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Daily Newsletter, Saturday, 08/25/2007

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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

Bottoms Up?

The Dow rebounded 300 for the week but that does not mean the bottom is behind us. I would love to believe it and some individual stock prices are definitely finding buyers but the volume has been very light. The leaders are definitely stretching their gains but the majority of the pack is still lagging. The Russell 2000, the fund manager sentiment indicator, is very weak and has not been participating in the rebound. Is the bottom in? I believe it is too early to make that determination.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday's economics may have thrown a monkey wrench in the works for a potential Fed rate cut at the September meeting. Neither of Friday's reports were potentially critical reports for the Fed but both were strongly positive and suggest the economy is not as weak as most expected.

The Durable Goods report for July had a headline gain of 5.9% growth in orders compared to estimates for a minimal 1.1% gain. Orders for June were revised up to 1.9% from 1.4%. Shipments also exploded by 3.8% compared to a drop of -1.1% in June. That was the strongest shipping number since early 2004. The gains in orders were the strongest since last September and suggest momentum is building. The numbers were substantially weaker at 3.7% once you remove the high dollar transportation orders but that was still well above estimates. Backorders rose 2.4% and the highest level since last September. The entire report was a strong indicator of underlying economic strength that could give the Fed a reason to not cut rates at the September meeting. However, this was for the July period and the ISM for August will be much more important when it is released on Sept-4th.

The other economic surprise came from the New Home Sales, which rose to 870,000 for July. This compares to estimates for a drop to 825,000 from the June level of 850,000. That 45,000 difference between actual and the estimate and that was a strong surprise. An even bigger surprise was a 3.57% jump in the median home price to $245,668 from the prior months low of $237,208. Sales are still down -10% from year ago levels. Inventory levels fell slightly to a 7.5-month supply. The strength came mostly from the West with support from the South. The Northeast was the weakest region. Months on the market rose to 6.1 months and a high for this building cycle. The higher prices may be deceiving since builders are throwing in every extra they can find to close the deal rather than impact their market by lowering prices. If you sold 250 houses in a subdivision for $125 a foot and then drop prices to $75 a foot to sell the next 250 homes you will have a buyer revolt on your hands. The recent sales at $75 devalue the ones you sold at $125. It also makes it hard to get a higher appraisal once the glut is over and you start raising the price again. Future appraisals will be based on the $75 price not the $125 price. It will take a long time to overcome that price drop. Builders would rather give you anything you can name as a freebie including no payments for a year, decks, pool, landscaping, etc, to entice you to buy at the listed price. Since this was a July report it also captured the last of the summer relocation crowd. August closings should drop since most families want to be moved in well before school starts. I view this as a blip on the screen and expect the new mortgage rules and the change in mortgage availabilities in August to have severely hampered sales.

Last week was a very light week for economics and the market was left to wander on its own driven only by news events. Next week has a heavy economic calendar with several high profile reports. Two Fed surveys, FOMC minutes, NAPM, PMI and Factory Orders will produce plenty of analyst discussions. With only two weeks before the FOMC meeting every report will be weighed against its impact on the Fed rate bias. Currently there is a 100% chance of a rate cut at that meeting based on the Fed funds futures. However, there are a surprising number of analysts now predicting no change in rates. The market has definitely priced in a rate cut and no cut now could be dangerous. With many high profile individuals including the CEO of Countrywide predicting a recession if the Fed does not act fast the analyst community is definitely polarizing. I will wait until next Sunday to provide further rate analysis after the week's heavy economic schedule. Anybody with an opinion today can change it several times before next weekend. Bernanke will speak at the annual Jackson Hole conference next Friday at 10:AM on monetary policy and housing.

Economic Calendar

The various events in the debt market appear to be pointing to an easing of the debt wreck. The Fed's discount rate cut, $2 billion in borrowings from that window and Bank America's $2 billion infusion into Countrywide appear to have had an impact. Corporations sold $23 billion in bonds this week to make it the busiest week since May-2006. The events leading to these sales narrowed the spreads significantly over the prior week and corporations holding off on their planned sales jumped at the chance to collect the money. Elsewhere everything was not as rosy. Over the past two weeks nearly $200 billion in leverage debt sales have been postponed due to no buyers or high rates. Home Depot reported on Friday that it will have to cut the price of its Home Depot Supply unit by -$1.2 billion and guarantee part of the debt in order to obtain financing for the sale to a group of private equity firms. Reportedly three banks were reluctant to fund the debt given the recent credit concerns in the market. Home Depot had already delayed the closing by a week in hopes of finding a resolution. The next big deal in the pipeline is the $28 billion acquisition of First Data (FDC) by KKR with the debt expected to close on Sept-4th. This is considered to be a "covenant light" deal and those will have a much harder time getting funded. Other deals rumored to be in trouble include the $8.2 billion management buyout of Affiliated Computer Systems (ACS) for $59.25 per share. The stock is now trading at $50 and well below the deal price. That suggests there is trouble brewing. Other troubled deals include $5.3 billion for Ceridian (CEN) for $36 with the stock now at $32. Also, United Rentals $6.6 billion sale for $34.50 with the stock at $30.50 today. The $44 billion buyout of TXU by KKR is also thought to be at risk along with the $8.2 billion for Tribune (TRB) and $25 billion for Sallie Mae (SLM). The credit default swaps, insurance on the deal debt, have risen dramatically on SLM to 287 basis points or $2.87 million per year to insure $100 million of debt against a default. This is about twice what the broader market gets for insurance suggesting there is a lot of implied risk in the deal. That is still chicken feed compared to the $8.75 million per year required to insure $100 million of Sam Zell's debt on the Tribune acquisition. This swap is rising fast and signaling the deal may not close despite Zell's claim on Aug-14th that he is committed to the transaction. Citigroup said the major brokers had increasing exposure to unsold LBO debt. According to Citigroup, JP Morgan had $40.76 billion in unsold debt, Goldman $31.88B, Deutsche Bank $27.27B and Credit Suisse $27.16B.

