FED relief

The FOMC released their statement today at 2:15 PM and decided to keep the target fed funds rate at 5.25%. It seemed a foregone conclusion that they would not cut rates, but judging from the action in the markets starting at 2:15, I'm thinking what people needed to hear was that there wouldn't be a rate hike. Even if slower, the economy is still growing and the bulls seem to want to run further. Look at today's chart with 15 minute candles for the SPX, Nasdaq composite, Dow Jones Indusrials (Thinkorswim doesn't support the ticker for the dow, so the DJX is the same thing at 1/10 the size) and the Russell 2000 small cap index. The red line is drawn before the 2:15 candle.
(click image to see it bigger)


Look at the total volume New York Stock Exchange for the past 4 days broken down into 15 minute chunks. The cross hairs on each day show the level right before the 2:15 period began. Today's trading increased significantly as the market pushed rapidly higher in the last hour and forty five minutes of trading. Perhaps that seems like a silly and obvious observation to make, but it is a good piece of confirmation for the upside sentiment.
(I still can't figure out why this Total volume chart doesn't' show the same numbers we see for total volume on the NYSE home page or Yahoo. Nevertheless, it gives a good relative picture.)

Though the Nasdaq and especially the SOX still look somewhat questionable in their technical strength, the Dow is back working on a new high and the SPX has jumped back above the 1431 resistance line I've shown on recent posts. So it seems the breakout may get another chance.
But most of all, I like the look of the Russell 2000 moving above it's relatively orderly period of sideways consolidation. This would indicate that small caps would be good stocks to look for buys, or you could just play the IWM, Russell 2000 ETF. Remember that even if you're wrong about a bullish stance, it's best to get in near support so you know where to get out for a small loss. It did come in more than the other indexes off the high of the day, but strength tomorrow could be a great entry. I would look to 79 for new support and aim for a target of 81 judging from the height of the sideways channel.


Notice that the FOMC statement mentioned tentative signs of stabilization in the housing market. The housing stocks have been rising steadily since September and were up nicely today even before the statement and more so after. Our KBH is looking well on its way. 55 may yet be a point of resistance in the short term, but 60 seems like an inevitable destination.


I'm kicking myself over ISE, which I discussed briefly in the last post. If had stuck to my original plan to give it room up 'til 47.50, I'd be feeling very good right now. I guess this is one nof the major realities of options trading. The massive swings in option price can really bring out the emotions. This is why we have to examine what we as individuals are comfortable with. Mine was a good analysis and the exit was not such a horrible decision either based on what I was seeing. But the added pressure of time decay and the leverage of the option are more what weighed on my decision, emotionally, than my certainty that it was going to go upward, the wrong direction.
I don't know what happened today, as there's no major news, but the stock is down on big volume. The ideal bearish entry to make here would have been on the first lower high after second of equal highs. That also was a bouncing down off the MA and had 3 red arrows. Would have been much easier to sit through the turbulence during which I bailed out. Double GRRRRRR!
That this stock had such a down day with no obvious news when the market rallied strongly does not say good things for it at all.


Happy Hunting. If the market is going to start a another leg up, this is the place to be looking for entries. The VIX, by the way, feel lower again today for a definitive lower high.

Handbags, anyone? - COH, Knee implants? - ZMH

Looking through our list, COH appears to be the most buyable at the moment.
The Industry group is looking good in the green on the big chart. The group chart is pulling back a bit after a very strong move since July. In the last six months, COH has considerably outperformed its group.

If the market and this group continues with strength, it would be a good bet that this stock would remain a leader. They just came out with earnings beating estimates for the 5th straight quarter.
The fundamentals are looking very strong here. The 5 year annual growth estimate at 20% is a touch lower than we'd like, but the ROE(Return on Equity) of 40 is very favorable. The brief run down from the press on the earnings announcement looks pretty nice. Sales in Japan grew 17%, (I assume that's year over year) and they're adding 10 new stores in Japan for a total of 20 new stores in 2007. Using the estimate for annual earnings in the fiscal year 2007, it now has a PEG of 1.24, which is still pretty attractive for a leading stock.
The day of the earnings announcement there was some odd intraday action, but it formed a Dragon Fly Doji, much like a hammer, that was confirmed with a bullish engulfing candle the next day. This coincides with the MA acting as support as it did twice in December. While the trend has clearly flattened out a bit, an entry here would put us closer to support levels where we might choose to use for exit points to the down side. Considering the potential sideways action, one might be inclined to wait for a close above the 45 area, which has been a minor point of resistance lately.


So what do we do with this, particularly considering the market is looking a bit ify right now? Buying the stock here would be pretty reasonable since it is so near support. Even with the uncertainty in the market, a tight stop under 43.50 or 43 would be reasonable with a plan to use one of those two support lines as an exit. But where's the target? Obviously a near term target of the recent high at about 46 or 47 would be reasonable. And looking back at the average distance above the MA in the last two years, I'd say somewhere between 3-4 pts. With the MA now at about 44, I'd say 37 would be a reasonable near term target. But for a longer term trend ride, I can't see why at least a nice, round number like 50 shouldn't be in the cards. So to play it as a regular stock buy, you'd have to decide if you're comfortable with the risk/reward and whether or not you'd want to look for a quick profit or to let it ride for a longer term trend play.

