HOTS Weekly Options Commentary

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Peter Stolcers
February 10, 2007

Last week there were only a few economic releases. Productivity rose 3% and unit labor costs were only up 1.7%. Workers are being paid more to produce much more and those statistics could be used to defend concerns over wage inflation. The Senate passed the minimum wage proposal by a landslide last week and the impact of rising hourly wages will be debated in future months. Fed official William Poole stated that economic growth is sustainable and inflation is largely in check. His comments set the stage for Chairman Ben Bernanke who will deliver the Fed's formal economic forecast to Congress when he testifies on Fed Monetary Policy next week(better known as Humphrey-Hawkins Report delivered semi-annually). That testimony will be the economic highlight next week, but there are a number of key reports including: retail sales, industrial production, housing starts and PPI.

Mid-day Friday, sellers came in and drove an otherwise flat market - lower. Earlier in the week, HSBC (the world’s 3rd largest bank) commented that it would take a much larger than expected write-off on non-prime loans. The initial response was contained, but as additional comments came in from other lenders and homebuilders, it was apparent the trough to the housing cycle is far from over. The financials and housing stocks were hit hard. Then, Micron Technologies (MU) warned of lower DRAM and NAND prices and the tech stocks joined the decline. From a technical perspective, the chart shows the long-term strength of the market. We will respect Friday’s price action and acknowledge that a 2%-3% retracement is overdue. However, we will place greater importance on the long-term trend.

In this week’s HOTS Report, we will position ourselves on the bullish side of the market while keeping our distance. The implied volatilities are still near historic lows and the VIX was only up marginally on Friday. We will sell put credit spreads on two stocks that have relative strength and well-defined support levels. One is a major financial institution that just announced an enormous buy-back and the other is one of the fastest growing gold producers in the world. We will also scale into a call position on a stock that has strong momentum and just broke out. Profits are on the rise as it caters to the rich, generating half of its revenue from Asia. If the market pulls back, we will add to the position. If the market rallies Monday, we’ll be satisfied with what we have.

Market Timing

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Fari Hamzei
February 9, 2007

Well......the PAUSE we talked about on Wednesday is here today........McClellan Oscillators foretold this move.......with both SPX and NDX putting in outside bar reversals today, we expect additional weakness next week (Feb Options X) till McClellan Oscillators get in to the oversold territory, maybe by Wednesday.

Video Part 1


Video Part 2

Heard on the Floor

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From our Virtual Trading Room Transcript
February 9, 2007
about 1136 PST

Brad_Sullivan> hearing from the [CME] floor
Fari_Hamzei > ????
Brad_Sullivan> that BSTEARNS
Brad_Sullivan> HAS SOLD NEARLY 4000
Brad_Sullivan> MAJORS
Cary_Kahn> wow
Brad_Sullivan> FROM 1447 TO CURRENT LEVELS
Cary_Kahn> nice day

Editor's Note: MAJORS is S&P-500 pit-traded big index futures contract.

Frank Barbera at Large (Part II of II)

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Continued from February 7, 2007

Fari: OK Frank, you also follow Gold, and other metals, what do you like in that area?

Farnk: Well, basically everything, … I am kidding, but I like what I see happening in all the metals, especially Gold, where a move over $665 on nearby April Gold would be bullish as all get out. Near term support for Gold is shaping up nicely at $648 to $650. I like GLD, and I like the Gold Stocks. Among the large cap mining stocks, Agnico Eagle (AEM), Yamana Gold (AUY), Silver Wheaton (SLW) and Goldcorp (GG) are my favorites. AEM is amazing in that they have a negative cost for mining gold, due to the fact that they have poly-metallic output from their mines, and with copper and zinc prices where they are, -- even down a fair amount in recent months, for AEM, the cost of mining gold is zip, nada, zero as Copper and Zinc credits pay the whole freight. Yamana, managed by Peter Marone, is a great growth gold, well on its way to production of 1 Million Ounces a year, -- what a great CEO, the guys a rock star in my book. In the juniors, and now I am really talking my own book, in the interest of full disclosure, I love, love, love Eastern Platinum (ELR-TSE). Eastern Platinum trades on the Toronto Stock Exchange (http://www.tse.com), and is usually on the Top Ten or Top 15 Most Actives. Today, it is No 3 Most Active (http://www.tsx.com/HttpController?GetPage=MDFMarketView&MarketView=MostActive&DetailedView=DetailedPrices&Market=T&Language=en).

