Option Investor
Newsletter

Daily Newsletter, Monday, 10/5/2009

Table of Contents

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

Market Wrap

Gold And Goldman Boost Stocks

by Todd Shriber

Click here to email Todd Shriber
A weak dollar, surging gold and crude oil prices combined with a Goldman Sachs upgrade of large cap banks to send stocks soaring on Monday, helping equities rebound from their first two week drop since July. The S&P 500 added 1.5% to close at 1040.46, its best performance in a week, while the Dow Jones Industrial Average rose 112 points, or 1.2%, to close at 9599.75. Technology issues got a jolt from mergers and acquisitions scuttlebutt and that sent the Nasdaq higher by 20 points to a close of 2068.15.

Stats Table

Last week, stocks were dragged down by a spate of bad economic news, namely Friday's unemployment number, but this week got off to a markedly better start on the data-point front as the Institute for Supply Management's (ISM) non-manufacturing index rose to 50.9% in September from 48.4% in August. That marked the first expansion in a year and that sent the index to its highest reading since May 2008. The reading, which shows the services sector is expanding, came in well above the consensus estimate of 50%.

ISM Chart

While the market did not deliver a sequel to last Monday's ''Merger Monday,'' the Nasdaq benefited from news that Brocade Communication Systems (BRCD) is seeking a suitor. Back in the go-go days of the technology boom, Brocade once traded for close to $180 a share. Closing at $9.09, on Monday, it is fair to say that Brocade is shadow of its former self, but that also means an acquisition of the company may come at a decent price. Brocade competes with Cisco Systems (CSCO) in the data and telecom gear arenas and while Cisco's penchant for acquisitions is well-documented, press reports said the most likely suitors for Brocade would likely be Hewlett-Packard (HWP) and another voracious Silicon Valley acquirer, Oracle (ORCL).

Another tech name to get a boost from acquisition-related news was NetApp (NTAP), the provider of data storage services. NetApp's CEO Thomas Georgens said in an interview with Barron's that a sale of his company may make sense at some point. It is worth noting that NetApp has been the subject of takeover talks in the past and, obviously, no deal has materialized. After being bested for Data Domain by rival EMC (EMC) this summer, NetApp may find life easier in the arms of a larger rival.

Another big catalyst that helped lift the Dow to a triple-digit day was a Goldman Sachs upgrade of large bank stocks, saying that the big boys would deliver better profits than their regional rivals over the coming quarters. Capital One (COF) was added to Goldman's Conviction Buy List, while Wells Fargo (WFC) was upgraded to ''buy'' and Comerica (CMA), actually a regional bank, got a boost to ''neutral'' from ''sell.''

Not to nitpick, and it truly is hard to argue with Goldman, but they might a tad late to this party. The worst performer of this trio, Comerica, is up 50% in the past six months, while Wells Fargo is up more than 60% and Capital One is up more than 150% in the same period. Regardless, the Goldman upgrade got investors feeling cheery about financials for at least one day and the trickle-down effect was obvious as Dow components Bank of America (BAC) and J.P. Morgan Chase both finished the day higher by 3.8% and 4.6%, respectively.

Commodities, namely gold and crude oil, had their say in the market bounce today as well. December gold futures rose $13.50 to settle at $1017.80 an ounce and crude oil for November delivery again appears to be making its way toward $71 a barrel, closing at $71.46. Of course, both commodities were bolstered by a weaker dollar, but gold might legitimately be in its own bull market right now. The yellow metal has added more than $50 an ounce in just a month.

Gold Chart

As far as crude goes, black gold's consistent failures in the mid-70s range has become almost comical, if not predictable at this point, so one of day of gains is not much to get excited about if you are an oil bull. Crude oil stocks now rest 11.4% above year-earlier levels and Wednesday's inventory data is expected to show a rise 1.3 million barrels over the price week. That would add 400,000 barrels to the highest inventory level in more than 26 years, according to press reports.

