Option Investor

Daily Newsletter, Saturday, 10/13/2007

Printer friendly version

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Drum Roll Please

I can just hear it now. That slow, almost imperceptible rise in the background music as we approach the first major week of earnings. The tempo is accelerating even more because this is an expiration week. Just imagine a one of those great war movies with an ocean full of boats filled with bulls ready to charge ashore. The bears are guarding the beachfront hills (resistance highs) ready to fight to the death. The tension is mounting and the bugler is getting ready to sound the charge! The tempo brings emotions on both sides to a peak just as the action starts. What a great time to be in the markets. We have major Q3 earnings and option expiration in the same week! Volatility is going to be huge and this is going to be a pivotal point for the fourth quarter direction. Who will the winners be?

Dow Chart - Daily

Nasdaq Chart

The economics for Friday produced a Fed puzzle for analysts. The Producer Price Index (PPI) rose +1.1% for September pushing top line inflation at the producer level to 4.4% on a year-over-year basis. That inflation rate has risen +6.9% over just the last nine months. The majority of the increase came from spikes in food and energy prices. For those of you that don't use food and energy the core rate of inflation rose only +0.1% at the producer level. However, there are some strong pressures building in the crude products, things made from gas/oil, with a 21.6% gain year to date. Finished energy goods rose +4.1% for the month pushed higher by a +8.4% rise in gasoline prices. Food prices actually rose sharper than energy prices in September with a year to date rise of +26.3% and a +16.9% rise in intermediate food products. While this top line inflation appears to be rising sharply and pushing costs up for everyone in America the core rate is continuing to drop and that lets the Fed off the hook without having to worry since core inflation is still falling. This seems to me like another "emperor has no clothes" scenario. If the press and the Fed keep telling us inflation is falling we will eventually believe it even if it is not so.


The Most Profitable 4 Letters in Trading

Master them with Hotstix QQQ Trader. We'll show you exactly when to buy and sell the QQQQ and turn you into a master trader who knows how to cut your losses, nail short term gains and rack up some incredible profits.

30-Day FREE Trial:


The retail sales for September rose +0.6% and twice the consensus rate of +0.3%. It is getting so you don't know whom to believe. All the retailers are complaining about bad sales but we have had positive sales growth for the last three months. What is it, good or bad? Actually both. We had positive sales growth in September because gasoline stations posted a +2.0% increase due to higher prices and auto parts dealers posted a +1.2% gain because people are fixing their older cars rather than buy new ones. Food stores saw a +0.8% gain due to higher food prices. Ex-autos and ex-gasoline the sales gain was barely positive at +0.2%. The majority of the consumer categories lost ground for the month. Furniture and home furnishings fell -0.6%, clothing and accessories -0.4%, general merchandise -0.1%. Ironically building materials dealers saw a minor gain despite the implosion in the home sector. Retailers said warmer weather depressed sales with nobody buying fall items. Meanwhile that same warmer weather should have helped building material stores by making it easier to work on those outside projects. That may have been the only thing keeping them positive with that +0.1% gain.

Consumer Sentiment for the first reading in October fell to 82.0 from September's 83.4 level. The expectations component was the drag falling from 74.1 to 71.6 while present conditions was almost flat. All the talk about a coming recession and the increase in gasoline prices was credited with the depression. The constant stream of negative housing news offset the sentiment benefits from the rising stock market. Sentiment is not expected to improve in the coming months until the home market improves and homeowners start breathing easier again.

Consumer Sentiment Chart

The economic calendar for next week has three reports that could move the market and those are the Consumer Price Index (CPI), Beige Book and Philly Fed Survey. The CPI will show how much of the increase in producer prices have been passed down to the consumer level. The Fed Beige Book is a survey of business conditions in all the Fed regions and gives an in-depth look at the current state of the economy by region. This could be very market positive if it shows conditions improving. The last report is the Philly Fed Survey. This survey tends to track well with the national ISM survey and is seen as a preview of the ISM numbers. One report that will also attract a lot of attention is the Risk of Recession on Monday. This indicator spiked to 40% in August and well out of its recent range. Expectations are for a decline but nothing is ever guaranteed. While we do have a full economic calendar next week I believe the markets will be much more interested in the full earnings calendar.

