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Daily Newsletter, Saturday, 02/11/2006

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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

Much Ado About Nothing

Volatility everywhere, buy programs, sell programs, competing economic analysis, nerve gas and fading earnings gave investors another case of indigestion. The markets reacted to these sound bites as though as though hearing them second hand and not sure of their importance. Competing buy/sell programs provided the majority of the week's activity and with the exception of the Dow the indexes close very close to flat for the week. Blue chips were up, techs flat and Russell hit a new two week low. The NYSE composite swapped sides with resistance and support twice on either side. Volatility, although lethargic, was the name of the game with the S&P finishing only +3 points from where it started the week.

Dow Chart - 180 min

Nasdaq Chart - 60 min

SPX Chart - 60 min


The economic calendar was light for the week but several reports provided some of the volatility responsible for the market swings. On Friday the U.S. Trade numbers were released showing the deficit rose to -$65.7 billion in December making 2005 the largest trade deficit in history of -$725 billion. This was significantly higher than the $617 billion deficit in 2004. The high price of oil imports continued to push the numbers higher but imports from China also padded the totals with a -$201 billion rate. This compares to -$162 billion in 2004. Energy imports rose to $108 billion. The trade numbers helped push the indexes lower at the open but traders finally realized it was old news. We have been running a -$65 billion or more monthly deficit for the last four months and simple math could have predicted the annual number within a couple billion. The market drop was simply volatility as traders looked for an excuse to trade.

A stronger move came from the Treasury Budget released at 2:PM. This report showed a budget surplus in January of $21 billion but that was not the key. The portion that provided some market lift was the details showing rising individual income and rising taxes despite the lower tax rates. This was seen as a positive for the economy along with a jump in corporate tax payments of a whopping +27% through January. Revenues from personal income taxes were up +11% for the first four months of the 2006 fiscal year. The fiscal year for budget accounting runs from Oct through September. Friday's numbers represented the first four months of the 2006 fiscal year. The Treasury Budget was released at 2:PM and a strong buy program kicked off several minutes later adding +2000 issues to the A/D line over the next hour. While the market gains were attributed to the budget release I believe it was simply end of week short covering sparked by the buy program rather than some misplaced euphoria over a dull report on budget accounting.

A continued drop in energy prices has not provided a bounce in equities and has actually removed some support with implosions in numerous energy stocks. Sunoco was the poster child for the end of momentum in energy stocks. SUN has fallen from $96.50 on Feb 1st to close at $72.50 on Friday. This -24 points, -25% drop is purely a result of sector rotation out of the energy group. Those momentum leaders over the last few months have switched directions and are now the leaders on the loser board. I have been predicting this pre-March dip in oil for weeks but the magnitude of the selling in some individual issues has been very surprising. Valero (VLO) is another example of traders bailing with their profits with a drop from $64 on Jan-31st to $50 on Friday. That $50 level represents a strong buy level for me and I did act on it.

Sunoco Chart - Daily

Crude Oil Chart - 90 min

Oil fell to close at $62 and -$7 off its Feb highs and Natural Gas fell to a new 52-week low at $7.33. Oil at Friday's $61.20 lows was under the 200-day average at $61.69 and only the third time this year that oil has touched that 200-day level. Despite this intraday break I still believe oil is going lower. $58-$60 is strong support and I believe this correction will eventually see those levels. We are close enough to that expected bottom I did see some bargain hunting in some energy stocks just before the close.

The northeast is facing their first real winter storm of the season this weekend but there is no shortage of gas or heating oil. The mild winter has allowed natural gas supplies to grow to near record levels and +36% over the five-year average for this time of year. Heating oil supplies are also well stocked and refiners are already shifting to gasoline for the summer season. The storm should not cause any material jump in energy prices unless the cold is so bad and lengthy that the water around Manhattan freezes over and commuters walk across the ice to work. In short, it is not going to happen this year!

Oil service companies and drillers were not completely immune to the selling but stocks like HAL, SLB, DO and RIG finished positive for the day. They are not tied dollar to dollar to oil prices with service and drilling contracts now going for record prices with commitments for several years into the future. The Oil Service Index (OSX.x) has only declined just over -9% in February compared to monster drops in a few individual stocks.

