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Daily Newsletter, Sunday, 10/28/2007

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Table of Contents

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

Market Wrap

Tensions Increase As Fed Meeting Nears

Next week will be packed full of critical economics and a FOMC meeting and the tensions are mounting as the days tick off the calendar. Earnings excitement is beginning to fade with the majority of the big cap reports already behind us. Attentions are now turning to the full calendar of economic reports that may indicate recession or inflation and the FOMC decision.

Dow Chart - Daily

Nasdaq Chart - 60 min

Friday was devoid of any material economics with the Consumer Sentiment update the leading report. Sentiment fell from the first reading of 82.0 to 80.9 for the last half of October. This was a new 17 month low that was triggered by a sharp drop in future expectations from 74.1 to 70.1. Gasoline prices and now high heating oil prices are pressuring consumer budgets. The new highs in crude prices are telegraphing even higher prices at the pump and consumers are already aware those prices are coming.

Consumer Sentiment Chart

Recession Probability Chart

The Risk of Recession report for September came in at 32.1%, which seems high but this was a major change from the August levels. They August report showed this risk to be 40% but that was revised down in the September report to only 31.6%. This nearly 10-percentage point drop in the August number brings the index back into a more realistic range and removes some of the tension from the report. The recession risk is still up significantly over the 20% or so we have seen over the past year but not yet in a critical range thanks to the downward revision. The contributing factors remain rising mortgage delinquencies, tighter credit markets and a weakening housing market. The current headline number at 32.1% is the highest level seen since 2002. The Fed's 50 basis point rate cut was the main reason behind the sharp revision in the August number with the revised jobs report and rebound in the stock markets also contributors.

Last week was a light week for economics but the coming week is chock full of potential potholes for the market. Monday and Tuesday are very slow with minimal reports but the next three days make up for the gap. On Wednesday the big report will be the first look at the Q3 GDP with expectations calling for +3% growth. This will be very closely watched for signs of weakness and recession concerns. Also on Wednesday we get the Chicago PMI and analysts are worried that it could decline from last months 54.2 to something closer to 50 and possible contraction territory. Both of those reports will be closely watched by the Fed and that brings us to the third event on Wednesday.

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The two-day FOMC meeting ends on Wednesday and they are expected to cut rates by an additional 25 points. The Fed funds futures are showing a 110% chance of that coming to pass. This is already priced into the market. There is a growing feeling they will cut another 50 points and cut the discount rate as well. This is about the only thing that will produce a material post Fed bounce. With the first 25 points already priced in a 25 point cut could produce a sell the news event. I am leaning to the 50 point cut as a potential option. The next meeting is Dec-11th and the Fed historically avoids any rate moves in December. The next meeting after that is Jan-29th. That means there is three full months between next weeks meeting and the end of January meeting where they can adjust rates again. That suggests they should take the plunge next Wednesday and go the full 50 points. Officially, inflation is tame even with the higher oil and commodity prices. That gives the Fed plenty of room to move without any material risk. There is no downside to another 50-point cut but there is downside if they don't cut and have to wait another 90 days to make another move. Reportedly the activity at the discount window has risen to the highest level since the first discount rate cut. This suggests liquidity in the credit markets is drying up again after the major financials reported larger than expected earnings losses and higher levels of subprime exposure. Another rate cut here would be an insurance move to improve sentiment rather than improve the economy and it is a sentiment move that would make a big impact. Let's hope the Fed sees the positive impact a 50-point cut would make.

The economics continue on Thursday with the ISM Index the major report and a clear view into the recession worries. The ISM headline number in September was a drop to 52.0 and the 3rd monthly drop from the 56.0 cycle high in June. Estimates are for another small drop to 51.8. If we get a drop below 50 and into contraction territory it could be very negative for the markets. The Fed will undoubtedly have access to this number before they make their rate cut decision. The last major report for the week is the NonFarm Payrolls on Friday with estimates for a gain of +85,000 jobs. You may remember there was a disaster in August where we saw job losses rather than gains but those were erased with some strong revisions in the September report. The market collapsed after the August report and then rebounded strongly after the September revisions. September saw gains of +110,000 jobs. Clearly there is some volatility in the numbers and that could carry over into the October report. The current estimates are for job gains of +85,000 but the whisper numbers are beginning to trend lower. This is going to be another critical report and one that the Fed will see before they make their rate decision. This suggests that whatever happens at the Fed meeting will already have these reports factored in and that will diminish their individual impact "IF" the Fed cuts 50 points. A 25-point cut would suggest a strong ISM and Jobs report to come. It will definitely be a very volatile week in the markets.

