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Daily Newsletter, Wednesday, 09/26/2007

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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

Accumulation or Distribution

The market for the past week has been a little choppier than usual and when that happens at the high of a move it always prompts the question about whether price action is showing accumulation or distribution. Guess right, and trade that way, and you will probably make some good money. Guess wrong and you had better be using stops.

Oftentimes at market tops and bottoms you'll see the market churning a lot. Rounded bottoms are bullish and rounded tops are bearish as inventory is accumulated by large funds at bottoms and distributed at tops. So when we see the kind of chop we've seen lately, including the whole bounce from the August low, we're left wondering if this is indicative of some larger accumulation plan (buying the dips) or distribution plan (selling the rallies). Unfortunately this is better recognized in hindsight and I've yet to perfect that trading technique.

One way to help figure it out is to look at market breadth. When the market is making new highs you'd like to see broad participation with strong advance-decline numbers, new 52-week highs vs. lows, volume, etc. When we see bullish divergences at lows or bearish divergences at highs then we know we should be preparing for a reversal. As traders we look for reversals and therefore their advance signals. Many trade momentum but unless you've got a real solid trend in progress we've seen lately that momentum is fleeting at best. Spread traders do well when there isn't momentum and the last couple of years have favored spread trading (that could change and last month was hard on a lot of them).

This year's highs have been marked by a lot of bearish divergences--new price highs have tended to be accompanied by weaker market breadth. This hasn't always helped pinpoint tops but it does give us a heads up for a potential reversal. That was true at the February and July highs this year. Now as the market approaches or in some indices passes the July highs we are again checking the pulse of the market and listening to the heart beats to see if it's strong and healthy. I'd have to say I hear a bit of a heart murmur in there and has me thinking the patient may be sicker than it looks on the outside.

I'll discuss that a little more below but first the economic reports:

Economic reports
It was a quiet day today with only the Durable Goods report having the power to move the market. Even though it was not a good report the market wanted to rally anyway. The Crude Inventories report helped drop crude prices a little.

Crude Inventories
There was an unexpected rise in oil inventories and that was credited for the drop in the price of oil today. The Energy Dept reported crude supplies rose for the first time since mid-August, up +1.8M barrels to 320.6M. Analysts had expected a drop of -2.15M barrels so that was a swing of almost 3M barrels to the plus side from expectations. However that increase is only a small reversal of the 18.3M barrel drop over the previous four weeks.

Gasoline demand has weakened and supplies climbed +600K barrels to 191.4M. API's data showed a larger increase of +1.0M to 199.1M. Refiners are now demanding less crude to be converted to gasoline and other distillates so that has helped increase the crude supplies. Distillate stocks also rose, up +1.6M barrels to 137.1M (but API showed a drop of -1.9M). Refinery capacity dropped sharply from 89.6% to 86.9%.

Some interesting data from gasoline vs. distillate demand verifies that the economy is slowing even if the consumer has not (yet). Gasoline demand is up about +0.4% year-over-year but distillates (which include diesel fuel) dropped -1.2%. Jet fuel demand is down -1.9%. So the lower demand for distillate fuels indicates less demand for shipping (truck and air) which supports the other indicators that we're getting of an economic slowing. A weaker economy will likely mean lower commodity prices in the near future, including oil.

Durable Orders
The durable goods number dropped sharply by -4.9% in August after a +6.1% gain in July. The orders component for new aircraft is swinging the total number more than usual. Excluding the -11.2% drop in transportation goods orders for July and August shows a drop in new orders from a gain of +3.4% in July to a drop of -1.6% in August. Shipments for durable goods also dropped, down -1.6% in August which as the largest drop in eleven months. Businesses also reduced their orders for capital equipment, a sign of economic weakening, by -0.7%.

The stock market rallied on the news. Go figure. We of course can guess what market participants are thinking--a weak economy must be good for the stock market because it means the Fed can get more aggressive about lowering interest rates. This is such hogwash and belies the truth about what's happening, and will happen to the market, but don't argue with it when it goes against fundamentals (it's why I insist you can't trade the market from a fundamental perspective, except for perhaps very long term swings). Instead understand the obtuse logic it sometimes uses for doing what it does. Only later will the facts prove how stupid the market really is (personal comment not shared by many).

