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Daily Newsletter, Saturday, 09/08/2007

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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

Fed Wakeup Call

It was not the type of wakeup call the Fed wanted to get on Friday. The August employment report did not just miss estimates but missed them by several miles. The unexpected drop in new job creation tanked the market and sent bonds to new two-year highs. The news produced a knee jerk reaction across all the consumer sectors and sent recession chills rippling through the markets.

Dow Chart - Daily

Nasdaq Chart - Daily

The Employment report for August surprised everyone. The consensus for new jobs created in August was running around +120,000 jobs. This was weaker than recent months but still decent. The headline number showing a loss of -4,000 jobs for the months was a serious shocker but the damage did not stop there. July jobs were revised down from gains of 92,000 jobs to gains of only 68,000. Even worse the July number was revised downwards from 126,000 jobs to only 69,000. The net result of this report was a drop of 205,000 jobs from what the market was expecting. That is calculated from the missed consensus of +120,000 for August and a downward revision of -57,000 in July and -24,000 from June. There is no way to sugar coat this report because it was a disaster in a period where the market was counting on some decent numbers to provide assurance the economy was still growing. Instead of assurance they got proof that the economy was actually much weaker than expected. The recession bears came out grinning with that "I told you so" smirk as they doubled down on their shorts. This was the first loss in jobs in four years after 47 consecutive months of gains. The record is 48 months and without an upward revision next month that record is not going to be broken this year.

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The drop in jobs caught everyone off guard because the other reports like the ISM were still showing positive growth. The unemployment rate remained near its multiyear low at 4.6% and average hourly earnings were also flat with July at +0.3%. Manufacturing lost 46,000 jobs and 22,000 were lost in construction. Service jobs posted a gain of +60,000, education/healthcare +63,000 and leisure/hospitality grew by +12,000. Those are some good numbers but they were not enough to stave off the losses in other areas.

Household employment, the birthplace of entrepreneurs and typically the leading indicator for economic growth turned negative in job creation for the year. Over the last eight months household employment is now showing a loss of -16,000 jobs for the year. The household number had been averaging about 225,000 new jobs per month. The last three months has seen a substantial drop in new startups.

Non-Farm Payrolls

The overall economy took a sudden turn for the worse over the last three months and everybody agrees the real impact from the subprime crisis has yet to appear. All we are seeing today is the leading edge of the impact from the crisis which first came to the public's attention less than three months ago. The Fed has said for the last three months that the subprime crisis was NOT spreading to other sectors and the damage was "contained." Evidently somebody opened Pandora's box and let the evil out. It is clearly spreading to other sectors as we have seen by numerous profit warnings over the last couple weeks.

On Friday Harley Davidson (HOG) warned that consumers were curbing their spending and Harley would produce and ship fewer motorcycles, a cut of up to 10% of its annual production. Harley reported that dealer sales fell off sharply in August and sales were likely to be down the rest of the year. Harley said earnings would drop -4% to -6% per share. Granted Harley Davidson is not a mainline purchase for most American consumers but they also said sales were off worldwide by -1.2% in the current quarter. This is the first time in 15 years that domestic sales had fallen in consecutive quarters.

The same problem is starting to be seen in other areas with slowing high dollar purchases for everything from flat screen TVs to motor homes. The retail sector, despite some positive sales reports last week, is taking a beating and job losses continue to mount. After the bell on Friday Countrywide said it was cutting another 12,000 workers or 20% of its workforce. This was in addition to 900 announced earlier in the week. Remember, I predicted it here several weeks ago when the trouble first started. They can't support their current staff levels on 50% fewer mortgages. Mortgage lender Indymac (IMB) also reported cutting 10% of its workforce earlier this week. Lehman reported job cuts of 850 jobs on Wednesday. It is only going to get worse. Countrywide said they expected mortgage loans to drop by 50% in Q4 and by 25% for all of 2008.

We are not even into the biggest months for ARM resets. There are $1.2 trillion in mortgages resetting in 2007-2008. Lenders are trying to restructure these loans ahead of the reset to prevent an even bigger foreclosure problem in 2008. This week the Mortgage Banker Association said foreclosures in Q2 rose +57% over 2006 and ARM loan foreclosures increased +96%. These are monster spikes and the heaviest months for resets are still ahead.

What the jobs news did for Fed forecasting was turn a strong possibility of a rate cut on Sept 18th into a slam-dunk. The only question now is 25 or 50 points? With the current rate at 5.25% the Fed Funds Futures are predicting a 4.99% rate by the end of September, 4.81% in Oct and 4.58% in November. That translates to total cuts of 75 basis points by the Halloween meeting.

