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Daily Newsletter, Saturday, 05/20/2006

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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

Short, Sharp and Scary

They say bull market corrections can be short, sharp and scary. This has been the case for the markets since the May 10th FOMC meeting. The commodity markets have posted losses even more dramatic than most equities and this has been reflected in those stocks. Some individual materials stocks have seen declines of -15% to as much as -30%. That is extremely scary for holders of those issues. Gold hit a high of $732.50 the morning after the FOMC meeting but has declined -11.8% to Friday's close of 657.50. Copper, in a major bull market that has seen a +100% rally since Jan-1st saw a drop from last weeks high of 4.01 to 3.45 intraday on Friday for a decline of -14%. Copper started the year at $1.95 a pound and rose to $4.01 the day after the FOMC meeting. For those who were riding the gains since the rally began last year or even just since mid March at $2.35 the -14% drop was just a hiccup. For those late to the party it was an ugly event with copper stocks taking much more severe hits. Phelps Dodge fell -20% in the last seven days. Southern Copper (PCU) fell -29% over the same period.

The commodity drop combined with the drop in the broader markets produced some serious pain for investors and only a last minute rebound on Friday prevented a 22-year streak from being matched on the Nasdaq. The Nasdaq had fallen for eight consecutive days through Thursday to equal the consecutive day loss streak last seen in 1994. Had Friday also ended with a loss that nine-day losing streak would have taken us back to 1984 to match it. That is 22 years for those of us who are mathematically challenged. The Nasdaq has dropped farther in shorter periods of time but not since 1984 has it dropped nine days straight. The CRB commodity index fell -25 points to 340 intraday on Friday from its 365+ high on May-11th. This was the largest weekly loss for the CRB in 25 years.

The commodity sell off was being attributed to the unwinding of a hedge trade by several large hedge funds. Reportedly hedge funds had shorted bonds on their fall from the Jan-18th high and used the proceeds to go long commodities. The yield had risen from 4.289% at the January to 5.192% last week after four months of heavy selling. When the Fed appeared to be saying it was going to halt the rate hikes and the inflation numbers took a sudden spike higher bonds were suddenly a safe haven again. With the surge in bond buying the funds raced to sell commodities and cover their bond shorts. While the CRB was falling -7% this week the bond yields fell -3.2% as investors bought back those bonds. Bond buying pushes yields lower. The intraday yield low on the ten-year note was 5.024% compared to the 5.192% high the day after the FOMC meeting. In bond terms this was a major move and took yields back to levels not seen since April 25th. Fedspeak from several Fed heads last week seemed to indicate they might be targeting commodities to reduce inflation pressure. This added to the commodity demise. In the 1980s the Fed targeted speculation in real estate, the 1990s they attacked the speculation in emerging markets and in 2000 they raised rates to 6.25% to burst the Nasdaq bubble. In 2005 they put their sights on the housing bubble and Greenspan pronounced it dead on Thursday night. Now with energy and metals pushing inflation higher some feel the Fed is going to focus its power on crushing commodity speculation and therefore prices on energy and critical metals like copper. Bottom line, with some speculating the Fed could raise as much as +50 points in June, rather than the pass everyone expected just a week ago, it strikes fear in the hearts of highly leveraged hedge funds.

Sharp? Yes. Scary? You bet. Short? That is yet to be seen. The rebound on Friday was a struggle when the morning dip was followed by a small bottom fishing rebound that had no legs. As the afternoon wound down they tried to sell them off once again as has been the pattern all week but another bout of short covering and position squaring brought the indexes back into positive territory just before the close. It was hardly a bullish end to a highly bearish week. Missing was the high volume rebound as traders rushed to pickup bargains. Also missing was the "V" bottom rebound investors are used to seeing after a major market dip. Friday's volume was extreme at better than 6.3 billion shares but the internals were nearly flat. Much of the volume was due more to options expiration than buyers returning to the market. There was evidence of bargain hunting but it was weak.

The Nasdaq rebounded +13 points but it was a very narrow gain. Only a couple sectors contributed to the move and it was related to the Dell decision to begin using AMD chips in its servers. The SOX jumped +15 points, more than the Nasdaq, due primarily to the +3.60 jump in AMD. This more than offset the -29 cents decline in Intel. Dell rallied +62 cents. The Semi Book-to-Bill released on Thursday night showed that growth in orders exceeded that of shipments in April. The BTB rose to 1.11 from the 1.03 posted in March. That represents $111 in new orders were received for every $100 shipped. This was the highest level since April-2004 and the largest monthly increase since Dec-2003. The BTB contributed to the strong gains in the SOX. According to SEMI orders are now +60% over cyclical lows seen in 2005 when the BTB was only 0.77. This is the kind of news investors were waiting for and some brave souls actually snacked on chip stocks on Friday after a -11.46% correction from the recent highs.

