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Daily Newsletter, Saturday, 01/12/2008

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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

40 More Years?

We have gone it alone for the last 40 years and we will go it alone for the next 40 years, Angelo Mozilo, Aug-2008. That quote will probably go down in history since only four months passed before the Mozilo had to eat his words to avoid filing bankruptcy. In theory this should have invigorated the markets and produced a monster short squeeze in financials. Even more so since JP Morgan is rumored to be in talks to acquire Washington Mutual (WM) and relieve its pain. Unfortunately the earnings calendar got in the way with Citi, JPM, Merrill and other big financials set to report next week. This is likely to be the "kitchen sink" quarter where every possible charge off is thrown into the write-down stew. Since the quarter is already going to be the worst in years those firms will throw everything into the mix to get it off their books in one big ugly quarter. Some analysts are expecting as much as $40 billion in write-downs to be announced next week. Add in growing recession fears and the markets had another really bad day when they should have been celebrating.

Nasdaq Chart - Weekly

Dow Chart - Daily

There was nothing in the economics on Friday to get excited about. The entire week was very lackluster with the biggest event a speech by Paulson and another by Bernanke. Next week is entirely different economically with inflation reports leading the list. In Bernanke's speech on Thursday he indicated he was not that concerned about inflation and more focused on slowing economic growth. That suggests the Fed is going to be proactive on the rate front and the Bernanke himself already suggested there could be substantive rate cuts ahead. As long as the inflation reports next week (PPI/CPI) show inflation remains tame then the Fed will be free to act. If, as we saw last month, inflation is spiking sharply higher then the Fed will have a tough decision ahead. In November the PPI headline number spiked +3.2% and that was the second highest gain since the PPI began in 1947. The core rate rose +0.4% and that was also well above the recent ranges. The CPI jumped +0.8% in November and that was the largest increase in over two years. These numbers have got to be giving the Bernanke Fed indigestion in the current recessionary environment. I am sure they are waiting to move on rates until they get the numbers from the December PPI/CPI due out next Tue/Wed. Since we are still more than two weeks away from the January 29th FOMC meeting we could see an intermeeting rate cut as early as Monday since the Fed will get an advance look at the PPI/CPI. If inflation cooled in December I would look for a Mon/Tue rate move but that is sheer speculation.

Also out next week is the Fed Beige book, an overall look at all 12 of the Fed districts. This will also give the FOMC a better understanding on the state of the economy. Lastly we get the Philly Fed Survey on Thursday to begin the next series of regional manufacturing reports. The Philly Fed is seen as a proxy for the general economy and is given more credence than the rest.

Bernanke will also testify on Thursday to the House Budget Committee on the economic outlook for the U.S. economy and that is a question and answer session. He will really be on the hot seat this time around and that means it will be even more likely the Fed could move before Thursday. Then Bernanke could say we are taking positive steps, blah, blah, blah. It is easier to face the inquisition if you have an action point to lean on.

Economic Calendar

Alcoa may have been the kickoff to the earnings season when they reported on Wednesday but the vast majority of companies have not yet stepped up to the plate. Next week is financials week with quite a few of the major banks/brokers reporting. This overhang is weighing on the market. Citigroup reports on Tuesday and they are now expected to write-down as much as $24 billion in loans and CDOs. Along with that monster write-down they are expected to report another bailout by a consortium of firms that could be as much as $15 billion. Regardless of how it is structured this will be dilutive to the current shareholders but shares of Citi have been up for the last two days. Still there is a concern that many of the regional banks reporting next week that have been flying under the radar may suddenly rocket into visibility with an unexpected loss. The big boys are still in the crosshairs as well with Merrill expected to announce write-downs could increase to $20-$23 billion from the current $8.5 billion. Morgan Stanley could increase to $9 billion and Bear Stearns another $2 billion. S&P is now expecting financial earnings for Q4 to drop -72%. That will drag the entire S&P earnings to an -11.3% drop. Without the financials the rest of the S&P is expected to post +11.6% earnings growth. Techs are still holding at +22% growth and energy +20%.

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There are two major tech stocks reporting next week and those are Intel on Tuesday and IBM on Thursday. These two companies will either be the tech saviors or the hammers that crush current support. Intel is expected to report earnings of 40 cents and IBM is expecting $2.60 for Q4. Seagate will also report and they were making very bullish comments at CES early last week. Evidently the demand for disk drives is very robust. That suggests overall tech demand is also strong. As long as Intel or IBM does not drop an earnings bomb this could be a turning point for tech stocks. This is also going to be a prime week for determining guidance. The guidance for Intel and IBM will be more valuable than their actual earnings numbers. We also have GE reporting on Friday and their guidance will be seen as a proxy for the U.S. economy.

Earnings Calendar

Stinking up the Dow on Friday was American Express with news it was taking a $440 million Q4 charge due to increased delinquencies and loan write-offs. AXP said it was seeing particular weakness in states with the largest real estate problems like Florida and California. They said they were surprised by the acceleration of the weakness. They expected to see some problems in 2008 but were caught off guard when the credit deterioration accelerated into Q4. AXP will report earnings on Jan-28th and warned those earnings would be around 71 cents and below the prior year's comparison quarter. AXP also warned that further tough times are ahead and growth in cardholder spending will slow. These warnings shocked many investors because they thought the weakness was restricted to the subprime crowd. The higher net worth American Express customers were expected to be mostly immune to the credit weakness. AXP fell -4.92 and was responsible for nearly 40 points of the Dow loss.

