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Daily Newsletter, Sunday, 12/25/2005

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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

Ho, Ho, Ho!

Santa Claus appears to be playing a trick on traders by teasing us with dreams of new highs but delivering bouts of profit taking as we near those highs. After a week of volatility produced by fund sales and tax selling the indexes returned to close very near to where they started the week. Given the sharp periods of selling early in the week a return to the last weeks levels is a positive event. Many commentators referred to the weakness last week as the absence of a Santa Claus rally. This is incorrect. The Santa Claus rally refers to the last five days of the year and the first two days of the next. The week before Christmas typically has a bullish bias but has been plagued with tax selling in recent years as funds clean up lose ends before they leave for the year. Last week saw some broad based selling events but no real damage was done to the indexes. The return to the high end of the range by Friday may have erased the index losses but investor sentiment was still badly bruised.

Dow Chart - Daily

Dow Chart - 60 min

Nasdaq Chart - Weekly

The markets started off in the dumps Friday morning after a sharp drop in New Home Sales. Sales in November fell to 1.245 million units on an annualized basis. This was a drop of -159,000 from the October rate of 1.404 million units. It was the biggest drop since 1994. While this looks negative on the surface we need to remember that October was a record high and the current pace is still very strong and just slightly under the 1.29M average rate for the six months prior to October. The inventory of new homes rose to 503,000 units and a 4.9-month supply. This was the highest level since 1996. However with sales much stronger than prior levels this rising inventory is not necessarily as bad as it looks on the surface. November and December are not strong months for home sales with the pace accelerating once the holiday lights come down in January. Talk of a bursting bubble continues and the internals of this report suggest the West Coast is in full decline. Sales of new homes in the west declined by -22% with the Midwest dropping -18%, the South -5% and Northeast rising +13%. Remember this is a survey of contracts signed not houses closed and is less reliable than the regular Home Sales survey. The markets reacted negatively to these numbers and erased their early gains. It took several hours before the indexes fought their way back to positive territory.

This housing news came on the heels of a prediction by Fannie Mae that the housing market has peaked and will continue to decline in 2006. Fannie said housing starts in 2006 could drop from -5% to -10%. They predicted existing home sales would decline by -4% and new home sales by -5%. 30 year fixed rate mortgages are expected to rise to 6.6%. The New Home Sales for November as reported above fell -11% from October to November and that seemed to provide validity to Fannie's claims.

Offsetting the drop in New Home Sales was a stronger than expected Consumer Sentiment at 91.5 for December. This was +10 points over the November level at 81.6 and significantly over the cycle low at 74.2 set in October. Expectations provided the biggest jump adding +10.6 points to 80.2 with the present conditions component rising +8.9 to 109.1. The headline number rose +2.8 points from the initial December reading suggesting the holiday sentiment accelerated as December progressed. As heating bills for those December cold fronts and holiday credit card bills begin hitting mailboxes in January this positive sentiment could fade.

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Durable Goods Orders surged in November for the second consecutive month. November posted a +4.4% jump compared to +3.0% jump in October. Both months were pushed higher by aircraft orders. Looking under the hood the orders ex-aircraft actually fell -2.0%. Inventories also rose sharply in all categories. Spending has been steady but the rise in inventories could be a warning that this buying trend is slowing. While the sharp jump in aircraft orders is good for the economy it is far less a driver than home sales. It may be good news for Boeing but not especially a positive economic indicator for the U.S. economy. Some estimates suggest that the home building sector has produced up to 50% of the GDP growth in 2005.

After Friday's economic reports the talking heads were consumed with the potential for an inverting yield curve as an indicator of a coming recession. The yield on the 10-year sank to 4.38% only one point away from merging with the yield on the two year note. An inverted yield curve is said to be one of the best indicators of an approaching recession 6-9 months in the future. Unfortunately for the doomsayers none of the other indicators are cooperating. Other indicators needed for confirmation are falling commodity prices and a declining stock market. While oil is off its highs it has not turned into a nosedive yet. Copper, an excellent indicator of economic activity hit a new high on Friday at $2.04. While the equity markets have been volatile of late the S&P is only six points from a four-year high. Transports, another indicator of economic activity hit a new all time high at 4282 on Friday. The CRB Index (CR00Y) is only ten points off its all time high set last week at 336. Without confirmation an inverted yield curve is an indicator without a home. Once confirmation from the other indexes begins to form you can bet there will be a rush to the exits but that is a problem we are not likely to see until January or later.

