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Daily Newsletter, Saturday, 03/11/2006

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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

Hot Potato, Hot Potato

The jobs numbers have been the hot-potato issue this week, and indeed those numbers came in hotter than expected. That potato had been baking all week, however, and by midmorning Friday, articles featured titles that credited the jobs number with bouncing the markets. Those articles looked to the downward revision of January's number to 170,000 and the slight moderation in the hourly earnings component of the report as prompting that bounce.

At least as likely in this writer's opinion, the week had seen a sell-the-rumor effect and market participants were ready for the buy-the-fact follow-up. Commentators across the globe had been speculating on our jobs numbers for two weeks and all had positioned their portfolios where they wanted them. After digesting the numbers, participants bounced the markets. When the February Treasury Budget was released in mid-afternoon, the record $119.2 billion deficit produced a dip, but that dip was soon reversed in most indices.

Even with newly heightened interest-rate worries and in the face of rising bond yields, the financials led indices higher. Also helping to lead the indices higher, at least early in Friday's session, were the embattled semiconductor and computer hardware sectors, suggesting the possibility that the bounce could have been an oversold bounce. That's especially true since the SOX could not maintain most of its gains.

When all was said and done, the SPX has spent the last four days chopping around between moving averages that offer support and resistance. When writing Wednesday's Wrap, I counseled to watch for a rollover Thursday, noting that I thought indices needed at least one more day of choppy consolidation. Indices have since had two days of choppy consolidation.

Annotated Weekly Chart of the SPX:

The Dow also saw buying action, but there's been a suspicious tendency lately to drive this narrowly based index higher. That could be looked at as a defensive move into blue chips, and perhaps also an attempt to show mom and pop newspaper readers that the stock markets perform well. While traveling recently, I was frustrated by a radio station's stock market updates, as those updates included only the Dow's figures. Many still count the Dow as "the" stock market.

However, an upgrade of GE and speculation that its Universal Pictures studio might be in talks with Amazon for AMZN to provide downloadable movie service prompted that Dow component and big cap's rise. With GE's help, the weekend editions of newspapers can tout the Dow's recovery from the week's sell-off. The Dow even attempted a breakout, but its chart is an ugly and difficult-to-interpret one.

Annotated Daily Chart of the Dow:

This index may not yet be through chopping around between support and resistance. Near-term resistance is at that descending red trendline and near-term support at the 30-sma. Next and stronger resistance lies at February's high, and next and stronger support lies at the 50-sma or possibly even the 72-ema. It's easier to run this index higher than it is many others, so watch for a possible attempt next week, but you want to see corroboration from the other indices before you believe too strongly in the strength of the markets. For now, I'd recommend small positions that sell resistance and buy support.

That corroboration from other indices did not come from the Nasdaq on Friday. The Nasdaq had also rolled over Thursday, as I suggested as a possibility for markets when writing the Wednesday Wrap, both because of chart characteristics and seasonal tendencies. I'd suggested that bearish positions be protected at Wednesday's low, which is where the Nasdaq stopped Thursday. However, Friday it punched down to the 100-sma, a possibility that I'd mentioned but thought less likely.

After bouncing, the Nasdaq barely managed a close back above the 72-ema and at the former triangle's support. That's not particularly convincing of strength and it wasn't corroboration of the Dow's attempted breakout.

Annotated Daily Chart of the Nasdaq:

Since an early bounce in the SOX helped prompt bounces in other indices, a look at that chart might be instructive. That chart is an ugly one, but still one that preserves the possibility of a bounce attempt early next week.

Annotated Daily chart of the SOX:

U.S. nonfarm payrolls for February started the Friday's releases and ended two weeks of speculation from U.S. and foreign commentators. Payrolls rose a greater-than-expected 243,000, the Labor Department noted in its 8:30 release this morning. Some sources pegged the expected number at 206,000-210,000, but whisper numbers had been as high as 250,000. The jobless rate inched up to 4.8 percent from January's 4.7 percent, with January's number having been a five-year low. The labor force participation rate increased to 66.1 percent. Average hourly earnings rose 0.3 percent for the month and 3.5 percent for the last year. That 3.5 percent growth worries those who now fear that the Fed "will be around longer" as one CNBC commentator voiced his concern that rate hikes will not end as soon as had previously been hoped.

