Option Investor

Daily Newsletter, Tuesday, 12/26/2006

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Table of Contents

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

Market Wrap

Housing Prices Fall Further

Despite a very low volume day the markets managed to post some gains but we should not draw too many conclusions from this performance. Oil was extremely volatile with the bottom falling out of natural gas ahead of the January expiration on Wednesday. Economic reports continued to show weaker trends as shoppers stampeded to the malls. It was a typical post holiday trading session as fund managers try to run out the year-end clock with gains still intact.

Dow Chart - Daily

Nasdaq Chart - Daily

The Richmond Fed Survey fell to -6 in December from a +7 in November. This was the lowest reading from the Richmond manufacturing sector since Sept-2003. New orders fell -14 points to -8, shipments lost -10 points to -4 and order backlogs fell to -16 for the 13th consecutive month in negative territory. Raw material costs rose at a +3.44% rate with finished goods prices rising +2.59%. Hiring fell to -5 and the average workweek also turned negative at -8. Using the same components from the Richmond Survey as are used in the national ISM this report is projecting another reading in contraction territory below 50 for the ISM. The Richmond Survey has the tightest correlation to the ISM of the four regional Fed surveys. The rising inventory levels suggest there is weakness in the entire supply chain from raw materials all the way through to retail sales.

The S&P Case/Shiller housing survey released today continued to show weakness with home prices shrinking to a +2.4% year over year increase. The headline survey covers 10 major markets in the US. The 20-city composite index saw home prices shrink to a gain of only +2.9% year over year. This was the slowest rate of increase since the data has been recorded. For the 10-city headline index this was the lowest rate of price appreciation since Feb-1997. This report covered October period and was a significant drop from the +3.7% Y-O-Y gain seen in September. We should be glad to see any gain given the drastic plunge in new home sales. The fact that housing prices are still positive is amazing to me. The worst performing markets were Detroit, Boston, Cleveland, San Diego and San Francisco. The strongest markets wee Seattle and Portland. This report produced nearly the same results as the National Association of Realtors survey which showed a drop in prices last month of -3.5% to $221,000 and the biggest decline on record. Currently there is a 7.4 month supply of homes for sale at the current rate of sales. That is expected to decrease slightly once the spring selling season arrives.

Stock news was minimal with many traders, researchers and analysts still off for the holidays. Telik (TELK) lost -70% of its value when its experimental cancer drug failed to improve survival in patients. More than 32 million shares were traded as the price fell from $16 to $4.75. More than 17 million shares had been sold short ahead of the data and that is 30% of all outstanding shares. That is a monster payday for those TELK bears holding short positions.


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A Finnish security research firm announced that a new security flaw had been found in the new Windows Vista operating system that would allow hackers to take full control of a user's PC. They said the flaw would also affect any PCs running earlier windows versions if they have upgraded to Explorer 7.0. That release has been available as an update on the Microsoft website for several months. Microsoft downplayed the flaw saying Vista was still the most secure software they have ever released.

Amazon said it had its best ever sales in 2006. December 11th was the strongest single sales day ever with more than 4 million orders placed. This was well above the prior record of 3.6 million set on Dec-12th 2005. Their biggest shipping day saw 3.4 million orders shipped. I cannot even comprehend shipping on that scale. Amazon ran an Xbox 360 promotion in December and they sold 1000 Xbox consoles in 29 seconds when the promotion launched. Top items sold this season was the cold fighting Airborne preparation, Apple iPods, Canon Powershot Digital Elph cameras and Garmin GPS systems. They also sold the most expensive digital music player ever at $19,999. DVDs were very strong despite the reported demise of sales due to rental companies like NetFlix, Redbox and others. The leading title sold was Pirates of the Caribbean: Dead Man's Chest. Leading the book sales were titles like "You: On A Diet" by Oprah's favorite doctors Mehmet Oz and Michael Roizen.

