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Daily Newsletter, Wednesday, 12/21/2005

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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

Were Those Jingle Bells I Heard Receding in the Distance?

Indices across the globe broke out to new multi-year highs during the overnight session, preparing the way for a Santa Claus rally in the U.S., historically slated to begin today. The Fed chipped in to help pay for the party with a hefty $18 billion repo, all a net add according to Jonathan Levinson's notation on OptionInvestor's Market Monitor. With equities rushing higher and bonds turning lower, that money seemed destined to fund the equity party. New couples created by a host of merger and acquisition activity added to the festive spirit.

Party time had arrived. With the other invitees cheering the U.S. on, not even a few disappointments were going to dampen the party spirit for the first few hours. However, the Senate's failure to pass a bill characterized as a must-pass defense bill may have dampened party spirits. Failing to gain the needed sixty votes to ward off a filibuster, sponsors of the bill may now withdraw it to remove the controversial measure to allow drilling in an Alaska wildlife refuge. The bill had also included measures meant to provide money to troops in Iraq, relief for Katrina victims and help with energy bills for low-income families. Some detractors labeled the last-minute insertion of the drilling measure into a bill that would be so difficult to vote down to be legislative blackmail. Some speculate that supporters of opening Alaska's ANWR field to drilling will try again next year by attaching it to a different bill.

By the time the Senate vote had been tallied, market participants had already had time to digest the particulars of the crude inventories release, listen to Richard Federal Reserve President Lacker claim that energy prices could still be passed through, contributing to inflation, and watch crude prices maintain above $58.00. The party was over before Santa Claus even made an appearance.

Annotated Daily Chart of the SPX:

Sectors that contributed to the small gains on many indices included the materials sector. Positive analyst comments on Nucor (NUE) helped the materials sector, with insurers, retailers, oil services and financials being among the sectors that gained. Homebuilders were flat, and the utility sector dropped.

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

In overnight trading, the Nikkei briefly climbed above 16,000, a new five-year high, before drifting back to a mere 316-point gain for the day. The news of a single dissenting vote for rate reduction at the Bank of England's meeting this month propelled the FTSE 100 to its highest level in four years. The DAX hit levels last seen in March 2002, although it couldn't quite tag the 2002 high of 5,467.31 achieved on March 19 2002. The CAC 40 topped its 2002 high of 4,720.07, achieved on January 4, 2002, and hit levels not seen since the third quarter of 2001.

Disappointments, at first discounted by the partygoers, came from a few earnings reports and some economic releases, tempered by positive earnings from FDO, ATYT and PALM. Starting the day off, the Mortgage Bankers Association released mortgage applications for the week ending December 16 at 7:00 EST. The market component index was down on both seasonally adjusted and unadjusted measures. Compared to this time last year, that index, measuring mortgage loan application volume, was lower by 15.2 percent. The purchase, refinance and conventional indices all dropped, while the government index was flat. Four-week moving averages dipped for the market, purchase and refinance indices. Refinance activity rose to 41.7 percent of total activity, however, with the average contract interest rate for 30-year fixed-rate mortgages dropping to 6.22 percent from the previous week's 6.28 percent, and with points decreasing, too.

An hour and a half later, the GDP revision surprised to the downside. Most economists and market watchers had expected the final third-quarter GDP to show the same 4.3 percent increase as the previous estimate. Instead, a slightly lower consumer spending figure detracted from the final number, coming in now at 4.1 percent growth. Other revisions included a slight upward revision of the core personal consumption expenditure price index--a measure of inflation--and slight downward revisions of corporate profits and final sales of domestic product. The chain deflator rose to 3.3 percent from the former 3.0 percent, increasing inflation worries.

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Despite the surprise revision lower, the Q3 GDP measures the strongest growth since Q1 2004. The SPX e-minis closed the 15-minute period immediately before the release at 1271.25 and closed pre-market trading at 1271.00, showing little reaction in the pre-market period. The TNX, measuring the ten-year yield, jumped to a high of 44.88, up from yesterday's close of 44.66 and above yesterday's high of 44.78, presaging an eventual climb to a high of 44.98 and a close at 44.86.

The inventories numbers proved surprising, too. While crude inventories rose more than expected, by 1.3 million barrels, gasoline supplies unexpectedly declined by 300,000 barrels and distillates declined by 2.8 million barrels, more than had been expected. The inventories adjustments brought crude inventories above the upper end of the average range for this time of year, but dropped gasoline and distillate inventories into the lower half of the average range for this of year.

During this season, distillates prove the most important component of this release, and the number should have been crude positive and equity negative. According to a Bloomberg TV commentator, the distillate drop was six times deeper than had been anticipated. She quoted a UBS analyst saying that this drop was of particular concern this early in the season.

The climb in crude didn't begin immediately, however, with crude first dropping to its $58.10 low and then continuing to climb. Investors in transports paid more attention to the headline number and sent the transports into a new high, charging above 4200 to a day's high of 4216.80. The TRAN's breakout brought it less than sixty points from a possible target and probable strong resistance level.