But let's consider some ideas using options. There doesn't quite seem to be enough juice in the options chain to make a covered call buy-write very attractive. Look at how the IV dropped very quickly after the earnings announcement. You may remember my mention back in December that this could be a good stock to play a run up into earnings and the accompanying rising implied volatility.

Buying the stock now and selling the March 45 call for 1.50 would bring a profit, if called out, of under 5%. Depending on how close you'll choose a support level to use as an exit, that might not be the most attractive risk/reward. What would make it more attractive would be buying a deep ITM call instead of the stock itself.


Buying the May 32.5 for 12.80 and selling the Mar 45 for 1.50 would technically be a "Diagonal" spread with options from different months with different strike prices. But used this way, it is essentially like a covered call. This position would cost $11.30 and bring a potential profit of 1.20 or 10.6% return on investment. The real question is whether that profit is worth what we'd be risking if we sold on a break of support. I think it's pretty debatable. But don't forget about the possibility of selling the following month after March expires if we're still somewhere under 45. What I'd be more inclined to do along these lines would be to buy the May 32.5 and wait until the stock moves a bit higher to "leg in" to a covered call, selling maybe the 47.5 or even the 45 for a higher premium.
Looking at the potential with vertical spreads, hedged positions buying and selling different strike prices but in the same month, the bull-put credit spread doesn't have enough premium in it to make it worthwhile, even further out in March. Using the support levels we have beneath us, it'd be nice to sell the 42.50 strike price, but a 42.50/37.50 March put spread would only bring in .60 for a potential return of 13% on the money at risk.
But what if we looked at doing a vertical spread with directional bias. We can do virtually the same spread with either puts or calls, buying the 40 strike price and selling the 45.

Here is the options chain for these 5 pt. vertical spreads. Because they are 5 pts. wide, the most one can ever make or lose is 5 pts. minus the credit or debit of the spread you opened.

Looking at the Feb spreads, buying the 40 call and selling the 45 call will cost $4 with a potential profit of $1. If we use 42.50 as a trigger to get out of the trade all together, the loss would be about $1.50 because we know that the 40 call will have at least 2.50 of intrinsic value in it. Depending on how close it is to expiration, there might still be enough time value in the combined position to make the loss less than that. Of course, you could use 43 as the trigger to get out or even 43.50. But giving it room to move with a trigger at 42.50, we're risking about 1.50 to make 1. That's not bad at all considering the high probability of the win. The stock only needs to move up .50 in the next 18 days to get full profit. Notice that the same position in puts, the Feb 40/45 put spread, selling the 45 put and buying the 40 put will bring in a credit of $1, exactly the same.
If we want to be a touch more conservative we could give it more time. Using a March spread will both give us more time for the stock to go where we want it and will get us a better profit potential(and smaller potential risk) because there is more time value(fluff) built into the options we would be selling.

Buying the March 40/45 call spread costs 3.70, leaving a potential profit of 1.30, the balance of the 5 pt. spread. But selling the March 40/45 put spread would bring a credit of 1.40, a better potential return on the money at risk.

Investools seems to teach credit spreads as something to be used only selling the short strike price out of the money and behind support of some kind. But notice here that the credit spread that is actually a bit in the money here is more attractive than the debit spread. Also, one of the benefits of the credit spread(though very dicey) is that you can "reverse" the trade.
For example, with the March put spread, we'd be buying the 40 and selling the 45. If the stock suddenly broke through support in a dramatic way and with volume, we might expect it to go much further. We would then have a few choices: We could close the whole position for a loss. Or we could buy back the 45 put for a loss and let the 40 put pick up value as the stock continues to fall. If it goes far enough, the profit from the 40 put will compensate for the loss taken on the 45 and we might even end up with a net profit on a trade that went the wrong direction.
I want to emphasize that this type of trade reversing is very tricky and has further risk involved, but it's something we should understand as a possibility going into a trade. I'll do a post soon about a trade reversal I made on BHI. It was a successful fix, but more often than not I've screwed things up worse when I've tried that.
In conclusion, it seems to me that this is a tough options chain to deal with because there's not a lot of fluffy premium to sell. I would probably be more inclined to buy the stock or a deeper ITM call and look to leg into a covered call or diagonal spread. Or doing the March 40/45 bull-put credit spread(slightly in the money) for a potential 38% return on risk if the stock moves up .48 by March expiration.

I hope that all wasn't too confusing. There have been very comments/questions left on this blog. If any of this is confusing or brings up questions or thoughts to share, please do not hesitate to write them in the comments section below.

In other news, ZMH reported solid, estimate beating earnings today after the close and raised the outlook for 2007. Strangely, before the announcement, the market had already begun a strong bounce off the MA and trendline support for a break above resistance on volume well above average. Perhaps people are really interested in this one. Industry group is in the red on the big chart, though the group's chart looks quite strong still.
The F/E score is just at 3.25 our minum with the Estimates score at 2.75. Not quite the forward looking strength we'd like to see. Can you account for why the Estimate score is that low? I can. How to figure out the scoring is in your manuals.


