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Daily Newsletter, Saturday, 12/31/2005

HAVING TROUBLE PRINTING?
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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

Trouble Ahead

When Santa fails to call, bear may come to Broad and Wall. Santa definitely failed to appear and the outlook for January is rapidly turning negative. A failure to rally during the last week of the year sends shivers through the analyst community. The weakness was not due to a lack of cash with investors sending $2.8B to mutual funds for the five days ended on Dec-28th. This was in addition to the inflows of $4.9 billion in the prior week. The drop was due to profit taking by funds ahead of a potentially weak January.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The undercurrents are turning into a whirlpool as we approach 2006 and the market weakness over the last week represented early exits by nervous funds. Funds talk to each other and there is a real fear that January could see a market reset as the year begins. The profits from the October lows will need to be taken with markets stalling at the resistance highs. The S&P and Wilshire-5000 both ran into a brick wall at 1275/12750 and five weeks of trading failed to penetrate. The last week saw very little retail buying and every sell program turned into a disaster in the low volume. Traders are seeing that 1275 level as a top and are waiting on the sidelines to see what January will bring.

For 2005 the year ended with a thud and were it not for the strong November rally it would have been even worse. 2005 duplicated performance for 2004 with weakness for most of the year punctuated by a year-end bounce back to the highs. Unfortunately that bounce was just enough to push the indexes back into the green with the exception of the Dow. Note the slowing from the 2004 pace.

TTable of U.S. Indexes with Changes for 2005 and 2004

The -0.6% loss for the Dow was the smallest annual loss dating back to 1902. That is slim consolation for traders. With several dogs losing large amounts it is amazing it was not worse. GM led that list by giving up -51% for the year. That was offset in part by strong gains from HPQ, BA and MO. The gains shown for AT&T in the table are skewed from the SBC/AT&T merger.

Table of Dow Components Sorted by Yearly Change

The poor performance by the U.S. markets is even worse than it appears when compared to some other markets around the world. Granted some of the smaller ones contain huge amounts of risk but you can see why international funds and iShares have been so popular. Investing has taken on a global view for retail traders more so than any other time in the past. Instead of being confined to the 7500 U.S. stocks we can invest in an individual basket of stocks from a single country like Japan or trade a basket that covers all of Asia. The investing world has changed and the ability to invest globally has taken cash out of the U.S. markets that would have been fuel used in the past to push our indexes higher.

Table of Global Indexes

Money flows into funds in general have been weaker than in 2004. Overall stock funds received $125.5 billion through November 30th compared to $167.6 billion for the same period in 2004. This raised total assets of U.S. based mutual funds to $8.76 trillion as of November's end. TrimTabs said expected inflows in December would be in the $20.2 billion range with only $8.6B remaining in U.S. equities while $11.6B would be heading overseas. This is well above prior years and a key reason why the U.S. market is floundering.

Commodities have also taken their place on the retail stage in the U.S. markets. Instead of having to use separate brokers and different accounts with reams of complicated paperwork the rules have changed. Many major brokers are offering combination accounts where the various futures contracts can be traded as simply as trading stock like IBM and GE or options on stocks or indexes. With the greater volatility and higher leverage the futures markets have also been attracting traders away from conventional equities. Metals have also been very attractive with copper and titanium taking their places with silver and gold as strong gainers for the year. Steel prices soared with the global construction boom and traders participated using individual stocks not normally known from multi month moves.

Table of Commodity Gains

However, 2005 will be known as the year energy caught fire. Oil prices jumped from $40 in January, already up strongly from the $27 low in 2004, to more than $70 in the aftermath of Katrina. Natural gas prices more than doubled from their January low of $6.53 to trade over $15 as huge amounts of U.S. production was taken offline in the Gulf. More than 2.3bcf is still offline and much of that could be offline until Q2. While prices for both commodities have declined significantly from the highs they are still holding above the yearly average of $57.38 with oil at $61 and natural gas at $11.25. OPEC appears to be headed for a production cut at the end of January of at least one million bbls and the future is clear to those watching the proceedings. Prices are not going much lower with the average price of oil in 2006 expected to be $58.46 according to a survey of energy analysts. It should be no surprise that the S&P Oil and Gas sector rose +38% for the year. Retail investors piled into the sector iShares, Holders and SPDRs and were rewarded with spectacular gains through year-end.

Energy iShares, Holders and SPDRs

2005 could also be called the "Year of Takeovers." According to the bean counters that keep records of these things more than a trillion dollars in takeovers either occurred or were announced. The list below is only a representative few but they amount to nearly $300 billion in ten deals. This is a massive amount of money and shows how much corporate cash had accumulated but also suggests that valuations had improved significantly enough to stimulate these transactions. Conversely there is another train of thought that suggests corporations had topped out on organic growth and cost savings and were forced to shift to acquisitions to maintain forward motion. $277 billion of the acquisitions were cash takeovers of public companies and that topped the $231 billion record set in 1999.