Economic Calendar

Risk of Recession Chart

Earnings will be the focus next week with six of the big techs reporting. We will see Intel, AMD, IBM, Google, Yahoo and Ebay. On the financial side Citigroup, JP Morgan, Washington Mutual, Capital One, Wells Fargo, State Street, Bank America, Bank of New York, Wachovia, Merrill and Fifth Third report. It will be the first big week of earnings with 13 Dow stocks and 80 S&P stocks reporting. By the end of this week we will know without much doubt how this earnings cycle is going to end. That makes this week a pivotal week in the markets. Pessimism is still rampant and earnings estimates were revised down again last week to a negative growth level of -0.1%. This would be the first negative growth quarter in years and could sour investor sentiment if the negative earnings really came to pass. Not everyone believes the pessimism is warranted. The Q3 earnings will be critical but guidance is going to be the key. The earnings estimates for Q4 are still in the low double digits and traders want it to stay that way. A one-quarter dip can be ignored as a subprime disaster but earnings guidance needs to remain strong for Q4. If it appears Q4 earnings are going to fall sharply the underlying bid in this market could evaporate.

Partial Earnings Calendar

On Thursday the bears got a gift from the market in the form of a sell order for 17 million shares on the QQQQ. The order caused thousands of sell stops to be hit and knocked -1.66 off the QQQQ in just minutes. That was magnified in the broader market with the Dow falling from 14198 all the way to support at 13950. That -250 point dive shook up the markets but the impact was brief. Since there was nothing in the news the selling was initially attributed to a technical sell program. It was not until after the close that the QQQQ trade hit the wires.

If you look at the market statistic table at the top of this article you will notice that all the major indexes turned in anemic results. The Dow transports were weak because of rising oil prices and the banks were weak ahead of a long list of financial earnings reports next week. The Semiconductor sector was weak with a -2.29% loss for the week. This loss was after a strong +1% rebound in the sector on Friday. The QQQQ sell order knocked over 15 points off the index from the intraday high on Thursday. On Friday UBS upgraded Novellus (NVLS) and chip stocks began to recover. Stifel Nicholas put out a note saying that Samsung was going to boost its 2007 apex spending on semiconductor production equipment by $1.2 billion. The note said it was a clear positive for equipment makers in 2007 but it could replace orders originally scheduled for 2008. The chip companies expected to benefit from the Samsung increase were Varian (VSEA), Lam Research (LRCX), Rudolph Technologies (RTEC) and Applied Materials (AMAT). All sprinted higher giving the SOX that +1% gain for the day but it was not enough to rescue the index from a weekly loss.

Baidu (BIDU) rebounded from Thursday's -65 point drop with a $14 gain after Jim Cramer said on CNBC at 2:45 it could go to $500. The drop was due to a JP Morgan downgrade and with $150 in gains over the last 6-weeks it was a rush to the exits. Personally I like BIDU but I would rather buy it closer to $290 than its $322 close on Friday.

Apple (AAPL) was knocked for a -17 intraday drop on Thursday to $153 but the dip was quickly bought and Friday's close was only $3 below its Thursday high. Apple is expected to post strong earnings and guidance and could easily run to $200 before Q4 is over. I would be a buyer now but a seller after the holidays.

Google got another upgrade when Oppenheimer joined six other firms upping their price target to $700 or more. GOOG gained +15 on the news to $637. Analysts point to development of the product and advertising models and additional services as drivers to profits. The Oppenheimer analyst raised earnings expectations for Q3 to $3.81 per share. Google reports earnings on Thursday after the close. Google has a very bad habit of dropping sharply after earnings so I would enjoy the ride now but probably bail out before the actual report.

BEA Systems (BEAS) received a $6.7 billion unsolicited offer from Oracle and Carl Icahn got an early Christmas present. BEAS had flat lined at $14 after Icahn accumulated a large portion of the outstanding stock in the $11-$13 range. Icahn claims BEAS should sell itself to unlock value in the company. BEAS quickly rejected the Oracle offer saying it was too low and that was the equivalent of putting up a for sale sign on the company lawn. Oracle offered $17 per share but the stock shot up to nearly $19 on expectations of a larger offer ahead. Oracle has a habit of throwing out low-ball bids to flush other buyers off the sidelines. Once an offer is made anyone else considering a move has to quickly decide it they want to bid before agreements start getting signed. Other prospective bidders could be IBM or HPQ. One analyst said BEAS was probably only worth $18 and an Oracle buy could double margins overnight. The analyst speculated that Oracle could fire everybody but the software engineers without rocking the boat. Since Icahn started calling for a sale and the stock topped at $14, 21.6 million shares or nearly 5.5% of the outstanding stock was sold short on expectations that Icahn would fail in his proxy battle with the board and eventually give up the fight. The Oracle bid squeezed those shorts with a $4 gap open on Friday. Icahn just reported on Friday morning that he had increased his stake in BEAS to 51.82 million shares or 13.2%. He did this by exercising 8.5 million call options for $9 a share and 26.05 million call options for $7.50 a share. The Oracle news gave him an instant $275 million profit in addition to the gains he made while accumulating his shares from $11 to $14.

