Option Investor
Newsletter

Daily Newsletter, Saturday, 08/05/2006

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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

Goldilocks Returns

The Non Farm Payroll number on Friday was as perfect a number as possible with the Goldilocks attributes of not too hot and not too cold. It was just right according to analysts despite missing estimates by -37,000 jobs. The Dow spiked 80 points at the open on euphoria over an end to rate hikes. That euphoria evaporated almost immediately as traders began to look into the future and worry about profits. At least that was the official view as to why the markets imploded. I believe it was just profit taking after another "Fed done" rally. It would be nearly impossible to find anyone that does not believe a Fed pass on Tuesday was not already priced into the market. Everyone had already voted with their cash there was nobody left to buy the top. Even more amazing there was no short squeeze from the spike over resistance. Shorts just added to positions rather than covered existing ones.

S&P-500 Chart - Daily

Dow Chart - Daily

Nasdaq Chart - Daily

The Non Farm Payroll report showed that 113,000 new jobs were created in July. June was revised higher by 3,000 to 124K and May was revised higher by 8,000 to 100K. The headline number missed the consensus of 150K by -37,000 suggesting the economy was weaker than expected. On the surface this would seem to guarantee a pause by the Fed next week but the tendrils of inflation were clearly evident. Average hourly earnings rose 0.4% and wage inflation is a major stimulant to Fed rate hikes. That represents a 3.8% jump in wages over the last 12 months. Also pressing the case for a pause was an unexpected jump in the unemployment rate to 4.8% from 4.6% in June.

The first table below compares the consensus estimates to the actual headline numbers for the last twelve months. The second table adds in the household payroll survey to show the monthly total. Normally the household survey shows a significantly higher production of new jobs than the non-farm survey because this is where new home-based businesses are born and the Internet economy is most easily utilized. This is also where the unemployment rate is calculated. You will note that there was a LOSS of jobs in the household survey in July. This is the first loss since the hurricane related drop in the 4th quarter of 2005. Clearly the production of new jobs fell off a cliff in July. The only lower number was in September 2005 and a direct result of Katrina, not the economy. Something changed dramatically and this is why traders celebrated and end to Fed hikes at Friday's open.

12 Month Non Farm Payroll Consensus Vs Actual Table

12 Month Jobs Non farm and Household Table

12 Month Non Farm Payrolls Chart

Unfortunately the household portion of the jobs report is like a stealth component and is not widely reported. Once that job loss number filtered through the markets over the next couple of hours those same traders celebrating at the open recoiled in shock at the -34,000 job losses. The feeling the Fed would pause was quickly replaced by concerns that the economy was slowing faster than expected and profits were likely to get squeezed. Whether it was the true reason for the selling or not it was the reason the talking heads used to explain the sudden change in sentiment.

I think the selling was more likely the result of two factors. The first was profit taking on yet another Fed done rally that saw the indexes spike above current resistance on a Friday before the Fed meeting. You have to admit the anticipation for a Fed pause was fully priced into the market and even overpriced in the opinion of many. That set up a prime sell the news event. Profits are not profits until turned into cash.

The second reason could be a lot of chicken counting before the Fed eggs are hatched. While traders were counting their chickens the Fed was counting the different ways inflation was creeping into the system. The July wage inflation of 0.4% pushing the 12-month rate to 3.8% was just more confirmation the Fed's work is not done. In other words the foundation began to crumble on Friday's Fed done rally when reality settled in on traders. As of Friday morning a Fed pause was fully priced into the market and the only possible surprise would be another hike. 22 of 23 bond dealers surveyed by Dow Jones expected the Fed to pause. The Fed funds futures fell to only an 18% chance of a rate hike. There was no upside potential left for traders at the end of a long rally. The fear of a faster than expected drop in the economy sent other investors into the safety of bonds driving yields to multi month lows. The 30-year yield fell under 5.0% for the first time in four months. The ten-year note traded below 4.9% intraday.

