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Daily Newsletter, Saturday, 02/02/2008

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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

Micro-Hoo!

Shareholders of Yahoo (YHOO) should be celebrating this weekend after Microsoft offered to acquire the company for $31. For years it has been rumored that Microsoft wanted to acquire Yahoo but millions of option contracts bought on those countless rumors all expired worthless. Yahoo sank to a 4-year low at $18.59 after their disappointing earnings and this may have been the trigger Microsoft was looking for. The stepped up with an offer that was a 62% premium to Yahoo's Thursday night close and virtually guaranteed investor acceptance of the deal. YHOO rebounded +9 on Friday or a 48% gain. With Google taking over the world Microsoft should have no trouble getting the deal approved by regulators but I doubt they will be changing the combined company name to Micro-Hoo.

I am going to add something different this week. Normally I give you the economic calendar for the coming week with a couple bullet points about the more important items. Unless you read the commentary every day of the week you might not know what actually happened. That is like telling you the Giants and Patriots are going to play an important football game on Sunday and then never telling you who won. Last week was such an event filled week I am going to quickly recap the important numbers and how they impact the market outlook.

First up was the New Home Sales, which fell to an annualized rate of 604,000 units and the weakest pace since the spring of 1993. The median price was down by 10.4% from a year ago and inventory of homes on the market rose to 9.6 months of supply. This did not deter the buying in homebuilder stocks with many now on a two-week rally.

New Home Sales

The S&P/Case-Shiller Home Price Index saw home prices fall year-over-year by 8.4% in the 10-city composite and -7.7% in the 20-city composite. The decline in just the last month was over 2% in both indexes. Home sales and prices are still falling but the homebuilders are acting like we have seen the bottom.

The Mortgage Applications composite index soared to a three-year high at 1054.9 as refinance applications poured in at an astounding rate. The index was up +22% over just the past week. The sudden drop in interest rates from the Fed is feeding this sudden rise in refinancing. Loans for outright purchases continued to fall in line with the continued drop in home sales.

Durable Goods Orders exploded +5.2% in December with the help of a +132% jump in defense aircraft orders. Strength in orders was fairly broad based and did not suggest the economy was struggling.

The GDP for Q4 on Wednesday fell to +.64% from the +4.91% rate in Q3. This is a dramatic drop and shows the nearly instant impact from the subprime crisis as it bled over into the corporate bond arena. The 4-point drop in the GDP was a strong incentive for the Fed to cut rates at Wednesday's meeting. The majority of the indicators suggest the economy began dropping even faster in December so analysts worry that the decline into Q1-08 has already put us into a recession.

Another troubling indicator was the sharp spike in initial unemployment claims to 375,000 for the prior week. Rising unemployment is another indicator of a pending recession.

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The Chicago PMI fell to 51.5 from 56.4 showing yet another data point indicating a sharp decline in economic activity in December. Readings below 50 indicate economic contraction. New orders fell to 44.7 from 56.7 and backorders fell to 48.0 from 60.7. Meanwhile prices paid rocketed to 81.7 from an already high 67.4 indicating rising inflation. The Kansas Fed Manufacturing Survey slipped to 7.0 from 12.0 but remains more stable than in other regions.

Global Semiconductor Billings fell -3.6% in December with the decline the 3rd consecutive month of slowing sales. Chip sales were still up +3.2% for the year but slipping fast. Demand for consumer devices remained strong, +14% for PCs, but over capacity problems are flooding the market and forcing prices down.

The Employment report on Friday showed a loss of 17,000 jobs in January. If this is not revised in the March release it will be the first month of job losses since August 2003. Official expectations were for job gains of 75,000-100,000 jobs. January is when the BLS releases its benchmark revision and that knocked -376,000 jobs off the total for the year as reported in December leaving 1.14 million net jobs added for all of 2007. In the table below you can see the revisions over the last 7-months.

Jobs Revision Table

The last item of note for the week was the Institute of Supply Management (ISM) report for January. The headline number came in at a 5-month high of 50.7 and back into expansion territory. The December number had fallen to 48.4 (upwardly revised from 47.7) and a multiyear low. This is probably just a blip in the data and the downward trend will resume next month. There is nothing in the components that suggest a sudden resurgence of activity. New orders and order backlogs remain mired in the high 40 range. Prices paid moved higher to 76.0 from 68.0 and again indicate inflation filtering through the system.

Last Week's Economic Results Summary

For the coming week there is almost nothing of importance on the calendar. The Factory Orders for December are due out on Monday and they are expected to show the same type of positive blip as we saw in durable goods last week. This blip is thought to be replenishment orders for items sold during the holidays. Because this is a lagging report it is not normally a market mover.

The ISM Services is due out on Tuesday and there are not expected to be any material changes. The ISM Manufacturing last week showed a slight bounce back into expansion territory but the services sector has not yet dipped below 50.

Other than those two reports the rest are just filler and just smooth out the reporting schedule. The economic schedule does not intensify again until the week of the 18th.

Economic Calendar

On Friday we also heard from the automakers about their January sales and it was not a pretty picture. Sales sank to a seasonally adjusted annualized rate of only 15.2 million units. This is the lowest pace of sales since after the employee sales promotion in 2005. Of the top five companies only GM posted a sales gain for the month of 2.8%. Toyota sales fell -2.3%, Honda -2.3%, Ford -4% and Chrysler sales fell -12% for the month. On the bright side GM did say they did not expect a recession.

