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Daily Newsletter, Saturday, 03/24/2007

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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

What A Difference A Week Makes

A dozen major buyouts by private equity firms and a surprise statement change by the Fed did wonders for the investing climate. A record number of buyouts and potentially the biggest buyout ever helped convince investors the big money is still bullish on the global economy. The Fed addressed the subprime issue very skillfully by not mentioning it at all but with a surprise change of their bias to neutral. Thinking this was a prelude to a future rate cut the bulls stampeded and bears were trampled as the markets raced higher. The end result was the strongest week in the markets since 2003. Gains in the indexes from 3% to more than 6% produced a lot of green on our screens and end of quarter window dressing is just ahead. What a difference a week makes!

Dow Chart - Daily

Nasdaq Chart - Daily

The only material economic report on Friday was the Existing Home Sales for February. That report saw the headline number spike to 6.69 million or a gain of +3.9%. This was a huge jump on top of a +2.7% jump in January. The 12-month chart below shows how sharp a rebound this really is. Sales are still below levels seen in Feb-2006 but they are improving rapidly. Analysts claim this is a weather related rebound due to much warmer than normal weather in Dec/Jan that led to lots of home shopping. That does not explain the +9% jump in housing starts in February. I am sure there was some weather benefit but there was also a continued drop in home prices as the subprime loan problem provided some motivated sellers. The median price of a home fell for the seventh consecutive month with a -1.3% drop to $218,000. This spring is shaping up to be a strong selling season and with inventories at 6.6 months of supply there are plenty of homes to be sold. Friday's existing home sales numbers gave the market a strong opening bounce and continued to ease investor fears that the subprime meltdown was going to sink the economy.

Existing Home Sales

The subprime doomsayers appear to be losing their voice. Buyers have come back into the subprime stocks and deals are getting done again. Fremont General (FMT) said it sold $4 billion in loans at a discount of only 3% off face value. This is nearly business as usual in this sector. Hedge funds and private equity firms are beating the doors down at the subprime firms with handfuls of cash to buy those loans and invest in their assets. Fallon Capital agreed to loan Accredited Financial (LEND) $200 million to help solve its liquidity crisis. Farallon will also get 3.3 million warrants from Accredited with an exercise price of $10 per share.

The biggest lift to the subprime sector came from the Fed. This may surprise everyone since the Fed did not even mention the word subprime. Their only comment was that "the adjustment in the housing sector is ongoing" and that was only a small change from the "tentative signs of stabilization have appeared in the housing market" we saw in the January statement. The Fed instead took the surprising step of removing bias statement even though they said "recent readings on core inflation have been somewhat elevated" and "the high level of resource utilization has the potential to sustain those pressures."

Why would the Fed remove the bias statement and pave the way for a future rate cut while at the same time increase their comments about inflation worry? This move was completely aimed at shoring up the housing sector in light of the subprime meltdown. They know the easiest way to give the housing sector a lift is to lower rates or at least make the market think lower rates are coming. This energizes buyers, raises housing prices, creates jobs and can add significantly to overall economic growth. In this current scenario it could also prevent a large number of foreclosures as rates fall and prices rise. Bernanke is a very smart guy and I warned you last Sunday he might change up the Fed statement to offset the recent Greenspan comments. This was a perfect way to do this and reassure the market without actually mentioning subprime. By restructuring the statement without actually mentioning subprime he avoided giving the doomsayers additional ammo. Had he mentioned subprime in the statement the doomsayers would still be running down the halls screaming "see even the Fed is worried about the subprime meltdown, we must be right! The housing sky is really falling!" I believe the statement was a stroke of genius by Bernanke and a real game changer. It was such a shock it took a few minutes before the market really understood what had happened and I doubt everyone really understands the implications today.

Another wave of positive subprime news is being seen today. It is the wave of quickly commissioned studies to determine exactly what we are going to see in the form of impact from those loans blowing up. In one study they found that subprime loans accounted for only 12.75% of the $10.2 trillion in loans made in 2006. In 2001 those same loans accounted for only 8.5% of the total. Not all of those loans are going to default. Even if the worst case numbers came to pass at 14% it is only a drop in the bucket compared to the total. $10.2T times 12.75% = $1.3 trillion total subprime loans in 2006. If 14% default that is roughly $182 billion but that default could occur over a five-year period. Many loans don't reset to the worst rate until 2010 and 2011. A study by First American says that $370B will reset in 2007, $250B reset in 2008 and 2009 and another $700B won't reset until 2010 and beyond. Any drop in interest rates or rebound in the housing sector could cut that default rate substantially. As one analyst put it the Tsunami of defaults could turn into only a ripple. Another study found that of all homeowners in the US only 5.1% were classed as subprime with fewer than 8% of those loans less than 5 years old. If defaults in that base did occur it would be only 5.1% * 8% * 10% default or .04 out of every 100 loans. This would hardly be a major event.

One study suggested that we could see one million subprime foreclosures over the next four years. Another study predicted 2.2 million. These numbers sound horrendous but remember they will be spread over the next four years. To put this into perspective there were 1.2 million foreclosure actions in 2006 and the economy did not implode. When the next wave of foreclosures hits the pain will be felt in places where the most subprime loans were written. California heads that list and yet prices are still rising in California. We forget that over 8 million homes are sold in the U.S. each year with 1.6 million of those being new homes. America creates 200,000 new households every month from graduations, marriages, divorces, etc and we see our population swell by 2.25 million immigrants each year. This consumes a lot of housing production and there are no signs of these trends slowing. Unless the subprime problem suddenly spikes well above current estimates we are likely to see only a small slowdown in the housing sector with the worst likely behind us. I admit I bought into the original fear factor when subprime loans took center stage earlier this year but I believe that was in error. Employment is still growing and the economy is still progressing. This is a far more positive time than what we saw post 9/11 when 3 million workers lost their jobs and foreclosures hit 10%. We weathered that bust and the resulting housing boom was one of the greatest booms on record. There is nothing like that on the horizon and the Fed could erase the weakness in housing with one simple rate cut any time they feel it necessary. Bernanke winked at the economy on Wednesday and told us not to worry without actually using the word subprime. Good job, Ben!

