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Daily Newsletter, Tuesday, 03/21/2006

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Table of Contents

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

Market Wrap

Faded Glory

The rally to new multi year highs over the last ten days finally rested on Tuesday. The market shine of new high glory faded as the indexes retreated from intraday highs and returned to lows not seen in a week. While it sounds grim the selling was calm and reserved despite its persistency. The Dow only lost -39 points according to the closing ticker. That would seem to be non-threatening for the bulls but in reality it was slightly worse. The loss was more significant if you count the evaporation of the +57 point intraday gains in addition to the -39 point close making a -96 point drop from the new intraday high at 11334. The -19 on the Nasdaq and -7 on the S&P both carry similar intraday losses.

Dow Chart - Monthly

Nasdaq Chart - Monthly

The markets were mixed on Monday in advance of the Bernanke speech and while the speech provided no excuse to rally the markets opened higher on Tuesday but only barely higher. It was not until some strong buy programs hit the futures pits at 11:30 that the markets began rising sharply. The buy programs sent the Dow, Nasdaq, S&P, Russell, Wilshire 5000 and the Dow Transports to new multi year highs. Only the NYSE Composite failed to join the party. The intraday spike to those new highs failed and the resulting drop produced what is called a negative outside day and suggests there could be more selling in our future.

The morning economics provided no reason to rally and traders were at a loss as to why the buy programs appeared. The only major piece of economic news was the Producer Price Index or PPI. The headline number posted a huge drop of -1.4% in the price of finished goods. On the surface this would appear to be good news for the inflation hawks. This was the sharpest drop in the last three years. However, as you know the headline number does not always tell the story. The core rate excluding food and energy actually rose +0.3% for finished goods and +0.5% for intermediate goods. This rapid rise in core inflation was in addition to a +0.4% gain last month in finished goods and a larger +1.0% gain in intermediate goods. The positive impact of a falling headline number was trumped by the core rates.

This put the Bernanke speech back in focus with the next FOMC meeting only a week away. Despite his attempt to explain away the current low long-term interest rates the outlook for the Fed is for further hikes in rates. The rising core rate of inflation is a key signal for the Fed and after last nights speech the majority of analysts are still thinking we will see 5.0% in May and possibly higher. Bernanke offered several scenarios that could lead to a lower Fed rate and halt to rate hikes. None of those scenarios are readily apparent today. The various Fed heads have taken up the new mantra of "data dependent" instead of the tired "measured pace" phrase. If we are truly going to be data dependent for future hikes once a neutral position is achieved then everyone is eagerly awaiting that neutral position, which is commonly expected to be 5.0%.

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Bernanke said a lower rate could become neutral if falling yields are really signaling economic weakness ahead. Nobody will admit to this being the case and cite other reasons for the abnormal yields. The number one reason given was treasury buying by foreign central banks and the shortage of bonds for sale. While I am sure the government is going to sell some more notes to continue financing the deficit there is actually competition for those debt instruments. Bernanke said in this environment the very flat yield curve was not signaling a recession ahead. His speech did not give traders a reason to buy or sell stocks, as it was very balanced ahead of next weeks meeting. If anything it produced some selling in bonds because it was so neutral. The yield on the ten-year note jumped from 4.646% to 4.729% on strong selling after the speech. This almost erased the sharpest drop in the last six months we saw last week. Buy the rumor, sell the news.

Now that Bernanke and the PPI are behind us the markets are left to focus on the housing data coming on Thursday and Friday. If the Fed is going to be data dependent this is the next piece of material economic data ahead of their meeting on Tuesday. The data will probably not impact their decision for next week but sets up the next meeting in May as the critical end point.

The sectors showing the most weakness today were those with the biggest recent gains and those interest sensitive issues. The homebuilders continued their swoon that started on Monday after a six-day rally. Clearly traders were taking profits ahead of the monthly numbers due out later this week. The incentive for the early exit was the jump in the ten-year rates. The brokerage sector gave up early gains and several brokers closed back on critical support with a negative setup for tomorrow. Lehman (LEH) would be an example with a loss of -$3.27 to support at $142.