Economic Calendar

Microsoft hit a six-year high at $36 on Friday after posting a +27% increase in earnings. The stock pulled back from its highs but still finished with a +$3 gain at $35. This was the strongest gain for MSFT since May-2002. Microsoft has 9.4 billion shares outstanding and this gain produced more than a $27 billion increase in market cap. This was a very strong report and possibly enough to give Microsoft a "get out of range free" card. Microsoft had been languishing in a $22-$28 range for years and only moved to a $28-32 range in 2007. It was dead money since the Nasdaq bubble collapsed and Thursday's report and Friday's gains appear to have escaped from that range. Microsoft said strong sales of Vista and a spike in video game sales driven by Halo 3 were the primary movers. Microsoft beat the street estimates by +6 cents and raised its guidance for the full year. Microsoft raised top line revenue estimates for the full year to $59.7B and earnings to $1.81. Analysts had been expecting $57.4B and $1.73. Vista sales grew to $4.1 billion and more than the $3.9 billion expected by most analysts. The Halo effect prompted a +91% increase in gaming devices revenue. The sales forecast had been pegged at 40%.

The earnings from Microsoft energized the entire tech sector with the exception of the semiconductor stocks. Ironically semiconductors should be the primary industry to benefit from the strong PC sales and forecasts given by Intel and Microsoft. Chips appear to be in a death spiral with the SOX falling nearly 50 points in the last four weeks. Some analysts are calling for buying in Intel and the major chipmakers while others are telling us to avoid them like the plague. I would be bullish on the chips if they would at least try to form a bottom. So far that has not happened.

Semiconductor Index Chart - Weekly

Countrywide Financial Chart - Daily

Countrywide Financial (CFC) surprised the bears with an optimistic outlook and a comment that the worst was over for them and the mortgage market. Countrywide reported $1.2 billion in losses mostly on write-downs related to bad loans. They currently have over 500,000 loans in default. It was their first quarterly loss in 25 years. However, they promised that changes they made in their business would return them to profitability in Q4 and that shocked nearly everyone. Morgan Stanley said they were "substantially more confident in the company's liquidity." Many had been concerned that Countrywide would not be able to remain solvent given the number of defaults they were experiencing. Despite Countrywide's claim of a return to profitability they did predict that defaults would increase and the housing market would not recover until 2009. Pretty bearish predictions but not much worse than what others had been saying. Some think we could see a rebound in 2008 but that outlook is not widespread. A friend of the family that works at Countrywide gave me an inside to how Countrywide is handling the slowdown. This person was making about $130K and they were cut to $30K but not laid off. Countrywide is trying to retain key people for when business returns to normal. It is going to create some hardships over the next 12-18 months but those employees that stick it out will benefit when the mortgage volume returns. Meanwhile they had to take on a second job and put their house up for sale because of the $100K drop in income. However, they retain their benefits and their job while Countrywide retained their experienced workforce. Obviously not all Countrywide employees were this fortunate but this is a multi-decade housing event so there will be some casualties.

Yahoo spiked +2.29 on Friday to extend its two-week winning streak to +$7. It was also responsible for 5% of the option volume at the CBOE with Microsoft accounting for another 5%. Between them they traded 1.2 million option contracts. Yahoo is spiking on expectations over the Alibaba IPO. Yahoo owns 39% of Alibaba and the IPO is expected to be a monster blowout. The IPO is scheduled to begin trading on Nov-6th and analysts expect this to bring $13-$15 to Yahoo over the next year. Alibaba's two primary business segments include Taobao, an Ebay like business and AliPay its PayPal clone. Taobao did $2.1 billion in business the first six months of 2007 and AliPay is running at a $4.7 billion annual rate. Both are expected to be worth $15 billion each in two years. Probably more as they mature. The expectations prompted somebody to buy 180,000 Jan $40 calls on Friday and 50,000 Jan $35 calls. This set off a buying frenzy as other traders heard the news of the exceptional option activity and followed suit. Yahoo has been moving up almost vertically since the Alibaba news began to break back in early September. Getting to $40 is going to be tough and not a bet I would have taken with Yahoo at $30 but evidently somebody with deep pockets thought it was worth the risk. Do you think they know something we don't know?

Yahoo Chart - Weekly

Tesoro Chart - Weekly

Capitan Kirk is back in action. No, not on the Enterprise but in the refining sector. Kirk Kerkorian announced he had taken a 4% stake in refiner Tesoro and was going to offer $64 each for another 21.9 million shares to raise his stake to 20%. This was a surprise shock to the refining sector and sent shares of all refiners higher on the news. This was an astoundingly ill timed move according to many analysts since profitability at the refiners is at a multiyear low as crack spreads become nearly invisible. On Friday crude soared to $92 a barrel but refined gasoline was only $95 a barrel. This leaves no room for profits and a point where something has got to give. Nearly all analysts have been predicting a drop in crude prices or a rise in refined product prices and so far they have each been doing the exact opposite. With profits shrinking to losses it would appear that refiners could be bought cheaper in the future. Buying Tesoro now has everyone scratching their head. With profits shrinking there is not likely to be a competing offer from another refiner and Valero can't bid due to antitrust concerns. This will be interesting to see how it plays out. Tesoro has seven refineries with total output of 660,000 bpd. Bear Stearns called refiner share prices "precariously high" and reiterated an underperform rating on the sector. A Goldman Sachs analyst distanced himself from the pack saying it was a bullish move and considered the sector undervalued. Since I follow Tesoro I am also shocked because I was looking for a pullback under $50 as a buying opportunity. That is a long way from captain Kirk's $64 offer. Guess I will mark that one off my list. The TSO Chief Economist, Lynn Westfall, was on CNBC on Thursday night. He said crude should be $60 based on all the known factors. He said there was "NO SHORTAGE OF CRUDE." Tesoro buys oil on the liquid markets every day. They have no long-term contracts and bank instead on the prices fluctuating with demand. With no long-term contracts he said they would be the first to be cut off if there was a shortage. He said they can buy all crude they want from any supplier they want. He said people they had never bought from before were "banging on the door every day begging them to buy their crude." He repeated several times there is no shortage and the current high price was speculators over geopolitical concerns.

