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Daily Newsletter, Wednesday, 12/20/2006

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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

Stir in a Little of This, a Little of That

Adventurous cooks sometimes add surprising ingredients to recipes, such as adding a cup of red wine to a chocolate cake recipe. Sometimes their creativity is rewarded; sometimes, not. As the morning began, the ingredients for a sweet confection for today's trading had been assembled. Then market watchers noticed some surprising ingredients and weren't sure what to make of the recipe. The cake rose in the oven, but then the beautiful chocolate layers collapsed.

Introduction

Ericsson's (ERIC) agreement to buy Redback Networks (RBAK) and the overnight rebound in the Asian markets were the leavening ingredients that were supposed to lift the markets this morning. JP Morgan's addition of General Electric (GE) to its Recommended Portfolio and Banc of America Securities' affirmation of Hewlett-Packard's (HPQ) buy rating and top-pick status sweetened the batter. So did Maxim Integrated Product's (MXIM) change in executive lineup. Dell's (DELL) naming of a new chief financial offer and President Bush's mid-morning conference were a little of "that," however, throwing in surprising ingredients. Sometimes such ingredients increase power of the leavening agent or just temper the sweetness, but FedEx's disappointing trimming of its third-quarter outlook had done some of its own tempering, too, and the leavening agents just couldn't work.

Among other details revealed in the press conference today, President Bush said that he would support a boost in the minimum wage paired with tax relief. This evidenced his professed willingness to work with the incoming Democratic Congress while adhering to his own agenda for the economy, too. He mentioned Social Security and immigration reform. He pointed to economic strengths he believes have been seen in the U.S, but also urged Americans to shop for the holidays. He also wants to permanently increase the size of the U.S. Army and Marines, he said today, with such a development perhaps adding to recent speculation that he intends to attack Iran before he leaves office.

President Bush followed through on his intentions to provide tax relief, signing a tax and trade bill that provided 20 tax breaks and brought forward trade benefits for developing countries. The bill also included protection for doctors from a large cut in Medicare payments.

Today's Wrap is lengthened again beyond the optimum, this time by company-related news. If you don't want to read the entire thing, you know the organization by now. Look at the charts and then skip to the "Tomorrow" section at the end.

The charts show that the mixture of events and news bites failed to please traders today.

Charts

Annotated Daily Chart of the SPX:

The SPX ended the day at Keltner support, also near the support at the day's low. One comes to the opinion after looking at the chart that only the closing bell saved the SPX from breaking through that support. That gives some credence to the idea that the tentative support might not hold, evidence that's perhaps backed by a look at the 30-minute chart. That chart shows a potential short-term downside target of 1421 and perhaps even 1419.

If the SPX bounces instead, resistance is layered near 1425, 1427 and then, stronger, near 1431, at least as of the close.

The Dow was also sinking toward its morning low as the closing bell sounded.

Annotated Daily Chart of the Dow:

The Dow's 15-minute Keltner chart suggests that 12,429-12,442 may be tested tomorrow, with potential short-term support at those levels. Unless the Dow plunges through that potential support, I would expect some kind of hesitation or perhaps even a bounce attempt. If that fails, the 30-minute chart suggests that 12,400-12,410 could be tested.

If the Dow bounces instead, first resistance for the morning is layered at 12,473, 12,486 and then, stronger at 12,499.

Bulls have been pushing at that former rising trendline for a while now, however, without being able to break through it. Unless they do so soon, the Dow may need another pullback to its 10-sma and perhaps even to its 30-sma to retest support. Bulls should assess whether they're willing to wait out such a test, if it should occur.

The tech stocks were slated to provide most of the leavening today, but they failed at that task, as evidenced by the Nasdaq's daily candle.

Annotated Daily Chart of the Nasdaq:

The Nasdaq's 15-minute Keltner chart sets a potential short-term downside target near 2,421 and the 30-minute chart, near 2,423. The support at those levels is already turning lower, weakening. However, the Nasdaq also has today's low just below to provide potential support.

If the Nasdaq should bounce first thing tomorrow, resistance is layered at 2,431 and then stronger, from 2,436-2,441.