Top Ten Acquisitions Announced in 2005

There was so much excess cash stuffing the corporate coffers that stock buybacks set a new all time record of more than $456 billion. This shattered previous record of $312 billion set in 2004 by +46%. 728 companies bought back shares in 2004 compared to 1012 companies in 2005. Historically whenever record amounts of money were used for buybacks the markets moved higher according to TrimTabs.com. Not so in 2005. According to Charles Biderman of TrimTabs.com investors did not see the buybacks as evidence of a strong domestic economy. They saw the buybacks as evidence that companies did not have any better use for the money. CapEx spending was not especially strong and they had to do something with the money to keep shareholders happy. If you are not growing revenue or making acquisitions that will help future growth then buying back shares seems to be the right thing to do. Investors were not impressed. This perceived lack of growth potential helped to push investors into those investments in other countries I outlined above. Growth is growth regardless of country. To illustrate this lack of investor interest Exxon bought back a massive $13 billion in shares and the stock only gained about +10% for the year. Microsoft repurchased $9 billion but its shares ended flat. The key to attracting American investors is growth and that was noticeably absent from the economic picture despite a +3.5% GDP.

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Also sucking money out of equities was a very strong IPO calendar in 2005. Every new issue takes money away from the rest of the market. Google, who launched their IPO in Aug-2004 shot higher throughout 2005 adding more than double its $59 billion market cap as of 12/31/2004. With a current market cap of $123 billion that was a huge blackhole sucking money out of other stocks as investors abandoned other equities to jump on the Google train. The IPO bubble is only getting stronger with 140 already registered for 2006 for an estimated $23 billion. Thomson Financial thinks there will be as many as 300 in 2006 with more than a $50 billion price tag.

If 2005 was a dog for everything but energy stocks how is 2006 going to rate? If I knew beyond a shadow of a doubt I would be mortgaging everything I owned to bet on that outcome. Unfortunately nobody has that proverbial crystal ball but there are quite a few analysts betting their reputations this week. Various analysts were interviewed publicly or published their expectations for 2006. The list below also includes an unscientific survey of 112 NYSE floor traders. Their average target for 2006 was 1293 for a +3.8% gain. However, fully one third of those traders were bearish and expected a rocky year. For five of the last six years traders were more bullish than the actual market the next year. On the one year they were bearish the Dow rose +25% the following year. This illustrates perfectly that the markets exist only to frustrate the most people possible in any given year. Despite one third of those being surveyed being bearish the survey still projected that +3.8% gain for 2006 to 1293. If those traders have historically been too bullish then it would suggest something less than 1293 for 2006.

Table of Broker Targets for 2006

The vast majority of analysts taking a position in print agree mostly with a target in the 1300 range with those three companies above with estimates at 1400 standing well out of the crowd.

About the only thing most agree on is that the energy sector will continue to provide above average returns. With OPEC likely to support a price in the mid $50 range the odds of oil retreating under $50 are slim, always possible but slim. Energy companies are still seeing their stock being valued using oil in the $30 range. This suggests there is still plenty of room for price appreciation. Does anybody really believe ConocoPhillips is overpriced with a PE of 7? How about ChevronTexaco at 9 or even ExxonMobil at 10? The price of energy stocks will continue to rise but maybe not at the meteoric rate we saw in the summer of 2004. They will rise because very few companies outside the energy sector are growing earnings at rates of +40% to +85% or more. Of course there is always the expectation for Peak Oil to arrive in 2007 to keep the speculators active.

Crude Oil Chart - Daily

I am sure there will be some more consolidation in the industry simply because it is cheaper to buy reserves than find them. There are plenty of companies with valuations far below acquisition levels. For instance Apache (APA) has a market valuation of only $13 per bbl of reserves and very strong management. Chesapeake Energy (CHK) has been on an acquisition binge but it may be just to keep potential acquirers of itself off balance. CHK controls the third largest reserves of natural gas in North America and yet has a market cap of only $11 billion and a price to reserves of only $17 a bbl. Coincidentally insider buying at CHK is out of sight. Since Dec-14th the Chairman and the President have purchased 2,272,000 shares in the open market for something north of $72 million dollars in 14 separate transactions. Personally if they are buying their own stock at $32 in that quantity I seriously doubt it is going much lower. If they are willing to invest $72 million near the top of the market what does that tell you about their expectations?

The downside for 2006 remains the homebuilders and the housing sector in general. Even if the Fed rests at something under 5% there is still a lot of negative sentiment about the sector. Several years of speculative excess has pumped prices to extreme levels and inventory for sale is growing quickly. Once the speculators finally accept reality there could be a sudden downdraft. Inventory numbers for existing homes for sale were just released last week at 2,903,000 and that is a +31% increase over the same period in 2004 at 2,214,000. New homes for sale were reported at 503,000 a week earlier and +83,000 over 2004. Add those numbers together and you have a total of 3,406,000 homes for sale, up +29.4% from 2004. Since new households only increase at a rate of about 1.2 million per year there is a lot of inventory for sale. Many of those new households will be apartment dwellers making the inventory numbers even more dramatic. I would be very surprised if the homebuilders rise from the dead in 2006. However, many builders have backlogs up to 12 months out so they will still continue to produce profits, just not at the rate of past years. Since some estimates say new homes account for as much as 50% of our current GDP levels that will make it hard for GDP to post any gains in 2006. (Thanks Joe for the heads up)

