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Daily Newsletter, Saturday, 01/20/2007

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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

Initial Earnings Increase Confusion

Despite mostly positive earnings reports the market have failed to respond positively. Individual stocks have been hammered after posting better than expected earnings and some with earnings misses actually rose on the news. For instance GE more than doubled their profits for the quarter and gave positive guidance but lost -$1.05 on the day. This is not unusual in earnings cycles but the severity of some of the post earnings losses has emphasized the uneasiness in the market.

Dow Chart - 30 min

Nasdaq Chart - Daily

Falling gas prices, warm weather and a bounce in housing expectations combined to send Consumer Sentiment for January soaring to 98 compared to the 91.7 reading last month. The consensus estimate was for only a small gain to 92.8. Friday's headline reading was the highest in three years and the second highest since 2000. The expectations component jumped from 81.2 to 88.7 and the present conditions component rose from 108.1 to 112.5. Clearly consumers are expecting better times ahead. Analysts said the highly publicized drop in oil prices and the new market highs were instrumental in pushing sentiment higher. Consumers equate $50 oil with gas under $2 and relief from monster gas bills. Year-end bonuses were also reported to be the largest in years as corporations flush with cash rewarded employees. Year-end retirement statements also reflected the Q4 rise in the markets, which produced many smiles I am sure. Next week is a light week for economic reports but there will be plenty of earnings to review.

Economic Calendar

It is too bad that strong bounce in sentiment did not carry over into the markets. With even good earnings being punished I am sure company executives will be putting on body armor before stepping in front of the camera next week. IBM was the most recent casualty losing -3.28 after reporting very strong earnings that beat estimates. They showed the best revenue growth in five years with bookings of $17 billion in their service business. The problem was a forecast of 10% to 12% growth that fell short of some optimistic expectations by analysts. IBM was the biggest drag on Friday's Dow accounting for more than -25 Dow points.

Citigroup posted earnings that beat estimates but fell -26% and the stock ended up for the day. Citigroup promised to bring down costs and evidently investors bought the story. GE posted profits of $6.8 billion that more than doubled the $3.2 billion in the comparison quarter. GE lost -$1.05 after their positive guidance disappointed investors. GE also said it was going to restate financials from 2001-2005 to adjust accounting on some debt. The restatement will erase -$343 million in earnings for that period.

Motorola rallied on Friday after disappointing investors earlier with a -48% drop in profits due to shrinking margins on cell phones. Everyone felt the stock was already beaten with its drop to an 18 month low in early January. Nokia, Qualcomm and Texas Instruments all report next week and they will have to overcome the negative impact of Motorola's claim of weakness in the handset market.

Earnings have been mostly positive despite the tepid market reaction. According to Thomson Financial 15% of the S&P has reported and 57% beat estimates, 20% were inline and 23% missed expectations. Of those that reported, earnings have risen +14.5% and that is about +6% over estimates for those companies. However, Thomson is still projecting Q4 earnings for the entire S&P to only hit +9.3% and break the 13-quarter string of double-digit earnings growth. Thomson also revised their estimates for Q1 earnings. On Jan-1st the Q1 earnings estimate for the S&P was +8.7%. That number has now fallen to only +7.3% based on the guidance received. 51 S&P companies have issued guidance for Q1 and 12 were positive, 7 inline and 32 guided lower. This is not a positive sign for the markets long term.

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According to one analyst we were seeing a perfect setup with decent earnings, weak inflation, a growing economy and oil prices at 18 month lows. Even Bernanke's positive testimony on Thursday failed to impress anyone. According to him if that is not enough to push stocks higher then there is nothing on the horizon to improve the picture.

In early January investors sold oil and commodities and bought tech. This week that role reversal changed again with the energy sector the winner for the week. The Energy Select SPDR (XLE) gained +4.6% this week with Exxon holding up the Dow with a +3.7% gain. The perception that $50 was the bottom for oil and strong earnings and guidance from Schlumberger (SLB) helped put a floor under energy stocks. SLB said its Q4 profits jumped +71% due to significant price increases, heavy exploration activity worldwide and business bookings for years in advance. SLB beat estimates by +7 cents with profits of $1.13 billion. SLB did not just predict strong growth for 2007 but said they continue to see "high growth" through the end of this decade and into the next. SLB also squashed rumors that lower prices would depress earnings.

