Option Investor

Daily Newsletter, Saturday, 01/21/2006

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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

Factors Lining Up For Bears

The bears finally got their wish as the various market factors began lining up in their favor. The four E's of earnings, economics, energy and expiration combined with Iran concerns and enabled the bears to get the upper hand. The Dow plummeted to 10665 for a loss of -213 points, and bulls were not able to slow the descent despite several strong support levels in the markets path.

Dow Chart - Daily

Nasdaq Chart - Weekly

Nasdaq Chart - Daily

This was the proverbial perfect storm for the markets with news flying on all fronts and none of it market friendly. Normally bad news from one front is offset by good news from another. On Friday it was all negative or at least that is the way investors reacted. While some earnings concerns were making news the biggest pothole was news about Iran. According to the AP Iran was moving its foreign currency reserves out of European banks to an undisclosed location. This was seen as a preemptive move ahead of any sanctions by the UN or a unilateral move from some European nation. Iran confirmed it was moving the money and this added fuel to investor concerns. If Iran is taking this step it suggests they are not going to buckle under UN pressure to abort their nuclear program. When taken into context with Iran's warning on oil earlier in the week it sent shivers through the market.

Iran said it could send global oil prices soaring higher if any sanctions were put in place by the UN or otherwise. They appear to be staging their forces, both economic and military, to prepare for tougher times ahead. Iran has the second largest oil reserves in the Middle East and is second only to Russia in natural gas. Iran exports 2.4 mbpd and represents nearly 10% of OPEC volume. There are fears that Iran may cease exports temporarily just to show the world what kind of power they have. They could easily send prices to $100 within weeks of any drop in output.


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If you recall my commentary from last Sunday I warned that Iran was in control of the oil card and not the UN. Last week everyone was worried about what UN sanctions could to Iranian oil and I warned that this was the wrong view. I warned that Iran could use its oil as an offensive weapon and could hurt the world a lot more than the UN could hurt Iran. Several days later Iran warned that oil prices could hit $100 if they cut exports and proved my point exactly.

Iran also has a strangle hold on nearly 50% of OPEC exports through their control of the Straits of Hormuz. This choke point for shipping of oil from Saudi, Kuwait, Iraq and other Persian Gulf nations is controlled by Iran. Over the last decade they have built hardened missile sites in numerous locations all around the straits. In the picture below the entrance to the Persian Gulf is on the left and Indian Ocean on the right. All the land on the top is Iran. The straits narrow to only 50km and is easily controlled by a few well placed anti-ship missile launchers.

Straits of Hormuz

Iran is fully aware of this and has fortified the area in anticipation of future conflict. You may wonder whom they were planning on fighting when they built these defenses over the last decade but looking at the political map today and their UN defiance I think the plan is now clear. They are in the drivers seat when it comes to controlling the world's oil supply. That makes them a very tough nut to crack for military planners. The straits are so well fortified that even U.S. navy vessels take extra precautions when forced into the narrow passage. They could shut down much of the regions exports without firing a shot simply by warning that tankers making the passage could come under attack. No shipper wants their half-billion dollar tankers sunk in the strait. The revenues from each tanker represent million of dollars per year to them not to mention the potential loss of a ship. Several times in the past we have seen tankers stack up in a holding pattern in the Indian Ocean for weeks while waiting for a potential confrontation to pass. Iran would not have to shoot at them all and clearly this is not the threat. Iran would only need to sink one in the narrow channel to slow oil movement or stop it all together. They could easily do this with missiles in place and no outside military could stop them. The sites are too spread out and consist of mobile launchers as well. Heck, just firing one missile at a tanker would create a floating parking lot in the Indian Ocean that could wreak havoc in the global oil markets. Over 15 mbpd of OPEC oil passes through the strait. Oil prices would rocket higher instantly if that 15 mbpd were held up for just a day or two and even higher for a multiple week delay. This is a SERIOUS threat in the making and Iran knows they hold the trump card.

On Thursday Vice President Cheney said a significant spike in the price of oil due to conflict with Iran was preferable to a nuclear Iran capable of threatening anyone with nuclear weapons. Iran has a history of belligerence and aggressive behavior with recent comments about wiping Israel off the map. Make no mistake. There is a conflict brewing and while it could take many months to come to a head the odds of a peaceful solution are slim. Cheney's comments should be a warning that they are willing to suffer higher prices after a military solution.

While Iran concerns were storm clouds over the market the foundation was under attack from another direction. High profile earnings disappointments were coming from all directions and earnings estimates were dropping faster than the thermometer. Citigroup, GE, Intel, Yahoo, Motorola, etc, all said something investors did not like and the results were not pretty. These were not the only culprits but their high profiles made the news worse. Intel fell -15% since its Tuesday confession, Yahoo -16%, Motorola -8%, Dow component Citigroup -5% on Friday alone. GE fell drastically short of estimates on revenue and lost -4% on Friday but the damage was felt across the board. GE is seen as a proxy for the economy and while the companies forecast was inline with estimates investors were disappointed with slowing revenue.

