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Newsletter

Daily Newsletter, Wednesday, 12/28/2005

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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

Will It or Won't It?

Market watchers might have applied that question to many aspects of market behavior as they prepared for the trading day on Wednesday morning. Will the yield curve invert again? Will the much-watched but narrow-based Dow close this week and year above its 10,800.30 close last year? Will any early bounce be sold again? they might have asked themselves.

The early bounce was nearly guaranteed. Futures moved higher, buoyed by yet another fresh five-year closing high in the Nikkei 225 and a strong overnight performance on the DAX after Germany's consumer confidence number beat expectations. Before the cash market open, the yield curve flattened, an improvement from an inversion. Strong pre-market upside moves in companies such as Celgene (CELG), Covad Communications Group (DVW) and Linens 'n' Things (LIN) hinted that some investors were ready to buy. Crude bounced, predicting that energy-related stocks might perform well in early trading.

When a slightly better-than-expected showing on December's consumer confidence number resulted in only a brief further bounce and then a sell-off to new daily lows, market watchers had their answer to at least one of the questions. Yes, the early bounce would be sold again. The Dow, SPX and OEX chopped most the day, while the Nasdaq, SOX, RUT and TRAN did a more credible job of bouncing off the day's lows, producing possible short-term and perhaps untrustworthy reversal signals. Almost all indices produced some sort of possible reversal signal, however, starting with the SPX.

Annotated Daily Chart of the SPX:

The SPX presents mixed chart evidence. The day's candle was the second of a possible three-part reversal signal formation, suggesting a possible bounce attempt tomorrow, but the day produced a second close below the 30-sma. A 120-minute chart may provide some insight tomorrow.

Annotated 120-Minute Chart of the SPX:

Those looking for new bearish entries will hope for a bounce and then a rollover beneath the midline of that regression channel.

The Dow also produced a potential reversal signal, suggesting that an attempt could be made to bounce this index tomorrow. The failure at the 30-sma today suggests that bounces remain suspect, however, unless there's a break above the descending trendline off the late November high, with that trendline now at 10,928.

Annotated Daily Chart of the Dow:

If the Dow bounces past the 10- and 30-sma's, watch for next resistance at the descending trendline off the late November high. An upside break there suggests a test of 11,000, but for now choppy trading conditions with resistance at the 10- and 30-sma's appears most likely.

The Nasdaq produced a doji, a possible short-term reversal signal, but this index chops around within a possible right-shoulder formation for a head-and-shoulder. Trade with care this week while it decides on final direction. For now, selling bounces appears the best tactic, but bears should be wary of any zoom that begins to invalidate the formation, whether or not we give full credence to these formations any longer.

Annotated Daily Chart of the Nasdaq:

The SOX again resisted dropping below the last gap higher on the daily chart, a likely exhaustion gap. Today it sprang up from the bottom of that early December gap, suggesting that there could be an attempt tomorrow to follow through on today's gains. If so, watch for potential resistance at the 10-sma, signified either by a rollover at that average or by a rollover back below it after punching through it. A daily close above the 10-sma suggests a test of the top of the descending regression channel, at 500. The flag-like pullback off the December high looks bullish; the potential head-and-shoulder formation inside that flag is not.

Annotated Daily Chart of the SOX:

The economic calendar was light, with the crude inventories release delayed until tomorrow. The Mortgage Bankers Association released mortgage applications for the week ending December 23 at 7:00 EST, the earliest release of the day, with the headline of that release already telling the tale. Mortgage application activity slowed again for that week. The market composite index fell 6.8 percent on a seasonally adjusted basis that included a holiday adjustment. On an unadjusted basis, the composite, measuring mortgage loan application volume, fell 17.0 percent, but it was up 3.1 percent when compared to the same week a year earlier. The purchase, refinance, conventional and government indices all declined on a seasonally adjusted basis, some by double-digit percentages. Four-week moving averages for the market, purchase and refinance indices weakened. The interest rate for a 30-year fixed-rate mortgage also decreased, to 6.21 percent from the previous week's 6.22 percent, and points fell. The DJUSHB, the Dow Jones U.S. Home Construction Index was to close negative, near its low of the day.