"While we remain of the opinion that there is no overall shortage of oil and gas reserves, the world is realizing that the period of cheap hydrocarbon energy has ended and new and higher sustained levels of investment are necessary to meet demand and guarantee future supplies," according to Chairman Andrew Gould.

SLB has repeatedly guided analysts higher but many fail to understand the reality of current exploration efforts. Current discoveries cost more to find and produce and these costs will continue to rise. SLB jumped +$3.10 on the news.

February Crude Oil Chart - 30 min

Cold weather blanketing the US and snow in the northeast helped to propel oil and gas prices higher. Oil closed right at $52 and natural gas rose +9% to close at $6.88. The weather service modified their forecast for February saying a weakening El Nino would produce colder weather than previously predicted. The American Petroleum Institute (API) said the warmer weather had cut oil demand by -3% in the US.

All the posturing by the weatherman, API and even a lowered OPEC forecast for 2007 had little real impact on oil prices. The real reason for the bounce was simply short covering ahead of futures expiration on Monday. With $50 seen by some as a potential bottom there was little to gain by holding shorts over the weekend and risk some geopolitical event producing a spike in Monday's thin market. Next week will be the key with the March contract closing at $53.39 on Friday. March will become the current month on Tuesday. It remains to be seen if its lows of $51 will be tested or if traders decided that last week's low was a buying opportunity. Most oil stocks quit declining in the prior week and began trading higher as this week progressed.

On the downside the semiconductor sector was the biggest loser with a loss of -5.3% for the week. This came after earnings from Intel and Motorola and warnings from several small chipmakers. The SOX broke several levels of support and fell -37 points from last Friday's high of 488 to this Friday's low of 451. This problem is not likely to be resolved in the near future. Multiple chip companies report next week and warnings last week suggest there is trouble ahead. One company said large orders were either being cancelled or pushed well into the future due to lack of demand. This is not a good sign for chip stocks or techs in general.

SOX Chart - Daily

Last week we had a flurry of analysts tell us to prepare for a tech high in late January. According to them techs typically peak between Jan-15th and Jan-31st and decline into summer. These were probably the same guys that were telling everyone to buy tech back in December. Unfortunately history does prove this trend but there is nothing to prevent that trend from being broken.

Despite the lackluster performance of the indexes on Friday the market internals were very positive. Advancers beat decliners by nearly 2:1 and volume was also positive at better than 2:1 on 5.3 billion shares. This was a significant reversal from Thursday when volume was nearly 3:1 negative. Has the tide turned in favor of the bulls after a weeklong tech wreck? I would strongly doubt it because the +8 gain on the Nasdaq was not even a decent dead cat bounce given the huge bout of selling that left the Nasdaq down -2.6% for the week.

Next week we will be faced with earnings from tech giants like YHOO, EBAY, MSFT, QCOM, TXN, AMD, SYMC, NVLS and dozens of others. Over 250 companies report earnings and the outcome will be very important. If the quality begins to decline then we could see some rough sledding ahead. As always the guidance will be key and 63% of guidance received for Q1 over the last two weeks has been negative. If that trend continues we could see a serious bout of profit taking. EBAY appears to be setting up for a break of $29.50 ahead of earnings and a significant drop if they disappoint. I warned everyone in December that EBAY was famous for a Q1 swoon and the chart is setting up perfectly.

EBAY Chart - Daily

Another problem ahead is going to be the Fed. Since the last rate hike in June 2006 investors have been expecting the next move to be a rate cut. Due to the stronger than expected economic results we have seen in January there is almost zero chance of a rate cut through September as evidenced by the Fed funds futures. In reality, if the economy continues to strengthen the next move could be another rate hike and that could come as soon as May. That would of course mean the economy had shaken off the weakness we saw in late 2006 and was heading back into strong growth mode with inflation rising. The problem is not the hike or the economy since strong growth can occur during a hike cycle. It is the perception that no rate cut will be forthcoming. That could change the momentum in the bond market pushing yields back over 5% and produce an overhang in the equity market. Yields over 5% put a strain on equities. All of this will transpire over time, months instead of weeks, and is not something we need to worry about today. It is just something to keep on the radar if the economy continues to strengthen. As long as equities are rising investors will ignore the hike prospects until the Fed begins to warn in their speeches.

