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Daily Newsletter, Saturday, 02/09/2008

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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

Not A Fun Week

A -561 point loss by the Dow and -108 on the Nasdaq does not qualify for the record books but it does create a lot of pain. For the record the Dow gained +535 the prior week so a dip back to 12150 could qualify as a retracement rather than a new leg down. The economic calendar was very tame with only the normally ignored ISM Services to rock the boat. When it came it was more like a tidal wave than an ignored report. Add in the cautious comments from Cisco and the prior week's rally was scuttled without any material breakout effort. Rallies were sold and despite some Friday afternoon short covering the Dow closed near its lows.

Dow Chart - 60 min

Friday had no material economics and that trend will carry over into next week with only a couple of significant items. The Retail Sales numbers for January will be released on Tuesday and expectations are for a drop in sales of -0.3% as consumers hoard cash to pay for holiday bills. On Friday the Industrial Production for January is expected to be nearly flat with only a +0.1% gain and Consumer Sentiment is expected to decline again to 77.0. It is a stretch to expect the market to really react to any of those reports. The following week will see the economics begin to ramp up again with the CPI and Philly Fed Survey leading the list. Until then it is just another week of filler. I added the various speeches by Fed officials to the calendar since the outlook for the Fed appears to be changing on almost a daily basis.

Economic Calendar

The earnings parade will also slow with only 341 companies reporting compared to more than 700 last week. There are only a couple of brand names that most traders would recognize. Applied Materials and Expeditors International will be watched for news on the chip sector and the shipping sector. There are several energy companies reporting including XTO, TOT, COG, FDG, ECA and PTEN. Abercrombie & Fitch rounds out the list when they report on Friday. The earnings parade is coming to an end with the equine cleanup crew visible in the distance. After the potential droppings from next week's group they are going to need some big shovels.

Earnings Calendar

It was a bad week for AMD. After opening on Monday at a new 6-week high of $8.07 it was downhill from there. On Friday Dell announced it would no longer sell computers on its website with AMD processors. You can still call Dell and request one be built but they will not be advertised on the site. Dell will still market AMD computers through some discount retail outlets where low prices are the only consideration. Any AMD PCs sold there will be the very cheap extreme low margin products. This is a major blow for AMD and their continuing battle for profitability. For the week AMD lost 20% of its value by Friday's close.

MGM Mirage (MGM) now expects Q4 earnings to be in the range of 39-44 cents and well below the consensus estimates of 55 cents. MGM stock fell -5% or -3.88 on the news. MGM actually raised its guidance for Q4 but that guidance included things like hurricane insurance payments in the mix. Minus items it looks grim. UBS said they were even more concerned with softness in Las Vegas revenue for January. Revpar is still expected to have risen in January but much less than prior expectations. UBS lowered their rating on MGM to neutral. All the casinos must be hurting because hardly a day goes by that I don't get 2-3 letters with special offers at various casinos. I don't remember receiving the same volume of advertisements for any period over the last 10-years.

Weyerhaeuer (WY) posted earnings that missed estimates with profits that fell -19% over Q3. The drop came from a significant drop in volume caused by the slowdown in homebuilding. WY said the slowdown in building was not over and they forecast significant losses in Q1.

The fuse is growing shorter at the bond insurers and there is a good chance we could see a tape bomb explode next week. There has been no bailout announced yet and while the participants still believe there is hope everyone concedes the discussions could fall apart at any time. The rating agencies are literally crushing the life out of the discussions with almost daily press releases about the impending downgrade of the companies. This was a major factor in the weakness of the financial sector over the last week. Analysts are afraid a deal will not get done OR that the banks in their desperation will give up the farm to shore up the insurers and avoid another write-down cycle. MBIA managed to float $1 billion in stock at $12.15 on the hopes a deal is going to get done. MBIA stock closed at $14.90 before the announcement. Goldman Sachs was the spoiler and immediately cut its price target to $12 after the announcement. Next week is seen as the make or break week for the three companies under the gun, MBI, ABK and FGIC. If a deal is not completed the rating agencies are expected to follow through on their threats to drastically lower ratings on the three and force write-downs on hundreds of billions in bond/CDO debt. With $2 trillion of this debt as a foundation under the major banks any downgrade will turn that foundation into a house of cards.

Fannie Mae (FNM) is expected to report decaying credit quality in its mortgage portfolio according to Morgan Stanley. In November Fannie said 0.9% of their single family loans were seriously delinquent. That is expected to climb sharply in Dec/Jan despite the falling interest rates. Fannie has $2.4 trillion in mortgage loans on its books. Morgan Stanley said delinquency trends and transition rates have deteriorated over the last several months at an accelerating pace. FNM fell -4% on the news.

While I am on the topic of mortgages I should mention that Friday was the one-year anniversary of the subprime crisis. It was last February when HSBC brought the word subprime into the daily news when they reported write-downs of $10.5 billion due to subprime problems. This started the cascade of announcements from other banks and now a year later those announcements are still occurring. The bond insurer problem is just the last chapter in the subprime saga.