Most analysts feel a Fed rate cut is not the answer. Most argue that we have a credit crisis not a rate crisis. The commercial paper market has closed until after financials report earnings later this month. Nobody wants to loan money until they know what skeletons are hiding in the closet. Banks needing to fund mortgages, corporate paper or even normal business loans have to struggle to find takers for that debt. Until time has passed and the big banks are convinced nobody is in danger of a blowup this situation is not likely to improve.

A rate cut is a Band-Aid on the credit problem and more of a token action rather than a real solution. A rate cut or more likely a series of rate cuts will only help the mortgage community, as the reset problem gets worse. If rates fall those facing a refinance to higher rates would benefit by a sharp drop in the Fed's target rate. Every little bit helps when shopping for those loans and the Fed could actually help contain the problem and keep it from getting worse by rapidly cutting rates. I am not holding my breath that the Fed rides to the rescue. They may make a token cut in September but future cuts will definitely be decided in the future on evolving economic news.

To further complicate the issue Philly Fed President Charles Plosser said on Saturday morning that the Fed may not need to cut rates to deal with the current problem. He echoed the sentiment that it is not a rate problem but a credit problem and by using other tools at their disposal the Fed could avoid changing their rate policy. Plosser put it this way: "It is not appropriate for the Fed to ensure against financial volatility per se, or against individuals or firms taking losses or failing." This type of talk next week will cause even more market volatility and increase uncertainty.

October Crude Chart - Daily

A rate cut will only push bonds higher and the dollar lower and the dollar hit a new 15 year low on Friday while bond yields hit a 2-year low. The lower dollar is great for large cap multinationals but not necessarily good for consumers. If your dollars are worth less it takes more to buy things like food and energy. That is called inflation and the Fed just pronounced inflation dead if you don't count food and energy. Oil, which is priced in dollars around the world, gained ground on Friday even with Exxon CEO Rex Tillerson saying there was no fundamental justification for oil over $70. In fact he said the fundamentals support something much less. Oil continued to move higher because the dollar was dropping like a rock. A rate cut will only make it worse but the Fed appears to be trapped between a cheaper dollar and a recession. Given the choice they will vote for the cheaper dollar to keep the economy afloat.

US Dollar Index Chart - 15-Year Low

Next week the economic calendar is crowded but there is really nothing on it that is critical. All eyes and conversation will be focused on the Sept-18th FOMC meeting. I added the 9/11 anniversary to the calendar because of the potential for a new incident. Osama released a new videotape on Friday, the first one in nearly three years and analysts say it was basically a recruitment tape. He rambled for about 30 minutes touching many topics but the real message was not spoken. By putting out a video after three years he was advertising he was in good health, aware of what is going on in the world and still pressing the fight against the West. The 9/11 anniversaries have not drawn attacks in prior years but produced a flurry of press releases by al Qaeda in attempts to capitalize on their success and convince new martyrs to join the fight. Let's hope this year is only another press release event.

I also included the OPEC meeting on Tuesday. There is a war of words being fought by all the major players and Exxon's CEO jumped right in the middle of it with his "oil over valued" claims on Friday. Oil ministers for Algeria, Iran, Libya, Qatar and Venezuela said in the past week they support keeping the quota at its present 25.845 million barrels per day until December. Of course those are countries without any excess production so raising the quota would not help them and oil prices would fall. I would vote the same way if I were in their position. It is widely believed that OPEC has unofficially raised its target price for crude to $70 according to Claude Mandil, director of the IEA, which advises 26 of the largest oil consuming nations. They won't officially say that for fear of bringing reprisals but they are definitely acting as if that is the new base. The 10 OPEC members with quotas are pumping more than their quota now by about a million barrels per day at 26.71 mbpd but they will not admit it publicly since it would drive the price down. That number came from the IEA and was gathered from individual production shipments. Iraq and Angola have no current quota and are allowed to pump as much as they can. Production from all 12 OPEC nations was 30.33 mbpd in August. OPEC leaders claim an increase in production is not necessary because the subprime problem in the U.S. will cause consumers to use less this winter and push us into a recession. Pure smoke and mirrors, they just need a reason to justify holding the price up.

Lastly I added the BSC/LEH earnings on Thursday as a potential pivot point for the markets. There are increasing rumors that Bear Stearns was in serious trouble several weeks ago and has been trying to sell itself as a merger partner or a partial takeout over the last three weeks. If it was in that much trouble their earnings report on Thursday could be the trigger that causes another market implosion. Conversely if they report stronger results than expected and no lingering, life threatening problems on their balance sheet they could explode back into health. Lehman reports on the same day and could also disappoint but the expectations are not so dire. Goldman Sachs (GS) reports on the 20th and rumors are growing that they will have a blowout quarter because of their trading desk. It might be a good idea to pick up some Goldman calls the day before LEH/BSC report because any surprise there could be felt in Goldman for a week leading up to their earnings.

