Option Investor
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Daily Newsletter, Wednesday, 05/28/2008

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Table of Contents

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

Market Wrap

Crude Reality

I know I didnt come up with that title. I am not that creative. But the fact is that crude is on an uptrend as indicated by the daily chart shown below. It looked like we had a nice reversal and that oil may be on its way down to the 50 day moving average. But it ran down to its 21 day exponential moving average at about 126.

Then at about 9:00 AM EST crude began to run up to close positive on the day at $131 per barrel. I am sure everyone is tired of the coverage of this commodity. But it is affecting the economy and therefore the stock markets. Stochastic on the daily chart show that oil may still have room to move down. But the fact is it bounced hard off of the 21 day EMA.

Those of us with huge vehicles can only hope that the price comes down. The reality is that we should look for long opportunities on the commodity or related stocks. The Proshares DIG and DUG provide a leveraged ETF that allows investors/traders to go long the DJ Oil and Service index with two times leverage. On Saturday, I wrote about the DUG trade we put on in the Option Writer section of the newsletter. To review we sold the DUG June 24 Puts for $0.55 per contract. The current mid price is $0.225 with a bid/offer of $0.15 to $0.30. I didnt look at the price of the position at the open of the market. Unless it reaches $0.05 I probably wont close out the position. Why you may ask? Because I mostly intend to let the option expire worthless unless crude breaks above the previous high of $135 a barrel.

Todays summary is that futures were signaling a gap up open of $4 points on the S&P 500. The main reason is that Durable Orders were only down 0.5%. That was actually better than expected and caused the S&P Futures to open higher. The pre open on crude futures were also down which was giving a sense of false comfort. The market is very reactive to the commodity right now and basically declined while crude advanced. The market hovered around the break even line most of the day only to run up into the close. On the 15 minute time frame chart the $SPX looks to be breaking out with the 8 bar exponential moving average chasing the price of the stock up and also nicely above the 21 bar exponential moving average. The close was also above the 21 bar exponential Upper Bollinger Band. The can be a sign of continued strength and momentum. RSI or Relative Strength is trying to break above the 3:30 PM close. But it all starts over tomorrow.

The SPX

The bigger picture or daily chart below shows that the S&P 500 bounced off its 50 day moving average. On Saturday I was concerned that the indexs downward momentum was going to pull it to the 89 day moving average at 1360. The end result was that the market pulled off an up day after being down as much as a seven points. Frankly, the market may have some follow through unless some of the economic reports surprise us.

The Open Interest for the June SPX options can sometimes give us a different perspective of support and resistance. I have highlighted the peak open interest levels on the Puts and Calls in pink. The Puts show peak open interest at 1400. However, 1375 is next in line with 122,927 Puts open. On the call side 1400 is the peak open interest level at 209,583. That suggests to me that there is pretty good resistance at the 1400 level. You may be asking Why is out of the money call open interest resistance. One popular concept is to only think of the open interest as short options that institutions and hedge fund bets place. In addition, I think this way since it is one of the trades I made when running the fund. Furthermore, we assume these traders are more astute traders and considered the smart money that has more capital and market influence than us. What that basically means is that the smart money may be able to make the index close between these numbers. Another view is that a huge majority of retail option traders are buying out of the money puts and calls at these strike prices. If you are in the contrarian camp as I am you can view these levels are support and resistance since average (non-optioninvestor.com readers) investors are generally wrong the majority of the time.

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Not to forget the Dow Jones Industrials, but it was up 45.68 points today. The S&P 100 ($OEX) closed the day up 1.33 at 634.38 today. The NYSE was up 50.2 at 9364.34. Except for the last 30 to 45 minutes today was just a really boring day. The TRIN was at 0.80 at the end of the session. On the NYSE, there were 1700 Advancers versus 1400 decliners on 1,442,627,000 shares traded. That was higher than yesterday but less than the 50 day moving average (1,510 million). In summary, net advancers on higher volume counts as an accumulation day. The final internal report is that there were 48 New Highs and 92 New Lows.

