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Daily Newsletter, Saturday, 11/04/2006

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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

Never A Dull Moment

It seems like the Halloween spirits lingered all week and tried to think of things to complicate the markets for traders. Economics are all over the map and expectations for future rate cuts/hikes change dramatically almost daily. The confusion has caused the Dow to lose traction with Friday's loss the 6th consecutive day of losses. Earnings have been great but recent guidance has been less than exciting. What is a trader to do?

Dow Chart - 60 min

Nasdaq Chart - 180 min

Friday morning started off with yet another economic shock. The jobs report for October showed a gain of +92,000 jobs and well below the consensus estimate of +133,000. By itself that would have been market neutral but there was a significant revision to the prior two months. August was revised up from +188,000 to +230,000 or +42,000 jobs. September was revised up from +51,000 to +148,000 or a gain of +97,000 jobs. The total revision for both months was a whopping +139,000 jobs or the equivalent of an entire month of additional jobs. You may remember just a month ago we saw a monster benchmark revision of +880,000 jobs covering the past year ending in March. That means the Bureau of Labor Statistics missed their estimates by more than a million jobs over the last year. Friday's revision only four days before the election brought sharp criticism from many sources that it was electioneering. Commerce Secretary, Carlos Gutierrez, was grilled on CNBC as to why they could not count correctly and he did not have a satisfactory answer. Bonds took a sharp drop as the interview progressed.

The markets sprinted higher on the jobs news thinking the economy was stronger than expected but then imploded once the bond market began to factor in the Fed impact. The +139,000 revision was a game changer for the Fed. The unemployment rate fell to 4.4% and a five-year low while wages rose at a +4% annual rate. The bond market imploded and ten-year note yields jumped to 4.71% almost instantly. We were talking about the rising chances for a rate cut in the March/May time frame as late as Thursday. Now some analysts feel we are facing another rate hike as early as March. The Fed was fading and are now likely to come back with a vengeance. It was not just the employment report but there was also a gain of +437,000 jobs in the Household survey. With jobs surging so strongly it appears the economy is far from last week's crash landing scenario or even the prior week's soft landing and is possibly headed for no landing at all. Confused? Join the crowd. The current pace of job creation is actually the rate for an economy growing at full potential. The October economic reports had all shown slowing growth but the jobs show increasing activity. That suggests the October economics were just a blip rather than the beginning of a dive. One side of this scenario is wrong but we won't know which until December. We need another full month of economics and the November jobs report to see which indicator is right.

To further complicate the picture the ISM Non-Manufacturing Index jumped sharply to 57.1 from 52.9 and well over the consensus estimate of 54.8. The service sector appears to be growing sharply while the regular ISM reported on Wednesday showed a drop in manufacturing activity to 51.2% and well under consensus for a gain to 53.1. Economists are running in circles trying to decide exactly what is happening. The key here will be the Fed and their next meeting is not until Dec-13th. There will be plenty of economic data between now and then and the outlook for rates is sure to change over and over again if the current weekly reversals continue. If we start to see some stronger economic reports from the various Fed regions you can bet the outlook for the Fed will turn even more hawkish. Personally I would rather have an economy running at +5% and higher rates ahead. It is a lot more pleasant than facing a recession as many were predicting last week. Earlier in the week Fed funds futures had reached a 56% chance of a rate cut in March. That fell to 16% by Thursday and only a 2% chance by Friday's close. Analysts are now saying any further bullish news would push the Fed right back into hike mode. Anthony Chan with JP Morgan does not expect a cut now until Q4-2007 and said this would continue to push the housing sector lower.

10-Year Note Yield Chart - 30 min

Wal-Mart fired a third salvo at the retail sector with news they were lowering prices on nearly 100 electronic items well in advance of the holiday season. Wal-Mart already cut prices on 100 top selling toys and is in the process of cutting prices on more than 200 generic drugs to $4 each. Wal-Mart issued a statement saying they were reinforcing their price leadership position in areas of toys and electronics. They claim they are already seeing a significant lift in volume from the toy cut several weeks ago. It appears they need to cut some more after they warned that October sales at +0.5% were lower than expected. Regardless, Best Buy and Circuit City both lost ground on Friday as investors priced in lower sales and lower margins. Prices cuts from Wal-Mart included things like a Panasonic 42-inch HD Plasma TV slashed to $1,294 from $1,794. LCD HDTVs were cut from $1,297 to $997. Another -50% cut or so and I could actually justify buying a couple.

Whole Foods Market (WFMI) got a -23% haircut to $46 after warning that sales are likely to suffer from increased competition. This was in addition to a -$4 drop before earnings on Thursday. WFMI said sales would likely drop to +6% to +8% in 2007. That is down from +13.6% in 2006. Maybe they should not build stores only 2 miles apart. Looks like they are competing with themselves as well as the other grocers.

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Electronic Arts (ERTS) jumped +12% after reporting strong earnings on a sharp jump in revenue to $784 million from $657 million in the comparison quarter. ERTS posted earnings of +21 cents per share compared to analyst's estimates for only +2 cents. They also raised guidance for the full year ending in March 2007 to just over $3 billion. Jeetil Patel, an analyst with Deutsche Bank, agreed that the quarter is "impressive" but noted there are "bearish themes" looming and reiterated his sell rating. He feels the Madden 07 and NCAA 07 games will run their course and increased competition from other games targeted for the PS2 transition will reduce market share. He feels the PS2/PS3 transition will be three times bigger than the Xbox transition. Patel is not alone in his view but he is definitely in the minority. Several other brokers are expecting further sharp jumps in revenue for 2007. ERTS has strong resistance from $60-$62 so further gains could be difficult without some profit taking to build a base at this level.

Caterpillar (CAT) gave an investor presentation on Friday and while they still expect weakness in the housing sector in 2007 they are raising estimates slightly for 2007. This came just a couple weeks after they shocked the market with a warning for the same period. They also said demand for heavy duty engines would fall by -45% and -25% for mid-range engines due to the new emission standards for 2007. They claim dealers have stockpiled the old engines to avoid the higher prices and 2007 rules. CAT said they expected revenue to grow to $50 billion by 2010 compared to estimates of $41 billion in 2006 and $43 billion in 2007. First Call was targeting $39.41B and $41.23B for those respective periods. Unfortunately investors were not listening to the stronger forecast or possibly not believing it and CAT closed fractionally lower.