BEAS Chart - Daily

Biogen Idec Chart - Daily

After the bell Biogen Idec (BIIB) said it was putting itself up for sale, possibly to Carl Icahn. Why not, he is definitely flush with a little extra cash after the BEAS deal. BIIB said it had hired Goldman Sachs and Merrill Lynch to pursue offers and billionaire Carl Icahn had already expressed interest. Icahn already took control of ImClone and appears to be interested in other biotechs. Analysts said there will likely be some big name drug companies also in the bidding. BIIB spiked to $81.50 on the announcement in after hours trading from its $69 close. Icahn already has a sizeable position in BIIB. The rich get richer and we get to tag along. Option Investor will be closing the long call position on BIIB on Monday.

Electronic Arts (ERTS) sprinted higher with a +2.71 gain after saying it expects to beat its Q3 earnings forecast. ERTS also said it was buying VG Holdings the parent of BioWare Corp and Pandemic Studios for $860 million. Those two studios produce action-adventure games. Several analysts questioned the high price and thought they paid too much and could have bought other game makers with better games for the same price. Traders evidently like the deal and the positive guidance.

On the surface last week looked bullish ahead of earnings. However, there were sell offs, one on Wednesday morning and one on Thursday afternoon. Those erased the gains for the week leaving the indexes relatively flat except for the NDX. The Nasdaq 100, the biggest stocks on the Nasdaq, continues to push higher with EBAY, RIMM, GOOG, etc adding to their gains. The NDX and the corresponding ETF the QQQQ have been on a vertical ascent since the last dip in early September. I see nothing on the horizon to change that but it will all depend on earnings of those same bid caps techs next week.

Merrill Lynch analyst, Mary Ann Bartels, thinks the markets will go higher thanks to the large short position held by hedge funds speculators. According to Bartels there is roughly $60 billion in buying power represented by these shorts. She gets her data from analyzing fund trading patterns and from the commitment of traders reports. Bartels said the speculators have been adding to short positions at the new highs and would eventually have to cover and go long if the indexes kept moving higher on earnings. With plenty of pessimism flowing about earnings it is drawing additional hedge fund shorts. Bartels said there was approximately $600 million in buying power on the NDX futures if shorts were forced to change sides. That was the lowest level of short interest on the futures she tracks. She said the Russell-2000 futures were second with $14 billion in buying power followed by the S&P futures at $47 billion. That is a lot of short interest in a bull market. I had been worried that the shorts were already converting to longs and that would reduce the buying power on an upside surprise. Bartels does not think so. Merrill has a 1670-1700 target on the S&P for year-end and they are reportedly buying the dips. Merrill may not have $60 billion to go long futures but I would not want them to be betting against me. What they may lack in dollars to commit to battling the bears they more than make up for with the power of their press releases. They can create any scenario they desire in the press to get the market moving in their direction. This looks like a short squeeze that will eventually end badly as long as the earnings don't disappoint.

The Dow may have only gained +29 points for the week but it is still holding very close to its all time highs set on Thursday at 14198. It would not take very much good news to produce another breakout that may have some conviction attached to it. With 13 Dow stocks reporting this week it would be an understatement to say there will probably be some increased volatility. Obviously all 13 will not surprise to the upside but all they have to do is not disappoint and let those that can surprise produce the gains. Current resistance is 14200-14250 and a strong break over that range could set the trend for the next several weeks.

The Nasdaq has more to risk since it has been the most bullish index. Positive earnings are already priced in and it will take a lot of good news to push it higher. I worry about Google earnings on Thursday night. I did not go back and research it again but I seem to remember that Google was knocked for losses on something like 9 of the last 11 earnings reports. Seems nothing they can say in earnings ever makes up for the unbridled expectations investors have placed on them. I think they dropped something like -28 on their last report. Makes me want to buy an expiring October put option just out of the money at Thursday's close. It would be a coin toss for Friday. You will either lose the entire premium or hit a home run. If Google announced their anticipated gPhone with earnings it would be a game changer and the monster of all short squeezes.

YYahoo earnings are not expected to produce fireworks and Ebay may have a little too much in the expectations department. Intel should do well but probably not a blowout. AMD is taking back share even if it is only a miniscule amount. It is forcing Intel to lower prices to compete. Like I said, this will be a pivotal week. IBM, not a Nasdaq stock but still an influence on techs, is the sleeping giant. Accenture recently reported +23% revenue growth and that should bode well for IBM. I scanned several weeks of news headlines on IBM and could not find anything other than the normal carbon copy press release by analysts saying revenue will be X and earnings Y. Replace those letters with differing amounts depending on the analyst. There was no excitement and no fears. With IBM stock moving sideways since Sept-1st there appears to be no expectations building. This could be a bright spot in next week's tech results.

