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Daily Newsletter, Sunday, 07/29/2007

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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

Bears Back In Force

This was an ugly week and the bears ruled from start to finish. The last four days saw record volume and it was heavily weighted to the downside. The say bull market corrections are short, sharp and scary and last week definitely fit that description. The same market moving factors remain and none had improved by Friday's close. The housing sector is sinking faster than ever and the LBO party appears to have come to a sudden halt when the liquidity punchbowl ran dry. Buybacks were the only positive force and TrimTabs said 29 were announced on Thursday. That is the most on any single day since 9/11. Companies are taking advantage of the decline to buy their stock back cheaper and it is also common for major companies to announce buybacks in a freefall market in an attempt to stop the damage to their own stock.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday's economic reports were headlined by a stronger than expected GDP for the second quarter. The GDP showed +3.38% growth in Q2 and much stronger than the +0.6% growth in Q1. This should have been market friendly but the post GDP bounce was short lived. The weak housing market knocked -0.5% off the headline number and weaker growth in consumer spending also produced a drag but not enough to keep the headline number from posting a big gain. Residential investment fell -9.3% but that is only half the rate of decline in Q1. Core inflation rose only 1.4% annualized and the lowest since Q2-2003. Corporate profits remained high and the excess inventory problem from prior quarters has passed. This report will be neutral for the Fed when they meet on Aug-7th. It was not strong enough to pressure them to raise rates but it was definitely strong enough to prevent them from cutting rates to help the housing sector.

The other report, which went unnoticed behind the market volatility, was Consumer Sentiment at 90.4. This was a drop of -2 points below the initially reported 92.4. Higher gasoline prices and the continued decline in housing prices were the major depressants. Both present conditions and future expectations saw gains despite the growing negativity in the economic arena.

Next week is a monster week for economics with a packed schedule of important releases. Monday the National Association of Purchasing Management - New York (NAPM-NY) will provide a business update for the New York area. It is probably the least important report of the week and the only report scheduled for Monday. That leaves the market free to concentrate on the leftover negativity from last week. On Tuesday there is a full schedule headed by the Employment Cost Index and the Chicago Purchasing Manager Index (PMI). Both of these reports are headliners with indications for wage inflation and economic conditions.

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On Wednesday the Institute for Supply Management (ISM) Index will give us the national look at economic conditions. The index has rebounded sharply from the January low of 49.3, just under 50 and indicating economic contraction, to 56.0 in June and the highest level since early 2006. The expectations for July are for a flat report with no change from June. New orders and order backlogs were weak in June and economists expect this to carry over into July.

Thursday has Factory Orders and expectations are for a slight -0.5% decline. This would extend the weakness seen in June that saw durable goods fall -2.4%. Weakness in consumer buying is pressuring those durable items. That weakness is related to the weakness in the housing sector. The dramatic slowdown in housing means fewer dishwashers, water heaters and other durable household goods are purchased. How much the continued housing decline has impacted this report will be a matter of concern for analysts.

The biggest report for the week will be the July Employment report next Friday. Officially the estimate for new jobs is flat with last month with 135,000 new jobs created. The normal whisper number chatter in the market has been strangely quiet this time around. We have been seeing a strong pattern of upward revisions but even that speculation has been silent. This suggests there is a fear of a dramatic decline in employment but nobody wants to be the scapegoat that goes public first and attracts all the criticism. A solid drop in new job creation would be about the only thing that would push the Fed to cut rates next week.

Economic Calendar

Nearly 400 of the S&P-500 have already reported earnings with another 99 scheduled for next week along with four Dow components. So far earnings growth for the S&P has been just over +5.7% and higher than the official 4.1% estimates we were seeing just before the earnings cycle started. There have been some high profile misses and some large upside surprises. Other than some amazing gains on the individual stocks beating estimates the impact of the earnings cycle has been negative. Exxon was the biggest negative influence last week when they missed estimates and fell nearly -10% over the following two days to close at $85.60 on Friday. Exxon posted horrible earnings of ONLY $10.26 billion for the quarter and well below the $10.36 billion in the comparison quarter. Of course I am kidding about the giant earnings miss, still the 4th largest quarterly profit ever for a U.S. company, but the way the stock was pummeled you would have thought they had missed it by 50%. Their revenue of $97.6 billion for the quarter beat estimates but nobody noticed. Analysts criticized them for falling production but Exxon has committed to spending $20 billion a year for the next three years on 20 new projects to increase production. It was not that Exxon's earnings were bad it was the market that was bad and by failing to surprise to the upside Exxon shareholders paid the price. That same earnings story was repeated dozens of times throughout the week with the same result.

Next week the big names on the schedule include Kraft, Procter Gamble, Eastman Kodak and Mastercard along with some leading energy stocks including VLO, MRO and EOG. Add in a few banks, drugs, chips and techs and there is something for everyone. I don't expect everyone to be paying attention given the market hysteria but for those traders focused on earnings there are around 1,033 companies reporting next week.

