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Daily Newsletter, Wednesday, 12/19/2007

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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

Looking for Santa in all the Wrong Places

The bulls are certainly trying hard to find Santa but each time they think they've found him it turns out to be a bear in disguise. The DOW needs about 165 points to get back to break even for the month and the way the bears keep spiking the ball when it's laid up by the bulls it seems like it's going to be a hard task. Certainly this month's opex is probably not quite as bullish as many had hoped. But the market is still above its November lows and there's always tomorrow. We might not see the market make much progress this week for opex but the days between Christmas and New Years tend to be bullish so we'll see how it sets up for next week.

Today's price action was choppy and had a couple of whipsaws that hit both sides with a couple of program buys and sells. The end result was pretty much a flat day with the techs and small caps doing a tad better than the big caps. Bonds had a nice rally (depressing yields some after their recent rise) and that buying may have taken some money out of the stock market. While the equity prices were relatively flat today the numbers in the table above were weaker than the indices would have us believe.

The down volume and declining issues beat out up volume and advancing issues (which was also true in the Nasdaq). I was surprised to see again that the number of new 52-week lows completed dominated the new highs but what we don't know is how much of that is tax-loss selling. The equity put/call ratio finished a bullish .75 (bullish from a contrarian perspective) but that is also a suspect reading during opex.

The volume of advancing stocks vs. declining stocks is one of the market breadth measurements we look at to see if the prices we're seeing are supported by what's going on under the hood. Looking at the NYSE and the corresponding a-d volume line we can see that the market might be even weaker than price is letting on:

NYSE vs. Advancing-Declining Volume

The blue line is the 20-day moving average and smoothes out the spiky daily data. Notice that the 20-dma has dropped below the lows back in August and September and yet price has remained above those lows. This chart is hinting that unless the market breadth improves there's a real good chance we're going to see price join the a-d volume line and break the August low.

There were several mixed signals coming from the market today and I suspect it's a combination of opex, end-of-year position squaring and just general confusion by market participants. From hopeful bottom fishing in the banking and housing stocks to fear that there's another shoe about to drop, there is a lot of uncertainty in the market right now. The market hates uncertainty (almost as much as certainty about bad news) and that makes it difficult for the bulls to maintain any buying pressure after the program buying stops.

Depressing the market initially was news from Morgan Stanley about more mortgage-related write-downs (although the hopeful bottom fishers swooped back in and drove their stock price up +4.2% to 50.26). They wrote off another $5.7B which gives them almost $10B is losses for the 4th quarter. But they also announced a deal with a Chinese sovereign fund that will invest $5B with the right to mandatory conversion into common stock. It would appear that not only are we becoming more and more indebted to foreign governments through our trade imbalances but now we're selling our banks to them as well. And we seem to be applauding this as it's happening. That's what fear does.

To provide a sense of the damage to the banks from the write-downs thus far (and I emphasize thus far), here's a table showing the tally so far:

Banker's Write-downs, data courtesy MarketWatch.com

Bear Stearns was one of the first to confess their sins this past summer and report trouble with their hedge funds tied to the subprime mortgage mess. They've written off $1.9B. That's starting to look like a small number compared to what others have now reported. Rumors are spreading that Goldman Sachs may be next to report a surprisingly large loss and that probably wouldn't sit well with the market if they do.

The thing to remember about these mortgage-backed loans that have gone bad, and therefore have had their credit ratings reduced significantly, is that they're really just the tip of the iceberg. The banks weren't just generous with OPM (Other Peoples' Money) when making loans to homeowners who could fog a mirror. They were just as generous to companies whose balance sheets clearly did not support the ability to pay back the loans even in good times. Now with the economy slowing down there are a slew of construction companies which owe more money than the value of their assets, let alone how much cash flow they have available to pay back their loans.

More and more economists are saying a recession is better than a 50-50 chance (which is where the Great Greenspan is currently) and that the economy has probably already slowed enough to have tipped us into a recession now (it's always recognized in hindsight, about six months later). Therefore, as a recession looms ahead there will be more weakness in credit fundamentals. High-yield bonds (those would be the junk bonds) will likely suffer the same fate as have the mortgage-backed bonds.