Bernanke and Paulson have been summoned to the hill for testimony next Thursday and it is not for a valentine party. They will be grilled on the economy and the health of the banking system. San Francisco Fed President Janet Yellin hinted in a speech on Friday that there could be more rate cuts ahead. She said the U.S. may avoid a recession but more cuts could be necessary. Cleveland Fed President Sandra Pianalto said the "economy is in the midst of some very difficult times." Atlanta Fed President Richard Fisher said the steps already taken are likely to mitigate the downside risks to growth suggesting he would continue to oppose future rate cuts. Fisher was the only dissenting vote on the last rate cut. Fisher believes the risks to inflation remain and should be feared. Richmond Fed President Jeffrey Lacker and Philly Fed President Charles Plosser echoed those same inflation concerns. It appears to me that the Fed is setting the stage for taking a pass on further cuts at the March 18th meeting and the market is also picking up on those clues.

Amazon helped lift the Nasdaq out of a slump on Friday with an announcement it will buy back up to $1 billion of its shares or roughly 3% of the outstanding shares. They probably need some for employee stock options. AMZN, a major Nasdaq component, gained +$2.59 for the day. Apple (AAPL) +4.24 and RIMM +4.76 also contributed to the gain.

CNET rose +8% on a rumor that Google might be interested in acquiring a stake. Google declined comment and Pacific Crest Securities said a Google interest was "highly unlikely." Options volume spiked to 31 times the normal level.

The acquisition of Lucent by Alcatel was supposed to rescue Lucent from the ruins of the telecom sector and create a giant that would have pricing power and plenty of business. The merged company Alcatel-Lucent (ALU) posted a $3.76 billion loss for Q4 and $5.12 billion for the full year. To be fair the majority of that loss was write-downs to the reduced value of the assets acquired in the Lucent deal. I question the rationality of paying $11 billion for a company and then writing off $5 billion in the first year but that is business as usual. Based on recent reports there is a lot more to come. ALU said it will cut 12,500 more jobs, adding to the 6,700 cut in 2007 and bringing the total workforce down to 77,400. On the bright side revenue was up +18% for the quarter to $7.61 billion. Once they fire all the Lucent employees and write down all the assets to zero they should be able to make a profit. It won't be in the first quarter since ALU warned they will lose money in Q1 due to a revenue drop of 20-25%. ALU has fallen from $14.50 back in July to close at $6 on Friday. Lucent closed at $2.55 the day the deal closed on Nov-30th 2006. Each LU shareholder got 0.1952 of an Alcatel share for every share of LU they owned. ALA was trading at $13.25 the day the deal closed. With the merged company now trading at $6 that 0.1952 fractional exchange is worth less than a fountain Coke.

March Crude Oil Chart - Daily

Crude oil exploded for a gain of +3.78 to close at $91.89 on multiple news events. Shell said oil exports from Nigeria could fall by as much as a million barrels per day in February and March due to a deteriorating security situation and planned maintenance. That is an increase of 130,000 bpd from prior outage levels. Total said production from the North Sea was cut by 280,000 bpd due to technical problems. There was also news that output from a Russian field could fall sharply due to rising depletion rates. Exxon won a battle in the war with Venezuela but the war is far from over. Exxon was kicked out of Venezuela last year after Chavez nationalized the Exxon facilities in the Orinoco oil belt. Exxon took Venezuela to court in several countries to recover billions in lost assets. A British high court froze $12 billion in PDVSA assets in England until further notice from the court. Courts in the Netherlands and Netherlands Antilles also issued similar orders for up to $12 billion each. Exxon also has suits in the U.S. against Venezuela assets. A U.S. court froze $300 million in assets in December. Exxon can't go after assets in Venezuela because the government there just levies fines for previously undisclosed offenses or claims previously unknown taxes to offset any asset recovery award. Outside Venezuela they don't have that option. Exxon should eventually be successful in their suit but it could take years. Venezuela knew the freeze was coming and changed the terms of their oil sales two weeks ago to cash in advance instead of the normal terms. If I were going to buy oil from Venezuela I would think twice before laying down $90 million per tanker load in hopes that Venezuela would actually deliver. Chavez is running out of money to fund his programs meant to keep him in office. He has nationalized banks, telecoms, utility companies and just about everything else that generates cash every month. He has run out of nationalism targets and existing cash flow is drying up without the use of operating funds to continue to operate the businesses. If Exxon is successful in getting additional funds and assets seized in the U.S. it could squeeze Chavez and an already unstable country to the point where Venezuela oil shipments are slowed. This potential helped provide the boost to crude on Friday. If the world really had two million barrels per day of excess production capacity like OPEC and the various government agencies claim these types of news events would not cause nearly a $4 jump in crude in one day. Crude prices are volatile because we don't have that spare capacity where all we have to do is turn a valve and let it flow. Get used to the volatility because it will only get worse as we get closer to the peak of production.

The Dow lost 561 points for the week. This was the worst week since March 2003 but that was only a 4.4% drop. The banking sector lost 8% and the homebuilders lost 11%. Those two sectors were responsible for the majority of the market losses. Actually there were a lot of reasons for the selling but nothing we didn't already know about except maybe the Cisco comments. We knew about the bond insurers, subprime mortgage defaults, credit card defaults, recession worries and the Fed decision. Unfortunately those factors have each taken on a life of their own and a bear market mentality has formed. Dips were still being bought the prior week but the trend changed to sell the rallies once that ISM number scared traders with the magnitude of the drop. I still have not heard anyone talking about the new methodology influencing the number but that is water under the bridge today.