Economic Calendar

Alan Greenspan was back in the headlines on Friday after a speech in Washington. He said the current financial crisis was similar in many respects to the crashes he saw in 1998 and 1987 and even those as far back as 1837 and 1907. In 1837 the collapse of the land boom was a major economic disaster and the bank panic of 1907 was also a major economic event. In 1998 Long Term Capital collapsed and their derivative book was so large there were worries they could take down the entire banking system. The 1987 crash of the stock market was blamed on many things including trading excesses and lofty valuations. He did not say how he would fix this crisis but said it was equivalent to those mentioned above. He said, "Fear is a driver, which is going on today, is far more potent than euphoria." There have been several recent comparisons of the stock charts from 1987 and 1998 and their likeness to today's charts. While I think the older charts are similar they just represent normal chart patterns where an overbought market struggles at the top before giving up. If somebody tries to convince you the world is coming to an end again I suggest you change the topic.

Dow 1929-1987 Charts

Ben Bernanke will also give a speech on Tuesday in Germany on "Global imbalances, recent developments and future prospects." That should garner its share of attention from the analyst crowd.

If the jobs report caused the chance of a rate cut to rise to 100% then why was the market so ugly? The key is simple. The market always wants a rate cut even when they don't need it. Every time the market or economy catches a cold they want the Fed to rush in with a rate cut and fix it. Friday's employment report skipped the cold stage and went straight to pneumonia. Traders were shocked back into reality that maybe the subprime virus was not contained and might have turned into an epidemic. The facts now facing the Fed are serious. The real impact of the credit crunch is still in our future. It is not over and not contained. It is spreading and will get worse as the foreclosures grow and home values shrink. Home equity is a prime source of consumer spending and that ATM is quickly running dry. Secondly the risk to the economy is now recession not inflation although a case could be made for both. Thirdly the Fed appears to be behind the curve. At the last meeting they were still focused on inflation as the biggest risk with the subprime problem contained. Less than two weeks later they were lowering the discount rate because a sudden shift had occurred and the biggest risk was now the subprime credit crunch. An entire team of supposedly educated and highly professional Fed officials doesn't miss a change of epic proportions unless they are asleep at the wheel and already behind the curve. Now, despite the fact it is not a rate problem, the Fed will have to race to catch up with the outbreak of the credit virus. The markets took about 60 seconds to figure this out once the employment report was released. The opening gap on the Dow was -165 points and that was the best level seen for the rest of the day.

The Dow continued to fall to dip below 13100 and -277 just before the close. The drop to 13100 saw support begin to firm at that level but there was no rush to buy. The Dow closed only +28 points off its lows with a -250 point loss. If it were not for the light short covering at the close there would have been no rebound at all. There was no bargain hunting and no calls by analysts on stock TV to buy the dip. There was no joy on Wall Street at the close because the future is looking grim. Of course that was the view on Friday and Monday's outlook will be different. Traders will convince themselves over the weekend that the August employment number was just a blip on the screen and September will be better. They will convince themselves that the earnings warnings last week were also blips on the screen and the majority of companies will report stellar earnings in spite of the economic decline. They may be wrong on both counts but have you ever tried to tell a drunk they are drunk? A market bull already has their mind made up and does not want to be confused with the facts.

This is going to cause some more volatility before we climb out of this mess. When newsletter writers say expect some more volatility it is a polite way of saying we could be going lower and expect some more triple digit losses. Some people can't take it when an analyst says there is selling in our future. I get emails all the time when I say something negative and people tell me I am poisoning the market. I wish I had that kind of pen power. We would be at 15,000 next week.

We will see some increased volatility next week and that is not a joke. It has been a long time since I can remember so many triple digit days and lopsided internals. This is the kind of market that chews up investors and spits out the pieces. Traders fare only a little better but also find themselves on the wrong end of a swing more often than not. The problem will get worse as the earnings warnings increase. Earnings expectations for Q3 have already fallen from just over 8% to something in the low 5% range in just the last 3-weeks. I suspect it is going a lot lower before the reporting cycle begins next month. We have seen numerous companies warn already but we are not even close to the official warning period yet. Once those earnings expectations fall below 5% it could get ugly.

Can the Fed rescue us from this downward spiral with a simple rate cut? It is entirely possible if they cut aggressively at the September meeting and move -50 points. It would not have any immediate impact on the economy but would have a strong impact to investor sentiment and could ease the worry in the market. We have 7 days to contemplate that potential and I am sure many of those days will be triple digits.

I would love to see another retest of the August lows on the Dow and S&P. I believe that would be very therapeutic for the market and bring fund managers back with aggressive buy programs. Fund managers have plenty of cash. One estimate I heard was 12% to as much as 20% from selling winners in the August dump in anticipation of redemption requests. TrimTabs said there were some outflows but mostly from hedge funds ($55B) not mutual funds. Mutual funds saw inflows last week as investors bought the rebound. If normal funds are sitting on 12-15% cash and waiting for a normal October bottom then any future dump will likely be bought and even more so if the Fed takes the lead. Those funds are not likely to enter the market until it either firms or retests the August lows. Either way that plays into the Sept-18th Fed calendar.

