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Daily Newsletter, Saturday, 03/18/2006

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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

Bulls In Charge

The breakout over S&P 1297 came with a bang on Wednesday and while Friday's gain of +1.92 to 1307.25 may not have been exciting but it marked the sixth straight day of gains and a new 4.5-year high. The Dow added +26.41 to close at 11279 and the highest level since May 2001. The bulls charged out of the gate on Tuesday and right up to Friday's close they never looked back. Friday's gains may have been lackluster but it was a bullish confirmation that the indexes shook off a quadruple witching event and added to their gains.

Dow Chart - Daily

Dow Chart - Weekly

Dow Chart - Monthly

The last two weeks were interesting for stock watchers with the typical early March weakness limited to a drop of only -29 S&P points and that drop completely erased beginning on Monday. The negativity and caution from various economic reports translated into a wall of worry for the bulls. They scaled that wall with ease and even after a week of gains the bullish sentiment is still running rampant. The retail investor is back and funds are having trouble spending the money. Some small cap funds are closing because they have more money than they can spend. Individual investors are also adding funds to their accounts. Charles Schwab reported that it received $10.6 billion in new cash in February alone. Average daily trades at Schwab rose to 319,600 in February compared to 210,900 in February 2005. While this is still significantly lower than their high of 420,100 in 2000 it is still a huge improvement over just last year. If you have been trading long you probably realize that retail traders are normally the last into the market and this suggests trouble ahead. Not necessarily next week but in the long-term outlook.

This bull market is already very old in relative terms, 36 months as of March 12th. The S&P has risen +529 points or +65%, +3863 Dow points or +52%. Those numbers pale in comparison to the small caps and transports. The Russell rose from 343 to Friday's 746 close or +117% over the same period. The Transports exploded from their March 2003 low of 1918 to Friday's close of 4563 for a gain of +2645 points or +137%. By any measure of the market these are huge gains. Everyone knows that smart investing requires buying stocks when nobody else wants them such as in March of 2003 at the market lows. Using the Schwab numbers for comparisons they averaged only 153,400 daily trades for that period in 2003 and accounts were being closed by the thousands. Today with the markets breaking out to new 4.5-year highs and monster gains already in place those same traders are reopening accounts and putting hard earned money back into stocks at the highs.

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The current bull market at 36 months of age is right at the peak for an average bull, which lasts an average of 37 months using market data going back to 1942. There were 15 bull markets in that period with seven beating the averages with a length of more than 37 months. The longest was 60 months from 1982 to the crash in 1987. The second longest was the 52 month bull from April 1994 to July 1998 for a +170% gain. However, we know that the bear market that hit in July 1998 was news related and only lasted one month for a -20% drop. The dip was met with a rebound of monumental proportions to the March 2000 high of 1527 on the S&P and a +60% gain from the 1998 bottom. In retrospective it was really a 71-month bull and the longest on record with a monster event driven correction in the middle. That bull would have added +1089 S&P points for a +248% gain from the 438 low in April 1994 if you disregard that -20% correction in the middle.

What prompted that monster bull was a rising economy and the expectation that the Fed was going to stop raising interest rates soon. The Fed raised rates six times in 1994 and ended their hike cycle with a 7th hike in Feb-1995. The last four hikes were for +50 basis points or more with the Nov-1994 hike a whopping +75 basis points. The total for the seven hikes was +3.0% taking the Fed funds rate from 3.00% to 6.0%. This was to slow inflation and return to a neutral rate after 18 consecutive rate cuts starting in July 1990. The Fed cut rates from 8.0% to 3.0% over that period. The economy finally caught fire and the Fed had to push rates higher very quickly to offset the suddenly exploding economy. That produced the seven hikes in rapid succession starting in early 1994, which returned rates to neutral at 6.0%. It also created an environment where the economy could prosper and set the stage for the Y2K Internet bubble. Life was good and money was flowing.

That brings us back to today and the current market. The Fed lowered rates to 1.0% over 2001-2003 to counteract the devastation from the market bubble and the 9/11 attacks. For one year, June 2003 to June 2004 there were no changes as the economy built a base using that nominal 1.0% rate. Beginning in June 2004 the Fed began its "measured pace" removal of their economic stimulus program. When they meet on March 28th they will hike rates for the 15th consecutive time to 4.75%. Because of the slowdown in housing, autos and some of the recent economic reports most Fed watchers now expect only one more rate hike in May to bring the Fed rate to 5.0% and hopefully a neutral bias. The equity markets are focusing on the May meeting as the end of rate hikes and the all clear signal for the economy. There are some who believe there will be another hike at the June meeting but they are currently in the minority.

