Option Investor

Daily Newsletter, Thursday, 04/06/2006

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Table of Contents

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

Market Wrap

A Little Fear Went a Short Way

With the nonfarm payrolls number tomorrow morning, the market still worries about what it perceives the Fed will do with this data. It needs to be a Goldilocks number so that neither the bears nor the bulls feel they have one over the other. The number needs to leave both sides guessing how the Fed will react to that number. So today was put on hold until we get past that number. Actually, it seems like the whole week, make that 3 weeks, the market has been on hold. I don't know about you but I'm ready for a break, literally. And now if the market will make a break perhaps we'll have something other than this ugly chop to trade.

Today was a quiet day all around so there's not much to tonight's Wrap. We'll go over the charts and I'll finish up my discussion that I started on Monday to review the Gann Wheel, or Square of Nine chart, and show some real-life examples at how useful this chart can be for identifying potential support and resistance and turn dates.

Today's lonely economic report was the jobless claims data. Initial claims fell by 5K to 299K, once again putting it underneath the 300K level that is considered a good sign for job strength. Last year at this time the number was 346K. Economists were expecting an increase of 1K so this drop came unexpectedly. The 4-week average of initial claims also fell by 2,750 to 308,500. This number suggests we'll see a payroll gain of more than 200,000 and a further decline in the unemployment rate. The market is expecting the payrolls number to be 190K, a drop from February's 240K. So 200K would probably be the Goldilocks number. Much higher than that and the bond market will probably sell off (yields up) on concerns the Fed will be aggressive about their rate-tightening path.

Continuing jobless claims fell by 22K to 2.44M and the 4-week average remained at a 5-year low of 2.455M (as compared to 2.663M a year ago). Again a drop in the continuing jobless claims number could be a sign of tightening in the labor market which would result in wage inflation. Real wages have been steadily dropping since 1998 so we certainly can't have wage increases (smirk). Obviously if we start to see wage inflation though, that will be passed along through price increases of products and services which would boost inflation. Of course they've been worried about the same thing with higher energy prices. Corporations have enjoyed their greatest profitability, as a percent of GDP, since 1966. I think they can afford to raise peoples' wages.

Gold got some attention today by breaking the $600 mark, a level not seen since 1981, when it was on its way to $850. Metals in general rallied today--silver hit another new 22-year high of $12.15. I'm not sure when the ETF is coming out for silver (SLV) but you can bet when it does, we'll see a good sized correction in silver. Same thing happened to gold after its ETF came out. Plus silver has been on a parabolic spike since February and these never end well. In order to sell shares in SLV, physical metal must be on hand to back up the shares and that has created a lot of recent demand. If too much silver has been purchased and then later released to the market to balance demand for SLV with the actual metal on hand, we could see a sharp pullback in the metal. Buyer beware if you're thinking of investing in SLV. Wait for the correction.

Copper also hit a new all-time high and this is normally very bullish for the market since it's typically a sign of industrial and home building needs and shows a strong manufacturing sector. It could also be due to the U.S. dollar starting to break down which is inflationary for the commodities. In other words we may have some other factors at work here that could be skewing the prices of commodities. If the Fed is creating a lot of new money (we don't know for sure what they're doing anymore since they stopped reporting M-3 and repos), and there's no reason to believe they're not still creating lots of money, then that is inflationary for commodities. In fact they've been creating money at a hyperinflationary rate for a long time now, which shows up in our markets as excess liquidity, all while jawboning the market about how vigilant they are about inflation in the economy. Well they should be! They're creating the inflationary pressures.

Initially depressing the market somewhat this morning was the slew of March sales reports from retailers, most of whom disappointed. The colder temperatures and the timing of Easter in April both got the blame. Higher gasoline prices and a slowing housing market were also blamed--expect to hear this line a lot in the near future. Almost 60% of 50 of the largest retailers came in below, some well below, market expectations. But it didn't hurt the sector--it ran flat for much of the day and closed in the green.

DOW chart, Daily

Decision day tomorrow. Either the DOW will break above resistance as I've depicted on this chart (maybe with a quick pullback first), or it's going to drop hard to its October uptrend line, currently near its 50-dma at 11062. Any break below 11K could spell serious trouble for the market. But until that happens, and assuming we continue to push higher I have several upside targets between 11400-11500 for a major high. Hopefully we'll see that into our turn window next week (we entered the window yesterday).

SPX chart, Daily

Similar story to the DOW--tomorrow could be important. I depict a break out of the 3-week range we've been in (by rallying, and sticking, above 1310). I have a few upside targets starting with 1325 and then 1335 and 1345. It takes a break below 1294 that would be a heads up that we may have seen a high and a break below 1287 (50-dma) to confirm it.

