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Daily Newsletter, Saturday, 06/02/2007

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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

Traders Celebrate A Goldilocks Spring

The markets celebrated Friday's "just right" economic reports and new highs were made across all the major indexes. The Goldilocks economy appears to be experiencing the euphoria of spring and there are no clouds on the horizon. The bulls continue to frolic and feed on the mountains of buyout cash currently shrinking the amount of available stock to buy. The bears are being forced to eat their shorts on a daily basis despite the short interest on the NYSE and margin loan balances still at record levels. As Friday came to a close nobody wanted to be out of the market in hopes one of their companies would announce a takeover on Monday. It is a scenario for traders to love and lets money managers sleep at night.

Dow Chart - Daily

Nasdaq Chart - Daily

Leading the list was the ISM Manufacturing report for May with the headline number of 55.0 and the highest level of activity since April 2006. The September through March decline into contraction territory appears to have ended. Momentum appears to be growing and that was somewhat confirmed by the strong jobs report. The individual internal components failed to show any specific surge producing an even clearer picture of sustainable growth rather than a random spike. Expectations had been for a slight decline in the headline number but a slight increase in new orders and a drop in prices paid surprised analysts. New orders at 59.6 now stand at levels not seen since Feb-2006. This entire report was encouraging for the bulls since it confirmed a rebound in manufacturing to a 12 month high but still a rebound that was progressing at just the right speed.

ISM Chart

The May employment report surprised everyone with a gain of +157,000 jobs compared to estimates for a gain of +138,000. April jobs were revised down from 88K to 80K bringing the total reported net job gains to 149,000 and closer to the estimates. The unemployment rate remained near its cycle lows at 4.5%. The labor market continues to absorb workers displaced by the housing slowdown and analysts are now expecting employment trends to improve by year-end.

Personal income for April fell by -0.1% compared to estimates for a +0.3% gain. This was the first dip into negative territory for income since the accounting anomaly we saw back in Aug/Sep 2005, which was caused by Katrina. The decline in April was caused by a -0.4% drop in wage and salary income. The good news was a corresponding drop in the core PCE deflator to 2.0% inflation year-over-year. This is the first time since March 2006 that inflation has fallen into the Fed's comfort range of 1.5%-2.0%. This suggests the Fed has no reason to hasten either a rate hike or a rate cut and should be content to watch from the sidelines for the rest of the year.

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Consumer sentiment for May rose +1.2 in May to 88.3 despite a very slight downtick in late May. If the current housing/fuel problems can't dent confidence then better times must be ahead. The expectations component showed this with a gain of 1.7 points. The strong jobs report will help boost sentiment for June.

Friday's economic reports were about as good as it gets. They showed moderate growth and more importantly moderating inflation. The bond market appears to be correctly predicting the direction of Fed rates with the yield on the ten-year rising to a ten-month high of 4.95% at Friday's close. That new high is very close to the problematic 5% rate that tends to weigh on stocks. With yields over 5% bonds become an attractive alternative to equities with no risk. However, with equities rising 1-2% per week there is little chance of a sudden flight to safety in the bond market. Let the equity market cool for a couple weeks and bonds over 5% may become a more attractive option. The Fed Funds Futures for November are only suggesting an 8% chance of a rate cut for the rest of the year. The Fed rarely moves rates at the December meeting so it is a non-event for rate speculation. With expectations for any Fed move at nearly zero the bond market is doing the Fed's work for them with real rates rising to levels where further economic growth should remain constrained. The two wild cards for the Fed today are still the housing slump and gasoline prices. With real rates rising it is putting even more pressure on homebuyers already cautious about buying homes in the face of daily headlines warning of continued problems. Mortgage applications fell -7.3% last week and this should be the prime home shopping season. While the Fed worries that housing could eventually cripple the economy the price of gasoline continues to rise. High fuel prices reduces discretionary income and produces a corresponding drag on the economy while pushing inflation higher. It is the economic conundrum for the Fed but for the bulls it was just economic noise.

The global liquidity wave is continuing with takeovers and buybacks being announced daily. The pool of available stock is shrinking daily while cash levels are increasing. It is a classic short squeeze but not the kind of squeeze you think. The increasing amount of cash is chasing a decreasing quantity of stock creating a stock shortage. When you consider that better than 50% of all stocks you would not buy on a bet and another 30% are marginal that leaves the best 20% being chased higher. Complicate it with massive buyback programs like the Wal-Mart's $15 billion announcement and IBM's $12.5 billion and companies with deep pockets are competing for the available outstanding stock. Companies are even going into debt to buy back stock and that always makes me scratch my head in wonder. I thought debt was the enemy of profits with that interest clock running 24/7 365 days per year. IBM is going to borrow $11.5 billion to complete its $12.5 billion buyback. With rates moving higher debt service on $11.5 billion would probably fund a more favorable dividend increase for years to come. IBM was rewarded with a credit downgrade as a result. Do you think investors will remember the bounce in stock prices caused by the buybacks when earnings fall due to higher debt service? I doubt it. Investors are always motivated by what corporations are doing for you now and not last quarter. At least IBM knows how to play the game. They have been stock buyers in the last couple weeks of a quarter for years whenever they needed to reduce outstanding shares so they could hit earnings estimates. Earnings divided by shares equals earnings per share. Lower shares outstanding and the earnings per share rises. That brings up another question. Could IBM be facing an earnings problem that will require a larger than normal late quarter buyback to bring them in under the wire when earnings are reported in July?

