Option Investor

Daily Newsletter, Wednesday, 12/06/2006

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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

Another New Record

It's not difficult these days to find an index that's making another new high or new recent high. Despite an early negative tenor in the markets, the SPX hit another new six-year high by early afternoon, a six-year high that wasn't to hold.

The SOX offered confirmation of short-term bullishness from another sector. The early negative bias had finished off the head and right shoulders of a head-and-shoulders formation on the SOX's intraday chart. However, while the Iraq Study Group was presenting its report, the SOX gradually crept up to and then beyond the right shoulder level, invalidating that formation.

Breadth indicators weren't offering much confirmation of the bounce off the early lows, however. During that bounce, advancers and decliners proved equally matched on both the NYSE and the Nasdaq. Eventually, that lack of confirmation from breadth indicators was to prove prophetic as indices began falling back off their highs, accompanied by breadth indicators that turned slightly more negative.


Some credit should perhaps be given to the homebuilders for reversing that early negative tenor in the markets. With the Mortgage Bankers Association reporting that mortgage application volume had jumped significantly in the week ending December 1, the DJUSHB, the Dow Jones U.S. Home Construction Index, jumped, too. That index had recently climbed above its 200-sma and 200-ema's and had gained significantly after breaching that resistance. With worries voiced this last week that the weakness in the housing sector might spill over into other sectors of the economy, the rebound may have significantly impacted investor sentiment, at least for a few hours. With an intraday high of 766.82, the DJUSHB approaches resistance in the 780-810 zone, and it will also need a weekly close above 745-747 to confirm its breakout. Some homebuilders' stocks left a big gap to perhaps be tested or else consolidated through a sideways movement.

What do other charts show?


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The SPX's chart shows a small-bodied candle that formed at resistance.

Annotated Daily Chart of the SPX:

The SPX's two days of consolidation have flattened intraday indicators, so that they provide no sense of where the SPX might be headed next.

The small-bodied candle that formed at resistance could be part of the SPX's typical pattern lately, which would suggest that further consolidation in the form of a sideways to sideways-up pattern would continue for another day or two at least. That fits with the idea that markets might chop around ahead of Friday's jobs numbers, too. However, due to the RSI pattern and the continued SPX struggle for more than a month with the midline of that channel, I'm more wary on behalf of the bulls than I had been. My advice must remain the same, though, to keep ratcheting those stops higher with each movement higher of the indices.

The RSI suggests that bears need to have their heads up now, watching for anything that confirms a change in the bullish trend. No confirmation has yet occurred.

The Dow, too, has trouble with a rising trendline, but in the Dow's case, that trendline is the former supporting trendline.

Annotated Daily Chart of the Dow:

The Dow flirts with bearish RSI/price divergence, but such divergences provide only a warning and not a confirmation of bearishness. The Dow's goodbye-kiss, a test of its former supporting trendline, did not result in the expected goodbye which should have come in the form of a sharp drop away from that trendline. Prices have managed to climb the underside of that trendline. It's possible that instead of falling away, the Dow will form another rising channel, this one with a more sedately inclining angle so that the gains are more sustainable. I'm also watching for the possibility that its recent pattern of gains could be breaking up and that the Dow will consolidate sideways for a while.

None of these possibilities--a steep decline after the kiss goodbye, a sideways consolidation or even the formation of a new but less steeply rising channel--are proven or even yet strongly predicted by what's happening on the charts. Some minor differences have arisen in the way indices are handling their previous tests of bottom-of-the-channel support. The Dow's break through that support is one of those differences. Indices may be beginning a pattern of disorganization.

The Nasdaq's chart also shows some minor differences of concern to bulls. The Nasdaq can't seem to pull away from the support of its rising channel, at least not yet.

Annotated Daily Chart of the Nasdaq:

The Nasdaq's intraday charts provide a little more information than do the SPX's or Dow's. The Nasdaq appears to have relatively strong Keltner support near 2440-2441, but it's been testing that support and then bouncing away from it into a series of lower highs. The formation is beginning to look suspiciously like a bearish right triangle, so a prolonged breakdown through that 2440-2441 zone would seem to suggest that the short-term bearishness is being confirmed. In bullish climates, however, such breakdowns sometimes result in a morphing of the formation into a bull flag. If that's happening, support could be found at 2427-2430, at least as of the early part of the day.

