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Daily Newsletter, Tuesday, 01/22/2008

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Table of Contents

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

Market Wrap

That Was Fun

After watching the Asian and European markets implode for two days we finally got our chance to show what we could do. The Dow plunged -464 at the open amid rampant pessimism and expectations for a repeat of the 1987 crash. The Nasdaq lost -118 before the short covering appeared. Compared to some of the Asian markets our drop was tame. Several of the Asian markets were down over 10% for the week at some point on Tuesday. A 10% drop on the Dow would have been more than 1000 points and knocked us back to Dow 11,000.

The Fed stopped the drop this morning by announcing a surprise 75-point rate cut taking the Fed Funds rate down to 3.5%. They also cut the discount rate by 75 points to 4.0%. This was the first intermeeting rate cut since 9/11 but I don't know how you could really call it a surprise. Traders expected a 50 point cut all last week. After the weekend implosion around the globe most thought 50 points would not cut it any more and it appears the Fed realized that more was needed if only for the sentiment effect. The Fed statement said it was "in view of a weakening of the economic outlook and increasing downside risk to growth." And, "broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets." The statement also said "appreciable downside risks to growth remain. The Fed will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks." This is Fedspeak for we will cut again if conditions continue to decline. The Fed Funds futures are pricing in another 25 points at the Jan-29th meeting and an 80% chance of another 50 point cut. The vote was not unanimous with William Poole voting against the rate cut saying conditions did not justify a cut before the regular meeting next week. This does not bode well for the chance of another cut next week.

There were economic reports this morning but they were ignored in light of the market turmoil. The Chicago Fed National Activity Index (CFNAI) fell to -0.91 in December. This was a multiyear low in contraction territory and activity continues to suggest the country moved very close to recessionary levels at the end of Q4.

The Richmond Fed Manufacturing Survey fell to a -8 in January. This was down from the -4 seen in December. Order backlogs actually improved slightly to -12 from -19 but shipments fell to -17 from -10. The six month outlook posted the biggest positive gain to 31 from December's 24. It is unknown why manufacturers feel better about conditions six months out but it is possible they are assuming the recession will be brief. Tomorrow will be light with only the Mortgage Applications and Oil inventories.

After the bell Apple and Texas Instruments reported earnings and traders were hoping a couple of good reports would be the boost needed to continue the market rebound on Wednesday. Apple (AAPL) posted earnings that soared +58% over the same quarter in 2006. Unfortunately those earnings were completely ignored after sales of iPods slowed to 22.1 million units compared to estimates of 24.7 million and Apple warned of drastically lowered profit expectations for the current quarter. Apple is normally conservative on their guidance but recession fears and slowing iPod sales evidently forced them to be more conservative than normal. Apple said they expected to earn 94 cents in Q1 compared to the Wall Street average estimate of $1.09. AAPL lost $20 in after hours trading to close at $138. That equates to a $14 billion drop in market cap lost after the close.

Apple Inc Chart - 90-min

Texas Instruments (TXN) reported earnings that rose +13% and said sales had reversed a yearlong decline. Earnings were 54 cents compared to estimates of 52 cents. TXN also guided slightly higher for Q1 to a range of 43-49 cents compared to analyst estimates of 45 cents. TXN said the company was well positioned if there is an economic slowdown and was pretty optimistic about future profitability. TXN rose a buck in after hours to close at $30.

Earnings due out tomorrow include EBAY, MOT, QCOM, SYMC, UTX, PFE, COF, ATI, EAT, COP, TER and about 120 others.

Research in Motion (RIMM) had rallied to a +1.50 gain in regular trading after a past downgrade over slowing sales was debunked by another firm saying channel checks show increasing sales instead. RIMM also showed off its BlackBerry enhancements at the Lotusphere 2008 event. Unfortunately RIMM was crushed after the close on the Apple news and gave up about $5 before buyers appeared.