Fed watchers are hoping to get a clue on Monday night when Bernanke will give a speech at the Economic Club of New York. While everyone will be on pins and needles almost nobody expects any specific news. Deutsche Bank expects Bernanke to remain neutral to prevent a bias to the FOMC mindset ahead of the coming meeting. Lehman Brothers expects a balanced speech that reaffirms a March hike is likely but that subsequent moves are data dependent. Those are the keywords, data dependent. If Bernanke does use the data dependent phrase it will be seen as a potential halt to rate hikes in May. After a full week of economic reports the coming week is devoid of any material input for the Fed. They will make their decision on the basis of data already released. One exception could be the existing home sales on Thursday and the new home sales on Friday. We saw a firming of construction numbers on last Thursday signifying perhaps that the decline in housing may have found a bottom. If next weeks sales numbers confirm this then the Fed should be convinced to move again for added insurance. The Fed wants the housing bubble to cool but not burst. If sales fell sharply then the Fed could be convinced to quit with the March hike depending on the data.

I know I spent a lot of time on this today but it is really the key to the market focus for the next two weeks. Traders are looking back at the 1995-2000 rally and wishing hard for a repeat in some form. Since we do not have Y2K and the creation of the Internet to fuel the fires the expectations are much lower but still include a scenario where the Dow could retest its highs at 11750. That would be a stretch given the age of the current rally but entirely possible. Just keep in mind that only four times in the last 63 years has a bull market made it to its fourth birthday. Thomson financial believes we may have another year left on the bull despite 2006 being what they believe is the last year of double-digit earnings in this economic cycle. Q4 earnings are over except for a few stragglers, Oracle and Morgan Stanley report next week, and the Thomson estimate is +14.1% growth for Q4. That will be the 10th consecutive quarter of double-digit growth for the S&P according to Thomson. S&P, which calculates operating earnings differently than Thomson claims this will be the 15th straight quarter of double-digit growth and an all time record. However you calculate it the recent numbers have been strongly influenced by the massive gains in the energy sector. According to Thomson Q4 earnings ex-energy were only +8.5% AND are expected to fall to +6.0% in Q1. For comparison Q1 earnings in 2005 ex-energy was +11.2%. Overall earnings in Q1 are expected to be only +10.3% and the smallest gain since Q2-2003.

The farther you go in an economic expansion the harder it is to post earnings growth. You may remember for most of 2003-2004 earnings were rising more than +20% per quarter. This was due to the depressed earnings results post 9/11 that provided easy comparisons as the economy began to recover. Strong cost cutting measures during the 2001-2002 recession provided a strong base for a rebound as companies streamlined operations after the bubble burst. Since oil prices broke over $25 a bbl in early 2003 companies have seen costs pushing steadily higher but their ability to raise prices at the consumer level has been hampered by slow wage growth. With expectations for consumer spending to slow in 2006 the ability to raise prices will continue to be nearly nonexistent. For example earnings growth in the healthcare sector is expected to be only +3%. This has been a strong performer but they have priced themselves out of the market until consumer incomes catch up. The consumer staples sector is expected to grow by only +4% due to slower consumer spending. The basic materials sector including chemical manufacturers are actually expected to drop -7% due to higher raw material costs. Copper hit a new all time high on Friday at $2.36 due to rising demand and rising transportation expenses. Copper is a key component in nearly every manufactured item other than clothing and plastics. Industrials are expected to drop to +12% growth from +17% in Q4 with tech companies posting +15% growth down from +17%. Thomson is projecting overall earnings growth to be +14.9% in Q3 and +12.8% in Q4 driven mostly by the energy sector and financials. Q4-2006 should be the end of the double-digit streak and the beginning of a period of flat growth.

The current market gains appear to show that investors are pinning their hopes that those earnings will continue through Q4-2006 and the hopes that the Fed halts their hike cycle in May. The question for traders is simply how much longer do they expect this bull market to last? Investors typically look six months into the future and that takes us to September. Given the still decent earnings expectations for Q4 we could stretch the market gains for another couple months under optimum conditions. The end of Fed hikes would provide fuel for that continued move. However that only gets us to May just in time for a sell the news event after the May 10th Fed meeting. Remember the adage "sell in May and go away." While that six month trading strategy has not been especially accurate the last couple years we have been in a bull market. While we don't see any evidence of crutches today the bull is in the twilight of its life and will eventually die. Can it make it to four years and March of 2007? I would bet against it but we could easily have a couple more months before the pallbearers begin to appear.

Consumer spending is going to be the key. I read last week that there is $2 trillion of adjustable rate consumer mortgages which will reset to current rates over the next 18 months. Because of the extremely low short term interest rates we saw back in 2003 some of those mortgage payments could rise as much as +50%. Citigroup estimated as many as one million of the 1.4 million loans affected would have to be terminated either by sale or foreclosure. Mortgage delinquencies rose last month to 4.70% from 4.44% with adjustable rate and sub prime loans driving the increase. That may not sound like much but it represents 1,936,400 loans more than 60 days overdue. Since the majority of borrowers opting for the risky adjustable rate mortgages were trying to qualify for more house than they could afford the tidal wave of foreclosures could be huge. If they live in a market where housing prices have not fallen they could get out alive by flipping the property and downsizing to a more affordable home. However, many areas of the country have seen prices decline and homeowners may end up taking a hit to escape the pain. The bottom line to this scenario is a depression in consumer spending. Those staying in their mortgage will have a significantly higher payment and less discretionary income. Those bailing out for a loss will be tagged with a different type of payment but the piper will still have to be paid. Those unable to escape the debt and opting for bankruptcy or foreclosure will also have less cash and less credit. Another funds drain is the lack of home equity financing due to tighter credit standards and falling home prices. Those with a habit of borrowing against their equity will find the well drying up and less able to borrow for new consumer purchases.