If the Nasdaq bounces early tomorrow instead, watch for a lower high or a higher high, with the latter undoing the possibility of that being a bearish right triangle. If the Nasdaq does break down through the first support zone, watch that 2427-2430 area for possible bounce potential.

The SOX's morning run-up had taken it up to and slightly beyond Tuesday's high, but then the SOX rolled over from that level, forming a potential double-top formation on the intraday chart.

Annotated Daily Chart of the SOX:

A sustained move through 482.50 would confirm the double-top formation on the SOX, but remember that the formation has not been confirmed yet. If the SOX should drop, look for potential support at the 30-sma. Bull want to see that moving average hold, but there's such a river of support coursing below the SOX's current position that it's going to take either a prolonged period of chopping around or a strong whoosh lower to break through that support.

Short-term Keltner evidence suggested that the SOX could test 485 again, but didn't promise such a test or suggest what would happen after such a test, if it should occur.

Intraday Keltner evidence also suggested that the RUT could be pressured lower, perhaps toward 794 or even 792, but didn't suggest what would happen after such a test. So far, that support has held, but the RUT's intraday pattern also begins to look a little like a bearish right triangle.

Annotated Daily Chart of the RUT:

The RUT's chart pattern puzzles me. If the slant of the line along which the RUT consolidates is correct, then the RUT struggles to break above it, but hasn't yet given up the test, either. Watch the RSI for confirmation of either an upside breakout or a downside breakdown.

Today's Developments

After several weeks of declining mortgage application volume, the Mortgage Bankers Association reported that the week ending December 1 produced an 8.1 percent week-over-week seasonally adjusted increase in volume. If not seasonally adjusted, the volume increased 52 percent. Contrary to recent patterns, it was higher year over year, too, by 1.9 percent.

Other components were markedly higher, too, with the refinance component up 13.7 percent; the conventional, 8.6 percent; and the government, 2.5 percent. Four-week moving averages climbed. Refinance activity increased as a percentage of total applications.

All this occurred as the average contract interest rate for 30-year fixed-rate mortgages dropped below six percent again, to 5.98 percent, down from the previous week's 6.13 percent. The rate for a one-year ARM also fell, dropping to its lowest rate since March.

That was good news for the housing market, but whether it was a one-week blip or not remains to be seen, and that depends to a great degree on what happens with interest rates. Friday's view of the labor market will tell the Federal Open Market Committee (FOMC) something about how tight the labor market might be, therefore giving FOMC members information about how labor market costs might impact inflation in the future. This morning provided a forecast of Friday's number in the form of the ADP index of private-sector jobs. The ADP announced a gain of 158,000 private sector jobs in November. When the estimated 15,000 government jobs are added in, that brings November's jobs gain to 173,000, far above the expected 110,000.

In last weekend's Wrap, Jim Brown noted that if Friday's number shows a significant climb in employment, fear-of-the-Fed in the form of another rate hike could reassert itself. The ADP number may have been at least partially responsible for the early negative tenor, then, as it resurrected those fears.

Although the ADP index is constructed to forecast the Labor Department figures, supposedly using the same methodology and conducting surveys over the same time period, the ADP number missed spectacularly in June and, on a less colossal scale, in October. Both times, the ADP estimate was higher than the Labor Department's report. Perhaps some market participants remembered those misses and discounted the specter of a higher-than-expected jobs number on Friday.

According to a Marketwatch.com report, the jobless rate is expected to rise from its current 4.4 percent to 4.5 percent, and wage inflation is forecast to ease from its current 0.4 percent to 0.3 percent. Since the markets are watching these figures to ascertain the effect that the labor market might have on inflation, an easing in wage inflation would be good news to the markets. Market watchers wouldn't want to see a sharp rise in the jobless rate, however, as that would suggest an economy cooling more than is optimum, but a modest rise would be in keeping with that wanted easing of inflation pressure.

Some of the component stocks in the XOI and OIX, both sectors related to crude production or services, contributed to the midday bullishness, although not all crude-related stocks rose. In last night's Wrap, Jim Brown addressed the EIA's outlook on crude, including forecasts that Jim apparently considered Pollyanna-ish. Today, Norsky Hydro ASA (NHY) perhaps offered more reason to doubt the EIA's forecast. NHY trimmed its 2010 oil and output target by 6.7 percent, making the point that this was "an industry challenge, not just a Hydro challenge." This fits with the information that Jim Brown has been giving OIN readers for more than a year. NHY's chief executive used words such as "stretching" when describing the efforts the company is making to meet production targets. NHY did go on to point out that beyond 2010, the company believed that its broader portfolio would add to growth.

