Option Investor

Daily Newsletter, Thursday, 05/03/2007

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Table of Contents

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

Market Wrap

Taking Turns


This morning, indices decided to play nicely. The Dow took a step back, letting other indices bask in the new-recent-high limelight. The Dow didn't have to make a new intraday record: it could achieve a new closing high just by waffling around, mostly above yesterday's close. That gave other indices the chance to grasp the new-recent-high headlines. The Dow did produce its new closing high. It also closed higher than it had yesterday, a "record day" in candlestick parlance, making it something like 22 out of the last 25 trading days that it has created record days, if I've counted correctly. Need I say how out of the ordinary that is?

[Note: For you English majors who are shrieking at my anthropomorphism of the indices, I apologize.]

It was another index that grabbed headlines, however. By mid-morning, CNBC headlines touted the SPX's highest level since September 2000. The big-cap OEX had accompanied the SPX in its early climb above Wednesday's highs, too, as had the NYSE. The NYSE closed higher again, eking out a close just above the April 25 close, but by less than 8 points.

It was the Dow Jones Transportation Index's (TRAN) performance that most astounded early this morning, however. Although the TRAN did not reach a new recent high, it had added more than 111 points within an hour and a half of the open, most of those within the first twenty minutes of trading. The TRAN performed like a sprinter taking off, but it was taking off without its sister index, the Dow. The Dow's relative hesitation provoked even more attention when her sister index was performing so strongly. The TRAN tends to lead the Dow, SPX and OEX.

Therefore, it was the TRAN I watched closely this morning as the index pulled back off that astonishing gain and crept up into a slightly lower high. While the SPX had been rising to and through its almost obligatory 1500 test, the TRAN's zoom had brought it right up to an important Keltner resistance level, a level it was to spend the rest of the day trying to maintain and even surmount.

But the TRAN couldn't hold near the day's highs. That index resisted confirming that intraday lower high until shortly after noon, when it suddenly dropped through that level. It did manage a close above its 10-sma, but that long upper shadow it left on its candle was indicative of some selling of transportation stocks into the morning's rise.


Annotated Daily Chart of the SPX:

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the NDX:

Annotated Daily Chart of the SOX:

Annotated Daily Chart of the RUT:

Today's Developments

Today's economic reports began with several reports clumped together at 8:30 EST. Those included the usual weekly Jobless Claims and the first-quarter Preliminary Productivity and Preliminary Unit Labor Costs.

Initial jobless claims fell 21,000 to 305,000. Economists had predicted a rise of 4,000, so this release somewhat argued against the weak ADP data yesterday. It's better to look at the four-week moving average, however, than examine too closely the more volatile weekly data. For example, last week's data has been revised to a decrease of 15,000 rather than the previously estimated 20,000. The four-week average showed also showed claims dropping, but by only 4,500 in that case. Continuing claims fell 93,000 with the four-week moving average still rising, by 1,500.

In the previous quarter, productivity climbed 1.6 percent. Economists had predicted that the preliminary figure for this quarter would rise 0.8-1.0 percent, but productivity instead rose by a more reassuring projected annual rate of 1.7 percent when compared to the fourth quarter of last year. When compared to the first quarter a year ago, it rose a more moderate 1.1 percent.

That rise wouldn't have provided much reassurance for the markets, however, if unit labor costs had risen too much. Preliminary unit labor costs had risen 6.6 percent in the previous quarter, but growth was expected to moderate to a tamer 2.1-3.6 percent, depending on the source quoted, in the first quarter. Instead, unit labor costs rose at an annual rate of only 0.6 percent, easing fears that labor costs would drive up inflation. For the previous year, the costs have risen 1.3 percent, far lower than the 3.4 percent rate from the fourth quarter. Real hourly compensation declined 1.5 percent.