Our old friend ISE appears to be following through with the double top pattern, if a bit sheepishly. I'm pretty sure I've mentioned this pattern on this stock a few times already. Earnings come out Feb. 5, so use caution before then.
Notice the little note I put on the chart. On 1/22 I bought a March 50 put. Looking at the chart action, I chose 47.50(around where the MA was) as a bail out point but got out early because the candles seemed to be telling me that support at 45 was going to hold. I closed it 1/26 for a small loss after seeing a morning star formation at support and then a Hammer on the day I closed it. Perhaps I should have waited for confirmation on the hammer with a close higher. That didn't happen. It went lower and I would be profitable right now. Grrrrrrr!


Lots of important economic announcements this week, especially the FOMC meeting statement on Wednesday. So be careful out there.

Sideways Market?

The market has shown amazing resilience in recent months. But it continues to show chinks in its armor. Most notably this week, the SPX had a nice breakout day demolished by a bearish engulfing day to follow it. That leaves the index kissing the MA and heading toward a likely third red arrow. If it does break the MA, it will also likely break the support line from the channel since November. Nevertheless, the tracks for a downtrend will not begin to be laid until the last significant low at support in the 1410 area is broken. Until that time, we have to assume we're still moving at least sideways, if not up.


The Nasdaq already has older red arrows on the MACD and Stochastic and a relatively fresh red arrow on the MA. Its breakout failed two weeks ago already, but what's most amazing is that the big bearish engulfing on Thursday of this week happened right at the old resistance line. It's just weird the way this stuff works out sometimes. In any case, sideways action seems even more likely on the Nasdaq, even if this 70 pt. wide channel is likely to be broken in the near future. The biggest message is that the uptrend is very much in question for the near future.


So this brings me to one of the basic principles taught by Investools. We should adapt our trading to the market. Though it may take time to become proficient and confident in such a variety of strategies, eventually we want to be able to make money in all markets, up, down or sideways. Here is the general application of strategies:

• Uptrending market- Long stocks(buying), long call options

• Sideways market - Covered calls, advanced options strategies(spreads, protective puts, etc.)

• Downtrending market - Short stocks(selling), long put options

Of course, advanced options strategies can be applied to all markets, but this is the simple ideal. Theoretically, the best way to take the most money out of the market if you know what you're doing.

With the assumption that we're moving sideways, let's explore what we might do if we were long shares of SPY. Assuming we're using the Investools method, the 3 red arrows are a sell signal. However, for the purpose of not getting whipsawed in an intermediate term trade every time we show 3 red arrows, we might use the "3 and 3 rule." This guides us to move our stop loss order up when we receive 3 red arrows to 3% below recent support or the MA. Using the MA currently at 142, that would put our stop at 137.74. (To find the level of 3% below support, just multiply the support level by .97)
Realize that because the SPY trades at 1/10 the size of the SPX this distance of over 4 points here is over 40 SPX points, seemingly quite a swing. If we're in a longer term position, that would be a fairly normal occurrence to ride out. But who likes to ride out a 40 point down swing? Perhaps the seller of covered calls wouldn't mind.

With the market showing signs of a sideways inclination but not yet a full blown down turn, three red arrows would be a good time to think about selling calls on our spy position.
Looking at resistance from the failed breakout being at 144, I would probably be most inclined to sell that strike price in case there is something of a bounce off the MA. This way, I'd still have some room to profit from the rise in the underlying shares owned.


Looking at the options chain as it is over the weekend(but will change somewhat at market open on Monday) we can get .60 for the Feb 144 call with 19 calendar days (15 trading days) left in its contract. With a credit of .60 taken in from the covered call, if we get called out upon the stock closing above 144 at expiration, our selling price will be essentially 144.60. One could also opt to sell the 143 for a higher credit, but the likelihood of being called out of the stock would be higher as you can tell from the Probability of Expiring (in the money) column.

One might even decide to sell the further out month to bring in more premium. Under 20 days out seems to be the recommended cut off for selling options, but 19 or 18 is probably okay if all the analysis is there. This is just getting into the rapid acceleration of time decay. Notice that the Theta is higher on the February options than on the March options. Ideally, as the stock moves sideways, we'll burn down most of the time value on the Feb call and then roll it(buy back the Feb call for cheap and sell the March call at the same strike price).

While the downside of doing covered calls is capping your potential profits, sometimes it is still quite attractive to squeeze out a little more juice from a holding. Though it is certainly possible that the SPX would rally more than 24 pts. to beyond 14,460 in the next 3 weeks, judging from the analysis above, it seems unlikely. So in this case, though we'd be very happy to see the stock move above 144 and call us out for this profit, the strategy is being employed to "generate income" on our holding as some people say, or better yet, reduce our cost basis on the shares owned.