In addition to the home equity ATM running out of cash we have the new restrictions on credit card bills. The new minimum payment rules are going into effect forcing borrowers to pay a minimum of 1% of their principal plus interest every month. Some banks, Citibank, Bank of America and MBNA for example, are raising the minimums from 2% to 4% per month. The rules were announced in January of 2003 and gave lenders/borrowers two years to make the transition. Of course most waited until the last minute to take advantage of collecting the most interest possible from John Q. Public. Many lenders fear that this will be the tipping point for many consumers where just getting by will be a real challenge. The average consumer has eight major bank cards and twice that amount if you add in department stores and gas cards. Average family credit card debt is reported to be around $10,000. That average must take into account anyone warm and breathing from newborns to age 100 because I don't know anybody with less than $10K in card debt. Most are well over that level. You would not believe the number of credit card rejections we get for subscriptions every month. It always boggles my mind that we have so many subscribers to an investment newsletter whose cards will not authorize for a monthly subscription fee. I believe the new payment rules will take enough cash out of consumer pockets that it will be readily observable in the economy. It does not take any stretch of the imagination to predict what a doubling of all the monthly credit card payments in the U.S. will do to a population used to spending more than they make.

Adding to the consumer problems this summer will be higher gasoline prices. New rules for gasoline formulation are going into effect that will make gasoline and diesel more expensive to refine and reduce the number of refiners capable of producing those products. That price increase will be passed on to the driving public. This is in addition to whatever price oil is trading at due to geopolitical concerns. Oil rebounded from last week's drop to $59.25 and appears comfortable in the $63 range just under resistance. Once the refineries finish their maintenance cycle and begin drawing down crude supplies again that resistance at $63.75 could easily be broken. In a discussion of the oil scenario on Friday several analysts predicted $60 would be the new floor due to increased geopolitical risks. Nigeria was at the top of the list due to the increasing amount of rebel activity. Damaged installations are being repaired slowly and the rebels are still making threats about future attacks. The new civil war in Iraq is threatening to disrupt the flow of the 1.5 mbpd currently trickling out of that country. Saudi Arabia is under increased terrorist alert after the failed bombing a couple weeks ago. It is only a matter of time before an attack is successful. Saudi can prevent 99 out of 100 but the terrorist only needs one success to create a major disruption. The Iran problem is in diplomatic limbo and there is not likely to be a positive resolution. The tone of commentary coming out of Iran is becoming harsher with each passing day. Last but not least is Venezuela. It now appears the threat to oil production from VZ is not going to be from VZ but from the U.S. side. Chavez is running for reelection and there are rumors making the rounds that the U.S. may put some sanctions in place to apply pressure in hopes of having him defeated. If the U.S. does start applying pressure to Venezuela then Chavez will likely fight back with his oil card. Chavez has also pledged to support Iran with like cuts if Iran plays its oil card. Either way there is a growing risk that future shipments from Venezuela could be in jeopardy.

The top five oil exporters in the world in order are Saudi Arabia, Russia, Norway, Iran and Venezuela. I was originally going to say that exports from four of the five could be disrupted at any time due their political instability but Norway also falls into that group as well. Elections in Norway in Sept 2005 ended a nearly 20-year reign by a conservative coalition. In September the Labor party, headed by Jens Stoltenberg, seized control of 60 of the 169 seats in Parliament. In order to strengthen his hold on the government he reached out to the far left "Socialist Left" party and the agrarian "Center" party to form a coalition controlling a majority of the seats in Parliament. Because of the substantial differences between the three groups there has been dissention and there are threats of strikes in the energy sector. That makes it official that oil output from all of the top five exporters is in daily danger of disruption. Achieving a stable flow and a stable price under these conditions will be virtually impossible. Count on higher prices as the summer driving season progresses.

Crude Oil Chart - Daily

I am not trying to paint a negative picture of the markets or the economy but every once in awhile we do need to step back and take a look at the longer term view. Currently the economy appears to be thriving. GDP for Q1 is widely expected to be over +5% growth. Jobs are improving and inflation while at the high end of the acceptable range but apparently cooling. Banks and financials are soaring on the possibility of an end to the rate hikes. Homebuilders have also rebounded strongly with six days of strong gains after the homebuilder index ($HGX.x) hit a four month low last week. The transportation sector is on fire despite the price of oil hovering just under $64. The Dow Transport index jumped nearly +250 points from the 4352 low on the 8th to Thursday's high of 4597. That is a +5.6% jump in just one week and a new historic high. The railroads are powering the sector due to the higher cost of diesel and the lack of truck drivers. Union Pacific raised its estimates on Tuesday from 80-90 cents to $1.00-$1.10 for Q1. Analysts had expected 89 cents. UNP jumped +$7 on the news and provided a lift for the entire sector. In later interviews with various transportation executives the outlook for the sector was always very strong. The railroads appear limited only by a lack of rail cars. Manufacturers of cars, Greenbrier (GBX), Trinity (TRN) and FreightCar America (RAIL), all have substantial backlogs with no slowdown in orders. UPS and FDX are battling it out in the global package-shipping arena and both continue to gain share in a market that is far from saturated. The FDX chart has been nearly vertical since Feb-3rd on the strength of strong earnings. Even the airlines have found favor with investors as they remove in-flight services and pack travelers even closer together. The post 9/11 fears have evaporated and American traveler is on the move again.