Oil prices fell over the weekend on recession fears and profit taking to $86.11 before buyers rushed in to scoop up the bargains. Crude returned to trade back over $90 before the close. This was also the last day of trading for the February contract. The March contract became the current month and it was trading at $89 after the close. If a U.S. recession appears and the rest of the world catches it from us then oil demand and prices will decline for several months until the economic slump is over.

March Crude Chart - Daily

The global markets imploded over the long weekend. You already knew that unless you were camping out with polar bears and playing in the sub zero weather. With the Dow futures down -550 before the open there were fears we would follow some of the global indexes into oblivion. India's Sensex fell 11% on Tuesday before triggering circuit breakers in time for calmer heads to prevail. It finished well off its lows. The Australian market, the ASX 200, suffered its worst loss ever of -394 points or -7% with more than $95 billion evaporating from investor accounts. The Nikkei fell -752 points, Shanghai -354 and the Hang Seng lost -2061 points. Those were single day drops!

Fear was rampant before the open of the U.S. markets. Those trading on margin were in terror of major gap down open wiping out their accounts. Fortunately the Fed came to the market's rescue but that may only be a temporary Band-Aid on the problem. The Apple warning tanked the U.S. futures but the Asian markets still appear poised to open higher. That would be a good sign given their very oversold conditions but there are still serious concerns plaguing the market.

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The panic produced a serious dip but in retrospect it was less than two days of the intraday ranges we have been seeing for 2008. The Fed rate cut caused some instant short covering and that took us to 11:AM and then the music died. All the major indexes returned to initial resistance and stopped dead in their tracks. There was no follow on buying and there was no additional short covering after the 11:AM stall. In fact every weak attempt to move above that 11:AM level was met with additional selling as bears reloaded their shorts.

The three sectors performing the best on Tuesday were finance, retail and homebuilders. Those were exactly the three sectors with the highest short interest. Banks and homebuilders stand to gain the most from an accelerated Fed rate cut scenario. Financials make more money when rates are cheaper and they are directly responsive to the Fed moves. Homebuilders will find more buyers if mortgage rates continue to fall and that could not have come at a better time ahead of the spring selling season. Retailers have been hammered on worries over shrinking consumer cash. The Fed move provided a sentiment lift for consumers even though the rate cut would have little if anything in the form of help for consumers. All three sectors were up on short covering not because conditions suddenly changed.

If you look at the market internals it is not a pretty picture or a picture that suggests we are going to rocket off of Tuesday's low for a week long rally. If you look at the new 52-week lows that is the highest level since 1998. That volume number is also a record level. If the markets had recovered all their losses and posted gains for the day with increasing buying all afternoon I might have a different opinion.

Internal Snapshot

I believe the Apple earnings guidance is a clear indication that the next three weeks is going to be ugly. The vast majority of earnings reports are still ahead and I think we can expect weak guidance from nearly every report. It's a recession stupid! Every company will guide lower just in case the recession does appear. Earnings estimates are going to fall and every report is going to further sour investor sentiment.

According to late reports it still appears the overseas markets are going to open big but that does not mean the gains will hold. Just like our market saw short covering at the open on the Fed cut the overseas markets are going to spike on follow through to our minimal losses. The key to Wednesday's trading is whether the global markets hold their gains. If they do post significant rebounds then the U.S. markets could continue higher. Unfortunately it may be just a bear marker rally. Nothing fundamental has changed and the technicals still look terrible.

The Dow fell to 11634 intraday crushing the support at 12000. Before day's end it recovered to close at 11971 and nearly recovering that support level. This is not strong support and all the longer term technical indicators are suggesting we will eventually see a retest of the July-2006 lows at 10750. In every bear market there are many rebounds from oversold conditions but they eventually fail. Until the fundamentals of the market and the economy recover and sentiment improves I think we should be skeptical of any bounce.