There are covenant-lite loans (where a company gets a "pass" if they miss accomplishing their financial requirements for a quarter, or two , or three) and "PIK-toggle" loans (allows the borrower to forego payments in cash and instead make a payment-in-kind, whatever that means--want a cement truck instead of cash Mr. Banker?) and as defaults rise in these business loans you can bet the ratings agencies are not going to be slow on the trigger this time in downgrading those bonds that are backed by these loans. The PKK-toggle loans were created by the private equity firms to finance leveraged buyouts and these were going wild in the first half of this year before the door slammed shut. The price has yet to be paid for all this financial wizardry and it's soon going to be hard to ignore that man behind the curtain.

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There are also a slew of CDOs (Collateralized Debt Obligations) that were sliced and diced and doled out to investors with AAA-ratings and an economic slowdown could have just as negative an impact on those financial instruments as what's been happening to the mortgage-backed loans. Loan defaults are already ticking higher on these and the ratings agencies will also be quick to mark them down. A whole new round of write-downs by the banks (and hedge funds and private equity firms) will be the likely result. All these loan packages are sitting on the books at mark-to-computer model just as the mortgage-backed loans were. Once they have to start selling them, requiring them to mark-to-market, then round two will ring. It's not going to be a pretty picture if it all comes to pass.

Many believe the central banks are here to rescue us and they have done a decent job at lifting the moral of the markets, at least for short periods of time. But even with a $501B cash injection by the ECB (European Central Bank) this week, the money seems to have been absorbed by the banks who are probably more than happy to sit on the cash in case they need it. The level of interest in borrowing that money is way down and it's not likely the cash will serve the purpose the bankers are hoping for.

As for our Fed, any money they inject into the monetary system is quickly absorbed by the deficit requirements of our government. Even Helicopter Ben has trouble keeping up with the hungry Uncle Sam and his voracious appetite for dollars. Fortunately we have lots of foreigners who have a vested interest in continuing to feed the hungry monster. It remains to be seen whether the $40B the Fed promised the market will be an addition or just a replacement of the $39B that was coming due this week (through their repo operation).

Basically the Fed is trying to sooth worried investors while they sort all this out but in the end it will be the market that sorts it out, as it should be, and the process will be at least short term painful so stay on your toes and try not to get sucked into believing everything will be all right and that it's safe to get back into the shark-infested waters (which you can't see because the water is so red).

One more thing I'll pass along about the mortgage mess and bankers' troubles. I don't listen to CNBC because it's too distracting. Maria's voice is worse than finger nails on a blackboard. A reader (thanks Mark) passed along the following information:

SLM disaster conference call gone way wrong as the CEO melts down in front of everyone. CEOs last comment: Steve, lets go. There are no questions. Lets get the f--- out of here.

Sallie Mae is planning a meeting with investors in January. After a series of blistering questions from one caller during the conference call, the exasperated CEO (Steve Lord) said "...and so when I stand before you in January I will be prepared to answer all of your questions, and I would suggest maybe you get there early because I can assure you, you will be going through a metal detector".

This is all being reported on CNBC and SLM is crashing [SLM was down -21% today, closing at 22.89 and now back down to a level not seen since 2001]. Can the financial crisis get any worse? Yes much worse! (they have no idea).

Investors will be going through a metal detector before being allowed into the investors' meeting with SLM management in January. Do you think that the CEO was joking? I don't and what he said is extremely significant. The market blew it off. I suggest you don't.

Economic reports
There was only one scheduled economic report today, crude inventories. Mortgage applications numbers were also released.

Crude Inventories
Crude inventories fell -7.6M barrels to 296.9M last week, the lowest since February 2005. Gasoline supplies rose +3.0M barrels while distillate stocks dropped -2.1M barrels. Oil was up +$1.16 to $91.24 and broke a 4-day losing streak for oil.