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KeyBanc Capital Markets analyst Brett Hoselton said on Friday that auto parts maker Magna International was preparing an unsolicited bid of $4.7 billion for Chrysler. He said they were being aided an unnamed private equity firm and Magna would only retain 25% of Chrysler. Cerebus Capital and Blackstone were seen as possible players in an eventual deal. Unfortunately the Magna bid is seen as way too low to have a chance. It was also viewed negatively since it would put Magna in the position of competing with their customers primarily Ford and GM. GM is also seen as a potential bidder for Chrysler. The final value of a winning bid is seen as something north of $6 billion. Daimler Chrysler (DCX) gained +4.76 on the news.

After the bell on Friday Discover Financial Services filed with the SEC to spin itself off from parent Morgan Stanley. The ticker symbol would be DFS and be listed on the NYSE. The long awaited spinoff will include a generally tax-free distribution of its shares to Morgan Stanley shareholders. Morgan said earlier in the week that the spinoff was on track for the 3rd quarter. Since shares of MasterCard nearly tripled after its IPO this seems to be the right time for Discover to make the break. Visa is also rumored to be planning an IPO later this year. Visa has 1.5 billion cards, MasterCard 750 million, American Express 78 million and Discover 50 million cardholders. Obviously the Visa IPO will be eagerly awaited.

PALM gained fractionally even after posting disappointing earnings. Palm received downgrades from UBS and Banc America Securities. UBS went from hold to sell and BAC from buy to hold. Palm had been trading higher in March on takeover speculation. RIMM, MOT and NOK all have deep pockets and have been suggested as potential buyers. Citigroup analyst Daryl Armstrong wrote on Friday that while he still expects Palm to be sold it is difficult to expect anyone like MOT or NOK to justify purchasing the company at current levels. The company CFO dodged acquisition questions on the earnings call saying, "All you need to know is that we are 100% focused on running an independent supplier of mobile computing products. End of story."

Kronos, (KRON), always a company that conjured up visions for me of a fictional computer in a SciFi movie, agreed to a $1.74 billion buyout led by Hellman & Friedman and JMI Equity. The 30-year old software company accepted an offer of $55 per share or about a $9 premium over Thursday's closing price.

Vonage (VG) suffered a major blow on Friday after it was hit by a restraining order calling for it to halt any use of technology related to patents held by Verizon. Vonage has already been found in violation of 3 of the 5 VOIP patents Verizon holds and was just waiting on the next phase in the suit to transpire. The unexpected restraining order was a major blow although they claim they will win in the end. Any win for Vonage is going to be a major uphill battle from here and investors were not betting on Vonage at the close. After being halted for trading for most of the morning VG closed down -25% at $3.00 and I doubt the selling is over. There is speculation that any deal with Verizon will be too expensive and any work around will be far too bulky and cumbersome. That leave Vonage with a serious challenge that it may not be able to overcome and analysts were already talking about a potential business closing. Vonage has turned into the worst IPO of the decade with its fall from the IPO high of $17.25 last May to Friday's close at $3.00.

Vonage Chart - Daily

In a week led by a strong flurry of M&A deals there was news on Friday that Citigroup may be considering a bid for ABN Amro. ABN has already agreed to be acquired by Barclays for $80 billion and would be one of the largest deals ever. Insiders at Citigroup are said to be pushing management to make a rival bid for ABN.

May Crude Oil Chart - Daily

Oil prices returned to their recent highs on Friday at $62.65 before seeing some profit taking at the close. This was well above the lows of $56.10 we saw on Tuesday. I told everyone in these pages to buy the dip and I hope you took my advice. There were multiple reasons for the dip, mostly profit taking post OPEC and some futures expiration pressures. The rebound needed no reason since the fundamentals did not change. Inventory levels were falling, gasoline prices were rising and refineries were either down for maintenance or suffering from various outages. VLO, COP and Shell (RDS) all saw outages this week from power problems. Exxon also had problems and lost production. However, Friday's gains were also prompted by new concerns over Iran. Iran patrol boats captured 15 British naval troops in Iraqi waters while they conducted a search of a private vessel. The British personnel and boats were then taken back to Iranian waters and to an Iranian base in the Shatt al Arab waterway. This attack on British personnel in Iraqi was witnessed by various military patrols in the area and was a blatant move into Iraqi waters. Considering the capture came only one day before the UN Security Council is set to vote on new sanctions against Iran it is even more puzzling. After a week of posturing by Iranian officials the act showed even more defiance than normal. Iranian President Mahmoud Ahmadinejad called off his visit to New York to address the Council on Saturday and blamed the cancellation on the lateness of getting Visas for his trip to the US. Others said it was likely he would find it difficult to claim to be peaceful after seizing British troops in Iraqi waters.

There were also the strong words by the supreme leader earlier in the week. Supreme Leader Ayatollah Ali Khamenei warned again on Wednesday that Iran would strike back at anyone who attacked them and would exact a terrible price. He also said UN sanctions would have no impact because Iran would continue its nuclear efforts illegally until it was successful. I believe Iran caught the British and US forces off guard with its dash into Iraqi waters to capture the British personnel. Both the British and US commanders in the area have demanded the immediate return of the personnel and equipment. I believe it will happen eventually and once they are returned the rules of engagement for allied forces will be raised significantly. The next Iranian ship that ventures towards an allied force in Iraqi waters may quickly find itself a permanent obstacle to shipping from its resting place on the bottom of the channel. This is exactly the kind of head busting confrontation the allies will be looking for to prove Iran is not immune to hostile fire. Trick us once, shame on you. Trick us twice and lose your ship. The low-key confrontation may have occurred without any shots being fired but the ramifications to the oil market were clear. The escalation of tensions between the US and Iran is drawing ever closer to a real confrontation and with two carrier battle groups in place there will only be one winner. Analysts are starting to talk about $70 oil again before summer is over and the target price rises with every Iranian news item.