As Jim Brown noted last night, last night's Semi Book-to-Bill report produced the fourth consecutive month that orders were less than shipments. SOX-component supposedly MXIM sweetened the day's mixture for the SOX as well as the markets in general. The company said its founding CEO would retire on the advice of his doctor, also relinquishing his place on the board. Separate appointments will be made for his CEO and chairman positions, with Tunc Doluca, a company employee since 1984, now set to become CEO. This news and today's bounce comes just a few months after MXIM received a delisting warning from the NASDAQ, when the stock was still in a choppy recovery period off its August low. The bounce punched MXIM up to the top of a descending trendline off its November high, but it couldn't break through that descending trendline and was destined to pull back off its day's high as some of that leavening power failed to work. MXIM closed up 1.32 points or 4.37 percent, but more than $0.80 off the day's high.

The SOX also pulled back from its day's high.

Annotated Daily Chart of the SOX:

The SOX may provide the first indication that the stalemate on the indices is breaking up. I noted last week and, I think, the week before that the river of averages below the SOX's current position would provide support strong enough that it would take either some chopping up and down to soften or else a strong plunge that pierces straight through it. Since then, we've seen the requisite bounce from that support and then some chopping away at that support when the bounce didn't get far. It will take a daily close below the neon-green 200-ema or above November's high to convince me that the SOX has chosen any direction, even a short-term one, but I would be watchful for one of those to happen any time now. Keltner evidence confirms my impression that these are the breakout levels to watch, both on the topside and the downside, but be prepared for a fake-out move that quickly reverses. My gut reaction has been that a breakout won't happen until after the holidays, but I think the minimum chopping-around period has now been fulfilled, so it could happen any time now.

Over the short-term, both 15- and 30-minute Keltner charts suggest that the SOX is more likely to head down than up first thing tomorrow, but perhaps not until after a first test of the 474.31 zone. The 15-minute chart sets a potential first downside target of 470; the 30-minute chart, 469. If the SOX should bounce and get past that 474.31 zone, it's still got resistance layered up to 476.34 and then at 479-480.

The RUT could be headed down for a retest of the 50-sma tomorrow, too, if technical analysis holds. It doesn't always. I, unlike some others, don't consider this a failure of technical analysis. Instead, I think it tells us something important about the markets: that big money funds and institutions are holding markets at certain levels for reasons we don't yet know. I think it tells us to be careful about any play or any assumption, that the climate isn't yet clear, and I personally believe that's important to know.

Annotated Daily Chart of the RUT:

For example, the RUT's RSI churns within a triangle shape, churning near the neutral 50-level. So far, that indicates indecision to me, and not a confirmation of the bearishness of the breakdown out of that rising wedge. That predisposes me to believe that, until such signs change, we're likely to see chop between the top of that former rising wedge and the rising aqua-colored 72-ema now at 765.04. If the RUT should turn lower tomorrow, however, and you're in short-term bearish positions, know ahead of time how you'll deal with a test of the 50-sma as that could prompt a bounce attempt.

The RUT's 15-minute Keltner chart showed prices caught between support and resistance, with resistance having only a slightly stronger look than support. If that support should hold, it's going to take a strong thrust up to break through resistance at 787-790, on 15- and 30-minute closes, but then the RUT sets a first upside target of 795. If support should break, an event given only a slightly higher probability by the Keltner evidence, a first downside target would be found near 781.50. Traders should be aware of potential support near the day's low, the top of the RUT's gap higher today. The 30-minute Keltner chart has already set a tentative target of 781, but gap support can be important.

The TRAN, the Dow Jones Transportation Index, has already spent two days meeting and exceeding downside targets on the 15-minute and 30-minute charts, which means that traders should begin watching for a potential bounce, although not necessarily expecting it. There's some danger about any assumption with this important index. It broke through and closed below its 200-sma today, but the TRAN, like the SOX and the RUT, can easily overrun intended targets.

Annotated Daily Chart of the TRAN:

The TRAN should be watched tomorrow, but expect potential support near its 200-sma or perhaps a little higher if it should drop. The TRAN's daily Keltner chart shows a possibility that the TRAN could sink to 4,534.40. As of the close of trading today, resistance was beginning to firm, too, however, leading to the conclusion that it's going to be tough for the TRAN to get much higher than its 10-sma on a bounce.

