Option Investor
Newsletter

Daily Newsletter, Saturday, 7/10/2010

Table of Contents

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

Market Wrap

Oversold to Overextended in Four Days

by Jim Brown

Click here to email Jim Brown

The markets have seen a marked change in sentiment over the last week as we head into the start of the Q2 earnings cycle.

Market Statistics

After languishing around the flat line most of the day we saw another short covering rally in the last 30-minutes of trading push all the indexes into the green. This capped a stellar rebound week where half of the +511 Dow points were gained in the last 30 minutes of the trading day. The sell the close trend has changed into a buy the close trend. This is probably caused by funds that were hoping for a dip to buy each day but when the dips don't appear they have to buy the close or risk being left behind.

The economic news was sparse with only the WLI and the Wholesale Trade report for May. The trade headline number rose +0.5% compared to +0.2% in April. This was a slightly bullish report except that the sales component fell -0.3% after a +0.9% gain in April. That was the first decline in sales in 15 months. While the decline in sales was disconcerting this report still suggests the U.S. is growing at a +3.0% GDP rate.

The report that continues to be troubling is the Weekly Leading Index. The headline number declined to 121.5 from 122.2 and the smoothed annualized growth rate fell to -8.3% from -7.6%. This was the eighth decline in nine weeks for the headline number and it is closing in on the lows for 2009. The annualized growth rate bottomed at -30.2% in December 2008. The decline in the WLI is a leading indicator to U.S. economic health and it is definitely heading lower.

Weekly Leading Index Chart

The economic calendar next week has quite a few more entries and plenty of data points for investors to stress over. The most market reactive will be the release of the FOMC minutes on Wednesday. This is the minutes for the June 22/23rd meeting and analysts will be pouring over the phrasing to see if the Fed is really thinking the economy is going to sink again or maintain its forward motion.

Economic Calendar

The real focus of investors next week will be the beginning of the Q2 earnings cycle. Alcoa officially kicks off the cycle when they report on Monday but investors will be watching INTC, GOOG, JPM, BAC, C and GE for the real news. Intel and GE will be the biggest tells on the state of the economy. JPM, C and BAC will tell us about the health of the banking sector. Traders are evidently expecting big things from the banking sector. There were 287,000 calls traded on the XLF on Friday. That was three times the four-week average and twice the number of puts traded.

There are a few high profile companies on the schedule next week but the following week there are hundreds more announcements. This week is just the pre-show.

Earnings Calendar

Earnings for S&P companies are expected to have risen +34% in Q2 compared to 52% in Q1. The estimates for Q3 are for a +25% gain and the slowest quarter in 2010. That is mostly do to the harder comparisons with 2009-Q3. Tech earnings are expected to have risen +57% in Q2. This will be the third quarter of consecutive earnings growth after nine quarters of decline. With the pace of earnings growth expected to decline in the current quarter this makes the earnings guidance much more critical. Do analysts have it right or are they too optimistic or too pessimistic? The next two weeks will answer that question.

In stock news Visa (V) was added to the "conviction buy" list at Goldman and the stock gained +3.1%. Visa does not report earnings until July 28th.

Research in Motion (RIMM) gained +8% after the company said it was going to extend Internet services and application stores in China. The company launched Blackberry service there in May.

Google said its Internet license in China was renewed after they made concessions to the government on forwarding search traffic to their uncensored Hong Kong website. Google stock had lost nearly 25% of its value in Q2 over the China censor issue as well as earnings guidance for Q2. Google rallied +2.39% on the news and Baidu (BIDU) lost -1.7%.

NTP Corp is a company whose sole reason for being is to come up with obscure patents they hope applies to somebody's current technology and then sue those who might be inadvertently violating that patent. NTP Corp filed suit against Apple, Google, Microsoft, Motorola, HTC Corp and LG Electronics on Friday. NTP claims the smart phones sold by those companies violate their "email over wireless" patent. NTP was founded in 1992 on patents held by a Chicago inventor named Tom Campana. He had developed wireless email technology in the 1980s that was never commercialized. I struggle to understand how wireless email would have been transmitted in the 1980s without wireless devices but I guess the concept is the key.

They sued Research in Motion over this same patent several years ago in reference to the Blackberry. RIMM eventually settled for $612.65 million after NTP won an injunction to shutdown the Blackberry network. Apparently NTP's bank account is running low so they decided to attack those six other companies. However, when you take on six giants at once that are sitting on more than $200 billion in cash the odds are not as good as they were against RIMM as a much smaller company at the time. Microsoft, Apple and Google can afford the best lawyers and NTP will be the equivalent of a pesky mosquito for years to come. Eventually they will get their day in court but I doubt they will get a major judgment. Courts have recently taken dim views of these kinds of generic technology suits.

NTP has previously sued Verizon, Sprint and T-Mobile over the same issue. Since the RIMM settlement there have been other cases and one against Ebay that went to the Supreme Court changed the legal process and getting a shutdown injunction today would be next to impossible. That takes away much of the NTP leverage. However, the phones at risk the most are the Android versions. The license fee awarded in the RIMM case was 8.5% and that would be a big hit to the cost of the low cost Android phones.

