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Daily Newsletter, Saturday, 01/14/2006

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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

Market Wrap


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
FODRSNone
GCIEXPD 
SIGI  

New Calls

Fortune Brands - FO - close: 77.95 change: +0.55 stop: 76.45

Company Description:
Fortune Brands, Inc. is a leading consumer brands company with annual sales exceeding $7 billion. Its operating companies have premier brands and leading market positions in home and hardware products, spirits and wine, and golf equipment. Home and hardware brands include Moen faucets, Aristokraft, Omega, Diamond and Schrock cabinets, Therma-Tru door systems, Master Lock padlocks and Waterloo tool storage sold by units of Fortune Brands Home & Hardware LLC. Jim Beam Brands Worldwide, Inc. is the company's spirits and wine business. Major spirits and wine brands include Jim Beam and Maker's Mark bourbons, Sauza tequila, Canadian Club whisky, Courvoisier cognac, DeKuyper cordials, Starbucks(TM) Coffee Liqueur, Laphroaig single malt Scotch and Clos du Bois and Geyser Peak wines. Acushnet Company's golf brands include Titleist, Cobra and FootJoy. (source: company press release or website)

Why We Like It:
Last year, 2005, was a rocky year for FO. The stock rallied from $75 to $96 from January to July and by late October it was trading near $74. If you look closely at its daily chart over the last couple of months you'll see a pennant or wedge-like consolidation pattern of higher lows and lower highs. We suspect that FO will breakout to the upside. The Point & Figure chart supports this vision with an upward target near $90. However, a true pennant is a neutral consolidation pattern and the stock could breakout either way. We're listing FO as a call candidate in the newsletter but we have two triggers and it could end up being a put play. If FO breaks out of its pattern and moves higher then we want to use a trigger at $78.65 to buy calls. More conservative traders may want to wait for a new four-week high above $79.30 or even wait for a move over $80 and its 100-dma since both levels ($80.00 and 100-dma) could offer overhead resistance. If triggered at $78.65 then our short-term target will be the $83.00-84.00 range. Our alternate entry will be at $76.35. If FO breaks down and hits our trigger at $76.35 then we want to buy puts and we'll target a decline 72.50-72.00 range. If triggered to the downside we'll use a stop loss at $78.55. We only have about three weeks before FO is expected to report earnings so we're trying to keep the targets reasonable. We do not want to hold over the earnings report. It is possible that FO could produce a very volatile session and hit both our triggers in the same day thus creating two positions. If that's the case we'll see where FO closes and adjust our strategy and probably close one side at a loss. Traders without the ability to monitor their positions during the day may want to just wait for the breakout to occur before initiating a position.

If you want to consider more alternative look into a strangle play. Aggressive players could buy a strangle using February options with an $80 call and a $75 put for about $2.00. A March strangle at the same strikes would cost about $7.00.

Suggested Options:
If FO trades at $78.65 buy calls. The following calls are for quick reference. We're not suggesting any one strike.

BUY CALL FEB 75 FO-BO open interest= 10 current ask $3.90
BUY CALL FEB 80 FO-BP open interest=280 current ask $1.10

If FO trades at $76.35 buy puts. We're not suggesting any one specific strike.

BUY PUT FEB 80 FO-NP open interest= 67 current ask $3.20
BUY PUT FEB 75 FO-NO open interest=337 current ask $0.90

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/03/06 (unconfirmed)
Average Daily Volume = 803 thousand

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Gannett Co - GCI - close: 64.28 change: +1.26 stop: 61.99

Company Description:
Gannett Co., Inc. is a leading international news and information company that publishes 91 daily newspapers in the USA, including USA TODAY, the nation's largest-selling daily newspaper. The company also owns more than 1,000 non-daily publications in the USA and USA WEEKEND, a weekly newspaper magazine. Gannett subsidiary Newsquest is the United Kingdom's second largest regional newspaper company. Newsquest publishes more than 300 titles, including 17 daily newspapers, and a network of prize-winning Web sites. Gannett also operates 21 television stations in the United States and is an Internet leader with sites sponsored by its TV stations and newspapers including USATODAY.com, one of the most popular news sites on the Web. (source: company press release or website)

Why We Like It:
Shares of GCI are extremely oversold after a two-year decline. The action over the last four weeks suggests that GCI has now produced an intermediate bottom. The breakout over resistance near $62.00 and its simple 50-dma is bullish and many of the technical indicators remain bullish following the January breakout. We see the Thursday-Friday bounce from the 50-dma as a new bullish entry point and would suggest call positions here. More conservative traders may want to wait for GCI to clear potential resistance at the $65.00 level and its 100-dma (near $65) before initiating call positions. Our target is going to be the $68.50-69.00 range. However, we do not want to hold any positions over the January 27th earnings report.