Dow Chart - Daily

The Nasdaq support at 2340 failed and unlike the Dow the Nasdaq failed to return anywhere near that support. With the Apple profit warning and falling iPod sales that suggests tech earnings guidance is going to be a three-week plague for the tech index. I would not be a buyer here until we are back over 2340 or manage a successful retest of 2000.

Nasdaq Chart - Daily

S&P-500 Chart - Daily

The S&P-500 chart is similar to the Dow except the S&P has already violated the March-07 lows and appears headed straight down to a retest of 1225. The financial stocks may be 21% of the S&P but they were unable to push it back to positive territory despite the strong short covering in those stocks.

I left you on Sunday with a recommendation that we watch Russell 675 as the key level for deciding to be long or short. The Russell fell 25 points to 650 intraday BUT returned to 675 and ONLY a -1.61 loss for the day. I would like to think that fund managers suddenly decided to buy small caps on the dip but I think it was more a case of small caps being the most heavily shorted. Some of those shorts covered but others reloaded at 675.

Note in the chart above that Russell 675 is strong resistance and every attempt to move higher was immediately hit by strong selling. For the rest of the week I would recommend we continue to watch the 675 level as our long/short indicator. To avoid having to make that decision 2-3 times per day I will suggest we remain short under 670 and long over 680. That gives the warriors 10 points to battle for control. Once a winner breaks out of that range we will hop on for a ride.

This may not be a market where everyone should be invested. If this kind of volatility makes you seasick then stay on shore until the waves subside. The Volatility Index (VIX) spiked to 37 on Tuesday and the same level we saw at the August bottom. Some are calling Tuesday a bottom because of the VIX spike. I remain doubtful and remind everyone that it can go higher and in bear markets it normally does. In the major averages look for a retest of the Tuesday lows and a failure there means the Fed rate cut band-aid has failed. It does not mean it will not be effective long term but only the sentiment bounce has been over powered by negative news.

Jim Brown
 


New Plays

New Option Plays

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

Play Editor's note: We were looking for a washout in the markets. This definitely felt like a capitulation sort of day but the bounce just died after the first 100 minutes of trading. That isn't very inspiring. There are plenty of stocks on our watch list but we're not willing to jump in just yet. Remember, we are in a bear market. Rallies will get sold and we should be using them as new entries for bearish positions. The question is how long will each individual bounce last (a day, two days, more?).


New Calls

None today.
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

AGCO - AG - close: 59.09 change: +1.28 stop: 48.99

Hmm.. we may have been too conservative with our suggested entry point. Over the weekend we listed AG as a bullish candidate and suggested that readers buy calls on a dip into the $51.50-50.00 zone. AG gapped open lower at $54.34 this morning and dipped to $53.00 before rocketing higher again. The stock rallied to round-number resistance at $60.00 and closed up with a 2.3% gain. We're not completely convinced that the bottom is behind us so we're going to keep AG on the list and stick with our $51.50-50.00 entry zone for now although we would seriously consider buying another dip near $53.00 if one appeared. We do not want to hold over the February 7th earnings report. Please note that we're adjusting our target from $56.00-57.60 to $58.00-60.00.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/07/08 (confirmed)
Average Daily Volume = 1.8 million

---

Blackstone - BX - close: 18.77 chg: +0.10 stop: 17.24

The morning market meltdown sent shares of BX toward the January lows and the stock bounced at $17.25. This is an 8.5% rebound off its intraday lows. The trend is still bearish with a pattern of lower highs but readers might want to consider buying calls on another dip into the $18.00-17.50 region. Remember, this is a high-risk, speculative play. We do not want to hold over the February earnings report. Our target is the $24.00-25.00 range for now but we'll probably need to adjust that and will do so once it looks like BX has produced a bottom.