Nasdaq chart, Daily

Another index, a similar pattern. Notice that they're all ascending wedges and these continue to portray bearish things just ahead. Obvious a break above 2400 that sticks would be very bullish but until then that level should cap an new rally leg. It takes a break below its 50-dma and October uptrend line at 2294 to suggest we've already seen the high.

QQQQ chart, 240-min

The QQQQ, and SOX below, give the most bearish impression from an EW perspective. As shown here, QQQQ jumped up to the top of what could be a bear flag. A pullback into a sideways/down consolidation would be bullish. A drop below 41.50 would be a heads up that something could be wrong with the rally potential. Based on this chart I would not want to be long tomorrow.

SOX index, Daily chart

While the daily chart of the SOX looks bullish, having rallied and closed above its 50-dma there are a couple of concerns I have. One, the SOX didn't have full participation of the rest of the techs as measured by NDX and the COMP. The generals (INTC, IBM, MSFT) are still notably absent. Short term the SOX looks extended which portends a pullback tomorrow.

SOX index, 60-min chart

A closer view of the rally in the SOX shows a break above its relatively flat parallel up-channel and ran into the top of its steeper up-channel. This is why I'm thinking a pullback here. If there are more bullish things ahead of the SOX I would expect to see support around the top of the old channel, 515, hold. If this got an early pop tomorrow morning I'd be real tempted to short it. That depends on what the broader market is doing at the same time.

BKX banking index, Daily chart

The techs might look ready for a pullback but the banks look ready to rally. A brief pullback in the morning could be an opportunity to buy the market based on this index. Unfortunately we have a large difference in the pictures of the techs (and small caps) and the blue chips. Possibly we'll see more tub sloshing tomorrow as money abandons the smaller high-beta stocks and runs to the safety of the blue chips for the final rally leg into next week (that's what I'm currently thinking anyway).

On Monday I introduced the concept of the Gann Wheel, otherwise known as the Square of Nine chart. Basically it's a squared circle with numbers starting with 1 in the center and then spiraling out and continuing the count as far as you'd like. Here's a simple one:

Gann Wheel

I also provided a link to one I built using a spreadsheet which you can see at this link -- http://keene.little.googlepages.com/gannwheel -- I like to use the one on the spreadsheet because it's easier on the eyes and I can also "rotate" the dates around by changing the starting date at zero degrees which then automatically updates the rest of the dates. If you missed the introduction to this you can read it in this past Monday's Market Wrap. Tonight I want to finish this intro with a couple of examples and I'll use the larger chart and SPX values to show how it works. I'll then give some projections for the DOW and the COMP as well.

Looking at the prices inside the chart find 789, which was the low on March 12, 2003. Here's a little snippet of the section of the chart with 789 and the surrounding values to help with this exercise:

Section of Gann Wheel with 789, the March 2003 low

It's a little harder to do on the chart with the dates fixed as compared to changing it on the spreadsheet but basically by moving 90 degrees around the circle from that date gives me June 11, 2003. And then 180 degrees gives me September 10, 2003 and 270 degrees gives me December 10th, 2003. Those dates were potential turn dates as the year progressed and would have given you a heads up to watch for a turn. We never know which direction it will turn, or even for sure if it will turn, but as I said it gives a heads up. Going back to look at 2003 we see a high was made on June 17, 2003 which was 4 trading days beyond the 11th. There followed a pullback into the August low from there. The next date, September 10, 2003 saw a minor pullback but didn't really give us anything. Then December 10, 2003 marked the low of a small pullback and the market accelerated form there into the January 2004 high.

This acceleration of a move is another possibility that needs to be watched for. We look for potential turns on these dates but the opposite could also happen--an existing trend (up in this case) can accelerate from the turn date so obviously one has to be cautious about what these dates could mean. Now looking at the price level of 789 on the chart we see that it is on the 325 degree radial and looking at prices around the circle in that ring we see that the numbers don't even get over 1000, which is where the market had rallied to before its first turn date in June 2003.

So moving out on the rings we look for the numbers on the 55 degree radial (90 degrees from 325), 145 degrees, 235 degrees and then back to 325 degrees. This gives us the numbers that are 90, 180, 270 and 360 degrees from 789. So after 906, which is one ring out or 360 degrees, we move out from there to the next successive rings (another 360 degrees for each ring) and get 1031 at 720 degrees, and then 1164 and 1305 in the 3rd and 4th rings out. If we had been tracking this at the time, once SPX rallied above 1000 the next number of interest was 1031. Hopefully I explained it well enough to follow that. It so happens that 1031 was the high on September 8th, 2003 which was the date (-2 days) that was 180 degrees from March 12, 2003. So we had a date and a price level that "resonated" off the low of 789 on March 12, 2003. As that date and price level approached we would have been on guard to watch for a potential turn (or acceleration).