Much of the Nasdaq thunder this week was stolen by weakness in stocks under suspicion for backdating option incentives for executives. Safenet (SFNT) -4.28 and (Juniper (JNPR) -1.04 led the list but other Nasdaq stocks surfaced as potential losers as well. VTSS, BRCM, FFIV, MEDX, DPTR and CNET are under suspicion as well. On the NYSE United Health (UNH), Affiliated Computer (ACS) and Caremark (CMX -3.34) were tagged as under investigation. This list will undoubtedly grow larger and it is being touted as the market scandal of the year. We are just getting over the accounting scandals from several years ago that prompted the passage of Sarbanes-Oxley reform bill. Prosecution of the current option scandal is said to be a slam-dunk since the clear and public paper trail required for the option process is going to be used as evidence against these companies. This is only going to build as the weeks pass and many companies will be tarred and feathered in the market place that did nothing wrong until the suspicions are erased. This could be the thorn in the Nasdaq side for weeks to come.

Oil prices imploded from $73.90 on May 11th to support at $68 a drop of -8%. There was no material change in demand despite what some talking heads were reporting. There was also no material change in supply and there was a drop in refinery utilization. The only event that produced this decline was profit taking and the rotation out of leveraged positions by some large hedge funds. Chavez did say he was thinking about pricing his oil in euros as just one more way to aggravate the United States. Iran made comments all week about ignoring the UN but started making conciliatory sounds on Friday after the EU offered to help Iran build several light-water nuclear reactors and setup a fuel bank if Tehran will stop its nuclear program. Reportedly the EU had also gotten permission from the US to offer them new civilian aircraft, which they need desperately. They can't buy them on the open market due to sanctions stemming from the 1979 hostage crisis. That may be the icing on the cake for the agreement. However, there is a clause in the agreement guaranteeing Iran they will not be attacked in the future. This is the get out of jail free card and understandably the US is against this guarantee. Everyone knows Iran will continue its research on some scale in top secret installations but they are willing to wink and look away if Iran will at least say they have stopped. If they are found to be conducting experiments on a bomb at some point in the future the US wants the ability to take corrective offensive action. I don't know how this will work out over the next week but the fact the parties are talking is removing some of the Iran premium from the market.

Gasoline demand chart for last week

Natural gas was crushed after the gas inventory report on Thursday showed a +91 BCF build instead of the +85 BCF expected. Gas inventories are now +53% above the five-year average. Total gas in storage is now more than 2 trillion cubic feet and a record for this time of year. It is simply a matter of a winter that was much warmer than normal and a spring that has been blessed with mild weather. That is assuming you don't live in Texas or Arizona. Triple digit temperatures are already making an appearance. I heard one forecaster saying that Phoenix had the potential this year to break its record of 145 triple digit days in one summer. Dang, that is hot! The excess gas has pushed prices under $6 and a new 52-week low. However, it is a highly seasonal commodity and once that warm weather starts moving farther north those supplies will begin to fall. The trouble with cheap gas from an investor perspective is the impact on coal. Coal is the other fuel that generates much of our electricity. When the price of gas on a BTU level falls in relation to coal it causes the price of coal stocks to fall as well. If gas is cheap electric companies will use it instead of coal when possible because of the lower emissions. The actual coal price does not decline but coal stocks do. Coal is typically sold far in advance of its production, years in many cases. Power companies contract well in advance to lock in prices but many companies have both coal and gas facilities. Coal plants will be used for backup power whenever possible while their clean burning gas cousins toil away producing electricity at maximum levels to combat the heat. The coal will continue to pile up in storage for later use. This scenario has knocked the blocks out from under BTU, ACI, CNX and MEE. While I want to buy the dip it would not be advisable unless you have a long-term outlook until gas prices begin to firm.

Greenspan was uncharacteristically frank in his speech on Thursday night as he covered several topics of interest. He said the Fed had killed the housing bubble, which is no surprise to those in the areas with the biggest recent gains. Homes are flooding to market as speculators abandon ship. For instance, the Phoenix market had 4,500 homes for sale four months ago. That number has risen to 45,000 today. An avid subscriber in Phoenix normally emails me a couple times a month. I have not heard from her recently because I expect she is really busy. The foreclosure rate nationwide actually dipped -10% in April from March levels but was still +33% over levels seen in April 2005. 91,168 new properties were added to the pending foreclosure rolls in April. Colorado continued to hold on to the top foreclosure rate despite a -31% decline from March. The lowered April level was still +43% higher than April 2005. Texas accounted for 15% of all new foreclosure activity nationwide. This was the fifth consecutive month Texas held the top spot. California was second followed by Florida.

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Greenspan warned that consumers would have a lot less money to spend now that loan standards had been raised and the access to home equity was shrinking. He warned that this could have a negative impact on the economy in the latter half of 2006. He also cautioned that the impact of higher energy prices had yet to be seen given the falling buying power of consumers. He then took on the derivatives business calling the failure to clean up the current antiquated system as "unconscionable." Despite the dramatic growth of the derivative market into the trillions many systems are still processing orders on paper with no standardization. Some brokers relate stories of writing orders on napkins or the back of a restaurant checks or credit card slips. Greenspan has always warned that the derivatives industry was a house of cards on the verge of collapse. Bernanke has pledged to support a clean up as well as discuss new hedge fund changes. He still feels the market is the best disciplining factor for the $1.2 trillion hedge fund business. "The primary mechanism for regulating excessive leverage and other aspects of risk-taking in a market economy is the discipline provided by creditors, counterparties, and investors," Bernanke said in a speech to an Atlanta Fed conference on hedge funds at Sea Island, Georgia. He feels the Fed could do more harm than good by imposing new rules but agrees there is a need for better reporting. He did talk down a proposal for a central database of positions as not useful to regulators. Some have advocated this as a way to prevent another Long Term Capital meltdown like we saw in 1998.

