Option Investor

Daily Newsletter, Thursday, 04/13/2006

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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

Pre-Holiday Day to End a Pre-Opex Week

We've had some slow days before but this was also a slow week. Other than the occasional buy program spike and an occasional bout of selling, this week was much of the same--boring sideways consolidation. The DOW ended the week up +13 points, the S&P 500 was down -6 points (equivalent to DOW 60 points so you can see where the relative strength was this week) and the COMP ended the week down -12 points. Each day it seemed there was a different stock selected out of the DOW to be blessed with buying and it doesn't take much more than that to keep the DOW levitated. Keep the DOW up and the retail crowd stays happy since that's what gets reported in the news. Keep the retail crowd happy and buying and the Boyz can continue to distribute their stock to them. I hope you're not taking that stock from them--you should be following their example and using rallies to lighten up your exposure to the market right now.

By the way, for those of you looking for the conclusion to what I started on Monday, the rest of the trading rules have been placed at the end of this Wrap.

We've got opex week ahead of us next week and anything goes during this coming week. The equity market is dancing on some critical support areas and can't tolerate much more of a pullback without sounding the dive horn which would signal batten down the hatches 'cause we're goin' down. As I'll show in some of the charts, we could still get another leg higher to finish the bull market rally and in fact I'd like to see it so that it would give a little cleaner count to the wave pattern. But it's certainly not necessary and I consider the risk to be clearly on the bulls' side. As I see it any more upside potential is very limited and simply not worth chasing. But without some better sell signals, such as breaking important support levels, it's a tad early to be thinking of shorting the market. It's one of those times where it's good to be in cash as we wait further signals. Think of yourself as a special forces guy hiding in the bushes while watching the market through a high-powered night vision scope. You know what your plan is but you're waiting for the signal to attack. In the meantime you're sitting very quietly. OK, too many action movies for me, moving on.


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It was a busy day for economic reports but in the end they didn't mean much of anything to the market. That's the surprising thing actually--we're getting lots of signs, if you look carefully, that the economy is not as robust as people would like to believe. We're in lala land and the market has turned a blind eye towards the danger. Even the geopolitical risks are having no impact on the psyche of the market. But when it does, it will probably register quickly. Certainly that's the way I read the tea leaves in the price patterns at the highs now.

At any rate, we got the new unemployment numbers which unexpectedly rose by 12K to 313K (actually up 14K from the previously reported 299K). This is the level of claims in the past month. The 4-week average for initial claims fell by 1,500 to 307,500. Continuing claims rose by 29K to 2.50M and its 4-week average fell 7,750 to a 5-year low of 2.43M. This number had peaked at 3.75M in May 2003, 2 months after the market found a low in March 2003. I suspect we'll see the same thing happen in reverse again.

We received the data on import prices which declined -0.4% in March. Many credit this for helping contain inflation in the U.S. This decline follows a -0.5% decline in February. Excluding oil, which dropped -0.7% in March (that'll change for April) imported prices fell -0.3% following a -0.6% drop in February. Export prices were up +0.2% which is good combination to have--pay less for imports and receive more for exports. As was reported yesterday, the U.S. trade deficit was down -4.1%.

The Retail Sales numbers for March showed a rebound from February's poor numbers--up +0.6% even after an upwardly revised number for February. The previously reported -1.4% for February was revised to -0.8%. Auto and auto parts sales were up +1.6% so outside the auto sector the retail sales increase was +0.4% which is still respectable.

U.S. business inventories were unchanged in February while sales dropped -0.6%. It was the largest drop in sales since a -1.5% drop in April 2003. The inventory-to-sales ratio rose to 1.26 from a record low 1.25 in January. Economists had expected inventories to rise +0.4%.

The Michigan Sentiment (preliminary) hit expectations at 89.2, up slightly from 88.9 in March. This made for the 3rd straight increase in sentiment. As long as the consumer is feeling confident enough in their present situation we'll see the purchasing continue which of course is important to our economic growth. The current conditions index rose to 1111.1 in April from 109.1 in March. It's the future expectations component that hasn't been doing as well lately and April's number fell to 75.1 from 76.0 in March. If conditions stay OK, the current conditions component tells us what the consumer is feeling today. And as we know, when we look at the overall savings rate (negative), we know consumers are living for today.

The problem for our near future, as far as how will have an impact on our markets, is that the numbers are not keeping up with current consumer confidence. In other words I'm thinking many consumers have their heads in the sand. They're concerned about the future but not doing much about it yet. They're in denial about their current situation and continuing to spend like there's no tomorrow. The record debt levels, bankruptcy rates and rising interest rates are not a good combination. I've discussed this before so I won't repeat a lot of it but when we, collectively, are faced with rising costs (energy, housing, food, etc.) and reduced earnings (new jobs replacing lost ones are lower paying service jobs) we all know that sooner or later something has to give.