Chart of Ten year Yields - Daily

Another realization also came back to haunt traders. A Fed pause Tuesday does not mean a halt in rate hikes. The November Fed funds futures are still showing a 70% chance of a hike over the next three months. That was down from a 90% chance before the jobs report but still nearly a guarantee of another hike. Major analysts were split on how it would happen but several were openly predicting further hikes. Further hikes? That was far from the Fed pass that was priced into the market at the open. A noted Cantor Fitzgerald analyst expects a 25-point hike next week and a statement saying the hikes were over unless conditions worsened. A Barclay Capital analyst expected a two meeting pause then another hike in October. A JP Morgan analyst said the Fed had to hike again to cover its inflation bases given the continued signs of rising inflation. He felt the Fed would keep hiking and produce the proverbial Fed rate hike recession. Traders were faced with both an economy falling faster than expected as evidenced by the household jobs survey and by a crumbling belief that the Fed would pass on Tuesday. It was not a pretty sight and that combination of factors erased a 80 point Dow gain and pushed the Dow to a -55 point loss intraday.

From a purely sentiment point of view the markets had rallied above current resistance of 11250, 2100, 1280 on the morning spike and the worst two months of the year are August and September. It was the perfect opportunity for funds to exit on strong volume at market highs ahead of their normal vacation period. Typically fund managers take their vacations over the last three weeks of August. Earnings are over, volume is low and there is little to stimulate market movement. TrimTabs said on Friday the cash inflows to funds for the first week of the month was the lowest level since February. Funds need to keep cash on hand for withdrawals ahead of the normal Q3 weakness and there is a shortage of cash in the mail. Given these factors I am surprised the selling was not worse. An end of day bout of short covering did rescue the markets from a deeper slide but it may have been only a short-term reprieve.

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If the Fed does pause next week I am sure we will see another sprint higher but it may be very short lived given the placement on the calendar. It is already priced in and the economic fundamentals are weakening. Yes, traders will be glad they paused but now we are at the point where a pause could have a deeper meaning. I know this analysis is brain numbing but stick with me for one more point. If the Fed does pause in the face of rising inflation THEN the question immediately becomes, "does the Fed know something we don't?" Is the economy worse than it appears on the surface? This used to drive me crazy back in prior hike cycles. We want the Fed to pause but will they pause for the right reasons? Is the underlying jobs data pointing to larger issues? Is the housing sector about to implode rather than slump? What does the Fed know that we don't? This almost makes another rate hike a reassuring event. We would assume the Fed would not hike again if the economy were really weaker than we have seen from recent reports. Of course the Fed has a history of over hiking and pushing us into recession but you get the idea. I could continue this train of thought for several more paragraphs but I think everyone understands now that a) a Fed pause is not guaranteed and b) a pause is not a halt and c) a pause on Tuesday could create a new set of sentiment problems.

One more thought before I end this Fed topic. If the Fed did pause next week they have to leave us with a hawkish statement or leave themselves open for a serious bout of second-guessing. They have to say in strong words that future decisions will be data dependent and that further rate hikes are always an option. They can't just say, "we are done" and move to the sidelines. They have to keep the bond markets off balance or rates will implode forcing them to come back with further hikes to offset that decline. Bond yields are already well under Fed funds so the bond market is already discounting an end to hikes. The Fed has to combat this and their only tool other than hikes is a strong verbal attack. If the Fed did pause I would expect the Fedspeak over the next couple weeks to be very hawkish to keep the bond market indecision high.

If you have any doubt a halt to rate hikes is not priced into the market you only need to look at the homebuilders. Even with Hovnanian warning again on Friday the sector is still showing signs of life. Most builders found a bottom in mid July and anticipation of an end to hikes has given them wings. For instance Toll Brothers (TOL) has risen 22% since hitting their low of $22.25 on July-18th. If the Fed pauses you can expect these companies to quickly recover more lost ground despite the profit warnings. HOV is still projecting earnings of up to $5.75 per share ($354 million) compared to analyst estimates of $6.46. That is down from record profits of $7.16 per share in 2005 but still a nice chunk of change.

Apple Computer announced on Friday that financial statements dating back to 1997 could be restated due to further investigations into backdating options. Steve Jobs is under fire for options on 27.5 million shares granted several years ago. The options expired underwater without being exercised but the board then gave Jobs restricted stock in their place. Most analysts expect little change to the financials but are more afraid of ramifications to the continued employment of Jobs after the Brocade CEO was jailed. If Jobs was attacked by the SEC and forced to resign, or worse, it would be extremely negative to Apple stock. AAPL dropped nearly -$5 intraday but recovered at the close to end down only -$1.29.