Annotated Weekly Chart of the TRAN:

Although not a component stock of the TRAN according to one source, FedEx's (FDX) upside earning surprise propelled some TRAN components higher, too. For its fiscal second quarter, FDX beat expectations by 13 cents and gave encouraging full-year 2006 guidance. The Dow does count FDX as one of its components, and the Dow headed higher, too, before the Senate turned the lights out on its defense bill and perhaps on the equity party, too.

Other early disappointments that the market at first discounted showed up with Nike's (NKE) report that future orders could decelerate and news that Calpine (CPN) had filed for protection from creditors and Kirk Kerkorian's Tracinda had sold about 20 percent of its position in GM.

The new couples showing up for the party early in the day included a much-touted GOOG and AOL pairing. GOOG will take a five percent position in Time Warner's (TWX) AOL, paying $1 billion for the honor. Seagate Technology (STX) has bid for Maxtor (MXO), bidding $1.9 billion. These two comprise two of the largest manufacturers of disk drives. Allergen (AGN) is willing to spend about $3 billion to take over Inamed (IMDC). Reportedly, GE has made an offer for Arden Realty (ARI) in conjunction with unidentified partners. IBM will buy Micromuse (MUSE). Yesterday's news that American International Group (AIG) would acquire $3.5 billion worth of property in Japan boosted morale for AIG and other multi-line insurers.

Although the Senate failed to approve the defense bill, it did pass a bill to trim spending by $40 billion over the next five-year period. It did so only with Vice President Cheney voting in a tie-breaker, however. The bill cuts funds for Medicaid, Medicare and student loans. Because the bill was changed when Democrats forced some provisions to be struck, the bill will require another vote by House members. Although the House is not expected to reconvene until late January, CNBC commentators noted that sometimes arrangements can be made to approve such changes without waiting for all members to return. Lawmakers were looking into such a possibility.

Tomorrow's earnings reports include those from AGE, CAG and GIS.
Economic reports include the typical initial claims at 8:30, but that 8:30 reporting period will also see the releases of November's personal income and personal spending numbers. Leading indicators for November will be released at 10:00, and natural gas inventories, at 10:30.

Charts prove difficult to decipher. Rallies get sold. Bearish rising wedges produced over the last couple of weeks on some indices have been broken to the downside and then retested. The former support held as resistance, suggesting that markets are ready to fall further to probe for stronger resistance. Yet the TRAN broke higher again, and on many other indices prices congregate near recent highs while daily MACD turns lower, not a bearish development. As long as rallies get sold, continue selling rallies, but be ready to exit if proven wrong by upside breaks through those recent consolidation patterns.

Join the commentators on the Market and Future Monitors for live appraisals of the market action. If not compelled to trade each day, this light-volume end of the holiday week might be a good time to test a new indicator with a few paper trades rather than with your hard-earned money.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
CYT PGR None
GILD    
X    

New Calls

Cytec Ind. - CYT - close: 46.47 chg: +0.87 stop: 44.99

Company Description:
Cytec Industries is a specialty chemicals and materials technology company with pro forma sales in 2004, including the Surface Specialties acquisition, of approximately $3.0 billion. Its growth strategies are based on developing technologically advanced customer solutions for global markets including: aerospace, coatings, mining, plastics and water treatment. (source: company press release or website)

Why We Like It:
CYT's business and profits were impacted by the hurricanes earlier this past fall since the company has operations in Louisiana and Texas. The company eventually had to lower earnings expectations. After the September sell-off shares of CYT appears to have put in a bottom in the $39-41 range. More recently the stock has been consolidating sideways above its 200-dma but under resistance near $46.60. It's probably not a coincidence that this resistance also lines up with its five-month trendline of lower highs. We want to try and catch a breakout over that trendline. Therefore we're suggesting a trigger at $47.01. If triggered we'll target a run toward the $50.00 level by its early February earnings report. The P&F chart for CYT points to a $65 target.

Suggested Options:
We are suggesting the February calls but we do not want to hold over the February earnings report.

BUY CALL FEB 40 CYT-BH open interest= 81 current ask $7.00
BUY CALL FEB 45 CYT-BI open interest= 89 current ask $2.85
BUY CALL FEB 50 CYT-BJ open interest=164 current ask $0.75

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 333 thousand

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Gilead Sciences - GILD - close: 54.07 chg: +2.45 stop: 49.99

Company Description:
Gilead Sciences is a biopharmaceutical company that discovers, develops and commercializes innovative therapeutics in areas of unmet medical need. The company's mission is to advance the care of patients suffering from life-threatening diseases worldwide. Headquartered in Foster City, California, Gilead has operations in North America, Europe and Australia. (source: company press release or website)

Why We Like It:
If you like fundamentals then consider this a bird-flu play. If you're a technical trader than this looks close to a bull-flag breakout pattern. GILD actually invented Tamiflu and sold it to Roche. GILD still gets royalties on the drug so today's news that the U.S. has okayed Tamiflu as a potential treatment of birdflu in children is certainly bullish. The move in GILD (+4.7%) is a breakout above its four-week trendline of lower highs. Short-term technical oscillators are already starting to turn bullish and its MACD is nearing a new buy signal. We want to see more confirmation so we're suggesting a trigger to buy calls at $54.51. More conservative traders may want to wait for a move over $55.00 instead. Our four-week target is the $59.00-60.00 range. We do not want to hold over the January earnings report.