Earnings Schedule

This was a major week for the markets and the bears were the clear winners. The sell off knocked -585 points off the Dow, -125 from the Nasdaq and -75 from the S&P. The broader indexes saw even larger losses. The NYSE composite lost -564 points with the Wilshire 5000 lost a whopping -795 points. The biggest loser of the major indexes was the Russell-2000 with -58 points and that equates to -7.1% for the week. These losses produced some serious indigestion for traders and conditions were still worsening at Friday's close.

The market internals for the week set volume records that may stand for quite a while. Tuesday's volume was a record, followed by another record on Wednesday and then a massive +3 billion share bump for yet another record on Thursday. Think about that! Three billion shares more than the prior record just a day earlier. Unfortunately the increase in volume was entirely to the downside with Thursday's declining volume more than 10 times the advancing volume. While Thursday's volume imbalance was off the charts the declining volume was well ahead all week. If you add the days together as I have done in the table below there were more than 33 billion shares of down volume for the week. This compares to an average week of about 10 billion. Friday was also a record volume day coming in second on the all time list.

Market Internals Table

Obviously there are two key questions. What caused it and when will it be over? The cause of the sudden decline was exactly what I warned about last week. It was the perceived (real or imagined) evaporation of liquidity in both the public and private markets. The subprime meltdown has turned into a meltup and now prime loans are beginning to default in large numbers according to Countrywide Financial (CFC). Because of this there were several reports of "no bids" for mortgage debt of any type. If the housing problem has gotten so bad that even prime loans are defaulting and about to add to the foreclosure problem and further depressing prices than banks do not want to own the mortgages at any price. Reportedly mortgage portfolios and structured loan products are flooding the secondary market as banks already holding the paper try to offload the problem to somebody else. Over the last decade creative bankers derived a way to turn subprime debt into AAA credits by creatively packaging the loans into heavily leveraged products. Ratings agencies S&P and Moody's blessed these products with an investment grade rating and everybody profited. None of these products had ever defaulted so the investment history was 100% golden.

When the housing boom went bust and these products started imploding it became a game of hot potato with quick thinking banks swapping paper as fast as they could unload it to buyers less educated or more risk aware then themselves. As the situation worsened and lenders started declaring bankruptcy, over 60 at last count, nobody wanted to be caught holding the paper when the music stopped. Unfortunately bids dried up and the paper stopped moving. Everyone from Bernanke and Paulson down to the lowest civil servant in the administration claims the damage is contained and it will not spread any further. In reality it has already spread in the form of a credit crunch on American consumers. There are many stories making the rounds about banks turning away borrowers or asking astronomical rates making loans unaffordable. Those shopping for loans are giving up and home sales have slowed to near zero. According to one survey over the last quarter new household creation has plunged by more than 70%. That means new first time buyers are being locked out of the market by factors beyond their control. Prime buyers who are lucky enough to get loans can't move because nobody can finance the house they are selling. Home prices are falling faster than any time since the great depression. Bear Stearns added fuel to the flames on Thursday when they reported they seized the assets of one of their troubled hedge funds when they could not meet their margin calls. Bear just loaned the firm $1.5 billion a couple weeks ago and the fund had already fallen further into default. Bear said it would put the assets on their books and hold them until they could be repackaged and resold after a period of calm de-leveraging. I thought they de-leveraged the fund a couple weeks ago with that $1.5B investment. Evidently that double-edged sword called leverage is still coming back to haunt them. This kind of news just makes it harder for the rest of the sector to conduct business as usual.

That may sound like it is just a mortgage problem. Unfortunately it may have started out as a mortgage problem but it has contaminated the corporate credit market. Lenders finding out that their investment grade paper is no longer investment grade and in many cases there are no takeout bids are finding themselves suddenly a lot more cautious in what paper they are willing to buy. It is though they are relating the subprime credit problem in mortgages to what could be considered subprime corporate paper. While Blackstone, KKR and Fortress may not be considered subprime credits the deals they structure do contain risk. Many times a lot of risk for the buyers of the debt generated in these leveraged buyouts. Buyers have pulled back from the marketplace until the smoke clears. They do not want to be left with "hung paper" in banker terminology. That means the money they loaned as a bridge loan to get the deal closed can't be sold off to somebody else leaving the bridge loan to mature on the books of the originating bank. Typically a bank like Citigroup would provide a loan commitment to the deal originator like Blackstone. Citigroup would then shop the deal and sell it off to another bank that did not have the deal generating capacity of Citigroup but had money to loan. Citigroup would take a fee for placing the debt. Those second party debt buyers have gone into seclusion just as subprime mortgage buyers. The major banks are finding it very hard to place the deal debt and many deals are starting to crumble around the edges. In an effort to calm nerves on Friday Citigroup said their total exposure to hung deals was less than 5% of revenue. That gave them about a 30 min reprieve from the selling before moving down again. $12 billion of the Chrysler deal failed to find a home and the deal had to be restructured with Citigroup agreeing to hold the debt until later in the year when they hope to place it once the credit crunch eases. There are reportedly more than 30 deals that have already been postponed and we are hearing about more every day. Cadbury Schwepp (CSD) announced on Friday that they were postponing a sale of their U.S. beverage unit due to unfavorable financing conditions. The rumors on the floor late Friday suggested there were several other deals on the verge of collapse. Bloomberg reported on Friday that $32 billion in debt sales were cancelled or restructured last week. According to various sources there are between $325 billion and $440 billion of deals in the pipeline to be funded. With buyers closing the door on new debt until the smoke clears it could be months before the market returns to normal.

