting 2:1 after the close last Thursday. The $110 high flyer is now affordable at $52 after the two day expiration related decline in oil prices. Peabody Energy (BTU) would also be a potential winner with a steep expiration decline and strong support at $80. I hesitate to recommend any other energy stocks due to the potential for profit taking into year end. If the selling this week was really related to options/futures expiration as I expect then we could see a new uptick begin on Monday. I bought energy on the close on Friday with that expectation. If you see futures rise on Monday then energy stocks would be back in play. Gas plays like Ultra Petroleum were crushed late in the week on the sell the news gas storage numbers and expiration pressures. With gas still hovering just under $14 a new high is not that far away. I would look at UPL as a way to capture a rebound in gas prices. The drillers are less susceptible to oil prices as their revenue is derived from day rates for drilling. Diamond Offshore gave up about -$3 as oil declined but managed to hold the high ground. Diamond (DO) and Nabors (NBR) would be my choices in that sector.

Streettracks Gold Trust Chart - 30 min

One last suggestion would be the gold ETF, GLD. GLD appears to have found support at $50 and nothing has changed in the global picture for gold. Sorry, no options but it would work in retirement accounts where options are not allowed. Optionable gold stocks with a strong trend include Freeport McMoran (FCX). You could also use the $XAU.x Gold/Silver Index with the shorter month strikes. Farther months tend to be expensive. Watch the spreads and use limit orders only.

This is going to be a short commentary this weekend and far less than the nearly 5000 words I penned last Sunday. Sometimes there is a lot to talk about, sometimes very little and there is no reason to add useless market trivia as filler. The trading next week is going to be the same. There is little to motivate the markets other than good old investor sentiment. Volume will decline as the week progresses but it should not inhibit any gains as retail traders leave early for the holidays and find themselves in front of their home PC trying to find a home for that holiday bonus. Plan on capturing the gains from that scenario but being out of those trades before year end.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None PCAR BMHC

New Calls

None today.
 

New Puts

PACCAR Inc. - PCAR - close: 70.12 change: -0.26 stop: 72.51

Company Description:
PACCAR is a global technology leader in the design, manufacture and customer support of high-quality light-, medium- and heavy-duty trucks under the Kenworth, Peterbilt and DAF nameplates. It also provides financial services and information technology and distributes truck parts related to its principal business. (source: company press release or website)

Why We Like It:
The late October and early November rally has died for PCAR. The stock has spent the last several weeks consolidating sideways as upward momentum slowly faded and was replaced with more bearish technicals. PCAR has been sinking for months after peaking in late 2004. Since then the stock has a steady trend of lower highs and this recent "high" in November and December is essentially a failed rally under the long-term trendline (see chart). This isn't a perfect set up. The P&F chart is still bullish but we see the recent weakness in the last two sessions as a sign of things to come. Currently PCAR is trading at its 200-dma and just above its 50-dma. We want to set a trigger under last Thursday's low to catch the next breakdown. Our trigger will be $69.49. If triggered we'll target a drop into the $65.25-65.00 range before

Suggested Options:
We are going to suggest February puts although we plan to exit ahead of the January earnings report. Our trigger to buy puts is at $69.49.

BUY PUT FEB 75 PAQ-NO open interest=485 current ask $5.80
BUY PUT FEB 70 PAQ-NN open interest=796 current ask $2.75
BUY PUT FEB 65 PAQ-NM open interest=422 current ask $1.60

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand
 

New Strangles

Building Materials - BMHC - cls: 80.95 chg: +0.89 stop: n/a

Company Description:
BMHC, a Fortune 1000 company, is one of the largest providers of residential construction services and building materials in the United States. We serve the homebuilding industry through two subsidiaries: BMC West distributes building materials and manufactures building components for professional builders and contractors in the western and southern states; BMC Construction provides construction services to high-volume production homebuilders in key growth markets across the country. (source: company press release or website)

Why We Like It:
This looks like a pretty good set up for a strangle on BMHC. The stock has been coiling tighter and tighter into a pattern of higher lows and lower highs (a.k.a. a wedge or pennant). The more tightly it coils the closer it gets to a breakout. The company is due to report earnings in late January so we're going to suggest the March options. We'll suggest an $81.50-79.00 entry window but the closer to $80.00 the better.