Energy commodities were not the only futures taken behind the woodshed for a beating. Gold has fallen -$26 for the week to close at $549.50 on Friday. There are many reasons being given for the drop including the suggestion that a recession is less likely today than last week. I think whoever floated that excuse is delusional but they are welcome to their opinion. Personally I think the Iran factor has cooled and oil prices have fallen. That takes the fear factor out of gold as a safe haven and cuts down on the petrodollars available for investment into gold as an oil hedge. The Middle East producers export about 30 mbpd. At an average drop of $7 a bbl that is a loss in revenue of $210 million per day or $1.47 billion per week. That excess cash buys a lot of gold even if only a minor portion is allocated to that hedge. Like the dip in oil prices the dip in gold should only be temporary. Iran will come back to the headlines and OPEC will prevent oil prices from falling much further.

Another commodity on the ropes is copper. Friday's -5% intraday drop was the largest single day drop in copper futures in several years. The drop was blamed on downgrades to the copper stocks rather than a drop in demand unless of course you listen to Prudential. Phelps Dodge was downgraded by Prudential on Friday but it was already in free fall before that late hit. Prudential should get a 15-yard penalty for that personal foul. Prudential cut its investment rating on the copper industry in general to "Neutral" from "Favorable" on what they called "weaker-than-expected demand" in the U.S., South Korea, Taiwan and Japan. PD closed at $142 and well off the high for the week at $166. (-$24) With Market Vane still showing a 90% bullish rating for copper it was only natural that copper stocks were hammered by the current commodity correction. Pigs get fat, hogs get slaughtered being the current theme.

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Prudential's downgrade was not unanimous in the analyst community. On Thursday, Goldman Sachs analyst J. Alberto Arias said he sees more evidence of an extended copper cycle ahead -- not less. On Thursday he wrote, "Over the past two weeks, three major copper producers have cut their 2006 production guidance by 145,000 tonnes, which supports our view of a market deficit this year." The analyst forecast a "bull-case scenario" for copper prices at $2.12 per pound, with the price floor at $1.60. He noted that Phelps Dodge Corp. and Freeport McMoRan Copper & Gold Inc., in particular, are poised to benefit from copper prices anywhere in that range. Freeport McMoran (FCX) was hammered for a -$10 loss after the government of Indonesia said they wanted to raise their cut in the current profit sharing arrangement with FCX.

I should comment here about stock ownership. What commodities have been the momentum favorites over the last year? Oil, gold and copper. I listed the two biggest losers above, SUN and PD both losing -$24 each since February began. My point? These are two of the highest institutionally owned stocks in the market. PD is 95% institutionally owned and SUN is 79% owned by institutions. SUN traded more than three times its average volume on Friday and PD more than twice its average. Profits are being taken by funds and sell stops are being hit daily. It does not mean there is a bear market forming in commodities, just that profits are being taken in prior momentum leaders. The question for us today is where are they putting that money?

It appears much of it is going into international funds, overseas Ishares and Holders. TrimTabs reported that $3.9 billion came into the market last week but U.S. funds only received $1.3 billion of that total. I think we can assume that money received from selling those momentum stocks above may be allocated in the same ratios for current investments. With a battle brewing in the U.S. between the Fed rate hikes and a possible recession U.S. equities may not be seen as a safe haven based on current money flows. For money going into U.S. stocks it appears the favorite sectors are healthcare, defense, a few biotechs, oil drillers and oil service stocks and selected transports. Railroads, BNI, CNI, UNP, CSX are seeing inflows as well as a couple airlines AMR, CAL and UPS. You would think with oil imploding it would have greased the transports for a strong gain. However, transports have already run their race as we saw in Q4 and are fighting for traction today. Financials have stopped falling but have yet to rally. I believe the uncertainty about the Fed is holding them back.

