Option Investor

Daily Newsletter, Friday, 08/11/2006

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Table of Contents

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

Market Wrap

We Ain't Afraid of No Terrorists

That was the statement of the market today. Futures dropped overnight as a result of the news about the foiled plot by terrorists to blow up U.K. to U.S. bound planes, and the negative reaction by the European markets, but then started to recover before the cash market opened. There seemed to be an underlying bid to the market to hold it up, perhaps as a way to thumb our noses at the terrorists. Who knows who was behind the buying. The problem for the bulls is that it looked like a feeble attempt to get the market to rally. The problem for the bears is that shorts are not working. The problem for traders is that the market is just chopping around and whipsawing people out of their trades.

You'd think the only ones making money these days would be the brokers but one look at their chart tells me they're not doing well either. I'll review their chart later with you since it's been a very good weather vane for the equity market and right now it's predicting a storm coming in.

I have heard from both sides how much money they've been leaving on the table because the market looked like it was finally moving in a direction to then turn around and take it all back. The only ones making money fairly regularly are those who are selling options such as credit spreads. Directional trades are an exercise in frustration and if you're buying front month options you're probably watching your money wither and die. That's not true of course if you're quick to take smaller profits and/or you're finding individual stocks that are not stuck with the indices.

Unfortunately for traders this is probably how it's going to be for at least another month. Ah, summer trading at its best. Or should I say worst. We've had a choppy year leading into the summer and it's continuing. The way the larger price pattern is unfolding it's looking like we'll get a big move down in the fall but until then either keep your powder dry (trading capital intact) or trade light and trade quickly.

As I'm sure you've heard (and if not then that means you listen to NO news at all) there was a terrorist plot to blow up U.S. bound airliners departing from the U.K. They were intending to use liquid nitroglycerin to blow up the aircraft over the ocean (so nothing could be recovered). Kudos to the intelligence agencies who were on top of this one. The details of how they knew and how it was stopped will likely never make it into print (at least I hope not) and we can only thank those who work tirelessly to foil these idiots who haven't a clue about life. I'd love to see the look on their faces as they end up in hell instead of in front of 40 virgins or whatever it's up to now (inflation you know).


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Without help from our friends in government and the mega banks' trading teams, the European markets sold off on the terrorist scare and never really recovered. Right on time for our markets, futures started lifting before the cash market opened and then price was never really able to settle back. There were two quick thrusts higher today but mostly back and forth consolidation. If I were a bull I would not be inspired by today's price action. But if I were a bear I'd be frustrated by this market's inability to get a sell off going. If I were neutral and selling credit spreads I'd be a happy camper with this market.

Today was light day as far as other news and earnings. There were only two economic reports in the morning and then the treasury budget numbers in the afternoon. The unemployment claims for the prior week showed a rise of 7K to 319K. It was also higher than market expectations for 315K. The 4-week average fell 3,750 to 308,750. Continuing claims rose by 48K to 2.48M while the 4-week average rose to 2.47M and is the highest number since March 11th.

The trade imbalance numbers were also released this morning and the good news is that at $64.8B it was narrower than the gap in June. The bad news is that it narrowed only because the number for May was revised upward to $65B, from $63.8B, which was the 2nd highest on record. China accounted for $19.7B (30%) of that deficit. So far were on course to a record year--for the first 6 months our trade gap was $383.9B vs. $340.2B the previous year's first 6 months.

In the afternoon we received the treasury budget number which came in close to expectations at -$33.2B. That's down from June's -$53.4B so we're making progress in cutting our deficit! If only. Let's hope the trend of declining outlays and larger receipts continues. July's numbers showed outlays were down 1.3% to $193B while receipts were up sharply by 12.4% to $159.8B. Year-to-date shows the deficit is down 20.8% to $239.7B.

Today's price action looked bullish on the face of things, especially since it was done in the face of the terrorist threat. After all, this was the most serious threat since 9/11. The airlines are at their highest alert ever and the U.K. and U.S. are also at high alert levels. The market shrugged it off. It's either a very resilient market or it's not far from having a very nasty surprise sprung on it. But as I poured over the charts I came away with more of a bearish feeling than a bullish one. I'll explain in the charts.