Chart of Lehman - 30 min

Speaking of brokers the portfolio manager for Merrill with $570 billion in stocks under management said today that the economy is going to slow due to slowing consumer spending. This was the same train of thought I tried to convey in my Sunday commentary. His advise to investors was to overweight energy stocks. I like this guy more every day. He said despite the decline in oil prices this week the price of oil should continue to hold at these high levels and continue to produce profits for the energy companies. Most of the oil companies are trading at extremely favorable ratios. For instance Conoco has a PE of 6.26 on a trailing basis. Despite soaring prices for energy stocks last year their profits have risen even faster leaving their valuations very low.

While on the topic of oil prices I want to comment on Monday's drop. I believe it was purely expiration driven. The current April contract ceased trading today and May became the current contract. We saw prices soar into Friday's close just under $64 as options expired. We saw the actual price of oil crash on Monday as traders still long bailed out rather than be forced to take delivery. It is one thing to speculate in oil futures but an entirely different matter to be faced with taking delivery of the product. The April contract closed at $60.40 and the May contract was two dollars higher at $62.30. It was simply a matter of expiration and delivery manipulating the prices. Once we see how the new May contract trades this week we will have a better idea about the future of oil prices heading into the summer. Support on the May contract is $61.25 and resistance at $65.50. For comparison purposes the December contract, post hurricanes, summer driving and winter heating demand, closed at $66 today. As in options trading the more time you buy the more expensive the premium.

April Crude Chart - Daily

May Crude Chart - Daily

December Crude Chart - Daily

China bought a lot of time today with three different deals for Russian oil and gas. It will take a long time for them to reap the rewards because of the time needed to build pipelines but it was a major agreement for Russia to supply oil and gas to China's hungry horde. I would rather see China and Russian fighting it out over energy a decade from now rather than have China imposing its will on Canada or Mexico. Let the two bullies trade blows and we can watch from afar. Remember, Putin likes free markets anywhere else but in Russia. He recently hiked prices of natural gas and then cut off that gas when the consuming countries threatened not to pay. Cutting off oil/gas supplies to China would have dire consequences.

The SOX was a major factor in the Nasdaq today as a large block of those early morning buy programs targeted the chip stocks. This appeared to rescue the SOX from its two days of sideways trading under 500. The rally sent the SOX from 497 to just over 510 but the hang time was very brief. The decline was about as rapid as the ascent with a close right back at its 497 start. Intel heads the problem list for the SOX. Intel is expected to miss estimates when they announce earnings on April 19th and the stock declined to a new two year low of $19.39 on Friday. Today's buy program spike added a buck intraday, a +5% spike, but it was almost completely erased before the close. INTC traded 124 million shares and +50% more than the current 80 million daily average. This scenario was repeated across the other leading chip contenders as shorts were stopped out and then reinstated their positions. Unless something positive happens soon the Sox is going to lose its grip on 500 and begin targeting real support back at 450. This would be very detrimental to the broader market.

SOX Chart - Weekly

Microsoft Chart - Weekly

After the close today Microsoft announced their new Windows operating system expected out this year would now be released to consumers sometime in 2007. This is the new Windows product codenamed "Vista" and the one the hardware makers were hoping would produce a new wave of PC buying. Hardware makers had hoped it would be out in time to spark that new buying during the holiday season. The new release will contain an updated user interface, better security features and a new search tool for finding information stored on your PC. The product was expected to power Microsoft's next round of profits and the delay will force analysts to lower earnings estimates for 2006. MSFT shares dropped nearly a buck in after hours trading and should give the markets a negative push at tomorrow's open since hardware makers and chip suppliers will also trade down on the delay.

Tuesday's spike and retracement had all the earmarks of a blow off top or climax spike. This is typically seen when a rally runs out of steam and traders park sell orders just over the prior highs in hopes of maximizing profits on longs and switching to the short side for a potential correction. With earnings warning season upon us there is more potential for downside risk than upside surprise. The guidance given with the Q4 earnings was weak in many cases and traders are probably not very confident that Q1 earnings will be strong. This sets up this week as a soft spot with nothing to provide guidance but warnings and guessing about next week's Fed meeting. For three days the indexes have struggled only minutely higher and todays buy program spike provided the entry point the shorts were looking for.

I showed you on Sunday that the Dow was trading just below the resistance from 1999-2001 between 11328-11418. This is a very strong resistance level and a likely place for more consolidation until the Fed actually halts the rate hikes. Today the Dow hit 11334 and triggered sellers waiting at the beginning of that resistance band.