Oil prices eased ahead of the weekend as tropical storm Chris was downgraded into a tropical depression. Oil closed down -71 cents at $74.75. Based on the projected path below it may be too soon to start cheering since it will be into the Gulf by noon on Monday. It could easily revive into a full-fledged hurricane and be well within the 3-day warning cone that would require shutdown and evacuation of the offshore oil patch. Don't count Chris out just yet.

NOAA Hurricane Path Map

Crude Oil Chart - Daily

For the week the markets were bipolar with the major indexes mixed for the week with small gains or losses. None were more volatile than the transports. The transports hit a low of 4265 on Tuesday and a high of 4560 on Friday for a range of 295 points or 7%. The index closed on Friday at 4378 and a -36 point loss for the week or less than -1%. A 7% range with less than a 1% result. That would have been a nice trade using the Transport ETF (IYT). Unfortunately there are no options. You could use options on FDX or CSX as a proxy for the Transports for future moves.

The Dow spiked at the open to 11344 ( 80) and well over the recent resistance at 11250. That spike was erased with a -157 point drop to 11187 and the low of the day. The end of day short covering pushed the Dow back to 11240 and right under that previous resistance. Normally a complete erasure of that kind of spike is a very negative omen. I believe the morning drop was simply profit taking along with shorts opening new positions. The afternoon rebound was short covering and dip buying. The retail bulls are convinced the Fed will pause and an explosive rally will result. Where the Dow will be when that rally starts and how long it will last is anybody's guess but I would not be surprised to see any rally erased as quickly as Friday's once the selling begins.

Weekly Market Internals Snapshot

If I only had the chart on which to base my predictions I would be bullish. The strong advance since the July 18th low at 10683 appears to still be intact despite four strong attempts to sell off. The closing rebound on Friday would appear to be an indication of a strong open on Monday. However, once you add in the Fed and the calendar I become much more cautious.

The Nasdaq also spiked over current resistance at 2100 to hit 2119 intraday. The same profit taking pushed it back to 2068 intraday for a -51 point drop but the Nasdaq also recovered at the close to end only -7 at 2085. This is right in the tight 2055-2095 range we have seen for the past two weeks with resistance at 2100 still intact. The NDX closed at 1503 and in the middle of its 1480-1520 range. The NDX is showing far less bullishness than the other indexes but managing to avoid the cliff edge. The SOX rallied as high as 424 intraday and closed at 411 with the two-week uptrend still intact.

The S&P-500, my indicator of choice, managed to spike past 1280 resistance to briefly peek over 1290 before crashing back to earth. The close at 1279 was right at the same 1280 resistance that has held it in check since early July. Like the other indexes the SPX has a bullish trend but is still looking for buyers to hold any spike over 1280. There appears to be no shortage of sellers on every foray over resistance but continued spikes would eventually exhaust supply without any external forces like the Fed and the calendar.

For next week I would be cautious. Every Fed done rally has been sold because it was based on speculation and hope. Next Tuesday we will know for sure what the Fed is going to do and the expectation and hope will fade under the glare of reality. If the Fed surprises everyone and takes a pass and posts a positive statement I think everybody will want to rally but immediately start asking why the Fed was so accommodative. What do they really know? The best outcome would be a hike and post a halt statement that clearly says they are done unless the data forces another move. Traders would celebrate the end of uncertainty and a low upper rate of 5.5%. I would not hold my breath for that event. Whether they hike or not I expect a hawkish statement and that could spoil investor sentiment. It is not the hikes at this point but the expectations of more hikes that will give traders indigestion. Let's hope the Fed takes a chance and throws the market a bone. The economic calendar for next week is rather bland with only the FOMC meeting and Productivity on Tuesday to wake the bond groupies. Clearly the only focus for the week is the Fed at 2:15 on Tuesday.

Economic Calendar

I would not get too excited about any market moves before 2:15 on Tuesday because speculation and fund positioning will be rampant. Funds could be looking to use any post Fed spike to exit on volume so market internals will be of critical interest on Tuesday night. We will have this discussion again in the Tuesday newsletter and hopefully we will have a clear vision of the future with the Fed behind us.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None NIHD None
  RIG  

New Calls

None today.
 