Takeover speculation is rampant with several announcements made every day. Micron (MU) spiked +4% on Friday on rumors they were going to be bought. With a PE of 46 they are not cheap and with constant worries about falling chip prices why would anybody bother to buy them? Navteq (NVT) is rumored to be a target by Google, which uses NVT for their various mapping products. Trimble Navigation (TRMB) is also speculated as a target along with numerous biotech companies ahead of the ASCO conference next week. With a dozen buyouts announced each week and few companies too big to be immune the fear of being out of the market when merger Monday arrives is a powerful motivator. Even American Idol, the most popular show on TV was not immune. CKX Inc (CKXE) the owner of American Idol, the Elvis and Mohammed Ali brands and several lesser-known assets spiked +38% on Friday after the board accepted a $1.33 billion buyout offer from the CEO Robert Sullivan. One investor group was quick to sue saying the 29% premium was vastly too low given the value of those brands. Just last January Silverman was listing the benefits to keeping it a public company. Now Silverman claims he needs to take it private in order to raise capital to invest in "real estate and location based attractions" for the names it owns. I thought you went public so you could raise capital? Silverman's group owns some land in Vegas and the rights to build an Elvis themed hotel/casino called what else but the "Heartbreak Hotel."

Dell rose +.38 cents after posting better than expected earnings in a clear case of under promise and over deliver. The stock gains were actually due to their announcement of a 10% layoff and expected cost reductions from a new restructuring effort. Dell said their profit increase was due to a favorable decline in component prices. Several analysts cut their ratings saying the positive trends are unlikely to persist. Dell's results were unofficial since they have not filed an official report in the prior two quarters due to ongoing accounting probes. Dell did not give any estimates for the current quarter but warned that margins would be under pressure as business slowed due to seasonal factors.

Homebuilder Hovnanian (HOV) warned again late Thursday that subprime problems continued to plague new home sales with drops in new home sales and average selling prices. Most analysts expected the current spring selling season, the year's busiest, to revitalize the home sales market. Hovnanian joined the other builders confirming that has not yet happened. They said the market weakened even further as the quarter progressed. HOV withdrew its guidance for the rest of 2007 due to the downturn in outlook. Banc of America analyst Daniel Oppenheim said he expects HOV and others to continue to cut prices until they can find a level where buyers find value. CEO Hovnanian appeared on a TV show late Friday and said we (all the builders) thought we had seen the bottom in Q1 but the subprime problem killed the rebound. Now it appears Q2 will be the bottom but we will not know until later this year.

July Crude Futures Chart - Daily

Commodity stocks like oil, copper and steel led the charge higher on Friday for a variety of reasons. Various countries have recently reported higher than expected growth and that is squeezing already tight supplies of metals. There are rumored mergers involving nearly every major name in the sector so nobody wants to be left out if a major roll up occurs. Oil prices rebounded sharply after the week's inventory report showed a drop of 2 million barrels of crude and no material build in refined products like gasoline. Crude had declined on Thursday to $62.48 on cooling geopolitical tensions in Iran and Nigeria and the passing of the Memorial Day weekend. Typically oil prices rise into Memorial Day on expectations of a strong driving season and then weaken as the season actually arrives. BP said on Friday the restart of the Whiting Indiana refinery could be put off longer than expected and they declared force majeure on Canadian crude purchases. They are devoting what capacity they have available to gasoline from light sweet crude but that is a small stream in a very big pipe. The plant was supposed to be offline for 4-6 weeks but that has now stretched into months. They declined to give an estimate for a restart. The Whiting refinery is BP's largest in the U.S. and the 5th largest of any U.S. operator. Further complicating the gasoline problem is a leak in the main crude pipeline linking Canadian oil to Midwest refineries. The pipeline is owned by Enbridge. They discovered the leak in mid-April and cut daily throughput by 90,000 barrels. Enbridge is in the "final stages" of determining the cause of the leak and work should begin soon to repair it. That could impact earnings for Canadian suppliers unable to ship their oil to the U.S. for refining. Refinery utilization for the week remained at 91.1% and well below the 94% average for this period and the level needed to stay ahead of demand.

Higher prices have failed to materially dent gasoline demand with demand averaging 93,000 bpd (+1%) over the same period in 2006 while the average price per gallon is 25 cents higher at $3.14. The next big consumption weekend is the July 4th weekend and with the 4th falling on a Tuesday it will be a long weekend for most with plenty of driving. The gasoline demand table below shows the steady increase in prices over the first four weeks of the demand period. The gasoline demand chart shows the current demand over the prior year. We should expect continued high gas prices until refinery utilization can catch up with demand.