DOW chart, Daily

The DOW is still struggling with that trend line along the highs since January 2004 which is where price has failed the last 3 attempts to penetrate it the past 3 months. As I've labeled on the chart, it's possible that we just completed an A-B-C correction to the May-June decline which would set us up for a big leg down as the next move (minimum downside target below 10400). Obviously the bears have some work to do since the 50 and 200-dma's are both above 11K and that makes breaking 11K a very difficult task. I think it's too early (seasonally) to look for a big decline and that's why I'm thinking we'll continue to consolidate for at least another month or more.

SPX chart, Daily

If we're to consolidate into September it might look something like I've depicted on the SPX chart. While it's still possible we'll see the market chop its way higher into the fall I no longer believe that will happen. The price pattern and deteriorating internals lead me to believe the best the bulls can hope for here is more sideways action before it lets go. The bears need to hold their fire for a little longer.

Nasdaq chart, Daily

The COMP bounce up/over to the top of its down-channel, the downtrend line from May, and has since pulled back. But it continues to look a little more bullish than the large caps. Whether that means we can expect a short term rotation into the techs (and small caps) is hard to say here but if I were going by just this chart I'd be leaning to the long side. This is based on a choppy pullback from the downtrend line which is usually a prelude to a rally above it.

QQQQ chart, Daily

To give a little longer term perspective on the techs here's a weekly chart of the Q's. The bottom of 2-1/2 year up-channel is close to the weekly 200 moving average, and the Q's appear to be getting support there. At the same time the weekly oscillators are threatening to turn back up from oversold. This looks downright bullish. The one caveat is that a failure here would likely be a hard failure as I'm sure there are many tech bulls that would be caught by surprise. That's actually the way I'm leaning if only because of the broader market. As for MACD being oversold, check out MACD back in 2003. We could see the reverse situation setting up.

SMH index, Daily chart

The semiconductors were leaders of the pack today and rallying off a retest of its broken downtrend line looks very bullish here. Then I look at where it stopped (50-dma) and the oscillators rolling over and I don't feel so bullish. Looking at this chart I don't want to be short the semis but nor do I want to short them here. Standing aside on this index until the picture becomes a little clearer.

BIX banking index, Daily chart

If you look at the bounce off the June low you will see a very clear ascending wedge, including the little throw-over above the top of it on Friday August 4th which is a very typical ending to these wedges. Now price has broken hard down through the bottom of it. The throw-over and drop back inside the pattern was sell signal #1. The drop through the bottom of the pattern was sell signal #2 and if it bounces back up to retest the bottom line (near 385) with a kiss goodbye that will be sell signal #3 and it'll be taps for this index as the June low should be taken out relatively quickly. That would of course be a bearish sign for the broader market. Even more bearish is the fact that the brokers index agrees with the banks here.

Securities broker index, Daily chart

It's amazing how well this index trades technically. It's also been a very accurate barometer for the broader market. We now have another failure at a broken uptrend line and at the same time a failure of a retest of the July high. Oscillators are rolling over. This is a bearish chart, pure and simple. What I don't know yet is whether or not this will start the next big leg down from here or continue to consolidate into September, the same as I'm expecting for the broader market. If true then we should see this index find support around 200, get another bounce and then it'll be set up for the grand fall.

U.S. Home Construction Index chart, DJUSHB, Daily

The home builders bounced slightly above the level where it had two equal legs up off the July low and that could be it for the correction. It will either stay in a sideways consolidation pattern from here or else head for another new low. I think the consolidation before heading lower is the more likely scenario. That's a lot of selling this year that needs to be consolidated.

Oil chart, September contract, Daily

Oil got the 3-wave bounce off its July low and looks ready to continue its southbound journey. I expect to see its uptrend line at $73 get taken out as oil heads for its 200-dma which may be around the June low near $70 by the time it gets there.

Oil Index chart, Daily

The oil stocks held up very well today considering the drubbing oil took. I don't think oil stock traders quite believed the story they were being told as to why oil dropped so hard (less airline demand for jet fuel). I don't blame them. However, if oil continues to drop like I think it will, the oil stocks should follow. Negative divergences abound on this index at various time frames so it's about to let go to the downside. If we first see a minor new high I would consider that a gift to lighten up on your long positions and even consider a short. At least sell some covered calls or buy some puts, or both.