Why is this a big deal? One commentator offered a perfect analogy. If you worked in a gunpowder factory and suddenly smelled smoke would you keep working? I seriously doubt it. You and everybody around you would run for the hills as fast as possible and you probably would not venture back into the factory until well after the all clear sounded. This is exactly the same scenario in the banking sector. There is smoke everywhere and it is so thick they can't tell fact from fiction. The only solution is to run to the safety of your vault until the smoke clears. Some analysts are saying now they don't expect any major new LBO deals until after Labor Day at the earliest. LBO firms can't get loan commitments and without commitments they can't commit to new deals. Why Labor Day is the magic date on the calendar is unclear. What the market needs is to see some major deals get funded like the Chrysler deal on its scheduled August 3rd closing date. Seeing deals getting done will relieve tensions in the sector. Seeing more deals blow up will increase the anxiety and lengthen the time needed for the sector to cool.

Another problem is the unwinding of the Yen carry trade that Linda described earlier last week. Hedge funds have been borrowing Yen at interest rates next to zero and using the proceeds to buy higher performing equities and things like mortgage loans and LBO debt. Now that these debt instruments are coming unwound, and many without a bid, those hedge funds are scrambling to sell other assets to cover the Yen loans. There are other currencies involved as well but the Yen is the predominate one due to its low interest rate. If you can't sell mortgage debt and you can't sell deal debt you are stuck selling other assets to raise cash and that is where equities enter the picture.

Borrowing Yen to invest in the stock market was the greatest free lunch ever devised. With base rates of .25% to .50% over the last decade Japan has been the banker of choice for the 9,000 or so hedge funds needing deep pockets. An impending rate hike in August might take that base rate to a whopping 0.75%. You would think that would not matter much in the greater scheme of things. However as I have been reporting the value of the dollar has been dropping almost daily for months AND these same hedge funds were able to leverage those loans to 10-20 times their actual value. That is ok when you are buying dollars with Yen for investment purposes but when you need to switch back to Yen to cover your highly leveraged loans it now takes a lot more dollars to buy the same amount of yen. The dollar has declined in value by roughly 14% since Nov-2005 and 4% since mid June and has been in virtual free fall. That -4% drop over the last month is like an additional 4% interest surcharge on your loan. If you had the loan since Nov-2005 that is an additional 14% surcharge to payoff your loan. For many hedge funds the pain threshold was broken with that last 4% drop since June 18th. As long as the stock market was climbing they could do the daily math and hold on. Once the market topped out and the dollar continued to fall the house of cards began to collapse. Since they could not cash out their various CDO, MBS and LBO debt they had to turn to the stock market to raise cash. The Bank of International Settlements reported in March that more than $370 trillion was outstanding in over-the-counter derivatives with much of that fed from the Yen carry trade. There are more than $262 trillion in interest-rate derivatives and $38 trillion in currency derivatives. Others believe this is just a tip of the iceberg and Ron Insana reported on Friday that the total derivatives were probably more than $750 trillion with most of it in unregulated OTC form. How much of that is ultimately based on some form of Yen carry is unknown. Just 1% would be earthshaking if it needed to be unraveled quickly.

The subprime contagion, the credit crunch and the unraveling of the Yen carry trade were not the only reasons the stock market imploded but they definitely hastened the decline. For the last two weeks I have reported that short interest and margin loans have been at record levels. Well you can now make that three weeks because those vehicles hit new high levels again last Tuesday. The shorts were finally rewarded at the expense of those leveraged to the hilt with margin loans. Given the strong dump in the markets 15 minutes before the close and in the futures for 15 min after the close, Monday is going to be another bad day for those still on margin. On Thursday alone the stocks in the Dow lost more than $105 billion in market cap. I can't even imagine the market cap loss in the S&P or Nasdaq.

The massive selling knocked the S&P back to 1460 for a weekly drop of -4.9%. That is the biggest weekly drop since September 2002. It was a mini correction in just one week. If you go back and study the charts you will find a -5% correction on average about twice a year. Remember bull market corrections are short, sharp and scary. It is just our luck to have two such memorable events in the last five months. In February the S&P plunged -88 points in seven days compared to the -96 points (-6.1%) lost since the July 19th high.

