This was a tough week for stocks with news from the subprime sector hogging the headlines. The blowup of two Bear Stearns mortgage backed securities hedge funds rocked the financial market and the damage is far from over. With the market already unsteady lawmakers slipped in a couple of sucker punches that nobody saw coming. Add in the Russell rebalance and Blackstone IPO and volatility was very high.
Dow Chart - Daily
Nasdaq Chart - Daily
Friday's economics were completely ignored due to the breaking news headlines hitting about every 15 min all day long. The only report of note was the Mass Layoffs for May, which fell to 1,190 events from 1,218 in April. Overall 119,089 workers lost their jobs in May compared to 126,047 in April. Manufacturing continued to be the biggest sector loser with 26,521 layoffs. The continued drain in jobs will pressure the housing sector and cause even more problems in the subprime sector. However, the rate of jobs decay is not serious compared to the number of new jobs created each month.
This was a very light week for economics but next week is a veritable minefield of critical reports and the FOMC meeting. There are four Fed surveys, two home sales reports and two consumer confidence/sentiment reports. The Chicago PMI on Friday is officially expected to see a small decline from last month's activity spike but the whisper numbers are for another strong gain. Since the Fed will have this data ahead of its two-day meeting they will take any continued strength into account in their rate decision. As of today nobody expects the Fed to change rates but it is entirely possible the Fed could change its bias stance and put comments in the statement signaling a coming rate hike at the August meeting. There will always be a liberal dose of caution around a Fed meeting and this week will be no different.
The biggest market mover on Friday continued to be the mortgage blowup at Bear Stearns. You probably already know they had two hedge funds that specialized in collateralizing mortgage loans and leveraging the debt to obscene levels. These collateral debt obligations (CDO) and collateral mortgage obligations (CMO) were a major source of funding for the hundreds of mortgage companies that sprang up during the housing boom. You could get almost anybody financed because the debt was sold off in so many pieces that no single entity had all of it. By spreading the risk and knowing that the vast majority of loans would pay satisfactorily it was a no brainer for hedge funds, pension funds, mutual funds, etc, to invest some of their cash assets into these income-producing securities. Unfortunately these CDO/CMO debt placements were designed to unwind if the defaults exceeded certain levels or the value of the securities fell below a threshold price. These fair-weather investments promised large returns and low risk to the end purchaser. The risk fell back on the packager and in this case the CDO/CMO hedge funds created by Bear Stearns. They had repurchase agreements and collateral agreements with their buyers that required a repurchase when default conditions appeared. The financial backers like Merrill, Barclay's and Goldman Sachs also had agreements that protected them from defaults and put the liability back onto the Bear Stearns hedge funds.
Bear Stearns raised $600 million in their fund offerings when these funds were launched. They immediately leveraged it to more than $11.5 billion using the $600 million for collateral. They then shorted various instruments to raise additional cash and increase that leverage another $5.5B. With $17 billion in cash/debt backing them they proceeded to package up to $30 billion in loans for resale. Remember, they only started with $600 million in real money. As things started to crumble around them they continued to add money but the snowball was already gaining speed. With CDOs and CMOs being put back to them and with no new buyers the funds began to self-destruct. Backers began demanding repurchase of their securities or they would exercise their right to sell them on the open market and bill the hedge funds for the shortfall.
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With tens of billions in defaulting CDO/CMO securities suddenly flooding the market nobody wanted to be a buyer. Bids evaporated and it became a fire sale. Nobody really knows what they are buying and if the mortgages behind the debts will ever be repaid. Barclay's is said to have $500 million at risk with Merrill, Goldman, Lehman, etc already underwater for that much or more. Cantor Fitzgerald offered $400 million in CDOs at auction on Friday and said they were getting bids as low as 10 cents on the dollar. Even assuming they could double that and get 20 cents on the dollar it would be a huge loss for hundreds if not thousands of debt holders and all of those holders are going to go after whoever sold them the debt.
To get a perspective of how much of this debt exists one noted analyst claims $140 billion in subprime and Alt-A CDOs were sold in 2005 and over $500 billion in 2006. As the debt is collateralized and the various strips are sold off it produces further billions in derivatives, swaps, etc. To protect themselves further the companies buying/dealing in this debt will buy or short various other derivative instruments to maintain or enhance their yield. According to another analyst trading in these derivatives increased +24% in Q1 alone to more than $533 TRILLION. Yes, trillion not billion. Of course much of that is the same debt jumping from firm to firm but it is still a big number. It is also a number that even if overstated by a factor of 10 it would mean $50 trillion in outstanding obligations from tend of thousands of investors. Since firms writing these derivative instruments never expect them to be used they can vastly over leverage themselves while producing a trivial amount of real cash in the process. They never expect to be called or have the instruments put back to them. If they used the same 10:1 or 20:1 leverage that Bear Stearns used it would mean a monumental house of cards that could collapse at any moment.