Capital One (COF) warned they would take a charge of $1.9 billion for Q4 of which $1.3 billion is loan charge offs. They cut their earnings outlook for the full year to $3.97 from the prior forecast of $5 per share. Capital One was knocked for a $3 loss on the announcement but recovered all of it before Friday's close. Everyone knew COF was going to have problems since they have a large number of lower credit borrowers. Washington Mutual will also have the same problem when it reports next week because they bought Providian last year and Providian was heavily into credit card accounts for low credit borrowers.

Tiffany (TIF) was knocked for an 11% loss of $4.50 after it lowered the top end of its 2007 guidance. Tiffany said it was seeing weakness in its high-end buyers and especially on big ticket items over $50,000. That is definitely big ticket and you would think anyone throwing down an American Express card for a $50,000 trinket would not be hurting in any environment. This further spoiled the idea that the subprime credit crunch only impacted the blue-collar crowd. This problem has risen to the higher echelons of consumers and it does not paint a rosy picture for Q1.

Of course the big news was the Bank America acquisition of Countrywide for $4 billion or roughly $6.90 per share. You may remember BAC paid $2 billion for a preferred stake in Countrywide back when CFC was trading at $18. The press releases and the analyst comments liked the deal with BAC paying roughly 31% of book value or 2.9 times expected 2009 earnings. There are two important points about this deal. BAC not only gets the $1.5 trillion in loan servicing operations from CFC and roughly $40 billion a month in mortgage loan originations but they get hundreds of billions in liabilities from dozens of lawsuits and regulatory challenges. They also added exposure to tens of billions in pending foreclosures they will have to eat when the loans are put back to them. Countrywide loans in default have risen to 7% and foreclosures have doubled over 2006 even with their attempts to rewrite as many as possible. I heard late Friday Countrywide loan-servicing agreements require Countrywide to make the payments on delinquent loans while they are trying to collect from the borrower. That means they have to make monthly payments on 7% of their loan portfolio. Talk about a cash drain! BAC is in a much better position to handle this problem than Countrywide and the acquisition announcement probably prevented a Countrywide bankruptcy. However, there is still the possibility they will let CFC file bankruptcy to limit future liabilities and get rid of some problems they would rather not assume. There was a rumor circulating in the markets on Friday that the Fed was involved in both the CFC and WM deals. Both were headed down a path that would have likely grown progressively worse without a deep pocket acquirer to halt the problem.

Another reason BAC may have taken this leap was to rescue their recent $2 billion investment. Essentially BAC CEO Ken Lewis doubled down on the initial $2 billion investment to roll the dice BAC could turn CFC back into a profit machine. Lewis said he did not plan on Mozilo staying with the merged company. Mozilo's severance package is seen to run from $85 million to as much as $150 million. BAC also said they would move away from the CFC process of buying bulk mortgages from loan originators and would not do subprime loans.

McDonalds (MCD) fell -$4 on fears that the sharp decline in consumer spending would trickle down to big macs and fries. A routine survey of 195 specific stores showed same store sales rose just 1.8% and the lowest increase in six years. Gasoline prices were said to be the culprit with shopper's budgets being squeezed even to budget meals. One obscure analyst downgraded MCD and said the expectations for gains from their big move into the coffee business was already priced into the stock. Almost everyone else disagreed with that prediction and with the worry over a material decline in low dollar fast food. There were several reiterated buy ratings. The -3.85 drop in MCD was responsible for the loss of nearly 35 Dow points.

RF Micro Devices (RFMD) was crushed for a 26% loss after warning that excess inventory and slowing sales would force them to miss earnings. RFMD said customers were reducing orders and overall demand was weak in the infrastructure and broadband markets. RFMD now expects a loss of 4-5 cents per share compared to its prior forecast for a profit of 6-7 cents. The SOX fell to 353 and a level not seen since Sep-2004. Given the Intel earnings next week this may be a pessimistic support level worth buying.

Crude prices fell to $92.69 making the six-day drop -7.36 from the $100.09 historic high hit on Jan-3rd. This may sound strange since oil inventories fell for the 8th consecutive week with a drop totaling 32 million barrels over the eight week period. Inventory levels have now fallen to 9.8% below the year ago level. So why are prices falling? Fears of a recession and a sharp drop in demand for gasoline is putting pressure on crude prices. The sharp drop in gasoline demand is similar to that seen heading into the recession of 2001. Gasoline inventories soared 5.3 million barrels last week compared to an expected rise of only 1.6 mb. Because of high crude prices the cost of gasoline is not declining and this is putting pressure on consumers already hit by the subprime crisis. Secondly, we are in a bear market and everything previously bullish is now being sold. Even a helium balloon goes down in an elevator. We are seeing profit taking in nearly every sector and every individual winner heading into 2008. This will fade and consumers will adjust to paying higher prices. It always happens this way and I would view this as a buying opportunity as we approach $90.