Google (GOOG) was hammered on Friday for a -$48 loss to close at $515 after disappointing on earnings Thursday night. The news of the MSFT/YHOO deal just added to the Google drop. Google earnings and revenue growth slowed more than analysts had expected. They posted earnings of 4.43 per share compared to analyst expectations for $4.44 per share. For a company used to beating estimates by a mile the fall from grace was a shock for investors. Downgrades flowed like Saudi oil with new price targets in the $600 range the norm.

The combination of Microsoft and Yahoo will create a serious competitor for Google. Yahoo claims over 500 million unique visitors and over 4 billion page views per day. Another source claims the global audience for actual users of each site breaks down to 265 million for Google, 198 million for MSN and 182 million for Yahoo. Those are users that set the sites as their home page or have some other connection like email or instant messaging. That would give Microsoft a lead over Google in eyeballs and potential advertising audience. Yahoo just finished spending a fortune on recreating their backend advertising model and Microsoft can take advantage of that new system almost immediately. Reportedly Microsoft and Yahoo have been in discussions for the last 14 months and Microsoft described them as frustrating. When Yahoo declined to a 4-year low Microsoft decided to go hostile and made them a bear hug offer. That is a price that is high enough to prevent anyone from bidding higher and with enough premium that current shareholders can't afford to pass it up. Yahoo claims they will review the offer in light of their future plans and the benefits of staying independent. Translated that means "guys we are screwed so let's see if we can negotiate for another couple of bucks before we throw in the towel."

Merrill Lynch is getting no love these days and Friday was no different. Massachusetts securities regulators filed fraud charges against Merrill for selling the city of Springfield $13.9 million in CDOs. Those CDOs have declined in value to $1.2 million. Merrill announced on Friday they had repurchased the CDOs from Springfield at the original $13.9 million price they paid. When the value of the CDOs began to fall Springfield told Merrill they wanted to sell them but Merrill said there were no buyers. There are still no buyers for CDOs and that is hampering efforts for banks to unload paper they took in over the last six months.

It would not be an update for the week without an update on the bond insurers. The major rating agencies reiterated their current negative outlook on Friday. That was their way of warning the current crop of negotiators that time was rapidly slipping off the clock. The current consensus of opinion suggests a settlement needs to be reached on ABK/MBI before the end of February or the sky is going to fall in on them. There were several good discussions of potential damage if their credit ratings do plunge and I think that is why 8 banks are still in talks to bail out the insurers. Reportedly a downgrade to junk status on MBI/ABK would cause between $75 billion and $150 billion in further write downs by the major banks. Reportedly the majority of that would be in the top five banks. That brings up a serious conflict of interest for those banks. They either come up with $20-$30 billion in capital to keep the monoline insurers liquid or take a paper hit of as much as $150 billion over the next 12-18 months. That is not much of a decision for me. The initial cost to keep the insurers afloat was estimated to be $15 billion but as more problems appear that number continues to rise.

CNBC reported on Friday that eight banks were working on a bailout for Ambac. Those banks are Citi, Barclays, BNP Paribas, Allianz, Dresdner, RBS, SocGen, UBS and Wachovia. Moody's said on Thursday that some bond insurers would likely NOT be able to raise their finances to levels that would repair their credit ratings. Another report hitting the wires on Friday spelled out there were $1.3 trillion in CDOs written over the last 3-years. There was no number given for their value today but based on the Merrill CDO buyback they could be worth less than 50% of their original value. Since banks have only written off about $100 billion in value this suggests a failure to rescue the insurers could result in much more massive write-downs in the future.

Rating company Egan-Jones, which was ahead of the crowd with downgrades on New Century, Enron, Worldcom and Global Crossing, also has warned on Ambac and MBIA. Egan rates them either a B+ or BB- with negative implications. Egan believes the other rating companies will eventually match his ratings.

In the various news articles out on this topic this week it appears the problem has drawn the help of several agencies, not just the lone New York insurance regulator trying to patch a deal together. The Washington Fed is involved along with the New York Fed, the Presidents Working Group on Financial Markets otherwise known as the Plunge Protection Team (PPT) started by Reagan after the 1987 crash, and the Treasury Dept. This bond insurer problem has the potential to be worse than the Long Term Capital blowup in the late 90s.

Motorola (MOT) rallied 10% on Friday on news that the company may be broken up to release value. The company hinted it might be preparing to sell its handset business. One of the companies rumored to be in the running to buy the handset business is Dell Computer. Personally I think that would be a major mistake for Dell but they did not ask me. If Motorola can't make their own division fly when they have major market share already then why would Dell, already struggling with their own problems, want to put another millstone around their neck? Carl Icahn nominated four new members to the board and increased his stake to 5%. Motorola said that Greg Brown would become the new CEO of the handset unit while they explored strategic alternatives.

Miner BHP woke up with a headache on Friday after a dawn raid by competitors on Rio Tinto (RTP). Alcoa (A) and Aluminum Corp of China (ACH), a Chinese aluminum company, joined together to spend $14 billion for 12% of RTP's London listed shares in a move designed to block a BHP bid for RTP. The investment gave them a 9% overall stake in RTP. The dilution came from the dual listing RTP enjoys on both the London and NYSE exchanges. BHP was expected to launch a formal offer of 3 BHP shares for each RTP share next Wednesday. That was the deadline set by the UK Takeover Panel for BHP to either launch a formal bid or drop its acquisition plans for a minimum of six months. Aluminum Corp of China officials said the move was to diversify outside of China but the real reason Alcoa gave was to prevent BHP from gaining a virtual monopoly on iron ore supplies into China. BHP would also have garnered over a third of global aluminum supplies with a RTP takeover. The move by Alcoa and Aluminum Corp of China put BHP on notice that there were some deep pockets ready to assist RTP should BHP continue its takeover plans. RTP surged +$34 on the news and BHP gained $6 on thoughts that the acquisition was dead. BHP had been depressed for several months as it considered its options for upping it's bid for RTP. Aluminum Corp of China paid $119 per share for the London shares, a 21% premium over the prior close. Alcoa was a minor player in the $14 billion deal contributing only $1.2 billion to the purchase.