The longer term view of the market in a slowing economy should be very clear--it's bearish. A slowing economy means slowing businesses means layoffs means lower consumer spending means fewer products/services purchased means lower corporate earnings means lower stock prices. Show me the illogic in this argument and I'll gladly buy you a cup of coffee (the limit of my betting). A slowing economy will always have the Fed lowering interest rates in an attempt to re-prime the economic pump by making credit cheaper and more available (whether people do anything with easier credit is the real issue).

So when the Fed starts to drop interest rates it is mind boggling to me that the market thinks this is bullish. It's usually good for short term bursts higher (why, I have no clue) but it's always bearish longer term. Charts like this one bear this out:

SPX weekly chart, 2000-2007

I showed this chart about a month ago which has been updated through today's price. After the market peaked in 2000 and the economy headed south the Fed stepped in and started aggressively lowering interest rates. Greenspan was trying to flood the market with liquidity, which he did and those who get hurt in the collapse of the housing bubble can thank him for that. But those 12 rate cuts between January 2001 and June 2003, so over 2-1/2 years, did not give us a stock market rally. Bursts higher following rate cuts were followed shortly thereafter by stronger selloffs.

Just the opposite happened after 2003. As the market strengthened the Fed started removing their "accommodation" but the market kept rallying because the economy was getting stronger. And therein lies the message--follow the economy and not the Fed (since the Fed also follows the economy). Understand we'll see short term bursts higher, like we're seeing after the last FOMC meeting and the rate reduction, but don't get sucked in thinking the brief period of euphoria is going to last. It is a gift presented to you to get out of your long positions. Bow and say thank you (like your mother taught you) and exit your long positions. You will have another opportunity to put that money to work later (but first use a little of it on the short side).

With the Fed and other country's central bankers flooding the monetary system with liquidity there's been a lot of speculation as to how bullish that will be in several areas. I've mentioned the stock market--many believe the added liquidity will inflate most assets and that's generally the reason that many traders position themselves for the coming rally. It's when the rally fails that these new buyers suddenly jump ship and cause the big selloffs.

Re-inflating the economy is the goal of the central bankers (which is like giving a junky more crack so he feels better, but usually only crashes harder later) and the result is traders think the result will be either inflation of assets and/or higher economic activity. After all, that's what the extra money is being pumped into the economy for--banks lend it out and the credit expansion continues. So traders rush to buy those assets they feel will do better with inflation (stocks, commodities) and dump that which will not do well with inflation (the US dollar).

But a funny thing happens in a period of credit contraction--the central banks aren't in charge, the market is. So when they try to pump extra liquidity into the system the bankers are afraid to lend it out and the credit contraction continues. It's why I've been saying when it comes time for the Fed to try to re-inflate the economy they will be pushing on a string.

I came across an interesting chart in an article by GaveKal in one of John Mauldin's recent newsletters. They talked about the velocity of money (meaning velocity of money growth) and showed this chart:

GaveKal Velocity Indicator,

As GaveKal pointed out in their newsletter, buyers of gold and oil (and sellers of the US dollar) have been focused on the idea that the extra liquidity push by central bankers is going to inflate the money supply (in other countries as well, not just the U.S.) and that it will be good for commodities (bad for the US dollar). But they're failing to realize that the Fed and other central bankers don't control the money supply. The market does. If credit is not created through the aggressive lending practices that led us to where we are today then the central bankers couldn't possibly create enough new money to compensate (not without creating hyperinflationary problems).

And the chart above shows the velocity of money growth is now in negative territory and has been trending down since 2006, just as it did from 1999 to 2002. The central bankers know this and have been attempting to plug the dike by dumping helicopter loads of cash into the market. The stock market followed the money in 2000-2002 and it's very likely it will do the same thing again this time. And the sharp spike up in commodities (such as gold and oil) will very likely get reversed quickly once traders realize what's happening (the EW count I've shown on gold the past couple of weeks supports the idea that the gold rally will likely fail hard).

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Banks have recently been forced to buy back many of the loans they were hoping to farm back out to investors. Having these loans back on their balance sheets has taken a lot of cash out of the market place. This will force banks to severely curtail further lending as they will literally have run out of money to lend. The credit collapse is likely in the very early stages.

