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Daily Newsletter, Saturday, 05/13/2006

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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

Were You Expecting a Rally?

I hope readers were not expecting a post Fed rally because I have done my best over the last three weeks to warn that storm clouds were growing a post Fed drop was highly probable. You will probably read in the newspapers of hear a sound bite on the news that the market tanked for any number of reasons. Some are saying high interest rates, others declining consumer confidence, rising gasoline prices or fear the economy will grow too slowly. Others will say the economy is growing too strongly or earnings were not strong enough. The Fed will be the number one excuse de jour with their last 25-point hike and/or the vague language in the statement. There are dozens of excuses being used this weekend but all but one of them are wrong. They may be contributing factors but the primary cause is simply what I have been telling you for the last several weeks. The market was priced to perfection. The bull has run a good race but even prize bulls are eventually slaughtered. What we don't know is whether this is the start of something big or just a quick retracement before another leg higher. What we do know is that the current bull market has lasted nearly 800 days since a normal -10% correction. That is the third longest streak in modern times and like any streak it will eventually be broken. If Wednesday's high was the break high then the current streak has lasted 798 days.

Top Five Streaks Without a 10% Correction

The Q1 earnings are over and those released last week were less than stellar. Dell and Cisco head the list but there were plenty of others with weak guidance. This weak guidance should not be a surprise to anyone. The second half of 2006 has been expected to show a decline in earnings for more than a year now. The guidance in the Q1 earnings was actually stronger than analysts expected but it still pointed to a cooling of profits and the economy. Earnings are great but the comparisons will continue to get harder as the year progresses. It is not a problem, companies will still be highly profitable but the pace of growth will slow. That also assumes the economy continues to grow steady as well. None of this had any material impact on the market drop. The Dell and Cisco earnings may have helped get the ball moving but the Nasdaq was already on shaky ground.

The analysts and broadcasters on CNBC were consumed with talking about the bursting bubble in metals and energy and completely overlooked the coming option expiration. Anyone using options to capture the Q1 earnings gains was faced with an expiration of the earnings cycle as well as the expiration of May options. It was simply time to take profits. Funds using options to enhance their returns and the thousands of hedge funds who leverage themselves to the moon with options almost ALWAYS exit those positions late in the week before expiration week. That should be no surprise to anyone. Years ago they would wait until expiration week but that changed early this decade. We have had two dozen quarterly expiration cycles since the 2000 crash so the timing of option exits for funds should not be a surprise to anyone. Since it only happens four times a year in volume it is often overlooked as a contributing factor to market performance.

I warned readers over the last three weeks that there was trouble ahead. The monster short squeeze the preceding Friday on the benign jobs report was a hiccup in the aging process for Q1 earnings cycle because the majority of professional traders were already setting up for the drop. It was only a temporary setback and they were forced to reload their shorts at a higher level. The timing of the FOMC meeting was an added plus.

Combination of reasons blamed for the market drop:

1. End of Q1 earnings cycle, future earnings slowing
2. Massive profits to protect
3. Post earnings cycle option expiration
4. Fed announcement was already priced into market
5. Fed announcement was less clear than expected
6. Transport spike +250 points over support
7. Record oil prices near end of expiration cycle
8. Gold, copper, silver, palladium, etc at 25yr highs
9. Arrival of summer doldrums period
10.Third longest bullish streak in 50 years

While all of those factors listed above contributed to the drop it was simply time to take profits. You may have noticed I did not say anything about rising inflation. The talking heads on TV were putting the "rising inflation" phrase in nearly every sentence as though it was the holy grail of reporter credibility. While inflation may be a problem eventually it had nothing to do with the drop over the last two days. Repeat after me, Profit Taking, Profit Taking, Profit Taking.

There were signs of inflation in the Import/Export Prices report on Friday but it was primarily due to the surge in energy prices. Import prices rose +2.1% to end a streak of two consecutive down months. The jump was more than consensus estimates for a +1.0% gain. Export prices also rose +0.6%. The jump in import prices was primarily due to a jump in oil products of +11.5%. This was the biggest jump in imported energy prices since the +13.4% jump in March 2005. The jump was also powered by a rise in metals prices and a price hike on imported autos. The Fed will be worried about a pass through of energy prices contributing to inflation but to date it has not shown up on the consumer side.

The trade deficit for March shrank unexpectedly to $62 billion compared to $65.6B in February and estimates of $66B by analysts. However, our deficit with our currency manipulating trading partner, China, rose from $13.8 billion to $15.6 billion. I am sure Treasury Secretary Snow was cursing under his breath knowing this would produce an entirely new round of questions about their currency problems. The U.S. Treasury reported last week that China had made "far too little progress in introducing rate flexibility." In english that means they are keeping it low to make their products more attractive to U.S. consumers. Analysts think the yuan is undervalued by 40% or more making their products very cheap and aggravating the deficit problems.

The most depressing report on Friday was an extremely large drop in consumer sentiment. The headline number fell to 79.0 from 87.4 or -8.4 points. The slide was led by a drop in the present conditions component from 109.2 to 96.2. This -13 point drop was the largest monthly drop on record. The expectations component also declined from 73.4 to 68.0. Since the stock market was up for the period covered in the report most analysts feel it was the constant whining about gasoline prices that poisoned consumer sentiment. If you remember over the last two weeks we had gasoline prices around $3 and shortages in several areas as the MTBE/Ethanol conversion began. Talking heads on the network news shows were obsessed over the price of gasoline during a non-crisis period. Speculations about the coming hurricane season and higher prices during the summer vacation season had every politician within reach of a microphone making a speech. Consumers already pinched by falling housing prices, higher credit card payments and rising interest rates were feeling the pain at the pump. This report should give the Fed an additional reason to take a pass at the June meeting.