The S&P is still struggling. It did move over resistance at 1555 but it can't seem to find any traction over that level. With 25% of the S&P earnings coming from financial stocks next week will be critical for direction. With more than a dozen big name financials reporting it would not take much to influence S&P earnings in either direction. The financials have been beaten, flogged, burned at the stake and buried alive in an attempt to rid Wall Street of the subprime stench. Expectations are non-existent and the bank index lost -2.29% last week. The potential for an upside surprise is huge. How bad would their earnings have to be for them to move any lower? I can't imagine anything they could say that we have not already heard. On the flip side the next largest segment is the energy sector with 18% of the S&P earnings. Incredibly we have been getting almost daily warnings from energy companies even when oil is at record highs. That sector could actually surprise to the downside. With 80 S&P companies reporting next week the odds are good we will not be pinned at 1560 this time next week. With support at 1540 and again at 1520 along with abundant pessimism should be a good recipe for a move higher. Bartels thinks any pullback on earnings could be 2-3% and that puts us right at 1520 support. I would like to see a surprise 3% breakout instead but the market rarely cares about what I would like. We just need to realize that there is still a bid under the market and how long that bid remains is predicated on the strength of earnings next week.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

The Russell 2000 actually lost its momentum last week with a small -3 point loss. I don't know if it was just fund managers withholding any more funds until the see how earnings are going to turn out or if it was those hedgies getting short at resistance. Resistance appeared at 846 and held firm all week. We also need to realize that Q3 end of the quarter retirement contributions have slowed to a trickle. Thursday's opening spike across all indexes carried the Russell to 851 but it was short lived and ended badly with the Thursday afternoon sell off to nearly 830. In the end the Russell returned to 840 to wait another day for the earnings cycle to begin. No harm, no foul and still within striking distance of a new high at 857. Since all the indexes ended the week about where they started it is hard to make a case that fund managers abandoned the Russell since there was no real selling. I think it was simply a case of buyers having established their positions ahead of earnings and settling in to wait for the first batch of results. Nothing should be deduced from the lack of movement.

This is earnings week and just like Oscar week the preparations have been made. The reporters compiled their lists and made their guesses. The companies are making their way down the red carpet and headed for their seats. The curtain will go up Monday morning followed by an endless stream of earnings applause and catcalls. Reporters will be jockeying to ask those seemingly important sound bite questions and corporations will be employing their own form of Greenspeak to spin the answers. Those answers found pleasing will be rewarded with a rise in their stock price. Those answers confessing misdeeds and failed expectations will be punished severely. We the spectators will be able to share in the rewards if we guessed right and be punished if we guessed wrong. It is a great week to be option traders!

Friday will be the 20th anniversary of Black Monday and the worst one-day decline in the U.S. markets. The Dow fell 508 points or 22.6% on one day. Analysts doubt it we could ever see a repeat because markets are more diverse and leverage is considerably less. The economic backdrop to the crash was materially different. We were facing a looming recession then and interest rates were high. The things that could trigger a market collapse today are much different including a derivatives disaster or a terrorist event. There will be numerous specials on TV this week to take you back in time and explore what happened and why. It would probably be very educational to watch at least one even if you lived through the real crash. Our brains numb over time and we forget how panic can grip the markets. As Harry Brown said so often, "Never count on being able to recreate your wealth." Protect it as though you never could. The first step in protecting it is to know how it could evaporate in another market crash. The equivalent 22% crash today would be -3209 Dow points. How would that change the value of your current positions?

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays

Play Editor's Note: This is the first real week of third quarter earnings. Earnings reports can produce some very big moves in individual equities so it's a great time to play a strangle or some sort of neutral strategy. I would like to give readers an early look of what we are considering as potential plays. MAN reports earnings on Wednesday morning. We are thinking about a strangle on MAN. IBM reports earnings on Tuesday. We're thinking about adding a strangle on IBM for Monday night. GOOG reports earnings on Thursday. Our bias for GOOG is bearish. We're expecting a sell-the-news reaction. Instead of a strangle we're considering a put spread for the Tuesday night newsletter. At the moment we're thinking readers could buy the November $600 GOOG put for $14 and sell the November $550 put for $4.60.

New Calls

Caterpillar - CAT - cls: 80.30 change: +0.86 stop: 78.59

Company Description:
For more than 80 years, Caterpillar Inc. has been making progress possible and driving positive and sustainable change on every continent. With 2006 sales and revenues of $41.517 billion, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines and industrial gas turbines. (source: company press release or website)

Why We Like It:
This is a very short-term, aggressive play. CAT is due to report earnings on Friday, October 19th, before the opening bell. We suspect that shares will rally into the report. Last week the stock pulled back but traders bought the dip near its trendline of higher lows (see chart). We'll put the stop loss just under last week's low. Our target is the $84.00-85.00 range. We will plan to exit on Thursday at the closing bell if CAT doesn't hit our target.

