6:00pm (EST)

1.  Market Summary

2.  Covered Call Options              

3.  Special Offer from Momentum Options Trading   

4.  Patriot Coal Looks Attractive

5.  Earnings  

6.  Week Ahead

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1. Market Summary

The bulls are trying to make this a December to remember.

The market got off to a strong start for the month after a flat but volatile November as Wall Street decided to see the glass half-full instead of half-empty.  We knew going into Friday’s nonfarm payrolls report that things could get dicey despite good news leading up to the report but we remained cautious by taking some profits off the table.

We knew a good report would probably push the market through resistance but we weren’t sure how the market was going to react if we got worse-than-expected news.  We thought support levels would be tested after the Labor Department announced that only 39,000 jobs were added last month the unemployment rate soared 9.8% in November…and they were.  However, the market was able to finish in positive territory on Friday.

We said in our 9am update the bulls could push through this report because the momentum has been strong, and, after seeing major support levels hold for a few weeks, we have been planning for one more push higher to close out the year despite the headwinds.

The bulls are getting some robust economic and retail readings which have been huge and the Financial stocks appear to be stabilizing at the moment.  We also told you that there is a possibility of fund managers playing catch-up and these events could continue to play out.

As a result, the Dow managed to add 20 points on Friday and settled at 11,382 after spending much of the day in negative territory.   The index traded to a low of 11,318 but was easily able to hold the 11,200 level.  Further support remains at 11,000.  We are still looking for a break over 11,400 which could get the Dow to 11,600-11,700 by yearend.  For the week, the blue-chips added 290 points, or 2.6%.

The S&P 500 gained 3 points to finish at 1,224 and stayed in the 1,220-1,225 area we have been targeting.  The next push should be to 1,250 with support at 1,200 and then 1,170-1,175.  A possible run to 1,300 could be in the cards if 1,250 is taken out.  For the week, the index popped 35 points, or 3%.

The Nasdaq is also within reach or our 2,600-2,700 targets as it advanced 12 points to close at 2,591.  Tech looked strong on Friday and actually spent much of the session near the breakeven level before setting a new multi-year high of 2,593.  A run to 3,000 could be in the cards with support strong at 2,500-2,450.

We said we would continue to ride the bulls back on Friday and we have since October.  We also told you things could get choppy after the market made a break past resistance but support held.  The current trend is still higher as the bulls climb a wall of worry but we know things can change quickly.  We have already set stops on all of our profitable trades and have closed half positions to lock in gains on others so we are good to go.

If the market continues higher, we win.  If the market stalls, we will lock in profits and plan our next moves.

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2.  Covered Call Options

We wanted to take the time this weekend to explain covered calls.  This is a popular option strategy for investors who OWN stock because it allows them to receive extra income for selling an option against the shares they already own.

We have covered quite a few stocks over the years and we are mainly an option based newsletter.  That will remain the same but we also want to use our Weekly Wrap to show you the power of covered calls and how they can be used to lower your cost basis in a stock you may already own.

Our goal is quite simple.  We will be looking for “flat” stocks that have strong fundamentals and seem to stay in a trading range, and, we will be looking for “breakout” stocks that look poised to double or triple.

Here is how a covered call works.  Let’s say that you own shares of Microsoft (MSFT, $27.02, up $0.13) which have been in a trading range for years.  We like the long-term prospects as well and the share price but the stock seems to stay in a trading range of $20-$30.

We think shares will stay flat at current levels but could trade to $30.  If not, we still believe the stock will stay within a few dollars of its current price.  Having this in mind, we could sell a call option on Microsoft which allows us to keep the premium from the option sale.  This limits our upside but lowers our overall cost in the stock.

Here is how it would play out if we sold a Microsoft January 27.50 call (MSFT110122C00027500, $0.64, down $0.02).

1) If Microsoft stays below the $27.50 strike price – the option will expire worthless and we keep the premium from the option.  This lowered our cost basis in the stock to $26.38.

2) If shares fall below $25 – the option expires worthless, we keep the premium, and we still own the stock.  We can then right another call option or wait for shares to rise back before selling another call.

3) If Microsoft trades above $27.50 by mid-January – the option is exercised, and we have to sell our shares for $27.50, even if the stock is at $29.  We will still make 4% but miss the 7% return from $27 to $29 because we had to sell shares at $27.50.