Oil prices slipped to close just over $58 despite comments from OPEC that they would have to trim production after January if prices continued to fall. How quickly they became comfortable with the new price range after saying they wanted a $30 range just over a year ago. Boone Pickens was on TV this week saying he could see prices fall to $53 in early 2006 as winter demand declines but will reach $100 before the decade is over. More detrimental to the price of oil this week was a sharp drop in gas prices after a smaller than expected drop in gas storage levels of -162 bcf. Many had expected the drop to be over -200bcf given the very cold weather the prior week. Natural Gas closed Friday at $12.28 after trading up to $14.42 before the inventory report on Thursday. With no cold front on the horizon and warmer weather forecasted for the holiday week traders were quick to take profits. That urge to sell was hastened when Pickens said gas prices could fall to $9 as winter demand declined.

Crude Oil Chart - Daily

Natural Gas Chart - Daily

This drop in oil and gas prices helped to push the transports to another new high. Stellar performers have been the airlines, AMR, CAL and JBLU. Railroads have been making the grade with NSC, UNP, BNI, CSX and CNI the leaders there. FDX spiked to a new all time high on Thursday after better than expected earnings but UPS failed to break resistance after the FDX earnings news. I am mentioning all these outperformers because January has not been kind to the transports for the last five years. In 2005 the first three weeks of January saw a drop of nearly -400 points in the transportation average. In 2004 the decline did not begin until the 3rd week of January but continued for nearly -400 points. The decline in 2003 begin with the opening of trading for 2003 and continued for nearly -500 points to bottom on the week of March 9th. 2002 losses were somewhat moderate compared to 2003-2005 with only a decline of around -250 points but it did start with the opening of trading for 2002. 2001 was ugly with more than -575 points lost from the end of December high at 3157 to the March low at 2578. In 2000 the index fell from 3017 to 2260 for a whopping -757 point drop. I listed this history for those looking for a post holiday trade. The transports can be traded using the $DXT.x options or the transportation iShare (IYT). Past performance is no guarantee of future results but given a five year trend and transports at an all time high it seems to me to be an opportunity ahead. You could also use options on some of the stocks that make up the index and I would pick on those who have the weakest recent performance and the largest index components. The top ten components are FDX 11.5%, UPS 10.4%, UNP 8.1%, EXPD 7.0%, R 6.4%, CHRW 6.3%, YELL 6.2%, CNF 5.9%, JBHT 5.3% and BNI 5.1%.

Transport Chart - Weekly

The Chairman for Norfolk Southern was on CNBC on Friday on the eve of their 175th birthday. David Goode said business was as good as he had seen it in his forty years in the business. Railroads have better than a 4:1 advantage over trucks in energy consumption and the performance of the rails is showing it. He said there is currently a shortage of rail cars and trucks due to the demand and a lack of CapEx spending by truckers over the last five years. NSC has been expanding since the acquisition of Conrail and appears to be in a good position to profit from the current cycle. NSC is a big coal shipper and the price of natural gas has increased demand for coal to the point where there are not enough cars to carry it. I would probably not pick NSC as a short candidate for January. They are tied with BNI at 5.1% as a component in the transportation index.

Unless Santa's face shows up on a milk carton over the weekend we should see another attempt at the highs next week. The game plan for last week was to buy any Monday dip and hold on the rest of the week. Well, as they say the best laid plans of mice and men sometimes go astray. The Monday dip continued into Tuesday and accelerated into the close. That may have scared many traders out of the plan and back to the sidelines. The indexes did return by Friday's close to near their recent resistance levels but there was far less bullish excitement than we had hoped.

This lack of excitement could have been the result of several weeks of selling the rallies by funds. This has given investors numerous cases of indigestion and a reluctance to hold stocks as we close in on resistance. While I was expecting a bullish year end once we consolidated the November gains I am quickly losing that bullish sentiment. As I indicated last week January has seen some substantial losses in recent years and the Transportation Index losses I highlighted above suggest it is about time for that transportation rally to correct. Falling transports typically drag the Dow down with them. In straight English I am beginning to fear there is a serious dip in our immediate future. Because funds have a strong interest in keeping the indexes supported at these levels I do expect some tape painting into year end but they have been less than successful over the last week. Hopefully they will apply a little more effort once the weekend has passed.