New Puts

Editor's note: If you have not yet read the market wrap for this weekend please read it first. Our market bias is growing bearish and while there could be some intraday strength on Monday and Tuesday this week we believe the end result following the FOMC meeting on Tuesday will be a move lower in the markets. Stocks are likely to just hover sideways the next two days as investors wait for the Fed's decision on interest rates Tuesday afternoon. Because of the FOMC meeting we've decided to limit the number of new plays this weekend and we don't expect to add any new plays on Monday. However, some traders may want to prepare early for opening new bearish positions. Therefore we're listing several stocks that we'll be watching as potential bearish candidates. Some of these you'll want to watch for a breakdown while others you'll want to watch for a bounce and failed-rally sort of entry point. Here's a partial list of candidates that we'll be watching the next two days: AAPL, AGN, AZO, BNI, CRS, DE, GRMN, HAR, IPS, ISRG, RTP, SHLD, UNP.

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NII Holdings - NIHD - close: 50.83 chg: 0.29 stop: 52.51

Company Description:
NII Holdings, Inc., a publicly held company based in Reston, Va., is a leading provider of mobile communications for business customers in Latin America. NII Holdings, Inc. has operations in Argentina, Brazil, Mexico and Peru, offering a fully integrated wireless communications tool with digital cellular service, text/numeric paging, wireless Internet access and Nextel Direct Connect, a digital two-way radio feature. (source: company press release or website)

Why We Like It:
NIHD's rebound from the June low failed at resistance near $58.00 in early July. Ever since the stock has been consolidating sideways above support at the $50 level and its 200-dma. Now the stock looks poised to breakdown again. Shares are under the 200-dma and testing the $50 mark. Daily and weekly technicals are bearish but we do note that the P&F chart is still bullish. We are suggesting that readers use a trigger at $49.90 to buy puts and catch a breakdown under support. NIHD does have additional support near $47.50 on both the daily chart and the P&F chart but the next significant level of support appears to be $45.00 (see chart below). Our target is the $45.50-45.00 range.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 55.00 QHQ-UK open interest= 429 current ask $5.40
BUY PUT SEP 50.00 QHQ-UJ open interest=1137 current ask $2.30
BUY PUT SEP 45.00 QHQ-UI open interest= 625 current ask $0.75

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 2.2 million

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Transocean Inc. - RIG - cls: 70.08 chg: -1.72 stop: 75.25

Company Description:
Transocean Inc. is the world's largest offshore drilling contractor with a fleet of 87 mobile offshore drilling units. The company's mobile offshore drilling fleet, consisting of a large number of high-specification deepwater and harsh environment drilling units, is considered one of the most modern and versatile in the world due to its emphasis on technically demanding segments of the offshore drilling business. The company's fleet consists of 33 High-Specification Floaters (semisubmersibles and drillships), 20 Other Floaters, 25 Jackups and other assets utilized in the support of offshore drilling activities worldwide. (source: company press release or website)

Why We Like It:
The oil services sector has been weak recently thanks in part to some heavy selling in shares of RIG. Investors were not happy with the company's recent earnings report. The stock has produced a failed rally at the $80 level and its 100-dma and sank past potential support at $75 and the 200-dma to fall towards support near $70. At this point the trend is bearish but RIG is so short-term oversold we're expecting a bounce early next week. Aggressive traders can use a failed rally under $75 as a new entry point to buy puts. We're going to suggest that readers actually wait for the breakdown under support at $70. Our trigger to buy puts is at $69.49, which is under Friday's low. We are suggesting two targets: a conservative target at $65.25 and a more aggressive target at $61.00. The P&F chart points to a $59 target.

Suggested Options:
We are suggesting the September puts. November puts would also work.

BUY PUT SEP 75.00 RIG-UO open interest=1749 current ask $6.50
BUY PUT SEP 70.00 RIG-UN open interest=5462 current ask $3.50
BUY PUT SEP 65.00 RIG-UM open interest=2621 current ask $1.55

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 6.4 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

The Andersons Inc. - ANDE - cls: 38.44 chg: -0.56 stop: 38.75

Update: ANDE spiked to $40.44 on Friday morning but the rally ran out of steam like the rest of the market. After reading the Option Investor market wrap this weekend we're not so sure we should be adding bullish call plays at this time. It seems like any spike higher on Monday or Tuesday may end up being a trap. For this reason we're going to adjust our trigger to buy calls on ANDE to $41.85, which is above the descending 50-dma. As the 50-dma descends we'll move the trigger. More conservative traders may just want to pass on adding any new bullish plays even if ANDE hits our trigger. A reprint of our Thursday night play description follows:

The incredibly volatile shares of ANDE have cooled somewhat after the stock's 2-for-1 split in June. The stock can still produce some violent moves and traders may want to use a wider stop loss. We suspect that the next move will be higher. ANDE has produced what appears to be a bullish double-bottom pattern over the last couple of months with support near $35.00. Technicals indicators have turned positive and now ANDE looks ready to breakout over $40.00 and its three-month trendline of resistance (lower highs, see chart). Aggressive traders may want to consider positions now. We're suggesting a trigger to buy calls at $40.51(the trigger is now set to $41.85). There is potential resistance at the 50-dma near $42 but if the markets breakout higher on the jobs report and/or the FOMC meeting then we expect ANDE to push past the 50-dma. Our target is the $46.00-47.00 range.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 40.00 AQA-IH open interest= 60 current ask $2.90
BUY CALL SEP 45.00 AQA-II open interest= 91 current ask $1.05

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 1.2 million

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Avalonbay Comm. - AVB - close: 118.46 chg: 1.58 stop: 114.90

Update: Our new play in AVB is now open. We cannot find any news or catalyst to explain it but shares of AVB gapped open higher on Friday at $117.70. Our suggested trigger to buy calls was at $117.55 so we would have been triggered at the open. The move is definitely bullish as AVB has now broken out above its multi-day trading range. However, more conservative traders may want to think twice about opening new bullish positions. The market wrap for this weekend outlines why the markets may be more likely to sell the FOMC news on Tuesday. We do not see any changes from our AVB new play description from Thursday and we're reposting it here:

The REIT stocks seem to be doing well and showing plenty of relative strength. AVB is one REIT that is trading near all-time highs. The stock has been consolidating sideways the past few days in a narrow trading range. Thursday's bounce has put AVB on the verge of another bullish breakout. We want to catch the next leg higher so we're suggesting a trigger to buy calls at $117.55. If triggered our target is the $124.00-125.00 range. Currently the Point & Figure chart points to a $132 target. We do expect the $120 level to act as short-term resistance so don't be surprised to see AVB bounce around the $120-117.50 range. Once AVB breaks resistance at $117.50 it should become new short-term support. Please note that the jobs report is due out on Friday morning before the market open. More conservative traders may want to wait and watch how the markets react to the news before considering new plays.

Suggested Options:
We are suggesting the September and October calls. You choose which month and which strike best suits your trading style and risk. Currently we don't see any $125 strikes available.

BUY CALL SEP 115.00 AVB-IC open interest= 2 current ask $6.80
BUY CALL SEP 120.00 AVB-ID open interest= 13 current ask $4.10

BUY CALL OCT 115.00 AVB-JC open interest=1275 current ask $7.80
BUY CALL OCT 120.00 AVB-JD open interest=1483 current ask $4.70

Picked on August 04 at $117.70 *gap higher*
Change since picked: 0.76
Earnings Date 07/26/06 (confirmed)
Average Daily Volume = 319 thousand

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Cytec - CYT - close: 53.73 change: -0.02 stop: 52.45

CYT still looks like it wants to breakout higher from its current two-month consolidation pattern. However, our market bias is turning bearish and we suspect that the markets will eventually move lower following the FOMC meeting next week. That definitely dampens our enthusiasm for starting new call plays. Yet we can only trade what we see not what we believe. For the time being we're going to keep CYT on the play list but more conservative traders may want to think about not opening new bullish positions. This could be a tough decision if we see some intraday spikes following the FOMC announcement since at the time of any spike we don't know it's a spike yet and only see the rally. Shares of CYT are trading under resistance at the $55.00 level. We want to catch the breakout so we're suggesting a trigger to buy calls at $55.11. If triggered our target is the $59.00-60.00 range. We do expect to see some resistance near $57.50 so expect a pull back but broken resistance at $55 should become new support. The Point & Figure chart is bullish and points to a $64 target. FYI: You can notice how volume has been declining as more and more investors just sit back and wait for Tuesday's FOMC announcement.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 50.00 CYT-IJ open interest= 23 current ask $4.80
BUY CALL SEP 55.00 CYT-IK open interest= 92 current ask $1.65

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 07/20/06 (confirmed)
Average Daily Volume = 313 thousand

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Femsa Fomento - FMX - close: 90.60 chg: 0.94 stop: 85.85

Our bullish play in FMX is now open. The stock gapped open higher on Friday morning opening at $90.50 and trading to $91.75 before paring its gains. We had been suggesting a trigger to buy calls at $90.05 so we would have been triggered at the open. The breakout over $90.00 is bullish and the move has produced a quadruple-top breakout buy signal on the Point & Figure chart with a $102 price target. We want to remind readers that at the moment our market bias is turning negative and we expect the markets to trend lower following the FOMC announcement (minus any post-announcement spikes) so readers should carefully consider opening new bullish plays. Taking everything into consideration this is still a bullish entry point for FMX. Our target is the $97.00-100.00 range.