Suggested Options:
This is a strangle so traders need to buy an out of the money call and an out of the money put. You might consider a straddle, buying a call and put at the $80 strike, but it would cost about $16 or more. We're suggesting the March options. At current prices this strangle should cost about $8.20. We'll target a rise to $12.50 by March expiration. Try and balance your investment on both sides (calls and puts) unless you have a specific bias for the stock. If you want you could do a $75put, $85 call strangle for about $11.70.

BUY CALL MAR 90 BGU-CR open interest=397 current ask $4.60
-and-
BUY PUT MAR 70 BGU-ON open interest=323 current ask $3.60

Picked on December 18 at $ 80.95
Change since picked: + 0.00
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand
 


Play Updates

In Play Updates and Reviews

Call Updates

Apache - APA - close: 69.50 change: -1.72 stop: 67.99

Oil stocks have turned soft in the last two days. The recent action is making crude oil's early December breakout over resistance, the $60 level, and its 50-dma look like a bull trap. Crude oil fell more than 3% on Friday on new forecasts for a warmer winter than previously expected. We all know how unreliable the weather can be so this may just be more year-end profit taking. Currently the OIX oil index and the OSX oil services index are both pulling back toward their supporting trendlines of higher lows. Until these oil indices breakdown below this support the trends for the sector are still up. We are not suggesting new bullish positions in APA. Friday's drop in APA (2.4%) pulled it under the $70.00 mark and its 10-dma. More conservative traders may want to bail out early right here to protect their capital. We're watching the 100-dma near $69 and the $68 level for short-term support.

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

Picked on December 08 at $ 70.98
Change since picked: - 1.48
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 3.6 million

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Dominion Res. - D - close: 80.87 chg: -0.22 stop: 74.75

The utility sector was one of the few groups that closed in the green on Friday. We believe that D probably would have joined its peers but news out on Friday may have prompted some selling. Dominion issued a press release stating that according to its succession plan they are promoting Thomas Farrell, president and chief operating office, to chief executive officer after the current CEO retires from his post this January. We would not suggest new bullish positions in D right here. Watch for a dip and a bounce from the $80.00 level before considering new bullish positions. If the market averages turn lower then we'd look for D to test its 10-dma (near $79). Our target for D is the $84.50-85.00 range compared to the P&F chart, which points to a $92 target.

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

Picked on November 27 at $ 78.24
Change since picked: + 2.63
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 1.8 million

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FMC Corp. - FMC - close: 52.67 chg: -0.56 stop: 51.95

We have been writing about a potential pull back in FMC toward the $52.00 level for days now. It looks like that is where shares of FMC are headed. The $52 level is near the top of its gap higher in November and should be short-term support. This area is also bolstered by technical support with its simple 50-dma. Unfortunately, the recent weakness has turned the technical picture bearish and produced a new MACD sell signal. We are actually a little surprised by FMC's weakness. Fundamentally the pull back in oil prices the last two days is good news for FMC, since the company is a chemical producer. We do notice that volume during the last two sessions has been very low so it may just be an absence of buyers and not a flood of sellers. We would not suggest new positions at this time.

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

Picked on December 01 at $ 55.04
Change since picked: - 2.37
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 270 thousand

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Femsa Fomento - FMX - close: 69.68 chg: +0.23 stop: 67.75

The Mexican stock market hit new highs on Thursday but Friday gave back one percent in profit taking. Meanwhile shares of FMX continue to creep higher toward resistance at the $70.00-70.50 level. The bigger picture for FMX remains bullish so we're going to keep FMX as a candidate. Our strategy involves using a trigger at $70.65 to buy calls. If we are triggered we'll target a run into the $74.75-75.00 range. The P&F chart points to an $81 target.

Suggested Options:
We are suggesting January calls, which have five weeks left until expiration. You may want to consider buying April strikes instead.