Other data revealed that weather may have impacted the average workweek, with that workweek falling to 33.7 hours from January's 33.8 hours. The manufacturing workweek rose by a tenth of an hour, however. Payroll growth was broad based across the various industries, although manufacturing firms did trim their workforce by 1,000 jobs.

With little slack in the job market and wages ticking higher, inflationary pressures can gain a foothold. The Fed faces a difficult task of controlling inflation, if inflation should build, without shutting down the growth engine that the housing market has provided the economy. For Friday, however, market participants decided that the news was no worse than expected and they turned to positive news.

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They did not neglect to send the dollar higher, however, with our currency at a one-month high against the yen. The dollar often strengthens against other currencies when it appears that our rates will be further hiked. When turning to positive news, market participants also ignored the Fed's Fisher's statement that if the Fed was going to make an error, it should make that error on the side of tightening too far rather than being too loose. Some term that statement old news, however, although it's still not welcome news to those who had hoped that rate hikes were nearly done.

Today's positive news came from Walt Disney (DIS), Air Products (APD) and Nucor (NUE). DIS reiterated its forecast of double-digit earnings growth through 2008. Morgan Stanley added APD to its U.S. Model Portfolio. NUE raised its earnings estimate for the first quarter, and this action also boosted the stocks of peers and competitors. All three companies' stocks saw gains, but only NUE held onto all of those gains into the close.

Other positive news for some was the decline in the crude contract, although it closed off Wednesday's three-week low of $59.25, at $59.96. Geopolitical tensions still abound, but the International Energy Agency has assured the world that if Iran cuts exports, the IEA will release inventory from their strategic stocks. That statement may have tempered gains.

The afternoon's release of the February Treasury Budget revealed a record $119.2 billion deficit, as mentioned earlier, but the impact on equities appeared muted. Seasonal patterns usually produce slower receipts in February as the government mails out those tax refunds while the majority of those owing additional taxes haven't yet paid. Hurricane and weather-related expenditures drove up costs.

Another reason behind the muted impact might be that the cumulative deficit for the fiscal year to date moved down slightly, to $217.5 billion from the previous $223.4 billion for the same five months last year. The government forecasts that the year's deficit will be $423 billion.

Friday afternoon also included the release of February's U.S. Leading Inflation Indicators, with the ECRI falling 0.3 percent after January's 1.7 percent climb. The smoothed three-month average dropped to a 3.5 percent gain from the previous 4.6 percent gain. Another leading inflation index, the FIBER index, also dropped in February, by 0.65 percent in that case. These figures perhaps assuaged rate-hike fears produced by the morning's release of job's number.

Other economic news also provided some comfort, although it perhaps indicates a heating-up of the economy, too. A tightening in the inventory/sales ratios was seen when January's wholesale inventories rose a less-than-expected 0.1 percent while sales trended up 1.0 percent. The inventories/sales ratio moved to 1.14/1, down from December's 1.15/1. Strong declines in auto and drug inventories helped produce that lower inventories number.

Next week will include a number of important events to be watched. Economic reports include the fourth quarter's Current Account figure, February retail sale, and January's Business Inventories on Tuesday. Many reports will be crammed in on Wednesday, with the MBAA's weekly report on mortgage activity, February's Export/Import prices, March's NY Empire State Index, January's Net Foreign Purchases, the usual crude inventories, and the Beige Book. Thursday follows with Initial Claims, February's Building Permits, February's CPI, natural gas inventories and March's Philly Fed number. Friday rounds up the week with February's Industrial Production and Capacity Utilization and March's Preliminary Michigan Sentiment.

Many of those numbers have the capacity of moving the markets, notably Retail Sales, the Beige Book, Building Permits, CPI, and production and capacity utilization figures. January's Beige Book noted some scattered tightening in labor markets, but indicated that the wage increases were moderate. Many will watch to see what this Beige Book says about the labor markets, particularly after Friday's jobs release and in view of heightened rate-hike concerns.

