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Daily Newsletter, Tuesday, 10/09/2007

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Fed To The Rescue Again

The best gift is one that keeps on giving. The Fed provided that gift with their rate cut at the last FOMC meeting. We had a sharp rally on the news that led to new highs in the markets over the last couple weeks. Today the minutes from that FOMC meeting were released at 2:PM and that same meeting that produced the rate cut sent the markets to new highs once again.

Dow Chart - Daily

Nasdaq Chart - Daily

The key to today's FOMC spike came from what analysts read into those minutes and how that analysis carried over to the coming FOMC meeting on Oct-31st. There was surprising unanimity among the members towards the 50-point cut. Analysts were expecting some dissention with arguing over 25 or 50 points and concerns over what that would do for inflation. The minutes clearly showed the Fed was more concerned over the impact of the credit crunch than inflation. While inflation was discussed the members felt confident the decline in inflation would continue even if they cut rates. What the Fed feared was a significant decline in growth and jobs from the impact of the credit crunch. They lowered the growth outlook for Q4 and all of 2008 with expectations that growth would not recover until 2009. Members also felt the coming wave of foreclosures would further cripple the housing market, consumer spending and consumer confidence.

Basically the Fed changed its view completely to concerns over growth and inflation concerns disappeared. Since the FOMC meeting we have seen a resumption of activity in the credit sector. New deals are being announced, write-downs even at $25 billion so far were less than expected and all the major players said Q4 should be almost a return to business as usual. So if the Fed was worried about growth and business conditions those concerns have largely been erased. The subprime mess although far from being over is now old news and steps are being taken to lessen its impact on consumers. Inflation is continuing to fall and even high energy prices have failed to prop it up.

The FOMC minutes today, when coupled with the positive business outlook from the major banks and brokerages, set the stage for a strong Q4 rally. The Fed is not likely to cut rates when they meet in October but they are clearly open to that action should conditions warrant. With inflation no longer a concern the Fed will again move to the sidelines and the markets will be free to run without any negative concerns surrounding the next couple of Fed meetings. If by chance the Fed does cut again it would be icing on the cake. The comments about economic growth below potential for "a while" and lower rates "unlikely to affect adversely the outlook on inflation" still leave room for another cut this year but analysts are not going to bet on it.

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We are seeing things in the market that could convince the Fed to cut rates again even though the disaster has been averted by the recovery of the credit markets. The warning by Ryder (R) on Monday stressed that weakness in the housing sector was spreading to the broader economy. Ryder said, "Economic conditions have softened considerably in more industries beyond those related to housing and construction" - "consequently freight and shipment levels have weakened to a greater extent than previously anticipated." "Softer demand, lower pricing and higher costs will pressure earnings."

Today Oxford Industries (OXM) reported profits that fell -56% and blamed the drop on consumer credit problems, the sinking real estate markets and very challenging conditions in the retail sector. These two warnings and dozens of others before them confirmed the theory of weakness moving out of the housing sector. This subprime contagion is the wildcard in the Fed's future rate decisions. The Fed Funds Futures fell again after the FOMC minutes as expectations declined to 35% for future rate cuts but a weak earnings cycle could change that view.

With the earnings warnings this week the expectations for earnings growth gave back last week's estimate bounce and now analysts are expecting nearly zero growth for Q3. Those estimates have fallen from roughly 8.2% at the beginning of the quarter to +2% a couple weeks ago followed by a bounce to 3.2% on the Citigroup comments. That 3.2% has now evaporated and gone back to zero profit growth. This compares to 8.5% growth in Q2 and 22% growth in Q3 2006. Earnings between now and the Fed meeting on Oct-31st could push them to cut again. However, you may remember that Citigroup warned last week that too much earnings pessimism has already been priced in and there was more chance of an upside surprise than a downside risk. It is always easier for companies to over warn and then do better than under warn and do worse. The sky is no longer falling and the storm clouds are turning into just a slow drizzle.

