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Daily Newsletter, Wednesday, 06/28/2006

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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

Confusion

Ahead of tomorrow's FOMC decision, much confusion abounds as to what the decision is likely to be. Increasingly, some cry for the FOMC to raise the target rate by fifty basis points and just be done. With little economic news to distract equity investors from the pause/25-basis-points/50-basis-points arguments, those investors showed their confusion in today's trading patterns.

That's been true all week. Instead of clamping down into tight ranges, as often happens ahead of a FOMC decision, some indices have been zigging and zagging from one side to another of recently established consolidation zones. Admittedly, the ranges narrowed this week, but not in the way they often do.

Intraday, the evidence contributes to the confusion. For example, what were tech investors to believe yesterday? The early action showed the Russell 2000 heading higher, climbing above 700 in early trading, and the SOX heading lower. All knew that one direction was eventually going to prevail, and the confusion produced by opposite actions of these two signal indices finally resulted in a down day for techs.

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Today's early trading pattern produced another conundrum. Rate-sensitive financials, particularly those comprising the BIX, the S&P Banks Index, and BKX, the KBW Bank Index, immediately headed higher, but techs soon weakened. Were investors to believe the important financials or the equally important techs? Figuratively, indices staggered around for a few hours before a late afternoon push brought most into positive territory and created long lower shadows springing up from support on several others that didn't quite make it to positive territory.

Breadth indicators were positive during the earliest part of the session, but by mid-afternoon, advancers were only slightly ahead of decliners on the NYSE, while decliners had pulled slightly ahead of advancers on the Nasdaq. By 3:30, that mixed-up pattern had resolved, with advancers ahead on both exchanges, although only slightly so on the Nasdaq. During much of the day, the VIX was higher than yesterday's readings, the TRIN, lower.

Several IPO's debuted, also with mixed results, but they may have drawn the attention and the funds of some investors who were tired of trying to game the major indices. At one point at least, J. Crew's shares were the most active on the New York Stock Exchange, but those who jumped into a J. Crew play soon found themselves caught in an ever-narrowing triangle that didn't break upward again until late in the session.

Confusion reins and will until the immediate volatility dies down tomorrow, after the FOMC decision is announced. Because I don't want to encourage short-term plays in such a confused market environment, I'm going to focus on weekly charts and a longer-term look at what's at stake in tonight's charts.

Annotated Weekly Chart of the SPX:

This weekly chart shows that although there have been some intraweek piercings of support and resistance, that support and resistance are bound by the weekly 72-ema on the bottom and the 50-sma on the top. It would take a weekly close above or below that resistance or support to break the SPX out of the latest range.

Over the short-term, however, I turned to Keltner charts and the five-minute 100/130-ema's to look for support and resistance. Since the five-minute 100/130-ema's served as such a good bearish/bullish barometer this week, bulls will want to see the SPX stay above those averages on any retest. They're currently just above 1243 and are rising toward the SPX, with the SPX pulling back in a sideways/sideways-down regression channel off the day's high. That could likely be a bull flag, but bulls want to see that five-minute 100/130-ema support hold. Fifteen-minute Keltner channels suggest that a Keltner line currently at 1248.28 but rising slightly, could serve as resistance. I put less credence than usual in my trusted nested Keltner channel setup, however, since investor sentiment will be keyed to the impending FOMC decision. Trade with care tomorrow, if tempted to trade.

With the Dow again today testing its daily 200-sma, a daily rather than a weekly view of the Dow might be best.

Annotated Daily Chart of the Dow:

It's somewhat ominous that the Dow confirmed a head-and-shoulders pattern, rose to retest the neckline of that pattern and since has pulled back. In addition, bulls would have felt more comfortable if the Dow had managed a close above its 10-dma. In the bull's favor is the fact that bears weren't able to drive the Dow lower today after it retested the 200-sma.

A short-term look reveals that the Dow's five-minute 100/130-ema's are at 10,951 and 10,954, support that short-term bulls want to see hold on pullbacks. Those averages are dynamic so don't expect them to stay at the same level all day. Keltner resistance is also dynamic, but at the close was just above the Dow at 10,979 on 15-minute closes and then again at 11,001.40.

Yesterday, the Nasdaq broke below the support of a triangle it had been forming on the daily chart, but today it charged right back up toward the bottom of that triangle. In doing so, it moved back toward the long-term supporting trendline on its weekly chart.