Suggested Options:
We are suggesting February calls since we plan to exit ahead of the late January earnings report. We are not suggesting any one strike. This list of calls is for reference.

BUY CALL FEB 60 GCI-BL open interest= 10 current ask $5.00
BUY CALL FEB 65 GCI-BM open interest=165 current ask $1.50

Picked on January 15 at $ 64.28
Change since picked: + 0.00
Earnings Date 01/27/06 (confirmed)
Average Daily Volume = 1.4 million

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Selective Ins. - SIGI - close: 55.19 chg: +1.11 stop: 53.79

Company Description:
Selective Insurance Group, Inc., headquartered in Branchville, New Jersey, is a holding company for six property and casualty insurance companies that offer primary and alternative market insurance for commercial and personal risks, and flood insurance policy, administration and claim services. The insurance companies are rated "A+" (Superior) by A.M. Best. Through other subsidiaries, the company offers claim management services; human resources administration services; and risk management products and services. (source: company press release or website)

Why We Like It:
SIGI soared to new all-time highs back in late October and early November. The stock has since spent the last several weeks consolidating those gains. The trading action over the last week or so suggests that the consolidation may be coming to an end. Short-term technical oscillators have turned bullish and its daily MACD indicator is flirting with a new buy signal. We want to catch a breakout over resistance at $56.00 and its simple 50-dma (55.75). Our trigger to buy calls will be $56.05. If triggered our target will be the $59.50-60.00 range. We only have a couple of weeks for the play to perform since we don't want to hold a position over the end of January earnings report. FYI: SIGI might announce a stock split with its earnings report. The company last split its stock in December 1997 in the $50-52 region.

Suggested Options:
Traders can choose the February or March options. Given our time frame we'd prefer the February strikes but the option volume is very low so we're suggesting March strikes.

BUY CALL MAR 55 IVU-CK open interest=225 current ask $2.85
BUY CALL MAR 60 IVU-CL open interest=188 current ask $0.90

BUY CALL FEB 55 IVU-BK open interest= 18 current ask $2.10

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/31/06 (unconfirmed)
Average Daily Volume = 163 thousand
 

New Puts

DRS Tech. - DRS - close: 48.80 change: -1.35 stop: 51.01

Company Description:
DRS Technologies, headquartered in Parsippany, New Jersey, provides leading edge products and services to defense, government intelligence and commercial customers. Focused on defense technology, DRS develops and manufactures a broad range of mission critical systems. The company employs 6,000 people worldwide. (source: company press release or website)

Why We Like It:
After a very impressive two-year rally it looks like shares of defense contractor DRS are finally headed for some profit taking. Actually the stock has been consolidating in a choppy, sideways fashion for the last five months. Friday's decline marks the fourth breakdown attempt at the stock's rising 200-dma(s) in the last four and a half months. If you study the daily chart you'll notice that the previous three breakdown attempts all rebounded during the same session. Yet this last Friday did not see much of a rebound and that suggests that the selling pressure might finally over come the dip buyers. We are going to suggest a trigger at $47.95 to catch a breakdown. If triggered we'll target a quick decline into the $45.00-44.00 range. More aggressive traders may want to use a lower target. We do not want to hold over the February earnings report.

Suggested Options:
We are suggesting February puts. If you want more option volume consider using March puts.