You may remember the internals table I posted last week with sharply alternating days where volume was heavily weighted to one side. This week was an exact carbon copy of the prior week and volume picked up only slightly as we moved away from the holiday. There is tremendous indecision in the market and that is not conducive to a strong rally. The remaining weak holders need to be flushed one more time so the big money can create a support base with heavy buying.

Internals Table

The Nasdaq is still the market leader but you could not tell it from the -48 point drop on Friday. Much of that drop was thanks to Apple and the broker who downgraded it. Apple has lost nearly $15 in the last three days and as the heaviest weighting in the Nasdaq the damage was severe. I believe the selling is overdone in AAPL and Friday's support at $130 could be a decent entry point. However, just remember a helium balloon will always rise above the crowd but will still go lower when that crowd is in a down elevator. I am not sure if this market elevator knows yet which floor it is searching for. $120 would be my preferred entry but I may not get filled if I wait for that target to be hit. The Nasdaq has strong support at 2500 and again at 2400 and has no direct subprime exposure. Network stocks, software and biotech normally do well in Q4 and especially well once a Fed rate cut program begins.

I wrote about S&P 1490 last Tuesday and how critical it was to remain over that level. Tuesday saw the S&P trade higher but still closed under that resistance at 1489. That resistance held and we are nearly -40 points lower today. The S&P is hostage to the financial sector. That is the largest group in the S&P and it is currently an anchor dragging the index back to support. That initial support is 1430 followed by 1375. A dip below 1430 produces a very negative chart and almost guarantees a retest of 1375.

S&P-500 Chart - Daily

Dow Transport Chart - Daily

The Dow Transports lost -100 points on Friday to close just over 4700. This is the lowest level the Transports have seen since the August 16th crash to 4487. With oil rising, consumers staying home and budgets getting tight a break of the August low would be a critical failure. Bill Zollars, CEO of Yellow Roadway (YRCW) said two weeks ago there was no holiday shipment surge building. Holiday buying for inventory had not been seen and truck shipments were falling. I get a daily UPS delivery and I am pretty good friends with the driver. His truck has been empty this week, literally empty. Normally it is a fight to locate and dig out my packages. On Thursday there was less than 50 packages on his entire truck. I mentioned it and he said volume was very light and UPS was going to consolidate routes if it did not pickup soon. Was it just an end of summer slowdown where people did not ship around Labor Day? I did not get that impression and it is very possible that those consumer wallets are finally slamming shut now that summer is over. Time to pay for the vacations instead of order stuff online. Ebay announced last week that there would be no insertion fees for the entire month of September. It is basically a free listing month. Ebay did not do that just because they wanted to be friendly. They needed to attract sellers back to their auctions. No sellers equals no buyers and therefore no UPS shipments. I know all this is likely unrelated but I like to try and group things together to see if there is a common thread. Getting back to the topic at hand, the transports are ailing and I believe we have a good chance of retesting the 4500 level this month. Falling transports is typically contagious and weakens the Dow and S&P.

Russell-2000 Chart

For weeks now we have been watching Russell 800 as a critical level for the rebound. A move over 800 would be bullish and buyable. Another failure there would be a strong warning signal. On Tuesday the Russell pushed just over 800 in the afternoon and closed at 800.79 and right on resistance. On Tuesday night I discussed the Russell and my pending urge to be long if we could push farther over 800. I mentioned possibly buying any dip below 800 on the idea the bottom was in. I discarded that idea and maintained my recommendation to go short under 790 and wait for the index to move over 800 to go long. On Wednesday the Russell gapped down at the open and collapsed back to support at 790. That support held for two days but Friday was another gap lower and it closed at 776 for a -2.16% loss for the day and the week. I continue to believe this is bearish for the overall market. It clearly shows the fund managers are NOT buying the small caps. They are still avoiding risk and sticking to the liquid large caps for any random buys. Until the fund managers are confident enough in the market to risk buying small caps we are not moving higher. The Russell has support at 770, 760, 750 and again at 740. Every increment of 10 is covered with 750 the most likely target. I would buy a dip to that level. Until then continue to maintain a short bias under 790.

I do believe we are about to reach a selling climax. It may not appear until after the Fed meeting but I believe we will see a lasting rebound begin soon. (2-4 weeks) Until then I would go shopping for stocks but confine your actions to window-shopping only. Traders should always plan on being late to the party. They say the early bird gets the worm but in trading the early entry is normally foiled by a retest of support. Be patient and wait for this volatility to ease. Tomorrow is always another day to trade as long as you have money to trade with.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None ASH BSC
  FXI  
  LLL  
  WHR  

New Calls

None today.
 