Annotated Weekly Chart of the Nasdaq:

Tuesday, the Nasdaq headed lower, and the after-hours developments from Rambus (RMBS) mentioned in last night's Wrap sent tech-related indices lower this morning, too. The SOX, for example, dipped into a retest of its 200-week moving average. INTC buyers stepped in, however, sending the tech giant and SOX component up to challenge the neckline of a canted-sideways inverse head-and-shoulder on its daily chart. INTC was to confirm that small inverse H&S and continue climbing all afternoon, posting a 3.49 percent gain by the end of the day.

INTC helped the Nasdaq push above its five-minute 100/130-ema's in that same period when other indices did so. So far, it's been holding their support on retests, with those averages at 2105.52 and 2107.02 at the end of the day. Although these averages and this chopping back and forth matter little in the longer-term, short-term bulls want to see the Nasdaq continue to find support on these averages on pullbacks. Nested Keltner channels suggest that, as of the close, next short-term resistance would be found from 2115.26-2117.64. At about that level, the Nasdaq will be testing the neckline of its own inverse H&S on the 15-minute chart. Bulls want to see this formation confirmed, as INTC did its similar formation, and don't want to see another case when the right shoulder lengthens in time, with prices moving sideways while the formation dissipates.

While INTC helped the SOX, too, it didn't help it move above the five-minute 100/130-ema's. The SOX is testing those averages, but hasn't managed a five-minute close above them. Therefore, that's where next resistance lies for the SOX: at 428.75-429.97. Turning to the nested Keltner channels for information on support turns up possible support at 426.37-427.53, and bulls want that to hold on pullbacks, on 15-minute closes. They would prefer that 428.08 support hold on 15-minute closes, however.

The SOX's daily candle produced a potential reversal signal, with the SOX springing up and leaving a long candle shadow beneath. A study of the weekly chart turns up the reason for that spring: the SOX's dip had tested the important weekly 200-sma. That's the blue average on the chart seen below.

Annotated Weekly Chart of the SOX:

Several companies made announcements late Tuesday that proved mostly negative, including those by WEN, NKE, and AMCC. Today, analysts jumped into the fray with some negatives statements of their own. A J.P. Morgan analyst speculated that Nokia's suppliers Texas Instruments (TXN) and RF Micro Devices (RFMD) might be negatively impacted by weakness in Motorola (MOT) and by evidence that suggested that Nokia (NOK) might be pushing back orders for components for its handsets. TXN is of course one of the components of the SOX. TXN closed lower by 2.32 percent. RFMD dropped 3.98 percent; MOT, 1.88 percent; and NOK, 2.34 percent.

Other company- or sector-related news included EMI's announcement that EMI Group PLC and Warner Music Group were discussing a merger. Yesterday, as many may recall, Warner had made a cash offer for EMI that the company rejected out of hand, with that offer coming four days after EMI had made an offer for Warner. Analysts appear to favor a deal that would combine the two companies, moving the combined companies into second place behind Universal in the recorded music market, but analysts aren't yet convinced that these two contentious companies can strike a deal.

The bad news wasn't over with those announcements. An analyst with Banc of America cut the firm's forecasts for profit estimates on D.R. Horton (DHI), Hovnanian Enterprises Inc. (HOV), Meritage Homes Corp. (MTH) and Pulte Homes Inc. (PHM). Price targets were lowered for each, to $26.00, $28.00, $39.00, and $26.00, respectively. It might be noted that DHI is already below that target price. DHI kept its buy rating; HOV, its neutral rating; and MTH, its sell rating; and PHM earned a neutral rating. Ryland Group's (RYL) target price was also lowered, to $39.00, and Standard Pacific Corp's (SPF) target price was lowered to $24.00. The analyst also lowered stock price targets on NVR, WCI and CHCI.

DHI managed a gain of 0.25 percent, but HOV dropped 1.42 percent; MTH, 0.44 percent; PHM, 0.24 percent; RYL, 1.26 percent; and SPF 0.70 percent. The DJUSHB, the Dow Jones Home Construction Index, dropped 0.46 percent.