The rapid drop in interest rates has killed the value of the dollar with the low on Friday very close to the 40-year low of 74.48 we saw back in November. Both rallies have failed and with our rates heading for the cellar the dollar had no chance.

Dollar Index Chart

After the Fed announcement the Dow rose +200 points then collapsed to close negative for the day. On Thursday the Dow fell -186 at the open then rebounded to close +200. On Friday the morning was volatile but buying began about 1:PM and never let up. I believe both days were signs the bear market may be over. Every major selling attempt since the Jan-23rd post SocGen low has been met with strong buying. The pessimism is being peeled away layer by layer and all the signs suggest there could be a lasting rally ahead.

As each day passes the odds are getting better that the bond insurer problem will be solved. A week ago I did not believe it but I am coming around given the continued news about Federal agencies taking an active part in the solution. The financial sector rallied +11% for the week and the housing sector gained +13%. This suggests traders also believe there is a bailout in the future.

The Fed has already bailed out homeowners and CDO owners. Their unprecedented 125 basis point cut in just over a week is a clear sign they are trying to rescue the economy by bailing out homeowners. I mentioned this a week ago that by cutting rates to the bone it would allow all those homeowners in serious trouble with resetting ARM loans to quickly escape the debt trap and convert to a low interest conventional mortgage. 30-year rates were down at 5.15% last week although the surge in loan applications pushed rates slightly higher this week. Since most of the ARMS were resetting in the 7%-8% range this is a windfall for beleaguered homeowners. Many of the 1.2 million homes expected to foreclose in 2008 may now escape that plight. The Fed is not done according to the futures, which are now close to pricing in another 50-point cut when they meet again on March 18th. A 2.5% Fed Funds rate would put mortgage rates under 5% and complete the rescue of the housing sector, mortgage sector and the economy. That $1.3 trillion in CDOs written over the last three years would suddenly recover in value and help solve the problem of the bond insurers. It is a win-win scenario and for whatever reason the Fed has decided to power flush rates it was the right thing to do.

The market has finally figured it out and the only cloud still making visibility questionable is the bond insurer challenge. If there is an announcement that a solution has been reached to liquefy the insurers and indemnify holders of those bonds then the market is going to explode. There is so much money on the sidelines that we were seeing the overflow trickle back into equities all week. With the ten-year treasuries yielding 3.6% at Friday's close there is a big incentive to go back to equities. If the Fed can cut rates fast enough and revitalize the housing sector in the process then the recession potential should be limited to Q1 and possibly erased completely. Once it appears the recession has been avoided the global economy will catch fire again. The only reason there is a global slowdown today is because of the U.S. subprime crisis and the resulting slowdown in the States. Reflate housing, solve the bond crisis and we will be off and running once again.

I believe part of the rally from the last two days was short covering in case a monoline insurer solution is announced over the weekend. It helped that January was the worst January in 17 years and the Dow came close to losing 2000 points from the December highs. We were extremely oversold going into the earnings cycle and now that cycle is almost over. Over 700 companies report next week but that will raise the total of reporters to something over 80%. Those remaining 20% will trickle in over the next month. The earnings for the S&P for Q4 now stand at a negative -20.5% as of Friday. On October 1st the estimate was for a gain of +11.5%. Financials are continuing to drag on the S&P with a -104% drop in earnings for the quarter and a loss of $2.5 billion compared to sector gains of $55 billion in profits in Q4-06. Tech stocks have been the strongest sector with earnings gains of 25%. Overall companies have been reporting earnings about 26.6% below estimates, again mostly due to the financials.

Earnings Calendar

On Friday the jobs report was ugly but buyers still showed up. That is a key sign of a change in sentiment. On the internals table below the new highs have risen slightly but the key is the drop in new lows. You may remember in the prior week there were 4 days with more than 1000 new lows and Jan-22nd had 2,389 new lows. Notice the volume as well. We started the week very cautious ahead of the many economic reports and the FOMC meeting. Only one day saw declining volume beat advancing. Notice also that the overall volume is rising. It is still not overly bullish but rising volume in a rising market is also a positive sign.

Internals Table

The gains for the week surprised many. The bears were so thick the prior week no bull dared venture into the daylight. Last week we saw many tentative buyers tiptoe back into the fray with cautious entries. The bears were unable to dent the sentiment even after a -200 post FOMC drop and nearly a -200 drop the next morning. The dip buyers rushed back into the market on Thursday filled with confidence the Fed was going to make the recession go away. The key now will be to keep that sentiment all next week.

I am on the list for numerous market newsletters and it was not even an hour after Friday's close before I started getting emails about the return of the bear. As much as I would like to discount those ramblings as lingering negativity we still have to be wary of this fledgling rally. Every newborn walks on wobbly legs until it has mastered the art of balance. The volatility all week was the newborn rally trying to acquire that balance. We also know that many a toddler loses his balance as he is learning and suffers a painful fall. This rally may be no different. We need to monitor it carefully until a real trend develops. If the bottom really was Dow 11,634 on Jan-22nd then there are plenty of profits left to capture on any continued move. Normally a 24-hour retest of a bottom is not considered a valid retest and that leaves the technicians wanting to see another drop. This is a good thing for the bulls because it means many traders a going to be waiting on the sidelines for that drop and get left behind if it never comes. Once they realize this they race to catch up and that frantic buying helps push the market higher. The remaining shorts are also unbelievers and will be waiting at the overhead resistance to load up again. A surprise rally like we saw last week can last for weeks if the conditions are right.

