Option Investor

Daily Newsletter, Tuesday, 05/02/2006

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Table of Contents

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

Market Wrap

Dow Continues To Lead

The Dow continues to creep higher with another new six-year closing high at 11415. That is lower than the intraday highs for the last week but the closing level just keeps inching higher. The Dow has been joined by the NYSE Composite but the Nasdaq, Russell and S&P are still lagging. The Dow gained +73 today with the Nasdaq only managing a paltry +5.

Dow Chart - Daily

Nasdaq Chart - 120 min

The economic data for today was lackluster with only the April Vehicle Sales and Challenger employment data. The Challenger Report showed that job cuts in April fell to 59,688 compared to 64,975 in March and 87,437 in February. This was the fourth consecutive month of declines in job cuts. The auto industry was the sector with the largest cuts at -13,334 jobs. Manufacturers of industrial goods lost -6,727 jobs with the computer sector coming n third at -6,611 jobs. The top sectors leading the job cut parade so far in 2006 were automotive -55,732, government/non-profit -37,754, telecom -26,418, food -26,082 and industrial goods -24,759. According to Challenger job cuts are seasonal with the spring typically showing a decline in job losses.

Total vehicle sales for April came in at 16.7 million (annualized) and flat with February and March. Sales for the major manufacturers declined with GM dropping -7%, Ford -3.2% and Daimler Chrysler -2.6%. Toyota surged +8.5%. Sales of hybrids continue to be strong with a five-month wait for the Toyota Prius and a +100% jump in sales of the Ford Escape. You may have noticed that the incentive programs for the US manufacturers have gone quiet with the companies trying to wean buyers off the costly specials used to stimulate sales for the last couple years. Auto buyers had been pulled forward in time as each special had to do better than the last one to entice the remaining buyers out of the herd. Now the advertisements have cooled as they wait for the next crop of buyers to mature. That may take several more months. Vehicles are being sold but the ratio is moving strongly towards foreign manufacturers. 23.5% of April sales were foreign cars led of course by Toyota. US manufacturers have announced plans for a -1.6% drop in production for Q2. While all of this news sounds really negative based on the rise in gasoline prices I should also tell you that GM saw a +15% jump in sales for the Chevrolet Tahoe, GMC Yukon and Cadillac Escalade. This are all the luxury midsize SUV models, smaller than the Suburban but larger than the Blazer models. Gas consumption appears not to be a consideration for those wanting a luxury SUV.

Gasoline prices rose again across the country with prices in the Northeast averaging $2.94 while California averaged $3.13. The price of crude also rose to $74.95 intraday with only a slight -30 cent decline into the close. Futures are holding at $74.85 as I write this commentary. The CEO of Sempra Energy was interviewed on CNBC today and he said $80 oil was nearly a forgone conclusion. The Deputy Oil Minister for Iran said oil would hit $100 by winter due to supply concerns for light sweet crude. These comments had funds piling back into the black gold ahead of the inventory report on Wednesday morning. The inventory report is expected to show a drop in crude of -400,000 bbls, gasoline -2 mb and distillates -600,000 bbls.

Iran continues to be the problem with the UN ambassadors from Britain, France and the US expected to introduce a Security Council resolution sometime this week to make Iran halt uranium enrichment. While this will not have any real impact on Iran's continuing enrichment efforts it should influence sentiment about oil prices. Russia and China have both said they will not support any resolution calling for sanctions or military action. With both of those countries on the Iran bench there is no reason for Iran to quit doing anything. They can continue to thumb their nose at the world and continue with their efforts to make a bomb. Still the constant sound bites should continue to push prices higher.

