Option Investor

Daily Newsletter, Monday, 10/15/2007

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Table of Contents

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

Market Wrap

Oil Breaks Above $86; Stocks Retreat

Crude Oil at the NYMEX broke above the $86/barrel mark today as supply concerns and tensions in the Middle East had NYMEX Crude Oil futures (cl07x) settling up $2.44, or 2.92% at $86.13.

The latest surge in oil prices was fueled with a one-two-punch after the Organization of Petroleum Countries (OPEC) said crude oil production by countries that are not OPEC members is probably falling despite rising demand.

Exacerbating oil's rise for a fifth-straight session was the Turkish government threatening to invade northern Iraq in an attempt to chase rebel fighters from the Kurdistan Workers' Party. The military tensions on the Turkish border are a potential flash point as a major pipeline that links Iraq's northern fields to Turkey is vulnerable to disruptions from bombings.

In a recent report, energy analysts at Lehman Brothers listed an unexpected growth in supplies from Iraq as one potential reason oil prices might fall.

Outside of energy and mining sectors, the Biotechnology Index (BTK.X) 849.83 +0.55% held onto a modest gain.

SShares of Biogen IDEC (NASDAQ:BIIB) $82.51 +18.83% surged as high as $84.75 in early morning trade after the company's board said it had authorized management to explore the sale of the company after drawing interest from potential buyers. Shares of Biogen IDEC churned a hefty 30.7 million shares, roughly 7-times its average daily volume.

Shares of Medtronic (NYSE:MDT) $50.00 -11.23% led the list of decliners for the S&P 500, after it suspended sales of four models of defibrillation leads because of a risk they could break.

Dow component and S&P 100 heavyweight Citigroup (NYSE:C) $46.24 -3.40% traded down $1.63 after the banking behemoth said third-quarter earnings declined to $2.38 billion from $5.51 billion a year earlier. While bottom line results were slightly better than analysts had forecast, the company warned that its third-quarter earnings would decline by 60%.

Citigroup's CFO Gary Crittenden cautioned investors that mortgage delinquencies have accelerated and said consumer credit market conditions "will continue to deteriorate."

I would appear that many market participants were looking for an "all clear, it's over," from Citigroup.

While I (Jeff Bailey) wouldn't read Citigroup's message as anything close to an "it is over," I did note today that the Pacholder High Yield (PHF) $9.20 +0.54% continues to show some sign of firming in my U.S. Market Watch (above). A recent Net Asset Value (NAV) computation from this closed-end "junk bond" fund on 10/11/2007 was $9.89/share, its highest NAV benchmark since 07/19/2007 when the fund reported a $10.01 NAV.

It should be noted that closed-end funds can trade above, or below their actual NAV. A closed-end funds NAV is derived from their actual holdings, which may not necessarily be reflected in the securities market price. On Thursday, 10/11/2007, Pacholder High Yield (PHF) closed at $9.15, a 7.48% discount to its NAV.

On August 16, when PHF's shares fell to a session low of $7.54 and closed $7.73, the fund reported a NAV of $9.33.

I do think we should listen to the world's largest banker's comments, but if PHF is any indication of the higher risk junk bond credit markets, we are seeing some firming and renewed liquidity.

Homebuilders as depicted by the Dow Jones U.S. Home Construction Index (DJUSHB) 365.93 -3.69% paced today's sector weakness and broke back under a trying-to-round-higher shorter-term 21-day SMA at 378.14.

Ex-Fed Chairman Alan Greenspan may not have helped sentiment towards the homebuilders after he reiterated his thoughts that housing prices had yet to bottom.

As I type this evening's wrap, current Fed Chairman Ben Bernanke has wrapped up his speech to the Economic Club of New York.

Some of the headlines are the Dr. Bernanke is keeping his options open by standing ready to "act as needed" if recent credit-market and housing turmoil affects the economy, but is also being prepared to "reverse" last month's rate cut should inflation return.

Dr. Bernanke did say the rate cut in September has helped to reduce financial strains, it is still too early to tell whether the housing slump and credit crunch will translate into consumer and business spending, though Fed officials reported that their business contacts were growing more cautious.