On the Nasdaq the news was just as bad. A whopping -54 point drop came after a flurry of weak earnings and guidance. The Nasdaq rise to a new high only a week ago came on the back of Google's addition to the Nasdaq-100 index. On Friday Google lost -37 points, its largest drop ever. The Nasdaq-100 benefited from Google's gain and imploded with Google's drop. The drop in Google came after it refused to honor a subpoena from the Dept of Justice for a random sample of search requests. Google said it was not going to honor the request and would fight it on grounds of competitive interest. They claimed the release of the data would give competitors inside information on Google's business. Google has archived EVERY search ever made on its site. That represents 200 million searches per day from 380 million unique visitors. Google has over 50,000 servers to store this data and over 400,000 advertisers that buy it on a per click basis. They want to keep all information private and not allow the outside world to look inside its operations. This is going to be a losing battle for Google and they could incur some additional Dept of Justice wrath for being obstinate. The DOJ said it does not want any user information but requires the search data to develop rules regarding a new child porn law.

While the bad earnings news seemed stronger than normal those that exceeded estimates were also penalized on Friday. The hero for the week was AMD and they gave up -4% on Friday as traders took profits. The actual breakdown of earnings to date does not show any significant change in trend but given the massive drop you would have thought all earnings had changed. With only 95 S&P companies reported, 58% beat estimates, 18% reported inline and 24% missed the target. Historically 60% beat and only 20% miss. This may not seem like a major change but it was the size and stature of the companies confessing that made the news worse. These were not small caps filling a niche market. They were major blue chip companies with many billions in revenue. They were not just techs but financials and multinationals. Earnings for the S&P have come in at +13.7% for the 95 companies reported. This is down from the estimates made last quarter for +18.6% growth but the cycle is still young. However, current overall estimates have fallen to only +12.5% growth down from 14.9% only a month ago. +12.5% earnings growth is nothing to complain about but the rate of decline is disturbing. Were it not for the energy companies we could have negative growth for Q4.

Analysts are still pounding the table claiming the string of double-digit quarters will continue even if earnings fall to 12%. The bears are equally quick to point out that more than +20% earnings growth over the last two years has not been enough to break the markets out of their range. If earnings of more than +20%, sometimes over +25% was not good enough for investors then what will the expectations for single digits later this year do for the markets? Historically the markets look 6-12 months ahead and earnings estimates in that window are shrinking rapidly. Guidance for 2006 has been less than stellar and the market is reacting to that fact. By next weekend over 250 S&P companies will have reported and the numbers should be clearer. However, I believe that most early blue chip reporters have better numbers than those smaller companies that follow. Typically the bigger the market cap the earlier they report and the better the results. This suggests the percentages could decline by next weekend except for the help from energy companies.

Crude Oil Chart - Daily

Soaring energy prices are not helping that earnings picture for non-energy corporations. With the many factors impacting oil prices this week investors are afraid that energy will be a serious drag on the global economy for the next two years. There were problems other than Iran pushing oil prices higher. In Nigeria rebels are continuing their attacks on oil facilities and Shell is evacuating personnel until the situation improves. Nigeria is a large exporter of light sweet crude and a drop in those exports will push prices sharply higher. Output has fallen by -200,000 bpd over the last two weeks. In Oslo Norway, Statoil reported that six platforms had been shutdown or had production halted significantly due to leaks, fires, dangers of explosions and weather. More than 350,000 bpd in production was offline.

The U.S. Minerals Management Service (MMS) released a report showing that hurricane damage in the Gulf was much stronger than previously thought. Katrina totally destroyed 46 platforms and Rita destroyed 69. 20 others were seriously damaged by Katrina and 32 more were heavily damaged by Rita. Over 83 pipelines were damaged including 28 large diameter pipelines of 10" or larger. Only 10 of those 28 have returned to service. The MMS said 15% of gas production and 25% of oil production was still offline and could be offline until late Q2 or early Q3. Approximately 255,000 bpd and 400 mcf of gas is not expected to be restored prior to the 2006 hurricane season. A shipping accident in Port Arthur on Tuesday has blocked the channel and crude deliveries to two refineries. They have been slowing production and may be forced to shut down completely by this weekend. The government has authorized 871,000 bbls of crude to be loaned to them out of the strategic reserve until the channel is reopened. The drop in output is just one more glitch in the supply equation.

Goldman Sachs said conditions were right to push oil prices over $70 by summer. Not to be outdone CIBC World Markets said oil prices could easily hit $100 this year. CIBC did a study of current production, production coming online by 2010 and the depletion rate of current fields and said Peak Oil for conventional production actually occurred in 2004. They are counting deepwater drilling as non-conventional oil and that is not expected to peak for several more years. However, debating words and categories will get us nowhere. The key here is that CIBC World Markets has added their voice to the Peak Oil discussion and it is not one that will be taken lightly. This suggests oil prices are headed higher and Iran, Nigeria and the North Sea outages are just signposts along the way. Those factors are adding $10 to the current price of oil according to analysts. Should tensions ease we could be back at $60 very quickly. The prospect of $70 oil any day now and not as a result of some Gulf disaster is going to drag on earnings and consumer spending. Remember $3 gas last fall? The February Crude Oil contract closed at $68.15 on Friday, only a heartbeat away from $70. However, since the February futures contract expired on Friday the end of life short covering could have been a big part of the gains for the week. The new front month contract, March, closed at $68.55 after hitting $69.20 intraday.