From the viewpoint of a casual investor the road ahead appears paved with gold and profits are falling from the sky. Memories are returning of the late 90s bull market where buying any stock on any dip produces a profit. Those same investors have forgotten the pain inflicted when that scenario changes suddenly. Let's keep that memory at the front of our subconscious as 2006 progresses. Every craps shooter eventually sevens out and the streak comes to an end. The points I outlined above are just signposts along the way. When this bull finally dies we can look back and see the roadmap clearly. Until then most retail investors will don the rose colored glasses that filter out the road signs with only the lure of dollar signs to lead them ahead. I will continue to remind you periodically to remove those glasses and adjust your vision.

The market action last week was very bullish. The Dow rallied within 10 points of 11300 and managed to hold that level on Friday despite a quadruple witching. This is very bullish in my view since investors have not shown much conviction over the last few months. December and January were volatile but remained in a relative narrow trading range as the gains from the October rebound were consolidated. In late February the Dow broke out of its range to test 11150 but the historical early March weakness blunted that effort and knocked us back for consolidation of those gains. Once it was evident that investors were not going to let 10950 break the bulls rushed in and a +300 point gain appeared. The complete lack of profit taking on Friday convinced me that this breakout is for real. We are only a week away from a Fed meeting and a little more than two weeks from the start of Q1 earnings. Investors appear confident that the news will be good in both cases and the sudden appearance of conviction was surprising. Stocks making new 52-week highs soared to 721 on Thursday and 534 still managed to make new highs on Friday. These are the strongest numbers in many months.

The S&P finally broke the 1297 barrier and sprinted another +13 points to top out at 1310 on both Thursday and Friday. Still, there was no selling and it closed at 1307. This is very bullish but the index is moving into a area of heavy congestion from the 1999/2000 period. 1300 to 1500 is going to be a game of inches rather than long yardage days. The S&P traded in that 200-point range for nearly two years so don't expect it to be a cakewalk ahead.

SPX Chart - Monthly

The biggest challenge of the week was the Nasdaq. It continued its rally off last weeks lows at 2240 and topped out once again at 2323 and the same level that held it back in early March and mid January. This is no coincidence since 2328 was also the resistance high back in May 2001 and support turned resistance from mid 1999 as well. Getting over 2330 will be a challenge and a very big accomplishment when it happens. I mentioned on Tuesday that the biggest problem for the Nasdaq was the SOX and its two-week decline to support at 500. We saw a rebound off that support on Tuesday but it was short lived and eventually broke on Thursday. That 500 level is now resistance and it could be formidable. Intel broke below $19.50 on Friday to make a new two-year low but that was not the incentive for the SOX break. The real anchor on the SOX turned out to be a warning by Kulicke and Soffa (KLIC) that knocked them from $11.27 on Wednesday to a close at $8.81 on Friday. Their warning was seen as an indictment of the entire semi sector with diverse stocks like AMAT, BRCM and TXN all taking a substantial hit. Even the better than expected semi book-to-bill number at 1.01 failed to provide any lift. This was the first time since August 2004 that orders surpassed billings. The SOX closed at 496 with next support in the 480-485 level. The drop in the SOX weakened the Nasdaq just as it approached that 2328 level and sapped the momentum it needed to make a decent breakout attempt.

Nasdaq Chart - Weekly

Nasdaq Chart - Daily

Semiconductor Index Chart - Weekly

Meanwhile the Russell shook off the chip dip and rebounded to close at a new historic high at 746. This is phenomenal given the -30 point drop, which started on March 5th. It appeared somebody wanted out of small caps in a hurry and that three-day dive was painful. However, it corresponds almost exactly with the drop in oil prices and makes a compelling argument on how much the Russell is impacted by energy stocks. The chip dip was barely noticeable in comparison. Note the charts below.

Russell and Oil chart - 30 min

The NYSE Composite also closed at a new high and only a handful of points off its intraday peak. The chart correlation between the NYA.x and oil is also amazing. The Wilshire 5000 also clawed its way to a new high and as the broadest index of market strength it is painting a bullish picture. The Wilshire does not have a lengthy chart pattern in terms of time and as such has no prior resistance to chart. It does however mirror the S&P 500 very closely only ten times the index value. This suggests the same 13000-15000 level is going to be tough hiking. The Wilshire 5000 closed at 13174 on Friday and right at the top of its historical channel.