Hopefully the Humphrey Hawkins testimony next week by Ben Bernanke will give us some insight into the Fed's future. This will be his first report to lawmakers on Tuesday and Wednesday and they are likely to take it easy on him since they don't have a lot of Bernanke history to pick apart. This will be his opportunity to layout his plan and tell them how he expects to run the Fed. He no longer has to answer to Greenspan and helicopter Ben is in charge of his own fate. With rate expectations currently at 5% and growing and GDP expectations for 2006 at 3% and shrinking there are some dangers ahead. The markets should pause ahead of Tuesday's testimony until some of those questions are answered.

Google took it on the chin this week that ended with a -$60 drop from its $432 pre-earnings close. Google seems to have found support in the $360 range but Barron's is going to do a hatchet job on them this weekend. The Barron's premise is that Google is overvalued even at the current level. Since GOOG is the REAL poster child for a momentum stock there may still be some sellers lurking just overhead. There is a gap still waiting to be filled at $303 but that is a long way from $360. Expect volatility in GOOG on Monday.

Google Chart - Daily

Pfizer (PFE) punished investors who capitalized on the strong early week rebound to near $27 by warning about future profits. 57 million shares traded on Friday knocking the stock back to $25.50 intraday. Pfizer said patent expirations would hurt earnings and revenue growth would be flat. Pfizer said the company was moving from the old Pfizer to a new Pfizer with old patents expiring but a new wave of new medicines approaching. Zacks Investment Research took exception to the news claiming the $4 billion cut in expenses last year was supposed to improve results in 2006 and beyond but those improvements seem to have disappeared. With the recent rebound to resistance at $26.50 investors should be cautioned about future gains until more guidance is made available.

Quality Systems (QSII) found out it is not nice to miss earnings targets with a drop from $92 to $70 after missing estimates by a dime. Piper Jaffray upgraded QSII after correctly sifting through the earnings and realizing that $4 million in net income had to be deferred to the next quarter cutting their recognizable income nearly in half to only $4.6 million. The nearly -50% cut in net income was responsible for the dime miss and had they been able to recognize the income as planned they would have beaten street estimates. The company did not say why the income was deferred but they did say the NextGen licenses were sold and paid in full during the quarter. On the surface it looks like a buying opportunity but we still need clarification as to why the income was deferred.

The market was bipolar for the week with a downdraft on Tuesday, rally on Wednesday, failed rally on Thursday and an end of day buy program on Friday. It is hard to determine a market direction when the last three market moves in alternating directions were a direct result of large buy/sell programs. Market direction simply depends on which program executed last. The Dow was the strongest index for the week and tested resistance at 10950 twice with no success. This level has resisted all but one breakout since November 23rd. We did see one spike out of the range the second week of January all the way to 11045 but the Dow could not hold its gains and it slipped beneath the 10950 level once again. This remains the level to be watched as February progresses.

The Nasdaq is slowly building a bearish formation with 2240 as support and a series of lower highs dating back to January 12th. The programs last week produced a spike to 2285 but it was short lived with a Friday close at 2262. The negative setup on the Nasdaq is nearly identical to the setup on the SPX. Lower lows and lower highs since mid-January. The SPX performed almost perfectly for those following the SPX as our long/short indicator. On Tuesday with the SPX at 1255 I told everyone that the market was oversold and a trading bounce was likely. I suggested shorting weakness on any oversold bounce given the negative fundamentals. The SPX rallied out of the 1253 intraday low on Wednesday to 1274.50 on Thursday morning before weakness appeared. You should note that is appeared right at 1275 where we expected resistance to appear. Once the roll over began our 1270 short indicator was crossed almost immediately giving everyone a perfect setup for an exit from their Wednesday long and right back into a short at 1270. The SPX crashed right back to 1254 at Friday's open before the afternoon buy program returned it right back to 1270 once again. You could not script this better for traders. If you followed my suggestions you should have made a couple very good trades.