BUY PUT FEB 50 DRS-NU open interest=980 current ask $2.75
BUY PUT FEB 45 DRS-NI open interest= 90 current ask $0.85

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/09/06 (unconfirmed)
Average Daily Volume = 275 thousand

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Expeditors Intl. - EXPD - cls: 66.87 change: +0.65 stop: 68.55

Company Description:
Expeditors is a global logistics company headquartered in Seattle, Washington. The company employs trained professionals in 164 full-service offices, 54 satellite locations and 7 international service centers located on six continents linked into a seamless worldwide network through an integrated information management system. Services include air and ocean freight forwarding, vendor consolidation, customs clearance, marine insurance, distribution and other value added international logistics services. (source: company press release or website)

Why We Like It:
January, especially the second half of the month, is not known for being very kind to the transportation stocks. Therefore it does not come as much of a surprise to see that the sector has not participated in the market's strength over the past couple of weeks. The Dow Transportation index's upward momentum has stalled and it looks poised to breakdown under its 50-dma. Meanwhile shares of EXPD have already broken down under its 50-dma. Actually EXPD has been consolidating for the past seven weeks. The stock soared last fall and now it's slowly grinding lower against support at the $66.00 level. If the market shows any weakness in the next couple of weeks it could be the catalyst for EXPD to breakdown. We want to catch a breakdown with a trigger to buy puts at $65.80. The P&F chart is bearish and points to a $61 target. We agree and will target a decline into the $61.00-60.00 range. We do not want to hold any positions over the mid February earnings report.

Suggested Options:
We are suggesting February puts.

BUY PUT FEB 70 URP-NN open interest=274 current ask $6.50
BUY PUT FEB 65 URP-NM open interest=220 current ask $1.65

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 972 thousand
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Biogen Idec - BIIB - close: 46.21 change: -0.85 stop: 44.45

BIIB continued to correct lower on Friday with an early morning dip to under the $46.00 level. Technical oscillators have turned lower but we suspect the correction may be about over in BIIB. Unfortunately, the stock's direction will probably be set by the markets on Tuesday and the market will most likely be reacting to any earnings news that morning. Readers have a choice here. There is the chance that investors will produce a sell the news reaction once earnings season truly begins next week. If you subscribe to that idea then it might be prudent to exit early in BIIB before it drifts any lower. We're going to remain optimistic for now but would only consider new bullish positions if BIIB traded back above its 10-dma near $47.00. The Point & Figure chart remains bullish and points to a $62 target. Our target for BIIB is the $49.85-50.00 range.

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

Picked on December 27 at $ 46.11
Change since picked: + 0.10
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 3.2 million

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Caterpillar - CAT - close: 62.33 change: +0.12 stop: 57.95 *new*

Heavy machinery producer and Dow-component CAT continues to show relative strength. The stock inched higher on Friday and closed near an all-time high. The breakout over significant resistance at the $60.00 level is bullish but we hesitate to suggest new positions here. A pull back to the $60.00 level, which should now act as support, or the simple 10-dma could be used as a new entry point. However, traders need to remember that CAT is due to report earnings on January 26th and we do not want to hold over the report. We are going to raise our stop loss to $57.95. Our target is the $64.75-65.00 range. The Point & Figure chart points to a $72 target.

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

Picked on January 08 at $ 60.45
Change since picked: + 1.88
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 4.0 million

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Goldman Sachs - GS - close: 133.26 chg: +1.01 stop: 127.45

We are happy to report that GS displayed some relative strength on Friday. The XBD broker-dealer index closed fractionally in the red but shares of GS added 0.7% and look poised to breakout over the $134 level. Our target is the $134.80-135.00 range. We are not suggesting new positions at this time. If GS were to see some profit taking we'd watch for the $130 level to act as support. A bounce near $130 could be used as a new entry for bullish positions.

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

Picked on January 09 at $130.05
Change since picked: + 3.21
Earnings Date 03/16/06 (unconfirmed)
Average Daily Volume = 3.6 million

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Holly Corp. - HOC - close: 64.12 chg: +1.03 stop: 59.95

The oil stocks continued to rally on Friday even though the price of crude oil has apparently stalled under the $65 a barrel level. Shares of HOC rebounded nicely but remain under resistance at the $65.00 level. If shares of HOC can breakout over $65.00 it will reverse its P&F chart from a sell signal into a new buy signal. It looks like HOC could hit new highs next week, especially if the oil sector continues to be strong. Our trigger to buy calls in HOC is at $65.65. If triggered we'll target a quick rally into the $69.75-70.00 range before the company's early February earnings report. We do not want to hold over the earnings report.

Suggested Options:
We are suggesting the February calls.