Consumer Sentiment climbed in January by +2 points to 93.4 but this was an anemic bounce. Rising gasoline prices, higher utility bills and constant warnings about a declining housing market are combining to pressure consumers. I reported last week that refinancing was slowing appreciably as home values were falling, at least in Colorado. This is preventing homeowners from continually using home equity to pay off credit card bills and cover unexpected expenses. Tighter lending rules are keeping marginal borrowers from qualifying for loans. I am selling a $500K second home here in Colorado and the purchaser has had three mortgage companies turn him down in the past week. We have already extended the contract twice due to loan problems. This type of problem is going to accelerate if the economy begins to weaken. First time homebuyers borrowing 100% has risen to 43%. In 2005 20% of new loans were interest only, up +5% from 2004. Sub-prime borrowers rose to 28% of the market in 2005. Foreclosures are already at record highs in several areas of the country and these types of loans will push that number even higher with any economic weakness. Flippers are finding their spec homes staying on the market longer and price competition is increasing. The number of homes for sale is rising sharply. Homebuilder optimism fell in 3 of 4 regions in the report issued on Wednesday. This is just one more set of reasons why economic growth may slow as 2006 progressives.

The SOX soared to a new two-year high on the 12th at 539. After declining to 508 intraday on Intel's numbers it rallied back to 538 on Thursday's short squeeze. That Thursday rally was completely erased to close at 512 on Friday and the low of the day. The AMD news was short lived and the book-to-bill on Thursday night became the real news. The BTB came in at 0.96 late Thursday, up only +0.03 from the prior month. This means for every $100 of orders shipped only $96 of new orders was received. This is right inline with the numbers for the last six months and far weaker than you would have expected for a SOX rally that took us from 413 in October to 538 in January (+30%). It appears that great chip results were already priced in and without some great results from the smaller companies reporting next week that rally could be over.

SOX Chart - Weekly

There was no joy on Friday on any index. Dip buyers and bottom feeders were absent and volume was huge. In fact volume increased every day last week to a high for the year on Friday at 5.8 billion shares. The down volume on Friday was six times up volume with decliners 2.5:1 over advancers. These are very negative internals that would normally present a very negative outlook.

Volume table for last week

The number that stands out the most to me was the new 52-week highs on Thr/Fri. Why would so many companies be making new highs with the markets so negative? After researching it for a few minutes the answer was clear, energy companies led the list. SLB, HAL, SU, KMG, UPL, BDE, UDRL, PDC, WFT, CEO, BHI, DPM, HOC, TLM, XTO, GSF, DRQ, to name a few. I could go on but you get the picture. Remove the energy sector from the indexes and Friday's volume imbalances would have been much worse.

Much of the volume was related to option expiration for January. Some futures contracts including the current crude oil contract expired. This created a significant amount of additional volume as option traders were punished by futures moves. The earnings problems last week put bulls in a precarious position. Those with long positions on companies scheduled to report over the next couple weeks were faced with a decision after last week's disappointments. Do they continue to hold and hope for better times ahead or bail out and protect their capital. It appears they decided to bail. After the short squeeze on Thursday gave them a last minute reprieve they exited in mass on Friday. Those holding January contracts were faced with a complete reversal of fortunes in only 24 hours.

The Dow dropped -213 points and the biggest one-day percentage drop since May-2003. The Nasdaq fell -54 points and the biggest drop since Jan-2005. The next largest drop on the S&P dates back to April 2005. The magnitude of the drops was even more apparent after the strong bounce on Thursday. The Nasdaq rebounded more than +48 points from Wednesday's low to Thursday's short squeeze high but that spike over 2300 attracted sellers in volume. Friday's decline actually started at 2:PM on Thursday on the Nasdaq and there was never any doubt about direction. The drop took the Nasdaq back to under 2250 and there was no attempt to buy the closing dip.

The Dow fell from Thursday's high at 10915 to close at 10665 and a two-month low. Hard to believe the Dow was at a new 4.5 yr high just six days earlier. Friday's drop erased the gains for the entire year putting the Dow 52 points into negative territory for 2006. 10700 was the last material support level for the Dow before a potentially long drop to something in the 10400 range.

The S&P lost -23 points or nearly -2% to close at 1261. Considering it was only 7 points away from a new 4.5 yr high at 1288 on Thursday the drop was very dramatic. As our indicator of choice for market direction it has now slipped into a negative bias. The game plan for the week was to buy dips above 1270 and then short any break of that 1270 level. That plan worked well with Tuesday's drop to 1272 and +16 point rebound. With the break of 1270 it sets up a potential drop to the next support level at 1250. Should that level fail 1200 becomes the next target.