The problem has become one of fear instead of greed. Investors are now fearful of taking on debt instruments that they don't know or understand. They don't want to see their investment turned to dust. Therefore much of the commercial paper (short term collateralized loans between banks and corporations) that is coming due will end back on the banks' balance sheets.

Today started the Congressional inquiry into the ratings agencies (Moody's, Standard & Poor's and Fitch) and how "they let this happen." First they will be accused of rating everything AAA or AA when it was in fact at best BBB, and then they will be accused of the credit collapse when they started downgrading these investment-grade assets to something less than. They're in a can't-win situation and out of this will come more onerous legislation and fearful bankers and ratings agencies. To think that lending will suddenly become easier out of this mess is to not recognize reality. Like I said, I hope the string that the Fed is pushing on is a stiff one.

Let's see where we are on the chart:

DOW chart, Daily

The rally pattern for the DOW would look better with another push higher. The past week's consolidation looks bullish for another rally and the parallel up-channel for price action since the August 16th low supports another high above 14K. Price even found support at the mid line of the up-channel on Tuesday's pullback. The very short term pattern of the rally off Tuesday's low shows a small 5-wave move and therefore leaves open the possibility that Wednesday's high completed the rally. Therefore any break back below Tuesday's low would be a heads up that something more bearish may have begun. It takes a break below 13400 to put the bears back in the driver's seat and I suspect we'd see the DOW struggling to hold onto the 13K level for October opex.

But as long as Tuesday's 13696 low holds then I'd continue to buy the dips (scalp trade only) for a run up to a target zone of 14K to 14200. Then it would be time to get short for a large decline from there.

DOW chart, 60-min

The corrective wave structure the past week leaves open several possibilities and without trying to make it too complicated that's what I'm trying to show on the 60-min chart. The more immediately bullish possibility (in green) is that Tuesday's low finished the pullback and now we're seeing the next (and should be last) rally leg that will take the DOW above 14K. It's possible we're seeing a larger sideways consolidation that is forming an expanding triangle (shown in pink) which calls for another leg down inside the pattern to finish it. It should stay above 13600 in that case and from there we'd get a strong rally leg to potentially the 14200 area. This scenario would likely have the DOW finishing October opex in the 13500-14000 area.

The more immediately bearish scenario (dark red) calls Wednesday's high as the end of the 5-wave run up from Sept 10th. The rally from Tuesday's low counts well as a small 5-wave move for the 5th wave (wave-(v) on the chart). The bulls do not want to see the DOW back below 13780 in any pullback from here otherwise it would likely mean we're either on the pink or dark red price path. As noted by the negative divergence shown on RSI, this is either bearish with the 5th wave bearishly divergent against the 3rd wave (as it should be) or else the oscillators have been resetting themselves with time instead of price (which would be bullish). That's why a break below 13780 would be potentially bearish.

SPX chart, Daily

Some Fib projections based on the wave relationships in the move up from the August low point to 1548-1567 as a target zone for the rally by early next week. From there it should be a steep selloff through October. A drop below Tuesday's 1507 low would be more immediately bearish and a break below 1489 would have the bears in control.

SPX chart, 60-min

It's possible SPX finished its last leg up with a truncated finish (lower price high) but that's usually best identified in hindsight. At least the DOW has made a new price high. But that's why a drop below Tuesday's low would be bearish. Until that happens I see the possibility for a retest of the July high before this is ready to turn back down.

Nasdaq-100 (NDX) chart, Daily

NDX looks like it could be forming a bearish ascending wedge for its bounce off the August low. That's speculation at this point since we don't yet have a tested trend line across the highs but today's doji star finish has the potential to form an evening star if it closes down on Thursday so we have a heads up for a potential reversal at today's close. NDX is also up very close to the top of its parallel up-channel from July 2006 which is where price was rejected in July. There is the possibility we'll see a choppy pullback and then one more push higher into early October (pink) which gets slightly above 2100. That would be an excellent short play setup if it happens. In the meantime the bulls don't want to see NDX below 2032 and a break below 2050 would be a bearish heads up (down).