Guidance will be the short-term key and plenty of companies will give guidance next week. The Dow is continuing to hold near its highs and blue chips should do better than small caps in this environment. 12525 is the key support on the Dow that needs to hold if the current rally is to continue. However, we could even stand a drop to 12350 and still maintain the bullish bias on the Dow. Next week 9 Dow components report and there will be plenty of chances for a smack down if somebody else disappoints.

The Nasdaq lost -2.5% but came to rest just above decent support at 2420-2440. I believe the majority of the selling was a major fund asset allocation program on Thursday with the Apple earnings as a trigger. Maybe quite a few funds were planning to exit on the typical January peak in techs. While there was no material bounce on Friday there was also no follow through on the selling. I am not saying the tech selling is over but I believe much of it was program trades. The Nasdaq like the Dow is still very near its highs with strong support from 2400-2420. We could easily see both indexes pull back a little further without any damage to the overall market.

Russell-2000 Chart - Daily

SPX Chart - Daily

Should the Dow break 12350 and the Nasdaq 2400 the entire picture would change. Until then it is just profit taking and digestion of recent gains. The S&P-500 has been attracted to 1430 like a moth to a flame. We have spent time on both sides but never more than 5 points either way. This remains the purest indicator of broad market health. On Friday the rebound in the oil patch rescued the S&P from a small Thursday decline but it could not push the index back over 1430 despite a 2:1 advance decline ratio in Friday's trading. The S&P seems to be clinging to 1430 as we await earnings in hopes of a sudden burst of earnings enthusiasm that will launch it higher. Conversely a few more earnings disappointments and lowered guidance announcements and that hold could easily slip. Remember last week I showed that this market was on 4th longest streak without a correction since 1928. We are due and corrections typically occur unexpectedly. They are blamed on some external event but normally the orders are already in place and funds are just waiting for somebody to knock out the props. With limited economics next week the focus on earnings will be the key. Given the damage to Apple, IBM, GE, etc, on strong results what will happen if a couple reporters suddenly miss sharply? While that is not expected it is always a possibility. I would rather believe that the bulls are alive and well and waiting for a real buying opportunity. If you believe the various talking heads on CNBC everybody is expecting a decline and waiting to buy the dip. This sets up another possibility. If something did spark a sudden burst of buying it could send those same funds racing into the market to buy stocks rather than miss out on a continued rally. It is one thing to sit on investor's money while waiting for a buying opportunity but another problem entirely if the market starts to run away from you. Obviously nobody knows which event will come to pass but we only need to watch S&P 1430 to make the right decision. I am amazed by the lack of volatility in the market and that suggests a complete lack of fear in traders. Despite the Nasdaq sell off complacency is rampant. The VIX has barely budged in a week and remains stubbornly low at 10.50. It has been six months since there was some decent volatility in the high teens and mid June since it was over 20. This is not a normal event and one that should end badly for the bulls.

I received several emails asking what to do since the SPX continues to trade several points on both sides of 1430. How should I trade that? In circumstances like this I suggest moving your entries five points on either side of what has become a critical pivot point. Go long on a break over 1435 and short on a break under 1425. That allows the index to continue moving sideways without triggering any trades. This will allow you to sleep at night and not be worried about being short or long with the S&P resting on 1430. I will continue to use that level as my line in the sand but readers should decide for themselves when they enter any trades based on a movement away from that level. Either way I do expect a major move relatively soon.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
KBH None None
MHK    
MRO    

New Calls

KB Home - KBH - close: 51.74 change: +0.81 stop: 48.99

Company Description:
Building homes for nearly half a century, KB Home is one of America's premier homebuilders with domestic operating divisions in some of the top markets. Kaufman & Broad S.A., the Company's publicly-traded French subsidiary, is one of the leading homebuilders in France. In fiscal 2005, the Company delivered homes to 37,140 families in the United States and France. KB Home also offers complete mortgage services through Countrywide KB Home Loans, a joint venture with Countrywide Financial Corporation. (source: company press release or website)

Why We Like It:
Once again investors are hoping that the homebuilders really have put in a bottom. The markets ignored earnings warnings and a rash of bad news with homebuilders taking huge hits as they write off options on land they no longer plan to build on. The DJUSHB home construction index turned in a decent week and shares of KBH rallied sharply to breakout through resistance at the top of its consolidation (bull flag) pattern. Technical indicators are turning bullish again and the MACD has produced a new buy signal. We are suggesting call option positions on KBH with the stock above $50.00. Readers can choose to open positions now or look for a dip back toward the $51.00-50.00 region. Our target is the $54.90-55.00 level. More aggressive traders may want to aim higher. Traders should be aware that rival homebuilder DHI is due to report earnings on January 23rd and their results and guidance could have a big impact on the sector's direction.