Brookstreet Securities, a California securities dealer, announced it had terminated the staff of more than 100 and closed its doors on Friday. It could not meet its margin calls on its CMO debt and its clearing firm National Financial Services, sold the securities at a substantial loss to cover the margin calls. The NASD ordered the company to liquidate any remaining customer accounts and shutdown. Brookstreet said many of their customers lost their entire investment when NFS seized the Brookstreet assets. That would be bad enough if the story stopped there. Unfortunately NFS and securities regulators are going to pursue Brookstreet for realized losses that will be huge. Brookstreet claims it had reduced exposure by $400 million as the subprime meltdown continued but that left nearly $85 million in exposure at the beginning of the week with mark to market margin calls occurring daily. This is the tip of the iceberg.
Across America there are tens of thousands of investors and firms with positions in these CDO/CMO securities and much of it bought on margin. As the value of these securities falls they are faced with margin calls to avoid having the positions liquidated and the investor charged with the loss. When Cantor Fitzgerald said on Friday they were receiving bids as low as 10 cents on the dollar that public admission will require another round of mark to market margin calls on those thousands of investors. Regardless of whether you are an individual investor or institutional investor you are facing a very real threat of having to cough more money on Monday just to avoid having your investments sold to cover margin calls. Since there are no buyers they will be sold for pennies on the dollar and you will be liable for the shortfall. These securities and the dozens of derivatives they secure are held by hedge funds, banks, insurance companies, investment firms, hedge funds, pension funds and individual investors. They serve as a base of an inverted pyramid of leveraged loans including much of the consumer finance sector including credit card loans, auto loans, etc. If a company has a lot of these CDOs in their portfolio and face a margin call what are they likely to sell to raise money? The answer is equities and potentially a lot of them to cover repeated margin calls.
This is a very real short-term risk to the financial system and as many commentators were saying last week, this story is far from over and just took a major turn for the worse. With no buyers and the value of the CDO/CMO market dropping every day there could be as much as $500 billion in CDO/CMOs that will be hitting a market where the bid is only pennies on the dollar. Even for major institutions this will cause major pain in the current earnings cycle. Those markdowns, real or imagined, will have to be reported with a charge to earnings for Q2. Even if you are a long-term holder and you are perfectly happy with your securities you will still have to mark their value down to whatever the current value supports even if it is pennies on the dollar. Since these obligations for major players tend to be in the billions it will be a major charge to earnings.
To put this in perspective I am going to use a housing analogy. If there were 10 similar homes all for sale on the same block and the asking price for each was $500,000 the market equilibrium would be balanced. If a couple sellers were unable to make the payments and the houses were foreclosed and then quick sold by the banks for $300,000, what would happen to the value of the rest of the houses? Right, the new valuation is $300,000 for all of them. If a couple more sellers realizing they would never get out whole decided to bail the next bank sale could be $200,000 because we had already established the new value level at $300,000. The remaining home owners may be perfectly happy taking down their for sale signs and just waiting out the storm but the value of their homes is still half of what it was before the selling began. Their loan value is probably well below their current loan and the idea of refinancing is now out of the question. If they have an adjustable loan that will reset soon to nearly double the initial rate as many homeowners do in the coming Q4/Q1 period then they will be faced with paying twice the house payments for a house that is worth half. They can't refinance because the home value is underwater. If they were initially trying to sell because of financial problems then their problems and their future just got a lot bleaker. Odds are good they will end up losing their home because they can't sell it for what they owe on it and the next round of foreclosures will lower the prices even further. There are stories making the rounds now about $200,000 condos in Florida going for $40,000 in foreclosure auctions. When there are no buyers there is no value.
This is what is happening in the CDO/CMO market today. The weekly fire sales have been occurring for months but there was always a buyer for 70%, 60% or even 50% of the original value so the news never made it to the street in such stark terms as the Bear Stearns news this week. Now everyone holding these CDO/CMO securities are like the homeowners above. Their value is currently less than junk but their obligations are still 100%. The vast majority of CDO owners will just hold the debt knowing the long-term payout of the principal will continue in most cases and the market will eventually improve. It may take many years but if they are patient they may get most of their money back. In the short term they will take a paper hit and possibly be forced to put up some more money if the value of the security falls below certain levels. While the news value to the market of $500 billion in defaulting CDOs is tremendous the real impact to the major players will be minimal. The headlines will be scary and there will likely be many more firms like Brookstreet that close their doors. In the long run the market will survive. Bear Stearns said it was investing $3.2 billion in the better of the two hedge funds to provide "an orderly de-leveraging." What that means in english is Bear Stearns will wait patiently until CDO buyers begin to return to the market and then repackage the securities to sell to them. In the end everyone knows Bear Stearns is going to be a seller so it could take quite a while before any meaningful bids appear. All the major investment banks took a tumble on the Bear Stearns news with GS -4.50, LEH -2.60 and -$5 since Wednesday, MER -2.80, -6 from Wednesday and BSC -2.06 and -$8 from the prior Friday high.
IIn the short term the real damage is to prospective homebuyers. With the CDO/CMO market in complete disarray the options available to anyone with less than perfect credit are dropping fast. The number of people who can afford to buy a home with the new underwriting standards is a fraction of those buying homes just two years ago. The homebuilders are probably due for another leg down and another year before some semblance of normal returns. This will continue to depress the economy and probably keep the Fed on the sidelines for a long time. On the bright side the reemergence of this subprime blowup has put an end to the selling in bonds. They are being bought once again and that forces real interest rates to fall.