St Louis Fed President Poole, one of the FOMC's more hawkish members, said today that the housing market will not stabilize until next year. He said the falling home prices are keeping potential homebuyers from entering the market. He called the current home market as "uncharted territory" and the forecast for home prices as "highly uncertain." He called the financial sector "fragile" but recovering. Based on these comments from an inflation hawk it appears even he is still open to another cut. He also called the drop in the dollar as "inexplicable." After the bell SF Fed president Janet Yellen said she was keeping an open mind about future rate moves because it was too soon to know how market woes would affect the economy. "Any forecast and analysis of events should be made with a great deal of humility about its correctness." She also said she would not be surprise to see inflation in the core PCE deflator continue to move lower. This should convince us that when all the Fed officials are telling us they have no clue, we should not be that confident in our own opinions.

The next set of economic reports likely to move the market will be on Friday. The Producer Price Index (PPI), Retail Sales, Business Inventories and Consumer Sentiment could combine to alter the current view of the Fed's next action.

After the close today Alcoa kicked off the official Q3 earnings cycle as the first Dow component to report. Alcoa reported earnings of 63 cents and missed analyst's estimates for 65 cents. Revenue declined slightly due to some restructuring. With the metals markets in full consumption mode I would have expected Alcoa to do better than miss by 2 cents. Higher costs are being felt along the food chain and even the darling in the aluminum sector is seeing profits squeezed. Alcoa is still thought to be a takeover target.

On Wednesday we will have earnings from COST, HELE, INFY, LRCX, MON and RT. LRCX would be my canary in the coalmine with the chip sector already weak. The SOX was the only index in the red today with a -5 point loss. A bad report from LRCX could further slow any Nasdaq advance. Costco should be a barometer for the consumer sector and a sharp decline in sales there would be evidence of further consumer pressure. On Thursday FAST, IDT, MTB, PEP, SWY, WGO and SLM will report. SLM will be the point of interest for the day with its current fight with J.C. Flowers about the aborted buyout. All of these reports are just foreplay ahead of the main event to come over the following two weeks. All the tech giants with the exception of Microsoft will report next week. With the Nasdaq the strongest of the major indexes these tech earnings will be the key to keeping the rally going.

Today was the 5th anniversary of the current bull market and by any measure it is getting old but you could not tell it from the levels reached today. All the major indexes with the exception of the Russell broke out to new highs or new 6-year highs in the case of the Nasdaq. It would not appear there is any fear of earnings when the indexes are breaking out to new highs a week before the earnings cycle begins. There is definitely no fear of the Fed and there appears to be no lingering fear of the economy, subprime loans, foreclosures, slowing retail sales and a drop in shipping traffic. The only fear remaining appears to be getting left behind in the Q4 rally.

The Dow ran for +120 points to a new high close at 14164 and only -2 points off the high of the day. No shyness there ahead of the Alcoa earnings. Despite missing estimates Alcoa gained slightly in after hours after closing at a new 2-month high before the earnings. Nobody seems concerned about the estimate miss. Bad earnings news appears to be no longer a concern with all the pessimism currently priced into expectations. The Dow has support at 13950 and resistance at about 14250. Those numbers are lost in the analyst chatter with 15,000, 15,500 and even 16,000 now being mentioned as highs before year-end. All the stars appear to be aligned for this rally and that should be a worry in itself. When conditions are too perfect they normally are and we just havent seen the speeding truck heading our way.

The Nasdaq blasted off to close over 2800 for the first time since Jan-24th 2001. The Nasdaq has not had two consecutive losing days since Sept-10th. It has rebounded more than +400 points since the August-16th low and the angle of ascent is increasing. That could be the reason the Nasdaq lagged the other indexes on a percentage basis for the day. With all the major tech earnings next week there could be some profit taking creeping into the picture before the event. I do believe any dip will continue to be bought but next week I would be more cautious until we hear from Intel, IBM, GOOG, AAPL, etc. While everyone expects computer sales to be strong based on recent reports we don't know for sure if that is going to translate into profits.