BUY CALL FMX 65 FMX-AM open interest= 16 current ask $5.70
BUY CALL FMX 70 FMX-AN open interest=249 current ask $2.10
BUY CALL FMX 75 FMX-AO open interest=102 current ask $0.60

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 308 thousand

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Garmin ltd - GRMN - close: 61.04 change: -1.16 stop: 57.90

The pull back in GRMN may be offering us another bullish entry point but we would hesitate before initiating new plays at the moment. This past Tuesday the stock broke out over resistance at its two-month trendline of lower highs. The last two days look like profit taking after a strong December performance. We would watch for a dip to and a bounce from the $60.00 level, which should be support. The $60 level is also supported by the 50-dma and the 100-dma. Our mid-January target is the $69.00-70.00 range. We do not want to hold over the January earnings report. More conservative traders may want to tighten their stop losses.

Suggested Options:
We like the January calls since we plan to exit ahead of the January earnings report. However, we're not suggesting new positions here. Wait for a bounce above the $60 level.

Picked on December 13 at $ 63.54
Change since picked: - 2.50
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

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Kerr Mcgee - KMG - close: 92.52 chg: -1.89 stop: 88.99

KMG is another oil stock that suffered on Friday from a pull back in crude and widespread profit taking in the sector. Shares of KMG lost 2% and closed under their 10-dma. This move suggests there is more weakness to come and we'd look for a dip back toward the $90.00 level, which should offer some support. We would not suggest new positions at this time. Our mid January target is the $98.50-100 range.

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

Picked on December 02 at $ 90.26
Change since picked: + 2.26
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.8 million

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Kinder Morgan - KMI - close: 93.97 chg: -0.12 stop: 91.90 *new*

Natural gas futures traded in a narrow 20-cent range for most of the session on Friday. That didn't stop shares of KMI from trying to breakout over resistance at the $95 level. The rally in KMI failed early Friday morning but the stock was rebounding higher again late Friday afternoon on a surge of volume. We are not suggesting new positions at this time. A move over $95.00 might be used as a new entry point and if that occurs you might target the $100 level. We are raising our stop loss to $91.90 since KMI hasn't traded under $92 for the past two weeks and the 100-dma can be found near $92.35. Our target is the $98.50-100 range. We do not want to hold over the mid January earnings report.

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

Picked on December 02 at $ 92.75
Change since picked: + 1.22
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 749 thousand

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Polaris Ind. - PII - close: 49.89 change: -0.30 stop: 48.49

PII is still consolidating sideways near the $50 level after the December 8th downgrade. Shares appear stuck in a $2.50 range. We are not suggesting new positions and more conservative traders may just want to exit early right here before time erosion steals any more from the option values. There is still a chance for a Santa Claus rally in the second half of December so we're going to keep this play open. If it can breakout over $51 then there's a good chance it will fill the gap near $53.00-53.50. We're going to keep our target in the $54.00-55.00 range.

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

Picked on November 21 at $ 48.47
Change since picked: + 1.42
Earnings Date 01/12/06 (unconfirmed)
Average Daily Volume = 467 thousand

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Ryland Group - RYL - close: 75.14 change: +0.02 stop: 69.90

Homebuilders traded mostly sideways on Friday despite positive news from KB Home (KBH). KBH reported earnings on Thursday night and beat estimates by 17 cents a share. KBH then went on to offer a positive spin on 2006 and announced a stock buy back program. Oddly enough this good news was not enough to move the homebuilding stocks on Friday. We remain bullish on RYL but would probably wait for a dip toward $74 or its 10-dma near $73.50 before considering new bullish positions. Our target is the $79.50-80.00 range. FYI: next week does have some economic news that could move the homebuilding stocks. Monday brings the housing starts and building permits data. Friday we'll see the new home sales numbers.