Suggested Options:
October options expire in five days. We plan to exit in four days. It's up to you if you want to play the October or November strikes.

BUY CALL OCT 80.00 CAT-JP open interest=14581 current ask $2.36


BUY CALL NOV 80.00 CAT-KP open interest= 8687 current ask $3.55
BUY CALL NOV 85.00 CAT-KQ open interest=16271 current ask $1.62

Picked on October 14 at $ 80.30
Change since picked: + 0.00
Earnings Date 10/19/07 (confirmed)
Average Daily Volume = 5.6 million


Diamond Offshore - DO - cls: 117.20 chg: +0.90 stop: 112.45

Company Description:
Diamond Offshore provides contract drilling services to the energy industry around the globe and is a leader in deepwater drilling. (source: company press release or website)

Why We Like It:
We have been avoiding the oil sector because we keep thinking that crude oil is going to see a significant correction. Instead crude oil has gone on to hit a string of new highs. This strength in the commodity and the stock market has led the oil services sector to breakout to new all-time highs after a multi-week consolidation pattern. Shares of DO are seeing a similar breakout to new record highs. Broken resistance near $115 should be new support. We're going to try and play this with a stop at $112.45. If we had more time we'd put the stop under $110. Time is an issue. DO is due to report earnings in nine trading days. If shares don't hit our target we'll plan to exit on October 24th at the closing bell. Our short-term target is the $124.50-125.00 range. One of our biggest concerns is that a correction in crude oil would spark some heavy profit taking in the oil service stocks. FYI: The P&F chart is bullish with a $173 target.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 115 DO-KC open interest= 554 current ask $6.70
BUY CALL NOV 120 DO-KD open interest=2253 current ask $4.20

Picked on October 14 at $117.20
Change since picked: + 0.00
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 2.0 million


Vulcan Materials - VMC - cls: 92.32 chg: +1.74 stop: 89.90

Company Description:
Vulcan Materials Company, a member of the S&P 500 index, is the nation's largest producer of construction aggregates and a major producer of asphalt and concrete. (source: company press release or website)

Why We Like It:
Shares of VMC are bouncing from support near $90 and its 50-dma. Friday's move looks like a new bullish entry point to buy calls. This rebound follows a bullish double bottom pattern through August and September and it follows a bullish breakout in early October. We are suggesting positions now. Our target is the $99.00-100.00 range. The P&F chart is bullish with a $103 target.

Suggested Options:
We are suggesting the November calls. We do not want to hold over the late October earnings report.

BUY CALL NOV 90.00 VMC-KR open interest=424 current ask $6.20
BUY CALL NOV 95.00 VMC-KS open interest=360 current ask $3.60
BUY CALL NOV 100.0 VMC-KT open interest=557 current ask $1.85

Picked on October 14 at $ 92.32
Change since picked: + 0.00
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume = 1.4 million

New Puts


New Strangles

NASDAQ 100 trust - QQQQ - cls: 53.53 chg: +0.87 stop: n/a

Company Description:
The QQQQ is an Exchange Traded Fund (ETF) based on the NASDAQ 100 index.

Why We Like It:
This week could be a turning point in the markets. It is the first real week of third quarter earnings and the parade of earnings is bound to raise market volatility. This looks like a good spot to try and capture that volatility with a strangle on the QQQQs. We want to exit this strangle if either side hits $1.50 or higher. This is somewhat aggressive since we're using October options, which expire in five days. You could do the same play using November options but you'll pay more and have to adjust your exit price.

Suggested Options:
A strangle involves buying both an out of the money call and an out of the money put. We are suggesting the October $54 call and the October $53 put. Our estimated cost is $0.76. We want to sell if either side hits $1.50 or more.

BUY CALL OCT 54.00 QQQ-JB open interest=141201 current ask $0.41
BUY PUT OCT 53.00 QQQ-VA open interest=118111 current ask $0.35

Picked on October 14 at $ 53.53
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 125 million

Play Updates

In Play Updates and Reviews

Call Updates

Amgen Inc. - AMGN - cls: 58.17 change: +0.34 stop: 54.90

AMGN was getting some positive press on Friday. Shares managed to close over short-term resistance near $58.00. Yet the rally wasn't strong enough to breakout past the 200-dma or the $60.00 level. The stock under performed the BTK biotech index on Friday. Overall the pattern continues to look bullish. Friday's close over $58 looks like a breakout from its four-week trading range. We would suggest new positions here. However, we want to remind readers that the 200-dma and the $60.00 mark will be a hurdle and more conservative traders might want to wait for further signs of strength before initiating positions. 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.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 55.00 YAA-KK open interest=5657 current ask $4.35
BUY CALL NOV 57.50 YAA-KY open interest=6615 current ask $2.62
BUY CALL NOV 60.00 YAA-KL open interest=9816 current ask $1.38

