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Daily Newsletter, Wednesday, 02/20/2008

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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

Market Wrap

Wednesday, February 20, 2008

Marking Time


1.0 Overview

1.1 Markets at a Glance--Three 'C's--Choppy Consolidation Continues
1.2 Bonds and Credit Spreads
1.3 Economic Reports

2.0 Equities

2.1 S&P 500 Index (SPX)
2.2 Dow Jones Industrial Average (DOW)
2.3 Nasdaq-100 Index (NDX)
2.4 Russell 2000 Index (RUT)

3.0 Selected Industry Groups

3.1 Banking Index (BIX)
3.2 U.S. Home Construction Index (DJUSHB)
3.3 Transportation Index chart (TRAN)

4.0 Currencies

4.1 U.S. Dollar (DXY)

5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)
5.2 Gold Fund (GLD)


6.0 Summary


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1.0 Overview

Today's Numbers

1.1 Markets at a Glance--Three 'C's--Choppy Consolidation Continues

Nice 200-point rally in the DOW off today's low. We've got some pretty wild swings in the market and yet it continues to march in place. The market has essentially gone nowhere since the middle of January. And yet in the last month or so we've seen the DOW swing more than 1100 points and today's close places it within 340 points of the high of the past month's range.

Many of us are having a hard time keeping up with these moves. As those of you who follow my commentary live on the Market Monitor know, I try to keep up with the day's moves and use EW (Elliott Wave) analysis in an attempt to maintain a "roadmap" of where the market is and therefore where it could be headed. It's a good thing I can make changes on the screen instead of a piece of paper--my eraser would have rubbed through the paper by now.

The choppy price action and whipsaw moves are very challenging for traders to follow, let alone trade. If you're struggling with your trading the past month you are not alone. I mentioned a couple of weeks ago that professional traders who have been doing this for 30 years can't remember a more difficult market than the current one. It's a good sign that you should be backing off a bit, trading lightly or not at all, and let the market pick a direction that will hopefully then be tradeable.

The trouble of course is figuring out when the market has established a short term trend that you can join. Since the January low there has been a major battle between the bulls and the bears and the market reverses on a dime with every little bit of news about the banks or bond insurers, who is going to write down how much, how much the Fed is lending the banks right now ($50B), whether the Fed will lower rates or not, etc. Each bit of news is used by the bulls or the bears to support their argument as to why the market should rally or sell off. We traders who are trying to take a little nibble out of the cheese and scurry back into our holes are finding the cheese keeps getting moved.

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One look at the daily charts will show you that this market is coiling for a big move. It may only be good for one shot in either direction before getting reversed again, but a 1000-point move in the DOW is not something you want to let go against you. By the same token, it would be a very nice move to catch for a trade. As always I'll set the charts up with key levels to watch so that we can identify the early part of the move and then ride that wave, up or down, we don't care.

Whether or not we get a blast higher before the market turns back down is the biggest question in my mind. The consolidation pattern we've seen since the January low is a continuation pattern, meaning we should see the decline continue. But the question as of tonight is whether we get a quick pop higher first and I'll show some upside targets to trade in case that happens.

1.2 Bonds and Credit Spreads

But one area that is giving us a heads up for another leg down in the market is what's happening with the credit spreads, which is a measure of bond traders' willingness to accept risk. The higher the risk the larger return they want. Therefore the spread between the riskier bonds (rated less than 'A') and the 10-year Treasury Notes is a good way to see how bond traders are feeling about the market risks.

First we'll look at the updated 10-year yield:

10-year Yield (TNX), Daily

The rally in yields (selling in the bonds) since the January low has yield right up against its downtrend line from October. Slightly higher is the downtrend line from June through the October high. I've been expecting a rally up to the 4.0%-4.3% area and today's high is just under this range. From an EW perspective it would be typical to see a 50% retracement of the June-January decline which would have it testing the December high--near 4.3%. If at any time TNX drops back below 3.5% it will likely mean the bounce is over and we'll get another leg down.

While TNX is rallying, which means bond holders are earning a higher return, the spread between these and the riskier bonds continues to widen. The following chart shows the DOW and an inverse chart of the credit spread (the higher the spread the lower the line, shown in dark blue):

Credit Spread between BAA Bonds and 10-year Note, Daily, courtesy Elliott Wave International

As noted on the chart, the spread is measuring the difference between the Moody's Bond Indices Corp. BAA and the 10-year yield. The spread has continued to widen through the month of January and into February. This says bond traders in this riskier category are demanding a higher return for what they perceive as higher risk. The point to take away from this chart is how the stock market generally follows the credit spread. As bond traders see higher risk in the junkier bonds so too do stock traders see higher risks in stocks, and both sell. Selling in the riskier junk bonds drives yields higher and selling stocks of course drives prices lower.

Notice the divergence between the credit spread and the stock market back in October--the higher high in stocks was not matched by a higher high in the credit spread. The stock market soon followed the bond market down. Now we have a similar negative divergence between the bounce in the stock market since the January low and a lower low in the credit spread (again, higher spread but it's being graphed inversely to better show a match with stock prices). Care to guess who will win in this divergence? My money is with the bond market and therefore being short the stock market is the better play here.