The economic calendar picks up again next week with several reports on housing, PPI, CPI, Industrial Production, several Fed business surveys as well as the Semi book-to-bill report. All will be dissected to see if they fall into the guidelines required to keep the Fed on hold. While these will keep market reporters busy they should not have any material impact on the indexes unless there is a major consensus miss.

What may cause trouble is news reported after the market close on Friday that IAEA inspectors had found uranium enriched to 90% at a site in Iran. Uranium only needs to be enriched to 5% for electrical generation and 90% is bomb grade material. Enriching to 90% requires substantially more effort than the simple reactor fuel they claim they are producing. The site, a weapons research facility at Lavizan, was reported by an informant as an undercover nuclear research site several years ago. When the IAEA arrived to examine it the entire site, consisting of a block of substantial buildings, had been bulldozed with even the topsoil removed. The IAEA took environmental samples from the surrounding area. They later tested some equipment that reportedly was moved from the building to another location. Those samples tested positive for the highly enriched uranium. The times, dates and method of collection are still fuzzy since the story just broke. However, a quick Google of the keywords produced hundreds of pages relating to the swift removal of the site once the IAEA told Iran they were going to investigate it. Muhammad el-Baradei, head of the IAEA, reported the intelligence and the destruction of the site to the UN in late 2004. The discovery on the relocated equipment was just disclosed on Friday. This site and its sudden removal was featured on the Discovery channel documentary they are currently running called, "Is Iran the New Iraq?" Check your listings. They had some very clear satellite pictures of the site before and after the removal. It is very hard to decipher the reality from the propaganda due to the highly charged atmosphere surrounding the Iranian nuclear problem. This may be old data with a new spin, disinformation or propaganda designed to keep the pressure on Iran within the global press. Since the uranium traces, which had been enriched to weapons grade strength, were found at a weapons research installation only hikes the importance and the inflammability of the news.

Oil prices fell on Friday partly on statements from the Iranian president that Iran would comply with any valid restrictions that were in line with international rules. He did not say of course that Iran would decide how the rules applied. While this received a lot of press there was also comments from him that Iran was not afraid of possible military action by the U.S. because of Iran's military strength. He also said "the U.S. is trying to frighten Iran by waging a propaganda war using strong words but Iran was not afraid." Mahmoud Ahmadinejad was called the man of the year as he spoke to more than 1000 cheering students in Jakarta Indonesia on Friday.

The U.N. committee putting together the carrot and sticks resolution said it could be another week before it is ready for a vote. Mahmoud said he was not interested in any UN bribes to halt the research. UN Secretary General, Kofi Annan, called on the U.S. to negotiate directly with Iran saying Iran would never negotiate with the UN alone. The U.S. State Dept rejected Annan's appeal saying it was simply another delaying tactic and that the confrontation was not with the U.S. alone but with the world. The next committee meeting is May-19th to discuss a new package of incentives as well as penalties if Iran does not comply. French President Jacques Chirac said Europe should seek the imposition of UN Security Decisions on Iran due to growing concerns. What? A backbone from a French politician?

Oil prices probably fell more from a result of options expiration than from any Iran news. Even a pipeline explosion in Nigeria that killed as many as 200 people failed to produce any bounce in oil prices. It turned out to be a gasoline pipeline that vandals had dug up. They drilled holes in the pipeline to siphon out gasoline to sell to willing buyers. A spark ignited an explosion that incinerated everything within a 20 yard radius and produced severe burns for another 50 yards. Over 150 corpses, some turned into ash were visible near the pipeline but eyewitnesses said many more were blown into a large nearby creek. Rescue workers used makeshift stretchers to carry the remains to a shallow grave dug a short distance away. Nigerian authorities said it was not related to the rebel attacks that have cut production by 20% over the last several months. Some oil workers taken hostage earlier in the week were released unharmed.

For a Friday the oil scene was fairly calm. Prices declined from the $73 level on pre expiration activity to close at $72. I would be surprised if we do not see a rebound in crude early next week. The oil inventory report we got Wednesday showed that crude levels had risen only +300,000 barrels but gasoline had risen +2.3 million bbls. This depressed prices temporarily until traders realized that gasoline demand had rebounded from the prior week to the high for the year at 9.346 million barrels despite the high prices. Since this was the numbers for the first week of May I decided to do some research so we can track the demand growth from May-1st through the July-4th weekend. This is when demand spikes as Memorial Day kicks off the summer driving season followed by a peak around July 4th. The table below shows the historic demand since 1991 for the 9-week period beginning with the first reporting week in May. I added the average gasoline price for that period to illustrate the recent change and its impact on demand. As you can see from the table there was almost no discernable impact. Demand continued to increase despite a nearly +300% increase in prices. I will continue to update this table each week until the period expires. If demand continues to rise through May I expect crude prices to follow.

Gasoline Demand Table

The EIA restated their demand growth targets for 2006, again. They are now targeting demand growth of crude oil of +1.25 million barrels per day for all of 2006. This was down slightly from their last upward revision to +1.47 mb of growth. They cited a -10% drop in gas/diesel demand in Germany and a lower than expected demand from China for April. Since the IMF raised their growth targets last week for China to +9.5% for all of 2006 I expect the next EIA revision to be higher. Another survey I saw expects China to continue growing by the +10.2% rate we saw in Q1. China now has 23 million autos and that is double the number they had in 2003. While China has taken steps to slow the growth of automobiles they are still adding between 6-8 million per year. Add that to our +16 million in the U.S. and it will take a few more dinosaurs to fill the tanks. Actually that is only a figure of speech since oil is derived from plant material not animal.