Suggested Options:
We are suggesting the February calls even though we plan to exit in January ahead of GILD's earnings report.

BUY CALL FEB 50 GDQ-BJ open interest=1696 current ask $5.80
BUY CALL FEB 55 GDQ-BK open interest=4061 current ask $2.75
BUY CALL FEB 60 GDQ-BL open interest=2406 current ask $1.10

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 4.3 million

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United States Steel - X - close: 46.49 chg: +1.55 stop: 44.65

Company Description:
United States Steel Corporation headquartered in Pittsburgh, Pa., manufactures a wide variety of steel sheet, tubular and tin products; coke, and taconite pellets; and has a worldwide annual raw steel capability of 26.8 million net tons. (source: company press release or website)

Why We Like It:
The steel industry was mostly positive on Wednesday and shares of X are bouncing after testing support near the $45.00 level. It's probably not a coincidence that Tuesday's low was also a test of the 38.2% Fibonacci retracement level. Today's bounce was fueled by better than average volume and looks like a new bullish entry point. However, we want to see more follow through before opening new plays. A breakout over the 10-dma should work. We're suggesting a trigger at $47.05. If triggered we'll target a rise into the $52.00-52.50 range. We do not want to hold over the January earnings report.

Suggested Options:
We are suggesting the February calls even though we plan to exit in January ahead of X's earnings report.

BUY CALL FEB 40 X-BH open interest= 51 current ask $7.70
BUY CALL FEB 45 X-BI open interest=238 current ask $4.40
BUY CALL FEB 50 X-BJ open interest=489 current ask $2.25

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 3.8 million
 

New Puts

Progressive Corp - PGR - cls: 118.90 chg: -0.72 stop: 121.25

Company Description:
The Progressive Group of Insurance Companies, in business since 1937, ranks third in the nation for auto insurance based on premiums written and provides drivers with competitive rates and 24/7, in-person and online service. (source: company press release or website)

Why We Like It:
It looks like the upward momentum in PGR has topped. Of course bears have probably been saying that for almost five years straight. The stock is a huge momentum candidate and the biggest risk for bears here is probably some end-of-quarter window dressing in the last two weeks of December. The recent pull back toward the 50-dma did not produce much of a bounce and we suspect that PGR may dip back toward its 100-dma under $110 before it continues much higher. This should be considered an aggressive play. We're going to suggest a trigger at 117.45 to open the play. If triggered we'll target a decline into the $110.50-110.00 range. We do not want to hold over the January earnings report.

Suggested Options:
We are suggesting the February puts so we can hold them right up to PGR's earnings report.

BUY PUT FEB 120 PGR-ND open interest=751 current ask $4.90
BUY PUT FEB 115 PGR-NC open interest=235 current ask $2.90

Picked on December xx at $ xx.xx <-- see Trigger
Change since picked: + 0.00
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 836 thousand
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Apache - APA - close: 70.96 change: +0.51 stop: 67.99

A minor rebound in crude oil prices helped lift the oil sector on Wednesday but the gain wasn't very convincing. APA's rebound back over the $70.00 level looks like a new bullish entry point but we would enter new positions very cautiously.

Picked on December 08 at $ 70.98
Change since picked: - 0.02
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 3.6 million

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Femsa Fomento - FMX - close: 72.08 chg: +1.67 stop: 67.75

FMX is showing lots of relative strength today. The Mexican markets were mostly flat on Wednesday but FMX rallied to a 2.3% gain on above average volume. Our target is the $74.75-75.00 range.

Picked on December 19 at $ 70.65
Change since picked: + 1.43
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 308 thousand

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Garmin ltd - GRMN - close: 62.79 change: +1.41 stop: 58.90 *new*

After GRMN's fourth dip toward the $60.00-60.50 region in the last four days the stock finally found the strength to rebound. This could be used as a new bullish entry point but you might want to tighten your stops. We're going to raise our stop loss to $58.90. Our mid-January target is the $69.00-70.00 range. We do not want to hold over the January earnings report.

Picked on December 13 at $ 63.54
Change since picked: - 0.75
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

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Kerr Mcgee - KMG - close: 92.99 chg: +0.10 stop: 88.99

Like many in the oil sector today shares of KMG only managed a minor gain. We remain cautious and hesitant to suggest new long positions here. Our mid January target is the $98.50-100 range.

Picked on December 02 at $ 90.26
Change since picked: + 2.73
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.8 million

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Kinder Morgan - KMI - close: 93.07 chg: +0.17 stop: 91.90

KMI didn't fair much better than KMG. The stock added a very minor gain and remains under resistance at the $95.00 level. We are not suggesting new positions here.