That $60 claim did not keep crude from hitting $92.22 in electronic trading on Friday. The reasons for the continued spike were given as heightened tensions between Iran and the U.S. and the potential for an attack. The U.S. imposed additional unilateral sanctions against Iran and made noises about shutting down their oil exports by putting pressure on the buyers. The administration was very clear in saying Iran's oil exports are funding their terrorist support and arms exports. Vice President Cheney was interviewed on CNBC and basically said anyone doing business with Iran was not going to do business with the U.S. and framed that comment with the oil claim. While he did not explicitly say, "buy Iran oil and the U.S. will cut off trade with you" the intent was clear. The problem with that tactic is China. They buy oil from Iran and could care less about Cheney's threats. They know we are not going to cut off trade with them. Of course there are others who buy and could be convinced to shop elsewhere. Oil is fungible and that just means the tanker traffic will change direction as the buyers and sellers adjust but eventually it will adjust to business as usual. The U.S. also named several more banks in Iran as off limits to those wishing to trade with the U.S. in an attempt to prevent payments for exports from reaching Iran. OPEC also repeated their claim that there was plenty of oil and they were not likely to increase production again when they meet in December. Meanwhile the presidential contenders are stiffening their positions against Iran. Mitt Romney said he would be willing to use a military blockade or a bombing campaign of some sort to prevent Iran from building nuclear weapons. Several democrats spoke out against his stand but Hillary Clinton, the democratic front-runner, has already taken a strong stance against Iran. While he was governor Romney refused to provide a security escort or any state services when former Iranian President Mohammad Khatami visited Massachusetts to speak at Harvard. Odds are good we are moving towards a blockade and eventual bombing of Iran before the elections.

December Crude Oil Chart - Daily

BEAS Chart - Daily

BEA Systems (BEAS) dropped more than a buck on Friday after rejecting Oracle's $17 per share offer. BEA indicated it would consider an offer of $21 so at least they are ready to deal. Oracle's offer of $17 self-destructs on Sunday baring any new developments. Carl Icahn threatened a proxy fight to take control of BEAS if the company was not sold and he threatened to sue the board if they did not put the company up for sale. He currently owns a 15% stake. A Morgan Stanley analyst said they doubted a white knight would appear to provide a competing offer before Sunday. Without any new offers it appears certain that BEAS shares will continue to decline as speculators move to new opportunities and current holders grab what they can of the inflated price before it disappears completely. It is entirely possible Oracle could let it decline slightly then make another offer for $17 to see how many shareholders decide $17 is really better than $14 and the level it was trading before the offer. Oracle's president Charles Phillips said $21 was an impossibly high price for Oracle or for any other acquirer and Oracle would move on to other opportunities if the offer was not accepted by Sunday. HPQ and IBM have also been named as potential buyers and they could be waiting to see what Oracle does next before making a decision. Both refuse to comment on their intentions. BEAS has not filed financials since April 2006 due to an option grant audit underway. Analysts said they could be dragging their feet today to prevent anyone from knowing what they were really worth until Oracle went elsewhere.

Nobody ever wants to work for Larry Ellison. His ego and conspicuous consumption are legendary. He once had a yacht built a foot longer than Paul Allen's so he could claim ownership of the largest private yacht. That yacht, named the Rising Sun, is now 4th in the world at 452.75ft. After Bill Gates finished his home and it was valued at $125 million including the land, Ellison launched an effort to find a new home and his new one was valued last week in one report at $147 million and $200 million on Wikipedia.org. Now if Larry would only try to outdo Bill Gates in his charitable giving that would be something. Gates has given away over $30 billion since 2000. Ellison was allowed to donate $100 million to charity to settle an insider-trading lawsuit a couple years ago. That was hardly voluntary. In 2004 Ellison made the Forbes list of charitable donations by pledging $115 million to Harvard. In 2006 Ellison announced he would not honor that pledge. Sorry Larry, looks like Gates has you beat by a mile. There is a book by Mike Wilson titled, "The Difference Between God and Larry Ellison." The difference according to Wilson, "God does not think he is Larry Ellison" leaving you to draw the obvious conclusion.