Anadarko Petroleum (APC) told BP to take a hike when BP presented them with a $272 million bill for the first installment of the oil cleanup expenses. APC is a 25% "non-operating" owner of the leaking Macondo well. Anadarko's CEO has gone on record in recent weeks saying that BP engaged in reckless and potentially criminally negligent actions that caused the Horizon explosion. He believes the reckless and irresponsible actions leading up to the explosion violated the agreements between BP and APC and APC is not going to pay the BP bill. BP also sent Mitsui, a 10% non-operating owner a $112 million bill. There is no word yet on Mitsui's intent but I think we all know how they are going to react.

Chart of Anadarko

Goldman Sachs has raised their estimates of the cleanup costs to as much as $163 billion if the spill was halted today. Cleanup costs are just a part of the problem. The government has already started a criminal investigation that will almost undoubtedly find cause for negligence. That will earn BP another round of fines and penalties over an above the cleanup costs.

BP said it would begin the process of changing out the LMRP containment cap as soon as Saturday in order to take advantage of an expected week of mild weather. The current cap is a loose fit contraption that allows BP to capture about 25,000 bpd of oil but allows as much as 30,000 bpd to continue escaping into the gulf. The new cap is reportedly a tight fitting custom built cap that will be bolted onto the flange where the bent pipes were cut off several weeks ago. In theory the new cap will allow up to four containment vessels to be connected at once and will prevent any further oil from leaking into the gulf. Unfortunately it will take 5-9 days to make the switch and during that time the well will be flowing at full force into the gulf. The robotic vehicles worked all day Saturday to remove the bolts and the old flange with the broken pipe.

Chart of BP

Crude prices rallied to close over $76 on Friday on improving global sentiment and solid demand for gasoline in the U.S. over the last two weeks. The decline in initial jobless claims on Thursday and the hike in global economic estimates by the IMF on Thursday helped to improve sentiment.

Also helping push prices higher was the beginning of the new quarter. Every quarter end there is a new flow of long only money hitting the commodity funds. This translates into rises in the price of crude and other commodities. This flow of cash into funds normally ends by the 10th of the month and commodities will be left to trade on real fundamentals for the rest of the quarter.

Helping fuel positive sentiment on crude was a five million barrel decline in crude inventories in Thursday's EIA report. That was the second consecutive weekly decline. However, the declines were related more to output cuts in the gulf and tanker rerouting for hurricane Alex than a sudden surge of consumption. The July 4th weekend helped raise gasoline demand by +2% for the prior two weeks. Analysts were somewhat disappointed in that increase since the July 4th weekend is normally a high consumption period.

The results of the stress tests on European banks are expected on July 23rd. Recent comments from analysts in Europe suggest most banks will pass with flying colors. This has improved sentiment about a banking crisis in Europe. The banks are being tested on three scenarios. One scenario will assume economic growth hits targets from the European Commission. The second scenario is for a -3% drop in GDP and the third scenario is a so-called "shock" event in the bond markets. Ninety-one banks are being tested and the results are due out on July 23rd.

In the U.S. the FDIC closed two more banks on Friday bringing the total to 90 for the year. New York based USA Bank and Oklahoma based Home National Bank were closed for a cost to the FDIC of $140.4 million. FDIC head Shelia Bair said the pace of closures should decline after Q3.

There were several positive data points last week. The IMF upgraded its estimate of global growth and this buoyed markets around the world. German exports rose by 9.2% in May and imports rose by +14%. Australia and Canada both reported a strong increase in employment. Canada said there were 90,000 new jobs created in June compared to estimates for 20,000.

In the U.S. tax receipts from corporations rose by +37% in May indicating corporate profits are rising. Costco said same store sales were up +4%. Capital spending in the U.S. was up +20% year-over-year in May.

On the downside the IMF said there was a strong possibility of a double dip in housing caused by a large backlog of foreclosures, negative equity and elevated unemployment. However, several indicators in the U.S. suggested the foreclosure backlog was shrinking and we could be seeing a smaller numbers of homes on the market in the coming months. The weekly mortgage applications survey spiked +6.7% from the prior week to 721 on the index. Purchase applications plummeted to a 12 month low thanks to the expiration of the tax credit but refinance applications rose to a 12 month high with a +9.2% gain thanks to record low interest rates. The 30-year fixed mortgage rate was 4.68%. This is a positive indicator for consumer sentiment.

Overall I am shocked at the change in economic sentiment in just the last two weeks. Just a couple weeks ago the analyst chatter was almost entirely consumed with the potential for a double dip recession. In the space of two weeks it has turned 180 degrees and they are talking about a 3.2% to 3.5% GDP rate for Q2. I find that exceedingly hard to imagine given the rate of decline in May and June but I am not an economist.

The market has also turned on a dime and despite negative technical indicators it is in strong rally mode. I told you I expected a rally this week but I did not expect it to be a 5% gain. This proves how a good short squeeze and sentiment change can catch everyone off guard.

