Option Investor
Newsletter

Daily Newsletter, Tuesday, 7/21/2009

Table of Contents

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

Market Wrap

Earnings Losing Their Impact

by Jim Brown

Click here to email Jim Brown

A flurry of large companies reported decent earnings today along with multiple Dow components but the positive impact on the market was muted.

Market Stats Table

Earnings were the focus of the day and that was a good thing since the economics were minimal and uninspiring. The Chicago Fed National Activity Index rose to -1.80 from last months -2.30 reading. 75% of the component categories improved in June but only 15 of the 85 indicators made positive contributions to the index. Are you excited yet?

CFNAI Chart

The Risk of Recession index came in at 37% for June. This is a forward-looking indicator and projects the percentage risk of the country being in recession within six months. Since we are in a recession and this is a lagging indicator for the June period it was and is normally ignored by the market. The highest level this indicator reached in the current economic cycle was a 60% chance back in November. In July 2008 as we headed into the recession this index only projected a 35% chance. Needless to say this is not a market mover.

Fed Chairman Bernanke told Congress today that the economy was still too weak to begin tightening monetary policy. He said inflation was not an immediate threat despite market expectations for inflation at the highest level since 2004. Bernanke reiterated his expectations for prices to remain subdued over the next couple years. Bernanke said the Fed had the tools to remove the excess liquidity once conditions improved. However, Bernanke warned about fiscal responsibility by Congress and the administration and how it could upset the economy and the Fed's plans to keep it moving forward. The Fed has taken on over a trillion in assets in an effort to reduce the impact of the economic decline. They will have to unload those assets once the economy begins to improve. They would like to do it before interest rates begin to rise.

In prior recessions the Fed began to raise rates 9-12 months after unemployment peaked. Since unemployment is not expected to peak until early 2010 that means the Fed may not begin raising rates until the middle of 2010 if they follow the previous trends. In 1982 unemployment peaked at 10.8% in November. The Fed did not begin raising rates until May 1983. The next largest unemployment was May 1975 at 9.0% and the Fed raised rates in June 1975. This shows there is a precedent for quick removal of the liquidity once unemployment peaks even though the average is 9-12 months.

Bernanke's assessment of the economy was slightly more upbeat than his previous testimony but stressed that consumer spending remained fragile and that would warrant keeping interest rates low for a "extended period." Analysts felt the Bernanke testimony was slightly upbeat but still cautious given the length of time the Fed expected the economy to remain stagnant. Bernanke will repeat the performance before a House panel on Wednesday.

That brings us to the big news of earnings. Tuesday was chock full of earnings by major companies and not all were positive. Leading the hit parade was Caterpillar (CAT) with revenue that fell -41% and profits that fell -66%. However, CAT still beat the street and CAT stock was up +12% in early trading and powered the Dow to another gain. Actually the response was muted intraday after they said on the conference call that Q3 could be very tough and they might even lose money. CAT is going to schedule rolling factory shutdowns to cut costs.

I heard from somebody familiar with business inside CAT that the workforce has been cut to skeleton crew strength. Reportedly there is only a trickle of orders for Q3/Q4 and upper management's forecast is not expecting a recovery until sometime in 2010. The number of orders in one plant could be counted on both hands according to this person. Obviously CAT does not want to portray that kind of weakness to the public and simply warning that Q3 could be "very tough" and possibly a loss is the sanitized outlook equivalent. 61% of their orders come from overseas and they did say they were seeing some improvement in China.

On the positive side CAT said they were seeing some stabilization in the credit markets. They were able to secure financing for some customers in what the CEO said was a dramatic improvement in what they had seen over the prior two quarters.

CAT Chart

United Technology (UTX) said profits fell -24% on a $2.7 billion drop in revenue. Earnings of $1.05 beat the street by a penny. However, UTX cut its revenue guidance for the year and lowered estimates for profits. UTX lowered revenue guidance by $2 billion and full year profits in a range from $4-$4.20. That is down from $4-$4.50. The CEO said they DO NOT expect a significant economic recovery next year although cost cutting will help them weather the storm. UTX already cut its guidance in March and cut 11,600 jobs. UTX shares lost $1 on the news.

UTX Chart

AMD did not match Intel's performance but nobody should have expected that to happen. AMD lost -62 cents compared to street estimates for a loss of -53 cents. AMD stock fell -12% in after hours. Gross margins slid to 37% from 43% in what AMD called a "disappointment."

