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Daily Newsletter, Monday, 05/21/2007

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Table of Contents

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

Market Wrap

Another Piece of the Puzzle Falls Into Place

The major indexes started the week off mixed, but the small caps of the Russell 2000 Index (RUT.X) 833.65 +1.21% were a standout and look to play "catch up" after Friday's revelation that China continues to take steps toward revaluation of the yuan against the U.S. Dollar and level the playing field for global trade.

The broad S&P 500 Index (SPX.X) 1,525.10 +0.15% challenged its March 24, 2000 all-time closing high of 1,527.46 intra-day after another impressive display of buyer enthusiasm into last week's option expiration for May.

Could it be that the "lagging" we've seen in the Russell 2000 Index (RUT.X) relative to the large cap indexes was simply due to a greater focus among bulls to increase their exposure to the large caps? A focus so great, where various market internals mentioned in my April 30th market wrap, "Run on Mouthwash Due to Bull's Bad Breadth," was only a near-term phenomenon?

Large caps, where a greater extent of their products/services would eventually benefit should Chinese currencies see strength against the U.S. dollar? A shift, where a stronger Chinese currency might further drive greater demand for U.S.-made products and services?

It didn't make sense, in recent weeks that the "junk bond" Pacholder High Yield (PHF) $10.18 -0.09% had been holding tough, and trading at a discount to its net asset value, as many smaller capitalized stocks struggled to move higher.

But Friday's "China revelation," and perhaps a tidbit of news out of China today, suggests U.S. equities may be in a sweet spot for further M&A activity.

Volume at the big board was notably heavy today.

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NYSE-listed shares of Elan Corp. (NYSE:ELN) $18.69 +12.59% were a big part in today's above-average volume at the NYSE. Elan's shares rose sharply for a second-straight session on heavy volume of 61.6 million shares, which is well above average daily volume of 3.2 million shares. The Dublin, Ireland-based company and US-based Wyeth (NYSE:WYE) $58.41 +3.60% said that they were initiating a Phase III trial for their Alzheimer's drug Bapineuzumab.

The companies said that there was no conclusion about the current Phase II trial underway, and that no conclusion would be reached until 2008. In a joint press release, the companies said "This decision (Phase III) was based on the seriousness of the disease and the totality of what the companies have learned from their immunotherapy programs, including a scheduled interim look at data from an ongoing Phase II study, which remains blinded."

Meanwhile, drug maker GlaxoSmithKline (NYSE:GSK) $53.18 -7.84% fell sharply on heavy volume of 13.6 million shares after the New England Journal of Medicine reported that Avandia, a drug used to treat Type-2 diabetes, "significantly increases" the risk of heart attacks.

The U.S. Food and Drug Administration (FDA) said it was reviewing the safety of Avandia, but regulators have not yet determined the significance of risks reported in the study. The agency said it was not asking GlaxoSmithKline to take any action at the present time but would ask a public advisory committee to weigh in at a later date.

A blockbuster M&A deal in the telecom sector also added to today's volume at the NYSE.

Shares of Little Rock, AR-based Alltel Corp. (NYSE:AT) $69.60 +6.73% surges as high as $70.45 after the wireless voice and data communications provider said it had agreed to be bought by TPG Capital and GS Capital Partners in a deal valued at $27.5 billion, or $71.50/share in cash.

Dow component General Electric (NYSE:GE) $37.10 +0.37% edged higher after the conglomerate said it would sell its GE Plastics unit to Saudi Basic Industries Corp. in a deal valued at $11.6 in cash plus the assumption of liabilities.

One of today's "tidbits" I found of interest was China saying it had agreed to place $3 billion (U.S. Dollars) of its massive foreign exchange reserves with US-based private equity group Blackstone. Foreign equity watchers see the move as a signal out of Beijing that the government is starting to switch investment focus from US Treasuries into more "risky" equity holdings and that China is testing the water for a much bigger investment in private equity.

U.S. Market Watch -

Treasuries? Did somebody mention Treasuries and the shifting of "risk?"

The benchmark 10-year Treasury Yield ($TNX.X) rose to a 3-month high at 4.816% in early morning action, but buyers gobbled up that yield to today's close as the benchmark bond reversed course with its yield finishing down 1.6 basis points to 4.788%.

Despite the rise in Treasury yields over the past week, the Dow Jones Home Construction Index (DJUSHB) 641.33 +1.51% has gained 4.11% since last Monday's close. Sector and industry watchers will be tuned in to Thursday's earnings out of luxury homebuilder Toll Brothers (NYSE:TOL) $28.81 +0.91%.