Two groups reported on crude inventories today, the Energy Department and the American Petroleum Institute. This week, crude futures for January delivery had been consolidating sideways to sideways-down, hit by forecasts of milder weather (and so, lesser demand) for next week.

Today's report was to prove more bullish for crude futures, at least over the short-term and within the recent consolidation zone. Crude futures for January delivery were to close at $63.00 a barrel, up from yesterday's $62.43 close, with both these numbers according to a DTNIQ feed source. Jim discussed some option-related considerations last night that also must be factored into any forecasts for crude prices, of course.

The Energy Department reported a drop in crude inventories of 1.1 million barrels, a drop in distillates of 400,000 barrels, and a drop in gasoline of 1.1 million barrels. The API reported that crude and distillate supplies dropped a much larger 4.1 million barrels and 1.5 million barrels respectively. The API reported that gasoline supplies climbed by 674,000 barrels. The Energy Department and the API seldom agree, but both reported an draw-downs that were unexpected.

Another economic report was issued yesterday, but I don't think it was widely covered until today. As expected after President Bush's April 2005 signing of the Bankruptcy Abuse Prevention and Consumer Protection Act, a new and tougher bankruptcy law, bankruptcies have fallen drastically year over year. For the year ending September 30, they are 38 percent lower than the previous year and are, in fact, at a 10-year low. Some groups believe that bankruptcy rates will rise again to their previous levels, however, with many debtors having rushed to declare bankruptcy just before the new law went into effect in the fall of 2005.

In company-related news, Yahoo (YHOO) announced the departure of its CEO and the head of its media group, among others. Its CFO was promoted. YHOO turned lower, but stayed within a recent consolidation pattern. Other negative news involved Novellus Systems (NVLS), with the company receiving a downgrade, and Novell (NOVL), with that company guiding expectations lower for its full-year 2007 revenue. Both turned lower, with NOVL gapping lower but bouncing strongly off its low of the day. The three companies negatively impacted the Internet, semiconductor equipment and systems software sectors.

In addition, an analyst with Lehman Brothers suggested that investors take profits in Oracle (ORCL) before the company releases earnings on December 18, as he believes that the company's database results could disappoint. ORCl gapped lower at the open, but held tentative support at its 72-ema.

Frontier Airlines (FRNT) announced that instead of breaking even in the third quarter, it now expects a loss of $0.12-0.17 per share. November's load factor, which measures the percentage of a plane that is filled with passengers, also dropped while capacity rose. That news as well as perhaps the rise in crude prices pressured the TRAN, the Dow Jones Transportation Index, turning it lower to retest its 30-sma. Merck (MRK) reaffirmed its fiscal 2007 guidance and earnings-per-share outlook, with those in line with analysts' expectations.

The discussion of the day's events can't be concluded without a mention of the Iraq Study Group's report, "The Way Forward: A New Approach," presented and much discussed today. The group classifies itself as a non-partisan group or as a group of "has-been's," as former Secretary of State Baker humorously characterized them when responding to a relatively young reporter's question about why President Bush should listen to them and not to the people he had on the ground in Iraq. The report's suggestions and conclusions include enlisting the help of other regional powers such as Syria and Iran, initially raising the number of U.S. troops inside Iraq for the purpose embedding more U.S. troops in Iraqi units and supporting those units while avoiding "making open-ended commitments" to retain large numbers of troops inside the country, and to move troops not involved in security efforts out of Iraq by 2008. As one reporter mentioned, the report does not use the word "victory," but former Secretary of State Baker commented that it also did not use other charged words, such as "civil war."

The merits of the study's suggestions will be much debated in the coming weeks, but the purpose of this mention of that report is not to debate those suggestions or engage in a political discussion. Rather, it's to recognize that the outcome of those debates will have implications for the economy and for particular sectors of the economy. Ahead of December's FOMC meeting, another source of uncertainty, this may add to a jittery mood in the markets.

Tomorrow's Economic and Earnings Releases

Thursday's economic releases begin with November's Monster Employment Index at 6:00, followed by the weekly Jobless Claims at 8:30. Information about the labor market won't be ended there, however, because Job Openings Labor Turn for October will be released at 10:00. I'm actually not familiar with this last report and it's not listed in my sources of economic releases, but Jim had it on his calendar, and his is usually more complete than mine.