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Today's Developments

Perhaps the most important ingredient today was the overnight development in Asia. The rebound in Asian markets came as a result of the development Jim Brown noted in his Wrap last night: the government in Taiwan has said that it will reverse the announcement by the country's central bank that had set new rules for foreign investment. Jim said last night that the government's position was still unclear. It's still unclear to me whether the word "reversal" being used today means a complete reversal of all the rules the central bank was attempting to impose or only some. I don't want to merely rehash Jim's excellent observations in my Wrap tonight, so go to the archives to read Tuesday's Wrap if you'd like more background about the important ramifications of any such decision on all global markets.

The day's economic releases provided only a few dollops of interest. After a period of improvement in the Mortgage Bankers Association's weekly survey of mortgage application volume, the survey for the week ending December 15 showed a decline again. This was no minor decrease, either, but a 10.2-percent decline on a seasonally adjusted week-over-week basis. The decline was larger when unadjusted. However, the good news, if any was to be found, was that volume was 13.9 percent higher than the year-ago level.

Components of this number also fell by double-digit percentages on a week-over-week basis. The exception was the government component, which fell only 3.1 percent. Refinancing activity also fell as a component of total volume, down to 50.8 percent from its previous 52.6 percent. Four-week moving averages climbed, still influenced by the last couple of weeks, which had shown increases. Last week, the average contract interest rate for a fixed-rate 30-year mortgage had already climbed above 6 percent again, and this week, it increased to 6.10 percent. The DJUSHB, the Dow Jones U.S. Home Construction Index, dropped to 721.46 today, a minor decline below yesterday's 720.94 close, but the index looks as if it could slip back toward a test of the 710 level.

Some commentators expected today's crude inventories to be bullish for crude prices, with many other reasons being cited for bullishness in crude. Those reasons included continued difficulty with delivery of crude due to the fog in the Houston/Texas City ship channel. After having driven through a several-hundred-mile swath of Texas last night, I can stand witness that the fog was still present last night, at least.

The government reported a drop of 6.3 million barrels in crude inventories, a climb of 1.2 million barrels in distillate supplies and a climb of 1 million barrels in gasoline supplies. According to a Marketwatch.com analysis of the government's figures, crude inventories have dropped 12 million barrels in a month.

The American Petroleum Institute didn't see that same climb in distillates, however. The API said that crude inventories dropped 4.3 million barrels, distillates fell 1.4 million barrels, and gasoline supplies dropped 300,000 barrels. The Department of Energy and the API almost always disagree.

Crude prices ended at $63.69 according to my feed source, $0.23 above yesterday's close on futures for February delivery. The TRAN, the Dow Jones Transportation Index, proves sensitive to both crude and the economy, and the disappointing third-quarter outlook of TRAN-component FedEx (FDX) illustrates that sensitivity. FDX beat expectations for its second-quarter earnings, with an easing of crude prices helping the company to provide that earnings surprise, showing its sensitivity to crude prices. The company said that third-quarter earnings would be $1.20-1.35, below the $1.55 currently expected. Some consider this company a bellwether for the economy as it ships both for businesses and people, and the volume of its shipments is indicative of the health of the economy.

Much company-specific news has already been mentioned, but it was a day when company-related news garnered much attention. That included the news about Ericsson's (ERIC) agreement to buy Redback Networks (RBAK) at an 18 percent premium to yesterday's close. The news impacts the networking sector, too, because ERIC believes that the acquisition will allow it to better compete against Cisco (CSCO). ERIC closed at $40.56, down from yesterday's $40.62 close after opening higher. RBAK jumped, closing at $25.66 after yesterday's $21.17 close. CSCO managed a positive close at a closing level not seen since early 2004, but it did so with a red candle that moved down all day.

Another acquisition deal was announced. Texas Pacific Group and Apollo Management Group will buy Harrah's Entertainment (HET). Other M&A news was on the wires. Over the last months, much speculation has surrounded global building materials companies, and two more were in the news today. Arcelor Mittal (MT) will buy Mexico's Sicartsa from Grupo Villacero.

In other company-specific news, Ford (F) received another upgrade today, this to a hold rating from its previous sell rating at KeyBanc Capital. Investors should hold what they've already sold? Some apparently took the upgrade to mean buy back what you sold, with F closing above its 10-sma for the first time in about a month.

After hours, Merck (MRK) announced that the FDA had approved its IVANZ for prevention of surgical-site infection, a new indication for the drug.