A quick look at the December Thirty-day Fed Funds futures (CBOT:ff07z) 95.40, suggest that market participants now see a 60% probability of an additional 25 basis point rate cut by year's end. I establish this analysis by taking the base 100, then subtracting current trade of 95.40, or (100 - 95.40) = 4.60%. The current target for the Fed Funds rate is 4.75%.

As recently as September 25th, the December Fed Funds futures contract rose as high as 95.64, suggesting a Fed Funds target of (100 - 95.64) = 4.36%. That would have equated to a 55% probability of an additional 50-basis point rate cut.

December Fed Funds Futures (ff07z) - Daily Intervals

Just after Dr. Bernanke's speech, I see the ff07z down tick to 95.40. Not much of a reaction, but the above chart gives some observation of the "uncertainty" that market participants are dealing with.

Why would the ff07z rise all the way to 95.625 just over a week ago? I would have to think "worrisome economic slowing."

I like to simply "divide the ranges" of what would be 25 basis point moves with a retracement bracket, where each level is simply a "10% probability" level.

Again, the above chart suggests market participants see a 60% chance of an additional 25 basis point rate cut by year's end.

We did get some regional economic data today, which was stronger than forecasted. The NY Empire State Business Conditions Index came in at 28.8 for October, which was well above the 13.0 forecast and September's 14.7 reading.


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The diffusion index measures sentiment at manufacturing firms, with readings over zero indicating that more firms say conditions are better. The index is seen as an inconsistent predictor of national manufacturing activity.

A quick look inside the numbers showed the new orders index rose to 25.0 from 13.6, while the shipments index rebounded to 28.6 from 5.1.

The prices-paid index was roughly unchanged at 36.1, while the prices-received index rose to 15.1 from 11.7, the highest since January.

The employment index rose, and the average workweek index reached its highest level in more than a year.

Manufacturers expect business conditions to remain favorable; the future index increased to 50.6.

Market Internals (NYSE & NASDAQ) - Since 09/04/07

Market internals at both the NYSE and NASDAQ were weak today, and from the opening bell, decliners easily outnumbered advancers by roughly 3:1.

In Thursday's Market Monitor at OptionInvestor.com, I did suggest traders holding some of my bullish plays take some profits off the table, and cut one loss. With some profits booked, I think bulls will want to be set to reload and target new highs in the not-to-distant future.

By the end of the month for those that read last Monday's Market Wrap. I'm still sticking with an SPX target of 1,600 by Halloween.

Global Equity Benchmarks and Currencies -

While oil's rise may get some "bearish" broader market headlines here in the U.S. and perhaps European bourses, it wasn't the case on Monday in China.

Since last Monday, China's Hang Seng ($HSI) has surged an additional 6.37%.

Alan Greenspan also said today that the rising China stock markets are not sustainable for very long.

Stock's I like to follow, and trade from time-to-time with a "China flavor" had Baidu.com (NASDAQ:BIDU) $314.71 -2.56%, Sohu.com (NASDAQ:SOHU) $43.66 -1.66%, PetroChina (PTR) $236.44 +9.39% (currently PUT in Market Monitor from $181.42 on 10/08/07) and CNOOC Ltd. (NYSE:CEO) $188.26 +5.73% showing some very mixed results.

While I might tend to agree with Alan Greenspan's view on China, I've yet to see the market confirm those thoughts.

One "reason," I did encourage traders to book some profits on Thursday of last week, may also present itself in the above table.

On Thursday, Bundesbank president Axel Weber said if risks to price stability materialize it may no longer be possible for the European Central Bank (ECB) monetary policy to remain accommodative to help support the EU member states' economic growth.

In essence, I think Mr. Weber was saying "rate cut less likely."

The euro rebounded against the dollar (Euro/US$) and the euro was also strong against the Japanese yen (Euro/Yen).

London's FTSE-100 was up 1.59% week-over-week, and we'll remember that the UK is NOT on the euro currency. However, Germany's DAX and France's CAC-40 may reflect euro-currency economies.

In essence, monitor the DAX and CAC-40. It has been my analysis in recent weeks that market participants want to see the ECB take a less hawkish stance on rates.

Should the ECB continue to RAISE rates, that would likely STRENGTHEN their currency further and pressure the European block's exports to other countries.