The last two releases are the weekly Natural Gas Inventories at 10:30 and October's Consumer Credit, at 3:00.

Of course, many traders will be looking forward to Friday's November Employment Report rather than focusing on Thursday's economic releases.

Reporting companies include CMOS, FLE, IDT, JJZ, and NSM.

What about Tomorrow?

Last Wednesday, my prognosis of choppy trading behavior for Thursday, with prices mostly within Wednesday's range was exactly right . . . for the morning. Then buy programs sent indices higher again, although not much higher. Many indices produced doji or similar candles indicative of consolidation or uncertainty, so although I was wrong about the range, the tenor of the day was still in keeping with that expected consolidation or choppy behavior.

That's what we're getting again: choppy intraday behavior that produces candles indicative of consolidation or uncertainty. After months of typing that the SPX or some other index was just repeating its usual pattern as it climbed within its rising channel, I have to say now that most indices are repeating their usual pattern, but with a few minor stumbles. Those stumbles--the Dow's breakdown through its channel's support, the SPX's more-than-month-long struggle each time it tests midline resistance, the Nasdaq's heaviness, if that's the right word, that hampers it from climbing strongly off bottom support of its rising channel--bother me. They are not yet, however, strong evidence of a downturn in the making, although they certainly are making me pay attention to that possibility.

Actually, I think the strongest suggested possibility as of this moment is a period of disorganization that could chop both bulls and bears out of their positions.

Some time ago, I suggested that when prices next dropped to the bottom of the upward rising channels in which most indices were moving, that traders be careful about buying that dip, that they do so with smaller positions or more careful placement of their stops. I've been advising for a while that long-term bulls had nothing more to do than to ratchet up their stops, but now I'm not advising: I'm warning. I continue to warn bears, however, as there are heads-up signs to pay attention, but absolutely no confirmation yet that indices won't just take off to the upside again.

Tomorrow is more difficult than usual to predict, although I always seem to write during one of those sideways-to-sideways-up consolidation patterns. If such patterns are to play out as they have in the past, we should be due for another day or two at least of such consolidation. Such a period would also be true to form in front of important economic releases such as Friday's.

However, I'm not so certain that the consolidation will hold. Those scrambled intraday patterns on the SPX and Dow's intraday Keltner charts are of the type that can continue for a day, but then eventually see a strong breakout one direction or the other. Indices are near recent highs and so vulnerable ahead of Friday's numbers, and we've definitely seen some who want to take profits in the markets these days. If I'm seeing those signs, though, so are bears out there, bears who have been taught through the long months since July that they better step right back out of positions and quickly if they're not going to be skinned. For newbies: when bears step out of positions, they're forced to buy to cover, sending prices higher. In addition, tomorrow is the dreaded Thursday before opex week, a day when wild market action can occur.

Be ready for anything. I think it may be a case of who blinks first tomorrow or whether anyone blinks at all.

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

Burlington Nor.SantaFe - BNI - cls: 76.07 chg: -2.54 stop: 74.49*new*

Wow! You have to hand it to Merrill Lynch. Their timing was perfect. Shares of BNI and the rest of the railroad sector had just begun to breakout from a multi-week consolidation pattern on Monday. This morning before the bell MER yanked the carpet out from under the group with two downgrades. The analyst firm downgraded BNI and CNI from "buy" to a "neutral". Shares of BNI gapped open lower at $77.40 and closed with a 3.2% loss just above its simple 200-dma. The move forms a short-term bearish reversal, which is also very evident on the railroad sector index. More conservative traders may want to exit early to cut their losses now. We're not willing to give up yet with BNI still north of $75.00. However, we are going to raise our stop loss to $74.49.

Picked on December 04 at $ 77.26
Change since picked: - 1.19
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.5 million


B.P.Prudhoe Bay - BPT - close: 75.10 chg: -1.55 stop: 73.75*new*

BPT displayed some relative weakness on Wednesday. It is a mystery as to why the stock sold off. Shares spent most of the day consolidating sideways before plunging lower in the last hour of trading. The stock managed a very minor bounce from support near the $75 level. We would be very cautious here and we're raising our stop loss to $73.75. More conservative traders may want to use a tighter stop loss. Today's decline might just be profit taking so a bounce from $75 is technically a good place to look for a new entry point. Our target is the $79.75-80.00 range. The P&F chart is bullish with an $85 target.