Because the holidays are being recognized on Monday the back-to-back three day weekends will produce even lower trading volume next week. That is actually a plus for the tape painters. The lower the volume the easier for funds to move the prices higher. Unfortunately it is also easier for sell programs to push them lower and sharply lower if the fund is really dumping positions. For those still bullish the odds of strong sell programs are less in the coming week than they were in the week just over. Funds want to sell into volume so that prices remain firmer and not fluctuate wildly. They will get an overall better price with higher volume. Volume levels last week started out at 4.3B on Monday and declined to 3.6B on Thursday and 2.5B on Friday. We will be lucky next week to break 3B shares on any day. This is not the kind of volume funds want to sell into. We can't ever guarantee any outcome but hopefully the Santa rally will arrive as expected and produce the +1.5% average S&P gain. That is a little less than +20 points and with the 4.5 yr resistance high at 1275 it would give us a new breakout attempt. Notice I said attempt.

Chart of VXO - Weekly

Chart of VIX - Weekly

Despite the bullish sentiment normally prevalent this time of year the VIX/VXO are both flashing warning signs. The VIX closed at 10.27 on Friday when the indexes were barely able to rebound back into the green before the close. The VXO or the old VIX closed at 9.87 and only .75 above its low for the year. While the volatility last week was extreme the volatility indexes failed to confirm with a move higher. Far too many traders are expecting the post Santa bounce and nobody is protecting against a fall. When the VIX/VXO is low it is time to go because nobody is buying puts. Traders are too confident that the market will move higher and just like curiosity killed the cat, overconfidence kills traders. The VXO 9.87 reading ahead of the expected Santa rally suggests any market rise next week could produce a new low for the year below 9.12. I have set my chart alarm at 9.12 and I will be exiting any longs on that signal and loading up on puts on the first signs of weakness. That weakness could come very quickly given the resistance on the current charts.

The SPX has solid resistance between 1275-1280. The Nasdaq has correspondingly hard resistance from 2270-2280. Combine that with the Dow resistance from 10900-10950 and traders will have a hard time making any rally stick. It is entirely possible to see a breakout into year-end, it has happened before, but you can bet there are still some sell orders waiting at those highs. The bullish sentiment has faded and worries about January are appearing on all sides. January begins a new earnings cycle and with Q4 performance seen as mediocre the January numbers could be weak. For 2006 S&P earnings are expected to fall into the single digits and that is not going to be market friendly. I am not going to launch into a 2006 outlook this week and will save it for next Sunday. But, I still believe that long term investor sentiment is fading fast as the year closes. If Santa suffers a reindeer transit strike and fails to show next week we all know what will happen. Remember the adage, "If Santa fails to call, the bears may come to Broad and Wall." Typically weakness between Christmas and New Years is a leading indicator of selling to come in January. Keep your fingers crossed that Santa produces a breakout next week but keep those stops tight just in case he fails. Until next week Merry Christmas and Happy Chanukah to all and to all a good night!
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BIIB None None
CME    

New Calls

Biogen Idec - BIIB - close: 45.52 change: +0.05 stop: 43.45

Company Description:
Biogen Idec creates new standards of care in oncology, neurology and immunology. As a global leader in the development, manufacturing, and commercialization of novel therapies, Biogen Idec transforms scientific discoveries into advances in human healthcare. (source: company press release or website)

Why We Like It:
The BTK biotech index is breaking out higher after Thursday's move through its four-week trendline of resistance. If the sector continues to show strength we suspect that BIIB will be able to breakout over significant resistance at the $46.00 mark. Short-term technicals are bullish and the P&F chart is very bullish with a $62 target. We are suggesting a trigger to buy calls at $46.11. If triggered we will target a rally into the $49.85-50.00 range. We do not want to hold over BIIB's late January earnings report.

Suggested Options:
We are suggesting the February calls.

BUY CALL FEB 45 IDK-BI open interest=455 current ask $2.55
BUY CALL FEB 50 IDK-BJ open interest=363 current ask $1.00

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 3.2 million

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Chicago Merc. Exhg. - CME - cls: 379.75 chg: +3.54 stop: 372.49

Company Description:
Chicago Mercantile Exchange Inc. is the largest futures exchange in the United States. As an international marketplace, CME brings together buyers and sellers on CME Globex electronic trading platform and on its trading floors. CME offers futures and options on futures primarily in four product areas: interest rates, stock indexes, foreign exchange and commodities. The exchange moved about $1.4 billion per day in settlement payments in the first three quarters of 2005 and managed $43.8 billion in collateral deposits at September 30, 2005, including $3.8 billion in deposits for non-CME products. (source: company press release or website)

Why We Like It:
CME has rebounded strongly from its December lows. Technical indicators have turned positive again. If the stock can breakout over the $380 level it will produce a new triple-top breakout buy signal on its P&F chart. If that occurs we believe CME may be able to rally towards the $400 level. We are suggesting a trigger to buy calls at $380.55. We'll set a target in the $395.00-400.00 range. CME is a very volatile stock so this is an aggressive, speculative play. More conservative plays may want to just paper trade this one.