The NDX

Today on the tech heavy NASDAQ 100 (NDX) we saw slightly higher volume (1812 million shares) on a slight advance of 4.63 points. However, the advancers fell to 1434 from 1894 yesterday and the decliners increased 423 to 1441. That means there were more declining issues than advancing ones. Therefore I cant call this as an accumulation day.

As did the S&P 500 the NASDAQ 100 opened higher and dropped in the first hour of trading. The open was at 2002 and fell 17 points to 1985 by 10:30 AM. By the end of the day the market almost made it up to the open print. That is somewhat negative to me. Perhaps the strength of the SPX will bring the NDX some help tomorrow. In addition the 5 bar RSI is still showing there is some room for the index to advance. But this stops at 4 PM while the futures trade all night. As I write this the futures are down 3 points.

The longer term daily chart provides more insight by presenting us with a view of the index bouncing off the 200 day moving average (Red Line). By the way, todays bar is red because it opened higher than it closed. The Stochastic indicator is based upon five bars and is showing that the NDX still has room to advance before reaching over bought status. Resistance is at 2050 from last Mondays intraday high while support (1943) is from Fridays low.

The open interest on the NDX is viewed the same way as the SPX. With a close at 2000, the peak open interest is at the money (2000) on both the Puts and Calls. However, we are looking where there might be resistance and support. The next level of peak open interest on the calls is at 2050 while the peak on the puts is at 1950. The strong point here is that the price resistance is at 2050, as mentioned earlier, from Monday. And the peak put open interest correlates to the price support from Fridays low at 1950.

The TNX

The TNX or CBOE 10 Year Treasury Yield has been slowing gaining strength over the last two months. The above chart is a daily view of the yield and is showing that there is heavy resistance at 4%. The high broke above the 200 day moving average (40.23) intraday and posted a high of 40.28. However, the yield closed at 4.01% just below the big red line. A close above the 200 SMA may put the yields back in bonds. If you trade bonds or bond derivatives, it has been frustrating to create a desirable bond ladder. Why do I watch bonds and trade them? Bonds can be applied as a cash collateral alternative to sell options against. Money markets (1 2%) arent paying very high and a properly allocated bond portfolio can be much better (5 8% corporate; 4 5.5% municipal).

I would normally cover the VIX and the Put/Call ratio here but that is way down at the bottom. Please read that section for my contrarian views. The $VIX declined 0.57 to 19.07 and the $VXO declined 0.32 to 19.67. I didnt spend much time on Gold today but it was more volatile than crude oil. Gold gapped way down to 891 and was down as much as 19 points before closing down about 8 points. On a daily basis, Gold Futures are looking weak and have near term support at todays low and then again at 861 (the 200 daily exponential moving average).

Important Earnings and Economic news due tomorrow are:

Other news today that moved the market include Chicos FAS (CHS) and American Eagle Outfitters (AEO) reported earnings today that surprised the markets. CHS beat by a penny while revenues fell 9.6% on year over year. Co said, "We continue to expect negative comparable store sales for the first half of 2008, and expect to have lower earnings than the first half of 2007. Our current expectations are to gradually improve and return to positive comparable store sales increases sometime in the second half of 2008 if we can expect some level of improvement in the economic environment resulting in overall earnings growth during this time frame." AEO beat by 2 pennies and revenues rose 4.6% on the year. The company issued in line guidance for the second quarter.

In transportation news, the Tranny or Dow Jones Transportation Index ($TRAN) increased about 1% on some news that UPS was going to step in and help DHL with its routes. The agreement, when finalized, would be expected to extend for 10 years and produce up to $1 billion in additional annual revenue for UPS. The company said it would begin phasing in a limited amount of volume in 2008 with ramp up in 2009. The agreement would not involve the pick-up or delivery of DHL packages to their customers, only the transport of packages, primarily between airports, in North America. As such, the work will be similar to that currently performed by UPS for the U.S. Postal Service.

Strategy Discussion

I truly enjoy educating option traders. So I want to continue that and review the SSO trade from last weekend that was based upon writing a short put trade on the June 71 strike. Dont forget, the SSO move 2 times the S&P 500. This is a turbo option. In our assumption, we sold 10 contracts at $2.65 for a total initial credit of $2,650 and an initial margin of $14,000. So if we wait until expiration, there is a chance of a max return of over 18% on the initial margin or over 20% on the cash needed.