Picked on December 02 at $ 92.75
Change since picked: + 0.32
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 749 thousand

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Ryland Group - RYL - close: 73.22 change: -1.03 stop: 71.85

The homebuilders still aren't showing much strength despite the bullish economic news this week. RYL fell 1.38% but remains above its trendline of rising support. We'd probably wait for a move over $74.50 before considering new bullish positions.

Picked on December 13 at $ 73.96
Change since picked: - 0.74
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 1.3 million

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Questar Corp - STR - close: 78.55 chg: -2.10 stop: 77.45

Okay, now we're starting to get concerned. Over the weekend we pointed out the bearish reversal pattern and so far STR has followed through with a decline and now a breakdown below the $80.00 level and its 10-dma. There was a very minor bounce late this afternoon from the $78 level. If the $78 level fails the next level of support is the 50-dma near $77.75. We are not suggesting new positions at this time unless STR can rebound back above the $80 mark and even then we might wait a day or two. FYI: STR is also a current strangle play on the newsletter's play list.

Picked on December 13 at $ 80.85
Change since picked: - 2.30
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 752 thousand

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Total S.A. - TOT - close: 127.00 change: -0.28 stop: 126.49

TOT tried to rally this morning but its early strength failed and shares remain just above support near the 50-dma. We don't see any changes from our previous updates. We are not suggesting new positions at this time.

Picked on December 13 at $130.25
Change since picked: - 3.25
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 936 thousand

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Tractor Supply - TSCO - cls: 54.70 chg: +0.17 stop: 51.95

TSCO displayed a little bit of strength today with a minor breakout over its two-week trend of lower highs. We are not suggesting new plays at this time. Our target is the $57.00-58.00 range.

Picked on November 30 at $ 52.75
Change since picked: + 1.95
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

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Valero Energy - VLO - close: 52.92 chg: +1.70 stop: 49.74

Refining stocks turned in a very bullish session. Shares of VLO added 3.3% after testing support on Tuesday. This could be used as a new bullish entry point but consider using a tight stop loss. Our post-split target is $58.50. FYI: VLO is also a current strangle play in the strangle section.

Picked on December 08 at $ 53.28 (split adjusted)
Change since picked: - 0.36
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 9.8 million
 

Put Updates

Magna Int. - MGA - close: 69.38 chg: +0.42 stop: 70.31

MGA is still showing way too much strength for our liking. The stock broke out over resistance at the $70.00 mark and its 200-dma on an intraday basis today. Thankfully the rally failed but we remain cautious. Normally, a failed rally near resistance like this could be a great place to consider new bearish positions. We would wait for a move under $68 before considering new positions. More conservative traders may just want to exit early right here since MGA is not cooperating. We'll give the stock through the end of this week assuming we don't get stopped out.

Picked on December 04 at $ 68.14
Change since picked: + 1.24
Earnings Date 02/07/06 (unconfirmed)
Average Daily Volume = 318 thousand

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PACCAR Inc. - PCAR - close: 69.72 change: +0.97 stop: 72.51

We cannot find any news or catalyst to explain PCAR's sudden show of strength today. The stock spiked to $70.51, above technical resistance at its 200-dma, before sliding lower again. Maybe this was just an oversold bounce. We would be very careful about initiating new positions here. Our target is the $65.25-65.00 range.

Picked on December 20 at $ 69.49
Change since picked: + 0.23
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

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Amer. Eagle Out. - AEOS - cls: 21.02 chg: -0.45 stop: n/a

AEOS is under performing its peers in the retail sector with today's 2.1% decline. We don't see any change from our weekend update for AEOS. 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/$1.95ask.

Picked on November 13 at $ 25.47
Change since picked: - 4.37
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 63.76 chg: +0.29 stop: n/a

We don't see any change from our weekend update for ANF. 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: + 4.09
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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Blue Coat Sys. - BCSI - cls: 42.59 chg: +0.11 stop: n/a

The stock tried to bounce a bit this morning but the early strength failed. The stock looks poised to breakdown under support at the $42.00 level and its 100-dma. At this time we're not suggesting new plays. 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.

Picked on December 04 at $ 45.43
Change since picked: - 2.84
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand

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Building Materials - BMHC - cls: 81.80 chg: +1.82 stop: n/a

We don't see any change to our previous update on BMHC. The stock is still oscillating around the $80.00 level. We initiated this play over the weekend with a suggested $81.50-79.00 entry window. The closer to $80.00 the better the entry point. The options we are suggesting are the March $90 calls (BGU-CR) and the March $70 puts (BGU-ON). Our estimated cost is $8.20. Our target is $12.50 by March expiration.