Hedge funds pulled in $24 billion in new investment in the first quarter. That investment may have been the primary reason for the surge in commodities that prompted the unsupportable spike. $24 billion in the hands of hedge funds produces 3-5 times that in buying power or even more when it enters the futures markets. They undoubtedly had prior commodity bets and this additional money just added fuel to the fire. In order to capitalize on the profits and capture the management fees they have to turn those positions into a profit by selling them hence the sudden implosion when the bond/commodity trade began to collapse. Add in the expiration of options and futures contracts this Friday, sharply rising inflation in the CPI headline number and we got the perfect storm for the markets.

The scary portion of the correction has been how quickly everything collapsed. From the post Fed meeting opening spike on Thursday May 11th to Friday's lows was only seven trading days. In those seven days several of the commodities fell more than -10% with silver the leader with a -18.68% drop. The SOX was the only index to officially break -10% but several others came within a whisker of nailing a -10% decline. You will note in the table below that the indexes with the largest and most bullish gains, the NYSE Composite, Russel-2000 and the Transports joined both the Nasdaq indexes at the -9% range. The Dow, which had been pushing new six year highs almost daily prior to the Fed has failed to correct meaningfully in the percentage category despite the nearly -600 point drop.

Correction table for major indexes and commodities

I am boring you with the nitpick details of the index drops to make a point. I believe we are close enough to start looking for the end of the selling. The expiration pressures are nearly over and with the Russell and Nasdaq 100 close enough to -10% to reach out and touch it there is little incentive for further selling. Sure, there are probably some sellers remaining but at -10% level the bargain hunters will start coming back in force. Maybe not enough force to start a new rally but at least enough to weaken any further attempts at a meaningful decline. I told you last Sunday I expected a return to a trading range once the drop was over and I still expect that to happen. This is after all May and the sell in May and go away crowd will not be back until summer is over. It may take a few weeks for that range to be defined. Once it is clear the selling has slowed the bulls will probably limp back into the market only to have the sellers reappear once the bounce begins to fade. The short sellers have huge gains and at this point very tight stops. Let a couple good buy programs hit the tape and those stops will be popping faster than corn at the Da Vinci Code opening this weekend. (Fandango.com reported that 78% of all movie tickets being sold this weekend were for the Code.)

A problem facing the markets next week will be a strong IPO schedule. The largest to come to market next week are Vonage at $500 million and MasterCard at $2.8 billion. MasterCard is expected to price in the $40-$43 range for about 66 million shares. MasterCard is a complicated IPO due to a sudden surge in class action suits for alleged price fixing on fees between the major card companies. They also are being sued for restricting competition and blocking member banks from issuing cards of their own. Still, MasterCard is expected to have no trouble extracting $2.8 billion from the equity market. When added to the $500 million Vonage IPO and a couple smaller issues it will amount to a -$3.5 billion market draw. Since the IPO stocks are not in any indexes it is a negative to the current indexes. Hopefully those planning on participating used the selling over the last seven days to raise cash rather than wait until next week.

The economic calendar is dull next week with the only reports of interest being the Richmond and Kansas City Fed surveys, Durable Goods and another look at home sales. The Q1 GDP revision will arrive on Thursday and Personal Income and the revision to Consumer Sentiment on Friday. With the rampant debate on the future of interest rates we are sure to get more Fedspeak to cloudy the waters. After the normal week long quiet period after the FOMC meeting the airwaves were filled with Fed comments on Thursday and Friday. I said cloudy the waters because some of the comments were vague at best with different Fed heads expressing opposing views. Poole said on Thursday that he could not rule out a +50 point hike at the June meeting but he could also not rule out a pass. He said inflation risks were rising but that the decision would be made on the data at the meeting rather than guessing in advance. Jeffery Lacker roiled the markets on Thursday saying a pass in June was less likely with inflation pressures now borderline. The Kansas City Fed President Thomas Hoenig warned that the Fed needed to be reminded of the lags to interest rate changes before making another move. Hoenig said his view was that inflation was set to slow. His personal comfort range is inflation between 1.5% and 2.5% with the current core index at +2.3% and rising. Hoenig is seen to be an inflation hawk and is not currently a voting member. His bank has declined to ask for a hike at the last two meetings and asked for patience to see how the economy was progressing. After the rocky start Bernanke made with seemingly conflicting statements on inflation and the need for further hikes it is now expected he will have to be firm to regain credibility. The Fed funds futures are now pricing in a 62% chance of a hike at the June 20th meeting. Only a week ago that chance had declined to only 35%. JP Morgan is predicting a pause in June but then an increase to 6.0% by year-end. Former Fed governor and senior economic advisor at Schwab, Lyle Gramley, is predicting a hike in June and a pause in August. Bill Gross at Pimco is predicting a stop at the current 5.0%.