Real earnings have been dropping for the past 8 years but we've gone into more debt or financed our purchases through the equity gained in the stock market or our houses. The stock market hasn't gone anywhere for more than 2 years (and in some cases still well below the 2000 highs) and home values will level off at best. Kiss the money tree in the backyard goodbye. When the expectations index becomes the current conditions index, we will have already seen the result in the stock market and that's why we watch these numbers. When we see waning momentum in the market at new highs (bearish divergences), deteriorating internals (such as the increasing number of new lows vs. new highs) and these program buying spikes that have no follow through, you can guess what's happening--the Boyz have been unloading their inventory on rallies. Are you doing the same?

As we look at the charts the question in my mind is whether or not we've got another rally leg ahead of us in the next couple of week or so or if instead we've seen the high. On to the charts.

DOW chart, Daily

The DOW, particularly with its relative strength this past week, looks the most bullish as far as supporting the idea for a continuation of the rally. Support at its 50-dma and October uptrend line is holding and the price pattern would look best with another new high. Therefore, as long as the recent lows hold I'd say this is pointing us higher. It's possible, as I look at the short term charts, that we'll see a dip early in the week to finish the pullback. I could see the DOW pulling back to something just above 11K (11040 is a potential Fib target where we'd have two equal legs down from its high) but it would have to be a quick drop down to tag the level and then a quick reversal so that it would only look like an under-throw of support. Watch for that possibility.

SPX chart, Daily

SPX gives me the impression it's only at the beginning of its break down. So between the DOW and SPX I've got a different impression and it has to do with the relative strength displayed over this past week. The SPX is consolidating on top of its 50-dma but unable to break free and rally. The previously broken October uptrend line, currently at 1295 (which is also the level of its break down from its most recent congestion), hasn't even been tested from underneath yet. MACD has moved into negative territory. If this lets go of its 50-dma at 1288 and can't recapture it, it could be bombs away down to its 200-dma at 1248. Interestingly, for those of who were playing with the Gann Wheel as I reviewed it last week, 1242 is 180 degrees from 1314, the high made last week.

Nasdaq chart, Daily

The COMP looks even more bullish than the DOW. So do 2 out of 3 make the case for a short term bullish outcome here? Could be. The 50-dma and October uptrend line at 2296 haven't even been tested yet so by this measure the COMP looks bullish. The trouble I have with the techs is that the leadership doesn't look so good and without the generals can the techs make it very far? They might but then they'll probably got shot along the way so I'd be careful.

QQQQ chart, 240-min

First impression from this chart is that support held and now we should see a bounce back up in its up-channel. That may be good for a little more lift but the problem I have with this index is that the current bounce looks very corrective--much more like a bear flag than something more bullish. I'm thinking short the rallies on this one.

SOX index, Daily chart

Short the rallies on this one too. A failure to recapture its 50-dma is a bearish sign. The choppy overlapping highs and lows in its bounces tells you to not trust the upside. While it could always bounce higher, it looks like corrective price action against the declines. Therefore when buying momentum appears to be waning, pick on your favorite (weakest) component to short or select bearish plays on SMH. I would not want to be long the semis.

I came across an article (thanks to Joe for pointing it out to me) in Trader Daily (a part of Trader Monthly publication) that discusses the top traders in the market. The 15 top Wall Street traders were all from the mega banks that I discussed a few weeks ago (the ones with trading teams who use a "proprietary trading system" and who have been able to reduce their risk in the market). Today saw the usual program buying spikes that went nowhere and now whenever I see them I think about these trading teams in the mega banks doing their thing and jerking the market around to their benefit. Some day they'll pay dearly when they become so arrogant to think they control the market and get a few nasty surprises when the market overwhelms them. Happens to them all. But for now we have to be careful around these program spikes.

At any rate, the top trader on the list, Mark McGoldrick (should be Goldbrick), works for Goldman Sachs and made GS over $2B (that's with a B) in 2005. For his efforts GS paid him roughly $40-50M. GS was not at all happy with this article coming out and has instructed their traders not to talk with reporters. The other big winners were traders with UBS, Lehman Brothers, Deutsche Bank, Morgan Stanley and Merrill Lynch. Interestingly enough (and of course not at all surprising) these 6 banks just mentioned were the primary banks responsible for the bulk of the program trading in the market. I'm telling you, something smells in the state of Denmark here.

BKX banking index, Daily chart

If the DOW or COMP looks bullish and SPX looks bearish, the banks are right down the middle. They're barely holding on to support but for the time being I'm giving them the benefit of the doubt and think they'll hold support and give us another leg up to finish their rally. However, if they close below the 50-dma at 369.50, we'll probably see the 200-dma get tagged next.

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

The housing index has broken down from its small corrective bounce and looks like it will at least test its uptrend line from March 2003. This is obviously an important trend line and should be good for another bounce. The inability to hold the 50-dma after recapturing it is a bearish sign. I wonder sometimes whether we'll see this index bounce around inside its sideways triangle for a while before it makes a bigger move (down is what I'm guessing). This index is taking a long time to correct which obviously chews up time premium on any long put positions. Bear call spreads is a good way to play these stocks. If and when we get the break below 830 then it'll be time to get more aggressive on the short side. Until then be careful with option plays.