Suggested Options:
We are suggesting the September or October options. At the moment we don't see any September strikes above $90.00. FYI: The spreads on these options look too wide and it could be a quote error.

BUY CALL SEP 85.00 FMX-IQ open interest= 13 current ask $9.00
BUY CALL SEP 90.00 FMX-IR open interest= 10 current ask $5.20

BUY CALL OCT 90.00 FMX-JR open interest=132 current ask $7.20
BUY CALL OCT 95.00 FMX-JS open interest=208 current ask $4.80
BUY CALL OCT 100.0 FMX-JT open interest= 89 current ask $2.70

Picked on August 04 at $ 90.50 *gap higher*
Change since picked: 0.10
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 524 thousand

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Goldman Sachs - GS - close: 152.99 chg: 0.89 stop: 146.95*new*

Target achieved! The jobs report data pushed bond yields to spike lower on Friday morning and that fed the rally in financials and broker stocks. The XBD spiked to 220 but the rally failed and the XBD index closed under technical resistance at its 100-dma. The Friday morning spike in shares of GS hit an intraday high of $156.29. Our main target for the stock was $154.00. We were suggesting that readers exit the majority of their position at $154 and only consider holding a small play open with an aggressive target at $157.50. The overall pattern in GS looks bullish but Friday's action is a short-term bearish reversal. The next move might be a drop towards $150. We're not suggesting new plays and we are adjusting our stop loss to $146.95.

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

Picked on July 25 at $148.05
Change since picked: 4.94
Earnings Date 09/21/06 (unconfirmed)
Average Daily Volume = 5.2 million

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Petroleo.Brasiliero - PBR - cls: 93.66 chg: -0.79 stop: 89.49

In the U.S. markets oil stocks were mixed as crude oil dipped under $75 a barrel. The OIX oil index churned sideways and closed with a fractional gain on Friday. The OSX oil services index was hit with some profit taking and a 2.5% decline. Shares of PBR managed to spike over resistance at $95.00 and hit $95.98 before seeing some end of week profit taking after a decent move over the last few days. Our bias on PBR is still bullish given its breakout over resistance above $90.00 but the next move could be lower. Shares might dip toward short-term technical support at its 10-dma near 91.70 or back to the $90 level. Broken resistance at $90.00 should act as new support. A bounce from either level, $90.00 or the 10-dma, could be used as a new bullish entry point. Our target is the $99.50-100.00 range. We do not want to hold over the mid-August earnings report. FYI: The Point & Figure chart is forecasting a $116 target.

Suggested Options:
We're not suggesting new plays in PBR. Wait for the dip and bounce to appear.

Picked on July 30 at $ 92.72
Change since picked: 0.94
Earnings Date 08/11/06 (unconfirmed)
Average Daily Volume = 3.4 million
 

Put Updates

US Airways - LCC - close: 44.95 chg: -1.61 stop: 47.51

Another day of positive July traffic numbers and another day of declines in crude oil were not enough to sustain the rally in airline stocks. The XAL index fell 1.1% and shares of LCC dropped 3.4%. Investors appeared to focus on cautious comments from British Airways talking about a tougher third and fourth quarter in 2006. Friday's move in LCC looks like a bearish reversal/failed rally under its 10-dma. The drop back under $45.00 and its simple 100-dma looks like a new entry point We would consider new puts right here but more conservative traders may want to see a decline under $44.00, near Friday's low before opening positions. We suspect that the $40 level might offer some support for LCC so we're setting our short-term conservative target at $40.25. We're also setting a more aggressive target at $36.00. FYI: The P&F chart points to a $35 target.

Suggested Options:
We are suggesting the September puts. You choose the strike price that best suits your trading style.