When I talk about oil, I usually like to use the Oil Services HOLDRs ETF (OIH) as a reference point. I am not going to do that today, but I am going to bring up an interesting anecdote from of OIH's largest holdings, Diamond Offshore (DO). As you might surmise, Diamond Offshore is engaged in the offshore drilling business and that makes the stock especially sensitive to the price fluctuations in crude futures.

So what's the punchline? Diamond Offshore priced $500 million in 30-year notes today at yield of 5.7%. That is fairly mediocre compensation on a corporate bond issue of that duration given the volatility of the oil market. For less risk, investors could get a higher yield on the stocks of both AT&T (T) and Verizon (VZ). Not to mention, Diamond Offshore's chart (below), indicates the stock may have some downside in its near-term future.

Diamond Offshore Chart

Cyclicals, materials, commodities stocks, whatever the vernacular, have played a major part in the market rally and one of those names is Dow component Caterpillar (CAT), which is becoming a frequent guest here in the Monday Market Wrap. I have mentioned more than once the gloomy sales reports that Caterpillar, the world's largest maker of construction and mining equipment, has been turning in recently. Well, the company apparently is not worried about that and announced today it would be raising prices on most of its offerings by 2% in January. The announcement appeared to assuage investors that were bracing for price cuts. Caterpillar chipped into the Dow's rally, rising $1.92 to $50.75.

If you are feeling bullish on the mining sector and ready to take a tad more risk, Bucyrus International (BUCY) and Joy Global (JOYG) might be names to consider. Both are up about 85% in the past six months and both are within sniffing distance of their 52-week highs. Bucyrus looks like it has found support at the 50-day moving average of $32.26 and with more room to run to its 52-week high, I included that chart below.

Bucyrus Chart

All of this talk of commodities and cyclicals is a good segue to the all-important third-quarter earnings season that is now upon us. As the chart below illustrates, commodities-related stocks are fairly important contributors to the S&P 500's earnings (encompassed in the ''other'' category) and that will have investors combing over Alcoa's (AA) earnings report on Wednesday with a fine-tooth comb.

S&P 500 Sector Earnings

The largest U.S. aluminum producer and Dow component is expected to post a fourth consecutive quarterly loss. Analysts expect Alcoa to post a loss of 11 cents a share on sales of $4.5 billion for the third quarter. Aluminum prices picked up a bit in the third quarter from the second quarter, but lower production and foreign currency issues will likely hold Alcoa's bottom line back. That means the Street will be looking for, no surprise here, lower costs. Any upside surprise out of Alcoa could juice the market through the end of the week.

While Alcoa traditionally signals the start of a new earnings season, there was another materials name that delivered results after the close Monday. Mosaic (MOS), the second-largest producer of potash fertilizer, delivered glum news, saying its fiscal first-quarter profit slumped by 91% to $100.6 million, or 23 cents a share, from $1.8 billion, or $2.65 a share, a year earlier. Sales fell 66% to $1.46 billion. Analysts had been expecting Mosaic to earn 35 cents a share on sales of $1.54 billion.

I am not going to say Mosaic's grim report portends anything for the rest of earnings and for some reason the stock was actually up a little bit in after hours trading, but it certainly would have been nice to get earnings season off to a better start. Monsanto (MON), another agriculture issue, reports on Wednesday and a disappointing number there could spell disaster for at least one part of the commodities complex.

There is not much in the way of earnings fanfare before the bell on Tuesday, but after the market closes, Yum! Brands reports third-quarter results. The operator of the KFC, Pizza Hut and Taco Bell fast-food chains is expected to earn 58 cents a share on sales of $2.79 billion. While not quite the blue chip that rival McDonald's (MCD) is, Yum! has exhibited some blue chip-esque traits recently, raising its dividend by 11% and initiating a $300 million share repurchase program.