Nasdaq-100 (NDX) chart, 60-min

The dark red wave count calls Wednesday's high as the end of the rally. If we do get a pullback on Thursday then it will be important what form it takes. If it's a choppy pullback with overlapping highs and lows then it would be pointing to a pullback that will lead to another push higher (pink). A stronger impulsive decline that breaks the uptrend line from August 16th, currently near 2030, would be a strong signal that we've seen the high.

Relative Strength chart of NDX vs.COMPX, Daily

The NDX has been outperforming the COMP ever since the July 2006 low and that's been a good thing in some respects. You want to see the generals out there leading the troops. But if and when the generals tuck tail and run then we will probably see the COMP fall right in behind. So it'll be important to now start watching the NDX vs. the COMP relative strength chart.

Remember, the RS chart simply shows who's outperforming who. Both could be heading down but if the COMP is selling off faster than the NDX then this chart would continue to show a higher move for the RS line. The current move up has poked above the trend line along the highs since July 2006 but notice the bearish divergence against the current high.

This tells us the generals are getting tired and the next likely move will be down. In my opinion that will be a bearish signal even if the market heads slightly higher first. At that point I would become more confident in finding a market top based on the EW count, but not yet.

Russell-2000 (RUT) chart, Daily

Like the DOW and SPX it looks like the RUT could give us another poke higher before finding stronger resistance in the 825-830 area. If it rallies up to that level then I'll be watching closely for failure as an opportunity to short this index. If the RUT breaks down below 796 it would be a heads up that something more immediately bearish is happening but it takes a break below 775 to confirm it for the bears.

Russell-2000 (RUT) chart, 60-min

Wednesday's dip held the uptrend line from last week's low so any break of that uptrend line would be the first sign of bearishness. Otherwise I'm looking for another (and potentially last) leg up to the 830 area.

NYSE (NYA) vs. Advancing-Declining Volume chart, Daily

The Advancing Volume - Declining Volume for the NYSE continues to be a good example of the lack of market breadth for the rally off the August low. As price has pressed higher the market is getting weaker. The rally is being confined more and more to fewer select stocks and it's often a very good heads up that the rally won't last. It's certainly not indicative of a new bull market leg but instead the sign of either a correction or the last leg of a bull market.

BIX banking index, Daily chart

The very choppy pattern since the early August low is either an extremely bullish pattern with price about to explode to the upside or else it is a correction of the previous decline. Considering the difficulties the banks are facing with the credit crunch, lack of funds and lack of revenue generation, I have a real hard time believing the first possibility. That leaves it more likely as a correction. The correction is either over, having completed it at the September high or it has one more leg up (pink) to finish it. A break below 350 would confirm the next leg down is already underway (dark red).

U.S. Home Construction Index chart, DJUSHB, Daily

As I had projected last week the home builders continued their descent after testing the top of the parallel down-channel on the September spike up (just like in August--bear market rallies typically look just like those two spikes). But the index could be nearing the end of their strong selloff and could consolidate for a longer period of time before heading lower again. In other words the selling may be temporarily exhausted soon. Support might be found near 340 to be followed by a larger sideways/up correction over the next month or so.

The monthly chart though shows more downside before potentially finding support:

U.S. Home Construction Index chart, DJUSHB, Monthly

The bottom of the longer term parallel down-channel is closer to 250 (also the 2002 low) so another 100 points lower (another 30% haircut). From there it could get the slightly larger sideways/up consolidation into the end of the year before finding a final low early next year just below 200 (the 2001 low). The wave pattern would then call the pullback complete and the selling in the home builders would likely be finished.

I don't think that will be the bottom in the housing market but all the bad news for the builders will have been flushed out by then. It'll probably be a long period of recovery for the builders and not necessarily a good investment (dead money for a while) but nor will it be a good short. By then we should have better shorting candidates to choose from.

Oil chart, December contract (CL07Z), Daily

The December contract never made it as high as the October contract but it did manage to tag the top of its parallel up-channel and has since broken its steep uptrend line from the August low. I maintain my stance that commodities and stocks will sell off together. If oil has topped and is starting back down, which this chart says is a very good possibility, then stocks should not be far behind. The wave pattern of the oil rally from January 2007 is a correction to the decline from the 2006 high and as such should mean we'll see oil decline below 55, potentially much lower (lower demand from a slowing global economy).