Transportation Index chart, TRAN, Daily

The Trannies are fast approaching what should be solid support--its long term uptrend line from March 2003. If this index doesn't bounce from there then the broader market is in more immediate trouble than I'm thinking. With the uptrend line just under 4060, or about 50 points away, we shouldn't see much more selling here before we get a bigger bounce started.

U.S. Dollar chart, Daily

The dollar looks on track for a drop down to the $83 area. It could of course keep on truckin' south below that level but I think we'll see some bullish divergences develop as this drops lower which will clue us into a bigger bounce coming, one that takes the dollar back up to the $87-88 area. If it plays out that way then that will theoretically lower the price of gold for a stretch of time before the dollar heads lower again next year.

Gold chart, October contract, Daily

It'll be interesting to see how the relationship between the dollar and gold plays out over the next several months. If the dollar falls only a little more before getting a bigger bounce, that would mean gold is going to drop out of this consolidation. But if the dollar needs to fall a little more then gold should break to the upside out of its triangle. I'm thinking gold should run like the devil whichever way it breaks from the triangle but an upside break doesn't quite jive with the picture I have for the dollar. So either my dollar picture is wrong, the dollar/gold relationship won't hold for a little while or a combination of the two. At any rate I'd play the direction of the break here since it should be a runner.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's economic reports are unlikely to cause a ripple in the market. We'll get retail sales numbers but retailers already got a boost today thanks to earnings reports from Target (TGT 47.51 +2.23) and J.C. Penney (JCP 65.72 +1.72), which reported improved profits for Q2 of 13% and 37%, respectively. Tomorrow's retail sales number should not add any surprises.

Sector action was generally positive today which reflected the broader market. Those in the red today were gold and silver and the energy indexes. The drugs, utilities, banks and networkers were flat. Leading the pack to the upside today were the retailiers, semiconductors, airlines (oversold bounce), transports and healthcare.

The "reason" for the drop in oil was because of the anticipated drop in oil demand by the airlines. Give me a break. Any drop in demand would be a drop in the barrel. Besides, why did airliners rally then? What's amazing is that these people say this stuff with a straight face. They probably have laughing fits once they're off camera.

While today looked bullish on the outside, and was even supported by some of the internals such as the adv/decl volume and a-d issues, take a look at the number of new 52-week lows in the chart at the top of this report. At 401 new lows to 123 new highs I'd say something smells in the state of Denmark. I'm seeing bearish charts and evidence of distribution, like these new lows tell me, and that's when I become more cautious about the upside. I think today was manipulated higher and while tomorrow, being just a summer Friday, may not give us much, I'd be careful about the fake pass here. The bears just might intercept the ball.

This doesn't mean I'm turning super bearish about the market. I'm leaning towards the consolidation-into-the-fall scenario which is what I've boiled my two weekly SPX chart scenarios into. The longer we consolidate between the June low and August high the more bearish it will become. It's possible we've seen the high for the correction to the May-June decline and now we'll start a new leg down to new lows. But at this point I'm not ready to declare that's what we have. For now I'm thinking a drop lower to be followed by another choppy bounce into September and then another leg down. This is the combined scenario of the two that I was following for a couple of months:

SPX chart, Weekly, More Immediately Bearish

The type of pattern that we've had since the June low leads me to believe we'll continue to hang around the bottom of the ascending wedge pattern that we've been in since January 2004. If true we should get a leg down and then back up before we head for new lows.

That's why I think selling credit spreads or fast trading (trading small and taking profits early) will be the way to go for another month at least). Don't let this market take your money away from you. That's rule #1. You know what rule #2 is--see rule #1. Trade carefully and I'll see you here next week or on the Monitor tomorrow. Good luck.