Oil chart, May contract, Daily

Between the geopolitical risks and the new ETF (USO), which could be creating some additional demand, the price of oil has been slowly working its way back up towards its hold high. By this consolidation pattern that I believe is playing out (ascending triangle with risking bottom and flat top), we should get another multi-week pullback before rallying out of it. If we who will be doing a lot of driving this summer are lucky, that pullback will take us well into the summer but it'll probably bottom before summer starts and be making new highs as peak driving hits.

Oil Index chart, Daily

I'll continue to urge caution in all stocks, including oil stocks, but I'll also continue to show a path I think oil stocks could follow if they follow the same path as oil. We should be due a multi-week pullback that then sets up a rally to new highs. Support, assuming we see a drop back down, should be its uptrend line and 200-dma.

Transportation Index chart, Daily

Ideally we'll see one more push to a new high in this index before it's all done. It's possible it finished at its last high, having missed its Fib target by only 11 points but from a wave count standpoint it could use one more new high. Right now the TRAN broke below its uptrend line from March and dropped below its previous high, both of which tell me to be heads up for a potential high having been made. Price bounced back up and found resistance at the broken March uptrend line (at 4650) so if that continues to act as resistance, the next test is just below at its October uptrend line at 4575. And then the 50-dma just below that so there's layered support before this one can be declared finit.

There can't be any discussions of the US dollar without recognizing its value as the world's reserve currency. It's what gives us the ability to print as much of it as we want (and you can bet we'll defend against any threats to the dollar). We've become beholden to foreign countries and their ability to buy our debt. China alone held $854B in reserves at the end of February, the highest of any country in the world. If I were John Snow, I'd make nice with the Chinese. If they decide to unload their dollars and diversify into euros I'm thinking our financial system might take a small hit, especially since it could create panic among the other dollar holders.

U.S. Dollar chart, Daily

So far the dollar is hiding its intentions very well as it continues to consolidate more and more tightly in its sideways triangle pattern. I'm thinking the break will create a fast move so continue to keep your eye on this. It will clearly have an impact on commodities and bonds and it will ripple through all financial systems.

Gold chart, April contract, Daily

Gold looks like it's pooping out. Silver is in its parabolic spike and when I look at that chart I want to cover my head. That one won't be a soft landing. But gold appears to just running out of steam here. The last two weeks have seen price chop its way higher and this is the sign of an ending pattern (in fact is forming an ascending wedge for an ending diagonal 5th wave). I have a Fib projection on the chart at 607.83 which is where the extended 5th wave will equal 162% of the 1st wave. This is very common in commodities (extended 5th waves) and therefore watch this level carefully if you like a short trading opportunity in gold). And if you're brave, keep an eye on silver and try to grab a short in that one if it looks to be breaking down. That one should give a nice ride on the southbound train when it breaks.

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

What happens if an economic report comes out and there's no one there to hear it? Did it really get issued? If we don't pay attention to the news tomorrow, we'll never know. Supposedly the Capacity Utilization and Industrial Production numbers are coming out tomorrow but I'm not sure if that's true or if someone forgot tomorrow is an exchange holiday. At any rate, if they do come out my guess is that they will have no impact on the market (wink).

As briefly mentioned in the beginning, market breadth has been deteriorating and today was no exception. While price was marginally in the green today a look under the hood says we're about to split some water hoses and throw a few belts off their pulleys. New 52-week lows handily beat new highs 237 to 195. We've seen the new highs-new lows curve start to tip over for the first time since last October. The advance-decline line has been diverging against new price highs for quite a while now. These are not necessarily tradeable indicators but they're a heads up that the strength is not there so again be careful if trading on the long side of this market. That is the current trend, and as discussed in the rules below you certainly want to trade with the trend. But you also want to know when to pull your stops up tight and get a little less aggressive in any new positions.

On Monday I had started a discussion of trading rules that I got from Dennis Gartman's "Rules of Trading" and I highly recommend copying and pasting the first 5 rules I went over on Monday and then the other 8 rules below. We spend hours developing and back testing trading systems, explore and test a myriad of trading tools, read and research reams of analytical and fundamental data about the market and then when we finally trade we often forget very fundamental trading rules. Violate these rules and you will likely bust your account sooner or later. Follow these rules and manage your risk and account properly and it really won't matter which trading system you use.

For a quick review, the first 5 trading rules are:
#1 -- Never ever add to a losing position
#2 -- See rule #1
#3 -- Learn to trade comfortably in both directions without bias or preference
#4 -- Do not hold on to a losing position--it will cost you both mental as well as trading capital.
#5 -- Go where the strength is--the trend is your friend and you should trade with it (buy high and sell higher, sell low and buy lower).

Sell markets that show the greatest weakness; buy markets that show the greatest strength.

This is an extension of rule #5. Look over the various sectors to identify the strongest and weakest ones. If you want to be long the market, buy the strongest sector. Identify the strongest stocks within that sector and buy that stock. Do the opposite if you want to be short the market. If you're long and you have a stock/sector that's not keeping up with the others, sell it and put that money to better use in stronger stocks/sectors. Do not develop an attachment to any of your holdings no matter how good it was to you in the past. Most traders do the opposite--they sell their strong stocks and put the money to work in their weaker stocks doing themselves double damage.

In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral.