Gasoline Demand Chart

Gasoline Demand Table

Now that summer is officially here it brought with it the beginning of the hurricane season. June 1st is the official start date and right on schedule a new storm appeared in the Gulf. Tropical storm Barry with winds up to 60 mph appears headed for the west coast of Florida and will likely cross the state and head up the eastern seaboard towards New York. Currently the track is well away from oil patch but the appearance of a sudden storm in the Gulf is a warning that others are coming. The National Weather Service reiterated their prediction of 7-10 hurricanes with 3-5 storms of category 3 intensity or above.

Remember the Russell 1000, 2000 and 3000 indexes will face their annual rebalancing on the last Friday in June. Russell will select the 3000 largest stocks in the U.S. and name them to the Russell 3000 index. The largest 1000 will become the Russell 1000 large cap index and the bottom 2000 will become the new Russell 2000 small cap index. The additions and deletions will be announced about a week before the rebalancing to give funds time to plan their proration strategy. When Friday June 29th arrives it will likely be one of the heaviest trading days of the year as funds change weightings on 3000 stocks. The change in shares owned for stocks remaining in the index is minimal but remember there are 3000 stocks to adjust if the fund wants to index to exactly the Russell index weightings.

The markets are officially in breakout mode and various analysts are starting to pull numbers out of their head like Dow 16000 and S&P 1725 by year end. With all the liquidity chasing stocks it could easily happen simply because there are an equal number predicting an earth shaking crash. As I reported earlier the short interest on the NYSE remains at an all time high and represents more than 3.1% of all outstanding shares. That is a huge bearish bet that the bulls are winning on a daily basis. Because bears and bulls are both stubborn when it comes to changing their coats the bears continue to stupidly re-short at every sign of weakness. The bulls pile into every dip as though it was the last chance to buy before Dow 16000. The bears are forced to cover and the scenario repeats.

Those waiting for a correction dip to buy have ended up chasing prices higher and higher and higher. The markets have overcome earnings worries, recession worries, Fed worries, housing worries, geopolitical concerns, high oil prices and the list just keeps growing. Bull markets need adversity to keep moving. It is said that bull markets do best when climbing a wall of worry. That has surely been the case over the last few months. The worry factors lure the bears into their short positions and a day later the bulls stampede over them. I must have heard 20 analysts on CNBC over the last two days cautioning about the coming correction. This is great news for the bulls because it gives the bears another glimmer of hope to keep the process functioning.

The markets have been moving higher for the last nine weeks. Not all at the same time or the same pace. Over the last three weeks the Nasdaq and Russell lagged the Dow and S&P and appeared to be weakening. It was a clever post earnings trap and the bears fell into it. We had two China events with Greenspan warning about a crash and several days later China raised the stamp tax on trading. Both events caused sharp drops led by the Chinese markets but the dips were bought on a global scale. I lost count this week on how many exchanges around the world were at multi year if not historic highs. It is that liquidity wave everybody is surfing and it is worldwide. All waves of any type eventually crash onto shore and disappear but there is no land in sight today.

When markets truly go into breakout mode it is a powerful sight to watch. Here in the U.S. the Dow Transports broke out of strong overhead resistance on Thursday to a new high at the same time the Dow Industrials were hitting new highs over 13600. For long time market watchers the dual action is a powerful confirmation signal. The breakout twins were quickly joined by the Nasdaq Composite, NDX, Russell 1000 and 2000, SPX, OEX, and the Wilshire 5000 to name a few. The respective breakouts over their prior resistance highs triggered broad based short covering as well as new buying by those keeping cash on the sidelines until the breakout appeared.

Friday's market wandered intraday but the final direction was never in doubt. Advances were 2:1 over decliners and for a post holiday, summer Friday, volume was decent at 5.2 billion shares. When the breakout began on Thursday the internals were just as strong and volume was well over 6.1 billion shares.

After spending three days in the dumps the Dow managed to sprint higher to close at 13668 for a +161 weekly gain. The Dow has posted gains for 8 of the last 9 weeks. The projected target generated by the last dip to 12000 was 13600 and that has been hit. (12800 high + (12800 high - 12000 low)) = 13600. There is no material resistance ahead for the Dow and no reason for it to decline other than being severely overbought. At least no outside reason we can see today. The event that will eventually kill the rally will be one that comes out of the blue completely unexpected. Until then, buy the dips.

The Nasdaq is the perennial laggard here and would have to add another 2500 points to reach its 2000 high at 5132. However, it has finally broken out again to a new six-year high and techs are coming back into favor. Unlike the other indexes at new historic highs the Nasdaq has chartable resistance at 2650, which is a 38% retracement from the 2000 high at 5132 to the 2002 low at 1108. Look at the Nasdaq chart at the beginning of this commentary and notice the long legged doji candle from Friday. This represents strong indecision and typically indicates a direction change. I am sure the bulls have other plans but based strictly on the doji I would be a little more cautious on Monday.

The SPX finally broke through the 2000 closing high at 1527 but has failed to match the 1552 intraday high from that same period. With targets being mentioned from 1600 to 1725 it would seem there are only blue skies ahead but the S&P has been moving even slower than the Nasdaq. At this point slow is good. It implies calm rational buying as opposed to irrational exuberance. With uptrend resistance at 1545-1550 it still has room to run. In the last month the S&P dipped five times or roughly every five days. 1510 is decent support but it would take more than just a normal dip to hit it. Something in the 1520 range would be a dip to buy.