Market Internals Table

To wrap up my outlook for the week I would have to say it was positive. Our game plan for the last two weeks was to short a break below SPX 1315 after the FOMC meeting. That worked out well. Last Sunday I suggested buying a rebound over SPX 1295 on volume for a short-term trade only. We never got that rebound with both attempts failing at 1297 and 1296 respectively making good entry points for new shorts when it rolled over. The SPX dropped to 1256 on Friday. That is support from Jan/Feb and the 200-day average. It is also a logical place to stop even though it is only a drop of -5.31%. The SPX had not been as bullish as the other indexes and had lagged back with the Nasdaq as the SPX consolidated in place for much of March and April. This means there was less pent up bullishness in the index that needed to be removed.

All of the charts from last week show an amazing correlation. All crashed through early support levels that had previously held but nearly all ended on decent support once again except for the Nasdaq. The Nasdaq chart is a picture of broken support from the 2300 level through various support points including the 100/200 day averages and all the way back to 2200 where the uptrend support from Oct-2002 was broken. In a word, ugly.

Russell Chart - Daily

NYSE Composite Chart - Daily

SPX Chart - Daily

Dow Transport Chart - Daily

Since the Nasdaq, Russell and NYSE Composite have for all practical purposes already hit the -10% correction level the incentive for further declines should fade. The very strong volume of 5.98B, 5.15B and 6.3B from Wednesday through Friday was cleansing. Wednesday's -214 drop on the Dow, -33 on the Nasdaq produced a 6:1 ratio of down volume to up volume and had all the signs of a capitulation event. Decliners beat advancers 4:1 with only 72 new 52-week highs compared to 431 new lows. All of those numbers improved as the week ended. Friday's volume was nearly 2:1 advancing over declining despite the anemic closing numbers on the indexes. Bargain hunters or should I say bottom fishers were definitely entering the market but the sellers were still making their presence felt. With our potential range over the next several weeks being SPX 1250-1295 there is plenty of room for upside while the downside may be limited. If sellers do return in force and 1250 breaks the outlook becomes VERY bearish. It could be a long drop. Hopefully that will not happen but we always need to be ready for that potential event. My recommendations for next week would be to buy the bottom of that SPX range and be prepared to short the top. Since that is a 45-point range we will probably see several aborted rallies before we see the top of that range again. I plan on shorting them.

Dow Chart - Daily

Nasdaq Chart - Daily

Until the June Fed meeting I believe the market bias will remain negative even if we see some material attempts at a rebound. The summer doldrums are approaching and the bulls have taken a serious pounding. This has depleted their account size and left a bad taste in their mouth. They will not be rushing back into the momentum stocks until their wounds heal. I have taken about 20 stocks off my trading list and pared it down to only five plus the Russell, gold and crude oil futures. That is more than enough to keep me busy until a new market trend develops. I believe that process is being repeated by millions of other traders this week and that takes a lot of juice out of the market. I am sure everyone has seen choppy summer markets bleed funds out of their accounts. I have a lot of expensive experience in trying to trade the chop and I have learned to step aside when it appears. I believe we have another few weeks of decent trading ahead of us but then we need to go into vacation mode if the market starts trending sideways. I will continue to watch it for you and keep you updated with my outlook. It is your choice to act on it. Did you short SPX 1315? Do you wish you had?
 


New Plays

New Option Plays

NEW OPTION PLAYS TABLE-->
Call Options Plays
Put Options Plays
Strangle Options Plays
APC None None
CRS    
DE    
EXP    
KOMG    
OXY    

New Calls

Play Editor's note: Overall the tone of the market and our bias remains bearish. However, the markets are due for an oversold bounce. We're going to suggest a few call candidates today in an effort to capture any bounce but we're suggesting readers use relatively tight stops and be ready to exit quickly should the markets turn south again. We are moving into a slow time for oil and crude oil prices may continue to slide lower but we are choosing to add some oil stocks to the play list based on their short-term technical picture. The above comments about not getting married to your position and keeping an eye on the exits are especially true with our new oil candidates.


Anadarko Petrol. - APC - close: 99.44 chg: +1.89 stop: 97.99

Company Description:
Anadarko Petroleum Corporation's mission is to deliver a competitive and sustainable rate of return to shareholders by exploring for, acquiring and developing oil and natural gas resources vital to the world's health and welfare. As of year-end 2005, the company had 2.45 billion barrels-equivalent of proved reserves, making it one of the world's largest independent exploration and production companies. Anadarko's operational focus in North America extends from the deepwater Gulf of Mexico, up through the western U.S. and Canadian regions and onto the North Slope of Alaska. Anadarko's international activities are focused on its major positions in North Africa, the Middle East, Indonesia and exploration or production operations in several other countries. (source: company press release or website)

Why We Like It:
The sell-off in oil stocks has pulled APC toward the bottom of its long-term rising channel and technical support near its simple 200-dma. Traders bought the dip on Friday and the stock produced a bullish engulfing candlestick pattern, which is usually interpreted as a one-day bullish reversal. Volume on the reversal was strong. We are suggesting a trigger to buy calls at $100.15. We are only looking for a short-term bounce. Our target is the $104.50-105.00 range. We'll use a tight loss at $97.99. Please note that crude oil prices may continue to slide toward $66.00-65.00 a barrel and that will put pressure on the oil stocks. If you don't see any follow through on this bullish reversal we'll exit quickly! FYI: APC is due to split 2-for-1 on May 29th.