Getting back to the markets the expectations for next week are bullish at least for me. The real direction will depend on the various economics and the Fed decision on Wednesday. Since the markets are expecting a rate cut they should continue to creep higher into that decision as long as nothing appears in the news or earnings to sour sentiment. We have had a run of bad results and some very good results. Unfortunately with about 50% of the S&P already reported the Q3 earnings growth is actually negative at -4.1%. Earnings expectations for Q4 are still in double digits at just over 10%. The Q4 scenario is clear. Assuming earnings guidance does not suddenly decline sharply it appears Q3 will go down as a one time event triggered by the subprime implosion. If Q4 expectations remain around 10% we should see a decent Q4 rally assuming the Fed and economics continue to be positive. Current targets being quoted for Q4 are still 15,000-15,500 on the Dow, 1600-1650 on the S&P and over 3,000 on the Nasdaq. With only 40 or so days left to trade that would suggest we better get our move on or those targets will be very tough to reach.

The Dow rebounded off strong support at 13500 after two successful tests on Monday and Wednesday. Friday's close at 13806 is nearly 400 points off the Monday lows but still 300 points below strong resistance at 14100. The Dow's Friday's gains were attributed in large part to the +3 move in Microsoft and dollar gains in AA, HPQ, JPM, IBM and Citigroup. Closing right in the middle of our recent range means the Dow can whipsaw wildly and still maintain its bullish bias. A move under 13500 would still be a strong sell signal. Otherwise traders should be in dip buying mode.

The S&P-500 mimicked the Dow in rebounding strongly off support at 1490 after two tests on Mon/Wed. Resistance is 1555 and 1565 and the close at 1535 is bullish with its +45 point rebound off the week's lows. With the major S&P reporters already behind us we do have earnings risk since the future reporters tend to post less positive earnings than those early big caps we have already seen. Still, a Fed rate cut will help financials and they are the biggest percentage of the S&P.

S&P-500 Chart - Daily

The Nasdaq has returned to the scene of the crime at 2800. That resistance level has held firm for more than two weeks and rebuffed every breakout attempt. The close at 2802 was due to the strong gains in Microsoft, Yahoo and Google. They were helped by monster moves in BIDU +19 and DECK +31. With moves like that you would think the Nasdaq would have been higher but it is a composite index of 3078 stocks and one third of them were down on Friday. That is a problem that has been plaguing the indexes over the last week. Volume has been strong but fairly evenly weighted between advancers and decliners. The bullish conviction had cooled early in the week but appeared to return on Friday. I believe if the Nasdaq can continue to push over resistance at 2800 the tech sector will be successful in pulling the broader markets higher.

Russell 200 Chart - Daily

Normally I would be looking at the Russell at this time of the year but the Russell support has weakened. Fund managers appear to be favoring large caps again and it is probably due to the weak earnings. Big caps offer more earnings safety and small caps are sudden death if they announce a bad report. For instance Wellcare (WCG) fell -$84 in the last 2 days after reporting problems with the SEC, shareholder lawsuits and a raid on its headquarters by state and Federal agents. Granted this was not a normal small cap ($1.3B cap) or simply an earnings miss but it shows how quickly a company with only 40 million shares outstanding can collapse when problems arise. The Russell actually rose +2.8% for the week but the majority of those gains came on Friday (+1.9%). The rest of the week the Russell was dead money. The Russell has major resistance at 850 and we are not even close. That resistance has been rock solid since June. The lack of fund manager commitment to small caps is why I am focusing on the Nasdaq as the leading index for next week.

The majority of market movement will be predicated on the economic events rather than the earnings but that does not mean earnings no longer matter. Next week is the busiest earnings calendar of the cycle but it will be more about the overall guidance rather than individual reports. There will still be winners and some disasters but they will not matter as much except on an individual basis. This is the week where the bulls have to prove their conviction again or we can write off the year-end rally until next year.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BA None None
HAYN    
LLL    
SI    
WHQ    

New Calls

Boeing - BA - close: 96.02 change: +0.02 stop: 94.85

Company Description:
Boeing is the world's leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined. Additionally, Boeing designs and manufactures rotorcraft, electronic and defense systems, missiles, satellites, launch vehicles and advanced information and communication systems. (source: company press release or website)

Why We Like It:
Defense stocks, as a group, have been able to hit new all-time highs in spite of BA's big sell-off in October. The company recently reported earnings and the stock didn't see any further selling. We suspect that all the "bad" news is out. Shares have been consolidating sideways the last couple of weeks and the stock has bounced multiple times near support around $92.50. We are suggesting a trigger to buy calls at $97.25. There is potential resistance at its 50-dma and the $100 level but if the markets make a fourth quarter run then BA could rally back toward the $105 region. If triggered at $97.25 our target is the $104-105 zone. FYI: The P&F chart is still bearish from the October sell-off.

Suggested Options:
We are suggesting the December calls. Our suggested trigger to open positions is at $97.25.