BUY CALL FEB 60 HOC-BL open interest= 66 current ask $5.80
BUY CALL FEB 65 HOC-BM open interest=135 current ask $2.85
BUY CALL FEB 70 HOC-BN open interest= 14 current ask $1.10

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/06/06 (unconfirmed)
Average Daily Volume = 303 thousand

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Lehman Brothers - LEH - close: 135.65 chg: -0.18 stop: 129.45*new*

LEH may have dipped 18 cents on Friday but we see the lack of more serious profit taking as relative strength. LEH was rebounding higher in the last couple of hours of trading on Friday. Yet this probably isn't a spot to consider new longs. The markets are at a pivotal spot and could go either way. If you're looking for new positions wait for a potential dip into the $130.00-132 region. More conservative traders may actually want to consider taking some money off the table right here. The P&F chart points to a $177 target. We are going to maintain our target in the $138.50-140.00 range. We are raising our stop loss to $129.45.

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

Picked on January 09 at $131.05
Change since picked: + 4.60
Earnings Date 03/14/06 (unconfirmed)
Average Daily Volume = 2.3 million

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Ipsco Inc. - IPS - close: 83.93 change: +0.11 stop: 81.95 *new*

Unfortunately, we don't have much new to report on for IPS. Rival steel maker U.S.Steel (X) received an upgrade on Friday but it failed to have any affect on shares of IPS. The overall trend in IPS is bullish but its momentum has stalled. The technicals are offering a mixed picture. Meanwhile the P&F chart, which tends to eliminate some of the noise, is still bullish but looks overbought. We are not suggesting new positions at this time. We might change our mind and consider buying calls if IPS trades over $85.25 again. However, we suspect that if the markets see any sort of sell the news reaction on Monday that IPS will turn lower. Therefore we're going to raise our stop loss to $81.95. If IPS rallies our target is the $89.00-90.00 range. We do not want to hold over its February earnings report.

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

Picked on December 30 at $ 83.55
Change since picked: + 0.38
Earnings Date 02/13/06 (unconfirmed)
Average Daily Volume = 396 thousand

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Lennar Corp. - LEN - close: 63.99 chg: -1.24 stop: 61.90 *new*

The Thursday retreat in the homebuilders continued into Friday and shares of LEN fell below the $65.00 level. It looks like the selling stalled near its rising 10-dma and LEN was just beginning to rally late Friday afternoon. We suspect that the weakness was just some profit taking after the sector's earlier strength in the week. LEN had some resistance in the $63.00-64.00 region and it should now act as support. Meanwhile the bonds have been rising (yields falling) and that should help drive mortgage rates lower, which in turn is good for the homebuilders. Watch for a bounce back above the $65.00 level before considering new call positions in LEN. We are raising our stop loss to $61.90. The P&F chart is very positive with a bullish triangle breakout and a $75 target. Our target now is the $69.50-70.00 range before February options expire.

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

Picked on January 09 at $ 64.01
Change since picked: - 0.02
Earnings Date 03/16/06 (unconfirmed)
Average Daily Volume = 2.6 million
 

Put Updates

Scotts Miracle grow - SMG - cls: 46.26 che: -0.29 stop: 47.05

The weakness on Friday in shares of SMG has awakened new hope that shares may indeed turn lower. The stock has spent the last two weeks consolidating under resistance at the $47.00 level with a bullish trend of higher lows. That trend was broken on Friday with a drop under its 50-dma. Aggressive traders may want to consider new put positions here. We would prefer to open new put positions on a decline under the $46.00 level. Please remember that we do not want to hold over SMG's January 24th (unconfirmed) earnings report, which would give new positions less than five trading days to perform. Our target is the $41.50-41.25 range.

Suggested Options:
We are suggesting the February puts but only if SMG trades under $46. Remember, that we plan to exit ahead of its earnings report.

BUY PUT FEB 50 SMG-NJ open interest= 49 current ask $4.20
BUY PUT FEB 45 SMG-NI open interest=1051 current ask $1.15

Picked on January 01 at $ 45.24
Change since picked: + 1.02
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 354 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: 25.43 chg: +0.21 stop: n/a

Our strangle play in AEOS is pretty much dead. There are four trading days left before January options expire. For this strangle play to have a chance at exiting at breakeven or better then AEOS needs to trade above $29.50 or under $20.00. We are 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 have changed our target to breakeven at $2.35.