Japan remains "most vulnerable" in my opinion should the US$ weaken vs. the yen (US$/Yen) and the euro weaken vs. the yen (Euro/Yen).

Excellent Work!

One of today's "best" technical comments and thought processes came from Ms. Louise Yamada. Perhaps some of you caught her comments regarding past history and the 10-year anniversary of "Black Monday" and October 2007.

In brief, Ms. Yamada made a case (for which she will continue to test) that the recent PRO-ACTIVE, instead of REACTIVE Fed policy may have averted another crash like that found 10-years ago to the day.

Dow Industrials (INDU) - Daily Intervals

There are some "spooky" similarities that may indeed have presented themselves just a couple of weeks ago when the Dow Industrials (INDU) fell sharply below its 200-day SMA on August 16th. The next day, the Fed cut the Discount Rate by 50 basis points to 5.75%.

Just recently, as the INDU hovered at its 50-day SMA, the Fed cut the Fed Funds target by 50 basis points, and once again lowered the Discount Rate 50 basis points to 5.25%.

Dow Industrials (INDU) "Black Monday" - Daily Intervals

It was 10-years ago today that the Dow Industrials plunged more than 500 points. Just one day after it had closed below its 200-day SMA.

Ms. Yamada sees some striking technical similarities, with one difference. A more PRO-ACTIVE Fed instead of a Fed that was more REACTIVE.

Here's what I see taking place in the S&P 500 Index (SPX.X) into October's option expiration, and into the end of the month. At Friday's close there was a pretty good BULLISH setup. Bulls NEEDED some type of pullback in order to set the trade up, they got some of it today.

S&P 500 Index (SPX) - 60-minute interval chart

In last Monday's Market Wrap I showed the SPX with the MONTHLY (dark purple) MONTHLY Pivot retracement. We're going to "zoom in" with a 60-minute interval chart here tonight.

The SPX closed a little stronger than I thought it might (ABOVE WEEKLY S1) so a Tuesday decline to WKLY S2 is questionable.

But that's the "lower risk" bull entry as it comes right near the previously broken to the upside downward trend, and some VERY heavy option open interest.

What a Pivot trader bull likes to see is a PULLBACK early in the week like we did get today, and then a "sling shot" move back higher with a Wednesday CLOSE at or near all that overlapping MONTHLY R1 and WEEKLY Pivot of 1,561.54.

The Dow Transports (TRAN) couldn't quite close the deal above their 150-day SMA last week and that could well have limited gains for the SPX.

Oil prices have weighed on the Transports, and once again, this Wednesday's EIA inventory figures could set the tone for the rest of the week, and perhaps the month.

The ability of the SPX to see strength ABOVE the MONTHLY R1 suggests institutional computers have limited supply of stock and a move back above WEEKLY Pivot and that MONTHLY R1 should get a catapult move to my Halloween target of 1,600.

With volatility having spiked today, I'd trade IN-THE-MONEY , or AT-THE-MONEY call options. I'm going to be looking to buy the SPY November $153, or $154 calls.

If the Transports (TRAN) are NOT above 4,980 should the SPX/SPY trade MONTHLY R1 (1,563.90/$156.52) bulls can tighten up some stops.

Watch the Market Volatility Index (VIX.X) 19.25 +8.57%. It's WEEKLY R1 is 19.35 (see SPX at WEEKLY S1) and its WEEKLY R2 is at 20.96. Should the VIX.X hit 20.96 and reverse back lower quickly, that suggest that institutional computers, and traders that LOVE to SELL PREMIUM have found a level they have confidence in.

Remember, VIX declines when call BUYERS/put SELLERS are more aggressive than call SELLERS/put BUYERS.

New Plays

New Option Plays

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

New Calls

None today.

New Puts

None today.

New Strangles

Intl. Bus. Mach. - IBM - cls: 118.03 chg: +0.22 stop: n/a

Company Description:
International Business Machines Corporation (IBM) is one of the largest and most diversified hardware, software and services IT company in the world.

Why We Like It:
IBM is due to report earnings tomorrow, October 16th, after the market's closing bell. Shares have been consolidating sideways for weeks and we're expecting a big post-earnings move. Tomorrow is our day to open strangle positions. We're going to suggest both an aggressive October strangle and a less aggressive November strangle.