The reality of the markets boils down to actual market activity not what traders want to believe. There are a lot of people who still want to be long but Trimtabs.com said on Friday $9.2 billion was withdrawn from mutual funds over the past week. This compared to $1.5 billion in inflows the prior week. Investors are starting to believe the recession worries and money is leaving the market. We know historically that recession bottoms typically lead to monster gains but the key word there is bottom. With the homebuilders, suppliers like Weyerhaeuser, freight companies like YRC Worldwide and now Cisco telling us that the future still looks weak, many investors are suddenly becoming believers. The cult of the recession bear is growing and volume surges are coming on the dips instead of the spikes. This is not a good sign for the bulls.

The Dow failed at 12750 resistance on Monday and found light support at 12125 on Thr/Fri. The key question here is will that support hold or are we looking at a retest of the 11650 lows from January. In round numbers that would be another 500 point drop and take the Dow to -18% off the all time closing high in October of 14,164. We were there just three weeks ago so there is no reason why we can't return to that level. Granted the first trip was induced by the two day $73 billion futures dump by SocGen but that drop did clear out a lot of support on the way down. In reality Dow 12000 is more visible support and a more likely stopping point on any continued sell cycle. The volume has risen but it is only about 65% of the volume we saw on the SocGen futures dump. Bearish conviction may be increasing but the internals are not showing any massive imbalances. We are looking at more of a buyers boycott than a selling frenzy.

The S&P and the Dow are similar in pattern with current weak support around the Jan-22nd congestion at 1320. Both could easily crumble and retest the January lows without much effort. That low on the S&P is 1270.

S&P-500 Chart - 90 Min

Nasdaq Chart - 90 Min

The Nasdaq broke through support at just over 2300 on Thursday and fell to 2250 on the Cisco earnings news. That low is just 45 points above the low set on Jan-23rd at 2205. For all practical purposes Thursday's dip could be considered a valid retest. Or it could just one more interim low on the way to 2200. We won't know until we can look back several weeks from now and see the chart.

For the last week I recommended using the Russell 2000 as our indicator with a dip buy at 685 support. The Russell came very close with a drop to 688 and a nice rebound on Thursday. Friday's loss was a miniscule -4 points. It appears there were some buyers nibbling at support the last 3-days. The loss for the week was the same -4% as the other major indexes but it started from a stronger relative position after the prior week's big gain. My recommendation this week is going to be the same. Buy a dip to 685 and remain flat or short under 685. Add another dip entry buy at 660 just in case 685 breaks. These may only be trades rather than long term holds but any successful trade is still a win.

Russell 2000 Chart - 90 Min

The indexes fell over 4% over the last four days. You would think that would produce perfect conditions for an oversold bounce. However, the slowness of the drop except for Tuesday really kept the oversold conditions from building. From where we are sitting this weekend anything is possible. I personally believe the bond insurer scandal is the biggest pressure on the market. Everybody got excited a couple weeks ago when it appeared a deal might get done. All that excitement has turned to fear with insiders being quoted on Friday as saying it may not ever happen. All the major banks have tens of billions in additional write-down exposure if no deal appears.

Goldman Sachs thinks the total write-down exposure is over $400 billion. Fitch warned in the Wall Street Journal on Friday that there could be $139 billion in additional losses from individuals walking away from mortgages even before foreclosure because the homes had dropped in value. Fitch expects 26% losses on all subprime loans written in 2007. Defaults on credit cards rose to 7.6% in December. Credit card debt is bundled and sold in CDOs just like mortgages. The $2 trillion CDO market is in lockdown. Nothing is being traded and these were as liquid as cash in the past. The following chart tracks the value of a group of BBB CDOs. These CDOs in this index were written by companies including Morgan Stanley, JP Morgan, Merrill Lynch, Bear Stearns, Carrington, Citigroup and others. These CDOs are currently worth roughly 14 cents on the dollar. This is an example of how the $2 trillion CDO market is being valued. The possibility of massive additional write-downs is guaranteed unless a miracle occurs in the CDO market. It also illustrates the challenges of trying to construct as bailout of the bond/CDO insurers. Who in their right mind would want to take on that exposure?

Markit.com ABX Chart

This makes the bond insurer bailout problem even more critical.

Investors are selling the banks like the outcome was already known. Given the loose lips inside that community it may already be known and they just have not told us yet. Regardless of the outcome the markets are going to move by hundreds of points when it is announced. Hopefully with all the interested government agencies a deal will be forced rather than allow a melt down of the system. While a bailout would be the desired result we have to be ready for either eventuality. Actually regardless of whether they announce an outcome next week or not we need to trade what the market gives us and not what we want to see. Watch Russell 685 for directional guidance with 660 as a secondary support level.

Every couple years we poll the subscriber base to see if we are doing our jobs correctly. It is that time again and I would really appreciate if everyone would spend a couple minutes to give us your opinions. No identifying information is collected so you can be frank and open with your answers. We really want to know what we could do to improve the newsletters value to you. It should take less than 5 min to complete and your answers will be valuable for us.

Survey link

Thank you in advance for your participation.


Jim Brown

 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
AAPL BSC None
APOL FDX  
CNX GWW  
  SHLD  

Play Editor's Note: I wanted to share some of the stocks on our watch list. Potential bullish candidates are: RTN, SII and some of the metal stocks. Potential bearish candidates are: PFCB, AVB, MAC, VNO, VMC, and TM. Some of these did not make the newsletter because earnings are this week. TM is probably the only carmaker we would consider owning but it has rallied right to significant resistance and looks overbought. This would be decent spot to consider puts because your stop loss is easily defined.