Three prominent authors have not changed their estimates. Robert Prechter is predicting Dow 1000 over the next six years. He believes we are going to see a major bear market as a result of the economic problems. Richard Russell author of the Dow Theory letters for the last 30 years is also predicting a major bear market but has not targeted a specific Dow level. Robert Kiyosaki said in his online blog that he expects a return to Dow 5000. Obviously opinions are like noses, everybody has one. Research has proven that those analysts with the most radical forecasts are accepted as likely right in their predictions over those who are less radical with say a Dow 9000 target. Apparently those with radical forecasts are assumed to have done extensive research before they risk their credibility with such a radical claim.

I reported last week on Abby Joseph Cohen's continued S&P target at year-end 2010 of 1,250-1,300. David Bianco at BACML also has a 1275 target. A Morgan Stanley analyst was targeting 1375 as of Friday. These analysts were not getting as much airtime as the major bears until this week. Now that sentiment has turned they are getting plenty of face time on stock TV. Amazing how quickly the news feed changes.

The S&P rallied to close at 1077 and just under decent support at 1080 for better than a 5% gain for the week. The majority of the gains came in the last 30 minutes of the trading day every day last week. We have gone from a sell the close mentality the prior week to a buy the close mentality. As I mentioned earlier the end of quarter cash flows are predominantly into long only funds and this end of day buying is that money being put to work. The funds would buy a dip if one appeared but in a rising market like this they can't afford to be left out so if no dip by 3:30 they buy the close. This helps juice the shorts to cover as well because they are hoping for another end of day sell on close and when it does not happen they are forced to cover.

Last weekend I said I was looking for a rally into earnings and that has come to pass. I expect it to continue for another week or so but I doubt it will continue at the same vertical rate. The S&P has decent resistance at 1080 and it is over extended from the +5.5 gain. The market as a whole is still long-term oversold but in the very short-term it is over extended. We still need a 20-point decline on the S&P to equalize pressures before we can move higher in confidence.

I can't tell you how many times in the last 14 years I have written "it should pull back after last week's gains." Sometimes rallies don't cooperate with logical concepts and they move up in defiance of what logic would dictate. This forces traders to chase stocks higher just so they don't get left out. I believe that is a possibility for next week. We should rest for a day but I think any dips will be bought until 1111 or so and the bears will make an initial stand there. The 200-day is interim resistance at 1111 along with the 50-day at 1100. A break over 1120-1125 would be very bullish. The 50/200-day "death cross" is in full bloom and will remain an active technical indication for the weeks ahead.

S&P-500 Chart

On the Dow the initial resistance is 10250 (red line) followed by the 200-day at 10365. The brick wall will be 10500. The Dow has several components reporting earnings next week with INTC, JPM, BAC, AA and GE. Their guidance will be the critical support for any continued gains. The Dow is over extended with a +511 point rebound for the week. This is the most visible indicator of the market and a decline here could poison sentiment for the other indexes. If you look at the chart you will see an identical 500-point rally that started on June tenth and ran for five days to end at 10400. A 500-point short covering rally is not an indication of a bullish market but simply an oversold bounce.

Dow Chart

The Nasdaq rallied the least of the major indexes despite some strong gains by the big caps. Tech stocks are not normally favored in the summer months despite expected earnings growth of 57% for Q2. The Nasdaq performed a perfect test of the 50% retracement level as support but even with a +5% rebound it is just now moving back into the congestion range from May/June. When individual tech stocks report in July they normally sell off almost immediately as investors move on to other plays. There is no conviction for techs in the summer months. They are kicked to the curb and picked up again in October.

The next resistance point is 2235 with an interim gap fill at 2220. The Nasdaq as an index is not showing me any trading signals this week. You need to key on the individual stocks for tech plays. Support on profit taking should be 2150.

Nasdaq Chart

I would like to say the Russell made a technically perfect test of support at 590 but as I reported on Tuesday the decline was really just a carry over from the rebalance and not fundamentally significant. However, support is support and I am sure it played a part in the process. The Russell, like the Nasdaq is entering its congestion range again and other than continued short covering I suspect 650 will be resistance. Critical resistance is 670 but I would be very surprised if the Russell made it that far.

Russell Chart

In summary the rally I predicted last week appeared on schedule although the short covering was stronger than I expected. The sudden improvement in global economic indicators overshadowed the weak jobs report from the prior Friday. The earnings calendar will be the main focus for the next two weeks. I expect the markets to continue to trend higher until the last week of July and then weaken again. We need to see the economics in the U.S. begin to improve before the rally will gain any real strength.

Jim Brown


Index Wrap

Possible Bullish Falling 'Wedge' Forms

by Leigh Stevens

Click here to email Leigh Stevens
THE BOTTOM LINE:

This past week's decline stopped at the lower support trendlines seen on my major index charts and a strong rebound followed. After the big advance of last week another minor pullback ahead would 'correct' a short-term overbought condition as the major indexes near some technical resistance. Another reason for thinking that this is not just going to be a straight-up move is that bullish sentiment increased pretty fast. Prolonged rallies can occur with consistently high sentiment numbers no doubt, but in terms of our still ongoing correction I think there will be more two-sided price swings (and typical of summer), although within an overall bottoming pattern as seen currently.

I wrote yesterday in a Trader's Corner piece (7/9) about the diminished likelihood that a major top formation was/is in play, especially a major Head & Shoulder's Top. Moreover, there is no Dow Theory sell 'signal' in terms of a reversal of the primary stock market trend, which is still up.