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Countrywide appears to be out of trouble but not yet out of the woods. The CEO was interviewed on CNBC on Thursday and he said all of the right things while denying Bank America was going to buy the company. He admitted to selling 40 million shares for $142 million over the last year saying, "I am getting old and I need to diversify." With BAC now a 16% shareholder and AllianceBerstein 11% and Fidelity, T.Rowe Price, Legg Mason and Vangard other major holders it appears they are in good hands. AllianceBerstein bought 37 million shares on July-31st as the crisis began, bringing their holdings to 64 million shares. The Countrywide CEO said a lot of people volunteered to help and BAC was not the only offer of money. Angelo Mozilo already had a working arrangement with BAC since they loaned him the $75,000 to start CFC in 1969. The conversion price for the $2 billion BAC investment is $18 so the $18-$20 level should be support as the mortgage mess continues to unwind.

After the bell on Friday the Fed clarified that it would accept investment grade asset-backed commercial paper as collateral at the discount window. The Fed also said it would accept subprime mortgages as long as they are performing loans and not in default. They also said they would accept collateralized debt obligations (CDO) containing subprime mortgages. This would be a "get out of trouble free" card if those holding the subprime debt were all banks. Unfortunately most of those financial institutions holding debt that can't be sold are not banks and are not eligible for the discount window. There are plenty of banks that are eligible so the window could be very busy next week. I view this as very market positive and a sign the worst of the debt wreck is probably behind us.

The rescue did not come fast enough for Lehman Brothers. On Wednesday it announced it was shutting down its subprime mortgage unit BNC Mortgage and laying off 1,200 people. Lehman will take a $50 million charge for the closure. Relatively speaking that is chicken feed. When Capital One closed its Greenpoint unit last week they took a charge of more than $800 million. More than 50,000 jobs have been cut in the mortgage arena in the last year with 25,000 of those in August alone. The table below outlines only those big name companies and there were dozens of smaller firms that closed completely.

Job Cuts in Mortgage Sector

There are still some big problems in the pipeline. Merrill is on credit watch for its exposure to the subprime mess. Merrill bought subprime lender First Franklin late in 2006 and they are expected to confess some problems with their next update. Merrill may have to take a hit on more than $1 billion in subprime loans held by First Franklin. Merrill also has $1 billion in good will on its books from the First Franklin acquisition and analysts expect that to be written off as well. Bear Stearns bought subprime lender ECC Capital in a deal that closed in February. I bet they wish they could do that over again. Morgan Stanley bought Saxon Capital for more than $700 million in December. Subprime loans were hot because of the higher interest rates and fat fees. These loans have now rotted the portfolios of the parent lenders. On Friday S&P slashed the ratings on seven classes of Bear Stearns Asset Backed Securities, citing increasing delinquencies and erosion of credit quality. When the credit ratings are cut it can sometimes force a sale of the securities by the current holders. The vast majority of pension funds cannot hold other than investment grade paper. Once the grade is cut the paper must be flushed. This results in massive margin calls on whoever initially sold the paper to them. The debt wreck may be easing but it is far from over. Earnings from BSC and LEH are Sept-13th and MS on Sept-19th.

The main earnings cycle may be over but there are still a few stragglers. Dell will report on Thursday and has already warned they will miss earnings due to a series of charges for their accounting scandal. They will also have to give an update on the SEC probe and several other legal problems. Meanwhile Hewlett-Packard is beating them like a rented mule in the PC sector. Dell said last week it was having trouble getting parts because Hewlett-Packard was buying them up. What a difference 5-years makes. Dell used to be the PC king using its just in time component acquisition strategy to keep PCs at the lowest cost possible. Now HPQ is buying up the parts and squeezing Dell from both ends.

The rebound for the week came from techs, networkers, energy, materials and metals. The metals and miners rebounded 12% led by BHP Billiton (BHP), Rio Tinto (RTP), Southern Copper (PCU) and Freeport McMoran (FCX). Steel and aluminum stocks rebounded strongly but are still down -20% to -24% from their recent highs. Still plenty of room for the sectors to move higher on the strong global economy.

