Option Investor

Daily Newsletter, Saturday, 07/14/2007

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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

Lucky 13

Friday the 13th turned out to be lucky for investors with another round of new highs across the board. The Dow broke 13900 for the first time and the S&P broke through its prior historic intraday high of 1552.87 set back on March 24th 2000 and came within a few cents of closing over that level. The Friday follow through to the Thursday breakout was lukewarm but still positive. New records highs on a Friday make good headlines for the weekend news.

Dow Chart - Daily

Nasdaq Chart - Daily

The continued market gains were even more surprising in the face of the very negative Retail Sales numbers for June. The report out Friday showed retail sales fell -0.9% in June due to major drops in auto dealers, furniture stores and building supply dealers. Anything housing related showed accelerating weakness. Sales were weak across the board with the exception of drug stores and nonstore retailers. The sharp drop reversed more than half of the strong 1.5% gain in May. Year over year growth, now 3.8%, has been cut by more than half since January-2006 when overall sales growth was 9.4%. This was a negative report but it was somewhat expected so the market damage was minimal and the dip was quickly bought.

On the positive side the July Consumer Sentiment surged to 92.4 from June's 85.3 number. This wiped out five months of declines that led to that June low. January's 96.9 was a 3-year high and July's reading suggests there has been a significant reversal of fortunes back towards that high. The expectations component jumped nearly 10 points from 74.7 to 83.9. The current conditions component was less exuberant with a still decent gain to 105.7 from 101.9. This was the biggest headline increase since October of 2006. Gasoline prices contributed to the gain with a -25 cent fall from their record early July level. This was a positive report but risks still remain with the housing decline still expected to hit consumer finances harder by year-end.

This was not a busy week for economics but next week the calendar is full. We have both the Producer Price Index (PPI) and the Consumer Price Index (CPI), both keys to pegging current inflation changes. The FOMC minutes for June's meeting will be out on Thursday and they could be market moving. The regional Fed surveys are headed our way led by the Philly Fed on Thursday. There are two sets of housing numbers due out on Tuesday and Wednesday and there are plenty of filler reports to crowd the headlines.

Economic Calendar

The full economic calendar will take a back seat to the increased pace of earnings reports with numerous key reports that could add fuel to the current rally rocket. The major reports are Intel and Yahoo on Tuesday, Ebay, Juniper and JP Morgan on Wednesday and AMD, GOOG, MSFT, BRCM and MOT on Thursday. One interesting report could be the MGIC (MTG) earnings on Thursday. MGIC is the company that insures the majority of subprime loans and their earnings are expected to be under extreme pressure. An upside surprise here could light a fire under all the financials. With expectations for financials in general extremely low any good news could produce a strong rebound in the sector. Financials are 21% of the S&P so a major rebound would strongly impact the S&P.

Earnings Calendar

Earnings last week got off to an ugly start with the first few reporters missing the targets either on actual earnings or future guidance. Warnings were coming from every sector including the very robust energy sector. This further depressed overall estimates and expectations.

GE turned the tide on Friday with earnings that rose 10.2% and inline with expectations. The market moving news was the guidance and their announcement of a $2 billion addition to their existing $12 billion buyback program over the next six months. GE stock broke $40 and hit a new 5-year high on the news. With their market cap of $410 billion it would take major news to move the stock very much more than the 50 cent gain posted on Friday. They have 10.3 billion shares outstanding. GE also said the subprime heat was too hot to handle and they were going to sell WMC their subprime mortgage company. WMC did $22 billion in loans in 2006 and was one of the biggest players in the sector. GE sold off $3.7 billion of poorly performing loans in the last quarter in an effort to shed exposure to those subprime losses. They only have $1.1 billion in remaining loans outstanding so that give you an indication of how much they have been liquidating of the $22 billion in loans in 2006. WMC is a subprime arm of GE Money and the subprime losses were offset by the rest of the GE Money profits letting the entire division add 8% to the total GE earnings. GE said WMC lost -$182 million in Q2 and that was on top of a -$370 million loss in Q1. GE took a $500 million charge in Q1 when it laid off 460 WMC employees and sold off part of its subprime assets. GE did not say if it had any offers for WMC or what value they expected to get for the ailing company. A division leading the GE earnings parade was the energy services group posting a 76% profit jump. GE has several ventures in the oil and gas and energy services sector and you can expect them to have more soon. GE is so positive on energy you can bet there will be some acquisitions down the road to help fill out that services portfolio. GE did say they did not expect any acquisitions over $2 billion for the rest of 2007 preferring to buy back stock instead. Makes no sense to me why they want to buyback stock rather than spend their $20 billion cash hoard for improvements to existing divisions. Given their 10 billion shares outstanding and the current price at $40 a $14 billion buyback is only 350 million shares or 3.5%. It probably won't make a material difference in the stock price and does nothing for individual investors. Using that money to pay a tax advantaged dividend or improve the business would make more sense to me.


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Thomson Financial reported 13 buyback announcements for the week for a total of $45 billion. This was the second strongest week on record. Recent announcements included GE $14B, COP $15B, Home Depot $11B, JNJ $10B and AMGN $5B. There were $117.7 billion in buybacks completed in Q1 and that was the sixth straight quarter over $100 billion in completed buybacks. In 2006 there were a record $432 billion in announced buybacks and Thomson is estimating that record will rise to $459 billion in 2007. You have to ask yourself why so many companies are opting for buybacks at market highs rather than using the cash in their business or giving the cash back in tax advantaged dividends. Could it be that so many executives at these companies are compensated based on stock prices? I am sure that is a big factor. Executives have compensation plans, which kick in at various stock prices, and the stock option plans are almost exclusively related to stock prices. Buying back stock benefits officers and employees more than the actual stockholders. Also, buying back stock increases earnings per share by reducing the number of shares in the calculation. That helps them beat earnings estimates, which makes them look like winners to the retail investor. Also, buying back stock does not erase it. That stock goes back into the company treasury and they can use it for acquisitions or stock options exercised by those executives with millions in stock option compensation. Follow this train of thought. Executives are given millions of shares of stock options, which are only exercisable above a certain stock price. The executives plan massive stock buybacks to temporarily push the stock prices higher. The company puts the shares in the treasury. The executives exercise those massive option grants and the stock comes back out of the treasury and into executive pockets. They then sell that stock back into the market making tens of millions in the process. The amount of stock in circulation did not go down materially and the price of the stock fades again when the shenanigans end. If they issued dividends to stockholders with a 15% tax rate it would be real money into the pockets of millions of stockholders. Instead the executives pocket the money and the stockholders end up holding the same stock as it fades back to mediocrity. Sorry for the rant but this buyback craze needs to be exposed for what it really is.