Other oil related events include the nationalism fight in Bolivia. Evo Morales had to rethink his "agree or leave" mandate for the major energy companies in Bolivia. He found some stout opposition from most and Petrobras told him to take their $1.5 billion prior investment and stick it where the sun doesn't shine. After a hurried flurry of meetings and consultations Bolivia said they would compensate everyone for the confiscated property. That appeased everyone for about a day until Morales changed it to "we are not obligated to compensate anyone who has already received enough to energy to cover their initial investment" and from the tone Bolivia would manage the accounting to make sure it included everyone. Morales then accused Petrobras again of operating in the country illegally. Morales then proposed a 60% hike in gas prices to Brazil to quiet the state owned Petrobras. With Brazil consuming two-thirds of the gas exported by Petrobras from Bolivia a 60% hike would be a disaster. Morales raised the stakes and Brazil can't afford to call. As of press time on Friday it was still a stalemate and one that Brazil/Petrobras may not win. Other companies affected were Repsol YPF, Total, BP and BG Group. To reward Morales for his leftist nationalism decision Venezuela's Hugo Chavez provided Bolivia with a credit line of $100 million and a promise to donate $35 million for computers in Bolivian schools.

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Chavez also announced he was pulling out of the Andean Trade Community because fellow members Peru, Columbia and Ecuador were signing free trade deals with the United States. He asked Morales to join him in the revolt. Both leaders were attending a summit of European and Latin American leaders in Vienna. Together they received stern rebukes from nearly every speaker for their restrictive stand. Chavez is now targeting the heavy oil producers of the Orinoco River basin in Venezuela. The majors lifting oil there include Chevron, Exxon, Statoil, Shell, Conoco, ENI and others. They would be forced to turn over 60% of their business to Venezuela effectively giving the state total control. The government also moved to add a 33% extraction tax in addition to the 50% income tax already in place. They also added a +1% export tax. Needless to say the future of energy production from Venezuela and Bolivia is looking grim. According to Dow Jones exploration companies in Venezuela quit drilling in advance of the nationalism play and production is now -7.8% below last years levels. Bloomberg reported that the lack of new investment by the majors was forcing PDVSA, the Venezuela state owned oil company to seek up to $20 billion in loans from international banks to increase production. Would you lend a billion to Venezuela given their recent disregard for formal contracts? I doubt it. PDVSA also said it was going to look to its partners for another $20 billion. I am sure its partners, XOM, TOT, ENI, COP and CHV can't wait for that phone call. Meanwhile Venezuela subsidizes gasoline for its citizens providing it to them at the equivalent of 12 cents per gallon. This is how Chavez maintains control over the voting public. Not that votes actually count. Attempts in the past to raise gasoline prices have met with significant amounts of social unrest. Chavez is now trying to pass a referendum to allow him to retain his position until 2031. Fortunately the world is a big place and we can afford to look elsewhere for trading opportunities while the bullies destroy their sandbox.

I read an article on Bloomberg last week discussing China's voracious appetite for commodities of any flavor. China's State Reserve Bureau said it was going to step up acquisition of critical commodities to avoid any future shortages. With the Olympics in 2008 and the Shanghai World Expo in 2010 they are on a monster building binge. They expect 1000 new skyscrapers to be built between now and 2010. That is in addition to the more than 4000 that currently exist. China's economy grew by +10.2% in Q1 and China Daily said last week the economy is expected to grow by +8% annually through 2010. That is a monster growth rate in a country of more than a billion people. To fuel this growth the Reserve Bureau said it was going to increase reserves of iron by 5 billion metric tons, copper by 20 million tons and bauxite (aluminum ore) by 200 million tons by 2010. They are planning 2-3 additional strategic petroleum reserves of up to 5 billion metric tons each as well as 100 billion tons of coal. Since a metric ton of oil equals 7.3 bbls that would be 36.5 billion barrels per reserve or 429 days of total global output. I think somebody got their decimal point in the wrong place and meant 5 million tons or 36.5 million bbls. Still a lot of oil when you add three reserves to the one they have not yet filled. Longer term they are adding over 50 and as many as 100 nuclear power plants and more than 300 coal fired electric plants. More than 80% of China has no electricity for much of the day due to power shortages. They just signed a deal with Australia for $71.4 billion in uranium ore for initial deliveries to begin as their plants begin to come online within four years. I am telling you this now because I want you to be in the front of the line as China tries to acquire these commodities. This is a buying spree unknown in modern history and the end result is going to be much higher prices for everything. Almost any oil stock will benefit because that big sucking sound is oil heading for the Chinese market. See the LEAPS Trader newsletter this weekend for my favorite China energy play. I also like the mining stocks BHP, PCU, CCJ, RIO and GG for the continued bounce in gold.

Without looking at the table below I am sure everyone agrees the week was a disaster. Actually the losses for the week were almost all generated after Wednesday's open. That means those loss percentages represent roughly three days of trading not five. To say the selling was sharp would be an understatement.

Table of percentage losses for Friday and the week.

The damage done over the last three days was substantial. As you can see from the table below the change in the internals compared to the Thr/Fri from the prior week was very negative. Thursday's down volume was 6:1 over up volume and Friday's was only slightly better at 5:1. The new highs plummeted from 802 on the monster jobs related Friday short squeeze to only 104 a week later. The severity of the selling suggests it will be short lived.

Table of internals for last seven days

I am sure you heard all the statistics from the news sources like worst two days for the S&P since October, worst two-day drop on the Nasdaq since March 2005 or NDX low for the year. There were plenty more being tossed about but I know you get the picture. Now that the bull barbeque is in full bloom the real question we all want to know is when will it stop?