New Puts

Ashland Inc. - ASH - cls: 58.84 change: -1.20 stop: 61.01

Company Description:
Ashland Inc., a diversified, global chemical company, provides quality products, services and solutions to customers in more than 100 countries. (source: company press release or website)

Why We Like It:
The oversold bounce from ASH's August lows has been struggling near the $60.50 region for the last two weeks. Now the technical indicators are starting to roll over into new bearish signals and Friday's decline saw ASH breakdown under its 10-dma. We are suggesting new put positions now. More conservative traders may want to wait for a drop under $58.00 before opening new bearish positions. We have two targets. Our first target is the $55.15-55.00 range. Our second target is the $52.65-52.50 range.

Suggested Options:
We are suggesting the October puts.

BUY PUT OCT 60.00 ASH-VL open interest=568 current ask $3.10
BUY PUT OCT 55.00 ASH-VK open interest=458 current ask $1.15

Picked on September 09 at $ 58.84
Change since picked: + 0.00
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume = 796 thousand

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FTSE/Xinhau China iShares - FXI - cls: 146.78 chg: -3.74 stop: 151.51

Company Description:
The FTSE/Xinhau China 25 iShares index is an Exchange Traded Fund (ETF) designed to track the Chinese stock market.

Why We Like It:
If the market is worried about the U.S. economy falling into recession and how the U.S. consumer might pull back their spending habits then the Chinese market could be facing a big correction soon. The iShares for the Chinese market (FXI) already look overbought from their August rebound. We're suggesting put positions now although readers do have a couple of choices. You could wait to see if the FXI bounces and then produces a failed rally under $150 as a potential entry point or you could wait for a drop under $145.00 as a new entry point. Our target is the $135.50-135.00. More aggressive traders may want to aim lower. We may start looking for a bullish entry point near $130. Be aware that the Chinese markets and the FXI have been very volatile this year so readers should consider this a more aggressive play.

Suggested Options:
We are suggesting the October strikes. September options are available but they only have two weeks left. Options are available in $1.00 strikes so feel free to pick one you like.

BUY PUT OCT 150 FFP-VT open interest= 816 current ask $11.50
BUY PUT OCT 148 FFP-VR open interest= 335 current ask $10.40
BUY PUT OCT 145 FFP-VO open interest= 340 current ask $ 8.90
BUY PUT OCT 140 FAH-VH open interest=7006 current ask $ 7.10

Picked on September 09 at $146.78
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 3.2 million

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L-3 Comm. - LLL - cls: 96.95 change: -0.91 stop: 98.55

Company Description:
Headquartered in New York City, L-3 Communications employs over 63,000 people worldwide and is a prime system contractor in aircraft modernization and maintenance, C3ISR (Command, Control, Communications, Intelligence, Surveillance and Reconnaissance) systems and government services. L-3 is also a leading provider of high technology products, systems and subsystems. The company reported 2006 sales of $12.5 billion. (source: company press release or website)

Why We Like It:
LLL has developed some bearish symptoms. Shares have a bearish pattern of lower highs and the technical indicators are rolling over. We suspect that if the markets continue lower then LLL could retest the August lows. We're suggesting a trigger to buy puts at $95.90, which is under short-term support near $96.00. We're going to try and limit our risk with a tight stop at $98.55. More aggressive traders will want to use a wider stop (maybe above $100). If triggered at $95.90 our target is the $90.75-90.00 range but we may need to adjust that as the 200-dma continues to rise.

Suggested Options:
We are suggesting the October puts. Our suggested trigger to open positions is at $95.90.

BUY PUT OCT 100 LLL-VT open interest=365 current ask $5.00
BUY PUT OCT 95 LLL-VS open interest=355 current ask $2.50
BUY PUT OCT 90 LLL-VR open interest=871 current ask $1.20

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/07 (unconfirmed)
Average Daily Volume = 936 thousand

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Whirlpool - WHR - cls: 92.77 change; -3.30 stop: 97.01

Company Description:
Whirlpool Corporation is the world's leading manufacturer and marketer of major home appliances, with 2006 annual sales of approximately $18 billion, more than 73,000 employees, and more than 70 manufacturing and technology research centers around the world. (source: company press release or website)

Why We Like It:
If the economy is headed into a recession then WHR could be in for another leg down. The stock's recent bounce attempt is rolling over and shares are developing a pattern of lower highs. Friday's move pushed shares to a new two-week low and helped the technical indicators roll over into new sell signal. We are suggesting put positions now but readers could wait and see if WHR gets a bounce and failed rally near $95 early next week. We have two targets. Our first target is the 87.75-87.50 range. Our second target is the $85.00-84.00 range.