Earnings next week will be the focus with several high profile big cap techs likely to take the spotlight. Microsoft reports on Thursday and earnings are expected to be decent but tempered by problems with the Xbox consoles. They reported they have sold 40 million copies of Vista and have not even scratched the surface of their long-term expectations. Unfortunately outside reports claim Vista acceptance is slowing due to the upgrade problems associated with the conversion. The word of mouth from existing Vista owners about how much horsepower is required to run it has been negative. Several reports I heard claim many users had to upgrades several times to get to a level of performance that was acceptable. More memory, faster processors and even motherboard upgrades were needed to solve the resource demand problems.

That is great news for Intel, which reports on Tuesday night. They are expected to report a very robust quarter and strong margins due to the Vista upgrade cycle. Intel hit a new 18-month high on Friday at $26 and most analysts expect them to move even higher after earnings. Intel has another new product cycle coming and we could get the next announcement with earnings. It is also rumored that they will cut prices on existing processors by as much as 50% on July 22nd. That will crush AMD again only weeks before their Barcelona chips are scheduled for release. So far the Barcelona chip has failed to impress analysts, as it is too little, too late. First shipments are due in August. The current Intel Xeon Quad Core, 4 processors on one chip, is extremely popular for the current server upgrade cycle currently underway. Those processors require lots of memory and faster disks before they can be stressed to any degree so the rest of the tech sector is benefiting from the Intel processor growth path. I look for Intel to surprise higher than their optimistic statements from last week.

Intel Chart - Weekly

AMD Chart - Weekly

AMD reports on Thursday and their earnings loss is not expected to impress traders. AMD is expected to report a loss of 85 cents so there is a chance of an upside surprise. Intel price cuts have been crushing AMD margins and taking back market share. The Barcelona chip is also a quad core meant to compete with Intel's offerings and AMD claims it will be 70% faster than prior AMD chips when running database programs and 40% when doing scientific calculations. The AMD chip will run at speeds of up to 2.0 Ghz while the top line Intel quad core already runs at 2.66 Ghz. Intel is expected to announce an even faster quad core chip over the next several weeks, probably along with their rumored price cuts on July 22nd. An 8-processor core is rumored to follow later this year. AMD has a tough battle ahead of them and Intel is quickly stretching its lead.

By year end Intel will be making chips with transistors measuring 45 nanometers (45 billionths of a meter) and smaller than most human viruses. Using a 300mm wafer (12 inches across) Intel can etch 2,500 chips on each wafer slashing their production costs. The super small chips are targeted for super cheap mobile PC products that currently don't exist. Intel expects three new $10 billion a year markets, one each in mobile, consumer electronics and handheld PCs to devour these chips on a massive scale. Intel claims PCs powered by its chips now make up over 850 million of the slightly more than one billion computers connected to the Internet. That took 12 years to reach the one billion PC mark. Intel expects that number to more than double in less than half of that time and they are preparing the chips for that to happen. I know this sounds like a sales pitch for Intel but computers have always been my hobby and I own a server company. Intel is smoking hot in the server market today and I believe their earnings will show it.

Partial Earnings Calendar

Google, Yahoo and Ebay report next week with Google expected to wow investors once again. Many analysts claim the good news for Google is already baked into the stock price and this could be the quarter that the walls come tumbling down. They keep saying that and Google continues to surprise and move higher. Google does have a history of declining after earnings twice as often as it rose so a word to the wise is to take profits early. Over the last ten quarters Google has always beaten estimates but seven of those quarters saw Google decline, sometimes sharply, after their report.

Google Earnings Chart - Weekly

Yahoo will report on Tuesday and they already toned down expectations so most traders are not expecting any excitement over the report. Ebay reports after the bell on Wednesday and expectations are mixed but positive with Ebay maintaining its lead over Google in the PayPal/Checkout war. Motorola will report on Thursday but they already warned of a Q2 shortfall last week so no trade there.

Also important next week will be a flurry of earnings from various financials. Merrill and State Street lead on Tuesday, JP Morgan on Wednesday and followed by Citigroup on Friday. There are about a dozen smaller names scattered throughout the week. Two names that might make good reversal trades are US Bank (USB) and Piper Jaffray (PJC). Both have been sold hard on the subprime problem but neither has significant exposure. Warren Buffet increased his position in USB from 6 million shares to 23 million shares back in March and he is a very conservative investor.

The subprime slime has pushed expectations for financials to extreme lows. Everyone is afraid to even guess which ones will confess subprime losses from mortgages, auto loans and credit cards. The term subprime does not just apply to mortgages. Defaults are also soaring in auto loans and credit card accounts. If people are bailing on their home loans in record numbers it stands to reason the less important consumer goods loans are also going into default. The mortgage lender has something to foreclose on. The auto lender also has collateral to some extent but the credit card companies are going to be hung out to dry.

With these factors pressuring earnings expectations there is a real possibility for an upside surprise in the financial sector. The bad news is already priced in and a sudden rush of better than expected news could start a real flurry of bargain hunting. The real key for me will be the MGIC earnings on Thursday. They write private mortgage insurance for residential mortgages where the homeowner puts less than 20% down. That would normally be subprime or alt-a borrowers or those will little cash reserves. By insuring these loans the lender can sell them into the secondary market and reduce the implied risk. When these loans default MGIC has to jump into the gap and take the loss. How much loss they have had to eat over the last quarter is going to be the key factoid the markets are eagerly awaiting. This is a true glimpse into the health of the subprime market. UBS downgraded MGIC last week to neutral saying the reserve allowance for bad loans could be substantially greater than the previous MGIC forecast. UBS expected a reduction in earnings and slower returns through 2008. According to UBS, mortgage credit quality is deteriorating rapidly, especially in California and that is a problem because of the larger loans. UBS cut MTG and PMI but said they still liked PMI Group because of their lower exposure to California.

MGIC Chart - Daily

MGIC has $178.3 billion of primary insurance in force covering 1.3 million loans as of March 31st. As I said, this is going to be a critical look inside the subprime problem. At the current 5.3% default rate being tossed around in the news that would be roughly a $10 billion hit but remember they reinsure by selling the risk and are only out the difference between the loan amount and the eventual sale value of the property. Their net profits have declined from $149 million in Q2-06 to $129M in Q3, $121M in Q4 to $92M in Q1 but they are still profitable. Analysts are expecting earnings of $1.44 per share. They missed estimates of $1.71 in Q1 due mostly to an increase in loan loss reserves and lower income from a joint venture. The shares hit a nine month low at $54.30 on the report but rocketed back to $67 over the following weeks. The news was not as bad as many had expected. Fast-forward to June and the reemergence of the subprime meltdown. MGIC has fallen back to support at $56 and has held there for the last two weeks. This is strong support and it is poised to fly again if the news is better than expected.

