Option Investor

Daily Newsletter, Tuesday, 07/26/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Confusion Reigns

Mixed earnings left investors scratching their heads and pondering future direction. Conflicting earnings surprises like the very strong TXN news and the very bad Lexmark news are keeping investors reeling as we approach the dog days of summer. Guidance appears to be weakening but despite some high profile misses the positive earnings surprises are still beating negative surprises 6:1.

Dow Chart - Daily

Nasdaq Chart - Daily

Economic news is about as mixed as earnings with Consumer Confidence showing an unexpected drop to 103.2 fro 106.2 for July. The drop in confidence put the index back at the May levels but still very near its cycle highs. Drops in both the expectations component and the present situation component led the headline number lower. Consumer views regarding the employment market fell and suggests there is a growing worry that a new round of layoffs are coming. I mentioned last week that announced layoffs for the week were the largest in four years. This may have colored consumer perceptions of the job market.

Ironically the actual Monthly Mass Layoff report for June was released today and fell slightly to 1175 from 1196 for layoffs involving more than 50 workers. The number of workers impacted rose from 101,358 to 120,463. This is a trailing indicator and given the number of cuts in July the next report could be significantly different.


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The Richmond Fed Manufacturing Survey posted its second month in negative territory at -3. The Order Backlog component fell to -23 from -14 and offset minor improvements in new orders which was still negative at -3. Shipments also fell to only 2 and very close to negative territory. The six-month outlook fell from 22 to 17. Manufacturing activity in the Richmond area continues to contract from its recent high in September 2004 at 22. This is not an encouraging sign and suggests further employment problems lay ahead as manufacturers adjust the workforce to the reality of a weakening environment in that region.

On Wednesday we will get Durable Goods, New Home Sales, Kansas Fed Survey, Beige Book and Oil and Gas Inventories. The oil inventories were stronger than expected last week with drawdowns as a result of Hurricane Dennis only minimal. Another week, another hurricane, Emily this time and a drop in production shipped from Mexico. It will be interesting to see what Wednesday's numbers will bring. Oil climbed to trade very close to $60 intraday on Tuesday but dipped at the close to end at $59.20. Earnings from various oil companies are beginning to appear with BP posting a +29% jump in profits. VLO also posted record profits beating the street by +12 cents.

In the case of BP their earnings were nothing short of phenomenal. BP earned +$4.98 billion for the quarter on revenues of $88 billion. BP has said repeatedly that they were going to return to shareholders everything they receive over $20 per bbl. They admit that finding new oil is becoming increasingly difficult and instead of pouring all their profits back into expensive exploration for a decreasing return they have decided to pay the shareholders instead. They bought back $4.1B in stock for the first six months of 2005 and will continue buying back stock with their profits. They said strong margins and high demand helped Q2 but Q3 had started weak as refining margins shrank on higher oil.

Valero beat the street by +12 cents and despite the record highs on the stock the CEO said it was a great value for investors given their current outlook. Valero said as good as 2005 has been 2006 will be even better. They are acquiring Premcor and once complete Valero expects to increase margins and market share. The CEO was on CNBC today and he said oil prices will continue to rise because demand is continuing to increase. As a refiner they are in the sweet spot as the largest refiner able to process sour crude. Sour crude is selling for record discounts to light sweet crude and this enables Valero to increase their margins. The current discount for sour crude is $13 but VLO expects this to rise to $16-$17 in 2006 as competition for sweet crude intensifies. VLO retreated a little more than a buck as earnings players moved on to other trades.

December Crude Oil Chart - Daily

All earnings announcements were not as positive as those in the oil sector. Lexmark posted earnings that fell to $79 million or 64 cents, from $136 million or $1.02 for the same period in 2004. There was a charge of 42 cents for repatriating foreign profits under the American Jobs Creation Act. This is an economic stimulus program that allows companies to bring profits back into the country at a lower tax rate if the money is used to create jobs. It obviously did not work for DD as they announced they were laying off 275 in Q3. They gave cautious guidance for Q3 due to uncertain market conditions and the potential for aggressive price competition. DD was a disappointment to the Dow with a nearly -$3 drop to $41.

Black and Decker beat analyst's estimates but guided to the low end of its range and said it would cut 675 jobs and close its Fayetteville plant. Lockheed Martin posted a +56% jump in profits beating estimates by +25%, as defense sales surged. LMT raised its guidance for Q3. NFLX turned in a blockbuster quarter and posted profits of nine cents that doubled last year's performance and beat analyst's estimates of only a penny.