Suggested Options:
We are suggesting the January calls since this will probably only be a two or three week play.

BUY CALL JAN 370 CMJ-AE open interest=2061 current ask $17.80
BUY CALL JAN 380 CMJ-AG open interest= 881 current ask $11.70
BUY CALL JAN 390 CMJ-AI open interest=1341 current ask $ 7.60
BUY CALL JAN 400 CMJ-AK open interest=2946 current ask $ 4.40

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 888 thousand
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Apache - APA - close: 70.31 change: -0.84 stop: 67.99

Neither crude oil nor stocks really moved much on Friday. The markets were left to drift sideways as many investors took the day off ahead of the upcoming Christmas holiday (don't forget the markets are closed on Monday). We did notice that the OIX oil index dipped to its simple 50-dma and bounced. Meanwhile shares of APA dipped to $68.89, near its 100-dma and bounced. This might be used as a bullish entry point to buy calls but we would be careful. The stock is also bouncing from its eight-week trendline of rising support (a.k.a. higher lows) but today's intraday low actually broke that support on an intraday basis. It might be more prudent to wait for a move over $72.00 before considering new bullish positions. We do not want to hold over APA's late January earnings report. Our current target for APA is the $76.00-77.00 range. The P&F chart for APA points to an $83 target.

Suggested Options:
We are not suggesting new bullish positions in APA at this time. More aggressive traders might want to consider it. If you do initiate call positions we like the February strikes.

Picked on December 08 at $ 70.98
Change since picked: - 0.67
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 3.6 million

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Cytec Ind. - CYT - close: 47.55 chg: +0.21 stop: 44.99

Our relatively new play in CYT is on the right track. The stock rebounded strongly from the bottom of its December trading range on Wednesday. On Thursday the stock broke out over resistance at the top of its trading range (near 46.60) and hit our trigger to go long calls at $47.01. The move on Thursday is also a bullish breakout over the five-month trend of lower highs (see chart). Technicals have turned bullish again and its P&F chart points to a $65.00 target. Our target is a modest move into the $49.85-50.00 range. Readers can choose to initiate new positions here or look for a dip back into the $46.60-47.10 range.

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 $8.20
BUY CALL FEB 45 CYT-BI open interest= 89 current ask $3.80
BUY CALL FEB 50 CYT-BJ open interest=198 current ask $1.20

s

Picked on December 22 at $ 47.01
Change since picked: + 0.54
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 333 thousand

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Femsa Fomento - FMX - close: 72.16 chg: +0.59 stop: 67.75

The Mexican markets were almost as flat as Wall Street's on Friday. That didn't stop FMX from posting another gain (+0.8%). This past week's breakout over resistance in the $70.00-70.50 range is very bullish. Currently the Point & Figure chart for FMX points to an $87 target. We are only looking for a move into the $74.75-75.00 range so it may not be wise to initiate new positions right here. Look for a dip back into the $70.50-71.00 region before considering new call positions.

Suggested Options:
We are not suggesting new positions at this time. If you're looking for a new entry point consider buying the February strikes.

Picked on December 19 at $ 70.65
Change since picked: + 1.51
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 308 thousand

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Gilead Sciences - GILD - close: 54.56 chg: -0.84 stop: 49.99

After three days up in a row and a strong gain for the week shares of GILD finally hit some profit taking ahead of the weekend. The stock dipped to $54.15 before some dedicated traders bought the dip and pushed GILD off its lows into the weekend. We call them dedicated because most investors took the day off or left early to merge with the Christmas holiday traffic. The $54 level was minor resistance last week so it makes sense to see the same level act as short-term support. Therefore this pullback on Friday looks like a new bullish entry point. If you missed the last couple of updates on GILD take note. The stock broke through resistance and its consolidation pattern on Wednesday after German drug company Roche announced that the U.S. had okayed Tamiflu as an approved treatment for children. Shares of GILD rallied because the company invented Tamiflu, sold it to Roche, and now gets paid royalties. The rallied continued on Thursday despite negative news stories from Vietnam reporting on human cases of avian flu where Tamiflu only made the virus more resistant. On a technical basis we remain very bullish on GILD. The daily chart has a new MACD buy signal and the P&F chart points to a $66 target. Our target is the $59.00-60.00 range. We do not want to hold over GILD's mid January earnings report. That doesn't give us much time (maybe three weeks) before we have to exit.