Picked on December 18 at $ 80.95
Change since picked: + 0.85
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand

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Chicago Merc. Exchg. - CME - cls: 374.05 chg: +2.34 stop: n/a

We do not see any change from yesterday's update on CME. Thus far this play in CME is not working out. It's been one month since we started this strangle at $375.90. Since then CME has rallied to $396.90 and fell to $344.00. Unfortunately, this sideways trading we're seeing right now over the past week is the worst thing that can happen to us with a strangle. More conservative traders may want to seriously think about exiting early before the options premiums deteriorate any more. 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: - 1.85
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

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D.R.Horton - DHI - close: 36.64 chg: +0.24 stop: n/a

DHI is bouncing from the $36.00 level but it's not very convincing. The homebuilders remain sluggish despite the positive economic data out this week. 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 $2.40bid/$2.50ask.

Picked on November 13 at $ 32.56
Change since picked: + 4.08
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million

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Four Seasons - FS - close: 49.50 chg: +0.93 stop: n/a

FS is trying to rally and the stock added 1.9% today. The rally did fail near the $50.00 level but shares are so oversold all the technical indicators have turned positive again. If FS breaks out over the $50 level or the 50-dma (your choice) more conservative traders may want to think about exiting early. We still have less than five weeks left before January options expire. 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 $1.70bid/$1.75ask.

Picked on November 08 at $ 55.37
Change since picked: - 5.87
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

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Lear Corp - LEA - close: 27.64 chg: +0.11 stop: n/a

LEA tried to rally this morning but significantly pared its gains by the closing bell. We do not see any change from our weekend update on LEA. 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.

Picked on November 06 at $ 30.24
Change since picked: - 2.60
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million

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Verifone Holdings - PAY - cls: 23.00 chg: -0.33 stop: n/a

The relative weakness in PAY these last couple of days is not a good sign and today's 1.4% drop put the stock under its rising 50-dma. Volume came in way above the average and that's not a positive sign either. We have less than five weeks before January options expire. More conservative traders may want to cut their losses right here. 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 $1.30bid/$1.55ask.

Picked on October 12 at $ 19.98
Change since picked: + 3.02
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

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Questar Corp. - STR - close: 78.55 chg: -2.10 stop: n/a

Volume was very heavy on STR's decline under the $80.00 level today. That doesn't bode well for the bulls. If STR breaks down under the 50-dma near $77.75 the stock might be headed for the $70 level and its 200-dma. 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: + 2.30
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

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Texas Ind. - TXI - close: 51.00 chg: +1.42 stop: n/a

We see no change from our weekend update on TXI. 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.

Picked on November 27 at $ 49.57
Change since picked: + 1.43
Earnings Date 12/15/05 (unconfirmed)
Average Daily Volume = 354 thousand

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Valero Energy - VLO - close: 52.92 chg: +1.70 stop: n/a

Refining stocks turned in a very strong session on Wednesday. VLO added 3.3% after testing support near its 50-dma on Tuesday. 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.

Picked on November 21 at $ 50.50
Change since picked: + 2.42
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Dropped Calls

Dominion Res. - D - close: 79.36 chg: -1.46 stop: 74.75

We are choosing to exit early in D. The utility sector was the worst performing group today and the UTY index produced a bearish engulfing candlestick pattern. Shares of D followed suit with a big bearish engulfing candlestick pattern. These patterns are usually seen as one-day bearish reversal patterns. Today's drop in D also took it below round-number support at $80.00 and technical support at the 10-dma. A bounce from $78.00 might be used as a new bullish entry point.

Picked on November 27 at $ 78.24
Change since picked: + 1.12
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 1.8 million

---

Zimmer Holdings - ZMH - close: 69.30 chg: +1.05 stop: 67.75

We have been stopped out. ZMH continued to sink following yesterday's sell-off. The stock gapped lower to open at $67.56, which was below our stop loss at $67.75. We have adjusted our exit price to the opening price today. Unfortunately, ZMH produced a very sharp rebound and it looks like a one-day bullish reversal. Keep an eye on ZMH for a move over $70 or its 100-dma as a potential bullish entry point.

Picked on December 11 at $ 68.62
Change since picked: + 0.68
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 2.6 million
 

Dropped Puts

Netflix - NFLX - close: 27.39 chg: +2.28 stop: 27.45

We have been undone by an analyst upgrade. Citigroup started coverage on NFLX with a "buy" this morning and a $39 price target. The positive analyst rating pushed NFLX to gap open at $26.43 and soar to $27.56 above technical resistance at its 50-dma. Naturally, this heavily shorted stock saw some short covering on the news. We have been stopped out at $27.45. It's easy to be frustrated since NFLX came within four cents of our target on the December 14th low.

Picked on December 09 at $ 25.99
Change since picked: + 1.40
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 1.4 million
 

Dropped Strangles

None
 


Trader's Corner

Moving Average Envelopes

I received a Subscriber e-mail question on this topic, and will get to that in a moment. Someone wrote our support staff with the following question and I thought I would provide this first as a matter of possible interest to others and as general information:

SUBSCRIBER E-MAIL:
"Is there a way to see (search for) all of the articles written by Leigh Stevens on your site?"