AMD Chart

Merck (MRK) beat the street with earnings of 83 cents compared to estimates of 77 cents. Schering Plough (SGP) posted earnings of 45 cents and beat by a penny. SGP is being acquired by MRK and the deal should close in Q4.

The airlines also reported earnings of sorts. Southwest (LUV) beat the street by a penny with earnings of 8 cents. Continental missed estimates by a penny with a loss of -$1.36 per share. Continental said the average fare price had declined -18% and there was a -24% drop in overseas travel. United (UAUA) posted a loss after items of -$2.23 per share and beat analyst estimates for a -$2.56 loss. UAUA said business traffic had died and revenue fell -25.2%. The eight largest U.S. airlines lost a combined $1.2 billion for the quarter.

United said it was going to cut international capacity by 7% to offset falling demand. UAL has $2.8 billion in cash and the burn rate is causing analysts to predict another chapter 11 bankruptcy filing. Southwest earned $54 million for Q2 but warned it could lose money in Q3. Continental said Q3 was shaping up to be dismal and would cut additional jobs and raise fees for extra services. CAL said it was going to add a fee for telephone reservations and for bags checked at the curb like Delta did recently. They are hoping to raise $100 million through their new fee schedule.

After the bell Apple Inc (AAPL) posted earnings of $1.35 that blew past analyst estimates of $1.18. Revenue was inline at $8.3 billion. Apple said it sold 2.6 million Macs, up +4%. Apple also said it sold 5.2 million iPhones including the new 3GS version for $99. The company said that almost 20% of the Fortune 500 companies had purchased at least 10,000 iPhones and demand was so strong that they could not make enough 3GS phones to fill orders. Several analysts had worried that the $99 iPhone would be a drag on margins as would the 40% rise in flash memory costs. However margins came in at 36.3% and above the 34% analysts expected.

Apple issued another downbeat forecast for Q3 with an earnings range from $1.18 to $1.23 that was below the analyst estimate for $1.30. Nobody really pays attention to Apple guidance because they always talk down estimates significantly. Apple sold 10.2 million iPods and the CFO said he expected iPod sales to decline as the iPhone cannibalized iPod demand. Apple shares rose to $158 in after hours trading and up from the close of $151.56.

Apple Chart

Yahoo (YHOO) crumbled after the close despite earning a small profit. Ad sales worsened for Yahoo with Google continuing to take market share and now Microsoft Bing is also stealing share. CEO Carol Bartz implied that ad sales for the second half "might" improve but stopped short of saying it. Bartz said there was just too much conflicting information in the market to make an accurate call. Yahoo earned 10 cents and analysts expected 8 cents. Revenue fell -13% to $1.57 billion for the biggest decline in the last three years. By contrast Google's revenue rose +3% to $5.5 billion. Bartz did not mention a potential search partnership with Microsoft that is still being discussed. YHOO declined to $16.23 in afterhours.

Yahoo Chart

With 150 S&P companies reporting earnings this week we are blazing right through the heart of the earnings cycle. So far 71% of companies reporting have beaten estimates, 22% missed and 8% reported inline. We have seen numerous companies report a beat of a penny or two on accelerated cost cutting and then warn that Q3 was going to be "very tough." This downbeat guidance has yet to phase the market but eventually the markets are going to catch this guidance virus.

Need a hotel cheap? The Watergate Hotel in Washington was auctioned off to bidders today after GE Capital foreclosed on the $40 million mortgage. The opening bid was $25 million and that turned out to be the only bid for the historic 250 room riverside hotel. The hotel was purchased for $45 million in 2004 and has been vacant since 2007. It appears there is a small matter of $100 million in needed renovations. GE Capital was the bidder at $25 million and said it will attempt to sell the property.

In a corresponding article an analyst said hotel room revenue in general has declined -20% since last year and operating cash flows have declined -35%. Commercial mortgage delinquencies are running 2.55% and 13 major loans defaulted in June. Three of those loans were for more than $100 million.

Crude futures for August expired today at just under $65. This was the lowest price for the coming months as the contango in crude continues. For instance the December Z9 price today was $69. However, that same contract was trading over $76.50 last month. This is a factor of a lack of hurricanes and a continued rise in global inventory levels. Some refined products are now at a 25-year high.