The closing mid price is $1.75 which provides a potential profit of $900 on ten contracts. It is always nice to show how a trade works and also have it be profitable. I am sure I will pick one that will lose money so we can discuss money management and risk management techniques. My favorite topics to write on include discussing money and risk management and helping option traders understand why to use proper and consistent methods. The next view shows the Profit/Loss line of the position as of today as well as a very faint green line that shows profit points of the short put on expiration.

The max gain (Green Line) is the initial premium of $2,650 less transaction fees. Not that we covered the aggressive setup much but the June 73 puts that were in the money could have been sold for $3.70 per contract and are now marked at $2.60. Lets compare the trades.

Out of the Money: Current Profit of $900.
In the Money: Current Profit of $1,100.

The initial margin on the 73 Put is greater than the 71 Put. The 73 strikes compensation isnt enough to take risk of selling the 73 strike versus the 71. If we decide to hold the position to expiration then the 73 strike could provide enough added return for the added risks. As for now, we will keep this position and possibly cover it more next time. If the S&P 500 becomes extended on the upside, we should close out the position.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
APA None None
MUR    
NOV    
OII    
XOM    

Play Editor's note: I am adding several oil and energy stocks tonight. The group is bouncing from its trendline of support so we have an opportunity to buy calls and use relatively tight stops. One of our biggest risks with the oil stocks is tomorrow's oil inventory report. If the report shows a big build in inventories then crude oil could see a short-term sell-off and we might get stopped out across the board in these energy stocks. More conservative traders may want to wait until after the report comes out. A few more energy stocks that look like potential plays are DO, RIG and the refiner VLO. A breakout over $50-51 in VLO could be a big buy signal. ARA is a Brazilian paper stock and it looks poised to hit new highs. SID is a Brazilian steel stock and we would be tempted to buy today's rally with a tight stop under Tuesday's low.

Please note that I am cautiously bullish. I think the market is poised to rally for a few more days but I am concerned that the market might roll over so don't get married to any of your bullish positions and be prepared to switch to bearish plays.


New Calls

Apache - APA - close: 138.97 change: +3.12 stop: 133.39

Company Description:
Apache Corporation is a large oil and gas independent with operations in the United States, Canada, the United Kingdom sector of the North Sea, Egypt, Australia and Argentina. (source: company press release or website)

Why We Like It:
The bounce in oil today was timed perfectly. It seems like the whole oil and oil services sector is bouncing from its trendline of higher lows or some form of support. APA, an oil and gas company, is bouncing from its trendline (see chart). We're suggesting readers buy calls on the bounce with a stop loss under today's low. Part of our risk is tomorrow's oil inventory report, which might surprise the market with a build in inventory. Thus, patient traders may want to wait until after the report hits the market. Our short-term target in APA is the $147.00-148.00 range.

Suggested Options:
We are suggesting the June or July calls. Keep in mind that the June options expire in less than four weeks.

BUY CALL JUN 135 APA-FX open interest=2172 current ask $7.90
BUY CALL JUN 140 APA-FY open interest=5150 current ask $5.20
BUY CALL JUN 145 APA-FZ open interest=4333 current ask $3.20

BUY CALL JUL 135 APA-GX open interest=1773 current ask $10.90
BUY CALL JUL 140 APA-GY open interest=6171 current ask $ 8.20
BUY CALL JUL 145 APA-GZ open interest=1915 current ask $ 6.00

Picked on May 28 at $138.97
Change since picked: + 0.00
Earnings Date 07/31/08 (unconfirmed)
Average Daily Volume = 4.5 million

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Murphy Oil - MUR - close: 95.28 change: +1.57 stop: 91.85

Company Description:
Murphy Oil Corporation is a worldwide oil and gas exploration and production company with refining and marketing operations in the United States and the United Kingdom and crude oil and natural gas exploration and production operations in Canada. Murphy Oil also has an office in Kuala Lumpur to oversee its E&P activities in Malaysia. (source: company press release or website)

Why We Like It:
MUR is another oil and gas stock that is bouncing. We are suggesting readers buy calls on the bounce with a stop under today's low. We're setting two targets. Our first target is the $99.50 mark. Our second target is the $104.00 level.