U.S. Chain Stores Sales was next on the economic release schedule, with the early morning release revealing that consumers produced a late surge in holiday spending. Procrastination and a late Hanukkah might have been responsible for the late surge. Those sales grew 2.8 percent for the week ending December 24 and 3.9 percent above the previous year's level for that week. The International Council of Shopping Centers' chief economist predicted that sales growth stayed on track for an increase of 3-3.5 percent for December and the holiday season. Target (TGT) reported strong December sales. Like the Dow, SPX and OEX, the RLX was knocked back from its high, but managed a slightly positive day.

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The Conference Board's December U.S. Consumer Confidence report showed a rebound to pre-Katrina levels, with the headline number rising to 103.6, above the predicted 103.1 and November's 98.3. Among component indices rising were the present situation index, the expectations index, the "plans to buy a car" index, the major appliances index, and the "jobs plentiful" index. In combination with a decline in the "jobs hard-to-get" index, the jobs outlook proved encouraging. The "plans to buy a home" component dropped back to its recent low, however.

Part of the improvement in consumer confidence could be attributed to the decline in crude prices seen recently, some economists concluded. With the Iranian Oil Minister Kazem Vaziri Hamaneh claiming that OPEC should consider trimming production by a million barrels a day when it meets January 31, some might have felt that the benefit endowed by lowered crude prices was temporary. That impression was seconded by a steady climb in crude prices. Crude closed up $1.65 at $59.80, and has moved to $60.05 as this report is prepared.

To keep this report as succinct as possible, individual company developments will be covered briefly, with the suggestion that traders delve deeper into relevant news if trading a stock or sector likely to be impacted by the news. Late Tuesday, Celgene (CELG) made several announcements: that the FDA had approved Revlimid, its drug for the treatment of transfusion-dependent anemia; its stock would split 2 for 1 and its chief executive would retire in May. Today, Bank of America increased its price target for CELG. CELG was to close more than six percent higher. Covad Communications Group (DVW) announced an agreement with Verizon Communications (VZ) that would settle all pending litigation and also expand DVW's current deal with VZ. VZ was to lose 0.62 percent by the end of the day. In addition, DVW announced its status as the preferred provider of local access and network services for MCI's DSL business customers. DVW closed sharply higher.

Linens 'n' Things (LIN) said late Tuesday in a regulatory filing that it should be able to satisfy conditions needed for Apollo Capital Management, a private equity firm, to complete its acquisition of the company. Shareholders will vote on the acquisition at a meeting January 30. LIN closed higher by 10.91 percent. Other news included a J.P. Morgan upgrade of Albertson's (ABS) to a neutral rating, with the failed takeover talks last week perhaps inviting shareholders to act. The board reportedly still stands behind the CEO. ABS gained 1.34 percent. Boeing (BA) received a contract worth $1 billion from the U.S. Navy. BA rose 0.60 percent. Additional news was that Microsoft (MSFT) and Yahoo (YHOO) might be talking about some kind of deal.

In a light-volume environment, tomorrow will offer several economic releases that could move the markets. Initial claims for the week ending 12/24 will be released at 8:30. At 10:00, December's Chicago PMI and November's Existing Home Sales and Help-Wanted Index will be released. Last week's November New Home Sales proved disappointing and today's MBAA information did, too. The DJUSHB, the Dow Jones U.S. Home Construction Index, has been climbing in a choppy fashion off October's low, but appears to be stalling beneath a 50 percent retracement of the decline off the July high and today's decline brought it almost to the 200-ema. Caught between 964 resistance and the 200-sma support, the index needs an impetus to push it one direction or the other. Crude inventories, typically released on Wednesday, will put in an appearance at 10:30 tomorrow instead.

With only two trading days left in the week and the year, some tape-painting effects should be expected to keep the Dow above the last year's close. That, coupled with potential reversal signals on many indices, may suggest some attempts to bounce the indices tomorrow morning, barring some development that gaps them below key support levels at the open. Chart characteristics suggest that indices will have difficulty breaking out to new highs and that rollover potential persists, but don't ignore such breakout attempts if they should occur. Volume is low and likely to get lower, and it will be easy to push markets one direction or the other, whether such a move is sustainable.