SPX chart - Weekly

SPX Chart - Daily

I am not completely convinced that market direction has changed. While our indicator at SPX 1270 remains in force I feel there were far too many external influences on Friday to assume that the true market direction has appeared. Option expiration could have provided an extreme external influence due to those earnings that set the ball in motion. Just like Thursday's short squeeze triggered buy stops for shorts the Friday drop triggered sell stops for longs. Monday morning should provide some more expiration volatility as exercised positions are cleaned up and retail traders on the sidelines try to determine market direction. Given the severity of the drop, the TRIN at 2.59 and the VIX at 14.35 and nearly a three-month high there is plenty of reason to expect a bounce. If it does occur I would watch SPX 1275 as a critical resistance level and 1270 as critical support. If a bounce does not appear then simply remain short with 1250 as the next support target followed by 1200. If it does appear I would probably wait for a move over 1275 before entering any trading longs. Use that five point zone between 1270-1275 as a neutral zone and trade accordingly on any move out of that range.

The current bull market started back in July-2002 and has stretched its gains for 42 months without a material correction of -10% or more. The average length of a bull market is 38 months making this one overdue for a pause although two years of range bound trading probably qualified. For example in the bull market that stretched from 1996-2000 there were six -10% or larger corrections. January is one of the most volatile months of the year and that distinction has been well earned. I posted some numbers several Sunday's ago outlining the market movement in recent January's past and this month has finally fallen right into that pattern after a surprisingly strong start.

To further complicate our immediate future there is a strong slate of economic reports due out next week along with more than 450 earnings reports. These will be closely followed by Greenspan's last Fed meeting on Jan-31st. Given the rising oil prices, and slowing economics like we saw in the Philly Fed last week, there are more than a few investors expecting an end to rate hikes on the 31st. They are likely to be disappointed. The market could anticipate a favorable outcome but I believe in the long run it will just be another artificial bounce. The end of Fed hikes is already priced in according to many analysts and we may not get the usual post hike cycle rally. Economics are simply too weak and there is nothing especially positive on the long-term horizon. Energy prices are going to be a crippling anchor to economic growth and oil over $70 this time will be a major weight on the market. All these factors make it even more important to trade the plan rather than trade on emotion. Focus on 1275 resistance and 1270 support if we get a bounce. Remain long over 1275 and short under 1270. Add to shorts under 1250.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays

New Calls

Wynn Resorts - WYNN - close: 58.78 change: +3.29 stop: 54.99

Company Description:
Wynn Resorts is traded on the NASDAQ stock exchange under the ticker symbol WYNN and, since December 2004, it has been part of the NASDAQ-100 Index. Wynn Las Vegas, a $2.7 billion luxury hotel and destination casino resort located on the Las Vegas Strip, opened to the public on April 28, 2005. Wynn Las Vegas features 2,716 luxurious guest rooms and suites; an 111,000 square foot casino; 22 food and beverage outlets; an on-site 18-hole golf course; approximately 223,000 square feet of meeting space; an on-site Ferrari and Maserati dealership; and approximately 76,000 square feet of retail space. (source: company press release or website)

Why We Like It:
It's nice to see some relative strength on a day like Friday. While the rest of the market was sliding lower shares of WYNN added 5.9% on above average volume. The move was sparked by Citigroup who initiated coverage on WYNN with a "buy" rating. The shorts panicked and pushed shares higher. The latest data puts short interest at 13% of WYNN's 99.5 million-share float. We believe that WYNN may have more upside ahead. A recent news article reported that gambling revenues for casinos on the Las Vegas Strip were up almost 24% in November. Since WYNN Las Vegas is the new kid on the block we suspect they're bringing in a good chunk of that revenue and might be out doing their peers. Technically we like the bounce from its rising 50-dma and the $55.00 level and the P&F chart points to a $72 target. We are willing to buy calls here above $58.00. More conservative traders may want to wait for a move over $60.00 or the November high at 61.50 before initiating positions. We're going to target a rally into the 64.75-65.00 range. We do not want to hold over the February earnings report.

Suggested Options:
We are suggesting the February calls since we plan to exit ahead of the February earnings report.

BUY CALL FEB 55 UWY-BK open interest= 391 current ask $5.20
BUY CALL FEB 60 UWY-BL open interest=1574 current ask $2.05
BUY CALL FEB 65 UWY-BM open interest= 868 current ask $0.65

Picked on January 22 at $ 58.78
Change since picked: + 0.00
Earnings Date 02/09/06 (unconfirmed)
Average Daily Volume = 1.1 million

New Puts

Biotech HOLDRs - BBH - close: 195.78 chg: -4.94 stop: 201.55

Company Description:
HOLDRS are trustissued receipts that represent your beneficial ownership of a specified group of stocks. HOLDRS allow you to benefit from the ownership of the stocks in a particular industry, sector or group. (source: company press release or website)

