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Daily Newsletter, Saturday, 02/18/2006

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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

Inflation Race

Friday's PPI report showed core inflation rising at a surprising rate just when the market had discounted only two additional Fed rate hikes. The market gains this week surrounding the Bernanke testimony were on the hopes that the Fed was nearly done. Two more hikes had been discounted into the market and traders applauded Bernanke's strong outlook on the economy. Everything was right with the world until storm clouds began to appear on Friday. Now it appears the Fed may be heading into a sprint to the finish to head off further inflation. Two hikes remaining, try four say some analysts.

Dow Chart - Daily

Nasdaq Chart - Daily

The headline number on the PPI was only +0.2% and well below the +0.6% we saw last month. However that was quickly ignored due to the strong jump in the core inflation rate by +0.4%. This was the strongest jump in core inflation in more than 13 months. The rise in core intermediate goods was three times the rate of finished goods. The sharp jump was reportedly caused by a rise in auto prices with the expiration of the December incentives. Auto prices reversed a three-month decline and increased at the sharpest rate in 19 months. Overall finished goods prices are +5.7% higher than in January 2005 and finished energy goods have risen by +25% over that same period. Crude producer goods have risen +23.6% in the same period driven of course by the rise in oil prices. The sharp jump in producer prices suggests rising inflation may continue in the months ahead. With the nation at almost full employment we are likely to see some wage pressures ahead and wage inflation is a critical economic warning sign for the Fed. There is little doubt that we will be at a 5.0% Fed rate or higher in May and now there are some analysts suggesting we could see 5.5% by October. The inflation monster appears to be gaining strength despite 14 consecutive rate hikes. While the market appears to have already discounted a 5% rate we are likely to see some apprehension build against additional hikes.

Consumer Sentiment fell nearly -4 points to 87.4 in February from 91.2 in January. The reason for the decline was a drop in the expectations component of -4.5 points and a drop in the present conditions component of -2.6 points. Rising gasoline prices and the weakness in the stock market were listed as consumer concerns as well as the return of cold weather in early February. Increases in home heating bills received over the next four weeks could continue to pressure sentiment through March.

This was a week for startling economic news. For instance New Residential Construction for January jumped +14.5% to an annualized rate of 2.276 million units. December was revised higher by +55,000 units and November was revised up by +15,000 units. Housing permits spiked +6.8% thanks to the warmer January weather. This was the highest level of housing starts since March 1973. Did the housing bubble suddenly reverse into a new rally? Not hardly. January's numbers simply relate to the warmer weather and a drop in mortgage rates early in January. Those rates have already moved higher and colder weather in February will likely push the housing numbers back into the normal range. Still, the spike did energize the equity market somewhat as investors breathed easier. However, homebuilder stocks quickly lost any early gains and remained under pressure as the week ended.

Another report that was mostly overlooked was the Semi book-to-bill for January. That number rose only +0.01 to 0.97 compared to the previously published December number at 0.96. However the December number was revised down to only 0.93 making this +0.04 point spike noteworthy in the eyes of the SEMI association. Personally I believe these numbers are routinely "managed" by SEMI in order to put forth a positive front. For example September 2005 was originally reported as 1.02 and August as 1.05. This was heralded as a breakout of the sector from a two-year slump. The numbers were revised down over the next couple months to 0.90 and 0.97 respectively without any fanfare or comment despite the drop to 0.90 and a substantial difference from the two months of "breakout" performance. Last weeks 0.97 for January will likely be revised down in March long after investment decisions have been made. As it stands it represents the 16th consecutive month of below parity performance where fewer orders were received than shipped. This is the longest period of weakness in the last decade. Meanwhile the SOX is at the highest level we have seen since Jan-2004. For investors I believe it is like betting the next flip of a coin will produce tails after 24 consecutive flips that produced heads. They have been told for so long that semis are improving but the proof of that improvement has failed to appear. Conventional wisdom suggests the streak of sub par performance has to end soon and investors will be rewarded by stellar gains. Let's hope that actually comes to pass.

While we are waiting for the SOX news to appear the news for Intel continues to get worse. Soft guidance from Dell sent Intel spiraling lower to close just above $20. Helping that plunge was a downgrade from RBC Capital Markets. Analyst Apjit Walia said there is no bottom in sight for Intel as it loses market share to AMD. RBC said there was a noticeable buildup of inventory in the channel and Intel's Q1 performance and 2006 as a whole could be significantly lower than current expectations. RBC said the weakness in Intel products could spill over into other areas of the chip sector. RBC cut their price target for Intel to $21 and said the stock is likely to fall noticeably below that target in the near term. Jefferies and Co. analyst John Lau said that recent price cuts by Intel were more dramatic than previously expected but the market could stall before they take effect. Those sharp price cuts along with slowing sales could force Intel to miss estimates for Q1. Ironically Intel announced in January it was discontinuing its mid-quarter business updates. That will prevent investors from making decisions between earnings reports. Let your conscience be your guide!