An interesting potentially bullish pattern is being traced out, that of a falling Wedge, which is seen prominently, but not exclusively, in the Dow 30 (INDU) which is my first chart.

A FALLING 'WEDGE' PATTERN:

This is one of a number of chart patterns that can appear at key reversal points, some more important than others. The 'Falling' or 'Rising' Wedge is not all that common but when it occurs it often represents a trading opportunity. The 'wedge' pattern that points down is usually bullish. A falling wedge is a downward price trend bounded by two down-sloping, trendlines that will 'intersect' at a point in the future if you extend the trendlines out. The wedge pattern typically forms over 3 months or less and is most often a consolidation of the prior trend.

A falling wedge should have at least 5 'touches' to the down-sloping trendlines forming the opposite sides of the 'wedge'; e.g., 3 along one side and 2 along the other. This can be seen on the INDU chart below as well as on other major indexes. The volume trend should be declining. When prices achieve a decisive penetration of the upper trendline there is generally a good-sized advance that follows.

Some traders, including me, may buy on the third touch (around 9614) to the lower trendline as seen above and set an exiting stop just under that line. Especially so if the index (or stock) is 'fully' oversold as measured by the 13-day RSI, which is displayed on my charts that follow.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) chart is bearish in terms of its declining trend as the relative highs and lows fall under prior highs and lows. There is the possibility that a bullish falling Wedge is forming, per my initial 'bottom line' comments above. The (upside) breakout point in SPX is at the intersection of the down trendline; e.g., at 1095 on Monday. 'Confirmation' of a renewed uptrend however is on a couple of consecutive closes above the prior upswing high in the 1130 area.

I was mostly on target on key technical support as coming in at the lower trendline; the low was 1011 at that line. The market then rebounded from there, the third 'touch' to the lower trendline. SPX was also 'fully' oversold as seen with the 13-day Relative Strength Index (RSI). SPX just managed to close above its 21-day moving average on Friday showing renewed up momentum. The most important averages to clear are the 50 and 200-day ones.

I've noted near support around 1060 and fairly major support in the 1000 area, at the lower trendline. There is also likely support in the 1020-1016 area.

MARKET SENTIMENT:

Trader sentiment levels rose this past week (as seen above) with the rally. My 'sentiment' indicator is not suggesting 'extreme' bullishness yet but I'd be more confident about the timing of a bigger rally if my call to put ratio stayed neutral or edged down toward the bullish 'oversold' line for a day here or there. The next sell off should tell the story on just how bullish options traders will remain. If the next downswing is accompanied by a jump(s) in put volume, this could be a contrary indicator; i.e., bullish. Since earnings are expected to be good, traders are no doubt positioning for that.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) chart remains bearish until or unless there is a breakout above the upper down trendline, currently intersecting at 495, followed by a Close above the prior 510 (up) swing high. The same potentially bullish falling wedge is outlined in OEX. This (wedge) pattern, if true, may continue to unfold, with the upper trendline representing resistance. Prices could bounce back and forth between the two trendlines but in a narrowing price range and which usually represents price 'compression' ahead of a spring to the upside.

I've noted resistance at 495 and then at 510. OEX cleared minor resistance implied by its 21-day moving average. Closes above the 50 and 200-day averages are further benchmarks to watch.

Near support is at 480, with fairly major support back at the down trendline, currently intersecting at 455; the prior 459 low is potential support of course as well.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 Average (COMP) shows a potential bullish falling wedge pattern the clearest of all the major indexes. The chart remains bearish in its pattern of declining swing highs. The falling wedge pattern only suggests bullish potential. However, the falling wedge is a striking pattern and when I've seen it get fully developed (having 5 or more alternating 'touches' to the two down-sloping trendlines), this has often preceded a substantial new up leg.

Near support is in the low 10000 area, then back at the prior 9614 low and then at the low end of the pie-shaped wedge, intersecting around 9566 currently.

Near resistance is bumped up to 10350 this week, at the current intersection of the upper down trendline. Even more key resistance, in terms of a shift in the intermediate trend, is at the prior 10594 rally high. A couple of consecutive Closes above this prior top would suggest an upside reversal in the intermediate-term trend.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) Index's chart has been bearish for some weeks now and will remain so until the pattern of lower relative lows and lower relative highs turns around. Needed to suggest a shift in the intermediate-term trend is a rally that pierces the prior swing high (and for more than an isolated single day) to suggest a shift in the intermediate downtrend.

I wrote last week that "I think we're at or near where support/buying interest will be found in COMP between 2050 and 2100 in the coming shortened week. Enough buying interest ahead in this oversold market for a rebound toward 2200." With the low at 2161 and the week's high at 2197 I couldn't do much better (in forecasting) than that. I intended this advice to apply to covering Nas 100 (NDX) puts, short QQQQ stock, as well as to bearish positions in 'bellwether' Nasdaq stocks.

Near resistance is noted where the downside gap would get 'filled in' at 2208, with next resistance at the upper trendline at 2267; even more key resistance is seen at 2341 and last upswing high.