London based storm forecaster Tropical Storm Risk (TSR) said on Tuesday the six-month season, which begins on June 1st, was expected to bring 17 tropical storms, of which nine will strengthen into hurricanes. Four of those nine are expected to become more destructive or intense storms. The long-term average is 10 storms with 6 reaching hurricane strength. TSR said current climate signals indicate land-falling hurricane activity will be 75% above the 1950-2006 averages. Back in December that estimate had been only 60% but the sudden dissipation of El Nino in February raised the risk. The Colorado State University forecasters have also warned the 2007 season is likely to be busier than normal. In 2005 there were a record 28 storms and 15 hurricanes and following only a slightly less active season in 2004. Everyone agrees the very calm 2006 season was a statistical fluke and is not likely to happen again in 2007.

Last Sunday the Dow was resting on support at 12100 and that support looked poised to break. I speculated that odds were high it would break and we would see a new low under 12000. While I had a fever of 103 when I wrote it I am not claiming it influenced my thinking. The charts show what they show and last Sunday they were showing a greater chance of decline than rally. That all changed on Monday when a flurry of M&A deals, including the record breaking $80 billion ABM Amro deal, sent the indexes on a short covering ride higher. The start of the FOMC meeting on Tuesday and the +9% jump in housing starts applied even more fuel to the fire. The Dow leveled off at just below resistance at 12300 to wait for the Fed announcement. Surprise, surprise, surprise as Gomer Pyle would say. The unexpected removal of the tightening bias caught everyone off guard and the rest as they say is history. Friday saw the Dow bumping its head on 12500 and +400 points off last Friday's support.

In only a few short hours the game has changed substantially. The bulls no longer have a wall of worry to climb but an interstate highway paved with gold bricks stretches out before them. There are only five days left in the quarter and earnings warnings have been suspiciously absent. With all the stars in alignment it is entirely possible we could be back at new highs before the quarter ends. What a picture perfect scenario that would be for fund managers! New highs at the end of a messy quarter. Retail investors confident the correction was behind them would be pouring money into funds. What is wrong with this picture? Frankly I can't see anything wrong with it today. The summer doldrums lay ahead but Q1 earnings are about to begin. According to the bean counters the earnings estimates for Q1 have declined from just over 8% growth two months ago to only about 5% growth today. I doubt most investors have come to that realization yet. The string of double-digit quarters has run so long that everyone just expects them to continue. 5% growth may suddenly cause investors to jump back in alarm even though 5% is still decent for the long term. Nearly 70% of companies have been beating estimates recently and investors will expect that to continue. We all know that is from managing expectations but what happens when those expectations shrink to only 5% growth. Will investors suffer sticker shock when the numbers begin two weeks from now? Who knows but I suspect they will be more focused on the perception that the Fed is going to cut rates later this year and that will blot out a few earnings disappointments. It will be several weeks before we get enough announcements for the reality to sink in and reporters to polish their sound bites discussing the earnings decline. Until then the punchbowl has just been refilled courtesy of the Fed and the revelers are going to drink themselves giddy.

The Nasdaq closed at 2449 and almost exactly where it closed for the prior two days. Nasdaq 2455 appears to be strong resistance but there has been no credible effort to sell it off. The index is pinned to 2450 and several less than exciting tech events late this week failed to have any impact. There were some bad trades posted at 1:55 on Friday that spiked the index from 2450 to 2457 but those trades were corrected at 3:20 and the print returned instantly to the same level it was holding prior to takeoff. Donegal Group (DGICA) had several trades cross at $1,999 instead of the $18 level where it was trading when they were entered. The Nasdaq immediately cancelled the trades once they were located and the index values were corrected.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

The S&P-500, like the Nasdaq, found itself pinned to 1435 and the level reached after Wednesday's Fed announcement. Moves over that level were very limited and very brief but like the Nasdaq there was no concentrated effort to sell it off. Both indexes appeared to be exactly where the fund managers wanted them to be ahead of quarter end window dressing. Friday's volume was negligible at 4.6 billion shares and the lowest level since Feb-12th. Internals were strongly positive but given the very light volume but there appeared to be no conviction.

That conviction came from the Russell. The Russell closed at 810 and a new 4-week post crash high. That is only 20 points from the all time high set on Feb-22nd. This is all the conviction I need to believe we are going higher next week. Fund managers are buying small caps ahead of quarter end and that suggests we will see plenty of tape painting next week. It is entirely possible we will see new highs. The NYSE Composite also closed at a new post crash high to confirm the move in the Russell.

Economic Calendar

The economic calendar for next week will give us another look at home sales and several regional Fed surveys. The GDP revision for Q4 should not be earth shaking since the major revision from 3.5% to 2.2% was seen last month. The expectations for next week are for a flat revision to a nominal +0.2% rise to 2.4%. The PMI on Friday could be the big report for the week since the last two reports showed contraction. A rebound above 50 would be very positive for the market although potentially troubling for the Fed. The Fed would like to see a couple more months of contraction to keep inflation pressures under control. This is even more important now that they have removed the tightening bias. We don't need any sudden rebound in the economy to upset their plans.

As traders we need to stick with the trend and that trend should last through Friday. Fund managers are in control and they will be trying to keep the rebound going through quarter end if at all possible.