The trouble of course is if you look at just 2004-2005 you have to wonder whether we've been in a bull, bear or flat market. So obviously your time frame matters for this rule. If you're a day trader you obviously don't care what kind of market we're in. But regardless, the point with this rule is that you want to find the primary trend. As Jesse Livermore would say, find the path of least resistance and trade in that direction. If you identify an up trend, trade long, let it correct and then get long or add to your long position. Trading against the trend will almost always be more difficult and choppy. When you fight the trend you consume precious mental capital if not trading capital. Losing mental capital then causes you to make more errors in judgment. When you're nervous about what the market is doing, flat is the best position as it's the only position from which you can think straight.

"Markets can remain illogical far longer than you or I can remain solvent."

Lord Keynes is the person credited for first saying this and I think it's truer today than in his time. If you fight this rule it means you're violating some of the other rules, such as holding a losing position or adding to a losing position or failing to identify the trend and trading with it. The markets are driven by human emotions and not by funnymentals. And this brings us to the next rule:

Rule #9
Understanding psychology is more important than understanding economics.

This happens to be one of my favorite ones and the reason I like to use EW analysis in the market--EW is based on the swings in human emotions and can accurately predict its next swing based on the current pattern. Without an understanding of human psychology the more trouble you will have following the market and you will likely find yourself fighting the market more often. Trying to understand this component is why we look at such things as trader sentiment, consumer sentiment, bullish vs. bearish opinions and put/call ratios. The moment you trade the market by what it should do vs. what it is doing is the moment you will lose money. The market tends to swing too far to the extremes and logic will tell you you're crazy to trade in that direction but logic will often get you into trouble. Don't argue with the market; make money from it instead.

The hard trade is the right trade.

This is a corollary to rule #9 because it has to do with human psychology. If it's easy to sell, don't: if it's easy to buy, don't. If it feels easy to make the trade, so too does it feel that way for everyone else and it will probably be the wrong trade. Trading in the same direction with the masses is more comfortable but often wrong. It's hard to pull the trigger when it feels like the worst trade you could make. Just be careful you're not fighting rule #8 in the process.

RULE #10
Trading runs in cycles; some are good, some are bad, and there is nothing we can do about it other than accept it and act accordingly.

This is hard for many to understand, unless you're a trader. Those of us who trade for a living know that there are times when every trade, no matter how foolish, is profitable and we feel invincible. Conversely, there are times that no matter what we do--no matter how great the setup was; no matter how insightful our analysis was--our trades will be losers and we'll feel like miserable failures, that we've lost our touch. Therefore, when things are going well, trade often, trade larger, and try to maximize those times when everything seems to be working in your favor. But when your trading turns south on you, trade infrequently, trade smaller, and continue to get steadily smaller until the you start getting steady base hits again. The latter usually happens when we begin following the rules of trading again. Funny how that happens...

RULE #11
To trade/invest successfully, think like a fundamentalist; trade like a technician.

It is obviously important for us to understand the economic fundamentals behind why the market might move in one direction vs. the other but as traders we must understand the technicals behind the current move. If we can get the two in synch, all the better for our trading. If we're trading technicals counter to the fundamentals we should be aware and be heads up for the winds to change. Trading against the fundamentals is one of those times rule #8 prevails. But when you can get in synch that's the time when you want to trade with the market and to do so aggressively.

RULE #12
Keep your technical systems simple.

Many very bright people have developed super sophisticated trading systems. You can't visit a trading site without reading about why you should spend $3000 and up for a trading system guaranteed to win you money. Guess what--nearly everyone comes back to the basics of oscillators, moving averages and trend lines. The KISS principle applies here so save yourself a lot of money and angst and use what works. Simple systems and these trading rules will make you money, pure and simple. The battle-tested and successful traders attribute their success to their knowledge gained over the years that complexity is the home of the young and untested.

RULE #13
Do more of that which is working and do less of that which is not.

This is the rule that sums up the rest and is a simple rule in writing but a difficult one to act upon. But by working on these rules and making them the core of your trading plan you will find success. Adding to a winning trade while cutting back on losing trades is the big one--focus on it above all else and you will do well. And interestingly this concept works in your life outside of trading as well.

I hope everyone has a great long weekend and enjoys time with family and friends. Be safe and we'll see you fresh-eyed and bushy-tailed for a new week, opex no less.

New Plays

New Option Plays

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

New Calls

CNOOC Ltd - CEO - close: 81.90 change: +1.29 stop: 79.45

Company Description:
We are a Hong Kong-incorporated public company that engages primarily in the exploration, development and production of crude oil and natural gas offshore China. We are the dominant producer of crude oil and natural gas .The Company is also one of the largest offshore crude producer in Indonesia. (source: company press release or website)

Why We Like It:
CEO is another oil stock to our growing list of oil-stock bullish candidates. However, this one is a bit different as CEO is the ADS shares traded in the U.S. for the Chinese oil conglomerate CNOOC. The stock has been consolidating lower in a descending channel for the last ten weeks but Thursday's gain might just be a breakout over resistance. The stock is challenging technical resistance at the 50-dma and the $82.00 level. We want to see more confirmation before initiating call plays so we're suggesting a trigger to go long at $82.26. If triggered we will target a run towards the February highs in the $87.50-88.00 range. We do note additional overhead resistance in the $84 range so be aware of it. Another point to consider is the company's earnings report is due out around April 29th. We do not want to hold over the report.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 80.00 CEO-EP open interest= 32 current ask $4.50
BUY CALL MAY 85.00 CEO-EQ open interest=107 current ask $1.70