Microsoft is reportedly close to putting targeted ads on its Hotmail network based on behavioral targeting. Microsoft has reportedly begun using demographic data provided by Hotmail users to deliver ads when those same users perform searches on any Microsoft site like MSN. Microsoft has been collecting data on its more than 240 million hotmail users for years but is just now starting to use it. This is seen as a positive event for those advertisers tired of bidding on pay per click sites with no material response. By targeting web surfers with a certain profile those same pay per click ads should do much better.

February Crude Chart - Daily

January Natural Gas Chart - Weekly

Oil prices started out the morning higher with a sprint to 63.20 on concerns over continued Nigeria violence and the new sanctions on Iran. The spike was brief and was followed some serious selling on very thin volume. It appeared as though a major sell program was triggered and there was not enough volume to handle it. Volume reached 98,000 contracts compared to daily volume last week of 150,000 to 215,000 contracts. Were it not for the sell program the price would have remained well over $62. There were 35,000 contracts traded during a single 30 min candle when that sell program hit. That was one-third the volume for the entire day in a single event. This compares to a single candle volume back on the 20th of 43,000 contracts but very little movement in price. There was just not enough volume today to support that kind of program.

Why the program was triggered we will never know but the impact remains. Oil closed at just under $61 and right at support on the February contract. Oil companies themselves did not do badly as end of year shoppers appeared to be adding to energy positions. Some strong performers included Sinopec +4.62, PetroChina +2.29, Petrobras +1.14, Conoco +0.64 and Exxon +.64. Considering the -$1.50 plunge in oil pries those gains are even more amazing. Analysts attributed the gains in major oil stocks to end of year window dressing. Natural gas fell even further lowing -8% to $6.09 as weather continued to be unseasonably warm in the Northeast. Evidently investors hoping for a cold snap to boost prices before the January contract expires on Wednesday finally ran out of patience and dumped expiring positions. The drop was expiration related more than a negative view of nat gas for the near future. Enjoy any dips in retail prices while they last because OPEC appears determined to support prices above $60 and that level is sure to rise. We are already seeing notices delivered by OPEC countries to their customers that shipments for February will be cut. The UAE warned customers it would cut exports in February by 3-5%. Even Santa is worried about the price of gas and its inflationary impact on everything we touch and eat.

This was the lightest volume day for the year with volume across all exchanges of only 2.5 billion shares, less than half of a normal day. This trend should continue the rest of this week. Internals were 2:1 in favor of advancers as retail traders went shopping to spend their holiday bonus checks.

The Dow rebounded with a gain of +64 points after closing at the lowest level in a week on Friday. This holiday period is typically bullish and the low volume allowed the major indexes to post a gain without working up a sweat. The Dow closed at 12413 and right at the bottom of what was support in the prior week. This rebound should not be seen as a major recovery or return to its bullish ways but just a low volume holiday shopping session. Funds which did not dress up their portfolios last week could be taking advantage of the final four days of trading to put on those finishing touches. Support on the Dow is now 12350 followed by 12250.

The Nasdaq managed to add +12 points in a rebound off strong support at 2400. Resistance is currently 2415 with the days close at 2414. That suggests tomorrow's traders may have a little more trouble pushing techs higher to even stronger resistance at 2435-2445. The SOX added +4 points to 467 but remains in danger of a continued drop to next support at 445. The Russell added nearly a full percent with a +7 point gain pushing it back to resistance just under 790. It is too soon to tell if this is a turnaround in the small caps or just further window dressing by funds.

The S&P rebounded from support at 1410 to near initial resistance at 1420 with the bigger issues getting the majority of the cash. This was definitely a window dressing effort with the big caps finding favor as safe havens ahead of year-end. The index stopped right at our 1418 long/short trigger level. This time I would only go long over 1418 for a short term trade and look again to short any weakness at or just below 1430. That level is strong resistance and one that is not likely to be broken before year-end.