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Dell fell -1.58 on Friday after posting guidance that many thought was soft with sales growth in Q1 targeted between +6-9%. Some say Dell's strong Q4 profits were due to an extra week of sales in Q4 compared to Q4-2004. PC sales are growing slowly for Dell as competition heats up. Many analysts slashed forecasts for Dell for 2006 despite the fact that new products are selling briskly. Dell receives most of its revenue from PC sales and Hewlett Packard is taking market share. After two quarters of missing estimates Dell is thought to be back on track but there are some tough quarters ahead. With many notebooks now selling for less than $500 Dell's profit margins are being squeezed and there is no help on the horizon. I have mentioned many times over the last few years that Dell was going to fall out of favor with investors as PC prices continued to fall. It is easy to cut prices to hold off competitors but it is almost impossible to raise them again. As Dell cuts prices it is forced to sell even more units just to break even much less show revenue growth. If you sell 10 million PCs a quarter as they do, a -$100 drop in price on a $1000 computer means they have to sell +10% more units in the next quarter just to break even on revenue. That becomes +20% more in Q2, +30% in Q4, etc. It is a moving target and impossible to hit forever. Dell may be gaining share overseas but the overall model will eventually fail. Sooner or later they will be unable to sell enough additional computers to remain a growth company. Revenue will flat line as will their profits. This is not a bad thing for Dell to make nearly $1 billion per quarter but their stock price will suffer. They are currently at a PE of 22 compared to a trailing five-year average of 31. Once growth stops that PE could decline to 15. Coincidentally HPQ is currently trading at a PE of 37 and right inline with their five year average.

Hewlett Packard reported earnings on Thursday that showed a +30% increase in net income and gave guidance that was higher than analysts expected. HPQ reported falling costs and rising sales and that news sent HPQ stock to $34 and a new five-year high. The company reported all but two divisions produced better than expected results for the quarter. With improved performance and a strong outlook it appears HPQ is the growth story for 2006 and at Dell's expense.

Not all earnings surprises were positive. Radio Shack was hit with a -62% drop in earnings and announced plans to close 400-700 stores and two distribution centers. RSH fell -8% to $19 but the stock already had a negative bias going into the report. The CEO, David Edmondson, was ridiculed last week after he admitted he lied on his resume. He claimed he had a theology degree and a psychology degree from Pacific Coast Baptist College. Last week the school said Edmondson only completed two semesters of study and they never offered psychology degrees. Edmondson is awaiting trial on his third drunk driving charge and his future does not look bright given the new revelations. As for Radio Shack it appears Best Buy, Circuit City and CompUSA are stealing share at a rapid rate and the Radio Shack customers of old are finding other places to shop.

XM Satellite and Sirius reported earnings last week and both fell out of orbit. XMSR has 5.9 million subscribers and expecting 9.1 million by the end of 2006. SIRI has 3.3 million and expecting 6.5 million by year-end. Both sets of numbers are very strong given their short history but the problem came in acquisition cost per subscriber. Both saw prices soar as SIRI promoted Howard Stern and XMSR gave away free deals to offset the SIRI Stern promotion. SIRI claims they will see positive cash flow by Q4 and for all of 2007. That is the Holy Grail they both seek and I believe they will eventually find it. However both stocks took a dive on Friday with XMSR losing -10% and SIRI -7%.

Oil prices also kept a lid on the market on Friday after they rebounded from a low of $57.40 on Wednesday to hit $60 again on Friday. Driving the gains were several factors. Nigerian rebels called for an all out attack on pipelines after the military stepped up attacks on suspected oil thieves. Shell halted production at one 37,800 bpd flow station after a nearby well was set on fire. Oil companies in the region are evacuating nonessential personnel and putting helicopters on some rigs to enable a quick escape if the rig is attacked. This is not a climate conducive to continued production and Nigeria is a large exporter of the light sweet crude currently in demand. This problem is not expected to be resolved in the near future and production levels will be at risk.

Also impacting prices was a Venezuela call for OPEC to cut production. Amazing how that $58 level triggered those outbursts just as we expected. Venezuela was the first to call for a production cut because a cut will not impact their production. Venezuela is currently producing less than their quota due to numerous factors including the fight with 29 oil companies over a new retroactive tax on oil and the nationalism of their oil fields. Venezuela would benefit from a cut in OPEC production and the rise in price because even a 10% cut in their quota would still be more than they can currently produce. To put is simply, Venezuela would pump the same amount of oil at a higher price while other OPEC countries would collect higher prices but be forced to produce lower amounts. OPEC quotas have been acknowledged with a wink and a smile for the last year as countries try to capture as much of the higher prices as possible. I am sure as we get closer to the March meeting the number of calls for "verbal" production cuts will increase but it will take several months to see if they actually occurred.

China and Iran are doing a deal for Iran to supply oil to China for the next 25 years. China will acquire a 51% stake in the Yadavaran field reported to hold 3 billion barrels of reserves and output of 300,000 bpd. They will also receive 10 million tons of LNG annually for the next 25 years. Now, the question everyone should be asking is why would Iran do a deal of this magnitude with China? Answer, because China is a permanent vote on the UN security council and they have the clout to ignore any oil sanctions. Iran's deal with the devil in this case guarantees them revenue for the next 25 years and a friend in any international fight. China will stand behind Iran and support them in whatever trials they are going to face given their nuclear ambitions. While the world may try to penalize Iran for going nuclear their new bodyguard will make sure the penalties are minimum. Would the U.S. attack Iran if China huffed and puffed and warned them not to do it? I doubt the US has the stomach to take on China and Iran at the same time. This deal with the devil was a good play on the part of Iran as they face the UN problems ahead.