Bed, Bath and Beyond (BBY) announced a $1 billion buyback plan, but also announced that an SEC probe is ongoing. Nike (NKE) said strength in some brands and a tax benefit helped it overcome higher raw-material costs, currency fluctuations and uncertain spending by consumers to post an 8-percent rise in quarterly profit. As this report was prepared, the stock had dropped in after-hours trading, perhaps amid concern that it was losing market share as the preferences in shoe styles changes.

Tomorrow's Economic and Earnings Releases

Tomorrow offers a full economic schedule, but the most important release of the day may be the last one: the December Philly Fed Manufacturing Survey at noon. Expectations for this are a drop to 4.0 from the previous 5.1. The third-quarter's GDP will be released earlier, but, as Jim Brown mentioned this weekend, this will be the final revision for this number. Unless there's a big surprise, it should not be a market mover. I have sometimes found that markets tend to hesitate before such a release, just to make sure there's no surprise, but this one will be released at 8:30 tomorrow morning. Any hesitation would be in the future's market and not in the cash market.

Other releases include the weekly jobless claims number, also at 8:30; the Chicago Fed National Activity Index for November, at 10:00, the Conference Board Leading Indicators for November at 10:00; and Mass Layoffs for November at 10:00. Although the Conference Board's release is termed "Leading Indicators," most of the information provided in this release can be predicted.

Natural gas inventories will come at 10:30, and these could be important. Natural gas futures dove today.

Companies reporting tomorrow include CAG, GIS, RHT, RIMM, RAD, SLR and WOR.

What about Tomorrow?

Before I discuss what I think might happen tomorrow, that discussion has to be put into the context of my overall outlook. For the last several weeks, I've been changing my stance from the it's-just-the-usual-bullish-climb-and-consolidate-action advisories to increasingly strong warnings about protecting bullish gains. I had thought the markets were likely entering a period of disorganization that might extend longer than the typical week-long consolidation we'd been seeing up until then. I began pointing out some signs that I felt were disturbing, or should be, to bulls, while still warning bears that I didn't see convincing signs of a trend change.

Last week, I warned that the stalemate that had been going on might break as early as the next day, and it did, but I'm not sure that the choppy consolidation is finished. I think that the consolidation zones may instead be expanding, and that's dangerous for bulls and bears. Chop within a wide-but-as-yet-undefined zone can stop out both bulls and bears just before markets reverse and head the other direction.

Some would quibble with my definition of this as chop. Didn't the Dow climb to yet-another intraday high today? Didn't the OEX hit another six-year high on Monday? Didn't the SPX, too, on Friday? Granted, that all happened, but market action is marked by some indices chopping between a key moving-higher moving average and a moving-higher midline of a rising price channel, mostly moving higher but with small-bodied candles marking indecision. Others, like the SOX, are more clearly chopping around. So, to me, it all looks like dangerous and choppy action.

Whether this is a typical topping-out kind of move or a need for a prolonged period in which gains since 2003 need to be consolidated, I'm not sure. The VIX's action certainly warns that it could be the former, but could it also be warning of a prolonged and dreaded (for directional traders) period of consolidation? We're going to have to wait to see.

Bulls, however, should not be waiting for formulate their get-out plans. Some may have already begun laddering out of positions, and I don't think that's a bad thing. Whenever traders have massive gains, it's always a good idea to exit enough positions to lock in a profit, perhaps letting the rest of the now-free positions run with stops being ratcheted up as prices run higher. If they do. If you're in long-term bullish positions and you're sitting on big gains, you might consider laddering out of some positions, beginning to lock in some of your profits.

So, with that out of the way, what about tomorrow?

Tomorrow, before trade opens, traders should take a look at the overnight action in Asian and then take a look at our futures' reaction to that action. Although that's not a fail-safe exercise, it can sometimes tell you much about the tenor in the markets. If you're bullish and Asian markets have rolled over, you want our futures to have held up as they did so. That's no guarantee that cash markets will hold up all day, but it at least assures you that some effort is being made to prop them up into the open.

Watch the TRAN and the SOX when trading opens. Both ended the day at important levels, with the TRAN showing that it's short-term oversold. Don't bet on the Nasdaq going too far one direction if the SOX is going the opposite, and don't bet on the SPX, OEX or Dow going too far one direction if the TRAN is going the opposite.