1.3 Economic reports

Housing Starts and Permits

This morning's reports showed the housing market stabilizing a little, with housing starts improving slightly from the previous month but unfortunately permits did not. Starts improved by +0.8% to 1,012K but permits continued to decline, down -3.0% to 1,048K. The downward trend in sales has not slowed yet so these numbers can be expected to decline further. The following chart, courtesy briefing.com, shows graphically how much these numbers have dropped:

From the peak in 2005 the number has already been cut in half and nearly back to 1991 levels. When the number drops down to 800K (probably a little lower since the excesses were so significant at the high) then we'll probably start to carve out a bottom in housing.

New home inventories continue to make new highs and tighter lending standards by mortgage lenders is making it increasingly difficult to obtain a mortgage. The jump in the 10-year yield is also making new mortgages more expensive.

CPI and Core CPI

Inflation remains a worry as it continues to tick up and it came in slightly above expectations. This of course worries those who are expecting the Fed to continue lowering interest rates. The Fed has made it clear that it's more difficult to fight inflation than a slowing economy. With CPI up +0.4% (+4.3% year-over-year) and core CPI up +0.3% (+2.5% yoy), both are obviously above the Fed's target rate of 1%-2%. A slowing economy and rising inflation is very worrisome and many more are starting to talk about stagflation and a return to a time similar to the 1970s. Stagflation is not good for the stock market.

Inflation worries also spiked commodities today--gold and oil made new highs (not associated with a new low in the US dollar). Bond yields jumped higher on worries that inflation may continue. All of this is raising concerns that the Fed may be forced to back off on their assurances that they will do whatever they have to in order to alleviate the credit crisis. A rock and a hard place is where the Fed is currently located. They've been painted into a corner and there's no escaping getting paint on their shoes.

The following chart shows the spike up in CPI (red). While the core rate (blue) is less volatile, it too has turned back up from its recent low. The uptrend from 2004 is worrisome. Chart courtesy briefing.com:

With inflation (costs) heading higher, unemployment heading higher, and talk of recession, the almighty consumer may do a little less consuming and that of course will only accelerate the economic slowdown (on a global basis, not just in the U.S.). A consumer-led recession will not be over nearly as quickly as the business-led recession in 2002. And all of this has led to a spike in the misery index, chart courtesy nowandfutures.com:

The index is based on unemployment and inflation--the higher each goes the unhappier people become. Pretty logical. The trouble for the stock market is that unhappy people tend to be sellers rather than buyers of stock. You can see how high the misery index became by the early 1980s, the end of the previous bear market. This index is already higher than it was at the start of the 1970s and it makes me wonder where it's headed. This is very worrisome, and bearish for the stock market.

FOMC minutes
The Fed reiterated that it will do what is necessary to fight the slowing economy (to which I say let the economy and market do what it has to do to cleanse itself) and credit problems but they're starting to express more concern about inflation. Their confusion about which monster to slay has only added to the market's confusion (hence the battle royal between the bulls and the bears). Methinks they now have a two-headed monster and a rubber sword. They acknowledged that core inflation would increase at a faster rate than they had thought back in October. And they're projecting the economy to grow between 1.3% and 2.0%, down from 1.8%-2.5%. So they've ratcheted down growth expectations while increasing their inflation expectations. Sure sounds like stagflation to me. And I strongly suspect those growth expectations will continue to be ratcheted down.

As the Fed stated, "Still, with no signs of stabilization in the housing sector and with financial conditions not yet stabilized, the FOMC agreed that downside risks to growth would remain even after this action [the steep rate cut]." The market is still pricing in at least another half-point rate cut in March. As part of the mixed message though, the FOMC said "...when prospects for growth have improved, a reversal of a portion of the recent easing actions, possibly even a rapid reversal, might be appropriate." Think we've seen a roller coaster so far? Hang onto your hats if they reverse but the economy is still slowing. The stock market will not like it one bit.

And speaking of the stock market, time to check the charts and see what the past month's mess has left us.

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2.0 Equities

2.1 S&P 500 Index (SPX)

SPX chart, Daily

Speaking of a mess--the daily chart has way too many lines on it and I apologize for the spaghetti look to this chart. But there are a couple of things I want to point out. First, we're still in a downtrend--price is battling the top of the parallel down-channel for price action since the October high (blue downtrend line). But price might continue to chop sideways in a triangle pattern. Whether it breaks to the upside for a run to the 1460 area (and then head lower again) or breaks down from the current consolidation is difficult to determine from here. As noted on the chart, we've got the following levels to help guide us:

Key Levels for SPX:
- Short term bullish above 1369 and then it could find resistance around the 38% retracement level near 1387; a little more bullish above 1396 for a run to 1460
- Longer term bullish above 1460
- Short term bearish below 1336, today's low but it would find support above 1317 for another leg up inside the consolidation pattern; more bearish below 1317
- Longer term bearish below 1270

SPX chart, 60-min

Today's rally stopped at the downtrend line from last week's high and this could be the top of a smaller sideways triangle than that shown on the daily chart. This triangle points to another rally leg (if it finds support at or above 1336). I also show a parallel up-channel for price action since the February 7th low, with the top currently near 1380. A quick rally to there could be followed by some swift selling. Play the direction of the break of the key levels shown on the chart.

