Option Investor

Daily Newsletter, Monday, 02/06/2006

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Sideways Slide

The indices continued last week's sideways slide, failing on each small attempt to break upward out of Friday's sideways range and eventually breaking to nominal new lows. Volume breadth was mixed, slightly bullish on the NYSE and slightly bearish on the Nasdaq. It was a quiet, uneventful session, and it seemed like the heavy-hitters were playing hooky for the post-Super bowl session.

Prudential's Ed Keon was on the wire today, reducing his recommended equity weighting to 55% from 100%, raising bonds to 35% and adding 10% to cash. In support of his defensive shift, he cited lower productivity, wage gains and high energy prices, as well as negative fund flows, geopolitical risk due to weekend developments with Iran (see below). He said that he is overweight energy, utilities and telecom, underweight consumer discretionary, industrials and financials.

BAC's Thomas McManus estimated that investors withdrew $12 billion from money markets and invested $16 billion in foreign-stock funds, $2.2 billion in U.S.-equity portfolios and $4 billion in bond funds during the month of January. In his research note, McManus wrote that "One feature of this year's money flow derby appears similar to that seen in prior years: investors typically chase the best fund themes and categories of the year just ended."

The indices finished spitting distance from where they closed on Friday, the Dow and SPX eking out small gains.

Daily Dow Chart

The Dow closed higher by 4 points at 10797, bouncing off an afternoon low of 10771 nominally below Friday's low. The Dow has yet to test rising support off the October low, and the daily cycle downphase in progress has yet to do any real damage. Fibonacci support at 10735 is a key level that yet to be touched, above which the decline off 11000 can be seen to be corrective. Below that level, trendline support comes at 10650.

Daily S&P 500 Chart

The SPX gained .96 to close at 1264.99, holding at the low end of Friday's range below rising trendline support. The lower high came at 1267, the higher low at 1261. As with the Dow, the daily cycle downphase has so far failed to do any real damage, except that the October trendline support has failed. Below 1257-60, next confluence support is at 1245.

Daily Nasdaq Chart

Unlike the SPX, the Nasdaq did not print an inside day, instead hitting a lower low of 2249.75. For the day, the Nasdaq lost 3.78 to close at 2258.80. October trendline support has failed, but the previous low at 2240 was not tested by today's low.

If the broken October trendline is bear wedge support, then the implied target could be as low as 2025 Fibonacci support back at the October low. First sign of trouble for bears will be a break back above that trendline at 2270-75.

On the liquidity-front, the Fed was generous today, the open market desk announcing a $7 billion overnight repurchase agreement to replace Friday's maturing $1.75 billion, adding $5.25 billion net for the day. However, that net add was more than offset by the Treasury's new borrowing.

At 11AM, the Treasury announced the size of tomorrow's 4-week bill auction at $14 billion. There are $8 billion in 4-week bills maturing, and so this auction will raise $6 billion of new cash. Last week, today's 13- and 26-week bill auction sizes were announced- in total, $37 billion of the bills were auctioned this afternoon, refunding $34.458 billion and raising new cash of $2.542 billion.

That auction saw indirect bidders (foreign central banks) purchase $7.57 billion of the $37 billion total, a 20.4% participation rate. The high-rate on the 13-week bills was 4.375% yielding 4.485%, the bid to cover ratio a respectable 2.57. On the 26-week bills, the high-rate was 4.5%, yielding 4.669% at a bid to cover ratio of 2.24.

Tomorrow, the Treasury will auction the 4-week bills as well as 3-year notes, then ten year notes on Wednesday. But the big news will be Thursday's $14 billion 30-year bond auction.

Daily TNX Chart

Ten year treasuries opened weakly but recovered early in the session, spending several hours drifting sideways near unchanged before pulling back at the cash close. Ten year note yields finished higher by 1.2 bps at 4.545% despite the 4.541% print. The spring off the 4.3% daily cycle low is testing confluence to 4.56%, above which the November highs come into view.

The UN's 35-nation International Atomic Energy Agency (IAEA) voted to report Iran to the UN Security Counsel on Saturday, citing its concern that Iran's nuclear program might not be "exclusively for peaceful purposes." Russia and China voted in favor of the referral, but on the condition that no action be taken by the Security Council before March. The only member nations to vote against the resolution were Cuba, Syria and Venezuela, and 5 other nations, Algeria, Belarus, Indonesia, Libya and South Africa, abstained. The resolution noted Iran's violation of the nuclear nonproliferation treaty and the inability to determine that Iran is not producing or attempting to produce nuclear weapons.