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=2030 current ask $6.10
BUY CALL FEB 55 GDQ-BK open interest=4185 current ask $2.85
BUY CALL FEB 60 GDQ-BL open interest=3439 current ask $1.15

Picked on December 22 at $ 54.51
Change since picked: + 0.05
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 4.3 million

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Kerr Mcgee - KMG - close: 92.17 chg: -0.29 stop: 88.99

KMG has spent the last couple of weeks consolidating its early December gains. For the most part oil stocks didn't move much on Friday but KMG did produce some intraday volatility. We've been waiting for a dip toward the $90.00 level, which as broken resistance should act as new support. That's what happened on Friday. KMG dipped to $90.20 and quickly rebounded. This looks like a new bullish entry point to buy calls on KMG. However, the oil sector's performance hasn't been that great ever since crude oil fell back below $60 a barrel. If you're not excited about buying calls on KMG right here then consider waiting for a move over $93.50, which should be a breakout from what appears to be a bull flag pattern on KMG's daily chart. We do not want to hold over KMG's January 25th (unconfirmed) earnings report. Our target is the $98.50-100.00 range. The P&F chart points to a $106 target.

Suggested Options:
We are suggesting February calls because we may need to hold them right up to KMG's earnings announcement.

BUY CALL FEB 90 KMG-BR open interest= 40 current ask $5.80
BUY CALL FEB 95 KMG-BS open interest=832 current ask $3.20
BUY CALL FEB100 KMG-BT open interest= 60 current ask $1.55

Picked on December 02 at $ 90.26
Change since picked: + 1.91
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.8 million

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Ryland Group - RYL - close: 73.02 change: -1.03 stop: 71.85

Homebuilders were weak on Friday. The sector turned lower shortly after the opening following a negative report on new home sales for November. Oddly the selling didn't see much follow through. RYL dipped to $72.75 and then traded sideways for the rest of the session. The DJUSHB home construction index produced a similar pattern. Investors may not be in a hurry to sell homebuilders since 2006, even with expected declines from 2005, is poised to be the second best year for home sales ever. Currently the DJUSHB index has technical support at its 200-dma near 926 and additional, historical support near 920. Traders will want to keep a close eye on RYL and its rising trendline of support. The stock is currently testing that trendline after what looks like a recent double-top pattern, which is bearish. Plus some of the short-term technical oscillators (like the RSI) have grown bearish as well. We would not consider new bullish positions until RYL traded over $74.70 or even the $75.00 mark.

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

Picked on December 13 at $ 73.96
Change since picked: - 0.74
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 1.3 million

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Questar Corp - STR - close: 78.80 chg: -0.50 stop: 77.85 *new*

Aside from some minor volatility after Friday's opening bell shares of STR traded sideways in a 50-cent range for most of the session. The technical picture is mixed and the stock is trading between technical support at its 50-dma (near 77.80) and short-term resistance at $80.00. Natural gas has been suffering lately as warmer weather and brighter forecasts for January have reduced investor fears over a gas shortage. More conservative traders may just want to exit early right here. You can always consider new entries on a move over $80.00. We are not suggesting new positions at this time and would wait for a new breakout over $80.00. In the meantime we're going to inch our stop loss up to $77.85. FYI: STR is also a current strangle play on the newsletter's play list.

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

Picked on December 13 at $ 80.85
Change since picked: - 2.05
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 752 thousand

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Total S.A. - TOT - close: 127.84 change: -0.19 stop: 126.49

Shares of TOT are going nowhere fast. The stock has traded in a narrow $1.50 range for the last four sessions. We considered just exiting early and cutting our losses but the intraday rebound in the oil-related sector indices on Friday suggests we might see a stronger bounce come next week. We are not suggesting new bullish positions in TOT at this time. More aggressive traders might want to think about buying calls on a move over $128.50. We would wait for a move over $130.00-130.50. Currently our target is the $136.00-137.00 range. The P&F chart points to a $152 target.

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

Picked on December 13 at $130.25
Change since picked: - 2.42
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 936 thousand

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Tractor Supply - TSCO - cls: 54.00 chg: -0.11 stop: 52.65 *new*

TSCO has spent the last 2 1/2 weeks consolidating its early December rally. Volume has been pretty mild during this consolidation but the trend has been bearish with a pattern of lower highs. We considered just exiting early right here but the mirage of a possible Santa Claus rally next week is fueling some year-end bullish hopes. To protect ourselves we're raising the stop loss to $52.65. We are not suggesting new bullish positions at this time. Our target is the $57.00-58.00 range. The Point & Figure chart still points to an $87 target.