Energy stocks roared back to life after the post hurricane dip. Dean had not even made it into Mexico before oil dropped to $68.64 on excess supply fears. Inventory levels rose 1.9 million barrels for the first gain in six weeks. That should be bearish but prices rose instead. Feeding the price was a major fire at the Chevron refinery in Pascagoula Mississippi. CVX declared force majeure on its purchase of crude to feed the refinery. Unable to actually refine crude, stockpiles at the refinery quickly became filled to maximum. The 325,000 bpd refinery is only running at 50% and could be offline for many weeks from fire damage. Shell said it would return its Deer Park refinery in Texas to operation this weekend after closing it ahead of hurricane Dean. These refinery outages provided support for gasoline prices but both outages should have added to crude inventories backing up in the system while they are shutdown. This should produce another build in inventory levels for next week, bearish for prices, but low and behold crude was still gaining right into Friday's close. Crude closed at just over $71 for a gain of $1.26. This was powered by short covering after the stronger than expected economic reports suggested growth had not slowed and demand would continue to be robust. I believe it is just a blip in a downward trend while we wait for the OPEC meeting and the peak of hurricane season two weeks from now. OPEC will meet in Vienna on Sept 11th to decide if they need to raise output.

Crude Oil Chart - Daily

There are cracks beginning to form in the coalition's output restrictions given the high price of crude and the special deal given Angola when they joined OPEC a year ago. When they joined OPEC said they were exempt from the quota system until they completed some planned projects. Angola produces about 1.8 mbpd and once those projects are completed they could produce as much as 3.0 mbpd by 2010. This puts them right up there in the top ranks of OPEC producers and they are now saying unofficially now they will never agree to any production quota. This is not setting well with other OPEC members with Nigeria, Libya and Iran already complaining and lobbying for their own quota relief. Since OPEC cheating is a fact of life you can bet cheating will be increasing soon, especially if OPEC decides not to increase production on the 11th.

The markets, with the exception of the Russell-2000, rallied into Friday's close to cap a decent week after the Fed's discount window move. With the Fed funds futures pointing to three cuts by year-end it appears traders are already pricing in those cuts starting with the meeting on Sept-18th. A 300 point gain by the Dow and 71 on the Nasdaq compared with a miniscule 12 point move on the Russell. Small cap buyers, primarily funds, are nowhere to be found. Those betting on the Fed are doing it with the highly liquid large caps where a quick exit is guaranteed. The various ETFs are booming because they are also liquid and you don't have to go through the brain damage of picking a specific stock. These things make me think investors are not convinced the bottom is behind us but don't want to miss the move just in case the rally continues. September is normally a bad month in the market and that is weighing on market sentiment.

Internals for the week were mixed with very low volume. Friday's volume at 4.6 billion shares across all markets was the lowest volume since the Memorial Day holiday. This is well below the record of 11.769 billions shares set on the prior Thursday's drop. The Commodity Futures Trading Commission (CFTC) reported on Friday that short interest in the S&P futures hit record levels again on Tuesday. According to several hedge fund traders many of the funds shorted the 50% retracement of the July drop at roughly 13250 on the Dow, 1460 on the S&P. We saw the markets come to a screeching halt early in the week after the big rebound. The indexes barely moved as the week progressed but did maintain a slight upward bias. On Friday sellers tried to take the market down at the open but when it became obvious the market was not going to crumble the short covering began. That short covering lasted right into the close taking us roughly 100 points over that 50% retracement level. Shorts were throwing in the towel ahead of the weekend and what could be the lowest volume week of the year next week.

Dow Chart - Daily with Retracement

S&P-500 Chart - Daily with Retracement

The last week of August is vacation week. Everyone who did not take a vacation while the markets were imploding and volatility was hitting 4-year highs will try and squeeze in a vacation next week. It is a holiday week ahead of the Labor Day weekend, non-Farm payrolls and the FOMC meeting. With September normally a bad month in the markets this is the last week for traders to take time off. There is a lot of anguish in the fund community about bonuses. With the markets flat for the year and many positions blown out in July/August there are a lot of managers under pressure to find some profits as the year comes to a close. This is going to increase trading and increase volatility.

Barton Biggs was asked last week if the markets were going to retest their lows in September as everyone expected. He said, the market is a very mean master and it could easily just crawl higher while giving signals that it might roll over at any time. This would have 25% of the funds trying to short it and 25% of funds waiting in cash for the dip that never comes. All will eventually end up chasing prices higher. Unfortunately nobody knows what scenario to pick in advance of the event.

After the Fed news on Friday offering to accept subprime paper and CDOs at the discount window I feel market sentiment, especially in the credit markets, will improve even further. If the Fed does cut rates on the 18th it will improve even further. However, no rate cut would be a disaster since the markets are already pricing in more than one cut. Traders will be focused on the Bernanke speech on monetary policy next Friday. Hopefully this will give the markets a clue as to Fed direction two weeks before the meeting. Personally I would not hold my breath. I believe Bernanke will not give any clues OR guide to a continued no cut bias. The Fed is making it clear they will provide liquidity to anyone in need with almost any kind of paper for collateral. Bernanke might see this as all that is needed to fix the debt wreck and the Fed can remain neutral on rates. Contrary to this view was the statement by the Fed last week that the risk to the economy had changed significantly. Traders are hanging on each of those words as a guarantee the Fed is going to cut rates. This makes any Fedspeak next week very critical for market sentiment.