Oil Index chart, Daily

Oil stocks have not broken their steep uptrend line from the August low, as oil has done, and it didn't leave any bearish divergences at its last high. This points to the possibility that we'll see those stocks push to a new high before topping out. It takes a break below 787 to say a top is in and down with oil it will go.

Transportation Index chart, TRAN, Daily

The transportation sector has been flashing all kinds of signs about the economy slowing down and the lack of participation in the bounce off the August low tells us this sector is probably in trouble. The choppy pattern off the August low says "correction" all over it. Whether it gets one more push back up (pink) or drops from here (dark red), the next major move should be to new lows.

U.S. Dollar chart, Daily

People all over the world are ready to dump and spit on the US dollar. Even Greenspan dissed our dollar. When you're that unloved you know you've hit bottom. It's time for rehab for the US dollar and it should work (as opposed to Britney Spears and Lindsay Lohan). By tagging the downside Fib projection at 78.28 (two equal legs down from November 2005 for wave-(b) on the chart). But the dollar bulls need to step in now (and dollar bears be willing to take some profits) and drive the dollar back up above 79.50 to give it a buy signal (from the throw-under below its descending wedge pattern.) The weekly chart continues to show bullish divergence at the new low.

Assuming the dollar starts to rally it will be a sign of recognition by many that the Fed is not being successful in re-liquidating the monetary system which is what I continue to expect will happen. That would also get many gold bulls to dump their long positions that they scrambled into in the last month with the expectation that the Fed will reignite inflation.

Gold chart, December contract (GC07Z), Daily

The rally pattern in gold would look best with another push higher, especially if it can manage to tag the top of its parallel up-channel from September 2006, currently near 756. Two equal legs up from September 2006 would have gold tagging 771.40 but I'm not so sure that will happen. I don't even know if it'll make another run higher but that's the upside potential. The A-B-C move up from September 2006 (for wave-(b) on the chart) should be the completion of the correction to the 2006 decline and set up a strong decline as the next big move.

Results of today's economic reports and tomorrow's reports include the following:

Thursday will be busier than Wednesday as far as economic reports go but there's not a lot there that will be market moving.

SPX chart, Weekly

The weekly MACD looks bullish here having turned firmly back up and that certainly supports a continuation higher from here. But MACD is a lagging indicator and at this point is merely reflecting what price is doing. RSI continues to show some negative divergence as price presses back up near the July high. I continue to post this chart to show the downside projection for the next leg down (near 1239 currently) but so far there's nothing bearish about this chart--nice solid up-channel with no indication that the rally is ready to end.

The shorter term charts warn of that possibility but recognize the fact that we're still in a strong up trend and trying to short this market is trying to catch rising knives. That strong spike down into August and now strong spike back up has done some real damage to both sides as traders get whipped around and stopped out. It's been a very difficult trading environment so continue to trade cautiously--smaller positions, slightly wider stops in an attempt to avoid some of the whiplash moves, and don't let the market move too much against you. Stay disciplined.

I've provided some key levels for the various indices to keep an eye on to let us know whether the rally will continue, where the bears may be taking over and where to look for the next shorting opportunities. We are in the middle of a very vulnerable period for the market and downside surprises are very much a real possibility. For that reason alone I'm reluctant to recommend any long plays and only for those able to watch the market all day. Carrying a long overnight is an unnecessary risk in my opinion. There will be better and safer times for that.

Market participants have positioned themselves for what they think is going to be a bullish market based on misperceptions about what the Fed is doing for the market. When they discover that the Fed can't do and isn't doing what they thought then they'll bail from their positions in a heartbeat. I have no idea what will trigger the selling and obviously don't know for sure that it will. But the odds, and history, suggests the current rally will not last much longer. And the next leg down, from an EW perspective, could be a doozy. I'd like to at least have a small short position to take advantage of the move. The tough part has been finding an entry that'll stick. Just need to keep trying while keeping the bleeding under control. Be careful out there...
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Broadcom - BRCM - cls: 36.58 change: -0.34 stop: 33.95

BRCM pierced resistance at the $37.00 level on an intraday basis but couldn't hold it. Shares look like they need to regroup and build up another head of steam to try again. We would expect a dip toward the $36.00 level soon. Meanwhile both BRCM and rival QCOM have seen upward trends the last few weeks but it looks like QCOM is outpacing BRCM. Our BRCM target is the $39.85-40.00 range. The Point & Figure chart is bullish with a $49 target. Please note that we do not want to hold over the mid October earnings report.