Some commentators, including one of CNBC's, questioned whether the news was really as good as it appeared on the surface. The number reflected a decrease in numbers of hours worked, for example. However, the equity markets interpreted it only in a good light, as was reflected by an improvement in the futures and a climb in the cash market, too, at the open. Bond traders weren't so sure about the news: ten-year yields zoomed higher. By mid-morning, they were just beneath the 200-ema. They had pulled back slightly by the close but maintained most of the day's gains.

At 10:00, Tuesday's April Manufacturing ISM was followed by today's ISM Non-Manufacturing Business Index. Previously, the non-manufacturing or service-sector index had measured 52.4 percent, and economists had expected it to rise to 53.0-54.0 percent this time, depending on the source. That number beat expectations, too, rising to 56 percent. Components such as new orders, employment and prices-paid all rose, too, but the employment and prices-paid components did not appear to climb enough to increase inflationary fears.

Although this number is not typically a market-moving number, markets did pop about the time it was released, with the pop driving SPX prices above the rising megaphone resistance that had been forming on the intraday charts since mid-morning on Wednesday. Prices quickly reversed back within the megaphone shape, however, only to break above them later in the morning as the SPX drove toward and through that benchmark 1500 level. So much for a megaphone shape supposedly being bearish.

At 10:30, the EIA reported natural gas inventories. Those rose 87 billion cubic feet. Natural gas futures temporarily fell on the news, but the energy complex was already somewhat weak, and the decline was temporary. Earlier, crude futures had fallen beneath a rising trendline off the March lows. Natural gas futures dipped to test that trendline, but then used it as a springboard for a rally in prices. The rally brought natural gas prices up toward the top of its two-month-long triangle, but did not break them higher.

Despite signs of rising tensions in Nigeria, crude futures may have been at least temporarily adversely affected by news from China National Petroleum Corp. (CNPC), with the company detailing a find of crude oil and gas reserves in Bohai Bay. When Jim Brown does his weekend Wrap this weekend, he will be better able to update on whether this news has already long percolated through the globe or whether this is really new information.


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Company-related news today included General Motors' (GM) earning report. The company disappointed, reporting adjusted earnings of $94 million or $0.17 a share. Unadjusted, earnings were $62 million or $0.11 a share, down from $602 million and $1.06 a share in the year-ago period. Restructuring costs and GMAC's exposure to the sub-prime residential mortgage sector hit the company. Headlines trumpeted GM's 90-percent year-over-year profit decline and the stock price dropped to at close at $30.69, near the bottom of the recent consolidation zone.

Another car manufacturer, BMW, reported dropping first-quarter profits, too. BMW cited the costs of raw materials and start-ups for new models as well as disadvantageous exchange rates.

UBS's earnings announcement met with some attention, too, and not just because of its miss of forecasts. The Swiss banking group said that it was closing its Dillon Read Capital management hedge fund due to the complexity and expense of running the fund. I would have thought the news might have been more negative to the equity markets, including ours, but perhaps the firm's reassurances proved sufficient.

In a time when we're being assured that strong global economies will help take up the slack for any softening here in the U.S., investors in U.S. equities perhaps preferred to concentrate on UBS's assurances that weaknesses in the U.S. mortgage markets wouldn't negatively impact other economies on a long-term scale. The firm anticipates some slowing in the U.S.'s economic expansion but believes that the rest of the world's economies are performing well.

CBS produced mixed news when reporting. Adjusted earnings per share beat estimates according to news sources, but the company's quarterly profit fell 5.9 percent.

Another company produced better news. IBM announced that it has employed a nanotechnology process when manufacturing chips, giving it an edge in the energy efficiency and power of semiconductors.

INTC also updated analysts on some developments today. The CEO claimed that the company would gain market share "in every segment" this year, according to a www.marketwatch.com article. Cost-cutting actions will save the company $2 billion this year and $3 billion next year, he said. INTC has been building on some nanotechnology of its own, earlier this year saying that it had made microprocessors on 45 nanometer process technology. The company's stock dropped eight cents today and was down another penny in after-hours trading.