I am betting we should get a bounce very soon. While we are likely to see some margin call selling on Monday we are resting on strong support on most of the indexes. There was some bottom fishing late Friday but the few dip buyers taking the risk early were steamrolled into the close. The pre expiration option volume was simply too strong. Sell stops trigger selling and that triggers even more sell stops. When you get a day like Thr/Fri it is best to wait for clear signs of daylight before pulling the entry trigger.

The Russell and the NYSE Composite have been the most bullish of the broader averages coming into the week. The NYSE Composite fell to just above support at 8400 at the close and a decent spot for bottom fishing. If that level breaks the next material support would be 8200. The Russell 2000 declined to 742 and halted its decline exactly at support from early April. A break of 740 could target 720 as the next stop.

Chart of Russell-2000 - 60 min

Chart of NYSE Composite - 30 min

The Dow retraced nearly -300 points from Wednesday's six-year high at 11670 to close in congestion at 11379. The initial support at 11450 held for about two hours before collapsing on losses in CAT, XOM, AA, BA, MO and UTX. Meanwhile AIG, DIS, AXP and GM were the only Dow components to finish in the green. Considering the -$4 drop in AIG on Thursday the fractional gain on Friday was not even a respectable dead cat bounce. The Dow support at 11365 might contain any margin selling on Monday but a break there would indicate the fire drill is not over and the next target would be 11275. A normal -10% correction would take us well below that to 10500. While I can't imagine that in the near future that is the -10% level.

The Nasdaq went into free fall beginning with Dell's earnings warning and never looked back. The plunge past initial support at 2300 did not even merit a pause. Friday's close at 2243 is at what I would consider as very decent support for all of 2006. A break here targets 2190 and the low for the year. A normal -10% correction from the 2375 double top high in April would take us to 2137 but I believe a break under 2190 could spell trouble and a possible drop to retest the October low at 2025. I know it sounds grim and I don't expect that to happen but that is the risk.

Dow Chart - 30 min

Nasdaq Chart - 120 min

Dow Transport Chart - 120 min

I highlighted the Dow Transports last Tuesday as extremely overbought and most likely to correct. They did it in high style with a triple digit loss on Friday to close at 4840 and -172 points off the Wednesday historic high at 5013. That was only a -3.45% drop and a full-blown correction would take them to 4512 and -500 points off the high. I do not expect this to happen. Nothing in the market or the economy suggests any weakness in shipping and I believe the other indexes will bottom first and rescue the transports from a dismal plunge. The transports could retrace to 4700 and still remain in the current up trend.

Earlier I mentioned the current bull run is the third longest in recent history dating back to 1950. While it will eventually break that streak there is nothing that says it has to be now. I also mentioned above that I believe profit taking and funds closing option positions ahead of next week's expiration cycle is what produced the damage. I do expect the dip to be bought and I backed up the truck at Friday's close just in case. The simultaneous arrival at support on multiple indexes was enough for me to take a position ahead of any dead cat bounce on Monday. Most were positions in energy and metals that had already taken a major hit. Just because I took the chance does not mean I won't be hung out to dry on Monday if this plunge is not over. I simply calculated the risk with multiple indexes at support and took it.

I personally don't believe we are going for the full -10% correction although the Nasdaq Comp, Nasdaq-100, SOX and Russell are already more than -5% off their highs. Also, even if we are going to go for the full -10% it is inconceivable that it would happen all at once. Rarely do full corrections happen in a week. Two to three weeks maybe but normally it is a process that unwinds over several weeks with multiple bouts of dip buying followed by failed bounces. I calculated the levels for a -5% drop and a full -10% drop and compared it to Friday's close in the table below. I used the recent highs as the starting point. You can see the blue chips as evidenced by the Dow and S&P-100 held up the best while the SOX has nearly completed a -10% drop.

Table of percentage drops from recent highs

For next week I would look to buy a bounce over SPX 1295 but only for a short-term trade. Once any margin selling at Monday's open is over I would expect the current oversold conditions to ease. However, we still have a large number of retail traders who are probably still nursing some May option positions. While that is a far less damaging market force it could weaken any bounce. I believe the current underlying bullishness will return and it will be a fight to produce any new order imbalances either up or down. It is more likely that we enter a range bound period where positions are shuffled and traders setup for the summer doldrums. I believe the worst is over but as we all know the market sometimes gets caught up in its own momentum and overshoots the obvious targets. I would look to be long energy and metals as the only safe bets for the next month. Safe may be relative but that is where I plan on hiding. Keep tight stops on any dip buys and be ready to step aside if the power selling resumes.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None ATI None
  BEN  
  USG  

New Calls

None today.
 

New Puts

Allegheny Tech - ATI - close: 78.45 chg: -6.08 stop: 82.55

Company Description:
Allegheny Technologies Incorporated is one of the largest and most diversified specialty metals producers in the world with revenues of $3.7 billion during the most recent four quarters ending March 31, 2006. ATI has approximately 9,300 full-time employees world-wide who use innovative technologies to offer growing global markets a wide range of specialty metals solutions. Our major markets are aerospace and defense, chemical process industry/oil and gas, electrical energy, medical, automotive, food equipment and appliance, machine and cutting tools, and construction and mining. Our products include nickel-based alloys and superalloys, titanium and titanium alloys, stainless and specialty steels, zirconium, hafnium, and niobium, tungsten materials, grain-oriented silicon electrical steel and tool steels, and forgings and castings. (source: company press release or website)

Why We Like It:
Everything looks relatively bullish for ATI. The P&F chart points to a triple-digit target. The stock is a big momentum candidate but short-term things have turned bearish. The steel-related stocks, which have been such big winners in recent weeks, have turned into big targets for profit taking. The three-day candlestick pattern on ATI is a bearish reversal. Considering the upward momentum in this stock and the chance for an oversold bounce in the markets we are classifying this as a high-risk play. We're suggesting shorts under $80.00 with a target in the $72.00-71.00 range.