SPX Chart - Daily

NYSE Composite Chart - Daily

Russell-2000 Chart - Daily

The Russell 2000 recovered from its six-weeks of consolidation and broke over resistance at 835 to move the fund manager sentiment indicator back to bullish. With Friday's close at 853 the next material resistance is around 875. With all the indexes breaking out on Friday I was surprised not to hear any reporters talking about the NYSE Composite. The NYA closed over 10,000 for the first time ever at 10040 and very near the highs for the day. This is further confirmation of the increasingly bullish sentiment spreading through the market. I know that seems strange since the Dow rally has lasted for weeks but the sentiment has been lagging until this week. The dual breakouts by the Russell and NYSE are even stronger confirmation of market sentiment for me than the combination of the Dow and the Transports. Having all four in breakout mode is very bullish. We just need to be aware that lightning can strike at any moment. Enjoy the picnic but keep your umbrella handy.

Economic Calendar

For next week the economic calendar is mostly filler with the major reports coming up on the following week. Tuesday's ISM Services is the only major report for the week but after last week's manufacturing ISM it may be anticlimactic.

This is also the week before option expiration week and recently we have seen additional volatility as the week draws to a close. Funds rarely hold options until the last minute and lately it appears they tend to roll forward or exit around Thursday a week ahead of expiration. We saw some big swings in recent months leaving expiration week to be somewhat boring. Ignoring any option cycle gyrations I would continue to buy the dips until conditions change.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BHI None None
CRS    
FFIV    
GSF    
MO    
TSO    

Play Editor's Note: The S&P 500, DJIA, Dow Jones Transportation average and Russell 2000 are hitting new all-time highs. Investors don't seem to care that the markets are overbought and way overdue for a correction. We are adding new bullish positions given the trend but we continue to urge caution for traders. We could see a correction at any time and the correction is so overdue it will be painful when it appears. Watch your stop losses carefully and make sure they are in place.


New Calls

Baker Hughes - BHI - cls: 83.17 change: +0.69 stop: 79.95

Company Description:
Baker Hughes is a leading provider of drilling, formation evaluation, completion and production products and services to the worldwide oil and gas industry. (source: company press release or website)

Why We Like It:
Shares of BHI produced a huge move higher in April and the stock has spent the last month digesting those gains. Now it looks like the sideways consolidation is about to end as BHI coils more tightly under resistance near $84.00. We are suggesting a trigger to buy calls at $84.26, which is above the May 4th high. If triggered we'll aim for the $89.00-90.00 range near its 2006 highs. FYI: The P&F chart is still bearish and points to a $73 target.

Suggested Options:
We are suggesting the July calls. It is up to the individual trader to decide which month and which strike price best suits your trading style and risk.

BUY CALL JUL 80.00 BHI-GP open interest=2949 current ask $5.40
BUY CALL JUL 85.00 BHI-GQ open interest=6271 current ask $2.55
BUY CALL JUL 90.00 BHI-GR open interest=5721 current ask $0.95

Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 4.3 million

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Carpenter Tech - CRS - cls: 135.67 chg: +3.10 stop: 129.90

Company Description:
Carpenter Technology produces and distributes specialty alloys, including stainless steels, titanium alloys, and super alloys, and various engineered products. (source: company press release or website)

Why We Like It:
There has been a lot of speculation in the metals sector that the industry will continue to see more mergers and acquisitions. This has produced an underlying bid for a lot of stocks. Traders were quick to buy the dip in CRS near $130 this past week. We like Friday's bounce (+2.3%) back above the $135 level and its 10-dma. We are suggesting call positions now although traders might want to consider alternative entry points above $138 or on a dip above $130. The P&F chart shows a triple-top breakout buy signal that points to a $170 target. Our target is the $147.50-150.00 range although we would expect some resistance near its all-time high around $142. Traders should note that after the closing bell on Friday it was announced that the S&P will add CRS to the S&P midcap 400 index, replacing OSI. This news should produce another positive move on Monday as funds who track the midcap index adjust their positions and buy CRS. We would not open positions if CRS gaps open above $140.00.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 135 CRS-GG open interest= 63 current ask $7.40
BUY CALL JUL 140 CRS-GH open interest= 59 current ask $5.00
BUY CALL JUL 145 CRS-GI open interest= 38 current ask $3.30

Picked on June 03 at $135.67
Change since picked: + 0.00
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = 429 thousand

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F5 Networks - FFIV - close: 81.54 chg: +0.28 stop: 74.95

Company Description:
F5 Networks is the global leader in Application Delivery Networking. F5 provides solutions that make applications secure, fast and available for everyone, helping organizations get the most out of their investment. (source: company press release or website)