Suggested Options:
A strangle involves buying both an out of the money call and an out of the money put.

For the aggressive October strangle where the options expire in four days. Our estimated cost is $1.20. We want to sell if either options hits $2.40.

BUY CALL OCT 125 IBM-JE open interest= 9548 current ask $0.65
BUY PUT OCT 110 IBM-VB open interest=12331 current ask $0.55

For the November strangle. Our estimated cost is $3.00. We want to sell if either option hits $6.00.

BUY CALL NOV 125 IBM-KE open interest=6756 current ask $1.55
BUY PUT NOV 110 IBM-WB open interest=4186 current ask $1.45

Picked on October 15 at $118.03
Change since picked: + 0.00
Earnings Date 10/16/07 (confirmed)
Average Daily Volume = 7.5 million

Play Updates

In Play Updates and Reviews

Call Updates

Amgen Inc. - AMGN - cls: 57.69 change: -0.48 stop: 55.90 *new*

We have to issue a bearish reversal warning on AMGN. The stock has produced both a failed rally at its 200-dma and a bearish engulfing candlestick pattern. Together this looks like a bad spot for the bulls. Readers will want to seriously consider an early exit right now to avoid further losses. We are not suggesting new positions. Please note that we are adjusting our stop loss to $55.90. Should AMGN reverse higher 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 11 at $ 58.01
Change since picked: - 0.32
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 11.7 million


Cummins Inc. - CMI - cls: 140.16 change: +0.14 stop: 134.45

We do not see any changes from our weekend comments. CMI is still inching higher and looks poised to breakout to new highs. 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.

Picked on October 11 at $140.85
Change since picked: - 0.69
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 2.0 million


Deutsche Bank - DB - cls: 129.93 chg: -1.47 stop: 128.99

DB got caught up on the financial sector weakness. Shares broke down under what should have been support at the $130.00 mark. The close under $130 is definitely a negative signal for the bulls. More conservative traders may want to exit early right here to avoid further losses. At this point we would wait for a rebound past $131.50 or $132.00 before considering new bullish positions. 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.

Picked on October 01 at $130.79
Change since picked: - 0.86
Earnings Date 10/31/07 (unconfirmed)
Average Daily Volume = 633 thousand


Diamond Offshore - DO - cls: 118.22 chg: +1.02 stop: 112.45

Oil stocks were generally higher thanks to crude oil crossing $86 a barrel. Shares of DO hit another high at $121.38 before paring its gains. Readers can choose to open positions here or a potentially better move would be to wait for a dip back towards $117.00-115.00. 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.

Picked on October 14 at $117.20
Change since picked: + 1.02
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 2.0 million


Stryker - SYK - cls: 72.80 change: -1.12 stop: 69.45

Readers may want to exit early now. We only have a couple of days left. Currently the plan is to exit on Wednesday at the closing bell to avoid holding over SYK's earnings report due after the closing on Wednesday. Our target is the $74.90-75.00 range.

Picked on October 02 at $ 70.65
Change since picked: + 2.15
Earnings Date 10/17/07 (confirmed)
Average Daily Volume = 1.4 million


Terex - TEX - cls: 86.56 change: -1.61 stop: 84.75

Traders bought the dip near support at $85.00 but we would hesitate to jump in here. The stock is trying to bounce but it has a short-term pattern of lower highs over the last few days. We're not suggesting new positions. Our target is the $94-95 range although more conservative traders may want to exit near $91.00. We plan to exit ahead of next week's earnings.

Picked on September 25 at $ 86.50
Change since picked: + 0.06
Earnings Date 10/24/07 (confirmed)
Average Daily Volume = 1.8 million


Vulcan Materials - VMC - cls: 92.57 chg: +0.25 stop: 89.90

VMC continued to bounce and traders bought the dip at $91.75. We would continue to open new positions here. Our target is the $99.00-100.00 range. The P&F chart is bullish with a $103 target.

Picked on October 14 at $ 92.32
Change since picked: + 0.25
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume = 1.4 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: 139.85 chg: -1.08 stop: n/a

We only have three trading days left! Readers may want to abandon ship right now. The DJX is a European style option and trading will cease after Thursday even though the option doesn't expire until Saturday. 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.