At 7:00, the Mortgage Bankers Association released its weekly mortgage application volume survey for last week, with that survey possibly also impacting the DJUSHB. The headline on the release said it all. Mortgage rates rose, and application volume declined. The volume of those applications dropped to a four-year low, down a seasonally adjusted 6.2 percent from the previous week's number and 31 percent from the year-ago number. Refinancing loan applications fell a seasonally adjusted 7.5 percent from the previous week's number and 47 percent below the previous year's number. They also dropped as a percentage of total loan applications. Applications for adjustable-rate loans also dropped as a percentage of total loan applications. Meanwhile the average rate for a 30-year fixed-rate loan climbed to 6.86 percent, the highest it's been since April 2002.

Not all sectors received bad news. Ahead of the crude inventories release, Merrill Lynch raised its forecasts for oil price for 2006-2008. The firm also upgraded Hess Corp. (HES) to a buy rating. HES gained 4.58 percent. The XOI and OIX, oil indices, both climbed today, too, by 1.87 and 2.17 percent, respectively. Both rose ahead of the crude inventories number, pulled back to support afterwards, and then took off higher again. They did their part in helping to support the indices. The XOI, in particular, has been skipping along above its five-minute 100/130-ema's, propelled upward every time it approaches those averages.

Expectations for crude inventories had not prepared market participants for the deep draw downs in crude and gasoline inventories. Just ahead of the July 4 weekend, the Department of Energy reported that crude inventories dropped 3.4 million barrels and gasoline inventories dropped 1 million barrels. Inventories of distillates rose 1.8 million barrels. Crude jumped after the release, but only briefly. It chopped down toward $71.60 support, violating it for a few minutes before climbing again into the Nymex close. QCharts shows the close at $72.19.

More positive information included the introduction of J. Crew's (JCG) IPO, trading above its $20.00 IPO price at the open, and closing at $25.70, just off the high of the day. Nine IPO's had been scheduled for this week, although speculation now trims that estimate to seven to nine to be introduced, with some IPO's being delayed. Some of those IPO's are pricing below their expected ranges. Omniture's (OMTR) range had been expected to be $7.50 to $9.00 a share, but it opened at $6.50 and fell in early action to a low of $5.60. It saw an end-of-day bounce that closed it at $6.51. Like JCG, PGT (PGTI) closed near its high of the day, at $15.39, with the high at $15.50. Replidyne (RDYN) was priced at $10.00 and closed at $10.05, with a low of $9.66 and a high of $10.25.

In another development, the Senate confirmed Bush-nominee Henry Paulson as the next Treasury secretary. Some worried that in his official statement, he did not mention a desire for a "strong dollar," but many praised his experience in international finance and his relationships in China, in particular. Paulson believes that eliminating President Bush's tax cuts could dampen economic growth. He thinks that the federal deficit is too weighty, but believes that a growing economy can reduce that deficit.

Not a lot happened today on the economic front. Tomorrow's economic releases will be overshadowed by the FOMC decision, released at 2:15, but will include the first quarter's final GDP and chain deflator, released at 8:30. Estimates are for a final GDP of 5.3-5.6 percent, and a chain deflator of 3.3 percent. Although in normal circumstances, the final GDP might not move markets unless the revision was a big one, that chain deflator, an important inflation measure, will be closely watched ahead of the afternoon's FOMC decision. Watch for a bond market reaction to determine whether the numbers have worried the bond traders.

Be aware that while equity markets may not quite have decided whether they'll wait out the decision at support or resistance, the bond market may be one that's settled into its pre-FOMC mode. It may stay there and may not be a strong indicator of short-term sentiment, such as how the markets are reacting to the deflator. One source noted today that although the auction on 5-year notes drew the worse indirect bidder participation in three years, bonds showed little reaction. I would quibble with that impression and think the analyst was only a bit too quick to draw that impression, writing before bonds dropped and yields moved higher into the bond market close. However, the ten-year's yield rose back to challenge the 5.245 percent intraday high reached on Monday, and that may be where bond traders intend to sit out the decision.