New Calls

Apple Inc. - AAPL - close: 125.48 change: +4.24 stop: see details

Company Description:
Apple ignited the personal computer revolution in the 1970s with the Apple II and reinvented the personal computer in the 1980s with the Macintosh. Today, Apple continues to lead the industry in innovation with its award-winning computers, OS X operating system and iLife and professional applications. Apple is also spearheading the digital media revolution with its iPod portable music and video players and iTunes online store, and has entered the mobile phone market with its revolutionary iPhone. (source: company press release or website)

Why We Like It:
We're calling this our AAPL triple play. It would appear that shares of AAPL have bottomed near the $120 level. While the trend is still bearish we're willing to speculate that there is more upside risk than downside risk at this time. We're listing three different strategies and you may want to mix and match whatever suits your trading style and account flexibility.

AAPL play #1 - Directional call options

This is pretty simple. If AAPL has bottomed there is plenty of room for an oversold bounce or a retracement of its decline. We're suggesting readers buy calls. Our short-term target is the $139.00-145 range. Expect resistance at $140 and the 200-dma near $145. We are suggesting a stop loss at 116.99 under last week's low. More conservative traders may want to use a stop closer to $120.

Play #1 options:
We are suggesting the March 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 MAR 120 QAA-CD open interest=4286 current ask $11.55
BUY CALL MAR 125 APV-CE open interest=7308 current ask $ 8.70
BUY CALL MAR 130 APV-CF open interest=9662 current ask $ 6.30
BUY CALL MAR 135 APV-CG open interest=11308 current ask $ 4.35

AAPL play #2 - Credit put spread

If AAPL has bottomed and due for a bounce then let's sell some puts but we can limit our risk by making it a put spread. Here's the plan. We need to buy the March $110 put (currently around $2.50) and then sell the March $120 put (currently around $5.50). Buying the $110 put is a debit to our account but selling the $120 put is a credit to our account and we should make about $2.60-to-$3.00 on the trade. If AAPL continues to rally then these puts will quickly deteriorate and we can buy back the March $120s for a fraction of what we paid for them and removing our short (risk) position. It is possible to do both AAPL play #1 (buy calls) and AAPL #2 (credit put spread), which would help reduce the cost of our calls. If AAPL closes under $120 we would strongly consider closing this put spread.

BUY PUT MAR 110 QAA-OB open interest=4611 current ask $2.59
-and-
SELL PUT MAR 120 QAA-OD open interest=6301 current ask $5.50

AAPL play #3 - Sell Naked Puts

If you opted for the OptionInvestor year-end deal and you read Jim's strategy section on naked puts then you should already be familiar with this plan. If AAPL is due for a big bounce then we can sell deep in the money puts for a credit and buy them back after the bounce occurs. Deep in the money puts have a high delta (close to 1.00) so it's almost $1 for $1 on the rally. Our plan is to exit the play (buy these puts back) when AAPL hits $139.00. Thus we'll get a credit into our account for about $25.45 (per contract) and we'll buy them back around $10-13 each. We will use a stop loss at $116.99 to limit our loss and buy these puts back. Note: Not all traders have accounts with naked put selling permissions.

AAPL play #3 suggested options:
You could use any of the deep ($20 or more) in the money puts but we're suggesting the March $150s.

SELL PUT MAR 150 APV-OJ open interest=2281 current ask $25.45

Picked on February 10 at $125.48
Change since picked: + 0.00
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 44.4 million

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Apollo Group - APOL - close: 73.94 chg: +0.98 stop: 69.95

Company Description:
Apollo Group, Inc. has been an education provider for more than 30 years, providing academic access and opportunity to students through its University of Phoenix, Institute for Professional Development, College for Financial Planning, Western International University, Insight Schools and Apollo Global. It also owns Aptimus, a provider of innovative digital media solutions. (source: company press release or website)

Why We Like It:
Last week's market sell-off pulled APOL back down to technical support at the 100-dma. Bulls have been consistently buying dips to the 100-dma for months. It also happens to be Point & Figure chart support, which coincidentally is bullish with a $102 target. Thus looks like a good spot to buy calls. Our target is the $80.00-81.00 range.

Suggested Options:
We are suggesting the March calls.

BUY CALL MAR 70.00 OAQ-CN open interest=481 current ask $7.40
BUY CALL MAR 75.00 OAQ-CO open interest=622 current ask $4.60
BUY CALL MAR 80.00 OAQ-CP open interest=857 current ask $2.60

Picked on February 10 at $ 73.94
Change since picked: + 0.00
Earnings Date 04/07/08 (unconfirmed)
Average Daily Volume = 3.1 million

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CONSOL Energy - CNX - cls: 77.54 change: +2.88 stop: 69.95

Company Description:
CONSOL Energy Inc., a high-Btu bituminous coal and coal bed methane company, is a member of the Standard & Poor's 500 Equity Index and has annual revenues of $3.8 billion. It has 17 bituminous coal mining complexes in six states and reports proven and probable coal reserves of 4.5 billion tons. (source: company press release or website)

Why We Like It:
Some of the coal-related stocks have been real screamers lately yet some of the coal stocks like CNX look like they are breaking out from a consolidation phase and into a new leg higher. Cold weather, rising demand, and shortages in China is having a big impact on coal. Plus there has been more investor interest in coal since the new ETF came out (symbol:KOL) recently. Meanwhile rising oil prices tends to lift other forms of energy as well. Technical oscillators on CNX have turned bullish again and the stock broke out to new highs on Friday. We do have a wide stop loss so more conservative traders may want to consider a tighter stop. We have two targets for CNX. Our first target is the $84.50-85.00 range. Our second, more aggressive target is the $88.00-90.00 zone. The P&F chart has a brand new triple-top breakout buy signal with a $124 target.