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

Picked on November 13 at $ 25.47
Change since picked: - 0.04
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 3.6 million

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Abercrombie&Fitch - ANF - close: 63.76 chg: -2.37 stop: n/a

Murphy's law is alive and well. When ANF was above the $65 level we had a chance that shares might spike higher and give us an opportunity to exit at breakeven ($5.15). Friday's action may have just doomed the strangle play. ANF was downgraded Friday morning and the stock gapped lower to open at $65.00 and close with a 3.58% loss. We have four trading days before January options expire. The options in our strangle are the January $65 calls (ANF-AM) and the January $55 puts (ANF-MK). Our target has been adjusted to breakeven at $5.15.

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

Picked on November 13 at $ 59.67
Change since picked: + 4.09
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 2.7 million

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Blue Coat Sys. - BCSI - cls: 41.80 chg: -0.42 stop: n/a

Short-term technicals look bearish but we're running out of time before January options expire. BCSI needs to trade under $39 or well over $50 if we are going to have a chance at exiting near breakeven. Last week we adjusted our target to breakeven at $3.25. We are not suggesting new plays. Our current play involves the January $50 call and the January $40 put.

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

Picked on December 04 at $ 45.43
Change since picked: - 3.63
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 416 thousand

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Building Materials - BMHC - cls: 77.90 chg: +0.22 stop: n/a

The oversold bounce in BMHC ran right up to its trendline of resistance and stopped. Now the stock is starting to fade lower again. 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.

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

Picked on December 18 at $ 80.95
Change since picked: - 3.15
Earnings Date 02/07/06 (unconfirmed)
Average Daily Volume = 527 thousand

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Chicago Merc. Exchg. - CME - cls: 382.24 chg: +2.09 stop: n/a

Time is almost up for our strangle in CME. At the moment if we have any hope of exiting near breakeven we need to see CME trade under $340 or above $410 and do it pretty quickly. Odds of that happening don't seem very high at the moment. We are not suggesting new plays. Our current play involves the January $400 calls (CMJ-AK) and the January $350 puts (CMJ-MA).

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

Picked on November 20 at $375.90
Change since picked: + 6.34
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 879 thousand

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Encana Corp. - ECA - close: 45.61 chg: +0.21 stop: n/a

Shares of oil and natural gas producer ECA continue to consolidate sideways on either side of the $45.00 level. We don't believe this consolidation will last much longer. The energy sector has a lot of catalysts pushing it higher but on the off chance that the industry reverses course we're suggesting a strangle play in ECA. We're suggesting opening strangle positions in the $44.00-46.00 range. We would prefer to open new positions in the $45.25-44.75 region. We are using the April $50 calls and the April $40 puts. Our estimated cost is $3.45. At current prices that means we're betting that ECA will be trading under $36.50 or over $53.50 by April option expiration.

Suggested Options:
We are suggesting the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH) for our strangle play. A strangle requires that you buy both an out of the money call and an out of the money put. Our estimated cost was $3.45.

Picked on January 10 at $ 45.56
Change since picked: + 0.05
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

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Four Seasons - FS - close: 54.81 chg: -0.37 stop: n/a

January option expiration is just four trading days away and we see no reason that FS will move much from its current $54-55 trading range. Unfortunately, that means our strangle play will close with a loss. The options in our strangle were the January $60 calls (FS-AL) and the January $50 puts (FS-MJ). We have adjusted our target to breakeven at $2.60.

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

Picked on November 08 at $ 55.37
Change since picked: - 0.56
Earnings Date 02/26/06 (unconfirmed)
Average Daily Volume = 319 thousand

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Questar Corp. - STR - close: 81.12 chg: +0.35 stop: n/a

Oddly enough the natural gas sector continues to creep higher despite a very sharp three-week sell-off in natural gas futures. We are running out of time for our STR strangle. We have adjusted our target to breakeven at $5.10. Our strangle involves the January $80 calls (STR-AP) and the January $70 puts (STR-MN).

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

Picked on November 20 at $ 76.25
Change since picked: + 4.87
Earnings Date 02/09/06 (unconfirmed)
Average Daily Volume = 716 thousand

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Texas Ind. - TXI - close: 52.98 chg: +0.17 stop: n/a

TXI is still stuck in its trading range and that's bad news for our strangle play. The options in our strangle are the January $55 calls (TXI-AK) and the January $45 puts (TXI-MI). Our target has been reduced to breakeven at $2.70. A move into the $57-58 range might be enough to get our strangle there.