Next week is poised to be a monster earnings week. Earnings expectations were hammered last week and those few whisper numbers for earnings growth of nearly 10% were quickly quieted. Official estimates have fallen back to the 3.1% to 4% range and the whisper numbers are now 6-7%. There are solid fears about financials, retailers, automakers and consumer goods. The stage is set for an upside surprise because the bad news is already priced into stock prices. That is amazing when you consider stocks closed on Friday at record highs. Why do you think that happened?

S&P Futures Chart - Daily

As of Tuesday's close the short interest on the S&P futures was the second highest since 2004. The short interest on the Russell 2000 futures was the highest on record. Tuesday's decline on various news events and earnings misses had every hedge fund on the planet loading up on shorts for a summer correction. Wednesday's news was not that bad and there was no follow through to the downside. Nervous fingers caressed the mice buttons as Wednesday closed but volume was tame and internals were neutral. Shorts probably thought the lack of follow through to the downside or a material rebound was just a pause before the next big drop. There was a clear lower high formation in place and the outlook for earnings was turning even more negative by the minute. Surprise, surprise as a $38 billion Alcan buyout deal, multiple share buyback announcements and some better than expected retail news hit the wires before Thursday's open. The Dow opening gap was 120 points to 13696 and above the three prior tops. A new historic high and short interest was at record levels. Is it any wonder that the Dow posted a 283 point gain and the Nasdaq 50 before the day was over? This was a textbook short squeeze and it could not have been scripted better if the bulls had tried. Friday's follow through was listless with internals dead even and the lowest volume since the July 4th holiday sessions.

Technically we have a clear breakout in progress across all the major averages and the possibility for positive earnings surprises next week. According to an analyst at Merrill Lynch there are over $24 billion in S&P shorts, which could have the impact of $48 billion in a crowded cover scenario. That means if they all tried to cover on the same week it would generate additional market buys from other investors buying the bounce. I normally try to go into the weekend short the Russell futures just in case there is a geopolitical event or a terrorist attack somewhere over the weekend. Because I am watching for a short entry right at the close I saw a lot of selling in the futures in the last ten min of trading, both Russell and S&P. The S&P futures lost 5.5 points and the Russell futures -3 points in the last 20 min of trading. That covers the last 5 min of the cash market and the 15 min of extended trading in the futures market to 4:15. I doubt everyone was taking a position for the same reason I do so that last minute bout of selling was confusing. The cash markets also dropped in the last 5 min so the selling was broad based, likely a couple of program trades. I am not going to worry about it in the larger scheme of things because I think the shorts will still be on the run next week.

Russell 2000 Chart - Daily

Monday is a blank for economics and earnings are slow as well. Tuesday is when the fireworks should start and I plan on being long for the show. Let's hope there are some positive earnings surprises to fuel the party. There is always the chance the negativity from last Tuesday returns but I don't see it from the information I have seen today.

Oil is going to be another major factor for next week. Crude closed at $73.97 in after hours trading and an 11-month high. The all time high was $78.40 intraday and a close at $77.03 on July 14th 2006 one year ago Friday. That should give anyone long oil a cause for pause. Crude inventories fell -1.5 million barrels last week but gasoline stocks rose 1.1 mb. The drop in crude was due to a pickup in refinery utilization and that is expected to continue. There has not been any hurricane activity but we are still eight weeks away from the peak of the season on Sept 10th. With oil at $74 the appearance of a hurricane in the Gulf would send prices to $80 in a heartbeat. BUT, the farther we get into the summer the less gasoline inventories matter. Nymex gasoline futures fell -5.5% from Tuesday's high to close just over support at $2.20 on Friday. If gasoline traders decide there is enough inventory to last out the summer even if a hurricane appears that support at $2.20 will break and it could be a sharp drop. If it does crack that level the loud whoosh you will hear will be crude prices falling like a rock. After hitting a peak on July 14th last year crude prices wandered sideways for three weeks as traders waited for the expected active hurricane season. Once into August prices held until August 8th and then fell $15 in an almost vertical drop. With net long positions in crude futures at historic highs there is an overwhelming bet on those hurricanes yet to show. Odds are very good that some event over the next three weeks will trigger that invisible sell signal and the entire herd will plunge over the cliff at a dead run. I still like oil long term but without a hurricane soon I will be unloading long positions and loading up on shorts for the normal end of summer decline.

Crude Oil Chart - Weekly

The Dow closed at 13907 and 432 off Tuesday's lows but only up 295 for the week. This was a very respectable rebound and very out of character with recent market movement. This leaves the Dow very overextended in the short term but still in a bullish trend. We could easily see some backtracking on Monday as profits are taken and shorts blown out on Thursday take another position. The Dow is so far above obvious support there is plenty of room to roam. Historically, according to a CNBC calculation, when the Dow moves to within 1% of a major milestone like 14000 it takes an average of 2.5 days before that milestone is reached. I believe that CNBC calculation is a load of crap since hitting 14000 would put the Dow within 1% of 15000 and assume another even bigger milestone would be hit two days later and on and on. That kind of napkin math may have worked at lower levels but at today's ranges it is worthless. Where we go from here is going to be directly related to the quality of earnings with an emphasis on earnings from techs and financials.

Dow Transport Chart - Daily

On the tech side of the ledger the Nasdaq added 5 points to its 50 point romp on Thursday. That produced two consecutive closes above 2700 and a milestone in its own right. The Nasdaq is also well above any easily definable support with the closest support level at 2647 and then again at 2600. It would take several bad days to retrace that far. The biggest hindrance will be the strong resistance on the semiconductor index (SOX) at 555 with the index currently at 530. That resistance dates back to Jan-2004 and Jan-2006 highs where it repulsed the rally in both years. Depending on the Intel news on Tuesday that could be a major stopping point for chips and for the Nasdaq.

S&P-500 Chart - Daily

The S&P-500 finally followed its other index brothers into new high territory intraday and posted a new closing high at 1552.26. The prior intraday high of 1552.87 hit on March 24th 2000 took over seven years to equal and sellers appeared on light volume when that level was touched on Friday. I think it was more of a psychological event than real resistance since that initial high was so long ago. The S&P has been lagging the Dow for months and the 45 point rebound this week was a sharp testimony to the second highest S&P futures short interest since 2004. It took a major short squeeze to finally clear the resistance points at 1535-1540 and it appears to be firmly anchored over 1550 today except for that selling in the futures after the close.