China, A Piece of the Puzzle

On Friday, my trader/investor juices were flowing! I was scrambling to begin putting together this important piece of the puzzle. A piece of a puzzle that has been roiling the U.S. and global financial markets for the past couple of years.

One thing that I immediately had to do was to step back for a moment and review some of my recent analysis.

Here's a quick table of various U.S. major market indexes, as well as currency observations that you have undoubtedly read something about in recent months.

Could it be that China is actually willing to try and begin leveling the playing field for global trade?

US Large Cap, Small Cap, China and Japan

I can't forget the "sudden" and sharp weakness in the U.S. Dollar versus Japanese Yen ($/yen) in late February that seemingly pulled the rug out from under the large cap S&P 500 Index (SPX.X).

If you were long or short the S&P 500 (SPX.X) on February 27th, I know you won't forget that day.

But I do feel, and begin to tie together some of those events with Friday's "China revelation."

You may also have to believe that the MARKET is a forward-looking instrument, that tends to know something about the future.

Since that time, I and others have noticed/mentioned how the U.S. large cap indexes such as the Dow Industrials, S&P 100, NASDAQ-100 and even the broader S&P 500 have been outperforming the small caps as depicted by the Russell 2000 Index (RUT.X).

In the above table, I "benchmarked" these major U.S. equity indexes to their March 30 close, April 30 close, and now tonight's close.

From 03/30 to 4/30, we can perhaps begin to "grasp" the notable percentage change of large cap (INDU, OEX, NDX and SPX) relative to the small caps (RUT.X).

And even with today's handsome 1.21% gain for the small caps, the RUT.X still "lags" the large cap indexes from as recently as April 30th to tonight's close. I will note that the RUT.X is even with the large cap NDX.X.

What I really want traders/investors to be alert to, is that Friday's "China revelation" may have some small cap BEARS quickly making some adjustments.

I do tend to be more BEARISH a "weaker" group of stocks, be it sector, or MARKET CAP, but the junk bond strength we've been noting in my wraps just didn't make sense relative to how the small caps had been trading.

Again, I may be painting things with a broad brush to equate "junk bond" with "small cap equity," as there are some large cap stocks, whose debt carries a junk rating. And there are certainly some small cap stocks that have no/little debt, where debt is rated A- to AA+.

My "gut feel," based on that junk bond/small cap observation, and today's rather notable gains for the RUT.X has me thinking that some small cap bears may be putting the piece of the puzzle together that there wasn't anything BEARISH about the small caps, but there was such a focus among smart money in regards to China's steps to level the playing field, that small cap shorts begin to step up their short covering, and keep losses small.

But lets also take this a step further.

Wouldn't it also make some sense, that if China were going to level the playing field on global trade (revalue yuan against the dollar, or Hong Kong Dollar against the dollar) that their equity markets begin to "lag" U.S. equity markets?

That is ... If US exports to China pick up further on Chinese currency gains, but China exports to US level off, or don't grow as rapid pace, then China's Hang Seng Index ($HSI.X) begins to "lag" a bit?

I'm only mentioning the U.S./China relationship tonight, but it would behoove a trader/investor to also consider other global markets.

In fact, in recent Market Monitor commentary at OptionInvestor.com, Jane Fox has been noticing how Germany's DAX and the Dow Industrials have been "mirroring" each others strength in recent weeks.

Could German multi-nationals also benefit from yuan revaluations and the leveling of the playing field with Chinese exports? That is ... Chinese made goods/services versus German made goods and services?

I would think so.

And what about Japan? One of the "Asian Tigers?"

It is at least somewhat notable that Japan's Nikkei-225 ($NIKK) is lagging the other equity benchmarks in the above table.

Nikkei-225 ($NIKK) - 50-point box

If there's going to be "trouble" for the bulls, even here in the U.S., I think it is going to start overseas, and with the $NIKK "lagging," this is a market to monitor.

Remember, while the Fed has been holding steady at 5.25% on fed funds here in the U.S., the Bank of Japan's key interest rate is just 0.5%. They have little room to "stimulate" monetary policy with rate cuts.

I would NOT want to be short a trade at 17,700 as that could unleash a strong round of short covering. See the developing lower highs and lower lows? A jump above 17,700 breaks that pattern.

A trade at 17,200 becomes quite bearish and would break some very meaningful support. This would be THE level in the $NIKK that I think U.S equity traders need to keep an eye on.