Russell-2000 Chart - Daily

I have been recommending readers wait for the Russell 2000 to break resistance at 800 before racing back into long positions. After spending all week in the 790-800 range the Russell closed on an uptick at 798.93 and right at that resistance line at 800. If we do move over 800 next week I would definitely be a buyer. It is going to be a low volume week and the shorts will likely be on vacation. Longs play all the time but shorts do take vacations. At this point on the calendar I would have a long bias over 800 and a short bias under 790. We saw a week of consolidation on the Russell and the shorts were unable to knock it down. That is slightly bullish. I believe fund managers will jump on board the 850 express once 800 is broken. You can play this directly with the Russell ETF (IWM). Calls are cheap with strikes at every dollar increment. Just be faithful to the 790/800 suggestions above.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
AAPL AYI None
CVX    
IBM    
IWM    
MSTR    
RIG    

New Calls

Apple Inc. - AAPL - cls: 135.30 change: 4.23 stop: 127.75

Company Description:
Apple ignited the personal computer revolution in the 1970s with the Apple II and reinvented the personal computer in the 1980s with the Macintosh. Today, Apple continues to lead the industry in innovation with its award-winning computers, OS X operating system and iLife and professional applications. Apple is also spearheading the digital media revolution with its iPod portable music and video players and iTunes online store, and has entered the mobile phone market this year with its revolutionary iPhone. (source: company press release or website)

Why We Like It:
Now that the market is bouncing it looks like the momentum traders are pouring back into shares of AAPL. The stock is blasting through potential resistance levels like they don't exist. The last couple of days investors have been buying dips near $130 and its 50-dma. If the market can keep the bullish tone alive then AAPL could try and retest the July highs. We're suggesting call positions now but another dip toward $130-131 would also work as an entry point. We're using a stop loss at $127.75 but you could also try a tighter stop just under $130.00. There is potential resistance at $140.00. Our target is the $145.00-148.00 range. The P&F chart has already turned positive again with a $180 target. FYI: AAPL has been volatile and the options are not cheap!

Suggested Options:
We are suggesting the September calls although October calls would also work well. As with all of our plays it is up to the individual trader to decide which month and which strike price best suits your trading style and risk.

BUY CALL SEP 130 APV-IF open interest=20188 current ask $ 8.80
BUY CALL SEP 135 APV-IG open interest=32285 current ask $ 5.70
BUY CALL SEP 140 APV-IH open interest=31467 current ask $ 3.50

Picked on August 26 at $135.30
Change since picked: 0.00
Earnings Date 10/18/07 (unconfirmed)
Average Daily Volume = 37.9 million

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Chevron - CVX - cls: 87.22 change: 1.74 stop: 82.45

Company Description:
Chevron is one of the largest integrated energy companies in the world. Headquartered in San Ramon, California, and conducting business in approximately 180 countries, the company is engaged in every aspect of the oil and natural gas industry, including exploration and production; refining, marketing and transportation; chemicals manufacturing and sales; geothermal and power generation. (source: company press release or website)

Why We Like It:
We realize that the correction in crude oil futures may not be over. Yet we can't deny the bullish reversal in shares of CVX. The stock has produced a bullish double-bottom pattern and broken through resistance near $85 and its 50-dma. Technicals have turned bullish again and its P&F chart has reversed back into a buy signal that now points to a $104 target. Our only complaint would be the declining volume on the rally. We are suggesting call options here near $87 but a dip back toward $85 would definitely be an attractive entry. Our target is the $94.00-95.00 range.

Suggested Options:
We are suggesting the September calls although October strikes would also work well.

BUY CALL SEP 85.00 CVX-IQ open interest=9196 current ask $4.00
BUY CALL SEP 90.00 CVX-IR open interest=8698 current ask $1.20

Picked on August 26 at $ 87.22
Change since picked: 0.00
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 12.3 million

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Intl. Bus. Mach.- IBM - cls: 113.24 chg: 1.79 stop: 107.49

Company Description:
IBM is one of the largest information technology hardware and services provider on the planet.

Why We Like It:
The hardware index is bouncing sharply and IBM looks poised to lead the way higher. The stock is breaking out from its recent consolidation pattern and technical indicators are turning bullish again. We are suggesting calls with IBM above $112 (actually above $110) and readers can choose to open positions now or look for a dip between here and $110. We're suggesting a stop loss at $107.49 but more conservative traders may want to use a tighter stop loss. Our target is the $118.00-120.00 range. We're also setting a secondary, more aggressive target in the $124-125 range but we suggest everyone take some money off the table in the $118-120 zone. The P&F chart is much more optimistic with a forecasted $177 target for IBM.

Suggested Options:
We are suggesting the September calls although October strikes would also work well.

BUY CALL SEP 110 IBM-IB open interest=3291 current ask $5.00
BUY CALL SEP 115 IBM-IC open interest=5938 current ask $1.85

Picked on August 26 at $113.24
Change since picked: 0.00
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

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Russell 2000 ishares - IWM - cls: 79.63 chg: 1.02 stop: 77.49

Company Description:
The IWM is the iShares exchange traded fund designed to track the small cap Russell 2000 index.