Jim Brown
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
ATINoneNone
BG  
CHAP  
LMT  

New Calls

Allegheny Tech. - ATI - cls: 108.01 chg: -0.39 stop: 105.75

Company Description:
Allegheny Technologies Incorporated is one of the largest and most diversified specialty metals producers in the world with revenues of $4.9 billion during 2006. ATI has approximately 9,500 full-time employees world-wide who use innovative technologies to offer growing global markets a wide range of specialty metals solutions. (source: company press release or website)

Why We Like It:
We are going to take another swing at ATI. We recently played it on the newsletter and shares hit our target on Thursday. If the markets continue higher then ATI has a decent chance of breaking out over resistance at the $110 level. This is especially true since steel stocks remain strong and ATI could see some window dressing buying pressure this week. We're suggesting a trigger to buy calls at $110.26. If triggered our target is the $117.00-120.00 range. An alternative entry for the more nimble trader would be a dip near $105.00-106.00. FYI: The P&F chart points to a $123 target. We do not want to hold over the late April earnings report. Caution, we do see a bearish divergence between price and the MACD on the daily chart.

Suggested Options:
Our suggested trigger to buy calls is at $110.26. We are suggesting the May calls. Alert - The CBOE lists the May 110 call with a -EX suffix. Normally it would be -EB so double check with your broker.

BUY CALL MAY 105 ATI-EA open interest=142 current ask $8.70
BUY CALL MAY 110 ATI-EX open interest=263 current ask $6.00
BUY CALL MAY 115 ATI-EC open interest=347 current ask $3.90

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/25/07 (unconfirmed)
Average Daily Volume = 2.6 million

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Bunge Ltd. - BG - cls: 79.89 chg: +0.54 stop: 77.95

Company Description:
Bunge Limited is a leading global agribusiness and food company founded in 1818 and headquartered in White Plains, New York. Bunge's over 22,000 employees in over 30 countries enhance lives by improving the global agribusiness and food production chain. The company supplies fertilizer to farmers in South America, originates, transports and processes oilseeds, grains and other agricultural commodities worldwide, produces food products for commercial customers and consumers and supplies raw materials and services to the biofuels industry. (source: company press release or website)

Why We Like It:
It looks like BG's correction is over and shares are rebounding back toward its highs. Traders bought the dip in mid-March where broken resistance had turned into new support. Technical indicators have turned positive on the daily chart. Plus, the P&F chart has reversed its sell signal into a new buy signal with a $93 target. Nimble traders may want to try and buy a dip in the $78.00-78.50 zone. We're suggesting that readers wait and buy a breakout over $80.70. Our suggested trigger to buy calls will be $80.75. If triggered our target is the $85.00-85.50 range. We do not want to hold over the late April earnings report.

Suggested Options:
Our suggested trigger to buy calls is at $80.75. We're suggesting the May strikes.

BUY CALL MAY 75.00 BG-EO open interest= 83 current ask $7.10
BUY CALL MAY 80.00 BG-EP open interest=220 current ask $3.80
BUY CALL MAY 85.00 BG-EQ open interest= 35 current ask $1.70

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/26/07 (unconfirmed)
Average Daily Volume = 990 thousand

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Chaparral Steel - CHAP - cls: 55.73 chg: +1.29 stop: 51.75

Company Description:
Chaparral Steel Company, headquartered in Midlothian, Texas, is the second largest producer of structural steel beams in North America. Chaparral is also a significant supplier of steel bar products. In addition, Chaparral is a North American recycling company. (source: company press release or website)

Why We Like It:
We don't have to worry about earnings for CHAP. The company reported last week and beat estimates by six cents. Management then guided higher going forward. The initial reaction in the stock price was to sell the news but traders quickly bought the dip near its rising 10-dma. CHAP is now hitting new all-time highs. Currently the steel sector is strong and we think CHAP has further to run. We are suggesting call positions now although a dip back toward $55 or $54 would be a preferable entry point. Our target is the $59.50-60.00 range. The P&F chart has a triple-top breakout buy signal with a $72 target.

Suggested Options:
We are suggesting the May calls. Please note that it is up to you, the individual trader, to determine which month and which strike price best suits your trading style and risk.

BUY CALL MAY 50.00 ZHQ-EJ open interest= 95 current ask $7.20
BUY CALL MAY 55.00 ZHQ-EK open interest= 87 current ask $3.80
BUY CALL MAY 60.00 ZHQ-EL open interest=162 current ask $1.65

Picked on March 25 at $ 55.73
Change since picked: + 0.00
Earnings Date 03/20/07 (confirmed)
Average Daily Volume = 627 thousand

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Lockheed Martin - LMT - cls: 99.15 chg: +1.24 stop: 97.49

Company Description:
Headquartered in Bethesda, Md., Lockheed Martin employs about 140,000 people worldwide and is principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. The corporation reported 2006 sales of $39.6 billion. (source: company press release or website)

Why We Like It:
LMT has been a consistent winner for stockholders and shares could see some window dressing before the end of the quarter on Friday. Currently shares are consolidating under resistance at the $100.00 mark. We're suggesting a trigger to buy calls at $100.25. If triggered our short-term target is $104.85-105.00. More aggressive traders may want to aim higher since the P&F chart aims at a $128 target. We do not want to hold over the late April earnings report.

Suggested Options:
Our suggested trigger to buy calls in LMT is at $100.25. We are suggesting the May calls although Junes would work and have more open interest.