Dell was upgraded by Goldman Sachs to neutral from sell on Thursday and ramped to $25. It was unable to hold that level and fell on estimates of low PC sales for the holidays. Intel was downgraded to neutral by Merrill and upgraded to a buy by Bank America. Intel lost ground on Friday as it detailed its plans to cut 6,900 employees over the next six months. Research firm Current Analysis, which tracks weekly PC sales, estimates consumers will hold off buying high-end PCs until after Vista is released. I have discussed that in these pages at length over the last several weeks. Current Analysis said prices on PCs are dropping sharply and predicted 70% of notebooks sold this holiday season would be under $1000 compared to 58% in 2005 and 38% in 2004. They feel only the low end, low margin computers will sell this season with high end computers being delayed until late Q1. That could pressure profits from Dell, HPQ and chip companies feeding the PC supply chain. The number two contract laptop maker, Compal Electronics, said component shortages especially batteries would limit output. Dell is offering free Vista upgrades but analysts claim there are few takers. The PC news pressured the computer stocks with losses across the board.

Red Robin (RRGB) lost -$12 or -26%, to $34 after posting profits that were lower than expected and slashed its guidance. LeapFrog (LF) fell -16% after posting disappointing earnings and taking the unusual tactic of blaming "management decision making" for the decline. CSC fell -7% after missing estimates and delaying a filing until it reviews its stock option practices.

Berkshire Hathaway posted earnings of $1,797 per share or $2.77 billion, more than quadrupling the $381 per share earned in Q3 last year. BRK.a shares closed at $105,010 per share on Friday. Revenue rose +24% to $25.36 billion. While Berkshire is not in the S&P the earnings for Q3 are shaping up to be spectacular. With 394 of the S&P 500 already reported the earnings are coming in at +18% and exceeding Thomson First Call estimates by +6.4%. 74% have beat the estimates, 10% reported inline and 16% missed the estimates. Tech profits were up a meager +9% with financials leading the charge with a +34% gain. Another weak sector was consumer discretionary with only +10% growth. According to Zachs Investment Research this is the closest to a sure bet you can find that 2007 will not see a recession. Recessions don't occur when companies are beating estimates so handily. Zachs expects earnings of +12.7% in 2007.

Oil ticked higher on Friday lifted for various reasons. There was a bomb scare at the 400,000 bpd BP refinery in Whiting Indiana. Personnel were pulled out of non-critical areas but nothing ever happened. The US Embassy in Nigeria warned that there was an imminent danger of 10-20 coordinated bombings against land based oil targets over the next several days. Nigeria is the 5th largest OPEC exporter and the 6th largest importer into the US. Their oil is the light sweet crude in high demand for gasoline. Iran also ratcheted up tensions after firing dozens of missiles including three new antiship missiles and missiles with a range of more than 1200 miles. This was part of a military exercise warning the US that any Persian Gulf pressure by the US would be met with strong force. Admiral Sardar Fadavi of the Iranian Revolutionary Guards warned the US saying, "Our enemies should keep their hostility out of the Persian Gulf. They should not initiate any move that would make the region tense." The US had just completed joint exercises with other Gulf nations that ended on Monday. Both countries are posturing for an eventual conflict. Maybe Iran does not realize that every missile firing give the US even more data as to capabilities, guidance, jamming, range and technical specifications of Iran's new missiles. That will make it easier to defend against them when the conflict finally arrives. Condoleezza Rice said "the Iranians are trying to demonstrate they are tough. They are trying to say to the world, you are not going to keep us from getting a nuclear weapon. The world has to say to them, yes we will." Iran expert Andrew Hess said Iran was also sending a message to other countries in the area to avoid taking sides with the US. The UN Security Council is expected to produce a new draft of sanctions against Iran next week. Russia has finally caved in and said they would support stronger measures next week but it remains to be seen just how much stronger.

The much stronger than expected jobs numbers, +668,000 including revisions and household employment, also convinced traders that there would be no slacking of oil demand from a soft landing economy. Oil prices rallied +1.26 but only closed at $59.15 after a week of testing new lows. $58 remains support and after a successful test this week I think we may have seen a bottom. Oil stocks continue to rise despite the declines in oil indicating investors are continuing to buy the dips.

December Crude Oil Chart - Daily

December Gold Chart - Daily

Gold prices broke over $615 this week on what analysts called both a technical and fundamental breakout. The conflicting economic numbers and fear of rising inflation from the stronger than expected jobs was given as reasons. There were also geopolitical concerns heightened by the high profile Iranian missile tests and public warnings by Iranian officials. OPEC was also seen as a buyer as the dollar continued to fall. OPEC countries typically use gold as a hedge against currency fluctuations. The United Arab Emirates actually announced they were diversifying out of dollars and into gold and other currencies. This pressured the dollar with the dollar index nearing a two month low. Since oil is priced in dollars a falling dollar causes the price of oil to rise.

Orbcomm Corp, (ORBC) a new satellite radio company, began trading their newly IPOed shares on Friday and it was positively ugly. Not since the Vonage IPO have we seen such a fiasco. The IPO priced at $11 and actually traded there for about 60 seconds before collapsing to end the day at $7.75, -$3.25 or -30% below its IPO price. On Thursday ORBC cut the size, 11.15 million shares to 9.23 million and the price from $12-$14 to $11 due to lack of demand. That should have been a strong clue to run for the exits. ORBC filed bankruptcy under its prior name of Orbcomm Global in 2000. The company was purchased by investors a year later and restructured. They have a fleet of low-orbit satellites used by the government and companies in the trucking, aviation and heavy equipment business to track mobile equipment and monitor assets in remote areas. UBS, Morgan Stanley, Banc America and Cowen and Company were the underwriters. This performance resulted in a black eye for everyone. Another satellite company named Globalstar Inc. (GSAT) also went public on Thursday at $17 per share and promptly dropped to $16.40 on Friday. Globalstar filed bankruptcy in 2002. It was originally the product of Loral Space and Qualcomm. Two years after the bankruptcy, Thermo Capital Partners LLP bought a principal stake and reorganized the company leading to the IPO last week. Globalstar owns a constellation of 40 Low Earth Orbiting (LEO) satellites that cover 80% of the globe supplying voice and data services to businesses and governments worldwide. Globalstar is using the entire proceeds from its IPO to fund the launch of a second-generation satellite system and related upgrades.

For next week there are no material economic reports. Last week was the economic building blocks, ECI, PMI, ISM, Productivity and Jobs and next week's reports are simply mortar to fill in the cracks. Last weeks reports will be cussed and discussed for weeks to come with the next material report being the PPI on the 14th. I would expect the election to be the churning factor for the week. The election trades will need to be unwound or even reversed depending on how the control of the house and senate turn out. Gridlock would be a good thing for the market and that is the current outlook. If the Democrats take control of both houses we could see some additional churning as funds modify their holdings to reflect their view of the next two years.