We could look at some other dates and price levels around the chart to see what other dates and prices we could have been watching at the time to see if a potential turn was in store. But now let's fast forward to October 13, 2005. The low on that day was 1168, only 4 points from 1164 which again resonated off that 789 low in March 2003. Look at the March 2006 highs--we've been struggling under 1310, only 5 points from the 1305 which is the next number 360 degrees out from 1164. By the way, the next number, 360 degrees from 1305, is 1454. I know a few bears who shudder at the thought of that level being reached. But isn't it amazing that these levels resonate off that March 2003 low this way, 3 years later and a whole lot of price movement since that time.

Now let's start with the 1168 low on October 13, 2005, and we find it on the 340 degree radial. Going 90 degrees at a time around the circle we get 70, 160, 250 and back to 340 degrees. When I go to the chart and follow the ring that contains 1168 and follow it around to those degrees we get 1202, 1236, 1272 and 1309. After that 1168 low these would be the values to watch to see if the market would find resistance at them. Looking at the daily chart of the SPX we can see it smoked up through 1236 in November but then stalled out around 1272 for November's and December's highs (1271-1275). Next up is 1309 and notice where price has been stalled lately--1310.

Looking at the calendar dates around the circle, 90 degrees from October 13, 2005 is January 12, 2006, and then 180 degrees is April 13, 2006. Looking at SPX we see it topped on January 11, 2006 at 1295 and pulled back to the February low. We had a date (January 12th) that warned us of a potential turn and as we rallied into that date, we would have guessed at the time that it would mark a high and not a low (or again, could have been the start of an accelerated move higher). The next date of interest per the Gann Wheel is April 13th which is a week from today. Oh by the way, it's also a full moon on that day.


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The other degree measurement to use is 1/2 of the 90 degrees which of course is 45 degrees. Smaller moves often resonate off these 45 degree marks (the COMP in particular which I'll point out in a bit). So, if we move 45 degrees from 1309 to see where the next potential turn level might be, we get 1325. Moving around 90 degrees from 1309 gives us 1345. Therefore 1325 or 1345 are the two next price levels to watch if we get a rally into next week, especially if it looks like it might happen around April 13th.

I had mentioned at the beginning of this Gann Wheel introduction that it doesn't matter what you use on this--it's the relationship between the numbers that matters. So if we plug in the DOW values (dividing the DOW by 10 and finding the number on the chart), we find that the October 13, 2005 low was 10,156 so we'll use 1016 on the chart. This is on the 295 degree radial. If we go 270 degrees around the circle to the 205 degree radial we get 1114 which is DOW 11,140. The February high and the pullback into the end of March have been working around this 11140 level. Continuing to 360 degrees (one ring out) we have 1147 or DOW 11,470. It's not inconceivable to think we could rally to that level in a week.

The COMP has had smaller moves and therefore I'm using 45 degree increments to see which levels we might want to watch on that index. The low on October 13, 2005 was 2026. I'll divide this by 10 to use 202-203 on the chart, which is between the 345 and 350 degree radials. Moving around the circle to get close to our current price I see 2315 at 180 degrees around and then 2380 at 225 degrees around (180 + 45). The highs of the consolidation in January through March were right around 1315. The next potential high we could look for resistance by the Gann Wheel is then 2380. Interestingly that's also where I have a Fib projection based on two equal legs up from the January 3rd low--at 2382 and is also near the top of its ascending wedge pattern as shown on the COMP chart above. It's hard to make this stuff up.

So, we have SPX 1325, maybe as high at 1345, DOW 1l470 and COMP 2380 all on the radar screen for potential highs and this is why I've been saying if we see a rally up to these levels some time next week I'd be looking for a market top, or at least a multi-week to multi-month pullback. As I had also mentioned in my Wrap on Thursday, March 30th that there is a cluster of Fib dates that creates a April 5-11 window where we can expect a possible market turn. We're of course now in that window. Based on the Gann date of April 13th, I'd open up that potential turn date window through the end of next week. Friday, April 14th is Good Friday and a market holiday so it could get interesting between now and then. We've got our levels and we've got our dates and now we'll watch to see what sets up.