Amidst the firestorm of subprime news Blackstone (BX) finally made it into the public arena. After setting the price at $31 on Thursday night BX opened as high as $38 before selling off to close just over $35 for a +13% opening day gain. For weeks we have heard that the offering was oversubscribed by a factor of 10. If that were true you would have expected a lot higher price by days end. The deals underwriters did NOT exercise their options for extra shares. 113 million of the 133 million shares offered traded hands on Friday. That kind of turnover suggests investors were in it just for the opening pop and in light of the "tax'em to the maximum" news coming from lawmakers this week and they wanted out in a hurry before the rules changed. It was announced on Friday that lawmakers are considering raising the taxes on "carried interest" earned by funds to the corporate rate on cash held for future investment. This was the second tax hike proposal for the week and it appears lawmakers are on a hunt for easy money ahead of the elections. Tax those fat cats and win votes. This was another reason Blackstone did relatively poorly in its debut. If lawmakers are on the warpath for hedge fund scalps it might be a good idea to hide on the sidelines until the smoke clears.
Despite the -185 Dow loss there were some stocks moving higher. Bernstein initiated coverage on Google and Ebay with an outperform rating and said the sector should continue to grow for another decade or longer. Google gained +11 on the news and Ebay +63 cents after trading up as much as $1.30 on a very down day. Bernstein has a $635 price target on Google.
Jabil Circuit (JBL) gained +1.93 after reporting earnings that beat the street. Jabil had warned earlier in the quarter that earnings would be weaker than expected. Jabil reported 23 cents compared to 21 cents analysts were expecting. Macy's (M) spiked +2.50 on five times normal volume on rumors a buyout may appear. RIMM was up at the open after Goldman Sachs said shipments for the quarter should be at the high end of prior estimates. PALM was cut by Jeffries on iPhone concerns. They believe Palm will suffer the most from the iPhone release. It was announced on Friday that iTunes is now the 3rd largest music retailer just behind leader Wal-Mart and Best Buy. The iPhone is expected to add to that volume.
PMCS and SANM both lost ground after S&P said they would be kicked out of the S&P-500 and replaced by the companies Tyco is spinning off, COV and TEL. Discover Financial Services (DFS) will replace ADCT.
Oil prices continue to hover just under $70 as traders become more comfortable over the $69 level. Fears this weekend come from Nigeria where the strike continues and shows potential signs of heating up next week. Nigeria is the 3rd largest crude exporter to the United States. Tensions over Iran are still making news but have little real impact on prices. The Iran premium has been priced in for months. The International Energy Agency (IEA) is almost begging OPEC to raise output quickly because of rapidly rising demand. The IEA said global inventory levels are down to only a 23-day supply. The IEA claims China's growth spurt boosted oil imports by +4.5% in May and China's demand is doubling every decade. They global claim demand is rising twice as fast as supply and without a rise in production now by OPEC we will see shortages this winter. They are expecting demand to rise to 88 mpbd in Q4 and that will be an all time record by nearly 2 mbpd. There is a lot of confusion about whether we can actually produce that much oil per day and the IEA wants to build up supplies well ahead of this winter demand spike. On the gasoline demand table below you will notice a jump in demand of 104,000 bpd over last week and +162,000 bpd over the same week in 2006 and we are not even into the highest demand period of the year over the July 4th weekend. The Senate passed a bill this week that would increase mileage standards for autos and light trucks to 35 mpg by 2020. That is nearly twice the average of those vehicles on the road today. They also would require 50% of vehicles on the road by 2015 to run on alternative fuels. That prompted a boost in ethanol stocks on Friday.
Gasoline Demand Table
August Crude Oil Chart - Daily
A lot of Friday's market volatility was attributed to the Russell rebalance. A change in the rules for who could be added to the Russell indexes allowed a lot of large companies to be added to the indexes for the first time. Companies like Tyco (TYC) and Schlumberger (SLB), which are incorporated outside the U.S. were not previously eligible for Russell index inclusion. With this year's change to the rules they are now being added. Their addition to the Russell 1000 index meant an influx of an additional $15 billion in investment capital from funds indexed to the Russell-1000. That capital had to come out of other Russell indexes. There were 277 stocks added to the Russell including 128 new Q1/Q2 IPOs and 184 stocks were removed. Volume on the Russell hit 1.159 billion shares and well over the average volume of 700,000 shares.
Russell-2000 Chart - Daily
With the Russell rebalance and the news driven market flush, volume across all the exchanges hit 7.54 billion shares. That puts Friday as the second highest volume day of all time. The top four days are all this year with Feb-27th 8.347B, Friday 7.54B, Mar-1st 7.4B and Feb-28th 7.17B. Unfortunately Friday's volume was significantly negative at nearly 3:1 down volume over up volume. Across the broader market declining stocks beat advancing stocks by 5:2. On the S&P-500 that ratio was extremely imbalanced at 9:1 in favor in decliners. (435 decliners to 49 advancers) This tells us what index saw the biggest withdrawal of funds to add to the Russell or what futures were being sold to cover margin calls.