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

Picked on December 13 at $ 73.96
Change since picked: + 1.18
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 1.3 million

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Questar Corp - STR - close: 81.92 chg: -1.97 stop: 77.45

Bulls need to get defensive here. STR has turned in a very strong performance this December. This past Friday saw some profit taking. More importantly the three-day pattern looks like a short-term top. We do expect shares of STR to pull back toward the 10-dma near the $80.00 level, which should offer support. Only on a bounce from the $80 level would we consider new bullish positions. Our target is the October highs in the $89.00-90.00 range. The P&F chart points to a $105 target. FYI: STR is also a current strangle play on the newsletter's play list.

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

Picked on December 13 at $ 80.85
Change since picked: + 1.07
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 752 thousand

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Total S.A. - TOT - close: 129.03 change: -0.16 stop: 126.49

French oil giant TOT is also looking vulnerable to more profit taking. More conservative traders may want to think about exiting early. Thus far the stock has not violated its five-week trend of higher lows but it may be a good time to raise your stop loss.

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

Picked on December 13 at $130.25
Change since picked: - 1.22
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 936 thousand

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Tractor Supply - TSCO - cls: 54.27 chg: -0.46 stop: 51.95

TSCO's performance has been very similar to PII's. The stock was surging higher only to see the rally killed by an analyst downgrade. TSCO has not recovered from the December 7th downgrade and shares have consolidated sideways since. Granted volume has been below average during the consolidation and that tends to be more bullish. A look at the intraday chart shows some late day weakness on Friday. We suspect that TSCO will test last week's lows near $53.50. If that fails then the stock should have more support near $52.50. We are not suggesting new positions.

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

Picked on November 30 at $ 52.75
Change since picked: + 1.52
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

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Valero Energy - VLO - close: 52.27 chg: -1.17 stop: 49.74

VLO's 2-for-1 split has taken effect but it didn't stop VLO from losing more than 2% during Friday's sell-off in the oil stocks. Currently shares are testing minor support near $52.00. If the group continues to see weakness we'll look for a dip back toward technical support with the 50-dma and 100-dma just above the $50 level. A bounce from here or the $50 level could be used as a new bullish entry point. We are not suggesting new plays at this time. Our post-split target is $58.50. FYI: VLO is also a current strangle play in the strangle section.

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

Picked on December 08 at $ 53.28 (split adjusted)
Change since picked: - 1.01
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 9.8 million

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Zimmer Holdings - ZMH - close: 71.55 chg: +1.56 stop: 67.75 *new*

ZMH continues to show relative strength and added 2.2% on Friday to breakout to new three-month highs. The move on Friday was also a breakout over the 100-dma. Our target is the $74.00-75.00 range under its simple 200-dma. The Point & Figure chart is pretty bullish with a $90.000 target. We are not suggesting new plays right here. We are raising our stop loss to $67.75.

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

Picked on December 11 at $ 68.62
Change since picked: + 2.93
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 2.6 million
 

Put Updates

Magna Int. - MGA - close: 69.25 chg: +0.31 stop: 70.31

We are growing increasingly uncomfortable with the rebound in shares of MGA. Fundamentally we don't see why investors would be buying MGA after GM and Ford issued major restructuring programs that includes production cut backs. If GM and F make fewer vehicles then MGA should be selling fewer parts. Technically we're seeing mixed signals. The volume over the last three days has been pretty bullish, which is of course bad news for us. Technically the stock is also looking short-term overbought and due for a dip since shares are up six out of the last seven days. MGA also remains under its multi-week and multi-month trendline of lower highs in addition to still being under resistance at the 200-dma near the $70.00 mark. The P&F chart points to a $61 target. We are going to leave the play open but we are not suggesting new bearish positions. More conservative traders may want to think about exiting early to avoid further losses.

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

Picked on December 04 at $ 68.14
Change since picked: + 1.11
Earnings Date 02/07/06 (unconfirmed)
Average Daily Volume = 318 thousand

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Netflix - NFLX - close: 26.30 chg: +0.36 stop: 27.45

NFLX is performing as we expected. The oversold bounce rocketed right up to the $27.00 level but under its simple 50-dma. This looks like a failed rally traders could use for a new bearish entry point but only aggressive traders may want to consider initiating new positions. The biggest risk is a short squeeze. We are not suggesting new positions and more conservative traders may want to tighten their stops toward Friday's high. Our target is $22.55. The P&F chart points to a $15 target.