2.2 Dow Jones Industrial Average (DOW)

DOW chart, Daily

The DOW is also battling against the top of its parallel down-channel from October. A break below today's low could be the signal that the consolidation is finished and the selling will resume (in earnest since the bearish wave count is extremely bearish). Rather than showing a sideways triangle pattern, as on the SPX daily chart, I'm showing the possibility we'll get another rally leg up to the top of a parallel up-channel from the January low. This projects a rally up to near 13300 before turning back down (coinciding with SPX pushing up to the 1460 area). A break above 12767, the February 1st high, would point to that move.

Key Levels for DOW:
- Short term bullish above 12572 and more bullish above 12767
- Longer term bullish above 13300
- Short term bearish below 12229 and more bearish below 12070
- Longer term bearish below 11634

DOW chart, 60-min

Depending on whether or not we have a small sideways triangle playing out, a choppy pullback tomorrow could find support near 12250 and launch a rally leg from there. A drop below 12229 will either be a larger corrective pullback or the start of something more significant to the downside. Below 12070 would likely mean a move down to at least the 11800 area.

2.3 Nasdaq-100 Index (NDX)

Nasdaq-100 (NDX) chart, Daily

NDX has a very nice fitting sideways triangle consolidation pattern playing out so far (as the 4th wave correction within the decline from October, a common pattern for the 4th wave). If anything I'd go with this index as an indicator for where the broader market will head next (the techs usually lead the way but not always, as we saw in October when the techs made their final high almost three weeks after the broader market). If the rally continues in the techs from here, watch 1886 for resistance. It could drop straight from here but the triangle pattern need a little more downside then another bounce before it's ready to head lower, probably around the first of March.

Key Levels for NDX:
- bullish above 1886
- bearish below 1715
- likely to be choppy in between

Nasdaq-100 (NDX) chart, 60-min

I've zoomed in on the potential sideways triangle pattern. If it chops a little lower and then chops up to a lower high by the end of the month it will be a very good setup for a short play for the 5th wave down into early March (which would then set up a long play for a bigger rally to correct the October-March decline). As shown with the pink wave count, a rally from here could take it up to the 1886-1900 area before turning back down.

2.4 Russell 2000 Index (RUT)

Russell-2000 (RUT) chart, Daily

The RUT is also staying within its parallel down-channel from October. It could also be forming a sideways triangle (not drawn on the chart) and which way it will break is a bit of a toss-up. If it breaks higher watch for a move to about 760. If it breaks lower we could see some very strong selling due to the very bearish wave count potential (start a series of strong 3rd waves to the downside).

Key Levels for RUT:
- Short term bullish above 723 and then more bullish above 731
- Longer term bullish above 770
- Short term bearish below 695 and then more bearish below 688
- Longer term bearish below 650

Russell-2000 (RUT) chart, 60-min

The RUT's pattern on the 60-min chart is one of the cleanest right now and shows both wave count scenarios that I consider the highest potential. The pink count shows a little more rally followed by what should be a choppy pullback that finds support at the bottom of the triangle pattern and then rally up to the 760 area from there. The dark red count shows the very bearish scenario is about to unfold in a series of strong 3rd waves to the downside.

You don't need to understand EW to know that the 3rd waves are the strongest moves and this count portends some very serious selling is about to hit. It should sell off from here but the bearish potential isn't negated until it rallies above 723. A break below 695 would be a heads up and a break below 688 could get serious.

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3.0 Selected Industry Groups

3.1 Banking Index (BIX), Daily chart

The pattern of the decline in the banking index the past two weeks is a bit funky looking. It's been a slow drop with lots of overlapping highs and lows within the move down. This is typically found in an ending pattern so a rally out of this is very possible (green arrow). It may be part of a larger correction before heading lower and it takes a break above its February 1st high near 297 to put it on the bullish price path. In the meantime I continue to think we have not seen the final lows for the banks and a move down to 200 continues to look like a good possibility.

3.2 U.S. Home Construction Index (DJUSHB), Daily chart

The banks and home builders continue to look very similar, as though they were joined at the hip. I see the possibility for a brief pop up in the builders but then a turn back down as it heads for what could be the final low near 213. A break of its last high near 410 would put it on a bullish path.

3.3 Transportation Index chart (TRAN), Daily chart

The sideways chop in February for the Trannies looks like a continuation pattern and should resolve to the upside. But the pattern for the rally off the January low suggests the new high will be short lived and reverse lower. The 200-dma could be a good resistance level to short (pick your weaker transport stock with a similar pattern setup).

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4.0 Currencies

4.1 U.S. Dollar (DXY), Daily chart

While commodities (gold, silver, oil and many others) rally, it's not because of a sinking dollar this time. Inflation worries are spooking commodities, and may be indicating what the dollar will do next. The US dollar continues to support the idea that it will stay within a sideways triangle into March before heading lower again (downside target near 72). But if the dollar should rally out of this, and rally above 77.85, there's a good chance we'll then see a strong rally in the dollar. Commodity prices would probably have a hard time staying aloft in that case.