Economic Calendar

The Dow closed under 12000 for the first time since Oct-18th but it was only by -14 points. The Dow has fallen for six straight sessions and that has not happened since June 2005. However, since its high close at 12160 those six sessions have only accounted for -174 points or an average of -29 points per day. This is hardly a crash. The bullish internals are still intact and 11950 is decent support. Unless something new pops up we should spend Monday and Tuesday above that level. The next real support is 11800 but without a change in the internals it could be a slow decline. I believe the weeklong drift lower was simply profit taking ahead of major economics and the election next week. It was fear of the unknown rather than a strong urge to sell.

The Nasdaq is a different story. It was hammered on Wednesday by a major end of day sell program on it and the Russell-2000. It was driven below support at 2330 at the close but the dip was quickly bought the following morning. After holding over that support all day on Thursday it was hammered again by a sell program on Friday morning. That dip was again bought quickly and it closed back over 2330 but that was two days with two strong penetrations. I fear the Nasdaq may have suffered some lasting damage. Traders may want to test the next support level at 2290 before being willing to invest any large amount of money. Techs have been hit with bad news almost every day last week and there is no reason to expect that trend to change. It is a Vista lacking holiday and the Nasdaq may not be able to recover to new highs while dragging that anchor. The SOX has returned to critical support at 445 and is on life support. A break of 445 could see a strong drop. The Russell-2000, a strong supporter of any Nasdaq gains, broke critical support on Wednesday and failed to recover on Thr/Fri although it was showing signs of life. If the Nasdaq continues to slip the support from these indexes could evaporate.

The NYSE Composite ($NYA) has declined to initial support at 8700 and it also showed no inclination to bounce. The NYSE Composite is made up of 2,020 stocks with a total market cap approaching $20 trillion. Financials represent 26% of the index with oil and gas the next biggest component at 12.5%. The largest market cap company is $423 billion and the smallest is $13.2 million. Because of its breadth and diversity it is widely watched as an indicator of the health of the broader market. The Russell-2000 is watched as a leading indicator of fund investing trends and the NYSE Comp is watched as an indicator of general market health. On Friday the internals on the NYSE were still positive with 121 new highs and only 20 new lows. Decliners at 1721 beat advancers of 1448 but only barely. There was no real weakness there. The Russell-2000 internals were even better with advancers beating decliners 993 to 617 and a +2.60 positive close. Again, no real weakness in the Russell. So to recap, neither index is showing any weakness but the NYSE is not yet showing a rebound spark. I think the bulls are still alive and well and just passing time until next Wednesday.

Russell 2000 Chart - 120 min

NYSE Composite Chart - 180 min

SPX Chart - 180 min

The S&P-500 is our indicator of choice for making trading decisions. We are in short/flat mode since the S&P broke below 1373 on Wednesday. The SPX settled right on initial support at 1363 on Thursday morning and has made no material effort to rebound. The next support level is 1350. If I was just watching the S&P I would be worried at its lack of strength. Decliners were 2:1 over advancers and new highs fell to only 16 from the +60 levels we saw last week. With 394 companies already reported the majority remaining are the weaker stragglers. There is little news left to produce any earnings buzz to lift the index. That leaves us in a quandary. Do we stick with the plan and wait for a dip closer to 1350 to buy or change the plan and anticipate a rebound based on the NYSE/Russell and SPX uptrend support at 1360? I think we stick it out. The techs are still weak enough to be a drag and Cisco does not report until next Wednesday. I think we should stick with the plan and wait for something in the 1350-1355 range. I am expanding it because I think the bulls will be eager to buy the dip at the 1350 level and will probably jump in early. Since the best laid plans of mice and men usually go astray we need to have a backup plan. If we rally out of the gate on Monday I would look to go long over 1370 but only on a sustained gain. A simple opening spike could be another opportunity to get short/flat. If we do go lower and break under 1350 I would revert back to short/flat again. I believe any dip to the 1350 range will be bought and I would buy it as well but with a careful eye on the internals to watch for a breakdown. The stock TV stations are going to be completely focused on the election and little market info will make it through the election cloud. That could provide a lack of incentive to trade no incentive for the bulls to charge higher.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
CEO CAH None
GSF CTX  
HOC ICE  
PBR LEH  
RIG    
SLB    

New Calls

Editor's note: We are adding multiple bullish candidates in the oil sector. We suggest you only pick one or two that you like the most to consider as candidates for your own portfolio instead of trying to trade them all. It's not advisable to have too much exposure to one specific sector.

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CNOOC Ltd - CEO - close: 84.84 change: +0.73 stop: 82.89

Company Description:
We are a Hong Kong-incorporated public company that engages primarily in the exploration, development and production of crude oil and natural gas offshore China. We are the dominant producer of crude oil and natural gas .The Company is also one of the largest offshore crude producer in Indonesia. (source: company press release or website)

Why We Like It:
Oil and gas stocks look poised to move higher next week. We like CEO as a call option candidate because shares have been trying to breakout over resistance at the $85 level for days now and after last week's Thursday-Friday bounce the stock looks ready to succeed next week. Many of the technical indicators are positive or they are turning bullish. The P&F chart already points to a $100 target. We are suggesting a move over Friday's high to open positions. Our suggested entry point will be $85.25. If triggered our target is the $89.50-90.00 range. FYI: Another Chinese oil company with an improving chart is PTR.

Suggested Options:
We are suggesting the December calls. Our trigger to open plays is at $85.25. As with all of our plays it is you, the individual investor, who should decide which month and which strike price best suits your trading style and risk.

BUY CALL DEC 80.00 CEO-LP open interest=826 current ask $8.50
BUY CALL DEC 85.00 CEO-LQ open interest=856 current ask $4.30
BUY CALL DEC 90.00 CEO-LR open interest=717 current ask $1.05

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/31/06 (confirmed)
Average Daily Volume = 264 thousand

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GlobalSantaFe - GSF - close: 52.39 chg: +1.88 stop: 49.39

Company Description:
GlobalSantaFe is a leading provider of offshore oil and gas drilling and drilling management services. The company owns or operates a mobile fleet of marine drilling rigs that operates in major drilling regions around the world, including premium and heavy-duty, harsh-environment jackups, semisubmersibles, and dynamically positioned ultra-deepwater drillships. (source: company press release or website)

Why We Like It:
Traders bought the post-earnings dip in GSF near its 50-dma. Now the three-day pattern looks like a bullish reversal. Short-term technical indicators are turning positive and the MACD on the weekly chart recently produced a new buy signal. The P&F chart points to a $67 target. GSF is an oil services stock and the oil services sector tends to be more volatile than its oil and energy brethren. We're suggesting positions here near $52 although anywhere above $50 should suffice. We do expect some temporary resistance near $54 and again at its 200-dma near $55.00. Our target is the $57.50-58.00 range.