For the oil community they means the potential for oil sanctions has been reduced and UN actions will be tempered with restraint. It does increase the likelihood that selected nuclear sites in Iran may be destroyed since sanctions are no longer a valid option. I am sure the US could convince China that it was in everybody's best interest not to have a nuclear Iran and convince China to look the other way while a couple key sites were targeted. Once China has its deal in place with Iran it will want to maintain the status quo and that may include not letting Iran reach the point where its oil fields are threatened. This may sound a bit confusing but the bottom line is that China just captured 300,000 bpd of oil for the next 25 years and in doing so may have stabilized Iran as a producer for that period. You can bet that any Iranian attempts to halt the flow of oil to China would be dealt with harshly by China. Iran sold its oil soul to the Asian bully in order to protect itself from the west and the UN. It will be interesting to see how this plays out over the coming years.

The New York Times had an article this week on the increase in global consumption with specifics about China's growing needs. The article suggested prices could rise to $80 on any blip in output. At the same time OPEC lowered its demand growth forecast for 2006 to +1.7 mbpd to 84.69 mbpd. This is still a hefty amount. Boone Pickens was on CNBC this week saying he did not expect to see $50 again in his lifetime and felt $53 was only a remote possibility. Boone, I hope you live a long time!

March Crude Oil Chart - Daily

The March crude contracts roll over next week and we will begin dealing with the April contract as the current month. March closed at $59.88 on Friday with April at $61.29. For reference purposes I thought it would be interesting to show the closing price for some of the longer dated contracts.

Light Sweet Crude Futures Contracts

You will notice that the price peaks in June 2007 and begins to decline. It does not mean specifically that prices are going lower after 2007 but that is about the limit of visibility for future production. Production can be charted by well/field but reliability of guesstimates decreases after about 18 months. There is also the cost of money to consider. Someone buying a December 2012 Crude Futures contract at $61,000 must consider his cost of money and margin costs for six years into the future. Personally I think you can double all those numbers after June-2007 and by 2012 consumers would be glad to pay it. We will revisit this conversation as each year passes to monitor the progress.

I believe the spike in oil prices on Friday was related more to expiration pressures and the fear of being short over a three-day weekend rather than investors thinking oil was a bargain. We did get the bounce I was expecting right at $58 but it remains to be seen if it will stick.

This was a big week for the markets but the majority of the gains came on Tuesday at the open. Investors covered shorts ahead of the Bernanke testimony and positioned themselves for some upside should his testimony appear bullish. That Tuesday rally took the Dow to 11068 and the next three days of trading only managed to add +42 points. That was a total of +63 points if you count the intraday high on Friday. Still it was a monumental week with the Dow moving over 11000 and then holding that level for four days while inching slowly higher. This puts the Dow at a new 4.5 year closing high and would appear to be sending a message that it is ready to go higher. If this bullish move continues higher the next material resistance is 11350-11425. Those are some awfully big numbers considering the weakness in the recent earnings cycle. Not to look a gift horse in the mouth but I would advise caution at this level due to a lack of confirmation by the other indexes.

The Nasdaq failed on Friday exactly on the downtrend resistance dating back to Jan-11th. Dell disappointed and the chip sector led by Intel lost ground for the week. This does not produce a strong confirmation for the Dow. It appears the Nasdaq will be the anchor the Dow will have to drag on any further advances. The Nasdaq 2290-2295 level could be tough to crack without any positive news from tech land.

Nasdaq Chart - 60 min

Dow Chart - Daily

In a remarkable show of strength the SPX caught fire and rallied back over the 1287 resistance level and managed to stay there most of Friday. The close right at 1287 indicates that there is still upward pressure but there is a battle underway at that level. I believe the S&P benefited from the rebound in energy stocks with many of them up several dollars since Wednesday. In round numbers some of the leaders helping the S&P were AHC +5, APC +6, BHI +4, BR +3, CVX +2, COP +3, DVN +4, EOG +5, HAL +4, KMG +3, KSE +5, KMI +3, MRO +6, MUR +2, NOV +4, OXY +5, SLB +4, SUN +6, VLO +6 and XTO +3. These are all S&P components and those are the gains in round numbers from the Tue/Wed lows. Numbers like those help offset some of the losers like Radio Shack. Energy stocks not helping the S&P were RIG and NBR both of which crashed on RIG's warnings on Tuesday. Also helping the S&P was a strong rally in financials after the Merrill/Blackrock merger was announced. The Broker Dealer Index (XBD) jumped +5% for the week and many of those leading financials are S&P components. The Biotech Index (BTK) also jumped +6% on various news items from the sector. When you have energy, financials and biotechs all spiking strongly I am surprised the S&P did not move higher. This causes me to question direction for next week since we are not likely to have all three of those sectors continue their moves higher. Since Tuesday the S&P was only able to add +11 points despite all that sector help. Kind of makes you go hmmmmm as you ponder why. I had a hard time fighting off the urge to short it at the 1286 closing level and I finally took a small short in the futures at the close just to hedge my energy longs over the weekend.