Before you start charging to your broker screen to place buy orders you should be aware that we are approaching strong resistance. The ideal scenario would be a bounce off that resistance to give latecomers a chance for an entry and then a breakout that catches the bears holding their shorts. The Dow has a 100-point resistance range from 12800-12900. Over 12900 it should be clear sailing for several hundred points.

Dow Chart - 90 Min

Nasdaq Chart - 90 Min

The Nasdaq has the same resistance range as the Dow but the Nasdaq is starting next week from a lower level. The major earnings problems on the Nasdaq slowed its rebound. This should give tech traders an extra day of gains before running into that resistance.

The resistance range on the S&P is a little wider than the Dow and by definition less precise. That suggests there is no single point of potential failure other than the top at 1425. This could allow the indexes to creep up for a stealth test rather than a sudden sprint. Either way I would expect a pause somewhere between now and 1425 if this rally continues.

S&P-500 Chart - 90 Min

I left the best chart for last. The Russell-2000 is the most bullish of the major indexes. It has already surpassed the corresponding resistance ranges I drew for the other indexes. It is right on the verge of a major breakout and a run to 800. This is a clear sign that fund manager sentiment has changed. Sure part of this rebound was short covering since the Russell was heavily shorted but this has progressed beyond short covering and you can tell from the rate of climb that something else is juicing the Russell from the prior week's lows. The Russell posted gains of 6.08% for the week and the second largest gain of the major indexes.

Russell-2000 Chart - 120 Min

Dow Transport Chart - Daily

The largest gain of the major indexes was the Dow Transports with a +7.43% rebound to 4807. The rebound in the transports came on the drop in oil prices and on the expectations for a Fed produced economic recovery. The Transports rallied to close at 4800 and just slightly below major resistance at 5000. Should that 5000 level be broken the markets would see it as a strong sign of confidence and odds are good the other major averages would charge ahead as well.

I should also note that the SOX posted a better than 7% gain but the SOX is considered a sector index. The SOX rebound was confined to a nearly 6% gain on Friday alone. It was not a weeklong event but a party over the joint announcement by Intel and Micron of a NAND chip that was five times faster than current models.

For the watchdog index for next week I am choosing the Russell-2000. It closed on Friday right at the upper limit of its resistance range at 730. I would look to enter the longs of your choice with a confirming move over 732 and buy a dip back to 715. Should we retrace under 715 I would remain flat unless the bottom fell out under 685. I am not expecting a retracement of that magnitude but we always have to be prepared for any potential possibility. For the more passive traders I would simply look for a more over 732 and don't try to game any dips. The economics for the week are slim and although there are over 700 earnings reports there are probably less than 10 that anybody cares about. Cisco on Wednesday would be the highlight. Based on guidance from Intel and Microsoft I expect good news from Cisco. That does not mean they are going higher since the their earnings late in the cycle are often anticlimactic. With only two weeks until option expiration there are probably some good earnings plays using front month options but you need to be selective on the expectations for the company. Look to trade against any existing trend into their earnings report. Rarely do companies surprise enough to produce a continued spike in the same direction. For broad market direction focus on Russell 732 and everything else will be easy.

Jim Brown
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
ATI None None
BGC    
CTX    
DIA    
FWLT    
MOS    
PBR    
SGR    

Play Editor's Note: A week ago the major indices had rallied to resistance and the market was flooded with bearish reversals. Thoughts of a retest of the January low were rampant among traders and analysts alike. My what a difference a week makes. Investor sentiment seems to have changed. Now that investors believe that the Fed will protect the economy from recession and there is growing hope for a bond insurer bailout everyone is in a buying mood (or a short covering mood). However, last week was one of the best weeks for the market in five years. It's probably time for a dip.

FYI: We found a lot of stocks we liked as potential bullish plays this weekend. I think TEX looks attractive here over $60.00. Additional stocks I am watching for potential entry points are: CEO, HUM, UTX, JEC, FLR, POT, PSA, APOL, MAC, SIGM, VNO, RYL.

Remember, it is up to the individual trader to decide which month and which strike price best suits your trading style and risk.


New Calls

Allegheny Tech. - ATI - cls: 74.02 chg: +3.73 stop: 68.65

Company Description:
Allegheny Technologies Incorporated is one of the largest and most diversified specialty metals producers in the world with revenues of $5.5 billion during 2007. (source: company press release or website)

Why We Like It:
Shares of ATI appear to have bottomed. The short-term trend of higher lows looks good. We have two alternative entry points. We're suggesting readers buy a breakout over $75.00 (at $75.11) or buy a dip in the $71.00-70.00 zone. If triggered our short-term target is the $79.75-80.00 range or the 50-dma, whichever is hit first. The P&F chart for ATI looks very bullish with an $87 target.

Suggested Options:
We are suggesting the March calls.