BUY CALL DEC 95.00 BA-LS open interest=1470 current ask $4.60
BUY CALL DEC 100.0 BA-LT open interest= 916 current ask $2.30
BUY CALL DEC 105.0 BA-LA open interest= 559 current ask $1.00

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/07 (confirmed)
Average Daily Volume = 6.3 million

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Haynes Intl. - HAYN - cls: 86.49 change: +2.33 stop: 82.45

Company Description:
Haynes International, Inc. is a leading developer, manufacturer and marketer of technologically advanced, high-performance alloys, primarily for use in the aerospace, land-based gas turbine and chemical processing markets. (source: company press release or website)

Why We Like It:
Many of the steel and metal stocks are on the rebound and HAYN just broke through short-term resistance in the $85-86 zone. Looking at the chart you can see the pattern of higher lows. Meanwhile both the daily and weekly technical indicators are improving. We are suggesting call positions now with HAYN above $85.00. There is clear resistance at $90.00 but if the market makes a fourth quarter run we suspect that HAYN can hit new relative highs. We'll set a conservative target at $89.90-90.00 and an aggressive target in the $94.50-95.00 range. The Point & Figure chart has broken through resistance and points to a $100 target. FYI: There are a couple of big names in the steel and iron sector (like U.S.Steel) that will report earnings this week. Their results could influence shares of HAYN.

Suggested Options:
We are suggesting the December calls. November calls could work but they expire in three weeks. We do not see any $95 strikes available yet.

BUY CALL DEC 85.00 HQR-LQ open interest= 5 current ask $8.10
BUY CALL DEC 90.00 HQR-LR open interest=13 current ask $5.80

Picked on October 28 at $ 86.49
Change since picked: + 0.00
Earnings Date 12/10/07 (unconfirmed)
Average Daily Volume = 166 thousand

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L-3 Comm. - LLL - cls: 106.98 chg: +0.27 stop: 103.90

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

Why We Like It:
LLL recently reported earnings that were better than expected. Shares did not move much on the news but the overall trend remains bullish. We are suggesting that readers buy a breakout over resistance at $108. Our suggested trigger to open positions is at $108.10. You might want to wait for a new relative high over $108.30 (the Oct. 11th high). If triggered our target is the $114.00-115.00 range. The P&F chart is bullish with a $133 target.

Suggested Options:
We are suggesting the December calls although Novembers would also work. November options expire in three weeks. Our suggested trigger to open positions is at $108.10.

BUY CALL DEC 105 LLL-LA open interest= 26 current ask $5.40
BUY CALL DEC 110 LLL-LB open interest= 76 current ask $2.80
BUY CALL DEC 115 LLL-LC open interest=204 current ask $1.25

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 627 thousand

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Siemens - SI - close: 132.50 change: +1.55 stop: 127.40

Company Description:
Siemens (Berlin and Munich) is a global powerhouse in electrical engineering and electronics. The company has around 475,000 employees (incl. discontinued operations) working to develop and manufacture products, design and install complex systems and projects, and tailor a wide range of services for individual requirements. Siemens provides innovative technologies and comprehensive know-how to benefit customers in over 190 countries. (source: company press release or website)

Why We Like It:
It looks like both shares of SI and the German stock market have turned around. Both put in some bullish performances last week. The U.S. ADR shares of SI bounced twice in the $126-127 region. Now SI looks poised to breakout from its two-week consolidation. We are suggesting a trigger to buy calls on SI at $133.55. More conservative traders may want to wait for a rally past $135 before initiating positions. Our primary target is the $139.85-140.00 range. More aggressive traders can aim higher.

Suggested Options:
We are suggesting the December calls. Our suggested trigger is at $133.55.

BUY CALL DEC 130 SI-LF open interest= 50 current ask $8.60
BUY CALL DEC 135 SI-LG open interest= 0 current ask $6.10
BUY CALL DEC 140 SI-LH open interest= 0 current ask $4.20

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/27/07 (unconfirmed)
Average Daily Volume = 582 thousand

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W-H Energy Services - WHQ - cls: 59.96 chg: +1.03 stop: 56.95

Company Description:
W-H Energy is a diversified oilfield service company that provides products and services used in connection with the drilling and completion of oil and natural gas wells and the production of oil and natural gas. The Company has operations in North America and select areas internationally. (source: company press release or website)

Why We Like It:
A couple of weeks ago WHQ issued a third quarter earnings warning. The stock was crushed with a drop from $72 to almost $55 in a few days. Shares have rebounded sharply from its test of support near $55.00. Normally we avoid holding over an earnings report. WHQ is an exception. All the bad news should be priced into the stock already. That gives WHQ a decent change to beat Wall Street's lowered expectations. More aggressive traders may want to jump in now. We're suggesting a trigger at $60.05 to open plays. WHQ is due to report earnings on Tuesday morning. If triggered our target is the $66.50-67.50 zone. WHQ may have resistance at $65.00 and then again at the 100-dma and 50-dma overhead.

Suggested Options:
We are suggesting the December calls. Our suggested trigger to open positions is at $60.05.