Why We Like It:
This past week saw the NWX networking index breakout to new three-year highs. Meanwhile shares of FFIV broke out to new all-time highs with its rally past resistance at the $80.00 level. Thursday's session also marked a breakout from its six-week trading range. Technicals are positive and the P&F chart points to a $93 target. We are suggesting calls with FFIV above $80.00. Readers can choose to buy them here of wait for a dip towards $80 again. More conservative traders might want to use a tighter stop loss in the $78.00 or $77.50 zone. Our target is the $89.00-90.00 range.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 80.00 FLK-GP open interest=2265 current ask $5.70
BUY CALL JUL 85.00 FLK-GQ open interest=2592 current ask $3.30

Picked on June 03 at $ 81.54
Change since picked: + 0.00
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 1.3 million

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Global SantaFe - GSF - cls: 68.86 chg: +0.56 stop: 65.90

Company Description:
GlobalSantaFe is one of the largest offshore oil and gas drilling contractors and the leading provider of drilling management services worldwide. The company owns or operates a contract drilling fleet of 37 premium jackup rigs; six heavy-duty, harsh environment jackups; 11 semisubmersibles and three dynamically positioned, ultra-deepwater drillships, as well as two semisubmersibles owned by third parties and operated under a joint venture agreement. In addition, an ultra-deepwater semisubmersible is under construction and scheduled for delivery in early 2009. (source: company press release or website)

Why We Like It:
GSF is another oil service stock that is trading near record highs. Shares broke out over significant resistance at the $65.00 level days ago and have since slowly marched higher. The bullish trend of higher lows looks ready to push GSF past round-number resistance at the $70.00 level. The P&F chart displays a triple-top breakout buy signal with an $87 target. We are suggesting call positions now in the $67.50-70.00 zone. Our target is the $74.50-75.00 range.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 65.00 GSF-GM open interest=10729 current ask $5.60
BUY CALL JUL 70.00 GSF-GN open interest=33491 current ask $2.80
BUY CALL JUL 75.00 GSF-GO open interest=11559 current ask $1.20

Picked on June 03 at $ 68.86
Change since picked: + 0.00
Earnings Date 08/01/07 (unconfirmed)
Average Daily Volume = 4.8 million

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Altria Group - MO - cls: 71.82 change: +0.72 stop: 69.90

Company Description:
Altria Group, Inc. is the parent company of Philip Morris USA, Philip Morris International and Philip Morris Capital Corporation. Altria Group owns 100% of the outstanding stock of Philip Morris USA, Philip Morris International and Philip Morris Capital Corporation. Philip Morris USA is the largest tobacco company in the United States, with approximately half of the U.S. cigarette market. Philip Morris International is a leading international tobacco company with seven of the top 20 global cigarette brands. Philip Morris Capital Corporation maintains a portfolio of leverages and direct finance leases. In addition, Altria Group has a 28.6% economic and voting interest in SABMiller, plc., the world's second-largest brewer. (source: company press release or website)

Why We Like It:
A couple of weeks ago shares of MO managed to breakout to new all-time highs. The stock hit resistance near $72.00 but traders were quick to buy the dip near $70.00, which was a clear case of broken resistance acting as new support. MO has regained its bullish pattern of higher lows and we suspect shares are about to hit new highs again. We are aiming for the $76.00-77.00 range, which would coincide with the $77.00 target on the P&F chart. More conservative traders may want to wait for a new high first before opening positions.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 70.00 MO-GN open interest=4140 current ask $2.70
BUY CALL JUL 75.00 MO-GO open interest=4098 current ask $0.50

Picked on June 03 at $ 71.82
Change since picked: + 0.00
Earnings Date 07/19/07 (unconfirmed)
Average Daily Volume = 11.7 million

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Tesoro - TSO - close: 63.74 change: +1.96 stop: 57.99

Company Description:
Tesoro Corporation, a Fortune 150 Company, is an independent refiner and marketer of petroleum products. Tesoro operates seven refineries in the western United States with a combined capacity of approximately 660,000 barrels per day. Tesoro's retail-marketing system includes 881 branded retail stations, of which 464 are company owned retail stations. (source: company press release or website)

Why We Like It:
Oil refining stocks have been super hot. Given the rising demand and the onset of the summer driving season we don't see any reason for them to slow down. TSO just spent the last four-week digesting its previous gains so it looks rested and ready for another leg higher. The MACD on the daily chart has produced a new buy signal. Meanwhile the P&F chart shows a triple-top breakout buy signal with a $74 target. We are suggesting call positions now although a dip back toward $62.00 would be a very tempting entry point. Our target is the $69.00-70.00 range.

Suggested Options:
We are suggesting the July calls although August strikes would also work well.