Picked on October 11 at $ 58.01
Change since picked: + 0.16
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 11.7 million


Biogen Idec - BIIB - cls: 69.43 chg: +2.31 stop: 67.63 *new*

Attention - We are adjusting our target on BIIB. Shares of BIIB broke out to new multi-year highs over $69 a share on Friday afternoon. Yet the real story is what happened after hours. After the closing bell it was announced that BIIB's board of directors had authorized management to put the company up for sale. The company had hired Goldman Sachs and Merrill Lynch as financial advisors to facilitate the process. This news had a big impact on the stock price. Shares of BIIB soared more than 16% to more than $81.50 on Friday in after hours trading. If BIIB can maintain this bullish tone over the weekend then the stock will probably gap open higher on Monday morning. We are adjusting our exit target to $80.00. Hopefully the stock gaps open above $80.00 and we'll exit on the opening trading. More aggressive traders may want to aim higher, say the $84-85 range, since the stock might see an intraday spike before paring its gains. We're adjusting the stop loss to $67.63. FYI: The intraday after hours high on Friday was $85.00.

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

Picked on October 07 at $ 67.63
Change since picked: + 1.80
Earnings Date 10/23/07 (confirmed)
Average Daily Volume = 4.4 million


Citigroup - C - clos: 47.87 change: -0.45 stop: 46.64 *new*

Our position in C just got a lot more risky. The company has moved its earnings report from October 19th to October 15th and Citigroup will announcement before the opening bell. There is no way for us to avoid it. Wall Street expects the company to report a profit of 43 cents a share. Meanwhile after hours it was reported that C's CEO Mr. Prince was expected to lose his job next week and that shares of C were trading up over a $1.00 after hours on the news. We couldn't find any specific news about Prince but Citigroup was trading higher, around $48.60, after hours. We are not suggesting new positions at this time. Our initial target is the $49.85-50.00 range. Please note that we are adjusting the stop loss to $46.64.

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

Picked on September 16 at $ 46.64
Change since picked: + 1.23
Earnings Date 10/15/07 (confirmed)
Average Daily Volume = 40.7 million


Cummins Inc. - CMI - cls: 140.02 change: +3.13 stop: 134.45

Friday's market bounce lifted CMI as traders bought the dip near its rising 10-dma. Shares are back to the $140 level and Friday's rebound looks like a new bullish entry point to buy calls. If you're feeling conservative then wait for a new relative high before opening positions. Our target is the $149.50-150.00 range. Keep in mind that we do not want to hold over the October 25th earnings report.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 135 CDM-KG open interest=325 current ask $12.00
BUY CALL NOV 140 CDM-KH open interest=714 current ask $ 9.10
BUY CALL NOV 145 CDM-KI open interest=452 current ask $ 6.80
BUY CALL NOV 150 CDM-KJ open interest=279 current ask $ 4.90

Picked on October 11 at $140.85
Change since picked: - 0.83
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 2.0 million


Ceradyne - CRDN - cls: 75.68 change: +0.36 stop: 73.95

Readers may want to seriously consider an early exit in CRDN to avoid any further losses. The stock under performed the defense sector and shares barely bounced from short-term support near $75.00. Many of the technical indicators have turned bearish. We also note that the weekly chart has produced a bearish engulfing candlestick pattern. We're not suggesting new positions and if you choose not to exit early then consider a tighter stop loss near $74.50. Our short-term target is the $79.50-80.00 range. The P&F chart is bullish with a $92 target.

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

Picked on September 25 at $ 74.61
Change since picked: + 1.07
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 653 thousand


Deutsche Bank - DB - cls: 131.40 chg: -0.30 stop: 128.99

We have been warning readers to expect DB's consolidation back toward the $130 level. Now that DB has retested $130 as support the stock should bounce. We are suggesting new bullish positions here however readers might want to wait for a new rise past the $132.00 or $132.50 mark before initiating positions. One of the biggest risks to be bullish on DB this week is the large number of earnings reports from the banking sector. Investors' interpretation of the parade of earnings reports this week will probably dictate direction for shares of DB's stock price. More conservative traders may want to tighten their stop loss toward $130.00. 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. FYI: The 100-dma near $137 may also be a level of resistance the bulls will have to fight through. Plus, readers should note that we cannot find a confirmed earnings date for DB's earnings report. The only data we can find suggests that DB will report on October 31st. We do not want to hold over the announcement.

Suggested Options:
We are suggesting the November calls.