Picked on January 10 at $19.84
Change since picked: - 1.07
Earnings Date 02/11/08 (unconfirmed)
Average Daily Volume: 2.7 million

---

Caterpillar - CAT - close: 63.82 change: +1.01 stop: 59.45 *new*

If you bought the opening dip in CAT this morning then you should be looking at some decent gains. The stock gapped open at $59.60, which proved to be the low of the day. CAT managed a 7% rebound off its lows. We were suggesting that readers buy calls in the $60.50-59.50 zone. Our suggested exit target is $64.50-65.00 and CAT hit an intraday high at $64.45 this afternoon. We would STRONGLY consider taking profits right here if you did jump in this morning. We are adjusting our stop loss to $59.45. Our target will remain unchanged but more aggressive traders may want to aim a couple of points higher. We have to be out of the play by Thursday night. CAT reports earnings on Friday morning and we do not want to hold over the report.

Picked on January 22 at $ 59.60 *triggered
Change since picked: + 4.22
Earnings Date 01/25/08 (confirmed)
Average Daily Volume = 6.0 million

---

Foster Wheeler - FWLT - cls: 127.13 chg: -2.81 stop: 118.99

We strongly suggest readers take some profits right here if you did enter FWLT this morning. We were suggesting readers buy a dip into the $123.00-120.00 zone. Our target was the $132.50-135.00 range. FWLT experienced a $12.00 intraday range (almost) with the gap dip to $119.12 and the bounced back to $131.00. The sad news here is that FWLT's rebound failed right at its bearish trendline of lower highs. That does not bode well for tomorrow thus we suggest readers take some money off the table. If FWLT continues lower we would expect another bounce near $120 again and we would be willing to consider buying calls again on a pull back into the $121.00-120.00 zone.

It is IMPORTANT to note that FWLT should begin trading split adjusted for a 2-for-1 stock split on Wednesday. We thought it was Tuesday. This means our suggested entry zone will become the $60.50-60.00 range. Our stop will be $59.49. Our target will be $66.25. The option symbols listed today will change due to the split.

Picked on January 22 at $120.00 *triggered
Change since picked: + 7.13
Earnings Date 02/27/08 (unconfirmed)
Average Daily Volume = 1.6 million

---

Henry Schein - HSIC - cls: 60.79 chg: -2.11 stop: 59.90

Which entry point did you pick? Our official entry point for HSIC is $64.01 as we wait for a breakout but we did suggest an alternative entry to consider on a dip near $60.00. Shares it $60.11 this morning. The $60 level should be bolstered by technical support with its 50-dma. Looking at the chart it suggests that HSIC might retest the $60 level again soon. If we see another bounce we might adjust our entry point to buy the rebound. Our target is the $69.00-70.00 range.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/21/08 (unconfirmed)
Average Daily Volume = 623 thousand
 

Put Updates

None
 

Strangle Updates

None
 

Dropped Calls

Cleveland Cliffs - CLF - cls: 91.07 change: -0.77 stop: 83.90

Our strategy in CLF would have worked perfectly. We were suggesting readers buy a dip near $85.00 and exit in the $92.50-95.00 range. The intraday high was $92.52. Unfortunately, the stock opened at $86.00 and dipped to $82.86 before bouncing back. Our stop appears to have been too tight at $83.90. The play has been opened and closed on the same day but we are going to keep an eye on CLF for another dip near $85 again.

Picked on January 22 at $ 85.50 *triggered /stopped 83.90
Change since picked: + 5.57
Earnings Date 02/21/08 (unconfirmed)
Average Daily Volume = 1.3 million

---

Covance - CVD - cls: 86.87 change: -3.07 stop: 86.45

The market panic this morning sent shares of CVD crashing lower. Shares opened at $85.42 and dipped to $84.00 before bouncing back. Unfortunately, our stop loss was at $86.45 so we would have been stopped out at the opening trade. The move today is very bearish with the breakdown and close under its 50-dma and the bottom of its rising channel.