BUY CALL MAY 95.00 LMT-ES open interest= 56 current ask $6.20
BUY CALL MAY 100.0 LMT-ET open interest=256 current ask $3.00
BUY CALL MAY 105.0 LMT-EA open interest=192 current ask $1.10

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/26/07 (unconfirmed)
Average Daily Volume = 1.8 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Apple Inc. - AAPL - cls: 93.96 chg: +0.09 stop: 88.85

The upward momentum in AAPL stalled on Thursday and Friday. Shares continue to look bullish with last week's breakout over the $90-91 zone. We suspect that with next Friday being the end of the first quarter that AAPL will benefit from window dressing. If you're looking for a new entry point we'd watch for a dip toward $91 or near its 10-dma (currently near 91.15). The next challenge for AAPL is potential resistance near $95. Our target is the $97.50-100.00 range. FYI: We can't help but notice that the trading in AAPL over the last four months is starting to look like a potential head-and-shoulders pattern, which would be bearish.

Suggested Options:
If AAPL pulls back and provides another entry point we'd suggest buying the May calls. We do not want to hold over the late April earnings report.

Picked on March 19 at $ 91.01
Change since picked: + 2.95
Earnings Date 04/25/07 (confirmed)
Average Daily Volume = 35 million

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Boeing - BA - close: 90.98 chg: +0.41 stop: 88.95

BA is still consolidating sideways but if you look inside at the intraday trading the stock seems poised to move higher. Friday's session was strong right from the start and BA produced a bullish engulfing candlestick pattern. More aggressive traders might want to consider new positions now. We're going to stick to our plan, which is to wait for a breakout over resistance near $92.00. Our suggested entry point to buy calls is at $92.15. If triggered our target is the $99.50-100.00 range. We do not want to hold over the late April earnings report. The P&F chart is already bullish and points to a $107 target.

Suggested Options:
We are suggesting the May calls. Our suggested trigger to open plays is at $92.15.

BUY CALL MAY 90.00 BA-ER open interest=8502 current ask $3.70
BUY CALL MAY 95.00 BA-ES open interest=9557 current ask $1.35
BUY CALL MAY 100.0 BA-ET open interest=6948 current ask $0.45

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/25/07 (unconfirmed)
Average Daily Volume = 4.2 million

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CACI Intl - CAI - cls: 48.00 chg: -0.25 stop: 46.64

Lack of follow through on CAI's bullish breakout from Wednesday is somewhat discouraging but the major market averages haven't moved the last two days. Shares of CAI remain above its simple 50-dma, which is a positive. Traders can choose to buy this dip or wait for another show of strength like a move over $48.50 as a new entry point. More conservative traders may want to wait for a move over the January 18th high near $48.90 first. Our target is the $52.50 mark. We do not want to hold over the late April earnings. FYI: The P&F chart is still bearish from the big drop in January.

Suggested Options:
We are suggesting the May calls. Traders might want to consider using April calls, which have more open interest.

BUY CALL MAY 47.50 CAI-EB open interest= 20 current ask $2.60
BUY CALL MAY 50.00 CAI-EJ open interest= 26 current ask $1.40

Picked on March 21 at $ 48.36
Change since picked: - 0.36
Earnings Date 04/25/07 (unconfirmed)
Average Daily Volume = 517 thousand

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Celgene - CELG - close: 55.02 chg: +0.55 stop: 49.95

CELG out paced the rally in biotech stocks on Friday. The stock got a boost after news hit that the European Medicines Agency had approved CELG's Revlimid as a treatment for myeloma better known as bone-marrow cancer. Shares of CELG responded with a spike to $55.49 and a bullish breakout over resistance at its 100-dma and the $55.00 level (just barely). We remain positive but we're not suggesting new positions at this time. Our target is the $57.50-60.00 range. We do not want to hold over the late April earnings report.

Suggested Options:
We're not suggesting new positions in CELG at this time. However, if shares were to dip or bounce near the $53.50 region it could be used as a new entry point. We like the May calls.

Picked on March 19 at $ 52.65
Change since picked: + 2.37
Earnings Date 04/26/07 (unconfirmed)
Average Daily Volume = 3.5 million

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ConocoPhillips - COP - cls: 69.25 chg: +0.57 stop: 64.85

In this weekend's market wrap Jim talks about how news that Iran had captured some British armed forces renewed fears about an armed conflict with Iran, which would send oil prices skyrocketing. Oil is already climbing on concerns about adequate gasoline supplies for this summer's driving season. COP's breakout over $69 this week has produced a new quadruple top breakout buy signal on the Point & Figure chart with a $78 target. We're aiming for the $74.00-75.00 range. However, traders may want to wait for a dip toward $68.75-68.50 as a new entry point or look for a move over $70.00 as a new entry point. We do not want to hold over the late April earnings report.

Suggested Options:
We are suggesting the May calls.

BUY CALL MAY 65.00 COP-EM open interest=37094 current ask $5.70
BUY CALL MAY 70.00 COP-EN open interest=44511 current ask $2.40
BUY CALL MAY 75.00 COP-EO open interest=23879 current ask $0.70

Picked on March 20 at $ 66.31
Change since picked: + 2.94
Earnings Date 04/25/07 (unconfirmed)
Average Daily Volume = 12.1 million

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ESSEX Prop. - ESS - cls: 135.03 chg: +0.81 stop: 129.75 *new*

Shares of ESS, a REIT, continued to show relative strength on Friday. The stock posted its fifth gain in a row and the seventh gain in the last eight sessions to breakout over round-number resistance at the $135 level. The breakout wasn't very convincing but we do note that volume came in pretty strong. We are not suggesting new positions at this time and more conservative traders will want to seriously consider taking some money off the table right now. We see potential resistance at its 50-dma overhead so we're aiming for an exit in the $137.00-140.00 range. We are adjusting the stop loss to $129.75.

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

Picked on March 12 at $130.26
Change since picked: + 4.77
Earnings Date 02/07/07 (confirmed)
Average Daily Volume = 196 thousand

---

Holly Corp. - HOC - cls: 61.37 chg: +1.01 stop: 56.45 *new*

Continued strength in oil and oil stocks, thanks to the Iran news, helped push HOC to another new all-time high. The stock is nearing our $62.00-62.50 target so we're not suggesting new positions at this time. The intraday high on Friday was $61.74. More aggressive traders may want to aim higher but bear in mind that HOC is starting to look overbought with the non-stop run from its March lows. We are raising the stop loss to $56.45. The $60 and $58 levels should act as short-term support.