After the close today Amazon posted earnings of 12 cents that beat the street by two cents. They beat revenue estimates only marginally despite a +26% jump in sales. They raised guidance for Q3 and shares spiked nearly +3.50 in after hours trading. Sun Micro posted earnings of six cents that beat estimates of only a penny. It appears SUNW has finally started gaining traction in its comeback attempt. Corning posted earning of 20 cents that beat estimates of 18 cents. They also guided higher for next quarter to 20-22 cents with analyst estimates of 19 cents. Biogen Idec beat estimates of 36 cents with earnings of 43 cents after items. IMCL fell a buck after reporting revenue that fell short of expectations. ERTS posted a loss of -18 cents that was better than the -24 cent analyst estimate.

TXN was a big impact on the SOX with a +1.70 jump after very strong earnings. Strong sales of analog chips and a strong product replacement cycle for cell phones is pushing them higher. Motorola helped provide support for the SOX by not giving back any of their strong gains from Monday. Motorola earnings were helped by the Blackberry killer they announced. The Moto Q is their competition for the Blackberry devices currently sold by RIMM. They also announced a new series of ultra slim cell phones along the lines of their high demand Razor model.

SOX Chart - Daily

The SOX rallied to a new 52-week closing high at 477 and continues to creep up on that very strong resistance at 485-490. The chip stocks refuse to give up ground despite chip earnings being one of the weaker sectors for this cycle. The high profile winners like TXN overshadow weak results like those from Taiwan Semi. TSM posted profits that fell -21.5% for the quarter on a -9% drop in revenue. The CEO said they were pleased it was not worse as most had predicted. He said business in late Q2 improved better than expected to everybody's relief. TSM said if business continued to improve they would do better than breakeven for the year as previously predicted. TSM is the largest maker of made to order chips in the world.

Earnings continue to be the news headline moving the market but the market can't decide which way to move. Volume was slightly higher but it was far from exciting. The Dow and Nasdaq have failed to return to the highs set last week but the SPX, Russell and Wilshire 5000 set new highs on Monday. All were weaker today despite the Nasdaq posting a +9 point gain. The markets have all the appearances of struggling at a top. The Dow closed only 10 points above the bottom of its two-week range and was very listless due to the Dupont drop. While the broader averages, SPX, RUT, DWC, are all showing a positive trend the Dow was definitely the anchor. A break below 10575 could setoff some sell stops with 10485 the initial support.

SPX Chart - Daily

I have been writing about the resistance at 1225-1230 for several weeks and nothing has changed during that period. Despite strong earnings by some and weak earnings by others the SPX remains fixed around the 1225-1235 range. It is trying to move higher but intraday spikes are met with afternoon selling for only fractional gains at the close. Mixed earnings results coupled with mixed economics still suggest there are no problems ahead but the earnings deceleration is becoming a challenge. Currently earnings for the quarter through Monday are showing +9.8% growth. If that level is maintained it will be the first time in 13 quarters that earnings failed to grow by double digits. However, with the rest of the week loaded up with energy stocks at an average of +40% profit growth we should easily break into double digits by the weekend. Beginning next week we start hearing from the smaller stocks and earnings are typically less than the big blue chips that have already reported. This could dampen any warm feelings left by the hot oils.

This earnings cycle seems to have brought more confusion to the markets rather than clarification. I don't see that changing over the next two weeks. If anything the big news is already out and we know how this movie ends. Unless a breakout occurs very soon to trigger some short covering and technical buying the odds still favor the historical August dip. Anecdotal evidence suggests long-term traders are not jumping into new long positions at these levels. Buying the top is never a strong incentive for most traders. However, the dip buyers are alive and well with every short dip quickly bought. What we are seeing in the guise of a boring range bound market is a day trader war in progress. The choppy sessions are chewing up anybody trying to make a living in the markets. Until a direction appears the big boys are going to wait patiently on the sidelines and avoid the chop. This type of range bound pattern typically ends with a major move and the intraday volatility is from traders trying to anticipate that move. My recommendation is still to watch 1225 for a signal. We want to remain cautiously long over that level and short should 1225 break. With the SPX creeping only minutely higher each day I would hesitate to get to excited about being long. I remain concerned that longs could be trapped as we near the historical August dip. If you are playing in this market traffic I would step off the curb carefully and only after looking both ways several times. Enter very passively, exit aggressively and try very hard not to let your emotions get the best of you.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Las Vegas Sands - LVS - close: 37.99 chg: -1.01 stop: 36.99

The sell-off continues in LVS and its bullish posture is quickly eroding. Shares fell back to its simple 50-dma before attempting any sort of bounce late this afternoon. After two strong days of declines we might begin to look for an oversold bounce. However, the major indices still look poised to move lower and that will probably push LVS below support in the $37.50 region. We would not suggest new plays here and more conservative traders may want to abandon the play now to minimize their losses.