As detailed above, some indices show signs that they're likely to head lower toward stronger support, but that support is not too far below in some cases and remember that noon Philly Fed? What if the support or resistance detailed above is hit or approached just before the release of the Philly Fed? You'd better have a plan in mind tonight about how you will handle this occurrence. The release could be market moving and, in a light-volume environment, markets can really move. Have a plan. Be prepared.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None SHLD None

New Calls

None today.
 

New Puts

Sears Holding - SHLD - cls: 170.51 chg: -0.94 stop: 173.05

Company Description:
Sears Holdings Corporation is the nation's third largest broadline retailer, with approximately $55 billion in annual revenues, and with approximately 3,800 full-line and specialty retail stores in the United States and Canada. Sears Holdings is the leading home appliance retailer as well as a leader in tools, lawn and garden, home electronics and automotive repair and maintenance. (source: company press release or website)

Why We Like It:
The rally in the retail sector has reversed and the RLX retail index looks poised to break support at the 500 level and its rising 50-dma. SHLD is showing a similar short-term decline and bearish rollover in its weekly technicals. Aggressive traders might want to consider positions now after today's failed rally under SHLD's 50-dma or look for a drop under Tuesday's low near $169.28. We are suggesting a trigger to buy puts at $167.90, which is under support at the $168.00 level. If triggered at $167.90 our target is the $162.00-160.00 range. Keep an eye on the simple 100-dma near $162.40, which might offer some support.

Suggested Options:
We are suggesting the January puts although February puts would also work well. You, the individual trader, should determine which month and strike price best suits your trading style and risk.

BUY PUT JAN 175.00 KDU-MO open interest=6495 current ask $6.60
BUY PUT JAN 170.00 KDU-MN open interest=5092 current ask $3.80
BUY PUT JAN 165.00 KDU-MM open interest=6054 current ask $2.00

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/15/07 (unconfirmed)
Average Daily Volume = 1.9 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Lockheed Martin - LMT - cls: 91.60 change: -0.25 stop: 88.99

Defense stocks continued to inch higher on Wednesday but the market weakness appeared to put a lid on LMT's advance. The lackluster session for LMT is a bit of a surprise after the company announced another $57 million in military deals today. We remain bullish with the stock above $90.00 but more conservative traders may want to tighten 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.

Picked on November 29 at $ 90.62
Change since picked: + 0.98
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.1 million

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Sepracor - SEPR - close: 57.37 chg: -0.09 stop: 55.99

We still don't see any changes from our previous updates. SEPR continues to bounce around the $56-58 trading range. More conservative traders might want to exit early now and try and lock in some time of gain. We're not suggesting new positions at this time. Our target for SEPR is the $59.50-60.00 range.

Picked on November 19 at $ 54.69
Change since picked: + 2.68
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 2.3 million

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MEMC Electronic - WFR - close: 41.78 change: +0.31 stop: 39.95

The situation with WFR is not looking very healthy. Shares tried to bounce this morning but failed multiple times near $42.75. The result was a failed-rally session. WFR appears headed for the $40.00 level and the technical picture is turning bearish. More conservative traders may just want to bail out now since the NASDAQ and technology stocks seems to be the investor target for profit taking right now. We're not suggesting new positions at this time.

Picked on December 10 at $ 42.40
Change since picked: - 0.62
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 4.4 million
 

Put Updates

Intuitive Surg. - ISRG - cls: 100.44 change: -1.06 stop: 107.51

ISRG slipped just over 1% to close near round-number support at the $100 level. The technicals continue to deteriorate and the MACD on the daily chart produced a new sell signal yesterday. More conservative traders might want to consider a tighter stop loss. Our target is the $96.00-95.00 range. We do not want to hold over the early February earnings report.

Picked on December 18 at $102.05
Change since picked: - 1.61
Earnings Date 02/01/07 (unconfirmed)
Average Daily Volume = 938 thousand

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Mohawk Industries - MHK - cls: 74.94 chg: +0.24 stop: 79.01

MHK is trying to bounce from technical support near its 200-dma. If you are looking for a new entry point consider a new relative low under $74.00 or a failed rally near $76.00 or $77.00. Our target is the $70.75-70.00 range.