On the positive side the Fed is likely to quit raising rates in March if not before. This is typically an all-clear signal for the markets BUT it is also typically a signal that the economy is in good shape. Our economy is far from ready to sprint higher when the Fed moves to the sidelines. Besides the expected drag from the housing sector we will have the continued drag from higher energy costs. Earnings from Q4 will be the first round where the real impact from record energy prices will be felt. I suspect there will be quite a few companies use the energy excuse for lackluster earnings. This will continue to drag on the economy simply because everything made or transported in the U.S. is impacted by those higher prices. Few analysts have connected the dots that $55 oil and $10 gas is not going away and anyway you count it that is a significant earnings drag over 2004 levels.

Earnings are expected to decelerate into single digits after a very long run of consecutive double digits quarters. This will force some PE compression and probably give us another year of range bound trading. The S&P spent most of 2004 in 1075-1150 range. The Q4 rally in 2004 pushed the S&P above that range to establish a new range from 1150-1250. That range held all year until the same Q4 breakout occurred in 2005. These two years of consolidation from the +350 point rebound out of the 2002 bottom has pushed the S&P about as far as it can push without some help from somewhere. We already know the indexes would have been severely negative for all of 2005 without the +38% jump in the energy sector. Still they just broke even for the year.

With 2006 coming under attack from all directions it is highly unlikely there will be a breakout soon. I believe traders are going to be focused on the Fed and on energy. The last Fed meeting for Greenspan will be Jan-31st and odds are good he will leave with a 4.5% Fed rate. Bernanke will then take charge with his first meeting on March 28th. If the Fed does not change the statement to a neutral position in January then all eyes will be on Bernanke's first meeting in March. There are mixed feelings now on whether he will hike again to prove his manhood or go soft on the markets with a wait and see position. This should be the key pivot point for 2005. Regardless of what the markets do for the next 90 days that should be the make or break moment for 2005. Of course all bets are off should the Fed stand aside in January. That could light the rally fire before the energy grinch has a chance to damage investor sentiment over earnings.

Dow Transport Chart - Weekly

Personally I believe January could get rocky. Last week should have been a wakeup call for everyone. The tape painters tried to recover from the Monday massacre but they were either under funded or too scared to make much difference to the outcome. Wednesday and Thursday traders were walking on eggshells afraid the next tick was going to be the one that setoff the next sell program. That tick finally hit at 3:PM on Thursday and the selling continued into lunch on Friday. I mentioned on Tuesday that I expected 10725 to be defended by the tape painters and that was exactly where they drew the line. They again tried to resurrect the indexes in the last hour of trading and probably got some help from traders covering shorts in the last hour but they had the props kicked out from under them once again by a sell program at the close. I told you last Sunday my calendar had a skull and crossbones on it for Friday and my fears came to pass. It worked out well for me and anybody following my Tuesday night suggestion to short any rally. Remember the VIX chart from last Sunday when the VIX had fallen to 10.27 and very close to a new low? Well, it only rebounded slightly despite the volatility for the week. This suggests far too many traders are still too bullish.

VIX Chart - Weekly

I don't think we need to look any farther into the future than next week. There should be plenty of volatility and opportunity for everyone. If you are a bull just surviving the week may be a trick. While nobody can predict the future exactly I would say the setup has the classic earmarks of a fund dump. I reported earlier that funds received inflows of $7.7 billion in the two weeks ended on Wednesday. Obviously they did not put it into the markets. This should tell us something about next week's chances. Funds have been holding their breath trying to escape 2005 with what little profits they have intact. They probably dressed up their portfolios over the last few weeks with a few winners to make themselves look like heroes but come Tuesday morning all bets are off. They are free to liquidate at will and then shift back into their less visible positions once the dip ends. Some of those positions will be in energy futures. If you want to know which stocks they will be dumping next week you only need to look at the winners for the last two months. Quite a few have already been taken to the woodshed like MHC, PGR, CI, PD, JCOM, UNH, ADSK and GMXR. This is only a taste of what we could see next week. Don't think the energy stocks will be exempt either. The run up in futures we saw the last two days to push crude back to $61 could have been just tape painting designed to keep energy stocks from buckling into year end. The inverted yield curve has gotten enough press over the last week that anyone currently invested should have thought at least once about lightening up on their positions just in case the warning was accurate.

SSOX Chart - Daily

The Transports appear poised to nose dive to 4100 with very little effort after two separate attempts to hold 4275 failed. It is not that the rest of the indexes will need any help moving lower next week but a collapsing Transportation Index will speed up the drop. The SOX collapse under 475 is all the asdaq stocks will need as a warning flag that trouble is near. The SOX found buyers at 475 on Friday but I believe it was tape painters trying to avoid free fall. My suggestion to you this weekend is to tighten up stops on any long positions and be prepared to go to cash or go short on any weakness on Tuesday. In theory the Santa rally continues through Jan-4th but since Santa had a sleigh wreck on his way to Wall Street I would not count on an upside surprise. If we do get one I would consider it a gift of a better entry for a new short position. I hope I am wrong about my bearish outlook but that is the way I am playing it. Plan your trades and trade your plan but be ready to abort that plan if your bias turns out to be wrong.