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


Picked on December 09 at $ 25.99
Change since picked: + 0.31
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.)

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Amer. Eagle Out. - AEOS - cls: 21.16 chg: -0.33 stop: n/a

AEOS is turning lower again after spending a week failing to breakout over resistance at the $22.00 level. New comments on Friday that holiday retail sales were only so-so could be undermining investor confidence in the sector again. 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 $1.80bid/$1.90ask.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 13 at $ 25.47
Change since picked: - 4.31
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million


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Abercrombie&Fitch - ANF - close: 63.34 chg: -0.50 stop: n/a

ANF is still trying to breakout over resistance at the $65.00 level but the same concerns affecting AEOS are influencing ANF as well. We have about five weeks left before January options expire. If you don't think ANF is going to make it over the $65 mark then consider exiting early right here to salvage trading capital. We haven't given up yet on a year-end rally. 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.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 13 at $ 59.67
Change since picked: + 3.67
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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Blue Coat Sys. - BCSI - cls: 43.26 chg: -2.19 stop: n/a

BCSI has finally broken out from its narrow, four-week sideways consolidation near the $45.00 level. The stock broke down under the $44 level and dipped toward the $42 area and its 100-dma. Shares did bounce after essentially "filling the gap" from the November 22nd gap higher. We're not convinced that the new direction will be down but BCSI is no longer in our entry window of $45.50-44.50. If the stock rebounds back to the $45 level next week we would consider new strangle positions but we'd probably use the February (not available yet) or April strikes. Thus far we've been suggesting the January options. Our current play involves the January $50 call and the January $40 put. Our estimated cost is $3.25. We're aiming for a rise to $5.50. Remember we have about five weeks left before January options expire.

Suggested Options:
We are not suggesting new strangle positions.

Picked on December 04 at $ 45.43
Change since picked: - 2.17
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand

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Chicago Merc. Exchg. - CME - cls: 369.01 chg: +0.89 stop: n/a

Market makers managed to do a fine job of pegging CME near the $370 level on Friday. This incredibly volatile stock traded in a very narrow range for the last four hours of the trading day on Friday. Where the stock goes from here is a guess. The charts are throwing off mixed signals with the daily chart very close to a new MACD buy signal versus the weekly chart showing a relatively new MACD sell signal. The Point & Figure chart displays a sell signal that points to a $312 target. 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.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 20 at $375.90
Change since picked: - 6.89
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

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D.R.Horton - DHI - close: 37.81 chg: +0.27 stop: n/a

The homebuilding stocks churned mostly sideways on Friday in spite of positive earnings news and comments from KB Home (KBH) on Thursday night. Investors could be waiting for some economic data next week with the building permits and housing starts out on Monday. DHI turned in a solid week with a breakout from its bull flag pattern. We are not suggesting new strangles in DHI 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. FYI: the DHI-AG calls are currently trading at $3.50bid/$3.70ask. The high today was $3.90.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 13 at $ 32.56
Change since picked: + 5.25
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million


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Four Seasons - FS - close: 48.49 chg: -0.06 stop: n/a

FS continues to slowly decline. The pattern looks very bearish but we may be facing a time crunch challenge. If we hold on to this play we're betting that FS will trade into the $46-45 range before January options expire in five weeks - at least with our current target at $5.00 for the strangle. Traders may want to adjust their target or consider exiting early at breakeven. 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 $2.35bid/$2.65ask.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 08 at $ 55.37
Change since picked: - 6.88
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

---

Lear Corp - LEA - close: 28.48 chg: +0.11 stop: n/a

LEA's performance on Friday was almost an exact mirror of what happened to the stock on Thursday. The stock gapped higher at the open, immediately failed, drifted to its lows by the afternoon and then rebounded higher into the closing bell. The overall pattern for the past week has been a sideways trading range between $28-29 with the 50-dma adding extra resistance to the top of the range. We have five weeks left before January options expire. By holding on to this play we're essentially betting that LEA will trade under $25 before January expiration. Right now the odds of that happening don't look so great so we're adjusting our target to break even at $1.60. 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.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 06 at $ 30.24
Change since picked: - 1.76
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million

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Verifone Holdings - PAY - cls: 24.45 chg: -0.20 stop: n/a

PAY managed to rally back toward resistance at the $25.00 level this past week. If there is a Santa Claus rally for the markets then odds are good that PAY might manage to breakout. We have five 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 $2.25bid/$2.65ask. The high on Friday was $2.70.