While the consensus might be that the target rates will be hiked to 5.25 percent, it seems that less consensus results the closer the announcement draws. One headline this morning speculated whether the Fed would announce a bigger rate hike this time, a rumor that has roiled the markets for the last several weeks. One MarketWatch article by Rex Nutting concluded that none of the 44 economists surveyed for the article expected a half-point rate hike this week, despite all the swirling rumors. Still, some seem to want the one-and-done 50-point hike, and that group includes some doves, who want that signal that the Fed is done. At least one Bear Stearns economist and two CNBC guest commentators today believe that this strategy could work since it would signal Bernanke's willingness to be tough on inflation and would also reassure market participants that there was now room for a pause to await further data, if not a cessation of rate hikes.

Others differ, with some speculating now that the eventual target rate will be a 6.00 percent one. With speculation ranging from a pause all the way up to a one-and-done 50-basis-point hike and even up to several more hikes, equities proved more volatile this week going into the meeting, bouncing back and forth to the boundaries of recently established support/resistance zones rather than clamping down all week.

The usual post-FOMC-decision volatility may be exacerbated, too, especially with forex news sources reporting that recession models are now predicting a 45.5 percent chance of a recession if the target rate is raised by 25 basis points tomorrow and a 49 percent chance if it's raised by 50 basis points. These estimates were reported yesterday by Reuters and incorporate estimates from Merrill, using a model proposed by Fed economist Jonathan Wright. The model employs the yield curve, however, and some, including our own FOMC's former chairman Alan Greenspan, have noted something strange happening with the yield curve. The model may not be as helpful as it has been in the past, some believe.

I'm not an economist, and I don't know what to make of the yield curve conundrum. Like Jim last night in his Wrap, I'm not going to speculate on what the FOMC will do. FOMC Chairman Ben Bernanke has too little history as chairman to make that speculation. Opinions about what he has been signaling and what it would mean for the markets diverge too widely. I wondered if this time, the most expected option of a 25-basis-point hike wouldn't be the one to cause the most damage, but that's pure speculation. My thinking was that a pause might reassure markets that Ben Bernanke wouldn't lead the committee into its usual tactic of going too far, and a 50-point hike might prompt a short-squeeze at least, as some speculated that the Fed might be done, while a 25-basis-point hike would keep that hatchet poised over the market. That's pure speculation, however, and, in the case of a 50-point hike, any pop would depend on whether the FOMC signaled that it might be through. Even then, it might not hold. Don't trade on my speculations any more than you would anyone else's. I'm not going to do that. I've got some credit spreads and intend to use the post-FOMC reaction to establish some others if the markets swing widely enough that I can swing some spreads far away from the action, but I will not be guessing ahead of the decision.

Market participants have had less opportunity than usual to position themselves ahead of the decision because of the uncertainty that has crept into the markets due to recent data. Unless you're an adept scalper, I would not day trade this market ahead of the decision and would be leery of trading it afterwards, too, until the post-decision volatility has been tamped down. I've pointed out some likely support and resistance levels, on both the weekly and intraday charts.

As Jim did, I would also warn of the impact of a Russell rebalancing at Friday's close. Last year, due to some peculiarities of the rebalancing, the Russell 2000 actually broke higher during and after the rebalancing period, with the last trading day of June being the expected down day, but Jim has already well laid out the traditional reaction. Whether we see a repeat of last year's reaction or a reassertion of the traditional one, the rebalancing is likely to contribute to the post-FOMC volatility as will normal end-of-quarter action.

Instead of window dressing, there may have been some window undressing at play this week, since some of the previously weakest sectors were those being sold, with fund managers perhaps not wanting to be holding the dogs in their baskets of stocks. However, late this afternoon, I began noticing that several indices were breaking above their five-minute 100-ema's within a few minutes of each other, from about 2:25-2:40, with some such as the SOX, lagging that action, and some, like the BIX, leading it. News that Sunni insurgent groups would consider stopping attacks if the U.S. agreed to withdraw its troops from the region had surfaced just before the buying occurred, so the buying may have been prompted by this development. However, seeing so many indices break above the same averages in such a lockstep manner suggests some across-the-board buying this afternoon, either as part of a positioning ahead of the FOMC decision or as part of a window-dressing attempt or maybe even as a result of that geopolitical development. My first "undressing" theory was partly thrown out the window this afternoon, although confusion persists due to the timing.

My best advice is to wait out that initial volatility, watch until a formation sets up, and then, if inclined, enter on a break of that formation. Typically, a triangle sets up, lines can be drawn, and you can identify a breakout or breakdown. Remember, though, that our nation is not the only one in which financial experts are on inflation watch. The ECB meets next week. Keep stops at account-appropriate levels and heed them.