Suggested Options:
We are suggesting the February calls. Aprils strikes could also work well.

BUY CALL FEB 50.00 KBH-BJ open interest=2339 current ask $2.90
BUY CALL FEB 55.00 KBH-BK open interest=2636 current ask $0.70

Picked on January 21 at $ 51.74
Change since picked: + 0.00
Earnings Date 03/19/07 (unconfirmed)
Average Daily Volume = 2.2 million

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Mohawk Ind. - MHK - close: 78.38 chg: +1.15 stop: 76.49

Company Description:
Mohawk is a leading supplier of flooring for both residential and commercial applications. Mohawk offers a complete selection of carpet, ceramic tile, wood, stone, laminate, vinyl, rugs and other home products. (source: company press release or website)

Why We Like It:
If the market's bias on the homebuilders is turning bullish again then it's only natural that flooring provider MHK will begin to follow the builders higher. The stock has been trading with a bullish pattern of higher lows but struggled with resistance near $80.00. We are suggesting new call positions now but this is an aggressive, higher-risk entry point. More conservative traders should use a trigger above resistance at the $80.00 mark! We'll try and keep our risk to a minimum with a stop loss under Friday's lows. Our target is the $84.00-85.00 range. We do not want to hold over the February earnings report.

Suggested Options:
We are suggesting the February calls. As with all of our suggested plays it is you, the individual trader, who should decide which month and strike price best suits your trading style and risk.

BUY CALL FEB 75.00 MHK-BO open interest=1008 current ask $4.90
BUY CALL FEB 80.00 MHK-BP open interest=1956 current ask $1.95
BUY CALL FEB 85.00 MHK-BQ open interest= 45 current ask $0.50

Picked on January 21 at $ 78.38
Change since picked: + 0.00
Earnings Date 02/16/07 (confirmed)
Average Daily Volume = 557 thousand

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Marathon Oil - MRO - close: 87.17 change: +1.99 stop: 83.90

Company Description:
Marathon is the fourth-largest U.S.-based fully integrated international energy company engaged in exploration and production; integrated gas; and refining, marketing and transportation operations. (source: company press release or website)

Why We Like It:
Crude oil has plunged from its highs but appears to have found some support near $50.00. Whether or not this is a real reversal or just an oversold bounce remains to be seen. That's why we're dipping our toe into the oil sector with just one bullish candidate. MRO looks like a stronger candidate than some of its peers because shares have spent almost two weeks consolidating sideways above rising technical support at its 200-dma. Should the oil sector rebound then MRO will probably breakout from its trading range. If that occurs we want to be ready. Our suggested entry point to buy calls is at $88.05. If triggered our target is the $93.50-94.00 range. There is potential resistance near $90 and its 50-dma.

Suggested Options:
We are suggesting the February calls but we do not want to hold over the February 1st earnings report so we have less than two full weeks. Our trigger is at $88.05.

BUY CALL FEB 85.00 MRO-BQ open interest=1418 current ask $4.50
BUY CALL FEB 90.00 MRO-BR open interest=2464 current ask $2.00

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/01/07 (confirmed)
Average Daily Volume = 3.7 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Chaparral Steel - CHAP - cls: 45.16 chg: +1.24 stop: 41.99

Steel stocks rebounded with the wider market on Friday. Shares of CHAP out performed with a 2.8% bounce. The rebound back above its simple 50-dma and the $45.00 level has given new life to the recent MACD buy signal. Readers can use Friday's bounce as a new entry point to buy calls. However, we remain wary of the market and its lack of direction lately. Traders may want to wait for a rise past $45.75, which would be a new three-week high, before opening new call plays. Our target is the $49.00-50.00 range. The P&F chart points to a $64 target.