Picked on November 29 at $ 75.25
Change since picked: - 0.15
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 219 thousand


Biosite - BSTE - close: 49.89 change: -0.05 stop: 47.49

BSTE is still trying to breakout past resistance at the $50 level. Traders bought the dip at $49.14 this morning but the stock was unable to hold its gains above the $50 level. Today's bounce from its rising 10-dma might be used as a new entry point but more conservative traders may want to wait for a rally past $50.53, which is above the bottom of its May gap down, which might be resistance. Our target is the $54.50-55.00 range.

Picked on December 05 at $ 50.05
Change since picked: - 0.06
Earnings Date 02/07/07 (unconfirmed)
Average Daily Volume = 263 thousand


Centex - CTX - close: 57.84 change: +1.08 stop: 52.45

Homebuilding stocks were the best performing sector today. The DJUSHB rose 2.1% and the HGX climbed 1.6%. Shares of CTX rallied 1.9% to close at a new seven-month high. The rally in builders was fueled by positive comments from the annual homebuilders convention held in New York today. Analysts and industry experts were predicting a low in the first half of 2007. We remain optimistic but we're not suggesting new positions at this time. We have two targets. Our conservative target is the $59.50-60.00 range. Our aggressive target is the $63.50-64.00 range. Be aware that the bottom of CTX's April 2006 gap down near $57.25 might be resistance as may the to of its gap near $60.00.

Picked on December 03 at $ 55.89
Change since picked: + 1.95
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.0 million


Diamond Offshore - DO - close: 80.92 change: +1.56 stop: 75.75

Oil service stocks out performed the rest of the energy sector today. Shares of DO managed a 1.9% rally and a close back above round-number resistance at the $80 level. This looks like another entry point for bullish positions. Our target is the $85.00-86.00 range near its early July high. The P&F chart points to a $92 target.

Picked on December 03 at $ 80.59
Change since picked: + 0.33
Earnings Date 01/26/07 (unconfirmed)
Average Daily Volume = 3.8 million


Enerplus - ERF - close: 45.90 change: -0.27 stop: 44.45 *new*

It looks like momentum in shares of ERF is beginning to wane. We are going to try and reduce our risk by raising the stop loss to $44.45. More conservative traders might want to put theirs closer to the $45 level, which should act as short-term support. Overall the trend in oil stocks is still bullish and today just looks like a pause in the rally. Our target is the $50.00-51.00 range.

Picked on November 29 at $ 46.01
Change since picked: - 0.11
Earnings Date 11/10/06 (confirmed)
Average Daily Volume = 973 thousand


EOG Resources - EOG - close: 69.35 change: +0.02 stop: 67.99

We are still concerned with the relative weakness in EOG. Today's failed rally above the $70 level doesn't help the bulls' case. Technicals are turning bearish. More conservative traders may want to exit early right here. We're going to give EOG one more day to show some strength or we'll close the play and look elsewhere.

Picked on November 29 at $ 72.06
Change since picked: - 2.71
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 3.6 million


General Dynamics - GD - cls: 75.40 chg: -0.36 stop: 71.90

Wednesday's pause in the market's rally was felt in shares of GD. The stock spent the session trading sideways. We don't see any changes from our previous updates. Our target is the $78.00-80.00 range. The Point & Figure chart points to an $82 target. More aggressive traders might want to aim higher than $80 (or $82) given the breakout in the sector index.

Picked on November 29 at $ 74.35
Change since picked: + 1.05
Earnings Date 01/24/07 (unconfirmed)
Average Daily Volume = 1.4 million


KLA-Tencor - KLAC - close: 51.92 chg: +0.34 stop: 49.49

Semiconductor stocks managed to perform better than the rest of the tech sectors. The SOX index rose 0.35% and shares of KLAC out performed its peers with a 0.65% gain. The stock looks poised to move higher. Currently our target is the $54.50-55.00 range.

Picked on November 14 at $ 50.81
Change since picked: + 1.03
Earnings Date 01/00/07 (unconfirmed)
Average Daily Volume = 3.9 million


KB Home - KBH - close: 53.49 change: +1.32 stop: 47.99

Positive comments about a potential bottom in the homebuilders helped lift shares of KBH to a 2.5% gain. Volume behind the move was above average, which is bullish. Shares are hitting new six-month highs and look poised to move higher. Our target is the $57.50-60.00 range. The P&F chart looks pretty bullish with a spread triple-top breakout buy signal with a $73 target.