While the Dow and Nasdaq have been making new highs the S&P has been lagging. Resistance above 1554 has been tough but it appears to have finally broken with today's gains. This should produce further short covering by those bears still hoping for an October decline. Short interest is dropping rapidly and this will eventually slow any further advance. Without shorts acting as our stepping-stones to new levels the road higher could be slick and lacking traction for the bulls. The S&P has good support at 1540 and again at 1520. Next resistance is around 1585 with many year-end targets at 1585-1600. On that basis it would suggest that the upside on the S&P could be limited.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

The Russell 2000 is the only major index that has not broken out to new highs. The Russell closed at 845 and still 10 points below its July highs. As my sentiment indicator I am still bullish on the Russell for its +65 point gain in just the last 3-weeks. It started later than the other indexes and waited for the rate cut before blasting off. I definitely expect some resistance slowing at 855 but baring any serious earnings disappointment I think we will get through it. The bulls appear to be in control and there is nothing on the horizon the rest of the week that might derail them. Next week should also be bullish but that really depends on the earnings. Keep your fingers crossed there is no speeding truck heading in our direction.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BNI None None
CMI    
LEH    

New Calls

Burlington N.SantaFe- BNI - cls: 86.50 chg: +0.56 stop: 83.90

Company Description:
A subsidiary of Burlington Northern Santa Fe Corporation, BNSF Railway Company operates one of the largest North American rail networks, with about 32,000 route miles in 28 states and two Canadian provinces. BNSF is among the world's top transporters of intermodal traffic, moves more grain than any other American railroad, carries the components of many of the products we depend on daily, and hauls enough low-sulphur coal to generate about ten percent of the electricity produced in the United States. (source: company press release or website)

Why We Like It:
Three trading days ago the railroad sector broke out higher from a two-month consolidation. Shares of BNI lead the way with a rally past resistance near $84 and again near $85 and its 100-dma. Traders have since been buying the dips in BNI near $85 and its 100-dma so the stock has already tested broken resistance as new support. The group looks like it has farther to rally and we like BNI as a candidate to capture any further strength in the sector. We're suggesting call positions now with BNI above $85.00. Our suggested stop loss is at $83.90 but more conservative traders might want to place their stop closer toward $84.60. We have two targets on BNI. Our first target is the $89.75-90.00 range. Our second target is the $92.50-94.00 range. We only have two weeks and plan to exit ahead of the October 23rd earnings report. FYI: The P&F chart is bullish with a $96 target.

Suggested Options:
We are suggesting the November calls but plan to exit ahead of October 23rd.

BUY CALL NOV 85.00 BNI-KQ open interest=3068 current ask $4.70
BUY CALL NOV 90.00 BNI-KR open interest=1107 current ask $2.25

Picked on October 09 at $ 86.50
Change since picked: + 0.00
Earnings Date 10/23/07 (confirmed)
Average Daily Volume = 4.3 million

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Cummins Inc. - CMI - cls: 139.98 change: +3.16 stop: 134.45

Company Description:
Cummins Inc., a global power leader, is a corporation of complementary business units that design, manufacture, distribute and service engines and related technologies, including fuel systems, controls, air handling, filtration, emission solutions and electrical power generation systems. (source: company press release or website)

Why We Like It:
CMI has been a market leader and given the bullish breakout in the major indices we are expecting CMI to keep up the pace. The stock has a bullish trend of higher lows and shares look poised to breakout over resistance near $140-141. We're suggesting a trigger to buy calls at $140.85, just above today's high. However, we'll also be watching for a dip and bounce in the $136-135 range as an alternative entry point. If CMI hits our trigger at $140.85 then our target is the $149.50-150.00 range. This is an aggressive play given CMI's volatility and our two-week time frame. We do not want to hold over earnings.

Suggested Options:
We are suggesting a trigger to open positions at $140.85. We'd suggest the November calls.