BUY PUT SEP 45.00 LCC-UI open interest= 727 current ask $3.60
BUY PUT SEP 40.00 LCC-UH open interest=1831 current ask $1.50

Picked on August 01 at $ 43.54
Change since picked: 1.41
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 1.6 million

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Manpower Inc. - MAN - close: 58.75 chg: -0.82 stop: 60.76

The Friday morning rally in MAN failed right at its simple 21-dma and shares closed with a 1.3% loss. The move is also a failed rally/bearish reversal near round-number resistance at $60.00. The move looks like a new bearish entry point to buy puts. Please note that on Thursday we adjusted our target to $55.75-55.50 to account for the rising 200-dma, which we suspect will act as technical support. The P&F chart currently points to a $48 target. FYI: It is worth noting that the weekly chart's most recent candlestick does look somewhat like a "hammer" pattern, which is usually seen as a bullish reversal.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 60.00 MAN-UL open interest=210 current ask $3.10
BUY PUT SEP 55.00 MAN-UK open interest=367 current ask $1.05

Picked on July 20 at $ 59.42
Change since picked: - 0.67
Earnings Date 07/19/06 (confirmed)
Average Daily Volume = 1.0 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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Bausch Lomb - BOL - close: 46.78 change: -0.36 stop: n/a

After several weeks shares of BOL finally broke down under support at the $47.00 level on Friday. We suspect that the stock did not see a stronger decline because investors are still in a wait-and-see mode ahead of Tuesday's FOMC meeting. The pattern in BOL has definitely turned bearish and we're not suggesting new strangle plays. We have two weeks left before August options expire and need to see a bigger move in BOL soon. Our estimated cost on the strangle was $2.15. Our goal will be to sell if either option rises to $3.25 or more. The options in our suggested strangle are the August $50 call (BOL-HJ) and the August $45 put (BOL-TI).

Suggested Options:
We are not suggesting new strangle plays in BOL.

Picked on July 23 at $ 47.40
Change since picked: - 0.62
Earnings Date 00/00/06 (unconfirmed)
Average Daily Volume = 2.2 million

---

L-3 Comm. - LLL - close: 71.50 chg: -0.77 stop: n/a

LLL continues to display relative weakness. On Friday the stock produced a bearish engulfing candlestick pattern with a 1% decline on average volume. The stock closed at new seven-month lows and is quickly approaching potential support at its December 2005 low and the $70 level. There are two weeks left before August options expire and we need to see LLL move towards the $68 region. We're not suggesting new strangle plays at this time. Our estimated cost for the strangle was $1.35. We will plan to sell if either option rises to $2.25 or more. The options in our LLL strangle are the August $80 call (LLL-HP) and the August $70 put (LLL-TN).

Suggested Options:
We are not suggesting new strangle plays in LLL.

Picked on July 23 at $ 75.26
Change since picked: - 3.76
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 1.2 million

---

3M Co. - MMM - close: 69.45 change: 0.17 stop: n/a

We have two weeks left before August options expire and shares of MMM are still hovering around the $70.00 level. We suspect that the markets, and MMM, will finally move after the FOMC announcement on Tuesday. We're not suggesting new plays but MMM is definitely offering traders a new entry point to buy a strangle. If you choose to open a new play we'd suggest the September options. Our estimated cost for our August strangle was $0.75. We are planning to exit if either options rises to $1.50 or more. The options in our strangle are the August 65 put (MMM-TM) and the August 75 call (MMM-HO).

Suggested Options:
We are not suggesting new strangle plays in MMM.

Picked on July 23 at $ 70.72
Change since picked: - 1.27
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 3.7 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

You've Heard the News

And so has everyone else. Yahoo (YHOO) reports earnings July 19, and traders don't like the results. Yahoo's stock gaps lower and falls on strong volume. Although the stock price closes off its day's low that day, it retains most of its loss. Was it time to sell YHOO?

Not right then. Contrary to popular lore, that strong volume might have been your clue to stay away from a short position at the close on July 19. Please note that the charts in this article are not current, as this article was prepared late in July. I have purposely not updated them as I review the article on Friday, August 4, so that we can see together how the predictions panned out.

Annotated Daily Chart of YHOO, as of 7/26:

YHOO's ultimate direction isn't yet known. What is known is that after one more day of consolidation after its earnings announcement, YHOO moved higher. As I review the article Friday morning, YHOO is currently at $27.32.