Suggested Options:
We are suggesting the December calls although January calls would also work well.

BUY CALL DEC 50.00 GSF-LJ open interest= 183 current ask $4.20
BUY CALL DEC 52.50 GSF-LA open interest=2066 current ask $2.70
BUY CALL DEC 55.00 GSF-LK open interest=1968 current ask $1.60

Picked on November 05 at $ 52.39
Change since picked: + 0.00
Earnings Date 11/01/06 (confirmed)
Average Daily Volume = 3.4 million

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Holly Corp. - HOC - close: 50.75 change: +1.46 stop: 46.99

Company Description:
Holly Corporation, headquartered in Dallas, Texas, is an independent petroleum refiner and marketer that produces high value light products such as gasoline, diesel fuel and jet fuel. Holly operates through its subsidiaries an 82,000 barrels per day ("bpd") refinery located in southeast New Mexico, and a 26,000 bpd refinery in Woods Cross, Utah. Holly also owns a 45% interest (including the general partner interest) in Holly Energy Partners, L.P., which through subsidiaries owns or leases approximately 1,600 miles of petroleum product pipelines in Texas, New Mexico and Oklahoma and refined product terminals in several Southwest and Rocky Mountain states. (source: company press release or website)

Why We Like It:
HOC's strong earnings report and gains in the oil sector have helped the stock breakout over resistance at the $50.00 mark and the top of its three-week trading range. Short-term and weekly technical indicators are improving or already bullish. We're suggesting calls on the breakout over $50.00. Broken resistance at $50 should now act as support so more conservative traders may want to use a tighter stop loss (maybe near $48 or $49). We're sticking our stop near the bottom of the trading range under $47. Our target is the $54.90-55.00 range.

Suggested Options:
We are suggesting the December calls.

BUY CALL DEC 45.00 HOC-LI open interest= 736 current ask $6.90
BUY CALL DEC 50.00 HOC-LJ open interest=1249 current ask $3.40
BUY CALL DEC 55.00 HOC-LK open interest= 949 current ask $1.35

Picked on November 05 at $ 50.75
Change since picked: + 0.00
Earnings Date 11/01/06 (confirmed)
Average Daily Volume = 1.1 million

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Petroleo Brasileiro - PBR - cls: 88.94 chg: +1.96 stop: 85.65

Company Description:
Petroleo Brasileiro is an integrated company that performs in oil and oil byproduct exploration, production, refining, marketing, and transportation, both in Brazil and abroad. (source: company press release or website)

Why We Like It:
PBR is another oil stock that looks prepared to move higher. Shares have been rising in a bullish channel the last few weeks and Thursday's bounce looks like a new entry point. However, since some of the technical indicators look a little overextended we want to see more confirmation of the trend. Therefore we're suggesting a trigger to buy calls at $90.05. More conservative traders may even want to wait for a new relative high over $91.40. Meanwhile if you don't want to wait more aggressive traders could open positions now or look for a dip back toward $86.50-86.00 as a potential entry point. Our target is the $95.00-96.00 range. FYI: PBR is a Brasilian stock traded as an ADR here in the U.S. One risk traders are facing is the company's earnings report. We cannot find a specific date or even a history of recent earnings reports. The risk is that they announce a negative report while we're trading them.

Suggested Options:
We are suggesting the December calls although January strikes are another choice.

BUY CALL DEC 85.00 PBR-LQ open interest=1672 current ask $6.40
BUY CALL DEC 90.00 PBR-LR open interest=1388 current ask $3.20
BUY CALL DEC 95.00 PBR-LS open interest=1105 current ask $1.35

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/06 (unconfirmed)
Average Daily Volume = 2.5 million

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Transocean - RIG - close: 75.07 change: +2.64 stop: 69.99

Company Description:
Transocean Inc. is the world's largest offshore drilling contractor with a fleet of 82 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. (source: company press release or website)

Why We Like It:
RIG is another oil service stock that's making progress. The company reported positive earnings on Thursday but the stock didn't really pop until Friday when the stock received an analyst upgrade. Volume was above average the last two days. We see the move over $75.00 as a new entry point to buy calls. However, this might be an aggressive entry point with potential resistance directly overhead at the 200-dma near $76. We're suggesting positions now with the stock over $75 but more conservative traders may want to wait for a move over $76. We're going to have two targets. Our conservative target is the $79.50 level. Our aggressive target is the $84.00 level.

Suggested Options:
We are suggesting the December calls although traders may want to consider buying January strikes.

BUY CALL DEC 70.00 RIG-LN open interest= 392 current ask $7.20
BUY CALL DEC 75.00 RIG-LO open interest=2472 current ask $4.00
BUY CALL DEC 80.00 RIG-LP open interest=1570 current ask $1.90

Picked on November 05 at $ 75.07
Change since picked: + 0.00
Earnings Date 11/02/06 (confirmed)
Average Daily Volume = 7.6 million

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Schlumberger - SLB - cls: 63.50 chg: +1.55 stop: 60.95

Company Description:
Schlumberger is the world's leading oilfield services company supplying technology, information solutions and integrated project management that optimize reservoir performance for customers working in the oil and gas industry. (source: company press release or website)

Why We Like It:
SLB is another oil services stock that is rising with a bullish trend of higher lows. Volume on Friday's gain was below average but the stock closed back above its 200-dma. Short-term and long-term technicals are positive or they are turning positive. We're suggesting calls with SLB above $62.00. Our target is the $67.50-68.00 range. SLB is an oil services company and the services sector tends to be a little more volatile than the rest of the oil sector.

Suggested Options:
We are suggesting the December calls although traders may want to consider buying January strikes.

BUY CALL DEC 60.00 SLB-LL open interest= 489 current ask $5.20
BUY CALL DEC 62.50 SLB-LZ open interest= 692 current ask $3.60
BUY CALL DEC 65.00 SLB-LM open interest=12232 current ask $2.30
BUY CALL DEC 67.50 SLB-LB open interest= 593 current ask $1.40

Picked on November 05 at $ 63.50
Change since picked: + 0.00
Earnings Date 10/20/06 (confirmed)
Average Daily Volume = 9.8 million
 

New Puts

Cardinal Health - CAH - cls: 63.26 chg: -1.36 stop: 64.85

Company Description:
Headquartered in Dublin, Ohio, Cardinal Health, Inc. is an $81 billion, global company serving the health-care industry with a broad portfolio of products and services. Through its diverse offerings, Cardinal Health delivers health-care solutions that help customers reduce their costs, improve safety and productivity, and deliver better care to patients. The company manufactures, packages and distributes pharmaceuticals and medical supplies, offers a range of clinical services and develops automation products that improve the management and delivery of supplies and medication for hospitals, physician offices and pharmacies. (source: company press release or website)

Why We Like It:
Investors were unhappy with CAH's most recent earnings report in late October. Some traders bought the initial dip but the stock failed at resistance near $66 and now shares are slipping toward new relative lows. Currently CAH has support near $63.00 and again at $62.35. Given the bearish turn in the technical indicators we suspect the stock may be ready to breakdown into a new trend lower. We're suggesting a trigger to buy puts at $61.99. If triggered our target is the $58.00-57.50 range. Be prepared for a bounce on CAH's initial test of the $60 level.