Near support is noted on my COMP daily chart at 2150 and up 100 points from my musings of last week. Next support is back in the 2080 area, extending to the prior 2061 low; the lower trendline intersects at 2036 currently and should again offer significant technical support.

MARKET SENTIMENT:

Trader sentiment levels rose this past week (as seen above) with the rally. My 'sentiment' indicator is not suggesting 'extreme' bullishness yet but I'd be more confident about the timing of a bigger rally if my call to put ratio stayed neutral or edged down toward the bullish 'oversold' line for a day here or there. The next sell off should tell the story on just how bullish options traders will remain. If the next downswing is accompanied by a jump in put volume, this could be a contrary indicator; i.e., bullish. Since earnings are expected to be good, traders are no doubt positioning for that.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart is bearish and its chart doesn't show the 'complete' formation of the bullish falling wedge pattern as seen in the Composite; a matter of not having a 3rd 'touch' to the lower trendline, what may seem to be a minor point and it may be. If the Composite didn't have the requisites of a completed wedge pattern, I'd be cautious about saying this chart is also shaping up as having bullish potential ahead.

There's much to 'prove' yet by the bulls, since there are layers of resistance implied by the key moving averages, the down trendline (intersecting at 1870 currently) and the prior 1939 top. A move above the prior intraday high at 1939 or just a new high Close above 1913 is needed to suggest a turnaround in the intermediate downtrend. As always, a single such event isn't 'conclusive' until a second such confirming high.

Near support is noted at 1780, then is seen in the low-1700 area and finally back at the lower trendline.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

The Nas 100 tracking stock chart is bearish, displaying also a downward sloping bearish price channel. I did forecast the potential for a rebound from the lower down trendline, and there was a decent bounce from there as you see below. This oversold rebound doesn't yet suggest any change in the bearish pattern for QQQQ.

To get bullish on this chart would start with the Q's rallying above near resistance at 44.8, extending to 45.2, then going on to pierce its down trendline (currently intersecting at 46.5), then climbing above the prior intraday high noted at 47.7; a couple of Closes above the prior closing rally high at 47.05 would be a big step in the right direction for the bulls.

Near support is at 43.7, then back down in the 42.0 area, extending to the prior recent low at 41.7.

A 'typical' low-volume QQQQ rally was seen this past week - see above. Volume has expanded in the direction of the trend mostly only on the declines in past weeks. As usual the only aspect of the volume pattern that seems relevant to a possible continued advance is the upturn in the On Balance Volume (OBV) line. Absent paying attention to heavy volume at key upside reversals (i.e., selling 'climaxes'), we need to mostly focus on price action and see where trade is within (or beyond) the downtrend channel.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 (RUT) has also traced out a well-defined falling wedge pattern that suggests bullish potential down the road, but within the context of a still bearish chart.

Support and resistance points are noted below with the key resistances being at the (upper) down trendline, currently intersecting at 643; than, more importantly, at the prior rally highs in the 672-677 area.

Support was seen in the 612 area on the recent advance. Fairly major support begins in the 595 area, extending to 587, then perhaps again to the lower trendline intersecting currently around 582.



GOOD TRADING SUCCESS!



NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS

CHART MARKINGS:

1. Technical support or areas of likely buying interest and highlighted with green up arrows.

2. Resistance or areas of likely selling interest and notated by the use of red down arrows.

I WRITE ABOUT:

3. Index price areas where I have a bullish bias or interest in buying index calls, selling puts or other bullish strategies.

4. Price levels where I suggest buying index puts or adopting other bearish option strategies.

5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only (CPRATIO) with the S&P 100 (OEX) chart. However, this indicator pertains to the market as a whole, not just OEX. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I tend to favor At The Money (ATM), In The Money (ITM) or only slightly Out of The Money (OTM) strike prices so that premium levels are not as cheap as would otherwise be the case, which helps in not overtrading an account. Exit or stop points, as well as projected profitable index price targets, are based on my technical analysis of the underlying indexes.


New Option Plays

Long Play on Pharmaceuticals

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: Good evening. The results of my scanning this weekend provided very little opportunities for long trades. I looked at several hundered charts and was unenthused with prospects to the long side. However, I did find a few in the pharmacuetical space and have chosen to release MRK below. I'll also share some additional trade set-ups with you that I think have some potential.

Long STP - The stock broke out of resistance near $10.50 and continued higher on Friday. I would look for the stock to retrace some of the gains and look for an entry near the broken resistance around $10.65. If it does the stock has some room to run up to $11.50 to $12.00 before any real resistance.

Long C - I like C as a speculative long play. The government has been selling its stake and when the selling begins to wane C could be in for a sustained run higher. If C breaks above $4.07 it could see see $4.50 to $5.00 fairly quick.

Long DF - The stock looks like it is ready to break out of resistance near $11.10. If it does there is a lot of clear air overhead with little resistance. There has been a big institutional seller of this stock over the past year which has beat it down. It is cheap now and looks ready to bounce higher, possibly up to $12.50 and then $14.00.