NYSE Composite Chart - 60 min

Next week the same rules apply. We need to remain short under SPX 1270 and cautiously long over 1275. That recommendation has not changed in several weeks. Until this trading range changes there is no need to do anything different. I know it sounds simplistic but it takes the emotion out of the decision and we trade in the direction of the trend. Next week the economic calendar has some more meat in it with the PPI, Industrial Production and a couple of Fed surveys. The semi book-to-bill comes out Thursday night and it will be interesting to see if bookings can go positive for the first time since Sept-2004. The last reading was .96 meaning only $96 dollars in orders were received for every $100 shipped. The SOX needs some good news to provide support for the Nasdaq. It has been holding above 530 but is starting to look heavy.

If I had to take one trade next week it would be Valero. The monster drop on Friday took it back to strong support at $50 and there is a much greater chance of a rebound than a continued drop. But, oil prices could continue to decline with strong support at $58 and -$4 below Friday's close. Whatever you decide to trade next week just don't get married to your position. The markets are not giving us any directional help and volatility is the only factor we can count on. Until a trend appears I would be continue to be cautious especially on longs over 1275.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
CI None None
LEH    

New Calls

Cigna - CI - close: 123.63 change: +1.08 stop: 117.85

Company Description:
CIGNA HealthCare, headquartered in Bloomfield, CT, provides medical benefits plans, dental coverage, behavioral health coverage, pharmacy benefits and products and services that integrate and analyze information to support consumerism and health advocacy. (source: company press release or website)

Why We Like It:
The markets can't seem to decide on a direction. The DJIA is arguably stuck in a trading range and the S&P 500 isn't much help either. Thus we're left to find stocks trading on their own relative strength. CI is one such stock. Shares had been trading in their own trading range for the last six months. That changed January 27th after Morgan Stanley upgraded CI to an "over weight". The broker upgrade launched CI higher and the stock eventually broke out over resistance at the $120 level. The rally began to fade until CI's recent earnings report on February 8th. The company beat estimates by 33 cents but guided lower for the current quarter. Normally if a company issues a warning the stock price is punished. Not so with CI. There was a gap down but traders bought the dip and now CI is hitting new five-year highs. The stock was upgraded again on February 9th by Prudential. The recent strength has also produced a new Point & Figure chart buy signal that now points to a $154 target. We are going to suggest bullish positions with CI above the $120 mark. Our six-week target will be the $129.50-130.00 range.

Suggested Options:
We are suggesting the April calls but March calls should also work fine.

BUY CALL APR 120 CI-DD open interest=446 current ask $8.00
BUY CALL APR 125 CI-DE open interest=685 current ask $5.00
BUY CALL APR 130 CI-DF open interest=291 current ask $2.80

Picked on February 12 at $123.63
Change since picked: + 0.00
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 979 thousand

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Lehman Brothers - LEH - cls: 137.50 chg: -0.71 stop: 134.49

Company Description:
Lehman Brothers, an innovator in global finance, serves the financial needs of corporations, governments and municipalities, institutional clients, and high net worth individuals worldwide. Founded in 1850, Lehman Brothers maintains leadership positions in equity and fixed income sales, trading and research, investment banking, private investment management, asset management and private equity. The Firm is headquartered in New York, with regional headquarters in London and Tokyo, and operates in a network of offices around the world. (source: company press release or website)

Why We Like It:
This is a bit of a speculative play. LEH, like most of the broker-dealer sector, has been in a long-term up trend for months. This relative strength should help out the bulls since the major indices are range bound. The broker stocks hit some profit taking on Thursday afternoon and Friday morning but bulls were quick to buy the dip when shares hit short-term support. We are suggesting that traders buy the bounce from Friday. More conservative traders may want to wait for a move over $138.50 as confirmation or even wait for a new move over $140.00. It is very common for the broker-dealer stocks to rally higher in the three-to-four weeks ahead of their earnings report. LEH is due to report in mid March so if shares are going to have pre-earnings run up now is the time for us to be looking for an entry point. We'll put our stop loss under Friday's low at $134.49. Our target is the $144.95-145.00 range. More aggressive traders could aim higher maybe $149.

Suggested Options:
We are suggesting the March calls. We plan to exit ahead of LEH's March earnings report.