Suggested Options:
We are suggesting the June or July calls. Keep in mind that the June options expire in less than four weeks.

BUY CALL JUN 95.00 MUR-FS Open interest=1513 current ask $3.80
BUY CALL JUN 100.0 MUR-FT Open interest= 418 current ask $1.70

BUY CALL JUL 95.00 MUR-GS Open interest= 606 current ask $5.70
BUY CALL JUL 100.0 MUR-GT Open interest=3324 current ask $3.60

Picked on May 28 at $ 95.28
Change since picked: + 0.00
Earnings Date 07/23/08 (unconfirmed)
Average Daily Volume = 1.6 million

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Natl. Oilwell Varco - NOV - cls: 83.15 chg: +2.51 stop: 78.69

Company Description:
National Oilwell Varco is a worldwide leader in the design, manufacture and sale of equipment and components used in oil and gas drilling and production, as well as in providing supply chain integration services to the upstream oil and gas industry. NOV recently completed its acquisition of Grant Prideco. (source: company press release or website)

Why We Like It:
NOV is another oil stock bouncing from support. Again we're suggesting readers buy calls on the rebound with a tight stop loss. Our target is the $88.50-90.00 zone. The P&F chart is bullish with a $105 target.

Suggested Options:
We are suggesting the June or July calls. Keep in mind that the June options expire in less than four weeks.

BUY CALL JUN 80.00 NOV-FP open interest=4715 current ask $5.80
BUY CALL JUN 85.00 NOV-FQ open interest=6353 current ask $3.20

BUY CALL JUL 80.00 NOV-GP open interest= 322 current ask $8.00
BUY CALL JUL 85.00 NOV-GQ open interest=3984 current ask $5.40

Picked on May 28 at $ 83.15
Change since picked: + 0.00
Earnings Date 07/30/08 (unconfirmed)
Average Daily Volume = 6.4 million

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Oceaneering Intl. - OII - cls: 73.36 chg: +2.10 stop: 69.95

Company Description:
Oceaneering is a global oilfield provider of engineered services and products primarily to the offshore oil and gas industry, with a focus on deepwater applications. (source: company press release or website)

Why We Like It:
Here's another stock in the oil services sector. Buy today's bounce or a dip in the $72-71 zone. We're suggesting a stop loss at $69.95. We have two targets. Our first target is $78.50. Our second target is $83.00.

Suggested Options:
We are suggesting the June or July calls. Keep in mind that the June options expire in less than four weeks.

BUY CALL JUN 70.00 OII-FN open interest=5316 current ask $5.20
BUY CALL JUN 75.00 OII-FO open interest= 519 current ask $2.55
BUY CALL JUN 80.00 OII-FP open interest= 413 current ask $1.05

BUY CALL JUL 70.00 OII-GN open interest=1266 current ask $7.10
BUY CALL JUL 75.00 OII-GO open interest= 708 current ask $4.50
BUY CALL JUL 80.00 OII-GP open interest= 757 current ask $2.65

Picked on May 28 at $ 73.36
Change since picked: + 0.00
Earnings Date 07/31/08 (unconfirmed)
Average Daily Volume = 1.0 million

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Exxon Mobil - XOM - close: 90.43 chg: +0.63 stop: 88.79

Company Description:
We are the world's largest publicly traded international oil and gas company, providing energy that helps underpin growing economies and improve living standards around the world. (source: company press release or website)

Why We Like It:
XOM is the last of our new plays in the oil sector tonight. The stock is bouncing from support at its trendline of higher lows and technical support at its 200-dma. Plus, the stock has produced a bullish engulfing candlestick at the bottom of a multi-day sell-off. This is our entry point to buy calls. Our target is the $94.85-95.00 range.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 85.00 XOM-GQ open interest=19871 current ask $7.25
BUY CALL JUL 90.00 XOM-GR open interest=26937 current ask $4.00
BUY CALL JUL 95.00 XOM-GS open interest=65672 current ask $1.88