Suggested Options:
We are suggesting the June calls since we expect this to be a short-term bounce.

BUY CALL JUN 100.00 APC-FT open interest= 908 current ask $3.80
BUY CALL JUN 105.00 APC-FA open interest=1504 current ask $1.90

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 2.3 million

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Carpenter Tech. - CRS - cls: 115.25 chg: +3.18 stop: 111.45

Company Description:
Carpenter Technology, based in Wyomissing, Pa., produces and distributes specialty alloys, including stainless steels, titanium alloys and superalloys, and various engineered products. (source: company press release or website)

Why We Like It:
We are going to try and hedge our bets on the steel sector. Currently we have a couple of aggressive, high-risk put plays IPS and NUE in the group. Several stocks in the steel industry has just been hammered lately after very big moves higher and most are all sporting bearish technicals and P&F chart sell signals. CRS is no different. The P&F chart points to a $90 target and weekly technicals look bearish but short-term the stock appears to have produced a bullish reversal with Friday's bounce from support. Volume on Friday's rebound was more than three times the daily average. We are going to suggest a trigger to buy calls at $116.51. If triggered we'll target a rebound into the $123.00-125.00 range. We'll set our stop loss at $111.45.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 115.00 CRS-FC open interest= 92 current ask $7.70
BUY CALL JUN 120.00 CRS-FD open interest=123 current ask $5.40

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/24/06 (unconfirmed)
Average Daily Volume = 448 thousand

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Deere Co - DE - close: 84.16 chg: +0.55 stop: 83.29

Company Description:
Deere & Company is the world's leading manufacturer of agricultural and forestry equipment; a major manufacturer of construction equipment; and a leading supplier of equipment used in lawn, grounds and turf care. The company was founded in 1837. John Deere agriculture, construction and forestry equipment is distributed through a network of more than 1800 independent dealers worldwide. (source: company press release or website)

Why We Like It:
DE has pulled back toward rising technical support at its 50-dma. The stock produced an intraday bullish reversal on Friday but we're not quite convinced yet. That's why we're suggesting a trigger to buy calls at $84.71. More conservative traders may want to use a trigger over $85.00. We're only looking for an oversold bounce since the P&F chart has turned bearish on the recent sell-off. Our target will be the $88.00-88.50 range. We'll use a stop loss at $83.29.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 85.00 DE-FQ open interest=3577 current ask $2.40
BUY CALL JUN 90.00 DE-FR open interest=1711 current ask $0.65

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/15/06 (unconfirmed)
Average Daily Volume = 2.1 million

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Eagle Materials - EXP - close: 52.21 chg: +2.49 stop: 49.45

Company Description:
Eagle Materials Inc. is a Dallas-based company that manufactures and distributes Cement, Gypsum Wallboard, Recycled Paperboard, and Concrete and Aggregates. (source: company press release or website)

Why We Like It:
After reaching all time highs near $75.00 in April shares of EXP were crushed in the month of May. Shares fell back toward support near $49.00. The stock is way overdue for a bounce and with the markets also due for a bounce this looks like a good spot to buy calls. Aggressive traders probably want to keep their stops under Friday's low (48.30) we're going to try and reduce our risk with a stop loss at $49.45. We are going to suggest two targets. Considering selling half your position at the $55.00 level. Then sell the rest of your position in the $59.00-60.00 range.

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

BUY CALL JUN 50.00 EXP-FJ open interest=1680 current ask $4.50
BUY CALL JUN 55.00 EXP-FK open interest=1409 current ask $2.15

BUY CALL JUL 50.00 EXP-GJ open interest= 204 current ask $5.60
BUY CALL JUL 55.00 EXP-GK open interest=1371 current ask $3.30

Picked on May 21 at $ 52.21
Change since picked: + 0.00
Earnings Date 08/01/06 (unconfirmed)
Average Daily Volume = 1.2 million

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Komag - KOMG - close: 45.70 chg: +1.98 stop: 41.99

Company Description:
Founded in 1983, Komag is a leading independent supplier of thin-film disks, the primary high-capacity storage medium for digital data. Komag leverages the combination of its world-class U.S. research and development center and Malaysian manufacturing operations to produce disks that meet the high-volume, stringent quality, low cost and demanding technology needs of its customers. By enabling rapidly improving storage density at ever-lower cost per gigabyte, Komag seeks to create extraordinary value for consumers of computers, enterprise storage systems and electronic appliances such as digital video recorders, game boxes and consumer electronic storage systems. (source: company press release or website)

Why We Like It:
Over the last week the DDX disk-drive index has produced a bullish turnaround. Leading the way appears to be shares of KOMG. The stock is up six days in a row on rising volume. In the month of May KOMG has produced what looks like a double-bottom (bullish) pattern. Friday's gain pushed KOMG above the 100-dma and resistance in the $45.15-45.25 region. Aggressive traders may want to consider positions now. We want to see more confirmation since a move over $46.00 will reverse the P&F chart into a new triple-top breakout buy signal. Plus, a move over $46.00 will be a technical breakout over its simple 50-dma. We're suggesting a trigger to buy calls at $46.11. Our short-term target will be the $49.75-50.00 range. More aggressive traders may want to aim higher. We are starting the play with a wide (aggressive) stop loss at 41.99. More conservative traders may want to put theirs closer to $44.00.