Mortgage Applications
Applications for mortgages dropped an adjusted -19.5% last week which reflected a sharp drop in refinancings. When compared to the same week last year, mortgage applications were up +1.7%. Splitting out new vs. refinancings, applications to buy a home were down a seasonally adjusted -10.6% while refinance applications were down a very significant -27.3%. It is the inability to refinance that's causing so much pain for those who are experiencing mortgage resets.

It was a relatively flat day today so let's see what setups we're looking at on the charts. The price pattern leaves open a few possibilities and I'm hoping they'll be cleared up by tomorrow. I'll be filling in for Linda and will be able to provide updates to the questions I'll be leaving hanging tonight.

DOW chart, Daily

The price pattern of the decline from the December 11 high has left the door open to several possibilities from an Elliott Wave (EW) perspective. I show two possibilities on the DOW's daily chart and the key level for the bulls is at 13525, the December 13 high. While I show a bullish projection back towards new highs into January, there is also the possibility that we'll only get a larger bounce that fails at or below the December 11 high (13778). I won't have a better feel for that until the rally gets going above 13525. If you're short I would use that level for your stop for now. If price continues to consolidate sideways, like it did today, then we should see price continue lower. This is shown on the 60-min chart:

DOW chart, 60-min

I've drawn in a little sideways triangle which calls for another range bound day on Thursday (watch the chop and whipsaws if you're day trading it). This kind of pattern calls for another leg down (depicted in dark red) and it means we'd probably see price drop to 13K fairly quickly (Friday or Monday). If it rallies above 13325, the December 12 low then it opens up several upside possibilities (including the possibility for a move only up to about 13400) but regardless I'd be very careful with short positions if 13325 is exceeded.

SPX chart, Daily

SPX has the same setup as the DOW. The 1490-1492 area has been tough resistance and it's also an important level for the bearish EW count--any higher and I'll be considering a couple of upside possibilities, one of which is shown--a rally to new highs into January. But if price consolidates tomorrow then we should see price continue lower.

SPX chart, 60-min

The December 12 low at 1469, like DOW 13325, is an important level for the bearish EW count (dark red). If price consolidates below that level and then drops below Tuesday's low then look for 1420 next. Any rally above 1469 opens up a few possibilities. At a minimum I would expect a rally back to 1473 where the bounce off Tuesday's low would have two equal legs up (for a larger a-b-c bounce).

Nasdaq (COMPX) chart, Daily

QCharts did us dirty by changing the symbol of the NDX and I lost all my chart setups. So I'm switching to the Nasdaq for chart analysis. I liked following the NDX for those who trade the futures (NQ) and the QQQQs so I'll switch back when QCharts gets their act together.

The NAZ has a cleaner EW pattern at the moment and is showing impulsive price action to the downside and corrective price action in the bounces. As long as that continues then it keeps us looking for shorting opportunities. The current small bounce should fail and tip back over, taking the NAZ down to near 2500. As with the DOW and SPX, we could see a little more price consolidation on Thursday before heading lower again. As shown on the daily chart, a rally back above 2672 would turn the pattern more bullish.

Nasdaq (COMPX) chart, 60-min

The December 12 low is also important on the COMP--any rally back above 2639 would be a heads up that something more bullish could be in store for us. I show the possibility for a little higher for the bounce off Tuesday's low or else a turn right back down from here. If it does turn back down, watch for the possibility that it will slide down the trend line from December 11th before finding support around 2500.

Russell-2000 (RUT) chart, Daily

The RUT has been looking weaker but the past two days have had it looking relatively stronger and any further rally tomorrow could put it on at least a short term bullish price path (pink). A rally above 770 would confirm there's probably more upside directly ahead. But if price turns right back down and breaks below this week's low and then 734, it will be confirmation that the next significant decline is underway.

Russell-2000 (RUT) chart, 60-min

The important low for the RUT is the one near 759 on December 13th, like the one on December 12th for the others. Any rally back above that level could be an indication that we'll have a rally for the next several days at least, perhaps even back up to 800. But as long as 759 holds then there will be further downside before finding firmer support around 710.