Do not expect much in the way of robust numbers from Yum! in the U.S., but that is OK. No matter how you cook it, Yum! is a China play because KFC is the largest fast-food chain in the world's largest country. Yum! is just about $2 off its 52-week and the chart shows it just cleared resistance at $34.50, so the earnings report should have a heavy hand in the stock's near-term fortunes.

YUM Chart

Taking a look at the charts, the Dow just barely missed out on a close at 9600, but appears to be finding support at the 50-day moving average of 9468. The August peak of 9630 could be a minor resistance point on the way back to 9800. While Alcoa is just one of 30 stocks in the index, an upbeat earnings report on Wednesday would help the Dow on its march to 9800 and then to 10000. Just remember that as a price-weighted index, Alcoa has the smallest impact on the Dow's daily performance because it is the lowest priced stock in the index.

It is all about earnings and a cascade of disappointing reports from Dow components could have us talking about 9300, then 9100 and worse. We will just have to wait and see if third-quarter estimates were set too high.

Dow Chart

It is a similar refrain with the S&P 500 as the measure of the 500 largest U.S. stocks is finding support at its 50-day moving average of 1022.93. With a close at 1040.46, the next resistance point for the index probably looms around 1052. Today's close is also significant because it put the S&P 500 in position to get back above the six-month uptrend line that had been broken late last week.

The 50-day average needs to hold as support and a violation of that level means 975 could become an issue and that means earnings quality is likely suspect.

S&P 500 Chart

Not much is different on the Nasdaq as the tech-heavy index, like the S&P 500, is trying to get back above the six-month upward trend line and finding support at the 50-day moving average of 2035.35. Until tech earnings start to pour in, the Nasdaq will likely take its cues from the other major indexes while waiting for more clarity on the aforementioned M&A news.

At nearly 100 points away from the recent peak of 2167.70, the Nasdaq has some work to do, but with the disappointing earnings report from Research In Motion (RIMM) out of the way, the index is poised to absorb more positive (hopefully) updates from its other major drivers including Apple (AAPL), Google (GOOG), Intel (INTC) and Microsoft (MSFT). A disappointing earnings season could have the Nasdaq down to 1950 and perhaps lower.

Nasdaq Chart

The last time all three indexes were hovering this close to their 50-day lines was in July and they proceeded to rocket higher. If that scenario is going to replay itself, then it will only do so on the back of earnings reports that have rejuvenated the market's previously bullish tenor.


New Option Plays

Resource Stocks Rally

by James Brown

Click here to email James Brown

Editor's Note:

FYI: There are a lot of commodity and material-related names showing strength today. Check out steel, oil, and coal names as potential candidates.


NEW DIRECTIONAL CALL PLAYS

Canadian Nat. Res. - CNQ - close: 65.04 change: +1.87 stop: 61.90

Why We Like It:
Resource stocks like oil and coal companies were showing a lot of strength today. CNQ is an oil stock that is bouncing from short-term support near $62.00 and its 50-dma. If this bounce has any legs this is a great spot to open bullish positions.

I would be cautious and only use small positions to limit risk. We'll also use a tight stop under Friday's low. More conservative traders may want to wait for a move over $66.00 or the 10-dma before initiating call positions. Our first target is $71.50.

Suggested Options:
I am suggesting the November calls. My preference is the $65s and 70s.

BUY CALL NOV 70.00 CNQ-KN open interest= 887 current ask $2.55

Annotated Chart:

Picked on   October 05 at $ 65.04
Change since picked:       + 0.00
Earnings Date            11/05/09 (confirmed)
Average Daily Volume =        6.4 million  
Listed on   October 05, 2009         



In Play Updates and Reviews

Oversold Bounce for Most

by James Brown

Click here to email James Brown

Most of our play list saw an oversold bounce from two-week lows. Our bearish plays continued to sink.


CALL Play Updates

Alcon Inc. - ACL - close: 136.23 change: -0.05 stop: 133.90

Traders should remain cautious on ACL. The stock under performed the market on Monday but is still holding up its bullish trend.