Suggested Options:
We are suggesting the March calls. Note: normally a March $85 call would end in -CQ but the CBOE is listing the CNX March $85 call as -CA. Double check with your broker.

BUY CALL MAR 75.00 CNX-CO open interest=3366 current ask $7.30
BUY CALL MAR 80.00 CNX-CP open interest= 653 current ask $4.80
BUY CALL MAR 85.00 CNX-CA open interest= 864 current ask $2.95

Picked on February 10 at $ 77.54
Change since picked: + 0.00
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 3.3 million
 

New Puts

Bear Stearns - BSC - cls: 80.67 chg: -2.36 stop: 84.31

Company Description:
The Bear Stearns Companies Inc. (NYSE: BSC) is the parent company of Bear, Stearns & Co. Inc., a leading global investment banking, securities trading and brokerage firm. Since 1923, we have helped corporations, institutions, governments and individuals reach their financial objectives. (source: company press release or website)

Why We Like It:
We still think there is pain ahead for the financial stocks, especially if the bond insurers go under (or get downgraded). We have been watching BSC since it flirted with breaking support near $85.00. Now shares have tested support at $80.00 twice and look poised to breakdown again. We are suggesting a trigger to buy puts at $79.49. If triggered our target is the $71.00-70.00 zone near its January lows. We'll use a stop loss at $84.31. Our biggest risk is that a bailout plan for the bond insurers does get done (and probably this coming week). If plan is announced and the street thinks it has a good chance of actually coming to pass then shares of BSC are bound to rally sharply due to its exposure to the sub-prime mess. Considering this explosive situation we thought about a strangle but even if we used the March $90 calls and March $70 puts it would still cost about $6.00 for a strangle, which we thought was too much. A March $80 straddle was even more outrageous at close to $13 for a position. Therefore we settled on playing the trend, which is bearish. Unfortunately, if BSC gaps open higher on news one day our stop loss may not be much help. FYI: The P&F chart is bearish with a $68 target.

Suggested Options:
Our suggested trigger to buy puts is $79.49. We are suggesting the March puts.

BUY PUT MAR 80.00 BVD-OP open interest=2310 current ask $6.20
BUY PUT MAR 75.00 BVD-OO open interest=1312 current ask $4.30
BUY PUT MAR 70.00 BVD-ON open interest=3855 current ask $2.90

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/13/08 (unconfirmed)
Average Daily Volume = 7.4 million

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FedEx - FDX - close: 88.00 change: -2.16 stop: 92.05

Company Description:
FedEx Corp. provides customers and businesses worldwide with a broad portfolio of transportation, e-commerce and business services. With annual revenues of $36 billion, the company offers integrated business applications through operating companies competing collectively and managed collaboratively, under the respected FedEx brand. (source: company press release or website)

Why We Like It:
FDX could be in real trouble here. If we're facing a consumer-lead recession then business is definitely going to slow down. Plus, FDX and the rest of the transports are struggling with the high cost of fuel thanks to high oil prices. Shares of FDX just rolled over under a new lower high and the stock looks poised to retest the January lows. There is potential support at $86 but our target is the $81.00-80.00 zone.

Suggested Options:
We are suggesting the March puts.

BUY PUT MAR 90.00 FDX-OR open interest=1864 current ask $4.90
BUY PUT MAR 85.00 FDX-OQ open interest=1264 current ask $2.60
BUY PUT MAR 80.00 FDX-OP open interest= 338 current ask $1.25

Picked on February 10 at $ 88.00
Change since picked: + 0.00
Earnings Date 03/20/08 (unconfirmed)
Average Daily Volume = 3.2 million

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W.W.Grainger - GWW - close: 76.65 chg: -2.43 stop: 80.05

Company Description:
W.W. Grainger, Inc., with 2007 sales of $6.4 billion, is the leading broad-line supplier of facilities maintenance products serving businesses and institutions in Canada, China, Mexico and the United States. (source: company press release or website)

Why We Like It:
We are suggesting puts on GWW right here but readers may really want to wait and see if a better entry point presents itself. The stock has an easy to see trendline of lower highs and shares just produced a bearish failed rally at $80.00, which happened on strong volume. The alternatives are to wait for a bounce back toward $78-79 and buy puts there. The market is arguably short-term oversold and due for a bounce. Another alternative would be to wait for a breakdown under support at $75.00. Our target is the $70.75-70.00 zone.

Suggested Options:
We are suggesting the March puts.