State television in Iran reported immediately that Iranian President Mahmoud Ahmadinejad addressed a letter to Vice President Gholamreza Aghazadeh following the adoption of the resolution, ordering the resumption of uranium enrichment and the end of snap inspections of its facilities.

Crude oil gapped higher overnight but spent the day drifting lower, dropping back to Friday's range in the final minutes of the day session to close lower by .275 at 65.10. The session high in the morning was 66.675.


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In corporate news, Toshiba Corp. announced that it has agreed to purchase a controlling stake of more than 51% in Westinghouse for $5.4 billion, outbidding GE and Japan's Mitsubishi. Westinghouse supplies nuclear power plant technology, the US arm of British Nuclear Fuels. The agreement is notable because expectations were for a deal around $1.8 billion. Some analysts believe nuclear power to be the most important alternative to fossil fuels in a future defined by scarcity of those fuels.

Canadian steelmaker Ipsco (IPS) reported Q4 earnings that fell from $199.1 million or $3.91 per share to $170.2 million or $3.52 per share in the current quarter. Sales rose from $801.1 million to $852.2 million. The results blew out estimates, however, with analysts looking for EPS of $2.84 on sales of $780 million. Shipments rose 12% to 953 tonnes, a new record, but on margins that shrunk from 35.5% to 30.3%. The company cited higher input costs of allows, energy and consumables over the past year. IPS gained 2.32% to close at 94.

Toymaker Hasbro (HAS) reported Q4 earnings that rose from $81.9 million or 44 cents on revenue of $1.06 billion in the year-ago quarter to 48 cents or $94.3 million on revenue of $1.07 billion. Excluding repatriation of capital charges, HAS earned 61 cents, beating expectations by 3 cents but missing on revenue by $40 million. The company cited strength in its Star Wars segment and weakness in its games segment. HAS closed lower by .29% at 20.69.

After the bell, Activision reported Q3 profits that declined 30% from a profit of 35 cents or $97.3 million to 23 cents or $67.9 million, missing by 13 cents. Revenue declined rose from $816.2 million from $680.1 million in the year ago quarter. Estimates were for $707 million. ATVI gained 1.99% to close at 14.36.

There were no economic reports released today, but there was economic news. The President delivered requested from Congress a $2.77 trillion budget for fiscal 2007, seeking increases for defense and the permanent extension of his first-term tax cuts alongside cuts to domestic programs from community policing to Medicare. The White House anticipates an increase in the federal deficit to a record $423 billion, or 3.2% of GDP, up from -$318 billion or 2.6% of GDP last year. The administration expects the deficit to narrow to 1.4% of GDP or $208 billion by fiscal 2009.

Later in the day, Defense Secretary Rumsfeld stated in a webcast that the Pentagon's budget request of $439 billion is historically low relative to GDP, at 3.7%-3.8% of GDP. The $439 billion remains the largest discretionary component in the proposed 2007 budget.

Chairman Ben S. Bernanke was sworn in today to replace departing Fed Chairman Greenspan this morning. Bernanke thanked the President as well as former chairmen Paul Volker and Alan Greenspan who attended the ceremony. In his brief remarks, Bernanke quoted FDR as follows:

"In his remarks in this building in 1937, President Roosevelt described as our purpose 'to gain for all of our people the greatest attainable measure of economic well-being, the largest degree of economic security and stability.'"

Bernanke's term of office will be 4 years, subject to renewal. President Bush added that he enjoys Bernanke's "sly sense of humor" and opined that "he will be a superb chairman."

This will be a very quiet week for economic data. Tomorrow's lone report is Consumer Credit in the afternoon. On Wednesday, we'll get the weekly Mortgage Bankers data and the EIA Petroleum report. On Thursday, it's the weekly Initial Claims, and Wholesale Inventories, and on Friday, the Trade Balance and the Treasury Budget.

For tomorrow, the question will be whether the current decline is going to reverse or grow teeth. So far, the light volume and sideways drifts have combined to feel like a reversal waiting to happen, right up until the next quick drop or gap down. With the Treasury continuing to borrow aggressively, diminishing liquidity available to market, the downside in stocks and bonds is not surprising- but the hesitant, slow, light volume with which it's been occurring continue to feel unconvincing. We'll be following all of it live in the Futures and Market Monitors- see you there tomorrow!

