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Daily Newsletter, Saturday, 12/09/2006

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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

Confused?

Confusion appears to be the condition of the market since the Thanksgiving holiday. Friday was also the lowest volume day since Thanksgiving. We saw a week of very strong volatility and a sharp drop followed by a sharp rebound (11/27-12/1) and then a week of very low volatility. Investors bought the dip but then did not know what to do next. Each day brings another view of the economy and many times the opposite view from the day before. To say the market and traders in general were confused would be an understatement.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday started off with the Non-farm Payrolls and economists were greeted with a decent surprise. According to the report 132,000 jobs were created in November. That is +40,000 over the October gain of +92,000. The consensus estimates for +110,000 had been raised by some analysts after the strong comments from ADP earlier in the week. ADP, a large payroll processor, said on Wednesday as many as 158,000 new private sector jobs were created in November. The non-farm payroll report failed to reflect as many as the ADP survey but much better than consensus. The report also showed revisions to both the September and October numbers. October job gains were revised down by -13,000 from 92,000 to 79,000. The September gains were revised higher from 148,000 to 203,000 or +55,000. The net gain including the revisions was +174,000 jobs. Despite the job gains the unemployment rate rose to 4.5% from last months cycle low of 4.4%.

Jobs Table

The manufacturing sector lost -15,000 jobs and construction lost -15,000. The service sector showed a monster gain of +172,000 jobs, led by +43,000 professional jobs, +41,000 in education/healthcare and +31,000 in the hospitality sector. Retail additions were minimal, only +20,000, suggesting retailers were trying to get by with fewer to compensate for door buster specials. Since the US economy has morphed to a 70% service, 20% manufacturing, 10% other split the spike in service jobs is right inline. The better than expected jobs number failed to impress many analysts who point to the earlier than normal survey week as potentially skewing the numbers. The survey was done earlier in November to avoid the Thanksgiving holiday. Some analysts point to weakening indicators as November drew to a close and suggest the December report could be a shocker.

The report was strong enough to take the Fed rate cut expectations for March off the table once again. The markets reacted sharply to the announcement and saw their lows of the day by 10:AM. Bonds hit the skids with the yield on the ten-year note rocketing higher to close at a fresh two week high of 4.55%. Remember, it was just last week we were talking about the potential for a yield under 4% by January. That seems like a slim chance now with the Fed back in the picture. You see the jobs gains were right inline with the last six-month average of +138,000 and showed no further weakening that would have hastened a Fed change soon.

Ten-Year Note Yield Chart - 30 min

The December Fed meeting is next Tuesday and after this week's data we can expect them to maintain a tightening bias and that will help dampen the markets. Also putting a negative spin on next week's Fed meeting was comments from Treasury Secretary Paulson on CNBC. He was very upbeat about the economy saying he was confident it was on track for a sustainable rate of growth. He also reiterated his stance for a strong dollar and his thoughts about next week's China trip. He said everything you would expect from a Treasury Secretary but he brings a lot of credibility to the position from his prior life. His views are bullish for the market long term but negative for the Fed in the short term. With the Fed meeting next week the markets turned sour on the job news and failed to post any material gains.

The only other report on Friday was Consumer Sentiment, which fell to 90.2 from 92.1 and well below the consensus estimate of 92.5. The present conditions component rose to 108.2 from 106.0 but the expectations component fell sharply to 78.6 from 83.2. Evidently the constant talk about weakening economy and possible recession in 2007 is having a negative impact on consumers. Climbing gasoline prices from the fall lows and the weak housing market were given as factors.

Next week the two most important economic events are the FOMC meeting on Tuesday and the Consumer Price Index on Friday. There are a lot of other reports but they are mostly just filler and not normally market movers. The FOMC will be the focal point and it has the potential to be a negative turning point. Hopefully they will stick to the script and not deviate only two weeks before Christmas. Just repeating their prior statement would be best for the markets. Any further elaboration about risks weighted toward inflation would not be viewed positively. The markets need to remain focused on the potential for a rate cut regardless of how far in the future it might be. Should the focus revert back to worrying about a rate hike it could be detrimental to the markets. Personally I would rather have a booming economy and slightly higher rates but the housing market is showing signs of a rebound and rates need to remain low to feed that bounce.

Economic Calendar

Rumors were running rampant on Friday with Citicorp at the top of the list. There were rumors Citigroup might be announcing a breakup to release value by spinning off one of its units. There was also a rumor that the departing CFO from Bank of America, Al De Molina would be replacing Chuck Prince as CEO of Citigroup. It was also rumored that Citigroup CFO Sally Krawcheck was leaving. While Citigroup said they do not comment on rumors a spokesman did say Sally was not leaving. When asked if she would remain in her present position they declined comment. Citigroup traded 54 million shares and was the second highest volume on the NYSE. They normally trade 16 million shares. The rumors did push the stock to a new two-year high at $52.70 and I am sure many long time holders were happy to exit. Citigroup stock has provided lackluster performance for years.

Another rumor making the rounds was that Bank of America (BAC) was going to make an offer for Barclays (BCS). This sent the stock of Barclays to a new historic high over $61 before falling back to close at $58.25 (+2.46) as analysts scoffed at the rumors. BCS began to rise on Wednesday as the rumors began to slip out but Friday's intraday gain came after several noted analysts said the deal would be a good fit. A Merrill Lynch analyst, Edward Najarian, wrote to clients on Friday that Merrill believes BAC is very interested in acquiring Barclays. Both BAC and BCS declined to comment on the rumors. One analyst pointed out that the rumors are not likely to be true because the Chairman of Barclays, Matthew Barrett, had sold almost his entire stake of 2.3 million shares over the last several weeks and he would not have done that if BAC was talking to the board about an offer. However, even if BAC was not looking at BCS before last week all the good press about the synergies of a wedding might cause BAC to pop the question anyway. Time will tell.