Suggested Options:
We are not suggesting new strangle positions.

Picked on October 12 at $ 19.98
Change since picked: + 4.47
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

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Questar Corp. - STR - close: 81.92 chg: -1.97 stop: n/a

STR has produced a very bullish December so far. Friday's session was profit taking. Unfortunately, the three-day pattern looks like a short-term top. There are about five 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. FYI: the STR-AP calls are trading at $3.90bid/$4.20ask.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 20 at $ 76.25
Change since picked: + 5.67
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

---

Texas Ind. - TXI - close: 50.75 chg: -1.15 stop: n/a

The mid December earnings report is a no show. New data puts TXI's earnings report at January 5th. That is bad news. We were counting on the earnings news to push TXI out of its sideways consolidation pattern. Waiting until January 5th doesn't give us much time for the stock to move before January options expire. Traders have a decision to make. Our estimated cost was $2.70. Right now we should be able to exit the calls (TXI-AK) at $1.00. That's a substantial loss but it's not a total wipe out. We are going to keep the play open because TXI's earnings reports tend to produce $5.00 moves in the stock price. 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.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 27 at $ 49.57
Change since picked: + 1.18
Earnings Date 12/15/05 (unconfirmed)
Average Daily Volume = 354 thousand

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Valero Energy - VLO - close: 52.27 chg: -1.17 stop: n/a

VLO's 2-for-1 stock split took effect on Friday. The stock lost more than 2% as traders took profits in the oil sector. We are not suggesting new strangle plays. Our current play involves the January $110 calls (VLO-AB) and the January $90 puts (VLO-MR). Our adjusted cost is $2.93. Our adjusted target is $4.75.

Suggested Options:
We are not suggesting new strangle positions.

Picked on November 21 at $ 50.50
Change since picked: + 1.77
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Dropped Calls

Hydril - HYDL - close: 67.37 change: -2.26 stop: 65.95

We are going to bail out of HYDL! Friday's 3.2% decline in HYDL does not bode well for the bulls. The stock is part of the oil services sector and while the overall trend for the OSX index remains bullish the group could easily see more profit taking. We initially listed HYDL as a candidate with a trigger over $71.00 since the stock shows a bullish or inverted head-and-shoulders pattern on the daily chart. Yet HYDL is not seeing any follow through on this past week's move over the $71 level. Instead the recent spike above $71.00 in HYDL is looking like a bull trap. The P&F chart also shows a new bull trap formation. The stock does have some support near $66.00 but it looks like shares are probably headed toward $65 and its 50-dma. We'll exit now and look for a new entry point down the road.

Picked on December 12 at $ 71.01
Change since picked: - 3.64
Earnings Date 01/23/06 (unconfirmed)
Average Daily Volume = 263 thousand

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Rockwell Autom. - ROK - cls: 59.81 chg: -0.13 stop: 57.95

The rally has grown pretty tired in shares of ROK. The stock has come close to hitting our target near $61 multiple times. We feel that the best course of action is to probably do a little profit taking of our own and exit early. There is still a chance for a year-end rally in the markets and in ROK but we don't want to risk it.

Picked on November 03 at $ 55.90
Change since picked: + 3.91
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 804 thousand

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Sunoco Inc. - SUN - close: 79.35 chg: -2.33 stop: 76.45

The profit taking in refiner SUN is picking up speed. The stock has consolidated sideways for most of December but the last two days have seen the stock fall through support at the $80.00 level. Friday's decline (-2.8%) also produced a new sell signal on its MACD indicator. We remain long-term bullish on the refiners (fyi: they've been one of the best performing industries this year) but short-term this looks like a sell signal so we're going to exit early! Keep an eye on the 100-dma, which has been consistent support in the past.