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5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)

Oil Fund (USO), Daily chart

The pattern in oil is starting to remind me of a broadening top formation. This is typically a reversal pattern and it's debatable whether it's nearly done or has another down-up sequence to play out (light green). A rally above 81 would be more immediately bullish but watch for resistance at or below this level. It takes a drop all the way back down below 68.50 (about 85 for oil) to say a top has been found. Keep an eye on oil stocks since they typically lead the commodity.

Oil Index chart, Daily chart

While it's certainly possible to consider the bounce off the January low as a bullish start to a run to new highs, that's not my preferred wave count on the oil stocks. I believe this index is now very close to finishing an a-b-c bounce off the January low that is now close to achieving two equal legs up (839.88). It could head a little higher for a retest of its broken uptrend line from August (near 850).

I like the setup, especially if it works its way slightly higher, for a short play on the oil stocks with a stop just above 850.

5.2 Gold Fund (GLD), Daily chart

It would appear that we might have had a small sideways triangle pattern play out from January and a rally up to the top of its parallel up-channel from August, currently near 95, looks like a good possibility here. But gold and silver give me the impression that it may find a top sooner rather than later. The bearish divergence against MACD is a big warning here not to chase this to the upside. When it breaks down it could go very quickly (which is true for many of the commodities which have built parabolic rallies and we know what happens to those). Tread carefully here. A break below 88.50 (about 900 for gold) would be followed by some fast selling.

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6.0 Summary

Bottom line is we're in a very choppy price environment and traders are getting whipsawed out of their trades. "Drawdown" is a commonly heard expression. Even among us writers on the Market Monitor, each of us using different trading tools, we're all complaining about the same thing--technical analysis seems to be broken (meaning the market is not doing what it normally does following a technical setup that we've seen time and again). This is when you need to take a step back and reevaluate. Drawdowns are a part of our business--they're our costs of doing business.

Normally you'll have periods of drawdowns that make you believe you couldn't trade your way out of a wet paper bag. There will be other times when you believe you're God's gift to the trading world and can do no wrong. One of the tricks that long term traders will tell you is that they will trade lightly during periods when they feel out of synch with the market and then trade with larger than normal positions when they feel like they're in synch. My guess is that most of you feel you're currently out of synch.

This too shall pass. But you want it to pass with your trading account still intact. Don't get chopped up in little pieces and bleed to death from a thousand paper cuts. Know when to trade and when not to trade. The market is battling big time right now so wait for some direction and then jump aboard. As a summary, use the following levels to help guide you in the direction to trade. In between, where we are now, expect a lot of chop and whipsaws. Good luck.

Key Levels for SPX:
- Short term bullish above 1369 and then it could find resistance around the 38% retracement level near 1387; a little more bullish above 1396 for a run to 1460
- Longer term bullish above 1460
- Short term bearish below 1336, today's low but it would find support above 1317 for another leg up inside the consolidation pattern; more bearish below 1317
- Longer term bearish below 1270

Key Levels for DOW:
- Short term bullish above 12572 and more bullish above 12767
- Longer term bullish above 13300
- Short term bearish below 12229 and more bearish below 12070
- Longer term bearish below 11634

Key Levels for NDX:
- bullish above 1886
- bearish below 1715
- likely to be choppy in between

Key Levels for RUT:
- Short term bullish above 723 and then more bullish above 731
- Longer term bullish above 770
- Short term bearish below 695 and then more bearish below 688
- Longer term bearish below 650


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New Plays

New Option Plays

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

New Calls

None today.
 

New Puts

None today.
 

New Strangles

Genentech - DNA - close: 72.37 change: -0.47 stop: n/a

Company Description:
Founded more than 30 years ago, Genentech is a leading biotechnology company that discovers, develops, manufactures and commercializes biotherapeutics for significant unmet medical needs. (source: company press release or website)

Why We Like It:
DNA has a big FDA decision coming up on its Avastin drug. Actually it's a decision by an FDA advisory committee and not final approval but it can still have a big impact on the stock price of DNA. Avastin is already approved for other cancers and has shown to retard the growth of tumors. The upcoming decision expected on February 22nd or February 25th is about using Avastin to combat breast cancer. We are suggesting a strangle to capture any post decision move. Looking at the open interest there appears to be a lot of investors considering a strangle.

Suggested Options:
A strangle involves buying both an out of the money call and an out of the money put. We are suggesting the March options. Our estimated cost for this play is $2.80. We want to sell if either option hits $5.00 or higher.

BUY CALL MAR 75.00 DWN-CO open interest=14557 current ask $1.40
-and-
BUY PUT MAR 70.00 DWN-ON open interest=11306 current ask $1.40

Picked on February 20 at $ 72.37
Change since picked: 0.00
Earnings Date 04/10/08 (unconfirmed)
Average Daily Volume = 3.5 million
 


Play Updates

In Play Updates and Reviews

Call Updates

Apple Inc. - AAPL - close: 123.82 change: 1.64 stop: see details

AAPL dipped toward yesterday's low early this morning before finally bouncing higher. We do not see any changes from our previous comments on our triple play.