Picked on January 18 at $ 90.50 *triggered / gap down 85.42
Change since picked: - 3.63
Earnings Date 01/30/08 (confirmed)
Average Daily Volume = 395 thousand

---

Flowserve - FLS - close: 83.19 change: +2.01 stop: 74.45

Target achieved! Our play on FLS has been opened and closed in the same session. We suggested readers buy a dip in the $77.00-75.00 zone and exit in the $84.00-85.00 range. The morning drop pushed FLS to $75.29 and shares hit an intraday high of $84.35.

Picked on January 22 at $ 77.00 *triggered
Change since picked: + 6.19
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 664 thousand

---

Genzyme - GENZ - close: 76.49 change: -0.34 stop: 74.95

Investor panic sent shares of GENZ to an intraday low of $74.00. We had warned readers that GENZ didn't have significant support until $74.00 but we were not expecting such a sharp decline. Shares opened this morning at $74.63, which was underneath our stop loss at $74.95, closing the play. In spite of the recent sell-off the overall pattern for GENZ is still bullish. We would keep it on our watch list.

Picked on January 13 at $ 78.56 stopped 74.63/gap down exit
Change since picked: - 2.07
Earnings Date 02/13/08 (unconfirmed)
Average Daily Volume = 2.5 million

---

L-3 Comm. - LLL - cls: 101.99 change: -1.44 stop: 98.90

We could argue that our stop loss was too tight with LLL. However, the rebound wasn't very impressive so we might be better off being stopped out. Shares of LLL gapped down at $98.63. This was outside of our suggested entry zone of $99.50-101.00. The stock sank to an intraday low of $97.21. However, LLL rebounded and hit $99.50 opening the play. Unfortunately, there was a late morning pull back and LLL dipped again to $98.23. With our stop loss at $98.90 we would have been closed out of our positions. Sometimes, during a volatile session, that's just how it goes.

Picked on January 22 at $ 99.50 *triggered /stopped 98.90
Change since picked: + 2.49
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 1.0 million
 

Dropped Puts

Liberty Media - LCAPA - cls: 102.02 chg: -1.02 stop: 110.05

Target achieved. Shares of LCAPA did not see the steep fall that the rest of the market did but shares still dipped to the $100.00 mark. Our target was the $100.25-100.00 range. The stock is very oversold and this looks like a good spot for a bounce.

Picked on January 15 at $107.49 *triggered /exit $100.25
Change since picked: - 5.47
Earnings Date 02/00/08 (unconfirmed)
Average Daily Volume = 653 thousand

---

Priceline.com - PCLN - cls: 96.54 chg: +3.56 stop: 100.51

It was a real struggle to decide how we wanted to play PCLN tonight. Long-term the stock's bullish trend looks broken although an optimist could argue this is just a significant retracement in the stock's two-year up trend. Super short-term today's session produced a bullish engulfing candlestick pattern, which is normally seen as a bullish reversal. Plus, this move follows an inside day from Friday. Plus, the intraday low today almost looks like a mini-double bottom combined with Thursday's low. Yet on the bearish side of things the rally stalled right where it was supposed at resistance near its 10-dma and 100-dma near $98.50. This is under round-number resistance at $100 and happens to line up almost perfectly with the bearish trendline of lower highs. In the end we decided to just exit early right here and cut our losses. More aggressive traders could leave the play open and hope that resistance near $100 holds. We would rather exit now and wait and watch for another failed rally, probably near the $105 level or its 50-dma.

Picked on January 17 at $ 93.99 *triggered
Change since picked: + 2.55
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 1.6 million

---

Shire Plc - SHPGY - close: 60.21 change: -2.65 stop: 68.07

Target exceeded! It was a very ugly day for SHPGY. The stock gapped open lower at $57.72 and hit $57.61 before bouncing back. Our secondary target was the $62.00-60.00 zone so we would have exited at the opening trade. Shares are way oversold and due for a bounce back.

Picked on December 13 at $ 68.07 *triggered/gap down entry & exit
Change since picked: - 7.86
Earnings Date 02/21/08 (unconfirmed)
Average Daily Volume = 956 thousand
 

Dropped Strangles

None
 

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

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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.

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