RESPONSE:
[Background note: there is not a search function per se currently on the OIN website, but there is another easy way of finding my articles. I tend to write on different topics in a regular and somewhat methodical way, which over time would re-produce a lot of what is in my book: 'Essential Technical Analysis'. In a way this is a value-added feature of OIN and my particular Trader's Corner articles, at least for those interested in technical analysis; I consider this 'market' analysis, but I do concentrate on technical aspects.]

FINDING PRIOR INDEX TRADER ARTICLES:
My Trader's Corner articles are written by me (Leigh Stevens) on Wednesday for the Option Investor Newsletter (OIN) that is both e-mailed to you and can also be found on the OIN website: click on any prior Wednesday Newsletter; these go back many months. A further click on the Trader's Corner name at top gets you directly to that section without having to scroll all the way down. Prior e-mailed OI Newsletters still in your (e-mail) inbox or in a saved file, are another way to access my prior Trader's Corner columns.

I also write the weekly 'Index Trader' (IT) column appearing usually on Saturday or (sometimes) Sunday, which is found on the OIN WEBSITE ONLY, as it's not weekend e-mailed OIN. [An easy way to go to the OIN web site is via any daily e-mailed Newsletter by use of the note at top: (for an) "online version of this newsletter: 'click here'".] Scrolling back in the INDEX TRADER section allows you to click on and view any and all prior IT articles; these can also be saved as web files.

SUBSCRIBER E-MAIL:
"There are three lines, moving averages I think, usually shown on the charts you use in your commentaries on the weekend. I see a 21-day average, then some percentages given on the other lines above and below. What are these again and how used?

Also since you turned bearish this past weekend, the market has fallen some but not sharply. Before that you were still bullish mor than not. What tipped you the most to the opinion the market would more likely go down than go on to new highs?"

LEIGH STEVENS:
I'll answer on the second part first, then on the Moving Average Envelopes, which is what you're refereeing to.

What got me leaning more bearish or at least cautious on sticking with bullish strategies were two things principally: one was the PATTERN of highs made repeatedly in the same area, in some cases at almost the exact same level in some major indexes, as can be seen in leading S&P 500 (SPX) and Nasdaq Composite (COMP) charts.

The longer that a market goes basically sideways after a strong and prolonged move, the more likelihood that a top is forming. However, there are, as of yet, no 'confirming' downside penetrations of prior (down) swing lows. So, the market is still kind of in no man's land so to speak.

The market could be building a top as signaled by the lack of buying follow through, coupled with repeated selling interest in key price areas; however, selling also has been drying up once the major indexes get much lower. The S&P 100 (OEX) and the Dow 30 (INDU) have formed possible double tops to boot.

Fundamentally, I figure that stock prices are pretty much in equilibrium ahead of more information; i.e., how earnings fared in the fourth quarter (Q4). We have earnings coming out in January, and there are a number of cross currents on how strong was the finish to the year. The market may be showing in its technical/chart patterns that they won't be good enough to push stocks much higher for a while. And, seasonally, there's a tendency to sell off in January.

The other factor that was my principle negative was that my 'sentiment' INDICATOR last week indicated a continued high bullish interest in calls. So high, that it suggested, along with the chart patterns, the contrary possibility of the market falling into a deeper correction than we've been seeing since when this current rally began in early-October.

Some charts, will illustrate both the moving average envelopes I keep up a lot as 'references' in the major indices (for where prices are in a typical trading range), and the other points about pattern and my 'sentiment' indicator:

CHART 1: S&P 500 (SPX); Daily

The S&P 500 built a top over a three day period at 1275. Of course the Index had stalled before this, not far under, in the 1266-1270 area. The tipping point to a more bearish viewpoint were intraday highs made three days running at 1275.

However, it also should be noted that the recent swing lows around 1250 have not been pierced either. SPX is in limbo so to speak. I don't want to be in calls and would rather be in puts at 1270 and above, allowing me to set an exit point/stop at 1277, with downside potential looking to be 1250, perhaps back to the trendline around 1230-1235.

The moving average in a MOVING AVERAGE ENVELOPE indicator is called the 'centered' moving average. The lines above and below this average are set to equal some percentage above and below the centered moving average. Often this percentage moving average indicator is displayed WITHOUT the moving average that it's based on. The S&P indexes tend to fluctuate from around 3 percent above and 3% below the 21-day average. Due to somewhat less volatility in recent months, I've set the lower and upper lines at 2.5 percent. More on the purposes of this indicator further on.

CHART 2: S&P 100 (OEX); Daily

The dominant or stand out feature technically of the S&P 100 (OEX) chart was the possible double top, relative to OEX's March price peak. It's also true that OEX was hitting highs at same level in several sessions; i.e., 582.6-583. But what trumps this so to speak is that we have this prior high made some months back that was touched once, making an exact double top. Double tops, separated by some weeks or months (even years) are frequently quite meaningful, suggesting places for at least a trade in options, sometimes also signaling a major top.

The spike up in my 'sentiment' indicator shows the recent spike up to a day where the daily volume on CBOE equities calls was 2.4 times the same day's put volume. The number of high readings also pulled the 5-day average up to 2, which is not greater than any prior period in the chart shown above, but the one-day reading IS. This kind of peak suggests a high degree of bullishness as suggested by call volume relative to puts.