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

Picked on March 14 at $ 57.87
Change since picked: + 3.50
Earnings Date 05/14/07 (unconfirmed)
Average Daily Volume = 651 thousand

---

Johnson Controls - JCI - cls: 95.68 chg: -0.18 stop: 93.99

The market's lack of follow through on Wednesday's big gain is very evident in JCI. The stock appeared to breakout from a pennant-shaped consolidation pattern on Wednesday but then failed to confirm it. Our expectation is that stocks will generally move higher next week due to end-of-quarter window dressing. That may be the catalyst JCI needs to make another run at its February highs. Traders can choose to buy calls now or wait for a new relative high over $96.40 before initiating positions. Our short-term target is the $99.75-100.00 range. More aggressive traders may want to aim higher! We do not want to hold over the late April earnings report.

Suggested Options:
We are suggesting the May calls although Aprils might work and have more open interest.

BUY CALL MAY 95.00 JCI-ES open interest=27 current ask $4.20
BUY CALL MAY 100.0 JCI-ET open interest=83 current ask $1.85

Picked on March 21 at $ 96.03
Change since picked: - 0.35
Earnings Date 04/20/07 (unconfirmed)
Average Daily Volume = million

---

Accredited Home Lenders - LEND - cls: 11.77 chg: -0.80 stop: n/a

We added LEND to the play list on March 14th with the (high-risk and very speculative) plan to buy calls on the expectation that someone would step in and buy the company given the massive sell-off in the stock price. Since that time there has been a lot of talk about a potential buyout and a few analysts have guessed that any buyout would be in the $15 range. Short-covering and a slow down in the bad news for subprime lenders has produced a significant bounce in the stock. There is still a chance that LEND will be taken over but we're not suggesting new positions at this time. We strongly suggest that readers consider taking some profits off the table now. We plan to exit in the $14.00-15.00 range whether there is a buyout offer or not. If you prefer, instead of exiting early, think about putting a stop loss under the $10.00 level.

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

Picked on March 14 at $ 6.04
Change since picked: + 5.73
Earnings Date 05/16/07 (unconfirmed)
Average Daily Volume = 3.0 million

---

New Century - NEWC - close: 2.00 chg: +0.44 stop: n/a

The beleaguered shares of NEWC showed signs of life on Friday. The stock rose 28% but it remains to be seen if this is a temporary bounce or something more sustainable. We don't have very high expectations at this point. We initially added NEWC as a lottery ticket play with a big risk and big reward on the speculation that someone would step in and buy the company. So far that has failed to materialize. It could still happen but we wouldn't bet on it any further. Thus we're not suggesting new positions.

Suggested Options:
We're not suggesting new plays in NEWC.

Picked on March 11 at $ 3.21
Change since picked: - 1.21
Earnings Date 11/02/06 (confirmed)
Average Daily Volume = 6.7 million

---

Sunoco - SUN - close: 71.16 chg: +0.85 stop: 65.65 *new*

Rising crude oil, in addition to rising concerns over Iran, lifted the energy stocks on Friday. The sector turned in a strong week and while the group may be due for some profit taking we'd use any weakness as a new entry point to buy calls. SUN broke out over multiple levels of resistance last week. If you are looking for a new entry point watch for a dip toward the $69.00-68.00 zone. The P&F chart is very bullish with an $82 target. Our target is the $74.00-75.00 range. Please note that we're adjusting the stop loss to $65.65. As a refiner, SUN, should do very well over the summer driving season and investors should eventually begin buying ahead of the summer quarter.

Suggested Options:
If SUN provides a new entry point we'd suggest the May calls.

Picked on March 20 at $ 68.15
Change since picked: + 3.01
Earnings Date 05/02/07 (unconfirmed)
Average Daily Volume = 2.8 million
 

Put Updates

Bausch Lomb - BOL - cls: 49.89 change: -0.05 stop: 52.51

BOL is still under performing the market and shares failed to close over round number, psychological resistance at the $50.00 mark on Friday. Shares remain somewhat oversold and thus short-term technicals are mixed but long-term the technicals look bearish. We suspect that with BOL down for the quarter, any funds that still own it might do some window undressing and dump the stock before the end of March. The last couple of weeks has seen a bearish breakdown under the 200-dma, the $50 level and what appears to be the bottom edge of a bear wedge pattern on the weekly chart. More conservative traders can tighten their stops. Our target is the $44.00-42.50 range but we want to warn readers that BOL may find some support near $47.50 and its December 2006 low.

Suggested Options:
We are suggesting the May puts.

BUY PUT MAY 50.00 BOL-QJ open interest=334 current ask $1.85
BUY PUT MAY 45.00 BOL-QI open interest= 67 current ask $0.45

Picked on March 18 at $ 49.51
Change since picked: + 0.38
Earnings Date 00/00/07 (unconfirmed)
Average Daily Volume = 678 thousand

---

Beazer Homes - BZH - close: 33.16 chg: +0.03 stop: 36.25

The homebuilders initially rallied on the better than expected existing home sales numbers that came out on Friday morning. Unfortunately for the bulls the rally didn't last long and investors sold into strength. Shares of BZH continue to look oversold but the lack of follow through on Wednesday's big bounce should be encouraging for the bears. More conservative traders may want to tighten their stops. Our target is the $30.50-30.00 range. FYI: Traders should note that BZH does have a relatively high amount of short interest (17% of the float) and that does raise the risk of a short squeeze.

Suggested Options:
We're not suggesting new plays in BZH at this time.