Earnings slow, but do include Goldman Sachs (GS) on Tuesday and Bear Stearns (BSC) on Thursday.

Next week is option expiration week, too, an event that shouldn't be ignored. The tendency lately has been for much of the volatility that used to come during opex week to occur the Thursday and Friday of the previous week. If that's true, that tendency could contribute to what's showing up on charts, too: the possibility for another day or two of chop. Many indices show the possibility of a continued bounce attempt for Monday, but the Dow, ending at resistance, and the Nasdaq, ending at former support, worry me. Watch for the possibility of a rollover from current levels, although my greatest expectation is for a continuation of the oversold bounce.

As I mentioned Wednesday, if there had not been such a persistent bid under the market since March, 2003, I would suggest more strongly that nearest and first resistance would be likely to hold and newly and tentatively established support to hold, too, at least for another day and possibly two. However, there has been that bid, and it's been accompanied by wild thrusts higher that come out of nowhere. My suggestion is to trade with smaller positions than usual, to buy support, which means that you're probably already too late if not already long, and sell resistance, but to be ready to jump out of that position if a wild thrust against it occurs.

Perhaps by Wednesday, markets will be ready to break out of these new consolidation zones if they haven't already done so, but you'll have guidance from others both Monday and Tuesday evenings to help you. If you want moment-by-moment guidance, turn to the helpful comments by the writers on the Market and Futures Monitors.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
CMI None None
COF    
HYDL    
TM    

New Calls

Cummins Inc. - CMI - cls: 104.66 change: +1.24 stop: 102.49

Company Description:
Cummins Inc., a global power leader, is a corporation of complementary business units that design, manufacture, distribute and service engines and related technologies, including fuel systems, controls, air handling, filtration, emission solutions and electrical power generation systems. Headquartered in Columbus, Indiana, Cummins serves customers in more than 160 countries through its network of 550 Company-owned and independent distributor facilities and more than 5,000 dealer locations. Cummins reported net income of $550 million on sales of $9.9 billion in 2005. (source: company press release or website)

Why We Like It:
Shares of CMI appear to be bouncing from their trendline of support. Some of the technical indicators for the stock say that CMI is short-term oversold and due for a bounce too. Of course some of the indicators are bearish and point lower. However, if the major market indices can build on Friday's rally next week then we suspect that CMI will re-challenge the recent highs near $110. We're going to suggest a trigger to buy calls at $105.05. If triggered then we'll target a move into the $109.75-110.00 range.

Suggested Options:
We are suggesting the April calls.

BUY CALL APR 100 CMI-DT open interest= 22 current ask $7.00
BUY CALL APR 105 CMI-DA open interest=243 current ask $3.90
BUY CALL APR 110 CMI-DB open interest=665 current ask $1.85

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/20/06 (unconfirmed)
Average Daily Volume = 867 thousand

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Capital One - COF - close: 89.92 change: +4.02 stop: 87.39

Company Description:
Headquartered in McLean, Virginia, Capital One Financial Corporation (www.capitalone.com) is a financial holding company whose principal subsidiaries, Capital One Bank, Capital One, F.S.B., Capital One Auto Finance, Inc., and Hibernia National Bank (www.hibernia.com), offer a broad spectrum of financial products and services to consumers, small businesses and commercial clients. Capital One's subsidiaries collectively had $47.9 billion in deposits and $105.5 billion in managed loans outstanding as of December 31, 2005. (source: company press release or website)

Why We Like It:
Financials turned in a decent day on Friday and leading the pack was COF after one analyst firm raised their earnings estimate for the company. Volume on COF's gain was very strong. The stock managed to breakout over the $90.00 level on an intraday basis and that move produced a new triple-top breakout buy signal on its P&F chart, which points to a $99 target. By adding COF as a bullish candidate we are sort of hedging our bets since we have a put play on UBB. We want to see more confirmation of the current move so we're suggesting a trigger at $90.25 to buy calls on COF. If triggered we'll target a move into the $94.75-95.00 range. More aggressive traders may want to aim higher (maybe $98-99).

