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Daily Newsletter, Monday, 12/31/2007

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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

Market Wrap

Due to technical difficulties we are unable to provide a Market Wrap today.

We apologize for any inconvenience.
 


New Plays

New Option Plays

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

Play Editor's Note: I want to wish a Happy New Year to all of our readers and their families!


New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Energen - EGN - close: 64.23 change: -0.65 stop: 63.45 *new*

This is it! This is a very important test of support for EGN. The stock has pulled back to the $64.00 level, the bottom of its rising channel, and its rising 50-dma. A bounce from here could be used as a new bullish entry point to buy calls. A breakdown could portent a decline to $60 or its 200-dma. We are adjusting our stop loss to $63.45. Our target is the $69.50-70.00 range. The P&F chart is bullish with a $74 target.

Picked on December 18 at $ 65.32
Change since picked: - 1.09
Earnings Date 01/24/08 (unconfirmed)
Average Daily Volume = 700 thousand

---

Express Scripts - ESRX - cls: 73.00 chg: 0.07 stop: 69.49

It was another quiet session for ESRX. The stock traded to $74.00 this morning before paring its gains. Overall the stock appears to be consolidating from the mid December rebound. We remain bullish. Watch for a bounce near $72.00 or $70.00 as a new bullish entry point to buy calls. Our target is the $77.50-80.00 range. The P&F chart is very bullish with a $97 target.

Picked on December 23 at $ 71.09
Change since picked: 1.91
Earnings Date 02/07/08 (unconfirmed)
Average Daily Volume = 2.5 million

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Goodrich - GR - close: 70.61 change: -0.34 stop: 69.95

Unfortunately, we have nothing new to say about GR. The stock continued to drift lower following Friday's bearish breakdown under the 50-dma. We warned readers that the stock looked poised for a dip toward what should be support at $70.00. Here's a repost of our Sunday comments: Given our outlook for next week being flat to down more conservative traders may want to exit early right now. We would still expect to see a bounce from support near $70.00 but Friday's performance is a little ominous. The DFI defense index also looks vulnerable to more selling pressure. We would want to see a convincing bounce in GR before considering new bullish positions. Our target is the $77.50-80.00 range. The P&F chart is bullish with a $99 target.

Picked on December 23 at $ 72.57
Change since picked: - 1.96
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 1.2 million

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Holly Corp. - HOC - close: 50.89 change: 0.55 stop: 49.45 *new*

HOC produced a decent bounce from the $50 region but not before slipping to $49.70 early this morning. The bounce looks like a new bullish entry point to buy calls. We are adjusting our stop loss to $49.45. More conservative traders might want to consider placing their stop closer to Monday's low. Our target on HOC is the $54.75-55.00 range. FYI: It does look like HOC has put in a bottom and the P&F chart now points to a $65 target. More aggressive traders may want to aim for the $58-60 zone.

Picked on December 03 at $ 50.58 *bad tick/gap open
Change since picked: 0.31
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 859 thousand

---

Hologic - HOLX - close: 68.64 chg: -1.01 stop: 65.99

No surprises here. We've been cautioning readers that HOLX looked poised for profit taking, especially after last Thursday's bearish reversal pattern. Today's close under the 10-dma is also short-term bearish. However, we would watch for the $68.00 or $67.00 level to offer support. HOLX has already hit our initial target in the $69.50-70.00 range. Our more aggressive target is the $74.00-75.00 range. FYI: The P&F chart is bullish and points to an $87 target.

Picked on December 18 at $ 66.22
Change since picked: 2.42
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 2.8 million

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Noble Energy - NBL - close: 79.52 chg: -1.14 stop: 75.75

NBL hit some profit taking this morning and the selling caught a second wind late this afternoon. The stock could bounce from its rising 10-dma near $79.28 but we would expect a dip back toward broken resistance and what should be new support at $78.00. Wait for the bounce to occur before considering new call positions. More conservative traders may want to tighten their stops. 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: 1.27
Earnings Date 02/26/08 (unconfirmed)
Average Daily Volume = 1.5 million

---

Syntel Inc. - SYNT - close: 38.52 chg: -0.52 stop: 35.75

As of Friday's close SYNT looked poised to rally higher. The stock did spike to $39.65 this morning and then quickly reversed. The upward momentum in SYNT is slowing but then most of the market has been slipping the past few days. So it's not a surprise to see SYNT's rally stall. Thus far SYNT has found support near $38 and its 50-dma. A bounce near $38.00 could be used as a new bullish entry point. However, our market bias for this week is flat to down so we would hesitate before jumping into a new bullish position at this time. Our target is the $44.00-45.00 range. The P&F chart has recently produced a new buy signal with a $50 target.