As noted in the above chart, you can see the SHARP 4-session declines in the $NIKK starting on February 27th.

If U.S. equity bulls are going to start locking in bullish gains, then further WEAKNESS in the $NIKK may be the trigger.

Russell 2000 Index (RUT.X) - Daily Intervals

I think the small caps of the Russell 2000 Index ($RUT.X) may be set to play "catch up," and could actually outperform the big caps if we see profit taking in that portion of the market.

In last week's Market Monitor, I was posting some of Dorsey/Wright's 10-week and 30-week bullish % charts.

I haven't shown these types of bullish % charts in my nightly market wraps before, but what they were suggesting to me was that the 10-week, or 50-day SMA were starting to see some near-term weakness.

The 30-week, or 150-day SMA was also starting to soften up a bit.

What I started to do then was "tie" individual stock's charts, as well as the various major indexes bar charts to both the 50-day SMA and the 150-day SMA. Usually, I show my bar charts with a 200-day SMA.

But check out the RUT.X with a 50-day and 150-day SMA on its chart.

Jim Brown and I have both commented on how the "small caps" tend to not be as impacted by a monthly option expiration.

Look how "clean" the small caps trade relative to these 50-day and 150-day SMAs.

I moved my 0% retracement to the 2/26/07 close, which would have been the day just before the USD/yen trade unfolded, where we might have expected the LARGE caps to have been more sensitive to currencies, which can impact global trade trends.

I think market participants may be "putting together the piece of the puzzle," that the small caps were left out of the bigger picture, only due to a focus on bullish large cap exposure.

Not it is time for the small caps to shine.

If not, then stop a close just under the rising 50-day SMA, with an assessment of near-term DOWNSIDE RISK to the rising 150-day SMA.

The Russell-2000 Index (RUT.X) was actually the 1st equity-based index in my MONTHLY Pivot Matrix to see a trade at its MONTHLY R1 (833.77) for the month of May!

The RUT.X's MONTHLY R2 is at 852.97, and the small caps could get there fast on a break to new all-time highs, where overhead supply becomes non-existent.
 


New Plays

New Option Plays

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

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Allegheny Tech - ATI - cls: 114.57 chg: +0.29 stop: 109.99

ATI posted another gain on Monday but it wasn't very convincing. Overall the trend in the stock remains bullish but we're growing a bit more cautious given the slow down in ATI's momentum. We're leaving our stop loss at $109.99 but more conservative traders may want to adjust theirs toward Thursday's low (near $111). Our target is the $119.00-120.00 range. FYI: The Point & Figure chart forecasts a $122 target. Given the bullish channel more aggressive traders may want to aim higher (see chart).

Picked on May 08 at $113.45
Change since picked: + 1.12
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 2.4 million

---

Baidu.com - BIDU - cls: 134.66 chg: +3.61 stop: 124.95

Many of the Chinese Internet-related stocks were trading higher today. BIDU surged at the open but hitting resistance at the $136.00 level, which held all day. The stock closed up 2.7% on above average volume. It didn't hurt that the Internet sector in general got a boost thanks to a big move in AMZN today. This is an aggressive, higher-risk play. Our target is the $139.50-140.00 range. The P&F chart is bullish with a $203 target.

Picked on May 14 at $130.51
Change since picked: + 4.15
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume = 2.2 million

---

General Dynamics - GD - cls: 81.96 chg: +0.70 stop: 78.85

GD has broken out from its recent trading range and closed at a new all-time high. Volume came in above average on today's rally, which is bullish. This looks like a new entry point to buy calls. We have two targets. Our conservative target will be the $84.75-85.00 range. Our aggressive target will be the $89.00-90.00 range. The P&F chart has produced a triple-top breakout buy signal with a $96 target.

Picked on April 29 at $ 80.27
Change since picked: + 1.69
Earnings Date 04/25/07 (confirmed)
Average Daily Volume = 1.4 million

---

Goldman Sachs - GS - cls: 229.23 chg: -1.11 stop: 224.25

The broker-dealer index, the XBD, managed to out perform the broader financial sectors but shares of GS under performed with a 0.48% decline. Volume was a bit stronger today than GS has seen recently and that might be noteworthy. Watch for a bounce anywhere above $225 as a new entry point to buy calls. Our target is the $238.00-240.00 range. The P&F chart points to a $244 target.