In theory the correction or at least the scary part should be over. The first few days are the hardest with the last few days a painful hunt for a bottom and then a retest of that bottom before moving higher. Remember I said "in theory." The calendar may be working against us next week. The decline in the various debt indexes has been brutal and many debt holders will have to "mark to market" as opposed to "mark to model" when valuing their portfolios for month end on Tuesday. Many have covenant restrictions in their working capital loans that require a certain debt to equity ratio and those ratios may be in danger given the violent repricing this debt has undergone. Some of these debt instruments are now being quoted at 30 cents on the dollar. How do you raise your debt to equity ratio? By selling assets to raise cash and reducing your leverage. Those assets are equities and I believe the various Friday sell programs including the massive sell program at the close was designed to raise cash before month end. Since the month end is Tuesday stocks had to be sold on Friday to clear before month end.

I said the calendar may be working against us but in reality the worst may be over except for the margin selling on Monday. We should open down on Monday due to the very heavy selling in the futures after the close. The S&P futures lost almost -10 points after the cash market close. That selling was also evident in the Nasdaq and Russell futures. This suggests Monday should open lower and that will cause even more margin selling. Once that dump is over I think we may be poised for a rebound but I doubt it will be straight up. I think damage has been done to investor sentiment and this is not normally the spot on the calendar known for bullish events. August is not normally kind to investors but maybe we have already had our bout of summer selling and it will be more of bottom testing rather than further implosions. It really depends on the hedge funds, credit news, month end, the Yen carry trade, earnings, economics and fear of the FOMC meeting the flowing week. Those are plenty of reasons for the market to remain indecisive.

Dow Chart - 180 min

On Friday the Dow bounced at the open into positive territory at 13517, fell over -210 points to 13303, rebounded +134 points to 13437 and then collapsed -170 points in the last hour to close at 13265 and a loss of -208 for the day. To say volatility had returned would be an extreme understatement. The VIX closed at a new 52-week high and well above levels seen in the March sell off. The closing level could not have been any closer to critical support if we had scripted it in advance. Twice in June we tested the 13250-260 level and both times it held. That makes this critical support that must hold again or we really will see a new round of computer generated sell programs. A rebound from here would be the perfect mini-correction event. A failure here would suggest a full -10% correction that would target 12600 but probably fail with support holding at the 200-day average at 12750. I don't want to test either of those levels but it would be a great buying opportunity.

NDX Chart - Daily

Nasdaq Composite - 180 min

The Nasdaq is in much better shape if you use the NDX as your guide. The NDX has only retreated to its uptrend support and has yet to break any serious technical level. The Nasdaq composite chart is a little more congested with the potential for a drop to 2525 from its current 2564 level. If the NDX holds the Compx will never make that trip but this is the current risk. The Semiconductor index gave up -6.4% for the week despite strong earnings from several chip companies. It has reached initial support at 495-500 and should resist further declines.

The chart of the S&P-500 is nearly as ugly as the Russell. The S&P collapsed below the 30, 50 and 100-day averages and is nearing the 200-day at 1448. Friday's halt at 1458 is almost exactly on critical support from February's high at 1460. There is no room for error here and the S&P needs to hold its closing level on Monday or the sell programs will kick in again. A move below the 200-day at 1448 would trigger major sell signals in many fund families. The 200-day average on the S&P is probably the most followed buy/sell indicator. The S&P signaled a buy when it crossed above the 200-day at 1271 on August 15th 2006. That resulted in a +22% gain to the market recent highs at 1555.

SPX Chart - 180 Min

The Russell-2000 is by far the scariest chart. It is also the one that should show the greatest decline if this is a normal August sell off. Small caps are normally sold into the summer doldrums and then bought again in October for the year-end rally. The Russell struggled at 855 since June 1st with repeated failures to break that level. The last test was July 17th and with that failure the funds threw in the towel and pulled the plug on small caps. That was followed by an eight-day drop of -9% to close on Friday at 778. All the gains for the year have been erased and the Russell is in danger of an even greater drop. It is already well below its 200-day average at 804. There are three levels of weak support at 775, 760 and 750 before facing another free fall event to 670. I don't expect the 750-760 support levels to be broken but it closed at a new 4-month low on Friday on very strong volume. It was not a pretty picture and definitely not one that has me rushing to buy the dip.

Russell 2000 Chart - Daily

Russell-2000 Chart - 180 min

I heard so many analyst/traders calling for a continued drop next week that I almost believe it is a contrarian signal. I would like to think any dip on Monday morning would be a buying opportunity but until we see the signs of selling abate we need to watch from the sidelines. The ferocity of the selling last week amazed me. Triple digit moves with no letup and extreme imbalances on the internals. If ever there was a picture of capitulation it was Thursday but then Friday came right back and was slammed even lower. There are forces at work behind the scenes that I attempted to describe above and we have no control over when they will stop. I would spend the weekend planning your buys but wait to pull the trigger until you see the selling diminish. It is better to be late to the party and join it in progress than come early and be put to work cleaning house. If the Dow does break 13250 and S&P 1460 on volume I would jump on for the ride to lower levels. Downside breaks are normally fast and furious as we saw last week. Under 13250/1460 it could be a long drop. Prepare for both directions and trade what the market gives us.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
ATI BHI None
LRCX LZ  
SHLD PCU  