BUY PUT MAR 80.00 GWW-OP open interest= 54 current ask $8.90
BUY PUT MAR 75.00 GWW-OO open interest=298 current ask $2.90
BUY PUT MAR 70.00 GWW-ON open interest= 39 current ask $1.40

Picked on February 10 at $ 76.65
Change since picked: + 0.00
Earnings Date 04/16/08 (unconfirmed)
Average Daily Volume = 1.0 million

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Sears Holding - SHLD - cls: 98.59 chg: -4.09 stop: 100.25

Company Description:
Sears, Roebuck and Co., a wholly owned subsidiary of Sears Holdings Corporation, is a leading broadline retailer providing merchandise and related services. Sears, Roebuck offers its wide range of home merchandise, apparel and automotive products and services through more than 2,400 Sears-branded and affiliated stores in the United States and Canada, which includes approximately 870 full-line and 1,100 specialty stores in the U.S. (source: company press release or website)

Why We Like It:
If we are facing a consumer-lead recession then the retailers could be in for hard times. The trend in SHLD is already bearish but we want to see a breakdown under short-term support at $95.00. We are suggesting readers use a trigger to buy puts at $94.75. However, we will be watching for an alternative entry on a failed rally in the $101-102 zone. If triggered at $94.75 our target is the $86.00-85.00 range. We do not want to hold over the end of February (unconfirmed) earnings report.

Suggested Options:
If triggered at $94.75 we are suggesting the March puts.

BUY PUT MAR 95.00 KTQ-OS open interest=2964 current ask $8.00
BUY PUT MAR 90.00 KTQ-OR open interest=8380 current ask $5.50
BUY PUT MAR 85.00 KTQ-OQ open interest=7552 current ask $4.00

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/28/08 (unconfirmed)
Average Daily Volume = 3.0 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Allegheny Tech. - ATI - cls: 76.60 chg: +1.41 stop: 69.75

A number of the iron, steel and metals stocks were up on Friday. ATI was one of them with a 1.8% gain capping off a decent week. The stock looks relatively strong here and readers may want to consider buying calls on another dip in the $75.00-74.00 zone. Conservative traders might want to adjust their stop toward $72.50. 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:
If ATI provides another entry point we would suggest the March calls.

Picked on February 04 at $ 75.11 *triggered
Change since picked: + 1.49
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 2.4 million

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Petroleo Brasileiro - PBR - cls: 111.57 chg: -0.03 stop: 104.95

PBR failed to see any follow through higher on Friday in spite of a sharp rally in crude oil futures. We're fundamentally bullish on PBR but we're waiting for an entry point. Currently our official suggested entry point is to buy calls at $116.00. However, we're also carefully watching the $105 region or the $100 level as an alternative entry point to buy calls. 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:
If PBR hits our trigger at $116 we would suggest the March or April calls. The $115 and $120 strikes would work.

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
 

Put Updates

Ambac Fincl. - ABK - cls: 10.99 change: +0.03 stop: n/a

Shares of ABK continue to idle sideways as the market waits for news on any potential bailout plan. As of Friday it seemed that hopes were fading that any plan would get done. Furthermore the rating agencies are expected to downgrade the bond insurers (ABK and MBI) some time in the next two weeks. If a plan does get announced then this stock could double overnight. It is our bias that a plan will not happen and ABK will see it share price fall toward zero. However, that doesn't mean we can't make money on the long side too. We are going to hedge our bets and make this more of a strangle-type of play. We initially listed this play with a suggestion to buy the May $5 or May $2.50 puts. We are now suggesting readers buy an out of the money call. However, instead of buying May calls we're suggesting March calls since a deal should happen in the next two weeks, otherwise the rating agencies are going to downgrade this company's credit rating.

Here's what we're thinking. Buy something like the March $20 call (ABK-CD) currently trading at $0.45bid/0.60ask. If a deal gets announced in the next two weeks then ABK will soar and the call could rise in value to cover all of our costs in both the put and call and probably still post a profit. Remember this is just an alternative to our speculative puts. Buying the call increases our cost in the play but gives us some upside potential on a surprise.

Suggested Options:
You could still buy May puts but we're now suggesting you hedge with a deep out of the money March call.

Picked on January 27 at $ 11.54
Change since picked: - 0.48
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 10.9 million

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iShares DJ Financial - IYF - cls: 88.29 chg: -1.82 stop: 93.01

Another round of credit concerns and sub-prime fears helped push financials lower on Friday. The bounce in the IYF rolled over and the equity lost 2%. This looks like a new entry point to buy puts. We're aiming for a test of the $80.00 region. Our official target is the $81.00-80.00 zone.

Suggested Options:
We like the March $90, $85, and $80 puts. Sadly these options have huge spreads. It's not a guaranteed execution but you could try a limit order with your price somewhere between the spread.

Picked on February 06 at $ 88.62
Change since picked: - 0.33
Earnings Date 00/00/00
Average Daily Volume = 1.1 million

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MBIA Inc. - MBI - close: 14.60 change: +0.40 stop: n/a

Claiming that their secondary offering (of convertible notes) was oversubscribed MBI announced that they were able to raise $1 billion, not just $750 million in the last two days of the week. This is a big bet by the buyers of these notes that MBI will survive and that some sort of rescue plan will come to pass. Our bias is still bearish. Most of the speculation this month is suggesting that the bailout needs to happen by the end of the month (February) or the ratings agencies are going to downgrade the big bond insurers and they will lose their essential triple-A credit rating. However, comments coming out Thursday and Friday this week are suggesting that something has to happen this coming week (Feb. 11-15) or the downgrades are going to fall sooner. It is a volatile situation. If a bailout plan is announced then MBI could rocket to $25-30 almost overnight. We're still betting that MBI will falter and trade toward $5 or less. However, like the ABK play, we're suggesting readers turn this into more of a strangle instead of just speculative puts. Something is going to happen in the next two weeks so why don't we buy some upside "protection" with a cheap out of the money call? We're suggesting readers buy the March $22.50 calls (MBI-CX), which is trading around 0.30bid/0.45 ask. This way if a deal is announced these call should more than pay for our entire investment on both sides and probably still come out with a profit. Naturally we are increasing our expense and thus our risk and this would be an optional adjustment to the initial play.