BUY CALL MAR 70.00 ATI-CN open interest=518 current ask $7.90
BUY CALL MAR 75.00 ATI-CO open interest=457 current ask $5.10
BUY CALL MAR 80.00 ATI-CP open interest=680 current ask $3.10

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 2.4 million

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General Cable - BGC - cls: 60.22 change: +1.96 stop: 54.95

Company Description:
General Cable, headquartered in Highland Heights, Kentucky, is a global leader in the development, design, manufacture, marketing and distribution of copper, aluminum and fiber optic wire and cable products for the energy, industrial, and communications markets. (source: company press release or website)

Why We Like It:
This is going to be a short-term play. BGC is due to report earnings on February 12th and we do not want to hold over the report. The stock has rebounded from support and aggressive traders may want to buy calls now with Friday's breakout over $60.00. We would rather wait for a dip. Our suggested entry point is the $57.75-57.00 range. If triggered our target is the $64.50-65.00 range or the 50-dma, whichever comes first. The Point & Figure chart is very bullish with a $73 target.

Suggested Options:
Traders can choose the February options (expire in two weeks) or the March options.

BUY CALL FEB 55.00 BGC-BK open interest=2080 current ask $6.60
BUY CALL FEB 60.00 BGC-BL open interest=2136 current ask $3.50
BUY CALL FEB 65.00 BGC-BM open interest=2225 current ask $1.35

BUY CALL MAR 60.00 BGC-CL open interest=608 current ask $5.90
BUY CALL MAR 65.00 BGC-CM open interest= 49 current ask $3.70

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/12/08 (confirmed)
Average Daily Volume = 1.1 million

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Centex - CTX - close: 29.00 change: +1.25 stop: 24.99

Company Description:
Dallas-based Centex (NYSE: CTX), founded in 1950, is one of the nation's leading home building companies. In addition to its home building operations, Centex's related business lines include mortgage, title and insurance services and integrated pest defense systems. (source: company press release or website)

Why We Like It:
It looks like the homebuilders may have really put in a bottom this January. A 125 basis point cut by the FOMC and a potential boost in the President's stimulus plan to raise the mortgage caps for FHA loans would be huge for the homebuilders. CTX looks like it has produced a bullish double bottom with the November and January low. We are suggesting readers buy a dip in the $27.00-26.00 range. Our short-term target is the $32.00-32.50 zone. We're also adding a second target in the $34.75-35.00 range but we do expect the 200-dma to act as resistance. The Point & Figure chart is very bullish with a $51 target. FYI: The numbers may not be up to date but the most recent data put short interest at 18% of CTX's 121 million-share float. That raises the odds of a short squeeze.

Suggested Options:
We are suggesting the March or April calls.

BUY CALL MAR 25.00 CTX-CE open interest= 661 current ask $5.90
BUY CALL MAR 30.00 CTX-CF open interest=1425 current ask $2.85

BUY CALL APR 30.00 CTX-DF open interest=11620 current ask $3.70

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/30/08 (unconfirmed)
Average Daily Volume = 5.3 million

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DIAMONDS Trust - DIA - close: 127.43 chg: +1.43 stop: 123.99

Company Description:
The DIAMONDS Trust is an Exchanged Traded Fund (ETF) that mimics the Dow Jones Industrial Average (DJIA).

Why We Like It:
This past week has seen the DJIA breakout past resistance and while the index is currently nearing another resistance level the short-term trend is up. We want to try and buy a dip near what should be short-term support around $125 in the DIA. Our suggestd entry point will be the $125.50-125.00 range. We'll try and limit our risk with a stop loss at $123.99. Our target is the $129.50-130.00 zone.

Suggested Options:
We are suggesting the March calls although Februarys would work, just be aware that February strikes expire in two weeks.

BUY CALL MAR 125 DAW-CU open interest=4785 current ask $5.65
BUY CALL MAR 127 DAW-CW open interest=4515 current ask $4.35
BUY CALL MAR 130 DAW-CZ open interest=8820 current ask $2.55

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 16.8 million

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Foster Wheeler - FWLT - cls: 71.80 change: +3.33 stop: 66.49

Company Description:
Foster Wheeler Ltd. is a global company offering, through its subsidiaries, a broad range of engineering, procurement, construction, manufacturing, project development and management, research and plant operation services. (source: company press release or website)

Why We Like It:
FWLT makes the list again. Shares look like they have bottomed and investors have been buying the dips. While we would prefer to buy a dip in the $68.00-67.00 range we are going to suggest readers buy calls now following Friday's breakout over $70.00. There is potential resistance near $75.00 but our target is the $77.50-80.00 range. The P&F chart is bullish with a $99 target.

Suggested Options:
We are suggesting the March calls but we do not want to hold over the late February earnings report. FWLT has some odd strikes because of its recent stock split.

BUY CALL MAR 70.00 UFB-CN open interest=456 current ask $7.50
BUY CALL MAR 72.50 UFB-CV open interest= 92 current ask $6.40
BUY CALL MAR 75.00 UFB-CO open interest=474 current ask $5.10
BUY CALL MAR 77.50 UFG-CW open interest=469 current ask $4.20

Picked on February 03 at $ 71.80
Change since picked: + 0.00
Earnings Date 02/26/08 (confirmed)
Average Daily Volume = 3.6 million

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Mosaic - MOS - close: 93.47 change: +2.54 stop: varies

Company Description:
The Mosaic Company is one of the world's leading producers and marketers of concentrated phosphate and potash crop nutrients. For the global agriculture industry, Mosaic is a single source of phosphates, potash, nitrogen fertilizers and feed ingredients. (source: company press release or website)

Why We Like It:
We suspect that there is still a lot of momentum in the fertilizer companies like MOS and Potash (POT). We are suggesting two alternative entry points to open call positions in MOS. If MOS breaks out over resistance near $95.00 then we are suggesting a trigger to buy calls at $95.51. If MOS sees another round of profit taking then we're suggesting readers buy calls on a dip into the $87.00-85.00 zone. These two entry points are rather wide so we have two stop loss. If triggered at $95.51 our suggested stop loss is $88.99. If triggered at $87.00 then our suggested stop loss is $84.45. Our target is the $108.00-110.00 range even though we do expect some resistance at $100.00.