Rating agency Fitch placed Ameriquest Mortgage on "rating watch evolving" due to the deteriorating condition of its subprime mortgage portfolio. Ameriquest's portfolio has shrink by -15% in loan volume and now has risen +9.4% in unpaid principal balances since their prior review. They currently have 437,000 loans for more than $71.2 billion. UBS recently said 8% of all subprime mortgages are in default nationwide, up from 4.5% last November. Fitch has also noted that numerous consumers have filed class action lawsuits against Ameriquest claiming improper loan procedures. I can see it now, "You loaned me more money than I could repay so I am suing you." Other public lenders under the subprime gun today include Accredited (LEND), Countrywide (CFC) and New Century (NEW). On Wednesday Ownit Mortgage closed their doors, an $8 billion casualty of the subprime collapse. Sebring Capital also closed its doors on Dec-1st but said it would honor any existing loan commitments if those loans could be closed by Dec-15th. Sebring had 325 employees and averaged about $250 million in loans per quarter, down from $450 million in 2003. Atlanta based NetBank closed its subprime operation in November. H&R Block is trying to find a takeout buyer for its Option One Mortgage Corp subprime business to stop the bleeding. Key Corp is also dumping its subprime Champion Mortgage business.

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Expedia (EXPE) surprised the markets with an announcement they would be buying back 30 million shares or roughly 10% of their outstanding shares. This sent the price of Expedia shares spiking to $21 from yesterday's close of $18.59. Expedia will make a tender offer between $18.50 and $22 between Dec-11th and Jan-10th. Moody's Investor Services immediately lowered its outlook on the company to negative saying this reduced Expedia's financial flexibility. Investors should wonder why Expedia can't find some place better to spend the money to increase earnings.

Ford was the largest volume mover on the NYSE with 195 million shares traded. Ford just announced $4.5 billion of 4.25% convertible bonds due in 2036 and investors are dumping the common stock in favor of the bonds. If Ford does manage a turnaround then the bonds can be converted. If they don't manage a recovery the bonds offer some level of security since they have priority over common stock. Those currently holding the stock will see their interests diluted at some point in the future by the debt conversion. The bonds can be converted at $9.20 per share. I guess those still holding the stock would be glad to have their stock diluted if it rises from the current $7.20 to more than $9.25 per share. The offering was so successful Ford doubled the initial amount. Ford already has 1.9 billion shares outstanding.

Two IPOs soared on their debut on Friday. Allegiant (ALGT) spiked +$7.10 or +39% to $25.10. Allegiant, based in Las Vegas, operates a low cost airline offering non-stop flights from smaller markets to popular vacation destinations. It also offers hotel rooms, rental cars and other travel services. Heelys (HLYS) jumped +11.60 or 55% to close at $32.60. Heelys makes a popular brand of shoes for kids with wheels in the heels allowing them to double as roller skates.

Chesapeake Energy surprised investors with a 30 million share offering which was snapped up by Deutsche Bank at $31.85 per share. DB said they would sell it at the public offering price of $32.15. That is a pretty small profit margin for DB but you can bet they placed most of it before it was announced. You can probably guess what price CHK fell to during the day, yes, $32.15. More than 31 million shares traded compared to the average of 7.5 million. I would be a buyer of CHK at this level not only because that 30 million share block at $32 should provide solid support but CHK is also moving to convert most of its 16.4 TCF of undeveloped and unproven reserves to proven and developed. When added to their 8.4 TCF of already proven reserves this will provide them nearly 25 TCFe to produce worth about $200 billion. This is a monster amount of gas and CHK already has 33,700 producing wells making them the 3rd largest independent US producer. They are currently valued ($14B) for something less than their 8.4 TCF of proved reserves because CHK has quietly grown from only 1.2 TCF in late 1999. They currently have more than a 10-year backlog of drilling prospects on the board. This is not a fast moving stock but one you could buy and forget. As gas prices continue to rise between now and 2010 you can bet CHK will rise as well. CHK has no foreign exposure and therefore is a safe play with little geopolitical risk. Gas prices will rise with mid double digit prices the norm by 2010. North America gas production has already peaked and begun its permanent decline.

CHK Chart - Weekly

The SOX continued to weaken as the list of chip problems grows. Over the last week National Semi (NSM), Altera (ALTR) and Xilinx (XLNX) led a list of companies posting weaker guidance for the current quarter. It appears the PC slump while waiting on Vista and a slowing in wireless sales has led to an inventory surplus. The SOX has stubbornly clung to its recent range at the top of a six-month high but that grip may be slipping. Next week Texas Instruments (TXN) will give us its mid quarter update and analysts have their fingers crossed. With comments from Motorola and Nokia making them nervous about wireless sales they fear TXN could disappoint. Others claim TXN is very diversified but has little exposure to the current PC sales slowdown. Either way the Texas Instruments update will be critical for any continued chip rally.