Picked on December 24 at $ 38.75 *triggered
Change since picked: - 0.23
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 232 thousand
 

Put Updates

Allegheny Tech. - ATI - cls: 86.40 change: -1.28 stop: 90.05

It was actually an interesting day for ATI. Shares started off weak and hit our suggested trigger to buy puts at $86.75. Traders bought the initial test of $85.00 but the bounce failed near $87.50. ATI was rolling over again into the closing bell. This looks like another great entry point to consider buying puts. Our target is the $80.50-80.00 zone.

Picked on December 31 at $ 86.75
Change since picked: - 0.35
Earnings Date 01/24/08 (unconfirmed)
Average Daily Volume = 2.0 million

---

Boeing - BA - close: 87.46 change: -0.79 stop: 91.43

BA continues to show weakness following last week's failed rally near $90.00. Yet before the bears get too comfortable we need to be alert on Wednesday. After the bell tonight it was announced that BA had won a $370 million order to provide aircraft for S. Korea's Jeju Air. Plus, BA announced it had won another big defense contract from the Pentagon. It is anyone's guess if this will have an affect on the stock price this Wednesday. It really depends on investors' moods when they come back to the office on Wednesday. Overall we don't see any changes from our weekend comments. 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: - 3.97
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume = 7.0 million

---

Genentech - DNA - close: 67.07 chg: -0.44 stop: 70.05

On the positive side DNA produced another failed rally at its 10-dma immediately overhead today. On the negative side shares are still holding above support near $66.75. At this point we would wait for a decline under $66.75 before considering new bearish positions. Our DNA target is the $62.50-60.00 range. The main hurdle for the bear is potential support near the early December lows. DNA's P&F chart is very bearish with a $54 target. FYI: Any time we play a biotech stock it should be considered high risk. You never know when news will come out about some successful or failed clinical trial or some FDA decision that could send the stock gapping one way or the other.

Picked on December 16 at $ 68.43
Change since picked: - 1.36
Earnings Date 01/10/08 (unconfirmed)
Average Daily Volume = 4.3 million

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Essex Property - ESS - close: 97.49 chg: 2.15 stop: 100.55

Ugh! We almost hesitate to play some of these REITs because they seem to whipsaw so often. As of Friday ESS was breaking down from its trading range. The stock bounced back today with a 2.2% gain. If we can catch the next leg down we'll do great. Our biggest risk is a short squeeze. The most recent data puts short interest at close to 16% of the 22.9 million-share float. That is a relatively high amount of short interest and a small float. This does raise the risk for this play. ESS should run into resistance in the $98-100 range. Wait and watch for a new failed rally under $100 before considering new puts. We have two targets. Our first target is the $90.25-90.00 range. Our second target is the $85.50-85.00 zone. We do not want to hold over the early February earnings report.

Picked on December 30 at $ 95.34
Change since picked: 2.15
Earnings Date 02/04/08 (unconfirmed)
Average Daily Volume = 315 thousand

---

Garmin - GRMN - close: 97.00 chg: -2.17 stop: 105.05

Bears were in control of GRMN today. The early morning bounce from its lows never made it past $99.50. The stock closed on its lows for the session, which is normally a bearish clue for the next trading day. More conservative traders might want to consider a tighter stop loss near $104. This remains a very high risk play due to the stock's volatility. Over a week ago GRMN exceeded our initial target in the $96.00-95.00 zone. Our second more aggressive target is the $91.00-90.00 range. The P&F chart is bearish with an $86 target but the P&F chart also shows potential support near $91.

Picked on December 11 at $104.78
Change since picked: - 7.78
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume = 6.2 million

---

Ralph Lauren Polo - RL - cls: 61.79 change: 0.03 stop: 66.26

It would be tempting to drop RL for lack of movement but the stock is actually heading the right direction. It's just moving too slowly for us. Today's session saw a late afternoon failed rally at the 10-dma, which is a good sign. We are expecting a bounce the first time RL hits $60 and readers could wait until after this bounce rolls over before considering new positions. The Point & Figure chart produced a quadruple bottom breakdown sell signal and points to a $55 target. Our target is the $58.00-57.00 range although odds are good the stock will see an oversold bounce near $60.00.