Picked on March 12 at $ 34.20
Change since picked: - 1.04
Earnings Date 04/26/07 (unconfirmed)
Average Daily Volume = 1.2 million

---

Electronic Arts - ERTS - cls: 50.13 chg: -0.13 stop: 51.55

Positive analyst comments on the video game industry on Friday failed to move the group higher so we're not willing to abandon the play just yet. Aggressive traders might want to use the Thursday-Friday failed rally near $51 and its 200-dma as a new entry point. We are suggesting readers wait for a new relative low under $48.70 before initiating new plays. Our target is the $45.15-44.00 range, which is a small adjustment from our previous comments. FYI: Normally video games stocks start heading up in spring as investors look forward to the huge E3 expo but this year it has been scheduled for summer time.

Suggested Options:
We are suggesting the May puts.

BUY PUT MAY 50.00 EZQ-QJ open interest= 194 current ask $2.10
BUY PUT MAY 45.00 EZQ-QI open interest= 43 current ask $0.60

Picked on March 18 at $ 48.92
Change since picked: + 1.21
Earnings Date 05/03/07 (unconfirmed)
Average Daily Volume = 4.0 million
 

Strangle Updates

None
 

Dropped Calls

Molson Coors - TAP - cls: 92.88 chg: +1.85 stop: 84.95

Target achieved. The markets turned in one of the best weeks they have seen in years. Leading the way was TAP, which surged to a series of new highs. Friday's session witnessed a 2% gain on above average volume. Our target was the $92.50-95.00 range so the play is closed.

Picked on March 14 at $ 87.15
Change since picked: + 5.73
Earnings Date 05/17/07 (unconfirmed)
Average Daily Volume = 782 thousand
 

Dropped Puts

MarineMax - HZO - close: 22.84 change: +1.01 stop: 22.26

We would have been stopped out of HZO at $22.26. Unfortunately, we could not uncover what prompted the rally or more likely the short squeeze in HZO. The stock broke out over short-term resistance at $22.00 and then just kept going.

Picked on February 11 at $ 22.59
Change since picked: + 0.25
Earnings Date 04/26/07 (unconfirmed)
Average Daily Volume = 300 thousand

---

Ryland Group - RYL - close: 46.12 chg: -0.11 stop: 46.77

The Friday morning existing home sales numbers came in a lot stronger than expected and that fueled an intraday rally in the homebuilders. Shares of RYL spiked to $47.48 before quickly reversing course. Yet it was enough to stop us out at $46.77. We would keep an eye on RYL for a new decline under $45.00 as another entry point to buy puts.

Picked on March 13 at $ 44.75
Change since picked: + 1.37
Earnings Date 04/25/07 (unconfirmed)
Average Daily Volume = 1.1 million
 

Dropped Strangles

None
 


Trader's Corner

More about Keltner Channels

This week's Trader's Corner continues a series of articles on nested Keltner channels. As noted in the first article in the series last week, I use them to determine where support or resistance might lie, make judgments about the strength of that support or resistance, and ask if/then questions that help determine when assumptions about the market might be confirmed or violated.

I also use them to determine when markets are in a runaway mode, times when countertrend or so-called fading-the-move trades should not be attempted, and to set upside or downside targets. Several of those topics were addressed in last week's article. This article builds upon that discussion.

When I prepared the Wrap for Thursday, March 15, I included this nested Keltner chart in the "What about Tomorrow?" section.

Annotated 30-Minute Chart of the RUT:

Determining that support looked strong enough to propel the Russell 2000 into a test of resistance was easy enough, wasn't it? The RUT was already moving up into the close, already testing resistance. However, my annotation had been made prior to the last 30-minute candle. I had begun annotating charts several hours previous to the close with the intention of editing them if needed. My original annotation wasn't based on what happened near the close but instead had to do with the way Keltner lines were configured, helping me to determine where support or resistance lay and which appeared stronger.

That chart's annotations also pinpointed potential targets. Determining the relative strength of support and resistance and setting targets are two of the ways that I use nested Keltner channels. They'll be discussed in this week's article.

Last week's introduction on Keltner channels employed one channel at a time, showing how effectively Keltner channels can pinpoint likely support or resistance. These channels, built around a multiple of a central moving average, can be set so that their boundaries contain most price movements of a security. Breakouts--periods when momentum controls price movements--can be identified as strong momentum carries prices above or below channel boundaries, converting upper channel lines to support lines and lower ones to resistance lines for the duration of the breakout.

However, I find Keltner channels most useful when several are nested together on a single chart. QCharts and QuoteTracker both allow the channels to be nested in this way, although the QuoteTracker guidelines say that they cannot be nested. I do it every day! ESignal also allows it, although traders have to import the formulas themselves or they did when I investigated eSignal several years ago.

I didn't invent the idea of nesting Keltner channels. I'm indebted to Jerry Wawrzeniak ("The Case for Keltner Channels") for the idea as well as for the settings I employ. Those settings are as follows:

Widest Channel: Based upon a 120-ema, 7.2 multiple
Next Widest Channel: Based upon a 45-ema, 3 multiple
Narrowest Channel: Based upon a 9-ema, 1.4 multiple

Nesting the channels together on a single chart produces a chart like the first one in the article or the one found below.

Annotated 7-Minute Chart of the SML:

The confusion of basis lines and outer channel lines proves disorienting for some traders, but there's much information to be gleaned from this chart once traders become accustomed to the confusion of lines.

First, upside moves tended to be stopped at the outer channel, showing that this channel line did have relevance to the then-current trading pattern. As prices were rebuffed from upper-channel resistance and then rebounded again, they tended to stay in the upper half of the channel, showing an overall bullish tenor during the time period covered. However, that bullish tenor was weakening slightly toward the right-hand side of the chart as the black-channel's support slipped just below the 120-ema, the basis line for the largest channel. These two lines tend to be important support when prices are above them.