New Calls

Allegheny Tech - ATI - cls: 102.41 change: -3.17 stop: 98.49

Company Description:
Allegheny Technologies Incorporated is one of the largest and most diversified specialty metals producers in the world with revenues of $5.3 billion during the most recent four quarters ending March 31, 2007. ATI has approximately 9,500 full-time employees world-wide who use innovative technologies to offer growing global markets a wide range of specialty metals solutions. (source: company press release or website)

Why We Like It:
We are expecting the markets to continue lower on Monday morning. That should pull ATI right toward support near $100 and its rising 200-dma, which is where the stock should bounce. While many of the technical indicators have turned bearish we're still willing to bet on an oversold bounce. We're suggesting readers use a dip into the $100.50-100.00 range as a new entry point to buy calls. We'll place the stop under the June low. If triggered our target is the $107.50-110.00 range.

Suggested Options:
We are suggesting the September calls. Our trigger to buy calls is at $100.50.

BUY CALL SEP 100 ATI-IT open interest=134 current ask $8.80
BUY CALL SEP 105 ATI-IA open interest=198 current ask $6.40

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 2.0 million

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Lam Research - LRCX - cls: 56.87 chg: -0.16 stop: 54.45

Company Description:
Lam Research Corporation is a major provider of wafer fabrication equipment and services to the world's semiconductor industry. (source: company press release or website)

Why We Like It:
LRCX broke out higher past significant resistance in mid July. The stock has since consolidated sideways in the $56-60 range and held up relatively well considering the sharp sell-off in semiconductors this past week. The stock does look poised to move lower and we expect markets to be weak on Monday. A dip into the $56-55 region would look like a new bullish entry point. We're suggesting readers use $56.10-55.00 as an entry zone to buy calls. We will set our initial stop loss at $54.45. We'll have two targets. Our conservative target is the $59.75-60.00 range. Our aggressive target is the $63.75-65.00 range. The P&F chart points to a $81 target.

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

BUY CALL SEP 55.00 LMQ-IK open interest=2070 current ask $4.80
BUY CALL SEP 60.00 LMQ-IL open interest=1962 current ask $2.40

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/24/07 (confirmed)
Average Daily Volume = 2.9 million

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Sears Holding - SHLD - cls: 136.20 chg: -5.84 stop: 127.49

Company Description:
Sears Holdings Corporation, the publicly traded parent of Kmart and Sears, Roebuck and Co., is the nation's fourth largest broadline retailer with over $50 billion in annual revenues and approximately 3,800 full-line and specialty retail stores in the United States and Canada. (source: company press release or website)

Why We Like It:
SHLD has just been crushed in the last three months with a plunge from $190 to $136. The stock has dropped 38 points in just the last three weeks. Needless to say SHLD is very short-term oversold and way overdue for a bounce. We expect stocks to continue lower on Monday morning but eventually the market should see a rebound after last week's carnage. SHLD has some support near $135 but it has stronger support near $130. We are suggesting that readers buy calls on a dip into the $133.00-130.00 zone, which is where we expect it will bounce. If triggered we'll target a rebound into the $139.50-140.00 range. More aggressive traders could aim higher. Bear in mind that we don't want to hold over the mid August earnings report.

Suggested Options:
We are suggesting the September calls. Our entry zone is the $133-130 range.

BUY CALL SEP 130 KTQ-IY open interest=305 current ask $11.80
BUY CALL SEP 135 KTQ-IX open interest=234 current ask $ 8.70
BUY CALL SEP 140 KTQ-IW open interest=383 current ask $ 6.30

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/16/07 (unconfirmed)
Average Daily Volume = 1.7 million
 

New Puts

Baker Hughes - BHI - cls: 79.43 change: -1.83 stop: 84.15

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:
BHI reported earnings on Friday morning. The results beat estimates by a penny and revenues came in better than expected. Yet the stock sold off anyway. Energy and oil stocks were unable to mount a rally even though crude oil rallied toward record highs. BHI has been acting bearish for days. The stock produced a bearish double-top pattern back in June and early July under resistance at $90.00. This actually turned out to be the second half of a much larger bearish double-top pattern (see weekly chart). The oversold bounce from July 18th struggled several times near $84 and eventually rolled over. Friday's breakdown under $80.00 looks like a new entry point for puts. Our target is the $75.25-74.00 range. The 200-dma near $74 is probably support.

Suggested Options:
We are suggesting the October puts although Septembers would work well.