Suggested Options:
We're suggesting the October puts.

BUY PUT OCT 95.00 WHR-VS open interest=1019 current ask $5.70
BUY PUT OCT 90.00 WHR-VR open interest= 154 current ask $3.40

Picked on September 09 at $ 92.77
Change since picked: + 0.00
Earnings Date 10/24/07 (unconfirmed)
Average Daily Volume = 1.1 million
 

New Strangles

Bear Stearns - BSC - cls: 105.37 chg: -2.30 stop: n/a

Company Description:
Founded in 1923, The Bear Stearns Companies Inc. is a leading financial services firm serving governments, corporations, institutions and individuals worldwide. The Company's core business lines include institutional equities, fixed income, investment banking, global clearing services, asset management, and private client services. Headquartered in New York City, the company has approximately 15,000 employees worldwide. (source: company press release or website)

Why We Like It:
There could be a lot of apprehension over BSC's upcoming earnings report. Will they disclose more exposure to the subprime meltdown? Are there any more hedgefunds in trouble? Whatever they announce the news could produce some big moves in the stock price. That's why we're suggesting a strangle. We're going to play the September strikes even though they expire in two weeks. Some readers might want to adjust this strategy and play the October strikes. We're suggesting readers try and open positions in the $106.50-103.50 range. BSC is due to report earnings on Thursday morning before the market opens. Considering the price of the options and our time frame (two weeks) this should be considered a more aggressive play. One idea to reduce the amount of time premium erosion we will suffer would be to wait until Wednesday to open positions.

FYI: We will probably add a strangle on LEH, which also reports on Thursday.

Suggested Options:
A strangle requires buying both an out-of-the-money call and an out-of-the-money put. We're suggesting the September strikes below. Our estimated cost is $4.40. We want to sell if either option hits $7.85.

BUY CALL SEP 115 BVD-IC open interest=4313 current ask $2.35
-and-
BUY PUT SEP 95 BVD-US open interest=6200 current ask $2.05

Picked on September 09 at $105.37
Change since picked: + 0.00
Earnings Date 09/20/07 (confirmed)
Average Daily Volume = 8.7 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Amazon.com - AMZN - close: 84.52 change: -1.69 stop: 78.95

AMZN had been out performing the markets all week long. However, it could not evade the market-wide sell-off on Friday. Shares gapped lower and dipped to $83.21 before bouncing. AMZN spent most of the day consolidating sideways and the end of day rally was encouraging. If the market bounces on Monday we expect AMZN to help lead the way higher. Our target is the $88.00-89.00 range. The P&F chart is very bullish with a $99 target.

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

Picked on September 04 at $ 80.85
Change since picked: + 3.67
Earnings Date 10/23/07 (unconfirmed)
Average Daily Volume = 9.5 million

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Eaton Corp. - ETN - cls: 91.38 change: -3.24 stop: 91.99

Fortunately, we're still sitting on the sidelines with ETN. The stock gapped open lower and after the initial decline slowly continued to sink. Shares look headed toward what should be short-term support near $90.00. Nimble traders could try and buy calls on a bounce near $90 or buy puts on a breakdown under $90. If you look at the technical indicators for the weekly chart and the daily chart it does look like the bears are retaking control. Readers may want to keep that put strategy in mind. Currently, we are still waiting for a breakout over resistance near $95 and its 50-dma. We are suggesting a trigger to buy calls at $95.25. If triggered we will have two targets. Our first target is the $99.75-100.00 range. Our second target is the $103.50-104.00 zone. Aggressive traders may want to put their stop loss under support near $90.00. More conservative traders could put their stop closer toward what should be technical support at the 10-dma around $92.50. FYI: In the news on Friday ETN announced it was realigning its business structure from four to six divisions.

Suggested Options:
If ETN hits our trigger to buy calls we would suggest the October strikes.

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/16/07 (unconfirmed)
Average Daily Volume = 1.3 million

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Intl. Bus. Mach.- IBM - cls: 115.55 chg: -2.07 stop: 111.59

We have been cautioning readers to look for a dip in IBM. The market's reaction to the jobs number pulled IBM toward short-term support around $115 and its 10-dma. We are not suggesting new positions but a bounce from here could be used as a new bullish entry point but if you do buy the bounce we would suggest a much tighter stop loss. Speaking of stop losses more conservative traders may want to tighten their stops toward our entry around $113. Technical indicators are turning bearish. Truly conservative traders may want to abandon the play now. The stock has already hit our $118-120 target range. Our second, more-aggressive target is the $124.00-125.00 zone. FYI: The Point & Figure is very bullish with a $177 target.