I wouldn't be surprised to see ACL retest the $134 area again. We can use a bounce in this zone as a new bullish entry point but keep a wary eye on the $140 level, which could act as resistance again. ACL has already hit our first target. Our second target is $148.00.

Picked on September 10 at $136.75
Change since picked:       - 0.52
                             /1st target hit @ 142.50 (+4.2%)
Earnings Date            10/27/09 (unconfirmed)
Average Daily Volume =        299 thousand 
Listed on September 10, 2009         


Allegheny Tech. - ATI - close: 34.63 change: +0.96 stop: 31.70

Material-related names performed well. ATI gained 2.8%. I'm not suggesting new positions at this time. ATI has exceeded our first target. We're currently aiming for $37.00.

Picked on   August 31 at $ 30.25 *triggered         
Change since picked:      + 4.38 
                               /1st target hit @ 33.85 (+11.9%)
Earnings Date           10/21/09 (unconfirmed)
Average Daily Volume =       2.7 million  
Listed on August 27, 2009         


Caterpillar - CAT - close: 50.75 change: +1.92 stop: 47.49

CAT performed very well with a 3.9% gain. The company announced they would raise their prices in 2010. If CAT is feeling confident enough to raise prices then business must be improving. The stock has now produced a three-day bullish reversal pattern. I would use this bounce as a new entry point to buy calls.

Our first target is $54.50. Our second target is $59.00. FYI: The P&F chart is bullish with an $85 target.

Picked on   October 01 at $ 50.00
Change since picked:       + 0.75
Earnings Date            10/20/09 (unconfirmed)
Average Daily Volume =         10 million  
Listed on September 19, 2009         


Core Labs - CLB - close: 101.39 change: +2.08 stop: 93.90

A drop in the dollar fueled a bounce in oil and the oil service stocks followed. CLB gained 2% but we still don't want to chase it. The plan is to buy calls on a dip at $96.00. If triggered our first target is $104. Our second target is $109.50.

Picked on September xx at $ xx.xx <-- TRIGGER @ 96.00
Change since picked:       + 0.00
Earnings Date            10/21/09 (unconfirmed)
Average Daily Volume =        175 thousand 
Listed on September 23, 2009         


Compass Minerals - CMP - close: 60.18 chg: +0.93 stop: 56.40

CMP is bouncing but volume has been low on the rebound. I'm not suggesting new bullish positions at this time. CMP has already hit our first target at $59.75. Our second and final target is $64.00. FYI: The Point & Figure chart has turned bullish with a $69 target.

Picked on September 03 at $ 55.55
Change since picked:       + 4.63
                               /1st target hit @ 59.75 (+7.5%)
Earnings Date            10/27/09 (unconfirmed)
Average Daily Volume =        415 thousand 
Listed on September 02, 2009         


Consol Energy - CNX - close: 45.52 change: +2.48 stop: 39.45

Coal stocks were included in the commodity rally today. CNX soared 5.7% and back above round-number resistance at $45 and technical resistance at its 10-dma.

Our first target is $48.50. Our second target is $52.40. We'll plan to exit ahead of the late October earnings report. FYI: The Point & Figure chart is forecasting a $73 target.

Picked on September 25 at $ 43.77 /gap down entry
Change since picked:       + 1.75
Earnings Date            10/22/09 (unconfirmed)
Average Daily Volume =        3.0 million  
Listed on September 19, 2009         


Capella Education - CPLA - close: 68.48 change: +0.68 stop: 62.40

CPLA is still showing relative strength and hit new highs today. I am suggesting readers buy calls on a dip at $65.25. If triggered our first target is $69.75. Our secondary target is $74.00 but we'll exit ahead of the late October earnings report. FYI: The Point & Figure chart is bullish with an $82 target.

Trading note: CPLA doesn't have a lot of volume and neither do the options. I would keep positions small.