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

Picked on November 30 at $ 52.75
Change since picked: + 1.25
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

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Valero Energy - VLO - close: 52.83 chg: -0.55 stop: 50.90 *new*

Refining stocks like VLO could not escape the drag on the oil sector this past Friday. VLO lost one percent but traded off its worst levels of the session. The recent bounce from the 50-dma in the Tuesday-Wednesday time frame looks like a bullish entry point but VLO still has overhead resistance in the 55.50-55.60 region. Considering the lack of relative strength in the sector we're not suggesting new bullish positions at this time. We are going to raise our stop loss to $50.90 in an effort to reduce our risk. Our post-stock split target is $58.50. The P&F chart still points to a $70 target. FYI: VLO is also a current strangle play in the strangle section.

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

Picked on December 08 at $ 53.28 (split adjusted)
Change since picked: - 0.45
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 9.8 million

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United States Steel - X - close: 47.50 chg: +0.91 stop: 44.65

Some merger and acquisition news in the steel industry helped inspire a 1.95% rally in shares of X on Friday. The stock's gain is a bullish breakout over its three-week trendline of resistance and its 10-dma. Short-term technical indicators are bullish. The move on Friday also opened the play after hitting our trigger to buy calls at $47.05. Our late January target is the $52.00-52.50 range. The Point & Figure chart for X points to an $86 target. 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= 90 current ask $8.50
BUY CALL FEB 45 X-BI open interest= 562 current ask $4.90
BUY CALL FEB 50 X-BJ open interest=1093 current ask $2.50

Picked on December 23 at $ 47.05
Change since picked: + 0.45
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 3.8 million
 

Put Updates

PACCAR Inc. - PCAR - close: 70.60 change: +0.35 stop: 72.51

We've been warning readers to look for a failed rally in the $71-72 region but the relative strength in shares of PCAR still makes us uncomfortable. The stock's recent sell signal on its daily chart is starting to look like its been reversed. Short-term technicals have certainly turned higher. We are not suggesting new bearish positions at this time. In fact we're going to tighten our stop loss to $72.05. Our target is the $65.25-65.00 range.

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

Picked on December 20 at $ 69.49
Change since picked: + 1.11
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand

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Progressive Corp - PGR - cls: 119.27 chg: +0.52 stop: 121.25

The upward momentum for PGR has stalled and there is a clear zone of resistance in the $124.50-124.65 region. However, there has not been a real rush of selling either. Our biggest challenge to a successful bearish play in PGR may be end-of-quarter window dressing by fund managers. Currently we are on the sidelines. Our strategy involves a trigger to buy puts at $117.45, which is under current support near $118. 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=757 current ask $4.60
BUY PUT FEB 115 PGR-NC open interest=235 current ask $2.70

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
 

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: 22.02 chg: +0.32 stop: n/a

The recent action in AEOS does not bode well for our strangle. The stock has been showing relative strength and the action in Thursday and Friday's session produced a short-term bullish breakout over its two-week trend of lower highs. Longer-term AEOS still has a trendline of resistance (see chart) but we only have about four weeks left before January options expire. More conservative traders may have to decide to cut their losses here and move on. We hesitate to exit early because our bias for January is growing more bearish. 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 $1.05bid/$1.15ask.

Suggested Options:
We are not suggesting new strangle plays in AEOS.

Picked on November 13 at $ 25.47
Change since picked: - 3.37
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

---

Abercrombie&Fitch - ANF - close: 64.98 chg: +0.60 stop: n/a

ANF is showing some relative strength and finally cracked resistance at the $65.00 level if only on an intraday basis. The technical picture is improving and if the markets do see a Santa Claus rally next week then we certainly expect ANF to participate. The P&F chart for ANF points to an $87 target. Remember, we only have about four weeks left before January options expire. We are not suggesting new strangle positions at this time. The options in our strangle are the January $65 calls (ANF-AM) and the January $55 puts (ANF-MK). Our estimated cost was $5.15. We're looking for a rise to $8.50.

Suggested Options:
We are not suggesting new strangle plays in ANF.

Picked on November 13 at $ 59.67
Change since picked: + 5.31
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

---

Blue Coat Sys. - BCSI - cls: 43.80 chg: +0.45 stop: n/a

The recent technical breakdown in shares of BCSI has struggled to produce any follow through lower. Shares of BCSI have been consolidating sideways along support at the rising 100-dma. Coincidentally this support also lined up with technical support at the bottom of its gap from November 22nd near $42.00. If BCSI were to trade back to the $45.00 level traders might want to consider launching new strangles with February options. At this time we are not suggesting new plays. FYI: currently the Point & Figure chart for BCSI is pretty bearish with a $27 target. 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 four weeks left before January options expire.