Watch the 120-minute chart of the SPX posted above for guidance. Watch GE. Today it moved through its 200-sma and hit its converging 50-sma and 72-ema, dipping down into the big gap higher produced in November but bouncing to close back above its 200-sma. GE perhaps produced one of the strongest potential reversal signal and this big-cap stock could pull others with it if it sustains a bounce. Look, however, for resistance near $35.25 as a sign that GE and perhaps some indices, could be stalling. Watch for next resistance at the converging 10- and 30-sma's.

My greatest expectation is for a bounce attempt, either right from the open or after a retest of today's lows, but the emphasis remains on "attempt" until resistance is broken. Watch for rollovers if you want new bearish entries, but remember the likely tape-painting effect before you enter a bearish play. Be quick to take profits on those bearish plays, if entered, unless markets cascade lower.

Remember the Nasdaq's possible head and shoulder when you're considering bullish trades. You'll need to see a strong invalidation of that formation before risk of a rollover is averted. It's possible that many traders might try to settle positions tomorrow and take off for a four-day weekend instead of the official three-day one, so a directional bias is possible, but so is chop, with many charts suggesting that as the strongest possibility.

Of course, with crude inventories tomorrow and with the TRAN often being a fast-moving index, it may lead a directional move. Keep an eye on it. By the way, here's what's happening based on the TRAN chart I've been posting over the last weeks.

Annotated Weekly Chart of the TRAN:

 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
IPS SYK None

New Calls

Ipsco Inc. - IPS - close: 82.64 change: +1.84 stop: 79.99

Company Description:
IPS operates steel mills at three locations and pipe mills at six locations in the United States and Canada. As a low cost North American steel producer, IPSCO has a combined annual steel making capacity of 3,500,000 tons. The Company's tubular facilities produce a wide range of tubular products including line pipe, oil and gas well casing and tubing, standard pipe and hollow structurals. Steel can also be further processed at IPSCO's five temper leveling and coil processing facilities. (source: company press release or website)

Why We Like It:
We're going to add another steel stock to the play list as a bullish candidate. Shares of IPS have been winners for the bulls this past year and the stock is trading near its highs. The sector has been ticking higher as investors speculate on further consolidation in the industry. Recent M&A activity certainly seems to confirm the idea. On the other hand IPS does look a bit extended and overbought. We certainly would not make any long-term investments here. This is purely a short-term (four-week) trade. We think that IPS could try and rally toward $90.00 by its earnings report in late January. The recent consolidation appears to be nearing an end and today's bounce from the $80 region looks like a new bullish entry point. However, instead of launching new positions here we want to use a trigger. The recent high was $83.50. We'll suggest a trigger to buy calls at $83.55. If triggered we'll target a run into the $89.00-90.00 range. We do not want to hold over the earnings report.

Suggested Options:
We are suggesting the February calls because we suggest holding any bullish position up to the company's late January earnings report.

BUY CALL FEB 80 IPS-BP open interest= 16 current ask $6.70
BUY CALL FEB 85 IPS-BQ open interest= 88 current ask $4.20

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 396 thousand

New Puts

Stryker Corp. - SYK - close: 45.29 chg: +0.07 stop: 46.51

Company Description:
Stryker Corporation is one of the world's leading medical device companies with the most broadly-based range of products in orthopaedics and a significant presence in other medical specialties. The Company's products include implants that are used in joint replacement, trauma, craniomaxillofacial and spine surgeries; orthobiologics; operating room and interventional pain products; surgical navigation, endoscopic, communications and digital imaging systems; as well as patient handling and emergency medical equipment. In addition, Stryker provides outpatient physical therapy services in the United States. (source: company press release or website)