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


Put Updates

Apple Computer - AAPL - close: 64.07 chg: +0.48 stop: 70.01

Shares of AAPL spent most of the session trading sideways. Bulls bought the dip near its simple 100-dma but the bounce stalled under the $65 level. We remain bearish but shares could still bounce toward the 10-dma and 200-dma still overhead. Our short-term target is the $60.50-60.00 range. The top of the July gap near $59.70 could act as support.

Picked on August 08 at $ 64.78
Change since picked: - 0.71
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 28 million


Autozone Inc. - AZO - close: 88.27 chg: +1.95 stop: 90.05

AZO produced a pretty sharp bullish reversal today. Shares closed with a 2.2% gain although we note that volume remains very low on the move. Unfortunately, we cannot find any specific news to account for the strength in AZO. The only news we did find was an earnings report from rival AAP, who beat estimates by a penny and then issued an earnings warning for the third quarter. Yet shares of AAP, rival ORLY and AZO all rallied strongly on the session. We are not suggesting new puts in AZO at the moment and more conservative traders may want to consider exiting the play immediately since today's rebound in AZO produced a bullish engulfing candlestick pattern. We're expecting AZO to bounce towards resistance near $90.00.

Picked on August 08 at $ 87.73
Change since picked: + 0.54
Earnings Date 09/21/06 (unconfirmed)
Average Daily Volume = 700 thousand


Boeing - BA - close: 76.20 change: -0.96 stop: 80.85

Our new put play in BA has been opened. The stock broke down under support at the $76.00 level and hit our trigger to buy puts at $75.75. The move was sparked by initial weakness on the terror-plot news coming from the U.K. followed by non-related headlines of BA still facing a government review of its cargo-plane contract fiasco that began back in 2000. Shares of BA did bounce from round-number support at $75.00 and more conservative traders, as we mentioned earlier, may want to wait for a breakdown under $75.00 before initiating positions. Currently shares look poised for a bounce towards their 10-dma near $78. Our target is the $70.50-70.00 range. Today's decline did produce another P&F chart sell signal.

Picked on August 10 at $ 75.75
Change since picked: + 0.45
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 4.2 million


Burlington Nor.SantaFe - BNI - cls: 65.55 chg: -0.22 stop: 72.05

Shares of BNI spent the session trading sideways in a narrow channel in spite of a bounce in the transports. The rebound in transports was probably fueled by a 3% sell-off in crude oil futures today. We do note that volume on BNI's session was high. We remain bearish but traders might want to wait for a bounce and failed rally near its 10-dma before considering new positions. Our target is the bottom edge of the current channel in the $62.50-60.00 range.

Picked on August 08 at $ 68.06
Change since picked: - 2.51
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 2.7 million


Chipotle Mex Grill - CMG - close: 48.67 chg: -1.61 stop: 54.01

Honestly, we were expecting more of a bounce in shares of CMG today after Brinker (EAT) reported a better than expected earnings report before the opening bell this morning. Instead shares of CMG continued to sell-off. The stock dipped to $47.37 before paring its losses to close with a 3.2% decline on heavy volume. Everything continues to look bearish but some traders may want to try and time an entry on an oversold bounce next. Our target is the $45.50-45.00 range.

Picked on August 09 at $ 50.28
Change since picked: - 1.61
Earnings Date 10/30/06 (unconfirmed)
Average Daily Volume = 414 thousand


Cummins Inc. - CMI - close: 118.12 chg: +1.12 stop: 123.51

CMI managed a bounce from the $116 level today. Short-term technicals are still bearish but readers could watch for a bounce and failed rally near $120 as a new entry point for puts. Our target is the $112.75 mark but some traders may want to exit near the 50-dma, currently near $113.30.

Picked on August 08 at $119.77
Change since picked: - 1.65
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 1.2 million


Fastenal - FAST - close: 35.68 chg: +0.48 stop: 37.75

Our new play in FAST has been opened but we're urging traders enter cautiously. The stock broke down under the $35.00 level and hit our trigger to buy puts at $34.90 on an intraday basis but some afternoon buying put FAST back into the green. A failed rally near $36.00 or $36.26 could be used as a new entry point but we'd prefer to wait for another decline under $35 before considering new positions. If triggered our target is the $30.75-30.00 range.