Picked on September 12 at $ 35.85
Change since picked: + 0.73
Earnings Date 10/10/07 (unconfirmed)
Average Daily Volume = 11.0 million

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Citigroup - C - clos: 46.55 change: +0.24 stop: 45.65

C is trying to bounce from the $46.00 level. The afternoon spike higher in C on the BSC news (see our BSC update) looked like a new bullish entry point to buy calls on C. Unfortunately, shares of C gave back most of its late afternoon gains with a failed rally near $47. We would stay defensive here. Meanwhile on CNBC today we heard one analyst say he liked C as a bullish candidate but suggested waiting for a pull back after the stock's run up on the Fed's rate hike news. Um... we'd like to let him know that C has already pulled back from its FOMC rate cut spike higher. Considering the stock's relative weakness the past few days readers might want to tighten their stops toward $46.00. Our initial target is the $49.85-50.00 range but we might decide later to add a more aggressive target at the 200-dma. Please note that we do not want to hold over the October 19th earnings report.

Picked on September 16 at $ 46.64
Change since picked: - 0.09
Earnings Date 10/19/07 (confirmed)
Average Daily Volume = 40.7 million

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Ceradyne - CRDN - cls: 76.01 change: +1.50 stop: 71.74

CRDN continues to show relative strength. The stock just broke out to a new two-month high and pushed through potential resistance near $75.00. Our only concern would be the lackluster volume on this rally. We would still consider positions here or on a dip in the $74-75 zone. Our short-term target is the $79.50-80.00 range. The P&F chart is bullish with a $92 target.

Picked on September 25 at $ 74.61
Change since picked: + 1.50
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 653 thousand

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Intl. Bus. Mach.- IBM - cls: 117.30 chg: +0.79 stop: 113.90

IBM is still churning sideways but the action was generally positive today. The stock is struggling with the $118 level overhead. We would not suggest new positions at this time. 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. We do not want to hold over the mid October earnings report.

Picked on August 26 at $113.24
Change since picked: + 4.06
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

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L-3 Comm. - LLL - cls: 102.47 chg: +1.51 stop: 95.99

LLL is off to a good start. The stock rose 1.49% following yesterday's bullish breakout. Shares are now challenging resistance in the $102.50-103.00 range, which we incorrectly identified yesterday as resistance near $105 with the July and August highs. Today's rally in LLL has produced a new triple-top breakout buy signal on the P&F chart with a $115 target. Our target is the $107.50-110.00 range.

Picked on September 25 at $100.96
Change since picked: + 1.51
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 904 thousand

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Lockheed - LMT - cls: 105.72 change: +0.76 stop: 98.99

LMT rallied to an intraday high of $107 and is challenging the July all-time high just over $107. LMT's rally might look a little bit tired so don't be surprised to see a dip back toward $104 or its 10-dma around $102. Our target is the $109.50-110.00 range. More aggressive traders may want to aim higher. The P&F chart points to a $117 target. We do not want to hold over the late October earnings.

Picked on September 24 at $103.81 *gapped higher
Change since picked: + 1.91
Earnings Date 10/24/07 (unconfirmed)
Average Daily Volume = 2.7 million

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Stryker - SYK - cls: 67.90 change: +0.23 stop: 65.90

Shares of SYK looked asleep today. The stock barely moved. We're sticking to our plan, which calls for a trigger at $70.65 to open positions. If triggered at $70.65 our target is the $74.90-75.00 range. Given the length of SYK's consolidation we would actually aim higher, maybe the $77.50-80.00 range, but we don't have much time and plan to exit ahead of the mid October earnings report. The P&F chart is bullish with an $83 target.

Picked on September xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/17/07 (confirmed)
Average Daily Volume = 1.4 million

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Terex - TEX - cls: 87.73 change: +1.23 stop: 79.99

TEX rose another 1.4% following yesterday's bullish move. Shares continue to look strong and we don't see any changes from our Tuesday comments. The P&F chart is very bullish with a $100 target. We're suggesting bullish call positions now with TEX above $85. There will likely be some resistance near $90 but our target is the $94-95 range.