Future Months Table

Oil Futures Chart

The two storms I pointed out last week have failed to materialize into anything but rain and the weather service claims each have less than a 30% chance of strengthening. One noted forecaster lowered his estimate today for the number of storms in 2009.

Atlantic Storms

The Nasdaq inched higher for a +6 point gain and stretched its string of consecutive gains to ten days. This is the first time in 11 years that the Nasdaq has accomplished this feat. You would think that a blowout by Apple and a +7 point gain in after hours would guarantee another Nasdaq gain tomorrow. I would not hold my breath. The Nasdaq futures were up strongly immediately after the Apple report but have since declined into negative territory. S&P futures have also declined into negative territory. Beating the street by a penny on cost cutting and then lowering guidance for Q3 is not conducive to continued gains.

Obviously no index can continue to post gains day after day and eventually the Nasdaq will have to take profits. The 1900-1905 level was decent resistance and that was cracked this week but not very convincingly. This could still come back to bite the index as the summer doldrums replace the Q2 earnings excitement.

Nasdaq Chart

The Dow has moved over prior resistance at 8800 although not very convincingly. It is nearing stronger resistance at 9000 and after gaining nine of the last ten days it is very over extended. Like the Nasdaq it can't continue to rally without some profit taking eventually taking place. The Dow would have been negative today were it not for the major gains by Caterpillar. CAT, MRK and XOM provided over 50 Dow points. Boeing contributed another 8 points and IBM 6 points. Basically it was a five stock rally for the Dow thanks to earnings reports.

With the Dow very extended with a +800 point bounce off its 7/10 lows at 8100 I can't help but believe this string is about to end.

Dow Chart

The S&P-500 has strong resistance at 950 and after two days of trading this week it could only muster a +4 point move over that level. Sellers are camped out on 950 and even the strong gains by the big Dow components could not move the S&P higher. 954 is not really a convincing break of 950 and with S&P futures down tonight it does not appear we are going to have a positive open although anything is possible. The S&P was negative for much of the day and only broke into the green at the close.

S&P Chart

The Russell-2000 is less bullish than the big cap indexes. The Russell is still below the comparison resistance levels and actually closed down on Tuesday despite the late day rally in the other indexes. As the mutual fund manager sentiment indicator it is warning us that there is little conviction in the market.

Russell Chart

I remain in watch mode on market direction. I am amazed that the markets have continued to gain ground this week but I believe their four-leaf clover is about to wilt. The S&P can't move over 950 with conviction and the Russell is lagging. If the Nasdaq can't rally on Wednesday on the strength of the blowout Apple earnings then the markets may take a needed break. I would be cautiously short on any failure at the S&P 950 level. On Sunday I said go long over 8800/950 and while the Dow did move over 8800 on Monday the S&P closed right at that level. I don't believe a +4 point close today has enough conviction to carry the rally forward but we have to respect that level in either direction. For Wednesday I would be cautiously long over 950 and short below that level.

Jim Brown


New Option Plays

Need To Be Nimble

by James Brown

Click here to email James Brown

Editor's Note:

I am suggesting the average trader step to the sidelines. The markets remain very extended. This is not a great place to be launching new positions. The NASDAQ is likely to gap higher at the open tomorrow thanks to AAPL's earnings but where it goes from there is anyone's guess. Will the NASDAQ stretch its gains to 11 in a row? Maybe. But what about day 12? or day 13? Are you willing to bet on new bullish positions with the market looking this extended?

The S&P 500 is also very extended and testing major resistance in the 950-956 zone. Will investors buy a breakout over 956? Will it spark more short covering? I'm encouraged by the market's recent strength but we don't want to chase this move. I saw a lot of failed rallies and bearish reversal patterns today. Our contrarian put play on the SPY tonight is very aggressive and we should be in and out in just a few days if not sooner but we could just as easily be stopped out tomorrow.

I would keep an eye on AAPL. Nimble traders can watch for a failed rally in the $160-162.50 zone as a chance to buy very short-term puts with a tight stop. My bias on AAPL is actually bullish but the stock is overbought and due for a correction. I'd look for a potential bullish entry point near the rising 40-dma or maybe near $145.00.