NEW DIRECTIONAL CALL PLAYS

Merck & Co - MRK - close 36.30 change +0.44 stop 59.38

Company Description:
Merck & Co., Inc. (Merck) is a global health care company that delivers health solutions through its medicines, vaccines, biologic therapies, and consumer and animal products, which it markets directly and through its joint ventures. The Company's operations are principally managed on a products basis. The Pharmaceutical segment includes human health pharmaceutical and vaccine products marketed either directly by the Company or through joint ventures. Human health pharmaceutical products consist of therapeutic and preventive agents, sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions.

Target(s): 37.95, 38.60, 39.35
Key Support/Resistance Areas: 39.50, 38.75, 38.00, 36.35, 35.80,
Time Frame: 1 to 2 weeks

Why We Like It:
MRK is building an ascending triangle on its daily chart with resistance near a key pivot level for the stock at $36.35. The stock formed a bullish inverse head and shoulders pattern that began with the left head in April (see large ovals on chart). If MRK trades above Friday's highs there is little resistance until about $38.00. Earnings are at the end of July and I expect this stock to make a run. I suggest we use any weakness to initiate long positions or a break above Friday's highs, whichever occurs first. The stock has closed above its 100-day, 200-day, and 20-day SMA's which are all converging so I don't expect too much pullback from here. Let's use a trigger of $36.50 and $35.85 to initiate long positions. Our stop will be $24.79 which is below all of the aforementioned SMA's and the lows from 6/21 and 6/23.

Suggested Position: Buy August $36.00 CALLS if MRK trades $36.50 or $35.85, whichever occurs first, current ask $1.40

Annotated Chart:

Entry on July xx
Earnings Date 7/30/10 (unconfirmed)
Average Daily Volume: 18 million
Listed on 7/10/10


In Play Updates and Reviews

Targets Adjusted on Most Positions

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


PUT Play Updates

Deere & Co. - DE - close 58.01 change +0.75 stop 60.05

Target(s): 56.30, 55.20, 53.25, 51.75
Key Support/Resistance Areas: 60.00, 57.50, 56.50, 56.00, 54.00, 52.70, 51.50
Current Gain/Loss: -40%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
7/10: DE is not acting as I suspected and the position is moving against us. The stock has rallied to close its gap down on 6/29 which is also just underneath its broken upward trend line that began in July 2009. DE also closed right at its 20-day and 50-day SMA's from below. This the area where I thought any bounce in DE would stop and I think new bearish positions could be opened here with tight stops. The volume on this bounce has been significantly lighter than the pullback which is a bearish signal because it indicates that the stock is being more heavily distributed rather than accumulated. However, if the bounce doesn't stop here readers should consider getting out of the way and closing positions. A tighter stop could placed at $59.30 which is above the 100-day SMA and Friday's high. Officially, I am sticking with the original stop but have tightened the targets. These are near support/resistance and are places where I would suggest tightening stops.

7/7: DE had a huge day and closed +3.61% higher. The stock closed right at a key support/resistance level at $56.50 and is entering a congestion zone, downtrend line, the backside of a broken upward trend line, and all of its SMA's from below. The stock could bounce a little further but I would be very surprised to see DE above $58.00. I suggest we use some patience and see how the this relief rally plays out in the coming days.

7/6: DE traded up to $56.06 this morning which triggered our entry to buy August $45.00 PUTS. The stock sold off the remainder the day and has peeked its head below the 200-day SMA for three consecutive sessions but has yet to close below it. If it does we should hit our first target of $53.25 relatively quick. If DE breaks down prior to bouncing I suggest readers be quick to take profits at the first target or tighten stops to protect against a hard reversal.

Current Position: August $55.00 PUTS, entry was at $3.00

Annotated Chart:

Entry on July 6, 2010
Earnings 8/18/2010 (unconfirmed)
Average Daily Volume: 5.4 million
Listed on July 3, 2010


Ingersoll-Rand - IR - close 34.04 change -0.21 stop 36.60

Target(s): 33.25, 32.05, 31.25
Key Support/Resistance Areas: 37.00, 36.50, 35.70, 34.50, 33.11, 31.50, 30.12
Current Gain/Loss: +0.00%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
7/10: I am comfortable with the fill we got in IR on Thursday. The stock is forming a bear flag and I expect it break down when the oversold bounce in the market loses momentum. I've adjusted our targets and added one just below for readers looking for a quick exit. If the first target is hit the gain should be 10% to 15%. This is good place to at least tighten stops to see if we get more out of the position.

7/7: IR has broken down hard since its YTD high of $40.65 on 6/21. Today the stock gained +1.73% compared to the broader indexes that all gained approximately +3%. This is underperformance. IR appears to be forming a bear flag on the daily chart and I suggest readers take advantage of a break down below its recent lows near $33.00, or on any strength the stock exhibits in the coming days. The stock has broken below its 200-day SMA (currently $35.29) and if it bounces I anticipate it struggling at this level. There is a ton of overhead resistance to deal with (see rectangle). I've chosen a trigger of $34.30 and $32.96 to initiate short positions, whichever occurs first. $34.30 is just below Tuesday's highs which IR couldn't get to today. We'll use a wide stop of $36.60 until we are in the position and then adjust it. If we get filled at the higher price it presents a good risk reward set-up, i.e. risking $1.85 to make $2.70 at our first target of $31.60, and $3.70 at our second target of $30.60. If IR breaks lower I believe the selling will gain steam quickly.