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

Picked on November 27 at $ 49.57
Change since picked: + 3.41
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand
 

Dropped Calls

Gilead Sciences - GILD - close: 59.40 chg: +0.96 stop: 54.51

Target achieved. GILD continued to rally on Friday and hit our target in the $59.00-60.00 range. It looks like GILD has changed its earnings date to January 30th.

Picked on December 22 at $ 54.51
Change since picked: + 4.89
Earnings Date 01/30/06 (confirmed)
Average Daily Volume = 4.3 million
 

Dropped Puts

Progressive Corp - PGR - cls: 116.67 chg: +1.22 stop: 119.15

It is arguable if we have been stopped out or not. The high for the day says $120.37. Yet if you look at any of the intraday charts you won't find PGR trading above $118.15 on Friday. Thus, the high-for-the-day reading appears to be a bad tick right near the opening bell on Friday morning. If it had been a real rally higher we would have been stopped out at $119.15. We're choosing to close the play anyway because PGR is due to report earnings on January 18th before the market open and we don't want to hold over the report.

Picked on December 30 at $117.45
Change since picked: - 0.78
Earnings Date 01/18/06 (confirmed)
Average Daily Volume = 836 thousand
 

Dropped Strangles

Lear Corp - LEA - close: 24.24 chg: -0.34 stop: n/a

We are choosing an early exit in the LEA strangle play. The stock continued to sink on Friday but shares now look oversold enough to produce an oversold bounce. The options in our strangle were the January $35 calls and the January $25 puts (LEA-ME). On Friday the LEA-ME puts hit a high of $1.55 and are currently trading at $1.20bid/$1.30ask. Our estimated cost was $1.60. We'd rather exit now and minimize our loss than bet on a continued decline in LEA next week. More aggressive traders may want to reconsider and keep the play open just remember that it won't take much of a bounce to make the option premium disappear.

Picked on November 06 at $ 30.24
Change since picked: - 6.00
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million
 


Trader's Corner

It's All About Commitment

Floyd Upperman wouldn't trade without studying the Commitment of Traders reports, and he doesn't think you should, either. The author of COMMITMENT OF TRADERS: STRATEGIES FOR TRACKING THE MARKET AND TRADING PROFITABLY outlines his trading methods in articles on his website and the November issue of STOCKS & COMMODITIES as well as in his book.

The Commodity and Futures Trading Commission (CFTC) publishes the Commitment of Traders (COT) reports. The reports break down open interest held by commercial, non-commercial and non-reportable participants in certain markets. The CFTC defines open interest as "the total of all futures and/or option contracts entered into and not yet offset by a transaction, by delivery, by exercise, etc." The markets covered are those in which twenty or more traders hold positions at or above levels that the CFCT sets. Markets included in the reports comprise such diverse issues as wheat, frozen concentrate orange juice, U.S. treasury bonds, VIX futures, the U.S. dollar index, and, of course, the major U.S. indices.

The CFTC makes the reports available at the www.cftc.gov website. Although beginning with a monthly report in 1962, the CFTC gradually increased the frequency of the releases over the years. Since 2000, the CFTC has published the report weekly, releasing it on Friday at 3:30, with the information compiled as of the Tuesday preceding the release. Since 1995, the information has been provided free, in both short and long forms. An example of a short form can be seen in the wheat contract on the Minneapolis Grain Exchange as of January 3, 2006.

COT Report for Wheat Futures as of January 3, 2006:

Because Upperman came from a farming background and understood grains, he made his first commodity trade in the wheat market. He remembered conversations in which wealthy farmers had talked about their use of futures to hedge their risks. He knew that those wealthy farmers wanted to lock in profits and do it at the point in the growing season when there's the most doubt about the outcome of the crop. With a first successful trade behind him, he began employing his area of expertise--analyzing data for high-tech companies--to find patterns that would help him pinpoint successful trades. He did find patterns but didn't always understand what was behind the patterns. It was when he found the COT reports that all those areas of expertise began to jell into his trading method.

Upperman believes that the "commercial" positions in wheat listed on the COT report illustrated above could be broken into two parts: the commercial producers and the commercial consumers. In the wheat market, the producers would be the large farmers. Upperman asserts that these producers nearly always take short positions because that's the only way they can lock in their profits. They want to be able to sell their wheat at a certain price. Commercial consumers are those buying the crops, and they almost always take long positions, so that they can lock in delivery at a certain price. These commercial traders, both producers and consumers, are the ones in the know, the ones most likely to have advance knowledge of supply and demand in the crops.

