Option Investor

Daily Newsletter, Tuesday, 08/22/2006

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Table of Contents

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

Market Wrap

Sleepwalking As August Fades

Low volume and even lower volatility are proof that investors are trying to cram more days into summer rather than more shares into their portfolio. The indexes sleepwalked through their second day of the week with the only market moving event some comments from Fed officials. The dog days of August are not known for bullishness but with the indexes still pinned at multi month highs the bulls to deserve some credit for keeping the bears at bay.

VIX Chart - Daily

Dow Chart - Daily

Nasdaq Chart - Daily

There were no economic reports on Monday and only one of note today. The Richmond Fed Manufacturing Survey for August fell to 3.0 from 12.0 in July. The survey had posted levels of only 4.0 in June and 1.0 in May but the July reading spiked to 12 suggesting conditions were reversing to the upside in the fifth district. Today's report suggests the July number was an anomaly due to some glitch in the survey process. The major internal components showed a significant decline in all categories. The six-month outlook has fallen from a high of 71 in February to only 5 in August. Shipments dropped into negative territory for the first time since January and the order backlog completed its 10th consecutive month in negative territory. The shipment component took the sharpest drop with a -21 point decline from July.

This report was mostly ignored with investors focusing on Iran and comments from a couple of Fed heads for market direction. The Fed heads making waves were Atlanta Fed President, Jack Guynn and Chicago Fed president Michael Moskow. After 40 years with the Fed, Guynn warned his FOMC colleagues "the consequences of high inflation were and remain economically poisonous." Guynn is leaving the Fed when he retires on Oct 1st and was a voting member on the FOMC. He also said we know from experience "a bit of inflation can get out of hand quickly, especially when consumers and businesses expecting more price increases, waste time and money trying to beat inflation and then rush to spend more money in a vicious inflationary cycle."

Michael Moskow was more direct saying, "This months pause to the Fed's string of interest rate hikes was constructive but more rate increases could still be needed to cut inflation." Also, "The risk of inflation remaining too high is greater than the risk of growth being to low. Thus some additional firming of policy may yet be necessary to bring inflation back into the comfort zone within a reasonable period of time." He also urged the FOMC not to wait too long to see how the lag between hikes and their impact on the economy is taking shape. "We need to balance the benefits of gaining new information against the costs of waiting too long. If inflation stays stubbornly high while we wait to see the effects of earlier policy actions, inflation expectations could increase and that would be very costly."


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The Guynn comments only made the markets uneasy since it was seen as his last public speech before retirement and "legacy" coverage of multiple points. Unfortunately the Moskow comments rocked the markets at 1:PM on fears that maybe the Fed is not really done. The multiple Fed is done rallies got us to this level and worries that they could come back to the market with another hike in September sent the indexes to the lows of the day. Those fears were short lived and the markets recovered to minor gains by days end. The Fed funds futures rose to only a 15% chance of a quarter point hike in September from their low of a 10% chance on Monday. This is as close as you can get to a lock on another Fed pass on Sept-20th. However, we have an entire month of economic reports to digest before that meeting.

The Iran problem blossomed this week and returned to the forefront on the news desks. On Monday Iran's Aytollah Ali Khamenei said the Islamic Republic "had made its own decision in the nuclear path and God willing, with patience and power, will continue its path." This sent oil prices higher as fears began to grow of a confrontation with Iran. On Tuesday Iran's top negotiator Ali Larijani said Iran had replied to the prior offering from the UN's P5+1 group with a new formula to resolve the issues through dialog. In other words, Iran is stalling again and betting on China and Russia to keep the UN on hold while they continue processing uranium. The written response to the UN demands was phrased as an offer to open "serious dialog" on the issue. Since it took them two months to respond to the UN proposal any serious dialog could take years. The US has said firmly that will not happen. Bolton has said they are ready to pursue sanctions if Iran has not accepted the prior proposal by August 31st. Since Russia and China both have veto power against any sanctions and both are friendly to Iran there is very little in the way of hard sanctions immediately ahead. Analysts think there could be some seizing of money and prohibition of travel by Iranian officials but nothing earth shaking in the near future. Iran moved all its large sums of money out of harms way several months ago so that is not really a risk for them.

The risk from them is clearly apparent. They made a big show of firing missiles on Monday to test their defensive capability. It was obviously a clear show of strength in case anybody was thinking of military action. Also on Tuesday Iranian gunboats attacked and seized an oil rig belonging to Romanian Grup Servicii Petroliere. The rig was under contract to drill for a unit of Iran's state oil company. Reportedly there was a contract dispute involving failure to pay by Iran but the event was clearly a warning for everyone that the Persian Gulf and the Strait of Hormuz could become a dangerous place for oil tankers and oil rigs if Iran was pressed about the nuclear issue. This problem is going to take a long time to come to a head but current odds makers are betting there is a 50:50 chance the US will bomb Iran before the end of Bush's term. Any attempt to block Hormuz would guarantee that result. 50% of the world's oil exports travel through that strait and Iran has numerous missile batteries covering it. One shot is all it would take to halt oil and bring the US bombs down on Iran.