Oil prices imploded at the close to hit $62 after trading as high as $63.65 intraday. I know I use the term imploded more than I should but today's drop in oil definitely fit the term. After holding most of the day over $63.25 it took only about 45 min to make the plunge. With an OPEC meeting next Thursday and almost a guarantee of another production cut many traders were scratching their heads in disbelief. Personally I think it is simply profit taking with a little more than a week left on the January contract. After spiking from a low of $57.80 in late November the price had rebounded to $63 and has held in the $61.50-$63.50 range for more than a week. With no further gains Friday turned into a ka-ching for those who had been long. Comments out of Saudi on Thursday also removed confidence from traders. The Saudi ambassador to the US, Prince Turki al-Faisal, said current prices were "acceptable and imminently fair." This is an offset to the comments from the OPEC president that prices were not yet back in an acceptable range. Phil Flynn from Alaron Trading said the conflicting remarks were just to keep the market off balance and give Saudi the appearance of being friendly to the US concerns over prices. For whatever reason the price fell back to support with only 6 trading days left on the January contract. I suspect we will see another sell the news dip after the OPEC meeting just before the contract expires. That would be another buying opportunity for me. OPEC keeps saying there is a surplus of 100 million bbls in the market. While that sounds like a lot it is only a little more than the 85 million bbls we consume every day. Having an extra day's supply lying around does not sound like a bunch to me.

January Crude Oil Chart - 2 min

January Crude Oil Chart - Daily

Dow Transports Chart - Daily

The transports also took a header on the morning spike in oil prices and slipping consumer sentiment. We have a troubling pattern appearing on the TRAN chart that looks a lot like a head and shoulders. If the transports move below 4700 again it could be trouble for the broader market because of the economic doubt falling transports imply.

The Dow rocketed back to its resistance highs on Monday and then failed hold any new gains for the rest of the week. We saw opening spike to 12360 on Thursday to equal the all time high set back on Oct-22nd. Both highs were very short lived opening spikes and neither held for more than a few minutes. Both were followed by declines to a multi-day low in the following session. It appears there is a considerable amount of supply waiting at that 12350 level and conditions are worsening as December passes.

The Nasdaq has been weaker than the Dow and put in a lower high last week. With weakness in the chip sector we could see a further move down if Texas Instruments disappoints. Support remains 2400 with 14 trading days left in 2006.

The S&P-500 showed the least volatility of the three major indexes. After a major spike from 1390 to 1415 early this week it fought very hard to hold the high ground. 1410 appeared as initial support and that is where we closed on Friday. No harm, no foul but we are on the cliff edge once again.

S&P-500 Chart - Daily

Next week is expiration week and Thursday's decline could have been expiration related. However, with the FOMC meeting on Tuesday we could see quite a few positions being held on the hopes that the meeting produces a result favorable to those positions. After Friday's jobs report the odds of a favorable statement have slipped. That means anyone holding now is probably hoping for a more hawkish statement to push the markets lower. All of this is simply speculation but we need to be aware of potential potholes. My recommendations for last week were to remain long over 1405 and reverse to a short under 1400. I am going to change that to reverse to a short under 1405. That level was dip support on Friday morning so a break there next week could signal a sharper plunge. The biggest event for the week will be the FOMC meeting on Tuesday followed by the OPEC meeting on the 14th (Wednesday night for us) and the CPI on Friday. We are still a week or so away from the warning cycle for Q4 but that does not prevent anyone from confessing early to avoid the holidays. We are in the period of December where funds sometimes shuffle portfolios to offset losers by selling some winners. That could continue to dilute any positive news. Bottom line; don't just expect the market to continue blindly higher. Be prepared for range bound volatility over the next week.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
WFR EXPD None
  YHOO  
  YUM  

New Calls

MEMC Electronic - WFR - close: 42.40 change: +0.00 stop: 39.49

Company Description:
MEMC is a global leader in the manufacture and sale of wafers and related intermediate products to the semiconductor and solar industries. MEMC has been a pioneer in the design and development of wafer technologies over the past four decades. With R&D and manufacturing facilities in the U.S., Europe and Asia, MEMC enables the next generation of high performance semiconductor devices and solar cells. (source: company press release or website)

Why We Like It:
WFR is a semiconductor company that specializes in the solar energy industry. With everyone concerned about energy these days this seems to be a growing market. The stock has definitely been out performing some of its peers in the semiconductor sector. This past week WFR broke through resistance near $40.00 and then later some bullish analyst comments helped push WFR past the September highs. We see the dip on Thursday and Friday as a new entry point to buy calls. However, more patient traders might want to wait for a potential dip towards short-term support near its 10-dma and the $40 region, which would also be a good spot to consider new call plays. Our big concern here would be a sell-off in the NASDAQ or the SOX, even though WFR has been out performing it will probably struggle if there is a tech stock breakdown. Our target is the $47.50-50.00 range. The P&F chart is bullish with a $48 target.

Suggested Options:
We are suggesting the January calls. You, the individual trader, should decide which month and strike price best suits your trading style and risk for all of our plays.