United Airlines (UAUA) said on Friday they were raising the fuel surcharge on tickets to $25 each way up from the current $10. United said they had to do this to survive in an environment where fuel costs had tripled in the last three years. Every penny rise in jet fuel costs the airline sector an extra $195 million per year in fuel expenses. I am telling everyone once again, if there is somewhere you always wanted to go you should schedule that trip soon because once peak oil arrives over the next several years those fuel charges will be significantly higher and be based on miles flown. If oil hits $150 by 2010 (24 months) that is roughly an extra $50 billion in fuel costs annually for airlines. How much will the fuel surcharge be then? On Dec-28th 2006 oil was $66 and jet fuel was $1.78 per gallon. On Dec-28th 2007 oil was $90 and jet fuel was $2.70 per gallon. That is a 51.4% increase in the cost of jet fuel for a 36% jump in oil prices. A crude jump to $150 will seriously cripple airlines and it will be here by 2010.

February Crude Chart - Daily

Elsewhere in the commodity sector gold prices hit $900 for the first time ever and analysts calling for selling began appearing in every sound bite. Corn prices hit an 11 year high on the January crop report Friday morning and went limit up with 18,000 contracts at the ask when the market closed. Soybeans hit a record high at $13 on that same report. Global demand for food is growing rapidly the commodity report showed there was insufficient supply to satisfy demand. This is not going to get better any time soon.

The worst 10 days ever for a new year. More triple digit days. Biggest losses. The records being broken are repeated in nearly every segment on stock TV. Volume is soaring and new lows are well into the quadruple digits. Volatility is huge and nobody knows which way to jump. When will it be over? Nobody knows. It will be over when it is over. I know that is the glib answer but it is true. We have seen a 10% correction in the first eight days of the year and now we are testing those lows.

The news is a lot better than the closing numbers looked on Friday. The Dow was the major loser that was dragging down the other indexes. The Dow was down over 300 points at 3:PM and recovered to hold in very light support at 12600. The Dow was down primarily due to six companies. AXP lost -4.92, MCD -3.85, MMM -2.63, PG -2.30 and IBM -2.25 and BA -1.84. Those six companies accounted for nearly 150 Dow points. AXP and MCD were down on specific news events. I believe the other four, the highest dollar stocks on the Dow, were down on ETF selling. We live in an ETF ruled world today and when those index ETFs are sold it impacts the entire index. Because the Dow is a price-weighted index the highest dollar stocks will be sold the hardest. The top 5 largest weightings in order are IBM, XOM, BA, MMM, MO and PG. Altria (MO) actually rose because they are a defensive recession play. Exxon was down -1.36 but with 6 billion shares outstanding it is tough to move that stock on anything other than a direct news event. I may be full of stuffing but I think Friday's drop was mostly story related on MCD and AXP with a little continuing recession fear thrown in.

If you look at the trend on the internals over the last seven days we saw a ramp up in volume and negativity to what appears to be a capitulation event on Wednesday with nearly 9.3 billion shares traded across all exchanges and a whopping 1530 new 52-week lows. On Thursday we was another 9 billion in volume with a trend reversal in the internals. Friday was a return to selling on a lot of different stories from AXP, TIF to MCD and RFMD. It was the last opportunity for companies to warn before earnings and several took advantage of it. We also had the overhang of increasing expectations for further massive write-downs from the financial stocks reporting next week.

Market Internals

I believe the bad news is priced into the market and while there may be some additional volatility on Monday we "should" start finding a bottom here. If you look at the S&P-500, the index I have been using for market calls for the last two weeks, we had a perfect bounce off 1380 on Wednesday that ran for +59 points. Even with all the negative news on Friday and a Dow dropping -300 points intraday on losses from only six stocks the S&P held its ground at 1400. That appears to me to be traders setting up for a potential rebound next week. We have MacWorld starting on Monday with the Steve Jobs market moving presentation on Tuesday. We have several high profile earnings events with all the bad news in the world already priced in. It would be extremely hard for those financial stocks to surprise to the downside. The odds are better they could surprise to the upside and that would really be a shocker to some traders.

S&P-500 Chart - Daily

Don't get me wrong we could still collapse under any number of news events like even more massive losses than expected in the financial sector or another sharp spike in inflation. Intel could tell us that PC sales have fallen off a cliff but I don't see it. I know distributors in the computer sector currently having a hard time getting components for servers. That is not a sign of slowing demand but it could be sector specific. I don't want to fall into the trap of trying to predict the market direction ahead of an event filled week. I believe we should just stick to the trading plan and let the markets pick the direction. Last week we planned to buy a dip to 1380 on the SPX and we got that on Wednesday. The secondary recommendation was to buy a breakout over 1400. Those would be the same recommendations for next week. With the S&P closing at 1401 I would look to stay long over 1400 and go flat under 1400 to prepare for a bounce at 1380. Should 1380 fail I would go short at 1375 and settle in for a long week. I want to believe Apple and Intel will help turn techs around and I want to believe the worst is for financial expectations. $5 and a belief you are hungry will get you a hamburger a coke at McDonalds but not much else. Let's put my belief on the shelf and let the market lead and we will follow.

Tomorrow is the last day for the end of year renewal special. If you snooze, you lose.

Jim Brown
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
ETR LCAPA None
GENZ PCLN  
MCD SHLD  
ZMH    

Play Editor's Note: Just a publishing note, I am going to be out of the office on Wednesday, January 16th so there will be no play updates that evening.

FYI: Stocks I'm watching... PCP and TGI look like put candidates.