Picked on May 28 at $ 90.43
Change since picked: + 0.00
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 24.4 million
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Carbo Ceramics - CRR - close: 47.69 change: -0.02 stop: 46.90

Shares of CRR are still not moving much. We're growing more cautious on the stock. If we could make a meaningful change in our stop loss we would but the intraday low today was $47.30. More conservative traders may just want to abandon ship. We're not suggesting new positions. Our target has been the $52.00-52.50 zone.

Picked on May 11 at $ 47.45
Change since picked: + 0.24
Earnings Date 04/24/08 (confirmed)
Average Daily Volume = 303 thousand

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Harsco - HSC - close: 61.79 change: +0.58 stop: 59.95

After two days of consolidating near $60.50 we're starting to see a rebound in HSC. This could be used as a new bullish entry point but you may want to raise your stop loss toward today's low of $60.45. If HSC fails at $62.00 we'll exit early. Our target is the $64.50-65.00 range but more aggressive traders may want to aim higher.

Picked on May 01 at $ 60.38
Change since picked: + 1.41
Earnings Date 04/22/08 (confirmed)
Average Daily Volume = 613 thousand

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iShares Russ.2000 - IWM - cls: 73.66 chg: +0.34 stop: 71.45

Small caps actually out performed the large cap stocks. The RUT added 0.55%. Meanwhile the IWM closed near its highs for the session and appears to be breaking out from a bull flag pattern, which is definitely positive for the market. Readers may want to consider an early exit near $74.50 as a way to scalp a couple of points and get out. If the IWM does continue to bounce we will seriously consider exiting in the $74.50-75.00 zone instead of waiting for a rally higher. Currently our target is the $77.50-80.00 range. The P&F chart is bullish with an $87 target.

Picked on April 28 at $ 72.55 *triggered
Change since picked: + 1.11
Earnings Date 00/00/00
Average Daily Volume = 84.6 million

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Martin Marietta - MLM - cls: 117.77 chg: -0.38 stop: 114.95

In spite of today's negative close the action in MLM still looks bullish. We would continue to buy calls at current levels. Our target is the $123.50-124.00 zone. This should be a quick, short-term move. If MLM doesn't continue to bounce in the next day or two we'll be quick to exit. FYI: The P&F chart is bullish with a $158 target.

Picked on May 27 at $118.15
Change since picked: - 0.38
Earnings Date 05/06/08 (confirmed)
Average Daily Volume = 561 thousand

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Priceline.com - PCLN - close: 134.13 chg: +2.82 stop: 126.99

PCLN out performed the broader market today. Traders bought the dip this morning and the rally began to pick up speed this afternoon. By the closing bell PCLN was up 2.1%. We see this as a new entry point to buy calls. Yesterday we were suggesting a move over $132.50 as a new entry point. Our target is the $139.50-140.00 zone.

Picked on May 27 at $132.75 *triggered
Change since picked: + 1.38
Earnings Date 05/08/08 (confirmed)
Average Daily Volume = 1.5 million

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POSCO - PKX - close: 134.60 change: +1.34 stop: 129.75

PKX was kind enough to trade sideways for most of the session, allowing us an entry point, before turning higher into the closing bell. We remain bullish here. Our target is the $143.00-145.00 range. This is an aggressive higher-risk play. PKX tends to gap open every morning as it adjusts to trade in Korea. Plus, the option spreads tend to be a little wide.

Picked on May 27 at $133.26
Change since picked: + 1.34
Earnings Date 07/14/08 (unconfirmed)
Average Daily Volume = 733 thousand

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Molson-Coors Brewing - TAP - cls: 57.26 chg: -0.75 stop: 55.49

TAP displayed relative weakness today. It could have been a knee-jerk reaction to negative comments out of Coca-Cola about their sales trends. On a positive note traders bought the dip in TAP near its short-term trend of higher lows. This looks like a new entry point to buy calls but if you're feeling cautious then raise your stop loss toward $56.00 or today's low (56.48). Our target is the $64.00-65.00 range. FYI: The P&F chart is bullish with a $69 target.