Wilshire 5000 Chart - Weekly

As we enter next week the potholes could start with Bernanke's speech on Monday night and continue with the PPI on Tuesday. Most analysts expect the PPI to be tame and the more important bit of economic news to be the home sales numbers on Thr/Fri. Here is a clue about the homebuilder sector. On Friday the CEO of William Lyons Homes (WLS) offered $93 a share to buy the company. The stock was trading at $75 at the time. If the homebuilding sector was in real trouble would you offer to buy the company now or wait for the expected hard times ahead? I know, dumb question. The offer by the CEO tells me that orders and projections are still strong and the current weakness is temporary. The market is telling us the same thing since the price of the stock zoomed to more than $100 after his $93 offer. Evidently the market believes there are better times ahead as well. WLS was trading at a PE of 5 based on 2007 projected earnings before the offer. We have heard a lot about the bursting housing bubble. If this is proof of anything in the market it suggests the economy is strong and homebuilders are about to post another amazing recovery. If the housing numbers next week are positive it may push the Fed to hike again in May but it will also confirm to investors that the bull is not ready for the slaughterhouse just yet. Heck, another week or two of gains and I will have to resurrect my signature close of "Sell Too Soon."
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
VRTX BSTE None
  GCI  

New Calls

Vertex Pharma - VRTX - close: 40.56 chg: +1.07 stop: 37.49

Company Description:
Vertex Pharmaceuticals Incorporated is a global biotechnology company committed to the discovery and development of breakthrough small molecule drugs for serious diseases. The Company's strategy is to commercialize its products both independently and in collaboration with major pharmaceutical companies. Vertex's product pipeline is principally focused on viral diseases, inflammation, autoimmune diseases and cancer. Vertex co-promotes the HIV protease inhibitor, Lexiva, with GlaxoSmithKline. (source: company press release or website)

Why We Like It:
VRTX presented at a conference this past week and the company revived the rally and interest in the company's hepatitis-C drug. The hepatitis-C drug isn't new news but investors certainly seem enthusiastic about its possibilities. On a technical basis shares of VRTX have a habit of bouncing from its rising 50-dma and the stock seems to have a lot of upward momentum. VRTX also have a decent amount of short interest. The latest data puts short interest at 8.7% of its 96 million-share float. We could be witnessing another short-squeeze. We're going to suggest bullish positions with VRTX above round-number resistance at the $40.00 mark. Our target will be the recent highs in the $44.00-44.50 range.

Suggested Options:
We are going to suggest the April calls.

BUY CALL APR 35 VQR-DG open interest=2150 current ask $6.20
BUY CALL APR 40 VQR-DH open interest=8785 current ask $2.60
BUY CALL APR 45 VQR-DI open interest=2016 current ask $0.80

Picked on March 19 at $ 40.56
Change since picked: + 0.00
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 1.5 million
 

New Puts

Biosite Inc. - BSTE - close: 50.21 chg: -1.45 stop: 52.55

Company Description:
Biosite Incorporated is a leading bio-medical company commercializing proteomics discoveries for the advancement of medical diagnosis. The Company's products contribute to improvements in medical care by aiding physicians in the diagnosis of critical diseases and health conditions. Biosite's Triage rapid diagnostics are used in approximately 50 percent of U.S. hospitals and in more than 50 international markets. (source: company press release or website)

Why We Like It:
BSTE spent most of 2005 in a very wide trading range. That changed in January. Some bearish analyst comments about the company's earnings and business sent BSTE gapping lower and falling out of its trading range. Since then the stock managed a rally on its earnings report but the rally has stalled under the $55.00 level. That was just enough for BSTE to fill the gap from January. Now shares are sinking and technical indicators are bearish. If BSTE trades under $49.00 it will produce a new P&F chart sell signal. We're going to suggest a trigger at $49.75 to buy puts since the $50.00 mark is acting as round-number support. The $49.00 level is also support and more conservative traders may want to wait for a breakdown under $49.00 before initiating positions. Our target will be the $45.25-45.00 range.

Suggested Options:
We are suggesting the April puts.

BUY PUT APR 50 BQS-PJ open interest=1039 current ask $2.15
BUY PUT APR 45 BQS-PI open interest= 374 current ask $0.70

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/25/06 (unconfirmed)
Average Daily Volume = 261 thousand

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Gannett Co Inc. - GCI - close: 59.04 chg: -1.53 stop: 61.76

Company Description:
Gannett Co., Inc. is a leading international news and information company that publishes 91 daily newspapers in the USA, including USA TODAY, the nation's largest-selling daily newspaper. The company also owns nearly 1,000 non-daily publications in the USA and USA WEEKEND, a weekly newspaper magazine. Gannett subsidiary Newsquest is the United Kingdom's second largest regional newspaper company. Newsquest publishes more than 300 titles, including 17 daily newspapers, and a network of prize-winning Web sites. Gannett also operates 21 television stations in the United States and is an Internet leader with sites sponsored by its TV stations and newspapers including USATODAY.com, one of the most popular news sites on the Web. (source: company press release or website)

Why We Like It:
Newspaper stocks are headed toward new lows. The industry has seen its stocks sink for several months now. Friday saw major stocks in the industry sprint lower after some negative comments from Moody's investors service. Here's a quote from an AP article, "Fundamentals in the newspaper sector will remain weak for the foreseeable future," Moody's said. "Of particular concern is the continuing downward trend in circulation and intensifying competition from online rivals." Moody's also said they were considering a downgrade for their credit rating on Tribune (TRB) and the New York Times (NYT). Shares of GCI did not respond well. GCI had already been struggling under resistance at its 100-dma and trend of lower highs. Friday's breakdown below support at the $60.00 mark was fueled by above average volume and looks like a new bearish entry point to us. We are going to target a decline into the $55.50-55.00 range.

