Purely Technical Weekly Newsletter (November 19, 2006) - Featured Articles:

The following are two featured articles from this week's Purely Technical. You can receive the full newsletter for FREE, by visiting our home page - www.themarketmessenger.com - and filling in the "Join Our Newsletter" form.

Here are the featured articles...

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Manage, yes Manage (not simply Take), Trading Risks through the Use of Options

One of our main goals, at TheMarketMessenger, is to help introduce the reader to the wonderful opportunities presented by the world of options trading, and to showcase a handful of methods by which the proper use of options can help a trader manage, yes manage not just blindly take, risk and harness the power of leverage.

Accordingly, we have dedicated a large part of this weekend’s newsletter to an introduction to the theory of options and options pricing. Over the next few week’s we will be presenting several more articles that will cover the gamut of basic options theory and of basic and advanced options trading strategies.

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Options Trading Picks

(..................)  Now let’s look at practical applications of options theory, in the form of a couple of options trading picks that we’ve highlighted in our Public Listing at Stockcharts.com over the past week.

The options prices that are depicted here might be, in some cases, different from those depicted in the public listing. Any such changes would only be with respect to updated prices (in some cases these prices are projected estimations – based on current underlying prices and assumed constant implied volatility – of likely prices this coming Monday). There are no changes to ratios, and/or to the options strategies themselves.

JPM – Long DEC 47.5 Straddle

JPM is currently trading within a potential bull pennant. RSI is coiled around its centerline and Bollinger Band Width is very low. All these are signs of tight volatility conditions that cannot last for much longer. Even implied volatility (see volatility chart below) is near the bottom of its range. A price breakout, in either direction should be imminent, and when this happens there is a good chance that implied volatility will also rise around 2-3 points.

Given these assumptions, and a potential target of 51.20 from the pennant, we’re highlighting a Long Straddle play on the front-month DEC 47.5 series. The net debit on this straddle is likely to be around $1.50, as of Monday. Our initial targets are to close 50% of the position at $2.50 and the rest at $4.00. Holding this position into the last week before expiration might not be wise and therefore we’ve set a time stop of Dec 5^th. The estimated max loss as on this date is 0.45-0.60, and the estimated breakeven points are approx. 46.2 and 48.7.

An alternative options strategy might be the JAN (rather than the DEC) 47.5 Straddle, which is likely to be trading at a net debit of $2.45 as of Monday. Choosing the longer-dated contracts will allow the bull pennant more time to play out and to meet its target. The downside to this strategy is that it will provide a smaller “bang for the buck”.

USG – Long JAN 50.0 Calls

After planting a positive divergence on RSI back in July, USG seems to have bottomed and is consolidating within what appears to be a large basing pattern. Resistance is clearly defined at approx. 53.50. If the stock can bust out above this level, it should be able to meet the bottom of the June-gap (57.5) fairly quickly. That level is our first target; at which we’d look to book profits on 25% of the position.

The highlighted options strategy is to go long the JAN 50.0 Calls, which should be trading at approx. $4.00 on Monday, if the stock opens unchanged. We project the calls to be worth $7.50-8.00 when the first target is met.

If the stock can then take out resistance at 57.5, we’d think that it could get sucked up through the vacuum created by the June-gap and rally to the top of that gap in next to no time. Accordingly, the final target is the top of the gap at 67.5 and we’d close the remainder of the position if/when this level was to be reached.

If neither target (a) nor target (b) has been attained by late-Dec, we might look to jump out of the trade, especially if the position is at a profit at that point.

WAG – Long JAN 42.5 Straddle

WAG is trading within a potential bull wedge. If the pattern proves legitimate, there should be a move to 47.0 fairly quickly. RSI and MACD are showing positive divergences and volume is hinting that the stock is being accumulated. On the other hand, the trend is still a falling one, at the moment, and we need to look at the possibility that this trend will continue over the coming weeks. There is strong support at 39.5, so this will be our alternate target.

Given that implied volatility is somewhere in the middle of its annual range (see volatility chart below), and the fact that price action is pointing to a breakout, in one direction or the other, a long volatility trade might not be a bad idea here. We’re looking at the JAN 42.5 Straddle, which is estimated to go for a net debit of $2.95 on Monday.

We wouldn’t want to hold this position, if it hasn’t started moving by Dec 15^th, and for now will set this date as our time stop. Assuming implied volatility remains constant, the max loss as of this date is estimated to be between $0.55 and 0.75. On the other hand, a reaching of the upper target (47) is likely to net a profit as high as $2.00, and a reaching of the downside target (39.5) is likely to net a profit of $0.20-0.30.

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Snapshot of the latest issue of Purely Technical:

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Articles included in this issue:

§      Manage, yes Manage (not simply Take), Trading Risks through the Use of Options

§      Another Good Week for Stocks, as Naz and Small Caps Smash through Resistance

§      Options Theory – Elementary Concepts

§      Options Theory – Introduction to Options Pricing

§      Options Trading Picks

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You can join the mailing list to receive the latest issue of Purely Technical each week, by visiting our homepage at www.themarketmessenger.com and filling in the "Join Our Newsletter" form.

We look forward to being your best source for technical market analysis, stock picks, options picks and education in technical analysis and trading.

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Have a Great Trading Week!

Asher Pinto

TheMarketMessenger.com