BIX banking index, Daily chart

The move down from December 10th looks like it needs a correction, shown with the little bounce in dark red, before continuing lower. Slightly more bullish is a bounce back up to the top of a parallel down-channel near 320 before rolling back over. I guess it will depend on how much "good" news comes out of the banks.

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

The home builders index has had tiny little range bound days for the past week and I can't quite figure out if it's getting ready to let go to the downside or get another leg up in its bounce. I show both possibilities and if it bounces then watch for resistance at the top of a parallel down-channel (and its 100-dma) near 375. Otherwise a continuation lower will have me looking for the first downside projection near 215.

Oil chart, Oil Fund (USO), Daily

I'll follow the USO fund to stay consistent month to month rather than continually switch to the new front-month contract. USO is currently finding support at its 50-dma and resistance at its lower broken uptrend line from August. It takes a rally back above its November high at 77.59 to negate the bearish wave count, I would become less bearish on oil if this breaks back above the December 12 high at 74.69. Until then I think the path of least resistance is back down and will be confirmed bearish with a break below the December low at 68.30.

Oil Index chart, Daily

The oil stocks have been holding up well and could get another little rally leg to finish its rally at a Fib projection just above 884. If it were to bounce up to there and then drop back below the trend line along the highs from July that would be a throw-over finish and a sell signal so watch for that possibility. This could down and then back up as part of an ending pattern so it takes a break below the November low near 770 to confirm a high is in.

Transportation Index chart, TRAN, Daily

The Trannies were weak today and that was a heads up for the bulls to not trust the upside, or at least not to get complacent. The weakness in the Transports is telling us the economy is slowing down. I expect to see this index head south but any rally back above the December 13 high near 4763 would negate the bearish count in the current leg down and could mean we'll get another bounce back to at least the December high.

U.S. Dollar chart, Daily

The US dollar is now getting overbought after nearly a month-long rally out of the hole. The rally has created a sharp up-channel so a break of it would mean we're at least into a correction of the rally. More bearishly we'll see the dollar turn back down for at least a retest of the low if not a marginal new low.

I've been waiting for the downside pattern on the dollar to finish and start a multi-month rally that eventually breaks its down-channel (the top of which is currently near 80). But as I watch gold consolidate I'm beginning to wonder if gold is setting up something bullish which would mean another leg down for the dollar.

Gold chart, February contract (GC08G), Daily

Normally when you see a sideways triangle form near the high of a previous rally you should be looking for another (and final) rally leg out of it. The bullish (green) wave count shows the triangle complete and we should be starting the rally, one which will take gold to at least 900-950. The bulls are salivating at that thought.

But, and this is a big but for bulls who don't have their stops tight, the bearish wave count has a series of 1st and 2nd waves to the downside and it's getting ready to rip lower. The bearish move out of this could be a big gap down and huge down day so protect your profits if you're trading gold (vs. holding for a hedge and/or long term investment). It could drop to 700 in a matter of days and then just stair step lower from there.

At this point I'd say both sides need to be very careful because we're going to see a big move out of this pattern and it's probably only days away.

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

Thursday will be a little busier for economic reports and the three that traders might pay attention to are the GDP, LEI (Leading Economic Indicators) and Philly Fed index. Each of these will reflect the economy and traders will be guessing what that might mean for further Fed action or just general economic news as it relates to the possibility that a recession in on the way. Friday will see the big numbers that the Fed watches as far as inflation goes. And we know inflation is jumping higher.

SPX chart, Weekly

Since last week's red candle we've got another down week staring at us unless the bulls can do something tomorrow and Friday. I drew a horizontal red line across from the December 2006 high near 1432. At today's closing price the SPX is up a whopping +1.5% for the past 12 months. Had we known of course, we would have done much better by pulling all our money out of stocks at the end of last year and simply buying US Treasury Notes for a no-risk +5%. Kudos to you if you did. I know I was recommending it.