Suggested Options:
We are suggesting the March calls.

BUY CALL MAR 90.00 MOS-CR open interest=2370 current ask $11.10
BUY CALL MAR 95.00 MOS-CS open interest=1868 current ask $ 8.50
BUY CALL MAR 100.0 MOS-CT open interest=2567 current ask $ 6.40

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/09/08 (confirmed)
Average Daily Volume = 5.6 million

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Petroleo Brasileiro - PBR - cls: 113.06 chg: +2.10 stop: 105.85

Company Description:
PBR is an integrated company that performs in oil and oil byproduct exploration, production, refining, marketing, and transportation, both in Brazil and abroad. (source: company press release or website)

Why We Like It:
This play is a little aggressive. Not only does PBR look a little overbought from its huge January bounce but shares are facing resistance at $115.00 and again at $120.00. We suspect that PBR still has a lot of momentum in it so we are suggesting readers buy calls at $116.00. More conservative traders could wait for a breakout over $120. If we are triggered at $116 our target is the $128.00-130.00 range. A move over $116 would produce a new Point & Figure chart buy signal. FYI: Another risk is PBR's earnings report. We can't find an earnings date and they normally report in mid February. That is a risk because we do not like to hold over an earnings report.

Suggested Options:
We are suggesting the March calls.

BUY CALL MAR 115 PMJ-CZ open interest= 488 current ask $7.90
BUY CALL MAR 120 PMJ-CD open interest= 594 current ask $5.50

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 7.6 million

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Shaw Group - SGR - cls: 58.85 chg: +2.34 stop: 54.85

Company Description:
The Shaw Group Inc. is a leading global provider of technology, engineering, procurement, construction, maintenance, fabrication, manufacturing, consulting, remediation and facilities management services for government and private sector clients in the energy, chemical, environmental, infrastructure and emergency response markets. (source: company press release or website)

Why We Like It:
It looks like SGR has produced a bottom as well. Shares found short-term support once it broke out over its 200-dma again. However, we have to point out that SGR is in a bearish trend of lower highs and lower lows. We are fighting the trend here. The stock is currently testing resistance near $60.00 and its 50-dma. We're listing two alternative entry points. If SGR breaks out over $60.00 we are suggesting readers buy calls at $60.25. If SGR pulls back then we are suggesting readers buy calls in the $56.00-55.00 range. We are listing two targets. Our first target is the $64.50-65.00 range. Our second target is the $67.50-70.00 range.

Suggested Options:
We are suggesting the March calls.

BUY CALL MAR 55.00 SGR-CK open interest=373 current ask $7.40
BUY CALL MAR 60.00 SGR-CL open interest=428 current ask $4.60
BUY CALL MAR 65.00 SGR-CM open interest=365 current ask $2.55

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/08/08 (confirmed)
Average Daily Volume = 2.0 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

United States Oil Fund - USO - cls: 70.47 chg: -1.88 stop: 68.59

Last night we warned readers that the USO looked poised for a dip and sure enough Friday saw the ETF slip 2.59% toward support at $70.00 and its rising 100-dma. The USO has two levels of support. One at $70.00 and the next in the $68.75-69.00 zone. Look for signs of a bounce and use it as a bullish entry point to buy calls again. Our short-term target is the $74.50-75.00 range. More aggressive traders could easily aim for the $77.50-79.00 region.

Suggested Options:
If the USO bounces we would suggest the February or March calls.

Picked on January 24 at $ 70.93
Change since picked: - 0.46
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 3.2 million
 

Put Updates

Ambac Fincl. - ABK - cls: 13.20 change: +1.56 stop: n/a

It has been one week since we added ABK as a high-risk, speculative put play and what a rocky week it has been. The stock experienced double-digit percentage moves almost daily. We listed this play with the expectation that this company was going out of business. The situation has changed dramatically, especially with the progress being made on a bailout plan on Friday. I suggest you read tonight's market wrap as Jim discusses the bond insurer scenario more in depth. We do not have a stop loss on this play. It was a lottery-ticket strategy. However, if you want to use a stop consider a stop loss above $15.50 or above the $16.50-17.00 region. Of course if ABK rallies that sharply these deep out of the money puts won't be worth much. ABK looks like it has resistance at $15.50, 16.50, and then $20.00. We are not suggesting new positions at this time. FYI: Most of the credit rating agencies have hinted that they're willing to hold off a couple of weeks before downgrading these companies. It could be a very volatile couple of weeks.

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

Picked on January 27 at $ 11.54
Change since picked: + 1.66
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 10.9 million

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MBIA Inc. - MBI - close: 16.36 change: +0.86 stop: n/a

MBI is the other big bond insurer that was on the verge of going under and still might but the stock is bouncing sharply on hopes that a bailout plan will work. We added MBI last Sunday with the expectation this company was going under. MBI reported earnings this past Thursday and tried to inspire some confidence with strong words that they don't see any circumstances that would force the company into bankruptcy. We do not have a stop loss since this was a lottery-ticket style of play but if you wanted to play one consider putting your stop above resistance near $17.50 or above $18.00. There are a lot of forces at work to try and save ABK and MBI and it looks like the various institutions might just get a rescue plan done in the nick of time. We are not suggesting new put positions. FYI: Most of the credit rating agencies have hinted that they're willing to hold off a couple of weeks before downgrading these companies. It could be a very volatile couple of weeks.