BUY CALL NOV 140 CDM-KH open interest=689 current ask $9.70
BUY CALL NOV 145 CDM-KI open interest=382 current ask $7.50
BUY CALL NOV 150 CDM-KJ open interest=210 current ask $5.50

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

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Lehman Brothers - LEH - close: 64.59 change: +1.81 stop: 61.99

Company Description:
Lehman Brothers, an innovator in global finance, serves the financial needs of corporations, governments and municipalities, institutional clients, and high net worth individuals worldwide. (source: company press release or website)

Why We Like It:
The broker-dealer stocks have recovered sharply from their August lows and the XBD index just broke through technical resistance at its 200-dma. If the group continues to rally then LEH should follow. Currently LEH is consolidating under resistance near $65.00. Traders have been buying the dips and the stock looks ready to breakout higher. We're suggesting a trigger to buy calls on LEH at $65.25. If triggered our target is the $69.85-70.00 range. More aggressive traders may want to aim higher and shoot for the 200-dma.

Suggested Options:
We are suggesting the November calls. Our suggested trigger to open positions is at $65.25.

BUY CALL NOV 60.00 LES-KL open interest=3195 current ask $6.20
BUY CALL NOV 65.00 LES-KM open interest=7665 current ask $2.90
BUY CALL NOV 70.00 LES-KN open interest=1538 current ask $1.10

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 12/13/07 (unconfirmed)
Average Daily Volume = 15.8 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Amgen Inc. - AMGN - cls: 57.08 change: +0.50 stop: 54.90

AMGN is still edging higher but remains under resistance in the $57.50-58.00 zone. We are waiting on a bullish breakout and suggesting that readers use a trigger to buy calls at $58.01. We do see what could be additional resistance at its 200-dma near $59.40 and again at the $60.00 mark. However, if triggered our target is the $64.00-65.00 range, which might be a little too aggressive given our time frame. AMGN is due to report earnings around October 25th and we don't want to hold over the report. It's also worth noting that AMGN's P&F chart is still bearish and it will take a breakout over $60.00 to change it back into a bullish pattern.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 11.7 million

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Biogen Idec - BIIB - cls: 67.24 chg: +0.82 stop: 64.95

Traders bought the dip in BIIB again and today's move looks like another bullish entry point to buy calls. However, our comments from yesterday still stand. You could wait for another dip and bounce near short-term support at $65.00 or you could wait for a new relative high and another breakout over its short-term trendline of lower highs. There is potential resistance near $70.00 but we're going to aim for the $72.40-72.50 range. The P&F chart points to an $86 target. Part of our challenge is time. We do not want to hold over the October 23rd earnings report.

Picked on October 07 at $ 67.63
Change since picked: - 0.39
Earnings Date 10/23/07 (confirmed)
Average Daily Volume = 4.4 million

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Citigroup - C - clos: 47.62 change: -0.18 stop: 45.79

Citigroup under performed the broader market and the rest of the financials on Tuesday. This relative weakness is a warning sign for the bulls. However, on the other side of the coin the stock did bounce (twice) near short-term support around $47 and its 50-dma. Readers might want to inch up their stops toward today's lows (46.80), especially if you choose to buy calls on today's afternoon rebound! Our initial target is the $49.85-50.00 range. 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: + 0.98
Earnings Date 10/19/07 (confirmed)
Average Daily Volume = 40.7 million

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Ceradyne - CRDN - cls: 78.19 change: +0.53 stop: 73.95

The intraday dip under its 10-dma was a concern but CRDN managed to recover. The stock is relatively close to our target so we're not suggesting new positions at this time. More conservative traders may want to tighten their stop losses again. 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: + 3.54
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 653 thousand

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Deutsche Bank - DB - cls: 134.20 chg: +0.59 stop: 128.99

Financial stocks rallied as investors reacted to the FOMC minutes released today. Shares of DB actually produced a minor bullish engulfing (reversal) candlestick pattern today. We are tempted to raise our stop again closer to the $130 mark. We're not suggesting new positions at current levels. There is potential resistance at the 200-dma near $138.70 so we're targeting a rally into the $138.00-140.00 range. The P&F chart is bullish with a $154 target.