Another interesting strategy taught by the people at Thinkorswim would be to do a virtual covered call on your entire retirement account, assuming it's in broad market funds. If you're in Mutual funds that roughly track the SPX, you could sell calls of SPY just like we did here. But since you don't own shares of SPY, they would be considered naked and you'd have unlimited risk since the index could shoot up to the moon. To cover the risk and keep it at a nice defined risk level, you would buy calls further out of the money than the ones you sold. You would then have the right to buy the stock just higher than where you'd obliged yourself to sell them to someone else. You could think about the bought calls as insurance. But being further OTM, they'll cost less than the ones you're selling. This creates a credit spread, in this case a Bear Call spread.
Using the quotes right now, it looks like a SPY Feb 144/145 call spread could bring in a credit of .30 or so, assuming we can fill somewhere between the bid and the mid price. Even if the market rallied hard and we lost the full .70 at risk in that spread, if the position were sized proportionally appropriate to your fund holdings, the profit in your funds would still compensate for the loss of this smaller position. Seems like a win/win situation. One could also do a bear call spread on the SPY even without mutual fund holdings, but you're then risking betting against an essentially bullish market without the benefit of an underlying component picking up profits if the market rallies.

Of course, selling calls or credit spreads does not negate the damage done when the market turns south. When the blatant sell signals are given to get out of the market, simply buy back any short calls or call spreads. Then, sell the underlying stock.

In closing, though I used the SPY as the model for selling covered calls on warning signs of an uptrend in trouble, this can of course be applied to stock holdings as they waver before either breaking down or resuming their uptrend.

On another subject, as if the whole risk factor hasn't been beaten to death lately by yours truly, here's an article from IBD on cutting losses short. Jeff Kohler has also recently done a blog posting about Position Sizing. Like mine, his postings are sometimes a bit on the casual side and less than definitive, but he gives good insights that are worth reading.

I will try in the next few posts to look at some of our stocks with an eye toward strategies for a sideways market.

ICEy Hot

(No this isn't a commercial for the Ben-Gay alternative. It's about our first change to the list.)

I hope everyone has had a good weekend. Are we getting our heads on straight for the coming week? It is a tough time to know what to do in the markets at the moment. In addition to the commencement of the unpredictable earnings season, we seem to be getting quite a dose of mixed signals between the SPX and Dow holding up nicely(even if at resistance) with potential support from the Transports, while the Nasdaq took back most of the promising strength it showed two weeks ago. Much worse is the SOX index at a two month low and in an intermediate term downtrend. It may find support on the backside of the old downtrending resistance line, but if it takes out the 445/450 area in a meaningful way, that will be a very bad sign.
(Click it)


Let me again urge you to watch Peter Reznicek's weekly ShadowTrader video. You can find it in the center column at redoption.com.
I also encourage you to visit the home page for BigTrends.com. There you will find four regular columns for which you can read through the archives. Their Weekly Outlook is always worth reading, if a bit heavy in indicator talk. I received my free membership email today for their Daily Trend Watch which focuses on different subjects from day today. The one I received is not yet posted on their site, but will surely be there by tomorrow, Monday. It is a good discussion of earnings expectations and reactions. Meanwhile, the most current topic is Using the Right Tools at the Right Time. In it they explore the application of different indicators in different environments including a focus on the MACD and Stochastic like we use with the Investools set. The application of the teaching in that article to today's environment might be that we could start looking a little more strongly at the Stochastic as our strong trend seems to be flattening out and we're looking more range-bound.
I know that it is very frustrating that there's always something new to consider which may refute our technical indicators and whatever combination we may use for buy/sell signals. But when it comes down to it, there is not "right" or "wrong" set of indicators or signals. The undisputed common denominator between any and all successful traders can no doubt be that they have rules with regard to money management, position sizing and controlling risk for the times that they are wrong.
We've talked about a trading plan and rules lately. I myself have wrestled with this one and get the sense that many of the members of our group are doing without them. I would agree that it is very difficult for a new trader to establish a plan or approach they're comfortable with, particularly with little knowledge of the market, much less which strategies they like. But there is no question that everyone, especially the new trader, should have rules for handling their money and managing the risk in any trade. PLEASE! If you have no other rules for the time being, at the very least, make rules regarding money management and position sizing.
On the Investools site now there is a section on the top right corner of the Online Home page that shows a scrolling, clickable list of the 10 mistakes new investors should avoid. There is a reason we hear these same tidbits over and over. Make the effort to put something in place.
The challenge will not only be to put some kind of rules in place, but even more so, to follow them.
I bought a LEAP many months ago on JLG. I won't go into the details of the trade, but since I had so much time in the option and the company had such strong fundamentals, I ignored the clear technical breaking down of the stock and watched the option lose all of its value. ALL of it. My rules told me clearly to get out of it, but I didn't follow them. So now I have been looking at this worthless option in my portfolio for months as a reminder. Thank God it finally expired!
Here is another good article from IBD which discusses cutting losses short and letting winners run. Investing Success Doesn't Require Perfection.