Suggested Options:
We are not suggesting new put positions.

Picked on January 27 at $ 14.20
Change since picked: + 2.16
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 15.2 million

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Polo Ralph Lauren - RL - cls: 61.23 chg: +0.55 stop: 62.55*new*

We only have two days left for this play on RL. The company reports earnings on Wednesday morning, February 6th. We do not want to hold over the announcement. Our plan is to exit on Tuesday afternoon at the closing bell. However, the situation is not looking very good for the bears and you may want to exit early. Thus far RL has held under resistance near its 50-dma. Yet the bulls could argue that the trading over the last couple of weeks is shaping up to be a bull flag pattern. With earnings just two days away I suspect that RL will just trade sideways as investors wait on the news but that may not happen if the market moves big one way or the other. We are going to try and reduce our risk by placing the stop loss at $62.55.

Suggested Options:
We are not suggesting new put plays in RL.

Picked on January 27 at $ 59.19
Change since picked: + 2.09
Earnings Date 02/06/08 (confirmed)
Average Daily Volume = 1.7 million
 

Strangle Updates

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

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DJIA 1/100 Index - $DJX - cls: 127.43 chg: +0.93 stop: n/a

The DJIA (and $DJX) continued to rally on Friday. The $DJX is now just over the $127 mark and the call side of our strangle is in the money - at least for now. We have two weeks left before February options expire. We are not suggesting new strangle positions at this time. The options we suggested were the February $127 calls (DJW-BW) and the February $122 puts (DJW-NR). Our estimated cost was $3.36. We want to sell if either option hits $4.85 or more. FYI: The intraday high for the call was $2.40.

Suggested Options:
We are not suggesting new plays on the $DJX

Picked on January 29 at $124.80
Change since picked: + 2.63
Earnings Date 00/00/00
Average Daily Volume = million

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Google - GOOG - close: 515.90 chg: -48.40 stop: n/a

Last night GOOG reported earnings and missed estimates. This sent shares to an after hours (Thursday night low) of $507.45 but the stock had recovered to $525 late Thursday night. Then Friday morning news comes out that Microsoft (MSFT) is making a hostile bid for Yahoo (YHOO) to better compete with GOOG. This helped reinforce the downdraft in GOOG and shares lost $48 or 8.5%. The intraday low on Friday was $5.10 and I'm surprised that the $500 put only traded to $15.20 at its best levels of the day. There does seem to be a lot of support for GOOG in the $510-515 zone but the oversold bounce in GOOG was already failing Friday afternoon and shares were headed lower. The $500 level should be support so if GOOG hits $500 we would be looking to exit even if the option price doesn't hit our target, especially since we only have two weeks left on February options. However, I have to note that technically speaking all trends remain bearish and GOOG has broken its very long-term trendline of support dating back to its IPO, which is very bearish. Aggressive traders may want to hold on to their puts. We are not suggesting new strangle positions at this time. The options we suggested were the February $600 calls (GOO-BT) and the February $500 puts (GOP-NO). Our estimated cost is $17.00. We want to sell if either option hits $27.00 or more.

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

Picked on January 30 at $548.27
Change since picked: -32.37
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 5.6 million
 

Dropped Calls

None
 

Dropped Puts

Perrigo Co - PRGO - close: 31.28 change: +0.44 stop: 32.11

We are out of time with PRGO. The company is due to report earnings on Tuesday morning, February 5th and we do not want to hold over the announcement. More aggressive traders could wait until Monday's closing bell to exit. The stock has been trading in a range the last several days between $29.75 and $31.50. Instead of exiting now you could put your stop loss just above $31.50 but we would still exit ahead of earnings. Wall Street expects earnings of 34 cents a share. FYI: Friday afternoon PRGO announced a $150 million stock buy back program.

Picked on January 28 at $ 29.85 *triggered
Change since picked: + 1.43
Earnings Date 02/05/08 (confirmed)
Average Daily Volume = 1.3 million

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Teleflex Inc. - TFX - close: 60.87 chg: +1.75 stop: 60.01

The bulls remained firmly in control with TFX on Friday. The stock powered through resistance at tits 50-dma and the $60.00 mark. Shares added 2.9% albeit on below average volume. TFX hit our stop loss at $60.01.

Picked on January 30 at $ 57.65
Change since picked: + 3.22
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 408 thousand
 

Dropped Strangles

None
 


Trader's Corner

It's Not Rocket Science

If you've picked up a trading-related magazine such as STOCKS & COMMODITIES, you know that purveyors of different software programs have developed ever more complicated systems to trigger trades.

It doesn't have to be that hard. It's not rocket science, folks. Pick out a moving average or a trendline and use it as a benchmark.

Annotated Daily Chart of the SPX:

Traders who had entered long SPX-related trades on the first tall green candle that broke out above 1290 in August 2006 were glad to then see the SPX take off again after dropping down to test it a second time. Those traders might have noticed that while 1290 support was being retested, so was the 30-sma. In fact, it was the second time the SPX had bounced off that average since the middle of August.

Light bulb moment. The 30-sma could be used as a benchmark. The long position was performing well as long as the SPX continued bouncing from the 30-sma and bouncing hard enough to keep the 30-sma climbing--this will be an important point later. Traders could even use that as a benchmark for adding to the position, on pullbacks to and bounces from the moving average.