Suggested Options:
We are suggesting the February calls. We would prefer using March calls but they are not available for CHAP yet.

BUY CALL FEB 40.00 ZHQ-BH open interest=147 current ask $5.80
BUY CALL FEB 45.00 ZHQ-BI open interest=462 current ask $2.10
BUY CALL FEB 50.00 ZHQ-BJ open interest=334 current ask $0.50

Picked on January 14 at $ 45.16
Change since picked: - 0.00
Earnings Date 03/20/07 (unconfirmed)
Average Daily Volume = 635 thousand

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iShares China Index - FXI - close: 106.35 chg: +1.55 stop: 99.49

Entry point alert! Shares of the FXI have broken out above its simple 10-dma. If you study the intraday charts it looks like the FXI has produced a bullish breakout from a bull flag pattern over the last couple of weeks. We're suggesting new call positions on Friday's rise. More conservative traders may want to tighten their stop loss. The FXI can be volatile so we have a wide stop, making this a more aggressive play. Our target is the $115.00-117.00 range. Remember, this is a Chinese ETF and it tends to gap open every day as it adjusts to how the Chinese markets traded the night before.

Suggested Options:
We are suggesting the February calls. February strikes are available at one-dollar increments. We're going to list a few we like. You should pick the one that best suits your trading style and risk.

BUY CALL FEB 100 FJJ-BT open interest= 484 current ask $8.60
BUY CALL FEB 104 FJJ-BZ open interest= 539 current ask $5.70
BUY CALL FEB 105 FJJ-BA open interest=1310 current ask $5.10
BUY CALL FEB 107 FJJ-BC open interest= 520 current ask $4.00
BUY CALL FEB 110 FJJ-BF open interest=1538 current ask $2.50

Picked on January 14 at $105.40
Change since picked: + 0.95
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 1.3 million

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Lehman Brothers - LEH - cls: 83.15 change: +0.85 stop: 78.95

Friday's 1% rally in LEH is the second bounce in three days near the $82 level. The lack of follow through on Thursday's bearish reversal pattern in LEH is definitely a good sign for the bulls. That doesn't mean that shares won't dip toward $80 or its 10-dma but it's a show of relative strength. We hesitate to suggest new positions at this time. A bounce from support near its 10-dma or the $80 level would be a preferable entry point. We have two targets for LEH. Our conservative target is the $84.85-85.00 range. Our aggressive target is the $89.00-90.00 range. FYI: LEH has a very bullish pattern on its Point & Figure chart called a bullish triangle breakout and it forecasts a $111 target.

Suggested Options:
We're not suggesting new positions at this time but if LEH does provide an entry point we'd suggest the February calls since March strikes are not available yet.

Picked on January 11 at $ 80.25
Change since picked: + 2.05
Earnings Date 03/15/07 (unconfirmed)
Average Daily Volume = 3.4 million

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China Life Ins. - LFC - close: 46.69 change: -1.00 stop: 43.95

The Chinese markets continue to rise and are nearing the early 2007 highs. Unfortunately, LFC is failing to rally with its home market. The stock under performed on Friday with a 2.1% decline and on strong volume. The only saving grace for Friday's session was a decent bounce from LFC's lows near $45.00. Aggressive traders may want to buy this bounce. More conservative traders may want to wait for a breakout past its simple 10-dma near $48.00. Our target is the $52.50-55.00 range. We want to remind readers that this is an aggressive, higher-risk play. Most of LFC's technical indicators are bearish and the P&F chart is bearish with a $36 target. If LFC doesn't bounce higher on Monday it might be a good idea to exit early and cut your losses. More conservative traders might want to go ahead and tighten their stops toward $45.00.

Suggested Options:
If LFC bounces on Monday we'd suggest the February calls.