OKAY. Enough of that. I have mentioned wanting to reshape our list a bit. Starting most obviously with the stocks that no longer match up to the Investools recommended minimum number of an F/E of 3.25, ISE is one that is looking pretty weak. Though still clinging to a 3.25, the forward looking Estimates score of 3 is the weaker of the two and we would rather see that score be the higher of the two. But more than anything, it is the chart that is most unappealing, particularly in the face of great strength of its group.


Even through the dialy look at the chart with the Investools study set, it doesn't look good at all. Three red arrows with the stock bounding down off a declining MA and it is once again pushing the pivotal support level which, if broken, would confirm the double top pattern. If it does break 45, this would call for a move down to 35. I must say, though, that I am a touch hesitant to cut this one loose because there are positive things to see here.
At the last earnings announcement, the stock gapped up strongly with high volume. Though it did immediately pullback almost 20%, the rally into the second top shows quite higher volume than the sell-offs surrounding it. With earnings coming out again on Feb. 5, that could be the catalyst for the next leg up. So continue to keep an eye on this one at home.

Just to give some perspective of what the industry group is doing, check out this index.


In the meeting last week we walked through the process to find a replacement for ISE and agreed that ICE was a good choice. Remember, in searching for something to represent this group, I want to keep dealing with stocks scoring 3.25 or higher and trading somewhere around 1 millions shares a day or higher for purposes of liquidity, a tight options chain, and more reliable technical analysis.
Look at this comparison of relative performance among top scoring and top performing stocks in this group over the past 3 months as the XBD index put in two new higher highs. ISE underperformed the pack while ICE has clearly outperformed by a mile.

I should mention that for the year ICE is up about 150%, by far the biggest gainer of the bunch. Here is the weekly chart of ICE since it's IPO in late '05.

Looking at the daily chart with the Investools set, it looks like we're pulling back a bit to digest some of these major gains. We want to be very careful to not be the last people to arrive at the party and leave unhappily. I would look for support right around 115 at the MA and the potential horizontal support from the old high. If that is broken, it would be a likely end to the long term trend, for a while at least.
What I find really interesting is that this last leg of the upward push comes after a relatively uneventful earnings announcement that was followed by a couple down days.


We looked at the F/E scores at the meeting and found them to be to our liking. The one shocker was the PEG of around 5, WAY higher than the ceiling of 2 we're looking out for. But Jim helped me realize that this was using the trailing P/E with earnings on the past year. Looking at the Earnings of the current year 2007 we find that Price(126.91)/2007 Earnings eastimes(3.36)=P/E(37.77). So we divide that by 5 year annual growth estimate of 24% and we get a much more digestible PEG of 1.57.
The P/E of 38 is still at premium to the group(23), but that is the price for being in a leading stock.
This stock has its next earnings announcement on Feb. 06, the day after ISE. I sure hope I don't wind up with egg on my face to see ISE take off and ICE fumble. ;-)

DTV Trade

It's pretty rare that a trade using the Investools arrows just jumps out at me. Well, this one did. I anticipated the official green arrow on the MACD, but it was pretty certain to come the next day. Volume spike was icing on the cake. But most of all, I liked that there wasn't problematic looking resistance and it was still close enough to the MA to use that as support.
Here's what it looked like the day I entered the trade.
(To see it bigger...say "open sesame.") ( and then click the image)

This was a paper trade. The idea was to ride the trend until it ends. My risk allowance in this paper account is 1 to 2K. I would use the MA as support and set my initial stop at 3% below the MA. That would be about 21. The end of day purchase price would have been 22.4. So the risk in the trade would be 22.40 - 21 = 1.40. My position could be established so: Risk allowance of 1000/1.40 = 714. I'd round it to 700 so I could do covered calls if I wanted to since options contracts deal with round lots of 100. This stock trade would require $15,680.

But I wanted to do a longer term option trade to particpate in this trend. So I chose an ITM option with plenty of time, the March 17.70 calls. With $4.90 of intrinsic value, the option costing $5.40 had only $.50 in time value and a very high delta, so this was very attractive to me. Because it was deep enough in-the-money and with a very high delta that it moved virtually dollar for dollar with the stock, I could work out the risk and position virtually the same. 1.40 risk in the set-up divided by my $1000 risk allowance comes to a rounded 700 just like before, but with options contracts in lots of 100 I would by 7 contracts. Remember that I said 1-2K was my risk allowance, so to keep it a nice round number, I bought ten contracts, still well under the 2K risk.
So, on 11/21, I bought 10 March 17.5 calls at $5.40 for a total of $5,400.
To do the equivalent upgrade to the stock purchase, that would have been 1000 shares costing $22,400 in total.
I was very pleased, of course to see the jump the next day and a just a few days of hesitation before powering higher.
You know how I like my support and resistance, so I drew lines around what looked like a clear channel. With that, I was not surprised to see the price take a pause when it hit the channel resistance on Dec. 11/12. I was happy with my profit but wanted to ride out the trade. However, it looked like a period of sideways action was a distince possibility. In order to squeeze a bit more out of the trade during this sideways action, I decided to "cover" the position by selling the Jan 25 call on 12/14 for $.95.