BUY CALL JAN 40.00 WFR-AH open interest=7415 current ask $4.00
BUY CALL JAN 45.00 WFR-AI open interest=9245 current ask $1.45

Picked on December 10 at $ 42.40
Change since picked: + 0.00
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 4.4 million
 

New Puts

Expeditors Intl.- EXPD - close: 43.68 change: -0.42 stop: 46.05

Company Description:
Expeditors is a global logistics company headquartered in Seattle, Washington. The company employs trained professionals in 167 full-service offices, 58 satellite locations and 5 international service centers located on six continents linked into a seamless worldwide network through an integrated information management system. Services include air and ocean freight forwarding, vendor consolidation, customs clearance, marine insurance, distribution and other value added international logistics services. (source: company press release or website)

Why We Like It:
Transport stocks have been struggling somewhat. Oil prices have been trying to stage a comeback and when oil rises it puts pressure on transport companies' profits. Shares of EXPD have been slowly withering lower since the late October peak. The mid-November oversold bounce from the 200-dma has failed and now shares are breaking down under multiple levels of support. The technical indicators on the daily and weekly chart are bearish or they are quickly turning bearish. This is in contrast to the P&F chart, which is still bullish. Plus, the stock might have potential support with a trendline near $42.50-43.00 (see chart). However, we suspect that EXPD will continue lower and fall toward support near $40 (or worse). We're suggesting put plays with EXPD under $44.00. Our short-term target is the $40.15-40.00 range. More aggressive traders may want to aim for the August lows. FYI: We'd keep an eye on the transportation index, which is poised to breakdown under its 50-dma.

Suggested Options:
We are suggesting the January puts.

BUY PUT JAN 45.00 URP-MI open interest=2443 current ask $2.60
BUY PUT JAN 42.50 URP-MV open interest= 919 current ask $1.40
BUY PUT JAN 40.00 URP-MH open interest=1391 current ask $0.65

Picked on December 10 at $ 43.68
Change since picked: + 0.00
Earnings Date 02/06/07 (unconfirmed)
Average Daily Volume = 1.4 million

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Yahoo! Inc. - YHOO - close: 26.34 chg: -0.29 stop: 27.05

Company Description:
Yahoo! Inc. is a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Yahoo!'s mission is to connect people to their passions, their communities, and the world's knowledge. Yahoo! is headquartered in Sunnyvale, California. (source: company press release or website)

Why We Like It:
YHOO has been getting a lot of press lately with its restructuring plans and management shake up. Yet all the press has failed to stop the bleeding in its share price. The stock produced a clear bearish reversal in late November and now the stock appears to be near the end of a bearish head-and-shoulders pattern. Technicals are bearish and the P&F chart points to a $16 target. We are suggesting that readers wait for a breakdown under support near $26.00 and its 50-dma. Therefore we're suggesting a trigger to buy puts at $25.85. If triggered our target is the $22.65 level near the October low. More aggressive traders may want to aim lower.

Suggested Options:
We are suggesting the January puts. Our suggested trigger to open positions is at $25.85.

BUY PUT JAN 27.50 YHQ-MY open interest=47369 current ask $1.80
BUY PUT JAN 25.00 YHQ-ME open interest=65182 current ask $0.55

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million

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YUM Brands - YUM - close: 59.72 change: -1.36 stop: 60.51

Company Description:
Yum! Brands Inc., based in Louisville, Kentucky, is the world's largest restaurant company in terms of system restaurants with over 34,000 restaurants, which includes over 2,000 licensed restaurants, in more than 100 countries and territories. Four of the company's restaurant brands -- KFC, Pizza Hut, Taco Bell and Long John Silver's -- are the global leaders of the chicken, pizza, Mexican-style food and quick-service seafood categories respectively. (source: company press release or website)

Why We Like It:
A downgrade for YUM on Friday morning sent the stock reeling. Shares gapped down and closed with a 2.2% decline on big volume. Looking at the intraday chart you can see that the intraday rebound struggled to fill the gap and eventually turned lower again. Shares of YUM were already looking vulnerable with a potential bearish double-top pattern at the top of its significant run up from the July lows. The technical picture has turned bearish although the P&F chart is still bullish (for now). We are suggesting a trigger to buy puts at $58.49, which is under the 50-dma and under Friday's low. If triggered our target will be the 55.75-55.00 range.

Suggested Options:
We are suggesting the January put. Our suggested trigger to open plays is at $58.49.

BUY PUT JAN 60.00 YUM-ML open interest=1628 current ask $2.40
BUY PUT JAN 55.00 YUM-MK open interest=4436 current ask $0.70

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/07/07 (unconfirmed)
Average Daily Volume = 1.6 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

B.P.Prudhoe Bay - BPT - close: 75.50 chg: +0.05 stop: 73.75

Oil stocks didn't move much today as crude oil dipped lower late in the session. Oil services still managed to produce a decent gain. Shares of BPT managed an early gain but eventually gave most of it back. We remain bullish on the stock with shares above resistance at the $75.00 level. Actually the $75.00 level should now be support that is bolstered by additional support at its 200-dma near $74.70. We would use dips near $75.00 as new entry points. Our target is the $79.75-80.00 range. The P&F chart is bullish with an $85 target.

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

BUY CALL JAN 70.00 BPT-AN open interest= 20 current ask $6.60
BUY CALL JAN 75.00 BPT-AO open interest= 98 current ask $2.45
BUY CALL JAN 80.00 BPT-AP open interest=245 current ask $0.70

Picked on November 29 at $ 75.25
Change since picked: + 0.25
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 219 thousand

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Biosite - BSTE - close: 49.32 change: -0.45 stop: 47.95*new*

Biotech stocks edged lower on Friday but BSTE managed to under perform its peers with a 0.9% decline. The technical indicators are struggling from lack of upward momentum in the stock and many are beginning to turn bearish. However, BSTE still has a bullish trend of higher lows and if there is any sector or market strength next week we would expect a bullish breakout in BSTE above the $50 region. Unfortunately, with the major averages looking vulnerable to more selling we would be careful around BSTE. We're going to raise our stop loss to $47.95. More conservative traders might want to consider a stop under $48.50. Aggressive traders might want to buy a bounce from $49.00. We would suggest most traders wait for a rally past $50.25 before opening new call positions. Our target is the $54.50-55.00 range. FYI: The P&F chart points to a $65 target.