Picked on December 03 at $ 52.04
Change since picked: + 1.45
Earnings Date 03/00/07 (unconfirmed)
Average Daily Volume = 2.7 million


L-3 Comm. - LLL - close: 83.45 change: +0.15 stop: 79.99

LLL is still slowing inching higher. Traders can choose to buy calls here or look for a possible dip back towards the $82 region, which should be new support. Our target is the $88.00-90.00 range. The Point & Figure chart forecasts a $104 target.

Picked on December 04 at $ 83.81
Change since picked: - 0.51
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 840 thousand


Lockheed Martin - LMT - cls: 92.28 change: -0.13 stop: 87.65

The rally in LMT also took a rest today. The stock spent the session trading sideways near $92. Traders can choose to buy calls here or wait for a potential dip back towards the $90 region, which should now be support. We have two targets. Our conservative target is the $94.85-95.00 range. Our more aggressive target is in the $99-100 range.

Picked on November 29 at $ 90.62
Change since picked: + 1.66
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.1 million


Merck Co. - MRK - close: 44.67 change: -0.34 stop: 43.29

Investors did a little profit taking in MRK today after the company reaffirmed its earnings guidance. The stock dipped toward the $44 level this morning but slowly began to climb from its lows. The $44 level is bolstered by technical support with its rising 50-dma. We would use the dip as a new entry point to buy calls. Our target is the $49.50-50.00 range.

Picked on December 03 at $ 45.06
Change since picked: - 0.39
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 10.3 million


Research In Motion - RIMM - cls: 135.44 chg: -0.51 stop: 129.99

RIMM spent another day consolidating sideways. The last couple of weeks have produced a pennant shaped consolidation with higher lows and lower highs. Normally these are neutral patterns and the stock can breakout either direction. Given the momentum in RIMM and the bullish trend in the major indices we suspect that RIMM will breakout higher. We are only aiming for the $142 level but aggressive traders may want to aim higher and use a rise past $137 as a new entry point to buy calls since it would be a bullish breakout from this pattern.

Picked on November 28 at $134.29
Change since picked: + 1.15
Earnings Date 12/21/06 (unconfirmed)
Average Daily Volume = 7.2 million


Sepracor - SEPR - close: 57.51 chg: +0.39 stop: 53.61

SEPR continues to inch higher. Shares rose 0.68% but volume came well below the daily average. We remain bullish but would not suggest new positions at this time. Our target for SEPR is the $59.50-60.00 range. In the news this morning SEPR issued a press release stating that studies have shown no significant difference in people's driving skills in the morning if they used SEPR's sleeping aid Lunesta the night before.

Picked on November 19 at $ 54.69
Change since picked: + 2.82
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 2.3 million


Thomas & Betts - TNB - close: 52.87 chg: -0.36 stop: 49.90

We don't see any changes from our previous updates. TNB, like many stocks that have been in rally mode, took a breather today. The stock is approaching short-term resistance at the $54.00 level. Our target is the $56.00-57.00.

Picked on November 12 at $ 51.36
Change since picked: + 1.51
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 471 thousand


Valero Energy - VLO - close: 56.28 change: +0.48 stop: 52.85

Oil refiner VLO displayed some relative strength with a 0.8% gain. However, the stock actually closed off its highs of the session and it might suggest more profit taking ahead. Some of our readers might want to watch for a dip towards $55 as a new entry point. Our target is the $59.50-60.00 range.

Picked on December 03 at $ 55.85
Change since picked: + 0.43
Earnings Date 01/30/07 (unconfirmed)
Average Daily Volume = 14.3 million

Put Updates

Genzymme - GENZ - close: 62.96 change: +0.01 stop: 66.05

Wednesday marked the second time in four days that shares of GENZ have managed a bounce from the $62.00 level. We suspect that the stock will see further strength tomorrow. Readers can watch for a failed rally near $64.00 (and its simple 10-dma) as a new entry point for puts. However, we would be somewhat cautious about opening new put plays with the major averages showing so much strength. More conservative traders may want to use a tighter stop loss. Our target is the $58.00-56.00 range.

Picked on December 03 at $ 62.77
Change since picked: + 0.19
Earnings Date 02/15/07 (unconfirmed)
Average Daily Volume = 1.9 million


NewMarket - NEU - close: 62.06 change: +0.07 stop: 62.25

We do not see any changes from our previous updates on NEU. Currently we're waiting for a breakdown under support. Our suggested entry point to open put plays is at $58.25. If triggered at $58.25 our target would be the $52.50-52.00 range.