The Iran comments overshadowed the promise by the Saudi Oil Minister that Saudi would increase production to 12.5 mbpd by 2009. They claim they are spending $50 billion to make this happen. This comment was virtually ignored for several reasons. First, because of the time frame it was not considered relative to the current supply squeeze. Secondly, because the majority of this oil will be sour crude and not light sweet crude it will have minimal impact on the supply squeeze. According to OPEC there is currently 1.5-2.0 mbpd of excess production today but unfortunately it is all sour crude and cannot be used by most refiners. Thirdly, Saudi has a habit of promising the world and delivering less. Oil traders are not going to bet the farm that "maybe" Saudi will increase production by 2009. Saudi also said this week that they have more than one trillion barrels of undiscovered oil. This is so absurd it hardly bears discussing. First, if it is undiscovered bow do they know it is more than one trillion bbls? Secondly, the nation of Saudi Arabia is one of the most heavily explored areas of the planet. When oil was discovered there early in the 1900s there was a gold rush of exploration where all the current super giant fields were mapped out with great precision along with discoveries of hundreds of smaller fields. After the discovery of the super giant fields the major oil companies were positively giddy with the prospects of finding other oceans of oil to fill their coffers with billions of dollars. This lure of untold riches prompted the drilling of thousands of exploratory wells and no other giant fields were ever found. The density of the exploratory wells was so close that it is virtually impossible for any major field to have been missed. Saudi is currently claiming proven reserves of around 260 billion bbls. This jumped +100BB overnight without drilling a single hole back in 1988 when OPEC went to a quota system based on the total amount of oil a member had in the ground. Now the Saudi Oil Minster is claiming that despite no material new discovery in Saudi since 1949 they are going to suddenly find +400% more oil that their currently "claimed" reserves. This would be +800% of the last reserves reported when third party oil companies actually ran the fields and published the numbers. Once Saudi nationalized the fields they quit supplying any detail by field and instead changed the reserve estimates to vague press releases.

In 1975 there were four US oil companies in control of all the Saudi fields. With what was seen as the finest geologic engineers employed by those firms the total Saudi reserves were reported as 107.9 billion bbls. This was after 24.4 billion bbls had already been produced since the fields were discovered. Saudi Aramco reported a similar number to the US General Accounting Office and at Senate hearings in 1978 and early 1979. This is seen to be the last accurate accounting for Saudi oil and numbers were published for individual fields along with production rates. Proven reserves actually declined in several incidental reports to barely 100 billion bbls as production exceeded 8.5 mbpd or more than 3 billion bbls per year. After the takeover of the fields by Saudi Aramco in 1979 those reserves suddenly shot up to 150 billion bbls. In 1982 the number rose to 160 BB and then jumped another 100 BB in one day in 1988 to a total of 260 billion bbls. These increases occurred despite very little exploration activity and no new fields or discoveries were announced. Now Saudi is claiming another trillion bbls are just waiting to be discovered? Clearly the oil emperor is wearing no clothes. Regaining their credibility in today's market is going to be next to impossible.

Iran has repeatedly claimed they would not use their oil card in any disagreement with the UN over their nuclear program. They have not said they won't trump the oil cards of other Persian Gulf nations. The Supreme Commander of Iran's Islamic Revolution Guards Corps, Major General Yahya Rahim Safavi, said on state television regarding the 20 mbpd that flow through the Strait of Hormuz, "The Strait of Hormuz on Iran's southern shore is the economic lifeline of the west and could be used to put pressure on Iran's enemies. The Strait of Hormuz and the Persian Gulf are the cornerstone of Iran's defense. The Strait of Hormuz counts as a point of economic control and pressure in the transfer of energy for aggressive powers from beyond the continent that want to endanger the security of the region." This is saber rattling in its finest form. If Iran continues its uranium program shots will eventually be fired. Oil will be over $100. Count on it.

Crude Oil Chart - Daily

On this side of the world Bolivia followed through on its threat to nationalize its energy assets and sent military personnel to more than 50 sites to protect them from sabotage by the current owners. Bolivia gave the oil companies currently running the sites six months to agree to the new deal or get out of the country. Silver stocks plunged on worries that Bolivia would also take control of its mines. For example Apex Silver Mines (SIL) has fallen nearly -$8 over the last two weeks as worries increased. Over 22,000 puts changed hands on SIL alone on Tuesday as investors tried to protect their positions.

Cuba announced that it had agreed to allow China, Venezuela and Spain to begin exploring for oil about 45 miles off the Florida coast. Senator Bill Nelson is sponsoring legislation to prevent this drilling to prevent a possible oil spill off the Florida coast.


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Back in the US markets Microsoft sank to a new low on worries that the new Windows XP update codenamed Vista could be delayed even longer, possibly until June 2007. Researchers at Gartner Inc, published a report claiming problems on the test versions suggest it may not be released until the end of Q2. Microsoft issued a statement disagreeing with the Gartner report and claiming to be on schedule. MSFT sank to a new 52-week low at $23.90.