Suggested Options:
We are suggesting the December puts although Januarys would also work well. Our trigger to open plays is at $61.99.

BUY PUT DEC 65.00 CAH-XM open interest=1660 current ask $2.60
BUY PUT DEC 60.00 CAH-XL open interest=3612 current ask $0.65

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/27/06 (confirmed)
Average Daily Volume = 1.3 million

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Centex - CTX - close: 50.39 change: -0.85 stop: 52.55

Company Description:
Dallas-based Centex, founded in 1950, is one of the nation's leading home building companies. Centex operates in major U.S. markets in 25 states and delivered more than 39,000 homes in the United States in its most recent fiscal year ended March 31, 2006. Its leading brands include Centex Homes, Fox & Jacobs Homes, CityHomes and Centex Destination Properties. (source: company press release or website)

Why We Like It:
The homebuilders struggled to build on their strength in September. Now after a month of trying to march higher it looks like momentum has reversed. Shares of CTX have begun to post lower highs and are on the verge of breaking support at the $50.00 level and its 100-dma. The P&F chart for CTX has already reversed into a sell signal. We are suggesting a trigger to buy puts at $49.75. If triggered our target is the $45.50-45.00 range.

Suggested Options:
We are suggesting the December puts although Januarys would also work well. Our trigger to open plays is at $49.75.

BUY PUT DEC 50.00 CTX-XJ open interest= 934 current ask $2.05
BUY PUT DEC 45.00 CTX-XI open interest=1409 current ask $0.60

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/23/06 (unconfirmed)
Average Daily Volume = 2.1 million

---

Intercont.Exchange - ICE - cls: 81.75 chg: -1.55 stop: 82.55

Company Description:
IntercontinentalExchange operates the leading global, electronic marketplace for trading both futures and OTC energy contracts. ICE offers a range of contracts based on crude oil and refined products, natural gas, power and emissions. ICE conducts its futures markets through its regulated London-based subsidiary, ICE Futures, Europe's leading energy exchange. ICE Futures offers liquid markets in the world's leading oil benchmarks: Brent Crude futures and West Texas Intermediate (WTI) Crude futures, as well as the leading heating oil futures contract by traded volume. (source: company press release or website)

Why We Like It:
ICE recently reported earnings. The company beat estimates by two cents but traders sold the news anyway in spite of some positive analyst comments and raised price targets. The XBD broker-dealer index looks tired and poised for more profit taking. Meanwhile shares of ICE may have produced a top formation over the last month. We want to buy puts on a breakdown under support at $80.00. We're suggesting a trigger to open positions at $79.85. If triggered our target is the $75.15-75.00 range. More conservative traders may want to exit at the rising 50-dma near $75. FYI: A decline under $81.00 would reverse the P&F chart into a new sell signal. More aggressive traders may want to consider opening early positions under $81.00.

Suggested Options:
We are suggesting the December puts. Our trigger to open positions is at $79.85.

BUY PUT DEC 85.00 ICE-XQ open interest= 556 current ask $6.40
BUY PUT DEC 80.00 ICE-XP open interest= 838 current ask $3.70
BUY PUT DEC 75.00 ICE-XO open interest=2919 current ask $1.85

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/02/06 (confirmed)
Average Daily Volume = 1.6 million

---

Lehman Brothers - LEH - cls: 74.43 chg: -1.57 stop: 77.01

Company Description:
Lehman Brothers (ticker symbol: LEH), an innovator in global finance, serves the financial needs of corporations, governments and municipalities, institutional clients and high-net-worth individuals worldwide. (source: company press release or website)

Why We Like It:
LEH is another investment-related stock that is seeing some profit taking after an impressive run up from its August lows. Technicals are bearish and shares are beginning to breakdown under various levels of support. Friday's session produced a failed rally under its 10-dma and it produced a bearish engulfing candlestick pattern. We are suggesting puts with LEH under $75.00 but more conservative traders may want to see a new relative low under Thursday's low of 73.69. There is potential support at its rising 50-dma but we are expecting a dip toward stronger support near $70.00 and its 200-dma. Our target is the $70.25-70.00 range.

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 75.00 LES-XO open interest=2437 current ask $3.10
BUY PUT DEC 70.00 LES-XN open interest= 664 current ask $1.25

Picked on November 05 at $ 74.43
Change since picked: + 0.00
Earnings Date 12/13/06 (unconfirmed)
Average Daily Volume = 3.6 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cerner Corp. - CERN - close: 49.09 chg: +0.83 stop: 46.90*new*

CERN's afternoon rebound on Thursday continued into Friday morning and the stock hit a new all-time high at $49.81. We expected potential resistance at the $50.00 mark so a pull back toward $48 could be in the cards. Readers can watch for a bounce near $48.00 as a new entry point to buy calls. We're going to raise our stop loss to $46.90. Our target is the $52.00-52.50 range.

Suggested Options:
We're not suggesting new positions at this time but a bounce near $48 could be a new entry point. We'd choose the December calls.

Picked on October 30 at $ 48.05
Change since picked: + 1.04
Earnings Date 10/19/06 (confirmed)
Average Daily Volume = 662 thousand

---

Frontier Oil - FTO - close: 31.11 change: +1.28 stop: 28.90*new*

Time is almost up for our bullish FTO play. The stock displayed a lot of strength on Friday. Shares rose more than 4.2% and broke through resistance at $30.00 and its 100-dma. The company is due to report earnings on Tuesday morning before the opening bell. To avoid earnings we're planning to exit at Monday's close or at our target at $32.50. Due to our time frame we're raising the stop loss to $28.90.

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

Picked on October 15 at $ 28.90
Change since picked: + 2.21
Earnings Date 11/07/06 (confirmed)
Average Daily Volume = 3.2 million

---

NTL Inc. - NTLI - close: 26.88 chg: +0.04 stop: 25.99

We were expecting a bounce near $26.00 and traders obliged by buying the dip at $26.20 on Friday morning. The strong rebound looks like a new entry point to buy calls. Our only complaint was the lack of volume on the bounce. The worst part here is our time frame. NTLI is due to report earnings on November 8th. It looks like the report is expected after the market's close. We're planning to exit at the closing bell on November 7th just to be safe and avoid the announcement. Due to this very short time frame we're not suggesting new positions in NTLI. Our target is the $29.90-30.00 range.