S&P Chart - Daily

The current bull market is moving into its 46th month and the S&P has gone 516 days as of Dec-31st without a -10% correction. This is the 4th longest bull market since 1900. With economic data weakening we could see a pause in the first quarter as some investors step to the side to see if the next economic event is a rebound or a recession. The bond market seems to be saying it will be a recession. Once out of 2006 and into the 2007 tax year the funds will be free to take profits and restructure ahead of any potential weakness in 2007. Nobody knows for sure what the future will bring but the odds are good there will at least be a pause in the markets while we wait on the economy and the Fed. This possibility marks the first couple weeks in January as volatile ground we must cross. Maintain your bullish stance above S&P 1418 but keep your eye on the road just ahead.

New Plays

New Option Plays

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

Play Editor's Note: It is the holidays and many of our readers are traveling and spending time with family as they celebrate the season. The research side of our newsletter staff is also traveling and unavailable this evening. Our stock pick updates and new play content will return with the next regularly scheduled newsletter.

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Lockheed Martin - LMT - close: 92.35 change: +0.65 stop: 88.99

LMT struggled to hold onto its early gains this morning and managed to rally back up to its early morning high. Hopefully it will add to its gain during this light volume week ahead of us. Because it's reaching overbought and showing some bearish divergences at new highs we don't suggest any new plays at this time. A pullback to its uptrend line from June and its 50-dma, both located near $89, would provide a good opportunity for a new entry. If that support doesn't hold then we have our stop in the correct place. We have two upside targets--our conservative target is the $94.85-95.00 range; our more aggressive target is in the $99-100 range.

Picked on November 29 at $ 90.62
Change since picked: + 1.73
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.1 million

Put Updates

Intuitive Surgical- ISRG - close: 96.46 chg: -0.56 stop: 104.05

ISRG is now down 10 days (with a minor bump up in the middle of that) and is oversold so it should be ready for at least a bounce. Today tacked on another 2% decline. Our target is the $96.00-95.00 range and we're almost there. We do not want to hold over the early February earnings report. With the stock oversold and price nearing an uptrend line from August, currently at $95.60, we're suggesting taking profits and exiting the play if $95.80 is tagged. There is a gap up on November 20, 2006 that would be closed at $95.79. We can always look for another entry on a bounce.

Picked on December 18 at $102.05
Change since picked: - 5.59
Earnings Date 02/01/07 (unconfirmed)
Average Daily Volume = 938 thousand


Mohawk Industries - MHK - close: 74.96 chg: +0.69 stop: 79.01

After breaking its 200-dma on Friday MHK bounced back above it at $74.45 today. Friday's sell off was on low volume but today's bounce was on even lower volume. That may be the name of the game this holiday week. Watch for potential support at its uptrend line from July, currently near $73.25. A bounce back up to its 10-dma at $75.73 or 20-dma at $76.55 would not be out of the ordinary and could make for another entry point for a short play. First it will need to get through its 50-dma at $75.16. A break below its uptrend line would also be a good entry. In the meantime we'll keep our stop above the December highs in case we see a bounce to relieve its oversold conditions. Our downside target is the $70.75-70.00 range, near November's low.

Picked on December 17 at $ 76.02
Change since picked: - 1.06
Earnings Date 02/22/07 (unconfirmed)
Average Daily Volume = 600 thousand


3M Co. - MMM - close: 78.03 change: -0.32 stop: 80.01

After dropping from its November highs MMM has been consolidating during December in what appears to be a sideways coil. This should be a continuation pattern for another leg down so our short play continues to look good here. We are suggesting puts for the more aggressive traders with the stock under $79.00 while more conservative traders can look for a decline under $78.00 or the 200-dma near $77.53. We consider this to be an aggressive, higher-risk play because MMM does have support at its 200-dma (where it found support today at $77.55) and is holding above its October gap up (top of the gap is near $77.35). It takes a break below $76.40 to enable bears to breathe a little easier. 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: - 0.28
Earnings Date 01/19/07 (unconfirmed)
Average Daily Volume = 2.8 million