Suggested Options:
We are suggesting the April puts.

BUY PUT APR 60 GCI-PL open interest=919 current ask $1.95
BUY PUT APR 55 GCI-PK open interest=205 current ask $0.30

Picked on March 19 at $ 59.04
Change since picked: + 0.00
Earnings Date 04/12/06 (confirmed)
Average Daily Volume = 1.1 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cummins Inc. - CMI - cls: 107.80 change: -0.26 stop: 102.49

The overall pattern for CMI remains bullish but short-term the stock might be suggesting its ready for a pull back. CMI has been rising in a channel for weeks now and its MACD indicator on the daily chart is nearing a new buy signal. Yet some of the short-term oscillators look overbought from last week's rally. Friday's pull back saw the stock bounce twice from the $107.25 level. However, we don't expect this level to hold if the major indices see any profit taking next week. Watch for a dip toward the $105 level, which should be stronger support, as a new bullish entry point. Our short-term target is the $109.75-110.00 range. The $110 level looks like short-term resistance but more aggressive traders might want to set their target higher.

Suggested Options:
We are not suggesting new bullish positions at this time. Watch for a bounce from the $105 region.

Picked on March 13 at $105.25*gap higher*
Change since picked: + 2.55
Earnings Date 04/20/06 (unconfirmed)
Average Daily Volume = 867 thousand

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Hartford Fin. Srv. - HIG - cls: 82.60 chg: -0.56 stop: 79.95

The trading action in HIG on Friday doesn't look good for the bulls. The stock has produced what looks like a bearish engulfing candlestick pattern and a failed rally at its simple 50-dma. Put the two together and signs definitely point to a bearish reversal. We would expect shares to consolidate lower toward last week's support near $81.00 or technical support at its 200-dma near $80.00. Weighing on shares of HIG was news from rivals AIG and STA. Thursday night AIG reported earnings that missed analysts' estimates. Meanwhile there were stories/rumors that STA was considering a merger with a European company. Normally one might think merger news (to be acquired) would be good for the stock but shares of STA closed lower on Friday. If you consider this earnings news from AIG and the reaction in shares of HIG then more conservative traders may just want to exit early right here to limit their losses. We are not suggesting new plays. The two potential entry points we will be watching for is a bounce from $80.00 or a move over $84.00 (and its 50-dma). Our target is the $87.50-90.00 range.

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

Picked on February 14 at $ 82.12
Change since picked: + 0.48
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 1.1 million

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Hydril - HYDL - close: 73.86 change: -1.53 stop: 69.49

Oil stocks pulled back on Friday following a decline in crude oil prices. We believe this is probably just normal profit taking after a week of gains. Shares of HYDL were looking a little short-term overbought after its rebound from the 200-dma. We remain bullish on HYDL but shares could be ready for a minor consolidation. Watch for a dip into the $72.00-70.00 range as a new bullish entry point. Our target is the $77.50-78.00 range.

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

Picked on March 12 at $ 70.23
Change since picked: + 3.63
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 289 thousand

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ITT Industries - ITT - close: 55.92 change: +1.18 stop: 51.69

The bullish breakout continues in shares of ITT. On Tuesday last week ITT broke out from a six-month neutral pennant-shaped pattern of higher lows and lower highs. The stock has seen a very strong follow through with volume coming in above average on the four-day rally. This is all very positive and so far ITT doesn't show any signs of slowing. However, nothing goes up in a straight line and the stock is looking a little short-term overbought. We need to prepare ourselves for a little consolidation in ITT. Of course the stock could surprise us and post another gain on Monday with the potential of hitting our target in the $57.00-58.00 range. We're not suggesting new bullish positions in ITT at this time.

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

Picked on March 15 at $ 53.84
Change since picked: + 2.08
Earnings Date 04/28/06 (unconfirmed)
Average Daily Volume = 1.4 million

---

Macerich Co. - MAC - close: 74.34 change: +0.52 stop: 69.95

Perfect! MAC has filled the gap from Thursday morning and traders bought the dip on Friday with shares rebounding higher on above average volume. This looks like a new bullish entry point in MAC. Our target is the $79.00-80.00 range. The Point & Figure chart is bullish with a double-top breakout buy signal pointing to an $87 target.

Suggested Options:
We would suggest the April or June calls.