After-hours developments this afternoon included Walt Disney Company's announcement that John Pepper, Jr., a current director of Disney and a former CEO of PG, will serve as its non-executive chairman, beginning January 1, 2007. Raytheon (RTN) announced that the SEC has authorized a $12 million penalty payment in which the company will not have to admit or deny wrongdoing, in a previously disclosed investigation into accounting and disclosure practices. CI said its board had authorized a $500 million stock buyback program. MANU announced that its shareholders had approved the acquisition of JDA Software Group (JDAS). Shares of Alexion Pharmaceuticals dropped heavily after the company said its Phase III clinical trials for its angioplasty drug did not produce statistically significant reductions in mortality.

Reports other than the GDP and deflator tomorrow include May's Help-Wanted Index. That will be released at 10:00, thirty minutes before the natural-gas inventories at 10:30. Companies reporting earnings include ACN, STZ, GIS, MON, PALM, and RIMM.
 


New Plays

New Option Plays

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

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Bear Stearns - BSC - cls: 135.41 chg: +1.82 stop: 129.99

We continue to sit on the sidelines waiting for BSC to push past the $137.50 level. Our trigger to buy calls is at $137.51. Our concern tomorrow is that the markets might overreact to any FOMC news and shares could spike higher only to reverse course again. It's pretty common to see the first reaction to an interest rate decision change course. While we are sticking to our plan more conservative traders may want to pay close attention tomorrow afternoon and use a tighter stop loss.

Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 09/14/06 (unconfirmed)
Average Daily Volume = 1.5 million

---

Chipolte Mex Grill - CMG - cls: 59.95 chg: -1.85 stop: 57.45

Ouch! CMG lost 2.99% today on low volume and no news. We shouldn't be too surprised since we've been warning readers to look for a pull back toward the $60.00 level and potentially the 50-dma (currently 58.91). We're not suggesting new call positions at this time. We do not want to hold over the late July earnings report.

Picked on June 18 at $ 61.76
Change since picked: - 1.81
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 384 thousand

---

Google - GOOG - close: 406.11 chg: + 3.79 stop: 384.50

GOOG showed some relative strength today with a minor bounce from the $401 level this afternoon. We would hesitate to open new positions ahead of the FOMC decision tomorrow. Any market weakness could send GOOG to its 10-dma or the 50-dma in the $393-395 region. Our target remains the $440-445 range.

Picked on June 21 at $401.00
Change since picked: + 5.11
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 9.8 million

---

Marathon Oil - MRO - close: 81.80 chg: +1.99 stop: 76.45*new*

Oil stocks continue to rally and shares of MRO added 2.49% on decent volume. We are raising our stop loss to $76.45. If you're looking for a new entry point we'd wait for a pull back instead of chasing MRO here. Our target is the $84.00-85.00 range. The Point & Figure chart's bullish price target has jumped from $85 to $97.

Picked on June 27 at $ 77.55
Change since picked: + 4.25
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 3.2 million

---

Reynolds American - RAI - cls: 113.87 chg: +1.44 stop: 107.75

RAI produced some relative strength with a 1.28% gain today. We are suggesting two targets. Our conservative target is $115.00. Our aggressive target is $119.00. The P&F chart is still bullish and points to a $148 target.

Picked on June 15 at $111.15
Change since picked: + 2.72
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 632 thousand

---

United Tech. - UTX - close: 61.33 chg: -0.07 stop: 59.95

Volume was pretty light for UTX today as investors wait for tomorrow's FOMC decision on rates. Shares of UTX dipped to $60.60 before bouncing. We would hesitate to open new positions ahead of the Fed decision.

Picked on June 08 at $ 60.13
Change since picked: + 1.20
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 3.7 million
 

Put Updates

Apple Computer - AAPL - close: 56.02 chg: -1.41 stop: 60.05

Our bearish put play in AAPL is now open. The stock finally broke down under support at the $57.00 level and hit our trigger to buy puts at $56.85. The stock suffered a 2.45% loss after some negative analysts comments and concerns over delays for the company's newest iPods. Our target is the $50.50-50.00 range. The P&F chart has produced a descending triple-bottom breakdown sell signal with a $44 target. Please note that we do not want to hold over the company's July earnings report.