Suggested Options:
We are suggesting the June calls. Hopefully we'll see some July options become available soon.

BUY CALL JUN 45.00 QKX-FI open interest=1800 current ask $2.90
BUY CALL JUN 50.00 QKX-FJ open interest=2123 current ask $0.85

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 1.2 million

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Occidental Petrol. - OXY - cls: 94.06 chg: +1.68 stop: 91.99

Company Description:
Occidental Petroleum Corporation (NYSE: OXY) is a world leader in oil and natural gas exploration and production and a major North American chemical manufacturer. (source: company press release or website)

Why We Like It:
OXY has been a great performer over the past several months and traders hammered it the last two weeks with profit taking. The move has produced a big sell signal on its P&F chart but it looks like shares have produced a short-term bottom. The stock rebounded from the $89.50 level on Friday and created a bullish engulfing candlestick pattern, which is normally seen as a one-day bullish reversal. Volume on the reversal was more than double the daily average. Aggressive traders may want to buy calls here. We want to see more confirmation behind the move so we're suggesting a trigger to buy calls at $95.05. We're only looking for an oversold bounce into the $99.00-100.00 range. Remember, this is an aggressive play because our short-term outlook on crude oil is bearish with an expectation crude will slide toward the $66-65 range before moving higher again. That will put pressure on the oil stocks.

Suggested Options:
We are suggesting the June calls.

BUY CALL JUN 90.00 OXY-FR open interest= 441 current ask $6.30
BUY CALL JUN 95.00 OXY-FS open interest=1247 current ask $3.50
BUY CALL JUN 100.00 OXY-FT open interest=2477 current ask $1.70

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 3.4 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cigna - CI - close: 93.25 change: -0.12 stop: 91.99

Considering the market weakness on Wednesday and Thursday this past week we can understand why CI's oversold bounce has stalled. Friday's performance was discouraging. Overall the pattern is unchanged but short-term technical oscillators are deteriorating. The daily chart's MACD is still in a new buy signal and the Point & Figure chart displays a buy signal with a $108 target. We are suggesting that traders wait for a move over $94.50 or $95.00 before considering new bullish positions. Our target remains the $99.75-100.00 range. More aggressive traders may want to aim higher but be aware that the $105 level looks like significant resistance in addition to lining up with the 38.2% Fibonacci retracement of its sell-off from its 2006 highs.

Suggested Options:
We are suggesting the June or July calls. Readers should choose which strike best suits their trading strategy. Remember, we're suggesting you look for a move over $94.50 or $95.00.

BUY CALL JUN 90.00 CI-FR open interest=3486 current ask $5.30
BUY CALL JUN 95.00 CI-FS open interest=1682 current ask $2.40
BUY CALL JUN 100.00 CI-FT open interest=8910 current ask $0.85

BUY CALL JUL 90.00 CI-GR open interest= 142 current ask $7.00
BUY CALL JUL 95.00 CI-GS open interest=1517 current ask $4.30
BUY CALL JUL 100.00 CI-GT open interest= 924 current ask $2.40

Picked on May 16 at $ 94.52
Change since picked: - 1.27
Earnings Date 08/02/06 (unconfirmed)
Average Daily Volume = 1.4 million

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Getty Images - GYI - cls: 64.26 chg: +0.47 stop: 62.49

GYI is still consolidating under resistance at the $65.00 level. Thus far we remain on the sidelines. It looks like shares of GYI have produced a bottom with the rebound from the $60 level but we want to see more confirmation before buying calls. That's why we're suggesting a trigger at $65.21. This trigger is above last Tuesday's high of $65.15. It is imperative that readers trade with a stop loss. GYI has produced these bottoming patterns before only to quickly reverse course when it nears technical resistance at its 50-dma. Currently the 50-dma has declined to $69.60 so we are going to adjust our target to $69.00-65.50. More conservative traders may want to put their stop under Thursday's low near $63.00. More aggressive traders may want to consider bullish positions now.

Suggested Options:
We are suggesting the June or July calls. Readers should choose which strike best suits their trading strategy. Remember, our trigger is at $65.21.

BUY CALL JUN 60.00 GYI-FL open interest= 193 current ask $5.30
BUY CALL JUN 65.00 GYI-FM open interest= 298 current ask $2.05


BUY CALL JUL 65.00 GYI-GM open interest= 141 current ask $3.00

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 997 thousand

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Omnicom - OMC - close: 91.85 chg: +0.10 stop: 89.99

OMC is a relative strength/momentum play. Unfortunately, last week's market crash really put the breaks on OMC's momentum. Fortunately, the stock resisted any profit taking attempts but shares continue to look overbought and the MACD produced a new sell signal a few days ago. We are not suggesting new plays at this time but more aggressive traders might want to consider opening positions if OMC can hit a new relative high (92.50). Our target is the $97.50-98.00 range. The P&F chart is very bullish with a $113 target.