BUY CALL APR 70 MAC-DN open interest= 7 current ask $5.40
BUY CALL APR 75 MAC-DO open interest=49 current ask $2.00

BUY CALL JUN 70 MAC-FN open interest=27 current ask $6.40
BUY CALL JUN 75 MAC-FO open interest= 7 current ask $3.20

Picked on March 16 at $ 74.05
Change since picked: + 0.29
Earnings Date 05/16/06 (unconfirmed)
Average Daily Volume = 371 thousand

---

Altria Group - MO - close: 73.55 chg: -0.35 stop: 71.85

We are growing more wary of the relative weakness in shares of MO. The stock has been down fractionally the last three days in a row. Short-term technical oscillators are turning bearish. We would watch for a bounce from the $73.00 level as a new bullish entry point or more conservative traders can wait for a new move over $74.50 to buy calls again. The P&F chart remains bullish and points to a triple-digit target for the stock. Our target is the $77.50-78.00 range.

Suggested Options:
We are not suggesting new bullish plays at this time. Watch for a bounce from the $73.00 level.

Picked on March 14 at $ 74.11
Change since picked: - 0.59
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 8.1 million

---

Silicon Labs - SLAB - close: 47.81 change: +0.23 stop: 45.95

This has been a volatile week for the semiconductors. On Monday the SOX semiconductor index finally dipped toward round-number support at the 500 level and technical support at the 100-dma. Tuesday saw the SOX rebound sharply from this support. Wednesday the index failed near its descending 10-dma. Thursday the index crashed under support after KLIC issued negative comments that sank the sector. Friday saw the SOX try and bounce but failed at old support, now new resistance, at the 500 level. Meanwhile Intel (INTC), the largest chip stock, continues to sink to new two-year lows. Before Thursday's bearish reversal in the group we were expecting a bit more of a rebound and SLAB looked like a good candidate to catch any strength in the semiconductor sector. Thus far SLAB is holding on to its bullish pattern with an intraday bounce on Friday from rising support at the 50-dma. However, we are going to stick to our plan and wait for a breakout over resistance near $51.00. We're suggesting that readers use a trigger at $51.05 to buy calls. If triggered we will target a rally into the $54.90-55.00 range. More aggressive traders may want to target the $58.00-60.00 range. Should SLAB close under its 50-dma we'll drop it as a bullish candidate.

Suggested Options:
We are not suggesting new bullish positions at this time. Watch for the breakout over resistance.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 1.2 million

---

Sunoco Inc. - SUN - close: 79.61 change: -1.76 stop: 74.99

A pull back in crude oil on Friday sparked some profit taking in the oil sector after a week of gains. SUN was not excluded and lost just over 2%, which almost erased the gains from Thursday. We would have expected the $80.00 mark and broken resistance at the 100-dma to act as new support. Unfortunately, they did not act as support and SUN may dip back toward the $77.80-77.50 level before trying to rebound. We are not suggesting new bullish positions at this time. Wait for a new move over $80.25 before considering new calls. More aggressive traders might want to buy a bounce from the $77.50 region. More conservative traders can wait for a breakout over the 50-dma (near $82). Our target is the $87.50-90.00 range. More conservative traders may want to plan an exit near $85.00, which could act as round-number resistance. The Point & Figure chart is bullish with a $96 price target.

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

Picked on March 16 at $ 80.26
Change since picked: - 0.65
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 2.4 million

---

Toyota Motor Corp. - TM - close: 108.20 chg: +0.27 stop: 104.75

Our relative strength/momentum play in TM is still creeping higher. The stock is struggling a little bit with resistance in the $109.00 region but the pattern remains bullish. TM has a history of bouncing from its rising 50-dma and its MACD on the daily chart has produced a new buy signal. We are not suggesting new positions at this time but should TM bounce from the $107.50 level again traders could use the move as a new entry point. Our target is the $112.50-115.00 range. Traders with a longer-term horizon may want to aim higher.

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

Picked on March 12 at $106.68
Change since picked: + 1.52
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 438 thousand

---

Valero Energy - VLO - close: 57.86 change: -0.66 stop: 53.49

VLO felt the same profit taking that hit shares of SUN (see above). After a week of gains the stock was ready for a consolidation. Watch for a dip to and a bounce from the $57.00 level or the 50-dma near $56.50 as a new bullish entry point in VLO. Our target is the $62.50-63.00 range. Thursday's move over $58.00 has produced a new P&F chart buy signal that points to a $72 target.

Suggested Options:
We are not suggesting new plays at this time. Should VLO produce another entry point we'd choose calls from April or June strikes.

Picked on March 15 at $ 57.55
Change since picked: + 0.31
Earnings Date 05/02/06 (unconfirmed)
Average Daily Volume = 10.7 million
 

Put Updates

None
 

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.)

---

Encana Corp. - ECA - close: 47.94 chg: -0.17 stop: n/a

We have a month left before April options expire. For this strangle play in ECA to be a success we need to see the stock rise to more than $53.50 or fall to under $36.50. Currently the stock is flirting with a breakout over its five-month trendline of resistance. 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: + 2.38
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

---

Ryland Group - RYL - close: 70.53 change: +1.22 stop: n/a

We have one month left before April options in our RYL strangle expire. For this play to work out we need to see RYL trade under $63.00 or above $87.00 by April expiration. The stock has obviously been leaning toward the put side but the homebuilders have produced a strong rebound over the last week. More conservative traders may want to plan an early exit to recoup some trading capital. 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 plays in RYL.