Why We Like It:
Medical device stocks, for the most part, have produced a pretty good bounce from their lows in October and November this past year. The bad news for bulls in SYK is that it looks like the rally is ending. Shares of SYK failed to breakout over its 200-dma in mid December. Now the stock is barely holding on to support near the bottom of its rising channel. A breakdown under round-number support near $45.00 would be a technical sell signal. The P&F chart already points to a $23.00 target. Plus, the MACD indicator on its daily chart in addition to some of its other technical oscillators are flashing sell signals. Aggressive traders may want to buy puts on a move under $44.90. We're going to suggest a trigger to buy puts at $44.29 under its simple 50-dma. If triggered we'll target a decline into the $40.25-40.00 range, near its October lows. We do not want to hold over the January earnings report. That gives us about three weeks, maybe less.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 45 SYK-NI open interest=385 current ask $1.75
BUY PUT FEB 40 SYK-NH open interest=126 current ask $0.40

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 2.1 million

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Biogen Idec - BIIB - close: 44.92 change: -0.60 stop: 43.45

Biotech stocks, like most of the market, managed a bounce on Wednesday but near the close shares of biotech companies were trending lower again. BIIB is no exception and its afternoon bounce was starting to fade into tonight's closing bell. We are not suggesting new bullish positions at this time. More conservative traders may want to tighten their stop loss toward the $44 level. We're going to leave ours at $43.45 for now. Wait for another move over $46.50 or Tuesday's high at $46.72 before considering new bullish positions. Currently our target is the $49.85-50.00 range. We do not want to hold over BIIB's late January earnings report.

Picked on December 27 at $ 46.11
Change since picked: - 1.19
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 3.2 million

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Cytec Ind. - CYT - close: 47.64 chg: +0.54 stop: 44.99

CYT bounced from the $47 level with a 1.1% gain. The move today erased yesterday's losses. This looks like a new bullish entry point but we hesitate to initiate new long positions with the major averages still looking vulnerable to more selling. The P&F chart points to a $65.00 target. Our target is a modest move into the $49.85-50.00 range.

Picked on December 22 at $ 47.01
Change since picked: + 0.63
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 333 thousand

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Femsa Fomento - FMX - close: 71.75 chg: -0.63 stop: 67.75

The Mexican stock market lost more than 140 points today (-0.8%) but remains near the recent highs. Meanwhile shares of FMX hit a new three-month high but failed to hold its gains. The stock's weakness today suggest it may pull back and retest short-term support at the 10-dma near 70.84 or even the $70.00 level. Look for a dip back into the $70.50-71.00 region before considering new call positions.

Picked on December 19 at $ 70.65
Change since picked: + 1.10
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 308 thousand

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Gilead Sciences - GILD - close: 53.40 chg: -0.78 stop: 49.99

Bullish traders may need to turn defensive here with GILD. The stock posted another decline (-1.4%) and shares have now retraced 50% of its December 19th-22nd rally. If GILD trades under the $52.50-53.00 region then more conservative traders may want to consider an early exit. We are not going to suggest new positions at this time. 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.

Picked on December 22 at $ 54.51
Change since picked: - 1.11
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 4.3 million

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Ryland Group - RYL - close: 72.58 change: -0.65 stop: 71.85

The action in RYL is still looking bearish. The stock continues to coil more tightly into a two-week pattern of lower highs against support near $72.00. A breakdown under $72.00 would also be a break in its multi-week trendline of support from the October lows. We would not suggest new plays at this time.

Picked on December 13 at $ 73.96
Change since picked: - 1.38
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 1.3 million

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Tractor Supply - TSCO - cls: 53.96 chg: +0.79 stop: 52.65

TSCO turned in a decent bounce today adding 1.48%. The retail sector got a bit of a boost after the better than expected consumer confidence number and news that Target (TGT) was reaffirming its December sales expectations. 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.

Picked on November 30 at $ 52.75
Change since picked: + 1.21
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

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United States Steel - X - close: 48.09 chg: +0.58 stop: 44.65

X is still showing relative strength and added 1.2% on Wednesday. The current bounce from the $45 level is now five days old so it may be time to look for a pull back. A dip into the 46.50-47.00 region might be a new bullish entry point. 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.

Picked on December 23 at $ 47.05
Change since picked: + 1.04
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 3.8 million

Put Updates

PACCAR Inc. - PCAR - close: 69.94 change: -0.19 stop: 72.51

Yesterday PCAR spent the second half of the trading session churning sideways in a narrow range. That range continued today with PCAR oscillating back and forth across its simple 200-dma. We don't see any changes from our weekend update. Our target is the $65.25-65.00 range.