BUY CALL MAR 135 LES-CG open interest=361 current ask $5.90
BUY CALL MAR 140 LES-CH open interest=914 current ask $3.10
BUY CALL MAR 145 LES-CI open interest=394 current ask $1.35

Picked on February 12 at $137.50
Change since picked: + 0.00
Earnings Date 03/14/06 (unconfirmed)
Average Daily Volume = 2.0 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Express Scripts - ESRX - close: 91.91 chg: -0.22 stop: 88.24*new*

ESRX is still hovering near all-time highs but it just can't seem to power its way through resistance in the $93.00 area. If the short-term technical oscillators are any clue then ESRX stands a good chance of breaking out next week. Our biggest concern here would be a substantial pull back in the major indices, which would probably drag ESRX back toward technical support at the 50-dma (near 88.40). We would consider new call positions here near $92 but more conservative traders might be better off waiting for a breakout over $93 before initiating positions. We are going to raise our stop loss toward the 50-dma and set the new stop at $88.24. Our target is the $99.50-100.00 range. We do not want to hold over the late February earnings report so that only gives us about a week and a half but so far the 22nd earnings date is unconfirmed.

Suggested Options:
We are suggesting the March calls since we plan to exit in late February. The March $100 calls are definitely more risky here. Some of the spreads between bid and ask on these March calls seem a bit wide. More nimble traders might be able to get a better price.

BUY CALL MAR 90 XTQ-CR open interest=1184 current ask $6.40
BUY CALL MAR 95 XTQ-CS open interest= 836 current ask $3.80
BUY CALL MAR100 XTQ-CT open interest= 474 current ask $1.95

Picked on January 29 at $ 92.42
Change since picked: - 0.51
Earnings Date 02/22/06 (unconfirmed)
Average Daily Volume = 2.1 million

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Universal Health - UHS - close: 49.54 chg: -0.13 stop: 48.49

Shares of UHS traded lower on Friday morning but investors bought the dip and the stock rebounded back above its simple 10-dma and exponential 200-dma. So far we remain on the sidelines. Our strategy is to try and capture a breakout over resistance near $50.00. We are using a trigger at $50.51 to open the play. If UHS trades at or above $50.51 then the play is open and we're targeting a run into the $54.50-55.00 range. This zone coincides with resistance from its August 2005 peak and P&F chart resistance near $56. Currently the P&F chart is bullish and points to a $61.00 target. We do not want to hold over the February 27th earnings report so we only have about two weeks for the play to be triggered and then for shares to run higher.

Suggested Options:
We are suggesting the March calls since we plan to exit in late February.

BUY CALL MAR 45 UHS-CI open interest= 57 current ask $5.00
BUY CALL MAR 50 UHS-CJ open interest=185 current ask $1.35

Picked on February x 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: 75.57 change: +0.64 stop: 78.05

Traders need to be a little cautious here with ABK. The stock bounced from its lows on Friday but failed to breakout over the $76.00 level and its short-term trend of lower highs (resistance). Pushing the insurance sector higher was a positive earnings report from AOC. AOC beat estimates by 11-cents and the stock responded with a 9.2% gain to hit new three-year highs. Looking back to ABK the overall pattern on its weekly chart remains bearish but short-term oscillators hooked higher due to Friday's rebound. Plus, we're fighting against a bullish P&F chart. More conservative traders may want to consider an early exit if ABK trades above 76.50. We have been warning readers to watch for potential support and a bounce at its 100-dma (now at 74.57) and the exponential 200-dma (now at $74.15). Our target is $71.00. Our time frame is four to five weeks, probably sooner.

Suggested Options:
Enter new positions carefully. We would not open new put positions if ABK trades over $76.00.