SPX Chart

NYSE Composite Chart - 90 min

The Russell-2000 and the NYSE Composite both rallied back to just below prior strong resistance on Friday afternoon. The Russell stopped at 733 and just under the 736 level which held as resistance back in late January. This would be the prime spot for a failure if that is what the market has up its sleeve. The NYSE Composite came to a dead stop at 8100 on Friday. This is also just below the 8125 level that held in late January. The NYSE Composite is heavily weighted with energy stocks since most of the 500 or so energy stocks trade on the NYSE or about 18% of the index. Financials are also a large portion of the index. The bottom line on both the Russell and the NYSE is they are both right below historic highs. This is where a failure has a stronger chance of occurring rather than a breakout at this point on the calendar. If both do break their highs with the Dow on a roll then the breakout could be huge. The Transports already hit a new high on Thursday so all the dominoes are lining up and we just need that next event to push them over and a new rally begin.

However, what will that event be? Earnings are over for all practical purposes. Monday is a holiday and the next material economic report is the CPI on Wednesday. After the PPI last week the CPI may be anticlimactic. Thursday has a flurry of reports including the CFNAI, Mass Layoffs and the Kansas Fed Manufacturing Survey. Friday closes the week with Durable Goods. Not a lot of market movers in that list. They normally attract attention but do little to produce movement. Options expired on Friday and Tuesday will be cleanup day. That normally produces extra volume but little in the way of direction. That directional push we are seeking may come from the FOMC minutes of the January meeting that will be released at 2:PM on Tuesday. While Bernanke probably gave us the condensed version in his testimony last week the reinforcement of the Fed's view of an on track recovery could energize the buyers once again. The problem remains the inflation rate. If the minutes suggest the Fed is more worried about inflation then traders may start really worrying about how many hikes are still ahead. The minutes will be sifted like tea leaves for clues to our future and our direction could come from those clues.

If you are following the SPX indicator I have been giving then you should be cautiously long over 1275. I already admitted above that I took a small short at the close to hedge my energy longs so you know I am very cautious at the 1287 closing level. With the Dow breaking out I would have hoped for more confirmation from the other indexes to allow me to strengthen my long recommendation but we did not get that confirmation. Remain cautiously long until we get a breakout across the board including the Dow, SPX, NYSE Composite and Russell. Hopefully that event will bring buyers back to the Nasdaq but I don't have high hopes. It would be really easy for me to roll over and suggest a short here but that would be my emotions speaking and not the facts. Continue to remain cautiously long over 1275 and short under 1270. Anyone not long the current market would be wise to stand aside and watch for a direction to develop.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
OXY APOL None
TS    

New Calls

Occidental Petrol. - OXY - cls: 90.04 chg: +1.36 stop: 85.95

Company Description:
Occidental Petroleum Corporation (NYSE: OXY) is a world leader in oil and natural gas exploration and production and a major North American chemical manufacturer. (source: company press release or website)

Why We Like It:
There are a ton of oil-related stocks that seem to be flashing some early buy signals with the recent bounce. We are not totally convinced that the group will continue higher short-term and that's why we're suggesting a trigger to buy calls here with OXY. We remain very bullish on a long-term basis for oil and oil companies. The OIX oil index has not violated its long-term bullish trend. Thus this recent pull back is a tempting spot to consider long positions. OXY is attractive because shares have bounced from support near $85.00 and its five-month trendline of support. We are suggesting a trigger to buy calls at $90.75. If you want to adjust that to $90.51 or $91.01 feel free. If we are triggered our target will be the February highs in the $97.50-98.00 range. A move over $92 will reverse the P&F chart into a new buy signal.

Suggested Options:
We are going to suggest March calls but you might want to consider using May calls instead.

BUY CALL MAR 85 OXY-CQ open interest=1510 current ask $6.60
BUY CALL MAR 90 OXY-CR open interest=7059 current ask $3.60
BUY CALL MAR 95 OXY-CS open interest=4487 current ask $1.60

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/09/06 (unconfirmed)
Average Daily Volume = 3.4 million

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Tenaris S.A. - TS - cls: 153.96 chg: +3.46 stop: 144.99

Company Description:
Tenaris is a leading global manufacturer of seamless steel pipe products and provider of pipe handling, stocking and distribution services to the oil and gas, energy and mechanical industries and a leading regional supplier of welded steel pipes for gas pipelines in South America. Domiciled in Luxembourg, it has pipe manufacturing facilities in Argentina, Brazil, Canada, Italy, Japan, Mexico, Romania and Venezuela and a network of customer service centers present in over 20 countries worldwide. (source: company press release or website)

Why We Like It:
It looks like TS is trading in a big bull-flag pattern. A breakout through the top edge (resistance) of the flag can be used as a new bullish entry point to buy calls. Short-term technical oscillators are turning bullish again and we suspect that the stock is poised to breakout next week. We also like that TS is a steel company that specializes in materials for the oil producers. If either sector, steel or oil, continues higher next week then TS could benefit. We are going to suggest a trigger to buy calls at $155.25. More conservative traders may want to wait for a move over $156 or even $158.25 - these two levels might offer some minor resistance. Our target will be the $164.00-165.00 range. We do not want to hold over the early March earnings report.