Suggested Options:
We are suggesting the April calls.

BUY CALL APR 85 COF-DQ open interest=137 current ask $6.40
BUY CALL APR 90 COF-DR open interest=282 current ask $2.95
BUY CALL APR 95 COF-DS open interest=340 current ask $1.00

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/20/06 (unconfirmed)
Average Daily Volume = 1.6 million

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Hydril - HYDL - close: 70.23 change: +2.40 stop: 66.95

Company Description:
Hydril Company, headquartered in Houston, Texas is engaged worldwide in engineering, manufacturing and marketing premium connections and pressure control products used for oil and gas drilling and production. (source: company press release or website)

Why We Like It:
We hesitated to add another oil-related play. Crude oil futures have been testing support in the $59-60/bbl range lately and frankly they look somewhat poised to move lower. In contrast the OIX oil index appears poised to bounce from its 200-dma and the OSX oil services index looks ready to rebound from its 100-dma. Meanwhile shares of HYDL have already begun to bounce from its 200-dma, which the stock has a habit of doing. Friday's gain in HYDL was fueled by very strong volume and the rally was a bullish breakout over its six-week trendline of lower highs. Short-term technical indicators are already turning bullish and its MACD is nearing a new buy signal. The weekly chart shows a new "hammer" style candlestick, which at the bottom of a trend can be seen as a bullish reversal. We are going to suggest call positions here with HYDL over $70.00. More conservative traders may want to wait for a move over $71.10 or a move over its 50-dma (72.18) before initiating positions. Our target is going to be the $77.50-80.00 range. Keep an eye on crude oil prices. If they start breaking down we might want to abandon this play early. We'll have to see if HYDL reacts to oil under $59/bbl. The stock might not since the company makes products for the oil sector instead of producing and selling oil.

Suggested Options:
We are suggesting the April calls.

BUY CALL APR 65 HBQ-DM open interest= 50 current ask $7.50
BUY CALL APR 70 HBQ-DN open interest=195 current ask $4.40
BUY CALL APR 75 HBQ-DO open interest=106 current ask $2.35

Picked on March 12 at $ 70.23
Change since picked: + 0.00
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 289 thousand

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Toyota Motor Corp. - TM - close: 106.68 chg: +0.68 stop: 104.75

Company Description:
Toyota Motor Corporation is one of the worlds leading automakers, offering a full range of models, from minivehicles to large trucks. Global sales of its Toyota and Lexus brands, combined with those of Daihatsu and Hino, totaled 6.78 million units in CY2003*. Besides its own 12 plants and 11 manufacturing subsidiaries and affiliates in Japan, Toyota has 51 manufacturing companies in 26 countries/locations, which produce Lexus- and Toyota-brand vehicles and components. As of March 2004, Toyota employs 264,000 people worldwide (on a consolidated basis), and markets vehicles in more than 140 countries. Automotive business, including sales finance, accounts for more than 90% of the company's total sales, which came to a consolidated 17.29 trillion in the fiscal year to March 2004. Diversified operations include telecommunications, prefabricated housing and leisure boats. (source: company press release or website)

Why We Like It:
The future of the American car makers may be in question but there seems to be no stopping Toyota (TM). The stock has been a huge winner and shares have a consistent trend of bouncing from its rising, simple 50-dma. Guess what it's doing right now? Yes, it just spent a few days consolidating above the 50-dma and now shares are rebounding higher again. There is some resistance near $109 but we believe that TM can breakout to new highs. The average analyst estimate on this stock is in the $114-120 range. We're going to target the $112.50-115.00 range.

Suggested Options:
We are suggesting the April calls.

BUY CALL APR 105 TM-DA open interest=1081 current ask $4.00
BUY CALL APR 110 TM-DB open interest=1171 current ask $1.35

Picked on March 12 at $106.68
Change since picked: + 0.00
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 438 thousand
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cigna - CI - close: 127.51 change: +1.91 stop: 121.90

CI finished the week off strong. The vaulted out of the gate on Friday morning and hit a high of $129.08. Shares did pare their gains but still closed with a 1.5% gain on above average volume, which is usually a good sign. The MACD indicator has reversed back into positive territory again. Our target is the $129.75-130.00 range so we're not suggesting new bullish positions at this time. The P&F chart points to a $166 target.