While I show the possibility for the market to chop its way higher into early next year (in green), that's not the way I'm leaning here. I think we'll see a down year next year and it could be significantly down. It's still not a bad idea to rotate out of stocks and put it in a safe place (be real careful of money market funds, many of which are heavily exposed to commercial paper, some of which we don't know the true value of). It's that ol' protection of capital vs. return on capital.

Tomorrow will hopefully answer the questions I've left on the board tonight. As I mentioned earlier, I'll be filling in for Linda tomorrow so I'll be able to update this and have some more answers. In the meantime tread lightly tomorrow. We could have a bullish day which could then lead to a bullish few days so watch the upside key levels I placed on the charts and look for long plays if the market breaks above. Otherwise I think we'll either head lower immediately tomorrow or more likely consolidate in an inside day before breaking lower out of the consolidation.

Opex Thursdays have tended to be boring choppy days and that would fit the bearish EW consolidation pattern idea I've got on the charts (such as what's shown on the DOW 60-min chart). If you see a triangle pattern finishing with a down-up sequence tomorrow, short that bounce against this morning's high and see if you can catch the next leg down in the decline. If stopped out on that kind of play then consider buying pullbacks from there.

Just be careful out there. This is opex week after all. See you tomorrow.

---

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New Plays

New Option Plays

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

New Calls

Ralph Lauren Polo - RL - cls: 63.11 change: -1.85 stop: 66.26

Company Description:
Polo Ralph Lauren Corporation is a leader in the design, marketing and distribution of premium lifestyle products in four categories: apparel, home, accessories and fragrances. (source: company press release or website)

Why We Like It:
Investors continue to worry about the consumer and almost anything related to retail is suffering for it. RL has a bearish pattern of lower highs and to make matters worse the stock just broke down under support near $63.50-64.00. Today's sell-off was fueled by strong volume, which is another bearish sign. Meanwhile the Point & Figure chart just produced a quadruple bottom breakdown sell signal and points to a $55 target. We are suggesting puts with RL under $64.00. Our target is the $58.00-57.00 range although odds are good the stock will see an oversold bounce near $60.00.

Suggested Options:
We are suggesting the January puts.

BUY PUT JAN 65.00 RL-MM open interest=1424 current ask $4.10
BUY PUT JAN 60.00 RL-ML open interest=1254 current ask $2.00

Picked on December 19 at $ 63.11
Change since picked: + 0.00
Earnings Date 02/07/08 (unconfirmed)
Average Daily Volume = 1.5 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cameron - CAM - close: 91.73 chg: -0.12 stop: 89.90

CAM did not see much change from yesterday. The stock continues to see support near $90 and its rising 100-dma. While we are suggesting call options here more conservative traders may want to wait for a bounce over $93.00 first. Our target is the $99.00-100.00 range. More aggressive traders could aim for $105 but the stock does have pretty clear resistance near $100. Since we're fighting the "trend" in the technical picture we're going to list this as an aggressive, higher-risk play. FYI: CAM is due to split 2-for-1 on December 31st, 2007.

Picked on December 18 at $ 91.85
Change since picked: - 0.12
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 2.1 million

---

China Security - CSR - close: 22.26 change: +0.14 stop: 19.99

CSR spent the session churning sideways. We don't see any changes from our previous comments. This is an aggressive play due to the stock's volatility. We're using a very wide stop loss at $19.99. More conservative traders may want to use a stop closer to $21.00. We have two targets. Our first target is the $26.00 level. Our second target is the $29.00 level. The P&F chart is bullish with a $34 target.

Picked on December 16 at $ 23.25
Change since picked: - 0.99
Earnings Date 01/24/08 (unconfirmed)
Average Daily Volume = 525 thousand

---

Energen - EGN - close: 65.59 change: +0.27 stop: 62.75

EGN continued to bounce following yesterday's reversal. Unfortunately, the stock ran into trouble near $65.80 intraday. Look for a move over $66 or a dip and bounce in the $64-65 zone as a new entry point. Our target is the $69.50-70.00 range. We're suggesting a stop under the 50-dma. The P&F chart is bullish with a $74 target.

