The Critical Next Test

The Dow’s Next Move Should Tell All

Dear Bottarelli Research Member,

Ever since late last week, it appears that most of our plays — both the calls and the puts — seem to be treading water. This is the type of action you get with an indecisive market — but that could all change soon. You see, the mainstream media will have you believe that the markets are lower today because of consumer confidence that dropped for the first time in five months — but a look at today’s DIA chart paints a more logical picture:

As you can clearly see, the Blue Chip average encountered resistance right at the 50-day moving average (as I warned about last week), which has sparked a mild downside retreat in today’s trading. If these levels fail to hold, we could witness another downside leg that re-tests the mid-March lows. This will be a very important test. You see, if we establish a support point higher than the mid-March lows, I’ll be comfortable playing the markets to the upside. But if the markets establish new lows, then it’ll make the most sense to continue playing predominantly in puts. We should know the answer soon — but in the meantime it continues to behoove us to own both call and put positions.

After all, as we wait patiently for the next directional signal, it’s my intention to capitalize on any shorter-term downside. That’s why I’ve initiated a series of new put positions — one such play being the WFT May 45 Puts (WFT QI).

The thesis behind this trade was two-fold. First, crude-oil futures shot up to $63 a barrel thanks to a new “political risk premium.” In other words, the news of 15 naval officers being taken prisoner by armed Iranian forces was all it took to add a premium valuation into crude futures. As a secondary result, oil names like Weatherford International (WFT – NYSE) extended themselves way past their 200-day moving averages — which signaled a coming pullback. In today’s trading, we’re seeing the beginning stages of this pullback, and the WFT May 45 Puts that we entered for $1.75 have traded as high as $1.85. Hold for more gains.

Also on the put side of the ledger is Big Lots May 35 Puts (BIG QG) and DOW May 45 Puts (DOW QI). BIG was a pure play based on 12 insiders all simultaneously selling shares — which indicates to me that the stock has possibly gotten ahead of itself in recent trading. I’m targeting a quick move back to the 50-day moving average at $28. Hold for more gains.

At the same time, Dow Chemical (DOW – NYSE) continues to rally off un-substantiated rumors that the company is a take-over target. I’ve initiated puts because rumors like this in the past have quickly turned south, and DOW has an un-filled gap down at the $44 level. I know that these puts traded for $0.90 yesterday, so the position is officially stopped out. But I’ll continue to monitor it for anyone still holding the puts.

While our put plays slowly inch higher, I’d like to simultaneously maintain exposure to the upside. By owing calls in stocks that I’m bullish on over an extended time horizon, we can effectively play near-term downside at the same time as profiting off any market rallies. Names that fall into this category are FDX May 115 Calls (FDX EC), which we entered for $2.45. If oil prices retreat, as I suspect, the Transport sector should benefit. And that could mean coming upside for FDX — especially as the stock has strong support at $110.

I’m also bullish into June on LMT June 100 Calls (LMT FT) and NDAQ June 30 Calls (NQD FF). Both LMT and NDAQ are showing strength today — which is a positive sign in an otherwise weak market. Chart-wise, LMT is quickly turning into a “coiled spring” play. In other words, it’s holding very tight to its 50-day moving average — and like a coiled spring — a strong break-out could push the stock aggressively higher. The calls that we entered for $4.00 on 3/12/2007 are a hold.

NDAQ continues to trade below its fair market value — as shares should rally up to the crossing of the 50-day and 200-day moving averages at the $32 level. The calls that we entered for $2.25 on 3/8/2007 are a hold as well.

In terms of Allergan (AGN – NYSE), I’m thinking that we take a longer-term time horizon by rolling the AGN April 115 Calls (AGN DC) into June or July. I’ll let you know when the time is right to execute this roll, but I’m still bullish on the Botox maker going into spring and summer.

Although its’ not the most exciting course of action, market environments that are in the process of sorting out their next major directional move can lead to flat call and put trading. But trust me, the moment something breaks, we’ll be in position for some really nice profits — and I’ll be with you every step of the way. So until then…

Lock and load!

Sincerely,