AAPL play #1 - directional calls

A rebound from here can be used as a new entry point to buy calls. However, the major averages are just churning sideways, up one day and down the next. If the market is down tomorrow then we might get a better entry point in AAPL closer to the $120 level. Our stop loss is under the early February low. More conservative traders may want to use a stop closer to $120. Our target is the $139.00-145.00 range.

AAPL play #2 - Credit put spread

For the credit put spread we want to wait for signs of a bounce before launching new positions. The options we suggested were buying the March $110 put and selling the March $120 put.

AAPL play #3 - Sell Naked Puts

Again, look for a bounce before launching new naked put positions. We had suggested selling the March $150 put with plans to buy it back when AAPL hits $139.00.

Picked on February 10 at $125.48
Change since picked: - 1.66
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 44.4 million

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Atwood Oceanics - ATW - cls: 95.36 change: 1.96 stop: 87.45

Perfect! We suggested looking for a dip near $91.50 as a new entry point. ATW hit $91.43 this morning and bounced sharply. Oil's strength and ability to maintain its hold on the $100 level is a plus for the sector. More important, Transocean (RIG) reported earnings and the results were strong, fueling gains in the oil services sector. ATW ended the day with a 2% gain on above average volume. Our target is the $99.00-100.00 zone. FYI: ATW has a moderate amount of short interest, about 7.4% of the 27.6 million-share float. That is about 4 days worth of short interest.

Picked on February 17 at $ 90.37
Change since picked: 4.99
Earnings Date 05/08/08 (unconfirmed)
Average Daily Volume = 654 thousand

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CF Industries - CF - close: 127.00 change: 0.42 stop: 109.49

CF took its turn to present at the basic materials conference today. The stock did not move on any news but neither did shares see much profit taking after yesterday's big gain. If you missed the entry point look for a dip back into the $122-120 zone as an alternative entry. Our target is the $138.00-140.00 zone. The Point & Figure chart is bullish with a $141 target. FYI: The most recent data puts short interest at 6.8% of the 53.4 million-share float.

Picked on February 19 at $121.03 *triggered/gap higher
Change since picked: 5.97
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 2.8 million

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Monsanto - MON - cls: 119.05 change: 1.18 stop: 107.85

MON did suffer some profit taking this morning but investors were quick to buy the dip near $115. We were suggesting readers buy a pull back in the $116-114 zone. Now the stock is poised to breakout over resistance near $120. We have two targets. Our first target is the $127.00 level. Our second target is the $137.00-140.00 range. As we discussed earlier a move over $118 triggered a new P&F chart buy signal, which now forecasts a $157 price target. These have been very volatile stocks so readers should consider them aggressive, higher-risk plays. FYI: MON is presenting at the Morgan Stanley Basic Materials Conference 2008 on February 21st

Picked on February 12 at $118.09 *gap higher entry
Change since picked: 0.96
Earnings Date 04/03/08 (unconfirmed)
Average Daily Volume = 7.1 million

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Mosaic - MOS - close: 114.04 change: 4.49 stop: 99.45 *new*

MOS continues to surge. The stock added another 4% on top of yesterday's big gain. Shares are now above the January peak and hitting all-time highs. Volume was above average on today's move. We are adjusting our stop loss to $99.45. MOS has already hit our first target near $110 and is quickly approaching our second target in the $118.00-120.00 zone. These are very volatile stocks with a lot of intraday spikes. We would consider this a more aggressive, higher-risk play.

Picked on February 12 at $101.83 *gap higher entry
Change since picked: 12.21
Earnings Date 04/09/08 (unconfirmed)
Average Daily Volume = 5.8 million

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Nucor - NUE - close: 65.99 change: 2.10 stop: 59.95 *new*

Shares of NUE continued to rally as well. The stock added 3.2% and broke through resistance at the $65.00 level. We are adjusting our stop loss to $59.95. Our target is the $68.00-70.00 zone since the $70.00 level is likely to be significant resistance. The P&F chart is bullish with a $76 target. FYI: In the news today NUE announced its 140th consecutive cash dividend and plans to build a processing plant in Mexico.

Picked on February 17 at $ 62.01
Change since picked: 3.98
Earnings Date 04/17/08 (unconfirmed)
Average Daily Volume = 5.0 million

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Petroleo Brasileiro - PBR - cls: 120.54 chg: 2.88 stop: 109.45

Continued strength in crude oil is lifting the sector. PBR added 2.4% and closed above round-number resistance at $120.00. This looks like another bullish entry point to buy calls. We are considering a second target near $140. Currently, our target is the $128.00-130.00 range. The move over $116 has produced a new Point & Figure chart buy signal. Actually it is a quadruple-top bullish breakout buy signal with a $150 target (it was a $138 target last week). 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.