Tomorrow's Economic and Earnings Releases

Tomorrow's economic report is one of the biggest of the week, April's employment report, jobs report or non-farm payrolls report, as it is variously known. Included in the report will be components measuring the average workweek, hourly earnings and the unemployment rate. The prior average workweek was 33.9 hours, prior hourly earnings had been up 0.3 percent and the prior unemployment rate had been 4.4 percent. Expectations are that the average workweek will inch lower, to 33.8 percent, hourly earnings will perhaps creep higher, by 0.3-0.4 percent, and the unemployment rate will inch higher, to 4.5 percent.

Yesterday, ADP provided its estimate of private-sector jobs, saying 64,000 had been created. This was the lowest increase in four years, the firm estimated, with the low growth prompted by cuts in goods-producing industries. This number does not include government jobs, and some doubt its accuracy in predicting the non-farm payrolls number after a number of misses the last year, but if an estimated 24,000 government jobs were added in, that would predict job gains of about 88,000 for April. Economists had previously forecast an addition of 100,000.

Last night on Bloomberg, a guest commentator worried that even 100,000 wouldn't be enough jobs to keep the unemployment rate from rising. He further worried that such a development would adversely affect the GDP, which he predicted would remain below wanted levels through the next quarter, too. Because jobs tend to peak after the economy does, a too-steep downturn in jobs and a rise in unemployment may reinforce some fears that the economy is slowing beyond the favored Goldilocks just-right amounts.

Companies reporting earnings tomorrow include a number of commodity-related companies such as LNT and AU, a number of realty-related companies such as AIV and ABR, and old-school companies such as EK and WY.

What about Tomorrow?

Anything can happen tomorrow. Nothing I show you on intraday charts is going to be able to predict what will result after tomorrow's non-farm payrolls number. Indices have been parked at resistance, not support, primed for further breakouts, but that leaves them so vulnerable. In many cases, as I've shown, indices have zoomed back up to the tops of their former rising channels, to resistance lines that have held since November. It's almost as if there was a concerted effort to bring them right back to where they would have been if that blip in February hadn't occurred. Hmm.

They're vulnerable to that resistance. They've still come very far, very fast, and tomorrow's economic report is important, especially ahead of next Wednesday's FOMC decision. No one expects the Fed to raise rates next week, at least among the authors whose articles I have read, but some nervousness remains about that might be said about the softening of the economy and inflation risks. In that context, the Dow's relative weakness today, the TRAN's sharp pullback off its day's high and some other indications I've pointed out certainly draw attention, but they don't prove a thing.

As I've said recently, those subscribers already in bullish positions have an easy task: keep raising your stops under your preferred support level. You may prefer the 10-sma's we often show on our charts: I also like the daily 9-ema when thinking about intermediate- or long-term positions. You may be following some rising trendline of your preference.

If you're so inclined, continue entering longs on tests of those averages, but only if indices drift down in a zigzag motion to those averages and only if those tests result in daily closes at or near the averages again. As extended as indices appear, I absolutely would counsel against jumping into new long positions if the indices barrel down to their 10-sma's. You want a pullback, not a barreling-lower move. Just stand aside if that happens, letting your stops take you out of long positions and waiting before initiating new ones.

If new long entries are taken, keep stops tight. Once markets have gone parabolic, as ours have, downturns can be sharp and swift and can begin out of nowhere, even after a supposed bounce from a 10-sma has begun. Have hard stops that are appropriate to your trading styles, because you don't want to be away from your computer for even a quick bite to eat if such a sharp downturn should begin.

So what about you want-to-be-bears? Your time will come, and could come as soon as tomorrow, but we've been given no firm evidence that the time is right to suggest bearish plays. I am personally disturbed by the breadth patterns that Keene has been showing, with the caveat that breadth patterns have improved this week. I do pay attention to volume patterns and try to understand what they're telling me, and right now, they're telling me to be cautious about conclusions because something isn't right.