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

Picked on May 15 at $ 92.05
Change since picked: - 0.20
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 1.1 million
 

Put Updates

Amazon.com - AMZN - close: 33.94 chg: +1.33 stop: 34.35 *new*

Danger! AMZN's failed rally on Thursday got another chance with Friday's rebound from the $32.00 level. Volume came in above average and shares broke through short-term resistance at the 10-dma. The stock stopped right at resistance at its seven-week trendline of lower highs. If shares move any higher we would suggest exiting early. We are going to lower our stop loss to $34.35. Our target has been the $31.00 level. We were trying to hit the trendline of support displayed on the weekly chart below. Looks like we were off by about 50 cents with AMZN testing the 31.50 region twice last week. More conservative traders may want to exit now!

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

Picked on May 01 at $ 34.85
Change since picked: - 0.91
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 6.3 million

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Apollo Group - APOL - close: 51.26 chg: -0.13 stop: 54.65 *new*

So far so good. Shares of APOL broke down under support at the $52.00 level during last week's market sell-off. The $52 level also happen to be the neckline to APOL's bearish head-and-shoulders pattern. Our trigger to buy puts was at $51.75. Our target is the $47.75-47.50 range near its early March lows. We do expect some support at the $50.00 level so it would not surprised us to see shares bounce around the $50-52 region for a while. The descending 100-dma is overhead resistance so we're going to adjust our stop loss closer to this moving average.

Suggested Options:
We are suggesting the June puts. We do not want to hold over the late June earnings report.

BUY PUT JUN 55.00 OAQ-RK open interest= 385 current ask $4.30
BUY PUT JUN 50.00 OAQ-RJ open interest= 491 current ask $1.10

Picked on May 17 at $ 51.75
Change since picked: - 0.49
Earnings Date 06/22/06 (unconfirmed)
Average Daily Volume = 2.1 million

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Franklin Res. - BEN - close: 88.75 chg: +2.01 close: 92.55

Friday morning saw shares of BEN gap higher after UBS upgraded the stock to a "buy". BEN closed with a 2.3% gain, which was better than the sector rebound in the XBD index of 1.5%. We'd like to think this is just a one-day pop but it could be the beginning of a painful bounce back toward resistance in the $92.00-92.50 region, especially if the major market indices follow through on Friday's oversold bounce. If you do not want to endure that kind of bounce then consider exiting early. You can always re-enter on a failed rally. We are not suggesting new positions at this time. Our target remains the $85.00-84.50 range.

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

Picked on May 14 at $ 89.30
Change since picked: - 0.55
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 1.1 million

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CB Richard Ellis - CBG - cls: 77.41 chg: -1.40 stop: 82.71

Shares of CBG lost 1.77% on Friday but we need to warn readers about a potential bullish reversal. Friday's rebound from its lows looks like the beginning of a short-term bullish reversal and odds are probably pretty good for a follow through if the major averages bounce next week. We would expect a bounce back toward the $80.00-81.25 region. We are not suggesting new bearish plays at this time. We will continue to target the 100-dma, currently at 73.29. To account for our moving target we'll use an exit range of $73.75-73.00.

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

Picked on May 17 at $ 77.93
Change since picked: - 0.52
Earnings Date 05/02/06 (confirmed)
Average Daily Volume = 613 thousand

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IDEXX Labs - IDXX - close: 76.61 chg: -0.21 stop: 78.55 *new*

The good news with IDXX is that shares failed to breakout over its descending 10-dma on Friday and the stock displayed relative weakness with another decline. The bad news is that we suspect shares are poised to move higher. The 10-dma is the nearest overhead resistance and the $78.00 level looks like the nearest price resistance so we're going to lower our stop loss to $78.55. We are not suggesting new put positions at this time. Our target is the $74.00-73.50 just above the simple 200-dma. FYI: the P&F chart points to a $64 target.

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

Picked on May 11 at $ 77.93
Change since picked: - 1.32
Earnings Date 04/28/06 (confirmed)
Average Daily Volume = 125 thousand

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Ipsco Inc. - IPS - close: 94.28 chg: +0.33 stop: 100.26

IPS is a new aggressive (high-risk) put play in the steel sector. Last week steel stocks were getting hammered as traders locked in profits on some of the market's best performers. On Friday shares traded in another wide range ($91.22-96.62). Odds are IPS could bounce back toward $100 before moving lower again. It may be prudent to wait and see where the bounce fails. We would hesitate to open new positions if the major averages are rebounding. Technically IPS looks bearish given the double-top pattern and the high-volume sell-off through multiple levels of technical support. The P&F chart points to an $83 target. We are targeting the $85.50-84.50 range, which is above what we suspect will be support at its rising 200-dma. FYI: while we have a wide stop at $100.26 it may not be wide enough. The 10-dma is at $101.07.

Suggested Options:
We are suggesting the June puts.

BUY PUT JUN 95.00 IPS-RS open interest= 408 current ask $5.00
BUY PUT JUN 90.00 IPS-RR open interest=2495 current ask $2.90

Picked on May 18 at $ 93.95
Change since picked: + 0.33
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 459 thousand

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Nucor - NUE - close: 104.95 chg: +0.15 stop: 112.81

NUE is in a similar situation to IPS. The stock was a high-flyer and shares witnessed a lot of profit taking last week that did a lot of technical damage to the stock. Now the stock is hinting at an oversold bounce. NUE could easily bounce back toward the $110 level and still look bearish. If the markets are green next week we would expect a rally back toward $108-110. A failed rally under $110 could be used as a new entry point. If the stock closes over $110 we might choose an early exit. We are targeting the $95.50-95.00 range, which is above what could be technical support at the rising 100-dma. The P&F chart is bearish and points to an $82 target.