For US investors, the stock trades under the five letter equivalent of ELRFF, and can be purchased through any US broker. Below C$1.60 ELR is an excellent buy. The company is in production, and has output flowing from several mines at its Crocodile River Complex near Capetown, South Africa and will soon be adding another mine, the Mareesburg Mine in early 2007. This is a growth Platinum story where output will go from 100,000 ounces a year in 2006, to over 500,000 in the next two years. The stock in my view is still a ten bagger from here, and would not be surprised to see it trade north of $10.00 US in a the next two years. It is an investment position, and not a trading stock, but the company has top notch management in CEO Ian Rozier, who I hold in the highest regard, he has done an awesome job for the company and this is one of the best values I see in the mining sector. In the small cap arena, I also like Minera Andes (MAI on the Venture Exchange) quite a bit, they have a great property in Argentina and are getting no credit in the market for a highly prospective copper deposit.

Fari: Looking at 2007, if things deteriorate in the Middle East, where would Gold go ?

Frank: In my view, Gold will break out above $1,000 per ounce, and after a long consolidation, could now be setting at the beginning of that move. All of the Gold Stocks, would go through the roof, and should turn in excellent returns. At my newsletter, The Gold Stock Technician, we keep people current with all of the latest on these markets and up to date with current buy/sell recommendations.

Fari: What about the broader stock market ?

Frank: Honestly, I cannot warm up to this market, not at these levels. The DJIA and S&P 500 have never gone this long without a 10% correction, or even a 2% down day, so the markets are riding this wave of euphoria that seems to ex-out any perception of possible risk. Last year, at the beginning of the year, I liked Tech and Healthcare with names like Zimmer Holdings (ZMH), Cisco Systems (CSCO), LSI Logic (LSI) and Microsoft (MSFT). This year, I simply have a hard time finding under-exploited situations, and the multiple on the market looks high to me considering we are talking peak earnings. I think the S&P 500 short term could start doubling back toward 1400 as first support. Ultimately, there is probably more time needed for the market to build an important top as carry over momentum levels are high, and will likely under pin the market most of the first quarter. That said, at some point, I would not be surprised to see this market roll over in dramatic fashion, and make haste for the 1200 zone on the S&P. That would wipe out the rally of the last few months, and in my view could be the beginning wave of a much larger bear market. I believe the stock market represents high risk investing and the only sectors I feel could buck a downward trend would be Gold and Oil, and that is where I operate day to day.

Inflationary Concerns

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Sally Limantour
February 9, 2007

A heavy flow of US Fed dialogue today could rekindle inflationary concerns. The Fed’s Poole is speaking now (7:45 am) and Fed Fisher at noon. With oil prices strong the March crude oil punched through that quasi triple top of 60 yesterday and gold seems to have solid footing now above the $650 level. There are a number of bullish themes for gold right now. First, as mentioned on Feb 7th, the European legacy banks are selling far less gold to meet the quotas of the Washington Agreement. The IMF is considering selling a “limited amount of gold” and in the past six to seven weeks the monetary base has exploded to the upside rising approximately $18 billion since the last week of December.

Bill Fleckenstein(http://www.fleckensteincapital.com/) wrote, Golden Glad Tidings? On the subject of gold, I received an email from a friend who said…

“The China Gold Association is claiming that the country plans to raise reserves by 3,500 tons over the next five years. (The Washington Accord selling agreement is 2,500 tons).
If that is true, we finally have hit the moment that I thought we’d eventually see – which is that Asia’s dollar-buyers of last resort are finally voting to exchange them for gold. They are willing to give them to the “European legacy banks”, which up until now have been so willing to part with their gold, though judging from the recent data I shared yesterday, they may be a little less excited about selling it than they once were.”