Why We Like It:
The Russell 2000 index, and thus the IWM, has been very volatile the last few weeks. The index produced an ugly-looking bullish double-bottom pattern in August but is struggling with resistance near $80.00 and its 200-dma. We are suggesting a trigger to buy calls at $80.25. If triggered our target is the $84.50-85.00 range.

Suggested Options:
We are suggesting the September or October calls. Strikes are available at $1.00 increments. Feel free to pick alternative strikes.

BUY CALL SEP 78.00 IOW-IZ open interest=32028 current ask $3.45
BUY CALL SEP 80.00 IOW-IB open interest=88275 current ask $2.13
BUY CALL SEP 82.00 IOW-ID open interest=94021 current ask $1.12

BUY CALL OCT 78.00 IOW-JZ open interest= 2434 current ask $4.35
BUY CALL OCT 80.00 IOW-JB open interest= 8474 current ask $3.10
BUY CALL OCT 82.00 IOW-JD open interest= 4935 current ask $2.01

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = million

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MicroStrategy - MSTR - cls: 76.05 chg: 3.68 stop: 68.99

Company Description:
Founded in 1989, MicroStrategy is a global leader in business intelligence (BI) technology. MicroStrategy provides integrated reporting, analysis, and monitoring software that helps leading organizations worldwide make better business decisions every day. (source: company press release or website)

Why We Like It:
MSTR spent the last two weeks consolidating sideways. Friday's rally was a bullish breakout from its trading range and on improving volume. This looks like an entry point to jump on the next rebound higher. There is potential resistance at the 50-dma so we're listing two targets. Our first target is the $82.50-85.00 range. Our second target is the $87.50-90.00 range. The Point & Figure chart has already reversed back into a bullish pattern with a $91 target.

Suggested Options:
We are suggesting the September calls although October strikes would also work well.

BUY CALL SEP 75.00 EOU-IO open interest=673 current ask $4.40
BUY CALL SEP 80.00 EOU-IP open interest=583 current ask $2.10
BUY CALL SEP 85.00 EOU-IQ open interest=303 current ask $0.90

Picked on August 26 at $ 76.05
Change since picked: 0.00
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 358 thousand

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Transocean - RIG - cls: 103.94 change: 0.36 stop: 99.50

Company Description:
Transocean Inc. is the world's largest offshore drilling contractor with a fleet of 82 mobile offshore drilling units. The company's mobile offshore drilling fleet, consisting of a large number of high-specification deepwater and harsh environment drilling units, is considered one of the most modern and versatile in the world due to its emphasis on technically demanding segments of the offshore drilling business. (source: company press release or website)

Why We Like It:
This is another aggressive play in the oil services sector. We're calling it aggressive because the correction in crude oil prices may not be over yet. Shares of RIG have rebounded strongly and are currently challenging resistance near $105.00 and its 50-dma near $105.60. We want to catch a breakout higher so we're suggesting a trigger to buy calls at $105.75. However, we will also be watching for an alternative entry on a dip and bounce near $100.00. If this secondary entry point occurs we'll make a note of it here in the newsletter. If we are triggered at $105.75 then we'll aim for the $114.00-115.00 range. Be aware that RIG will probably hit some resistance near $110. If the stock can trade over $106.00 it will produce a new P&F chart buy signal.

Suggested Options:
We are suggesting the September calls although October strikes would also work well.

BUY CALL SEP 100 RIG-IT open interest=2736 current ask $5.90
BUY CALL SEP 105 RIG-IA open interest=3474 current ask $2.80
BUY CALL SEP 110 RIG-IB open interest=8418 current ask $1.10

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: 0.00
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 7.3 million
 

New Puts

Acuity Brands - AYI - cls: 52.80 change: -0.88 stop: 57.11

Company Description:
Acuity Brands, Inc., with fiscal year 2006 net sales of approximately $2.4 billion, is comprised of Acuity Brands Lighting and Acuity Specialty Products. (source: company press release or website)

Why We Like It:
The trend has definitely changed for AYI. The stock peaked near $67 in July and then promptly crashed to an intraday low of $46.95. What followed was a massive rebound that turned into a bearish failed rally pattern near $60 and its 50-dma. Now the stock is trending down again. Needless to say the stock can be volatile but we'll try and limit our risk with a stop loss above its 200-dma at $57.11. We have two targets. Our first target is the $47.75-47.50 range. Our second target is the $45.25-45.00 zone.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 55.00 AYI-UK open interest= 70 current ask $3.60
BUY PUT SEP 50.00 AYI-UJ open interest= 58 current ask $1.30

Picked on August 26 at $ 52.80
Change since picked: 0.00
Earnings Date 10/04/07 (unconfirmed)
Average Daily Volume = 536 thousand
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Amazon.com - AMZN - cls: 79.25 chg: 1.95 stop: 74.90 *new*

Friday proved to be a strong day for online-retailer AMZN. The stock posted a 2.5% gain and produced what appears to be a bullish candlestick pattern. Looking at the intraday chart you can see where buyers were defending the stock near $78.00 most of the day. AMZN looks poised to hit our initial target in the $79.50-80.00 range on Monday morning. More conservative traders should definitely considering exiting soon and even more aggressive traders will want to consider taking some money off the table. The $80.00 level is short-term resistance. If the stock can breakout higher then AMZN has a shot at our aggressive target in the $84.00-85.00 range. We are not suggesting new positions at this time. Please note that we're raising the stop loss to $74.90.