Why We Like It:
There seems to be a bearish divergence between the BTK biotech index, which is still trading near multi-year highs and the BBH biotech holders that peaked back in November. Now after several weeks of lower highs it looks like the BBH is breaking down for a new leg lower. The HOLDR has produced its third failed rally near $201.50 in the last three days and closed under its simple 100-dma again. Volume was way above average on Friday's sell-off. We would suggest buying puts here with the BBH under $196 although another failed rally near $200 would work too. Our target is going to be the rising 200-dma (currently at 184.90) but we'll use a target range of $187.00-185.00 to exit. The biggest risk we see to this play is Amgen (AMGN). AMGN is one of the biggest components in the BBH HOLDR and the company is due to report earnings on January 26th. One of the great things about the BBH is we're not so vulnerable to one company's ups and downs but AMGN is a leader in the group and how investors respond to their earnings will certainly have an impact on the BBH. More conservative players may want to wait until after AMGN reports before considering plays in the BBH.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 200 GBZ-NT open interest=395 current ask $6.80
BUY PUT FEB 195 GBZ-NS open interest=772 current ask $4.20
BUY PUT FEB 190 GBZ-NR open interest=472 current ask $2.45

Picked on January 20 at $195.78
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 539 thousand


Express Scripts - ESRX - close: 86.10 chg: -2.91 stop: 90.01

Company Description:
Express Scripts provides integrated PBM services, including network- pharmacy claims processing, home delivery services, benefit-design consultation, drug-utilization review, formulary management, disease management, and medical- and drug-data analysis services. The Company also distributes a full range of injectable and infusion biopharmaceutical products directly to patients or their physicians, and provides extensive cost- management and patient-care services. (source: company press release or website)

Why We Like It:
ESRX is a high-flying drug stock that turned in an amazing year for 2005. Now it looks like the upward momentum has hit a wall with resistance in the $90.00-90.75 range. The stock has failed to breakout above this level multiple times in the last two months. Short-term technicals are bearish given Friday's failed rally at the $90.00 level. If the market continues to slid we expect to see some profit taking in ESRX. We are going to suggest a trigger under technical support at the 50-dma. Our trigger will be $84.95. If triggered we'll target a decline to the rising 100-dma (currently 74.28). We will be adjusting our target to account for the rising 100-dma. At the moment we'll use an exit zone of $77.00-75.00.

Suggested Options:
We are going to suggest the February puts. As with all of our plays the list of options in our suggested options section is merely for reference. You the individual trader need to choose which one strike price fits your trading style and risk. If you're the patient type we'd wait to see if March options become available some time this week and trade those instead of Februarys.

BUY PUT FEB 90 XTQ-NR open interest=1995 current ask $5.90
BUY PUT FEB 85 XTQ-NQ open interest=6282 current ask $2.90
BUY PUT FEB 80 XTQ-NP open interest=1789 current ask $1.45

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/22/06 (confirmed)
Average Daily Volume = 2.1 million


Sears Holding - SHLD - close: 120.76 chg: -2.49 stop: 124.05

Company Description:
Sears, Roebuck and Co., a wholly owned subsidiary of Sears Holdings Corporation, is a leading broadline retailer providing merchandise and related services. Sears, Roebuck offers its wide range of home merchandise, apparel and automotive products and services through more than 2,400 Sears-branded and affiliated stores in the United States and Canada, which includes approximately 926 full-line and 1,100 specialty stores in the U.S. Sears, Roebuck also offers a variety of merchandise and services through sears.com, landsend.com, and specialty catalogs. Sears, Roebuck offers consumers leading proprietary brands including Kenmore, Craftsman, DieHard and Lands' End -- among the most trusted and preferred brands in the U.S. The company is the nation's largest provider of home services, with more than 14 million service calls made annually. (source: company press release or website)

Why We Like It:
Several days ago we were successful in trading a rebound from the bottom of SHLD's trading range toward the top of its trading range. Now we're going to try and trade it the other way. The stock peaked at the top of its range around January 11th. As of Friday is looks poised to breakdown under the $120.00 level and its 50-dma. We're going to suggest a trigger to buy puts at $119.95. If triggered we'll target an exit in the $116.00-115.00 zone near the bottom of its trading range. Considering the stock's volatility and our stop loss this isn't the best risk/reward ratio.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 125 KTQ-NE open interest=1053 current ask $6.40
BUY PUT FEB 120 KTQ-ND open interest=1397 current ask $3.80
BUY PUT FEB 115 KTQ-NC open interest=1549 current ask $1.90

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/07/06 (unconfirmed)
Average Daily Volume = 2.5 million

New Strangles

Ryland Group - RYL - close: 75.19 change: -2.06 stop: n/a

Company Description:
With headquarters in Southern California, Ryland is one of the nation's largest homebuilders and a leading mortgage-finance company. The Company currently operates in 27 markets across the country and has built more than 245,000 homes and financed more than 205,000 mortgages since its founding in 1967. (source: company press release or website)