BUY PUT OCT 85.00 BHI-VQ open interest=1460 current ask $8.20
BUY PUT OCT 80.00 BHI-VP open interest=5478 current ask $5.10
BUY PUT OCT 75.00 BHI-VO open interest=2244 current ask $2.95

Picked on July 29 at $ 79.43
Change since picked: + 0.00
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = 4.6 million

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Lubrizol - LZ - cls: 61.62 change: -2.71 stop: 65.26

Company Description:
With headquarters in Wickliffe, Ohio, The Lubrizol Corporation owns and operates manufacturing facilities in 20 countries, as well as sales and technical offices around the world. Founded in 1928, Lubrizol has approximately 6,800 employees worldwide. Revenues for 2006 were $4.0 billion. (source: company press release or website)

Why We Like It:
Friday morning LZ reported what appeared to be pretty good numbers for its earnings report but investors sold the news anyway. The stock has already been trending down and has broken support near $65.00 and its 50-dma. We believe there is more profit taking ahead. We're suggesting puts and our target is the $57.00-55.00 range. $57.00 is near the top of the April gap and $55.00 is near technical support at its 200-dma. FYI: The $66.03 intraday high on Friday looks like a bad tick.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 65.00 LZ-UM open interest=153 current ask $4.60
BUY PUT SEP 60.00 LZ-UL open interest= 57 current ask $1.60

Picked on July 29 at $ 61.62
Change since picked: + 0.00
Earnings Date 07/27/07 (confirmed)
Average Daily Volume = 563 thousand

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Southern Copper - PCU - cls: 109.04 chg: -3.35 stop: 113.55

Company Description:
Our mining operations are located in Peru and Mexico. We own and operate four open pit mines and three metallurgical complexes that make SCC a fully integrated copper producer with significant byproducts of molybdenum, zinc and precious metals. (source: company press release or website)

Why We Like It:
PCU reported earnings on Thursday night and the results were impressive but investors decided to take some money off the table. We're actually bullish on PCU but we want to wait and watch for a dip near $100 or its rising 50-dma, which is where the stock appears to be headed. We are suggesting put positions now with PCU under $110. Our exit target is the $100.50-100.00 range.

Suggested Options:
We are short-term bearish on PCU and we're suggesting the September puts although August puts might work just as well.

BUY PUT SEP 110 PCU-UB open interest= 661 current ask $8.00
BUY PUT SEP 105 PCU-UA open interest= 543 current ask $5.60
BUY PUT SEP 100 PCU-UT open interest=1191 current ask $3.80

Picked on July 29 at $109.04
Change since picked: + 0.00
Earnings Date 08/02/07 (unconfirmed)
Average Daily Volume = 2.0 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Celgene - CELG - cls: 61.13 change: +0.32 stop: 57.49

CELG continued to show relative strength on Friday. The stock broke through resistance at the $61.00 level and closed up on above average volume, which is normally a bullish signal. Our suggested trigger to buy calls was at $61.25 so the play is now active. Our target is the $66.50-67.00 range. As predicted the move over $61.00 has produced a new Point & figure chart buy signal with a $73 target. While we remain bullish on CELG please take into account our expectation for the market to spike lower on Monday morning. If you are looking for a new entry point be patient. CELG might dip back toward $60 or even $59 on Monday before bouncing back.

Suggested Options:
We are suggesting the September calls. Our suggested trigger to open positions is at $61.25.

BUY CALL SEP 60.00 LQH-IL open interest=2748 current ask $4.20
BUY CALL SEP 65.00 LQH-IM open interest=2484 current ask $1.80

Picked on July 27 at $ 61.25
Change since picked: - 0.12
Earnings Date 07/26/07 (confirmed)
Average Daily Volume = 4.1 million

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Diamond Offshore - DO - cls: 103.27 chg: -3.09 stop: 99.75*new*

Friday proved to be another ugly day for oil and energy stocks even though crude oil rose toward record highs. Friday's session in DO was definitely bearish with a failed rally and a 2.9% drop. The five-month trend is still bullish but we're adjusting our plan for future entry points. We expect the market to be down on Monday morning. DO also looks poised to drop on Monday. We would wait and watch for a dip into the $101.00-100.00 range and use the dip as a new entry point to buy calls. DO should find support at the $100.00 mark and its rising 50-dma near $100. We're also going to peel back our stop loss to $99.75 just in case DO cracks the $100 level. We're suggesting two targets. Our conservative target is the $114.00-115.00 range. Our more aggressive target is the $119.00-120.00 range. The P&F chart points to a $137 target. FYI: We are expecting this to be a two or three week play since we plan to exit oil-related stocks when crude eventually corrects.

Suggested Options:
We're suggesting the September calls but wait for the dip toward $100 or better yet wait for the bounce from $100 to begin.

Picked on July 26 at $106.36
Change since picked: - 3.09
Earnings Date 07/26/07 (confirmed)
Average Daily Volume = 2.6 million

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Goldman Sachs - GS - cls: 192.65 change: -2.47 stop: 188.49 *new*

Friday was another rough day for the financials and the brokers were no exception. GS failed to rebound after Thursday's big drop. This definitely throws some cold water on our buy the dip strategy. Fortunately, the $190 level held up as support but we remain concerned. At the moment we're expecting the market to spike down on Monday morning before bouncing. Given the relative weakness in GS and the brokers this stock might hit a new relative low and out stop loss before trying to rebound again. We want to repeat that this is an aggressive, higher-risk play. The brokers have been primary targets for selling due to the sub-prime fears and now the merger-slowing credit crunch. We'd wait and watch for a bounce near $190 before considering new positions. We're going to widen our stop by half a point to give GS a little bit more room. The 200-dma, near $208, should now be overhead resistance. Our target is the $205-208 range. FYI: The P&F chart is incredibly bearish with a $144 target.