Picked on December 17 at $ 76.02
Change since picked: - 1.08
Earnings Date 02/22/07 (unconfirmed)
Average Daily Volume = 600 thousand

---

3M Co. - MMM - close: 78.83 change: +0.72 stop: 80.01

MMM managed a minor oversold bounce today but the rebound ran out of gas near its 50-dma. Shares remain under their three-week trendline of lower highs. Traders can choose to open positions now or look for another drop below $78.00 as a new entry point. More conservative traders may wan to wait for a decline under $77.00 since MMM still has potential support near its 200-dma and entries above the 200-dma should be considered more aggressive. Our target is going to be the $72.50-70.00 range. The P&F chart is more bearish with a $47 target.

Picked on December 17 at $ 78.31
Change since picked: + 0.52
Earnings Date 01/19/07 (unconfirmed)
Average Daily Volume = 2.8 million

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NewMarket - NEU - close: 57.19 change: -0.47 stop: 62.01

NEU continues to sink under a steady trend of lower highs. The stock might have technical support at its rising 200-dma. Therefore we are adjusting our target from $54.00-53.00 to $55.00-54.00. FYI: The P&F chart points to a $51 target. Plus, short-interest is about 7% of the 14.8 million-share float, which is probably enough to raise the risk of a short squeeze if NEU abruptly turns higher.

Picked on December 14 at $ 59.11
Change since picked: - 1.92
Earnings Date 01/29/07 (unconfirmed)
Average Daily Volume = 275 thousand

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Yahoo! Inc. - YHOO - close: 25.59 chg: +0.82 stop: 27.05

Our put play in YHOO is now open. The stock has finally produced a convincing breakdown under support near $26.00 and its 50-dma. Our suggested entry point to buy puts was at $25.85. Now that the play is open our target is the $22.65 level near the October low. More aggressive traders may want to aim lower. FYI: It might be worth noting that short interest is about 6.9% of YHOO's 1.2 billion share float.

Picked on December 20 at $ 25.85
Change since picked: - 0.26
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million

---

YUM Brands - YUM - close: 59.05 change: +0.10 stop: 60.51

There is little change in YUM or our outlook on the stock. The oversold bounce looks like it's trying to reach the $60.00 level, which should be overhead resistance supported by its 50-dma. We would wait and watch for a failed rally under $60 before considering new put positions. More conservative traders may want to tighten their stops toward $60.00. Our target is the $55.75-55.00 range.

Picked on December 12 at $ 58.49
Change since picked: + 0.56
Earnings Date 02/07/07 (unconfirmed)
Average Daily Volume = 1.6 million
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

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Blue Nile - NILE - cls: 35.61 chg: +0.20 stop: n/a

NILE continues to follow in the shadow of TIF, which is still in rebound mode. Shares of NILE are nearing short-term overhead resistance $35.60-36.00 and its 50-dma. We are not suggesting new strangle positions in NILE at this time. Keep in mind that we only have about five weeks before January options expire. More conservative traders may want to think about an early exit to salvage some capital if NILE doesn't begin to move soon. 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: - 3.31
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 

Dropped Calls

Baker Hughes - BHI - close: 75.90 change: -0.90 stop: 73.95

We are suggesting an early exit in BHI. The stock lost 1.1% and produced a failed rally while slipping closer toward support near $75.00 and its 200-dma near $74.00. There is a chance that BHI will bounce from $74 or $75 but we don't want to risk it. The oversold bounce in the OIX oil index and OSX oil services index on Tuesday failed to see any follow through today thanks to a 4% decline in natural gas. It appears that the energy sector is poised for more profit taking.

Picked on December 14 at $ 76.90
Change since picked: - 1.00
Earnings Date 02/09/07 (unconfirmed)
Average Daily Volume = 4.8 million

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NII Holdings - NIHD - close: 65.11 chg: -1.16 stop: 66.99

NIHD failed to see any bounce on Wednesday and the stock is poised to breakdown under support near $65.00 and its 50-dma. So far we've been waiting for a breakout over resistance at $70.00 but it doesn't look like it is going to happen any time soon. Nimble traders may want to consider puts on any further decline and target potential support near $60.

Picked on December xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/22/07 (unconfirmed)
Average Daily Volume = 1.6 million
 

Dropped Puts

Expeditors Intl.- EXPD - close: 40.94 chg: -0.64 stop: 45.05

Target achieved. Federal Express (FDX) issued a profit warning today and the news sent the Dow Jones Transportation index below technical support at its 200-dma. Shares of EXPD reacted with an intraday dip to $40.14. Our target was the $40.15-40.00 range. More aggressive traders may want to aim for the August lows.