Picked on December 19 at $ 63.11
Change since picked: - 1.32
Earnings Date 02/07/08 (unconfirmed)
Average Daily Volume = 1.5 million

---

Sears Holding - SHLD - cls: 102.05 chg: -0.05 stop: 110.55

We have nothing new to add from our weekend comments on SHLD. The stock continues to consolidate sideways above support near $100. If there was going to be an oversold bounce it should be here. The positive sign for the bears is that SHLD keeps trying to rebound and investors keep selling it. SHLD has already hit our initial target in the $100.50-100.00 zone. If you haven't taken any profits yet we suggest you do so. We are not suggesting new bearish positions at this time. 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: - 8.23
Earnings Date 10/27/07 (unconfirmed)
Average Daily Volume = 3.3 million

---

Shire Plc - SHPGY - close: 68.95 change: -0.12 stop: 70.26

Today was a non-event for SHPGY. The stock meandered sideways. We don't see any changes from our weekend comments. We would consider new put positions here or on a drop below $68.00. Our initial target is the $65.25-65.00 range and we have decided to add a second, more aggressive target in the $62.00-60.00 zone. The Point & Figure chart is bearish with a $54 target. 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: 0.88
Earnings Date 02/00/08 (unconfirmed)
Average Daily Volume = 956 thousand

---

Vornado Realty Trust - VNO - cls: 87.95 chg: 1.65 stop: 90.05

VNO displayed some volatility today. Shares rose about 1.9% following a three-day decline. If you look very closely technical traders will note that today's session almost looks like a bullish engulfing candlestick pattern, which is a negative for the bears! We would wait and watch for a failed rally under $90.00 before considering new put positions. Our initial target is the $80.50-80.00 range. We are considering a second, more aggressive target near $75. Currently the P&F chart is bearish with a $73 target. We would not want to hold over the late February earnings report.

Picked on December 30 at $ 86.30
Change since picked: 1.65
Earnings Date 02/27/08 (unconfirmed)
Average Daily Volume = 1.3 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.)

---

Encana - ECA - close: 67.96 chg: -1.25 stop: n/a

ECA ran into some headwinds today. The stock lost 1.8% and has pulled back to what looks like short-term support near $68 and its 50-dma. We only have three weeks left before the January options expire. We're not suggesting new positions at this time. The options we listed for the strangle were the January $75 calls (ECA-AO) and the January $60 puts (ECA-ML). Our estimated cost is $0.65. We want to sell if either option hits $1.85 or higher. FYI: The P&F chart is bullish with a $92 target.

Picked on December 20 at $ 67.52
Change since picked: 0.44
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume = 2.7 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Paying Attention to Technical Divergences

I don't think there is much more in trading terms more worthwhile than to be forewarned of the next substantial trend reversal. I look at 'substantial' reversals as being of a 2-3 week duration or more and especially and where there is a substantial price swing up or down. This being a holiday break, I've had more time on my hands and I perused some of my colleague's work and writings. (I intended to post this last week, as I usually write my Trader's Corner articles on Wednesday, occasionally on Thursday, but here it is on the eve of the new year!)

I ran across an Option Investor Trader's Corner article from Linda Piazza's, who I alternate these articles with, from April (4/8/07) where Linda wrote about 'divergences', with this excellent pointer on their use: "Divergences warn traders to prepare their trading plans. They do not promise that a move will occur or that the plan will immediately be put into effect. Notice divergences, devise or revise your trading plan accordingly, but then wait for price action to confirm."

I'll add my two cents worth about how to use divergences to be ready to pounce on a trade, in both stocks and the index and with a somewhat greater emphasize on the use of HOURLY charts, coupled with use of a particular technical indicator.

THE CONCEPT OF 'CONFIRMATION' AND THE CONTRARY CONCEPT OF 'DIVERGENCE'

Charles Dow was the first to write extensively about how and why his two stock market averages ought to move in tandem. Specifically, if the Dow Industrial Average (INDU) went to a new closing weekly (or monthly) High OR Low, so should the related Dow Transportation Average (TRAN) at some point and vice-versa. Since TRAN represents the shipping companies and INDU the producing companies (more so in Dow's time), a pick up or a fall off in shipping, as reflected in the Average's stock prices, could be the first signal of a strengthening OR weakening economy.

For example, if INDU went to a new closing weekly high, 'unconfirmed' by a similar new high in TRAN, this non-confirmation or 'divergence' in the Transports could suggest that INDU will fall later; e.g., after inventory build up finally caused a weakening of the Industrial companies' profits, a surge in employee lay-offs, and generally created a slowing economy and perhaps a recession at some point.

Around mid-July, BOTH the INDU and TRAN averages went to new closing weekly highs per my first chart below. In October, the new closing weekly high in INDU was NOT matched by a new closing high in TRAN, by a wide margin in fact! This warned of a sell off in the market that was to come and those who heeded this warning tended to be better prepared or profited from the ensuing downturn. The market then got further along to a point where BOTH INDU and TRAN went to new low weekly Closes, suggesting that the major trend may have shifted from up to down. My focus will now move to the advance warnings we can get from a price/momentum INDICATOR divergence.

This foregoing is just about how price action of one market sector could be compared. Likewise, a rise or fall in the semi-conductor stocks could be the first tip off for a later move in Nasdaq. A surging oil stock sector could signal related strength in the S&P.