Picked on October 01 at $130.79
Change since picked: + 3.41
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 633 thousand

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Intl. Bus. Mach.- IBM - cls: 118.30 chg: +0.53 stop: 114.49

IBM continues to creep higher following last week's test of support near $115. We don't see any changes from our previous comments. If you think IBM can breakout over resistance in the $119-120 zone then this is a new entry point for calls. The stock has already hit our first target in the $118-120 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: + 5.06
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

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Kohl's - KSS - close: 60.26 change: -0.19 stop: 57.90

Major retailers are expected to release their September same-store sales numbers in the next day or two. According to the Associated Press many are expecting the retail industry to report less than expected sales numbers due to warmer weather slowing the sale of winter clothes. This could be a good reason why KSS has been trading sideways the last couple of days. We're going to stick to our plan, which suggests readers use a trigger to open positions at $62.01. If we are triggered at $62.01 our target is the $67.00-68.00 range. Keep a wary eye on the 100-dma as potential overhead resistance. We do not want to hold over the November earnings report.

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/15/07 (unconfirmed)
Average Daily Volume = 5.9 million

---

Martin Marietta - MLM - cls: 138.26 chg: -3.24 stop: 134.85

The relative weakness in MLM is a concern today, especially without any news to account for this morning's sell-off. Fortunately for the bulls the stock held near what should be support around $137. Thus a bounce from here could be used as a new bullish entry point to buy calls. Watch for a move back above $138.60 or $139.00 as a new entry point. More conservative traders might want to consider a tighter stop loss, maybe just under today's lows ($137). The P&F chart now points to a $170 target. We have two targets. Our first target is the $149.00-150.00 range. Our second target is the $157.00-160.00 zone. We do not want to hold over the late October earnings report.

Picked on October 02 at $141.31
Change since picked: - 3.05
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 1.0 million

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Stryker - SYK - cls: 73.47 change: +0.99 stop: 68.49

SYK continues to show relative strength. We were expecting a bit more profit taking after the multi-day rally but traders bought the dip again. SYK's 1.3% gain pushed it back toward record highs. Our biggest concern today would be the lack of volume to validate the move. Our target is the $74.90-75.00 range. It would be tempting to aim higher, maybe the $77.50-80.00 range, but we don't have much time. SYK is due to report earnings on October 17th and we do not want to hold over the report. FYI: The P&F chart is bullish with an $83 target.

Picked on October 02 at $ 70.65
Change since picked: + 2.82
Earnings Date 10/17/07 (confirmed)
Average Daily Volume = 1.4 million

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Terex - TEX - cls: 89.73 change: +1.97 stop: 83.75

The rally in TEX continues. The stock added another 2.2% and is nearing potential resistance in the $90-91 zone. The P&F chart is very bullish with a $100 target. Our target is the $94-95 range although more conservative traders may want to exit near $91.00.

Picked on September 25 at $ 86.50
Change since picked: + 3.23
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 1.8 million
 

Put Updates

None
 

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: 141.65 chg: +1.21 stop: n/a

Market reaction to the FOMC minutes was positive and the DJIA and DJX rallied to new highs. This lifted the October $137 calls and they are currently trading at $4.80bid/$5.15ask. 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: + 7.22
Earnings Date 00/00/00
Average Daily Volume = million
 

Dropped Calls

Broadcom - BRCM - cls: 39.88 change: +0.41 stop: 35.75

Target achieved. It took longer than expected but BRCM finally hit our target in the $39.85-40.00 range. Following up on yesterday's news about BRCM expanding a deal with Samsung, one analyst firm upgraded their price target on BRCM to $45. Shares of BRCM do look short-term overbought but we would keep an eye on it for a pull back toward the $38.00 region as a potential entry point for new bullish positions.

Picked on September 12 at $ 35.85
Change since picked: + 4.03
Earnings Date 10/23/07 (confirmed)
Average Daily Volume = 11.0 million

---

L-3 Comm. - LLL - cls: 107.65 chg: +1.15 stop: 99.99

Target achieved. LLL continues to rally as traders bought the intraday dip near $106. Our target was the $107.50-110.00 range. Given LLL's relative strength readers might want to try and aim for an exit closer to $110.

Picked on September 25 at $100.96
Change since picked: + 6.69
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 904 thousand
 

Dropped Puts

None
 

Dropped Strangles

None
 

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

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