Suggested Options:
We are not suggesting new positions at this time with AMZN under resistance near $80.00.

Picked on August 19 at $ 75.02
Change since picked: 4.23
Earnings Date 10/23/07 (unconfirmed)
Average Daily Volume = 10.1 million

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L.B.Foster Co. - FSTR - cls: 38.50 chg: 0.60 stop: 34.95*new*

Traders continue to buy the dip in FSTR near its rising 10-dma. The stock posted another gain on Friday and volume was above the daily average. The technical picture is mixed but thus far momentum is holding. We're inching up our stop loss to $34.95. We're not suggesting new positions at this time. We have two targets. Our first target is the $39.90-40.00 range. Our second target is the $42.00-42.50 zone. Please note that this remains an aggressive, higher-risk play.

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

Picked on August 14 at $ 37.33
Change since picked: 1.17
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 148 thousand

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Goldman Sachs - GS - cls: 179.73 chg: 2.23 stop: 169.45 *new*

GS rebounded again but is still struggling with resistance near the $180 level. We are adjusting our stop loss to $169.45. We remain bullish on the stock but considering where it's at, just under $180, we would wait for a new rise over $181.00 before considering new bullish positions. We have two targets. Our first target is the $184.75-185.00 range. Our second target is the $194.00-195.00 range. One of our biggest risks is the intraday swings that could easily stop us out. FYI: We only have about two and a half weeks left as we do not want to hold over the earnings report.

Suggested Options:
If GS provided a new entry point we would suggest the September or October calls.

Picked on August 19 at $175.00
Change since picked: 4.73
Earnings Date 09/12/07 (unconfirmed)
Average Daily Volume = 11.6 million

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DJ Transports iShares - IYT - cls: 88.13 chg: 1.11 stop: 83.99

The transports bounced on Friday. This was good news for the bulls and lack of follow through on Thursday's bearish reversal pattern should frustrate and worry the bears. The MACD on the IYT's daily chart has turned bullish although we note that volume on Friday was pretty low. We are not suggesting new positions at this time. The IYT still has resistance near its 200-dma around $89. More conservative traders may want to protect themselves and raise their stops toward $85.00. Our target is the $89.75-90.00 range.

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

Picked on August 19 at $ 85.43
Change since picked: 2.70
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 600 thousand

---

Sears - SHLD - cls: 146.13 chg: 4.70 stop: 137.45 *new*

Retailers were a big part of Friday's rally. The RLX retail index rose 1.9%. Shares of SHLD were helping lead the pack with a 3.3% gain. Traders jumped in to buy the initial dip near support around $140, which was an area we suggested readers could use as a new entry point. The stock rallied to a new one-month high. Our only concern was the low volume behind the move. It's possible that the big gain could spark some more short covering next week. Please note that we are raising the stop loss to $137.45. We originally had two targets. Our first target is the $149.50-150.00 range. Our more aggressive target was the $157.00-160.00 zone. However, since we do not want to hold over the earnings report due out around August 30th (still unconfirmed and SHLD could announce any day this week) then that only gives us three more trading days. We're eliminating the aggressive target. If you're feeling optimistic you could aim for the 50-dma that is potential technical resistance near $151.85.

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

Picked on August 21 at $141.50
Change since picked: 4.63
Earnings Date 08/30/07 (unconfirmed)
Average Daily Volume = 2.1 million
 

Put Updates

None
 

Strangle Updates

None
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Surviving as a Trader

What's your first goal as a trader?

Surprise! It's not to make money: it's to preserve your trading capital.

While it's been nice to have some quiet days at the end of this week, some experts surmise that we've moved into a high volatility environment, one that might quiet down temporarily but then continue well into September and October.

Last fall's market action was relatively tame by comparison to that seen many Septembers and Octobers. Look back at a VIX chart over a several-year period, and you'll notice many summertime peaks are followed by new peaks in September or October. Although in recent years, those VIX peaks have tended to be lower highs than the summertime highs, switch to a longer-term chart using the VXO (the old VIX) and you'll see a different pattern emerging in some years.

Annotated Weekly Chart of the VXO:

As I edit this article, written earlier in the week, I can hear CNBC in the background. Commentators are discussing whether the Fed should ease as it did in 1998, again comparing this year to that year.

Those seasonal spikes in the VXO seen on the chart were accompanied by steep declines in equities, of course. In each case, the summertime lows were pierced.

While I'm not predicting that we'll see a repeat of the 1998 and 2001 declines this September or October, we can't assume that the pattern can't repeat just because it hasn't for several years. It can. Some year, it will. This could be that year.

How does one protect one's trading account? I've culled some ideas from various trading coaches and have added some of my own, including some of my thoughts about the types of options plays in which some of our some of our subscribers engage.

Make a plan.
Always set hard stops.
Diversify.
Consider trading smaller.
Consider not trading at all.