Picked on December 18 at $ 65.32
Change since picked: + 0.27
Earnings Date 01/24/08 (unconfirmed)
Average Daily Volume = 700 thousand

---

Energizer - ENR - close: 114.94 chg: +0.37 stop: 109.95

ENR is trying to bounce but ran into resistance near its 10-dma. More conservative traders may want to raise their stop toward $112.50. Our target has been the $119.00-120.00 range and shares hit $118.88 on Wednesday last week. FYI: The P&F chart has a very bullish pattern called a bullish triangle breakout and it is forecasting a $157 target.

Picked on November 26 at $112.75 *triggered
Change since picked: + 2.19
Earnings Date 01/28/08 (unconfirmed)
Average Daily Volume = 511 thousand

---

Holly Corp. - HOC - close: 51.27 change: +0.14 stop: 44.95

HOC failed to make any progress today. The stock was stuck churning sideways. Look for another dip near $50.00 as a new entry point for bullish positions. More conservative traders could raise their stop losses toward $48.00. Our target on HOC is the $54.75-55.00 range.

Picked on December 03 at $ 50.58 *bad tick/gap open
Change since picked: + 0.69
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 859 thousand

---

Hologic - HOLX - close: 67.52 chg: +1.30 stop: 63.75

HOLX is off to a strong start. The stock added close to 2% and broke out past its late November highs. We don't see any changes from our previous comments. We're listing two targets. Our conservative target is the $69.50-70.00 range. Our more aggressive target is the $74.00-75.00 range.

Picked on December 18 at $ 66.22
Change since picked: + 1.30
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 2.8 million

---

Noble Energy - NBL - close: 77.97 chg: +0.67 stop: 74.75

We did not have to wait very long for NBL to hit our trigger and open the play. The stock broke out over resistance at $78.00 on an intraday basis and hit our trigger at $78.25. The intraday high was $78.63. Wait for another move over $78.25 to launch positions again. More nimble traders could try buying a dip near its rising 10-dma. Our target is the $84.50-85.00 range. The P&F chart is bullish with an $86 target.

Picked on December 19 at $ 78.25
Change since picked: - 0.28
Earnings Date 02/26/08 (unconfirmed)
Average Daily Volume = 1.5 million
 

Put Updates

Amazon.com - AMZN - cls: 89.38 chg: +2.49 stop: 92.55

We cautioned readers that AMZN's bounce could bring it back toward $90.00. The stock is now challenging what should be resistance at $90.00 and its 10-dma near $90.60. A failed rally near $90.00 can be used as a new bearish entry point to buy puts. AMZN has already hit our initial target in the $85.25-85.00 range. Currently we're aiming for the $81.50-80.00 zone. The P&F chart is bearish with a $74 target.

Picked on December 16 at $ 89.08
Change since picked: + 0.30
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 8.8 million

---

Boeing - BA - close: 86.62 change: -0.55 stop: 93.26

BA continues to under perform. The stock is drifting lower under a pattern of lower highs. We're not suggesting new positions at this time. We have two targets. Our first target is the $85.55-85.00 range. Our second target is the $81.50-80.00 zone. The P&F chart is bearish with a $75 target.

Picked on December 04 at $ 91.43 *triggered/gap down
Change since picked: - 4.81
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 7.0 million

---

Genentech - DNA - close: 67.33 chg: +0.04 stop: 70.85

DNA spent most of the session trading sideways in a very tight range. Overall we don't see any changes from our previous comments. A failed rally in the $68.50-70.00 zone can be used as a new entry point for puts. Our target is the $62.50-60.00 range. The main hurdle for the bears is support near $65.50. More conservative traders could do some profit taking near $65.00.