Happy New Year!


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
FWLT NTES None
  SMG  

New Calls

Foster Wheeler - FWLT - close: 36.78 chg: +0.80 stop: 35.49

Company Description:
Foster Wheeler Ltd. is a global company offering, through its subsidiaries, a broad range of engineering, procurement, construction, manufacturing, project development and management, research and plant operation services. Foster Wheeler serves the refining, upstream oil and gas, LNG and gas-to-liquids, petrochemical, chemicals, power, pharmaceuticals, biotechnology and healthcare industries. The corporation is based in Hamilton, Bermuda, and its operational headquarters are in Clinton, New Jersey, USA. (source: company press release or website)

Why We Like It:
Our bias for January may be growing more bearish but FWLT has shown enough relative strength over the last year that it warrants a closer look as a bullish candidate. The stock has been a consistent winners for the bulls over the last several months. The consolidation in October promptly rebounded higher after hitting the 38.2% Fibonacci retracement level. Currently the stock is stuck in a trading range between $35.50 and $38.00. If FWLT breaks out higher we want to catch it. We're suggesting a trigger to go long calls on the stock at $38.05. If triggered we'll target a run into the $42.00-42.50 range. Currently the P&F chart is very bullish with a $73 target.

Suggested Options:
We are going to suggest the February calls.

BUY CALL FEB 35 UFB-BG open interest=1594 current ask $3.40
BUY CALL FEB 40 UFB-BH open interest=2184 current ask $0.95

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/15/06 (unconfirmed)
Average Daily Volume = 598 thousand

New Puts

Netease.com - NTES - close: 56.16 chg: -0.64 stop: 58.01

Company Description:
NetEase.com, Inc. is a leading China-based Internet technology company that pioneered the development of applications, services and other technologies for the Internet in China. Our online communities and personalized premium services have established a large and stable user base for the NetEase websites which are operated by our affiliate. As of September 2005, the NetEase websites had more than 614 million average daily page views, making us one of the most popular destinations in China and on the World Wide Web. In particular, NetEase provides online game services to Internet users through the licensing or in-house development of massively multi-player online role-playing games, including Westward Journey Online II, Fantasy Westward Journey and Fly for Fun. (source: company press release or website)

Why We Like It:
If investor sentiment does sour on stocks in early 2006 one of the losers could be NTES. The stock was hammered in November after missing earnings estimates. More recently there have been analyst comments suggesting the stock is fairly valued here. What we see is a sideways consolidation with a bearish trend of lower highs. The P&F chart is bearish with a $34 target. We're going to suggest a trigger to buy puts on NTES at $54.95. If triggered we'll target a decline into the $50.25-50.00 range. We do not want to hold positions over the February earnings report.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 60 NQG-NL open interest=1034 current ask $6.40
BUY PUT FEB 55 NQG-NK open interest=1982 current ask $3.50
BUY PUT FEB 50 NQG-NJ open interest= 355 current ask $1.55

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/21/06 (unconfirmed)
Average Daily Volume = 4.2 million

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Scotts Miracle grow - SMG - cls: 45.24 change: -0.46 stop: 47.55

Company Description:
With more than $2.3 billion in worldwide sales and more than 6,000 associates, The Scotts Miracle-Gro Company, through its wholly-owned subsidiary, The Scotts Company LLC, is the world's largest marketer of branded consumer products for lawn and garden care, with products for professional horticulture as well. The Company's brands are the most recognized in the industry. In the U.S., the Company's Scotts, Miracle-Gro and Ortho brands are market-leading in their categories, as is the consumer Roundup brand, which is marketed in North America and most of Europe exclusively by Scotts and owned by Monsanto. The Company also owns Smith & Hawken, a leading brand of garden-inspired products that includes pottery, watering equipment, gardening tools, outdoor furniture and live goods. In Europe, the Company's brands include Weedol, Pathclear, Evergreen, Levington, Miracle- Gro, KB, Fertiligene and Substral. (source: company press release or website)

Why We Like It:
It looks like the bloom on shares SMG is about to fall off. The stock has been a momentum winner since the current run began back in late June. Yet this last Thursday the company guided lower for the first quarter. Investors reacted by sending the stock lower and SMG broke down below technical support at the 50-dma. The attempted bounce on Friday failed near the 50-dma and the $46 level. Now that the quarter is over and the need for window dressing fulfilled shares of SMG could see a new wave of selling in January. Technically the stock has produced new bearish sell signals on its weekly chart. We are going to suggest puts here at $45.24. More conservative traders may want to wait for a decline under $45.00 before opening positions. A failed rally under $47.00 could also work as a new bearish entry point. There is some support near $44.00 and the rising 100-dma (43.63) but we're going to target a decline toward support in the $41.50-41.25 range. We do not want to hold over the late January earnings report.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 47.50 SMG-MW open interest= 42 current ask $2.65
BUY PUT FEB 45.00 SMG-MI open interest=309 current ask $1.00
BUY PUT FEB 42.50 SMG-MV open interest=630 current ask $0.35