The Dow has been up for the last 13 Fridays but evidently 14 was the unlucky number this time with that string broken this week. Only one Dow stock was positive and that was DD by a nickel. Volume was so heavy at the close that the Dow was still settling out nearly 10 min after the close. The Dow declined nearly -20 points well after the closing bell.
I have mixed emotions about the market direction for next week. I said on Tuesday that a break below 13600 on the Dow could produce a failed double top and that is exactly what it looks like this weekend. However, I am probably more bullish today than I was on Tuesday. We had several outside attacks on equities by lawmakers and the subprime blowup. Add in the selling on the Russell rebalance as another artificial event. Those outside influences knocked a lot off the indexes but they failed to penetrate major support.
Next week is going to very volatile because of the flurry of economic reports and the FOMC meeting. However, it is also quarter end and a prime setup for window dressing. Funds can buy the dip and especially focus on the winners like Mastercard, Schlumberger, etc, and look like heroes when they mail their quarterly statements. There is little risk in buying winners in a down market and those losers from last week will start to look even more attractive for new money. With the markets at or near their highs early last week it is tough to convince fund managers to invest new money one week ahead of the quarter. Now they have a chance to buy the dip one more time.
Despite the crash in the financials I believe it is a liquidity crisis not a credit crisis. CDOs are extremely illiquid and that exacerbates the problem. The major companies are going to pull through it. Bear Stearns has a market cap of $150 billion. A temporary $3 billion headache is not going to sink them. Goldman (GS) has pulled back nearly $15 from their 6/13 high and right to strong support at $220. That is a prime entry point for those looking for a long-term position. With a market cap of $225 billion any subprime hangover is only a few cents to earnings. Goldman reported on its house of subprime pain with its earnings on 6/15 and quarterly earnings of $4.79 per share still beat estimates.
Goldman said it did $1.7 billion in investment banking revenue and their backlog of deals is higher now than the record levels set back in the dot.com era. Goldman is the world's largest investment bank. Thomson Financial reported on Friday that worldwide M&A rose +53% in the first half of 2007 to $2.5 trillion. Goldman retained its slot as the largest global underwriter of mergers and acquisitions and rose to 1st in Europe for the period from its prior position at 4th. Thomson saw no letup in M&A activity ahead. Subprime problems are only a minor headache for Goldman and the other majors including Bear Stearns. It is not going to crash the financial system even if thousands of little guys have to bite the bullet.
Earnings are only two weeks away and earnings warnings have been nearly nonexistent. Technically there have been more warnings than positive pre-announcements but both have been very scarce. We are expected to see S&P earnings growth in excess of 6% and the whisper numbers are over 10%. The subprime problem is likely to keep the Fed on hold for the rest of the year even though the economy is rapidly accelerating. Global economic conditions are also accelerating and global markets are mostly at their recent highs. There is little to be gloomy about and a lot to be thankful for.
Obviously the markets don't need a reason to go down but the way I look at it
there are far more reasons for them to rise. Because of the many economic events
next week we could see some additional volatility and some caution ahead of the
Fed announcement. After the Fed meeting passes, assuming they don't do something
unexpected, I think the bulls will return and we will see a return to the highs.
Getting over those highs could be another story but we will cross that bridge
get there. In every market forecast there is always the potential for an
economic landmine in next week's reports but we have seen no evidence of
economic problems in recent weeks. Everything has been improving fine and a
couple of weak reports in our near future could help with the Fed picture. I
could be wrong but I think this is another dip to buy. A break below 13250 on
the Dow, Nasdaq 2550 and S&P 1490 would change that view back to bearish. Owning
the Russell-2000 futures
or the IWM ETF on Monday would not be a bad idea
either. Stocks being removed have no further impact and those funds late to the
rebalance party will only push it higher.
Play Editor's Note: We are not adding a lot of new plays to the newsletter this weekend. The major market indices look like they have built a bearish double-top pattern. Yet we hesitate to open a bunch of bearish positions as we move into the last week of June, which could see window dressing. Plus, there is a host of potentially market-moving economic reports and a FOMC meeting this week. There is no way to know if stocks will continue to sell-off, surge back to test the highs or just trade sideways as investors wade through the economic reports and wait for the fourth of July weekend and the beginning of second quarter earnings.
Cleveland Cliffs - CLF - cls: 79.46 chg: +1.30 stop: 74.99
Why We Like It:
BUY CALL AUG 75.00 CLF-HO open interest=194 current ask $8.00
Picked on June xx at $ xx.xx <-- see TRIGGER
Russell 2000 iShares - IWM - cls: 82.85 chg: -0.57 stop: 81.35
Why We Like It:
BUY CALL AUG 80.00 IOW-HB open interest= 11075 current ask $4.65
BUY CALL SEP 80.00 IQQ-IB open interest= 12045 current ask $5.75
Picked on June 24 at $ 82.85
Mastercard - MA - close: 168.43 chg: +3.74 stop: 157.99
Why We Like It:
BUY CALL AUG 165 MAL-HM open interest=451 current ask $13.60
Picked on June 24 at $168.43
Pacific Ethanol - PEIX - cls: 12.83 chg: +0.58 stop: 11.90
Why We Like It:
BUY CALL AUG 12.50 PFQ-HV open interest=186 current ask $1.30
Picked on June 24 at $ 12.83
Ashland - ASH - cls: 62.27 change: -0.50 stop: 59.95
Shares of ASH weathered the market sell-off on Friday relatively well. The stock pulled back 0.79% but maintained short-term support near $62.00. Odds are good that we'll see a bit more weakness on Monday morning. If that's the case we'd watch for ASH to dip near $61.50 or maybe $61.00. A bounce above the $61.00 level can be used as a new bullish entry point. Our target is the 200-dma (currently at $64.48). More aggressive traders may want to aim higher but we would not hold over the late July earnings report.