There are all sorts of variations of the covered call strategy.  You can also “write” calls on options that are two months, six months or even a year away or more from expiration.  You can also sell call options on stocks that are either in-the-money, at-the money, or out-of-the money.

We plan to use this covered call strategy every month on multiple stocks with the real prospect of generating a regular monthly cash flow for our subscribers while lowering your cost basis.  Stocks move in only three directions: up, down, or sideways.  With this strategy, you make money if the stock goes up or does nothing.  Two out of these three ways work in your favor and we will combine this with our fundamental and technical research to bring you a powerful covered call newsletter.

We have covered dozens of stocks since August in our Weekly Wrap with this goal in mind.  We recently started a covered call trade for our subscribers in our regular options newsletter but these trades take months and years to play out which is why we decided to change the format of the Weekly Wrap.

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3.  Special Offer from Momentum Options Trading   

Folks, we have made the Weekly Wrap a free publication for 3 years.  It has been a popular read for many of you but our goal is to get you involved in the market.  Many of you know we have spent the last 2 years writing an option trading manual “How to Trade Options on Momentum Stocks” and it has been a huge success.

We are also doing videos that are included with the course and we have gotten great feedback as many of our subscribers are starting to do their own trades.  This has been our ultimate goal but we have been trying to find a way to incorporate both the Weekly Wrap and our option trading manual, together.

We have decided to make the Weekly Wrap a paid newsletter and it will be available only on a 1-year subscription basis.  However, we have been trying to figure out how to make it a “free” newsletter so here is what we have come up with.

The cost of our option trading manual is $599 which will also be the cost of the Weekly Wrap starting at the end of December or early January.  If you purchase a manual, your membership will be free for a year to the Weekly Wrap.  If you have already purchased our option trading manual, don’t worry, you will also get the Weekly Wrap for free next year.     

We will have more details over the next few weeks but we really would like to have you on board.  We are excited about 2011 and we think there will be a ton of opportunities to find some undervalued stocks that look primed for covered call writing.

To read more on our options manual, please go here:


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4.  Patriot Coal Looks Attractive

Patriot Coal (PCX, $17.50, down $0.04) is a coal company operating exclusively in the Appalachian mountains of West Virginia and Kentucky. Most of their production is fairly “dirty” coal that goes to power stations under long term contracts. The coal is considered dirty not for its appearance, but because it contains high amounts of pollutants, mostly sulfur. This part of their business represents little growth and does not take full advantage of the huge jump in coal spot prices, which we will cover later.  However, their new Black Oak Mine is a different story, as it produces the highest grade of coal, metallurgical, and production should ramp up 30+% to around 8 billion tons in 2011.

For those of you who have our option trading manual, we cover the Coal industry more in-depth in our “Momentum Stocks Watch List” which is included with your purchase.  In it, we talk about looking for coal companies with metallurgical coal exposure. This is the coal that goes into smelters to produce steel and other metals, and it has to be very pure in order to produce the high temperatures these metals require.  Because of that, it also gets the highest prices, which is good for the bottom line.

We have also talked about the emerging markets which are seeing huge growth, and China is the big driver. These countries need coal to produce electricity, as well as coal for metal production, and the numbers don’t lie.

Australia is booming thanks to its proximity to China and thanks to its huge mineral reserves, including coal. The leaders in the coal space have invested heavily there and it shows in their stock prices. In addition, the spot price of coal is up over 30% this year across most grades, and up over 40% for metallurgical coal.

To illustrate the effect that can have on stocks, let’s look at two of our favorites, Peabody Energy (BTU, $63.28, up $0.56) and Walter Energy (WLT, $110.52, up $4.92).  Peabody has great Australian exposure, and made a fresh 52-week high of $64.18 on Friday, up from a low of $34.89.  A nice 90% return.  Walter Energy is very exposed to metallurgical coal and also hit a 52-week high of $111.67 on Friday, which is nearly a double from its 2010 low.  Now you can see why we are intrigued.

We like all three companies but Patriot Coal (spun off from BTU in November 2007) is a cheaper way to play coal for the future and a great prospect for our covered call portfolio.  