Suggested Options:
If BSTE rises past $50.25 we would suggest the January calls.

Picked on December 05 at $ 50.05
Change since picked: - 0.73
Earnings Date 02/07/07 (unconfirmed)
Average Daily Volume = 263 thousand

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Centex - CTX - close: 56.13 change: -0.79 stop: 53.99*new*

The homebuilders continued to sell-off on Friday after hitting new multi-week highs on Wednesday. The group still looks relatively bullish with the breakout early last week but the Thursday-Friday reversal is turning the short-term oscillators bearish. We would wait and watch for a bounce near its 10-dma or the $55.00 level as a new entry point to buy calls. Broken resistance near $55 should now offer support. We are going to try and reduce our risk by raising the stop loss to $53.99. Currently 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. FYI: The Point & Figure chart points to a $77 target.

Suggested Options:
If CTX bounces from the $55 level then we would use the January calls to open bullish positions.

Picked on December 03 at $ 55.89
Change since picked: + 0.24
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.0 million

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Diamond Offshore - DO - close: 81.10 change: +0.86 stop: 76.99*new*

Oil driller DO continues to show relative strength. The stock hit another new four-month high on Friday but shares trended lower from the opening high and closed with a 1% gain. We are bullish on oil and the oil stocks but both oil futures and the oil sectors might trade flat to down next week. We would watch for a dip toward $80.00 or maybe as low as $78.00 as a potential entry point to buy calls in DO again. Please note we're going to adjust our stop loss to $76.99. Our target is the $85.00-86.00 range near its early July high. The P&F chart points to a $92 target.

Suggested Options:
If DO dips and provides another entry point we'd use the January calls.

BUY CALL JAN 75.00 DO-AO open interest=3075 current ask $8.40
BUY CALL JAN 80.00 DO-AP open interest=9932 current ask $5.20
BUY CALL JAN 85.00 DO-AQ open interest=3478 current ask $2.85

Picked on December 03 at $ 80.59
Change since picked: + 0.51
Earnings Date 01/26/07 (unconfirmed)
Average Daily Volume = 3.8 million

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Enerplus - ERF - close: 46.06 change: +0.36 stop: 44.45

We remain concerned over ERF's lack of upward momentum. The stock broke out over resistance near $45 and the $46 levels a couple of weeks ago but has been unable to build on that move. The technical indicators are beginning to fail and roll over into bearish signals. We're going to keep the play open for now since ERF displayed some relative strength on Friday. However, traders may want to tighten their stop loss toward the $45.00 level. We would not suggest new bullish positions at this time. The Point & Figure chart is bullish and points to a $64 target but shows potential resistance near $52. We are aiming for a rise into the $50.00-51.00 range.

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

Picked on November 29 at $ 46.01
Change since picked: + 0.05
Earnings Date 11/10/06 (confirmed)
Average Daily Volume = 973 thousand

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General Dynamics - GD - cls: 74.14 chg: -0.59 stop: 73.39*new*

The rally in GD is struggling. Earlier this week the DFI defense index was breaking out to new all-time highs. The last couple of days has seen the sector see a little bit of profit taking. Unfortunately GD is under performing its peers and seeing a sharper pull back. The stock's bullish trend is in trouble. Technical indicators are turning or have already turned bearish. The drop round-number support/resistance at the $75 level was a bad sign for the bulls. Right now we're expecting a dip toward the simple 50-dma near $73.50. We're going to try and reduce some of our risk by raising the stop loss to $73.39 but given the waning momentum in the major averages more conservative traders might want to consider just exiting early right here. We're not suggesting new positions. Our target is the $78.00-80.00 range. The Point & Figure chart points to an $82 target.

Suggested Options:
We are not suggesting new positions in GD.

Picked on November 29 at $ 74.35
Change since picked: - 0.21
Earnings Date 01/24/07 (unconfirmed)
Average Daily Volume = 1.4 million

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KB Home - KBH - close: 51.54 change: -0.57 stop: 49.45

Warning! There could be trouble ahead for KBH. On Thursday we suggested that readers look for a dip toward the 10-dma, the 200-dma or the $50 level. The stock declined to its 10-dma before starting to bounce. We were somewhat encouraged by the rise in volume on the very late afternoon bounce from its lows. It looked like KBH had weathered the pull back and was ready to run higher again. Unfortunately we suspect he stock will see more profit taking on Monday. KBH tried to be sneaky and release some bad news after the closing bell on Friday hoping everyone had gone home and wouldn't notice. In the company's 8-K filing they said that, "The homebuilding industry in the United States is experiencing an increasingly challenging operating environment, which includes an oversupply of inventory, a decline in new home orders and sales prices and an increase in sales incentives required to generate new home orders." Furthermore the company went on to say that KBH..."anticipates that the aggregate non-cash charge associated with inventory impairments may range from $235 million to $285 million in the fourth quarter of its fiscal year ended November 30, 2006. Further, the non-cash charge related to the abandonment of certain land option contracts is expected to total approximately $90 million in the fourth quarter." KBH also addressed the issue of executive option grants and potential back dating with these comments..."On November 12, 2006, the Company announced that a subcommittee of the Audit and Compliance Committee and its independent legal counsel conducting an investigation into the Company's past stock option practices had concluded that the Company used incorrect measurement dates for financial reporting purposes for annual stock option grants for the fiscal years 1999 to 2005, and that the Company expected that the incremental non-cash compensation expense arising from these errors would not likely exceed an aggregate of $50 million, spread over the vesting periods of the options in question. The Company also announced that it expected an increased tax provision as a result of related tax issues. The Company stated that it was evaluating with its independent auditors whether a restatement of previously-filed financial statements would be required. The Company currently estimates that the total incremental non-cash compensation expense arising from the stock option matter is approximately $41 million..."