The same was true with the Nasdaq and the touch of 2332. That was the previous high of the year from Jan-11th and both days were just four points over the May-2001 resistance high at 2328. This was a critical level and the breakout failed. The same thing was true of the S&P at just over 1310. For four days the S&P has struggled at 1310 resistance and only -4 points under the 1315 resistance high from May-2001. Today the S&P spiked +11 points intraday to break 1310 one last time and set a new 4.5 year high by less than half a point before crashing back to earth with a close at 1297.

SS&P Chart - Weekly

SPX Chart - 60 min

These spikes to new highs and subsequent failures back to lower lows produced a negative outside day and a technically negative bias. Whether the markets will follow that bias or fight back on strong dip buying remains to be seen. Given the strong rally off the early month lows the odds are strong that the negative bias will continue. There is simply nothing visible on the horizon for Wednesday to provide positive momentum. Because of our stall at 1310 and Monday decline the morning buy programs could have been tailored to trigger short covering in hopes of breaking the stalemate with a move higher. Instead the spike gave shorts a perfect entry point and a nice sled ride down. I would continue to maintain a negative bias until proven wrong. The S&P has light support at 1295 but the Microsoft news has already depressed the futures to that equivalent level in overnight trading. A break of 1295 could see another -10 point drop or more before support returns around 1280. This is a throwaway week ahead of the Fed meeting and three weeks before Q1 earnings begin. This is a week for earnings warnings and some potentially market moving housing data on Thr/Fri. I would not be in any hurry to get long again until after the FOMC meeting. The exception to that would be to buy the dip in energy in hopes that traders switching to the May contract provide lift for energy prices.
 


New Plays

New Option Plays

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

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cummins Inc. - CMI - cls: 105.32 change: -2.85 stop: 103.85*new*

Watch out! The sell-off in CMI began to pick up speed midday after the stock produced a failed rally near $108.00 around 12:00 noon. The breakdown under $106.00 and its simple 10-dma is short-term bearish. More conservative traders may want to exit early right now and protect their capital or at least raise their stop loss. We are not suggesting new bullish positions at this time. Please note that we are adjusting our stop loss to $103.85. If we get stopped out we can always watch for a bounce from $102 or its 50-dma as a new entry point.

Picked on March 13 at $105.25*gap higher*
Change since picked: + 0.07
Earnings Date 04/20/06 (unconfirmed)
Average Daily Volume = 867 thousand

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Hartford Fin. Srv. - HIG - cls: 82.05 chg: -0.79 stop: 79.95

We see no change from our previous updates on HIG. The stock is struggling under its 50-dma. Odds are very good that HIG will retest support near $81.00 and probably test support at its 200-dma near $80.00. We are not suggesting new bullish positions but we are watching for a bounce from $80.00 as a potential entry point. Should HIG trade under our stop loss investors might want to consider short-term bearish positions.

Picked on February 14 at $ 82.12
Change since picked: - 0.07
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 1.1 million

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Hydril - HYDL - close: 72.76 change: -0.79 stop: 69.49

Oil stocks closed relatively unchanged today but the OIX and OSX oil indices and shares of HYDL all have similar failed-rally patterns given today's bearish reversal in the market. We are not suggesting new bullish positions in HYDL. More conservative traders may want to exit early. We do expect that HYDL will pull back and test support near $70.00 and its 100-dma.

Picked on March 12 at $ 70.23
Change since picked: + 2.43
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 289 thousand

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ITT Industries - ITT - close: 56.01 change: -0.34 stop: 51.69

Conservative traders may want to jump out early in ITT right now. The stock has produced a small bearish engulfing reversal pattern today. Now we will agree that ITT is short-term overbought and due for a pull back. Profit taking here would be normal. Yet traders should ask themselves, "do you want to exit now with a small gain and consider re-entering again later or hope that ITT bounces from support near $54.00?" The overall pattern remains bullish on ITT and the current rally has been fueled by above average volume, which is also bullish. We would watch for a bounce near $54.00 as a new bullish entry point.

Picked on March 15 at $ 53.84
Change since picked: + 2.17
Earnings Date 04/28/06 (unconfirmed)
Average Daily Volume = 1.4 million

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Macerich Co. - MAC - close: 72.99 change: -0.64 stop: 69.95

MAC is still consolidating sideways although shares display the same ominous failed rally pattern so prevalent across the market in today's session. We are not suggesting new bullish positions at this time. Wait for a new move over $74.15 before considering buying calls.