Picked on January 01 at $ 45.24
Change since picked: + 0.00
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 354 thousand

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Biogen Idec - BIIB - close: 45.28 change: +0.62 stop: 43.95*new*

The biotech sector was one of the few sector indices to close in the green on Friday. Contributing to the sector strength was BIIB with a nice bounce from the $44.00 level and its 40-dma. Friday's move was also a bullish engulfing candlestick pattern but we're not putting a lot of faith in the one-day bullish reversal pattern at the moment. Jim's market wrap this weekend is not bullish for January and traders may not want to be opening new bullish positions at this time. We're not suggesting new positions in BIIB. Instead we're going to try and reduce our risk by raising the stop loss to $43.95. A move over $46.50 or $46.72 (last week's high) might change our mind about going long BIIB. Currently the P&F chart is still bullish and points to a $62 target. Our target is the $49.85-50.00 range. We do not want to hold over BIIB's late January earnings report.

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

Picked on December 27 at $ 46.11
Change since picked: - 0.83
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 3.2 million

---

Cytec Ind. - CYT - close: 47.63 chg: +0.08 stop: 45.95 *new*

CYT has spent the last week trading sideways between $47.00 and $47.85. We're not going to complain about the sideways consolidation since the rest of the market was drifting lower last week. The pattern for CYT is still bullish following the late December breakout over resistance. What concerns us is the likelihood for a real market pull back in January. We would not suggesting new bullish positions in CYT at this time. Normally we might consider going long calls on a breakout over the $48.00 level but our short-term target is only the $49.85-50.00 range. The P&F chart points to a $65.00 target. We are going to tighten our stop loss to $45.95.

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

Picked on December 22 at $ 47.01
Change since picked: + 0.62
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 333 thousand

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Femsa Fomento - FMX - close: 72.51 chg: -0.04 stop: 67.75

The Mexican markets have out performed out own over the past year but they were afflicted by the same low-volume holiday malaise last week.
Shares of FMX merely churned sideways with a bullish slant for the last few days. Our target is the $74.75-75.00 range so we are not suggesting new long positions at this time. A dip and bounce from $70.50 or $71.00 could be used as a new bullish entry point. FMX's P&F chart points to a $90.00 target.

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

Picked on December 19 at $ 70.65
Change since picked: + 1.86
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 308 thousand

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Gilead Sciences - GILD - close: 52.57 chg: -0.27 stop: 49.99

The pull back in GILD has now reached five days in a row. The bad news is that the pre-Christmas breakout is looking like a bull trap. The good news is that GILD is due for a bounce! Unfortunately, the weeklong sell-off has turned most of GILD's daily technical oscillators bearish. We are not suggesting new bullish positions at this time. More conservative traders may want to adjust their stop loss toward the 50-dma near 51.60. 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.

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

Picked on December 22 at $ 54.51
Change since picked: - 1.94
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 4.3 million

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Ipsco Inc. - IPS - close: 82.98 change: +0.00 stop: 79.99

Our bullish play with IPS has been triggered but we urge readers to be careful. The fact that the stock spiked higher near the last hour of trading and failed to hold its gains is not very convincing. Granted IPS performed better than most of the market this past week but its relative strength may have just been window dressing with funds trying to add a "winning" stock to their portfolio before the quarter ends. Our trigger to buy calls was at $83.55 and IPS hit $83.60 on late Friday afternoon. Aggressive traders may want to go long here or look for a dip back toward the $81.25-81.50 region and buy a bounce. More conservative traders might feel better just sitting out for another day or two and see if IPS has any change of heart next week. Currently our target is the $89.00-90.00 range. We do not want to hold over the January earnings report.

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

Picked on December 30 at $ 83.55
Change since picked: - 0.57
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 396 thousand

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United States Steel - X - close: 48.07 chg: -0.66 stop: 44.65

We believe the major market indices are in jeopardy of turning lower next week. That could pull shares of X back toward the $46.00-46.50 region. We would wait for a dip and a bounce near $46.50 before considering new bullish call positions in X, especially since the stock is giving off mixed signals. In the meantime we're going to cinch up our stop loss a bit to $44.99. 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 not suggesting new bullish positions in X at this time.

Picked on December 23 at $ 47.05
Change since picked: + 1.02
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 3.8 million

Put Updates

PACCAR Inc. - PCAR - close: 69.23 change: -0.74 stop: 72.51

It looks like the pre-Christmas oversold bounce in PCAR has finally failed. After oscillating near the $70.00 level and its 200-dma for a few days shares of PCAR are now trending lower again. The selling began to pick up speed and volume on late Friday afternoon. This looks like a new entry point to buy puts. More conservative traders may still want to wait for a new relative low under $68.27 or $68.00. Our target is the $65.25-65.00 range. Technical traders should note that we are betting against a bullish P&F chart but PCAR can dip toward $65 and still not reverse its current P&F buy signal. We do not want to hold over the late January earnings report.