Suggested Options:
If GS bounces from $190 we'd suggest the August calls. Please note that August strikes expire in three weeks.

Picked on July 26 at $195.12
Change since picked: - 2.47
Earnings Date 09/12/07 (unconfirmed)
Average Daily Volume = 6.9 million

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PACCAR - PCAR - cls: 81.16 change: -1.71 stop: 79.45 *new*

It's the same story with PCAR. The stock was incredibly short-term oversold and Thursday's intraday bounce from $80 looked like a new entry point to capture a short-term bounce. Unfortunately, the markets continued to sink and PCAR lost another 2% and on big volume. The stock looks headed toward $80 and maybe a new relative low. We expect Monday morning to be weak so wait for PCAR to show signs of a rebound before considering new positions. We're inching our stop backward to $79.45 to give PCAR just a little more room to move. Our target is the $89.50-90.00 range. Yes, given the volatility, we would qualify this as a higher-risk, more aggressive play. FYI: The P&F chart is very bearish and points to a $61 target.

Suggested Options:
This is a short-term play so we're suggesting the August calls, which expire in three weeks. September options would also work well.

Picked on July 26 at $ 82.87
Change since picked: - 1.71
Earnings Date 07/24/07 (confirmed)
Average Daily Volume = 1.8 million

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Penn National Gaming - PENN - cls: 57.89 chg: +1.10 stop: n/a

Shares of PENN displayed relative strength on Friday with a 1.9% gain. The stock gapped higher after one analyst firm upgraded the stock. The analyst believes that the all-cash $6.1 billion deal to buy PENN, which would value the stock at $67/share, will get done. Traders may want to reconsider buying calls on PENN. Initially we were suggesting calls because of all the speculation that another bidder would show up with a higher offer. If we can look past the worries over M&A credit and deals falling apart the current buyout plan should push shares of PENN to another $9 gain. The question is how long will it take? We are NOT suggesting new positions at this time but readers have some food for thought if they want to speculate. PENN's original 45-day window to solicit a higher bid should expire this coming week.

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

Picked on June 17 at $ 62.12
Change since picked: - 4.23
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume = 1.0 million

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Terex - TEX - cls: 83.15 change: -0.72 stop: 79.49

We are making some adjustments to the TEX play. One change is the suggested entry point. We expect the markets to be weak on Monday morning. Therefore we'd look for a new bullish entry point in TEX on a dip into the $81.00-80.00 zone. Shares should find support near $80 bolstered by its rising 100-dma. The $90.00 looks like overhead resistance. Thus we are using two targets. Our first target is the $89.50-90.00 range. Our second target is the $94.00-95.00 range.

Suggested Options:
If TEX provides a new entry point on Monday we would suggest the September calls.

Picked on July 26 at $ 83.87
Change since picked: - 0.72
Earnings Date 07/25/07 (confirmed)
Average Daily Volume = 1.1 million
 

Put Updates

Harley Davidson - HOG - cls: 56.40 change: -0.90 stop: 60.26

HOG is extending its losses with a new relative low on Friday. The stock closed near its low for the session and look poised to continue lower on Monday. More conservative traders might want to consider tightening their stop loss toward the simple 10-dma. We're not suggesting new positions at this time. Our target is the $52.50-50.00 range. The P&F chart already points to $42.00.

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

Picked on July 23 at $ 57.75
Change since picked: - 1.35
Earnings Date 07/27/07 (unconfirmed)
Average Daily Volume = million

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Ryanair Holdings - RYAAY - cls: 36.21 change: -0.83 stop: 40.15

Airlines stocks continued to breakdown and RYAAY is beginning to catch up to them. Shares of RYAAY lost 2.19% on Friday and broke down under support near $37.50. Shares look poised to dip toward $35.00 on Monday so be prepared to exit. Our target is the $35.05-34.00 range, which is near the November 2006 gap. The P&F chart is already bearish and its target has moved from $26 to $22 this past week.

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

Picked on July 22 at $ 38.13
Change since picked: - 0.32
Earnings Date 06/05/07 (confirmed)
Average Daily Volume = 812 thousand
 

Strangle Updates

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

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Advanced Micro - AMD - cls: 13.87 chg: -0.86 stop: n/a

Semiconductor stocks plunged again on Friday. Shares of AMD lost 5.8% and broke down under a couple more levels of support. Volume was very high on AMD's decline, which is usually bearish. We're not suggesting new strangle plays at this time. The August options we suggested were the August $16 call (AMD-HQ) and the August $15 put (AMD-TC). Our estimated cost was $1.18. We want to sell if either option hits $1.85 or higher. Aggressive traders could aim for $2.40. FYI: Currently the August $15 put is trading at $1.34bid/$1.41ask.