The case with coal comes down to three things, increasing production, increasing coal prices, and rally participation.  As we said earlier, Patriot Coal is increasing production of the best coal, and it appears to be ahead of analyst’s estimates. This gives room for analyst upgrades. Combine that with what we see as a continued higher price for metallurgical coals in particular, and you get a nice one-two punch for increase sales and profits.

Finally, shares have not participated in the coal stock rally and is well off its 52-week high of $24.25, so it has some room to run.  Earnings are set to be released in early February and the 14 analysts who cover the stock have a consensus estimate for a loss of $0.30 a share. We believe with the increase of production and the fact that the sector is bustling with M&A activity are positive catalysts for a higher stock price and an earnings beat.

As part of our covered call strategy, this will be our second trade (we currently have one for Dendreon) that we recommend and we will cover this one for free up until we launch the Weekly Wrap as a paid subscription.

On Monday morning, shortly after the market opens, we suggest you buy shares of Patriot Coal and then sell one January 19 call (PCX10122C00019000, $0.83, down $0.05) for every 100 shares you purchase.  This would lower your cost basis to $16.67 and if the stock is above $19 by mid-January, your shares would be “called away” even if the stock is at $20.  You would still make 14%.

If shares stay flat, we would look to sell another call option in January to lower our cost basis even further.

We will cover NOT cover this trade in our daily updates and we will be moving Dendreon to the Weekly Wrap once we officially launch.

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5.  Earnings    

Monday:  Ciena (CIEN, $15.93, up $0.21), Ferrellgas Partners (FGP, $27.21, up $0.05), Gerber Scientific (GRB, $8.27, up $0.46), Lululemon Athletica (LULU, $53.38, up $0.01), National Beverage (FIZZ, $13.96, up $0.60), Oxford Industries (OXM, $25.96, up $0.25), Pep Boys (PBY, $12.63, down $0.02) and Sanderson Farms (SAFM, $41.05, down $0.33).

Tuesday:  AutoZone (AZO, $256.20, up $2.00), Bank Of Montreal (BMO, $59.79, down $0.86), Casey’s General Stores (CASY, $40.74, up $0.34), H&R Block (HRB, $13.16, down $0.21), Men’s Wearhouse (MW, $28.69, up $0.11), Talbots (TLB, $11.68, up $0.25), Toro (TTC, $63.29, up $0.33) and Vail Resorts (MTN, $47.79, up $0.29).      

Wednesday:  AgFeed Industries (FEED, $2.43, up $0.03), Diamond Foods (DMND, $47.31, down $0.11), Hooker Furniture Corporation (HOFT, $11.99, up $0.05), Imperial Sugar (IPSU, $13.63, down $0.26), Phillips-Van Heusen (PVH, $70.00, down $1.23) and United Natural Foods (UNFI, $37.00, down $0.01).      

Thursday:  Costco Wholesale (COST, $68.39, down $0.62), Learning Tree International (LTRE, $10.47, up $0.18), National Semiconductor (NSM, $14.77, up $0.66), Powell Industries (POWL, $36.97, down $0.23) and Smithfield Foods (SFD, $18.10, up $0.14),  

Friday:  Cubic (CUB, $48.11, up $0.42), Methode Electronics (MEI, $11.01, up $0.30) and Pall (PLL, $47.60, up $0.42).

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6.  Week Ahead

There isn’t much in the way of economic new due out this week and 4Q earnings are winding to a close.  However, there are a few events that are worth watching.

Tonight, Federal Reserve Chairman Ben Bernanke will appear on CBS’s “60 Minutes” and will be talking about a variety of topics.  Big Ben will be talking about the unemployment rate, the nation’s deficit and his decision to purchase $600 billion in U.S. Treasury’s.  We also hear he might mention the possibility of “QE3” in an effort to boost a weak economy, if needed.

In economic news, Consumer Credit numbers are due out Tuesday while Initial Claims will come out Thursday along with Wholesale Inventories.  On Friday, the preliminary University of Michigan Consumer Sentiment Index will be released. 

On a side note, the outlook for next year’s tax cuts continues to be cloudy, but could be a catalyst that moves the market.  The Democrats and Republicans are knocking heads on an extension of the Bush tax cuts but the issue could be resolved this week or next.

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We will be back Monday morning at 9am (EST) with all of the current trade updates and a fresh outlook.