New Calls

Entergy - ETR - cls: 124.39 chg: +0.08 stop: 119.95

Company Description:
Entergy Corporation is an integrated energy company engaged primarily in electric power production and retail distribution operations. Entergy owns and operates power plants with approximately 30,000 megawatts of electric generating capacity, and it is the second-largest nuclear generator in the United States. (source: company press release or website)

Why We Like It:
Safe haven stocks have been out performing and this electric company with a 2.4% dividend yield continues to look bullish. Traders bought the dip twice near $121 last week and Friday's rebound looks like a new entry point to buy calls. We've only got a couple of weeks before earnings come out. Our short-term target is $129.50-130.00. More aggressive traders may want to aim higher. We're suggesting a stop loss at $119.95 but more conservative traders could try a stop just under Friday's low.

Suggested Options:
We are suggesting the February calls. We plan to exit by the end of January.

BUY CALL FEB 120 ETR-BD open interest=180 current ask $7.70
BUY CALL FEB 125 ETR-BE open interest=141 current ask $4.40

Picked on January 13 at $124.39
Change since picked: + 0.00
Earnings Date 01/29/08 (confirmed)
Average Daily Volume = 1.6 million

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Genzyme - GENZ - close: 78.56 change: +0.48 stop: 74.95

Company Description:
One of the world's leading biotechnology companies, Genzyme is dedicated to making a major positive impact on the lives of people with serious diseases. Since 1981, the company has grown from a small start-up to a diversified enterprise with more than 10,000 employees in locations spanning the globe and 2006 revenues of $3.2 billion. (source: company press release or website)

Why We Like It:
This past week was a strong one for anything healthcare related. Shares of biotech company GENZ broke through resistance near $77.00 to hit new all-time highs. GENZ managed to hold on to those gains in the face of Friday's market sell-off. We are suggesting calls here at current levels or on a dip back toward $77.00. If you're worried about resistance at $80.00 then wait for a breakout. Our target is the $84.00-85.00 range. The P&F chart looks very bullish with a $94 target. Readers should note that rival Genentech (DNA) is due to report earnings after the bell on Monday night. DNA's results and their conference call could have a big impact on the biotech sector. More conservative traders will want to think about waiting until we see the market's reaction on Tuesday morning before opening new positions here in GENZ. We're putting our stop loss at $74.95. Conservative traders might want to put theirs closer to $77.00. FYI: Any time we play a biotech company it is always a high-risk play due to headline risk. You never know what news might come out concerning an important FDA decision or clinical trial that could dramatically move the stock price and see shares gap one way or the other.

Suggested Options:
We are suggesting the February calls but plan to exit ahead of the February earnings report.

BUY CALL FEB 75.00 GAA-BO open interest= 353 current ask $5.80
BUY CALL FEB 80.00 GAA-BP open interest=2775 current ask $2.70

Picked on January 13 at $ 78.56
Change since picked: + 0.00
Earnings Date 02/13/08 (unconfirmed)
Average Daily Volume = 2.5 million

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McDonalds - MCD - cls: 54.32 chg: -3.85 stop: 53.25

Company Description:
McDonald's is the leading global foodservice retailer with more than 30,000 local restaurants in more than 100 countries. More than 75% of McDonald's restaurants worldwide are owned and operated by franchisees and affiliates. (source: company press release or website)

Why We Like It:
Recession fears and negative analyst comments sent shares of MCD to a 6.6% decline on Friday. Volume was HUGE at close to four times the norm. The breakdown under technical support at the 100-dma and the $55.00 level is bearish. However, traders did buy the dip at MCD's rising 200-dma. We suspect that the move down was an over reaction. This is a speculative, higher-risk play since it's a counter-intuitive move. We're suggesting a stop under Friday's low. Our very short-term target is the $57.90-58.00 range. More aggressive traders could aim higher (maybe $60-62). We do not want to hold over the late January earnings report.

Suggested Options:
We are suggesting the February calls. Remember, it is up to the individual trader to decide which month and which strike price best suits your trading style and risk.

BUY CALL FEB 50.00 MCD-BJ open interest=181 current ask $5.40
BUY CALL FEB 52.50 MCD-BX open interest=210 current ask $3.70
BUY CALL FEB 55.00 MCD-BK open interest=504 current ask $2.25
BUY CALL FEB 57.50 MCD-BY open interest=1784 current ask $1.25

Picked on January 13 at $ 54.32
Change since picked: + 0.00
Earnings Date 01/28/08 (confirmed)
Average Daily Volume = 8.6 million

---

Zimmer Holdings - ZMH - cls: 69.95 chg: +1.44 stop: 67.49

Company Description:
Founded in 1927 and headquartered in Warsaw, Indiana, Zimmer is the worldwide #1 pure-play orthopaedic leader in designing, developing, manufacturing and marketing reconstructive and spinal implants, trauma and related orthopaedic surgical products. (source: company press release or website)

Why We Like It:
It looks like ZMH has put in a bottom following the October 2007 crash. The big gap down was from an earnings warning. Shares have since consolidated sideways and now look poised to breakout over resistance near $70.00. We're suggesting a trigger to buy calls at $70.51. If triggered our short-term target is the $74.85-75.00 range. Broken support near $75.00 should be new resistance. We do not want to hold over the late January earnings report.

Suggested Options:
We are suggesting the February calls. Our trigger is at $70.51.