BUY PUT MAR 80 ABK-OP open interest= 43 current ask $4.80
BUY PUT MAR 75 ABK-OO open interest=407 current ask $1.70

Picked on February 05 at $ 76.09
Change since picked: - 0.52
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 463 thousand

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Administaff - ASF - close: 38.49 change: -0.63 stop: 41.75*new*

So far so good. ASF has continued to show relative weakness and hit a low of $37.55 intraday on Friday. Volume on Friday's 1.6% decline came in above average, which is positive for the bears. The P&F chart is looking bearish too with a sell signal that points to a $35.00 target. Our target is the simple 200-dma but since the moving average is rising (currently at 34.11) we are using an exit target in the $35.25-34.50 range. The intraday bounce on Friday may not be over. We'd expect another move to the $40.00 level on Monday before shares roll over again. There is stronger resistance near $41.00, which is now bolstered by its simple 10-dma. We are lowering our stop loss to $41.75. Don't forget that we need to exit on Wednesday afternoon, February 15th, to avoid holding over the Thursday morning earnings report.

Suggested Options:
We only have three days left so we're not suggesting new positions.

Picked on February 08 at $ 39.90
Change since picked: - 1.41
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 367 thousand

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Cameco Corp. - CCJ - close: 70.02 change: -0.97 stop: 73.76

Hmm... Prudential downgraded mining and copper stocks on Friday. Equities like FCX and PD were hit hard by the downgrade. Yet CCJ, which is better known for its uranium mining, is stubbornly holding on to the $70.00 level. The intraday chart on Friday for CCJ shows the sideways trading coiling into a narrow point. That sort of pattern usually precedes a breakout. Let's hope the breakout is downward. The simple 10-dma, now at 72.37, should be short-term overhead resistance. We would not open new put positions until CCJ trades under Friday's low (68.75). More conservative traders might do well to wait for CCJ to trade under the simple 50-dma (67.25) before initiating positions. Our target is the $61.50-60.00 range. The P&F chart is bearish and points to a $57 target. CCJ is set to split 2-for-1 on February 23rd.

Suggested Options:
We are not suggesting new put positions in CCJ at the moment. See play details for potential entry points.

Picked on February 07 at $ 68.57
Change since picked: + 1.45
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 1.1 million

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Intl Bus. Mach. - IBM - close: 81.33 change: +0.93 stop: 82.05

This was a tough decision. Friday's bounce in IBM back above the simple 200-dma and the $81.00 level looks like a clear signal to bail out of any bearish put positions. We are going to suggest that more conservative traders consider exiting early right here. However, we're going to keep the play open. IBM is still trading under resistance (see chart). We are not suggesting new plays at this time. Our target is the $75.25-75.00 range.

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

Picked on February 06 at $ 79.49
Change since picked: + 1.84
Earnings Date 01/17/06 (confirmed)
Average Daily Volume = 6.0 million

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Ipsco Inc. - IPS - close: 87.25 chg: +0.80 stop: 90.01

Friday proved to be a volatile day for IPS. The stock traded in a wide $4.00 range. Our trigger to buy puts was at $85.90 so the play is now open. However, we would be a little cautious here. It looks like IPS bounced from its 50-dma near Friday's low. The overall pattern still looks like IPS has reversed course after the February 6 & 7th failed rally. Watch for the current bounce to fail at $89 or at $90 and then consider new bearish positions if IPS rolls over again. Our target is the $80.25-80.00 range. The P&F chart displays a triple-bottom sell signal and a $77 target.

Suggested Options:
We are suggesting the March puts.

BUY PUT MAR 90 IPS-OR open interest=1643 current ask $6.50
BUY PUT MAR 85 IPS-OQ open interest= 59 current ask $3.70
BUY PUT MAR 80 IPS-OP open interest=1383 current ask $1.85

Picked on February 10 at $ 85.90
Change since picked: + 1.35
Earnings Date 02/06/06 (confirmed)
Average Daily Volume = 343 thousand

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Johnson Controls - JCI - cls: 68.01 chg: +0.76 stop: 69.05

Prepare to exit JCI. The stock's bounce over the last three days is starting to look like a short-term bottom. The move has certainly turned many of its short-term technical oscillators higher. Friday's gain was fueled by a late day rally on rising volume. It also looks like JCI has broken out through its four-week trendline of resistance. More conservative traders might just want to exit early right here. We certainly considered it. We are going to keep the play open because JCI still has technical resistance at the 10-dma (68.33) and the 100-dma (68.75). We are not suggesting new plays. Our target has been the $65.50-65.00 range.