Picked on May 13 at $227.50
Change since picked: + 1.73
Earnings Date 06/12/07 (unconfirmed)
Average Daily Volume = 7.4 million

---

W.W.Grainger - GWW - close: 85.40 chg: +0.62 stop: 83.24

Our new call play in GWW is now open. A generally bullish market environment helped GWW breakout over resistance at the $85.00 level. Volume came in above average on today's move, which is a positive sign. Our suggested trigger to buy calls was at $85.25. The target is the $89.75-90.00 range. The P&F chart currently points at an $88 target.

Picked on May 21 at $ 85.25
Change since picked: + 0.15
Earnings Date 07/16/07 (unconfirmed)
Average Daily Volume = 507 thousand

---

Johnson Controls - JCI - cls: 110.22 chg: -0.38 stop: 107.45

We want to reiterate our weekend comments that JCI is overbought making this a higher-risk momentum play. Thus today's lack of momentum is a warning sign! We're still suggesting call positions here but some traders may want to wait for a new relative high (maybe over $111). More conservative traders might want to tighten their stop closer to the simple 10-dma near $109.00. We're leaving our stop at $107.45 for now. Our short-term target is the $114.50-115.00 range.

Picked on May 20 at $110.60
Change since picked: - 0.38
Earnings Date 07/20/07 (unconfirmed)
Average Daily Volume = 1.0 million

---

Monster Worldwide - MNST - cls: 49.78 chg: -0.30 stop: 44.99

It was an interesting day for MNST. We added it over the weekend suggesting it was a takeover target. At least one analyst firm disagrees and voiced their opinion that MNST was not an acquisition candidate. That's probably why shares of MNST gapped down toward $48 this morning. Fortunately, traders bought the dip. We see the dip and rebound as a new entry point to buy calls. More conservative traders may want to see more strength to confirm the breakout over resistance at $50.00 before initiating positions. This is an aggressive, higher-risk, speculative play and we are using a wide stop loss. Our target is the $54.75-55.00 range.

Picked on May 20 at $ 50.08
Change since picked: - 0.30
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = 3.6 million

---

Precision Castparts - PCP - cls: 116.43 chg: +2.13 stop: 110.91*new*

The PCP momentum train continues to climb. The stock broke out over the $115 zone and posted a 1.8% gain on above average volume. Our target is the $118.00-120.00 range but more conservative traders may want to exit now and lock in a profit. We are raising our stop loss to $110.91. Last Friday there was chatter about PCP becoming a candidate to be added to the S&P 500 index.

Picked on May 13 at $110.91
Change since picked: + 5.52
Earnings Date 05/09/07 (confirmed)
Average Daily Volume = 1.0 million

---

Sears Holding - SHLD - cls: 179.59 chg: -0.29 stop: 174.74

SHLD didn't move much on Monday. The stock traded in a relatively narrow $1.55 range. Shares remain under resistance near its 100-dma and the $180 level. We are still suggesting new positions now but more conservative traders may want to wait for a rise past $180 or its 100-dma near $180.20 before opening positions. Our target is the $184.00-185.00 range. Remember, we do not want to hold over the late May earnings report.

Picked on May 13 at $177.96
Change since picked: + 1.63
Earnings Date 05/31/07 (unconfirmed)
Average Daily Volume = 1.7 million

---
Sempra Energy - SRE - cls: 64.32 chg: +0.27 stop: 61.45

SRE continues to rally and on above average volume. Today's move is a positive sign with a more defined breakout over the $64.00 level. We don't see any changes from our weekend comments. Our target is the $68.00-70.00 range.

Picked on May 20 at $ 64.05
Change since picked: + 0.27
Earnings Date 08/01/07 (unconfirmed)
Average Daily Volume = 1.3 million

---

USEC Inc. - USU - close: 24.08 chg: +0.52 stop: 21.99

USU gapped open at $23.81 and rallied to its all-time high near $24.44. Volume came in strong on the 2.2% gain. If you don't want to chase it here then wait for a possible dip back towards $23.50-23.00. This is an aggressive, speculative play and readers should consider it higher-risk. We'll try and limit our risk with a stop under $22.00. Traders might be able to get away with a stop near $22.35. Our target is the $27.00-30.00 range. The P&F chart points to a $28 target.