Suggested Options:
CI is relatively close to our target so we're not suggesting new positions here.

Picked on February 26 at $124.57
Change since picked: + 2.94
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 944 thousand

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Garmin Ltd. - GRMN - cls: 74.77 change: -0.63 stop: 69.75

We were a little bit surprised by GRMN's under performance on Friday. The market turned higher yet GRMN failed to participate and erased Thursday's gain. The technical indicators might suggest momentum is stalling but we're not ready to give up yet. Volume on Friday's pull back in GRMN was very low and that suggests a lack of real selling pressure and more of a buyer pause. The current trend is still bullish but we'd probably not suggest new bullish positions here. Wait for a bounce from its simple 10-dma as a potential entry point. Our target is the $77.00-78.00 range. The Point & Figure chart points to an $85 target.

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

Picked on March 02 at $ 72.70
Change since picked: + 2.07
Earnings Date 02/22/06 (confirmed)
Average Daily Volume = 1.2 million

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Hartford Fin. Srv. - HIG - cls: 81.55 chg: +0.36 stop: 79.95

Unfortunately, we have nothing new to report on for HIG. The stock is still slowly drifting toward support near $80.00 and its rising 200-dma, which should also act as technical support. Of course this slow decline is bad news for traders with March options, which expire in a week. We are not suggesting new bullish positions at this time. However, we will be watching for a bounce from $80.00 or a new move over $83.00 as potential entry point. Keep an eye on the simple 50-dma, currently at 84.15, as possible resistance. Our target is the $87.50-90.00 range.

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

Picked on February 14 at $ 82.12
Change since picked: - 0.57
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 1.1 million

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Altria Group - MO - close: 73.86 chg: +1.03 stop: 71.85

On your mark. Get set... Shares of MO continued to rally on Friday and the stock looks poised to breakout over resistance at the $74.00 level. MO's strength on Friday did push the stock above technical resistance at its 50-dma (73.60) and even its 100-dma (73.78). We are suggesting a trigger to buy calls at $74.11. If triggered we'll target a rally into the $77.50-78.00 range. More aggressive traders may want to aim higher.

Suggested Options:
We are suggesting April calls but we do not want to hold over MO's April earnings report.

BUY CALL APR 70 MO-DN open interest= 8262 current ask $5.00
BUY CALL APR 75 MO-DO open interest=76562 current ask $1.95

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 8.1 million

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Ultra Petrol. - UPL - close: 52.81 change: +0.26 stop: 51.95

We will admit that last week the oil markets did not react to the ongoing Iran issue the way they thought they would. However, there is still a good chance for a rebound in the sector and the Iran story is far from over. The OIX oil index is currently trying to bounce from support at its 200-dma. Meanwhile the OSX oil services index is trying to rebound from technical support at its 100-dma. Likewise shares of UPL are trying to bounce from its support near $50. So far UPL has been unsuccessful in breaking out from its bearish trend of lower highs. Yet the technical picture suggests that the stock is nearing a bullish move higher. The MACD is close to a new buy signal and the shorter-term stochastics and RSI look ready to move higher as well. We are going to stick to our plan with a trigger to buy calls at $55.05. A move over $55.00 should reverse the P&F chart into a new buy signal. If we are triggered then we'll target a rally into the $59.00-60.00 range, where UPL will probably encounter technical resistance at its 50-dma (59.77).

Suggested Options:
We are suggesting the April calls.