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

Picked on January 25 at $ 69.90
Change since picked: - 1.89
Earnings Date 01/20/06 (confirmed)
Average Daily Volume = 955 thousand

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Loews - LTR - close: 95.85 change: +1.12 stop: 97.01

Now you see why we suggested using a trigger with LTR. We were concerned that Thursday's decline under support near $95 and the 100-dma looked a bit too much like a bear trap. That doesn't mean that LTR won't continue moving lower from here but short-term technical oscillators, which have been oversold, certainly look a bit more bullish today. More aggressive traders might consider a failed rally under the 50-dma (near $97.50) as a potential entry point for puts. We're going to stick to our original plan and use a trigger at $94.45 to open our play. If triggered we'll target a decline into the $90.25-90.00 range, which is still above technical support at its rising 200-dma. Please note that if LTR does not hit our trigger on Monday we're going to drop it as a candidate. We do not want to hold over the Thursday, February 16th earnings report.

Suggested Options:
We are suggesting the March puts.

BUY PUT MAR 95 LTR-OS open interest=493 current ask $2.15
BUY PUT MAR 90 LTR-OR open interest=681 current ask $0.85

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 508 thousand

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MGIG Invest. - MTG - close: 63.37 change: +0.36 stop: 66.05

MTG is still bouncing but we expect the bounce to fail near resistance at $64.00 and its simple 200-dma. This also happens to be the neckline for its bearish head-and-shoulders pattern (see chart). Wait for the failed rally to appear near $64.00 before initiating new positions. Our target is the $58.00-57.50 range. The P&F chart points to a $53 target.

Suggested Options:
We are suggesting the March puts.

BUY PUT MAR 65 MTG-OM open interest=1213 current ask $2.75
BUY PUT MAR 60 MTG-OL open interest=4065 current ask $0.90

Picked on February 06 at $ 63.70
Change since picked: - 0.33
Earnings Date 01/12/06 (confirmed)
Average Daily Volume = 833 thousand

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Meritage Homes - MTH - close: 58.56 chg: -0.82 stop: 61.11*new*

We feel like we have picked the wrong horse for the race in the housing sector. The DJUSHB home construction index has continued to sink but shares of MTH have been showing too much relative strength against its peers. We are not going to abandon the play but neither are we suggesting new put positions in MTH. Our concern is that if the homebuilders produce an oversold bounce next week then MTH will bounce with them and breakout higher. We are going to tighten our stop loss further to $61.11. Our target is the $52.00 level and this coincides with the P&F chart's target at $52. A move under $57.35 might change our mind about opening new positions.

Suggested Options:
We are not suggesting new put positions in MTH at this time.

Picked on February 02 at $ 58.76
Change since picked: + 0.62
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.)

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Building Materials - BMHC - cls: 71.24 chg: -1.53 stop: n/a

Reaction to last week's earnings announcement helped push BMHC lower and under support at the simple and exponential 200-dma's. Yet so far the stock has found support near the $70.00 level. 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 in BMHC.

Picked on December 18 at $ 80.95
Change since picked: - 9.71
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand

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Encana Corp. - ECA - close: 41.85 chg: -0.84 stop: n/a

Profit taking in the oil and gas stocks continued on Friday. Shares of ECA dipped toward the $40.00 level but traders bought the dip. The stock has broken down through multiple levels of support in the last few days. The P&F chart now points to a $31 target. However, it's worth noting that the P&F chart also shows ECA testing support and that means we can probably expect an oversold bounce from here. We are not suggesting new strangle positions but nimble, more aggressive traders might want to consider buying some short-term calls here and exiting on a bounce near $44.50-45.00. The $45 level, bolstered by the simple 200-dma looks like short-term resistance. Our strangle 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 in ECA.

Picked on January 10 at $ 45.56
Change since picked: - 3.71
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

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Ryland Group - RYL - close: 67.17 change: -0.65 stop: n/a

Shares of RYL and the housing sector have been sinking steadily for about a month now. We have no reason to expect a trend change but the group, and RYL, look oversold and due for a bounce. We're not suggesting new strangle 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.