Picked on May 20 at $ 23.56
Change since picked: + 0.52
Earnings Date 05/03/07 (confirmed)
Average Daily Volume = 1.8 million

---

Vangard Emergy Mkts ETF -VWO- cls: 86.97 chg: +0.19 stop: 83.45

The VWO marked another new high on Monday but the ETF pared its gains and was trading lower into the close. Volume came in pretty strong and given the lack of movement that might indicate a potential top. Technically this is still a bullish entry point with the breakout over $86.00. Our target is the $89.85-90.00 range. More aggressive traders may want to aim higher since the P&F chart points to $113.

Picked on May 16 at $ 86.15
Change since picked: + 0.82
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 416 thousand
 

Put Updates

Essex Property - ESS - cls: 120.67 chg: +1.44 stop: 126.55

After four down days in a row ESS finally produced an oversold bounce. We're not suggesting new positions at this time. We will reiterate our suggestion that more conservative traders may want to take a profit here. The next level of support looks like the $115 level. Our target is the $115.50-115.00 range. FYI: The P&F chart points to a $100 target.

Picked on May 16 at $124.65
Change since picked: - 3.98
Earnings Date 05/02/07 (confirmed)
Average Daily Volume = 281 million

---

Itron - ITRI - cls: 67.75 change: +0.58 stop: 69.35

Danger! ITRI looks like it's trying to breakout higher from its consolidation pattern. The stock dipped early this morning but investors bought the dip and they bought the dip again early afternoon. We are not suggesting new positions. More conservative traders will want to consider an early exit right here to limit any losses. The only reason we're not dropping it now is that the markets might see some profit taking tomorrow after the S&P 500's new high today.

Picked on May 08 at $ 65.85
Change since picked: + 1.90
Earnings Date 05/02/07 (confirmed)
Average Daily Volume = 547 thousand

---

Russell 2000 Ishares - IWM - cls: 82.76 chg: +1.03 stop: 83.55

Our aggressive put play in IWM is now open. The Russell 2000 and the IWM ishares turned in a strong session. The IWM rose 1.2% and traded above resistance at the $83.00 level on an intraday basis. There were probably a lot of stops and triggers hit on the breakout today and volume soared to almost three times the norm. Our suggested trigger to buy puts was at $82.90 so the play is now open. We have a relatively tight stop loss at $83.55. More conservative traders may want to use a tighter stop (above today's high) while more aggressive traders may want to place their stop above $84.00. We have two targets. Our conservative target is $80.25-80.00. Our aggressive target is the $78.25-78.00 range.

Picked on May 21 at $ 82.90
Change since picked: - 0.14
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 58.4 million

---

Las Vegas - LVS - cls: 75.91 change: -0.79 stop: 82.55

LVS continues to under perform the market. The stock slipped another 1% to a new relative low. More conservative traders may want to do a little profit taking here. Unfortunately, tomorrow morning might be a tough spot to do it. After the closing bell tonight news hit the wires that Tracinda Corp., the investment firm run by billionaire Kirk Kerkorian, wants to buy the Bellagio Hotel and casino in Las Vegas from MGM. This news sent many of the casino stocks higher after hours. Shares of LVS were trading near $78 after hours tonight. More conservative traders might just want to tighten their stops closer towards $80.00. Our target is the $71.50-70.00 range. Currently the P&F chart sports a triple-bottom breakdown sell signal with a $75 target.

Picked on May 07 at $ 79.85
Change since picked: - 3.94
Earnings Date 05/02/07 (confirmed)
Average Daily Volume = 2.1 million

---

Vital Images - VTAL - cls: 28.35 chg: -0.33 stop: 30.05

VTAL under performed the NASDAQ and the software sector on Monday. Lack of follow through on Friday's bounce is a good sign for the bears. Our target is the $25.15-25.00 range.

Picked on May 16 at $ 27.99
Change since picked: + 0.36
Earnings Date 04/26/07 (confirmed)
Average Daily Volume = 191 thousand
 

Strangle Updates

None
 

Dropped Calls

Peabody Energy - BTU - cls: 54.24 change: +0.73 stop: 47.99

Target achieved. Coal stocks continued to march higher on Monday. Shares of BTU hit an intraday high of $55.22. Our target was the $54.50-55.00 range. Volume came in above average on today's rally, which is bullish. It's worth noting that BTU does look short-term overbought so we'd wait for a dip back toward $52.00 or $50.00 before considering new positions (actually, we'd wait for a bounce in those areas).

Picked on May 09 at $ 50.70
Change since picked: + 3.54
Earnings Date 07/19/07 (unconfirmed)
Average Daily Volume = 5.3 million
 

Dropped Puts

None
 

Dropped Strangles

None
 

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

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