I of course faced the risk of being "called out" and having to deliver stock on my obligation as a seller at $25. But this would have been a very nice profit I'd have been happy to have. I could have used my 17.5 calls to buy the stock at 17.5 and then deliver it at 25. That is a difference of 7.50, and subtracting my net debit on the options positions (5.40-.95=4.45) I would have a net profit of $3.05 when all was said and done. Not bad for an initial investment of 5.40. However, that was just the reasoning behind selling the call. I was capping the profit potential, but if called out it would have been a 56% return on investment(before commissions).

Part of the plan was to let the short Jan 25 call tick away its time value and potentially buy it back cheaper and uncover the long calls for the stock to bounce up off channel support. All the while, I would get out of the whole position on a break of support.

The stock did move sideways and time ticked away. As it approached the channel support line, I put in a limit buy order to buy back the 25 call if it went down near the horizontal support line that had formed. It filled on 1/5 buying the 25 call back for .25. I was ready for another bounce up, but 1/9 the stock broke horizontal support, the channel support line and even breached the MA for a third red arrow, so I sold the calls for 6.65.

Here's what the trade summary looks like.

Total Credit at the end of these four trades is 1.95. So for ten contracts of 100 shares each, the profit is $1,950. Commissions cose $24.95 for each leg, so a total of $99.80.

Summary

Option Trade.
$1950 profit minus commissions of $99.80 = Net profit of $1850.20

• 34% return on the investment of $5,400.

Stock trade (would have been)
$1740 profit minus commissions of $30 = Net profit of $1710

• 7.6% return on investment of $22,400.

Though approached in a quite conservative way with no more risk built into the trade, the Option trade cost less than 1/4 of the stock trade, but made more money.

This is a good trade and I'm pleased with how I played it. However, I realize that I would have been more profitable buy just selling the initial call when it hit the channel resistance. Perhaps that is what I should have done. But since I wanted to ride the trend, it was right to not sell it. That was the plan. Since the trend was still very healthy and I had months of time left in the option, that was okay to stick with.
What is more important, is whether or not it was worth it to cover the position and cap upside gains potential for the purpose taking in a little premium on the 25 call. It's debatable, but I think in hindsight it wasn't worth it. If the stock had shot higher, I would have lost out on a much bigger gain. I did get .50 out of the sideways and downward move toward support before buying it back, but that didn't compensate well enough for the profits I gave up when the stock fell through support to feel that great about the idea. Simply put, the gain from the short call did not justify the risk of missing out on a much bigger gain.
If the way to make big money in the market is buy cutting losers short and letting winners run, legging into diagonal spreads or covered calls and capping gains is going to mess with that notion helping our accounts. Nothing wrong with spreads or covered calls, it just comes down to how you plan to trade consistently over time and what works out to a profitable expectancy you are happy with. Again, it comes back to the importance of a plan, what you intend to do and how.

I'm glad I did this review. It was very helpful to me to realize that this legging into spreads stuff isn't always as rosey as it sounds. Mike Coval pushes this kind of stuff a lot and I find it intellectually a very interesting challenge, but for its complexity including a great deree of relying on time decay (rather than just taking your profit when you see it) I'm not so sure it's always the right thing to do. In this case, it wasn't. I should have just stuck with the straight call and played it just the same minuse the short call.

Investor's Business Daily Articles

A discussion at the close of the meeting last night led me to look for this article on a concise and not too diversified portfolio. In short, if you really want to be broadly "diversified," just buy shares of SPY or a mutual fund.
Check it out.
Tapping The Power Of A Concise Portfolio

Also, here is an article that gives somewhat of a description of the IBD philosophy, at least the technical side of the approach, being based on a rigorous study of greatly successful stocks throughout the history of the market.
History Always Repeats Itself In Stock Market

I've recommended it before and I'll do it again. Buy William O'neil's book, How to Make Money in Stocks. It explains everything about his journey toward developing his successful approach to investing and ultimately the IBD CANSLIM approach. It's all based on the study of the past. It is very clearly written and makes a ton of sense. I think it is a fantastic complement to the Investools Education and the Investor Toolbox. Not only does it explain what to look for in a stock both fundamentally and technically, but it explains why those those criteria are significant. To my mind, the latter part is what is crucial to understand, the why. It is to this end that I feel Investools comes up a bit short and why I feel the IBD materials are a great complement.

In short, if you plan to invest time and money in the stock market on an ongoing basis, I feel that this is a MUST READ.

The IBD Website has plenty of great stuff to read even on the free site.

Quote from the January 17 Forbes Success desk calendar:

It is a funny thing about life--
If you refuse to accept anything but the
best, you very often get it.

---Somerset Maugham

Do you think that someone who refused to accept anything but the best would trade or invests without ANY kind of rules, much less a plan of some sort?
I didn't see the movie The Pursuit of Happiness. But this article on Chris Gardner paints a pretty impressive picture of determination and discipline. What did he do other than go after it? Do you think he's really made of anything different than you or I?

Start somewhere.