Suggested Options:
We initially suggested the May (out of the money) puts. We're not suggesting that readers hedge their position with a deep out of the money call (like March $22.50s).

Picked on January 27 at $ 14.20
Change since picked: + 0.40
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 15.2 million

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Myriad Genetics - MYGN - cls: 39.71 chg: +0.35 stop: 43.01

The DRG drug index continued to hit new multi-year lows on Friday while the BTK biotech index dipped to its January low. Shares of MYGN actually managed a bounce but round-number resistance near $40.00 held the bulls in check. We would still consider new put positions here. However, considering the big market decline it might be prudent to wait until we see if the market bounces Monday or Tuesday and then open new put positions. A failed rally at the 10-dma (41.50) or $42.00 could be used as a new entry point. Our target is the $36.00-35.00 range. The Point & Figure chart is bearish with a $34 target. FYI: We always consider a biotech stocks to be a more aggressive, higher risk play because you never know when an FDA decision will be released or some clinical trial info will come out that could send the stock moving sharply either direction.

Suggested Options:
We are suggesting the March puts.

Picked on February 07 at $ 39.75 *triggered
Change since picked: - 0.04
Earnings Date 02/05/08 (confirmed)
Average Daily Volume = 801 thousand

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Simon Properties - SPG - cls: 83.86 chg: -3.70 stop: 90.61

SPG rolled over pretty quickly on Friday and shares broke down under recent support posting a 4.2% loss. Short-term technicals have definitely turned negative. Most of the stocks in the REIT industry look similar so we're seeing a sector rotation lower. We are suggesting new put positions here but again, the market got hammered this past week, it might be time for a bounce. This time we can look for a failed rally in the $86-87.50 zone as an alternative entry point. Our target is the $76.00-75.00 range.

Suggested Options:
We are suggesting the March puts.

Picked on February 07 at $ 84.39 *triggered
Change since picked: - 0.53
Earnings Date 02/01/08 (confirmed)
Average Daily Volume = 2.7 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: 121.82 chg: -0.65 stop: n/a

This is make-or-break week for our strangle play in the DJX, a shadow of the Dow Jones Industrial Average. The trend is definitely bearish but after last week's reversal lower it's probably time for a dip. Unfortunately, we only have five days left before February options expire. Due to this time frame we are adjusting our suggested sell target to $4.40. Keep an eye on those puts. 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.

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

Picked on January 29 at $124.80
Change since picked: - 2.98
Earnings Date 00/00/00
Average Daily Volume = million

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Google - GOOG - close: 516.69 chg: +11.74 stop: n/a

We're down to our last five days on this GOOG strangle (earnings) play. The post-earnings sell-off was down but the bulls have been buying dips near $500 and shares of GOOG are starting to see an oversold bounce. This is a crucial week. If the bear market continues then GOOG should break to new lows in spite of all the folks claiming this is a buying opportunity (near $500). If this is too speculative for you then traders need to consider an early exit on Monday to salvage any remaining premium on the put side. If you just want to play defensive then start selling off your position as the put option rises to $15, then $18, then $21, etc. We are not suggesting new positions. 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 at this time.

Picked on January 30 at $548.27
Change since picked: -31.58
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 5.6 million
 

Dropped Calls

None
 

Dropped Puts

Suncor Energy - SU - cls: 94.74 chg: +2.67 stop: 95.01

The short squeeze in crude oil on Friday prompted a rally in the oil and energy stocks. SU rose 2.89% but managed to breakout intraday over multiple levels of resistance. Shares hit our stop loss at $95.01 closing the play.

Picked on February 07 at $ 89.75 *triggered
Change since picked: + 4.99
Earnings Date 01/22/08 (confirmed)
Average Daily Volume = 2.4 million
 

Dropped Strangles

None
 


Trader's Corner

Breakaway Gaps: What's the Theory and What's Behind Them

Standard lore says that gaps will be filled. Not always. Rather, not always immediately.

Annotated Daily Chart of Agilent Technologies:

Note: My articles are always prepared in advance of publication, and so charts do not always feature current prices. As of the morning of February 8, A had still not filled that gap.

Prices tend to behave differently after a breakaway gap than they do with some other types of gaps. Breakaway gaps are often not reversed, or at least not immediately. Anyone going short Agilent's stock or entering a bearish option play after that 2006 gap would have found themselves stopped out.

First, what is a gap? In TECHNICAL ANALYSIS OF THE FINANCIAL MARKETS, John J. Murphy describes a gap in simple terms: it's a place "on the bar chart" where no trading has taken place. If you employ candlestick charts, Nison defines gaps in candlestick terms as "windows." In BEYOND CANDLESTICKS, he says that when prices gap higher, "the top of yesterday's upper shadow should be under the low of the today's lower shadow." When prices gap lower, "the low of yesterday's session . . . is above the top of today's upper shadow."