More conservative traders might want to try and exit early on Monday assuming the stock doesn't gap lower at the opening bell. There is still a chance that some of this has already been priced into the stock since investors knew that KBH was investigating the options issue. The best-case scenario we see would be a dip near $50.00. However, odds are probably leaning toward a bigger correction. If KBH breaks the $50 level then broken resistance near $47.50 is the next level of support. Needless to say we're not suggesting new positions.

Suggested Options:
We are not suggesting new positions in KBH.

Picked on December 03 at $ 52.04
Change since picked: - 0.50
Earnings Date 03/00/07 (unconfirmed)
Average Daily Volume = 2.7 million

---

L-3 Comm. - LLL - close: 82.82 change: -0.53 stop: 79.99

Shares of LLL are holding up relatively well. The stock spent most of last week consolidating the gains from Monday. Traders bought the dip on Friday morning near its rising 10-dm. We remain bullish on the stock given its breakout over resistance near $82.00. Traders can choose to buy the dip on Friday or wait for another dip next week closer to the $82 level, which as broken resistance should now act as support. Some of the short-term technical indicators are rolling over into bearish signals after four days of trading flat to down. Yet the P&F chart is still bullish and points to a $104 target. Our target is the $88.00-90.00 range.

Suggested Options:
We are suggesting the January calls.

BUY CALL JAN 80.00 LLL-AP open interest=2345 current ask $4.30
BUY CALL JAN 85.00 LLL-AQ open interest=3751 current ask $1.45
BUY CALL JAN 90.00 LLL-AR open interest=1803 current ask $0.35

Picked on December 04 at $ 83.81
Change since picked: - 0.99
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 840 thousand

---

Lockheed Martin - LMT - cls: 91.82 change: +0.18 stop: 87.65

LMT managed to out perform most of its peers in the defense sector. Traders bought the dip early on Friday morning near the rising 10-dma. We remain bullish on the stock with shares above $90.00 but want to remind readers to monitor their stops. LMT does appear to have a bearish divergence between price and some of its technical indicators. If the market or the defense sector continues to see profit taking next week then we'd look for a dip closer to the $90 level. More conservative traders may want to raise their stops. We have two targets. Our conservative target is the $94.85-95.00 range. Our more aggressive target is in the $99-100 range.

Suggested Options:
We are suggesting the January calls.

BUY CALL JAN 90.00 LMT-AR open interest=1564 current ask $3.70
BUY CALL JAN 95.00 LMT-AS open interest=2340 current ask $1.10

Picked on November 29 at $ 90.62
Change since picked: + 1.20
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.1 million

---

Sepracor - SEPR - close: 57.28 chg: +0.21 stop: 54.69*new*

After Monday's big spike higher, thanks to rumors that Pfizer might buy SEPR, shares of SEPR consolidated sideways in a $2.00 range. The upward trend is still intact and thus far traders are buying the dip near its 10-dma above $56. We note that volume has evaporated as the week worn on. Optimistically we'd like to see another step higher next week but SEPR's intraday chart suggest another dip toward the $56 level soon. We're going to try and reduce our risk by raising the stop loss to $54.69. We are not suggesting new plays at this time. Our target for SEPR is the $59.50-60.00 range.

Suggested Options:
We are not suggesting new plays in SEPR at this time.

Picked on November 19 at $ 54.69
Change since picked: + 2.59
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 2.3 million

---

Thomas & Betts - TNB - close: 52.82 chg: +0.23 stop: 49.90

TNB spent the whole week trading sideways in a relatively narrow range. The technical picture is still mixed with both buy and sell signals among the indicators. Thus far the Point & Figure chart is still bullish with a $77 target. The lack of upward momentum does put us on the defensive but so far TNB has maintained a bullish trend of higher lows. More conservative traders may want to tighten their stops toward the 200-dma near $50.66 or the 50-dma near $51.30. If you are looking for a new entry point consider a bounce near $52.00. The next challenge is resistance at the $54.00 level. Our target is the $56.00-57.00.

Suggested Options:
If TNB provides a new entry point we'd use the January calls.

Picked on November 12 at $ 51.36
Change since picked: + 1.46
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 471 thousand

---

Valero Energy - VLO - close: 54.91 change: -0.67 stop: 53.45

Red alert! VLO displayed some relative weakness on Friday and closed under its 100-dma, exponential 200-dma and the $55 level. The selling stopped on its 10-dma and VLO should have additional support at its October and November highs near $54.70. The action over the last few days looks like a short-term bearish reversal following the late November early December bullish breakout. It was that breakout that produced a strong triple-top breakout buy signal on its P&F chart, now with a $67 target. We remain bullish on oil stocks and VLO but short-term it looks like the bears are in control. Readers can choose to buy a rally back above the $55 level or look for a bounce near $54.70. If the $54.70 level breaks then the next level of support should be the $54.00 mark. A bounce from $54 would also make a potential entry point. Our target is the $59.50-60.00 range.