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Aetna - AET - close: 97.60 change: -0.72 stop: 93.99

Attention! There was no follow through today on Friday's bullish surge higher. This could just be normal profit taking but more conservative traders may want to seriously consider exiting right now! We only have two days left before the company reports earnings and we don't want to hold over the report. Our plan is to exit on Wednesday, February 8th at the closing bell. Our target remains the $99.00 level.

Picked on January 30 at $ 94.05
Change since picked: + 3.55
Earnings Date 02/09/06 (confirmed)
Average Daily Volume = 1.7 million


Cummins Inc. - CMI - close: 102.01 change: +1.91 stop: 96.95

CMI continues to rally and the stock has broken out to new highs. This looks like a new momentum entry point for calls but the action in the major indices makes us nervous about opening new bullish positions. Our target is the $107.00-108.00 range. We will leave our stop loss under Friday's low.

Picked on February 2 at $101.01
Change since picked: + 1.00
Earnings Date 01/30/06 (confirmed)
Average Daily Volume = 742 thousand


Express Scripts - ESRX - close: 89.76 chg: -2.14 stop: 87.45

Uh-oh! This looks like danger. There was no follow through on Friday's rebound in ESRX. The stock gapped lower this morning and has closed under what should have been round-number support at the $90.00 level. Short-term technical oscillators are bearish. More conservative investors may need to seriously consider exiting early right here. There is still some technical support at the 50-dma currently near $87.65 so we're going to leave the play open but we're not suggesting new positions.

Picked on January 29 at $ 92.42
Change since picked: - 2.66
Earnings Date 02/22/06 (unconfirmed)
Average Daily Volume = 2.1 million


Universal Health - UHS - close: 49.70 chg: +1.03 stop: 48.49

We are still just spectators here with UHS. The stock dipped to the $48 level this morning and quickly bounced. UHS now looks poised to breakout over resistance at the $50.00 level. Our trigger to buy calls is at $50.51. If triggered then we'll target a rally into the $54.50-55.00 range. The P&F chart is bullish with a $61 target. We do not want to hold over the late February earnings report.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/27/06 (confirmed)
Average Daily Volume = 613 thousand

Put Updates

Ambac Fincl. - ABK - close: 75.85 change: -0.24 stop: 78.05

ABK continues to look bearish. We do not see any change from our weekend play description. There is some short-term technical support at its exponential 200-dma and simple 100-dma near the $74 level. We do expect a bounce there. Our target is $71.00. Our time frame is four to six weeks, probably sooner.

Picked on February 05 at $ 76.09
Change since picked: - 0.24
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 463 thousand


Intl Bus. Mach. - IBM - close: 79.51 change: -0.46 stop: 82.05

The play is now open. IBM continues to sink on Monday and hit a new three-month low at $78.93. Our trigger to buy puts was at $79.49. Volume came in more than 50% above the daily average, which could be interpreted as bearish. Our target is the $75.25-75.00 range.

Picked on February 06 at $ 79.49
Change since picked: + 0.02
Earnings Date 01/17/06 (confirmed)
Average Daily Volume = 6.0 million


Johnson Controls - JCI - cls: 67.99 chg: +0.08 stop: 72.01

We do not see any change from our weekend update on JCI. The stock looks ready to fall towards our target in the $65.50-65.00 range, above its exponential 200-dma. Currently the Point & Figure chart looks pretty bearish with a $57 target.

Picked on January 25 at $ 69.90
Change since picked: - 1.91
Earnings Date 01/20/06 (confirmed)
Average Daily Volume = 955 thousand


MGIG Invest. - MTG - close: 62.99 change: -1.24 stop: 66.05

Our put play in MTG is now open. The stock continued to sink on Monday and broke down below support near $64.00 and its simple 200-dma. Volume came in above average on the decline. Our trigger to buy puts on MTG was at $63.70. Our target is the $58.00-57.50 range.