BUY CALL APR 50 UPL-DJ open interest=1263 current ask $5.10
BUY CALL APR 55 UPL-DK open interest=1791 current ask $2.55

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/09/06 (unconfirmed)
Average Daily Volume = 1.7 million

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Valero Energy - VLO - close: 53.54 change: +0.28 stop: 53.49

We are still in a wait and see mode with VLO. The oil sector indices look ready for a rebound but crude oil is testing support in the $59-60 region and could move lower. Our plan with VLO is to catch a breakout over resistance in the $57.00-57.50 range with a trigger at $57.55. We are going to stick to the plan for now. If triggered we'll target a move into the $62.50-63.00 range. We would also keep an eye out for a dip to and bounce from round-number support at the $50.00 level, which should be bolstered by technical support with its 200-dma.

Suggested Options:
VLO is not currently near our trigger to buy calls. If triggered then we'd suggest the April or June calls.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/02/06 (unconfirmed)
Average Daily Volume = million
 

Put Updates

Amgen - AMGN - close: 73.49 change: -0.09 stop: 75.05

Be careful here. AMGN and the biotech sector did under perform the market on Friday but the rally in the major indices has made us more wary. We would not be surprised to see AMGN bounce back toward short-term resistance near $75.00 before heading lower if it heads lower. Other than that we don't see any change from our Thursday play description so we're reposting it here:

The BTK biotech index's longer-term trend is still up but short-term the sector index has weakened and its technical oscillators point lower. Dragging on the sector index is one of its major components AMGN. Shares of AMGN have been trading under a trendline of lower highs since the November 2005 peak. The recent failed rally near its 50-dma and 200-dma has finally produced a new MACD sell signal. The Point & Figure chart for AMGN currently points to a $60 target. We are going to suggest puts here under $75.00. Our short-term target is the $70.10-70.00 range. More aggressive traders might want to aim lower and use a wider stop loss.

Suggested Options:
We are suggesting the April puts.

BUY PUT APR 75 YAA-PO open interest=10949 current ask $2.90
BUY PUT APR 70 YAA-PN open interest=14573 current ask $0.95

Picked on March 09 at $ 73.58
Change since picked: - 0.09
Earnings Date 04/20/06 (unconfirmed)
Average Daily Volume = 10.1 million

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KB Home - KBH - close: 63.24 chg: +1.06 stop: 68.05

Interest-rate sensitive stocks, like the homebuilders, saw their descent pause on Friday. We suspect this is just a speed bump on the way down since it is widely accepted that rates will continue higher. We would watch for a failed rally in KBH under $65.00 and under its simple 10-dma as a new bearish entry point. Our target is the $60.50-60.00 range.

Suggested Options:
Look for the failed rally before considering new positions. We like the April puts.

Picked on March 06 at $ 64.75
Change since picked: - 1.51
Earnings Date 03/22/06 (confirmed)
Average Daily Volume = 1.9 million

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Phelps Dodge - PD - close: 137.32 change: +4.42 stop: 140.05

Watch out! We may have been wrong with PD or the stock has just experienced some short covering fueled by the market rebound this Friday. Overall the pattern hasn't changed. PD is still in a six-week bearish trend and the stock's long-term pattern suggests it will retrace toward the $124 region. However, Friday's move is a big warning flag for the bears. Volume was strong, well above the daily average, and PD produced a bullish engulfing candlestick pattern on Friday. These patterns are typically seen as one-day (bullish) reversal patterns. PD still has potential resistance at $140.00 and its 100-dma (139.47) but if the broader market continues higher on Monday then PD could breakout! We are not suggesting new bearish positions at this time and honestly more conservative traders, if you opened positions on Friday, you might want to consider exiting early and limiting your losses. Don't forget that PD splits 2-for-1 and should begin trading at its post-split price on Monday.

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

Picked on March 09 at $132.90
Change since picked: + 4.42
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 2.8 million

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Unibanco Brasilrs - UBB - close: 79.35 chg: +1.91 stop: 83.26

Financial stocks rebounded on Friday and that helped fuel a 2.4% bounce in shares of UBB. The overall trend in UBB remains bearish but we'd look for a new decline under $77.50 before considering new bearish positions. We're reposting our original play description from Thursday night here:

The momentum in shares of Brazilian bank stock UBB has finally reversed course. The stock struggled to breakout over the $90.00 level and in just a few days shares have broken their bullish support, the 50-dma and the $80.00 mark on above average volume. The Point & Figure chart points to a $65 target. We see Thursday's decline as a new bearish entry point due to the bearish engulfing candlestick pattern. We would suggest shorts here under the 50-dma (78.31) but more conservative traders may want to wait for a move under $77.00 before initiating positions. Our target is the $71.50-70.00 range.