Unfortunately, it would be another couple of months until the SPX was to pull back to the 30-sma, but the 10-sma was functioning as sort of a secondary benchmark, although not nearly as exact. For long-term traders, stops could follow the SPX higher, being placed an account-appropriate distance below that 30-sma. Perhaps traders might require a daily close beneath it or an intraday move a certain distance or percentage level below it.

Other conditions were being fulfilled. Most pullbacks were finding support at previous resistance levels, so that there wasn't much overlapping of highs and lows as the SPX climbed. It was possible to draw a rising trendline and buy pullbacks to the trendline. Perhaps it's possible to eyeball that chart, however, and note that in late November, the SPX would have violated a rising trendline while it still bounced again from the 30-sma. Traders following the trendline with their stops rather than the moving average certainly couldn't have complained if stopped out of their long SPX-related positions up near 1380, however, if they'd been in those positions since 1290.

At the second arrow, however, at the right edge of the chart, something appeared to be changing. The SPX was beginning to trade along the 30-sma rather than bouncing smartly from it. The 30-sma was beginning to flatten. It was no longer climbing. Was it time to get out?

Maybe, maybe not. It was certainly time to begin planning the conditions under which an exit would be made, if stops hadn't already been hit as that 30-sma was tested in early 2007. It was time to realize that the former stop-setting mechanisms, following the moving average higher, weren't going to work and a different stop mechanism would be needed, such as a stop beneath a certain horizontal support level or something similar.

A flattening of a benchmark moving average can signal that the trend is losing steam. Markets can then sometimes move into a period of disorganization in which the moving average loses its benchmark status and prices chop across it. Traders depending on bounces from a moving average to add to positions or drops below it to exit them would be whipsawed out of multiple positions.

Annotated Daily Chart of the SPX:

Traders who followed the SPX higher, placing their stops for their long SPX-related positions at an account appropriate level were stopped out either at Point 2 or Point 3, depending on how tight their stops were. Although there might have been some shoulda-woulda-coulda moments for those who were stopped out at the lower Point 2, even those traders had hefty profits in hand.

After a period of disorganization, the SPX began a new rally period.

Annotated Daily Chart of the SPX:

While it's not rocket science, it's not always as easy as these charts make it appear to determine when a new trend has begun. Prolonged periods of disorganization often follow an established trend, and a trader who isn't careful can get whipsawed. Expecting a period of disorganization after a trend benchmark has been violated is a good practice. Traders tempted to trade before a new trend is firmly established should keep stops tight to avoid incurring large losses in a time when they're more likely to be whipsawed out of trades.

Annotated Daily Chart of the SPX:

The progression tends to be the establishment of a new trend rising out of a period of disorganization, with some moving average or trendline established as a benchmark. Somewhere along the way, the move can grow so exuberant that prices swing far away from that benchmark, often a sign of danger. That can be an ending sign.

So, the cycle starts again. Prices that then come in but don't bounce sharply from or back from the average or trendline might hover long enough to flatten the average. As stated earlier, that's a signal that momentum may be slowing. Traders should prepare exit plans if not using trailing stops.

A flattening of the average often precedes a stronger violation. Once again, a period of disorganization often results before the establishment of a new trend or a resumption of the previous one. Once again, care should be exercised when trying to trade that period of disorganization. Tighter stops are often required. A new trend may appear to have begun, but it may only be soon reversed. Eventually another new trend is established or the old one is resumed, and so it repeats again.

Finding a benchmark and following it can be useful on short-term intraday charts and on weekly charts and everything in between.

Three-minute chart of IBM on 1/7:

The same pattern can be observed on this three-minute chart as was observed on the daily one for the SPX.

Of course it's not always that easy. I didn't pick and choose among charts, but I am looking backward and hindsight is always easier. The SPX's was the first chart I called up for a look at daily patterns, and I just took the last year or two for observation. IBM's was the first chart I looked at for an intraday observation, so it should be obvious that these patterns repeat. However, other periods on IBM's chart demonstrate how traders can get whipsawed trading those periods of disorganization that occur as one trend is ending.

Annotated 3-Minute Chart of IBM:

Which moving average should traders use as benchmarks? Whichever one works. There's no right or wrong, no one-size-fits-all. The rate of ascent or descent of the trend as well as the length of time you intend to stay in the trade help determine the moving average that might be used. I find that a benchmark average often converges with a rising trendline, and they can be used to corroborate each other.

An early trend may show some exuberance, bouncing from a 9-ema or a 10-sma, but those moving averages will not likely serve to define a long-term trend. If you don't believe the trend will be long-lived, you might set stops an account-appropriate distance beneath a moving average of that interval.

If you think the movement might be a long one and you intend a longer-term trade, you might check for a second corroborating moving average that's rising just underneath the one you have been following, perhaps a 20- or 30-sma. Play around with it. Find what works best for you. It's not rocket science.

Trading like this does require some kind of feel for how trends develop and then progress, however. It requires an ability to step aside and not jump in too soon when a period of disorganization develops. It requires an oh-well, another-trade-will-be-along attitude when a pullback or bounce gets too big and you're stopped for a smaller profit and the trend then continues to produce bigger profits, but you're not participating.

If you're already developing a feel for how trends develop and willing to stand aside when a period of disorganization has begun, then you're somewhat wary of participating in markets right now. The SPX has been in a period of disorganization, chopping back and forth, this week finally rising across the flattening 10-sma. We know from previous observations that the fast 10-sma may be violated when the initial stage of the trend has been spent. History tells us that it's too fast an average to serve as a long-term benchmark, however, so if we're in a long-term downtrend, a violation of the 10-sma won't be enough to make its end.

Annotated Daily Chart of the SPX (snapped midday 2/1/08):

 

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

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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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