Picked on May 23 at $ 58.51 *triggered
Change since picked: - 1.25
Earnings Date 08/07/08 (unconfirmed)
Average Daily Volume = 1.1 million
 

Put Updates

Apollo Group - APOL - close: 45.57 chg: +0.73 stop: 48.01

APOL continued to bounce as we suspected it might. The close above $45.00 is negative for the bears. The next test is potential resistance in the $46-47 zone. More conservative traders may want to lower their stop a bit. We're not suggesting new positions at this time. Our target is the $40.50-40.00 zone.

Picked on May 18 at $ 46.71
Change since picked: - 1.14
Earnings Date 06/26/08 (unconfirmed)
Average Daily Volume = 5.4 million

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3M Co. - MMM - close: 76.90 chg: +0.73 stop: 77.01

There is no change from our prior comments on MMM. We're still waiting on a breakdown below support. Our suggested trigger to buy puts is at $74.95. If triggered our first target is the $70.25-70.00 zone. Our secondary target is the $66.00-65.00 range. The P&F chart is bearish with a $69 target."

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 4.0 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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Amgen Inc. - AMGN - close: 42.82 chg: -0.22 stop: n/a

The ASCO conference starts on May 30th and it looks like investors are waiting to hear what the biotech sector has to say before placing any bets. Shares of AMGN continue to trade sideways. The conference is over on June 3rd. We are suggesting entry points in the $42.00-43.00 zone. We have suggested a July strangle and a slightly more aggressive June strangle. The options in the July strangle are the July $45 calls (AMQ-GI) and the July $40 puts (AMQ-SH). Our estimated cost for the July strangle was $1.65. We want to sell if either option hits $3.50. The options in the June strangle are the June $45.00 calls (AMQ-FI) and the June $40.00 puts (AMQ-RH). Our estimated cost on the June strangle was $0.56. We want to sell if either option hits $1.10 or more. June options expire in less than four weeks.

Picked on May 22 at $ 42.77
Change since picked: + 0.05
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 6.7 million

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McDonald's - MCD - close: 58.69 chg: +0.58 stop: n/a

MCD continues to see a minor oversold bounce following the recent down turn. We are not suggesting new positions at this time. The options we suggested were the June $62.50 calls (MCD-FZ) and the June $57.50 puts (MCD-RY). Our estimated cost was $1.10. We want to sell if either option hits $1.65 or higher. More aggressive traders may want to raise their target. Keep in mind that June options expire in less than four weeks and will see their premium erode more quickly.

Picked on May 18 at $ 60.53
Change since picked: - 1.84
Earnings Date 07/24/08 (unconfirmed)
Average Daily Volume = 7.5 million
 

Dropped Calls

IHOP Corp. - IHP - close: 47.76 change: -0.12 stop: 49.49

IHP is still struggling to bounce. It looks like shares want to rebound from their 100-dma but it just can't get any momentum. We were waiting for a breakout over resistance with a trigger at $53.75. The stock has not yet hit our trigger so we're dropping this play unopened. Meanwhile in the news today IHP announced that it is changing its corporate name from IHOP Corp. to DineEquity Inc. after it has completed its purchase of AppleBee's International Inc. last year. IHP's symbol will change to DIN beginning in June.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/27/08 (unconfirmed)
Average Daily Volume = 326 thousand

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Mechel OAO - MTL - close: 55.49 change: +4.01 stop: 47.69

Target exceeded. Shares of MTL sprang higher following yesterday's rebound from support. The stock posted an impressive 7.7% gain on strong volume today. The intraday high was $55.98. Our target was the $54.00-55.00 zone. MTL is due to report earnings tomorrow so we're happy to be out of the stock.