Suggested Options:
We are not suggesting new bearish positions at this time. Wait for a new move under $77.50.

Picked on March 09 at $ 77.44
Change since picked: + 1.91
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 755 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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Encana Corp. - ECA - close: 42.86 chg: +0.06 stop: n/a

Oil stocks could go either way next week. The OIX and OSX indices look ready to bounce from technical support at their 200-dma and 100-dma, respectively. Yet crude oil has fallen back toward support in the $59-60/barrel region and looks ready to slip even lower. Thus it really isn't a surprise that ECA churned sideways in a tight range on Friday halfway between resistance near $45 and support near $40. 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 positions in ECA.

Picked on January 10 at $ 45.56
Change since picked: - 2.70
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

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Loews Corp. - LTR - close: 95.04 change: +0.38 stop: n/a

Time is running out for our speculative, high-risk strangle play in LTR. We have five days left before March options expire. We are not suggesting new strangle positions.

Suggested Options:
We are not suggesting new strangle positions in LTR.

Picked on February 13 at $ 95.72
Change since picked: - 0.68
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 513 thousand

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Ryland Group - RYL - close: 65.71 change: +0.88 stop: n/a

Volume was a little bit stronger than normal on Friday's oversold bounce in RYL. We would not be surprised to see a bounce toward $68.00. 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 strangle positions in RYL.

Picked on January 22 at $ 75.19
Change since picked: - 9.48
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

None
 

Dropped Puts

Apple Computer - AAPL - cls: 63.19 change: -0.74 stop: 70.11

Target achieved. AAPL continued to sink on Friday and hit an intraday low of $62.45. Volume was above average on the decline. Our target was the $63.00-62.00 range.

Picked on March 05 at $ 67.72
Change since picked: - 4.53
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 31.1 million

---

Intl. Bus. Mach. - IBM - cls: 81.57 chg: +0.55 stop: 81.05

IBM is not cooperating with our put play. The stock is trying to breakout higher from its sideways consolidation. Shares are still struggling with resistance near $82.00 but the short-term trend has certainly grown more bullish. Our plan suggested buying puts if IBM traded at or below our trigger of $78.89 and that never occurred. We're choosing to drop IBM as a bearish candidate for now.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/18/06 (unconfirmed)
Average Daily Volume = 6.2 million
 

Dropped Strangles

Building Materials - BMHC - cls: 68.66 chg: +3.07 stop: n/a

Ouch! Friday's rebound in BMHC took a chunk out of the March put options. The stock is still trading under resistance at the $70.00 level but if the broader market indices continue higher next week then BMHC could rebound toward its 50-dma or merely churn sideways. Either action would spell doom for any remaining value in the March $70 puts (BGU-ON). More conservative traders may just want to exit here especially before the stock's 2-for-1 split coming on Tuesday. After the split BMHC's volatility will likely decline, which would further impede our chances for shares to sink low enough and allow us to exit near breakeven. This is the course of action we're suggesting - to exit now. More aggressive traders might want to keep the play open and cross their fingers for a big decline next week before option expiration.

Picked on December 18 at $ 80.95
Change since picked: -12.29
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand
 


Trader's Corner

Relatively Speaking, It's a Simple Indicator

While far from perfect, RSI, the relative strength indicator, remains a favorite indicator. Its calculation is relatively easy to understand and its use it, too. Some aspects of the indicator deserve more than casual attention, however.

A chart demonstrates some of those aspects.

Annotated Daily Chart of the Crude Contract for March Delivery:

The indicator's name sometimes causes difficulties because it suggests that strength is being measured relative to the strength of another entity. That's not true. On the chart of the crude contract, for example, RSI measures the strength of price action of that contract against its own past performance over 14 periods. Most traders refer to this indicator by its acronym, RSI, and this helps to avoid confusion.