Picked on   October xx at $ xx.xx <-- TRIGGER $65.25
Change since picked:       + 0.00
Earnings Date            10/27/09 (unconfirmed)
Average Daily Volume =        145 thousand 
Listed on   October 03, 2009         


Danaher Corp. - DHR - close: 65.04 change: +0.30 stop: 63.95

The bounce in DHR was somewhat muted. Shares failed at the 30-dma this afternoon. I remain cautious and would look for another dip near $64.00.

Our first target is $69.50. The Point & Figure chart is bullish with a $77 target. Currently we only have half a position open to limit our risk given the aggressive entry point.

Picked on September 05 at $ 66.37 (buy 1/2 position)
               /originally listed at $65.76, gap higher entry @ 66.37
Change since picked:       - 1.33
Earnings Date            10/22/09 (confirmed)
Average Daily Volume =        2.4 million  
Listed on September 05, 2009         


Diamond Offshore - DO - close: 94.17 change: +1.72 stop: 89.75

Investors continue to buy DO on dips near the long-term rising trendline of support. Shares gained 1.8% on Monday. This bounce looks like another entry point to buy calls.

Our first target is $99.90. Our second target is $104.50. More aggressive traders can aim for $110. The P&F chart is forecasting a $114 target. The plan was to use small position sizes.

Picked on September 15 at $ 94.69 *adjusted entry point
Change since picked:       - 0.52
Earnings Date            10/22/09 (unconfirmed)
Average Daily Volume =        1.8 million  
Listed on September 12, 2009         


Dril-Quip, Inc. - DRQ - close: 49.54 change: +1.23 stop: 45.90

Traders were quick to buy the dip in DRQ and the stock is back to challenging resistance near $50 again.

More conservative traders may want to raise their stops toward $47.00.

Our first target is $53.00. Our second target is $57.50. The Point & Figure chart is bullish with a $65.00 target.

Picked on September 28 at $ 48.50
Change since picked:       + 1.04
Earnings Date            11/10/09 (unconfirmed)
Average Daily Volume =        282 thousand 
Listed on September 26, 2009         


Flowserve - FLS - close: 99.29 change: +4.09 stop: 89.40

FLS displayed relative strength with a big bounce (+4.2%) on Monday. Shares are back above what should have been resistance at $96.00 and they're nearing round-number resistance at $100.

We want to buy calls at $91.00 but readers could wait for a bounce from $90.00 instead. The 50-dma is at $89.70 so I'm raising our stop loss to $89.40. Our first target is $99.50.

We will plan to exit ahead of the late October earnings report.

Picked on September xx at $ xx.xx <-- TRIGGER @ 91.00
Change since picked:       + 0.00
Earnings Date            10/28/09 (unconfirmed)
Average Daily Volume =        1.2 million  
Listed on September 19, 2009         


General Dynamic - GD - close: 64.77 change: +1.69 stop: 56.95

There is no change from my prior comments. GD still looks a little overbought. We want to buy calls on a dip at $58.50.

Our first target is $64.50.

Picked on September xx at $ xx.xx <-- TRIGGER @ 58.50
Change since picked:       + 0.00
Earnings Date            10/28/09 (unconfirmed)
Average Daily Volume =        2.3 million  
Listed on September 09, 2009         


Illumina Inc. - ILMN - close: 42.91 change: +0.89 stop: 37.45

ILMN continues to show relative strength. Today's gain should negate last Thursday's bearish reversal pattern. We might want to consider raising our trigger to buy calls from $39.10 to $40.10.

If we are triggered at $39.10 our first target is $42.40. We plan to exit before the October earnings report.

Picked on September xx at $ xx.xx <-- TRIGGER @ 39.10
Change since picked:       + 0.00
Earnings Date            10/20/09 (unconfirmed)
Average Daily Volume =        1.6 million  
Listed on September 26, 2009         


iShares Financials - IYF - close: 51.97 change: +1.40 stop: 49.49

Goldman Sachs issued some positive comments on big banks and the whole financial sector rallied. The IYF gained 2.7%. This looks like the convincing bounce I was talking about over the weekend. Our first target is $57.00. Our second target is $60.00.