Suggested Options:
We are not suggesting new strangle plays in RYL.

Picked on January 22 at $ 75.19
Change since picked: - 8.02
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Your Cup of Tea

Did you ever wish you could discover a new chart formation, one that proves more reliable than some of the others have over the last year? This article won't be about a new formation, but it will perhaps introduce some new ideas about an old one: the cup-and-handle formation. In a recent article on this formation in STOCKS AND COMMODITIES, technician Giorgos Siligardos discussed the pattern and brought up several points worth considering.

First, a review of the pattern might be appropriate. Although one of the charts used to illustrate Siligardos' description of this formation showed prices moving down just before a cup-and-handle formed, most consider these continuation patterns, and Siligardos' charts of actual price patterns suggest that, too. These form when prices have run up and hit resistance. If a cup and handle is going to form, prices then drop back in a rounding or cup formation and eventually rise back to the lip of the cup again. A second and smaller pullback forms the handle of the cup.

Annotated Weekly Chart of the DJUSHB:

Siligardos, at least, doesn't consider the handle a necessary part of the formation, but volume and other conditions must be watched if a handle does form. In fact, technicians have long warned that several conditions should also accompany the formation of the cup. First, there should be a trend to be continued. A cup-and-handle that forms after a long sideways action may not be as predictive of further upside as one that forms after a climb.

Both Siligardos and other sources emphasize that the cup should have a rounding bowl-shaped curve rather than a V-shape. While the DJUSHB formation was seen on a weekly chart, these can show up on daily and intraday charts as well, but the bowl's rounding shape should be appropriate to the time interval being watched.

In addition, ideally the cup will not retrace more than a third of the previous rally, some sources suggest. Some would consider a 38.2 percent Fibonacci level to be appropriate for a pullback, too, and one source notes that individual stocks or indices may differ in the way they form these cup-and-handle shapes. Some may typically retrace more than a third.

Volume considerations prove important. Volume should be high as prices move up to the left lip of the cup, drop off as prices drop back to form the bowl, and then rise again as prices move back toward the right lip of the cup.

If a handle is to form, similar volume considerations prove important. The handle's pullback should be short in duration--Siligardos sets the limit at 30 bars for the time interval he's watching--and volume should also drop off during the pullback that forms the handle, then explode as prices finally break above the lip. Most believe that the pullback should be shallow as well as occupying a short time frame, with many suggesting that the pullback should not take prices lower than one third the depth of the cup. Additionally, Siligardos believes that these formations tend to perform better if prices surge above the lip of the cup before falling back into the handle.

Something is wrong if the pullback that forms the handle is sharp, long in duration compared to the size of the cup or accompanied by strong downside volume. Be wary if that's what you see.

Confirmation comes when prices move back above the lip level after forming the handle, and when they do it on strong volume. After this confirmation, a price target can be found by adding the depth of the cup to the lip's price value. The DJUSHB example would have had an upside target of about 60 points, depending on how many candle shadows were included at the bottom of the cup and the level at which a trader judged the lip to be. If that lip were at about 697, the upside target would have been 757, a target that the index more than exceeded. Note that there was, however, a many-week consolidation just after the index had pushed through that target.

The question of how many candle shadows to include when setting the target leads into one of the salient points Siligardos makes. The choice of a candlestick or line chart might impact whether a trader perceives a cup forming at all. So does the choice of a semi-log or arithmetic chart. Siligardos suggests that semi-log charts be used, adding the comment that a cup shape on a semi-log chart will always look like a cup on an arithmetic chart, but that the opposite is not always true. A trader watching only arithmetic charts might not see the cup as it was forming.

Traders interested in these formations don't have to rely on what they see, however. Those using Metastock can incorporate Siligardos' program for recognizing these formations as they're building. You'll find the program and Siligardos' cautions about its shortcomings in the February issue of STOCKS AND COMMODITIES.
 

Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.

DISCLAIMER

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

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