BUY CALL JUL 60.00 TSO-GL open interest= 751 current ask $6.30
BUY CALL JUL 62.50 TSO-GU open interest=1968 current ask $4.70
BUY CALL JUL 65.00 TSO-GM open interest= 599 current ask $3.40
BUY CALL JUL 67.50 TSO-GT open interest= 362 current ask $2.40
BUY CALL JUL 70.00 TSO-GN open interest= 117 current ask $1.65

Picked on June 03 at $ 63.74
Change since picked: + 0.00
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = 6.2 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Chaparral Steel - CHAP - cls: 74.19 chg: +1.01 stop: 69.95

The markets turned in another solid day on Friday. CHAP displayed relative strength with a 1.3% gain and on improving volume. We are encouraged since Thursday's session looked like a short-term failed rally under resistance. Not only do we like CHAP for its bullish pattern but the steel and metals industry has seen some mergers and acquisitions and it's expected that the group will see more consolidation this year. That makes CHAP a potential buyout target. The company already announced back in April that it was exploring all of its strategic alternatives. Part of the risk here is that CHAP might announced a bid to buy someone else in which case we would expect CHAP's stock to go down as the buyer. We are suggesting call positions now. More conservative traders will want to strongly consider waiting for a breakout over $75.00 or the $75.50-75.60 zone before buying calls. We're going to set two targets. Our first target is the $79.50-80.00 range. Our aggressive target is the $84.00-85.00 range. The P&F chart currently points to a $99 target.

Suggested Options:
We are suggesting the July calls. It is up to the individual investor to decide which month and which strike price best suits their trading style and risk.

BUY CALL JUL 70.00 ZHQ-GN open interest= 592 current ask $6.90
BUY CALL JUL 75.00 ZHQ-GO open interest=2237 current ask $4.00
BUY CALL JUL 80.00 ZHQ-GP open interest=1945 current ask $1.95

Picked on May 30 at $ 73.69
Change since picked: + 0.50
Earnings Date 07/10/07 (unconfirmed)
Average Daily Volume = 801 thousand

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OM Group - OMG - cls: 62.73 chg: +0.22 stop: 59.85

Shares of OMG under performed the market this past week. The stock was stuck trading sideways as it consolidates under the $64.00 level. On the positive side it does have a bullish pattern of higher lows and the consolidation is narrowing, which would suggest a breakout higher is just around the corner. A dip toward the $61.00 region is still a viable entry point to buy calls but at this point we would probably wait for a breakout over $64.00 before opening positions. Our target is the $68.50-70.00 range. The P&F chart is bullish with an $86 target.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 60.00 OMG-GL open interest=203 current ask $5.90
BUY CALL JUL 65.00 OMG-GM open interest=308 current ask $3.20

Picked on May 27 at $ 62.44
Change since picked: + 0.29
Earnings Date 08/02/07 (unconfirmed)
Average Daily Volume = 801 thousand

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Sunoco - SUN - cls: 81.11 chg: +1.40 stop: 75.95

A $1.00 rally in crude oil powered a strong move in the oil stocks. SUN, a refining stock, surged 1.75% and broke out over resistance at the $80.00 level. Our suggested trigger to buy calls was at $80.26. If we had any complaints it is with the low volume behind Friday's move. Now that the play is open we have two targets. Our first target is the $84.00-85.00 range. Our second, more aggressive, target is the $88.00-90.00 range. The P&F chart has seen its buy signal rise from $94 to $100. We would still consider new positions here but we suspect that odds are relatively good that SUN will dip back toward the $80 level, which would be a better entry point.

Suggested Options:
We are suggesting the July or August calls. It is up to the individual trader to decide which month and which strike price best suits their trading style and risk.

BUY CALL JUL 80.00 SUN-GP open interest=2281 current ask $4.80
BUY CALL JUL 85.00 SUN-GQ open interest= 754 current ask $2.45
BUY CALL JUL 90.00 SUN-GR open interest= 368 current ask $1.10

BUY CALL AUG 80.00 SUN-HP open interest=2572 current ask $6.10
BUY CALL AUG 85.00 SUN-HQ open interest= 752 current ask $3.70
BUY CALL AUG 90.00 SUN-HR open interest= 889 current ask 42.10

Picked on June 01 at $ 80.26
Change since picked: + 0.85
Earnings Date 08/01/07 (unconfirmed)
Average Daily Volume = 3.3 million

---

Vangard Emergy Mkts ETF -VWO- cls: 89.29 chg: +1.97 stop: 84.99*new*

The emerging markets ETF, the VWO, really popped on Friday. The VWO gapped open higher above resistance near $88.00 and rallied to a new all-time high. The ETF is nearing our target in the $89.85-90.00 range. More aggressive traders may want to aim higher. It's very common for equities that reach the $90 level to quickly sprint toward the $100 zone. The $100 mark is such a strong psychological level it can act like a magnet. We suspect that VWO moves a bit too slowly for a sprint toward $100 but the ETF does have a strong bullish trend. Chart readers will notice that Friday's rally is a breakout over its multi-month trendline of resistance (higher highs). We're raising our stop loss to $84.99.

Suggested Options:
We are not suggesting new positions in the VWO at this time.

Picked on May 16 at $ 86.15
Change since picked: + 3.14
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 416 thousand

---

XTO Energy - XTO - cls: 58.37 chg: +0.36 stop: 54.99

We are surprised that XTO didn't show more strength on Friday. The surge in crude oil futures really pushed the energy stocks higher. Shares of XTO rallied toward short-term resistance near $59.00 and failed on Friday morning. While this is discouraging traders jumped in to buy the dip near $58.00 Friday afternoon. The stock continues to have a bullish trend of higher lows. Should XTO continue to dip then look for a bounce near $57.00. We would still consider new positions now but some readers may want to see a new relative high first. More conservative traders may want to raise their stop loss toward $56.00 just under technical support at the rising 50-dma. Our target is the $62.50-65.00 range. Aggressive traders may want to aim higher.