Picked on May 25 at $ 49.19 *target exceeded (55.98 high)
Change since picked: + 6.30
Earnings Date 05/29/08 (confirmed)
Average Daily Volume = 1.4 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


The Contrarian

The CBOE Equity Put/Call Ratio

 

The CBOE Equity Put/Call ratio 10 day moving average moved up from 0.615 on 5/19 (last Monday) and is trying to break back above 0.65. However, it has been stuck at 0.645 for two days in a row. The 20 day moving average of the CBOE Equity Put/Call ratio (blue line) has been at 0.651 for three days. I dont remember a time that both moving averages consolidated this tightly. We are still hold at the Neutral, for now. The 10 day MA usually finds support at the 0.60 level and resistance at 0.80. So far the lower level has provided support and given us the proper trade bias in a timely matter. There is a tendency for put traders to dry up at peaks in the market. Last week we saw the level of put traders begin to increase again or possibly the level of call buyers peak. The Put/Call ratio is a contrarian sentiment indicator because we mainly look at the buy side of the option trade to determine the sentiment signal. If there is a peak (high followed by a contraction) in call trading, which is assumed to be bullish trades, the signal suggests that most of the bullish traders have bought their calls and that the majority of bulls are already invested. Therefore if most traders have bought that were going to buy then who else will force the market higher?

If the 10 day MA closes above the 20 day MA the signal will become Negative (Bearish). For those of you that are new to contrarian concept we look for the CBOE Equity Put/Call ratios 10 day moving average (DMA) to reach certain levels of support and resistance to signal out portfolio bias. Those levels are as follows: when the 10 DMA dips below 0.60 the signal reverts to bearish and when the 10 DMA breaks above 0.80 the signal reverts to a bullish signal. I prefer to see the 10 DMA change direction and break above the 20 DMA for confirmation. I think you can trade the initial changes in direction or tests of peak levels. But this and the other indicators are best used to adjust overall portfolio directional exposure. SIGNAL: NEUTRAL BIAS

The CBOE Volatility Index ($VIX)

The CBOE Volatility Index ($VIX) closed 0.08 higher today after a long holiday weekend. Last week we saw the $VIX dip below the 16 for the first time since October and then forcibly bounce to a high of 20.95 today. As I stated last week I still think that the Bias should be neutral until the 10 DMA crosses above the 20 DMA. The mainly notable change occurred today in that the 10 day moving average actually moved higher. I knew it would happen.eventually. Even though the move to neutral was right (though a few days early), I still stand by the early interpretation to move into a Neutral posture. The 10 DMA moved up a whopping 0.20 to 17.88 while the 20 day moving average is steady at 18.52 for three days. The signal wont be Negative until the moving average cross to confirm. Should that occur in the next day or two, I will send out a special alert. SIGNAL: NEUTRAL BIAS

The Investors Intelligence Polls

This week the newsletter writers really changed their tune from a consistently increasing bullish sentiment to a more bearish outlook probably stemming from rising oil and food prices. In summary, the Investors Intelligence polls changed drastically this week the percent bullish decreased nearly 10% from 47.3% to 37.9% while the percent Bearish increased a little more to 32.2% from 30.8%. As I said last week, We will be on a negative signal if the spread declines next week. The spread declined a total of 10.8 to 5.7% from 16.5%. Bulls peaked lower than the normal 50 55% range. A contraction in bullish sentiment at 47% still counts as a reason to change the bias. Therefore, we are on a Negative (Bearish/Short) bias signal this week. The signal can reverse quickly with a tick back up on the Spread and/or the Percent bullish. Last week I also wrote I am probably early and a little cautious by going Neutral here but the spread is a little overbought. I ended up being right. It happens once in a while.

About the Indicator: The peak in Bullish Investor Sentiment usually tops 60% while the peak Bearish Investor Sentiment tops at about 45%. We normally look for bearish triggers when the Bullish % peaks and bullish triggers when the Bearish % peaks. I like to see confirmation after the peaks. But there is usually a lag because this poll comes out once a week.

The Signal: This weeks signal is neutral biased because the Bullish % increased to 47.3% and the spread only increased 0.4% to 16.5%. SIGNAL: NEUTRAL BIAS
 

Today's Newsletter Notes: Market Wrap and The Contrarian by Robert Ogilvie, and all other plays and content by the Option Investor staff.

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