Picked on March 16 at $ 74.05
Change since picked: - 1.06
Earnings Date 05/16/06 (unconfirmed)
Average Daily Volume = 371 thousand

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Altria Group - MO - close: 72.46 chg: -1.13 stop: 71.85

Bulls should be careful here. Shares of MO turned sharply weaker midday and this marks the fifth day in its current consolidation phase. The problem we have is that if MO continues to consolidate lower toward tested support at its simple 200-dma (near 71.44) the stock will hit our stop loss at $71.85. More aggressive traders may want to increase their risk and widen their stop placing it under the 200-dma (say 70.99). More conservative traders may want to inch their stop loss closer to the $72.00 level to take them out earlier if MO continues to sink tomorrow.

Picked on March 14 at $ 74.11
Change since picked: - 1.68
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 8.1 million

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Silicon Labs - SLAB - close: 47.70 change: +0.06 stop: 45.95

SLAB tried to rally today and actually traded above round-number resistance at the $50.00 level for a brief moment. Unfortunately, SLAB could not escape the bearish reversal in the semiconductor sector. We remain on the sidelines. 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.

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

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Toyota Motor Corp. - TM - close: 109.10 chg: -0.01 stop: 104.75

We do not see any change from our previous update on TM. The overall pattern remains bullish and TM shares remain above resistance at the $109.00 level. Our target is the $112.50-115.00 range. Traders with a longer-term horizon may want to aim higher.

Picked on March 12 at $106.68
Change since picked: + 2.42
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 438 thousand

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Valero Energy - VLO - close: 56.83 change: +0.08 stop: 53.49

VLO is certainly faring better than its rival SUN. The stock managed to close in the green but shares still produced an intraday failed rally. We are not suggesting new bullish positions in VLO at this time. Our target is the $62.50-63.00 range.

Picked on March 15 at $ 57.55
Change since picked: - 0.72
Earnings Date 05/02/06 (unconfirmed)
Average Daily Volume = 10.7 million

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Vertex Pharma - VRTX - close: 37.95 chg: -2.24 stop: 37.49

VRTX's upward momentum has failed. We are suggesting that traders run for the exits. Weighing on the stock is the BTK. The BTK biotech index broke down today out of a two-week trading range and the BTK index closed under its simple 50-dma. Shares of VRTX still have technical support at their rising 50-dma (37.30), which it has not broken in many months, but to test the 50-dma the stock would hit our stop loss at $37.49. More aggressive traders may want to widen their stops. We are not suggesting it.

Picked on March 19 at $ 40.56
Change since picked: - 2.61
Earnings Date 04/26/06 (unconfirmed)
Average Daily Volume = 1.5 million
 

Put Updates

Biosite Inc. - BSTE - close: 50.30 chg: -0.61 stop: 52.55

We are surprised that BSTE did not show more weakness today given the 1.9% sell-off in the BTK index. BSTE did produce a failed rally today but shares are still clinging to the $50.00 level. We are suggesting 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.

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: 59.12 chg: +0.31 stop: 61.76

Reversal alert! GCI has produced a bullish engulfing candlestick, which tends to forecast a bullish reversal. We would not suggest new bearish positions at this time. Watch for the stock to fail near $60.00-60.50 before considering new positions.

Picked on March 19 at $ 59.04
Change since picked: + 0.08
Earnings Date 04/12/06 (confirmed)
Average Daily Volume = 1.1 million
 

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: 46.12 chg: +0.27 stop: n/a

We do not see any changes from our weekend update on ECA. 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.

Picked on January 10 at $ 45.56
Change since picked: + 0.56
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

---

Ryland Group - RYL - close: 67.64 change: -1.12 stop: n/a

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.

Picked on January 22 at $ 75.19
Change since picked: - 7.55
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

Sunoco Inc. - SUN - close: 76.18 change: +0.81 stop: 74.99

We have been stopped out of SUN at $74.99. Of course Murphy's law is alive and the stock quickly rebounded since shares are testing the bottom of its trading range. Yesterday's "sell" rating downgrade didn't help matters.

Picked on March 16 at $ 80.26
Change since picked: - 4.08
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 2.4 million
 

Dropped Puts

None
 

Dropped Strangles

None
 

DISCLAIMER

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

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

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