Picked on July 21 at $ 40.31
Change since picked: - 2.32
Earnings Date 08/03/05 (confirmed)
Average Daily Volume = 934 thousand


Pediatrix Med Group - PDX - cls: 78.01 chg: +0.28 stop: 74.25

No change from our previous update. Our target is the $80-82 range. We would not suggest new plays at this time.

Picked on July 11 at $ 76.10
Change since picked: + 1.91
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 158 thousand

Put Updates

AutoZone - AZO - close: 97.61 chg: -0.52 stop: 100.01

So far so good. AZO confirmed yesterday's breakdown below its simple 10-dma and it also broke down under the $98 level and its low from last week. We also notice that the MACD has confirmed its new sell signal as well. This looks like a new entry point to buy puts. Our target is the simple 50-dma currently at 92.88.

Picked on July 25 at $ 98.13
Change since picked: - 0.52
Earnings Date 09/20/05 (unconfirmed)
Average Daily Volume = 748 thousand


Best Buy Co - BBY - close: 74.89 chg: +1.28 stop: 76.61

Our very aggressive put play in BBY is still currently sitting at the starting line. The stock bounced from yesterday's decline and is challenging the $75 level. This is a decent show of strength considering the negative consumer sentiment numbers. We are suggesting that readers wait for a drop (to or) under our trigger at $73.25 before buying puts. Our target is the 40-dma near $67.00. Please see yesterday's update for more details.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 3.3 million


Fannie Mae - FNM - close: 57.70 chg: +0.19 stop: 59.51

No change from our previous update. We are suggesting that traders wait for FNM to breakdown under its simple 100-dma before initiating positions. Our trigger to buy puts is at $56.49. Our target will be the $51.50-50.00 range. Please see yesterday's update for more details. FYI: it will be interesting to see if FNM (and FRE) see any movement tomorrow in reaction to news of an alternative senate bill regarding GSE's that came out after the closing bell tonight.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 00/00/05 (unconfirmed)
Average Daily Volume = 3.3 million


Infosys Tech. - INFY - cls: 72.55 chg: +1.01 stop: 75.01

More conservative traders may want to start eyeing the exits here. INFY still has technical resistance at the bottom of its gap down near $74.00 but its show of strength is a concern. We suspect it is due to the strength in the Indian stock market, which hit yet another new all-time high today.

Picked on July 20 at $ 69.92
Change since picked: + 2.63
Earnings Date 07/12/05 (confirmed)
Average Daily Volume = 922 thousand


KB Home - KBH - close: 81.04 chg: +1.04 stop: 82.51

It looks like the bulls are not going to give up on the homebuilders without a fight. Shares of KBH did dip below the $80.00 level and did trade at and below our suggested entry point at $79.85 today but traders bought the dip and pushed the stock back above the $81 level. The MACD may be pointing lower with a new sell signal but KBH could easily bounce from here making this just another head fake for the bears. In our play description we suggested that more conservative traders may want to wait for the DJUSHB index to breakdown under the 1050 level first before considering bearish positions and that may prove to be stronger strategy. The play is officially open but we're not suggesting new positions with KBH above the $80.00 mark.

Picked on July 26 at $ 79.85
Change since picked: + 1.19
Earnings Date 09/15/05 (unconfirmed)
Average Daily Volume = million


Lehman Brothers - LEH - cls: 105.94 chg: -0.09 stop: 108.01

The XBD broker-dealer index was actually one of the worst performing sectors behind gold and metals today. The move lower was driven by an earnings miss from Legg Mason (LM). Yet shares of LEH showed a lot of relative strength with only a minor decline and a bounce from the $105 region. This remains a very speculative play and traders may want to wait for a decline under the $105 mark before considering new put positions.

Picked on July 21 at $105.13
Change since picked: + 0.81
Earnings Date 06/14/05 (confirmed)
Average Daily Volume = 2.7 million


3M Co. - MMM - close: 73.78 change: -0.39 stop: 77.51

Good news! The weakness in the DJIA today helped push MMM under short-term support at the $74.00 level. Today's decline looks like another entry point if you didn't already buy puts. Our short-term target is the $70-68 range.

Picked on July 19 at $ 74.29
Change since picked: - 0.51
Earnings Date 07/18/05 (confirmed)
Average Daily Volume = 3.4 million


Children's Place - PLCE - cls: 46.09 chg: -0.52 stop: 47.51

No change from our previous update. PLCE continues to struggle with any sort of follow through on these bounces. Our strategy is to buy puts on a breakdown below the $45.00 level. Our suggested entry point is $44.90.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/11/05 (unconfirmed)
Average Daily Volume = 775 thousand

Dropped Calls


Dropped Puts



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