Let us remember not to just look at gold in US dollar terms. In other currencies, such as the South African Rand gold is breaking out. Gold denominated in Japanese Yen has gold moving to a new multi-year high.

Equity Index Update

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Brad Sullivan
February 8, 2007

During my quasi sabbatical from writing this update, I kept thinking about volatility and particularly the lack of it in our current index environment. Yesterday’s price action was interesting on a variety of levels. First, there seemed to be a general feeling of “I am throwing in the towel” on the short side of the equation. Second, there appears to be a tremendous “mark ‘em up on the close” type of settlement trade that is usually found towards the tail end of run, not the beginning. The ease in which the SP futures came off their respective high zone yesterday (1456 to 1457.50) should be seen as a near term warning. For those aggressively pushing the long side of the button, marking ‘em higher has earned a strong bit of admiration and defiance from those on the sell side. However, like the guest that stays too long at the party…you don’t want to be the last one to turn out the lights. I suspect that over the next 6 trading sessions, the indices will provide plenty of support to exit from profitable long positions.

The one fly in the ointment that I have uncovered for this scenario is the general lack of overbought levels on the index front. I have enclosed graphs of all 3 indices trading at their respective all-time highs (Midcap, DJIA, Russell 2k). Notice, that only the DJIA is at elevated levels on its 200 day extension, while the Midcap and Russell are at levels below last years highs. For a true reversal in the marketplace, these readings will have to move quite a bit higher – a final melt up if you will – before the odds favor such a happening. In the meantime, I suspect that the post expiration trade will begin a potential correction in the market. However, I would be surprised at anything greater than -3 to -4 % in the SPX.

Volatility

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Sally Limantour
February 8, 2007

Volatility or the lack of is on everyone’s mind. On CNBC early this morning they played the theme song from Jaws with the title, IS VOLATILITY COMING BACK – then phased out to a commercial. The NYT on Feb 3rd had an article IT’S CALM. LOOK OUT FOR A STORM. “If complacency breeds danger, then we might be sitting on a powder keg heading into 2007,” James Stack, editor of, Invest Tech Market Analyst.

The low reading in volatility which is trading close to record lows set in 1994 is comforting to many. A belief that the evolution of financial products makes the stock market inherently less volatile than it use to be is becoming its own mantra.

“People are very worried about risk,” says Tobias Levkovich, equity strategist at Citigroup Investment Research, and the fact that so many investors are focusing attention on volatility is another reason not to be concerned.

I see the logic in all of this – being concerned, not being concerned, being indifferent about being concerned all over this concept of volatility. My gut feel is this is going to be a volatile year. I have my reasons why and began putting on volatility strategies last week. We shall see…

Bonds

Dr. Plosser tried to crash the party yesterday with talk of higher rates. At the heart of his antinflationary remarks is a fear that labor costs are about to advance. The market remains well bid and shorts established two weeks ago were covered yesterday. Perhaps a light upward bias will take bonds back to 112 00, though I would be a seller there. You have a sector of the trade questioning overall growth prospects ahead and then you have the non-farm productivity up 3.0% annual rate in 4th quarter which was far better than the consensus of 2.0% (non-farm payrolls for all of 2006 rose 2.1%).

Stock Indexes

HSBC has warned that debts will be higher than the consensus due to further deterioration in third-party originated sub-prime mortgages in the US. Disney had impressive earnings and while I think we are building toward a correction you cannot argue with the pretty charts. The mid-cap and small caps are leading the market and that is usually a positive development. The NASDAQ is the only major index that has not set a new high this month. February typically is one of the worst performers, but seasonal tendencies cannot always be trusted nor followed. Trade with caution and perhaps tighten the stops.