Hovnanian (HOV) sank to a new 18 month low at $36 after warning that sales could decline as much as -20% in 2007. Centex and Beazer Homes have also cut their estimates for the year. The median price of a new home fell by -6.5% since February. HOV said the value of its current contracts could drop -20% due to cancellations during the second quarter. HOV said an increase in cancellation causes more expenses due to resale listings and the need for additional incentives. HOV said they had renegotiated or even walked away from deposits on several parcels of land they controlled through options. HOV said they would incur $5 million in write-offs in Q2 related to these events.

HOV Chart - Daily

The Dow recovered all its losses from Monday to close at another new six-year high. For those counting these new highs have been less than exciting since they represent only a couple points above the last one. The Dow is pushing resistance at 10420 and the rebound from Monday's Bernanke drop was surprising. For those who missed it Bernanke told CNBC's Maria Bartiromo that the markets got him wrong last week when he testified before the Joint Economic Committee. Traders had thought his testimony suggested one and done in May and then a rate hike pause. He told Maria that traders misunderstood his meaning. He wanted to get the idea across that the Fed would be flexible and data dependent not that a pause was coming. When this change in stance was announced on CNBC the bottom fell out of Monday's market. Today's rebound was bullish in my view since it would have been very easy to just keep selling if that was the general plan. Now it appears the Dow found its bullish legs once again.

Unfortunately the Nasdaq and S&P failed to catch the same wave. The Dow was up on the strength in CAT +1.85, BA +1.47 and XOM +1.25. There were no big techs with strong gains to prop up the Nasdaq. The Nasdaq gained +5 points but barely rebounded off the lows seen on Monday. The tech sector is simply not showing any strength that would suggest the market is ready to make a major move higher. The SOX has flat lined at just over 510 so at least it is not dragging the techs lower. The Russell has also found a range between 760-770 and refuses to leave the safety of that range. I just don't see any event in the near future that is going to change the negative bias for techs. Without any support from the Nasdaq the Dow could be limited on any upside break.

On Sunday I pointed out the volume similarities between the current volume at the highs and the volume in 2002 at the lows. The last two days have continued that volume spurt with both days over five billion shares each. However, new highs have spiked slightly to near 500 per day. That could be a reaction to the oil spike back to $75. I know many oil stocks were breaking out again on Tuesday. Oil has traded up to $74.97 during the nighttime session.

S&P Chart - 7 min

The S&P is not confirming the Dow move and still appears to be trapped under very strong resistance at 1315. That level dates back to May-2001 and has proven tough to break. Remember my recommendation is to remain short under 1310 and long over 1315. If we ever do make a breakout on volume there could be some huge short covering. Quite a few traders are still expecting a May swoon and I was in that camp. I will buy a breakout if it happens but my bias at this point is still to the downside. I believe there is more likely an event ahead that pushes us lower rather than one that will trigger a breakout. The FOMC meeting next Wednesday is the exception. If Bernanke is playing mind games with investors and actually does issue a statement that suggests they are not going to hike in June then we could get a reaction bounce. Just remember last week when analysts thought that was what he was saying in his testimony. The bounce was muted and many funds sold into it. The downside of waiting patiently for the FOMC announcement next week is the danger of a sell the news event if it does not work out as expected. The next FOMC meeting is not until June 28th and nearly two months away. That is a lot of time to wait for the next chapter in the Fed story. Don't fight the trend if one suddenly appears. Buy a breakout over 1315 and short anything under 1310. Eventually a directional move will result.

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

Apple Computer - AAPL - close: 71.62 chg: +2.02 stop: 68.45

A rebound across the major market indices and news that AAPL renewed contracts with the major recording studios for its iTunes online store helped fuel a rally in the stock. Shares of AAPL added 2.9% but failed to breakout over resistance at the $72.00 level. We remain on the sidelines. Our strategy is using a trigger to buy calls at $72.25. If triggered then we'll target a rally into the $77.45-80.00 range.

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 36.0 million


Progressive - PGR - close: 107.15 chg: -0.18 stop: 103.95

We do not see any change from our previous updates on PGR. PGR's 4:1 split is due May 19th but we plan to exit ahead of the May 8th earnings report. That only gives us three trading days before we exit therefore we're not suggesting new positions at this time. Our target is the $114.00-115.00 range.