Suggested Options:
We are suggesting the June puts for a short-term play.

BUY PUT JUN 80.00 ATI-RP open interest= 524 current ask $6.10
BUY PUT JUN 75.00 ATI-RO open interest=1301 current ask $3.60

Picked on May 14 at $ 78.45
Change since picked: + 0.00
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 2.2 million

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Franklin Res. - BEN - close: 89.30 chg: -2.07 close: 92.55

Company Description:
Franklin Resources, Inc. is a global investment management organization operating as Franklin Templeton Investments. Franklin Templeton Investments provides global and domestic investment management solutions managed by its Franklin, Templeton, Mutual Series and Fiduciary Trust investment teams. The San Mateo, CA-based company has more than 50 years of investment experience and over $504 billion in assets under management as of April 30, 2006. (source: company press release or website)

Why We Like It:
Investment-related stocks are getting hammered lately. It looks like BEN is headed even lower. Shares broke down under support at $92.50 and $90.00 and its 200-dma two weeks ago. Then BEN produced an oversold bounce that failed twice near resistance at $95.00. Now the stock is crashing lower again and shares fell through the 200-dma and the $90.00 level on strong volume this Friday. The P&F chart for BEN points to a $77.00 target. We are suggesting puts here under $90.00 with a target in the $85.00-84.50 range. Be advised that we do expect a bounce at the $87.50 region.

Suggested Options:
We are suggesting the June or July puts.

BUY PUT JUN 90.00 BEN-RR open interest=1231 current ask $2.95
BUY PUT JUN 85.00 BEN-RQ open interest=2336 current ask $1.10

or

BUY PUT JUL 90.00 BEN-SR open interest= 222 current ask $4.00
BUY PUT JUL 85.00 BEN-SQ open interest=1413 current ask $1.95

Picked on May 14 at $ 89.30
Change since picked: + 0.00
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 1.1 million

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USG Corp. - USG - close: 101.95 chg: -4.30 stop: 105.05

Company Description:
USG Corporation is a Fortune 500 company with subsidiaries that are market leaders in their key product groups: gypsum wallboard, joint compound and related gypsum products; cement board; gypsum fiber panels; ceiling panels and grid; and building products distribution. (source: company press release or website)

Why We Like It:
The upward momentum in building materials company USG is in jeopardy. The stock peaked near $120 and the recent bounce stalled under $115.00, establishing a lower high. Now shares are poised to breakdown under technical support at its 50-dma and the $100.00 level. The P&F chart is already bearish with a sell signal pointing to the $90.00 mark. We are going to suggest a trigger to buy puts at $99.75. If triggered we'll target a decline into the $92.00-90.00 range. We're a little concerned that the rising 100-dma, near 90.25, could be support. Take note, more conservative traders may want to use a lower trigger just to be sure of the breakdown.

Suggested Options:
We are suggesting the June puts. Unfortunately, there are no June $95s or $90s available at this time. Nor are there any July strikes available yet.

BUY PUT JUN 105.00 UZO-RA open interest= 800 current ask $8.20
BUY PUT JUN 100.00 UZO-RT open interest=4205 current ask $5.40

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 888 thousand
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Autoliv - ALV - close: 56.51 change: -0.17 stop: 54.99

The good news here is that ALV's decline appears to have stalled near $56.50. We were expecting a dip toward $56.00 or even the 50-dma and Friday would have been a great excuse to sell the stock given the market weakness. We're cautiously optimistic that most of the selling is over. However, we'd still wait and watch for a dip toward $56.00, better yet, a bounce from $56.00 as the next potential entry point to buy calls. Guard your stop losses. The damage done during last week's sell-off has turned many of ALV's technical indicators bearish. Our mid-June target is the $62.50-63.00 range.

Suggested Options:
We are not suggesting calls at this time. Wait for the next entry point. Our preference is the June calls.

Picked on May 04 at $ 57.53
Change since picked: - 1.02
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 513 thousand

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B P Prudhoe Bay - BPT - close: 72.74 chg: -1.51 stop: 72.45

Unfortunately, the oil stocks were unable to escape the market-wide sell-off on Friday. We're now facing a worse-case scenario with the stock hitting our trigger on Thursday and failing to hold the bullish breakout. So far BPT has held minor support near $72.50 but odds are really good, if the markets show any weakness on Monday morning, we'll be stopped out at $72.45. We would keep an eye on BPT for a dip toward support near $70.00. A bounce from $70.00 could be used as a new bullish entry point down the road. We remain bullish on the oil sector once this correction ends.

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

Picked on May 11 at $ 75.05
Change since picked: - 2.31
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 120 thousand

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Nexen - NXY - close: 57.38 chg: -2.14 stop: 56.75

NXY is another wounded oil stock that's experienced some profit taking in the last couple of days. Fortunately, we're still on the sidelines. Our strategy is to use a trigger at $61.75 to buy calls. We're going to stick to that plan for now. However, we'll be watching for a bounce from $55.00 and/or technical support at its 100-dma as an alternative entry point.