Suggested Options:
We are suggesting the July or August calls.

BUY CALL JUL 55.00 XTO-GK open interest=124 current ask $4.70
BUY CALL JUL 60.00 XTO-GL open interest=778 current ask $1.75
BUY CALL JUL 65.00 XTO-GM open interest=410 current ask $0.45

BUY CALL AUG 55.00 XTO-HK open interest=3533 current ask $5.40
BUY CALL AUG 60.00 XTO-HL open interest=5651 current ask $2.55
BUY CALL AUG 65.00 XTO-HM open interest= 720 current ask $0.90

Picked on May 27 at $ 57.63
Change since picked: + 0.74
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 3.2 million
 

Put Updates

Anixter Intl. - AXE - cls: 72.83 chg: -1.03 stop: 72.05

AXE under performed the markets on Friday with a 1.39% decline. Yet that didn't stop the daily chart's MACD indicator from producing a new buy signal. This past week was bullish for AXE with a big bounce from support near its 50-dma. We are currently sitting on the sidelines so it doesn't hurt to leave AXE on the newsletter as a bearish candidate but the bears are definitely having a hard time here and AXE looks closer to breaking out over resistance near $75.00 than breaking down under $70.00. Currently it is our suggested strategy to buy puts on a breakdown under $68.50. We are considering a higher trigger point at $69.00 or just under $70.00 but for now we'll stick with a $68.49. More nimble traders might actually want to scope out potential bullish positions if AXE can trade over resistance at the $75.00 mark.

Suggested Options:
We are not suggesting new positions at this time. If AXE hits our trigger at $68.49 we would suggest the August puts.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/24/07 (unconfirmed)
Average Daily Volume = 520 thousand

---

Gilead Sciences - GILD - cls: 83.00 chg: -0.00 stop: 82.55

We are still in a wait and see mode with GILD. Biotechs turned in a decent week and the BTK index has broken the trend of lower highs and the MACD on the BTK's daily chart is nearing a new buy signal. Meanwhile shares of GILD continue to churn sideways inside its $80.00-85.00 trading range. We are waiting on a breakdown to signal a correction lower. Our suggested plan is to buy puts on a breakdown with a trigger at $79.90. If triggered we will have two targets. Our conservative target is $75.25-75.00. Our aggressive target is the $72.50-70.00 range. Readers should note that the stock is set to split 2-for-1 on June 25th. FYI: The P&F chart is still bullish with a $97 target but a drop under $80 should reverse it into a new sell signal. If GILD can breakout over $85.00 we might switch directions!

Suggested Options:
If GILD hit our trigger to buy puts at $79.90 we would suggest buying the July or August puts.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/18/07 (unconfirmed)
Average Daily Volume = 4.1 million

---

Vital Images - VTAL - cls: 28.25 chg: +0.66 stop: 29.05 *new*

It is tough to be a bear when the markets are hitting new high after new high. While VTAL has under performed its peers and the broader market indices but the lack of downward momentum is starting to hint that VTAL may have found a bottom here. We are concerned that VTAL's recent sideways consolidation is going to end with a breakout higher. Please note that we're adjusting our stop loss to $29.05. The $30.00 level should be stronger overhead resistance but we don't want to risk that much of a move at this time. More conservative traders may want to just exit early right here or tighten their stop loss even further.

Suggested Options:
We are not suggesting new positions in VTAL at this time.

Picked on May 16 at $ 27.99
Change since picked: + 0.26
Earnings Date 04/26/07 (confirmed)
Average Daily Volume = 191 thousand
 

Strangle Updates

None
 

Dropped Calls

Freeport McMoran - FCX - cls: 79.25 chg: +0.80 stop: 74.45

Target achieved! The rally in FCX continued into Friday and the stock hit an intraday high of $80.00. Our target was the $79.50-80.00 range. We remain bullish on FCX but would look for a dip back toward the 10-dma or the $75.00 level before considering new positions.

Picked on May 27 at $ 74.61
Change since picked: + 4.64
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 12.3 million
 

Dropped Puts

Las Vegas - LVS - cls: 80.30 change: +2.28 stop: 81.15

We are throwing in the towel on LVS and suggesting an early exit! The stock has bounced more than once near the $75.00 level and now Friday's big bounce (+2.9%) has erased any unrealized gains. The close over round-number resistance at $80.00 on strong volume is bullish. We'd rather cut our losses now than see LVS rally toward overhead resistance at its 200 or 50-dma near $84.

Picked on May 07 at $ 79.85
Change since picked: + 0.45
Earnings Date 05/02/07 (confirmed)
Average Daily Volume = 2.1 million
 

Dropped Strangles

None
 


Trader's Corner

Time to Reassess

Early this year, I began a series of articles on the corrective fan principle. Every few months, I check on the conclusions suggested by that principle, seeing if the market has behaved in accordance with expectations.