Picked on February 12 at $116.00 *triggered
Change since picked: 4.54
Earnings Date 02/12/08 (unconfirmed)
Average Daily Volume = 7.6 million

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Potash - POT - close: 156.00 change: 3.50 stop: 144.75 *new*

Target achieved. POT hit an intraday high of $158.30. Our first target was the $158.00-160.00 range. It was POT's turn to present at the basic materials conference today. The company continues to issue very bullish comments for their business and the industry. The stock added almost 2.3% and closed at all-time highs. It is conceivable that POT might pull back when it hits $160. Look for a dip near $152-150 as a new entry point for calls. We are raising our stop loss to 144.75. Our second, more aggressive target is the $168.00-170.00 zone. More aggressive traders may want to aim significantly higher. The Point & Figure chart is forecasting a $222 target. Again, this is a very volatile stock. Readers should consider it an aggressive, higher-risk trade.

Picked on February 12 at $147.50 *triggered
Change since picked: 8.50
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 5.9 million

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Smith Intl - SII - close: 63.69 change: 0.96 stop: 58.45

Oil service stocks continued to rally thanks to a strong earnings report from RIG. Shares of SII added 1.5% and broke through its 200-dma. We are going to go ahead and add a second target. Our first target is the $64.25-65.00 range. Our second target is the $68.00-70.00 zone. We would expect SII to pull back initially when it hits $65.00 since shares will encounter additional resistance with the 50 and 100-dma. If you're looking for a new entry point wait for a dip in the $61-60.00 zone. The P&F chart for SII is very bullish with a $77 target.

Picked on February 17 at $ 60.52
Change since picked: 3.17
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 3.5 million

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Yahoo! Inc. - YHOO - close: 28.83 change: -0.18 stop: n/a

While MSFT yells, "ramming speed", shares of YHOO are pulling back in fear that this deal won't get done. The stock dropped again losing 0.6%. We do not see any changes from our previous comments. This remains a very speculative (high-risk) play but there is still a strong camp that believes MSFT will up their bid. We would suggest the March $30 or March $32.50 calls.

Picked on February 17 at $ 29.66
Change since picked: - 0.83
Earnings Date 04/17/08 (unconfirmed)
Average Daily Volume = 54 million
 

Put Updates

Ambac Fincl. - ABK - cls: 9.94 change: -0.00 stop: n/a

Wall Street continues to talk about dividing the bond insurers but the stocks aren't moving. ABK closed unchanged at $9.94. Overall we do not see any changes from our previous comments. Currently we are suggesting the May puts and a speculative out of the money March call as a hedge to protect us if a bailout deal does get done. Many on Wall Street expect something to occur this week but it could drag out to next week. The options we suggested were the May $5 or $2.50 puts and the March $20 call.

Picked on January 27 at $ 11.54
Change since picked: - 1.60
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 10.9 million

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Bear Stearns - BSC - cls: 83.05 chg: 3.03 stop: 85.05

It has been a volatile three days for BSC. The stock is up and down 3% and 4% at a time. This time the whole broker-dealer sector bounced higher. We also note that this time BSC looks better positions to carry through with another rally tomorrow. More conservative traders may want to cut their losses now. We're not suggesting new positions. Our target is the $71.00-70.00 zone. 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.

Picked on February 11 at $ 79.49 *triggered
Change since picked: 3.56
Earnings Date 03/13/08 (unconfirmed)
Average Daily Volume = 7.4 million

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FedEx - FDX - close: 89.94 change: 0.69 stop: 90.55

We just recently lowered our stop loss to $90.55 and now we're in danger of being stopped out. FDX is creeping higher and pierced resistance at its 50-dma and the $90.00 level this afternoon. The intraday chart would suggest FDX is poised for more gains tomorrow, which would see us being stopped out. Truly nimble traders could choose to buy calls above $90.50 and exit near resistance at $94.00. We are not suggesting new put plays at this time.

Picked on February 10 at $ 88.00
Change since picked: 1.94
Earnings Date 03/20/08 (unconfirmed)
Average Daily Volume = 3.2 million

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W.W.Grainger - GWW - close: 74.92 chg: 0.38 stop: 78.26 *new*

GWW hit a new relative low this morning before bouncing back into the green. We are going to try and reduce our risk by adjusting the stop loss to $78.26. Our target is the $70.75-70.00 zone.

Picked on February 10 at $ 76.65
Change since picked: - 1.73
Earnings Date 04/16/08 (unconfirmed)
Average Daily Volume = 1.0 million

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iShares DJ Financial - IYF - cls: 87.85 chg: 1.13 stop: 91.85

Everyone claims to still be worried about the financials and that the financials will probably see a lower low this year but the IYF has been trading sideways for days. Granted it has a bearish trend of lower highs but if the IYF can rally from here it might break that short-term trend (not the longer-term trend of lower highs). The sector is still very much in a longer-term bearish trend. More conservative traders will want to strongly consider adjusting their stop closer to $90.00. We're aiming for a test of the $80.00 region. Our official target is the $81.00-80.00 zone.