BUY CALL FEB 40.00 LFC-BH open interest= 227 current ask $7.40
BUY CALL FEB 45.00 LFC-BI open interest= 992 current ask $3.60
BUY CALL FEB 50.00 LFC-BJ open interest=3271 current ask $1.30

Picked on January 14 at $ 46.86
Change since picked: - 0.17
Earnings Date 04/18/07 (unconfirmed)
Average Daily Volume = 1.7 million

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Lockheed Martin - LMT - cls: 97.27 change: +0.47 stop: 93.95 *new*

Shares of LMT managed to hit another new all-time high on Friday with an intraday spike to $97.75. The stock has been a relative strength leader over the last couple of weeks. The question now is whether or not LMT will rally higher into its earnings report or will it just consolidate sideways as investors wait for the earnings results. LMT has already hit our conservative target in the $94.85-95.00 range and we're currently aiming for the $99.00-100.00 zone to exit. If you have not exited already more conservative traders may want to lock in a gain now. Due to LMT's fast approaching earnings report on January 25th and its proximity to our target we're not suggesting new positions. We are adjusting our stop loss to $93.95.

Suggested Options:
We are not suggesting new positions in LMT. We will plan to exit ahead of the earnings announcement.

Picked on November 29 at $ 90.62
Change since picked: + 6.65
Earnings Date 01/25/07 (confirmed)
Average Daily Volume = 2.1 million

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Altria Group - MO - close: 87.26 change: -0.69 stop: 85.95 *new*

A Friday morning downgrade pushes shares of MO to a 0.7% decline. The relative weakness over the last few days has turned the short-term technicals bearish. You'll notice that the MACD on the daily chart has produced a new sell signal. It might be time to consider an early exit. However, MO still has a supporting trendline near the $86.00 level and there is still a chance for a rebound from support. If you're looking for a new entry point we'd watch for a bounce from current levels near $87.00 or a bounce near $86.50. Please note we are inching up our stop loss to $85.95. Don't forget that MO reports earnings on January 31st and we do not want to hold over the report. We are targeting a rally into the $92.50-95.00 range. The P&F chart currently points to a $114 target.

Suggested Options:
If MO produces a new entry point with a bounce above $86.00 we'd suggest the February calls since we plan to exit ahead of earnings.

Picked on January 04 at $ 87.65
Change since picked: - 0.39
Earnings Date 01/31/07 (confirmed)
Average Daily Volume = 8.8 million

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Teleflex - TFX - close: 66.67 chg: -0.16 stop: 64.75

TFX did not move much on Friday and the selling pressure failed to break short-term technical support at its simple 10-dma. A bounce from here could be used as a new entry point but we still suspect a dip closer to $66 is in the stock's near future. Broken resistance near $66 should be new support. Chart readers will note that volume has dried up the last couple of days, which is what you would want to see on a pull back or consolidation. Normally we would expect the $70.00 level to act as resistance but looking at TFX's history the stock seems to encounter resistance in the $72.00 region. Our target is the $71.00-72.00 range. FYI: The P&F chart points to an $81 target. We plan to exit ahead of the mid February earnings report.

Suggested Options:
We are suggesting the February calls.

BUY CALL FEB 65.00 TFX-BM open interest= 26 current ask $2.75
BUY CALL FEB 70.00 TFX-BN open interest=151 current ask $0.55

Picked on January 14 at $ 67.11
Change since picked: - 0.44
Earnings Date 02/14/07 (unconfirmed)
Average Daily Volume = 202 thousand
 

Put Updates

Celgene Corp. - CELG - close: 54.98 change: -0.00 stop: 57.01

Shares of CELG closed unchanged on Friday. We do not see any changes from our new play description from Thursday night so we are reposting an updated version of it here:

It looks like the BTK biotech index is in the process of forming a bearish double top. If the pattern does appear then we should look for the sector to see some renewed selling soon. With tech stocks already experiencing profit taking it's not a stretch of the imagination to expect biotech to follow suit. CELG is already under performing its peers and the rest of the market. The recent oversold bounce has failed near its 10-dma and 50-dma and now the stock looks poised to drop. We are suggesting put positions with CELG under $56.00 (the 10-dma). Our target is the $50.50-50.00 range, near its rising 100-dma. We do not want to hold over the February 1st earnings report so we have eight trading days.

Suggested Options:
We are suggesting the February puts but remember that we plan to exit before the early February earnings report.