Picked on June 28 at $ 56.85
Change since picked: - 0.83
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 33.1 million

---

Amgen Inc. - AMGN - close: 63.94 chg: -0.04 stop: 67.25

AMGN continues to look bearish with a couple of intraday failed rallies on Wednesday. However, more conservative traders may want to seriously consider exiting early tomorrow morning and lock in some gains. There is no way to know how the markets will react following the Fed decision. Our target is the $62.65-62.25 range. We are inching our stop loss down to $67.25.

Picked on June 05 at $ 67.48
Change since picked: - 3.54
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 8.9 million

---

Digital River - DRIV - cls: 40.53 change: -0.10 stop: 42.05

DRIV looks a little bearish here with an afternoon failed rally but we are not suggesting new positions ahead of the FOMC decision. Besides, our previous updates suggested waiting for another drop under $40.00 or $39.50 before initiating plays and DRIV has failed to break either level lately.

Picked on June 19 at $ 39.45
Change since picked: + 1.08
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 1.0 million

---

Express Scripts - ESRX - cls: 68.74 chg: +1.72 stop: 70.10

An upgrade for ESRX before the opening bell sparked the gap higher and the mini-bullish breakout. We are not suggesting new plays. Our conservative target at $65.25 was hit days ago and now we're aiming for the $60.50 mark. The Point & Figure chart points to a $52 target.

Picked on June 08 at $ 69.59
Change since picked: - 0.85
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 1.8 million

---

Group 1 Auto - GPI - close: 55.34 chg: +0.99 stop: 58.46

There is no change from our previous updates. We're still suggesting that readers consider exiting early to lock in a gain. More conservative traders may want to adjust their stops toward the $56.00 level. Our target is the $51.50-50.00 range.

Picked on June 11 at $ 58.46
Change since picked: - 3.12
Earnings Date 08/01/06 (unconfirmed)
Average Daily Volume = 498 thousand

---

Intl. Bus. Mach. - IBM - cls: 76.56 chg: -0.07 stop: 79.05

We see no changes from our previous updates. IBM is churning sideways as investors wait for tomorrow's interest-rate decision. We would not suggest new plays ahead of that announcement. We don't want to hold over the mid-July earnings report expected in about three weeks.

Picked on June 06 at $ 78.75
Change since picked: - 2.19
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 5.2 million

---

IDEXX Labs - IDXX - close: 74.25 chg: -0.06 stop: 78.05

It's the same story here with IDXX. Traders are waiting for the Fed decision. We're not suggesting new plays. Our conservative target at $75.25 has already been hit. Now we're aiming for the $72.00 level.

Picked on June 12 at $ 77.95
Change since picked: - 3.70
Earnings Date 07/28/06 (unconfirmed)
Average Daily Volume = 144 thousand

---

Oshkosh Truck - OSK - close: 47.02 chg: -0.55 stop: 50.51

OSK continues to show relative weakness. The stock lost 1.15% today to close at a new five-month low. Our target is the $45.50-45.00 range. The P&F chart points to a $34 target.

Picked on June 13 at $ 49.49
Change since picked: - 2.47
Earnings Date 08/01/06 (unconfirmed)
Average Daily Volume = 737 thousand

---

Sears Holding - SHLD - cls: 150.24 chg: -3.62 stop: 154.36

We do not see any changes from our new play description from Tuesday night. Our suggested entry point to buy puts is at $148.99. If we are triggered at $148.99 our target will be the $142.00-140.00 range. Currently the Point & Figure chart displays a triple-bottom breakdown sell signal with a $140 target but we suspect that target will drop even further. The biggest risk right now is probably catching an intraday spike lower as markets move on the Fed decision tomorrow. We're going to stock to our plan but more conservative traders should monitor the stock tomorrow and consider using a tighter stop.

Picked on June xx at $xxx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/17/06 (unconfirmed)
Average Daily Volume = 2.0 million
 

Strangle Updates

None
 

Dropped Calls

Cognizant Tech. - CTSH - close: 63.59 chg: -0.29 stop: 62.49

We have been stopped out of CTSH at $62.49. Yesterday's sell-off continued this morning and the stock fell to $62.30 before bouncing.