NewMarket - NEU - close: 58.51 change: +0.73 stop: 62.01

It continues to be the battle of the trend lines here. NEU has a longer term uptrend line from October 2005 where price bounced last Tuesday 12/19/06, currently at $56.79. The downtrend line from the end of November coincides with the 10-dma, both near $58.50 and this line/dma held price down on Friday and today. The test of that resistance on Friday and again today offered another opportunity to buy some puts. Our stop level is above the 20-dma ($60.37) which makes it a good place to keep it for now although more aggressive traders can consider lowering it to $61.01. Our downside target is the $54.00-53.50 range. 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: - 0.60
Earnings Date 01/29/07 (unconfirmed)
Average Daily Volume = 275 thousand


Sears Holding - SHLD - close: 166.63 chg: -1.11 stop: 173.05

A trend line along the consolidation lows since October and the uptrend line from July are both near $169.50 and should continue to be resistance now that they have been broken. Our downside target is the $162.00-160.00 range. Aggressive traders can look for a further pullback to near $157 which is the October low and will be near the uptrend line from March 2006 by the time it gets there. Keep an eye on the simple 100-dma near $162.69 which might offer some support. If you missed the entry, any retest of the $169.50 area should offer another opportunity for an entry.

Picked on December 22 at $167.90
Change since picked: - 1.27
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million


Yahoo! Inc. - YHOO - close: 25.45 chg: -0.10 stop: 27.05

Internet stocks (INX.X) remained relatively weak today but were in the green. YHOO continues to be the weak sister in this sector so we at least picked the right stock. But YHOO is holding at its gap close from October 30th. With the 10-dma at $26.02 and 50-dma at $26.18 any bounce back up to that level offers another opportunity to play the short side. The stop at $27.05 is above the 20-dma at $26.54. Our downside 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: - 0.40
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million


YUM Brands - YUM - close: 58.74 change: -0.03 stop: 60.26

Price continues to consolidate in a bear flag since our play was triggered. It's consolidating on top of what could be a neckline (at $57.80) for a developing H&S pattern since October. The 10-dma ($59.11) continues to hold price down. It's possible we could see a bounce up to its 50-dma at $60.12 so our stop is at the right place. The 20-dma, at $60.00, crossed down through the 50-dma today which should help our bearish play. A break below the neckline at $57.80 would offer additional opportunities for entries. Our downside target is the $55.75-55.00 range, which is near the top of the gap up on October 12, 2006. Closing the gap at $54.57 makes for another downside target.

Picked on December 12 at $ 58.49
Change since picked: + 0.25
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.)


Blue Nile - NILE - close: 36.28 chg: +0.51 stop: n/a

NILE has been struggling to bounce off its December low and while the bounce is not making much progress it is unfortunately just chewing up time. The bounce continued today and was even able to close above its 50-dma at $35.89. The bounce stopped at the 50% retracement ($36.52) of the decline from October. With it being overbought here we could see the bounce top out here. Our problem is time and we don't know if we'll see enough of a move before January expiration. 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), which is only $0.05, and the January $35 put (JWU-MG), which last traded at $0.80. Our best guess is that this stock is ready for a drop which would obviously help the put side of this trade. There's not much value left in the call side. A drop through $34.25 could see some acceleration lower but it will still need to get through its 200-dma at $33.71. For January expiration we'll need a closing price of $32.60 or less in order to cover our cost. There is still a reasonable chance that will happen if the broader market starts to sell off so use that as your guide as to whether or not you want to limit your loss and exit earlier. We'll continue to monitor this play into January expiration or an exit at $3.90 for either side, whichever comes first.

Picked on October 29 at $ 38.92
Change since picked: - 2.64
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand

Dropped Calls


Dropped Puts


Dropped Strangles



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