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/29/06 (unconfirmed)
Average Daily Volume = 193 thousand


Cummins - CMI - close; 106.75 chg: +0.66 stop: 104.99

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

Why We Like It:
CMI has been consolidating against rising support at its 50-dma for the last couple of weeks. The technical picture is finally starting to turn positive again and this looks like a relatively low risk entry point to buy calls with CMI near support. We are going to suggest calls with CMI above $106.00 and we'll try and keep our risk to a minimum with a stop loss under the simple 50-dma at $104.99. Conservative traders can plan an exit in the $109.85-110.00 range (our conservative target). We're going to bet on a breakout over resistance at $110 so our more aggressive target will be the $112.00-112.50 range. We don't want to hold over the late April earnings. If you have a longer time frame you may want to aim even higher.

Suggested Options:
We are suggesting the May calls. FYI: at this time we could not get the current ASK price and what we have listed is the last trade.

BUY CALL MAY 105.00 CMI-EA open interest= 422 current ask $4.60
BUY CALL MAY 110.00 CMI-EU open interest=1445 current ask $2.35

Picked on April 16 at $106.75
Change since picked: + 0.00
Earnings Date 04/28/06 (unconfirmed)
Average Daily Volume = 804 thousand

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Arch Cap. Grp. - ACGL - cls: 58.63 chg: +0.77 stop: 55.95

The market was mostly up on Thursday but the lack of volume behind the move does not inspire any confidence. Many professional traders left early for the long, holiday weekend. Fortunately, the lackluster session was not so bad for shares of ACGL, which added 1.3% and on above average volume. We hesitate to open new bullish positions here given the lack of direction in the major averages but this relative strength in ACGL may be a new entry point to buy calls. Our target is currently the $62.50-63.00 range. We do not want to hold over the late April earnings report, which gives us just less than two weeks.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 55.00 UOZ-EK open interest= 51 current ask $4.70
BUY CALL MAY 60.00 UOZ-EL open interest= 74 current ask $1.20

Picked on April 03 at $ 58.15
Change since picked: + 0.48
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 195 thousand


Amerada Hess - AHC - close: 142.59 chg: -1.30 stop: 139.95

Hmm... the relative weakness in AHC on Thursday is worrisome. Crude oil rose back above $69 a barrel on Thursday as investors continue to fret over the ongoing drama between the west and Iran's nuclear program. Oil stocks were generally higher but AHC continued to sell-off. The stock did stall near technical support at its simple 50-dma and shares are still above their four-week trendline of support (see chart). We would not suggest new positions here. Watch for a bounce from the $140 region or a new rise above $144.50-145.00. Our target is the $154.00-155.00 range. We do not want to hold over the April 26th earnings report, which only gives us ten more days. FYI: Technical traders will note that the weekly chart shows a new bearish engulfing candlestick pattern, which is typically seen as a bearish reversal.

Suggested Options:
We are not suggesting new positions at this time. Wait for the bounce.

Picked on April 05 at $146.51
Change since picked: - 3.92
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 1.5 million


Anadarko Petrol. - APC - cls: 105.14 chg: +1.47 stop: 99.95*new*

Oil stock APC turned in a decent session on Thursday. Shares dipped toward $102 but bulls bought the dip and APC rebounded back into the closing bell. The stock looks poised to post more gains next week. If you were looking for an entry point this is probably it but remember we have a brief time frame. We do not want to hold over the April 27th earnings report and that only gives us about 11 days. Our target remains the $109.50-110 range. The P&F chart remains bullish with a breakout buy signal that points to a $127 target. Please note that we're raising our stop loss to $99.95.

Suggested Options:
We are suggesting the May calls but remember our time frame.

BUY CALL MAY 100 APC-ET open interest=3738 current ask $7.80
BUY CALL MAY 105 APC-EA open interest=2049 current ask $4.70
BUY CALL MAY 110 APC-EB open interest=2141 current ask $2.55

Picked on March 28 at $102.10
Change since picked: + 3.04
Earnings Date 04/28/06 (unconfirmed)
Average Daily Volume = 2.5 million


Burlington NrthSanta Fe - BNI - cls: 83.39 chg: +0.36 stop: 79.95

BNI tried to rally on Thursday morning but just ran out of steam. Yet buyers were ready to defend it on its midday dip back toward $82.50. Overall we remain bullish and the current bounce in the Transports looks positive for next week. Our time frame is running short. We want to exit ahead of the earnings report around April 25th. If you're looking for a new bullish entry point this would qualify although you might want to tighten your stop. Conservative traders may just want to pass on new plays. The action on the weekly chart is looking like a top. Our target is the $87.50-90.00 range. The P&F chart remains bullish and points to a $114 target.

Suggested Options:
We are suggesting the May calls but keep in mind our limited time frame.