Bad news drove YHOO lower on July 19, but the high volume and close off the low may have been a sign of accumulation by the big-money entities, rather than a sign of selling.

The case might have been clearer if the close off the low had produced a longer lower shadow and is somewhat inconclusive with the small shadow that was produced. Because of the inconclusiveness, I wouldn't be surprised to see YHOO come down and retest those July 19-20 lows.

However, on that day, any lower shadow in the context of high volume alerted me that the drop might be about finished for the short-term. I would have suspected that big-money entities could have been soaking up the stock that the retail crowd was selling. Although the case was inconclusive, I would have been worried about the possibility of a short-term bounce at least, a bounce that did occur.

Sometimes the evidence isn't so inconclusive. Be careful when good or bad news hits, because the truth is that big-money entities may have predicted that news and acted on it long before the retail public does. They may be waiting to use a news-driven move to accumulate or distribute stock. And they may be doing the opposite of what retail traders think is logical.

You definitely don't want to take a side against the big-money entities, so it's sometimes necessary to turn your thinking around a little. For example, to illustrate my concerns about the news-driven drop and the price/volume patterns on YHOO, take a look at what happened when Boeing (BA) reported earnings on October 26, 2005. The pattern was similar.

Annotated Daily Chart of BA:

When a badly received earnings report drove BA's stock lower, the inordinately high volume proved that big-money people were involved in the action. So what were they doing, if they were involved? The close off the low of the day suggested that they were snapping up the stock that retail investors were discarding. Note that BA did reach a lower low a couple of days later. Institutional involvement, most probably in accumulating, didn't guarantee against lower prices. Momentum sometimes carries prices lower after such a move, and BA had been dropping for several days. But then BA was ready to take off, as that likely accumulation pattern suggested that it would.

BA's bounce off its low after that news-driven drop was more pronounced that YHOO's was, but the other correlations are easily noted. Big-money people were clearly using that news-driven drop to accumulate BA stock, and there's at least a suspicion that they might have been doing so with YHOO's recent news-driven drop, too. As yet, it's unproven whether they were buying ahead of an anticipated short-term bounce into the gap or something more, and I would want to see how YHOO acted on retest before I made further predictions.

By the time most retail traders--you and I--learn some encouraging or damaging piece of news, big-money entities often have long known the news. GM's recent well-received earnings announcement might be one example.

Annotated Daily Chart of GM:

Big-money entities began their buying well in advance of GM's well-received July 26 earnings report. I was watching GM late last year and this spring and commented to another OptionInvestor writer that it was showing signs of accumulation, but I could not bring myself to buy, despite what I was seeing. Dire predictions were still being made daily about the likelihood of GM's swift demise. The signs were there, however, that those with deeper pockets were buying back then.

These illustrations all point to the necessity to be suspicious of news-driven spikes, whether to the upside or downside. When news hits, you should be asking how the big-money people are reacting? Small volume means that they're not paying much attention and it's the retail crowd driving price up or down. Big volume means they're involved, but are they buying or distributing? Did price close well off the high or the low of the day?

When you scan the chart below and the question it asks, remember that this chart was prepared in late July (as evidenced by the missing daily bars for subsequent days), but I've deliberately left it as it was so that we can test the veracity of the prediction.

Annotated Daily Chart of GM:

Given the close well off the high of the day after the earnings announcement and the larger-than-normal volume, I would have been suspicious that some of those big-money people who had begun accumulating stock earlier in the year when the stock was between $18.00-20.00 may have used the spike to sell or lighten their positions. That combination on a news-driven spike led me to suspect that GM might trade sideways or even dip. There has, in fact, since that the preparation of that chart, been a short-term dip at least, into the gap. As I review this article prior to submitting it on Friday morning, GM was at $31.71, having dipped and then risen a bit from the week's low. As yet, I don't see definitive signs that there was a whole lot of institutional buying on that dip, so I'll be eager to see what happens if it should retest that recent high.

You need to be suspicious, too, on a high-volume spike to a new recent high or new recent low move after news hits the wire. The big-money crowd has been involved if volume is inordinately high, and you need to decide what they were doing. Don't assume that high volume on a dip to a new low means that they're selling or that high volume on a climb to a new high means that they're buying. If that inordinately high volume is coupled with a bounce well off the new low or a pullback well off the new high, they might have been doing the opposite.
 

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

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