Picked on December 16 at $ 68.43
Change since picked: - 1.10
Earnings Date 01/10/08 (unconfirmed)
Average Daily Volume = 4.3 million

---

Garmin - GRMN - close: 96.96 chg: +2.61 stop: 107.25

After yesterday's sharp decline an oversold bounce today is not a surprise. We're not suggesting new positions at this time. GRMN has already exceeded our first target in the $96.00-95.00 range. We're currently aiming for the $91.00-90.00 zone. More conservative traders may want to lower their stop.

Picked on December 11 at $104.78
Change since picked: - 7.82
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume = 6.2 million

---

Sears Holding - SHLD - cls: 104.83 chg: -0.86 stop: 115.05

SHLD closed in the red again but for the most part the day was a non-event. SHLD spent the session trading sideways. We have two targets. Our first target is the $100.50-100.00 range. Our second more-aggressive target is the $92.50-90.00 zone. The P&F chart is bearish with a $78 target.

Picked on December 11 at $110.28
Change since picked: - 5.45
Earnings Date 10/27/07 (unconfirmed)
Average Daily Volume = 3.3 million

---

Shire Plc - SHPGY - close: 67.71 change: +0.10 stop: 73.51

There is still no change from our previous comments on SHPGY. Resistance near $68.00 is holding. A failed rally near $70.00 would be our preferred entry point to buy puts again. Our initial target is the $65.25-65.00 range although we're considering a more aggressive target in the $62-60 region. FYI: Any time we play a biotech or even a drug stock we're dealing with a higher-risk situation. We are at risk that some FDA decision or some clinical trial news could send the stock gapping one direction or the other.

Picked on December 13 at $ 68.07 *triggered/gap down entry
Change since picked: - 0.36
Earnings Date 02/00/08 (unconfirmed)
Average Daily Volume = 956 thousand
 

Strangle Updates

None
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

When Measured Moves no Longer 'Measure' Up

Saturday before last (12/8), when I wrote my Option Investor "Index Trader" column, the rally off the lows was looking good and, as always, I was doing my best to project upside objectives for the major indexes. I thought the S&P 500 (SPX) could get to 1540 and the Nasdaq Composite to 2750. I say 'as always' because I am forever assessing upside (or downside) potential for a move in one of the indexes (or in a stock).

I tend to work with pre-set objectives to gauge how the trend is shaping up relative to MY expectations. If I enter a trade I have to calculate my profit (reward) potential relative to what I risk; and I ALWAYS have a risk point or stop out (exit) point if I'm long calls or puts. Hey, I've been wrong before!

Fortunately, there are select brokers who will trigger an exiting market (buy or sell) order for options I'm in based on a pre-set price in the underlying index, which is my basis for exiting an option. This is easy enough to do in the age of computers. Moreover, if I want to trigger an exit myself, my TradeStation software will trigger a price alert I can get electronically such as on a pager. Estimating 'reward' potential is necessary to know if my 'risk' to reward is my required 1 to 3 ratio (or MORE) of risk to reward.

The point I want to make is not that SPX and COMP didn't get up to my price objectives, but to look at the fact that when there's a possible or likely major shift going on in the major trend, you have to SHIFT your expectations also. For example, stocks in general are not acting like the dominant trend is UP. Therefore, some technical techniques I use, such as 'measured move' objectives will now likely work more reliably on the DOWNSIDE than on the upside.

An EXAMPLE or two should help both explain the concept of a measured move and then move on to show what is suggesting that downside plays are looking like they have more potential or downswings are becoming a path of least 'resistance'.

Looking at the S&P 500 chart below which is a chart that reflects through the Close of Friday 12/7. I was calculating a 1540 upside objective, a move that would have carried a bit above my upper (moving average) trading envelope line where the Index would typically be getting 'overbought'. Why the 1540 objective? This objective was based on the one of the more simple chart techniques, where you assume that a second move up (after a consolidation or minor correction) will be at least equal to the FIRST upswing.

Going back to August price action first, rebound 'A' carried up to a point where there was a pullback. From the low point of that pullback, the next upswing ('B') should in an uptrend, carry at least as far as the first advance. It did indeed and SPX went on to go still higher; however, rally 'B' captured the lion's share of the move up to the 1576 high.