BUY CALL MAY 80.00 BNI-EP open interest=477 current ask $5.00
BUY CALL MAY 85.00 BNI-EQ open interest=794 current ask $2.05

Picked on March 27 at $ 82.51
Change since picked: + 0.88
Earnings Date 04/25/06 (unconfirmed)
Average Daily Volume = 2.1 million


ConocoPhillips - COP - close: 67.14 chg: -0.19 stop: 62.45

COP's upward momentum might be stalling and that's affecting the short-term technical oscillators. Of course Thursday's session didn't mean much with the markets going nowhere and on light volume. We remain bullish but don't be surprised by a dip toward the 10-dma (near 66.00) or even a dip back toward the $65.00 level. We do not want to hold over the April 26th earnings report. Our target is the $69.00-70.00 range versus the P&F chart with its bullish triangle breakout buy signal that points to an $82 target.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 65.00 COP-EM open interest=27979 current ask $3.70
BUY CALL MAY 70.00 COP-EN open interest=14846 current ask $1.20

Picked on March 29 at $ 64.80
Change since picked: + 2.34
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 10.5 million


Lehman Brothers - LEH - close: 150.23 change: +1.25 stop: 144.45*new*

The broker-dealer stocks turned in a decent session on Thursday and LEH rebounded back above the $150 level. We remain bullish and the recent consolidation is starting to look like a bull-flag pattern. We would consider new bullish positions here but you may want to tighten your stop loss significantly. Speaking of stop losses we are raising ours to $144.45, which is still under technical support at its rising 50-dma. LEH is due to split 2-for-1 on May 1st. We are suggesting that readers consider selling half their positions at $153.00 and then sell the second half of their position at $159.00. More conservative traders may want to exit completely near $152.50-153.00.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 145 LES-EI open interest=1017 current ask $8.10
BUY CALL MAY 150 LES-EJ open interest=2549 current ask $4.90
BUY CALL MAY 155 LES-EK open interest= 940 current ask $2.55

Picked on March 22 at $144.61
Change since picked: + 5.62
Earnings Date 06/14/06 (unconfirmed)
Average Daily Volume = 2.0 million


Marvell Tech. - MRVL - close: 57.54 change: +1.03 stop: 54.99

Volume was light again for MRVL so Thursday's relative strength and 1.8% gain is suspect. At face value we're encouraged by the bounce from the $56 level but without support from the SOX semiconductor index we worry that MRVL will not be able to breakout past resistance near $60 and its converging 50-dma and 100-dma. We are going to suggest bullish positions here but more conservative traders should strongly consider waiting for a breakout over $60.00 again. The P&F chart continues to look very tempting with its bullish buy signal rising off a test of support and pointing to a $73 target. Currently our target is the $65.50-66.00 range.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 55.00 UVM-EK open interest= 5025 current ask $5.30
BUY CALL MAY 57.50 UVM-EY open interest= 2322 current ask $4.00
BUY CALL MAY 60.00 UVM-EL open interest=12573 current ask $2.90
BUY CALL MAY 62.50 UVM-ES open interest= 5629 current ask $2.05

Picked on April 06 at $ 60.18
Change since picked: - 2.64
Earnings Date 05/25/06 (unconfirmed)
Average Daily Volume = 5.9 million

Put Updates

Apollo Group - APOL - close: 52.80 chg: +0.24 stop: 53.31

APOL's downward momentum has stalled but overall its long-term trend remains bearish. The weekly chart has a pattern of lower highs and lower lows and the P&F chart is bearish and points to a $44 target. We are continuing to suggest that traders use a trigger under support at the $50.00 level. Our trigger to buy puts is at $49.85. If triggered we will have two targets. Our first target is the $45.50-45.00 range. Conservative traders can exit near $45. We're suggesting that traders only sell half their positions near $45 and plan to sell the remainder in the $41.00-40.00 range. If APOL closes over the simple 50-dma we'll drop it as a bearish candidate. Aggressive traders might want to evaluate bullish positions.

Suggested Options:
We are suggesting the May puts although traders might want to consider the August puts. Our trigger is at $49.85.

BUY PUT MAY 55.00 OAQ-QK open interest=1583 current ask $3.20
BUY PUT MAY 50.00 OAQ-QJ open interest=2670 current ask $0.75

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 06/22/06 (unconfirmed)
Average Daily Volume = 2.4 million


Express Scripts - ESRX - close: 85.51 chg: +0.90 stop: 90.01

ESRX's oversold bounce has reached its third day. The stock has broken back above potential round-number resistance at the $85.00 mark and is now challenging potential resistance near its 10-dma and the $86.00 level. The rebound has turned short-term technical oscillators higher but the overall pattern remains bearish. The chart below shows the bearish head-and-shoulders pattern. Yet in spite of the trends we are going to suggest caution. The relative strength cannot be denied and traders should be extra careful considering new put positions. We'd look for a new move back below the $84.00 level before initiating positions. Keep in mind that we only have ten more days before we plan to exit to avoid the April 26th earnings report. Our short-term target is the $80.25-80.00 range. However, more aggressive traders may want to aim lower. The H&S pattern points to a target in the $73-74 range, which, coincidentally is where you'll find the simple 200-dma.