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/29/07 (unconfirmed)
Average Daily Volume = 275 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.)


Caterpillar - CAT - close: 63.05 chg: +0.90 stop: n/a

CAT rose 1.44% and is nearing the November highs and technical resistance at its 50-dma. A breakout above these levels would be pretty bullish and give new hope for our strangle play. We are not suggesting new positions at this time. Our estimated cost was about $0.75. We want to exit if either options rises to $1.50. The options in our strangle are the December $65 call (CAT-LM) and the December $55 put (CAT-XK).

Picked on November 08 at $ 60.10
Change since picked: + 2.95
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 7.7 million


Blue Nile - NILE - cls: 34.69 chg: -0.23 stop: n/a

NILE produced another volatile session but managed to bounce from its lows and close with a 0.6% loss. 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).

Picked on October 29 at $ 38.92
Change since picked: - 4.23
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand

Dropped Calls

Petroleo Brasileiro - PBR - cls: 96.28 chg: -0.93 stop: 91.49

Target achieved. Some of the oil stocks hit some profit taking on Wednesday. PBR was one of them with a 0.9% decline. Yet before the downturn shares traded to $98.24. Our target was the $98-100 range.

Picked on November 29 at $ 91.51
Change since picked: + 4.77
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 2.6 million

Dropped Puts


Dropped Strangles


Trader's Corner

Directional Movement Index (DMI): When a Market Starts/Stops 'Trending'

My 'mailbag' this week included the following e-mail note: "You discussed in your weekend index column how the strong upward trend has been flattening out lately. I recall that there's some indicator that measures trend direction and strength. is this telling us anything recently?"

RESPONSE: I did discuss in my most recent Index Trader how the uptrend line/uptrend channels were intact in the broader measures of the market, namely the S&P 500 (SPX) and the Nasdaq Composite (COMP), but that the trend was starting to go more sideways in some of the narrower big cap stock indexes, namely the S&P 100 (OEX) and the Dow 30 (INDU). This is not so in the Nasdaq 100 (NDX), which is also maintaining its uptrend. By 'maintaining' an uptrend, I mean that the rising trendlines have NOT been pierced by a fall to below those lines, especially on a closing basis. However, the rate of upward momentum can slow significantly even though the dominant rising/up trendlines are intact.

Before I launch into a discussion of the indicator I'm sure you're referring to, the Directional Movement Index or DMI for short, I'll just mention that my last 'Index Trader' column (12/2) titled 'Slowing Upside Momentum', can be seen on the Option Investor Daily.com web site by clicking here (if connected online).

A well-known trader and inventor of some technical formulas relating to market trends, Welles Wilder, came up with several technical indicators that remain in widespread use. Most of his indicators, while developed in the commodities futures markets, are also relevant to stocks and stock indexes. A market is a market basically, rather in foreign exchange (FOREX), commodities or stock market instruments.

In most periods or on average, a market is in a strong/dominate up or down trend only a minority of days, weeks or months of the year. In Wilder's experience, most markets only trended strongly about a third of the time. The rest of the time there are a lot of minor ups and downs and there's a tendency for many back and forth price swings, which result in 'whipsaw' trends and trades.

The whipsaw periods are when the use of a 21-day moving average for the major market indexes like the S&P 500 (SPX), coupled with 3 percent moving average envelopes, 'work' fairly well in suggesting where to enter calls or puts. Dips of 3 percent under the 21-day moving average in broad sideways trends will often be areas that favor call purchases and rallies to 3 percent or so above the 21-day average will tend to be the upper trading extremes for major stock market indexes like the S&P 500, 100 and the Dow; a move to the upper envelope lines suggest potential put opportunities. With the Nasdaq, the moving average envelope extremes tend toward 4-5 percent.