Picked on June 24 at $ 65.05
Change since picked: - 1.46
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 1.4 million

---

General Dynamics - GD - cls: 64.06 chg: -0.09 stop: 63.99

We have been stopped out of GD at $63.99. We've been cautious on the stock for a few days now given its lack of upward follow through. While GD did bounce well off its lows today the stock closed under technical support at its 100-dma.

Picked on June 18 at $ 66.12
Change since picked: - 2.06
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 1.5 million

---

Legg Mason - LM - close: 98.62 chg: -1.45 stop: 98.45

We have been stopped out of LM at $98.45. We're a little surprised at LM's relative weakness today. Shares definitely under performed the market and their peers in the broker-dealer sector. The only news we could find was a press release on some management shuffling to integrate its acquisition of Citigroup's asset management division. Chart readers will note that the short-term technicals are turning bearish and its MACD is now hinting at a bearish sell signal soon.

Picked on June 18 at $102.45
Change since picked: - 3.83
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 1.8 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Is Dow Theory Still Relevant?

I got a SUBSCRIBER E-MAIL asking me if I thought that Dow Theory was still useful in seeing the big market picture here at this juncture. Especially since the Dow Transportation Average (TRAN) has been so STRONG relative to the Dow 30 Industrials (INDU).

RESPONSE: Well, Dow Theory is mostly relevant to an investment oriented time frame; that is, determining the long-term year or over year trend as up or down. This is less relevant to options traders although most of us also have long-term equities holdings, especially in retirement accounts. However, it is useful to have some definition of whether the current market is a bull or bear market.

While I don't consider myself an expert on all nuances of Dow Theory, I find it very instructive to look at what the Dow Transports are doing relative to the Dow 30. Once in a while there is a STRONG indication to go more heavily into puts or calls from the RELATIVE action of the two averages.

By the way, this market has to be still considered a bull market in terms of Dow Theory. However, INDU has not made it to a new closing weekly high unlike TRAN, which did so long ago. This divergent action is, to date, a non-confirmation of the primary UP trend dating from late-2002/early-2003. At some point this year the Industrials should exceed its 1999 weekly closing high at 11,723 to suggest that that the primary market trend remains up.

Of course, since we now have two markets now so to speak, NYSE and Nasdaq and with the tech-heavy Nasdaq Composite (COMP) and even the S&P 500 (SPX), so far below their prior weekly closing highs, it does seem like we are in a new world and have left Charles Dow way back in the last century; COMP has retraced only 31% of prior decline only! SPX has regained 72% of what it lost from its 2000 peak to its 2002 low.

BEFORE CONTINUING ON DOW THEORY, ONE OTHER NOTE:

My INDEX TRADER articles:
This Wednesday Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column, an online (only) section at the Option Investor.com web site; you can bookmark this section or add to your 'favorites' by clicking HERE.

I wrote in my weekend Index Trader ("Into the Doldrums") that it looked more likely for the market to drift sideways to lower, (perhaps re-testing the lows) than break out above technical resistance; the initial/first rebound off the lows took the major indexes back to, not above, technical resistances.

In my Wednesday Trader's Corner articles I typically also work in a technical midweek update to my weekend Index Trader. Especially so when I can demonstrate the relevant technical/trader tools discussed here.

You will normally also see a web LINK to the Index Trader at the top of your weekend Option Investor Daily e-mail but was NOT the case for my most recent article of Sunday (4/30). This column can be seen by going to our web site using the above LINK; when connected to the Internet of course.

DOW THEORY CONTINUED:

What came to be known as "Dow Theory" and Charles Dow didn't call it that, it was simply a body of market 'observations', is not a system of market timing but more of a forecaster of the major or 'primary' trend (over many months and often years)and tends to predict economic downturns or recessions.

Back in the 1880s and 1890s, Charles Dow, who, along with Edward Jones formed Dow Jones & Co. (discloser: I worked for Dow Jones in the 90's), came up with the first stock
market averages, which became, over time, the Dow Jones Industrials (now 30 stocks) and the Transportation average (Symbol: TRAN and now 20 stocks) as well as a Utility stock average (now 15 stocks).

I tend to call the Dow Industrials, the 'Dow 30' as these 30 stocks have become more technological, communication, manufacturing and service oriented and less of what we think of as 'industrial', unlike the case of the heavy industry stocks like U.S. Steel that were part of the early Dow.