I also don't care how bullish a market is: when gains are this swift and unrelenting, some of those gains are dragging in latecomers and being fueled by bears covering, and when that fuel burns out, those latecomers will bail quickly. Downdrafts to next support, wherever that might be, could be hurtful, but we don't know when the fuel will be consumed. It would have been even more hurtful to have entered bearish play after bearish play against such momentum. As long as indices are bouncing from the key averages as they have been, then it's better to miss the perfect setup and not have your bearish dollars burned to a crisp by the fire flaming these indices higher.

For those who read my Trader's Corner articles on the weekends, you may remember a couple of articles on the corrective fan theory. This is a theory about how rallies progress and when they've ended. Rallies (and declines) tend to occur in a series of three trendlines. On a rally, the first is too steep to be maintained, so prices fall through and form a third rising trendline. This is still too steep to be maintained. Prices fall through again, forming a third trendline. It is when that third trendline is broken that the rally is completed and a new trend--either sideways disjointed trading patterns or a descent, usually--begins.

That trendline was broken in late February, and the descent was sharp, seemingly confirming that the trendline being broken was the third trendline in the corrective fan theory. That trendline is the neon-green one that you see on my SPX charts, the one that the SPX has spent all this time rising to retest. So, as unfathomable as it seems, I'm still not entirely convinced that this updraft is not part of the disjointed trading pattern forming after the rally off last summer's low was broken or even just a retest of that former support, to see if still holds as resistance.

We'll know soon. Until we do, you know what to do if you're in those bullish positions. Unfortunately, although I'm aware that a decline could start as soon as tomorrow, perhaps after the SPX answers the siren call to test that neon-green line or perhaps before (particularly in the 1505-1507 area), there's just no firm evidence I can hand the want-to-be-bears that such an effect will result tomorrow. If the SPX should test that neon-green trendline, adept traders who don't need my help anyway can see whether bearish setups are occurring, but only those who don't need any help assessing such signs.

New Plays

New Option Plays

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

Play Editor's Note: The close over 1500 for the S&P 500 is bullish but we do not want to add new positions ahead of tomorrow's potentially market-moving jobs report.

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Advance Auto Parts - AAP - cls: 40.73 chg: -0.57 stop: 39.90

We seriously debated dropping AAP today. The stock has been under performing for days now. Failure to participate in today's market rally is another warning sign. More conservative traders may just want to exit now. We're not suggesting new positions. If AAP doesn't rebound higher tomorrow we'll probably drop it in the weekend newsletter. FYI: The P&F chart points to a $48 target.

Picked on April 11 at $ 40.05
Change since picked: + 0.68
Earnings Date 05/17/07 (unconfirmed)
Average Daily Volume = 854 thousand


Ctrip.com - CTRP - cls: 70.23 chg: +0.33 stop: 67.45

CTRP spent another session, its third, churning sideways in a very narrow range along the $70 level. It almost seems like investors are waiting for something to happen with CTRP but we don't see any upcoming newsworthy events. CTRP's earnings report is expected on May 16th. We did notice that rival EXPE was due to report earnings on May 8th. The larger trend is still bullish but short-term upward momentum has died. We're turning much more cautious, especially with the major averages looking overbought. Maybe the market's reaction to the jobs report tomorrow will push CTRP one way or the other. Our short-term target is the stock's highs in the $74.50-75.00 range. The Point & Figure chart forecasts a $93 target. We do not want to hold over the May 16th earnings report.

Picked on April 29 at $ 70.63
Change since picked: - 0.40
Earnings Date 05/16/07 (confirmed)
Average Daily Volume = 389 thousand


General Dynamics - GD - cls: 80.47 chg: +0.65 stop: 77.75*new*

GD continued to rebound on Thursday. The stock is now near the top of its trading range and under resistance at the $81.00 level. If you're looking for a new entry point now we'd wait for a breakout over $81.00. Our target is the 84.75-85.00 range. More aggressive traders may want to aim higher. The P&F chart has produced a triple-top breakout buy signal with a $96 target. Please note that we're tightening the stop loss to $77.75, just under this week's low.