Suggested Options:
We are suggesting the January calls.

BUY CALL JAN 50.00 VLO-AJ open interest=13155 current ask $5.70
BUY CALL JAN 52.50 VLO-AX open interest= 5181 current ask $3.90
BUY CALL JAN 55.00 VLO-AK open interest=22899 current ask $2.40
BUY CALL JAN 57.50 VLO-AY open interest=16391 current ask $1.35
BUY CALL JAN 60.00 VLO-AL open interest=36412 current ask $0.70

Picked on December 03 at $ 55.85
Change since picked: - 0.94
Earnings Date 01/30/07 (unconfirmed)
Average Daily Volume = 14.3 million
 

Put Updates

Genzymme - GENZ - close: 62.24 change: +0.60 stop: 66.05

Friday turned out to be a volatile session for GENZ. The stock followed the same rocky path that the BTK biotech index produced with a big intraday rally that reversed midday. The only difference was that GENZ produced bigger swings and managed to close up 0.9%. It is interesting to note that the rally failed again near its 10-dma and in the $63.60-63.80 region. We remain bearish on GENZ but would probably look for a new decline under $62.00 before considering new put positions. The Point & Figure chart looks pretty bearish with a quadruple-bottom breakdown sell signal with a $51 target. Our target is the $58.00-56.00 range. More conservative traders may want to think about tightening their stops toward the $64 level.

Suggested Options:
If GENZ drops under the $62 level again we'd suggest the January puts.

Picked on December 03 at $ 62.77
Change since picked: - 0.53
Earnings Date 02/15/07 (unconfirmed)
Average Daily Volume = 1.9 million

---

NewMarket - NEU - close: 62.03 change: +0.76 stop: 62.25

We are still in a wait-and-see mode with NEU. A week ago the stock look poised to breakdown under a multi-month trendline of support and its 100-dma. Last Monday the markets rallied and NEU produced an oversold bounce. Since then the stock has been consolidating relatively sideways with a bearish trend of lower highs and lower lows. Shares are still at a pivotal spot where it will choose to continue the previous up trend or begin a new bearish trend lower. More aggressive traders may want to buy puts on a breakdown under $60 or its 100-dma (near 59.58). We want to see a drop under the early December low so we're suggesting a trigger to open positions at $58.25. If triggered our target will be the $53.50-52.50 range, which is an adjustment from our original target due to potential support at its rising 200-dma.

Suggested Options:
If triggered at $58.25, we are suggesting the January puts.

BUY PUT JAN 60.00 NEU-ML open interest=192 current ask $2.80
BUY PUT JAN 55.00 NEU-MK open interest= 75 current ask $1.35

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: 63.40 chg: +0.40 stop: n/a

We are down to our last five days with this strangle on CAT. It looks like the stock wants to climb higher with Friday's bullish breakout over its simple 50-dma. Unfortunately, the major market indices look like they want to go lower and if they do it could be the final nail in this strangle's coffin. We've been warning readers for weeks about CAT's lack of movement. For this play to have a chance of exiting at a profit CAT needs to trade above $66 or under $54 before Friday's close. We're not suggesting new positions. 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).

Suggested Options:
We are not suggesting new plays in CAT.

Picked on November 08 at $ 60.10
Change since picked: + 3.30
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 7.7 million

---

Blue Nile - NILE - cls: 33.32 chg: -0.52 stop: n/a

Shares of NILE continue to sell-off. The stock lost another 1.5% on Friday and closed back under its simple 200-dma. Shares look poised to hit new relative lows next week. Keep an eye on the put side of our strangle as it could be nearing our target soon. Aggressive traders may actually want to aim for more. 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 positions in NILE at this time.

Picked on October 29 at $ 38.92
Change since picked: - 5.60
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 

Dropped Calls

Burlington Nor.SantaFe - BNI - cls: 75.88 chg: -0.07 stop: 74.49

Unfortunately, Friday failed to help the railroad stocks establish any sort of trend. Shares of BNI have traded sideways in a narrow range for two and a half days while it hugs the simple 200-dma. The technical picture is mixed with various indicators suggesting both sell signals and buy signals. The P&F chart is still bearish and BNI has been unable to recover from Wednesday's bearish reversal. We are growing more worried about a potential bearish reversal in the major averages and with this in mind we're going to exit early our BNI play. More aggressive traders may want to keep the play open. We're going to exit here and just keep an eye on it for a new relative high over $79.

Picked on December 04 at $ 77.26
Change since picked: - 1.13
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.5 million

---

KLA-Tencor - KLAC - close: 51.06 chg: -0.44 stop: 49.90

We are throwing in the towel on KLAC. The stock and the semiconductor group have struggled over the past couple of weeks. The SOX index might be in the process of forming a bearish double-top pattern. The sector could turn around if Texas Instruments (TXN) has a positive mid-quarter update next week. However, we don't want to risk it. Shares of KLAC still look poised to drop toward the $50 level, where it should find support. Aggressive traders may want to keep the play open. We're opting for an early exit to avoid or limit any losses, especially now with the major averages looking vulnerable.