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

BUY PUT FEB 75 PAQ-NO open interest=629 current ask $6.40
BUY PUT FEB 70 PAQ-NN open interest=865 current ask $2.90
BUY PUT FEB 65 PAQ-NM open interest=515 current ask $1.00

Picked on December 20 at $ 69.49
Change since picked: - 0.26
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand

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Progressive Corp - PGR - cls: 116.78 chg: -1.84 stop: 121.25

Our put play in PGR has been triggered. The bearish pattern of lower highs has finally blossomed into a breakdown below support near $118 and its 50-dma. Our trigger to buy puts in PGR was at $117.45, which was hit quickly on Friday morning. Long-term the pattern for PGR remains very bullish but the stock is still very overbought and could easily consolidate toward the $110 level without doing much harm to its multi-year bull run. The weakness on Friday helped confirm the bearish technical signals on its weekly chart and it produced a new (weekly) MACD sell signal. Our target is the $110.50-110.00 range but we only have 19 days ifthe current earnings date is correct. We do not want to hold over the earnings report. If you're looking for a new entry point watch for an oversold bounce and failed rally near $118 and possibly $120, which is overhead resistance.

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=755 current ask $6.00
BUY PUT FEB 115 PGR-NC open interest=248 current ask $3.50

Picked on December 30 at $117.45
Change since picked: - 0.67
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 836 thousand

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Stryker Corp. - SYK - close: 44.43 chg: -0.48 stop: 46.51

Our bearish play in SYK is now open. The stock gapped lower on Friday and dipped to $44.29 and then proceeded to consolidate sideways above its simple 50-dma. Sometimes we wonder if it is just a coincidence that the low (or the high) of the day happens to be our trigger, which is the case here. Friday's decline in SYK does appear to be a bearish breakdown from its two-month rising channel. While the play is officially open readers may want to wait a day or two before initiating positions. Look for a failed rally near $45.00-45.40 or a new low under $44.25-44.00 before considering new put plays. The Point & Figure chart points to a $23.00 target. Our target is 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=378 current ask $2.10
BUY PUT FEB 40 SYK-NH open interest=141 current ask $0.45

Picked on December 30 at $ 44.29
Change since picked: + 0.14
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 2.1 million

Strangle Updates

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

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Amer. Eagle Out. - AEOS - cls: 22.98 chg: -0.14 stop: n/a

The retail index (RLX) does not look very healthy. The sector looks poised to produce a new leg lower in January. That would coincide nicely with AEOS's rally up to its five-month trendline of resistance (see chart). We only have three weeks left before January options expire. 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.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 13 at $ 25.47
Change since picked: - 2.49
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 65.18 chg: -0.17 stop: n/a

ANF is still out performing the rest of the retail sector but the rally may be in for a struggle with January at our doorstep. We only have three weeks left before January options expire. If ANF doesn't trade over $70 by expiration or near $50 then we do not have much chance of breaking even on this play. More conservative traders may want to lower their target. We are adjusting our target to breakeven at $5.15. 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.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 13 at $ 59.67
Change since picked: + 5.51
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million

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Blue Coat Sys. - BCSI - cls: 45.72 chg: -0.52 stop: n/a

As it stands right now we're in trouble with this BCSI strangle play. The December 16th breakdown from its sideways consolidation did not produce any follow through. Instead shares bounced sideways along its rising 100-dma. Then just a few days ago Standard & Poor's announced they were adding BCSI to their smallcap index. The stock naturally moved higher on the news but not high enough to breakout over resistance in the 46.50-47.00 range. We only have three weeks left before January options expire. In order to breakeven we need to see BCSI rally above $50 or fall under $40 in that time frame. We're adjusting our target to breakeven at $3.25. Our current play involves the January $50 call and the January $40 put. Our estimated cost is $3.25.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on December 04 at $ 45.43
Change since picked: + 0.29
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand

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Building Materials - BMHC - cls: 68.21 chg: -3.79 stop: n/a

The sell-off in BMHC is picking up steam. The stock lost another 5.2% on Friday. Volume came in very big at about double the daily average. Friday's decline was also a breakdown below support at the 200-dma and at the $70.00 level. Currently shares are oversold and due for a bounce but it looks like the new trend has been established. 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. Currently the BGU-ON puts are trading at $6.70bid / $7.30ask.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on December 18 at $ 80.95
Change since picked: -12.74
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand

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Chicago Merc. Exchg. - CME - cls: 367.49 chg: -0.52 stop: n/a