BUY CALL DEC 55 WHQ-LK open interest= 4 current ask $7.30
BUY CALL DEC 60 WHQ-LL open interest= 2 current ask $4.20
BUY CALL DEC 65 WHQ-LM open interest=20 current ask $2.10

Picked on October xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/30/07 (confirmed)
Average Daily Volume = 542 thousand
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Sina Corp. - SINA - cls: 56.56 change: +5.19 stop: 49.99

SINA recovered sharply from Thursday's swoon. A big move in BIDU and widespread strength in Asian markets not to mention strength in the U.S. markets helped SINA tack on a 10% gain. The stock shot past resistance at the $56 level and closed at a new high. Traders may want to consider adjusting their stops toward Thursday's low near $50.82. We remain bullish on SINA but would not want to chase a 10% move on Monday. Our target is the $59.50-60.00 range. SINA is due to report earnings somewhere in the October 29th-November 8th range. Hopefully the closer we get to the end of October we'll find a confirmed date since we do not want to hold over SINA's earnings report.

Suggested Options:
We are not suggesting new positions in SINA at this time although a pull back and a bounce near $54.00 would look like a potential entry point for bullish positions.

Picked on October 23 at $ 53.40
Change since picked: + 3.16
Earnings Date 11/08/07 (unconfirmed)
Average Daily Volume = 1.0 million
 

Put Updates

BEA Systems - BEAS - cls: 16.50 change: -1.03 stop: 18.05 *new*

Shares of BEAS sank 5.88% on Friday as the Sunday deadline to accept Oracle's $17/share bid draws near. All of the press this past week from BEAS told the markets that the Board of Directors would not accept ORCL's bid. Instead they want $21 a share. There is the chance that the Board changes their mind on Sunday but we're not expecting it. We're not suggesting new positions at this time. Instead we are adjusting our stop loss to $18.05. More conservative traders will want to consider taking some profits early but we suspect that BEAS will continue to plummet on Monday after ORCL's offer expires. Our target is the $15.25-14.75 range.

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

Picked on October 23 at $ 17.87
Change since picked: - 1.37
Earnings Date 10/27/07 (unconfirmed)
Average Daily Volume = 19.6 million

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Tsakos Energy - TNP - cls: 69.91 change: +1.65 stop: 71.01*new*

Market strength on Friday helped TNP produce a 2.4% bounce. Volume was low but the stock managed to close over its 50-dma, which is a bullish sign. The rally stalled right at round-number resistance at $70.00. A failure right here would be bearish and readers could use it as a new bearish entry point to buy puts. We are going to try and reduce our risk by adjusting the stop loss to $71.01. More conservative traders may want to tighten their stops closer to the $70.00 level. We are planning to exit on Friday, November 2nd to avoid holding over the November 5th earnings report. TNP's P&F chart turned bearish this week and points to a $61 target.

Suggested Options:
We have one week left for this play. If TNP fails here at $70 we'd suggest the November puts.

Picked on October 22 at $ 67.67 *gap down
Change since picked: + 2.24
Earnings Date 11/05/07 (confirmed)
Average Daily Volume = 114 thousand

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Sepracor Inc. - SEPR - cls: 23.09 change: +0.34 stop: 24.01*new*

Monday is our last day for the SEPR put play. The company is due to report earnings on Tuesday morning so we're planning to exit at Monday's close. The trend remains bearish but with earnings this close the stock might just trade sideways tomorrow as investors wait for the earnings news. We're adjusting our stop loss to $24.01. More conservative traders may just want to exit on Monday morning to cut their losses. We're not suggesting new positions at this time. Our target is the $20.25-20.00 zone.

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

Picked on October 21 at $ 22.91 *gap down
Change since picked: - 0.16
Earnings Date 10/30/07 (confirmed)
Average Daily Volume = 1.5 million
 

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

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Borg Warner - BWA - cls: 97.96 change: +3.31 stop: n/a

Friday morning BWA was upgraded to a "buy" and the stock responded with an early spike higher hitting $99.00. Shares closed up 3.5% but they also closed right at resistance near $98.00. If the market can keep the rally alive then BWA has a good chance of breaking out past the $100 level. The company's earnings report is behind it and we're not suggesting new strangles. However, a rally past $100 might make BWA a candidate for a directional call play. We have three weeks left for our November options. The options we suggested for a strangle were the November $100 calls (BWA-KT) and the November $90 puts (BWA-WR). Our estimated cost was $4.50. We want to sell if either option hits $7.25 or more.

Suggested Options:
We're not suggesting new strangle positions in BWA.

Picked on October 23 at $ 95.67
Change since picked: + 2.29
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 392 thousand

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Express Scripts - ESRX - cls: 61.37 chg: +0.43 stop: n/a

ESRX continued to inch higher following Thursday's post-earnings rally. The trend remains bullish and we'll focus on the call side of our strangle. We are no longer suggesting new strangle positions on ESRX. The options we suggested for a strangle were the November $65 calls (XTQ-KM) and the November $55 puts (XTQ-WK). Our estimated cost was $1.95. We want to sell if either option hits $3.50 or higher.