BUY PUT FEB 60.00 LQH-NL open interest= 597 current ask $5.50
BUY PUT FEB 55.00 LQH-NK open interest=4177 current ask $2.20
BUY PUT FEB 50.00 LQH-NJ open interest=2849 current ask $0.70

Picked on January 18 at $ 54.98
Change since picked: + 0.00
Earnings Date 02/01/07 (confirmed)
Average Daily Volume = 4.4 million

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eBay Inc. - EBAY - close: 29.66 change: +0.15 stop: 31.26

Strategy change! Shares of EBAY tried to bounce on Friday but failed on Friday afternoon at the $30.00 level. The action in EBAY over the last few days and actually the last couple of months definitely looks like shares want to head lower. Short-term technicals are aiming lower and the weekly chart's MACD is near a new sell signal. Please note we're making a strategy change. Normally we always exit ahead of an earnings report. There are too many variables that can go wrong with a company's earnings announcement and guidance. However, this time we strongly suspect that EBAY will sell-off after its report, which is due out on Wednesday, January 24th after the closing bell. We are going to hold the play open over the announcement. More conservative traders are strongly suggested to exit early instead. We're also going to adjust our target to the $26.00-25.00 range.

Suggested Options:
With our strategy change it is not too late to open new put positions on EBAY. We're suggesting the February puts.

BUY PUT FEB 32.50 XBA-NZ open interest= 7854 current ask $3.40
BUY PUT FEB 30.00 XBA-NF open interest=15286 current ask $1.70
BUY PUT FEB 27.50 QXB-NY open interest=14948 current ask $0.70

Picked on January 08 at $ 29.70
Change since picked: - 0.04
Earnings Date 01/24/07 (confirmed)
Average Daily Volume = 14.5 million

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Whole Foods - WFMI - close: 43.96 chg: -1.59 stop: 46.55

Our new put play in WFMI is now open. The stock spiked lower on Friday morning and quickly broke down under support near $45.00 and hit our suggested trigger to buy puts at $44.85. Volume on the technical breakdown was strong, which is definitely bearish! The catalyst for Friday's decline were negative comments from a Banc of America analyst who believes that WFMI's profit margins are likely to narrow in the first quarter. Now that the play is open our target is the $40.25-40.00 range. We do not want to hold over the early February earnings report. FYI: The P&F chart points to a $26 target.

Suggested Options:
We are suggesting the February puts but remember that we plan to exit before the early February earnings report.

BUY PUT FEB 50.00 FMQ-NJ open interest= 4405 current ask $6.10
BUY PUT FEB 45.00 FMQ-NI open interest= 8284 current ask $2.00
BUY PUT FEB 40.00 FMQ-NH open interest=11853 current ask $0.35

Picked on January 19 at $ 44.85
Change since picked: - 0.89
Earnings Date 02/08/07 (unconfirmed)
Average Daily Volume = 3.3 million
 

Strangle Updates

None
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

Blue Nile - NILE - cls: 37.66 chg: +0.28 stop: n/a

We are closing our strangle play on NILE with a loss. 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: - 1.26
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 


Trader's Corner

Is It Time Yet?

Everyone seems to be asking this question. Is it time for the SPX rally off last summer's lows to end? Many market-related publications have recently featured articles predicting just that. Others take the opposite tack, predicting a rally that will extend far into this new year.

An article I wrote last summer discusses the corrective fan principle, a principle that can help pinpoint the end of a trending move. It's time to revisit that article and see what the corrective fan principle might have to tell us about current market conditions.

A little background might be appropriate for those who didn't read that article last summer or don't remember its premise. In TECHNICAL ANALYSIS EXPLAINED, Martin Pring notes that trending moves tend to establish three trendlines. This is true of downtrends as well as rallies, but both that article last summer and this one will be focusing on rallies.

The first trendline is established as prices explode off a new or relative low. That first trendline can be too steep to be maintained, so that prices eventually break through the first trendline. My article last year employed charts of Callaway Golf (ELY) to illustrate the corrective fan theory. This break through the first trendline happened with ELY when prices climbed off the low in the fall of 2004 and then broke through that first trendline in April of 2006.

Some market watchers erroneously assume that a new downtrend has been established when that first trendline is broken, but that's often not the case. The corrective fan principle explains why. Although the first trendline might have been too steep to be sustainable, a new uptrend is often established.

The second trendline is likely not as steep as the first. Prices sometimes climb this second trendline into a new or new relative high. Sometimes the first trendline serves as resistance as prices zigzag high. Prices may appear at times to climb the underside of the first trendline although they find support on pullbacks at the newly established second trendline. Because there's been a break of the first trendline and because it continues to serve as resistance, some erroneously assume that those new or relative new highs won't be hit, but the corrective fan principle alerts chart readers that three separate rising trendlines may comprise the full trending move.