Picked on February 06 at $ 88.62
Change since picked: - 0.77
Earnings Date 00/00/00
Average Daily Volume = 1.1 million

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MBIA Inc. - MBI - close: 12.18 change: 0.48 stop: n/a

More talk about splitting up the bond insurers is not producing a lot of excitement in the stock price. MBI did rise 4.1% but shares are essentially churning sideways near $12.00. Overall we do not see any changes from our prior comments. Currently we are suggesting the May puts and a speculative out of the money March call as a hedge to protect us if a bailout deal does get done. Many on Wall Street expect something to occur this week but it could drag out to next week. The options we suggested were the May $7.50, $5.00 or $2.50 puts. We recently added a deep out of the money call, the March $22.50 call, as a hedge in case a rescue plan does get announced and the stocks react to it. (at this point you may want to consider the March $20 call instead)

Picked on January 27 at $ 14.20
Change since picked: - 2.02
Earnings Date 01/31/08 (confirmed)
Average Daily Volume = 15.2 million

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Mohawk Ind. - MHK - cls: 74.47 chg: 1.54 stop: 78.05

Our play went from -0.77 to 0.77 with MHK's 2.1% bounce. The stock is now testing resistance near $75.00 and its 50-dma. A failed rally here can be used as a new entry point for puts. There is potential support at $70.00 but we're aiming for the $66.50-65.00 zone near its January 2008 bottom.

Picked on February 14 at $ 73.70
Change since picked: 0.77
Earnings Date 02/13/08 (confirmed)
Average Daily Volume = 907 thousand

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Myriad Genetics - MYGN - cls: 37.78 chg: -0.10 stop: 40.51

Shares of MYGN traded sideways in a 35-cent range all day long. Lack of a bounce higher with the rest of the market this afternoon is bearish. Our MYGN target is the $36.00-35.00 range. More aggressive traders may want to aim lower. 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.

Picked on February 07 at $ 39.75 *triggered
Change since picked: - 1.97
Earnings Date 02/05/08 (confirmed)
Average Daily Volume = 801 thousand

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Sears Holding - SHLD - cls: 98.48 chg: 2.17 stop: 100.25

SHLD tagged the $95.00 mark this morning and bounced. The stock ended with a 2.2% gain after failing to breakout over $100.00. This may prove to be yet another entry point to buy puts but we are going to stick to our plan. Currently our official entry point to buy puts is at $94.75. 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 (now confirmed) earnings report.

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

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Simon Properties - SPG - cls: 84.97 chg: 1.60 stop: 90.15

SPG is trying to bounce. Look for another failed rally near $86.00 as a potential entry point. Our target is the $76.00-75.00 range.

Picked on February 07 at $ 84.39 *triggered
Change since picked: 0.58
Earnings Date 02/01/08 (confirmed)
Average Daily Volume = 2.7 million

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Legacy Vulcan - VMC - cls: 68.75 chg: 2.25 stop: 70.86

VMC produced an impressive 3.3% bounce today but we warned readers that the stock was volatile. Wait for a failed rally near $70.00 before considering new puts. Our target is the $60.50-60.00 zone. The stop loss is a little bit wider than we would like but VMC can see some big $3-$4 swings intraday so readers should consider this an aggressive, higher-risk play.

Picked on February 17 at $ 66.64
Change since picked: 2.11
Earnings Date 04/30/08 (unconfirmed)
Average Daily Volume = 2.1 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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CROCS Inc. - CROX - close: 27.44 chg: -4.64 stop: n/a

Concerns over rising inventory is what really spooked investors after CROX reported earnings last night. The stock gapped open lower and lost 14.4% by the closing bell. We are not suggesting new strangles at this time. The options we had suggested were the March $40 calls (CQJ-CH) and the March $25 puts (CQJ-OE). Our estimated cost was $2.50 and we wanted to sell if either option hits $4.25 or higher.

Picked on February 17 at $ 33.43
Change since picked: - 5.99
Earnings Date 02/19/08 (confirmed)
Average Daily Volume = 5.2 million
 

Dropped Calls

Boeing - BA - close: 84.00 change: -1.37 stop: 83.99

Our new call play in BA did not last long. We added it last night but warned readers that if the major averages were weak today we would probably get stopped out. The morning market decline was enough for BA to hit our stop loss at $83.99. Shares of BA continued to under perform all day long and did not bounce back like most of the market. It is possible that investors are reacting negatively to news that BA's aircraft rival, Airbus, said that they expect new orders in 2008 to be half of what they sold last year.

Picked on February 19 at $ 85.37
Change since picked: - 1.37
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume = 6.5 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

When Bearish News No Longer Drives Stocks Lower

There reaches a point in a bear market cycle where bearish news on the economy, on inflation, etc. no longer drives the market down much lower. This is what happens when we say that the market gets 'oversold' in a major way. Looking at the underlying dynamics at play here, it takes continued SELLING to drive prices lower.

On the way down, when the market is factoring in a bearish economic outlook and a bearish outlook for earnings, there is a lot of selling on each piece of negative news and the market keeps selling off. However, after so much of this, the market also reaches a state of equilibrium for the CURRENT outlook. Most everyone who is going to sell has sold, so to speak. A number of big market players are also SHORT a number of bellwether stocks.