Picked on June 10 at $ 61.49
Avery Dennison - AVY - cls: 66.42 chg: -0.28 stop: 64.90*new*
AVY also held up pretty well during Friday's market-wide weakness. The stock held above short-term support near $66.00 as it continues to consolidate sideways in the $66-67 range. The lack of upward movement over the last week is weighing on the short-term technical indicators but the two-month trend is still higher. We would use another dip in the $66.00-66.25 zone as a new entry point to buy calls. The 200-dma has risen above what should be round-number support at $65.00 so we are adjusting our stop loss to $64.90. Our target is the $69.75-70.00 range. We do not want to hold over the late July earnings report.
Picked on June 11 at $ 66.05
BP Plc. - BP - close: 69.76 change: +0.53 stop: 67.85
Shares of BP managed to buck the market trend on Friday. The stock gapped open higher at $70.17 and rose to $70.52 before paring its gains. Fueling the move was news about BP's stake in Russia. The Russian government negotiated a deal with BP to buy BP's 62% stake in some substantial Russian natural gas fields. It looks like investors were happy to hear the news that BP will be paid $900 million for its share and will be given a chance to become a minority stakeholder. The deal could have turned out a lot worse with the Russian government just confiscating all of BP's assets with zero compensation. This is just one more play by the Kremlin to seize control of all of its energy assets as we near peak oil and gas for the planet. Shares of BP dipped low enough on Friday to fill the morning gap and then bounce again. Normally, given the breakout over resistance at $70.00 and the pull back under it again we would issue a warning but this time it looks like another entry point. Our suggested trigger to buy calls was at $70.25 so the play is open. We are suggesting new positions now although more conservative traders may want to wait for a new relative high over $70.50 before opening positions. The P&F chart points to a $90 target. Our target is the $74.85-75.00 range. More aggressive traders may want to aim higher. FYI: We do see some resistance near $73.50.
BUY CALL AUG 65.00 BP-HM open interest= 65 current ask $5.70
Picked on June 22 at $ 70.25
Central Euro. Media - CETV - cls: 96.20 chg: +1.52 stop: 89.75
CETV displayed relative strength on Friday with a new all-time high at $97.83.
Furthermore the stock posted a 1.6% gain while volume soared to almost 20 times
the daily average. Unfortunately, we cannot find any news that might explain the
spike higher at the open or the huge surge in volume near the closing bell.
Sometimes big volume at a new high can mean distribution and a potential top but
that doesn't look like the case here with CETV rebounding sharply higher into
bell. Given the sharp rise in volume, and knowing that the Russell
rebalancing was this weekend, we decided to check the Russell.com website and
sure enough CETV was one of the new companies being added to the indices, which
explains the big volume. Why there was no press release from CETV about this
event we can't say. We are not suggesting new positions at this time. Our target
is the $99.00-100.00 range. It's worth noting that the price target on the Point
& Figure chart has
grown from $103 to $118 in the last couple of weeks. If you
look at the bullish channel on the weekly chart it is tempting to want to aim
higher. If you want to see the Russell additions click here:
Picked on June 17 at $ 92.75
Chevron Corp. - CVX - close: 81.55 chg: -1.30 stop: 79.90
Oil stocks could not evade the market sell-off even though crude oil futures rebounded on Friday. Shares of CVX lost 1.5% although it wasn't a true break from Thursday's "inside day". We are somewhat cautious here and would suggest waiting for a new rise past $83.00 before considering new positions. More conservative traders can wait for a new relative high over $84.00 before considering new positions. Our target is the $89.00-90.00 range.
Picked on June 18 at $ 83.75
Deere Co - DE - close: 123.35 change: -0.95 stop: 117.45
We think DE also held up very well during the market mayhem on Friday. Shares tagged a new all-time high at $125.64 before sliding into the red. Overall we remain bullish on the stock. Readers can choose to buy calls here or look for a dip near its rising 10-dma around $120.85. Conservative traders might want to consider a tighter stop loss closer to $120. We have two targets. Our first target is the $129.50-130.00 range. Our second, more aggressive target is the $134.00-135.00 range. The P&F chart is bullish with a $152 target.