Suggested Options:
We are not suggesting new positions at this time. Wait for a new decline under $84.00.

Picked on April 09 at $ 85.39
Change since picked: + 0.12
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 1.6 million


Genzyme Corp. - GENZ - close: 64.82 chg: -0.07 stop: 66.26*new*

Time is running low for our bearish play in GENZ. The company is due to report earnings on April 19th and we do not want to hold over the announcement. Therefore we plan to exit on Tuesday afternoon near the closing bell. More conservative traders may want to exit early on Monday since the BTK biotech index is bouncing. Fortunately, GENZ failed to maintain its gains on Thursday and the move looks like a failed rally under resistance. Nimble traders who can jump in and out quickly may want to use this as a new bearish entry point. We are going to lower our stop loss to $66.26.

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

Picked on April 10 at $ 63.97 *gap lower*
Change since picked: + 0.85
Earnings Date 04/19/06 (confirmed)
Average Daily Volume = 2.1 million


Overseas Shipping - OSG - cls: 47.02 chg: -0.43 stop: 50.01

Shares of OSG continue to show relative weakness and the stock is hitting new four-month lows. Last week's failed rally near $50.00 and its 50-dma has blossomed into a breakdown below support near $47.50 and now shares are headed toward the next level of support near $46.00. We do anticipate a bounce there but the prevailing pattern is bearish. We do not want to hold over the early May earnings report. Our target is the $43.00-42.50 range, which coincides with the bearish P&F chart target.

Suggested Options:
We are suggesting the May puts although we plan to exit ahead of the May earnings report.

BUY PUT MAY 50.00 OSG-QJ open interest= 95 current ask $3.80
BUY PUT MAY 45.00 OSG-QI open interest=148 current ask $1.05

Picked on April 11 at $ 48.10
Change since picked: - 1.08
Earnings Date 05/02/06 (unconfirmed)
Average Daily Volume = 469 thousand


Reynolds American - RAI - cls: 104.40 chg: -0.38 stop: 106.75*new*

Lack of follow through on RAI's recent breakdown below support at the 50-dma and the $105 level makes us nervous. Bears are fighting against a bullish P&F chart and lots of upward momentum. Yes, the stock has broken down below its five-month up trend but sellers have to overcome those looking to buy the dip. Helping the bears is the relative weakness in larger rival Altria (MO). We are going to continue to suggest puts with RAI under $105.00 but we're going to adjust our stop loss to $106.75. Our target is the 100-dma near the $100.00 mark. We'll use an exit range of $100.50-100.00. We do not want to hold over the late April earnings report.

Suggested Options:
We are suggesting May puts.

BUY PUT MAY 105 RAI-QA open interest= 779 current ask $3.70
BUY PUT MAY 100 RAI-QT open interest=4631 current ask $2.10

Picked on April 09 at $104.97
Change since picked: - 0.57
Earnings Date 04/27/06 (unconfirmed)
Average Daily Volume = 637 thousand


Texas Ind. - TXI - close: 58.36 chg: -0.16 stop: 61.11

Lack of follow through on TXI's recent failed rally makes us concerned. Overall the technical picture looks bearish and the MACD on the weekly chart is about to produce a new sell signal. We do have a relatively tight stop so if TXI reverses on us we should be taken out pretty quickly. Traders may want to wait for a move under $57.90 or below Thursday's low of $57.83 before initiating new positions.
Our target will be the simple 200-dma in the $54.00-53.50 range. A move under $57.00 would produce a new P&F chart sell signal.

Suggested Options:
We are suggesting the May puts.

BUY PUT MAY 60.00 TXI-QL open interest=640 current ask $3.40
BUY PUT MAY 55.00 TXI-QK open interest=557 current ask $1.20

Picked on April 11 at $ 58.34
Change since picked: + 0.02
Earnings Date 06/29/06 (unconfirmed)
Average Daily Volume = 423 thousand

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)


Encana Corp. - ECA - close: 47.75 chg: +0.09 stop: n/a

The technical picture is definitely mixed on ECA. The weekly chart's MACD is showing a new buy signal while shorter-term technicals are starting to look bearish again. ECA's lack of strength during crude oil's recent rise toward $70.00 is a big sign of weakness. Our strangle play has almost run out of time. April options expire next week. That gives us five trading days for ECA to trade significantly above $50 or under $40. At the moment odds of either aren't looking very good. Our strangle strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45.

Suggested Options:
We are not suggesting new plays on ECA.

Picked on January 10 at $ 45.56
Change since picked: + 2.19
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million


Ryland Group - RYL - close: 67.82 change: -0.78 stop: n/a

Traders have a choice to make. There are five days left before April options expire. Do you sell the April $70 puts, currently trading around $2.75 and recoup part of your trading capital? Or do you keep the play open and risk RYL producing an oversold bounce next week. The technical picture is mixed. One concern is that RYL is already down five days in a row and nothing falls in a straight line for very long. Then again the weekly chart has just produced a new bearish engulfing candlestick (a.k.a. bearish reversal pattern). Bond yields are still rising and that will continue to put pressure on the homebuilders. We are not suggesting new plays. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN).