The bounce from CME's December low appears to be failing again. Shares dipped to $361 on Friday morning and the stock closed under the simple 50-dma. Most of the technical indicators are bearish and the recent buy signal on its Point & Figure chart has reversed into a new bull-trap pattern. If CME doesn't starting moving one direction soon we're going to be in trouble. There are only three weeks left before January options expire. We are adjusting our target to breakeven at $26.70. That means CME needs to trade well above $400 or under $350 if we're going to hit our new target. We are not suggesting new positions. Our current play involves the January $400 calls (CMJ-AK) and the January $350 puts (CMJ-MA). Our estimated cost was $26.70.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 20 at $375.90
Change since picked: - 8.41
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand

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Four Seasons - FS - close: 49.75 chg: -0.01 stop: n/a

The long-term pattern for FS remains bearish but over the last couple of weeks FS is slowly building or coiling for what looks like a bullish breakout. If FS does breakout over $50.50 and its 50-dma it will be bad news for our strangle position. We only have three weeks left before January options expire. Considering this more conservative players may want to exit early and cut their losses here. Our bias for January is turning bearish so we're willing to risk it and keep the play open. In order to hit our target FS needs to trade near $45 before expiration. 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.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 08 at $ 55.37
Change since picked: - 5.57
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand

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Lear Corp - LEA - close: 28.46 chg: +0.18 stop: n/a

The volatility in shares of LEA has dried up over the last few weeks. This lack of movement has had the unwanted affect of evaporating the option premiums. The stock appears to have built a new base or bottom with support near the $27 level over the last couple of months. There are only three weeks left before January options expire. For this play to succeed or even breakeven we need to see LEA trade over $35 (not likely) or under $25 (a dwindling prospect). We might be able to recoup the cost of this play by buying calls on LEA if the stock can breakout over the $29.00 level. 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.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 06 at $ 30.24
Change since picked: - 1.78
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million

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Verifone Holdings - PAY - cls: 25.30 chg: +0.09 stop: n/a

Readers have a decision to make. So far PAY has been holding above broken resistance, now support, at the $25.00 level. Will the stock hold here and rally higher or will it turn lower potentially dragged under support by a market meltdown? If you think the stock will not rally from here than consider exiting now. Our cost for the January strangle was about $2.60. Currently the PAY-AX Jan. $22.50 calls are trading at $2.70bid/$3.30 ask. If you do think PAY will continue higher, and it might since the stock tends to follow its own course and not react too much to market momentum, then keep the play alive. Our target is for a rise to $4.50. Just remember that we only have three weeks left before January options expire.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on October 12 at $ 19.98
Change since picked: + 5.32
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand

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Questar Corp. - STR - close: 75.70 chg: -0.69 stop: n/a

STR continues to sink and shares closed under the $76.00 level on Friday. Oil may have bounced higher into New Year's but natural gas futures were drifting lower. Currently we're in bad shape with this strangle play. The stock has reverted back to our entry level near $75-76. We only have three weeks left before January options expire and to see this play even breakeven we'd need to see a rally towards $85 or a decline towards $65. We are adjusting our target to breakeven but the odds are against us unless natural gas really sees a big move soon. Our strangle involves the January $80 calls (STR-AP) and the January $70 puts (STR-MN). Our estimated cost was $5.10.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 20 at $ 76.25
Change since picked: - 0.55
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand

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Texas Ind. - TXI - close: 49.84 chg: +0.28 stop: n/a

We are still in a wait and see mode with TXI. The company is due to report earnings on Thursday, January 5th. The earnings report is pretty much our only chance to try and score (and/or breakeven) with this strangle play. If the news fails to jolt TXI out of its three-month trading range then our strangle is in deep trouble. We are not suggesting new plays but aggressive traders might consider a new position using February strikes. 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.

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 27 at $ 49.57
Change since picked: + 0.27
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand

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Valero Energy - VLO - close: 51.60 chg: +0.00 stop: n/a

VLO closed unchanged on the last session of 2005. The stock gapped down at the open but managed a late afternoon rally higher. Currently the short-term pattern looks bearish with a trend of lower highs. We're a little surprised that VLO hasn't rallied higher given the strength in crude oil the last few sessions. This divergence could be a bad omen if you're bullish. We have a bigger problem. January options are set to expire in three weeks. If this play is going to score we need to see VLO trade over $55 or under $45 before expiration. Unfortunately, at this time, we do not expect either move to happen before expiration. If by chance VLO does make a move we're adjusting our target to $2.93 (breakeven).

Suggested Options:
We are not suggesting new strangle plays here.

Picked on November 21 at $ 50.50
Change since picked: + 1.10
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million

Dropped Calls

Tractor Supply - TSCO - cls: 52.94 chg: -0.54 stop: 52.65

The retail sector has not shown any strength and the RLX index looks poised to breakdown next month. Shares of TSCO are also withering slowly lower. We're going to exit early before the stock hits our stop loss. We can always reconsider a new bullish position if shares trade over $55 again.