BUY CALL FEB 65.00 ZMH-BM open interest= 350 current ask $6.50
BUY CALL FEB 70.00 ZMH-BN open interest=2414 current ask $3.20
BUY CALL FEB 75.00 ZMH-BO open interest=1325 current ask $1.25

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/29/08 (confirmed)
Average Daily Volume = 2.0 million
 

New Puts

Liberty Media - LCAPA - cls: 109.69 chg: -0.15 stop: 111.15

Company Description:
Liberty Media Corporation owns interests in a broad range of electronic retailing, media, communications and entertainment businesses. Those interests are attributed to two tracking stock groups: the Liberty Interactive group, which includes Liberty's interests in QVC, Provide Commerce, IAC/InterActiveCorp, and Expedia, and the Liberty Capital group, which includes Liberty's interests in Starz Entertainment, News Corporation, and Time Warner. (source: company press release or website)

Why We Like It:
The trend in LCAPA looks bearish with a steady pattern of lower highs and failed rallies at resistance. This past week left LCAPA testing support near $109-108.50, which is where the stock bottomed back in August 2007. If shares continue lower we want to catch the move. Aggressive traders could use a trigger to buy puts at $108.65. We are suggesting a trigger at $107.49, which is under the August low. If triggered our target is the $100.25-100.00 range. The P&F chart is bearish with a $98 target. Warning: We cannot find an earnings report date for LCAPA but the company appears to have a history of reporting in February. Not knowing when they report is a risk since we don't want to hold over the event.

Suggested Options:
We are suggesting the February puts.

BUY PUT FEB 110 NLD-NB open interest=140 current ask $5.30
BUY PUT FEB 105 NLD-NA open interest= 47 current ask $3.30

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/00/08 (unconfirmed)
Average Daily Volume = 653 thousand

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Priceline.com - PCLN - cls: 96.24 chg: -6.54 stop: 100.51

Company Description:
Priceline.com Incorporated operates priceline.com, a leading U.S. online travel service for value-conscious leisure travelers, and Booking.com, a leading international online hotel reservation service. (source: company press release or website)

Why We Like It:
Given PCLN's longer-term up trend it would be tempting to try and buy a bounce from the stock's rising 100-dma. Investors do have a history of buying dips to the 100-dma. PCLN actually closed under its 100-dma on Friday. The intraday dip toward $94.00 looks like it was enough to "fill the gap" from last November. I'm actually expecting a short-term bounce. However, if recession fears persist then investors should worry about the consumer traveling less and that should lead shares of PCLN lower. Right now we're suggesting a trigger to buy puts at $93.99, just under Friday's low. If triggered we'll aim for the $82.50-80.00 range. More conservative traders will want to consider exiting near $85.00. Please note that PCLN can be a very volatile stock. Shares had a $10.00 range on Friday alone. Nimble traders could try and buy puts on a failed rally near $100 or $105. We do not want to hold over the mid February earnings report.

Suggested Options:
We are suggesting the February puts. Our suggested trigger is at $93.99.

BUY PUT FEB 100.0 PUZ-NT open interest=773 current ask $11.20
BUY PUT FEB 95.00 PUZ-NS open interest=282 current ask $ 8.40
BUY PUT FEB 90.00 PUZ-NR open interest=1299 current ask $6.20
BUY PUT FEB 85.00 PUZ-NQ open interest=163 current ask $4.30

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 1.6 million

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Sears Holding - SHLD - cls: 96.17 chg: -4.06 stop: 102.05

Company Description:
Sears Holdings Corporation, the publicly traded parent of Kmart and Sears, Roebuck and Co., is the nation's fourth largest broadline retailer with over $50 billion in annual revenues and approximately 3,800 full-line and specialty retail stores in the United States and Canada. (source: company press release or website)

Why We Like It:
I will be the first to admit that I was surprised by SHLD's breakdown last week. We knew the trend was bearish but it had held support at the $100 level so long that the stock looked ready to bounce back and hits its trendline of resistance. We had SHLD as a put candidate and capture a move from $110 to $100 but we had a second more aggressive target at $92.50. Last Wednesday's dip was $90.80. The oversold bounce from the $90 level looks like it's rolling over. We're suggesting puts here in the $95-100 zone. Our very short-term target is the $91.00-90.00 range but we have a second target in the $85.50-85.00 zone. FYI: SHLD is due to present at a retail conference on Monday. We're not expecting any fireworks. The P&F chart is bearish with a $78 target.

Suggested Options:
We are suggesting the February or March puts. Our preference would be March.

BUY PUT FEB 100.0 KTQ-NT open interest=3533 current ask $9.80
BUY PUT FEB 95.00 KTQ-NS open interest=1502 current ask $7.00
BUY PUT FEB 90.00 KTQ-NR open interest= 901 current ask $4.90

BUY PUT MAR 95.00 KTQ-OS open interest=1759 current ask $10.50
BUY PUT MAR 90.00 KTQ-OR open interest=2027 current ask $ 8.20

Picked on January 13 at $ 96.17
Change since picked: + 0.00
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 3.3 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Apple Inc. - AAPL - cls: 172.69 chg: -5.33 stop: 164.75

Friday's market sell-off pulled AAPL down to support near $170 before traders bought the dip. Our suggested entry point to buy calls in AAPL was the $171.00-168.00 range. This looks like a good spot heading into MacWorld next week. If you did not jump in on Friday it's probably not too late to buy calls here. I heard on Friday that AAPL's average gain from the MacWorld exposure was 8%. That would put AAPL near $186. I'm not really expecting a big move until Tuesday, which is when the MacWorld Expo begins and Steve Job speaks. Our first target is the $179.50-180.00 zone. Our second target is $188.00-190.00.