BUY CALL NOV 130 DB-KF open interest= 210 current ask $5.90
BUY CALL NOV 135 DB-KG open interest= 238 current ask $3.70
BUY CALL NOV 140 DB-KH open interest=1189 current ask $1.70

Picked on October 01 at $130.79
Change since picked: + 0.61
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 633 thousand


Kohl's - KSS - close: 60.62 change: -0.49 stop: 57.90

It was something of a rocky week for retailers. Most of the same-store sales numbers on Thursday were negative. Yet the government retail sales report on Friday was better than expected. KSS displayed relative weakness on Friday with another dip toward the $60.00 level. Readers could buy a bounce from here but we would suggest waiting for a new rally past $62.00 again. More conservative traders might want to tighten their stops toward $59 or Friday's low near $59.95. Currently our target is the $67.00-68.00 range but the stock has plenty of resistance with its 100-dma near $64 and its exponential 200-dma near $65.

Suggested Options:
If KSS trades back above $62.00 we would suggest the November calls.

Picked on October 11 at $ 62.01
Change since picked: - 1.39
Earnings Date 11/15/07 (unconfirmed)
Average Daily Volume = 5.9 million


Lehman Brothers - LEH - close: 64.63 change: +0.49 stop: 61.99

This could be a volatile week for the financial stocks. Most of the broker-dealers have already reported so now it's time for the banks. Investor reaction to the earnings news will determine direction for LEH. We would wait for a new rally past $65.00 or $65.25 before initiating new positions. More conservative traders may want to wait for a new rally past its 100-dma at $66.10 before opening new plays. 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:
If LEH provides a new entry point we would suggest the November calls.

Picked on October 11 at $ 65.25
Change since picked: - 0.62
Earnings Date 12/13/07 (unconfirmed)
Average Daily Volume = 15.8 million


Stryker - SYK - cls: 73.92 change: +0.79 stop: 69.45

SYK displayed relative strength again. Thursday's move looked like a bearish reversal but there was no follow through lower. SYK managed to post another 1% gain in spite of news that the company announced it had received an "informal inquiry" by the SEC into possible violations of the Foreign Corrupt Practices Act. We are not suggesting new positions at this time and some of our readers may want to exit early now to lock in a gain. Our target is the $74.90-75.00 range. SYK is due to report earnings on Wednesday after the closing bell. We do not want to hold over the announcement.

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

Picked on October 02 at $ 70.65
Change since picked: + 3.27
Earnings Date 10/17/07 (confirmed)
Average Daily Volume = 1.4 million


Terex - TEX - cls: 88.17 change: +1.29 stop: 84.75 *new*

Traders bought the dip on Friday but we're still a little concerned with the new bearish tilt in some of TEX's technical indicators. Shares have a bullish pattern of lower highs but are still struggling with resistance near $91. We would hesitate to open new positions here. Please note we are adjusting our stop loss to $84.75. One concern we have is that TEX might just consolidate sideways for the next week as investors wait to hear the company's earnings report on the 24th. 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.

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

Picked on September 25 at $ 86.50
Change since picked: + 1.67
Earnings Date 10/24/07 (confirmed)
Average Daily Volume = 1.8 million

Put Updates


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.)


Dow Jones Industrial Avg. - DJX - cls: 140.93 chg: +0.78 stop: n/a

Note: We are changing our exit price to $6.00.
We need to see a continuation of the DJIA rally if we're going to make it with this strangle play. We only have four trading days left before October options expire. Normally we would have five trading days left but the DJX is a European style option and trading will cease after Thursday even though the option doesn't expire until Saturday. Readers may want to consider an early exit now to salvage some capital. 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 $6.00.

Suggested Options:
We're not suggesting new positions in the DJX..

Picked on September 16 at $134.43
Change since picked: + 6.50
Earnings Date 00/00/00
Average Daily Volume = million

Dropped Calls

Intl. Bus. Mach.- IBM - cls: 117.81 chg: -0.24 stop: 114.49

We are closing the IBM call play. The company is due to report earnings this week. It was a challenge to find a correct earnings date and we finally found one on IBM's website suggesting that the company will announce on Tuesday, October 16th. We do not want to hold over the report with a directional play so we're suggesting an exit now. The stock has already hit our initial target in the $118.00-120.00 range. Our secondary target had been the $124.00-125.00 range.

Picked on August 26 at $113.24
Change since picked: + 4.57
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 9.5 million

Dropped Puts


Dropped Strangles


Trader's Corner

A Bad Report Card

I'm following up on an old article, and I'm going to give myself a bad grade for turning in my assignment a bit late.

In the middle of August, I took an initial look at what the corrective fan principle might be telling us about the decline. I promised at that time to follow up in a few weeks. Now it's been more than a few weeks. What decline, some might already be asking.