Picked on December 20 at $ 69.49
Change since picked: + 0.45
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand

---

Progressive Corp - PGR - cls: 118.55 chg: +0.36 stop: 121.25

PGR almost hit our trigger today. The stock dipped under support near $118 and hit $117.77 before inching higher again. We remain 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.

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: 22.95 chg: +0.95 stop: n/a

A better than expected consumer confidence number today and some positive comments from Target (TGT) gave the retail sector a bullish bias. Shares of AEOS out performed many of its peers with an unexpected and unexplained 4.3% rally. The stock appears to have broken out above its simple 50-dma but this may prove to be a bull trap (see chart). The stock has stalled right at its trendline of resistance. 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.

Picked on November 13 at $ 25.47
Change since picked: - 2.40
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 65.54 chg: -0.08 stop: n/a

ANF produced an intraday bounce from broken resistance, now new support, at the $65.00 level today. 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: + 5.87
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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Blue Coat Sys. - BCSI - cls: 46.26 chg: +2.75 stop: n/a

Shares of BCSI have produced a potential trend change. the stock added 6.3% on above average volume following yesterday's announcement that BCSI will be added to the S&P smallcap 600 index after the closing bell tomorrow. The stock is now testing resistance in the $46.50 region. 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.

Picked on December 04 at $ 45.43
Change since picked: + 0.83
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand

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Building Materials - BMHC - cls: 77.24 chg: -2.50 stop: n/a

BMHC lost more than 3% today on volume stronger than what it's seen over the last few weeks. Today's decline appears to be a breakdown below its short-term trend of support. We are not suggesting new strangle positions at this time. The options in our strangle play 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: - 3.71
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand

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Chicago Merc. Exchg. - CME - cls: 373.99 chg: -4.71 stop: n/a

CME's intraday high on Tuesday (above $380) produced a new P&F chart buy signal with a projected target of $416. Unfortunately for the bulls there has been no follow through. Instead the short-term technicals are turning more bearish and starting to align with some of the bearish weekly technical indicators. 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.

Picked on November 20 at $375.90
Change since picked: - 1.91
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

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D.R.Horton - DHI - close: 36.15 chg: -0.11 stop: n/a

The homebuilders didn't do much today but the action we do see in DHI (and RYL) looks bearish. Shares are trading lower in a two-week trend of lower highs as the stock pushes against support in the $36 region. A breakdown here would also be a breakdown below its eight-week trendline of support. If DHI closes under $36 any time this week then more conservative traders may want to think about exiting early and trying to salvage what they can from this play. 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.

Picked on November 13 at $ 32.56
Change since picked: + 3.59
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million

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Four Seasons - FS - close: 49.30 chg: +0.32 stop: n/a

We do not see any change from our previous updates on FS. We are not suggesting new strangles at this time. The options in our strangle were the January $60 calls (FS-AL) and the January $50 puts (FS-MJ). Our estimated cost was about $2.60. We're aiming for a rise to $5.00 or more.

Picked on November 08 at $ 55.37
Change since picked: - 6.02
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

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Lear Corp - LEA - close: 28.09 chg: -0.07 stop: n/a

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. We are lowering our target to $1.60. We have about four weeks left before January options expire.

Picked on November 06 at $ 30.24
Change since picked: - 2.15
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million

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Verifone Holdings - PAY - cls: 25.12 chg: -0.79 stop: n/a

PAY continues to see profit taking following last Friday's breakout. The $25.00 level should act as new support - we'll see pretty soon. 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.

Picked on October 12 at $ 19.98
Change since picked: + 5.14
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

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Questar Corp. - STR - close: 76.82 chg: +0.92 stop: n/a

Natural gas futures produced a decent bounce today and the natural gas stocks follow suit but shares of STR still look bearish. We do not see any changes from Tuesday's update. 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.

Picked on November 20 at $ 76.25
Change since picked: + 0.57
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

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Texas Ind. - TXI - close: 49.70 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.