Just as not all definitions are created equally, neither are all gaps. Nison calls any gaps or windows "powerful candlestick patterns," but breakaway gaps can be particularly powerful. Murphy notes their importance as trend reversal signals. They tend to occur when the prior trend has been completed by a major basing pattern and prices gap either higher or lower, beginning a new trend. All authors consulted warn that not every breakaway gap will be valid or a "sure thing," as Pring terms it, but breakaway gaps don't tend to be filled as do other gaps.

In a YouTube webinar, Tom Williams, a former syndicate trader, provided an explanation of how and why breakaway gaps occur. In the instance when prices have been declining during a long downtrend, smart money has been accumulating during the consolidation period, he says, and they're ready to benefit from their accumulation. They want prices to go higher. How do they accomplish that without spending more money than they want? They gap prices above the pattern.

How does this gapping action accomplish their goal? It traps shorts, for one thing. It convinces want-to-be bulls that they're missing the boat. The minimal money spent by big or smart money will then be augmented by those trapped shorts rushing to cover and those new bulls rushing to get on the train. Big money doesn't have to do much more at that point than support prices through an attempt to retrace the gaps and then enjoy the fruits of their labor. The opposite occurs when big money has been distributing stock, of course, or entering net short positions. Prices are gapped lower out of a consolidation pattern.

That's a primary reason that traders counting on a strategy that calls for a gap fill often find their trading accounts depleted by the attempt. Big or smart money intends to have prices go higher when they institute a breakaway gap after accumulation and lower when the institute one after distribution. In TECHNICAL ANALYSIS EXPLAINED, Martin J. Pring points out that "the presence of the gap emphasizes the bullishness or bearishness of the breakout."

Williams would further warn that not recognizing what's happening means that you're attempting trades counter to big or smart money. That's never a strategy that we retail traders want to employ. Williams says that big or smart money already has access to more information than we do, so we certainly don't want to ignore the information we're given in the form of recognizable chart patterns such as the breakaway gap.

The trouble is, as the article "Gap Trading Strategies" in Stockcharts.com's "Chart School" suggests, it's sometimes difficult to identify the type of gap until looking back on the action. How, then, does a trader identify a breakaway gap when it's occurring and differentiate it from other types of gaps that might be filled? First, breakaway gaps tend to occur after a trend has long been in place, but then wanes and a major basing or consolidation pattern forms. The necessity to include two years' of data on A's chart scrunched the candles together and didn't allow for channels to be drawn, but Agilent had been declining in a well-defined descending regression channel for a month when it gapped higher the morning of 8/17/06.

Such gaps usually occur on high volume, although Pring warns that downside breakaway gaps don't require high volume to be valid. Let's drill down on Agilent's chart from that period in August 2006 and see how many of those recognizable patterns were visible.

Annotated Daily Chart of Agilent:

Tom Williams' comments about the genesis of breakaway gaps prompted this article. In the current climate, the topic of breakaway gaps prompts us to look for them now.

Annotated Chart of the IWM:

Because volume information is not available on the Russell 2000, I used the IWM as a proxy.

After a study of that chart and knowing the characteristics of these gaps, it seems relatively easy to distinguish breakaway gaps from running or measuring gaps. We know not to anticipate that breakaway gaps will be filled or at least not until there's been a major trend change again. If we see a breakaway gap these days in a stock that had previously been zooming, with prices gapping below established formations, we won't expect a reversal up through the gap. We're good, right? We know the rules and we can recognize a breakaway gap when we see one.

So, what do we think about AAPL, with this chart snapped January 25? What could we have predicted, if anything?

Annotated Daily Chart of AAPL:

Time will tell, but when this article was first roughed out, before I had the benefit of watching subsequent actions that have occurred since, I typed these words: "AAPL could fall to 117-118 and then attempt a bounce back to the gap level, perhaps even consolidating at that level for a while before final direction is known."

On Friday, February 8, as I'm editing this article, AAPL has so far fallen to a low of 117.27. If AAPL does bounce, because of the nature of the gap and the possibility that it's a breakaway gap, I'd be particularly watch for rollover potential as it approaches that gap area.

What's the point of this look at AAPL's chart? It certainly wasn't to give trading advice in a particular stock. Although I did write the quoted statement late in January and not early in February, predicting the decline to 117-118, you don't even have to believe that. The point is to say that although we know the characteristics of a breakaway gap and they're quite easy to identify afterwards, they're not as easy to differentiate when they've just occurred.

I let the presence of another gap last fall near 145 guide me a bit in determining that this might be a breakaway gap, since the two gaps isolate the whole formation above 145, turning it into a consolidation pattern. Perhaps, though, it's just as valid to say that AAPL had clearly been in a downturn since late in December, and perhaps this is a measuring gap, of the type to be discussed next week.

Clearly, it's possible to argue either way at this point in time. However, knowing about the different types of gaps does give us some information even if we're not sure. Without being certain that our conclusions are right, our information this time is that AAPL might not fill that gap again until a new uptrend has been firmly established and so any who have entered bullish positions now should be particularly careful of their bullish profits as AAPL approaches that gap . . . just in case.
 

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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