BUY CALL AUG 120 DE-HD open interest=100 current ask $8.30
BUY CALL SEP 120 DE-ID open interest=1387 current ask $10.00
Picked on June 20 at $123.55
Global SantaFe - GSF - cls: 73.70 chg: +0.77 stop: 66.65
GSF also turned in a strong session with a 1% gain and a new closing high. The
stock saw record volume on Friday, which was due to GSF being added to the
Russell indices. You can see it on the additions lists here: http://tinyurl.com/39o3x3
Picked on June 03 at $ 68.86
Manpower - MAN - cls: 93.20 change: -0.90 stop: 89.90
The market weakness on Friday took the wind out of MAN's sails but we suspect it's a short-term issue. Traders bought the dip near $92.00 midday and MAN pared its losses by the close. We see the intraday rebound as a new entry point to buy calls. Conservative traders could try and reduce their risk by raising their stop loss toward $91 or toward $92.00. Just be aware that the market in general (and thus MAN) could see some weakness on Monday as stocks flush out any left over selling from Friday. Our target is the $99.50-100.00 range. The P&F chart has a triple-top breakout buy signal with a $110 target.
BUY CALL JUL 90.00 MAN-GR open interest=237 current ask $5.40
BUY CALL AUG 90.00 MAN-HR open interest= 0 current ask $6.60
Picked on June 20 at $ 94.15
Penn National Gaming - PENN - cls: 61.60 chg: -0.58 stop: n/a
Our high risk play on PENN is taking a turn for the worse. The stock is trading down towards its post-gap low. Shares gapped higher on June 15th after announcing it would be bought for $6.1 billion by two investment companies. There has been a lot of speculation that more suitors will show up and push the price higher. That's why we're suggesting calls, since one analyst believes the final buyout price could be closer to $80.00. However, this is a very speculative and high-risk play. If a suitor fails to show up then any out of the money calls will quickly disintegrate. Currently the final buyout price is $67 a share. After the deal was announced Jim, our weekend market commentator, disclosed that he bought a few calls expecting more suitors to make a bid for PENN.
BUY CALL AUG 65.00 UQN-HM open interest=1916 current ask $0.80
BUY CALL OCT 65.00 UQN-JM open interest=1512 current ask $1.35
Picked on June 17 at $ 62.12
SanDisk - SNDK - cls: 47.90 change: -0.12 stop: 43.45
SNDK turned in a strong week following its recent breakout over resistance near $46 and its 200-dma. We remain bullish on the stock but would only consider new positions if we saw a dip (or better yet a bounce) near the rising 10-dma around $46.25. More conservative traders may want to raise their stops. We have two targets. Our conservative target is the $49.50-50.00 range. Our aggressive target is the $52.50-55.00 range, which might be too optimistic given our time frame. We don't want to hold over the mid July earnings report.
Picked on June 17 at $ 46.40
Valero Energy - VLO - cls: 76.45 chg: -0.12 stop: 72.45
VLO did not produce any definitive moves following Thursday's "inside day" but we remain bullish on the stock and the sector. We are suggesting new positions here but it would be perfectly fine to wait for a new relative high over $78.00 before initiating positions. More conservative traders might want to think about raising their stop loss toward last week's low. We're going to keep our stop under $72.50 and its 50-dma for now. Our target is the $84.50-85.00 range.
BUY CALL AUG 75.00 ZPY-HO open interest=1106 current ask $4.60
Picked on June 18 at $ 77.55
XTO Energy - XTO - cls: 61.45 chg: -0.89 stop: 58.95
Last week was rough on XTO. The stock pulled back about 3% and Friday's session produced a bearish breakdown under short-term support at the 10-dma. We are not suggesting new positions at this time although we will be watching for a bounce near $60.00, which should be round-number support. We are repeating our suggestion that readers consider taking some money off the table and lock in a potential profit. Our target is the $64.75-67.50 range.
Picked on May 27 at $ 57.63
Allegheny Tech - ATI - cls: 106.77 chg: -2.48 stop: 112.15
The overall pattern continues to look bearish for ATI. There appears to be a clear top in place and both weekly and daily technical indicators are bearish. The stock produced multiple failed rallies under $112 and Friday saw another failed rally under $110. The recent weakness looks like a new entry point to buy puts. However, ATI has bounced twice in the $105.50-105.60 range. More conservative traders may want to wait for a new relative low under $105.50 before initiating positions. Currently we have two targets. The first target is the $100.50-100.00 range since the $100 level would normally be round-number support. Our second, more aggressive target is the $95.50-95.00 range although we may need to adjust this to the 200-dma, which is rising and currently near $94.00. The P&F chart currently points to a $94 target.
BUY PUT AUG 110 ATI-TX open interest=147 current ask $7.90
Picked on June 12 at $106.70
Gilead Sciences - GILD - cls: 78.48 chg: -0.87 stop: 82.55
The BTK biotech index lost 1.8% and plunged through support near the 780 level. Friday marked the close to a painful week for the sector and as a group they look a little short-term oversold and due for a bounce. Speaking of bounces GILD dipped to $77.46 near its rising 100-dma and then rebounded more than a $1.00. While the overall trend in GILD looks bearish we're not suggesting new positions. The stock looks poised to bounce back toward the $80 region. More conservative traders may want to tighten their stops. Our target is the $75.25-72.50 range but traders should be aware that the simple 100-dma nearing $77.50 might be technical support. FYI: The stock is set to split 2-for-1 on June 25th. Our post-split target is $37.62-36.25. Our post-split stop loss is $41.27. If you are currently holding options on GILD you will see the strike price and symbol change, the value will probably halve while the number of contracts you own should double due to the 2:1 split.