Why We Like It:
It seems like the talk about a housing bubble has lasted a couple of years now. The only change is that in the last few months there is actually some economic data to suggest that home sales are slowing a little. 2006 is still expected to be a great year for the homebuilders based on the number of homes sold but investor expectations are changing and any missteps could bring some serious profit taking to the group. We think RYL makes an attractive strangle candidate for two reasons. First off it appears to have the necessary volatility to make our strangle play successful. The last nine months have seen RYL trading in the $57.50-82.50 range more than once. The second reason we like RYL is the company's earnings report. We don't have to wait long for it. RYL is expected to report earnings on Tuesday, January 24th. It's the earnings report and market reaction to it that will probably set the next trend. Will RYL breakout over resistance at near $82.50 or will that become a double-top pattern. Currently the stock has three-month old support (higher lows) near the $75 region. We have two days to open plays before the earnings report since RYL announces after the close on Tuesday. We're going to suggest an entry range of $75.50-74.50 to initiate strangles. At the current prices (see below) we're expecting RYL to be trading above $82 or under $68 before April option expiration.

Suggested Options:
We are suggesting the April strikes for this strangle. Traders will need to buy an out of the money call and an out of the money put. Our estimated cost is $7.00. We are aiming for a rise to $12.00.

BUY CALL APR 80 RYL-DP open interest=781 current ask $3.70
BUY PUT APR 70 RYL-PN open interest=852 current ask $3.30

Picked on January 22 at $ 75.19
Change since picked: + 0.00
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million

Play Updates

In Play Updates and Reviews

Call Updates

Caterpillar - CAT - close: 60.78 change: -1.73 stop: 59.90

Dow-component CAT was hit with some selling pressure as the DJIA fell more than 200 points on Friday thanks in large part to big declines in GE and Citigroup (C). Shares of CAT lost 2.7% and closed below their simple 10-dma. Short-term technicals are now bearish as we move into the final days of our play. The company is expected to report earnings on January 26th. We do not want to hold over the report. That means we will plan to exit on Wednesday afternoon at the closing bell. That is assuming that we are not stopped out between now and then. The market sell-off on Friday looks pretty bad and a lot of traders are expecting Monday morning to be weak but it is anyone's guess if there will be an oversold bounce or if stocks will continue to decline. More conservative traders may just want to exit here in an effort to preserve their capital. We are going to keep the play open. CAT still has what should be support at the $60.00 level and there is still optimism over the company's upcoming earnings report. We are not suggesting new plays at this time. 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 bullish plays in CAT at this time.

Picked on January 08 at $ 60.45
Change since picked: + 0.33
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 4.0 million


Fortune Brands - FO - close: 77.53 change: -1.06 stop: 76.45

We are not very optimistic on FO at the moment. We listed the play a few days ago with two separate triggers to catch the breakout from its neutral wedge-like pattern. On January 18th the stock broke out to the upside and hit our trigger to buy calls. Unfortunately, there was no follow through on Thursday and that immediately made us cautious. Now the stock is slipping lower and could easily reverse into a bearish pattern. There is still a trendline of support (see chart) that should offer FO some support near $77.00. A strong bounce from $77 could be used as a new bullish entry point but we are not suggesting new bullish plays at this time (even on a bounce). We don't have a lot of confidence here given the market's weakness and conservative traders may want to abandon the play early. More nimble traders may want to consider switching to put positions if FO trades under $76.50. This is a strategy we are considering for the newsletter. Earnings are expected in early February and we do not want to hold over the report.

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

Picked on January 18 at $ 78.65
Change since picked: - 1.12
Earnings Date 02/03/06 (unconfirmed)
Average Daily Volume = 803 thousand


Giant Ind. - GI - close: 61.60 change: +2.36 stop: 55.45

Strength in the oil stocks and in crude oil helped push GI over resistance in the $60.00-60.80 region and close at a new all-time high. Our trigger to buy calls in GI was at $60.85 so the play is now open. If you read the market wrap this weekend then you already know that oil is likely to trade higher this year. The rising tensions between Iran and the west are bad enough but these concerns are exacerbated by ongoing violence in Nigeria who is also a major exporter of oil. It is very unfortunate for the rest of the world, which will have to face higher fuel costs but this will prove to be beneficial for the oil companies. Technically GI is looking bullish with the new breakout on above average volume. The Point & Figure chart shows a quadruple top breakout buy signal with an $85 target. Our target is the $66.00-67.00 range. More aggressive traders may want to aim for the $70 level. We do not want to hold over the February 20th (unconfirmed) earnings report.

Suggested Options:
We are suggesting the March calls so we can hold our position right up to, but not over, GI's February earnings report.

BUY CALL MAR 55 GI-CK open interest= 51 current ask $9.20
BUY CALL MAR 60 GI-CL open interest=271 current ask $6.20
BUY CALL MAR 65 GI-CM open interest=220 current ask $3.90

Picked on January 20 at $ 60.85
Change since picked: + 0.75
Earnings Date 02/20/06 (unconfirmed)
Average Daily Volume = 279 thousand


Holly Corp. - HOC - close: 68.68 chg: +0.94 stop: 61.95 *new*

HOC continues to rally fueled by the strength in crude oil. The stock is quickly approaching our target in the $69.75-70.00 range. We are not suggesting new positions at this time. More aggressive traders may want to aim higher. We are not suggesting you aim for it but the P&F chart points to a $92 target. We are raising the stop loss to $61.95. We would not hold over the February earnings report.