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

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/13/06 (unconfirmed)
Average Daily Volume = 500 thousand

---

Omnicom - OMC - close: 91.81 chg: +0.19 stop: 89.99

We continue to be surprised by OMC's relative strength. The stock isn't showing any weakness compared to the rest of the market. We're going to stick by our plan for now but traders may want to think twice about entering new call positions with the major averages sinking. We want to catch any upward breakout so we're suggesting a trigger to buy calls at $92.05. If triggered our target will be the $97.50-98.00 range. The P&F chart is very bullish with a $110 target.

Suggested Options:
We are suggesting the June or July calls. You pick which strike works best for you. Our trigger to buy calls is $92.05.

BUY CALL JUN 90.00 OMC-FR open interest=787 current ask $3.20
BUY CALL JUN 95.00 OMC-FS open interest=361 current ask $0.75

BUY CALL JUL 90.00 OMC-GR open interest=1732 current ask $4.20
BUY CALL JUL 95.00 OMC-GS open interest= 384 current ask $1.60

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

Red Hat - RHAT - close: 29.52 chg: -0.51 stop: 28.99

The sell-off in tech stocks continued on Friday and RHAT fell 1.69% to close under the $30.00 mark. Short-term technical oscillators are bearish and we're not suggesting new positions at this time. We'd like to see a bounce near $29.00 or its 50-dma near $29.15 but we are not suggesting new plays until RHAT trades back over $31.00. Our target is the $34.75-35.00 range.

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

Picked on May 04 at $ 31.11
Change since picked: - 1.59
Earnings Date 06/27/06 (unconfirmed)
Average Daily Volume = 3.4 million
 

Put Updates

Amazon.com - AMZN - close: 32.73 chg: -0.80 stop: 35.51

The selling in AMZN continues and the stock lost another 2.38% on Friday. This is a new one-year low for the stock. Our target is the $31.00-30.75 range. We see no changes from our previous updates.

Suggested Options:
We're not suggesting new positions.

Picked on May 01 at $ 34.85
Change since picked: - 2.12
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 6.3 million

---

Apollo Group - APOL - close: 52.26 chg: -0.32 stop: 55.05

APOL is a new play from our Thursday night newsletter. We do not see any changes so we're reposting the original play description here:

We are going to try again with APOL as a bearish candidate. We tried a few weeks ago but shares never broke support at $50.00 so they never hit our trigger to buy puts. We're going to try using a trigger again. The stock has produced two failed rallies under technical resistance at its descending 100-dma in the last couple of weeks. Plus, the hourly chart shows a bearish head-and-shoulders pattern with the neckline (support) near $52.00). We're going to suggest a trigger to buy puts at $51.75. There is probably some support near $50.00 but our target will be the March lows. We'll plan to exit in the $47.75-47.50 range.

Suggested Options:
We are suggesting the June puts. We do not want to hold over the late June earnings report. Our trigger is at $51.75.

BUY PUT JUN 55.00 OAQ-RK open interest=236 current ask $3.50
BUY PUT JUN 50.00 OAQ-RJ open interest=193 current ask $0.85

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 06/22/06 (unconfirmed)
Average Daily Volume = 2.1 million

---

Black Box - BBOX - close: 44.39 chg: -1.02 stop: 46.55

BBOX is a new play from the Thursday night newsletter. Shares broke down under support at $45.00 on Friday and hit our trigger to buy puts at $44.85. We do not see any changes from our new play description so we're reposting it here:

The networking sector took a blow when networking giant CSCO recently issued cautious comments about their quarter. Thursday saw a 3.2% sell-off in the NWX networking index, which helped push BBOX to a 5% loss. After three months of consolidating sideways we suspect that BBOX is poised to move lower. Thursday's decline ended with a breakdown under technical support at its 200-dma. If shares break the $45.00 level it will produce a new quadruple-bottom breakdown sell signal on its P&F chart. We are going to suggest a trigger to buy puts at $44.85. If triggered our target will be the 40.75-40.00 range. FYI: we would consider this play somewhat aggressive since we find stocks with low daily volume and low option volume somewhat dangerous!

Suggested Options:
We are suggesting the June puts. We do not want to hold over the June 1st earnings report. Our trigger is $44.85.

BUY PUT JUN 45.00 QBX-RI open interest= 63 current ask $3.10
BUY PUT JUN 40.00 QBX-RH open interest= 30 current ask $1.15

Picked on May 12 at $ 44.85
Change since picked: - 0.46
Earnings Date 06/01/06 (confirmed)
Average Daily Volume = 90 thousand

---

Bear Stearns - BSC - cls: 134.50 chg: -2.98 stop: 142.55

The broker stocks, and BSC, have been big targets for profit taking and the group lost 2.2% on Friday. The volume on BSC's decline on Friday was above average. We do not see any changes form our new play description from Thursday night so we're reposting it here:

It is amazing what a few days of trading can do to change the situation. A week ago BSC was bouncing from support at its 50-dma and look poised to challenge its highs and beyond. Now the stock is breaking down and looks ready to sink toward support near $130.00. The XBD broker-dealer index has produced a similar failed rally/bounce and breakdown. We are suggesting puts with BSC under $138.00. Since BSC can be somewhat volatile more conservative traders may want to wait for a decline under $137 before initiating positions. More conservative types may also want to plan an exit at the rising 100-dma, which may act as technical support. We're going to target a decline into the $132.00-130.00 range. We suspect that the $130 level will act as support since it close to the 38.2% Fibonacci retracement level of its October-April run up.