Basing an SPX objective on a measure move concept gave me a 1540 objective going into the 12/7 close. We have to of course now go to a second up-to-date SPX chart to see if the second rally carried as high as the first to equal a 'measured move' objective.

As we know and is highlighted below, SPX made a recent high at 1523, so the second part of the rally that began at 1407 and the area of the prior low close of August, carried less far than the first upswing (move 'A' above).

My objective for a move to the 2750 area in the Nasdaq Composite (COMP) highlighted below, was based on a similar measured move objective. In August, rally 'A', after a minor pullback/correction, was followed by a next advance ('B') that carried at least as high as the first COMP advance off the low in the 2400 area. The 'measured move' concept was useful in projecting a minimum upside target for the Index.

The next time I made a projection for a second advance in COMP to equal the first, as shown on the chart below, didn't work out either. I thought a 2750 target plausible and a move up to 2750 would have kept prices within the 'normal' price range suggested by my moving average envelopes. WRONG!

The Composite got up to its recent 2735 high and reversed to the downside as seen below. The break of the 21-day moving average was a key technical indication that the trend was reversing to the downside again. This type action tells us technically that the upside moves are getting weaker and that the path of least resistance is to lower levels.

While the November COMP lows have not been pierced yet, I don't have great confidence that they won't be ahead. Next is to examine some aspects of the bigger chart picture that provides some prospective as to a renewed bear trend.

DOW THEORY SUGGESTS THAT THE MAJOR TREND HAS REVERSED

In mid-July both Dow Averages went to new weekly closing highs, providing the expected (by Dow Theory) bullish pattern where both the Dow Industrials (INDU) and the Dow Transportation stock (TRAN) averages would 'confirm' each other by each moving to a new high. What we saw in July is what we would expect in a bull market. After mid-July, it was a quite different story. After this peak in both TRAN and INDU, it was then striking to see how TRAN went into a steep tailspin type decline from mid-July into early-September.

Charles Dow would have rightly assumed that weakness in shipping goods out (as reflected in TRAN) was showing up first and would eventually be matched by declining production or orders (in INDU stocks) and weakness in the Industrial Average would show up later as is happening now.

The anemic rebound in TRAN from early-September into October failed (by a country mile!) to 'confirm' the new weekly closing high of the Dow 30 (INDU) made in mid-October, as can be seen on the chart below. For the week ending 11/23, both Averages went to new closing lows. Given this recent market action with BOTH Dow Averages making new weekly closing lows, the two Dow averages are starting to 'confirm' each other in a BEAR trend.

If the major market trend is now down as is being suggested by Dow Theory we can no longer expect the same strength on upside moves as we've been used to. The idea that we are in the midst of a much more major correction than seen in years gives rise to the idea that the two broad major indexes may retreat to the lower end of their major uptrend channels, if not break out below them.

The SPX weekly chart has been in a well-defined and strong uptrend dating from its late-2002 bottom. The low end of SPX's major uptrend channel currently intersects in the 1366 area can act as a major support. If there is a move to this support area, the index would also be going to a substantially lower low than in it's prior correction and suggest a bearish major trend reversal and (like the Dow) fit the technical definition of a bear market according to some. I'm watching this all mostly in the certainty that there will be more two-sided trading opportunities ahead.

As with the SPX weekly chart above, the Nasdaq Composite could retreat some distance from current levels if it retests the low end of its long-standing bullish uptrend channel. It looks like COMP could be headed toward this area, around 2400. This chart suggests to me that better opportunities may be in buying puts on rallies such as the recent one back above 2700, then on buying calls on pullbacks.

At least, my expectations for the upside potential on rallies will be more modest than they've been. Moreover, COMP can fall substantially farther before reaching a major 'oversold' condition as is suggested by the 13-week Relative Strength Index (RSI).

GOOD TRADING SUCCESS!
 

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

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