This is option expiration week and I just love to play expiring options in expiration week in an earnings cycle. I feel I have given you numerous optionable opportunities in the stocks I mentioned above and you can rest assured I will be playing most of them. Just remember when planning your earnings trades the biggest earnings moves are normally a reversal of the pre report trend. Basically unexpected earnings catch the majority of traders leaning the wrong way. Recent expirations have given a bullish bias to the market and I don't see any difference today. Put option open interest is very high and that normally provides a bullish expiration bias. Let's hope that trend continues.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays

New Calls

GlobalSantaFe - GSF - cls: 73.05 change: -0.20 stop: 69.90

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. (source: company press release or website)

Why We Like It:
We believe that oil and energy-related stocks will continue to be bullish for the next two or three weeks - that is when we expect crude oil to see a seasonal peak. In the meantime we want to play the bullish trend in GSF. The stock is also an acquisition target, which should keep a bid under the share price. We're suggesting positions now although another dip in the $70-71 region would also be attractive. Our target is the $78.00-80.00 range. We do not want to hold over the early August earnings report. The P&F chart is bullish with an $87 target.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 70.00 GSF-HN open interest= 763 current ask $5.30
BUY CALL AUG 75.00 GSF-HO open interest=11411 current ask $2.50

Picked on July 15 at $ 73.05
Change since picked: 0.00
Earnings Date 08/02/07 (unconfirmed)
Average Daily Volume = 4.8 million


Helmerich Payne - HP - cls: 36.30 chg: -0.13 stop: 33.95

Company Description:
Helmerich & Payne, Inc. is primarily a contract drilling company. As of June 30, 2007, the Company's fleet included 147 U.S. land rigs, 27 international land rigs and nine offshore platform rigs. In addition, the Company is committed to complete another 16 new H&P-designed and operated FlexRigs*, expanding its total number of FlexRigs to 125. (source: company press release or website)

Why We Like It:
HP makes some of the best drilling rigs in the business and considering their market cap of $3.75 billion we're shocked that someone hasn't acquired them yet. The stock looks poised to breakout higher with its bullish trend of higher lows. We're suggesting call positions now although traders really have a choice. You could wait for another drip near $35.00 or a new high above short-term resistance near $36.60. HP does appear to have long-term resistance near $40.00 so we're setting our target in the $39.85-40.00 range.

Suggested Options:
We are suggesting the August calls and at this time we plan to exit ahead of the August 1st earnings report. We are considering an exception to that rule and holding over the earnings report. If you want to bet on HP being acquired any time soon you may want to buy September or December calls.

BUY CALL AUG 35.00 HP-HG open interest=104 current ask $2.30
BUY CALL AUG 40.00 HP-HH open interest=235 current ask $0.35

Picked on July 15 at $ 36.30
Change since picked: 0.00
Earnings Date 08/01/07 (confirmed)
Average Daily Volume = 923 thousand


MAGNA Intl. - MGA - close: 95.40 chg: 1.51 stop: 91.89

Company Description:
We are the most diversified automotive supplier in the world. We design, develop and manufacture automotive systems, assemblies, modules and components, and engineer and assemble complete vehicles, primarily for sale to original equipment manufacturers (OEMs) of cars and light trucks in our three geographic segments - North America, Europe, and Rest of World (primarily Asia, South America and Africa). (source: company press release or website)

Why We Like It:
MGA was actually on our list to add on Thursday night but we ran out of time. We still like it here with Friday's bullish breakout over resistance near $94.00. Technicals are improving and the MACD on the daily chart just produced a new buy signal. Readers might want to wait for a dip back toward $94.00, which should now be short-term support. Our target is the $99.50-100.00 range. The P&F chart is bullish with a $110 target.

Suggested Options:
We are suggesting the August calls. At this time we don't see any August $100 strikes available.

BUY CALL AUG 95.00 MGA-HS open interest=50 current ask $3.60

Picked on July 15 at $ 95.40
Change since picked: 0.00
Earnings Date 08/08/07 (unconfirmed)
Average Daily Volume = 719 thousand


PACCAR - PCAR - close: 93.77 change: 0.57 stop: 89.95

Company Description:
PACCAR is a global technology leader in the design, manufacture and customer support of high-quality light-, medium- and heavy-duty trucks under the Kenworth, Peterbilt and DAF nameplates. It also provides financial services and information technology and aftermarket support for its customers worldwide. (source: company press release or website)

Why We Like It:
We've been watching PCAR for a couple of weeks now looking for the right entry point. The stock spiked higher on July 9th after an analyst firm upgraded the stock. Shares dipped back to retest broken resistance as new support near $90.00. Now the bounce is our entry point to buy calls. This is somewhat aggressive because we don't have a lot of time. We plan to exit ahead of the July 25th (unconfirmed) earnings report. Our target is the $99.50-100.00 range. The P&F chart is bullish with a $109 target.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 90.00 PAQ-HR open interest=1370 current ask $6.40
BUY CALL AUG 95.00 PAQ-HS open interest= 787 current ask $3.50
BUY CALL AUG 100.0 PAQ-HT open interest= 530 current ask $1.70

Picked on July 15 at $ 93.77
Change since picked: 0.00
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 1.6 million


XTO Energy - XTO - close: 60.56 change: 0.67 stop: 58.45

Company Description:
XTO Energy Inc. is a domestic natural gas producer engaged in the acquisition, exploitation and development of quality, long-lived oil and natural gas properties in the United States. Its properties are concentrated in Texas, New Mexico, Arkansas, Oklahoma, Kansas, Wyoming, Colorado, Alaska, Utah, Louisiana and Mississippi. (source: company press release or website)

Why We Like It:
Buying dips near the rising 50-dma in XTO has been a profitable strategy the last several months. Shares are providing another opportunity to do it again. This is somewhat of an aggressive trade. We only expect oil and energy stocks to rally for another two or three weeks plus we plan to exit ahead of XTO's late July earnings report. Thus we don't have a lot of time. We'll try and limit our risk with a relatively tight stop loss at $58.45 but more conservative traders could put their stops closer to the 50-dma (around $59.15). An alternative entry point would be to wait for another rise past $61.50 to clear the congestion there. Our short-term target is the $64.85-65.00 range. More aggressive traders may want to aim higher but remember our time constraints. The P&F chart is bullish with a $73 target.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 55.00 XTO-HK open interest=3269 current ask $6.40
BUY CALL AUG 60.00 XTO-HL open interest=9173 current ask $2.55
BUY CALL AUG 65.00 XTO-HM open interest=5019 current ask $0.80

Picked on July 15 at $ 60.56
Change since picked: 0.00
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 3.8 million

New Puts

None today.

New Strangles

Advanced Micro - AMD - cls: 15.43 chg: 0.07 stop: n/a

Company Description:
Advanced Micro Devices is a leading global provider of innovative processing solutions in the computing, graphics and consumer electronics markets. AMD is dedicated to driving open innovation, choice and industry growth by delivering superior customer-centric solutions that empower consumers and businesses worldwide. (source: company press release or website)

Why We Like It:
We believe that larger rival Intel and its earnings report due out on July 17th will have a big impact on shares of AMD. We would expect AMD to trade down on the INTC news but we'd rather take a neutral approach so we're suggesting a strangle. We only have two days, Monday and Tuesday, to open positions.

Suggested Options:
We're suggesting a strangle so we need to buy an out of the money call and an out of the money put. We're suggesting the August strikes. If you really want to be aggressive you could play July strikes but they expire in five days. At current prices our estimated cost is $1.18. We want to sell if either option hits $1.85 or higher. Aggressive traders could aim for $2.40.