Even if it is super simple and basic, make a plan for what you want to do and basically how you'll do it. That plan might be to learn and understand the basic investools 5 step basic stocks approach. Maybe you want to be able to invest over the course of your life and count on beating the performance of the market. Aggressive trading could be your focus. It might be to develop a certain understanding of technical analysis. Whatever it is, now is the time to identify it.

Easier said than done, but no one will do it for you.

Sector run down

I'll use weekly charts here to run down some of the majors. Peter Reznicek, the shadow trader guy, mentioned recently in a video or in his daily show that candlestick patterns are much more powerful or reliable on bigger time frames. We've all seen plenty of daily hammers or bearish engulfings or whatever that were just steam rolled. While we have to always remember that they are merely another form of an indicator and therefore secondary to trend and support and resistance, it's very useful to size up weekly action with candles as they are stronger reads. This makes a lot of sense to me.
As I pointed out in the last post, Oil is moving down in a serious way and is more likely to continue a bit further than move meaningfully upward. The Oil index is actually still in a healthy uptrend the higher highs have been slightly less aggressive lately, but higher all the same. This week shows a potential hammer indicating a potential reversal. To play an ETF on this sector look to the XLE, one of the heaviest traded of ETFs.
(Click image to see it grow)


The oil services don't look quite so healthy. Long term trendline was breached months ago, but this is a clear break. You might also even call this something like a Head and Shoulders top, but it's not so clear. Tough to figure exactly where to place a neckline for a support break. Regardless, if you're looking for a bearish play on oil look to this sector or just play the OIH ETF.


The convergence of price swings in gold seems likely to bust out in one direction or another and from what I understand about the dollar, I'd think up would be more likely than down.

Gold stocks have formed a sideways channel for the latter part of 06. Intermediate down trend in place now, but there is likely support at 125. For a pure play on gold, look to GLD. For the gold stocks, GDX.


Biotech looks very impressive with a break above it's bull flag resistance. For Biotech ETFs, look at BBH and IBB, but check out their composition. Quite different. BBH is heavy in DNA. DNA had an big breakout above a channel of months sideways of sideways movement.



Broker Dealers are making even more money. Everybody loves the stock market right now.
Big bullish candle on a break above resistance to a new high. What's not to like? Not sure if there's a perfect tracking ETF, but XLF is close. Take a look at GS and LEH. Amazing stocks with ever new highs.

Transports seem to be making an effort, but the chart still has quite a bit of work to do to look attractive. Look to IYT to play this index.

The recovery in the homebuilders still looks healthy. That may change soon, but so far, so good. The chart is showing a potential hammer at the seemingly significant 700 level. I'm showing a much bigger time frame here to show the huge topping formation that looks like a pretty well defined head and shoulders pattern. It's height of about 250 pts. forecasted the downward move of around that distance that actually happened quite dramatically on the break of the neckline. XHB is the ETF to play this group with.

The Internet stocks are a touch worrisome in that they didn't have a strong week while the Nasdaq was super strong. But it has been a very strong rally from the inverted head and shoulder reversal pattern, so a bit of consolidation after it exceeded its projected target makes sense. In the last five weeks we have a seen a bearish engulfing pattern, a tombstone doji and two spinning tops. What does this mean? Nothing. We're moving sideways between support and resistance. Watch those two levels for the next move.

After almost two years of sideways action, Software has moved into higher territory and to my eye had a little pennant formation formed. This is a bullish continuation pattern and looks to have begun the next move higher this past week. 3 more points beyond 190 and we'll know for sure. You know what Software stock has been very strong in the last year?
ININ. - GRRRRRRRRR!!!!!!


The strength in the Nasdaq just wouldn't seem complete without some confirmation in the Semiconductors. The SOX index does seem to be working on breaking the long term down trending resistance line, but it won't feel like the job is truly done until 490 is successfully surmounted. SMH is the ETF to play on this group.



Banks ascending steadily in 2006, but looking at the two year period, it looks like an ascending wedge which is inclined to break do the downside. With the bearish engulfing of a shooting star in recent weeks, I'd expect some kind of pullback. For now, however, we've got support at 115 with a big bullish candle that broke above that level. A bounce there would be the most likely for the immediate short term.


Healthcare stocks have been very strong in the latter part of 2006. Starting off 2007 with a big bullish candle too. I have to play devil's advocate, though and draw in th same type of resistance line as on the previous chart. The difference is, this chart looks very likely to blow right through this wedge. It probably needs some healthy consolidation for much more meaningful gains, but it looks like it wants to keep going for now.


There's screwy data on this chart for Healthcare stocks, so it's tough to get up close with it. Generally a nice looking ascent over the last 3 to 4 years. Some minor topping action, though, at resistance for this very long term wedge. It's been very strong since July.
TWGP was one we talked about in a meeting months ago. It had a beautiful trend, but has since broken it and begun a intermediate down trend.