Picked on June 07 at $ 79.90
Las Vegas Sands - LVS - cls: 74.85 chg: -0.50 stop: 80.26
LVS has been flirting with a breakdown under round-number support at $75.00 for days. Shares finally did it on Friday and it closed under $75 on above average volume, which is bearish. However, before you jump in with new bearish positions it's worth noting that shares were trading up around $75.50 in after hours on Friday. We remain bearish on the stock but we're cautious since we can't see any news or event that would fuel an after hours rebound on Friday. Look for a failed rally under the 10-dma (near 76.85) or a new relative low (under 74.63) as potential entry points to buy puts. Stay on your toes. This has been a tough market for bearish strategies for the last few months. Our target is the $70.50-70.00 range. More aggressive traders may want to aim lower.
Picked on June 17 at $ 76.78
Mettler Toledo - MTD - cls: 94.33 chg: -0.50 stop: 99.11
On Thursday MTD bounced from technical support at its rising 100-dma. Yet the bounce did not get very far as shares slipped 0.5% on Friday. There is still support at the 100-dma so we're not suggesting new positions at this time. Wait and watch for a failed rally under the 10-dma near $97.00 (or under $96.00) before considering new put positions. Our target is the $90.50-90.00 range. FYI: The P&F chart has reversed into a new triple-bottom breakdown sell signal with an $87 target (was $91).
Picked on June 19 at $ 96.75
QUALCOMM - QCOM - cls: 42.99 change: -0.57 stop: 44.05
On Friday it was announced that the U.S. International Trade Commission (ITC) had denied QCOM's request to delay the ITC's previous order banning importation of mobile phones with QCOM's latest chips (source: Reuters). We are surprised that shares of QCOM did not trade lower than its 1.3% decline on Friday given this news. There is the off chance that President Bush will make an exception and step in to influence the ITC's decision but the White House has already said that is unlikely to occur. There is also a chance that QCOM will give in and work out some sort of settlement with BRCM, who won the patent infringement case that started this conflict. However, QCOM has not hinted it's willing to do any talking with BRCM thus far. Given this story we remain bearish on the stock. More aggressive traders may want to buy puts here. We would wait for a new decline under $42.00 or $41.00 to confirm the bearish trend. Our target is the $37.00-36.00 range. We do not want to hold over the mid July earnings report.
BUY PUT JUL 45.00 AAO-SI open interest=39348 current ask $2.45
BUY PUT AUG 45.00 AAO-TI open interest= 2181 current ask $2.95
Picked on June 10 at $ 41.87
Weyerhauser - WY - cls: 80.57 chg: -1.03 stop: 82.05
Shares of WY continue to flirt with a breakdown under $80.00 and technical support at its 50 and 100-dma. We are sticking to our plan and waiting for WY to hit our trigger at $79.49. If triggered our target is the $75.00-74.00 range. The P&F chart is very bearish with a $61 target.
BUY PUT JUL 80.00 WY-SP open interest=4980 current ask $1.50
BUY PUT AUG 80.00 WY-TP open interest= 750 current ask $2.85
Picked on June xx at $ xx.xx <-- see TRIGGER
PACCAR - PCAR - cls: 87.42 change: -2.01 stop: 85.95
We are giving up on PCAR. The stock lost 2.2% and did so on big volume this Friday. The breakdown under $88.00 suggests that PCAR has farther to consolidate and shares may dip toward the 50-dma or the $84 level before bouncing again. We are dropping it here but will keep an eye on it for a breakout (either direction) from its previous trading range.
Picked on June 17 at $ 90.66
SunPower - SPWR - cls: 64.18 change: +3.41 stop: 52.49
Target achieved. SPWR broke out to new all-time highs and past resistance near $62.50 on huge volume. SPWR hit an intraday high of $64.88. Our target was the $64.00-65.00 range. The play is closed but we'll be keeping an eye on the stock for another entry point down the road.
Picked on June 17 at $ 57.94
Do you set goals for yourself as a trader each year? I do. Last year, my goal was to gradually scale up in the number of positions I held each option expiration period. This year, my goal has been to research various exit or profit-protecting strategies. Up until this year, my exit strategy had been to determine a get-out point before initiating a trade, depending on where I thought the absolute strongest support or resistance might lie. In other words, my adjustment or exit was contingent mostly on the price of the underlying. As you can imagine, that approach has its pluses and minuses. A big minus is the price risk incurred when letting prices test resistance or support near a sold strike.
I tended to step out of troubled positions and only occasionally did I roll up or down. So, mostly I operated on what Mike Parnos of Couch Potato fame would call a "get the funds out" strategy. Last year, I managed to keep losses, when they occurred, relatively small. I still wanted to determine an exit strategy that best balanced the needs to take as few losses as possible, to keep those as small as possible when they occurred and to undergo as little stress as possible in the process.