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

BUY CALL MAR 150 TSW-CJ open interest=445 current ask $11.00
BUY CALL MAR 155 TSW-CK open interest=214 current ask $ 8.00
BUY CALL MAR 160 TSW-CL open interest=439 current ask $ 6.10

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/01/06 (unconfirmed)
Average Daily Volume = 516 thousand
 

New Puts

Apollo Group - APOL - close: 58.06 chg: -0.80 stop: 60.01

Company Description:
Apollo Group Inc. has been providing higher education programs to working adults for almost 30 years. Apollo Group Inc. operates through its subsidiaries: The University of Phoenix Inc., Institute for Professional Development, The College for Financial Planning Institutes Corp., and Western International University Inc. The consolidated enrollment in its educational programs makes it the largest private institution of higher education in the United States. It offers educational programs and services at 95 campuses and 153 learning centers in 39 states, Puerto Rico, Alberta, British Columbia, Netherlands and Mexico. (source: company press release or website)

Why We Like It:
APOL spent the last week trying to breakout over resistance at the $60.00 level and the stock failed every time. Friday's trading looks like an entry point to buy puts given the failed rally at $60.00 and its descending simple 50-dma. Short-term technical indicators are turning bearish again and the P&F chart is pretty bearish with a $44.00 target. We are going to suggest puts here near $58 and target a decline into the $53.00-52.50 range. More conservative traders may want to wait for a decline under $58.00 just to be sure since the $58 level has been short-term support for the last few days.

Suggested Options:
We are suggesting the March puts since we plan to exit ahead of APOL's earnings report in mid March.

BUY PUT MAR 60 OAQ-OL open interest=725 current ask $2.95
BUY PUT MAR 55 OAQ-OK open interest=870 current ask $0.80

Picked on February 19 at $ 58.06
Change since picked: + 0.00
Earnings Date 03/16/06 (unconfirmed)
Average Daily Volume = 2.0 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Beazer Homes - BZH - close: 64.68 change: -0.81 stop: 62.29

Traders need to be cautious here with BZH. The bounce has not materialized as expected and that's bad news. The stock seems to be struggling with the $66.00 level where it has produced a failed rally twice in the last three days. We seriously considered exiting this play early right here. If BZH hasn't bounced by now then it will likely pull back and retest support at the simple 200-dma again currently near $62.30. More conservative traders should strongly consider exiting early right now to limit losses. You can always jump back in if BZH trades over $66.00 again. Or if you don't want to exit consider a stop loss near $64.00. We're going to keep the play open for now but we're not suggesting new plays. We do expect a pull back toward the 200-dma. If BZH does bounce then our target is the $69.85-70.00 range.

Suggested Options:
We are not suggesting new call plays in BZH at this time.

Picked on February 15 at $ 65.05
Change since picked: - 0.37
Earnings Date 01/19/06 (confirmed)
Average Daily Volume = 1.2 million

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Cephalon - CEPH - close: 74.39 change: -0.82 stop: 69.99

CEPH hit a little bit of profit taking on Friday morning but the stock was on the rebound by Friday afternoon. We remain on the sidelines. Our trigger to buy calls is at $76.65. We are reposting the original play description from Thursday night here:

The BTK biotech index is in breakout mode. The index closed at new five-year highs today and the sector looks prepared to keep the bullish run going for a while. We're going to try and play the upward momentum in the sector with a bullish play on CEPH. The stock has already been a big winner over the last few months and now after several weeks of consolidating sideways it looks like CEPH is ready to breakout to new highs of its own. We are going to suggest a trigger to buy calls at $76.65. If triggered we'll target a run into the $82.00-82.50 zone. More conservative traders may want to exit near $80.00 since it might be round-number resistance. Traders should remember that any time you're trading a biotech stock there is an elevated status of risk. You never know when an unexpected announcement about a drug in development or even from a competitor can send the stock you're trading gapping higher or lower in an instant.

Suggested Options:
We are suggesting the March calls. If you want more time the next month available is Mays.

BUY CALL MAR 75 CQE-CO open interest=1836 current ask $2.75
BUY CALL MAR 80 CQE-CP open interest= 540 current ask $1.05

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/14/06 (confirmed)
Average Daily Volume = 2.5 million

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Chico's FAS - CHS - close: 48.37 change: -0.29 stop: 44.89 *new*

Stronger than expected sales data helped fuel a rally in retailers early last week. The group also got a boost from J.C.Penney who produced better than expected earnings results. CHS received a higher price target from one analyst a few days ago. The consumer confidence numbers that came out on Friday could have produced a bigger sell-off in the retail group but they did not. We would probably look for a dip back toward the $46.50-46.00 range before initiating new positions. Broken resistance near $46.00 should now act as new support. Of course the $50.00 mark might act as round-number, psychological resistance so expect some volatility as CHS encounters that level. The Point & Figure chart is bullish and points to a $70 target. Our target is the $52.00-52.50 range. We are raising our stop loss to $44.89.

Suggested Options:
Wait for a dip before opening new call plays. We would choose from the March calls. We do not want to hold over the March 1st earnings report.

Picked on February 14 at $ 47.61
Change since picked: + 0.76
Earnings Date 03/01/06 (confirmed)
Average Daily Volume = 1.8 million

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Cigna - CI - close: 122.21 change: +0.64 stop: 118.79

We remain leery of the trading action in CI. The stock had a lackluster week and twice it has gapped down and not quite filled the gap either time and this should be considered bearish. The MACD indicator on its daily chart is about to produce a sell signal while on the weekly chart it has recently produced a new buy signal. Short-term technical oscillators are mixed. On a big picture basis the breakout above the $118-120 range is pretty bullish since CI consolidated sideways between $105 and $118-120 for months. The P&F chart, which eliminates a lot of the noise we see on the daily chart, is bullish with a buy signal pointing to a $154 target. If you're the optimistic type you could also point out the short-term trend of higher lows. We would not suggest new call positions until CI traded back above the $123.00 or $124.00 levels (which one is up to you). Our target is the $129.50-130.00 range.