Picked on September 25 at $ 86.50
Change since picked: + 1.23
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 1.8 million

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Whole Foods - WFMI - cls: 47.97 change: +2.25 stop: 42.49

Thankfully we did not have to wait very long for WFMI to breakout over resistance at the $46.00 level. Contributing to WFMI's rally was some positive analyst comments and an "out perform" rating. The breakout over $46 sparked some short covering and bargain hunting. Our suggested trigger to buy calls was at $46.26 so the play is open. The intraday high today was $48.98. Our first target is the $49.75-50.00 range. Our second target is the $52.50-55.00 zone. We do not want to hold over the early November earnings report. We're suggesting a stop loss at $42.49 but it looks like readers might be able to get away with a stop much closer around $44.00.

Picked on September 26 at $ 46.26
Change since picked: + 1.71
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 3.2 million
 

Put Updates

Alexander & Baldwin - ALEX - cls: 49.06 chg: +0.09 stop: 52.01

The action in ALEX today sort of looks like a bearish failed rally pattern under $50.00, which would be a new entry point for puts. However, before you jump into a new play on ALEX we would probably wait a little while after shares open tomorrow to see how the first hour of trading pans out. We didn't see anything specific in the news today but shares of ALEX were trading higher after hours around $49.50. The P&F chart is already bearish with a $36 target. There is some support near $47.50 but we're aiming for a decline into the $45.50-45.00 range. We do not want to hold over the late October earnings.

Picked on September 23 at $ 49.50
Change since picked: - 0.44
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 337 thousand

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Cephalon - CEPH - cls: 72.45 chg: -0.01 stop: 74.25

Be careful with CEPH. Shares were consolidating sideways above support near $72.00 and the stock suddenly spiked lower to $71.05. Fueling the move was news that the FDA had issued a public health advisory warning on CEPH's cancer pain drug called Fentora. Normally, one might think that when the FDA has to issue a public notice about the risk of fatal overdose that we might see a bigger move in the stock price. Unfortunately, shares of CEPH bounced back and continued sliding sideways above support near $72.00. Our bearish play is now open since the suggested trigger to buy puts was at $71.70 but we would wait for a new decline under $72 before considering new positions. Our target is the $68.00-67.00 range. More aggressive traders could aim for the $65 region. The P&F chart is very bearish with a $50 target.

Picked on September 26 at $ 71.70
Change since picked: + 0.75
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 1.5 million
 

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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Dow Jones Industrial Avg. - DJX - cls: 138.78 chg: +0.99 stop: n/a

Wednesday was another bullish day for the DJIA and the DJX but we need to see further gains before this strangle will turn positive. We are not suggesting new positions on the October version of our strangle. The options listed for our October strangle were the October $137 calls (DJY-JG) and the October $132 puts (DJW-VB) with an estimated cost of $4.75. We want to sell if either option hits $6.75.

Picked on September 16 at $134.43
Change since picked: + 4.35
Earnings Date 00/00/00
Average Daily Volume = million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

Bear Stearns - BSC - cls: 123.00 chg: +8.76 stop: n/a

Target achieved. It was a big day for BSC. The stock was already in rally mode with a rise to the $120 level this morning. The gains had begun to fade and then late this afternoon the New York Times broke a story that Warren Buffett was in talks to buy a 20% stake in shares of BSC. This news sent the entire financial sector higher. Shares of BSC spiked to an intraday high of $128.00. The call side of our October strangle, the October $115 call (BSC-JC), hit an intraday high of $14.90. Our estimated cost for the strangle was $9.50 and we suggested that readers exit if either option hit $14.00. Meanwhile back to the news story...Warren Buffett was not the only investor mentioned as a potential player in BSC. The article also said that Bank of America (BAC), Wachovia (WB) and two different Chinese firms were all in talks with BSC about a possible minority stake. After the initial reaction in the stock price and the financials began to fade there was a rush of reporters who came out stating their opinions that Mr. Buffett was probably not a buyer in BSC at current levels and that this sort of deal doesn't fit his profile.