Suggested Options:
We're not suggesting new strangle positions in ESRX.

Picked on October 21 at $ 59.65
Change since picked: + 1.72
Earnings Date 10/24/07 (confirmed)
Average Daily Volume = 2.1 million

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Intl. Bus. Mach. - IBM - cls: 113.73 chg: +0.92 stop: n/a

The sideways consolidation in IBM has formed a pennant-type of pattern with lower highs and higher lows. These are usually neutral and we should see a breakout relatively soon. We have three weeks left on our November options. We are not suggesting new strangle positions at this time. Our November strangle suggested the November $125 call (IBM-KE) and the November $110 put (IBM-WB). Our estimated cost was $3.00. We wanted to sell if either option hits $6.00.

Suggested Options:
We're not suggesting new strangles on IBM.

Picked on October 15 at $118.03
Change since picked: - 4.30
Earnings Date 10/16/07 (confirmed)
Average Daily Volume = 7.5 million

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Monster Worldwide - MNST - cls: 39.60 chg: +0.80 stop: n/a

MNST continues to rally following Thursday's post-earnings pop higher. The stock is now challenging resistance near $40 and its exponential 200-dma. There are three weeks left for the November strikes. We are no longer suggesting new positions. The options we suggested for our strangle were the November $40 calls (BSQ-KH) and the November $35 puts (BSQ-WG). Our estimated cost is $1.75. We want to sell if either option hits $2.95 or higher.

Suggested Options:
We're not suggesting new strangles on MNST.

Picked on October 23 at $ 37.22
Change since picked: + 2.38
Earnings Date 10/24/07 (confirmed)
Average Daily Volume = 2.0 million
 

Dropped Calls

Microsoft - MSFT - cls: 35.03 change: +3.04 stop: n/a

Our strangle over MSFT's earnings was a big success, bigger than we expected. The company announced a huge surprise higher and the stock gapped open higher. MSFT hit $36.03 on Friday morning before paring its gains to close with a +9.5% move. We saw the after hours reaction on Thursday evening and adjusted our exit for the November $32.50 calls to $2.75. We were fortunate again. The November $32.50 calls (MSQ-KZ) gapped open higher at $3.50 and hit $3.55 before pulling back. We would have been taken out at the opening trade. Our estimated cost was $1.07.

Picked on October 23 at $ 30.90
Change since picked: + 1.09
Earnings Date 10/25/07 (confirmed)
Average Daily Volume = 53.0 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Backtracking

I lied. In my last Trader's Corner article, I said that this week's article would discuss gamma. It doesn't. All week, I kept worrying about tidbits of information about delta that I hadn't been able to squeeze into the last article.

For those who didn't read last week's article, delta measures the amount of movement one might expect in an option's price for each point move in the underlying. It also measures the theoretical probability that the option will be in the money at option expiration. It can also measure the risk an options position has due to price movement.

One of those tidbits concerned buying options for an expected short-term move. One example last week pointed out the benefits of buying an option with a delta of at least 0.70 when you expect a quick, small move. Lawrence McMillan speaks to this on his tome on options. When you're trading a short-term move, he warns traders that the delta should be as high as possible. In fact, he would suggest buying or shorting the stock instead if you're day trading since stock has a delta of 1 or -1, depending on whether it's being bought or sold.

Not all of us are going to do buy stock. Not all traders day trading an expected quick move want to buy options with deltas that high, either, and they would have a point. Let's review. I mostly traded OEX options when I was day trading. Those options feature wide bid/ask spreads. For example, on October 24 with the OEX at 707.86, the NOV strikes from 695 to 715 had bid/ask spreads from $0.60-1.20. It's a pretty good guess that the $0.60 spread was narrowed by someone coming inside the market maker's price with a small order (5 contracts), so that as soon as that 5-contract order was snapped up, that bid/ask spread would have widened a bit. Even the narrowest $0.60 spread was probably only temporarily that narrow.

Some traders say they can consistently get fills in the middle of the bid/ask spread for most securities, but I often had to look to pay 60-70 percent of the bid/ask spread to buy an OEX option and give up 60-70 percent to sell it if I wanted to get quick fills. In my experience, that meant buying an option with a delta of at least 0.70 or 70 percent if I wanted to pay commissions and my part of the bid/ask spread on both sides and still consistently make a profit on a three-point move.

Not all options have such wide bid/ask spreads, however, and other considerations might be important. Without the need for options prices to leap across that wide bid/ask spread, traders might instead be concerned about getting the most bang for their bucks in the form of the highest percentage increase in option price. For example, with the QQQQ at $53.77 near the close on 10/24, two QQQQ calls were priced as follows:

QQQKA
NOV 53 Call
Bid/Ask 1.82/1.84
Delta 0.63

QUEKD
NOV 56 Call
Bid/Ask 0.38/0.41
Delta 0.24

Assume a purchase price of $1.83 for the 53 strike call and $0.40 for the 56 strike one. If we imagine that the delta stays constant across a three-point gain, something that wouldn't strictly be true, the 53 strike would theoretically gain $1.89 (3 x 0.63), a 103 percent appreciation in price. The 56 strike would theoretically gain only $0.72, but that's a 180 percent appreciation in price. If you're looking at percentage gains, the option with the lower delta is often the one that shows the greatest percentage appreciation.