BUY CALL AUG 16.00 AMD-HQ open interest=7424 current ask $0.60
BUY PUT AUG 15.00 AMD-TC open interest=7774 current ask $0.58

Picked on July 15 at $ 15.43
Change since picked: 0.00
Earnings Date 07/19/07 (confirmed)
Average Daily Volume = 26.1 million


Intel - INTC - cls: 25.97 change: -0.03 stop: n/a

Company Description:
Intel, the world leader in silicon innovation, develops technologies, products and initiatives to continually advance how people work and live. The Intel-powered classmate PCs was specifically designed by Intel to meet the needs of classrooms in emerging markets. The affordable and fully functional PC supports collaborative learning environments for K-12 schools and has started volume shipment to emerging markets. (source: company press release or website)

Why We Like It:
We expect Intel's earnings report, due out after the bell on Tuesday night, to produce a big move in the stock price. Odds are good INTC will see a "sell the news" move but we can't count on it so we're suggesting a strangle. We only have Monday and Tuesday to open positions.

Suggested Options:
We're suggesting a strangle so we need to buy an out of the money call and an out of the money put. We're suggesting the August strikes. If you really want to be aggressive you could play July strikes but they expire in five days. At current prices our estimated cost is $0.96. We want to sell if either option hits $1.65 or higher. FYI: You will want to try and keep your investment amounts relatively even on both sides of the strangle to keep the strategy neutral.

BUY CALL AUG 27.50 INQ-HY open interest=12789 current ask $0.44
BUY PUT AUG 25.00 INQ-TE open interest=23250 current ask $0.52

Picked on July 15 at $ 25.97
Change since picked: 0.00
Earnings Date 07/17/07 (confirmed)
Average Daily Volume = 60.3 million


Manpower - MAN - close: 94.60 chg: 0.08 stop: n/a

Company Description:
Manpower Inc. is a world leader in the employment services industry; creating and delivering services that enable its clients to win in the changing world of work. The $18 billion company offers employers a range of services for the entire employment and business cycle including permanent, temporary and contract recruitment; employee assessment and selection; training; outplacement; outsourcing and consulting. (source: company press release or website)

Why We Like It:
Our directional play on MAN wasn't working out very well so we have decided to switch toward a strangle to take advantage of any post-earnings volatility. The company is due to report on Thursday morning. That gives us three days to open positions. We are suggesting an entry range in the $94-96 zone and the closer to $95.00 the better.

Suggested Options:
We're suggesting a strangle so we need to buy an out of the money call and an out of the money put. We're suggesting the August strikes. If you really want to be aggressive you could play July strikes but they expire in five days. At current prices our estimated cost is $3.35. We want to sell if either option hits $5.75 or higher. FYI: You will want to try and keep your investment amounts relatively even on both sides of the strangle to keep the strategy neutral.

BUY CALL AUG 100.0 MAN-HT open interest= 72 current ask $1.55
BUY PUT AUG 90.00 MAN-TR open interest=476 current ask $1.80

Picked on July 15 at $ 94.60
Change since picked: 0.00
Earnings Date 07/19/07 (confirmed)
Average Daily Volume = 636 thousand


MGIC Invest. - MTG - close: 56.98 change: -0.05 stop: n/a

Company Description:
MGIC, the principal subsidiary of MGIC Investment Corporation, is the nation's leading provider of private mortgage insurance coverage with $178.3 billion primary insurance in force covering 1.3 million mortgages as of March 31, 2007. MGIC serves 5,000 lenders with locations across the country and in Puerto Rico and Australia, helping families achieve homeownership sooner by making affordable low-down-payment mortgages a reality. (source: company press release or website)

Why We Like It:
If you read the market wrap for this weekend then you already know that Jim discussed MTG in detail so we don't feel the need to repeat him too much here. The stock has sunk on fears that the subprime meltdown will impact MTG's earnings. Shares are trading near support. An earnings surprise to the upside should spark some serious short covering and bargain buying. More bad news should push MTG to new relative lows. The company reports on Thursday morning so we only have three days to open positions. We are suggesting an entry range in the $56-58 zone. The closer to $57.50 the better.

Suggested Options:
We're suggesting a strangle so we need to buy an out of the money call and an out of the money put. We're suggesting the August strikes. If you really want to be aggressive you could play July strikes but they expire in five days. At current prices our estimated cost is $3.10. We want to sell if either option hits $5.95 or higher. FYI: You will want to try and keep your investment amounts relatively even on both sides of the strangle to keep the strategy neutral.

BUY CALL AUG 60.00 MTG-HL open interest=3243 current ask $1.35
BUY PUT AUG 55.00 MTG-TK open interest=3115 current ask $1.75

Picked on July 15 at $ 56.98
Change since picked: 0.00
Earnings Date 07/19/07 (confirmed)
Average Daily Volume = 1.8 million

Play Updates

In Play Updates and Reviews

Call Updates

Avery Dennison - AVY - cls: 68.33 chg: 0.22 stop: 65.90

Shares of AVY still look poised to move higher. The market-wide rally (or short squeeze) on Thursday pushed AVY past resistance to new relative highs. The stock might have some resistance near $69 but it looks like a relatively clear shot from here to our target in the $69.75-70.00 range. We do not want to hold over the late July earnings report, which are still unconfirmed at July 24th.

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

Picked on June 11 at $ 66.05
Change since picked: 2.28
Earnings Date 07/24/07 (unconfirmed)
Average Daily Volume = 728 thousand


Boeing Co - BA - cls: 101.88 change: 1.10 stop: 98.95

Our new bullish play in BA is now open. Shares of BA rallied to a new all-time high probably thanks to a big order for their Dreamliners. Chile's LAN airlines ordered 32 of BA's 787 Dreamliners on Friday. We wanted to see BA breakout over resistance before buying calls. Our suggested trigger was at $101.55. Now that the play is open our target is the $109.00-110.00 range. The intraday move over $102 has produced a new triple-top breakout buy signal on the P&F chart with a $119 price target. Remember, we do not have a lot of time and plan to exit ahead of the July 25th earnings report.

Suggested Options:
We're suggesting the August strikes.

BUY CALL AUG 100 BA-HT open interest=14127 current ask $4.20
BUY CALL AUG 105 BA-HA open interest= 8428 current ask $1.70

Picked on July 13 at $101.55
Change since picked: 0.33
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 4.1 million


Burlington Northern - BNI - cls: 88.68 chg: 0.51 stop: 83.99

We do not see any changes from our Thursday night new-play description. BNI continues to look bullish over $88.00. The Dow Jones Transportation sector index is at new all-time highs, which is a big bullish sign for Dow Theory enthusiasts. Most of BNI's technical indicators have turned positive. If we have a worry it's potential resistance at the 50-dma (near 89.20) and potential resistance at $90.00. Yet if the markets continue to rally we expect BNI to follow. The P&F chart is still bearish but we're aiming for the $94.00-95.00 range. This is somewhat aggressive given our time frame as we plan to exit ahead of the July 24th earnings report.