Picked on April 23 at $106.46
Change since picked: + 0.69
Earnings Date 05/08/06 (unconfirmed)
Average Daily Volume = 846 thousand


Rackable Systems - RACK - close: 48.05 chg: -2.67 stop: 47.39

As we feared yesterday the lack of follow through on the bullish breakout has shares of RACK looking a lot more bearish. Today's 5.2% decline was not fueled by anything specific we can find. The three-day pattern looks pretty bearish and we're concerned that RACK will test the 50-dma and given the lack of strength in the tech sector RACK might breakdown. We're not suggesting new plays and conservative traders may want to exit early!

Picked on April 30 at $ 51.39
Change since picked: - 3.34
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 825 thousand

Put Updates

Affiliated Mangers - AMG - cls: 98.38 chg: +0.93 stop: 102.55

The broker-dealer stocks produced a bit of an oversold bounce today. The XBD index added 1.29%. Shares of AMG bounced for a 0.9% gain on light volume. We would watch for the bounce to fail under the $100 level and use it as a new entry point to buy puts.
We do see two obstacles for the bears. The simple 100-dma, currently at 93.58, and the $95.00 level might offer some support. Conservative traders may want to exit near the 100-dma. We would expect a bounce near $95.

Picked on May 01 at $ 97.45
Change since picked: + 0.93
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 637 thousand


Amazon.com - AMZN - close: 34.38 chg: -0.21 stop: 36.51

AMZN continues to show relative weakness despite news today that their jewelry and watch sales grew more than 100% in the first quarter. Our target is the $31.00-30.75 range.

Picked on May 01 at $ 34.85
Change since picked: - 0.47
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 6.3 million


Atheros Comm. - ATHR - close: 25.52 chg: +1.75 stop: 26.51

Watch out! ATHR is reversing on us. The stock turned in a very strong 7.3% bounce on above average volume to close back above the 50-dma and support/resistance at the $25.00 level. This is bad news for any bears making Monday's decline look like a bear trap. More conservative traders, if you entered this morning, might want to consider exiting early or tightening your stop toward $26.00. We are not suggesting new positions.

Picked on May 01 at $ 23.77
Change since picked: + 1.75
Earnings Date 04/24/06 (confirmed)
Average Daily Volume = 1.6 million


Research In Motion - RIMM - cls: 74.44 chg: +1.41 stop: 79.01

We expected a bounce and got one with RIMM's 1.9% gain today. Fortunately, the rally stalled near the $75.00 level, which as broken support should act as new resistance. Our target is the $71.00-70.00 range but more aggressive traders may want to aim lower. We are going to lower our stop loss to $79.01.

Picked on April 30 at $ 76.63
Change since picked: - 2.19
Earnings Date 07/06/06 (unconfirmed)
Average Daily Volume = 5.8 million


Whole Foods - WFMI - close: 61.64 chg: +0.18 stop: 64.01 *new*

WFMI is still churning sideways as investors wait for the company's earnings report tomorrow. Our plan is to exit tomorrow at the closing bell to avoid holding over the report. We're going to tighten our stop loss to $64.01.

Picked on April 23 at $ 63.91
Change since picked: - 2.27
Earnings Date 05/03/06 (confirmed)
Average Daily Volume = 1.8 million


XM Satellite Radio - XMSR - cls: 18.45 chg: -0.26 stop: 20.55

A better than expected earnings report from rival Sirius (SIRI) did nothing to help shares of XMSR today. XMSR lost another 1.38% on strong volume closing at a new relative low. Our target is the $17.55-17.45 range but shares are starting to look oversold so it may be time to look for a bounce before continuing lower.

Picked on May 01 at $ 19.65
Change since picked: - 1.20
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 7.9 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.)


Fedex - FDX - close: 116.08 chg: +2.48 stop: n/a

A rally in the transport stocks, in the face of higher oil prices, helped FDX to a 2.18% gain today. If you missed yesterday's entry point in the $114.50-115.50 zone you got another chance today. We were suggesting the June $120 calls and the June $110 puts. This is a bet that FDX will trade significantly north of $120 or under $110 by June option expiration. Our estimated cost is about $2.60.

Picked on April 30 at $115.13
Change since picked: + 0.95
Earnings Date 06/21/06 (unconfirmed)
Average Daily Volume = 1.4 million

Dropped Calls


Dropped Puts


Dropped Strangles



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