Suggested Options:
We're not suggesting new positions in NTLI.

Picked on October 26 at $ 27.41
Change since picked: - 0.53
Earnings Date 11/08/06 (confirmed)
Average Daily Volume = 2.4 million

---

Vimpel Comm. - VIP - close: 64.17 chg: -0.59 stop: 62.49*new*

VIP's lack of follow through higher on Thursday's intraday rebound is bearish. Friday's decline might be a reaction to news that the company will pay 382 million euros for Armenia Armentel. Whatever the reason the daily technicals for VIP are starting to look bearish. We're not suggesting new positions and more conservative traders may want to exit early. We're adjusting our stop loss to $62.49. Another reason that traders may want to exit early is VIP's earnings report, which is an event we do not want to hold over. The company is expected to report this month but we can't find a specific date. Estimates for when VIP will announce range from November 7th to November 23rd. Our target is the $67.50-70.00 range.

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

Picked on October 12 at $ 62.17
Change since picked: + 2.00
Earnings Date 11/17/06 (unconfirmed)
Average Daily Volume = 1.0 million
 

Put Updates

Alcon Inc. - ACL - close: 105.62 chg: -0.63 stop: 110.01*new*

After a week of consolidating sideways and a few failed rallies under the $108 level it looks like ACL may finally be ready to head lower. Short-term, daily and weekly technicals are bearish or are turning bearish although it's worth noting that the daily indicators are near oversold levels. More conservative traders may want to tighten their stops toward the $108 level. We're adjusting ours to $110.01. We see the close under $106 as a new entry point to buy puts or readers can still wait for a new relative low under $105.15 or just wait for a decline under $105. Our target is the $100.10-100.00 range.

Suggested Options:
We are suggesting the December puts. You the individual trader should decide which month and strike price best suits your risk and trading style.

BUY PUT DEC 110.00 ACL-XB open interest= 75 current ask $5.70
BUY PUT DEC 105.00 ACL-XA open interest=128 current ask $2.90
BUY PUT DEC 100.00 ACL-XT open interest= 37 current ask $1.20

Picked on October 31 at $105.75
Change since picked: - 0.13
Earnings Date 10/23/06 (confirmed)
Average Daily Volume = 520 thousand

---

Advanced Micro Dev. - AMD - cls: 20.88 chg: +0.03 stop: 22.05

The SOX semiconductor index produced a minor bounce on Friday and shares of AMD followed with an even smaller bounce of its own. For the most part the stock has been trading sideways the last several days and the range is getting pretty narrow. Normally these coiling patterns end with a big breakout one way or the other. The overall pattern in AMD is bearish although some of the short-term indicators are oversold enough that any sort of bounce will start to turn them higher. Readers can choose to open new put plays here or wait for a decline under round-number support at the $20.00 mark. Our target is the $17.50-17.00 range.

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 22.50 AMD-XU open interest=1156 current ask $2.20
BUY PUT DEC 20.00 AMD-XD open interest=4167 current ask $0.80

Picked on October 29 at $ 20.86
Change since picked: + 0.02
Earnings Date 10/18/06 (confirmed)
Average Daily Volume = 23.0 million

---

Amazon.com - AMZN - close: 37.46 chg: +0.01 stop: 40.25

We warned readers that AMZN might bounce from its simple 10-dma and that's what the stock delivered on Friday albeit the bounce was pretty weak. We believe that AMZN will attempt to fill the gap from late last month. With overhead resistance at $39.00 and again at $40.00 this looks like a good spot to consider put plays. Readers can choose now to wait and watch for a failed rally under $39.00 (or $40 if it occurs) as a new entry point. We're using a relatively wide stop loss above $40 to give AMZN room to maneuver. Our target is the $35.00-34.00 range.

Suggested Options:
Wait for a failed rally under $39.00. We'd suggest the December puts.

Picked on October 29 at $ 38.24
Change since picked: - 0.78
Earnings Date 10/24/06 (confirmed)
Average Daily Volume = 7.9 million

---

CDW Corp. - CDWC - cls: 63.99 chg: -0.26 stop: 66.25

CDWC continued to slip on Friday and the technical picture continues to decay. The close under the $64.00 level (and the intraday dip under $63.87) looks like a new entry point to buy puts. The stock has broken its three-month trendline of support but we do note potential support at its rising 50-dma near 63.25. Our target is the $60.50-60.00 range. Be advised that CDWC is hosting an analyst day on November 8th.

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 65.00 DWQ-XM open interest= 192 current ask $2.55
BUY PUT DEC 60.00 DWQ-XL open interest=1043 current ask $0.80

Picked on November 02 at $ 63.90
Change since picked: + 0.09
Earnings Date 10/18/06 (confirmed)
Average Daily Volume = 762 thousand

---

Capital One Finc. - COF - cls: 76.56 chg: -0.10 stop: 80.05*new*

We were expecting an oversold bounce in COF and the stock traded higher on Friday morning but it failed near the $78 level. That's good news for the bears. Shares of COF are still relatively close to our target near $75.10-75.00 so we're not suggesting new positions at this time. We are going to adjust our stop loss to $80.05. More aggressive traders may want to aim lower.

Suggested Options:
We're not suggesting new positions in COF at this time.

Picked on October 31 at $ 79.33
Change since picked: - 2.77
Earnings Date 10/18/06 (confirmed)
Average Daily Volume = 2.4 million

---

DIAMONDS ETF - DIA - close: 119.78 chg: -0.22 stop: 121.16

The trading in the DJIA and the DIA diamonds looked bearish on Friday. The early rally failed and the DIA produced a failed rally near its 10-dma and at its very short-term trendline of lower highs. The move produced another bearish engulfing candlestick and the index still looks very overbought and due for consolidation. However, before you think about backing up the truck the DJIA (and the DIA) is nearing potential short-term support near $119.20. We remain bearish and would still open new positions here near the $120 level. Our target is the $118.00-117.00 range.

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 121.00 DAQ-XQ open interest= 4771 current ask $2.30
BUY PUT DEC 120.00 DAQ-XP open interest=27932 current ask $1.80
BUY PUT DEC 119.00 DAQ-XO open interest= 5419 current ask $1.40
BUY PUT DEC 118.00 DAQ-XN open interest= 6004 current ask $1.10

Picked on November 02 at $119.80
Change since picked: - 0.02
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 6.6 million

---

NewMarket - NEU - close: 62.14 change: -0.50 stop: 67.05

The early bounce on Friday morning failed at $63.86 near NEU's short-term trendline of lower highs. Most of the technical indicators are bearish or they are turning bearish. We do expect something of a bounce near $60 which is why we're suggesting two targets. Our conservative target is the $60.20-60.00 range. More conservative traders may want to exit completely here while more aggressive traders may want to sell part of their position. Our aggressive target is the $56.00 level although we may adjust that toward the rising 100-dma.