Suggested Options:
We are not suggesting new plays at this time. If CI does move higher we'd would choose from the March or April strikes; probably the $120s or $125s.

Picked on February 12 at $123.63
Change since picked: - 1.42
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 979 thousand

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Express Scripts - ESRX - close: 92.85 chg: -0.66 stop: 91.45 *new*

Hmm... we don't know what the catalyst was but late Friday afternoon ESRX suddenly turned more volatile and there was a big spike in volume. By the closing bell the stock had erased the gains from Thursday. We are quickly running out of time. ESRX is expected to report earnings on Wednesday, February 22nd. We do not want to hold over the report. Therefore we plan to exit on Tuesday afternoon near the closing bell. However, to reduce our risk we are raising our stop loss to $91.45.

Suggested Options:
We are not suggesting new call plays in ESRX.

Picked on January 29 at $ 92.42
Change since picked: + 0.43
Earnings Date 02/22/06 (confirmed)
Average Daily Volume = 2.1 million

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Google Inc. - GOOG - close: 368.75 chg: +2.29 stop: 344.48

We don't see any change from our original play description from Thursday night. However from the looks of GOOG's intraday chart we'd probably expect some profit taking on Monday. Watch for a dip back toward the $360 level at a minimum. A bounce from $360 or $355 could be used as a new entry point. Our original play description is reposted here:

This is a very aggressive speculation play. The reaction to GOOG's latest earnings report at the end of January was pretty drastic. The stock sank from $432 to less than $340 as of yesterday. The stock was very oversold and due for a bounce. That bounce came today after shares tested support near its simple 200-dma and the top of its October gap. Today's move was powerful enough to push shares above the top of its February 13th gap down and its simple 10-dma. We suspect that the bounce is not over yet. The next test of overhead resistance will probably be near the $380 level. However, we believe that GOOG can probably bounce back into the $394.00-400.00 range, which will be our target. The risk reward isn't great but we're putting the initial stop loss under today's low. We repeat this is very speculative and traders should only consider it if they're willing to risk a total loss. If you would prefer to buy a dip then watch for a pull back toward $360 or $355.

Suggested Options:
We are suggesting the March calls as the bounce will probably be a short-term affair. You, the individual trader, should pick which strike best suits your risk profile.

BUY CALL MAR 350 GGD-CJ open interest= 7235 current ask $28.30
BUY CALL MAR 360 GGD-CL open interest= 6419 current ask $21.90
BUY CALL MAR 370 GGD-CN open interest=11033 current ask $16.30
BUY CALL MAR 380 GOP-CP open interest= 8133 current ask $12.00
BUY CALL MAR 390 GOP-CR open interest= 8736 current ask $ 8.40

Picked on February 16 at $366.46
Change since picked: + 2.29
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 12.4 million

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Hartford Fin. Srv. - HIG - cls: 83.65 chg: +0.27 stop: 79.95*new*

HIG is nearing resistance at the $85.00 level. More conservative traders may want to consider an early exit close to $85 and/or its simple 50-dma (85.09). We will be expecting a pull back/profit taking back toward the $82.00 level, which looks like short-term support. use a bounce from $82 as a new bullish entry point. We would not open new plays at the moment. We are adjusting the stop loss to 79.95. Our target is the $87.50-90.00 range.

Suggested Options:
We are not suggesting new call plays in HIG at this time.

Picked on February 14 at $ 82.12
Change since picked: + 1.53
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 1.1 million

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Total - TOT - close: 129.31 change: +1.70 stop: 124.95

Our new call play in TOT is off to a good start. Oil stocks in general look prepared to bounce higher. Friday's gain in TOT appears to have broken the three-week trendline of resistance. We don't see any change from our original play description from Thursday night so we're reposting it here:

TOT's recent earnings report was not that impressive but that isn't stopping the stock from bouncing at the simple 200-dma. Actually the stock has a habit of rebounding from the simple 200-dma. Given today's rebound across the board in the oil stocks this looked like a tempting entry point to buy calls in TOT. However, keep in mind that the stock's short-term bearish trend has not yet been broken. While we would buy calls here more conservative traders may want to wait for a move over $130 or its 50-dma before initiating positions. Our target is the $137.00-140.00 range.

Suggested Options:
We are suggesting the March calls. You'd better double-check those current prices since it looks like an error.

BUY CALL MAR 125 TOT-CE open interest= 1 current ask $8.30
BUY CALL MAR 130 TOT-CF open interest= 20 current ask $2.90
BUY CALL MAR 135 TOT-CG open interest=773 current ask $1.00

Picked on February 16 at $127.61
Change since picked: + 1.70
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 836 thousand

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Universal Health - UHS - close: 51.18 chg: +0.02 stop: 49.24*new*

Last week was a positive one for UHS. The stock broke out through resistance near the $50.00 level and through the top of its six-month trading range. If you look at the weekly chart it looks like a big double or triple bottom pattern against the $45 level. We remain bullish on UHS but have a limited time frame. The company is due to report earnings on February 27th. We do not want to hold over the report so that only gives us about a week. If you were looking for a new entry point we'd watch for a dip toward the $50.50-50.00 region. The P&F chart is bullish and points to a $61 target but displays resistance near $56. We are targeting a rally into the $54.50-55.00 range. We are going to inch up our stop loss to $49.24.