Most times in the past, their long and short positions were balanced, but when there's an imbalance, it's the non-commercials taking the other side of the trade. Those non-commercials consist of funds and large traders when you're talking about wheat. Non-reportables might consist of small commercials, small funds, small traders and speculators, not big enough to be considered either large commercials or non-commercials.

An imbalance among the commercials demonstrates something about anticipated supply/demand imbalances. A large net short position shows that commercial producers believe that supply will outstrip demand, for example, because producers have been more worried about locking in their prices by going short than consumers have been about locking in the prices they'll pay by going long.

However, Upperman cautions that the mistake that most traders make is in following the commercials. The commercials scale in and out of their positions early, he claims, with the process sometimes taking a year to unfold. Besides, they rarely liquidate their positions. Upperman discovered that the non-commercials, in contrast, almost never take delivery of the product, and so will almost always liquidate their positions, looking to book profits. The funds have a higher correlation coefficient with the trends in prices, he claims, because they're the ones who will be liquidating their long and short positions. The commercials are in the market for different reasons, to hedge the prices they'll receive for their product in the case of the commercial producers and hedge their need in the case of the consumers. They serve as the balance between cash and futures rather than as market movers, Upperman claims.

Because the commodity index funds are growing, they might be changing the dynamics, Upperman states, thereby making the COT reports even more powerful tools than they were in the past. Upperman suggests that rather than following the commercials scaling into the markets, traders should be following or anticipating what the large funds are doing, since they're the ones who will be liquidating positions.

However, he recounts tales of rare instances when commercials have taken extreme positions. This does alert market watchers to an imbalance and warns them that non-commercials might be forced to make a move. The raw COT data isn't going to give traders enough information to determine when that occurs, he cautions. Such extreme positions will be different for each market, requiring the study of historical data.

Upperman uses statistical skills and proprietary studies to graph historical data from the commercials on a bell curve. He's looking for those instances when commercial positions are in the tails of the distribution curve, the times when they're at an extreme. This occurs 0.03 percent of the time. Major tops or bottoms may be being made when commercial positions move into the tails, but at the point they move into the tails, traders don't know how the imbalance will work out.

What is clear is that the large traders, taking positions opposite that of the commercials, must also have imbalanced positions. For example, if commercials have a large net short position, producers have surmised that supply may overwhelm demand, as noted earlier. While this is occurring, non-commercials are likely to be in large net long positions, opposite that of commercials. According to an article available on his website, Upperman looks for instances when the commercials reverse from those extreme positions as buy or sell signals. Such a signal was given April 7, 2000 in the Nasdaq when commercials moved positions from the tail on one side of the bell curve to the opposite tail.

Commodities are always cyclical, Upperman claims, unlike equities that are not always so. There's always at some point a reversion to the historical mean price. Upperman thinks that supply constraints may be changing that picture for crude, with a mean that might be increasing.

It's easy to understand Upperman's breakdown of producers and consumers among the commercials in commodity markets, although not always so easy to follow the rest of his arguments without a complete study of his book. Identifying commercial producers (taking short positions to lock in the prices they'll receive) and consumers (taking long positions to hedge the prices they'll) doesn't prove as intuitive when studying the stock indices. Upperman claims that the endowments, pension funds and biggest unions serve as the commercial producers and consumers when talking about the equity indices such as the SPX.

In neither of his articles, however, does he reveal the levels he considers extreme for the COT data for the SPX or other equity indices. As of January 3, commercials were net short the SPX, 77.2 percent of open interest being short and 69.1 percent being long. Without the knowledge of historical trends or access to Upperman's bell curve, it's difficult to know where such a position falls along that curve, although the position was net short more than it had been in recent weeks.

Traders who want to find out for themselves whether that position was extreme might check out Upperman's book, with Upperman reportedly discussing his methods of graphing the COT data in that book. Another possibility is to read Larry Williams' new book on the COT data. Williams has reportedly developed a method of determining proxy COT data for individual stocks. Industrious and talented statisticians also always have access to free historical data through the CFTC, where they can gather information needed to create their own studies.
 

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.

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