Suggested Options:
We are suggesting the August calls but plan to exit ahead of the late July earnings.

BUY CALL AUG 85.00 BNI-HQ open interest=1591 current ask $5.80
BUY CALL AUG 90.00 BNI-HR open interest=3184 current ask $2.90

Picked on July 12 at $ 88.17
Change since picked: 0.51
Earnings Date 07/24/07 (confirmed)
Average Daily Volume = 2.3 million


Deere Co - DE - close: 131.08 change: 2.75 stop: 119.95

Target achieved! DE continued to rally on Friday. Shares soared another 2.1% and broke through potential round-number resistance at the $130 level. Our first target was the $129.50-130.00 range. Friday's strength was boosted by positive analyst comments about the growth in the construction equipment industry. We remain bullish on DE but we're not suggesting new positions at this time. Our next target is the $134.00-135.00 range. Readers may want to tighten their stops.

Suggested Options:
We're not suggesting new bullish positions in DE at this time.

Picked on June 20 at $123.55
Change since picked: 7.53
Earnings Date 08/15/07 (unconfirmed)
Average Daily Volume = 2.6 million


FedEx - FDX - cls: 117.25 change: 2.83 stop: 111.85

FDX turned in a strong session and definitely lent some support to the transports. The stock surged to new four-month highs at $119.10 before paring its gains and closing with a 2.47% gain on Friday. Fueling the rally were renewed rumors that FDX was a takeover or leveraged buyout target. We remain bullish on the stock but we're not suggesting new positions at current levels. FDX almost hit our target on Friday morning. We're only aiming for the $119.50-120.00 range. Readers can watch for another dip or bounce above $115 as a potential entry point.

Suggested Options:
If FDX provides another entry point we'd use the August calls.

Picked on July 12 at $114.42
Change since picked: 2.83
Earnings Date 09/20/07 (unconfirmed)
Average Daily Volume = 2.4 million


GulfMark - GMRK - cls: 57.04 change: 1.08 stop: 53.49 *new*

Energy stocks continue to show strength and GMRK rallied more than 1.9% to another new high. If you are looking for a new entry point we'd watch for a dip into the $55.50-55.00 zone. We're adjusting our stop loss to $53.49. Our target is the $59.50-60.00 range. We don't want to hold over the late July earnings report. FYI: Don't forget that GMRK expects to change symbols when it moves to the NYSE around July 20th.

Suggested Options:
We're not suggesting new positions at this time but if an entry point appears we'd use the August calls.

Picked on July 09 at $ 55.05
Change since picked: 1.99
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = 284 thousand


Russell 2000 iShares - IWM - cls: 84.94 chg: 0.12 stop: 81.35

The markets may be hitting new relative highs but there seems to be some hesitation in the small caps. The Russell 2000 has yet to clear its June 2007 highs. IWM is keeping pace and the iShares are struggling with resistance near $85.00. We're not suggesting new positions at this time. Our target is the $86.50-87.50 range.

Suggested Options:
We're not suggesting new positions in the IWM at this time.

Picked on June 24 at $ 82.85
Change since picked: 2.09
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 71.6 million


Joy Global - JOYG - cls: 64.02 chg: 0.87 stop: 57.99

JOYG continues to show relative strength. The stock posted another 52-week high and cleared potential resistance at $63.75 dating back to April and May 2006. Most of JOYG's technical indicators are bullish. If you're looking for a new entry point to buy calls we'd watch for a dip towards $62.00. We are adjusting the stop loss to $59.75. Our target is the $68.00-70.00 range. Our time frame is six to eight weeks. The Point & Figure chart is forecasting an $81 target.

Suggested Options:
If JOYG provides another entry point we would suggest the August calls.

Picked on July 11 at $ 62.05
Change since picked: 1.97
Earnings Date 08/30/07 (unconfirmed)
Average Daily Volume = 1.9 million


L-3 Comm. - LLL - cls: 99.98 change: -0.17 stop: 97.45

LLL under performed the markets on Friday. However, readers can use a dip near $99.65 or near $99.00 as a new entry point. More conservative traders may want to see a new relative high over $100.60 before considering new positions. Our target is the $104.90-105.00 range. We would aim higher but we don't have a lot of time. We plan to exit ahead of the earnings report on July 26th. The P&F chart points to a $113 target.

Suggested Options:
We are suggesting the August calls but plan to exit ahead of the July earnings.

BUY CALL AUG 95.00 LLL-HS open interest=123 current ask $6.50
BUY CALL AUG 100.0 LLL-HT open interest=708 current ask $3.10
BUY CALL AUG 105.0 LLL-HA open interest=583 current ask $1.10

Picked on July 12 at $100.15
Change since picked: - 0.17
Earnings Date 07/26/07 (confirmed)
Average Daily Volume = 640 thousand


Pacific Ethanol - PEIX - cls: 14.15 chg: -0.29 stop: 12.83*new*

PEIX has suffered some profit taking the last few days. Shares peaked near round-number resistance at the $15.00 level and began to consolidate back towards $14.00 and its 10-dma. Technically PEIX has broken short-term support at its 10-dma with Friday's decline. However, the $14.00 mark is broken resistance so it should be new support. A bounce from here could be used as a new entry point although if you're starting new positions now you may want to put your stop loss just under $14.00 or maybe $13.50. We are raising our stop loss to breakeven at $12.83. Our target is the $15.40-15.60 range (essentially the 200-dma). FYI: We cannot find a future earnings date for PEIX but suspect it will be in August or September.

Suggested Options:
We're not suggesting new positions but if PEIX provided a new entry point we like the August calls.

Picked on June 24 at $ 12.83
Change since picked: 1.32
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 892 thousand


Penn National Gaming - PENN - cls: 59.98 chg: -0.12 stop: n/a

We are approaching the last two weeks for this PENN play. The company was given 45 days to solicit a higher offer than the current $67/share buyout price. Given the pull back in PENN it looks like investors are choosing to lock in profits instead of betting on a new suitor showing up. If you're willing to gamble on a new offer coming in over the next two weeks we would stick to the August strikes.

Suggested Options:
We would suggest the August $65 calls currently trading around 30 cents a piece.