Current Position: August $35.00 PUTS, entry was at $2.25

Annotated Chart:

Entry on July 8, 2010
Earnings 7/19/2010 (unconfirmed)
Average Daily Volume: 5.4 million
Listed on July 7, 2010


Lululemon Athletica Inc. - LULU - close 38.89 change +0.17 stop 41.30 *NEW*

Target(s): 35.80, 34.55, 33.50
Key Support/Resistance Areas: 42.25, 39.75, 37.00, 35.16, 32.75
Time Frame: 1 week

Comments:
7/10: LULU is getting ever so close to our entry. The stock traded to within 8 cents on Friday and backed off. The bounce over the past few days has been on extremely light volume showing a lack of participation. This is one of the most bloated retail stocks out there trading at a P/E of 38. It is a novelty retailer and sometimes the P/E doesn't matter so I will keep a tight leash on this and use a stop of $41.30 which is just above the 20-day and 50-day SMA's. LULU has not tested them from below since breaking through them in June. I like the short set-up and want to lower the entry trigger to $39.15. I have also adjusted the targets. I'm looking for LULU to make quick trip back down to test its lows and possibly break them.

7/7: LULU rallied +4.24% higher today and is getting closer to our short entry trigger at $39.25. If the stock trades to this level I feel comfortable suggesting a short position as it will be the first time the stock approaches its 50-day SMA since breaking it on 6/25. The 20-day SMA is also overhead, along with a downtrend line which will provide even more resistance. I think patience will pay off for us on this trade.

7/6: LULU came within 15 cents of hitting our trigger to enter short positions today, and then reversed down. The stock has faced a barrage of selling recently and is coming into a prior support/resistance area near our first target of $35.25. If the stock keeps testing this area the support should eventually break. I only wish LULU and the market were not so oversold. I am expecting this stock to bounce, maybe even up to its 50-day SMA which is near $40.00. Considering the conditions I would like to raise our entry back to $39.25 (below the 50-day SMA). If we are patient and get a good short entry it should pay off.

Suggested Position: Buy August $35.00 PUTS if LULU trades to $39.25, current ask $2.05, estimated ask at entry 1.55

Annotated Chart:

Entry on July xx
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 700,000
Listed on July 1, 2010


Polo Ralph Lauren - RL - close 77.16 change -0.06 stop 82.50

Target(s): 75.25, 73.50, 72.10
Key Support/Resistance Areas: 82.00, 80.00, 78.00, 75.00
Current Gain/Loss: -1.6%
Time Frame: 1 week
New Positions: Yes

Comments:
7/10: We initiated AUG $75 PUTS at the open for $3.00. The opening print was all RL could muster for the day as the stock drifted lower throughout the day. There is a lot of resistance to keep RL in check. I am looking to book a quick on this position and expect the stock to hit our first target of $75.25 relatively quick. This should give us a +20% gain on the position and is good place to tighten stops to protect profits. My primary target is $73.50 but that may take a bit longer depending on earnings, news, and how the market is reacting to it.

7/8: RL has rallied +8% off of its lows on Friday and is now approaching its 20-day SMA, two downtrend lines, and a price congestion area dating back to October 2009, all from below. The facts are that the consumer is not in good shape, jobs are hard to come to come by, and the housing market remains in the tank. This doesn't bode well for retailers and I believe we will see RL retest its lows before it breaks the downtrend lines. I've chosen $77.40 as the entry trigger which is just above today's closing price. I would like to buy August $75.00 PUTS for no more than $3.00 which is what they should be worth at $77.40. Our stop will be $82.50 which is below the 20-day and 200-day SMA's and will be below the 50-day SMA in a matter of couple of days.

Current Position: August $75.00 PUTS, entry was at $3.00

Annotated chart:

Entry on July 9, 2010
Earnings 8/5/2010 (unconfirmed)
Average Daily Volume: 1.8 million
Listed on July 8, 2010


PowerShares QQQQ Trust - QQQQ - close 44.62 change +0.42 stop 46.90

Target(s): 43.60, 42.55, 41.80, 41.05
Key Support/Resistance Areas: 46.77, 45.25, 44.46, 43.50, 42.50, 41.00
Current gain/loss: -11%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
7/10: QQQQ is bouncing but I expect the selling to resume soon. In light of the choppy trading that I foresee I am going offer a near term target of $43.60 which is $1 lower than current levels. For readers in PUT positions they should be worth about $2.15 (entry was at $1.85) which would be a +16% gain. This target is near the June 8 low and may form an inverse head and shoulders pattern. I suggest being quick to tighten stops at this level to protect profits. QQQQ may bounce up to its 20-day or 50-day SMA just overhead before reversing so I suggest being patient. There was a lot of volume in the August PUT strikes on Friday and large blocks bought on the offer. This is a good sign for a move lower but earnings is the wild card.