If ever traders needed a roadmap to help them negotiate difficult conditions, this may be the time. The global jitters are almost palpable. When some fifty-something somewhere in Asia panics about the money she has tied up in an Asian tech stock and begs her broker to just get her out at any cost, don't you almost feel the quaver in her voice in your own throat, too? (By the way, I'm a fifty-something, a late fifty-something, so I'm not picking on fifty-something female traders.)

In a calm time when the markets are closed, make a plan for how you'll approach the season, the week, the day, and the trade. Think about setups. Check economic calendars.

Include at least a brief glance at foreign markets, too. You can find one on www.forexnews.com. Last week and again early this week, I warned traders via my Wraps and Market Monitor comments that the Bank of Japan's rate decision Wednesday night would likely impact our equity markets, although the direction that decision would send our equities depended on the decision made, of course. I had an email from at least one subscriber who rued not taking the advice to carefully consider whether one wanted to hold positions overnight. That subscriber was stopped out of a short futures position during the overnight session.

Knowing what might impact your trade helps you determine whether the climate is good for trading at all. If you determine that the climate or your own life situation supports trading, determine what a good setup would be.

During periods of high volatility, options prices are inflated. That means that in addition to the normal premium decay that works against the options buyer, an additional element of risk has been added. To benefit from a long put or long call purchase, you'll need the markets to move in your favor, and perhaps move big in your favor, to overcome that possible premium decay. You need optimal setups.

You don't want to jump on a seemingly great long SPX play, only to find out a moment later that the TRAN and the USD/yen are headed south and the VIX and TRIN are headed north. Think twice before initiating any options play near the close if the ECB or Japan is due to receive an important economic release that might impact future rate-hike decisions for those central banks.

Pass up any trade that doesn't meet your desired setup parameters. We can all tell tales of the one that got away without us, but another big trade will always come along.

Part of that plan should include determining where a "this is a catastrophe, have to get out" type of stop will be. Almost every trading guru, coach or mentor I've heard advises setting such a hard stop.

Why set such a stop if you're sitting in front of the computer monitoring the trades moment by moment? I remember during early 2000 when I headed to the bathroom nearest my office to brush my teeth after a lunch eaten at my computer desk, returning to find that I had $9,000 less profit than when I'd left my seat a few moments earlier. I remember times when the market was moving so fast that it was tough to actually punch the order in and get it submitted before conditions had changed again, rendering that order unacceptable to market makers. Meanwhile, my profit had turned into a loss. For me, most of those times last occurred in late 1999 and early 2000, but they're happening again now to some traders.

If you were trading last Thursday morning, you experienced such a time. While these were unlikely occurrences only months ago, I can't tell you how many emails I've received lately with someone telling me about the disasters that occurred when a phone call was accepted or when someone stopped by to chat for a moment at an office door. Trades were ruined in the few minutes that attention was diverted.

The most important reason for setting such hard stops, however, is to help you control the emotions of trading. When you know you have that safety net below you, exit decisions are made with more equanimity. The goal is that you won't let the "this is a catastrophe, have to get out" stop ever be hit. You'll make a more reasonable exit at a more favorable price. It's easier to avoid the deer-in-the-headlights reaction when you know you have that safety net below you. Panic is more easily avoided.

Another tactic for those who buy calls and puts is sometimes employed by Jeff Bailey. He sometimes advises that you use your trading plan to determine what risk you're willing to take in an options trade. Once the purchase is made at that maximum risk amount, no stop is set and the trade is allowed to work. Or not work.

Not all OIN subscribers buy calls and puts, however. Many buy leaps or stock. Maybe their trading plans, taking into account their ages and goals, include attempting to weather market downturns. You still need that "this is a catastrophe, have to get out" hard stop. For those of you following Jim Brown's leaps suggestions, he's provided you with more favorable exits than those, and I'd advise that this is not a period of time that you want to ignore such stops.

Other protection is available for those who want to hold leaps or stock during times of market instability. A put can be purchased, although puts are expensive insurance these days. A previous Trader's Corner article addressed collars, a method that can provide some limited downside protection for little cost. That article can be found at this link.

Many subscribers trade condors or other spreads. Rising volatility widens those spreads, and that's not a good thing. In fact, rising volatility murders condors, as many who were trading condors during August's option expiration period can attest.

Frankly, condors aren't the best of vehicles to trade when you expect volatility to expand, but if you're considering trading them anyway, consider some methods for controlling risk. Dan Sheridan, a former floor trader and frequent www.cboe.com webinar presenter, offers a couple of suggestions. One is that you know when to adjust those condors. On one webinar devoted to adjusting condors, he suggests that when the delta of a sold call reaches 25-28, traders close out the condor and roll the whole thing upward. When the delta of a sold put reaches 20-22, he suggests it's time to roll the condor down.

I employed that method through August's option expiration period, adjusting positions when prices were 21-50 points away from my sold strike, depending on what point in the option expiration period those delta values were hit. The benefit was that the spreads still hadn't widened inordinately when the trigger delta values were hit. I didn't feel rushed making the decisions until Wednesday afternoon of opex week, when the delta of my sold put, at SPX 1385, began moving above 20 near the close. I managed to close out 10 of my 25 contracts that afternoon.