Even the second trendline's slope may be too steep to be maintained, however, and prices will eventually break through that line, too. At the time of the article last summer, ELY had just broken through the second trendline, after climbing it long enough to form a new relative high. One of the charts from last summer's article is found below, complete with its annotation from last summer.

Annotated Weekly Semi-Log Chart of ELY:

The corrective fan principle suggests that a third trendline will then be established, one with a slope not as steep as the second's. It's not until then third trendline is established and then broken that the rally has completed.

If that corrective fan principle was to hold in ELY's case, the principle suggested last summer that ELY should still form a third rising trendline. It wouldn't be until that third trendline would be broken that a change in trend--either to sideways consolidation or a downtrend--would ensue. The long rally from the fall of 2004 would have been completed.

Did ELY establish a third rising trendline?

I've changed charting services since last summer, so the chart will appear a little different, especially since I have not been able to successfully switch to a semi-log chart for a stricter comparison. This chart was prepared early this week, so does not capture all the price action from last week, but as you'll see later, I'm glad that the chart and its annotations was prepared early, before Friday's action, so that it's conclusions become more important.

Annotated Weekly Semi-Log Chart of ELY:

Friday morning's action points out the importance of not assuming that ELY's rally attempts are finished before that third trendline is violated. Friday morning, ELY gapped higher, with prices sitting at $15.64 as I type. That turns the pullback from November and early December into a potential bull flag.

Prices are now well above their level last summer when that article was written and the first chart snapped. At that time, my article concluded that while ELY's prices were in a short-term downtrend, they would likely rise along a yet-to-be-established new rising trendline. The correlative fan principle suggested that the rally might be on its third and final leg as it established that third trendline, however, and that anyone long the stock ought to take care to protect profits.

That's where it remains today, and I would assume that the second trendline will now serve as resistance and that, since ELY has now established its third trendline, gains remain suspect at this point.

What does this corrective fan principle have to tell us about the question everyone has been asking, the question that began this article? Is it time yet for the SPX's rally off last summer's low to end? Let's take a look at some possible rising trendlines that can be drawn off that rally's beginning.

Annotated Daily Chart of the SPX:

I'm not entirely sure that the first, aqua-colored trendline is valid. I could just as easily argue that only two trendlines could be drawn from this rise off last July's low, and that the third is yet to be established. Unfortunately, although the corrective fan theory was correct in its predictions about ELY last summer, it's not giving me clear insight into what's happening with the SPX. To help validate the three trendlines, I tried looking at them in combination with another indicator, the RSI.

Remember that the following charts were also captured at the beginning of this week and don't feature end-of-week price action.

Annotated Daily Chart of the SPX:

That first, somewhat improbably sloping trendline was mimicked by a rising trendline on the RSI, too. The RSI broke through its trendline and also through a tiny H&S formation's neckline at the same time that prices broke through that first rising trendline. This concurrent RSI action does appear to give some validity to that trendline.

The second trendline's break was also mimicked by a simultaneous RSI break through a second rising trendline. RSI has already broken through its third trendline, however, with that break occurring as the SPX stopped testing the red trendline from the underside and fell back further away from that sharply rising trendline. Sometimes RSI breaks anticipate a price break, so that's not necessarily a sign that the third trendline is not valid. In fact, I would definitely argue that both the red and the blue trendlines are valid.

Another interpretation still questions the validity of that first trendline, however.

Annotated Daily Chart of the SPX:

Drawing trendlines is as much an art as a science. In this case, the art is more subjective than is typical, as an argument could be made for either variation of three rising trendlines. What we're left with is this: we know that the blue trendline is a valid one, so the SPX really should not close much higher the rising blue trendline, allowing for a bit of error in this best-fit trendline's construction. The possibility exists that the blue trendline is the third and that it has already been violated, so that a period of sideways movement or a decline might be in the making. However, if that theory is refuted by the formation of a new third rising trendline, we will have clear evidence of when the rally mode might end. That will occur when that third trendline is violated, and a RSI break of its own new trendline occurs either before or concurrently with a price break.
 

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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