Picked on September 15 at $ 52.60 *triggered  
Change since picked:       - 0.63
Earnings Date            00/00/00
Average Daily Volume =        5.1 million  
Listed on September 01, 2009         


PPG Inds. Inc. - PPG - close: 57.54 change: +1.28 stop: 54.95

Nimble traders may want to buy calls on this bounce. I'm still a little concerned by the short-term trend of lower highs. A move over $58.50 should correct that concern. PPG has already exceeded our first target and we're currently aiming for $63.00.

Picked on   August 28 at $ 55.65
Change since picked:      + 1.89
                             /1st target exceeded @ 60.05 (7.9%)
Earnings Date           10/15/09 (confirmed)
Average Daily Volume =       1.6 million  
Listed on August 27, 2009         


SOHU.com Inc. - SOHU - close: 65.45 change: +0.82 stop: 63.75

The oversold bounce in SOHU didn't make it very far. The stock stalled at its highs from last Friday. I'm still bullish on SOHU but readers may want to wait for a new move over $68.50 before launching positions.

Our first target is $72.50. Our second target is $77.00.

Picked on   October 01 at $ 68.24 /gap open entry
                                 (small positions 1/2 to 1/4)
Change since picked:       - 2.79
Earnings Date            10/26/09 (unconfirmed)
Average Daily Volume =        577 thousand 
Listed on September 15, 2009         


Waters Corp. - WAT - close: 55.48 change: +1.58 stop: 51.90

I was expecting a dip closer to $53.00 but today's rebound has helped create a three-day bullish reversal signal. I'd buy calls now or on a new move over $56.25. Our plan is to use small position sizes (1/2 to 1/4 our normal size).

Our first target is $59.50. We do not want to hold over the mid October earnings report.

Picked on September 28 at $ 55.43 *new entry
Change since picked:       + 0.05
Earnings Date            10/20/09 (unconfirmed)
Average Daily Volume =        809 thousand 
Listed on September 12, 2009         


PUT Play Updates

Amazon.com - AMZN - close: 88.657chg: -1.18 stop: 92.55 *new*

I'm happy to see the decline in AMZN but I'm puzzled by it. Yes, the pattern looks bearish but with the NASDAQ up almost 1% I'm surprised to see AMZN down 1.3%. AMZN is one of the "generals" for the technology sector. If AMZN stumbles it makes it harder for the rest of the tech sector to rally. I'm inching our stop loss down to $92.55. We'll exit on a dip at $85.25.

Picked on   October 03 at $ 89.85
Change since picked:       + 0.00
Earnings Date            10/22/09 (unconfirmed)
Average Daily Volume =        6.2 million  
Listed on   October 03, 2009         


BIOGEN IDEC - BIIB - close: 48.54 change: -0.35 stop: 52.15

BIIB is another bearish candidate showing relative weakness, which is exactly what we want to see.

Don't forget - this is a higher-risk play because we're choosing to hold over the earnings report!

Our first target to take profits is at $44.50. Our second target is $40.50. FYI: The P&F chart is bearish with a $36 target.

Picked on   October 03 at $ 48.89
Change since picked:       - 0.35
Earnings Date            10/15/09 (unconfirmed)
Average Daily Volume =        2.6 million  
Listed on   October 03, 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.)

Cigna Corp. - CI - close: 28.70 change: +0.88 stop: n/a

CI is seeing an oversold bounce and shares gained 3.1%. I'm not suggesting new positions at this time.

The options I suggested were the October $35 calls (CI-JG) and the October $25 puts (CI-VE). Our estimated cost was $1.20. We want to sell if either option hits $2.50 or higher. The closer we can open this trade to $30.00 the better.

Picked on September 08 at $ 29.40
Change since picked:       - 0.70
Earnings Date            11/05/09 (unconfirmed)
Average Daily Volume =        3.8 million  
Listed on September 08, 2009