I felt a little rueful and maybe even a little silly closing them out when only one trading day remained in the opex period and the SPX was still more than 21 points above the sold strike at the close. However, as Jane Fox on the Market Monitor portion of the site sometimes says, "Rules is rules." You can betcha I was glad I'd closed out at least 10 of them the next morning.

Dan Sheridan said once, in answer to a webinar attendee's question, that he doesn't fear a big move, even one that brings prices through several standard deviations, as long as it's not a gap-open move. Barring that, he believes he can adjust positions.

I would add some caveats to that, however. It's not going to be optimal to roll down or up on the last trading day before option expiration or adjust any time when the markets are cascading or soaring on volume so high that trading desks and brokerages' online pages are swamped. Sheridan advises that, if markets are cascading or soaring, you wait a day or two before rolling into a new position after closing out the first one.

Another suggestion that Sheridan offers for trading condors in a trending market is to buy extra long options in the direction of the trend. For example, if markets were trending down and you felt compelled to trade a 10-contract condor or perhaps had even entered the trade several weeks before the trend began, Sheridan might suggest that the bull put spread be altered to contain 10 contracts of the sold strike and 12 of the bought strike. The extra long strikes would ameliorate the loss, he says, and wouldn't cost too much when initiated.

If the trend begins after the condors have been established and within a couple of weeks of option expiration, Sheridan suggests that the extra long strikes be between the current price of the security on which you have the condor and the sold strike, not at your original long strike. For example, if I had a 10-contract MID 910/920 bear call spread and, two weeks before option expiration, the MID had begun trending upward toward my spread, it would be too late to buy a couple of extra 920's. They wouldn't appreciate quickly enough in price to do me much good as the MID trended up toward the spread. Instead, Sheridan might suggest that I buy a couple of MID 900 calls. Their price would appreciate faster as the MID trended higher and better help ameliorate any loss, should I forced to take one. I haven't tried this suggestion and so can't give you any information as to how well or how little it tempers any loss.

A better idea might be to diversify the portfolio so that it didn't include so many condors in the first place. Traders are accustomed to thinking of diversification when investing 401K or IRA funds, but diversification is needed when considering options strategies, too. Investigate strategies that benefit from expanding volatility to combine with those that suffer from that expansion. If your trades are mostly of the cowboy/cowgirl speculative type, blend in some less speculative plays. Investigate the different types of options plays offered on our website as well as clicking over to the CBOE and listening to every webinar offered.

But don't try new strategies in a tough market condition. Paper trade them. I know that some traders and even trading gurus discount the value of paper trading. I understand their comments. I've been as guilty as anyone else of setting up a paper trade and then just letting it go when life gets tough. Admit it: you've done it, too.

However, my reason for paper trading in the first place was usually because my knowledge of the strategy or the complications in my daily life didn't allow me to responsibly commit funds to the strategy or to any strategy at that time. Paper trading in a difficult market allows one to judge all the things that might go wrong with a strategy. If you're wrong about your ability to concentrate on a trade during such market turmoil, it's far better to let a paper trade go unwatched than it is to let an actual trade do so.

Maybe you're relatively new to options trading, but you've been doing well. I would suggest that you've been doing well in a different market environment than we might have now. For months on end, it didn't much matter how good your technical analysis skills or account management skills were. As long as you went long and bought enough time, you were almost guaranteed to profit eventually.

That's not true any longer. So, if you're relatively new, you might need to know about some of the things that have changed. Paper trading, even for a few days or weeks, can be eye opening. For example, option values already inflated by the volatility can be further inflated near the open during the amateur-hour period. They're expensive. They can be exorbitantly expensive.

What happens if you buy one of those exorbitantly expensive options during amateur hour? Even if the underlying moves in the direction of your trade, you may discover a phenomenon that you haven't experienced much in the last year, until recent weeks. If you paid too much for those options during amateur hour, their price can deflate while the market moves in your direction. This wasn't as noticeable or problematic a trait when volatility levels were already low and options were dirt cheap, but it's certainly one now. Just last week, I received an email from someone whose call never again reached its amateur-hour value even though the underlying climbed all day. It just climbed too slowly for the underlying's price increase to make up for the deflation in extrinsic premium.

That leads directly into the next two suggestions. Consider trading smaller or not trading at all until market conditions appear more settled. If you went long a bunch of August calls at the SPX close at the 200-sma on August 13, with the day having produced the second doji in a row, something you considered a clear sign of steadying conditions and a bounce to come, don't you wish you'd either foregone that play or else had traded much smaller than you did?

Even with the best of account-management tactics and the best of technical analysis skills, trading in a volatile market can decimate an account. Isn't it better to spend a month or two in intense study of various options trades than to decimate both your account and your confidence in your abilities? One trading guru says that if you start experiencing one losing trade after another, your trading skills haven't changed: market conditions have. It's hard not to blame yourself, however, for each of those losing trades and to lose confidence. Recognize ahead of time that market conditions are changing. Don't put yourself in a spot in which you're almost guaranteed to take a hit to your trading account and your confidence level.

If, in the coming weeks, you're paper trading new options combinations or trying them on new underlying vehicles, I will be, too. If you're signing in to the latest CBOE webinar, I'll likely be listening right along with you. I'm taking my own advice.
 

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

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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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