Suggested Options:
NUE looks ready to bounce so we're not suggesting new positions at this time. Wait for the bounce to fail.

Picked on May 17 at $105.40
Change since picked: - 0.45
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 2.5 million
 

Strangle Updates

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

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Fedex - FDX - close: 109.34 chg: +0.09 stop: n/a

FDX dipped to $107.44, which pushed the June $110 puts (FDX-RB) to a high of $4.20 before the stock pared its losses. Both FDX and the Dow Transportation index look pretty short-term oversold and considering the recent weakness in crude oil we suspect the transports will bounce next week. We are not suggesting strangle positions at this time. The options involved in our strangle are 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 was about $2.60. We would plan on exiting if shares of either option rose to $4.50 or more.

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

Picked on April 30 at $115.13
Change since picked: - 5.79
Earnings Date 06/21/06 (unconfirmed)
Average Daily Volume = 1.4 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Making Adjustments

Imagine that you were long ten contracts of Lowe's (LOW) Sept 90 calls when the underlying company announced a stock split to be effective Tuesday, May 9. Each contract of those calls represented 100 shares of the underlying stock.

How many contracts will you be holding May 9? What strikes will you hold, and how many shares of stock will each contract represent?

That, of course, depends on the split. You might be surprised to learn that different rules apply to splits that result in round lots and those that don't. Round-lot splits are splits such as 2-for-1, 3-for-1, and 4-for-1, where the original number of stock shares held is multiplied by some integer such as 2, 3, or 4. Lowe's (LOW) split was a 3-for-1 stock split. If you were long ten contracts of Sept 90 calls previous to the effective date of the split, you'd have then been long 30 contracts of Sept 30 calls. Each contract would still represent 100 shares of the underlying stock.

Here's how it works in a round-lot split: the number of options contracts is multiplied by and the strike price is divided by the split factor. Thus, a 2-for-1 split would result in a doubling of the number of contracts and a halving of the strike of those contracts, a 3-for-1 split would result in a tripling of the number of contracts and the reduction of the strike price held by a third.

If instead of holding Sept 90 calls, you'd been holding June 100 calls when the 3-for-1 split occurred, a bit of a problem would occur. Those long ten contracts of June 100 calls would find themselves holding 30 contracts of 33-3/8 strike calls. The 100 strike is divided by three, with the resultant number rounded to the nearest one-eighth. New symbology is needed, and such new symbology was employed in Lowe's split, with the resultant June 33-3/8 calls now labeled LTRFX.

A different methodology is employed when a split does not result in a round lot of shares. For example, when Gerdau S.A. (GGB) announced a 3-for-2 ADS split with an ex-date for the split of Friday, April 21, the split was not a round-lot split. Someone long ten contracts May 25 calls would be long ten contracts of May 16-5/8 calls after that ex-date, with each contract representing 150 shares of the underlying. Here's how it works when the split is not a round-lot split: the number of contracts would not change, but the strike and the number of underlying shares represented by each contract would. To determine the new strike price, the original strike would be divided by the split ratio (3/2 or 1.5) and the contract unit would be multiplied by that same split ratio.

Whenever a split is announced, the option exchange that trades those options publishes the details of the options terms. In the previous two cases, the CBOE trades those options, and the details were located under the "Trading Tools" section of the site. If the Philadelphia Stock Exchange traded the options, as it does the LOW options, the information would be published there, with such information found under the "Mergers and Corporation Actions" portion of the site.

Splits aren't the only corporate actions that may cause an adjustment in options contracts. As of this writing, The Sports Authority, Inc. (TSA) was slated to merge with Leonard Green & Partners. As long as the merger goes forth as planned, the published adjustment on www.phlx.com states that "all outstanding TSA options will be adjusted as follows . . . $3,725.00 cash per contract ($37.25 x 100)."

Other adjustments may be different, according to the terms of a merger or acquisition, and sometimes they can be quite complex. Those conditions are always published, however, on the site of the exchange trading the options. So, if you should wake up one morning and find that the underlying company on which you hold options is being acquired, watch for the information to be published.

How soon will that happen? On March 31, TSA announced a convening of a special stockholders meeting May 2 to consider the acquisition. That day, news announcements by the company referred interested parties to the SEC and TSA sites (www.sec.gov and www.sportsauthority.com) for the definitive proxy statement which was to be filed. Also on that day, the company made available on its site form DEFM14A it filed, suggesting the treatment of stock options if the merger were to be accomplished. An unofficial summary of TSA's options adjustments was first published on the CBOE site April 17 with the merger being approved at the May 2 stockholder's meeting. Those holding TSA options were advised well ahead of that meeting what the terms will be.

If news mentions a merger, go the company's website for such filings, usually posted on the "Investor Relations" portion of the site, and then watch the exchanges for up-to-date and definitive statements.

Stock splits are handled in a routine manner, as described above, but mergers and acquisitions vary. While news on mergers and acquisitions may appear first on company websites, the exchanges provide you with the necessary information on both.
 

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

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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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