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

Picked on January 17 at $ 65.65
Change since picked: + 3.03
Earnings Date 02/06/06 (unconfirmed)
Average Daily Volume = 303 thousand


Lehman Brothers - LEH - close: 134.79 chg: -2.70 stop: 131.05

High-flying shares of LEH were not immune from the market-wide sell-off on Friday but they held up better than expected. The stock lost 1.9% and remains above its rising 10-dma. We are not suggesting new long positions at the moment. We'll watch to see where shares of LEH bounce. If the stock breaks down under its 10-dma (133.98) then the next level of short-term support looks like the $132.00 mark. Our target is the $138.50-140.00 range.

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

Picked on January 09 at $131.05
Change since picked: + 3.74
Earnings Date 03/14/06 (unconfirmed)
Average Daily Volume = 2.3 million


Ipsco Inc. - IPS - close: 86.10 change: +1.20 stop: 81.95

We are pleasantly surprised to see IPS displaying some relative strength on Friday. The stock actually gapped open higher and crept to a 1.4% gain by the closing bell. Volume came in above average on Friday's bullish breakout from its two-week consolidation. This is great news for our current play and it looks like a new bullish entry point but considering the market's weakness on Friday we hesitate to suggest new call positions here. Our target is the $89.00-90.00 range.

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

Picked on December 30 at $ 83.55
Change since picked: + 2.55
Earnings Date 02/06/06 (confirmed)
Average Daily Volume = 396 thousand


Selective Ins. - SIGI - close: 55.44 chg: -0.32 stop: 53.79

Insurance stock SIGI weathered the storm on Friday better than expected. The stock lost just over 0.5% and rebounded from its lows near the $55.00 level. This is encouraging but there is no guarantee that SIGI will continue to hold up if the markets continue to sink. Thus we are not suggesting new bullish positions at this time. If SIGI were to trade over Thursday's high near $56.42 we might change our minds. We do not want to hold over the late January earnings report. Our target is the $59.50-60.00 range. 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:
We are not suggesting new bullish plays in SIGI at this time.

Picked on January 19 at $ 56.05
Change since picked: - 0.61
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 163 thousand

Put Updates

DRS Tech. - DRS - close: 48.48 change: -0.72 stop: 51.01

Friday was a big reversal of fortunes and our play in DRS has new life. The action in DRS on Friday looks like a failed rally under the $50.00 level and new technical resistance at its simple 200-dma. We would use it as a new bearish entry point to buy puts. More conservative traders may want to wait for a little more follow through lower before initiating new plays. The upward momentum in DRS has stalled a long time ago and the stock is finally beginning to breakdown after months of consolidating. We believe that shares can trade into the $45.00-44.00 range before its 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 $2.50
BUY PUT FEB 45 DRS-NI open interest=233 current ask $0.75

Picked on January 17 at $ 47.95
Change since picked: + 0.53
Earnings Date 02/09/06 (unconfirmed)
Average Daily Volume = 275 thousand


Omnicare - OCR - close: 54.75 change: -1.35 stop: 57.51

OCR is a new put play from the Thursday night newsletter. The stock lost 2.4% on Friday with volume coming in way above the daily average. Shares have broken down below support at the 100-dma and the $55.00 level. Our trigger to buy puts was at $54.99 so the play is now open. We do not see any change from our original play description so we're reposting it here:

The bullish pattern in OCR appears to be in trouble. The stock has peaked back in early December and now the stock's upward momentum has reversed. Today's 3% decline was fueled by very strong volume, which is bearish. Plus, shares have broken down below technical support at the 50-dma. Technical oscillators on the daily and weekly charts are bearish and its P&F chart has produced a new sell signal. Aggressive traders may want to open put positions here under $57.00. We are going to suggest a trigger at $54.99 to open the play. We're suggesting a trigger because we want to see confirmation that OCR is going to breakdown under its 100-dma (56.08). If triggered we'll target a decline into the $51.00-50.00 range before its February earnings report.

Suggested Options:
We are going to suggest the March puts so we can hold the position right up to, but not over, its earnings report. The list of options here are for reference. You the individual trader need to decide which strike fits your trading style best.

BUY PUT MAR 60 OCR-OL open interest= 615 current ask $6.30
BUY PUT MAR 55 OCR-OK open interest=1025 current ask $3.20
BUY PUT MAR 50 OCR-OJ open interest=1724 current ask $1.30

Picked on January 20 at $ 54.99
Change since picked: - 0.24
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 1.3 million


Scotts Miracle grow - SMG - cls: 45.84 che: -0.76 stop: 47.05

Time is almost up. We have one more day and plan to exit at the close on Monday to avoid holding over SMG's Tuesday morning earnings report. Analysts are estimating that SMG will report a loss of $0.82 cents a share.