Picked on August 10 at $ 34.90
Change since picked: + 0.78
Earnings Date 10/11/06 (unconfirmed)
Average Daily Volume = 1.2 million


Hartford Fincl - HIG - close: 80.58 chg: +0.72 stop: 82.01

A big bounce in Dow-component AIG helped fuel a bit of an oversold bounce in HIG. Shares of HIG did hit an intraday low of $79.55 but our trigger to buy puts is at $79.20, which is under the March low. More conservative traders may want to wait for a drop under $79.00 before initiating positions. Our short-term target is going to be the $75.25-75.00 range. More aggressive traders may want to aim for the $72.50-70.00 range.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 1.5 million


Intuitive Surgical - ISRG - cls: 95.42 chg: -0.43 stop: 101.55

ISRG was weak the first half of Thursday's session and the stock dipped to $92.27 before an afternoon rebound reduced most of its losses. Our trigger to buy puts was at $94.90 so the play is now open. We want to remind readers that this is an aggressive, higher-risk play because shares of ISRG can be so volatile. Today's session, with its intraday bounce, does look like a short-term bullish reversal. Watch to see if the simple 10-dma (near 97.40) acts as overhead resistance before considering new plays. Our target is the $87.75-87.50 range.

Picked on August 10 at $ 94.90
Change since picked: + 0.52
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 1.1 million


US Airways - LCC - close: 40.52 chg: -0.26 stop: 45.26

Airlines were initially weak on the news that U.K. officials had arrested 21 in a massive terror plot to blow up U.S.-bound flights. Yet by the end of the day the XAL index recovered to post a 1.3% gain. Shares of LCC were not quite so strong and shares closed with a minor loss but held on to round-number support at the $40 level. We're not suggesting new put plays at this time. The stock has already hit our conservative target at $40.25 and we're now aiming for our aggressive target at $36.00. FYI: After the closing bell S&P downgraded their view on the airline sector.

Picked on August 01 at $ 43.54
Change since picked: - 3.02
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 1.6 million


NII Holdings - NIHD - close: 49.58 chg: +0.09 stop: 52.51

NIHD is still not seeing any movement. The stock looks bearish with the breakdown under its 200-dma(s) and the $50 level but it's just not seeing any follow through lower yet. We do expect some sort of bounce near $47.50 but our target is the $45.50-45.00 range since $45.00 looks like stronger support.

Picked on August 07 at $ 49.90
Change since picked: - 0.38
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 2.2 million


Transocean Inc. - RIG - cls: 66.25 chg: -0.78 stop: 72.25*new*

RIG can't seem to stop the bleeding. The stock posted another decline in spite of a broker upgrade this morning. Of course it didn't help that crude oil futures lost 3% today. The stock is so oversold we're expecting a bounce from the $65.00 level. We do suggest that readers take profits (some or all) at our conservative target. 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. FYI: We're lowering the stop loss to the 10-dma near $72.25.

Picked on August 07 at $ 69.49
Change since picked: - 3.24
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 6.4 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.)


Bausch Lomb - BOL - close: 45.03 change: -0.32 stop: n/a

There are no new changes from our previous updates on BOL. We're not suggesting new positions. We have less than 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).

Picked on July 23 at $ 47.40
Change since picked: - 2.37
Earnings Date 00/00/06 (unconfirmed)
Average Daily Volume = 2.2 million


3M Co. - MMM - close: 68.41 change: +0.11 stop: n/a

We do not see any changes from our previous updates on MMM. We're not suggesting new positions. 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).

Picked on July 23 at $ 70.72
Change since picked: - 2.42
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 3.7 million

Dropped Calls

Petroleo.Brasiliero - PBR - cls: 94.94 chg: +0.32 stop: 89.49

PBR displayed some relative strength with a late day bounce in spite of a 3% sell-off in crude oil futures today. The rebound from the $93 level looks like a new entry point to buy calls but we're closing the play. The only earnings date we can find for PBR is August 11th so we're closing the play early to avoid holding over any announcement.

Picked on July 30 at $ 92.72
Change since picked: + 2.22
Earnings Date 08/11/06 (unconfirmed)
Average Daily Volume = 3.4 million

Dropped Puts


Dropped Strangles



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