Suggested Options:
If you wanted to jump into AAPL here we would suggest the February calls. January strikes expire next week.

Picked on January 11 at $171.00 *triggered
Change since picked: + 1.69
Earnings Date 01/22/08 (confirmed)
Average Daily Volume = 38 million

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BP Prudhoe - BPT - cls: 83.12 chg: -1.55 stop: 77.90

BPT posted an impressive week in spite of the market turmoil. Having a double-digit dividend yield can do that for you when investors are searching anywhere for a safe haven. I recently received an email from a reader asking if we would still be bullish on BPT post-dividend on a dip to $80.00 (which could happen on Monday). Yes, we are sticking with our suggested strategy. The market environment is bearish and investors will still be looking for a place to park their money. Technically broken resistance at $80.00, which was significant, should now be support. We are suggesting a trigger to buy calls in the $80.50-79.00 range. If triggered our target is the $89.00-90.00 zone.

Suggested Options:
We are suggesting the March calls. Our suggested trigger is $80.50. These should be cheaper on a dip to $80.

BUY CALL MAR 75.00 BPT-CO open interest=261 current ask $9.00
BUY CALL MAR 80.00 BPT-CP open interest=485 current ask $4.10
BUY CALL MAR 85.00 BPT-CQ open interest=277 current ask $1.90

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/08 (unconfirmed)
Average Daily Volume = 84 thousand

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Blackstone - BX - close: 20.06 chg: +0.22 stop: 17.24

BX is a new call play from our Thursday night newsletter. Shares gapped open higher on Friday at $20.22 and hit $21.31 before pulling back. The breakout over $20.00 is bullish but we would not be surprised to see a dip back toward $19.50-19.00. We are reposting our comments from Thursday:

This play is for the adventuresome crowd. BX hit new all-time lows Wednesday near $17.25. Yet Thursday's sharp rebound, thanks to a stock buy back announcement, has produced a three-candlestick bullish reversal pattern. BX is currently facing resistance near $20 and its 10-dma (and its late November lows). The rebound could fail right here. We are suggesting calls right now but this is a higher-risk play and you may want to wait. You don't have to buy calls immediately. You could wait for a breakout over the 10-dma near $20.60. Or you could wait for a dip back toward Thursday's intraday support near $19.00. Our target is the $24.00-25.00 range. We do not want to hold over the February earnings report.

Suggested Options:
If we can hold up to February expiration we'll have five weeks for this play to work. If BX reports earnings before expiration then we'll exit earlier. We're rolling the dice on this one so we're going for out-of-the money options. If you are willing to risk holding over the earnings report we would buy the March $22.50.

BUY CALL FEB 22.50 BX-BE open interest=865 current ask $0.70

Picked on January 10 at $19.84
Change since picked: + 0.22
Earnings Date 02/11/08 (unconfirmed)
Average Daily Volume: 2.7 million

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Covance - CVD - cls: 95.92 change: +1.13 stop: 86.99

I'm still kicking myself for not listing a breakout over $90.00 as an official entry point. At this point CVD has gotten away from us. Broken resistance near $90 should be new support so we're suggesting readers wait for the dip. Unfortunately, it looks like CVD will hit our target near $100 before we even get the chance. I would not chase it at current levels. The stock looks short-term overbought and due for a correction. Our suggested entry point is the $90.50-90.00 zone. Our first conservative target is $94.50-95.00. Our second, more aggressive target is the $99.00-100.00 range. FYI: We are unfortunately, running low on time. We don't want to hold over earnings.

Suggested Options:
If CVD provides a new entry point we would suggest the February calls.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/23/08 (unconfirmed)
Average Daily Volume = 395 thousand

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Foster Wheeler - FWLT - cls: 141.58 chg: -5.98 stop: 137.85

If you are a day trader you have to love these big intraday swings. If you're not they probably give you heartburn. Honestly, FWLT is displaying a lot of mixed signals. You could argue a bullish or bearish case here. The stock did bounce as expected and hit our early target at $149.50-150.00 on Thursday. The sharp pull back on Friday is either another entry point for calls or a warning that FWLT is headed for its 200-dma closer to $120. I would be cautious about opening new plays now following Friday's market weakness. Friday is an "inside" day suggesting indecision. If FWLT bounces from $140 then great, we can buy calls again. How do you know it's "bouncing"? Try waiting for a rise past $145. Our second target is the $158.00-160.00 range. FYI: FWLT is due to split 2-for-1 on January 22nd.

Suggested Options:
If FWLT bounces consider buying the February calls.

Picked on January 09 at $142.90
Change since picked: - 1.32
Earnings Date 02/27/08 (unconfirmed)
Average Daily Volume = 1.7 million

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Hess Corp. - HES - cls: 91.74 chg: -0.94 stop: 89.90

Lack of follow through on HES' bounce from $90.00 is a warning signal for the bulls. On the positive side both oil stocks and crude oil have been trending lower but HES has managed to hold support. We remain bullish with HES above $90 but at this point you may want to wait for a rally over $94.00 before jumping into new positions. A rise over $94 should break the two-week trendline of lower highs. Our target is the $99.00-100.00 range. We do not want to hold over the late January earnings report.