Suggested Options:
We are not suggesting new positions in SMG.

Picked on January 01 at $ 45.24
Change since picked: + 0.60
Earnings Date 01/24/06 (confirmed)
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.)


Building Materials - BMHC - cls: 74.55 chg: -0.03 stop: n/a

We are very surprised by the trading in BMHC on Friday. The stock closed almost unchanged with shares hugging the simple 200-dma. The current pattern is bearish with its multi-month trend of lower highs but Friday's show of relative strength was unexpected. 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 strangle plays at this time.

Picked on December 18 at $ 80.95
Change since picked: - 6.50
Earnings Date 02/07/06 (unconfirmed)
Average Daily Volume = 527 thousand


Encana Corp. - ECA - close: 47.60 chg: -0.30 stop: n/a

ECA tried to rally past its 100-dma on Friday but the momentum failed. We're not suggesting new positions. Our strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45. We are aiming for a rise to $5.95.

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

Picked on January 10 at $ 45.56
Change since picked: + 1.74
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

Dropped Calls

Biogen Idec - BIIB - close: 44.93 change: -1.12 stop: 44.45

Biotech stocks sold off along with the rest of the market. What makes the 1.4% decline in the BTK index look so troubling is that the daily chart now appears to have a short-term double-top pattern. BIIB closed for a 2.4% loss but traded under support at the $45.00 level and its 50-dma on an intraday basis. We were stopped out at $44.45.

Picked on December 27 at $ 46.11
Change since picked: - 1.18
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 3.2 million


Gannett Co - GCI - close: 62.25 change: -1.29 stop: 61.99

It was a very weak Friday morning for GCI. The stock gapped lower to open at $63.10 and then quickly fell below support at the 50-dma and the $62.00 level. We were stopped out at $61.99. Volume was above average on the decline and technical indicators have turned bearish.

Picked on January 15 at $ 64.28
Change since picked: - 2.03
Earnings Date 01/27/06 (confirmed)
Average Daily Volume = 1.4 million


Hydril - HYDL - close: 76.44 change: -0.74 stop: 69.99

Target achieved. Shares of HYDL spiked higher on Friday morning and traded to $79.32. Our target was the $79.00-80.00 range. The stock was not able to maintain its gains even though the oil services sector was the best performing group on Friday. This looks like a failed rally and if you did not exit with us we suggest you trade cautiously. We'll be watching for a dip back to the 10-dma as a potential entry point for new bullish positions.

Picked on January 18 at $ 73.94
Change since picked: + 2.50
Earnings Date 01/31/06 (unconfirmed)
Average Daily Volume = 259 thousand


Lennar Corp. - LEN - close: 61.75 chg: -0.87 stop: 61.90

We have been defensive on LEN for a few days now and Friday's market meltdown was too much for the stock and the sector. The DJUSHB home construction index lost 1.7%, the HGX housing index lost 1.6% and shares of LEN fell 1.3%. We have been stopped out at $61.90.

Picked on January 09 at $ 64.01
Change since picked: - 2.26
Earnings Date 03/16/06 (unconfirmed)
Average Daily Volume = 2.6 million

Dropped Puts


Dropped Strangles

Amer. Eagle Out. - AEOS - cls: 24.30 chg: -0.57 stop: n/a

Our strangle play in AEOS has expired with January's option expiration.

Picked on November 13 at $ 25.47
Change since picked: - 1.17
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 3.6 million


Abercrombie&Fitch - ANF - close: 61.08 chg: -0.62 stop: n/a

Our strangle play in ANF has expired with January's option expiration.

Picked on November 13 at $ 59.67
Change since picked: + 1.41
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 2.7 million


Blue Coat Sys. - BCSI - cls: 41.12 chg: -0.35 stop: n/a

Friday's market sell-off was a last ditch opportunity for BCSI to breakdown under the $40.00 level before options expiration but it didn't happen. The stock failed to follow through on the current trend of lower highs. Our strangle play is closed.

Picked on December 04 at $ 45.43
Change since picked: - 4.31
Earnings Date 02/23/06 (unconfirmed)
Average Daily Volume = 416 thousand


Chicago Merc. Exchg. - CME - cls: 376.64 chg: -5.34 stop: n/a

Our strangle play in CME has expired with January's option expiration.

Picked on November 20 at $375.90
Change since picked: + 0.74
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 879 thousand


Four Seasons - FS - close: 53.74 chg: -1.00 stop: n/a

Our strangle play in FS has expired with January's option expiration.

Picked on November 08 at $ 55.37
Change since picked: - 1.63
Earnings Date 02/26/06 (unconfirmed)
Average Daily Volume = 319 thousand


Texas Ind. - TXI - close: 50.02 chg: -1.35 stop: n/a

Our strangle play in TXI has expired with January's option expiration.

Picked on November 27 at $ 49.57
Change since picked: + 0.45
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand

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.


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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