Some of you might not have read that original article or any articles dealing with the corrective fan principle. Ordinarily, in order to avoid boring those who did read that article, I would link the article to avoid going over all the details again. However, the production staff scrambled the charts in that original article. The article made little sense to those reading it originally because of that scrambling.

Review is necessary. Those of you well acquainted with the corrective fan principle can skip to the first chart, ignoring the next few paragraphs.

To review, Martin J. Pring explained the corrective fan principle in his book TECHNICAL ANALYSIS EXPLAINED, although I don't know that Pring necessarily developed the principle. The principle suggests that any trending move establishes three trendlines. The first sharp move up from a low or down from a high tends to be too steep to be maintained. Prices fall through the first ascending trendline or break up through the first descending one. A less steep second trendline is established. Prices bounce from that trendline for a while, too, but it's also too steep to be maintained. A third trendline is established.

When that trendline breaks, the principle suggests that the trending move is kaput. In the case of a rally such as the one off the 2006 low, the SPX break of that third trendline occurred in February. It suggested that either a period of disorganized trading or else a downtrend would follow.

Some traders were surprised when prices zoomed right back up again, reaching new highs, but they zoomed right to the underside of the third rally trendline. This summer's decline was a decline from that third trendline test.

The August article posed the following question: Can the corrective fan principle tell us something about when the downtrend since that began in July would end? The following chart explored some possibilities. The annotations are those that appeared on the chart in the August 18 Trader's Corner.

SPX Daily Chart from August 18 Trader's Corner:

What's happened since? Let's take a look.

Annotated Daily Chart of the SPX as of 10/11/07:

As is obvious, the fit wasn't perfect here. It wasn't even good. Have we learned anything anyway? Was the corrective fan worth drawing?

In retrospect, we've learned quite a bit, it turns out. Although the trendlines might be a bit messier than I like, with fewer touch points to validate them, RSI validates each. In addition, just as the corrective fan principle suggests will typically happen, the third trendline break was accompanied by a surge in prices and by an RSI break above its third trendline. After that third trendline break, RSI began trending above its third fan line while prices steepened their climb.

In retrospect, the fan worked. However, in real life, this correlative fan was difficult to discern as it developed. At no time, perhaps up until the break of the third fan line was accompanied by a steepened climb, was there any confidence in the trendlines drawn. Only the fact that congruent RSI trendlines existed seemed to give the fan lines validity.

But guess what? I might have been late to return to the corrective fan for the downtrend, but what about the new uptrend? It's already possible to draw three fan lines off the rise of the summer's low. Take a look.

Annotated Daily Chart of the SPX as of 10/11/07:

Although the price touch points on that third, green trendline are not well established, they are on the analogous green RSI trendline, lending some validity to that price trendline.

This chart was snapped Thursday evening. My charts show a red slider at the bottom of the chart when a chart is scrolled backward, so that's a good test for you to be sure this was snapped on Thursday evening. There's no red slider, as there would have been if I'd scrolled the chart back on Friday.

Nothing happened on Friday that either confirmed or refuted the evidence here. Prices didn't drop below their green trendline.

What do you do about this information? You sit down this weekend and calmly think about your portfolio. Would it benefit from a drop through that trendline or be hurt from it? What if the drop was precipitous? Maybe you've been in a long position play since August, for example. Maybe you've seen every trendline break during that time result in an almost immediate buy-the-dip reaction and a push higher, so you don't want to do anything about this newest trendline, either. If the corrective fan principle has validity in your eyes, maybe you want to consider whether this trendline break might be different, if it should occur. Think whether and where you'd be taking profits if that third trendline breaks.

Maybe, if you're already in a bearish position, you're looking at that green price trendline and noticing that prices have still been bouncing from it. You might be thinking about how no confirmation of the RSI's signal has yet occurred and might not occur for quite some time. You need to have your just-in-case plan in mind, too.

In other words, technical analysis allows you to study charts dispassionately, when markets are closed, and formulate plans. We get scared and get that deer-in-the-headlights reaction when something unexpected occurs and we haven't prepared for it. So prepare for these three scenarios:

1. No trendline break occurs and the SPX bounces hard.
2. A trendline break occurs and the anticipated precipitous drop occurs.
3. A trendline break occurs, but "break" is stretching it because candles essentially move sideways below the rising trendline.

These scenarios are bullish, bearish and neutral, respectively. Your plans should always include what you'll do if markets move against you, in the direction of your trade, or nowhere at all.

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.


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

To ensure you continue to receive email from Option Investor please add "support@optioninvestor.com"

Option Investor Inc
PO Box 630350
Littleton, CO 80163

E-Mail Format Newsletter Archives