If prices stop declining, it doesn't even take overtly bullish news to cause a rally. It's enough that the bearish news stops for a while. Shorts will start to cover (by buying) if prices rise on just a minimum of speculative/trader buying. The dynamic in an oversold situation is that there are not a lot of sellers tending to come in until the market rebounds some distance up from the low; e.g., a 10 percent rise.

Or, in terms of retracements, we could look at the rally potential, before substantial renewed selling, as a retracement of half (50%) or a bit more (e.g., 62%) of the last major downswing.

Bear market rallies tend to run out of steam due to it taking substantial new BUYING to drive prices up more than, say 10 percent off the low or to more than a 50-62% retracement of the last major decline.

One of the historical precursors for rallies that have extended above and beyond a nominal 8-10 percent up off the lows is a technical type measurement or 'indicator' that looks at the number of NYSE stocks trading above their 200-day moving averages; to use a shorthand: "percent > 200-day SMA". This is not a fast-gauge type indicator, as it can take weeks or even months for an oversold condition suggested by this indicator to play out with a sustained rally.

The concept is simple. The 200-day moving average is perceived to be the dividing line between a stock that is technically healthy and one that is not. Most traders, including myself, use the simple moving average (SMA) for this measure. (Some also employ exponential moving averages, which give more weight to recent data.)

A stock that is trading above its 200-day moving average is said to be in an uptrend and is being accumulated; one below it is in a downtrend and is being distributed.

On the surface, it seems as though the higher the 'percent > 200-day SMA ' goes, the more bullish the market is and the lower it goes, the more bearish. In practice, however, the reverse is true. Extremely high readings are a warning the market is becoming quite vulnerable to a reversal to the downside. High readings reveal that traders are far too optimistic. When this occurs, fresh new buyers are often few and far between.

Meanwhile, very low readings signify the reverse; the bears are in the ascendancy and a bottom may be near. You'll see examples of both situations on the chart below. Some weeks (or months) may pass before there is an upside or downside reversal that comes AFTER the low or high extremes.

We also need to take a look at just what levels represent high and low readings. On the LOW side (very oversold) are readings at 20 to 40 and BELOW and 70-80 or ABOVE (e.g., at or near 90) are on the HIGH side.

On the upside, traders should have been very cautious when the number of stocks above their 200-day moving average went above 80-85%. Historically, readings in this area have precipitated either a major correction or a bear market. The readings above 90%, which lasted into the early part of March 2003, was the most extreme seen on the chart below. When this percentage figure reversed to the downside in late-2003, there was a steep decline, but also an approximate year and half period of a broad sideways trend.

In the last 20 years, readings around 20 or lower have consistently marked key reversal areas, although rallies have sometimes been a few weeks off; for option traders, these low extremes may simply serve as a warning to not get too attached just to bearish plays. As the chart below shows, but not quite as clear as I would have liked, the 20 level and below marked a major market bottom in October 2001, late July 2002 and October 2002. With this in mind, when the percent above the stocks 200-day averages nears gets to 20% or below, traders should be on the alert for the possibility of a sharp, V-shaped reversal.

Chart from Bloomberg

Readings below 20% are noted on the chart above, where the market has been oversold enough to turn around. From the low in the S&P 500 (SPX) at 1270 until today, the recovery rally has only been 6.6 percent. So far at least, the recovery rally based on the percent of stocks below their 200-day moving averages (with a low extreme near 10 percent), has not carried very far relative to the rallies of around 23-24 percent back at the bottom of the last bear market.

CONCLUSION? We may not be near a bear market bottom; OR, it is going to take a while, such as if there is to be a long sideways (trading range type market) ahead.

From that January 23rd trough low, SPX gained 9.6% over 10 days; from that February 1 peak, the next 4 days brought a 5.7% decline. From the January low to today's close, as noted already, SPX is up 6.6%.

The current number of NYSE stocks above their 200-Day Moving Averages as an indicator, is a reading that, at least in the early part of a possible recovery cycle, have led to strong rallies in the short run. The first 3 readings (far left above in my FIRST chart) were deeply oversold conditions caused by a) the initial collapse from March 2,000; b) The 9/11 sell off; and c) the sell off following that 9/11 sell-off/bounce.

The recent 'percent < 200-day SMA' reading preceded a rally of 9.6% from its low to recent SPX high at 1400. The maximum rebound seen so far is a far cry from the past bounces after such low numbers of NYSE stocks above their 200-day averages.

IF you believe that history will repeat itself, then we still have a ways to go on the upside. IF you anticipate that those prior bounces were materially different than today, than this rally may not have a lot of upside potential before the current rally (from the 1317 area in SPX) runs out of gas.

I'm just taking a wait and see attitude and have a somewhat skeptical attitude about sustained and strong rally potential ahead, but I'm not going to pretend that the market couldn't climb a 'wall of worry', at least as long as the Fed is able to keep lowering interest rates. And, they're in a tough spot to keep doing that, given the inflation pressures.

QUESTIONS/COMMENTS:
Please e-mail Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

GOOD TRADING SUCCESS!
 

Today's Newsletter Notes: Market Wrap by Keene H. Little, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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