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

BUY PUT JUN 140.00 BSC-RH open interest=2372 current ask $5.60
BUY PUT JUN 135.00 BSC-RG open interest= 434 current ask $3.20

Picked on May 11 at $137.48
Change since picked: - 2.98
Earnings Date 06/15/06 (unconfirmed)
Average Daily Volume = 1.2 million

---

IDEXX Labs - IDXX - close: 77.03 chg: -0.90 stop: 80.05

IDXX is off to a good start. Shares lost 1.15% on Friday following Thursday's failed rally. We do not see any changes from Thursday's new play description so we're reposting it here:

The tide appears to have turned for IDXX. Shares peaked in late March, filled the gap in April, broke down under support at $80.00 two weeks ago, and broke down under support at its rising 100-dma following today's failed rally under the 10-dma near $80.00. The P&F chart is bearish and points to a $70 target. We think shares can slip to the rising 200-dma although we're keeping a watchful eye on potential support at $75.00. We're going to suggest puts with IDXX under $78.00. Our target will be the $72.50-73.00 range for now. We'll adjust it as the 200-dma rises.

Suggested Options:
We are suggesting the June puts although July puts are also available and currently have more open interest.

BUY PUT JUN 80.00 UID-RP open interest= 61 current ask $3.80
BUY PUT JUN 75.00 UID-RO open interest= 60 current ask $1.30

Picked on May 11 at $ 77.93
Change since picked: - 0.90
Earnings Date 04/28/06 (confirmed)
Average Daily Volume = 125 thousand

---

Merrill Lynch - MER - close: 72.74 chg: -1.26 stop: 77.26

The high-volume sell-off continues in shares of MER. We do not see any changes from our Thursday night new play description so we're reposting it here:

This looks like a pretty attractive entry point to buy puts on MER. The stock broke down from its multi-month up trend a couple of weeks ago but now we have the benefit of seeing the oversold bounce fail near its 50-dma. Volume was pretty strong on Thursday's decline and MER closed under potential support at $75.00 and its 100-dma. The P&F chart points to a $67 target. We're going to target a decline into the $70.50-70.00 range.

Suggested Options:
We are suggesting the June puts although July puts would also work well and appear to have more open interest.

BUY PUT JUN 75.00 MER-RO open interest=1760 current ask $3.30
BUY PUT JUN 72.50 MER-RB open interest=1191 current ask $1.95
BUY PUT JUN 70.00 MER-RN open interest= 996 current ask $1.10

Picked on May 11 at $ 74.00
Change since picked: - 1.26
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 4.7 million

---

Research In Motion - RIMM - cls: 74.26 chg: +1.19 stop: 77.55*new*

We are suggesting caution here. RIMM failed to participate in the market-wide sell-off this Friday. Instead shares bounced higher adding 1.6%. We are not suggesting new bearish positions and we'll try and reduce our risk by lowering the stop loss to $77.55. Our target remains the $71.00-70.00 range. More conservative traders may want to exit near $71.70-71.60 due to the simple 200-dma.

Suggested Options:
We are not suggesting new put positions in RIMM at this time.

Picked on April 30 at $ 76.63
Change since picked: - 2.37
Earnings Date 07/06/06 (unconfirmed)
Average Daily Volume = 5.8 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: 115.06 chg: -2.21 stop: n/a

The Dow Jones Transportation sector suffered an uncommon triple-digit loss on Friday losing more than 2%. Shares of FDX followed with a 1.88% decline putting it back at the $115 level just above technical support at its 50-dma. If you were looking for a new entry point to consider a strangle position then this is it! Our previously suggested entry zone was $114.50-115.50. 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 but you could probably enter a June strangle today around $2.25.

Suggested Options:
We were suggesting the June $120 calls and the June $110 puts.

Picked on April 30 at $115.13
Change since picked: - 0.07
Earnings Date 06/21/06 (unconfirmed)
Average Daily Volume = 1.4 million
 

Dropped Calls

Cleveland Cliffs - CLF - close: 93.75 chg: -2.54 stop: 94.45

Profit taking in the metal and mining stocks on Friday was pretty heaving. The XAU index lost more than four percent. Shares of CLF closed down 2.6% but bounced off its lows of the session. We warned readers on Thursday that CLF had produced a bearish reversal pattern but we didn't expect shares to break through support at $95.00. We've been stopped out at $94.45. We would keep an eye on CLF for a move past $95.00 as a potential entry point again.

Picked on May 08 at $ 95.11
Change since picked: - 1.36
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 692 thousand

---

Goldman Sachs - GS - cls: 156.11 chg: -3.17 stop: 157.95

We warned readers on Thursday that the drop under $160 was bad news and suggested an early exit. The profit taking continued into Friday and the XBD index lost 2.26%. Shares of GS followed with a 1.99% decline to close under technical support at its rising 50-dma. If GS moves under $155 it will look like a bearish candidate.

Picked on May 07 at $164.39
Change since picked: - 8.28
Earnings Date 06/13/06 (unconfirmed)
Average Daily Volume = 3.9 million

---

Schlumberger - SLB - cls: 68.85 chg: -2.66 stop: 69.59

The profit taking in the oil services sector was heavy. The OSX oil services index fell more than 4% on Friday rivaling the decline in the metals. SLB was not spared and lost 3.7% to breakdown below the $70.00 level. The stock's MACD indicator has produced a new sell signal. We've been stopped out at $69.59.

Picked on May 10 at $ 73.06
Change since picked: - 4.21
Earnings Date 07/21/06 (unconfirmed)
Average Daily Volume = 11.2 million
 

Dropped Puts

Atheros Comm. - ATHR - close: 22.01 chg: +0.30 stop: 25.26

Target achieved. ATHR slipped to 20.55 during the carnage on Friday. Our target was the $21.00-20.50 range. We expect shares to find some support at $20.00 or its 100-dma. Keep an eye on any failed rally under $25.00 or its 10-dma as a potential entry point for new bearish positions.