PRICE ACTION VERSUS TECHNICAL INDICATORS

A technical indicator is just a formula based on price or volume action so it's related for sure. If a stock or index goes to a new High or Low, an indicator type [Stochastics, MACD or the Relative Strength Index (RSI)] that measures price MOMENTUM should also go to a new relative high or low. The way I mostly look at divergences is by looking a trendline of new closing highs or lows in PRICE, versus what a trendline is showing as to the upward or downward trend in a related INDICATOR. My indicator of choice is the Relative Strength Index or RSI.

The RSI is basically a ratio of a moving average of the UP closes divided by a moving average of the DOWN closes for a certain period of time or a certain number of BARS in bar or candlestick chart. Lots of consecutive UP closes and the RSI line will go up steeply and vice-versa.

I'll use in my chart examples of price/RSI divergences the Close-only 'line' chart. While the RSI may be computed and re-computed for each price tick, the RSI line is not established until the Close of an hour, a day, week or month. The RSI indicator has to be told HOW MANY closing prices from what number of trading periods it's to use in order to compute an RSI line; e.g., 5 hours or days, 8 periods, 13, 21, etc. A daily moving average is always dropping off the Close of X number of days ago and using the latest Close to re-compute the average. You really have only one setting to make with the RSI, that of 'Length' or the number of trading periods to use in its calculations.

In my first chart example below, via the highlights I've used on the lower left of the daily line chart of Intel (INTC), the trend of prices was down, but the trend of the 13-day RSI was a pattern of higher highs; this divergence is easy to see as the price and RSI trendlines point in different directions as one is declining and one is (strongly) rising. A falling trendline drawn through the lows, accompanied by a rising trendline in RSI, is considered to be a bullish divergence between price and momentum (as measured by the RSI indicator) and points to a potential for an UPSIDE trend reversal ahead.

A bearish Price/RSI divergence developed in October/early-November and forecast the correction that followed, although not a major one and not leading to a trend reversal; at least we can't say yet that INTC has gone from a bullish trend to bearish. Stay tuned on that!

A bearish Price/RSI divergence is where prices are rising, but the RSI trend is not following suit as highlighted by the two diverging trendlines connecting the noted highs in both price and the RSI momentum indicator shown below in Home Depot (HD).

In both examples, that of a bullish Price/RSI divergence above and the bearish Price/RSI divergence pattern below, it's important to then WAIT for price action to CONFIRM (there's that word again!) a trend reversal. I just noticed that my HD chart illustration below was 'captured' a couple of days ago so the date and close is off slightly. No matter, as what I'm demonstrating is unaffected. HD Close today (12/31) was 26.94.

Speaking of WAITing, it's not necessary to wait for the just occasional instance of a bullish or bearish price/indicator divergence that comes along on a daily chart basis as such divergences are seen more frequently on hourly charts, especially in the indexes, using a 'length' setting of 21; i.e., measuring 21 hours of trading over a few day period.

For example, there was a substantial trading opportunity in DJX index calls presented by the rally that got underway in late-November as seen in the Dow (INDU) hourly chart below. I find that many if not most of the most powerful moves come after a bullish or bearish divergence (between price action and the RSI) that ALSO occurs by RSI readings in the typical 'oversold' area at or below 30-35 and the typical 'overbought' area of 65-70 in the 21-hour RSI.

After the first bullish price/RSI divergence highlighted (mid-November), a bearish divergence then set up a couple of weeks later after the strong run to the top. This divergence was, in turn, followed by a bullish divergence in mid-December. Lastly, the 4th and most recent divergence, a bearish one, didn't also occur accompanied by an overbought RSI extreme; I don't usually consider this pattern quite as 'strong' a trend reversal warning. Not like the chart following, of the S&P 500.

The SPX chart below shows its most recent 3 Price/RSI divergences: bearish, bullish, then bearish again. The reversals after the first two divergences led to reversal moves of around 70 and 50 points in SPX, respectively, before the trend shifted noticeably again.

The Nasdaq 100 (NDX) hourly and my last chart, has two key price/RSI divergences highlighted and those occurred well in advance of actual price reversals; all the more reason to have waited for price action to confirm a reversal by a trendline break or breakout. With the more volatile Nas 100 Index, putting more weight on buying puts at overbought extremes and calls on oversold extremes has made this aspect (overbought/oversold) of the 21-hour RSI indicator quite useful.

However, as with any indicator, I also caution against using overbought and oversold extremes strictly as a 'mechanical' trading trigger, as markets that get in a prolonged run can first get quite overbought (see the October period below) or oversold and thereafter have the trend continue to move substantially higher or lower. The time before a move really gets going can be obviously very important for those in long options also due to premium erosion in a sideways move; the sellers like these situations of course.

HAPPY NEW YEAR &
GOOD TRADING SUCCESS!
 

Today's Newsletter Notes: Trader's Corner by Leigh Stevens and all other plays and content by the Option Investor staff.

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