Picked on September 16 at $134.43
Change since picked: + 5.42
Earnings Date 00/00/00
Average Daily Volume = million


NASDAQ 100 trust - QQQQ - cls: 53.12 chg: -0.41 stop: n/a

Tomorrow the earnings parade should begin to hit full speed. Reaction to the earnings news and comments about the fourth quarter should produce some big moves in the NDX. 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 four days. You could do the same play using November options but you'll pay more and have to adjust your exit price. The options we suggested in our October strangle were the October $54 calls (QQQ-JB) and the October $53 puts (QQQ-VA). Our estimated cost was $0.76.

Picked on October 14 at $ 53.53
Change since picked: - 0.41
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 125 million

Dropped Calls

Biogen Idec - BIIB - cls: 82.51 chg: +13.08 stop: 67.63

Target exceeded. We hit the lottery with BIIB. As reported over the weekend BIIB announced after the close on Friday that they were putting the company up for sale. Shares soared after hours and we told readers that if the strength holds that BIIB would likely gap open higher. The stock opened at $83.35 this morning and hit $84.75 before pulling back. Kudos to any of the aggressive traders out there who took our suggestion to exit in the $84-85 zone. Our adjusted target was $80.00 but we would have exited at the opening trade.

Picked on October 07 at $ 67.63
Change since picked: +14.88
Earnings Date 10/23/07 (confirmed)
Average Daily Volume = 4.4 million


Citigroup - C - clos: 46.24 change: -1.63 stop: 46.64

It was a rough day for the financial stocks. The markets did not respond well to the news that several banks were joining together to repackage some debt that they've been unable to sell. Meanwhile Citigroup reported earnings and managed to beat the recently lowered expectations but the company did not have anything positive to say about the fourth quarter. Citigroup's comments about troubles continuing in the fourth quarter in the credit markets were partly to blame for today's market weakness. The stock hit our stop loss at $46.64.

Picked on September 16 at $ 46.64
Change since picked: - 0.40
Earnings Date 10/15/07 (confirmed)
Average Daily Volume = 40.7 million


Caterpillar - CAT - cls: 78.84 change: -1.46 stop: 78.59

We were expecting some Monday morning follow through on Friday's rebound in CAT. Instead the stock spiked lower and broke down under technical support at its 100-dma. Shares quickly hit our tight stop loss at $78.59. Nimble traders may want to keep CAT on their radar screens and buy a bounce from here. Shares were inching higher after consolidating near $78 all day long.

Picked on October 14 at $ 80.30
Change since picked: - 1.46
Earnings Date 10/19/07 (confirmed)
Average Daily Volume = 5.6 million


Ceradyne - CRDN - cls: 74.19 change: -1.49 stop: 73.95

It turned out to be an ugly day for CRDN. The early morning rally reversed lower under its 10-dma and shares eventually broke down under $75.00 and traded under $74 intraday. The stock hit our stop loss at $73.95. Today's move is both a failed rally pattern and a bearish engulfing candlestick, which would suggest the next move will be lower.

Picked on September 25 at $ 74.61
Change since picked: - 0.42
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume = 653 thousand


Kohl's - KSS - close: 58.54 change: -2.08 stop: 57.90

KSS really under performed the market and the retail sector with a 3.4% decline yet we could not find anything specific in the news to account for the weakness. If you look at an intraday chart you will see that traders bought the dip more than once near support at $58.00 and that the low today was $58.00. That means the intraday low at $56.50 was a bad tick. We have been choosing to play the bad ticks since they are a real hazard in the market. Thus, technically, we've been stopped out at $57.90.

Picked on October 11 at $ 62.01
Change since picked: - 3.47
Earnings Date 11/15/07 (unconfirmed)
Average Daily Volume = 5.9 million


Lehman Brothers - LEH - close: 62.33 change: -2.30 stop: 61.99

The broker-dealers took the brunt of the financial sector weakness today. Shares of LEH dipped under support at $62.00 and hit our stop loss at $61.99. The short-term technicals are starting to turn bearish and the MACD has just produced a new sell signal.

Picked on October 11 at $ 65.25
Change since picked: - 2.92
Earnings Date 12/13/07 (unconfirmed)
Average Daily Volume = 15.8 million

Dropped Puts


Dropped Strangles


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


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