Picked on May 01 at $ 23.77
Change since picked: - 1.76
Earnings Date 04/24/06 (confirmed)
Average Daily Volume = 1.6 million
 

Dropped Strangles

None
 


Trader's Corner

Did Ya?

Did you trade the indices the early part of this week? Although some traders, including some of the commentators on the OptionInvestor's Market Monitor, successfully traded during that difficult period, others must have pounded their keyboards in frustration when indices flattened.

A February 4 Trader's Corner article addressed the importance of knowing when not to trade, listing the time leading into an FOMC meeting as one of those times for all but the most accomplished traders. Action tends to flatten. Action flattened sooner and stayed flatter longer before this week's FOMC meeting.

Annotated 15-Minute Chart of the SPX:


As was pointed out in the February 4 article, the SOX's performance is sometimes more volatile than the SPX's heading into the FOMC meeting. That volatility this week took the form of quick moves followed by long periods of that same tight-range trading that was seen in the SPX.

That February 4 article noted that when indices begin displaying this tight-range behavior into the FOMC meeting, conservative traders might find it best to remain in cash until after the decision is made. First reactions after the decision also tend to be volatile, sometimes reversing directions several times.

Annotated Five-Minute Chart of the SPX:


Those quick reverses in direction sometimes set up a formation, most often a triangle. The break of that formation may then be more predictive of final direction. Is that what happened this week? Sure did.

Annotated Five-Minute Chart of the SPX:


Daily pivots, weekly pivots, extended-to-the-downside RSI, bullish divergences: none mattered Thursday after that formation broke. There's often a retest, sometimes one that briefly moves past the resistance or support just broken, but prices never even successfully retested the broken support Thursday. A trailing stop would have worked well, although it's probably true that the depth of the decline was likely exacerbated by options-related activity. This Thursday was the Thursday before option-expiration week. Rollover-related activity that used to be most prominent options-expiration week now frequently takes place on the Thursday and Friday of the preceding week.

Why make this hard? Some times exist when you just shouldn't trade, and the period leading into the FOMC meeting is probably one of them. There will be times when the market fears or looks forward to a certain decision and indices move ahead of that decision. That just means that you've missed one of the many successful trades that you're going to miss when you decide against a cowboy/cowgirl trading style and opt for a more conservative and possibly account-saving style. This exact setup happens far too many times to encourage traders to increase their blood pressure and decrease their trading accounts by trying to mentally move an index ahead of an FOMC meeting. The setup occurs so often that the text of this article, up to the "Is that what happened this week? Sure did." paragraph was written Tuesday evening, before the decision. All that was needed to complete the article were the after-the-decision charts and the summation.

You can find other times when it's best not to trade in that original February 4 Trader's Corner article. A note of caution, of course: even if this setup occurs often, as it does, stops are needed if you enter post-decision on a formation break, because . . . well, just about when you've figured out how markets tend to react, they change their reactions.
 

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


Trader's Corner

Did Ya?

Did you trade the indices the early part of this week? Although some traders, including some of the commentators on the OptionInvestor's Market Monitor, successfully traded during that difficult period, others must have pounded their keyboards in frustration when indices flattened.

A February 4 Trader's Corner article addressed the importance of knowing when not to trade, listing the time leading into an FOMC meeting as one of those times for all but the most accomplished traders. Action tends to flatten. Action flattened sooner and stayed flatter longer before this week's FOMC meeting.

Annotated 15-Minute Chart of the SPX:


As was pointed out in the February 4 article, the SOX's performance is sometimes more volatile than the SPX's heading into the FOMC meeting. That volatility this week took the form of quick moves followed by long periods of that same tight-range trading that was seen in the SPX.

That February 4 article noted that when indices begin displaying this tight-range behavior into the FOMC meeting, conservative traders might find it best to remain in cash until after the decision is made. First reactions after the decision also tend to be volatile, sometimes reversing directions several times.

Annotated Five-Minute Chart of the SPX:


Those quick reverses in direction sometimes set up a formation, most often a triangle. The break of that formation may then be more predictive of final direction. Is that what happened this week? Sure did.

Annotated Five-Minute Chart of the SPX:


Daily pivots, weekly pivots, extended-to-the-downside RSI, bullish divergences: none mattered Thursday after that formation broke. There's often a retest, sometimes one that briefly moves past the resistance or support just broken, but prices never even successfully retested the broken support Thursday. A trailing stop would have worked well, although it's probably true that the depth of the decline was likely exacerbated by options-related activity. This Thursday was the Thursday before option-expiration week. Rollover-related activity that used to be most prominent options-expiration week now frequently takes place on the Thursday and Friday of the preceding week.

Why make this hard? Some times exist when you just shouldn't trade, and the period leading into the FOMC meeting is probably one of them. There will be times when the market fears or looks forward to a certain decision and indices move ahead of that decision. That just means that you've missed one of the many successful trades that you're going to miss when you decide against a cowboy/cowgirl trading style and opt for a more conservative and possibly account-saving style. This exact setup happens far too many times to encourage traders to increase their blood pressure and decrease their trading accounts by trying to mentally move an index ahead of an FOMC meeting. The setup occurs so often that the text of this article, up to the "Is that what happened this week? Sure did." paragraph was written Tuesday evening, before the decision. All that was needed to complete the article were the after-the-decision charts and the summation.

You can find other times when it's best not to trade in that original February 4 Trader's Corner article. A note of caution, of course: even if this setup occurs often, as it does, stops are needed if you enter post-decision on a formation break, because . . . well, just about when you've figured out how markets tend to react, they change their reactions.
 

DISCLAIMER

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

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