Strait of Hormuz

Venezuela was also in the news on the oil front. Chavez is trying very hard to join the bad boys club of anti American leaders. Chavez was in China signing an agreement to sell up to 200,000 bpd of oil to China. China will spend $1.2 billion to build 20,000 homes in Venezuela as well as additional investment in Venezuela's Orinco oil belt. Chavez said he would buy 12 Chinese drilling rigs and agree to assemble 12 more at a new jointly owned facility to be constructed in Venezuela. Chavez is on his world victory tour visiting Cuba and Castro in his hospital room, Iran and its president, China and of course Russia to discuss future arms deals. The only country he did not add to his itinerary was North Korea. However, his vice president Jose Rangel said VZ would be willing to sell fuel to energy starved North Korea despite the sanctions surrounding their nuclear program. VZ supported the NK missile tests in July saying the country had every right to conduct the tests. Rangel said Chavez plans to visit NK eventually to discuss oil supplies and technological exchanges. Chavez has proclaimed himself as defender of weaker nations against US hegemony around the world. Seems to me Chavez is trying to make a name for himself in order to join the bad boys club. Reminds me of those perennial followers in school that always hung around the groups of bullies in hopes of improving their stature. Chavez got a big boost to his personal stature in late July when Iran awarded him its highest state medal, the Islamic Republic Medal, for supporting Iran in its nuclear standoff. Chavez used the opportunity to urge the world to rise up and defeat the United States.

Oil prices rose from their dip under $70 last week as the September contract expired and October contract became current. The Iran issue helped keep a floor under the gains. Also helping prices was tropical depression four in the Atlantic. The tropical wave was located 875 miles east of the windward islands, far away from the oil patch and moving at 20 mph. The NOAA does not expect it to turn into a named storm before Thursday at the earliest. Even if it did turn into a storm it is not tracking anywhere near the gulf and would more than likely hit farther up the east coast north of Bermuda. As you can see by the chart below the track for storm four is nowhere near the oilfields. Still oil and gas prices rose as we near the peak of the season. The image below shows the frequency of storms by date with the week after Labor Day the most likely timing for a hurricane. Considering the horrendous forecasts for another near record storm season we are nearly half done with no material storms. Makes you wonder what may lie ahead.

Chart Track for Tropical Depression Four

100-Year Chart of Storm Patterns by Date

Storm Frequency Patterns 1944-2002

In stock news it was mostly tech stocks that fought for attention while rate fears weighed on the industrials. AMD jumped +6.3%, +$1.48, after Bear Stearns upgraded the company to outperform. Bear Stearns expects the AMD market share to rise to 23.7% in 2006 and 25.8% in 2007 now that Dell has agreed to sell models based on AMD chips. Other analysts expect the AMD share to exceed 30% in 2007 on rising profits. AMD is slowly climbing out of the low margin entry-level PC market with its faster top end and server chips.

EBAY gained +.68 cents to a new six week high after the auctioneer raised fees for Ebay stores. This attracted a lot of angry comments from sellers but did not help EBAY stock that much. Ebay is already down substantially and there are fears that Google will eventually launch an auction site now that it has its own version of PayPal.

XM Satellite Radio also rose on an upgrade from Bear Stearns to outperform jumping +20% or +$2.28. The company has resolved the FM transmitter issue and Bear Stearns feels the company will not miss the end of year sales cycle. Bear felt XM had more options than Sirius and the end of year XM subscriber goal of 8 million is more than attainable.

Electronic Arts released the Madden NFL 07 video football game in Madden Mississippi by giving every household in the town an XBOX and the new game. ERTS is expected to sell 7 million of the games. Over 51 million copies of prior versions have been sold. ERTS only gained +.69 cents but the stock has been moving up steadily over the last six weeks in anticipation of the event.

RIMM got some attention after the close with one analyst saying RIMM should be trading at the same market valuation as Apple now that the patent battle is over. RIMM has new products in the wings and a strong fan base with subscribers as avid about their crackberry as Ipod users are about their music. Apple has a rising competitor base and the Ipod is supposedly fully priced into the stock. A equalization of value would add another $50 to RIMM's stock price according to that analyst.