Suggested Options:
We are not suggesting new strangle plays in BCSI.

Picked on December 04 at $ 45.43
Change since picked: - 1.63
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand

---

Building Materials - BMHC - cls: 80.84 chg: -1.45 stop: n/a

BMHC returned to our suggested entry window of $80.50-79.50 on Friday. Traders may want to consider launching new strangles as BMHC continues to coil more tightly inside its wedge-like pattern of lower highs and higher lows. Rest assured a breakout either direction is coming. The options we were 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.

Suggested 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: - 0.11
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand

---

Chicago Merc. Exchg. - CME - cls: 379.75 chg: +3.54 stop: n/a

CME continues to give mixed signals. Technicals on the daily chart have turned bullish while some of the weekly indicators and the P&F chart are still bearish. We do see that if CME can trade over $380.00 it will produce a new triple-top breakout buy signal on the P&F chart. Friday's action had CME coiling for a bullish breakout over the $380 level. The stock might make another run at the $400 level sooner than expected. We only have four weeks left before January options expire. 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 plays in CME.

Picked on November 20 at $375.90
Change since picked: + 3.85
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

---

D.R.Horton - DHI - close: 36.21 chg: -0.64 stop: n/a

The forecast for DHI is starting to look a bit cloudy. On Friday the homebuilding stocks turned lower after a negative new home sales report for November. Investors may want to remember that November and December are two of the slowest months of the year for home sales and this may be why the sell-off in the sector was not more severe. Even so we remain very cautious here. Friday's decline, while it did stop at short-term support near $36.00, still looks like a breakdown below its eight-week trendline of rising support. Following the mid-December failed rally near $38.50 this could be a trend-changing move. If DHI closes under the $36.00 level then more conservative traders may want to think about exiting early and trying to salvage some of their trading capital. We only have four weeks left before January options expire. 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 $2.05bid/$2.15ask.

Suggested Options:
We are not suggesting new strangle plays in DHI.

Picked on November 13 at $ 32.56
Change since picked: + 3.65
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million

---

Four Seasons - FS - close: 49.92 chg: +0.54 stop: n/a

FS is still trying to rebound back above the $50.00 level. So far it isn't having much success but if the market's rally into New Year's then FS may be successful. If FS does close over the $50.00 level then more conservative traders may want to think about exiting early and cutting their losses. We only have four weeks left before January options expire and if FS oscillates sideways for any additional length of time it will negatively impact the option values in our strangle. 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 $1.40bid/$1.60ask.

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

Picked on November 08 at $ 55.37
Change since picked: - 5.45
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

---

Lear Corp - LEA - close: 28.53 chg: +0.62 stop: n/a

Our strangle play in LEA is not working out! The stock's downward momentum has stalled and shares have consolidated sideways for the last few weeks. While the stock is still stuck under technical resistance at the 50-dma the technical indicators on its daily chart are turning bullish again. We are not suggesting new positions and more conservative traders may want to exit early even though the options values have diminished significantly. We are no longer suggesting new strangle positions. The options in our strangle are the January $35 calls (LEA-AG) and the January $25 puts (LEA-ME). Our estimated cost was $1.60. We are lowering our target to $1.60. We have about four weeks left before January options expire.

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

Picked on November 06 at $ 30.24
Change since picked: - 1.71
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million

---

Verifone Holdings - PAY - cls: 26.77 chg: +2.44 stop: n/a

Bulls can all send a Merry Christmas card to the Wall Street analyst who upgraded shares of PAY on Friday. The stock was upgraded to a "buy" with a $31 price target. Shares of PAY responded with a 10% gain on volume that was more than seven times the daily average. Friday's move is also a very bullish breakout over resistance at the $25.00 level. The January $22.50 calls (PAY-AX) high a high of $4.00 and are trading at $3.50bid/$5.50 ask. More conservative traders may want to exit as soon as possible before PAY sees any profit taking. We have less than four weeks 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.

Suggested Options:
We are not suggesting new strangle plays in PAY.

Picked on October 12 at $ 19.98
Change since picked: + 6.79
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

---

Questar Corp. - STR - close: 78.80 chg: -0.50 stop: n/a

STR has spent the last couple of days consolidating sideways between support near $78.00 and its simple 50-dma and resistance at the $80.00 level. Technical signals are mixed with the P&F chart pointing to a $105 target but the short-term trend looking bearish. 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. We only have four weeks left before January options expire. More conservative traders may need to be planning an early exit to try and salvage some trading capital, especially if STR breaks down under the 50-dma (since we doubt it will break support at the 200-dma near $70 before our options expire).