Picked on November 14 at $ 50.81
Change since picked: + 0.25
Earnings Date 01/00/07 (unconfirmed)
Average Daily Volume = 3.9 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Trader's Corner

Keltner Channels in a Trending Market

When attending a trading conference that included several new Option Investor subscribers, I realized that many had missed my previous articles on nested Keltner channels. I sometimes mention these channels in my Trader's Corner articles or Wednesday night Wraps, and new subscribers likely find such information confusing. Some attending the conference mentioned that they had never studied or used Keltner channels. That's not unusual: few in the trading world have. Articles discussing them prove few and far between.

Although new subscribers might need a primer on these channels, long-time readers have either long since set up Keltner channels on their own charts or decided that this charting tool doesn't fit their trading styles. I don't want to repeat the information from those old articles and bore long-time readers, so I thought this article should tackle a new slant that has been appropriate to the recent trading environment: using Keltner channels in a trending market and using them to determine whether the trend is still in place.

New subscribers might benefit from a brief review of Keltner channels, named for Charles Keltner. Keltner formulated these channels as a type of moving-average envelope. That's important when considering whether a market is a trending one, because moving averages can identify trending moves.

Since my articles are often written ahead of time, the charts may not be the most current ones. These aren't.

Annotated 30-Minute Chart of the Russell 2000 with 45-ema:

As long as the RUT kept producing 30-minute closes above that 45-ema and kept bouncing from it, traders were forewarned that the rally mode continued.

While the rally mode persisted, that 45-ema provided a benchmark for traders but not an upside target. That's where the Keltner channels come into play. One of the three nested channels I watch is built around a 45-ema. Charles Keltner formulated these channels with the envelopes spaced around a moving average by a multiple of the average true range. In the case of the 45-ema channel, the multiplier that I use is 3.

Annotated 30-Minute Chart of the RUT with One Keltner Channel:

Once a trend has been established, Keltner channel boundaries help set targets--upside ones in the course of a rally and downside ones when a decline is underway.

The tests of the 45-ema late 11/20 and early 11/21 resulted in a bounce to the outside Keltner channel boundary, where resistance was found. Twice, that upper channel location helped set potential upside targets, targets that were eventually met.

To review, Keltner channels have provided two tools for a trending market: determining whether a trend exists or persists and setting targets. They can provide other tools. Even in a trending market, it's useful to determine when support or resistance might be firming. This helps traders determine whether a trend's support or resistance might continue to hold or might break, or decide whether an upside or downside target is feasible. When two or more Keltner channels are nested on the same chart, that firming proves easier to discover.

Annotated Thirty-Minute Chart of the RUT, Two Keltner Channels:

The same principle works on longer-term charts and with three nested channels rather than two.

Annotated Three-Day Chart of the RUT:

Notice that the firming resistance did not stop the RUT from pushing higher, even though that resistance did basically hold on three-day closes.

However, something else had been holding, too: the support offered by the 9-ema, the thin red line on that chart. Although it had been breached by a few points on a few closes, so that the support wasn't perfect, the RUT had been mostly closing above that average or bouncing quickly back above it if there were minor breaches. That had been going on for months as May began. The RUT was trending over the intermediate term and not just on an intraday chart. Watching the RUT's action with respect to this support had shown that the trend was still intact.

That's one reason that, despite the firming resistance, the RUT was able to test it several times. The trend wouldn't be over until the RUT began consistently closing three-day periods below that average, then bouncing back from it when it rose to test it from the underside.

That began happening in May. A new trend had begun, a downtrend identified by prices closing beneath the red 9-ema on that three-day chart. Downside targets could be set at lower channel boundaries. The process was repeating, and, eventually, support could be seen thickening as channel lines lined up in June and July.

Was that what was happening when prices broke through the support of the 45-ema on Friday, November 24, in the pattern seen in the first charts at the beginning of this article?

Certainly, a downside target could have been set at the bottom channel line, a downside target that was simultaneously set and almost met during the same 30-minute period.

Annotated 30-Minute Chart of the Russell 2000's Downside Target:

These charts have illustrated the ways that Keltner charts can be used to identify a trend, set upside or downside targets as prices continue to bounce up from or back from a key moving average, and then determine when the trend might be weakening due to firming or softening of support or resistance.

Putting together all this information, what do Keltner channels show about the RUT as of noon Friday, December 08, 2006?

Annotated Daily Chart of the RUT:

The rally trend continues, but there's enough evidence here to urge protection of bullish profits if not to confirm that the trend is about to end. Keltner resistance lines are beginning to converge above the RUT's current position, but notice that those Keltner lines still slant upward, the blue and black rather strongly? That suggests that resistance is beginning to firm, but the lines haven't flattened enough to provide convincing evidence that the RUT will be repelled without at least reaching for the 809 level. It could be, as it's showing some Keltner-style bearish divergence. This is seen with each successive test of the upper black channel line since October. The first test broke prices strongly above that channel; the second, less strongly. That's Keltner-style bearish divergence. We have to factor this evidence together with what we know about the RUT's propensity to overrun targets. It looks as if the 801.55-809.40 zone is setting up as a zone for a potential short-term top, but the RUT can and does overrun such targets.

The conclusion? There's no conclusion yet except that the trend has not yet been broken, but that there is reason for bulls to be more cautious than they have need to have been for months about protecting profits while perhaps still allowing for the possibility of a continued move higher. Ratcheting stops higher, especially if there's an upside breakout out of the top channel, and letting the RUT's prices decide when the play is exited, is one tactic for a security with a chart like this.

Those who want to search the archives for more background information on Keltner channels can find my series on these channels in Trader's Corner articles on March 19, 2005, April 30, 2005, May 7, 2005, and May 21, 2005.
 

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

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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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