Obviously the steady price advance of the last several months has been an example of a strongly trending market. In order to provide a statistical 'model' for the point when a market or stock can be said to begin trending strongly up or down, Wilder came up with a Directional Movement Index (DMI) indicator. The Dow 30 average's (INDU) daily chart below has the Directional Movement Index or DMI indicator 'applied' to it, with the DMI's 3 components of ADX, DMI plus and DMI minus which are labeled as DMI+ (or DI+) and DMI- (sometimes called just DI-). Most charting programs or sites will have the 'DMI' among their indicators:

1. ADX provides an indication of HOW MUCH directional movement (trend) is present in a market and provides a way to compare the trend in different markets. Sometimes a separate indicator called 'ADXR' rates the directional movement for a market on a scale of 0 to 100; however, we see this same scale on the right hand side of the ADX indicator below. For a major stock market index like SPX, an ADX reading above 40 shows a very strong trend. Volatile commodity markets can see ADX reach 70 or above. An ADX line below 20 is usually defined as a 'non-trending market.
2. DMI plus or DMI+ is a measure of positive or upward movement.
3. DMI minus or DMI- measures downward movement and its intensity.

The rising ADX line seen above, as suggested by the dashed (black) up trendline from August until its recent (late-November) downturn, is simply a mathematical way of showing a strong uptrend; the same is seen in the rising price trendline that connects the various reaction lows of INDU and seen above the DMI indicator. When the ADX line turns DOWN (as seen above) for a period of a few days to a couple of weeks, it is showing a trend that is the process of eroding on an intermediate-term basis.

To generate a buy or sell 'signal' of a certain 'threshold' trend strength, the DMI+ line must cross ABOVE the DMI- line or vice-versa; the DMI+ line crosses BELOW the DMI- line. This can happen for just brief periods such as occurred around mid-August, only to see the DMI+ line flip back above the DMI- line.

The recent sideways trends in DMI+ and DMI- also as seen above are suggesting the same thing as the recent downtrend in ADX except that the sideways movement is showing us that there is not yet enough of a price decline for DMI+ to cross BELOW DMI- and generate a sell 'signal'. The value of such a study or indicator is that it gives you some confirmation of a trend direction of sufficient intensity to provide some technical 'confirmation' that the trend has shifted in the favor of a trade you've already entered or are thinking of entering; or of course, the DMI+/DMI- crossover direction might warn you off from or OUT of a trade you're already in.

Since the basic directional movement 'system' is to buy on an upside or downside DMI+/DMI- 'crossover', there is of course the pitfall of getting 'whipsawed' in a crossover of a short duration.

Wilder qualified the crossover 'system' with a simple 'extreme point (trading) rule' which would have prevented entry on the short (put) side of DJX puts back in the short-lived downside DMI+ decline to under the DMI- line; this, back on August 10th. A close up view of this August (downside) crossover will be used below to demonstrate how the 'extreme point rule' would have operated for us.

The extreme point rule requires that on the day that the DMI+ and DMI- lines cross, you should note the 'extreme' point; i.e., either the intraday high in the case of an upside crossover or the intraday low in the case of a downside crossover (of DMI+ below DMI-). When DMI+ rises above the DMI-, the extreme price is that day's high. When DMI+ falls below DMI-, the extreme price is that day's low.

The extreme point is then used as the point at which you should implement the trade. For example, AFTER receiving a buy signal, you should wait until the price NEXT rises above the extreme point. This would have triggered an Index call purchase back in late-July (see below). AFTER receiving a sell signal (DMI+ line crosses below the DMI- line), you would wait until the low of that day is exceeded. The right hand red down arrow on the chart below shows the low the day when a sell 'signal' became in effect. However, the next day's low was not below that extreme.

Actually, the Dow's theoretical low the day after the downside sell 'signal' (on 8/11) was 2 points below the prior days low (of 8/10). Since 2 points is so practically nothing in INDU, it would be better in this kind of situation to check as to what the S&P was doing relative to ITS extreme point.

The low in the S&P 500 (SPX) on August 10th was 1261, so this was the SPX extreme point. SPX's low on the next day of 8/11 was 1262 so the 'extreme point rule' would have suggested NO put trade that day. After August 1lth, the DMI+ line flipped back above the DMI- line and there has not been a downside (sell indication) crossover since then. Therefore, a call purchase in DJX calls has been in ongoing since a price of 111.3; the Dow Index (DJX) closed today of course at 123.

The 'DMI' indicator is worth checking out to provide an indication of the longer-term trends and can be used with weekly charts also. Like any directional movement system there is a danger of getting 'whipsawed' on traders when the DMI+/DMI- upside or downside crossovers are used 'mechanically'. I use it mostly as a confirmation of trend direction and intensity. We can see trend direction shift just by looking at the charts, but the DMI indicator is a good check on what you're seeing in the charts.


Please send any technical and Index-related questions for answer in Trader's Corner articles to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

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


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