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

Picked on August 26 at $113.24
Change since picked: + 2.31
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

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Manitowoc - MTW - cls: 79.39 change: -1.67 stop: 74.95

MTW suffered some sharp profit taking early on Friday but traders bought the dip at $77.25. The big intraday rebound actually looks like a new bullish entry point but readers may want to wait for a new rise over $80 again before considering new positions. Readers may also want to consider a tighter stop near $76 or $77. Our target is the $88.00-90.00 range. The Point & Figure chart is very bullish with a triple-top breakout buy signal and a $103 target. FYI: MTW is due to split 2-for-1 and will begin trading at its new price on September 11th. Don't forget that for current positions your option symbols and strikes will change due to the stock split. Plus you'll have twice as many contracts at a reduced value.

Suggested Options:
If you choose to open new positions in MTW we'd suggest the October strikes.

Picked on September 05 at $ 80.25
Change since picked: - 0.86
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 1.0 million

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Transocean - RIG - cls: 108.52 change: +1.13 stop: 104.85*new*

RIG bounced right on cue for us. Traders bought the dip near short-term support around $105 and its 50-dma. The move on Friday almost looks like a bullish engulfing candlestick pattern. We alerted readers to look for a new entry point near $105. The $110 region could be short-term resistance but our target is the $114.00-115.00 range. Please note that we're raising the stop loss to $104.85, which is under the rising 10-dma.

Suggested Options:
If you choose to open new bullish positions in RIG we'd suggest the October strikes. We also suggest you read over Jim's comments on oil in the weekend wrap before considering new positions.

Picked on August 31 at $105.75
Change since picked: + 2.77
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 7.3 million
 

Put Updates

Acuity Brands - AYI - cls: 50.19 change: -1.84 stop: 55.01*new*

Friday's market weakness really weighed on shares of AYI. The stock gapped open lower at $51.30 and sank toward the $50.00 level for a 3.5% decline. The $50 mark is naturally round-number support so don't be surprised if AYI produces an oversold bounce from here. However, the stock should run into resistance in the $52.00-52.50 zone. We are adjusting our stop loss to $55.01. More conservative traders may want to use a tighter stop loss. We're not suggesting new positions at this time. 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're not suggesting new positions at this time.

Picked on August 26 at $ 52.80
Change since picked: - 2.61
Earnings Date 10/04/07 (unconfirmed)
Average Daily Volume = 536 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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Diamonds - DIA - cls: 131.52 chg: -2.01 stop: n/a

The job report number sent the market and the DJIA sharply lower on Friday. The DIA naturally followed lower and closed with a 1.5% decline. We are not suggesting new positions at this time. Our strangle play suggested using the September $137 call (DAZ-IG) and the September $127 put (DAW-UW) with an estimated cost of $2.05. We want to sell if either option rises to $3.10 or more. We only have two weeks left before September options expire.

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

Picked on August 30 at $132.57
Change since picked: - 1.05
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 20.8 million

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S&P 100 Index - OEX - cls: 677.74 chg: -11.17 stop: n/a

The S&P 100 index has produced a pretty sharp bearish reversal this past week. Last Monday and Tuesday it was soaring higher but by Friday it was negative for the week. The index might have some support in the 665 region. We're not suggesting new positions at this time. Our strangle suggested using the September 700 call (OEZ-IT) and the September 660 put (OEY-UL) with an estimated cost of $14.30. We want to sell if either option rises to $21.45 or more. Considering these prices we probably need to see a move into the $705-710 range or the $655-650 zone to be profitable.

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

Picked on August 30 at $680.46
Change since picked: - 2.72
Earnings Date 00/00/00
Average Daily Volume = 1306 thousand
 

Dropped Calls

Ceradyne - CRDN - cls: 69.20 change: -1.42 stop: 68.49

The action in CRDN last Friday is very bearish. The stock broke down under what should have been support at $70.00 and its 100-dma. The midday rebound attempted failed near $70, which is another bearish sign. The stock did find support near $68.75, which was the previous week's low. This does provide some hope that if the markets bounce on Monday that CRDN will bounce with them. However, we are going to suggest an early exit now. More aggressive traders may want to stick it out and see if CRDN can rebound.

Picked on September 02 at $ 72.27
Change since picked: - 3.07
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 714 thousand

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Millicom - MICC - cls: 79.76 change: -0.96 stop: 79.90

The bullish breakout on August 31st proved to be a trap. The stock reversed course under technical resistance at the 50 and 100-dma. This past Friday the stock broke down under the $80.00 mark and hit our stop loss at $79.90. We did warn readers more than once that conservative traders would want to wait for MICC to clear that resistance at the moving averages. We'd keep an eye on MICC. A drop under $77.50 could be a bearish entry point forecasting a fall toward $70 or worse.

Picked on September 04 at $ 85.25
Change since picked: - 5.49
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 789 thousand
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

If It's Too Good to Be True

Last week, I discussed the way I might go about studying charts when deciding what might happen to prices. How would I put that into practice when making decisions about investments? I can show you with a real-life example of when I decided against an investment, at least.