However, support lines were still converging thickly enough that they should have held, especially since those two lines mentioned tend to be important support when prices are in the upper half of the widest channel. One of two occurrences would likely have been needed to break that support, and neither happened that next Monday morning. Either SML's prices would have to be gapped below that converging support or else prices would need to batter at the converged supporting lines until they separated further, weakening support enough that prices could slip lower.

That slight weakening had shown up in another way, too. Up until about 11:00 Friday, 3/16, candles were mostly closing 7-minute periods above the pink line, the 45-ema that is the basis line of the black channel. Not only had prices been staying in the upper half of the widest channel, but they had also been staying mostly in the upper half of the next widest channel. However, about 11:00 on Friday, candles began closing 7-minute periods under that 45-ema. The pink line began serving as resistance rather than support. Candles were still in the upper half of the widest channel, but these two changes noted were alerting traders of the possibility of some weakening, a possibility that wasn't realized when trading opened the next Monday.

However, that warning about potential weakness could have been gleaned from other sources, too. The second test of the upper channel line, at about 10:20-10:30 on 3/16, had been accompanied by bearish price/RSI divergence. When prices rose again, they rose into a lower high and flattened. Pretty obvious stuff, isn't it?

What wasn't as obvious, however, is where the SML might have been headed when it broke above the black channel, as it had done on the far left of the chart. That is, it wasn't obvious unless traders were studying these nested Keltner charts. The breakout above black-channel resistance immediately set an upside target at the widest-channel's resistance.

What happens if prices break out of that widest Keltner channel, as they were ultimately to do that next Monday morning? How is a potential target set then? In that instance, it's time to dial up to a longer time period. Depending on the security being watched and the type of trade being contemplated, I often transition from the 3-minute to the 7-minute charts and then to 15-minute, 30-minute and 60-minute charts. These intervals might be used for scalping, day or sometimes even swing trades, but the 15-minute and up intervals also might be used to perfect the entry or exit on a longer-term trade such as a position trade that might be held a couple of weeks. When considering longer-term trades or when wanting to put short-term trades into the context of the overall tenor of the markets, I look at 240-minute, daily, 3-day and weekly charts. It may not be possible to view all those intervals with all charting services. My current service does not work well with 60-minute charts; my previous one did. My current service allows 3-day charts, which turn out to be surprisingly useful, but it doesn't allow the 240-minute ones that I used to favor when using another charting service. Experiment.

Let's look at some other examples.

Annotated 15-Minute Chart of the XAU:

After being rebuffed from the resistance found at that target channel level, prices fell, and candles began closing 15-minute periods back inside the black channel again. That was a signal that the upside move had likely concluded. What was the downside target? Since it was the widest channel's resistance that had rebuffed the move, the logical target was the basis line of that channel, the aqua-colored line on my charts. Although prices could of course have continued moving lower, a test of that channel's basis line is all that can be presumed when setting targets. As this article was edited Thursday evening, March 22, that's all that had been hit, too, as the XAU continued bouncing from this central-channel support on each test. That 3/16 low that tested central Keltner channel support had not been breached as of the close on 3/22.

What judgments can we make about the strength of support and resistance from that chart? Let's take another look.

Annotated 15-Minute Chart of the XAU:

The converging of various Keltner charts allows traders to make some determination about whether support or resistance is stronger.

I moved the candles to the left to make the annotations so that traders could confirm that this chart was snapped on 3/16, so that the judgments voiced there were not made up after the fact. At that time, it would have been possible to make some statements about support and resistance and likely targets for the XAU. An end-of-day move had barely edged the XAU above the thin red line seen above, the 9-ema that is the basis line of the smallest channel, the blue one. Until then, that line had been providing resistance as the XAU fell inside the black channel again. I tend to distrust last-minute movements such as these. Essentially, the XAU was still mired in the converging channel lines that were providing resistance and hadn't truly broken free.

Support and resistance looked about equally weighted, with support having enough of an edge that the XAU might at least go on testing resistance if not breaking through it. This conclusion comes because the channel lines forming support lines tend to be a bit more important than those forming the resistance that was in play at the time the chart was snapped.

Therefore, at the close that day, it appeared that support would likely hold unless one of two things happened. Either a strong downside move would be needed to blast prices through that support or even gap them below it, or a period of choppy movement would be needed to separate the channel lines providing support. Otherwise, support would likely hold.

Short-term bulls had something to worry them at the close that day, however. Notice that there's nothing between those converging support lines and the lower channel support at 127.9998? Support was weak below the level being tested at the close. A push through that support on Monday morning could have produced a quick decline toward that support. That didn't happen but knowing what could happen could help traders prepare trading plans for that Monday morning.

More traditional technical analysis would have already noted the potential head-and-shoulder on this chart as of the close 3/16, complete with bearish price/RSI divergence as the head was formed. Although I don't trust H&S formations, and particularly don't trust them to meet their targets, they are useful to watch. It is notable that if this one had confirmed, the downside target would have been near the bottom Keltner channel line.

If prices continued climbing Monday morning, as they did, the chart seen above predicted that first short-term resistance would have been found near 134.63 on 15-minute closes, although any strong rise in prices would have shoved that black line up toward 135.51 resistance at the top channel line, too, so it would have appeared possible that resistance wouldn't have been found until that level.

Let's look at what did happen.

Annotated 15-Minute Chart of the XAU:

Nesting the Keltner channels together has allowed for some judgments as to whether support or resistance is stronger. It's provided for a way to make judgments about the likely next action and to set targets if resistance or support were broken.

Do Keltner channels always work? Of course not. However, they do give traders ways to judge whether and when their assumptions about the next action are being violated. That's the topic for the next article, next weekend.
 

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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