A high degree of bullishness, coming at a time when the market is significantly stalled, is suggestive that the market is at least vulnerable to coming down. Sometimes, most traders are highly bullish or highly bearish and are RIGHT. It's just not that often!

As with most aspects of technical analysis, patterns tend to repeat. That's why this form of analysis 'works' as well as it does, which is not all the time but often enough that you can make money using it. The probabilities involved in this is why I always suggest playing the percentages; e.g., what is the risk in shorting at a repeated high, using a stop just over that high, versus the reward potential of a significant correction? Usually, the odds favor this kind of trade. When wrong, loses are relatively small. When right, the profits are good. Add up a few trade like this and it's a winning year. But I digress!!

CHART 3: Nasdaq Composite (COMP); Daily

The Nasdaq Composite (COMP) Index keep hitting repeated highs around 2275-2275 and has experienced a fairly sharp correction from this area, once it fell under its 21-day moving average. However, it also has held at and rebounded some from its relatively steep up trendline. This action suggests that the strong up trend has not been 'broken' so to speak, at least not yet.

Now is where the LOWER envelope line comes into play as a kind of 'benchmark' on the downside possibilities in a 'normal' trading range for COMP. If COMP were to fall to the lower envelope line in the chart above, and this would be likely if the Index fell again under 2215, a possible downside target becomes 2164, at the green lower envelop line. Now would be a time to go into the Moving Average Envelope study a bit more as to why this might be a good indicator to follow.

THE MOVING AVERAGE PERCENT ENVELOPE (MAPE) INDICATOR

I will use some charts from PAST periods as illustrations from this point on. I also refer initially to Moving Average Envelopes as Moving Average PERCENT Envelopes, to reinforce the idea that these bands or envelope lines are set to equal a fixed percentage above and below the changing (each day's) moving average; e.g., lines that are set to equal 3 percent above and below the moving average.

There is not a set "default" for the Moving Average. Usually, but not always, the percentage above AND below is the SAME. In some software applications, the upper and lower line MUST be the same since the application allows only ONE input.

The moving average (percent) envelope indicator has 3 component lines, but, as I noted, the moving average in the center is not always shown. However, you can then always apply a simple 1-line moving average set the number of days on which the envelope percentages are based and you then see the center moving average which I find invaluable.

In the moving average envelopes Indicator you can at MOST, set
the following different inputs by varying the:
1. The type of moving average; e.g., simple, exponential, etc.
2. Length of the moving average; e.g., the number of trading
periods; e.g., 21-days on daily charts which I use most often.
3. Percentage figure above the moving average in question.
4. Percent figure below the moving average.

Not being able to set different moving averages (above and below) is a minor limitation in some charting applications. In an index uptrend, the moving average percentage will tend to increase on the upper side - that is, the percentage at and under which MOST trading occurs is a bit higher than the lower envelope line; e.g., 3.5% versus 3%, or 2.5 versus 2 percent.

Most of the time, a simple moving average (SMA) is used, so it a matter of adding the closing price of some number of trading periods (e.g., days, hours, etc.) and dividing by this same number, for example the sum of the past 10 closes divided by 10.

I use for Stock Indexes a 21-period moving average, on daily charts only. The blue chip market segment, as represented by the S&P 500 Index (SPX), in an 'average' market cycle or trend, will tend to see prices fluctuate roughly 90-95% of the time in a range that is 2-3 percent above or below an SPX 21-day average.

As we are interested in also seeing the high and low extremes relative to the envelope lines, bar (or candlestick) charts are used in the S&P 100 (OEX) chart shown below; to which is applied the moving average envelope indicator using upper and lower envelopes lines of 1.5% and 2%, respectively.

A number of down (red) arrows, indicating precise or approximate areas of resistance, are applied at different points by way of illustration of where the upper envelope line OR the moving average acted as resistance, even if this was temporary.

Conversely, the up (green) arrows, indicating precise or approximate areas of support, are applied at different points by way of illustration of where the lower envelope line OR the moving average acted as support, even if that was temporary.

There are some instances where the upper or lower envelope line also intersected an existing, or the start of, a trendline; e.g., such as those defining a price 'channel' like in the chart above. There are also instances where a touch to the upper or lower envelope line also coincided with, or were in vicinity of, extremes in key technical markings like trendlines. The convergence of a low or high reversing from both an envelope line AND a trendline can be a more definitive sign of a possible intermediate top or bottom.

Often it is the second touch to the upper or lower envelope line that marks a 'final' top or bottom for that move. So, for example in the chart above, another push in the OEX up to the 580 area, might mark a 'final' top for the advance prior to a corrective and tradable downswing.

In a volatile market, the S&P envelope line can expand to 4%
or more, but it won't typically be more than this; in a less volatile market trend, the envelope range might be 2 2.5 percent, as has been the case for most of this year.