Suggested Options:
We are not suggesting new plays at the moment. Look for a dip toward $50.00. We would pick the March calls since we plan to exit before the February earnings report.

Picked on February 15 at $ 50.51
Change since picked: + 0.67
Earnings Date 02/27/06 (confirmed)
Average Daily Volume = 613 thousand
 

Put Updates

MGIG Invest. - MTG - close: 62.80 change: -1.00 stop: 65.51*new*

Good news. MTG has produced a failed rally near resistance at $64.00, its exponential 200-dma and the neckline to its bearish head-and-shoulders pattern. The action on Friday looks like a new entry point to buy puts. More conservative traders might want to wait for a decline under $62.00, which is short-term support. We are inching our stop loss down to $65.51. More conservative traders may also want to consider using a stop closer to $64.50. Our target is the $58.00-57.50 range.

Suggested Options:
We are suggesting the March puts. Our readers should pick the strike price (and month) that best suits their trading style and risk.

BUY PUT MAR 65 MTG-OM open interest=1214 current ask $2.95
BUY PUT MAR 60 MTG-OL open interest=4106 current ask $0.80

Picked on February 06 at $ 63.70
Change since picked: - 0.90
Earnings Date 01/12/06 (confirmed)
Average Daily Volume = 833 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: 72.57 chg: -1.43 stop: n/a

It looks like shares of BMHC have produced a failed rally on Friday near resistance at the $75.00 level and the bottom of its earnings-news inspired gap down. We are not suggesting new strangle positions. Please note that the last day of trading for March options is Friday, March 17th. Yet BMHC is due to split 2-for-1 on March 15th. For ease of accounting we will probably plan on exiting this strangle ahead of the stock split. 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: - 8.38
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand

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Encana Corp. - ECA - close: 42.99 chg: +0.15 stop: n/a

Oil stocks bounced on Friday and ECA rallied to the $44 level before paring its gains. We are not suggesting new strangle positions. 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: - 2.57
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

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Loews Corp. - LTR - close: 95.43 change: -0.57 stop: n/a

Attention! We want to remind readers that this has been and remains a high-risk, speculative strangle play. Our goal was to capture any post-earnings volatility. LTR reported earnings on Thursday morning and the lack of real movement on Thursday and Friday does not bode very well for this play. If you have a strangle position in LTR using the March options then you may want to seriously consider exiting now to limit your losses! Buying this strangle was a bet that LTR will be trading at more than $102 (above resistance) or less than $88 (under support) by March expiration. The options in our strangle are the March $100 calls (LTR-CT) and the March $90 puts (LTR-OR). Our estimated cost is $1.75.

Suggested Options:
We are not suggesting new strangles in LTR.

Picked on February 13 at $ 95.72
Change since picked: - 0.29
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 513 thousand

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Ryland Group - RYL - close: 68.82 change: -0.41 stop: n/a

It looks like the oversold bounce in RYL is failing at the $70.00 level. As a matter of fact this looks like an entry point to buy puts with stop loss above round-number resistance at $70.00. However, before you get too exited the weakness was kept to a minimum on Friday and the MACD indicator on the daily chart is nearing a new buy signal. Lest anyone forget this is supposed to be an update on our RYL strangle play. We are not suggesting new strangle positions at this time. 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 strangles in RYL.

Picked on January 22 at $ 75.19
Change since picked: - 6.37
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

None
 

Dropped Puts

Cameco Corp. - CCJ - close: 73.37 change: +1.46 stop: 72.56

As we expected shares of CCJ continued to bounce on Friday and the stock has stopped us out at $72.56. In retrospect it looks like the bounce on Wednesday where CCJ closed at $70.26 would have been a good spot to bail out. Nimble traders may actually want to consider bullish positions here. We would not be surprised to see CCJ make a run for its highs near $80.00, especially if the mining stocks continue to rebound.

Picked on February 07 at $ 68.57
Change since picked: + 4.80
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Strangles

None
 


Trader's Corner

Shivers

Last week I read a letter to an editor in a well-known trading publication. That letter gave me the shivers. In that letter, a reader indicated his intention to begin trading options the next month. He wanted recommendations for options-trading software, analysis and alerts.

It's not that easy. Perhaps this trader indicated an intended time frame for beginning to trade options because he's been spending a number of months paper trading options or back-testing strategies through the programs offered by several trading platforms. He feels that his period of study will be completed in about a month. On OptionInvestor's Futures Monitor, Jane Fox often updates readers on the results of the back-tests she runs on her trading parameters. She uses those back-tests to hone her entry and exit parameters and check for the times when those trades are most and least profitable. Recently, she noted that the changes over a period of time in the profitability of trades taken during a certain time period on a certain instrument. She works hard, and her effort shows. She's put in the time and effort needed to decide whether her system works for her. Maybe the magazine's reader has done the same thing.

Anyone thinking about trading options needs to put in time studying and testing skills first, but back-testing isn't the only method available or needed. An online search including some combination of the words "options," "simulated trading" and "demo trading" will call up many companies offering free 30-day trials to those wanting to try their skills at trading options. If considering a trial of a simulated or demo trading site, finding one that offers real-time simulations will help recreate the drama of trying to make a decision about entries and exits when markets are moving. New traders need that drama because they need to know how they'll react to it.