As mentioned earlier, the computation proves easy. The explanation takes longer than the computation would. Although almost every charting service offers RSI and few traders will ever calculate it, an examination of the formula promotes a better understanding of how the indicator works and what it shows.

To calculate RSI, figures called "average gain" and "average loss" are first computed. These have been placed in quotation marks because their names are misnomers. For the purpose of calculating RSI, average gain equals (total gains over a period of n observations)/n, rather than total gains divided by the number of periods in which there were gains. Average loss equals (total losses over a period of n observations)/n rather than total losses divided by the number of periods in which there were losses.

A figure called RS is calculated by dividing the calculated average gain by the calculated average loss. Obviously, if prices are climbing, more periods produce gains, and RS is higher than if prices are dropping and more periods produce losses.

RS is used in the computation of RSI, with the formula as follows:

RSI = 100 - [100/(1 + RS)]

The larger RS is, the smaller that second term [100/(1 + RS)] will be. RSI will move closer to 100. The smaller RS is, the larger that second term will be. RSI will move closer to 0.

Most charting services then use a smoothing factor. Using 50 as a benchmark, traders can then determine that if RSI is above 50, average gains outstrip average losses and price action has a bullish tenor. If RSI is below 50, average losses outstrip average gains, and price action has a bearish tilt. RSI that squiggles around 50 tells traders that no trend has been established. Some traders are reluctant to enter a trade either direction with RSI chopping around near 50.

That smoothing factor mentioned in the previous paragraph is necessary because RSI can be somewhat jerky. One of the reasons that traders like this indicator is that it sometimes tends to lead price action more than other indicators might, but that also means that false signals sometimes occur, and the smoothing helps.

Because RSI sometimes leads price action but also sometimes gives false signals, few traders use RSI alone to signal trades. It offers a great heads-up that a trade may be developing, but its characteristics argue against entering trades based on RSI evidence alone.

Some traders tinker with the interval and overbought and oversold settings, depending on the security being watched or the presence of a trend. Although chart default settings for overbought and oversold levels are usually 30 and 70, traders can often reset them to 20 and 80 or even 10 and 90. Traders watching a stock, future or index that's trending higher might want to employ that 80 setting before prices are considered overdone to the upside, while traders watching a stock, future or index that's trading lower might want to use 20 before prices are considered overdone to the downside.

Annotated Daily Chart of the SOX:

An interesting article appeared in the February issue of STOCKS AND COMMODITIES. In that article, author David Sepiashvilli attacked the problem of creating a self-adjusting RSI that he claims adjusts itself to price movements across many periods. He uses a number of standard deviations from 50 as a benchmark of overbought or oversold conditions rather than using a number of points away from 50. He argues that when relying on a number of points away from 50 in the standard setup for RSI, periods lower than 14 often provide too many overbought or oversold readings while those longer than 14 may provide too few. RSI may narrow so much that no overbought or oversold readings are given if long intervals are chosen. His article describes the steps he used to develop his indicator and the way he uses it, for those interested in pursuing that option in more depth.

For the rest of us using the normally calculated RSI, further uses include identifying bearish and bullish divergences. Another peculiarity of the RSI is that its chart formations can sometimes be more important than its actual levels. To see what's meant by this, it's time to take a second look at that chart of the crude contract.

Annotated Daily Chart of the Crude Contract for March Delivery:

This last use of RSI makes it a favorite among many traders, including this writer. The neckline break on the RSI H&S provided the heads-up that matters were growing much more bearish. The subsequent price breakdown below the January 17 or 25 lows, or the retest that occurred on February 6, depending on trading style, would have been the price confirmation.

The same disclaimer that is appended to all articles about indicators can be added to this one. RSI offers a heads-up, and sometimes an early enough one that traders have time to prepare an entry plan, but that early signal comes with a price: false signals. This is particularly true, of course, of any countertrend signal that RSI might give. Don't use RSI alone as a reason to enter or exit a trade, but do use it as a tool to prepare trading plans and then to execute them if prices trigger an entry or exit according to your plan.
 

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

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