Here's the setup. From November through early January, several experienced fellow traders talked to me about their high-yield investments. These weren't neophytes in the trading world and the money they were making wasn't chump change. They had done their due diligence, studying charts, newsletters, books and fund ratings. I should try this category of investments, several urged. I could make dividends of 10-15 percent and participate in gains in the underlying, too.

I bought a book. Wincing at the title and the hyped-up if easy-to-read prose style, I made my way through the evangelizing first chapters into the meat of the book. These investments weren't fly-by-night bulletin-board type stocks, the book assured me, but "bond equivalents" that were "too good to pass up." They were "backed by strong underlying businesses." They would "really shine in tough times." These were investment grade entities, a former trading mentor told me, rated investment grade by Moody's and S&P.

You know where I'm going with this, don't you? Lately, we've been hearing a lot about securities rated investment grade by Moody's and S&P being subsequently downgraded. These high-yield investments included some terms and names we've heard mentioned on television this last year, not always in positive terms. For example, does New Century Financial ring a bell?

Annotated Daily Chart of New Century Financial

REITS weren't the only recommended high-yield investments to suffer. New taxes on Canadian income trusts late in 2006 adversely affected Canadian Business Trusts, a category of high-yield investments that were suggested as potential investments to be investigated in the book.

Annotated Chart of Precision Drilling Trust

So what saved me from jumping into one of these investments?

Most importantly, I didn't always understand them. They were packaged-up things. Like Warren Buffet, I want to understand a company or security, particularly if it's a long-term investment, and the book proposed these as long-term investments so that one could continue collecting those high yields. I knew what a convertible security or closed-end fund was, but I didn't know what an IDS (Income Deposit Security) was, and I didn't understand what could go wrong with a MLP, a Master Limited Partnership. I needed more time to investigate. By the time I investigated, some of the Canadian Business Trusts were already rolling over, and I was alerted that I would need in-depth research before putting my money at risk.

Another reason I hesitated? Volume wasn't large enough in some of these securities. Years ago, I had often traded the XAU's options but had given up trading them after I'd once been unable to exit in a fast-moving market. The volume was so low in these options that I was at the mercy of the market maker, and I think someone had to go hunt up that market maker from wherever he was having his lunch before a decision could be made. I didn't like trading low-volume stocks or options, and I didn't think I wanted to trade low-volume high-yield securities, either.

Annotated Daily Chart of Gabelli Utility Trust (GUT)

In addition, I saw some chart characteristics that worried me. Last week, my Trader's Corner article covered some of the processes I go through when considering a play, either an investment in a security or its options or some other tactic. Those were the same processes I employed when studying these investments.

Since New Century Financial (NEW) was one of the securities I had studied, let's look at what might have been visible on that chart back in late 2006 and early 2007, before NEW imploded.

Annotated Daily Chart of NEW:

I never saw that low-volume test of the mid-channel support that I had wanted to see. Such a test and volume pattern would have indicated that there was no more supply to be absorbed, and I would have then expected a subsequent bounce up through the channel. Instead, by the right-hand side of the chart, I had seen an instance when NEW attempted to bounce back above $32.00 on a strong-volume day, only to be knocked back by the end of the day and to close lower the next day. NEW was still being sold on bounces and sold more heavily than it had been in a while at resistance tests.

Meanwhile, the Keltner charts that I prefer and discussed last week were revealing even more troubling information.

Annotated Weekly Chart of NEW:

To sum up, my unfamiliarity with the securities and how investments in them might go wrong, my dislike of involvement in low-volume securities and some chart characteristics saved me from jumping into investments that wouldn't have worked well.

Does that mean that these high-yield investments are all bad and that the book's author and my trading friends were all wrong? No way.

Some of the potential investments detailed in that book and chosen by my trading friends have weathered the current market volatility quite well. One tanker stock I checked is now almost double its 2006 closing price, and both the book and one of my trading friends specifically suggested this tanker's stock. In addition, the book's author advises all the appropriate measures before investing in these high-yield securities: research, starting small, diversifying, limiting exposure to a particular security to five percent of the portfolio, and evaluating securities periodically with a goal of weeding out poor performers.

The author also warned that investments were chosen for their yields as well as their possible price appreciations and that some volatility should be anticipated. Although appropriate stops should be set, these weren't investments that would be actively traded.

Although deciding against NEW late last year and early last year didn't require an extensive knowledge of technical analysis, the process discussed in last week's Trader's Corner article did help me avoid a few investments I'm glad I didn't take.

Now I'm going to go back and study the rest of those suggested types of securities to see how they weathered the credit crunch, looking at their charts, learning what I can, seeing if they still look too good to be true.
 

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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