In April, the goals for those two years collided. I had just scaled up again in the number of positions I held when I attempted a new loss-hedging strategy. That strategy failed miserably, so miserably that I won't even mention what I did for fear that some other misguided soul might also attempt it. Let's just say that it sounded a whole lot better in theory than it turned out to be in practice, even though I had a notebook full of pages of computations I performed on iVolatility.com before considering the strategy.
I won't be employing that strategy again. However, in my continued quest to fine-tune my exit strategies, I happened across Dan Sheridan's name in a couple of places: a series of articles on options positions, including condors, in STOCKS & COMMODITIES magazine and a series of "Master Sessions" webinars on the www.cboe.com site. In both, he outlined his preferred procedures for entering and managing condors. Since I know that many of our readers trade condors, I thought I might mention what Dan Sheridan has to say about how they should be managed.
In his CBOE webinar, Sheridan claims that a condor "is a beautiful position, but it has a dark side." It's a beautiful position because probabilities favor the trader putting them on as long as the trader is careful not to get too close to the action. That dark side is that the risk/reward ratio "stinks in a condor." Remove risk whenever you can, Sheridan advises. He has suggestions for doing so both when a position is profitable and when it's going sour. Let's address the good outcome first.
His first suggested action point occurs when a spread narrows to a price that preserves 50-60 percent of the credit you originally received. For example, imagine that you originally received $800 for ten contracts of a bull put spread. Perhaps two weeks have gone by, and you discover that the spread on those contracts has narrowed to $320-400. You could close them, if you wanted, and keep $400-480 or 50-60 percent of the credit you originally received.
That's Sheridan's first action point. He's not telling you take profit. Instead, he wants you to make sure that the bull put spread is never allowed, from that point forward, to become a losing position. He advises you to change the point at which you would adjust or exit the position to one in which you would keep at least some of the profit. For example, you might reset that adjustment point to one at which you would keep $100 of your initial credit.
That's the first action point. If the spread keeps narrowing so that it requires only $0.15-0.20 per contract to exit, it's time to do so and remove the risk, Sheridan advises. The condor has done its job in providing income at that point, he believes, and the risk should be removed.
What about when a condor is going sour? Keep losses small, Sheridan advised. In his CBOE webinar, he provided an example of a spread in which the trader had taken in $1,000 for multiple contracts. The loss in that spread should never be allowed to accumulate above $1,500, he advised, before the position is exited or adjusted. In another place in the same webinar, he seems to counsel that no loss over $1,000 should be allowed to accumulate if the original credit was $1,000. The two bits of advice might not have concurred exactly, but the sense of them did. You just can't let losses mount on these condors or on any credit spread. Your losses can be large enough to wipe out many months of carefully accumulated profit if you don't manage the position. Trust me. I speak from experience.
Sheridan offers other specific guidelines related to adjustment points. He believes that a condor is in trouble and requires adjustment when the deltas measure +/- 25-30 for a sold call or +/- 20-22 on the sold put. Most online brokerages provide quotes that include measurements for delta.
For example, Brokersxpress.com provided these figures for the SPX July 2007 1565 Call, as of the close of trading on June 15.
Table for SPX JUL 2007 1565 Call (.SXMGM)
The delta shown was .2987, which would bring it up to 29.87 if the 100 multiplier for each contract were applied.
If a bear call credit spread involved selling the SPX JUL 2007 1565 Call, the spread should be rolled up at this point, Sheridan believes. He is adamant that both positions, the bull put and bear call spreads, be rolled up. When the sold put is the one with a delta that's indicating that the position is in trouble, both the bull put and bear call spreads should be rolled down.
When originally establishing a spread, Sheridan advises against selling calls with deltas greater than 7-9 or puts with deltas less than -6 to -8 (because deltas are negative on puts), he said on his webinar. However, the STOCKS & COMMODITIES article suggested that when rolling up or down, the new sold calls should not have deltas above +10 and sold puts, below -10. This keeps the probability that sold strikes will be violated low.
In an article on another strategy, Sheridan stresses his belief that any new strategy should first be paper tested and then employed in small numbers of contracts. I bet he'd advised the same about employing a new exit strategy, too. I have not tested these suggestions, although I did elect to roll up half of a JUN SPX 1555/1565 bear call spread last month when the delta of the 1555 reached about 0.24 (24 when the 100 multiplier was employed). That had been a 20-contract position, and I rolled up 10 of them into 20 May 1570/1580's for breakeven, thereby maintaining my original credit. I hadn't read Sheridan's article by that time, and this also fit with an exit strategy that a trusted trader friend employs.
Having a specific action point did make it easier to manage the emotions of the trade as well as that volatility risk that Sheridan cautions exists in these plays. He believes they're a great income-producing strategy as long as that risk is controlled.
So, it's obvious that I haven't tested out this exit or adjustment strategy
fully, but I will be testing it this year as part of my trading goals for the
years. I can't recommend Sheridan's suggestions yet, but I certainly can
recommend thinking about how you want to manage risk, dollar loss and emotion
when planning your own exit or adjustment strategies. If you want to hear about
Sheridan's strategy from his own mouth, the webinar can be found at
this link on the CBOE site. Happy planning.
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda
Piazza, and all other plays and content by the Option Investor staff.
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