Picked on December 02 at $ 81.75
Change since picked: - 2.40
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 2.8 million
 

Dropped Puts

None
 

Dropped Strangles

AmerisourceBergen - ABC - cls: 81.93 chg: +0.68 stop: n/a

ABC bucked the bearish trend in the markets on Friday. The stock added 0.8% to close at a new high. Our plan was to exit near Friday's close. The December $80 calls (ABC-LP) closed at $1.90bid/$2.00 ask. Our estimated cost was $2.80 for the strangle.

Picked on October 16 at $ 74.81
Change since picked: + 7.12
Earnings Date 11/03/05 (confirmed)
Average Daily Volume = 900 thousand

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Loews - LTR - close: 96.50 change: -0.40 close: n/a

By mid November this play was looking pretty good. Unfortunately, shares of LTR have been stuck in a range between $96 and $98 for the last four weeks. Our recently adjusted plans called for an exit near Friday's closing bell. The December $95 calls (LTR-LS) closed at $1.40bid/$1.65ask with a high for the day at $2.05. Our estimated cost was $3.05.

Picked on October 23 at $ 89.94
Change since picked: + 6.56
Earnings Date 10/27/05 (confirmed)
Average Daily Volume = 602 thousand

---

Protein Design Labs - PDLI - cls: 29.00 chg: +0.03 stop: n/a

PDLI never managed to pick a real direction after its earnings report in early November. The sudden rally higher in mid November stalled and the sideways trading action doomed our strangle play.

Picked on October 30 at $ 27.70
Change since picked: + 1.30
Earnings Date 11/01/05 (confirmed)
Average Daily Volume = 1.8 million

---

Spectrum Brands - SPC - close: 20.43 change: +0.37 stop: n/a

SPC is another failed strangle play. The initial post-earnings drop on November 10th was favorable but the stock rebounded too strongly and then churned sideways for three weeks. The upgrade-fueled spike higher this past week just put the nail in the coffin.

Picked on November 08 at $ 20.63
Change since picked: - 0.20
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 576 thousand
 


Trader's Corner

Divergence

When opinions diverge, someone proves wrong. When a security's price movements and that of its oscillators diverge, price movement usually proves to be wrong.

Annotated Daily Chart of TOL:

Divergence can exist on any time frame.

Annotated 15-Minute Chart of TOL:

Although a few technicians disagree, any divergence in price movement and oscillator movement at the top of a move is bearish divergence.

Annotated Weekly Chart of Dupont:

Any divergence between price movement and oscillator movement at swing bottoms can be labeled bullish divergence, so that bullish divergence, too, can come in several forms.

Annotated Daily Chart of the OEX:

Annotated 30-Minute Chart of SMH:

Although unconventional and not mentioned in technical analysis texts, I've found other forms of bullish and bearish divergence
helpful to watch, too. For example, if a security trades within a rising or falling regression channel, watch each approach to that channel's boundaries for divergences from the last test.

Annotated 60-Minute Chart of the TRAN:

Annotated 15-Minute Chart of the OEX:

As these charts demonstrate, recognizing bullish or bearish divergences can be a powerful tool for traders. In each instance above, prices fell away after producing bearish divergence and climbed after producing bullish divergence. Unfortunately, divergence and resultant price action doesn't always result in the suggested next move.

Annotated 60-Minute Chart of the RUT:

Wise traders use divergence as warnings to protect long positions, in the case of bearish divergences, and short ones, in the case of bullish divergence. Divergences signal that traders should begin watching for signs of a reversal while remaining aware that nothing more than pullback or countertrend bounce may be signaled. These divergences should not be used as buy or sell signals, but they do allow for planning profitable exits for existing plays and preparing for a new direction when other corroborating evidence, usually price movement, occurs.
 

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.

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