With the Nasdaq, this percentage range will tend toward 3.5 to 4, even as much as 5-6 percent; I typically start with around a 4 percent envelope in the Nasdaq indices and see if MOST of the trading is occurring within an envelope line of that percentage. The percent line we are looking for is the one that will contain within it most of the daily highs and lows that occur WITHIN the past 6-12 months.

You'll note, as in the daily chart of the Nasdaq 100 (NDX) chart below, a tendency for prices in the strong up trend shown, as well as in Chart 3 above, the tendency for the advance to keeping going up but to 'hug' the upper envelope line. There is less of tendency with tops, for the first touch to the upper envelope line to mark a 'final' top.

The final NDX bottom on the chart below was also the second touch, but prices did not keep going down along the line. There was an attempt to rally, followed by a sideways trend, then a couple of drops, one sharp, then a final 'touch' to the lower envelope line. This was the bottom and best place to cover puts and buy NDX calls.

I usually use moving average envelopes for the Indexes only. Due to the bouts of volatility associated with earnings, business developments, etc., individual stocks tend to work less consistently than for the indexes, which "smooth" out
the individual stock hiccups and reversals.

In an uptrend I often end up setting the UPPER band at a greater percentage ABOVE the center moving average. In a declining trend that goes on for a long period (a bear market), the declines will typically bottom at a greater distance BELOW the center moving average. There is not typically a huge gap between the upper envelope percent and the lower envelope line percentage; e.g., a half percent, more rarely, especially in Nasdaq, a full percent such as from a prior period in NDX below:

In an uptrend, a high probability trade is often to buy dips (e.g., buy Index calls) when prices fall to the lower envelope line. The reverse is true in a sustained downtrend - buy puts on moves up to the upper envelope, at least one that has been 'containing' the rallies that have occurred in the past 6-9-12 months.

After several weeks (e.g., 3-6) of an uptrend or downtrend that has been closely hugging the upper/lower envelope lines, the odds increasingly favor a correction and can be favorable to a bet on at least a sideways trend ahead which suggesting selling option premium; e.g., shorting calls or puts.

As I mentioned already, often in recent years in the Nasdaq 100 (NDX) Index one of the most volatile of the major indices, my current settings for the two envelope lines may be as much as a percent difference; e.g., 4% for the upper band, especially in an uptrend and 3% for the lower envelope line. However, currently, as can be seen in the NDX chart one chart back from the one directly above, both envelope lines are at 4%. I tend to adjust these lines from time as volatility increases or decreases.

In a prolonged or dominant uptrend, there will tend to be a number of lows that are 'contained' or held at the centered moving average and more touches to and along the UPPER envelope line. In a prolonged downtrend, there will be MORE instances of the index topping out in the area of the centered moving average and there will be more touches to the LOWER envelope line.

MY 7 TRADING RULES OF MOVING AVERAGE ENVELOPES:

1. Determination of what moving average to use somewhat arbitrary but is found by what 'works' for the past 6-9-12 months to contain within the lines most of the highs and lows. The variation is with the percentages above and below this line. I don't vary the 21-day moving average length for the stock indices. You can experiment yourself with different lengths.

2. A common starting point for the Index envelope size is 3% with the Dow and S&P and 4-5% in the Nasdaq. The envelope size varies from trend to trend and market to market. For an envelope size that "works" the percent figure that contains within it 90-95% of the price moves above and below the moving average -- start with 3% and expand or contract the envelope size as is appropriate for the dominant trend for the past 6-12 months.

3. If the last high was 4% above the moving average, the next high will often reflect the same extreme. Conversely, if the last significant downswing low was 3% below the moving average, keep this figure as the lower envelope setting until market action otherwise dictates.

4. If prices cross above the moving average, assume that this line will act as support on pullbacks and the next rally will have the potential to advance to the upper envelope line. If in an uptrend, the envelope line can act as a rising line of resistance for multiple rallies the rally tops will "hug" and move up 'along' the upper envelope line. The key thing is that rate of increase will SLOW - the index will not always reverse on move to or above the line.

5. If prices cross below the center moving average, assume that this line will act as resistance on any rebounds and that downside potential now becomes for a move to the lower envelope line. If the trend is DOWN, the envelope line may act as a falling support line and there may be multiple downswings that touch or 'hug' and move down 'along' the lower envelope line.

6. In an uptrend, the optimum Index Call purchases are the declines to the lower envelope line this area will both define where the stock or other item is both 'oversold' and the specific price area that offers a opportune buying opportunity. If in a downtrend, sell advances to the upper envelope line this area will help define where the market is both 'overbought' and the specific price area most opportune as a selling point.

7. Even if there is an extension of a price swing to above or below the envelope lines, the probability for a significant further move in that direction is limited, especially if the price swing is a counter-trend move. At a minimum, there should be a reaction (countertrend move) once prices are above or below the envelope line in question.

There is not much more to say about how to use envelopes except to say that the use of this technical indicator gives another kind of an idea about where a market might be at an extreme. While extremes don't happen all that often, when they do it often marks a good trading opportunity; not more than a few of these make for a profitable year trading options.


** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

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

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