7/7: QQQQ had a monster truck rally today but I believe this will be short lived. The ETF is nearing an important resistance level at $44.46 and has all of its SMA's and plenty of congestion overhead to act as resistance. The rectangle on the chart represents a gap that I suppose could get filled so conservative traders may consider waiting to enter at $45.00. I'm just not confidant the gap will get filled. Today was a relief rally and we may get a little more but I think the selling will resume again and QQQQ should easily retest its lows and possibly break them. Let's use a trigger of $44.30 to initiate short positions. Our stop is $46.90 and I do not see QQQQ trading up to this level prior to breaking down again.

Current Position: August $45.00 PUTS, entry was at $1.85

Annotated chart:

Entry on July xx
Earnings N/A (unconfirmed)
Average Daily Volume: 100 million
Listed on July 7, 2010


Starbucks Corp. - SBUX - close 25.30 change +0.48 stop 26.75 *NEW*

Target(s): 24.25, 23.70, 22.55, 21.30
Key Support/Resistance Areas: 26.50, 26.00, 25.25, 24.80, 24.00, 23.60, 22.50
Current Gain/Loss: -21%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
7/10: SBUX has retraced some of its recent decline as the market has bounced. The stock is testing its 100-day SMA from below and the backside of its broken upward trend line for the first time since breaking in late June. The 100-day SMA has been an important reference point for the stock in 2010. We are also near an important support/resistance level of $25.25 so this is a logical place for SBUX to reverse back down. However, the broader market direction will most determine our fate on this position. A tighter stop could be placed at $25.80 but the bounce may go a little further so patience is suggested. I am looking for SBUX to make a lower high and reverse back down to at least retest its lows. I like new positions at these levels.

7/6: SBUX came with 6 cents of our trigger to enter short positions and then proceeded close down -3.04%. I'm expecting SBUX to bounce with the broader market so I suggest being patient and ready to short the stock if it trades to our trigger of $24.75.

7/3: Last week SBUX broke below a trend line that began in October 2009 and collapsed below it 20-day, 50-day, and 100-day SMA's. These SMA's (in particular the 100-day SMA) have been key areas where the stock has bounced during its rally over the past year. And now that the stock is below them it has probably seen its best days, at least for awhile. I would like to use a trigger of $24.75 to enter short positions which is below the stock's 100-day SMA, the underside of the broken trend line, and the recent steep downtrend line, all of which are converging (see oval on chart). The $25.00 area could also be considered an entry point but I chosen $24.75 because it is near Friday's highs which could possibly form a double top on the intraday charts. Our primary target is $22.55 but I have also listed $23.70 as area to consider tightening stops. It is above the 200-day SMA which SBUX has not touched in over a year.

Current Position: August $25.00 PUTS, entry was at $1.40

Annotated Chart:

Entry on July 8, 2010
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on July 3, 2010


CLOSED BULLISH PLAYS

Allergan, Inc. - AGN - close 65.49 change +0.91 stop 62.12 *NEW*

Target(s): 63.75 (hit), 64.45 (hit), 65.25 (hit)
Key Support/Resistance Areas: 65.50, 64.50, 63.80, 61.80, 59.50
Final Gain/Loss: +35.5%
Time Frame: 1 week
New Positions: Closed (7/8/10)

Comments:
7/10: AGN hit all of our targets on Thursday and we closed the position for a +35% gain. The stock is near 2 year highs and if it breaks out higher the next resistance is $67.50 to $70.00 which is near the highs from late 2006/early 2007. The highest closing price of the past 3 years was near $68.50. I don't expect much more out of the stock and would use tight stops to protect against a reversal. There has been takeover chatter about AGN but I have not read anything to confirm it. If the information is not true the stock could fall hard.

7/7: AGN calls were initiated at the open this morning and the stock came within 1 penny of hitting our first target this afternoon. I would be hesitant to open new positions and chase the stock up here. I suggest readers tighten stops to $62.12 and be quick to take profits as our targets approach as I am not confident how long this rally will last. We should have no problem hitting our first target of $63.75 tomorrow. Our next target is $64.75. These areas are logical places to further tighten stops to see if we can get more profit out of the positions. For readers who do not trade intraday I think a good strategy on this position would be to place a one cancels the other bracket order (OCO) with the stop order based on the price of AGN stock (i.e. our stop of $62.12) while the sell limit order based on the price on the $65.00 calls. The projected price of the calls at our second target of $64.45 is approximately $3.80. The bottom line is we have a gain and I do not suggest holding on to the position trying to squeeze out more gains. The broader market can go down just as fast it went up today.

7/6: AGN closed above a downtrend line that began on 4/1 on Friday and has now retraced some of those gains and tested the backside of it. The stock is also above a key support level at $61.80 and all of its major SMA's, which should provide additional support if there is a pullback. I'm expecting the stock to bounce with the overall market and possibly retest its YTD highs. However, I suggest being quick to tighten stops if AGN moves higher. If AGN hits our first target we should be able to make 30% to 40% on the call position. Option activity has also been picking up mainly in the July strike prices. Our stop will be $59.38 which is below the opening gap up on Friday and all of the SMA's.

Closed Position: August $65.00 CALLS at $4.20, entry was at $3.10

Annotated Chart:

Entry on July 7, 2010
Earnings Date 8/8/10 (unconfirmed)
Average Daily Volume: 2.58 million
Listed on 7/6/10