Picked on June 17 at $ 62.12
Change since picked: - 2.14
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume = 1.0 million


China Petro - SNP - cls: 115.06 change: -1.20 stop: 112.35

We do not see any changes from our Thursday night new play description for SNP so we're reposting it here:

We are bullish on oil and energy stocks and the Chinese market continues to be red hot so SNP seems like a natural candidate for bullish positions. Shares have been consolidating with a bullish pattern of higher lows suggesting a new breakout higher is coming soon. We're suggesting a trigger to buy calls at $116.55, which isn't that far away. There is potential resistance at $120 but our target is the $124.00-125.00 range. The P&F chart is bullish with a $132 target. FYI: We would qualify this as somewhat aggressive. SNP is an ADR stock so it's prone to gap opens and the technical indicators are looking tired, which suggests the rally could fail at any moment.

Suggested Options:
Our suggested trigger to buy calls is at $116.55. We're suggesting the August calls.

BUY CALL AUG 115 SNP-HC open interest=323 current ask $4.90
BUY CALL AUG 120 SNP-HD open interest=290 current ask $2.80

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 08/27/07 (unconfirmed)
Average Daily Volume = 563 thousand


Toyota Motor - TM - cls: 125.98 change: -0.32 stop: 123.99

TM failed to see any follow through higher on Thursday's bounce from support near $125 and its 200-dma. That should make bulls cautious. This still looks like a tempting entry point to buy calls near the bottom of its short-term rising channel. However, readers may want to wait for a rise past $126.50 before initiating new positions. We have two targets. Our conservative target is the $129.75-130.00 range. Our aggressive target is the $133.50-135.00 zone. We do not want to hold over the early August earnings report.

Suggested Options:
We are suggesting the August calls.

BUY CALL AUG 125 TM-HE open interest=131 current ask $4.20
BUY CALL AUG 130 TM-HF open interest=390 current ask $1.90

Picked on July 12 at $126.30
Change since picked: - 0.32
Earnings Date 08/02/07 (unconfirmed)
Average Daily Volume = 557 thousand


Toro Co. - TTC - cls: 61.57 change: 0.28 stop: 57.95

TTC continues to look bullish here. Last week the stock broke out over resistance in the $60.00-60.50 zone and broke out from a multi-week consolidation pattern. Technicals have turned positive again and broken resistance should now act as new support. We would still consider new positions now but a more attractive entry point would be a dip near $61.00 or $60.00. More conservative traders may want to inch up their stop toward Wednesday's low (58.42). Our target is the $64.95-65.00 range. More aggressive traders may want to aim higher. The P&F chart points to a $77 target.

Suggested Options:
We would suggest the August calls.

Picked on July 11 at $ 60.75
Change since picked: 0.82
Earnings Date 08/23/07 (unconfirmed)
Average Daily Volume = 354 thousand


United States Steel - X - cls: 116.10 chg: 1.69 stop: 109.49

Thankfully we did not have to wait very long for X to hit our trigger and open the play. Shares broke through resistance near $115 on Friday and hit our trigger at $115.51. Volume was a bit light on the move but we're not going to complain. Short-term technicals are turning bullish again. Economic growth and constant M&A activity should keep the bulls in control with X. There is potential resistance near $120 but our target is the $124.00-125.00 range. We don't have much time. X is due to report earnings on July 24th. Given our time frame this should be considered a more aggressive play.

Suggested Options:
We like the August strikes. (Note - check your symbols. Normally the AUG 120 call should be -HD but the CBOE has it as -HU)

BUY CALL AUG 110 X-HB open interest=762 current ask $9.50
BUY CALL AUG 115 X-HC open interest=560 current ask $6.60
BUY CALL AUG 120 X-HU open interest=720 current ask $4.40

Picked on July 13 at $115.51
Change since picked: 0.59
Earnings Date 07/24/07 (confirmed)
Average Daily Volume = 3.4 million

Put Updates

Goldman Sachs - GS - cls: 222.18 chg: 1.89 stop: 225.26*new*

We are growing more concerned about GS as a bearish candidate. After speaking with Jim (this weekend's market wrap author) on Friday we are concerned that earnings expectations for financials are so low that the sector could see an upside surprise, which would fuel the rally. If the financials rally then GS is almost guaranteed to follow them higher. For now the stock is trading under a bearish trend of lower highs and it still has resistance at the 50-dma near $225.00. We are going to leave GS on the newsletter as a bearish play for now but we're not suggesting new positions. The trendline of support on the weekly chart, combined with a lack of follow through on last Tuesday's decline, makes us nervous. More conservative traders may want to bail out now and cut their losses. Our target is the simple 200-dma near $207. We are inching the stop loss down to $225.26.

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

Picked on July 10 at $217.08
Change since picked: 5.10
Earnings Date 09/12/07 (unconfirmed)
Average Daily Volume = 5.9 million


Mettler Toledo - MTD - cls: 98.51 chg: 0.20 stop: 99.11

There is no change from our previous comments on MTD. The stock continues to inch higher and came within 12 cents of hitting our stop loss on Friday. If the markets continue to show strength on Monday we would expect MTD to stop us out. We're not suggesting new positions at this time and more conservative traders may want to exit early!

Suggested Options:
We're not suggesting new positions on MTD at this time.

Picked on June 19 at $ 96.75
Change since picked: 1.76
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume = 215 thousand

Strangle Updates


Dropped Calls

Manpower - MAN - cls: 94.60 change: 0.08 stop: 89.90

MAN has been a disappointment. The stock has gone nowhere and the lack of movement just kills any option premium. We only have three days left before MAN is supposed to report earnings on the morning of July 19th. It is very possible that MAN will continue to trade sideways up into its earnings report. Therefore we are dropping MAN as a directional call play and adding it as a strangle play. Check the new play section for details.

Picked on June 20 at $ 94.15
Change since picked: 0.45
Earnings Date 07/20/07 (unconfirmed)
Average Daily Volume = 829 thousand

Dropped Puts


Dropped Strangles


Trader's Corner

Flipping for a Living

Have you noticed how many television programs focus on flipping houses? For the last several years, programs featured people from all sort of occupations flipping houses. The flippers go through a few setbacks but emerge from their six-week, three-month or four-month ordeals with sweaty, paint-stained hands grasping anything from $20,000 to $200,000 in profits.

Lately, some outcomes have changed with the changing housing market, and the television shows reflect that. One family-based group of flippers ignored the advice of an expert. They ended up leasing a house they couldn't sell. They hadn't taken that expert's advice to provide an extra bedroom for a house located in a family-oriented neighborhood. Several flippers saw their carrying costs rise, cutting into their profit, when they overspent on renovations, spending more than the comps for that neighborhood would support. Some found that the market had changed completely by the time they were ready to put the flipped house on the market, with prices depressed, cutting into or eliminating their profits entirely.

What does all this prove except that I watch far too many shows about flipping houses? What does flipping houses have to do with trading options, anyway? More than you might suspect. Read on a bit before options are discussed.

When the real estate market was hot, flippers could buy almost any property, spend almost any amount on repairs and dawdle away almost any amount of time due to poor planning and still count on profiting. Flippers didn't need a plan. They didn't need expertise. They didn't need much of a financial basis before starting the process. They didn't even need too much luck. They could count on a loan. They could enter the market as flippers at almost any point and exit at almost any point and be assured of their profits. They could repay those loans.