One of Dow's most important contributions was the idea that 'confirmation' of the primary trend occurs by the actions of BOTH the Industrial and Transportation averages. A related aspect to this, really the flip side of it - is the concept of 'divergence'.

Dow spoke mostly about confirmation divergences between averages and between prices and volume or between price action and indicators is mostly what came in this century by various technical analysts.

Dow said that if the Dow 30 Industrials (INDU) moved to a new closing high or low, without the Transportation average following suit at some point (within a few months usually) and failed to 'confirm' the new high or low or, if the Transportation Average (TRAN) goes to a new peak or new low, without the same action in the Industrials we should be on alert for a possible change or reversal of the primary trend.

If production is slowing, there may not be a slowing of production for a while as companies let inventories build up and we see little initial change in what the stocks of the Dow Industrial average are doing. However, the transportation companies will tend to see a slowdown in shipments more immediately and the Transport stocks start to slide; or, not go on to make yet another high.

If the Industrial companies see a pick up in orders when the economy turns up, they may work off inventory first, BEFORE we see a pick up in their earnings due to advance sales, whereas the transportation companies will tend to see a pick up in orders immediately. These are some of the ways that one average can go its own way, with the comparative difference in price action offering key tip offs at times to what is happening in the economy.

LAST MAJOR LOWS

The Dow Transportation Average (TRAN) made a new closing low in early-2003 as shown on the upper TRAN portion of the chart above, whereas the Dow 30 (INDU) make a higher low around the same period. INDU did not 'confirm' TRAN in its new low, generating a quite useful Dow buy 'signal'. At this time, inventories were low and as the companies ramped up production, the knowledgeable or savvy investors started doing some buying in the those stocks keeping the Average providing some good underlying support.

This Dow Theory 'non-confirmation' or bullish divergence, the fact that INDU turned made a higher relative low, was a helpful 'signal' to do some significant buying; buyers of DJX calls that bought heavily on that 'signal' did very well during that period. And market 'sentiment' was quite bearish during this period, which was another thing that Charles Dow first said was typical of the first lift off from a bear market.

The predominance of bearish readings (heavy put buying relative to calls) is shown graphically in my Call/Put Sentiment indicator seen under the S&P 100 (OEX) chart below, that is of the price history for early-2003. The Dow of course was in the same kind of very strong and steep advance as OEX.

That first very strong advance, armed with the knowledge of the Dow Theory buy signal, made my year in terms of index option profits. I don't believe in always buying at the same 'level'. There are just a few times in a year where there are compelling index option buy opportunities but a select number of those (e.g., 1-2) are worth trading as heavy as is still reasonably prudent relative to the money you have to trade with.

A failure to make a new high or low in the EITHER average that WAS made by the other Average, is sometimes if not often a good indication for a major turning point in the market.

CURRENT CASE

The Dow 30 Industrials (INDU) filed to make a new closing weekly high recently and has retreated sharply since then. Is this the REVERSE of the early-2003 situation and 'signaling' the start of a major downtrend in the months ahead? Perhaps. What else to watch for that would be 'benchmark' technical milestones? (The below chart was run when INDU was up a bit more than it was on the close +51.8, versus +48.8 at today's close.)

For one, I'm watching to see if the 'line' of prior closing weekly highs around 10,980-11,000 is pierced; this horizontal dashed line is seen on the lowermost chart of INDU below.

Major other benchmarks in terms of the primary trend, would be if the long-term up trendline was pierced, which intersects currently in the 10,500 area, which is where that green up arrow is under the trendline above.

The other major reference point technically on the Weekly Dow chart above is the prior closing weekly low at 10,215 from last year (late-2005). A weekly close under this level confirms a reversal of the primary trend.

In my 'Essential Technical Analysis' book I used an example of a major blockbuster type Dow signal that could have put anyone on the right track in terms of getting into stocks big time as a new low in the Transports was NOT confirmed by a new low in the Industrials, as seen on my last chart below:

When the lows were made in INDU, we can assume that manufacturing was holding relatively steady; there was probably not much of a build up of inventories. But, transportation stocks were suffering more relative to the heavy volume and good earnings that they were experiencing in the prior year(s).

** E-MAIL QUESTIONS/COMMENTS **
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** Good Trading Success! **
 

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

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