Suggested Options:
We are not suggesting new plays in RYL.

Picked on January 22 at $ 75.19
Change since picked: - 7.37
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million

Dropped Calls


Dropped Puts

Amgen Inc. - AMGN - close: 70.07 chg: +0.10 stop: 72.55

AMGN is due to report earnings on April 18th. Given the bounce in the BTK biotech index and the lack of follow through on AMGN's recent breakdown below $70 we're going to exit early. There is a chance that AMGN could move big on its earnings news and more aggressive traders might want to consider a strangle (or a straddle) position.

Picked on April 11 at $ 69.90
Change since picked: + 0.17
Earnings Date 04/18/06 (confirmed)
Average Daily Volume = 10.7 million

Dropped Strangles


Trader's Corner

A Trading Tactic Revisited

A November 5, 2005 Trader's Corner article described a tactic that involved fading a first-hour breakout. For months, choppy markets have rendered many technical trading setups less useful than usual. This has been so often seen lately that I have stopped all pure directional trades and limited my plays to those that take advantage of range-bound action. Last Friday's early morning rally prompted me to revisit that trading tactic first described in November.

Those who did not read the original article, especially those who have never studied Donchian channels, might go to the Option Investor archives and read that Trader's Corner article before proceeding further with this one. The tactic involved watching for a first sixty-minute Donchian channel upside or downside breakout. That breakout would be faded when certain other conditions were met. A five-minute Keltner channel chart was used to identify those conditions.

As stunning as last Friday's upside breakout appeared to be in those first few moments after the open, the move above the top of the Donchian channels caused me to start watching for the setup that had been detailed in that previous article. The rally was so short lived that the Donchian-channel breakout was not maintained into the close of the first sixty-minute period. It did not create a Donchian channel breakout signal on the sixty-minute chart, although it did on the fifteen-minute one. That day did not set up according to the parameters outlined in the November 5 article.

Annotated 60-Minute Chart of the SPX:

As the chart illustrates, the play never set up using the parameter described in the first article. Although other play setups might have occurred and certainly did, this one did not. A second look at that chart shows a setup on March 30, however.

Annotated 60-Minute Chart of the SPX:

Having discovered an initial setup that occurred that day, revisiting the play setup from that November 5 article required turning next to a five-minute Keltner chart.

Annotated 5-Minute Chart of the SPX:

A cautious trader would have scaled out of at least part of that position when the original target was hit and would have lowered the stop on the rest of the position to stop-even or better. Then, as price moved lower, the trader could have followed prices lower with stops, choosing either to continue to do so until stopped, to exit when stochastics showed oversold conditions or when stochastics indicated bullish divergence just after one o'clock that afternoon.

Another setup, this time for a bullish play, occurred March 21.

Annotated 60-Minute Chart of the SPX:

The Keltner set-up was less optimal that day.

Annotated 5-Minute Chart of the SPX:

Another similar setup, but this time for a bearish play, occurred March 13, with the original target hit that time, too, but with the outer channel on the 5-minute Keltner channel never violated. Although these required a little more judgment as to whether to enter or not, the first condition for the setup occurred and the plays proved viable.

I wanted to revisit this first-hour setup because it has seemed that few technical setups have followed through. However, even during the last few weeks when markets seemed so difficult to judge by technical analysis, these setups appeared to work well. They did not come frequently during this last few weeks, however.

Although that November 5 article talked about the logic behind these setups, some cautionary review might be in order at the close of this article. Donchian channels were created to identify breakout plays, and some back-testing has hinted that such plays to work best, against all logic, when stochastics are already measuring overbought or oversold conditions. So, this setup runs counter to that back-testing. However, when doing that back-testing, I noticed that two exceptions to that truism occurred: when the breakout occurred during the first hour of trading and when it occurred during the last hour of trading. Those breakout plays proved so unreliable that it looked as if fading those plays was a better bet than taking them. This conclusion fit with research that noted the high frequency with which the day's highs or lows occurred within the first hour of trading, so that a breakout during those times was likely to achieve the ultimate high or low of the day, and then, logically, could be faded.

However, because fading those plays goes counter to what Donchian channels were created to do--identify times when it was a good idea to play the breakout--caution should be exercised, and something further was needed to clarify the setup. I used Keltner channels for that purpose.

Adding to the above cautions, no official back-testing of this 60-minute Donchian/5-minute Keltner setup has occurred. QCharts does not yet provide that capability, so I urge you to do testing of your own, including some paper trading, before you attempt trading this setup. This is especially true if you're going to trade it using options. Options prices tend to be inflated the first hour of trading, so that even these successful plays--in terms of the SPX hitting the target--might not have been as successful if trading such a short-term move with options. While the SPX was moving the right direction and hitting targets, some of that excess amateur-hour premium may have been leaking away, too, so that the options play might have been only minimally profitable by the time the commissions and spreads were considered. Test it for yourself, and, if you're a futures trader, test it using futures instead of options.

At the least, though, this setup and its continued reliability over the previous few weeks demonstrates how dangerous it might be to get too enthusiastic about a first hour upside or downside break. You might just be seeing the ultimate high or low of the day.

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


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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