Picked on September 09 at $105.37
Change since picked: +17.63
Earnings Date 09/20/07 (confirmed)
Average Daily Volume = 8.7 million
 


Trader's Corner

Waving a Flag

Upside targets suggested by Bull Flag patterns

Last week, I wrote a bit about one chart pattern that was suggesting not only some further upside potential ahead, but also Index price targets based on a 'measuring' implications of a 'flag' formation. The Index I used as an example, the S&P 500 (SPX), has so far not turned out to be the one surging ahead however.

The surging ahead honor goes to the Nasdaq 100 (NDX), which has been quite strong lately, outperforming the S&P. As it seems unlikely that the S&P 100 (OEX) won't follow at some point, I'll speculate on what would be the upside objectives IF the OEX, the Dow (INDU) and even the quite far behind Russell 2000 (RUT) were to break out to the upside as NDX has done. INDU just managed today a bullish upside breakout and close just slightly above the high end of its recent sideways consolidation.

FLAG PATTERNS

A sharp run up (suggesting a 'flagpole'), that is followed by backing and filling in a relatively narrow price range represented by an upper and lower dotted line drawn across these highs and lows, creates a sideways or downward sloping formation looking much like the outline of a flag as seen below. This type bull 'flag' formation often represents a consolidation before a next up leg.

There is a price objective or a measuring implication WHEN the upper end of the flag is pierced (the 'breakout' point) within a few days: a second leg up often ends up equaling the height of the first advance (the 'flagpole') as measured from the upside breakout point. The chart picture presented by the Nasdaq 100 (NDX) below illustrates (1) the rally potential implied by a 'bull flag' pattern once prices pierced the upper end of the outlined flag and (2) the further upside potential (to 2128) by the second rally at least equaling the first. The thick light blue line (X) is the flagpole. The doted lines enclose the sideways consolidation that followed, the so-called flag.

Adding the distance carried by the first advance (the flagpole) to the upper end of the sideways flag, given the move above it, is suggested by the dotted line ('Y') ending around 2128. This pattern suggests that the advance of X may at least equal the projected subsequent advance of Y. Stay tuned on whether there is at least that much rally potential ahead in NDX! So far so good; imagine tech leading the market higher again.

To complete the possibilities of flag patterns, a BEAR flag and the opposite of a bull flag, starts with a sharp decline followed by a sideways move of a few days at most and having a narrow price range, which is then followed by a second decline that carries to new lows and winds up falling (at least) the distance carried by the first downswing.

Following the same bull flag pattern outlines below EXCEPT that the lower line was cut through by yesterday's low, making the 'flag' a bit irregular, that low nevertheless feels like part of a bullish consolidation as support was found precisely at the prior (13696) high; resistance once broken 'becoming' support later on. Today's strength in the Dow 30 (INDU) created a high and especially a Close that has pierced the upper end of the recent flag consolidation.

If we add the distance of the flagpole (X) to today's breakout point (the upper end of the flag), a new potential up leg ('Y') would extend to 14322 and becomes a possible rally objective. Of course, the big IF is whether INDU can achieve a new all-time high by piercing its 14022 July top. I think the potential is there for that based on the bullish chart pattern we're seeing.

WHAT IF ...

What if the S&P 100 (OEX) followed the lead of the Nas 100 and achieved a decisive upside penetration above the top end of ITS flag pattern, currently intersecting around today's high at 716? Such action could then suggest upside potential implied by the bull flag pattern to 744. Of course possibly tough resistance implied by the prior 720 high has to be overcome, but substantial OEX upside potential above that is a possibility suggested by the chart.

The laggard Russell 2000 (RUT) has potential on a bullish breakout above 810, at the upper end of the downward sloping flag consolidation, to rally to and through the 835 resistance I project beyond 820 and then to go on and challenge its 856 high based on the bull flag projection. A big stay-tuned on this possibility! Well, the small to mid cap RUT stocks used to be a favorite investment theme!!

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for my answer or feedback to Click here to email Leigh Stevens support@optioninvestor.com with my name ('Leigh Stevens') in the Subject line.

GOOD TRADING SUCCESS!
 

Today's Newsletter Notes: Market Wrap by Keene H. Little, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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