Picked on April 29 at $ 80.27
Change since picked: + 0.20
Earnings Date 04/25/07 (confirmed)
Average Daily Volume = 1.4 million


Holly Corp. - HOC - cls: 63.52 chg: -0.26 stop: 59.49

The OIX oil index continued to rally even though crude futures slipped again on Thursday. HOC has traded sideways this week but the larger pattern is still bullish. Readers should note that we're running out of time. We do not want to hold over the May 8th earnings report. Our target is the $67.50-70.00 range. The P&F chart is bullish with a $74 target.

Picked on April 22 at $ 62.30
Change since picked: + 1.22
Earnings Date 05/08/07 (confirmed)
Average Daily Volume = 669 thousand


Wynn Resorts - WYNN - cls: 103.63 chg: -3.42 stop: 99.95

Ouch! WYNN gave back more than half of Wednesday's impressive gains. The stock lost 3.19% today following a negative earnings report from rival MGM. MGM reported this morning and missed estimates by 8 cents. We are almost out of time with WYNN. We plan to exit on Monday at the closing bell to avoid holding over the earnings report. Please note we are adjusting the target to $107.50-108.00 since shares just missed our previous target by two cents.

Picked on April 15 at $102.44
Change since picked: + 1.19
Earnings Date 05/07/07 (confirmed)
Average Daily Volume = 1.4 million

Put Updates

AvalonBay - AVB - cls: 121.25 chg: +1.06 stop: 130.05

We have been warning readers to watch for an oversold bounce near $120 so today's gain shouldn't be a surprise. More conservative traders may want to think about tightening their stops toward $126 or $125, which should be new overhead resistance. Our target is the $112.50-110.00 range. The P&F chart points to a $110 target.

Picked on April 30 at $124.45
Change since picked: - 3.20
Earnings Date 04/26/07 (confirmed)
Average Daily Volume = 770 thousand


Lockheed Martin - LMT - cls: 96.40 chg: +0.33 stop: 97.51

LMT continues to under perform the market and its peers. The stock traded in a very narrow 43-cent range. We suspect the stock is coiling for a breakout. The question is which direction? More conservative traders may want to tighten their stops toward $97.00. We're not suggesting new positions until we see a new decline under $95. FYI: LMT announced that it will be presenting at an investor conference on Tuesday, May 8th. Our target is the $90.50-90.00 range.

Picked on April 24 at $ 94.82
Change since picked: + 1.58
Earnings Date 04/25/07 (confirmed)
Average Daily Volume = 1.7 million

Strangle Updates

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


Lockheed Martin - LMT - cls: 96.40 change: +0.33 stop: n/a

LMT continues to churn sideways, which is bad news for this strangle play. However, it's worth noting that the sideways consolidation is narrowing. Normally, we can think of a stock's narrowing consolidation as a spring coiling for a breakout. The question is which direction? We're not suggesting new strangle plays at this time. The suggested options we had listed were the May $100 calls (LMT-ET) and the May $90 puts (LMT-QR). Our estimated cost was $1.50. We want to sell if either option rises to $2.25 or more.

Picked on April 22 at $ 95.40
Change since picked: + 1.00
Earnings Date 04/24/07 (confirmed)
Average Daily Volume = 1.7 million

Dropped Calls

Armor Holdings - AH - cls: 77.69 chg: +5.61 stop: 68.99

Target achieved. Shares of AH soared 7.7% on big volume today. Volume came in over nine times the daily average. Strangely we could not find anything specific to account for the rally but did hear some chatter about potential buyout rumors. We had two targets on AH. Our conservative target was the $74.75-75.00 range and our aggressive target was the $77.50-80.00 range. Both targets were hit today.

Picked on April 30 at $ 71.51
Change since picked: + 6.18
Earnings Date 04/19/07 (confirmed)
Average Daily Volume = 482 thousand

Dropped Puts


Dropped Strangles


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


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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