NEW DIRECTIONAL PUT PLAYS

S&P 500 SPDRS - SPY - close: 95.57 change: +0.43 stop: 97.51

Why We Like It:
The short-term trend in the market has been extremely bullish. Most of it was a short squeeze from last week. Now the S&P 500 index is testing major resistance. The positive earnings news from AAPL could be enough to push the index over resistance. Yet I suspect the rally won't last. The AAPL news could be the big firework at the end of a fireworks show that caps off the finale. Now I'm not calling an end to the rally. I just think we're due for a correction and I want to catch some of it with some short-term puts.

Please see my editor's note before continuing. Tomorrow morning buy some August SPY puts. I wouldn't be surprised to see the SPY gap open higher but as of right now, looking at the after hours trading action tonight, a gap higher is not likely. This is a very aggressive, contrarian play. I would significantly limit my position size. We want to take profits at $92.00 or the 50-dma, whichever one the SPY hits first.

Suggested Options:
I'm suggesting the August puts.

BUY PUT AUG 96.00 SWG-TR open interest=13035 current ask $2.58
BUY PUT AUG 94.00 SWG-TR open interest=57535 current ask $1.76
BUY PUT AUG 92.00 SWG-TR open interest=189268 current ask $1.17

Annotated Chart:

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           00/00/00
Average Daily Volume =       197 million  
Listed on  July 21, 2009         



In Play Updates and Reviews

Volatility Strikes Again

by James Brown

Click here to email James Brown


CALL Play Updates

Euro Currency ETF - FXE - close: 141.97 chg: -0.28 stop: 139.40 *new*

Strength in the dollar helped the FXE produce a little bearish engulfing candlestick. We can probably expect a dip back toward $141.00-140.00. The 50-dma has risen to $139.54 so I'm raising our stop loss to $139.40. Our first target is $144.50. Our second target is $148.50. The P&F chart is bullish with a $168 target.

Picked on     June 23 at $140.76
Change since picked:      + 1.21
Earnings Date           00/00/00
Average Daily Volume =       461 thousand    
Listed on  June 23, 2009         


Gold Miner ETF - GDX - close: 39.74 change: -0.49 stop: 35.90

A bounce in the U.S. dollar sparked some selling in gold and the gold miners inched lower. Technically today's candlestick in the GDX is a one-day bearish reversal but we need to see confirmation. More conservative traders may want to raise their stops toward $36.50 or higher. I'm not suggesting new bullish positions. GDX has already exceeded our first target. Our second target is $42.40.

Picked on     July 13 at $ 36.49 /gap higher entry
                               /originally listed at $35.93
Change since picked:      + 3.25
            gap higher exit   /1st target hit @ 39.95 (+9.4%)
Earnings Date           00/00/00
Average Daily Volume =       6.8 million  
Listed on  July 13, 2009         


Lorillard - LO - close: 69.93 change: +0.82 stop: 68.40

LO is rebounding and is once again testing major resistance at the $70.00 level. I'm raising our stop loss to $68.40 - if we get triggered. Our suggested entry point is $70.50. Our first target is $74.50. Our second target is $77.00. We have to exit by Friday to avoid earnings due out Monday morning.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/27/09 (confirmed)
Average Daily Volume =       1.5 million  
Listed on  July 18, 2009         


O'Reilly Automotive - ORLY - close: 41.03 change: -0.04 stop: 38.49

Upward momentum is stalling in ORLY. It might be time to expect a dip back toward $39.00. I'm not suggesting new positions at this time. Wait for a dip or bounce near $39.00. Our first target is $44.00. We do not want to hold positions over the July 29th earnings report.

Picked on     July 13 at $ 40.00
Change since picked:      + 1.03
Earnings Date           07/29/09 (confirmed)
Average Daily Volume =       1.9 million  
Listed on  July 13, 2009         


Polaris - PII - close: 35.55 change: +0.05 stop: 31.45

There wasn't much follow through on yesterday's bullish breakout over the $35.00 level. I am suggesting that readers wait and buy calls on a dip in the $33.00-32.00 zone. We'll try and limit our risk with a stop loss at $31.45, which is just under Friday's low. Our first target is $37.25. Our second target is $39.50. Currently the Point & Figure chart is bullish with a $49.00 target.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/16/09 (confirmed)
Average Daily Volume =       436 thousand 
Listed on  July 18, 2009         


SPX Corp. - SPW - close: 54.02 change: +0.00 stop: 47.95

We have a similar story here. There was no follow through in SPW. The stock closed unchanged on the session but the move today looks like a failed rally at its exponential 200-dma. It's probably time for a correction.