Suggested Options:
We are not suggesting new strangle plays in STR.

Picked on November 20 at $ 76.25
Change since picked: + 2.55
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

---

Texas Ind. - TXI - close: 51.00 chg: +0.30 stop: n/a

Unfortunately we have nothing new to report on for TXI. The stock is still a lame duck with shares churning sideways between $45 and $53 over the last ten weeks. Hopefully the earnings report expected on January 5th will produce enough volatility for us to exit near breakeven or even score a potential gain. 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 plays in TXI.

Picked on November 27 at $ 49.57
Change since picked: + 1.43
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand

---

Valero Energy - VLO - close: 52.83 chg: -0.55 stop: n/a

Unfortunately, VLO is still consolidating sideways with no Friday follow through on the Wednesday-Thursday rebound from the 50-dma. We are starting to worry that if VLO fails to turn higher and breakout over resistance in the $55.50-56.00 range that it will be stuck in a range between $56 and $45 near its 200-dma. If this occurs then the options in our strangle will quickly deteriorate. We only have about four weeks left before January options expire. More conservative traders may want to think about exiting early to cut their losses. 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 plays in VLO.

Picked on November 21 at $ 50.50
Change since picked: + 2.33
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Dropped Calls

Garmin ltd - GRMN - close: 68.57 change: +0.27 stop: 61.99

We are choosing to exit early on GRMN. We still haven't found any news to explain Thursday's high-volume rally in the stock. The early morning dip on Friday was quickly bought and shares look poised to make a run toward the $70.00 level. While we are choosing to exit early it doesn't mean you have to. There is still a very good chance that GRMN will indeed trade into the $69.50-70.00 range (fyi: our target was the 69.00-70.00 range). We do suggest you significantly tighten your stop if you don't exit.

Picked on December 13 at $ 63.54
Change since picked: + 5.03
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

Kinder Morgan - KMI - close: 93.09 chg: -0.04 stop: 91.90

KMI dipped low on Friday morning only to recover and close almost unchanged on the session. The morning low was below support at the bottom of its $92.00-95.00 trading range and under technical support at the 100-dma. The stock hit our stop loss at $91.90. Watch for a breakout over $95.00 as a new bullish entry point.

Picked on December 02 at $ 92.75
Change since picked: + 0.34
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 749 thousand
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

The Transformers

In 1983, many parents spent December weekends hunting down the popular Transformers toys by Hasbro. Hasbro still produces the line, popular now with collectors as well as the primary audience. Disgruntled traders hope that the transformers being produced by our markets lately don't prove as long lasting.

Anyone watching charts unfold lately has noticed an unfortunate tendency for one formation to morph into another. An example was found on the SOX's 15-minute chart week before last.

Annotated 30-Minute Chart of the SOX:

Annotated 30-Minute Chart of the SOX:

Annotated 30-Minute Chart of the SOX:

Oscillators provided no clarity. MACD flat lined, RSI squiggled near the neutral level and stochastics chopped in a tight range. What was a trader to anticipate?

The trader should not anticipate. That's the point. When formations morph as this one did, with alternative bullish and bearish connotations, traders are witnessing an ongoing battle between bears and bulls, between supply and demand. Bears appeared to have the upper hand, supply overcoming demand, but enough demand remained to keep prices above converging support. Traders received a warning not to step in too soon on the bearish side.

Annotated 30-Minute Chart of the SOX:

The SOX wasn't the only index with one shape morphing into
another on that opex Friday. The TRAN's formation also morphed, but its eventual breakdown was to show that when formations morph, it's not always easy to determine where the most important
trendlines lie. This is particularly true with formations that broaden.

Annotated 5-Minute Chart of the TRAN:

Annotated 5-Minute Chart of the TRAN:

Annotated 5-Minute Chart of the TRAN:

Last week, the TRAN was to again morph one potential formation into another.

Annotated 30-minute chart of the TRAN:

Annotated 30-Minute Chart of the TRAN:

Formations can morph, and such transformations often warn of warring bullish and bearish forces. No trader can be sure that any formation will confirm as expected, but such morphing activity urges even more caution about forming too strong an opinion of the next move. Don't abandon your study of chart formations and their predicted resolution, but wait for confirmation before you act on those predicted resolutions. When transformers stalk the charts, there's danger in the air.
 

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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