Toll Brothers (TOL) reported earnings that beat the lowered street estimates and released guidance that analysts though was overly optimistic. Toll only gained +.43 cents after comments that housing may not have bottomed and it could take a couple years before growth reappeared. Toll cut back its land holdings to 82,900 acres from 91,200 in May. Toll still expects to sell about 7500 homes for an average price of $640,000. On August 9th Toll said its cancellation rate in its hottest markets was about 18% and they saw no change as of today.

The markets retested their recent highs once again at the open with the Dow hitting 11383 before heading south on the Moskow comments. Dow 11310 has been support and 11380 resistance. The Dow has tested those limits for four consecutive days. The next support level should sellers return would be around 11000.

The Nasdaq has posted two consecutive lower highs at 2165 and 2160 but I would be grasping at straws if I said that was relative after the strongest week in years last week. We are consolidating above support at 2140. I believe the Nasdaq is doing remarkably well considering the profit taking in the SOX. The SOX hit 450 on Thursday and has been consolidating slowly lower.

S&P-500 Chart - 15 min

The S&P-500 has been locked in a very tight range with 1295 as support and 1302 as resistance. Selling resistance and buying support would have been a good intraday plan for the last three days. We are using that 1295 level on the S&P as our market indicator. As long as the S&P holds over that level we want to maintain a bullish bias. Should that level crack we could easily see a sharp drop as bears jump on the bus.

The economic calendar resumes on Wednesday with a two-day surge of economic reports led by two different housing numbers and the Chicago Fed National Activity Index. The housing numbers are the key. The bad news bulls will want to see continued weakness but not enough weakness to suggest a weaker economy. I doubt there will be any material upside surprise in the numbers or Toll Brothers would have reported it. A sudden burst of strength in the housing sector could drag the Fed back off the sidelines. Oil and Gas inventories are expected to show a drop but with summer almost over it should be ignored unless there is a massive imbalance.

Internals Table

For the rest of the week I would expect volume to remain light and as you can see from the table above we only traded 3.8B shares today. If anything we should see even lighter volume between now and Labor Day. I would continue to use watch Dow support at 11310, Nasdaq 2140 and use SPX 1295 as your long/short indicator. We are experiencing a summer with no hurricanes where many were predicted. Likewise we are experiencing a market rally in a calendar period where none should exist. Cautious traders should be keeping a close watch on the news because in times like these one seemingly insignificant event can turn the markets on a dime. Remain bullish over 1295 but don't hesitate to switch sides if that level breaks.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays

New Calls

Cameco - CCJ - close: 40.33 change: +0.11 stop: 37.95

Company Description:
Cameco, with its head office in Saskatoon, Saskatchewan, is the world's largest uranium producer. The company's uranium products are used to generate electricity in nuclear energy plants around the world, providing one of the cleanest sources of energy available today. (source: company press release or website)

Why We Like It:
There are multiple reasons why we like CCJ as a bullish candidate. The company is a huge player in the uranium mining market. As oil continues to rise the world's interest in alternative energy sources like nuclear-powered electricity plants rises too. Long-term demand for oil will out strip supply and that makes CCJ a tempting long-term play. Short-term the upcoming U.N. showdown with Iran and the August 31st deadline could send oil higher. CCJ also produces gold and the same geo-political concerns will likely keep gold in demand. The chart also has various bullish signals. Yesterday's rally past the $40 level was a bullish breakout over its trendline of resistance. The recent bounce was a bounce from longer-term support on the weekly chart. The P&F chart is bullish and points to a $55 target. We are suggesting call options with CCJ above the $40 mark. Our time frame is four to six weeks and our target is the $44.50-45.00 range.

Suggested Options:
We are suggesting the October calls.

BUY CALL OCT 35.00 CCJ-JG open interest= 26 current ask $6.30
BUY CALL OCT 40.00 CCJ-JH open interest=475 current ask $2.85
BUY CALL OCT 45.00 CCJ-JI open interest=454 current ask $0.95

Picked on August 22 at $ 40.33
Change since picked: + 0.00
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 1.9 million


Freeport McMoran - FCX - close: 56.90 chg: -0.25 stop: 52.95

Company Description:
FCX explores for, develops, mines and processes ore containing copper, gold and silver in Indonesia, and smelts and refines copper concentrates in Spain and Indonesia. (source: company press release or website)

Why We Like It:
Shares of FCX, a miner of copper, gold and silver, look poised to breakout higher. The stock has already seen a strong week with a bullish breakout on Monday past its short-term trendline of lower highs and technical resistance at its simple 200-dma. Aggressive traders may just want to consider call positions here. We want to see a little more confirmation and a breakout past its simple 100-dma, which has been resistance in the past. We're suggesting a trigger to buy calls at $57.51. Currently the Point & Figure chart points to a $76 target. If triggered our target will be the $62.50-63.00 range since the bottom of the May gap down near $63.00 could be resistance. Traders should also note that we do expect some short-term resistance near $60.00 and a retest of the 100-dma, once broken as resistance, should act as support.