Picked on November 27 at $ 49.57
Change since picked: + 0.13
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand

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Valero Energy - VLO - close: 51.87 chg: +0.97 stop: n/a

Oil stocks rebounded somewhat but not as strongly as crude oil prices. VLO still appears stuck inside its two-week bearish trend. 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.

Picked on November 21 at $ 50.50
Change since picked: + 1.37
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million

Dropped Calls

Chicago Merc. Exhg. - CME - cls: 373.99 chg: -4.71 stop: 372.49

Our aggressive play in CME did not pan out. Yesterday's new bullish P&F chart buy signal may prove to be a bull trap instead. The stock dipped to $371.80 this morning before bouncing and it was enough to hit our stop loss at $372.49. A quick look at the intraday chart shows that CME suffered under the $376 level all day long. Another breakdown under the 50-dma near 369.00 and the stock might look like a bearish candidate instead.

Picked on December 27 at $382.00
Change since picked: - 8.01
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 888 thousand

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

When Trendlines Are Not Enough

I've had the position for some time that this current market was most likely building at least an interim top given the repeated rally failures and reversals from the same area or at the same level in the major indexes. An assessment of the TRADE potential is more on the basis of the risk to reward parameters of such a trade.

By that I mean, that buying puts around recent highs, made for a 'defined' point, of fairly low risk, at which to exit; i.e., just above the cluster of recent highs in either the S&P indexes or the Nasdaq. Exit can be by setting a 'contingent' stop based on the index price, if that is possible with your broker; I say 'possible' because of course traditional brokers will not accept buy or sell stops on options because, unlike stocks, this is not an exchange practice such as at the Chicago Board Options Exchange.

Reliance for me is either monitoring index levels at home or electronically; e.g., my TradeStation software will allow me to set alerts at a certain level and I can even get a message electronically where I am, when my 'stop' or exit point is reached; e.g., at 1707 in the Nasdaq 100 (NDX) where I would cover or exit the few January 1700 puts I have. If I can monitor the market at least hourly, generally at the 'top' of the hour, I will exit on any hourly close that pierces my stop point which is, again, based on where the index itself is trading.

Sometimes, I will exit the next morning at 'market' if there is a DAILY close above my Index exit point on puts; the reverse of course on calls. This strategy of strict adherence to cutting my loses 'short', which I learned the hard way in the index and bond futures markets in the 80's, is why I put a lot of emphasis on attempting to find the occasional intermediate top or bottom and trying to avoid trading much in the 'middle' so to speak; i.e., once a move is well underway, this is the middle of a move. And, where I have a hard time finding exit points that don't stop me out prematurely.

Leaving the mechanics of strategy, and looking at the chart/technical PATTERN that has formed over recent weeks, what keeps me from going more heavily into puts? Especially given that there is this fairly well-pronounced tendency for more significant corrections or pullbacks to develop in January after there was the common run up in later part of the old year.

There is one reason relating to the price PATTERN, which is the most important and not YET conclusive and two reasons regarding INDICATORS.

PATTERN considerations
While the steeper upper trendlines you'll see on the charts presented below, have been pierced, along with the 21-day moving average I rely on in assessing the trend, it is also true that the various pullbacks have been fairly shallow also. The pattern of repeated tops in the same area, coupled by repeated lows in the same vicinity on the pullbacks, makes what is called (in technical analysis) a 'RECTANGLE' pattern; Charles Dow called this a 'line' formation.

RECTANGLE patterns:
These are often consolidations of the prior trend; since greatest weight is usually given to the EXISTING trend it pays to be respectful of the potential for a breakout move in the SAME direction as the current trend.

On the other hand, there are rectangle tops that form after lengthily bull moves, and rectangle bottoms that form after prolonged declines. The important thing in EITHER case is the DIRECTION of the breakout above or below the rectangular boxlike pattern. Since pictures are worth thousands of words, time to stop 'talking' and move on charts.

The daily chart of the S&P 100 (OEX) below has an upper dashed level line that intersects most of the tops; as with 'internal' up or down trendlines, it is OK to have a couple of points outside the line as we're looking for the PREDOMINANT area of resistance or support. The lower dashed line is drawn through the lowest low for the period of the sideways move (after the last top).