The plan is to buy calls on SPW with a dip in the $50.25-48.00 zone. I'm raising the stop loss to $47.95. If we don't see SPW contract soon (Monday or Tuesday) I'll probably drop it as a bullish candidate. We don't want to hold positions over the July 29th earnings report. Our first target is $53.75. Our second target is $57.00.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/29/09 (confirmed)
Average Daily Volume =       777 thousand 
Listed on  July 15, 2009         


PUT Play Updates

Compass Minerals Intl. - CMP - cls: 50.30 change: -0.20 stop: 52.01

CMP is still churning sideways near $50.00. I'm not suggesting new positions at this time. CMP has exceeded our first target at $47.50. Our second target is $43.00. FYI: The P&F chart is bearish with a $35 target.

Picked on     July 06 at $ 52.25 *triggered     
Change since picked:      - 1.95
                               /1st target hit @ 47.50 (-9.0%)
Earnings Date           07/28/09 (confirmed)
Average Daily Volume =       792 thousand 
Listed on  June 29, 2009         


LEAP Wireless - LEAP - close: 25.74 change: -0.99 stop: 29.45

Hmm... after yesterday I was expecting a bounce. The stock immediately failed this morning and closed at new relative lows. Volume was above average on the decline, which is bearish.

Our first target is $22.65. Our second target is $20.25. The $22.50 level could be strong support so I suggest readers take off most of their position there. FYI: The P&F chart is bearish with a $19.00 target.

Picked on     July 17 at $ 26.80 *triggered    
Change since picked:      - 1.06
Earnings Date           08/06/09 (confirmed)
Average Daily Volume =       2.2 million  
Listed on  July 16, 2009         


WestAmerica - WABC - close: 46.30 change: -1.04 stop: 50.05

WABC continues to under perform the market. The stock broke down to new relative lows today. Our first target is $41.50. Our second target is $38.00. The Point & Figure chart is bearish with a $37.00 target. Readers may want to trade October puts because WABC doesn't move that fast.

Picked on     July 18 at $ 47.61 /gap higher entry
                               /originally listed at $47.07
Change since picked:      - 1.31
Earnings Date           07/14/09 (confirmed)
Average Daily Volume =       331 thousand 
Listed on  July 18, 2009         


Strangle & Spread Play Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

McDonald's - MCD - close: 58.63 change: +0.35 stop: n/a

MCD gave us another chance to open strangles today with a dip to $57.91. I would narrow our preferred entry range to the $58.00-57.00 zone. The closer to $57.50 the better. Tomorrow is our last day to open positions ahead of the earnings report.

I suggested the August $60 calls (MCD-HL) and the August $55 puts (MCD-TK). Our estimated cost is $1.25 (0.70 + 0.55). We want to sell if either option hits $2.75 or higher. This may take several weeks to succeed.

Picked on     July 18 at $ 57.84
Change since picked:      + 0.79
Earnings Date           07/23/09 (unconfirmed)
Average Daily Volume =       7.8 million  
Listed on  July 18, 2009         


CLOSED BULLISH PLAYS

AutoZone Inc. - AZO - close: 156.65 change: -0.33 stop: 154.25

Another day of random volatility in AZO has put an end to our bullish play. The stock immediately spiked lower, under performing the market, and eventually hit a low of $152.33 before bouncing back. Yesterday we had raised our stop loss to $154.25 following Monday's afternoon rebound. Our play is closed. Readers might want to try again on a bounce from the $148 level with a very tight stop or a breakout over $160.00.

Chart:

Picked on     July 14 at $158.77
Change since picked:      - 4.52 <-- stopped @ 154.25 (-2.8%)
Earnings Date           09/22/09 (unconfirmed)
Average Daily Volume =       1.0 million  
Listed on  July 14, 2009         


CLOSED BEARISH PLAYS

Sears Holdings - SHLD - close: 64.66 change: +1.94 stop: 65.05

I warned readers yesterday that odds were good SHLD would hit our stop loss today. Not only did SHLD break above $65.00 this morning but shares rebounded from their intraday lows to trade above resistance at $65.00 again right before the closing bell. Our play is closed at $65.05.

Chart:

Picked on     July 07 at $ 59.75
Change since picked:      + 5.30 <-- stopped out @ 65.05 (+8.8%)
Earnings Date           08/27/09 (unconfirmed)
Average Daily Volume =       1.2 million  
Listed on  July 07, 2009