Suggested Options:
We are suggesting the October calls.

BUY CALL OCT 55.00 FCX-JK open interest= 41 current ask $4.50
BUY CALL OCT 60.00 FCX-JL open interest=1173 current ask $2.20

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/17/06 (unconfirmed)
Average Daily Volume = 5.1 million


United Ind. - UIC - close: 51.27 change: +1.71 stop: 47.49

Company Description:
United Industrial Corporation designs, produces, and supports defense systems. Its products and services include unmanned aerial vehicle systems, training and simulation systems, automated aircraft test and maintenance equipment, armament systems, logistical and engineering services, and other leading-edge technology solutions for defense needs. The company also manufactures combustion equipment for business and refuse fuels. (source: company press release or website)

Why We Like It:
Today's 3.4% rally in shares of UIC is a significant bullish breakout over resistance at the $50.00 level. The move follows yesterday's bullish breakout over technical resistance at its 200-dma. The stock has been pretty strong the last several days and we suspect that UIC could be ready for a dip, especially with the simple 100-dma directly overhead near $52. We are suggesting that traders wait for a dip into the $50.25-50.00 region and we're going to suggest a trigger at $50.25 to open plays. However, more nimble traders might want to wait and watch since UIC may dip as low as $49.00-49.25 near its 200-dma. If triggered our target is the $54.75-55.00 range. More aggressive traders might want to aim higher. The bullish P&F chart points to a $64 target.

Suggested Options:
We are suggesting the October calls.

BUY CALL OCT 45.00 UIC-JI open interest= 5 current ask $8.30
BUY CALL OCT 50.00 UIC-JJ open interest= 1 current ask $4.50
BUY CALL OCT 55.00 UIC-JK open interest= 3 current ask $2.35

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 198 thousand


VF Corp. - VFC - close: 70.03 change: +0.86 stop: 68.45

Company Description:
VF Corporation is a leader in branded apparel including jeanswear, outdoor products, intimate apparel, image apparel and sportswear. Its principal brands include Lee, Wrangler, Riders, Rustler, Vanity Fair, Vassarette, Bestform, Lily of France, Nautica, John Varvatos, JanSport, Eastpak, The North Face, Vans, Reef, Napapijri, Kipling, Lee Sport and Red Kap. (source: company press release or website)

Why We Like It:
We're adding VFC as new relative strength play. The stock has been able to maintain its bullish trend higher over the past few months and now its recent trading range has narrowed. VFC's consolidation over the past few days looks ready to breakout to new highs. The P&F chart is already bullish with a $99 target and a move over $71.00 would produce a new triple-top breakout buy signal. We want to catch a breakout over resistance at $70.00. We are suggesting a trigger to buy calls at $70.25. If triggered we're targeting a short-term rally into the $74.00-75.00 range. More aggressive traders may want to aim higher.

Suggested Options:
We're suggesting the October calls.

BUY CALL OCT 65.00 VFC-JM open interest= 0 current ask $6.40
BUY CALL OCT 70.00 VFC-JN open interest= 0 current ask $3.10
BUY CALL OCT 75.00 VFC-JO open interest= 0 current ask $1.20

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 567 thousand

New Puts

Johnson Controls - JCI - close: 72.96 chg: -0.39 stop: 76.51

Company Description:
Johnson Controls is a global leader in interior experience, building efficiency and power solutions. The company provides innovative automotive interiors that help make driving more comfortable, safe and enjoyable. For buildings, it offers products and services that optimize energy use and improve comfort and security. Johnson Controls also provides batteries for automobiles and hybrid electric vehicles, along with systems engineering and service expertise. Johnson Controls has 136,000 employees in more than 1,000 locations serving customers in 125 countries. (source: company press release or website)

Why We Like It:
JCI looks poised to hit new relative lows. The stock had already produced a bearish head-and-shoulders top over the summer but eventually saw shares break below the neckline as investors reacted to the company's earnings report (around July 20th). The oversold bounce never made it very far and the recent rally last week failed under its 50-dma. Technicals have turned bearish and the P&F chart has produced a triple-bottom breakdown sell signal. Currently the P&F target is at $67 but that number could fall further. We are suggesting puts with JCI under $74.00. Our target is the $68.50-67.50 range.

Suggested Options:
We are suggesting the October puts.

BUY PUT OCT 75.00 JCI-VO open interest=480 current ask $4.30
BUY PUT OCT 70.00 JCI-VN open interest=305 current ask $2.00

Picked on August 22 at $ 72.96
Change since picked: + 0.00
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 1.3 million

New Strangles

None today.


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