Trading long calls was like that in late 1999 and early 2000. You could enter at almost any point and count on making a profit. This isn't really an exaggeration, either. You didn't need much expertise. Traders could and did finance those calls by buying on margin and count on profiting, just as flippers in the early 2000's could count on paying back their construction loans.

However, when the housing market cooled, home equity became a dwindling asset, not an escalating one. In many regions, equity evaporates while flippers redo the houses they've bought. If they take too long, the increased equity they've built into the house with those travertine floors, granite countertops and stainless-steel appliances will be balanced against the declining existing homes sales price in their region, and the balance may be negative. The flipper may have lost money.

Flippers are in more danger if they buy the wrong house or employ a bad design plan. If they've overspent their budget, those who have bought in the wrong market will find that danger escalating. Even if flippers have got the right house in the right market with the right design, flippers who overspend their original budgets may find that lenders aren't willing to pony up any more money. Even with that right house, market and design, they could go bust.

We realize instinctively that flipping houses in a declining housing market is a risky business. We may even reason that only the most experienced and best financed of those flippers will survive with the others almost certain to get caught at some point and lose money.

Why don't we reason the same with options? If your only options strategy is going long calls or long puts, you might as well be flipping houses in a declining market, right? Your actions are analogous to those flippers the last year or so, flipping wasting assets.

Think about it. Options are, by nature, wasting assets. Part of the value of options comes from the time left before expiration. That value, commonly called "time value," always decreases as time passes. It will be at or near zero at expiration. Only the intrinsic value, the amount by which an option is in the money, will be left.

Just as today's house flippers must count on their improvements overcoming the declining house values, those who are long options must count on the intrinsic values of their options--the part that reflects how much the option is in the money--escalating faster than the time value declines. When markets are trending strongly, either up or down, going long options with a portion of your portfolio is a valid strategy, but you're going to eventually get caught when conditions change.

If logic tells you that people who flip houses in a declining market are bound to get caught at some point or another, logic should also tell you that those who only go long options are also going to get caught. A few house flippers, the most experienced and the best financed, will succeed, but the majority just won't. If you have only one strategy in your trading arsenal, you probably won't, either.

Am I telling you to stop trading options, that no one can make money trading options? No way. I am, however, telling you that you absolutely can't count on one strategy alone--going long calls and options--to make that money. You're far better off buying and shorting stocks, ETFs or the like if going long and short are going to be your only strategies. Stocks may rise or they may decline, but every time a stock hits $50, it's worth $50. It's not a wasting asset in the same sense, although it may certainly feel that way when prices are declining!

However, every time a stock hits $50, the long 50 call may not be worth the same thing. It is a wasting asset. If you bought a 50 strike call three months out when the stock was at $52.00 and it since dipped to $35.00 but has laboriously climbed all the way back to $52.00 the day of option expiration, you can bet you've lost money. Let's try it on the iVolatility.com "Options Calculator" on www.cboe.com.

Value for a 50 Strike Call, 90 Days from Expiration, with Stock Price at $52.00:

Note that the call would be worth $2.85. Using identical inputs, except for the time to expiration, we can calculate the value for the call on the day it expires, with the stock having again labored up to $52.00, the value it held the day you purchased the call three months earlier.

Value for a 50 Strike Call, 0 days to Expiration, with Stock Price at $52.00:

The call would now be worth $2.00. The so-called "time value" has wasted as time passes, just as home equity wastes in a declining housing market, and you've just lost $85.00 per contract [($2.85 - 2.00) x 100 multiplier]. You would have needed some improvement--in this case, an escalation in the underlying's price--to counter that wasting effect.

Choices do exist for trading options and making money, even if they are a wasting asset. Experienced house flippers who have reasonable plans and stick to them; who take losses when needed, not letting their asset's value waste further; and who have deep enough pockets to weather the inevitable loss will fare better than the inexperienced flipper who takes unwise choices; has no plan; refuses to sell at a loss, letting the loss accumulate while carrying costs build up; and who has spent more than is affordable.

Educating yourself about how options work, having a plan and sticking to it, being willing to take losses and keeping them small and not investing more than you can afford to lose are necessary but not the only ingredients to a winning strategy. Read everything you can find on this website. Go to www.cboe.com and www.cbot.com, both of which feature excellent free webinars on trading options on various underlying securities, and watch them. Set up one night a week, if necessary, for listening to a webinar on trading.

Even experienced house flippers will occasionally get caught, and will need to keep losses small to avoid eating into the money needed to flip another house or even feed the kids and keep the electricity turned on. Keep losses small when trading options, too.

What is a "small" loss? "Small" to a trader with a $5,000 account may be much different than "small" to a trader with a $500,000 account. How does one quantify it?

Dan Sheridan, who often conducts free "Master Session" webinars found on the CBOE, offers a specific guideline for his students. He wants them to average their gains on their winning trades over a period of months. Then he wants to see the MAXIMUM loss, not the average one, be no more than the average gain on their winning plays. For example, if you were to find that over a period of six months or so, your winning trades averaged a gain of $750.00, Sheridan wants you to set your stops on each play so that you can lose no more than $750.00 at the most, and preferably less.

Consider diversifying so that you're more like the house flippers from the early 2000's, flipping in a climbing market, than like those who are attempting to flip in a declining one. You can do that by diversifying the types of options plays you enter. Some of the time, and maybe even most of the time, employ some income-producing strategies that let you benefit from the wasting of time premium. Some of those strategies include combination plays such as credit spreads, condors, butterflies, calendars, among others. Paper trade them. Get a feel for how and when they can go wrong before you invest a penny in them, and then devise a sound plan for when and where you'll take losses and gains. Don't over-use margin and don't put more money at risk than you can afford to lose.

I am not counseling you to jump right into complicated options plays. As I write, I am myself paper trading a number of strategies that I want to try as well as paper trading some familiar ones that are set up on underlyings that I haven't traded frequently. I always do this with new strategies, and I always will. I advise you to do the same before you click on an order. The market will be waiting when you're ready, when you understand what you're risking.

Mull this information over a bit. Turn on the TV and watch a few of those house-flipping shows. Think about the flippers who got caught flipping in a declining market. Then go to your trading journal and write out a plan. Boot up your computer and watch a webinar or two on different options strategies or read about them on our site or one of the sister sites that focus on specific strategies. Set up your spreadsheet and track some plays for a few months. Trade small until you're sure of what you're risking and, most importantly, until you're trustworthy about keeping those losses small.

A place exists in your trading plan for speculative plays. That's what going long calls and puts is: speculative. We should all include speculative plays as a small portion of our portfolio of plays. If you don't diversify, however, you're flipping in a declining market, and you know what that means for all but the most experience or luckiest among you.

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.


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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