Suggested Options:
If HES provides a new entry point we would suggest the February calls.

Picked on January 07 at $ 92.00 *triggered
Change since picked: - 0.26
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 4.5 million

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Hologic - HOLX - close: 70.36 chg: +0.62 stop: 66.75 *new*

HOLX showed some relative strength on Friday with a gain. The stock got a boost after receiving some bullish analyst comments and a raised price target to $81. However, before you get too excited we're concerned with the trading pattern over the last few days. It almost looks like HOLX is painting a bearish head-and-shoulders pattern over the last four weeks and it's currently on the right shoulder. We're not suggesting new positions at this time. 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. We are inching up our stop loss to $66.75. FYI: The P&F chart is bullish and points to an $87 target.

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

Picked on December 18 at $ 66.22
Change since picked: + 4.14
Earnings Date 01/30/08 (unconfirmed)
Average Daily Volume = 2.8 million

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Inverness Medical - IMA - cls: 60.02 chg: -2.33 stop: 55.99

After a five-day winning streak shares of IMA hit some profit taking Friday. The pull back to $60.00 looks likes a new bullish entry point. However, if you're patient the stock might see a dip to its 50-dma near $58.50. More conservative traders may want to consider a stop closer to $58. Our target is the $64.00-65.00 range.

Suggested Options:
We would suggest the February calls.

Picked on January 08 at $ 58.50 *triggered/gap open entry
Change since picked: + 1.52
Earnings Date 02/26/08 (unconfirmed)
Average Daily Volume = 857 thousand

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Jacobs Engineering - JEC - cls: 88.71 chg: -1.82 stop: 81.65

The trading in JEC actually looks similar to FWLT. The chart is just a little easier to read. One could argue both a bullish and a bearish case for JEC. However, the bullish trend is still the dominant pattern here. Investors bought the dip at JEC's rising 100-dma near the bottom of its channel. Friday's pull back after a $10 bounce is normal. We would still consider buying calls here or on a dip/bounce near $85.00. Our target is the $94.00-95.00 range. More aggressive traders may want to aim for $100. This is going to be a short-term play since we plan to exit ahead of the late January earnings report.

Suggested Options:
We are suggesting the February calls.

Picked on January 09 at $ 86.31
Change since picked: + 2.40
Earnings Date 01/22/08 (unconfirmed)
Average Daily Volume = 1.4 million

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Joy Global - JOYG - cls: 60.01 chg: -1.89 stop: 57.49

JOYG gave back all of Thursday's gains during Friday's market sell-off. Overall the pattern is still bullish and we would still consider buying calls right here. More conservative traders will want to see signs of a bounce first. We're keeping our stop loss under the 50-dma for now. We have two targets. Our first target is $67.00. Our second target is $71.50. We do not want to hold over the late February earnings report.

Suggested Options:
We are suggesting the February or April calls. It is up to the individual trader to decide which month and which strike price best suits your trading style and risk.

BUY CALL FEB 55.00 JQY-BK open interest= 38 current ask $7.50
BUY CALL FEB 60.00 JQY-BL open interest=453 current ask $4.40
BUY CALL FEB 65.00 JQY-BM open interest=459 current ask $2.30

BUY CALL APR 60.00 JQY-DL open interest=2068 current ask $7.00
BUY CALL APR 65.00 JQY-DM open interest=11722 current ask $4.80

Picked on January 09 at $ 60.19
Change since picked: - 0.18
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 1.7 million
 

Put Updates

Shire Plc - SHPGY - close: 68.87 change: -0.27 stop: 70.05

We don't have anything new to report on for SHPGY. We remain very defensive here given the stock's rally back toward resistance. If the market sees any sort of significant rally then we would expect to be stopped out at $70.05. A new decline through short-term support near $68.00 could be used as a new entry point for puts. The stock has already hit our first target near $65. Our second target is the $62.00-60.00 zone.

Suggested Options:
If SHPGY provided us a new entry point we would suggest the February or April puts.

Picked on December 13 at $ 68.07 *triggered/gap down entry
Change since picked: + 0.80
Earnings Date 02/21/08 (unconfirmed)
Average Daily Volume = 956 thousand
 

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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Biogen Idec - BIIB - cls: 59.02 chg: -0.16 stop: n/a

BIIB provided a good day for us. Shares traded sideways between $59 and $60 most of the session. That was an opportunity to open strangle positions. Now we wait. We are expecting Monday, January 14th to bring news. BIIB and its partner ELN are expecting an FDA approval to widen the acceptable uses for their Tysabri drug. We only have five days left before January options expire. All the action should happen Monday or Tuesday depending on when the announcement hits. The options we suggested for our strangle were the January $65 call (IHD-AM) and the January $55 put (IDK-MK). Our estimated cost here is $1.05. We want to sell if either hits $2.50. More aggressive traders may want to aim higher.

Suggested Options:
We are not suggesting new plays at this time.