After a few months of consolidation, Retailers reported much stronger sales than expected in December and pushed the index above resistance into open territory. The argument is being made that the strong consumer showing will support the economy for a bullish year ahead. I wonder what percentage of the consumers out there are buying on credit? For a very strong chart, look at MA, Mastercard. With some nice volume pushing through resistance here, it's a buy.
To play the retailers, look at RTH.



So there's the broad stroked look at it. I hope you agree that looking at weekly charts can really simplify things. Of these charts, there are 7 either at or near all times highs. I'd say that's a very bullish sign for the market.
From here you can choose the sector you like best and drill down further for stocks ripe for the picking. There are plenty of sweet ones.
Happy Hunting

Market Posture

I'm going to do another Market Posture now that we've got a couple weeks under belt in 2007 and the opening jumpiness is behind us. As much as it scares me, I'd have to say that the market has turned to remain quite bullish. (This being scared to bet bullish is something I need to work out, psychologically.)

The horizontal and diagonal support lines for the SPX held up and we're still in our channel from early Nov. Although the weekly close was just higher than the previous ones, we're still essentially at resistance. But it's certainly a big, strong bullish candle closing right at the top. On price action alone, which is of course king, since we're nudged right up against resistance with a whole lot of bullish momentum behind us, we can only assume we're more likely to move upward than downward. For the all clear, we'll need a break above 1432 and then we're officially back at a 6 year high. 1410 remains support just below us.
(Click image for larger view)

As a point of caution, let's consider what the indicators are telling us on this weekly chart. MACD has just crossed into the red, which indicates waning momentum. Stochastics are inching a bit lower in the overbought zone. These are weekly indications, remember, so they're a bit removed from what we can expect day to day. In any case, price is king and we must make the bulk of our decisions on trend and support and resistance, but it's not a bad idea to consider what the these lagging indicators are telling us.
One other point of consideration is that we're approximately 90 pts. above the 30 week MA. Looking back at the bull market since it began in '03, I find only two other places where we were 90 points extended from this MA. Make of that what you will. I don't think that necessarily means that we won't push higher. It's just to consider that we're extended and a correction would be a healthy thing. From what it looks like now, perhaps we'll have a "correction by time but not price," as Peter Reznicek says. That means that the price consolidates sideways while the MA gradually works its way up to meet it for a "correction" of the distance between price and moving average.


The Daily chart shows us that the 20 MA has been increasingly challenged, but the 50 MA held strong and provided us with the bounce. The Market forecast shows the Intermediate line turned back up with room to rise, so the outlook there is bullish. Even the longer term Market Sentiment line ticked upward ever so slightly.


Not much to say about the VIX other than....WOW. Seems a ceiling is being strengthened above us here. That's quite a serious red candle on this weekly chart indicating bullishness (as an inverse indicator).


As for the Nasdaq, HOLY COW! Is that a bull flag that just broke out? I'm not so sure that Flags are meant to be seen on such a large time frame, but if so, this would suggest a rise from the breakout point of about 450 pts.(The height of the Flag Pole). Notice that the index also decisively broke through the multi year channel resistance line in light blue once and for all.

The weekly indicators show essentially the same extended condition on the Nasdaq as the SPX. But I think the price action here is much stronger and trumps all, so I'll forgo that part. Market Forecast looks roughly the same too.
For a target perhaps more reasonable to deal with than 450 pts up, we could look to the Fibonacci Retracement levels of the fall from the bubble burst down to the low in 2002. Notice how the rally responded around the first and less significant 23.6% retracement level. The 38.2% level would give us a target of 2,645, about 140 pts. higher than where we are now.


Oil is now in a serious down trend with room to go further which, at least in the short term, seems to breathe life into the market.


In summary, I'm finding little reason to be other than bullish. The Vix remains in the low zone. The Nasdaq is now at a strong 6 year high. The SPX has a potentially magnetic affect drawing toward 15,000. The Dow is at an all time closing high. Remember the very, very simple truth: New highs lead to more new highs.

The main bits of caution as I see them are this:
If oil falls apart further and brings all of the energy related stocks with it, that could take a toll on the SPX. Rotation out of oil into Tech. is probably a big part of what's causing the Nasdaq to finally regain the leadership role.
The daily SPX chart with three green arrows is heading up in its recent channel with room to go. With a break above this minor resistance(a potentially nice buy point on the SPY), it should be able to shrug off the bearish divergence showing on the MACD.


The Nasdaq's three green arrows and breakout above a period of healthy consolidation look very strong. But with 5 up days in a row, I wouldn't be surprised to see a test of the 2,470 area in the near future to establish new support. A bounce off that level would be a great entry for bullish plays on the QQQQ.

It would be a very good idea to spend some time looking for strong Tech. stocks for your watchlist.

On that note, I'd like to put out an invitation for suggestions of stocks to add to our list. I'd like to rotate out some of the laggards. Take a look through the list and see which ones look like they should be fired. If you can come up with a replacement from the same or a similar industry group, leave the suggestion in the comments section below with a bit of your reasoning why you like it. The only stipulation I ask is that you aim for optionable stocks trading around 1 million shares per day or more.

I'll try to get a post up in the next few days with a look at the major sector indexes.