Picked on February 06 at $ 63.70
Change since picked: - 0.71
Earnings Date 01/12/06 (confirmed)
Average Daily Volume = 833 thousand


Meritage Homes - MTH - close: 60.40 chg: -0.11 stop: 62.05

The homebuilding sector was weak today but shares of MTH tried hard to resist the pull lower. Today's action looks like a failed rally but we are not convinced the bounce is over and would not open new bearish positions right here. Watch for another decline under $59 or even $58 before opening new positions. Our target is the $52.00-50.00 range.

Picked on February 02 at $ 58.76
Change since picked: + 1.64
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 560 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: 78.60 chg: +0.33 stop: n/a

Wall Street expects BMHC to report earnings of $2.33 a share. The report is due out tomorrow morning. We're expecting to see shares launch into a new direction on the news. We are not suggesting new strangle positions at this time. The options in our strangle play are the March $90 calls (BGU-CR) and the March $70 puts (BGU-ON). Our estimated cost is $8.20. Our target is $12.50 by March expiration.

Picked on December 18 at $ 80.95
Change since picked: - 2.35
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand


Encana Corp. - ECA - close: 47.65 chg: +0.87 stop: n/a

Oil stocks were bouncing higher today as tensions continue to build over Iran. We're not suggesting new positions in ECA right now. 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.

Picked on January 10 at $ 45.56
Change since picked: + 2.09
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million


Google Inc. - GOOG - close: 385.10 chg: +3.54 stop: n/a

As always there is plenty of news surrounding GOOG. We won't report on all of it but it is noteworthy that the stock only bounced to a minor gain after being upgraded from a "sell" to a "hold" this morning. Yet another analyst firm reiterated their belief that GOOG will be added to the S&P 500. We want to remind readers that this is a very aggressive play and we have less than two weeks left before February options expire. If you're concerned about an oversold bounce, which is a very real threat to us right now, then consider exiting early to minimize any losses.

Picked on January 29 at $433.49
Change since picked: -48.40
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 11.1 million


Ryland Group - RYL - close: 69.63 change: -1.37 stop: n/a

RYL is still trading under its 200-dma. We're not suggesting new positions. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN). Our estimated cost is $7.00. Our target is $12.00.

Picked on January 22 at $ 75.19
Change since picked: - 5.56
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million

Dropped Calls

Apple - AAPL - close: 67.30 change: -4.55 stop: 69.99

News reports are blaming the 6.3% decline in AAPL on Monday was caused by fears of a slow down in the company's sales growth. At least two analyst firms tried to defend the stock but they failed to have any affect on the share price, which closed near its lows for the session. We would have been stopped out at $69.99 when shares broke support at the $70.00 mark.

Picked on January 30 at $ 75.00
Change since picked: - 7.70
Earnings Date 01/18/06 (confirmed)
Average Daily Volume = 27.1 million

Dropped Puts

Phelps Dodge - PD - close: 165.19 chg: +6.70 stop: 167.15

Watch out! PD has reversed course again. The stock's strength was probably fueled by another new high for copper prices today and a bullish upgrade for fellow metal producer Alcoa (AA). We want to remind readers that this was labeled an aggressive, higher-risk play. We remain more fundamentally bullish on PD but our short-term strategy was to try and time a pull back toward stronger support since PD looks overbought and extended. There has been no confirmation of last Thursday's bearish reversal pattern. If you did buy puts it might be a good idea to bail out. Shares of PD were pretty strong throughout the entire session today. We have to choose - do we exit here at $165 or do we wait and see if we get stopped out at $167.15. We are going to choose to exit early.

Picked on February 02 at $158.10
Change since picked: + 7.09
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 2.6 million


XM Sat.Radio - XMSR - close: 23.55 chg: -0.79 stop: 27.01

Amazing! We keep thinking that XMSR has sunk low enough to produce an oversold bounce and it keeps sinking lower. Today's decline was fueled by an analyst firm lowering their price target to $37 for the stock. Volume continues to be very strong on the decline. Our target was the $21.00 level but we're choosing to exit early. Our reason is XMSR's earnings report. We do not know when the company will report. The most convincing data suggests that XMSR is expected to report earnings this week but we can't find any confirmation. Another source suggests XMSR will report next week. We'd hate to have the company report and then see shares rocket higher so we're choosing to exit early. More aggressive traders may want to keep the play open but we would not hold over the report once the date becomes known.

Picked on January 30 at $ 26.43
Change since picked: - 2.88
Earnings Date 02/09/06 (unconfirmed)
Average Daily Volume = 5.0 million

Dropped Strangles



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