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

Picked on July 15 at $ 15.43
Change since picked: - 0.70
Earnings Date 07/19/07 (confirmed)
Average Daily Volume = 26.1 million

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DaimlerChrysler - DCX - cls: 88.57 chg: -0.34 stop: n/a

DCX continues to look vulnerable and poised for more weakness. We are not suggesting new strangles on DCX at this time. The options in our suggested strangle were the August $95 calls (DCX-HS) and the August $85 puts (DCX-TQ). Our estimated cost was $3.70. We want to sell if either option rises to $6.45.

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

Picked on July 22 at $ 89.75
Change since picked: - 1.18
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume = 1.3 million

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Lexmark - LXK - cls: 41.79 change: -0.42 stop: n/a

LXK lost another 1% and looks poised to drop toward $40.00 soon. We are not suggesting new strangle positions in LXK at this time. The options in our strangle were the August $50 calls (LXK-HJ) and the August $40 puts (LXK-TU). Our estimated cost was $0.75. We want to sell if either option rises to $1.50.

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

Picked on July 22 at $ 45.43
Change since picked: - 3.64
Earnings Date 07/24/07 (confirmed)
Average Daily Volume = 1.9 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

Intel - INTC - cls: 23.54 change: -0.46 stop: n/a

Target achieved. Semiconductors continued to fall on Friday and INTC broke down under technical support at the simple 50-dma. Contributing to INTC's weakness may have been news that the European Union was filing an antitrust case against the company. We were suggesting that traders exit if either option in our strangle hit $1.65 or higher. The August $25 put (INQ-TE) is trading at $1.66bid/1.70ask. INTC looks poised to move lower on Monday morning. Aggressive, more nimble traders may want to try and squeeze another 25-30 cents out of that option before exiting. FYI: Our estimated cost was $0.96.

Picked on July 15 at $ 25.97
Change since picked: - 2.43
Earnings Date 07/17/07 (confirmed)
Average Daily Volume = 60.3 million

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Manpower - MAN - close: 79.81 chg: -6.14 stop: n/a

Target exceeded. MAN collapsed on Friday with a 7% decline on huge volume. This move sent MAN past support near $85 and its 100-dma and straight toward potential support near $80 and its 200-dma. The options in our strangle were the August $100 call (MAN-HT) and the August $90 put (MAN-TR). Our estimated cost was $3.35. We want to sell if either option hits $5.75 or higher. On Friday the August $90 put (MAN-TR) closed at $9.60bid/$10.50ask. We're going to use the suggested $5.75 exit price.

Picked on July 15 at $ 94.60
Change since picked: - 8.65
Earnings Date 07/19/07 (confirmed)
Average Daily Volume = 636 thousand
 


Trader's Corner

Controversy When Studying Breadth and Other Measurements

How can it be controversial to study breadth measurements such as the advance/decline line or the VIX?

Believe me, it can be. A couple of years ago, while still writing for the Market Monitor, the live portion of the OptionInvestor site, I mentioned technical analysis in conjunction with breadth measurements such as the advance/decline line. It appears that some market participants feel passionately that technical analysis of such studies prove useless. Others affirm just as passionately that technical analysis of these measurements or indicators is appropriate and useful.

Long-time subscribers may remember that a Trader's Corner article a couple of years ago addressed this topic, but it's time to tackle the subject again. Let's take a look, and you can make up your own mind about whether charting breadth and other such indicators proves helpful. First, let's take a look at the action of the NYSE early in July.

Annotated 15-Minute Chart of the NYSE:

What was happening with the advance/decline line and the VIX? Did they either confirm or predict what happened?

Annotated 15-Minute Chart of the NYSE Advancers-Decliners Line:

Annotated 15-Minute Chart of the VIX:

I don't know about you, but those charts and others like them that I've studied through the years are enough to convince me that employing technical analysis to study such indicators can prove helpful. As I mentioned in that past article, it doesn't seem like a stretch at all to believe that standard technical analysis tools might be applied to breadth or volatility measures. My belief is backed up at least in part by such greats as Lawrence McMillan, author of OPTIONS AS A STATEGIC INVESTMENT. He mentions in that very book that volatility measures of individual stock scan settle into a trading range.

So, what do we do with this knowledge, if it's true that volatility, breadth and other such measurements can be studied using technical analysis? I often follow such measurements on my favorite technical analysis tool, nested Keltner channels, looking for predictions, confirmations or divergences.

Annotated 15-Minute Chart of the Adv-Dec Line with Keltners:

Annotated 15-Minute Chart of the NYSE:

These are just a few ideas meant to convince you that it might be worthwhile to chart breadth and indicators such as the VIX, and then to employ your favorite technical analysis tools to study them.

Please don't act on the first supposed signal you see. Learn how your favorite breadth or other measure tends to act with regard to the technical analysis tools you prefer before you spend money on a setup. Do at least combine technical analysis tools with such indicators to warn you of a potential divergence or confirm your intended play.
 

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.

DISCLAIMER

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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