There is a lack of a well-defined lower 'line' of support given just the single low at it. A rectangle would be more defined if OEX again reversed around 571 and headed higher again, giving us TWO lows made at the low end of this possible sideways trading range or 'rectangle'.

You'll see that the UP TRENDLINE constructed on the chart was pierced this week. This is noteworthy since this penetration, along with the failure of OEX to stay above its 21-day average, shows slowing upside momentum. However, by definition, a sideways trend will show a LACK of upside, or downside, momentum. This doesn't necessarily mean that that pattern makes for a top. We need to see if the 570-571 level now holds as support.

It's helpful to strip away most other chart markings and indicators that don't relate to the pattern we're studying and look at it more in isolation. The chart below 'closes' up the box or rectangle on the left and right sides. The 'measuring rule for rectangles is that an upside breakout will carry as far above the upper line as the height of the rectangle.

583-571 or 12 points is the distance between the upper and lower lines. 583 + 12 points, or 595, becomes a 'minimum' upside objective on a move above 583. 571 minus 12, or 558, is a possible downside target if 571-570 gives way. 558.5 is a 'fibonacci' 61.8% retracement of the Oct-Nov advance which seems possible in the month ahead; and, still within the parameters of a 'normal' correction within what is still an UP trend.

I sometimes take the 'width' of the box (ending the right hand line at the last 'bar') as a 'maximum' upside or downside objective. But this is not the RULE OF THUMB for a bar chart, unlike other specialty charts that have the time and price scales set to equal lengths. But for fun, let's say that this gives a maximum upside objective (on a move above 583) of 606 and a downside objective on a penetration of 570, to around 548.

NASDAQ CHARTS:
We can see the basically the same sideways trading range in past weeks and forming the rectangle pattern, in the Nasdaq 100 (NDX) chart shown below. The top end of this trading range is at 1710 approximately and the lower end at 1658. I highlight just the rectangle on the chart after this one immediately below.

I also made a point in the beginning about TWO different INDICATORS that gave me pause about getting overly bearish at this juncture. One indicator is the Relative Strength Index or RSI, one of several 'momentum' type technical indicators (also, Stochastics and MACD) and shown above on the NDX chart.

It is a characteristic of the RSI or Stochastics Indicators to reach an 'oversold' reading at the low end of its scale, by simply going more or less sideways for long enough; this is the situation in the current several week old sideways trend.

Since I most like to short or buy puts when a market is near the UPPER end of its scale ('overbought') and I tend not to like shorting or buying puts when the RSI is at or near an oversold reading, recent RSI readings make me wonder if the breakout of the rectangle, more distinctly shown below, might not be to the UPSIDE. Stay tuned on that!

As I said about the OEX in the beginning, the rule of thumb about how far a move might carry once it breaks out ABOVE or BELOW the upper or lower end of the rectangle pattern, is to add or subtract the 'height' of the rectangle (the high minus low of the sideways trading range) to the top or bottom figure; once there's a breakout to the upside or downside.

This measuring rule of thumb would suggest NDX upside potential to 1762 (1710 minus 1658 = 52; 58 + 1710 = 1762) if there was an advance above 1710. Conversely, if NDX falls under 1658, downside potential is to 1606 (1658 minus 52). By the way, a move back down to this area would put NDX back to major support implied by the upside price 'gap' (between 1600-1610) of early-November.

Lastly, I'll mention that the OTHER (of two) indicator that gives me pause about being aggressively on the short side of this market and in Nasdaq Index puts, is the fact that total Nasdaq UP volume, on a 10-day moving average basis, is at the 'baseline' level where substantial RALLIES typically begin; this is shown on the chart below.

The subject of Nasdaq or NYSE 10-day Up Volume averages contracting to 'baseline' levels, as an (one) Indicator for significant bottoms, was covered in a prior (8/31/05) Trader's Corner article I wrote on my 'key indicators' which can be seen by clicking here.

NOTE: The subject of 'VOLUME' (as an indicator) is about halfway into this article and is (sub) titled as such.

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** 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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