Picked on December 10 at $ 43.68
Change since picked: - 2.74
Earnings Date 02/06/07 (unconfirmed)
Average Daily Volume = 1.4 million

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Potash - POT - close: 140.70 change: +4.66 stop: 140.01

We have been stopped out of POT at $140.01. Our aggressive put play in the volatile shares of POT did not pan out for us. The decline last week and failed rally under $140 now looks like a bear trap. We could not find any specific news to account for POT's 3.4% gain today, which was powered by above average volume.

Picked on December 18 at $134.67
Change since picked: + 6.03
Earnings Date 01/24/07 (unconfirmed)
Average Daily Volume = 957 thousand
 

Dropped Strangles

None
 


Trader's Corner

Concepts of Open Interest in Options

This week's mail brought this query from one of our Option Investor subscribers. This mail from my inbox seemed like a good topic to refresh the old knowledge bank with our readers. It may be also that my brain is on low partial shut-down holiday mode, but the topic is one that provides some useful information or a reminder to all us option traders:

"Hello Leigh, love reading your column. My question is on open interest. I've done some reading on it buy I can't find exactly what I'm looking for. Here are my questions:

1. How does volume impact open interest?
2. Can I tell if the Open Int is short or long the position?
3. Can I tell if the Vol is short or long the position?
4. What do the different levels of open interest tell you about what traders are expecting the underlying stock/index to do (for example 'max pain' or what could I discern from a large open interest 20 points above or below where the SPX is currently trading)?"

RESPONSE:
Well, of course, not for you so much but to cover all the bases, the DEFINITION of Open Interest (OI) is the number of outstanding option contracts in a particular option class or series; you also see OI quoted for the total of outstanding contracts for ALL index or all equities options, or both together. Open Interest is the total number of options that are not closed or delivered on a particular day, hence the term 'open'. [OI also pertains to the total contracts open or outstanding for a particular (month's) futures contract or for ALL contracts, such as for the S&P stock index futures.]

An option example:
Day 1: 5 new calls bought, 5 newly sold; Volume = 5; Open positions or Open 'Interest' = 5
Day 2: 10 new calls bought, 10 are new sells (shorts); Volume = 15; OI = 15 (rising volume, rising OI)
Day 3: 3 new calls are bought; 3 are newly sold; Volume = 3, OI = 18 (falling volume, rising OI)
Day 4: 10 new calls bought; seller is exiting 10 calls; Volume = 10; OI = 8 (rising volume, falling OI)

Question 1: How does volume impact open interest?

Volume doesn't 'impact' Open Interest directly. Trading volume is of course always relative to the average or recent trading volume of the option in question. We want to know if today's volume is large or small relative to what has come before. Mostly, in technical analysis terms, volume will be looked at in terms of the price TREND. In a technically 'strong' trend, volume should expand in the DIRECTION of the price trend. But Open Interest also has a relationship to volume. Volume and Open Interest 'should' or will tend to move in SAME direction, as suggested below in the rules relating to the price trend.

In an uptrend, we expect volume to increase with prices. In a downtrend we anticipate that volume will increase on declining days, at least on balance. A large percentage change in price that's accompanied by larger than normal trading volume is a good indication of market strength in the direction of the change. Conversely, a large percentage increase/decrease in price accompanied by a relatively (relative to the prior average daily volume) low small trading volume is less likely to indicate a new price direction. In fact, it might indicate a possible reversal in the trend.

There are some rules of thumb that have been seen to have validity over the years for BOTH volume and Open Interest (OI):

PRICE...VOLUME...OI...TREND
Rising...Up......Up...Strong
Rising...Dn......Dn...Weak

Prices in an uptrend, with daily Volume and OI rising is interpreted as new money coming into the market (reflecting new buyers) and is considered bullish. If however, prices are rising on falling volume with Open Interest also declining, short sellers are assumed to be covering their positions and causing the rally. Money is therefore leaving the instrument in question and is considered bearish.