Suggested Options:
We're not suggesting new positions at this time although a failed rally under its 10-dma near $65 could be used as a new entry point.

Picked on October 31 at $ 64.30
Change since picked: - 2.16
Earnings Date 10/25/06 (confirmed)
Average Daily Volume = 354 thousand

---

PACCAR Inc. - PCAR - cls: 58.53 chg: -0.68 stop: 62.51

It's becoming more clear that PCAR is sliding lower in a narrow, bearish channel. The stock dipped to short-term support at $58.00 before bouncing. The move on Friday also produced another bearish engulfing candlestick but we're not expecting another decline on Monday. Instead it looks like PCAR will bounce back toward $59 and maybe toward the 10-dma near 59.70. We're adjusting our stop loss to $61.05 and more conservative traders may want to think about placing their stop near $60. Our target is the rising 100-dma but we're going to use an official exit in the $56.00-55.50 range (for now). We're not suggesting new positions at this time.

Suggested Options:
We're not suggesting new plays in PCAR at this time although another failed rally under $60 or its 10-dma could be used as a new entry point. We prefer the December puts.

Picked on October 29 at $ 59.42
Change since picked: - 0.89
Earnings Date 10/24/06 (confirmed)
Average Daily Volume = 1.4 million

---

Pantry Inc. - PTRY - close: 52.31 change: -0.80 stop: 56.01*new*

PTRY displayed another round of relative weakness on Friday with a 1.5% decline. The stock fell through potential support at its exponential 200-dma and the 100-dma. We have been suggesting that a move through the $52.50 level was another entry point to buy puts and PTRY provided that decline on Friday. Our target is the $48.00-47.00 range but we do expect a bounce on PTRY's initial test of the $50 level. We do not want to hold over the November 16th earnings report. We are adjusting our stop loss to $56.01

Suggested Options:
We are suggesting the December puts.

BUY PUT DEC 55.00 PQR-XK open interest= 91 current ask $4.40
BUY PUT DEC 50.00 PQR-XJ open interest=161 current ask $1.90

Picked on October 29 at $ 54.05
Change since picked: - 1.74
Earnings Date 11/16/06 (confirmed)
Average Daily Volume = 383 thousand

---

NASDAQ-100 ETF - QQQQ - cls: 41.93 chg: -0.11 stop: 42.81

The QQQQs hit a new two-week low on Friday but bulls aren't giving up without a fight. Traders bought the dip even though the technicals are turning bearish. We would still consider new put positions as long as the Qs are under $42.25. Our target is the $40.25-40.00 range, which might be a little optimistic given potential support at its rising 50-dma. FYI: More aggressive traders may want to put their stop above the $43.00 mark!

Suggested Options:
We are suggesting the December puts. Our trigger to open plays is at $41.75.

BUY PUT DEC 43.00 QQQ-XQ open interest= 33942 current ask $1.50
BUY PUT DEC 42.00 QQQ-XP open interest=132820 current ask $0.95
BUY PUT DEC 41.00 QQQ-XO open interest=166786 current ask $0.60

Picked on November 02 at $ 41.75
Change since picked: + 0.18
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 106 million

---

Semiconductor HOLDRs - SMH - cls: 33.05 chg: -0.23 stop: 34.15

The SOX semiconductor index managed a bounce from the 445 level but the SMH displayed relative weakness and dipped under support at $33 and its 100-dma before bouncing back to close with a 0.18% loss. The SMH is not an exact replica of the SOX. It's an EFT of 20 stocks in the semiconductor industry. Thus far the SMH appears to be showing more weakness than the SOX. Friday's decline to $32.75 was enough to hit our trigger and open the play at $32.95. Our target is the $31.50-31.40 range. More conservative traders may want to wait for a new relative low (32.74) before initiating new plays.

Suggested Options:
We are suggesting the December puts. Our trigger to open positions is at $32.95.

BUY PUT DEC 35.00 SMH-XG open interest=11379 current ask $2.25
BUY PUT DEC 32.50 SMH-XZ open interest= 3033 current ask $0.80

Picked on November 03 at $ 32.95 <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 17.7 million

---

Univ.Forest Prod. - UFPI - cls: 43.81 chg: -0.38 stop: 48.05

The sell-off in shares of UFPI continued on Friday and it might be picking up speed. The stock lost 0.85% but volume came in relatively strong 18-month low. We're not suggesting new positions at this time. More conservative traders may want to tighten their stops. We're aiming for a decline into the $41.00-40.00 range.

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

Picked on October 24 at $ 46.13
Change since picked: - 2.32
Earnings Date 10/16/06 (confirmed)
Average Daily Volume = 192 thousand
 

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.)

---

Bear Stearns - BSC - cls: 146.69 chg: -1.37 stop: n/a

BSC continues to see profit taking and the technical indicators are growing more bearish. We're not suggesting new positions at this time. The options in our strangle are the November 155 call (BSC-KK) and the November 145 put (BSC-WI). Our estimated cost was $4.00. We're planning to exit if either option rises to $6.00 or more. FYI: Don't forget that November strikes expire in less than three weeks.

Suggested Options:
We're not suggesting new strangles on BSC.

Picked on October 22 at $150.19
Change since picked: - 3.50
Earnings Date 12/14/06 (unconfirmed)
Average Daily Volume = 1.6 million

---

Cephalon - CEPH - close: 70.25 change: +0.00 stop: n/a

Warning! We were expecting a big post earnings move in CEPH and it failed to appear. The company reported on Thursday night and shares saw some volatility in after hours but Friday's session closed with the stock unchanged. More conservative traders may want to exit their strangle positions immediately to limit any losses. We still suspect that CEPH is poised for a big move so we're going to keep the play open at least for a few more days. We're not suggesting new plays at this time. The options in our strangle are the December $75 call (CQE-LO) and the December $65 put (CQE-XM). Our estimated cost was $3.45. We plan to see if either option rises to $4.90 or more.

Suggested Options:
We're not suggesting new strangles in CEPH.

Picked on October 29 at $ 69.35
Change since picked: + 0.90
Earnings Date 11/02/06 (confirmed)
Average Daily Volume = 2.0 million

---

ConocoPhillips - COP - close: 60.97 chg: +1.27 stop: n/a

We are quickly running out of time for COP to perform. November options expire in two weeks and COP needs to move several points for this play to have a chance. More conservative traders may want to be thinking about an early exit or lowering their target to break even. We're going to do the latter and adjust our target to breakeven at $1.15. We're not suggesting new positions. Our suggested options were the November $65 call (COP-KM) and the November $55 put (COP-WK).