Paper-trading options in real-time can also offer some insights into how options decay. They provide an assessment of how much movement in the underlying is required in what time frame in order to profit.

It's still not that easy. That's not all it takes. With time and experience comes the knowledge that a trader buying an option on the OEX can probably split the bid/ask spread about 30/70, with the trader paying 70 percent on entry and getting 30 percent on exit, but that traders are probably just going to have to pony up all or most of the bid/ask spread if they're buying an option on the XAU. Even then, it may take a while before someone gets around to noticing that you've put in an order for an options trade on the XAU. Not knowing the differences in the way certain instruments trade can result in the unhappy circumstance of having gotten into an options play with your great entry when markets were quiet, and then either chasing options prices lower or putting in a market order and hoping for the best when an economic release sends the price of your options crashing.

Even if you decide to stick with liquid, heavily traded instruments such as the OEX's, it's still not that easy. As much as any back-testing method or simulated trading platform attempts to recreate the real-deal trade, it cannot recreate the heart-thumping reaction when a position goes against you and goes against you quickly. Competitive traders can recreate some of that tension because they can't stand to lose even on a simulated trading system--that would include this writer--but that's still not the real deal when it comes to handling emotions while trading. If back-testing, trading a demo platform or paper-trading, no harm is done when, moments before the FOMC announces its latest rate-hike decision, a child screams after busting a lip, a boss steps to your door with a new project or a dog that just got a bee sting on the nose goes tearing through the house. Those kinds of things can and do happen in real-life trading, and traders must be able to handle them and still maintain their trading accounts.

So what's the point? Should newbies just give up the idea of trading options at all? Should they hand over their trading decisions to professionals? In a back-handed way, all these paragraphs seem to argue in favor of new traders placing money in the hands of those who sell that software, not argue against that policy.

It's still not that easy. If any software or alert could provide all the help traders needed to be profitable, all the traders in the world would have gravitated to that same source. Some traders are Type A enough that they don't want to trade anyone else's system--that again would include this writer--but guaranteed profits would attract most of them, too. If a system or software solution could do it, we traders could all just program our trades, and then either mountain bike, kayak or do lunch, whatever the preference.

Even a profitable alert system or source doesn't work for all. Traders need to know enough to evaluate those alerts or software and their appropriateness for trading styles. Some systems might prove appropriate only for those traders with large enough accounts to allow them significant margin. This would include some positions established with credit spreads, for example. Some might prove appropriate only for aggressive traders; some only for conservative. Traders whose personalities best fit short, aggressive trades may find that they lose money on strategies intended to play out over weeks. Many a trader has traded a straddle or strangle into an unprofitable play when it might have been profitable when left alone. Boredom sometimes leads the aggressive trader to take any play offered, even if the writer or service offering the trade notifies subscribers that the play is high risk and without a strong risk/reward parameter.

The converse can happen, too. Fear can lead conservative traders to take profit too soon if they've latched onto a play on a momentum stock. A scared trader taking profits too soon can fail to build enough cushion to make up for the inevitable losing plays.

Trading options can be profitable. Some options tactics provide traders with enough leverage to trade with relatively small accounts. They allow directional traders to enter both bearish and bullish plays. Through various combinations, they can protect profits on long or short stock positions or benefit the trader who believes that prices will stay in a predetermined range.

Trading options can also deplete a trading account. They're wasting instruments. Traders can be right on direction and right on the eventual target but just a little wrong on the timing--as little as a few hours wrong, if we're talking about the difference between the close on an option expiration day and the open the next trading day--and the profitable play turns into a losing one. OptionInvestor's Jim Brown has always advocated the "teach a person to fish" philosophy, and that philosophy proves important whether traders are going to trade their own signals, another trader's or a software system's alerts.

So, how does one learn to fish? Reading, studying, back-testing, trading a simulated account or paper trading, and then going one step further. That simulated or paper trading should include at least one and maybe more option expiration weeks, at least one FOMC meeting or other market-turning economic or earnings release. Then and only then, it might be time to fund an account with a small amount of money that one EXPECTS to lose. Trading a small account will almost guarantee that there won't be enough funds to weather the inevitable draw-downs that occur when several plays in a row go wrong, as absolutely will happen, but it also limits how much money newbies can lose. It avoids trading through the children's college fund.

Trading a small account promotes familiarity with the mechanics of placing a trade and protecting it with stops or setting profit limits. Many a trade has gone sour when a new trader is too clumsy placing orders to exit when the profit target is hit and prices reverse. Perhaps while trading that small account, new traders will find that a particular broker's setup doesn't work for them.

While trading that small account, newbies should keep a trading journal that notes all the particulars of each trade, including the emotional ones. Examining emotions at the time of entries and exits are necessary to those who want to discover their trading styles. Those notations will reveal whether traders prefer to ring a trade with stops and walk away, not watching the moment-by-moment action, or if traders need to see every zig and zag of the trade if it unfolds.

Only when newbies know what kinds of options trades are workable, which fit their trading styles, and the mechanics of placing the trades and stops should they consider trading someone else's alerts or relying on software. I hope that's work that the letter writer did before asking for those recommendations, but I still get the shivers when I think perhaps it's not.
 

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

DISCLAIMER

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

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

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