It would seem that they're not. According to the corrective fan principle, the rally off last summer's low ended in February. Oh, yeah? Tell that to any bear trying to short the markets from mid-March through mid-May. Tell it to anyone in an SPX or OEX bear call credit spread in April. Or May.

Let's look, though, at what the principle says and what has happened. Basically, the principle suggests that any trending move establishes three separate trendlines. The first sharp move up from a low or down from a high tends to be too steep to be maintained. Prices fall through the first ascending trendline or break up through the first descending one. A less steep second trendline is established. Prices bounce from that trendline for a while, too, but it's also too steep to be maintained, too. A third trendline is established.

When that trendline breaks, the principle suggests that the trending move is kaput. In the case of a rally such as the one off last summer's low, the break of that third trendline suggested that either a period of disorganized trading or else a downtrend would follow.

That hasn't exactly happened:

Annotated Daily Chart of the SPX:

Note: That chart was snapped about 12:25 EST Friday afternoon and so doesn't indicate Friday afternoon's activity.

So, what happened? At least four possibilities exist:

1. I drew the trendlines incorrectly.
2. The current action isn't a continuation of the uptrend.
3. It really is different this time.
4. The corrective fan principle didn't work this time.

Let's start with number four. The corrective fan principle works on many time frames and across many kinds of markets. However, no system, no indicator, no nothing works all the time. In April 1997, the SPX began climbing off a low, establishing a series of three trendlines. The third wasn't broken until August 1998, and it was followed by a steep decline that, like February's, lasted only a few days. After rising for about a week, then dipping swiftly to retest the August low, the markets were off again, rising into their early 2000 highs.

The corrective fan principle didn't work that time. There's the possibility that the corrective fan theory just didn't work this time, either, other than to predict that the break of that third trendline would be steep. It was.

What about the possibility that "it," the markets' behavior, really is different this time? Anyone tuning into CNBC has certainly heard enough theories about why that might be true. The flood of money into equities is global, commentators will tell you, and not just the commentators appearing on our version of CNBC. CNBC Asia and Europe both feature commentators saying the same thing.

I can't help it: I almost groan when I heard that "different this time" statement. How many personal fortunes through how many centuries have been wiped out by people who believe that it's different this time? I'm sorry. I just don't believe that. I can easily believe that a formation break failed to produce the expected result, that the corrective fan theory just didn't work this time, just as a triangle breakout is sometimes quickly reversed and prices head in the opposite direction. Formation breaks sometimes don't deliver on their expectations. I also believe that momentum can sustain a trend far beyond the time when it would have died a natural death, but I don't believe that market behavior has truly changed.

That leaves the first two possibilities to be discussed. Is it possible that, as much as our eyes tell us that this is a continuation of an uptrend, that our eyes are deceiving us?

Annotated Daily Chart of the SOX:

The possibility exists that the entire post-February rally is nothing but the prelude to something like what happened on the SOX. We'll just have to wait and see, but the negative breadth measurements while the SPX has been climbing over the last couple of months beg that we at least keep this possibility in mind.

So does the SPX's dead stop on that neon-green third trendline (first chart) each time it's been hit. (Note: the SPX had again been stopped by that trendline Friday morning, but this article will be submitted before Friday's close, so it's possible that will have changed.) Unless Friday afternoon's move produces a big climb, that shows us that the trendline has some validity, bringing up the question of whether I just made a mistake drawing the first or second of three trendlines in that SPX chart. Maybe that third trendline isn't the third, but a second one.

Drawing trendlines is as much an art as a science. Knowing that, I made every effort to ensure that the trendlines were valid, as you might remember if you read the original articles on the corrective fan theory. For example, I correlated price trendline breaks with RSI trendline breaks. The first chart of this article demonstrates how I did that.

I could give some credence to the choice of the three trendlines, too, when February's break of the third one resulted in a strong downdraft. Something happened differently with the break of that third trendline than happened with the break of the first two. What happened was exactly what would have been expected if the corrective fan principle were holding in this instance: a steep decline at the break. It's what's happened since that's in question.

Where does all this leave us? Normally, I would be the first to blame myself, to say that my trendline-drawing skills were at fault, but that February action argues against that conclusion. I just don't believe in the "it's different this time" paradigm, so I'm rejecting that one out of hand. I tend to believe, then, that either this is one of those times that a formation just failed to perform as expected or that the whole climb off the March 2007 has been part of a different pattern, a consolidation or other pattern, that we just can't see yet.

And that's the purpose for this article. Keep that possibility in mind. Stare at the SOX's chart, the second in this article for a while, long enough to convince yourself that it's always wise to be prepared, to have an exit plan in mind, to not allow oneself to get sloppy when protecting profits. If a huge triangle were to be set up, the chopping back and forth within the formation can be death to directional options positions and the essential getting-nowhere results of a narrowing triangle can be death to those that depend on a big movement because each movement is quickly reversed at the as-yet-unseen boundaries of any such triangle.

I'm not saying this will happen. I'm saying that you need to plan how you'll address trading options in case it does.
 

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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