Suggested Options:
We're not suggesting new strangles in COP.

Picked on October 15 at $ 60.03
Change since picked: + 0.94
Earnings Date 10/25/06 (confirmed)
Average Daily Volume = 9.8 million

---

Blue Nile - NILE - cls: 35.77 chg: -0.21 stop: n/a

The post-earnings sell-off has been tough on NILE but not sharp enough for our strangle play to turn profitable yet. The decline in NILE under $36 and its 50-dma is definitely bearish but it may be time for a bounce. We're not suggesting new positions at this time. Our estimated cost was $2.40 and we're planning to sell if either side of our strangle rises to $3.90. The options in our suggested strangle are the January $45 call (JWU-AI) and the January $35 put (JWU-MG).

Suggested Options:
We're not suggesting new strangles on NILE.

Picked on October 29 at $ 38.92
Change since picked: - 3.15
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

Whole Foods - WFMI - close: 46.26 change: -13.86 stop: n/a

Target achieved and surpassed. Thursday night WFMI reported earnings and with that report came an earnings and revenue warning. Shares traded down to $51.50 in after hours on Thursday night due to the news so we adjusted our strangle exit from $5.40 to $7.50. It looks like we were too conservative. The stock gapped open at $47.49 and closed with a 23% loss. The put side of our strangle was the December $60 put (FMQ-XL) and the option gapped open to trade at $12.10 before spiking to almost $14. The gap open puts our exit at $12.10 instead of $7.50. Our estimated cost was $3.15.

Picked on October 29 at $ 64.75
Change since picked: - 4.63
Earnings Date 11/02/06 (confirmed)
Average Daily Volume = 2.1 million
 


Trader's Corner

A Conundrum Resolved

As new options traders, we dutifully trudge through descriptions about pricing models. We learn to reel off the words "Black-Scholes model." Some of us merely scan descriptions of the model, learning that option prices vary with strike price, the underlying's price, the time left until expiration, interest rates, dividends and volatility.

Many find their eyes glazing over and their brains shutting down after the first three or four such parameters. Some more persistent and mathematically inclined options traders actually study the model, going to CBOE's website or iVolatility's (www.cboe.com and www.ivotality.com). They methodically input various values for those parameters, developing a feel for the way an option's price might change as each of those parameters varies. So, most of us, whether we want to try calculating options prices or not, understand that there's a mathematical value that can be obtained once each of those parameters are set.

However, sooner or later, most options traders are going to hit upon a conundrum when they're thinking about options pricing. We know that any market, even an options market, is also driven by supply and demand. So, what determines the price of an option: a mathematical model such as the Black-Scholes model or good old supply and demand? Why do we even need a model if supply and demand are going to determine price?

Recently, a puzzled trader asked the same question of the CBOE's Options Institute's "Ask the Institute" staff. Which determines options prices? The Institute's answer: Both.

The CBOE is an exchange, just as the Philadelphia Stock Exchange and the American Stock Exchange are exchanges. The CBOE does not set the prices. Instead, for all equity options and some index options, a Designated Primary Market-Maker or DPM serves in the category that many of us would think of as a specialist. This person makes the market for a designated equity's options, for example. If a person such as the DPM were working at another exchange, that person might be called PMM or LMM, as in Lead Market Maker. The DPM works with options that are traded on the Hybrid system at the CBOE. Other options not traded on the Hybrid system might be represented by independent market makers.

On the CBOE, the DPM must make a continuous bid and ask prices for all the option series in that DPM's designated series of options. That's where the mathematical models come into play. The mathematical model helps the DPM determine a theoretical or "fair value" for the bid and ask for a particular option. (Note: "Fair value" is a term that can have many meanings in the trading world. This particular one is not the fair value you hear referenced on CNBC, for example.) DPM's also use their own experience to help guide the market they'll make for those options and the prices they'll set.

Other traders on the floor are deciding what they want to pay to buy or capture to sell, while you, at your computers, are also deciding what you think a fair value would be for that option. You're looking at the bid and ask the DPM has determined, but you're probably not wanting to sell exactly at the bid or buy exactly at the ask. You want a little better deal than that. So, orders start streaming in. For example, maybe you want to sell a RUT option you bought, but for more than the bid, and your neighbor down the street just happens to want to buy that same option at the same time, but at less than the ask. You both put your limit orders in through your online broker, and those orders are inside the bid and ask determined by the DPM. And so it goes. Supply and demand begin to change the original bid and ask that the DPM calculated.

If you and your neighbor compare notes later and you find that you sold your option at the same time your neighbor was buying it, and for the same price, you might be tempted to conclude you had sold your option directly to your neighbor. Funny story, but that's not technically true. You might also conclude that the DPM handled the sell. Maybe not true, either.

When you sell your option, you're selling it to the Options Clearing Corporation or OCC. When your neighbor bought it, your neighbor also bought it from the OCC. The OCC was established in 1975 and is the counterparty to options transactions. Options contracts are standardized contracts, so you're not physically selling your contract to your neighbor or to the DPM.

Also, in this hybrid system that includes the DPM, floor traders and orders received from individuals and others via their brokerage firms, either electronically or otherwise, the DPM may not handle the transaction. Your electronic order to sell may indeed match up with your neighbor's order to buy, and the order may be processed instantaneously and electronically without the involvement of the DPM.

Controversy remains about the role of DPM's and other market-makers. In the days before electronic trading, they were needed to create an orderly market, but they sometimes required an extended period of time before all calculations could be made, so sometimes a bit of time expired before all options opened at the start of the trading day. Now computers can perform those calculations in seconds. Some believe the day of the specialist of any stripe is dated, while others believe these market-makers perform a vital role. Discussing that topic is not the thrust of this article, however.

Your brokerage might be serving as a DPM for one or more appointed options. If you want to know, you can ask your broker, or you can check the symbol directory at www.cboe.com. That directory lists the DPM for each stock option.

The CBOE advertises now and then for new DPM's, as it did early in 2005 when it was seeking DPM's for Russell Index Market-Makers. DPM's must have deep pockets and lots of options-trading experience. Requirements also include providing continuous bids for 75 percent of the available trading hours in each calendar month, providing an average bid/ask spread of no more than $0.40 over a calendar month, and responding within ten seconds in some cases.

DPM's start the ball rolling each day by using a model such as the Black-Scholes model to calculate theoretical prices and to keep prices roughly in line during the day, but then the prices the DPM sets are acted upon by regular old supply and demand. Conundrum resolved.
 

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.

DISCLAIMER

Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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