Picked on January 22 at $ 75.19
Change since picked: - 4.66
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

None
 

Dropped Puts

KB Home - KBH - close: 67.28 chg: +0.54 stop: 68.05

Bullish comments from William Lyon Homes (WLS) and a strong market reaction helped fuel another day of gains for the homebuilders. KBH hit our stop loss at $68.05 closing the play.

Picked on March 06 at $ 64.75
Change since picked: + 2.53
Earnings Date 03/22/06 (confirmed)
Average Daily Volume = 1.9 million
 

Dropped Strangles

Loews Corp. - LTR - close: 100.05 change: +0.09 stop: n/a

Our high-risk, speculative play in LTR did not work out. The earnings report in mid February did not produce a big enough to reaction and when shares of LTR finally began to move they did not breakout from its trading range in time.

Picked on February 13 at $ 95.72
Change since picked: + 4.33
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 513 thousand
 


Trader's Corner

Overdone Moves

When is selling overbought indices or buying oversold ones a bad idea? Many traders trying to short indices or stocks over the last three years would answer, "More often than you might think."

My own research has confirmed the truth of that answer. Breakout plays on Donchian channels sometimes perform better when oscillators such as stochastics indicate that the movement is already overdone.

Annotated Daily Chart of the OEX:

Breakdowns out of the Donchian channels also tended to perform better if stochastics were pinned at levels signaling that prices were overdone to the downside.

A recent article discussed overbought and oversold levels. Depending on the market being watched and the time frame in which it's watched, stochastics' oversold and overbought levels are sometimes indicated at 30 and 70, or perhaps 20 and 80. Most charting services set them by default at 30 and 70.

My own observations and those of many would-be bearish traders over the last several years confirm that it's not always a good idea to assume that a trend reversal is in the making when those overbought or oversold levels are reached. Instead, as Richard Donchian and others have proposed, trading in the direction of the trend often proves more lucrative, and that often means buying in the face of overbought indicators and selling in the face of oversold ones. An Internet search of trend-following tactics turns up any number of sites willing to enroll new subscribers and provide them with their proprietary trend-following signals.

The thrust of this article is different. This article's intention is to help traders, particularly newbie traders, identify those times when it's dangerous to act on overbought or oversold signals. The article focuses on keeping traders out of trouble rather than getting them into trades.

When prices continue to bounce from a key moving average (MA), overbought oscillator signals should probably be ignored except to warn those in long plays to protect profits. Overbought conditions can be worked off by sideways movement or even by a temporary slowing of upward momentum, but profit-protecting plans of course need to be in place in case prices plunge.

Annotated Daily Chart of the SPX:

After stochastics had signaled extreme overbought levels, a first bearish warning was given when there was a bearish cross of the stochastics line. Bearish divergence had been created, when comparing the September and early November stochastics highs. Traders who jumped in with a bearish trade suffered through a few days of choppy sideways trading into the rising 10-sma before the SPX bounded higher again and stopped them out of their plays. Neither the overbought readings nor the bearish divergence produced a significant downturn. The trend remained intact. As long as moving average support was being maintained, bearish trades did not prove to be a good idea.

One chart exhibiting a long-term uptrend is that of Boeing (BA). While moving higher, the company's stock price has maintained the support of the weekly 50-sma. In addition, BA's weekly chart--prepared as of March 15--demonstrates many other warning signals that, despite overbought setups, a reversal should not be assumed.

Annotated Weekly Chart of BA:

BA's chart exhibits many of the signs that warn that only adept traders should have acted on a stochastics sell signal for the last three years. Those warning signs of an intact trend include prices that still bounce from a key moving average, prices that bounce from a rising trendline or rising regression channel's support, and prices that do not retrace below the last consolidation zone's top resistance line. If any or all of those conditions exist, then traders should consider sell signals generated by stochastics or other oscillators suspect. As is clear above, swing traders might have benefited from bearish plays when BA pulled back from the top of the rising regression channel to retest the supporting line, but even that pullback could not be assumed. Last summer's coiling move required some skill to know when to get in and exit in order to capture any profit.

The previous examples have all concerned rallies, but the same cautions should apply when prices trend lower.

Annotated Daily Chart of GM:

As these charts have demonstrated, trusting oscillator evidence alone can be a risky endeavor, especially when that evidence suggests a countertrend move. Neither divergences, bearish or bullish crosses, extreme levels or any of the other typical oscillator signals is enough to prove that a trend is about to reverse. Entering countertrend plays on such oscillator signals can deplete trading accounts.

A first task for any trader, then, is to identify when a trend remains intact. The charts in this article have illustrated some signs. When a key moving average continually serves as support or resistance, the trend remains intact. The same is true of support or resistance from rising regression channels or trendlines. Prices that never pull back below previous resistance or bounce up past previous support show that uptrends or downtrends remain intact.

When these signals exist, knowledgeable traders avoid countertrend plays or limit position size when they enter such plays. Let price prove that a trend reversal is underway. Those who do otherwise risk shorting a rallying market all the way higher or buying the dips all the long time a market drops.
 

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

DISCLAIMER

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

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