Picked on January 10 at $ 59.18
Change since picked: - 0.16
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume = 4.4 million

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Encana - ECA - close: 67.20 chg: -0.73 stop: n/a

There is no change from our previous comments. At this point our speculative, high-risk strangle on ECA is dead in the water. The stock will need to see a really big move in a short time frame to give us any sort of decent exit. We're not suggesting new strangle 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 $1.25 or higher. FYI: The P&F chart is bullish with a $92 target.

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

Picked on December 20 at $ 67.52
Change since picked: - 0.32
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume = 2.7 million
 

Dropped Calls

Humana Inc. - HUM - cls: 84.28 chg: -0.79 stop: 78.95

The pattern in HUM continues to look bullish but we've missed the entry point. Shares never pulled back to hit our suggested trigger. We would continue to watch HUM for a pull back near $81.00-80.00, which should be support.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/04/08 (unconfirmed)
Average Daily Volume = 1.3 million

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PetroChina - PTR - cls: 181.65 chg: -0.47 stop: 174.49

The Hang Seng index was down sharply on Friday while the Shanghai composite managed to rebound from its intraday lows. Combined with a pull back in oil prices, shares of PTR hit more profit taking. The stock hit our stop loss at $174.49. The recent highs near $182-183 now look like a bull trap.

Picked on January 09 at $182.12
Change since picked: - 0.47
Earnings Date 03/10/08 (unconfirmed)
Average Daily Volume = 1.0 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Is Mark to Market the Only Route to Trader's Status?

Last week's Trader's Corner article addressed some of the pros and cons of electing the mark-to-market accounting method for your trades. If you haven't had an opportunity to read that article, you might want to review it at this link before proceeding.

Is it necessary to elect the mark-to-market accounting method if you want to deduct trading-related expenses on your taxes? Some traders and experts believe that might be necessary. Others don't. Does electing the mark-to-market status automatically confer the right to deduct those expenses? Some traders and experts believe it does. Others don't.

Being able to deduct trading-related expenses such as charting programs, books, subscriptions and seminars depends on qualifying as a "Trader in Securities." It's possible that's a separate consideration from the election to use mark-to-market accounting methods. As I've stated in previous articles, I'm not a tax professional. This article is meant to present ideas that must be discussed and clarified with your own tax professional, not to give concrete advice. The question you should be asking that tax professional is whether it's necessary to elect the mark-to-market accounting method to be considered a "Trader in Securities." It may not be, but you must satisfy other, perhaps even more onerous conditions to qualify to qualify as a "Trader in Securities."

IRS Topic 429 sets forth no such requirement to elect the mark-to-market accounting method. In fact, the topic sheet says, "The tax treatment of sales of securities held in connection with a trading business depends on whether a trader has previously made an election under Section 475(f) to use the mark-to-market method of accounting." That doesn't seem to require that a trading business must elect that mark-to-market method of accounting, does it? Furthermore, the sheet goes on to say, "If the mark-to-market election was not made, then the gains and losses from sales of securities are treated as capital gains and losses that must be reported on Form 1040, Schedule D."

Being a trader in securities doesn't appear to require that mark-to-market election. Is the converse true, then, as some believe? Does electing the mark-to-market accounting method automatically confer status as a trader in securities running a trading business? It may not.

If a trader in securities can run a trading business using either accounting method, what is necessary to be considered a trader in securities? According to that same IRS Topic 429, a trader in securities must "seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation." While most day traders could honestly say their trading meets those conditions, the IRS specifies that it doesn't care if you call yourself a day trader or some other name. Further conditions must be met. "Your activity must be substantial, and [y]ou must carry on the activity with continuity and regularity."

The topic sheet continues, specifying the factors that should be considered when deciding whether you're a trader in securities who is conducting a trading business. Those factors include "[t]ypical holding periods for securities bought and sold," for example. In addition, the IRS wants you to consider how much time you devote to trading and the dollar amounts and frequency of your trades for the year. Another factor is "[t]he extent to which you pursue the activity to produce income for a livelihood."

Are you a retired person who engages in 30-40 trades a year? Are those trades condors that require maintenance of about $80,000-$150,000 a month and produce about $6,000 a month in income, upon which you depend to pay your bills? Are you monitoring those trades every day, listening to webinars and attending seminars to hone your skills? Or are you a thirty-something with an executive job at a Fortune 500 company, pulling a few hundred grand a year in salary, who fires off two or three QQQQ scalps a week between meetings? Are you bringing in a few hundred dollars here and there, trading on your gut feeling? The second trader might trade more frequently than the first, but which is most likely to meet the IRS's requirements?

I'd like to find the person who wrote IRS Topic 429 and give that person a pat on the back. That sheet proved the most accessible of any of the many IRS publications I researched when writing this series of articles. However, clarifications don't stop with the sheet itself but have been nailed down through many engagements with the IRS. How much documentation must a trader keep to prove that substantial time has been devoted to developing trades? Is it necessary to keep a daily trading log? Is the fact that trading condors requires less moment-by-moment monitoring than day trades offset by the sometimes greater maintenance requirements? Does it help that condors are considered one of a number of income-producing rather than speculative trades?

Discuss your particular situation with your tax professional or begin your own research on this topic with IRS Topic 429. This series of articles has pinpointed a number of issues to be researched or discussed with your tax professional. As traders, we don't want to get on the wrong side of the market action, and as taxpayers, we don't want to get on the wrong side of the IRS, either.
 

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.

DISCLAIMER

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

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

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