PRICE...VOLUME...OI...TREND
Falling..Up......Up...Weak
Falling..Dn......Dn...Reversal potential**

If prices are in a downtrend on increasing volume and open interest is on the rise, technical type traders figure that new money is coming into the market, showing aggressive new shorting. This scenario then suggests a continuation of a downtrend and a bearish condition.

**Lastly, if the volume trend and total open interest is declining along with prices, the decline is likely to being caused by disgruntled long position holders liquidating their positions. Technicians view this scenario as one of a declining trend but also being a 'strong' candidate for an upside reversal at some point, as the downtrend will end once all the sellers have sold their positions.

SUMMARY: OPEN INTEREST
Bullish: Increasing OI in a rising trend
Bearish: Declining OI in a rising market
Bearish: Increasing OI in a falling trend
Bullish: Declining OI in a falling market (potential)

When open interest is high at a market top, relative to what the average OI has been over the course of the trend and then prices fall dramatically, this situation is suggestive of a TOP, suggesting that all of the long position holders that bought near the top of the market are now in a loss position; and their panic will keep prices under significant pressure.

(Subscriber) Question #2:
Can I tell if the Open Interest is short or long the position?
NO.
When you are looking at the total open interest of an option, there is no way of knowing whether the options were bought or sold, which is probably why many option traders ignore open interest altogether. However, OI does provide some key or ancillary information as already discussed.

The question was not asked here, but one way to use OI is to look at it relative to the Volume of options traded. When the volume exceeds the existing OI on a given day, this suggests that trading in that option was exceptionally high that day. OI can help you determine whether there is unusually high or low volume for any particular option.

Open Interest (OI) also of course gives you key information regarding the liquidity of an option. If there is no or very little OI for an option, there is or a very limited secondary 'market' for that option. When options have a large OI, it means they have a large number of buyers and sellers and an active secondary market will increase the odds of getting option orders filled at good prices. So, all other things being equal, the bigger the OI, the easier it will be to trade that option at a reasonable spread between the Bid and Ask.

(Subscriber) Question #3:
Can I tell if the Volume is short or long the position?
NO

(Subscriber) Question #4:
What do the different levels of open interest tell you about what traders are expecting the underlying stock/index to do (for example 'max pain' or what could I discern from a large open interest 20 points above or below where the SPX is currently trading)?"

There's not a lot that a large Open Interest can tell you when it's well above or below the current level of the underlying index in the case of the S&P 500 (SPX), except that traders are anticipating a large move before expiration.

Martin Pring, a well-known technical analyst, wrote a good SUMMARY of what Open Interest can possibly 'tell' us about the future price direction as follows (some points are all/partial repeats):
1. If prices are rising and Open Interest (OI) is increasing at a rate faster than its prior 1-2-5 year trend, this is a bullish sign. More participants are entering the market, involving additional buying, and any purchases are generally aggressive in nature. (But who has these averages? Not I! Not usually anyway)
2. If the OI numbers flatten following a rising trend in both price and OI, take this as a warning sign of an impending top.
3. High OI at market tops is a bearish signal if the price drop is sudden, since this will force many 'weak' longs to liquidate. Occasionally, such conditions set off a self-feeding, downward spiral.
4. An unusually high or record OI in a bull market is a danger signal. When a rising trend of OI begins to reverse, expect a bear trend to get underway.
5. A breakout from a 'trading range' will be much stronger if OI rises during the consolidation. This is because many traders will be caught on the wrong side of the market when the breakout finally takes place. When the price moves out of the trading range, these traders are forced to abandon their positions. It is possible to take this rule one step further and say the greater the rise in open interest during the consolidation, the greater the potential for the subsequent move.
6. Rising prices and a decline in OI at a rate greater than the past 1-2-5 year average is bearish. This market condition develops because short covering and not fundamental demand is fueling the rising price trend. In these circumstances money is flowing out of the market. Consequently, when the short covering has run its course, prices will decline.
7. If prices are declining and the OI rises more than you are used to seeing or what has been the average, this indicates that new short positions are being opened. As long as this process continues it is a bearish factor, but once the shorts begin to cover it turns bullish.
8. A decline in both price and OI indicates liquidation by discouraged traders with long positions. As long as this trend continues, it is a bearish sign. Once open interest stabilizes at a low level, the liquidation is over and prices are then in a position to rally again.

GOOD TRADING SUCCESS!

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for answer in Trader's Corner articles to Click here to email Leigh Stevens 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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