Picked on November 30 at $ 52.75
Change since picked: + 0.19
Earnings Date 01/18/06 (unconfirmed)
Average Daily Volume = 428 thousand

Dropped Puts

None
 

Dropped Strangles

D.R.Horton - DHI - close: 35.73 chg: -0.48 stop: n/a

DHI has finally closed under the $36.00 level and the move has confirmed a breakdown below its two-month trendline of support. If shares of DHI follow through on this pattern and turn lower back toward the $32.50 level we'll end up with a nothing left of our initial investment. We're choosing to exit now. The DHI-AG January $35 calls are still trading in the $1.50-1.65 range. Our estimated cost was $3.15. More aggressive players willing to lose it all may want to hold on for an unexpected rally in DHI and the homebuilding sector.

Picked on November 13 at $ 32.56
Change since picked: + 3.17
Earnings Date 02/15/06 (unconfirmed)
Average Daily Volume = 3.2 million


Trader's Corner

Yielding Up the Answers

You've heard people talk about the yield curve. You even picked up enough of the discussion on CNBC to throw around the term at the last office water-cooler discussion, intoning your prognosis on whether the inversion predicted a recession. Despite your somber but brief discussion, however, you're secretly glad that no one asked you to explain what a yield curve was and what the terms "flattening yield curve" and "inversion of the yield curve" mean. You don't have a clue.

Neither do a lot of people, but it's a simpler concept than many imagine. First, for the benefit of newbies, what's a yield? The word can have several definitions, but for the purposes of studying the yield curve, it's the effective rate of interest paid on a treasury bond. Generally, when bonds go up in value, yields go down, and vice versa. When bonds are lower in value, higher yields are needed to entice buyers away from equities.

The bonds used to study the yield curve are government bonds. These bonds can be short-term treasury bills maturing in 12, 26 or 52 weeks; treasury notes maturing in 2,5 and 10 years, and treasury bonds maturing in 20 and 30 years. The three types of government bonds--T-bills, treasury notes and treasury bonds--are collectively known as "treasuries."

Normally, longer-term treasuries would yield a higher interest rate than shorter-term ones. That's to tempt investors to tie up their money for longer periods. Investors want more compensation if they're going to risk their money for a longer period of time.

To study the yield curve, yields are plotted on a chart. The vertical axis is the yield's amount and the horizontal axis is the maturity of the treasuries. Starting at the far left, where the two axes meet, the shorter-term T-Bills are plotted. Next come the treasury notes and then the treasury bonds on the far right.

When yields show a normal pattern, the yield curve arcs upward as it extends from left to right on the chart. This reflects the fact that yields increase as maturities do. The following chart illustrates a normal yield curve, although I'd argue that this illustration from Investopedia shows a flattening itself to the far right of the chart.

Normal Yield Curve:

A flattening yield curve occurs when the rates for shorter-term and longer-term treasures are equal or nearly equal. The line is horizontal. An inverted yield curve occurs when yields for shorter-term treasuries are higher than those for longer-term ones. This type of curve proves rare, but such an inversion occurred December 27 when the yield for the two-year treasury note moved higher than that for the ten-year. A simplistic and exaggerated representation of an inverted yield curve would look something like the chart below.

Inverted Yield Curve:

Some economists have noted that inverted yield curves sometimes predict economic slowdowns or recessions, with such an inversion showing that money is tight after a period of Fed tightening has driven short-term rates higher. With most inversions, yields or rates for short-term treasuries and longer-term treasuries are high with yields for a shorter-term treasury rising above those for a longer-term one. This week, many economists sound the "this time it's different" bell. That's a bell tone that chills investors who have heard that statement addressed to early 2000's high prices on stocks with no earnings and to low VIX levels just before rollovers.

A difference does exist, however: this time, the ten-year's yield remains low and an impending December 29 auction of two-year notes pressured prices for those treasuries, sending the two-year's yield higher.

One economist argues with the use of the two-year note to measure inversion, claiming that the 10-year's yield should be measured against that of the fed funds rate and not that of the two-year note. That discussion, however, remains beyond the scope of either my understanding of economics or the appropriate length for this primer on the yield curve.

One dramatic example of an inverted yield curve occurred in March 2000, as illustrated by the Dynamic Yield Curve chart available on StockCharts.com.

Dynamic Yield Curve:

Copyright, Stockcharts.com

This yield curve chart was benchmarked on March 10, 2000, just prior to the last swing high before the SPX toppled over and began falling into its 2002 low. As Jim Brown noted in his Wrap December 27 of this week, a severely flattened or inverted yield curve forecast every recession and many economic slowdowns since 1954.

Certainly, such memories worry some economists and have focused attention on the December 27 inversion, although others dismiss the belief that such an inversion predicts a recession now. Those nay-saying economists point to recent strong economic data and the impact that foreign buying of U.S. treasures might have on the curve. It's true, too, that while such inversions of the yield curve always precede recent severe slowdowns or recessions, not all such inversions are followed by severe slowdowns or recessions. In his December 27 Wrap, Jim Brown also reported the sometimes-heard Wall Street adage that "an inverted yield curve has correctly predicted ten of the last five recessions."

Although this article provides only an overview of the term "yield curve," and not an exhaustive discussion of the various reasons why this one might or might not be predicting a recession, you're primed to discuss it with more assurance at the next office water-cooler discussion. You're also primed to take protective measures just in case this time it's not different after all.

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.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

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