Moving on to housing, I noticed a little news piece yesterday about 2nd homes. Sales of second homes increased by 16% in 2005 to a record 40% of all U.S. housing sales. Sales of vacation homes rose 16.9% to a record 1.02 million, while sales of homes owned for investment purposes increased by 15.7% to a record 2.32 million. While this speaks of the strength of the baby boomers and their desire to have 2nd home, or investment home, the worrisome thing about this that those are the homes that typically get dumped fast in an economic slowdown. That could obviously have a depressing effect on home prices in general. But so far the index is holding up.

U.S. Home Construction Index chart, DJUSHB, Daily

The bounce off the low in March continues to look corrective (overlapping highs and lows) and makes me think bear flag here. It could top out around the 200-dma at 944 or even up to a 62% retracement at 955 but I continue to believe the next big move in this index will be down and a fast break below 800.

Oil chart, May contract, Daily

It took a long time but I've finally swung over to Jim's opinion on the shorter term (2006) pattern for oil. The consolidation we've been insce last September looks like it's building an ascending triangle. This pattern calls for another test of $70 (may not get there) and then a pullback that could take us into the end of May (just in time for a bottom on Memorial Day). But that last pullback is the one that should set up the next rally leg to new highs. Summer driving, certainly the end of summer, could be very expensive if this plays out. And I suspect it would finally kill growth in the economy.

Oil Index chart, Daily

I don't like this pattern for the oil index because of my opinion what the broader market will do (big decline) and I'm not sure how the oil stocks could rally without broader market support. So we'll either get only a relatively minor pullback in the broader market and then another rally high into the end of the summer, or else the oil stocks will not follow oil. This one is a big question mark for me at this time but so far it's better to be long the oil stocks than short. That's a big change for me this week. Now that Jim and I are both on the same side your realize of course that that means bombs away soon on this index (grin). A break below 540 would be bearish so until then, stay bullish (but expect a pullback with oil).

Transportation Index chart, Daily

Never Say Die. I think James Bond is in there somewhere. This has to be close now but of course I've been saying that since January/February. This is a classic example, with all those bearish divergences in place for the last 6 months, that the market can remain irrational far longer than you can remain solvent fighting the trend. If my wave count is correct, we've been in an "extended 5th wave" since the January low. This is typical of a blow-off top and the typical projection for this is 162% of wave-1. That gives us an upside target of 4771.50 so that's the level I'd watch for resistance. This is really really close now :-)

U.S. Dollar chart, Daily

After breaking below its longer term uptrend line I redrew the one from last September since it could be the bottom of the sideways triangle that's been playing since then. That's hard to say but the way this is drawn it says we should see the dollar bounce now. Upside resistance would be the downtrend line from November, currently near 90.50. If the dollar does rally back up, it will probably result in a pullback in commodities.

Gold chart, April contract, Daily

Gold closed above $600! Now what? I see the possibility for a little higher, perhaps 605-610 but then the pattern calls for a steeper pullback. If this is only wave-1 up from the March low, we should see a pullback stay above its 50-dma, currently near 563. If this leg up from March finishes the rally from July (which is the way I have labeled), we'll get a multi-month pullback from here probably down at least the low 500's.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow will be busier than today as far as economic reports go. As long as the numbers come in close to expectations there probably won't be much of a reaction. The big one of course is the payrolls number as discussed at the beginning of this report. If the number were to come in significantly higher than 200K, the market wouldn't like that. It would mean companies are growing and have been hiring more people so that's a good thing right? Wrong. It would spook the Fed, who is now in data-dependent mode, into thinking we could see wage price pressures and therefore inflationary pressures. That would probably tank both the bond and equity markets. If the number is really weak, signifying a slowing in hiring, and therefore a weaker economy, that would be bad so it would be good. Silly people.

Sector action and market breadth were not helpful in that they mirrored today's market. Sectors were equally split with the leaders of the red group the biotechs, airlines, healthcare, utilities and pharmaceuticals. Sort of a mixed bag there. Leaders on the green side were gold and silver, SOX, computer hardware and other technology, and securities brokers. Again, a mixed bag but a relatively strong showing by the tech leaders, or the NDX. The COMP was in the red. The small caps came in at the flat mark.

One internal measure of the market, new highs vs. new lows for the NYSE, remains a concern. The number of new 52-week lows has trended up since the January 3rd low even while the NYSE has continued to press higher. Today saw a strong spike up in the new lows, to 71, well above the previous number of about 50 seen at previous LOWS not highs like we're seeing now. This is an important heads up that we're probably seeing rotation out of a number of stocks as the Boyz continue to unload their inventory during rallies. This week we've seen the number of new 52-week highs dropping off a little bit even while the NYSE makes new price highs. We're seeing the same thing in the declining advance-decline number which is negatively divergent against the new price highs. Buyer beware here.