As is true of so many aspects of options, tradeoffs always exist. Trading the OEX, I needed the bigger price appreciation that a higher delta option provided. Those trading options with tighter bid/ask spreads might prefer the higher percentage price appreciation that a lower delta option provides. I still liked the highest delta I could afford, but others will make different decision.

Be cautious, though, not to buy an option with a delta so low that it won't move much at all. I've heard from subscribers who have bought options with deltas of 0.05 (calls) or -0.05 (puts) and then couldn't figure out why their options didn't gain much when the underlying moved a point.

Another tidbit not covered in the previous article about delta was the concept of "up delta" and "down delta." McMillan mentions the concept in OPTIONS AS A STRATEGIC INVESTMENT. Theoretically, if a call's delta were 0.80, the call should gain $0.80 if the underlying moved up a point and lose $0.80 if the underlying moved down a point. Theory and practical results don't always match, however. Traders might notice that when the underlying moves higher by a point, the call gains more than it might lose if the underlying dropped a point. McMillan gives an example of an ATM call with a delta of 0.50. When the underlying moved up a point, the call might appreciate by 5/8 of a point (the book was written when options were still priced in eighth's), but when the underlying moved down, the call might lose only 3/8 of a point.

Let's look at a real-life example. Near the close of trading on October 24, Dupont (DD) closed at $47.54. DD had November 47.50 strike calls. They were set up as follows:

Dupont
DDKW
NOV 2007 47.50 Call
Bid/Ask: 1.00/1.15
Delta: 0.4886

On October 25, Dupont (DD) closed higher by $0.80, so the DDKW could be expected to have gained $0.39 ($0.80 x 0.4886). Instead, the DDKW showed a bid/ask spread of 1.5/1.65, showing gains of $0.50. If DD had dropped $0.80 instead and we were to see that "up delta/down delta" effect, it's possible that the call would have lost less than $0.39.

A last tidbit concerns a possible misconception caused by a blanket statement that at-the-money options tend to have deltas near 0.50. While that's true, some variation in delta exists across in the ATM options with differing expiration dates. A front-month at-the-money option, one that expires in 30 days or less, might have a lower delta than an option that expires in several months. A front-month out-of-the-money option might also have a lower delta than one that expires in several months. The opposite might be true for in-the-money options, however. Front-month in-the-money options tend to have higher deltas than the same strike option several months out.

For example, on October 25, with QQQQ closing at $53.05, November, December and January 53.00 ATM calls showed the following deltas:

QQQKA/NOV 2007 53 Call/Delta: 0.5368

QQQLA/DEC 2007 53 Call/Delta: 0.5548

QQQAA/JAN 2008 53 Call/Delta: 0.5643

As predicted for ATM options, the delta for the further-out JAN 2008 option was higher than the delta for the front-month NOV 2007 one.

November, December and January OTM calls showed the following deltas:

QUEKH/NOV 2007 60 Call/Delta: 0.02

QUELH/DEC 2007 60 Call/Delta: 0.08

QUEAH/JAN 2008 53 Call/Delta: 0.15

As predicted for OTM options, the delta for the further-out JAN 2008 option was higher than the delta for the front-month NOV 2007 one.

November, December and January ITM calls showed the following deltas:

QQQKS/NOV 2007 45 Call/Delta: 0.88

QQQLS/DEC 2007 45 Call/Delta: 0.86

QQQAS/JAN 2008 45 Call/Delta: 0.85

As predicted for ITM options, the delta for the further-out JAN 2008 option was lower than the delta for the front-month NOV 2007 one. This is the inverse of the time relationship shown for ATM and OTM options.

The different results for ITM options make sense if you think about delta's prediction that the option will be in the money at expiration. If an option is out of the money, allowing more time increases the possibility that it will be in the money at option expiration. If an option is already in the money, however, extra time is just extra time when the underlying might move enough so that the option is out of the money by expiration.

This tidbit of information can be important when choosing an option. How many times have you tried to decide whether you ought to buy a front-month option or one further out? Do you tend to buy cheap OTM options? Do you anticipate that the movement that you're expecting in the underlying might take a number of weeks to be fulfilled? If so, you should know that the delta of your option will be decreasing during those ensuing weeks while you're waiting for the movement.

So, I lied about moving on to gamma this weekend, instead spending another few pages talking about delta again. There's more to cover, including a discussion of how delta varies with the volatility of the underlying. However, the purpose of these articles has been to introduce some ideas about delta, not to exhaust the subject. Traders interested in learning more should consult McMillan's book. We're moving on next week.
 

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

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