But I think we could be set up for another rally leg and if I've got this figured out, with the help of EW analysis and Gann analysis as reviewed above, we should be on the last leg up into next week. I'm just hoping the economic reports don't derail that tomorrow. But even if we pullback hard tomorrow, the larger pattern calls for a resolution higher and so far the timing looks good for next week for a major market high. It's obviously too early to count our chickens (as far as thinking of a shorting opportunity) but if you're long the market it could be days before we see a top.

Be careful tomorrow--I wouldn't be a bit surprised to see the Boyz take the market in one direction after the open only to reverse it hard within the first 30-60 minutes. This would catch the most people on the wrong side and help propel the market in the direction they want it to go. I'm hoping we'll see an early pullback (not much) that gets reversed and finally breaks to new highs. Just be careful of the whipsaws. Keep an eye on the bond market as well. Today's 10-year yield hit a Fib projection that satisfies an EW count for the current rally which would call for a deeper retracement in yields (bond rally). That would probably be deemed bullish by the equity market. Good luck and I'll see you on the Monitor.

New Plays

New Option Plays

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

New Calls

Beazer Homes - BZH - close: 68.78 chg: +0.53 stop: 64.74

Company Description:
Beazer Homes USA, Inc., headquartered in Atlanta, is one of the country's ten largest single-family homebuilders with operations in Arizona, California, Colorado, Delaware, Florida, Georgia, Indiana, Kentucky, Maryland, Mississippi, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Texas, Virginia and West Virginia and also provides mortgage origination and title services to its homebuyers. (source: company press release or website)

Why We Like It:
It might seem a bit odd to consider bullish call positions in a homebuilder in a rising interest rate environment. The yield on the 10-year bond has risen sharply lately and that's putting pressure on mortgage rates, which have risen to levels not seen since 2003. Yet historically speaking mortgage rates remain relatively low. Plus, there have been renewed comments that the Fed might be nearing the end of its tightening cycle. We also recently entered the spring/summer building and selling season for homes so maybe investors are counting on a few strong quarters from the builders. Several stocks in the group appear to have built an inverse or bullish head-and-shoulders pattern and they're all on the verge of breaking out above resistance at the neckline of this pattern. BZH is one such stock and today's gain looks like a breakout. We are going to suggest calls here but the 100-dma (near $69.00) and the $70.00 mark could still offer resistance so more conservative traders may want to wait for a move over $70.00 before initiating positions. Currently the P&F chart points to an $87 target but if BZH can trade over $69.00 it will produce a new triple-top breakout buy signal. We are going to target the $74.50-75.00 range. However, please keep in mind that this will be a short-term play. We do not want to hold over the April 27th earnings report.

Suggested Options:
We are suggesting the May calls but we plan to exit on April 26th to avoid holding over earnings.

BUY CALL MAY 65.00 BAD-EM open interest= 483 current ask $6.10
BUY CALL MAY 70.00 BAD-EN open interest=1539 current ask $3.20

Picked on April 06 at $ 68.78
Change since picked: + 0.00
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 1.2 million


Marvell Tech. - MRVL - close: 60.18 change: +2.21 stop: 54.99

Company Description:
Marvell is the leader in development of storage, communications, and consumer silicon solutions. The company's diverse product portfolio includes switching, transceiver, communications controller, wireless and storage solutions that power the entire communications infrastructure including enterprise, metro, home and storage networking. (source: company press release or website)

Why We Like It:
The SOX semiconductor index has reversed course. After a five-week consolidation pattern the semis have rebounded and now the SOX index is breaking out over the 520 level and technical resistance at the 50-dma. Strength in the sector is helping fuel as rebound and a breakout in MRVL. The stock spent about three weeks consolidating between $54.00 and $58.00 and now shares are breaking out on rising volume. The technical picture is positive and today's high-volume move is a breakout over the $60.00 mark and its 100-dma. We also like the Point & Figure chart, which looks very bullish for MRVL and currently points to a $73 target. We are suggesting bullish positions above $58.00 and our target is going to be the $65.50-66.00 range. The next level of resistance appears to be $66.50-67.00.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 55.00 UVM-EK open interest=4335 current ask $7.40
BUY CALL MAY 57.50 UVM-EY open interest=2156 current ask $5.80
BUY CALL MAY 60.00 UVM-EL open interest=4951 current ask $4.40
BUY CALL MAY 62.50 UVM-ES open interest=2652 current ask $3.30

Picked on April 06 at $ 60.18
Change since picked: + 0.00
Earnings Date 05/25/06 (unconfirmed)
Average Daily Volume = 5.9 million

New Puts

None today.

New Strangles

None today.


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